UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q |X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003 |_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 000-30929 KERYX BIOPHARMACEUTICALS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 13-4087132 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 750 LEXINGTON AVENUE NEW YORK, NEW YORK 10022 (ADDRESS INCLUDING ZIP CODE OF PRINCIPAL EXECUTIVE OFFICES) 212-531-5965 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Indicate by an (X) 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 an (X) whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |_| NO |X| As of August 7, 2003, the registrant had outstanding 21,073,310 shares of Common Stock, $0.001 par value per share. PART I. FINANCIAL INFORMATION Item 1. Financial Statements Interim Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002............................................ 3 Interim Consolidated Statements of Operations for the three and six months ended June 30, 2003 and 2002................ 4 Interim Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002.......................... 5 Notes to Interim Consolidated Financial Statements of June 30, 2003................................................. 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.............................. 12 Item 3. Quantitative and Qualitative Disclosures About Market Risk...................................................... 32 Item 4. Controls and Procedures............................................ 32 PART II. OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds.......................... 33 Item 4. Submission of Matters to a Vote of Security Holders................ 33 Item 6. Exhibits and Reports on Form 8-K................................... 33 SIGNATURES.................................................................. 34 2 ITEM 1. FINANCIAL STATEMENTS Keryx Biopharmaceuticals, Inc. (A Development Stage Company) Interim Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002 - -------------------------------------------------------------------------------- (in thousands, except share amounts) June 30 December 31 2003 2002 (Unaudited) (Audited) ----------- ----------- Assets Current assets Cash and cash equivalents $ 14,806 $ 13,350 Investment securities, held-to-maturity 6,068 10,575 Deposits in respect of employee severance obligations (current portion) 209 299 Accrued interest receivable 91 206 Deferred tax asset -- 170 Other receivables and prepaid expenses 67 267 -------- -------- Total current assets 21,241 24,867 -------- -------- Deposits in respect of employee severance obligations -- 117 Property, plant and equipment, net, held for sale 384 -- Property, plant and equipment, net 230 3,031 Other assets (primarily intangible assets), net 263 1,088 -------- -------- Total assets $ 22,118 $ 29,103 ======== ======== Liabilities and Stockholders' Equity Current liabilities Accounts payable and accrued expenses $ 540 $ 920 Income taxes payable 130 177 Accrued compensation and related liabilities 764 1,420 -------- -------- Total current liabilities 1,434 2,517 -------- -------- Liability in respect of employee severance obligations -- 188 Deferred tax liability -- 68 -------- -------- Total liabilities 1,434 2,773 -------- -------- Commitments and contingencies Stockholders' equity Common stock, $0.001 par value per share (40,000,000 and 40,000,000 shares authorized, 21,128,810 and 19,913,185 shares issued, 21,072,710 and 19,866,885 shares outstanding at June 30, 2003 and December 31, 2002, respectively) 21 20 Additional paid-in capital 71,552 72,067 Treasury stock, at cost, 56,100 shares at June 30, 2003 and 46,300 shares at December 31, 2002 (89) (77) Unearned compensation (1) (178) Deficit accumulated during the development stage (50,799) (45,502) -------- -------- Total stockholders' equity 20,684 26,330 -------- -------- Total liabilities and stockholders' equity $ 22,118 $ 29,103 ======== ======== The accompanying notes are an integral part of the consolidated financial statements. 3 Keryx Biopharmaceuticals, Inc. (A Development Stage Company) Interim Consolidated Statements of Operations for the Three Months and Six Months Ended June 30, 2003 and 2002 - -------------------------------------------------------------------------------- (in thousands, except share and per share amounts) Amounts Accumulated Three months ended June 30, Six months ended June 30, During the ---------------------------- ---------------------------- Development 2003 2002 2003 2002 Stage (Unaudited) (Unaudited) (Unaudited) (Unaudited) (Unaudited) ------------ ------------ ------------ ------------ ------------ Management fees from related party $ -- $ -- $ -- $ -- $ 300 ------------ ------------ ------------ ------------ ------------ Operating Expenses Research and development: Non-cash compensation (249) (764) (515) (1,344) 6,698 Other research and development 554 2,316 3,925 5,259 27,836 ------------ ------------ ------------ ------------ ------------ Total research and development expenses 305 1,552 3,410 3,915 34,534 ------------ ------------ ------------ ------------ ------------ General and administrative: Non-cash compensation 50 (2) 52 (8) 3,443 Other general and administrative 1,205 1,082 1,869 2,392 16,274 ------------ ------------ ------------ ------------ ------------ Total general and administrative expenses 1,255 1,080 1,921 2,384 19,717 ------------ ------------ ------------ ------------ ------------ Total operating expenses 1,560 2,632 5,331 6,299 54,251 ------------ ------------ ------------ ------------ ------------ Operating loss (1,560) (2,632) (5,331) (6,299) (53,951) Interest income, net 65 160 150 334 3,785 ------------ ------------ ------------ ------------ ------------ Net loss before income taxes (1,495) (2,472) (5,181) (5,965) (50,166) Income taxes 14 (61) 116 (11) 633 ------------ ------------ ------------ ------------ ------------ Net loss (1,509) (2,411) (5,297) (5,954) (50,799) ============ ============ ============ ============ ============ Basic and diluted loss per common share ($ 0.07) ($ 0.12) ($ 0.26) ($ 0.30) ($ 3.80) Weighted average shares used in computing basic and diluted net loss per common share 20,739,770 19,897,032 20,377,416 19,893,701 13,386,279 The accompanying notes are an integral part of the consolidated financial statements. 4 Keryx Biopharmaceuticals, Inc. (A Development Stage Company) Interim Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2003 and 2002 - -------------------------------------------------------------------------------- (in thousands) Amounts accumulated Six months ended June 30, during the -------------------------- development 2003 2002 stage ----------- ---------- ----------- (Unaudited) (Unaudited) (Unaudited) ----------- ---------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (5,297) $ (5,954) $ (50,799) Adjustments to reconcile cash flows used in operating activities: Employee stock compensation expense 79 8 9,039 Consultants' and third-party stock compensation expense (negative expense) (542) (1,360) 1,102 Issuance of common stock to technology licensor -- 359 359 Interest on convertible notes settled through issuance of preferred shares -- -- 253 Depreciation and amortization 731 431 2,057 Loss on disposal of property, plant and equipment 6 50 90 Impairment charges 2,482 -- 2,482 Exchange rate differences (9) 22 75 Changes in assets and liabilities: Decrease (increase) in other receivables and prepaid expenses 199 226 (63) Decrease (increase) in accrued interest receivable 115 (33) (91) Changes in deferred tax provisions and valuation allowance 102 17 -- Increase (decrease) in accounts payable and accrued expenses (333) (323) 537 Increase (decrease) in income taxes payable (47) (116) 130 Increase (decrease) in accrued compensation and related liabilities (656) (9) 764 Increase (decrease) liability in respect of employee severance obligations (188) 178 -- --------- --------- --------- Net cash used in operating activities (3,358) (6,504) (34,065) --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property, plant and equipment -- (1,080) (4,400) Proceeds from disposals of property, plant and equipment 40 33 77 Investment in other assets (64) (66) (1,187) Proceeds from (additions to) deposits in respect of employee severance obligations 117 (76) -- Proceeds from (additions to) deposits in respect of employee severance obligations (current portion) 90 -- (209) Proceeds from sale and maturity of (investment in) short-term securities 4,507 5,443 (6,068) --------- --------- --------- Net cash provided by (used in) investing activities $ 4,690 $ 4,254 $ (11,787) --------- --------- --------- The accompanying notes are an integral part of the consolidated financial statements. 5 Keryx Biopharmaceuticals, Inc. (A Development Stage Company) Interim Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2003 and 2002 (continued) - -------------------------------------------------------------------------------- (in thousands) Amounts accumulated Six months ended June 30, during the ----------- ----------- development 2003 2002 stage ----------- ----------- ----------- (Unaudited) (Unaudited) (Unaudited) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from short-term loans $ -- $ -- $ 500 Proceeds from long-term loans -- -- 3,251 Issuance of convertible note, net -- -- 2,150 Issuance of preferred shares, net and contributed capital -- -- 8,453 Receipts on account of shares previously issued -- -- 7 Proceeds from initial public offering, net -- -- 46,298 Proceeds from exercise of options and warrants 127 1 163 Purchase of treasury stock (12) -- (89) --------- --------- --------- Net cash provided by financing activities 115 1 60,733 --------- --------- --------- Effect of exchange rate on cash 9 (22) (75) --------- --------- --------- NET INCREASE IN CASH AND CASH EQUIVALENTS 1,456 (2,271) 14,806 Cash and cash equivalents at beginning of period 13,350 23,345 -- --------- --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 14,806 $ 21,074 $ 14,806 ========= ========= ========= NON-CASH TRANSACTIONS Conversion of short-term loans into contributed capital $ -- $ -- $ 500 Conversion of long-term loans into contributed capital -- -- 2,681 Conversion of long-term loans into convertible notes of Partec -- -- 570 Conversion of convertible notes of Partec and accrued interest into stock in Keryx -- -- 2,973 Issuance of warrants to related party as finder's fee in private placement -- -- 114 Declaration of stock dividend -- -- 3 Conversion of Series A preferred stock to common stock -- -- --* Purchase of property, plant and equipment and other assets on credit -- -- -- SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION Cash paid for interest $ --* $ --* $ 139 Cash paid for income taxes 60 85 431 * Amount less than $1,000 The accompanying notes are an integral part of the consolidated financial statements. 6 Keryx Biopharmaceuticals, Inc. (A Development Stage Company) Notes to the Interim Consolidated Financial Statements of June 30, 2003 - ------------------------------------------------------------------------------ NOTE 1 - GENERAL BASIS OF PRESENTATION Keryx Biopharmaceuticals, Inc. ("Keryx" or the "Company") is a biopharmaceutical company focused on the acquisition, development and commercialization of novel pharmaceutical products for the treatment of life-threatening diseases, including diabetes and cancer. The Company was incorporated in Delaware in October 1998 (under the name Paramount Pharmaceuticals, Inc., which was later changed to Lakaro Biopharmaceuticals, Inc. in November 1999, and finally to Keryx Biopharmaceuticals, Inc. in January 2000). The Company commenced activities in November 1999, and since then has operated in one segment of operations, namely the development and commercialization of clinical compounds and core technologies for the life sciences. Until November 1999, most of the Company's activities were carried out by Partec Limited, an Israeli corporation formed in December 1996, and its subsidiaries SignalSite Inc. (85% owned) and its subsidiary, SignalSite Israel Ltd. (wholly owned), and Vectagen Inc. (87.25% owned) and its subsidiary, Vectagen Israel Ltd. (wholly owned) (hereinafter collectively referred to as "Partec"). In November 1999, the Company acquired substantially all of the assets and liabilities of Partec and, beginning as of that date, the activities formerly carried out by Partec were performed by the Company. At the date of the acquisition, Keryx and Partec were entities under common control (the controlling interest owned approximately 79.7% of Keryx and approximately 76% of Partec) and accordingly, the assets and liabilities were recorded at their historical cost basis by means of an "as if" pooling and Partec is being presented as a predecessor company. Consequently, these financial statements include the activities performed in previous periods by Partec by aggregating the relevant historical financial information with the financial statements of the Company as if they had formed a discrete operation under common management for the entire development stage. The Company owns a 100% interest in each of Keryx (Israel) Ltd., organized in Israel, Keryx Biomedical Technologies Ltd., organized in Israel, and Keryx Securities Corp., a U.S. corporation incorporated in the Commonwealth of Massachusetts. For convenience purposes, unless otherwise indicated, the "Company", "Keryx", "we", "us", "it", "our" or "its" refers collectively to Keryx and its subsidiaries. In March 2003, the Company gave notice of termination to four employees in the Jerusalem, Israel laboratory facility. In addition, the Company indicated its intention to cease its early-stage research and development activities and to further decrease its administrative activities in the Jerusalem facility (a process sometimes referred to as the "current restructuring"). During the second quarter of 2003, the Company gave notice of termination to an additional one person in Israel and to one person in Cambridge, Massachusetts. In addition, during the course of the current restructuring, Barry Cohen, the Company's Vice President, Business Development, and Thomas Humphries, the Company's Senior Vice President, Clinical Development, each resigned his employment with the Company. In connection with Dr. Humphries leaving the Company, the Company closed its office in Cambridge, Massachusetts and consolidated its activities in its New York City headquarters. Substantially all of the biopharmaceutical development and administrative activities during 2003 were conducted in the United States, and therefore, the 7 Company has one geographical segment. The majority of the Company's fixed assets are held by its subsidiaries in Israel, and most of these assets have been classified as "held for sale" during the three months ended June 30, 2003. The accompanying unaudited interim consolidated financial statements were prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows in conformity with generally accepted accounting principles. All adjustments which are, in the opinion of management, of a normal recurring nature and are necessary for a fair presentation of the interim financial statements have been included. Nevertheless, these financial statements should be read in conjunction with the Company's audited financial statements contained in its Annual Report on Form 10-K for the year ended December 31, 2002. The results of operations for the period ended June 30, 2003 are not necessarily indicative of the results that may be expected for the entire fiscal year or any other interim period. The Company has not had revenues from its planned principal operations and is dependent upon significant financing to fund the working capital necessary to execute its business plan. If the Company determines to seek additional funding, there can be no assurance that the Company will be able to obtain any such funding on terms that are acceptable to it, if at all. STOCK - BASED COMPENSATION The Company applies the intrinsic value-based method of accounting prescribed by the Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, to account for stock option plans for employees and directors, as allowed by Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-based Compensation" (SFAS No. 123). As such, compensation expense would be recorded on the measurement date only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123 is applied to stock options and warrants granted to other than employees and directors. The Company has adopted the disclosure requirements of SFAS No. 123 and SFAS No. 148 for awards to its directors and employees. Had the compensation expenses for stock options granted under the Company's stock option plans been determined based on fair value at the grant dates consistent with the method of SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amount below: Amounts Accumulated Three months ended June 30, Six months ended June 30, During the --------------------------- --------------------------- Development 2003 2002 2003 2002 Stage (Unaudited) (Unaudited) (Unaudited) (Unaudited) (Unaudited) ----------- ----------- ----------- ------------ ----------- Net loss, as reported $ (1,509) $ (2,411) $ (5,297) $ (5,954) $ (50,799) Add: Stock-based compensation expense to employees and directors determined under the intrinsic value- based method, as included in reported net loss, net of related tax effects 76 4 79 8 9,039 Deduct: Total stock-based compensation expense to employees and directors determined under fair value-based method for all awards, net of related tax effects (129) (316) (849) (653) (12,212) --------- --------- --------- --------- --------- Pro forma net loss $ (1,562) $ (2,723) $ (6,067) $ (6,599) $ (53,972) Basic and diluted loss per common share As reported ($ 0.07) ($ 0.12) ($ 0.26) ($ 0.30) ($ 3.80) Pro forma ($ 0.08) ($ 0.14) ($ 0.30) ($ 0.33) ($ 4.03) 8 LOSS PER SHARE Basic net loss per share is computed by dividing the losses allocable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted net loss per share does not reflect the effect of common shares to be issued upon exercise of stock options and warrants, as their inclusion would be anti-dilutive. The common stock equivalent of anti-dilutive securities not included in the computation of net loss per share amounts was 3,801,016. NOTE 2 - NEW ACCOUNTING PRONOUNCEMENTS In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" (SFAS No. 150). This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of nonpublic entities. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of the Statement and still existing at the beginning of the interim period of adoption. Restatement is not permitted. The adoption of SFAS No. 150 should not have a significant effect on the Company's financial statements. NOTE 3 - STOCKHOLDERS' EQUITY During the six months ended June 30, 2003, the compensation committee of the Company's board of directors granted options to purchase 980,000 shares of the Company's common stock to the Company's employees, directors and consultants, pursuant to the Company's 2000 Stock Option Plan, adopted in June 2000. The exercise price of the options issued during the six months ended June 30, 2003 ranged between $1.10 and $1.44 per share. Options for the purchase of 537,092 shares of the Company's common stock were forfeited during the six months ended June 30, 2003. In addition, options for the purchase of 1,215,625 shares of the Company's common stock were exercised during the six months ended June 30, 2003. During the six months ended June 30, 2003, the Company repurchased 9,800 shares of its common stock at an aggregate cost of approximately $12,000 pursuant to the stock repurchase program approved by its board of directors in November 2002. Under its stock repurchase program the Company was authorized to repurchase up to 2,443,900 additional Keryx shares as of June 30, 2003. NOTE 4 - INCOME TAXES In September 2001, one of the Company's Israeli subsidiaries received the status of an "Approved Enterprise" which grants certain tax benefits in Israel in accordance with the "Law for the Encouragement of Capital Investments, 1959". In June 2002, the subsidiary received formal temporary notification that it had met the requirements for implementation of the benefits under this program. Under its Approved Enterprise status, the subsidiary must maintain certain conditions and submit periodic reports. Failure to comply with the conditions of the Approved Enterprise status could cause the subsidiary to lose previously accumulated tax benefits. Through June 30, 2003, this subsidiary has received tax benefits of approximately $731,000. As a result of the restructuring implemented in 2002, the staff and activity of this subsidiary were materially reduced. In January 2003, the subsidiary notified the Israeli governmental authority of such 9 reductions and requested that the program instituted prior to the cost reductions be upheld. In February 2003, the Israeli governmental authority informed the subsidiary that it may be in non-compliance with the conditions of its Approved Enterprise program because of the indicated reductions. As part of the restructuring implemented during the first quarter of 2003, as described in Note 5, the subsidiary decided to close down the Jerusalem laboratory facility. The subsidiary is currently engaged in discussions with the Israeli governmental authority and, at this point, it is uncertain as to whether or not any past benefits will need to be repaid. Accordingly, the Company has not recorded any charge with respect to this potential liability. NOTE 5 - RESTRUCTURING 2003 Restructuring In March 2003, the Company gave notice of termination to four of its employees in the Jerusalem laboratory facility, and, in addition, the Company indicated its intention to cease early-stage research and development activities and to further decrease the administrative activities in the Jerusalem facility. While the significant portion of the current restructuring was completed by July 2003, the Company anticipates that the current restructuring will be fully completed in the third quarter of 2003. During the second quarter of 2003, the Company gave notice of termination to an additional one person in Israel and one person in Cambridge, Massachusetts. In addition, during the course of the current restructuring, Barry Cohen, the Company's Vice President, Business Development, and Thomas Humphries, the Company's Senior Vice President, Clinical Development, each resigned his employment with the Company. In connection with Dr. Humphries leaving the Company, the Company closed its office in Cambridge, Massachusetts and consolidated its activities in its New York City headquarters. In addition, during the second quarter of 2003, as a result of the Company's decision to sell the majority of its fixed assets, those fixed assets, primarily office furniture and equipment, laboratory equipment, and computers, software and related equipment, located in the Jerusalem facility formerly classified as "held-for-use" were classified as "held-for-sale," in accordance with SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS No. 144). At June 30, 2003, $384,000 in fixed assets were classified as "held-for-sale." The disposition of the majority of these assets was completed during the early part of the third quarter of 2003. As part of the above, the Company reevaluated its long-lived assets in accordance with SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" and took a non-cash impairment charge of approximately $2,481,000 for the six months ended June 30, 2003, of which approximately $2,357,000 was included in research and development expenses and of which approximately $124,000 was included in general and administrative expenses. For the six months ended June 30, 2003, the impairment charge included a write-off of approximately $1,694,000 in fixed assets and approximately $787,000 in other investments relating to intangible assets. For the three months ended June 30, 2003, the Company took a non-cash impairment charge of approximately $186,000, of which approximately $62,000 was included in research and development expenses and of which approximately $124,000 of which was included in general and administrative expenses. For the three months ended June 30, 2003, the impairment charge included a write-off of approximately $185,000 in fixed assets and approximately $1,000 in other investments relating to intangible assets. In addition, with the Company's subsidiaries' decision at the end of the second quarter of 2003, to vacate the Jerusalem facility, the Company reevaluated and significantly shortened the useful life of the leasehold improvements associated with their administrative facilities, resulting in 10 accelerated depreciation of approximately $420,000 for the three months ended June 30, 2003. The current restructuring included an eight-person reduction in the Company's work force to 19 full and part-time employees at June 30, 2003. Six of such persons were research personnel and two were administrative personnel. As of June 30, 2003, six of these employees had left the Company, with the balance to cease employment subsequent to June 30, 2003. Through June 30, 2003, the Company had total accumulated expenses of approximately $50,000 for severance benefits for employees terminated under the current restructuring, almost all of which had been previously expensed, in both research and development expenses and general and administrative expenses, as part of the Company's ongoing accrual for employee severance benefits in accordance with Israeli law. As of June 30, 2003, six employees have left the Company under the current restructuring and approximately $32,000 of severance benefits have been paid. As of June 30, 2003, approximately $18,000 in severance obligations related to the current restructuring is included in accrued compensation and related liabilities. With respect to this liability, the Company had funded deposits in respect of employee severance obligations of approximately $16,000. The Company may also incur other costs related to the current restructuring of the Jerusalem-based activities. See Note 4 with regard to potential liability in respect of tax benefits received by a subsidiary of the Company as an Approved Enterprise. In addition, as part of the current restructuring, the Company may incur other costs relating to its subsidiary's lease in the Jerusalem facility. Although the Jerusalem facility was vacated in July 2003, as of the date hereof, the lease remains in effect. The remaining portion of the lease obligations relating to the Jerusalem facility amounts to approximately $1,044,000 through the end of lease term in December 2005. In light of this and in accordance with SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS No. 146"), the Company may record a charge for potential costs associated with this lease agreement. Severance benefits for any additional employees who are likely to receive notice of termination as part of this restructuring are accrued to the balance sheet date as part of the liability in respect of employee severance benefits in accordance with Israeli law. 2002 Restructuring In 2002, the Company implemented a strategic reorganization, sometimes referred to as the "2002 restructuring". The 2002 restructuring was designed to substantially reduce early stage research expenditures so that the Company could focus primarily on the development of its lead product candidate for the treatment of diabetic nephropathy, KRX-101, and on the acquisition of additional clinical stage compounds. The 2002 restructuring included a 46 person, or approximate 70%, reduction in the Company's work force, including senior management, administrative staff, and research personnel involved in early stage projects. Through June 30, 2003, the Company had total accumulated expenses of approximately $1,121,000 for severance benefits for employees terminated under the 2002 restructuring, almost all of which had been expensed in prior periods. 11 As of June 30, 2003, all 46 employees have left the Company under 2002 restructuring and approximately $716,000 of severance benefits have been paid. As of June 30, 2003, approximately $404,000 in severance obligations related to the 2002 restructuring is included in accrued compensation and related liabilities. With respect to this liability, the Company had funded deposits in respect to employee severance obligations of approximately $48,000. NOTE 6 - SUBSEQUENT EVENTS In July 2003, the Company's subsidiaries vacated the Jerusalem facility and relocated to smaller facilities. The landlord of the Jerusalem facility has alleged that the Company is immediately liable to pay the landlord a sum in excess of $1.1 million as a result of the alleged breach of the lease agreement for the Jerusalem facility. The amount being demanded by the landlord includes rent for the entire remaining term of the lease (through 2005), as well as property taxes and other costs. In August 2003, the landlord realized the bank guarantee, in the amount of $222,000, which had been previously provided as security in connection with the lease agreement. No litigation has yet been commenced in this matter and the likelihood of this claim cannot be estimated at this time. See Note 5 - Restructuring. In August 2003, the Company announced that the Collaborative Study Group (CSG), the largest standing renal clinical trial group comprised of academic and tertiary nephrology care centers, will conduct the US-based Phase II/III clinical program for KRX-101 for the treatment of diabetic nephropathy. It is anticipated that this clinical program will commence by the late third quarter or early fourth quarter of 2003. The financial terms of the arrangement have not been finalized. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the unaudited, consolidated financial statements and the related footnotes thereto, appearing elsewhere in this report. OVERVIEW We are a biopharmaceutical company focused on the acquisition, development and commercialization of novel pharmaceutical products for the treatment of life-threatening diseases, including diabetes and cancer. In August of 2002 and March of 2003, we initiated corporate restructurings that have resulted in the reduction of staff and a re-focusing of our efforts on the development of our lead compound, KRX-101, which has completed a Phase II trial conducted in Europe, and on the acquisition of additional late stage clinical compounds. For a further discussion of these restructurings, see "Restructuring" below. Our lead compound under development is sulodexide, or KRX-101, to which we have an exclusive license in North America, Japan and other markets. In 2001, KRX-101 was granted Fast-Track designation for the treatment of diabetic nephropathy and, in 2002, we announced that the FDA had agreed, in principle, to permit us to avail ourselves of the accelerated approval process under subpart H of the FDA's regulations governing applications for the approval to market a new drug. In August 2003, we announced that the Collaborative Study Group (CSG), the largest standing renal clinical trial group comprised of academic and tertiary nephrology care centers, will conduct the US-based Phase II/III clinical program 12 for KRX-101 for the treatment of diabetic nephropathy. It is anticipated that this clinical program will commence by the late third quarter or early fourth quarter of 2003. To date, we have not received approval for the sale of any of our drug candidates in any market. We were incorporated in Delaware in October 1998. We commenced operations in November 1999, following our acquisition of substantially all of the assets and certain of the liabilities of Partec Ltd., our predecessor company that began its operations in January 1997. Since commencing operations, our activities have been primarily devoted to developing our technologies and drug candidates, raising capital, purchasing assets for our corporate offices and laboratory facilities and recruiting personnel. We are a development stage company and have no product sales to date. Our major sources of working capital have been proceeds from various private placements of equity securities and from our initial public offering. We have two wholly owned operating subsidiaries, Keryx Biomedical Technologies Ltd. and Keryx (Israel) Ltd., which have historically engaged in research and development activities and administrative activities, respectively, in Israel. For a further discussion of our current research, development and administrative activities in Israel, see "2003 Restructuring" and "2002 Restructuring" below. We also have a U.S. subsidiary, Keryx Securities Corp., organized under the laws of the Commonwealth of Massachusetts for the purpose of investing the Company's liquid funds. Research and development expenses consist primarily of salaries and related personnel costs, fees paid to consultants and outside service providers for laboratory development, facilities-related and other expenses relating to the design, development, testing, and enhancement of our product candidates, as well as expenses related to in-licensing or acquisition of new product candidates. We expense our research and development costs as they are incurred. General and administrative expenses consist primarily of salaries and related expenses for executive, finance and other administrative personnel, recruitment expenses, professional fees and other corporate expenses, including business development, general legal activities and facilities related expenses. Our results of operations include non-cash compensation expense as a result of the grants of stock, stock options and warrants. We account for stock-based employee and director compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and FASB issued Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation," as allowed by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123), and comply with the disclosure provisions of SFAS No. 123 and SFAS No. 148. Compensation expense for options and warrants granted to employees and directors represents the intrinsic value (the difference between the stock price of the common stock and the exercise price of the options or warrants) of the options and warrants at the date of grant, as well as the difference between the stock price at reporting date and the exercise price, in the case where a measurement date has not been reached. Compensation for options and warrants granted to consultants and other third-parties has been determined in accordance with SFAS No. 123, as the fair value of the equity instruments issued, and according to the guidelines set forth in EITF 96-18, "Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services." The compensation cost is recorded over the respective vesting periods of the individual stock options and warrants. The expense is included in the respective categories of expense in the statement of operations. We expect to incur significant non-cash compensation expense in the future. However, because some of the options and warrants issued to employees, consultants and other third-parties either do not 13 vest immediately or vest upon the achievement of certain milestones, the total expense is uncertain. We have incurred negative cash flow from operations since our inception. We anticipate incurring negative cash flow from operations for the foreseeable future. We have spent, and expect to continue to spend, substantial amounts in connection with implementing our business strategy, including our planned product development efforts and our clinical trials. STOCK REPURCHASE PROGRAM In November 2002, our board of directors authorized a stock repurchase program of up to 2.5 million shares of our common stock. Purchases under the stock repurchase program may be made in the open market or in private transactions from time to time. The stock repurchase program is being funded using our current assets. During the six months ended June 30, 2003, we repurchased 9,800 shares of our common stock at an aggregate cost of $12,000 pursuant to the stock repurchase program. Under the stock repurchase program, up to 2,443,900 shares of our common stock remain available for repurchase as of June 30, 2003. CRITICAL ACCOUNTING POLICIES The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities and related disclosure of contingent assets and liabilities at the date of our financial statements and the reported amounts of revenues and expenses during the applicable period. Actual results may differ from these estimates under different assumptions or conditions. We define critical accounting policies as those that are reflective of significant judgments and uncertainties, and may potentially result in materially different results under different assumptions and conditions. In applying these critical accounting policies, our management uses its judgment to determine the appropriate assumptions to be used in making certain estimates. These estimates are subject to an inherent degree of uncertainty. Our critical accounting policies include the following: Foreign Currency Translation. In preparing our consolidated financial statements, we translate non-US dollar amounts in the financial statements of our Israeli subsidiaries into US dollars. Under the relevant accounting guidance the treatment of any gains or losses resulting from this translation is dependent upon management's determination of the functional currency. The functional currency is determined based on management's judgment and involves consideration of all relevant economic facts and circumstances affecting the subsidiaries. Generally, the currency in which a subsidiary transacts a majority of its transactions, including billings, financing, payroll and other expenditures would be considered the functional currency. However, any dependency upon the parent and the nature of the subsidiary's operations must also be considered. If any subsidiary's functional currency is deemed to be the local currency, then any gain or loss associated with the translation of that subsidiary's financial statements would be included as a separate part of our stockholders' equity under the caption "cumulative translation adjustment." However, if the functional currency of the subsidiary is deemed to be the US dollar then any gain or loss associated with the translation of these financial statements would be included within our statement of operations. Based on our assessment of the factors discussed above, we consider the US dollar to be the functional currency for each of our Israeli subsidiaries because the majority of the transactions of each subsidiary, including billings, payroll, taxes and 14 other major obligations, are conducted using the US dollar. Therefore all gains and losses from translations are recorded in our statement of operations. Had we used the Israeli currency as the functional currency of our subsidiaries, exchange gains and losses would have been treated as a component of stockholders' equity, as other comprehensive income, included in a statement of comprehensive income. We believe that the amount of such comprehensive income for the six months ended June 30, 2003 would not have been material. Accounting For Income Taxes. As part of the process of preparing our consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves management estimating our actual current tax exposure and assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have fully offset our US deferred tax asset with a valuation allowance. Our lack of earnings history and the uncertainty surrounding our ability to generate taxable income prior to the expiration of such deferred tax assets were the primary factors considered by management in establishing the valuation allowance. The deferred tax asset in our financial statements for the comparative period relates to our wholly owned Israeli subsidiaries. These subsidiaries have generated taxable income in respect of services provided within the group, and therefore we believed in the past that the deferred tax asset relating to the Israeli subsidiaries would be realized. It should be noted that as the income has been derived from companies within the consolidated group, it had been eliminated upon consolidation. During the quarter, we decided to cease our research and development activities in Israel and further decrease our administrative activities in our Jerusalem facility. In addition, since the Israeli subsidiaries are no longer expected to generate income, we do not believe that the deferred tax asset will be realized. We therefore have decided to record a valuation allowance against the deferred tax asset, resulting in an expense in the statement of operations for the six months ended June 30, 2003. In September 2001, one of our Israeli subsidiaries received the status of an "Approved Enterprise" which grants certain tax benefits in Israel in accordance with the "Law for the Encouragement of Capital Investments, 1959." Through June 30, 2003, this Israeli subsidiary will have received tax benefits of approximately $731,000 as a result of the subsidiary's status as an "Approved Enterprise." In June 2002, the subsidiary received formal temporary notification that it had met the requirements for implementation of the benefits under this program. In January 2003, the subsidiary notified the Israeli governmental authority of reductions in its staff and operations that had formed the basis of its Approved Enterprise program, and requested that the program instituted prior to the cost reductions be approved. In February 2003, the Israeli governmental authority informed this subsidiary that it may be in non-compliance with the conditions of its Approved Enterprise program because of the indicated reductions. As part of the restructuring implemented during the first quarter of 2003, as described below, our Israeli subsidiaries decided to close down the Jerusalem laboratory facility. We are currently engaged in discussions with the Israeli governmental authority and, at this point, are uncertain as to whether or not any past benefits will need to be repaid. Accordingly, we have not recorded any charge with respect to this potential liability. 15 Stock Compensation. During historical periods, we have granted options to employees, directors and consultants, as well as warrants to other third parties. In applying SFAS No. 123, we use the Black-Scholes pricing model to calculate the fair market value of our options and warrants. The Black-Scholes model takes into account volatility in the price of our stock, the risk-free interest rate, the estimated life of the option or warrant, the closing market price of our stock and the exercise price. We have assumed for the purposes of the Black-Scholes calculation that an option will be exercised one year after it fully vests. We base our estimates of our stock price volatility on the volatility during the period prior to the grant of the option or warrant. However, this estimate is neither predictive nor indicative of the future performance of our stock. For purposes of the calculation, it was assumed that no dividends will be paid during the life of the options and warrants. In accordance with EITF 96-18, "Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services," total compensation expense for options issued to consultants is determined at the "measurement date." The expense is recognized over the vesting period for the options. Until the measurement date is reached, the total amount of compensation expense remains uncertain. We record option compensation based on the fair value of the options at the reporting date. These options are then revalued, or the total compensation is recalculated based on the then current fair value, at each subsequent reporting date. This results in a change to the amount previously recorded in respect of the option grant and additional expense or a negative expense may be recorded in subsequent periods based on changes in the assumptions used to calculate fair value, such as changes in market price, until the measurement date is reached and the compensation expense is determined. Impairment Of Long-Lived Assets And Long-Lived Assets To Be Disposed Of. We have adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS No. 144) from January 1, 2002. This Statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future cash flows expected to be generated by the asset or used in its disposal. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Fair value of fixed assets "held for sale" was determined based on discussions held with prospective buyers as well as resellers of second-hand assets. We have conducted such review in light of our restructuring in 2003. Our review included estimating each drug candidate's chance of continued development, partnering and FDA approval, its estimated market size and share, and potential royalty rate. We believe, based upon this review of our future net cash flow estimates for each of our drug candidates and the decision to cease activity in the Jerusalem facility, that an impairment charge should be recorded for the six months ended June 30, 2003. Any changes in any of these estimates could affect the need to record an impairment charge or the amount of the charge thereof. See "Restructuring" below. RESTRUCTURING 2003 Restructuring In March 2003, we gave notice of termination to four of our employees based in our Jerusalem laboratory facility, and, in addition, we indicated our intention to cease our early-stage research and development activities and to further decrease our administrative activities in our Jerusalem facility. While the significant portion of the current restructuring was completed by July 2003, we 16 anticipate that the current restructuring will be fully completed in the third quarter of 2003. During the second quarter of 2003, we gave notice of termination to an additional one person in Israel and to one person in Cambridge, Massachusetts. As of June 30, 2003, our subsidiaries decided to vacate the Jerusalem facility and to consolidate our remaining limited Israeli activities at an alternative location. During the course of the current restructuring, Barry Cohen, the Company's Vice President, Business Development, and Thomas Humphries, the Company's Senior Vice President, Clinical Development, each resigned his employment with us. In connection with Dr. Humphries leaving the Company, we closed our office in Cambridge, Massachusetts and consolidated its activities in our New York City headquarters. In addition, as a result of our decision during the second quarter of 2003 to sell the majority of our fixed assets, those fixed assets, primarily office furniture and equipment, laboratory equipment, and computers, software and related equipment, located in the Jerusalem facility that were previously classified as "held-for-use" were classified as "held-for-sale," in accordance with SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS No. 144). At June 30, 2003, $384,000 in fixed assets were classified as "held-for-sale." We completed the disposition of the majority of these assets during the early third quarter of 2003. As part of the above, we reevaluated our long-lived assets in accordance with SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" and took a non-cash impairment charge of $2,481,000 for the six months ended June 30, 2003, $2,357,000 of which was included in research and development expenses and $124,000 of which was included in general and administrative expenses. For the six months ended June 30, 2003, the impairment charge included a write-off of $1,694,000 in fixed assets and $787,000 in other investments relating to intangible assets. For the three months ended June 30, 2003, we took a non-cash impairment charge of $186,000, $62,000 of which was included in research and development expenses and $124,000 of which was included in general and administrative expenses. For the three months ended June 30, 2003, the impairment charge included a write-off of $185,000 in fixed assets and $1,000 in other investments relating to intangible assets. In addition, with the decision of our subsidiaries to vacate the Jerusalem facility, we reevaluated and significantly shortened the useful life of leasehold improvements associated with their administrative activities, resulting in accelerated depreciation of $420,000 for the three months ended June 30, 2003. The current restructuring included an eight person reduction in our work force to 19 full and part-time employees at June 30, 2003. Six of such persons were research personnel and two were administrative personnel. As of June 30, 2003, six of these employees had left us, with the balance to cease employment subsequent to June 30, 2003. Through June 30, 2003, we had total accumulated expenses of $50,000 for severance benefits for employees terminated under the current restructuring, almost all of which had been previously expensed, in both research and development expenses and general and administrative expenses, as part of our ongoing accrual for employee severance benefits in accordance with Israeli law. As of June 30, 2003, six employees have left us under the current restructuring and $32,000 of severance benefits have been paid. As of June 30, 2003, $18,000 in severance obligations related to the current restructuring is included in accrued compensation and related liabilities. With 17 respect to this liability, we had funded deposits in respect of employee severance obligations of $16,000. We may also incur other costs related to the current restructuring of our subsidiaries' Jerusalem-based activities, with regard to potential liability in respect of tax benefits received by our subsidiary as an Approved Enterprise. In addition, as part of the current restructuring, we may incur other costs relating to the lease in the Jerusalem facility. The facility was vacated in July 2003, however as of the date hereof the lease remains in effect. The remaining portion of the lease obligations relating to the Jerusalem facility amounts to $1,044,000 through the term of the lease ending in December 2005. In light of this and in accordance with SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS No. 146"), we may record a charge for potential costs associated with this lease agreement. Severance benefits for any additional employees who are likely to receive notice of termination as part of this restructuring are accrued to the balance sheet date as part of the liability in respect of employee severance benefits in accordance with Israeli law. 2002 Restructuring In the second half of 2002, we implemented a strategic reorganization, sometimes referred to as the "2002 restructuring". The 2002 restructuring was designed to substantially reduce early stage research expenditures so that we could focus primarily on the development of our lead product candidate for the treatment of diabetic nephropathy, KRX-101, and on the acquisition of additional clinical stage compounds. The 2002 restructuring included a 46 person, or approximate 70%, reduction in the Company's work force, including senior management, administrative staff, and research personnel involved in early stage projects. Through June 30, 2003, we had total accumulated expenses of $1,121,000 for severance benefits for employees terminated under our 2002 restructuring, almost all of which had been expensed in prior periods. As of June 30, 2003, 46 employees have left us under the 2002 restructuring and $716,000 of severance benefits have been paid. As of June 30, 2003, $404,000 in severance obligations related to the 2002 restructuring is included in accrued compensation and related liabilities. With respect to this liability, we had funded deposits in respect to employee severance obligations of $48,000. 18 RESULTS OF OPERATIONS THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THE THREE MONTHS ENDED JUNE 30, 2002 Revenue. We did not have any revenue for the three months ended June 30, 2003 and June 30, 2002. Research and Development Expenses. Research and development expenses, including non-cash compensation expense related to stock option grants and warrant issuances, decreased by $1,247,000 to $305,000 for the three months ended June 30, 2003, as compared to expenses of $1,552,000 for the three months ended June 30, 2002. The decrease in research and development was due to the decline in early stage research and development expenditures as a result of the current and 2002 restructurings. These decreases were partially offset by the non-cash impairment charge associated with our subsidiaries' decision to sell certain fixed assets located in the Jerusalem facility and their consequent classification as "held-for-sale" instead of "held-for-use." We expect our research and development costs to increase sequentially during the second half of the year as a result of the expected commencement of our U.S.-based clinical program for KRX-101. However, we do expect research and development costs for the second half of 2003 to decrease compared to the second half of 2002. Non-cash compensation expense related to stock option grants and warrant issuances was negative $249,000 for the three months ended June 30, 2003 as compared to negative $764,000 for the three months ended June 30, 2002. This negative non-cash compensation expense was primarily due to the reversal of previously recorded compensation of milestone-based options pursuant to the provisions of SFAS No. 123 and EITF 96-18. General and Administrative Expenses. General and administrative expenses, including non-cash compensation expense related to stock option grants and warrant issuances, increased by $175,000 to $1,255,000 for the three months ended June 30, 2003, as compared to expenses of $1,080,000 for the three months ended June 30, 2002. The increase in general and administrative expenses was due primarily to the accelerated depreciation of leasehold improvements in the Jerusalem facility and due to a non-cash impairment charge associated with our subsidiaries' decision to sell certain fixed assets located in the Jerusalem facility and their consequent classification as "held-for-sale" instead of "held-for-use." These increases were partially offset by reduced personnel and related costs associated with the 2002 restructuring. We expect our general and administrative costs to increase sequentially during the second half of the year as a result of the expected commencement of our U.S.-based clinical program for KRX-101. However, we do expect general and administrative costs for the second half of 2003 to decrease compared to the second half of 2002. Non-cash compensation expense related to stock option grants was $50,000 for the three months ended June 30, 2003 as compared to negative $2,000 for the three months ended June 30, 2002. Interest Income (Expense), Net. Interest income, net, decreased by $95,000 to $65,000 for the three months ended June 30, 2003, as compared to income of $160,000 for the three months ended June 30, 2002. The decrease resulted from a lower level of invested funds and the general decline in market interest rates when compared to the comparable period last year. 19 Income Taxes. Income tax expense increased by $75,000 to $14,000 for the three months ended June 30, 2003, as compared to income of $61,000 for three months ended June 30, 2002. The increase in income tax expense was primarily due to our subsidiary's reversal of a previously recorded income tax liability, which resulted in income in the comparative period last year, pursuant to receiving formal temporary notification that it met the requirements for implementation of benefits under the Approved Enterprise; and due to an adjustment of a prior-period's tax liability which was done upon the presentation of a tax assessment. Income tax expense for the comparative period is attributable to taxable income from the continuing operations of our subsidiaries in Israel. This income is eliminated upon consolidation of our financial statements. Impact of Inflation. The effects of inflation and changing prices on our operations were not significant during the periods presented. SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2002 Revenue. We did not have any revenue for the six months ended June 30, 2003 and June 30, 2002. Research and Development Expenses. Research and development expenses, including non-cash compensation expense related to stock option grants and warrant issuances, decreased by $505,000 to $3,410,000 for the six months ended June 30, 2003, as compared to expenses of $3,915,000 for the six months ended June 30, 2002. The decrease in research and development expenses was due to a decline in early stage research and development expenditures as a result of the current and 2002 restructurings. These decreases were partially offset by the non-cash impairment charge associated with the decision to cease the Jerusalem laboratory activities, as described above. We expect our research and development costs to increase sequentially during the second half of the year as a result of the expected commencement of our U.S.-based clinical program for KRX-101. However, we do expect research and development costs for the second half of 2003 to decrease compared to the second half of 2002. Non-cash compensation expense related to stock option grants and warrant issuances was negative $515,000 for the six months ended June 30, 2003 as compared to negative $1,344,000 for the six months ended June 30, 2002. This negative non-cash compensation expense was primarily due to the reversal of previously recorded compensation of milestone-based options pursuant to the provisions of SFAS No. 123 and EITF 96-18. General and Administrative Expenses. General and administrative expenses, including non-cash compensation expense related to stock option grants and warrant issuances, decreased by $463,000 to $1,921,000 for the six months ended June 30, 2003, as compared to expenses of $2,384,000 for the six months ended June 30, 2002. The decrease in general and administrative expenses was due primarily to reduced personnel and related costs associated with the 2002 restructuring. The decrease in general and administrative expenses was partially offset by the accelerated depreciation of leasehold improvements in the Jerusalem facility and due to a non-cash impairment charge associated with the decision to sell certain fixed assets located in the Jerusalem facility and their consequent classification as "held-for-sale" instead of "held-for-use." We expect our general and administrative costs to increase sequentially during the second half of the year as a result of the expected commencement of our U.S.-based clinical program for KRX-101. However, we do expect general and administrative costs for the second half of 2003 to decrease compared to the second half of 2002. 20 Non-cash compensation expense related to stock option grants was $52,000 for the six months ended June 30, 2003 as compared to negative $8,000 for the six months ended June 30, 2002. Interest Income (Expense), Net. Interest income, net, decreased by $184,000 to $150,000 for the six months ended June 30, 2003, as compared to income of $334,000 for the six months ended June 30, 2002. The decrease resulted from a lower level of invested funds and the general decline in market interest rates when compared to the comparable period last year. Income Taxes. Income tax expense increased by $127,000 to $116,000 for the six months ended June 30, 2003, as compared to income of $11,000 for the six months ended June 30, 2002. The increase in income tax expense was primarily due to the creation of a valuation allowance against the deferred tax asset and the deferred tax liability of our Israeli subsidiaries, associated with the cessation of research and development activities and further decrease in administrative activities in the Jerusalem facility; due to our subsidiary's reversal of a previously recorded income tax liability, which resulted in income in the comparative period last year, pursuant to receiving formal temporary notification that it met the requirements for implementation of benefits under the Approved Enterprise; and due to an adjustment of a prior-period's tax liability which was done upon the presentation of a tax assessment. Income tax expense for the comparative period is attributable to taxable income from the continuing operations of our subsidiaries in Israel. This income is eliminated upon consolidation of our financial statements. Impact of Inflation. The effects of inflation and changing prices on our operations were not significant during the periods presented. LIQUIDITY AND CAPITAL RESOURCES We have financed our operations from inception primarily through various private and public financings. As of June 30, 2003, we had received net proceeds of $46.3 million from our initial public offering, and $11.6 million from private placement issuances of common and preferred stock, including $2.9 million raised through the contribution by holders of their notes issued by our predecessor company. As of June 30, 2003, we had $21.0 million in cash, cash equivalents, interest receivable and short-term securities, a decrease of $3.1 million from December 31, 2002. Cash used in operating activities for the six months ended June 30, 2003 was $3.4 million as compared to $6.5 million for the six months ended June 30, 2002. This decrease in cash used in operating activities was due primarily to reduced early stage research activities and associated personnel and general and administrative expenses. For the six months ended June 30, 2003, net cash provided by investing activities of $4.7 million was primarily the result of the maturity of short-term securities. As of June 30, 2003, we have known contractual obligations, commitments and contingencies of $1,156,000. Of this amount, $33,000 relates to other agreements due within the next year. The additional $1,123,000 relates to operating lease obligations of which $497,000 is due within the next year, with the remaining $626,000 due within one to three years. Of the amount relating to operating lease obligations, $1,044,000 reflects the remaining portion of our subsidiary's lease obligations for the Jerusalem facility through the term of the lease ending in 2005. Subsequent to June 30, 2003, our Israeli subsidiaries vacated this facility, however, as of the date hereof, the lease for the facility remains in effect. Following the departure, the landlord of the Jerusalem facility claimed that we have breached the lease agreement and are consequently liable to immediately pay all the monies owed in connection with that agreement. In 21 addition, the landlord claimed and obtained the bank guarantee, in the amount of $222,000, which was previously provided as security in connection with the lease agreement. At this time, no litigation has been initiated and the likelihood of the claim cannot be estimated at this time. - ----------------------------------------------------------------------------------------------- Payments Due By Period - ----------------------------------------------------------------------------------------------- Less than After 5 Contractual Obligations Total 1 Year 1-3 Years 4-5 Years Years - ----------------------------------------------------------------------------------------------- Operating Leases $1,123,000 $497,000 $626,000 -- -- - ----------------------------------------------------------------------------------------------- Other Agreements 33,000 33,000 -- -- -- - ----------------------------------------------------------------------------------------------- Total Contractual Cash Obligations $1,156,000 $530,000 $626,000 -- -- - ----------------------------------------------------------------------------------------------- Additionally, we have undertaken to make contingent milestone payments to certain of our licensors of up to approximately $5.0 million over the life of the licenses, which expire from 2017 to 2023. In certain cases, such payments will reduce any royalties due on sales of related products. In the event that the milestones are not achieved, we remain obligated to pay one licensor $50,000 annually until the license expires. We believe that our $21.0 million in cash, cash equivalents, interest receivable and short-term securities as of June 30, 2003 will be sufficient to enable us to meet our planned operating needs and capital expenditures for at least the next 24 months. Our cash and cash equivalents as of June 30, 2003 are invested in highly liquid investments such as cash, money market accounts and short-term US corporate and government debt securities. As of June 30, 2003, we are unaware of any known trends or any known demands, commitments, events, or uncertainties that will, or that are reasonably likely to, result in a material increase or decrease in our required liquidity. We expect that our liquidity needs throughout 2003 will continue to be funded from existing cash, cash equivalents, and short-term securities. Our forecast of the period of time through which our cash, cash equivalents and short-term securities will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties. The actual amount of funds we will need to operate is subject to many factors, some of which are beyond our control. These factors include the following: o the timing of expenses associated with product development of our proprietary product candidates, especially KRX-101, and including those expected to be in-licensed, partnered or acquired; o the timing of the in-licensing, partnering and acquisition of new product opportunities; o the progress of the development efforts of parties with whom we have or intend to, entered into research and development agreements; o our ability to achieve our milestones under licensing arrangements; o the costs involved in prosecuting and enforcing patent claims and other intellectual property rights; and 22 o the amount of any funds expended to repurchase our common stock. We have based our estimate on assumptions that may prove to be wrong. We may need to obtain additional funds sooner or in greater amounts than we currently anticipate. Potential sources of financing include strategic relationships, public or private sales of our stock or debt and other sources. We may seek to access the public or private equity markets when conditions are favorable due to our long-term capital requirements. We do not have any committed sources of financing at this time, and it is uncertain whether additional funding will be available when we need it on terms that will be acceptable to us, or at all. If we raise funds by selling additional shares of common stock or other securities convertible into common stock, the ownership interest of our existing stockholders will be diluted. If we are not able to obtain financing when needed, we may be unable to carry out our business plan. As a result, we may have to significantly limit our operations and our business, financial condition and results of operations would be materially harmed. RISK FACTORS THAT MAY AFFECT RESULTS This Quarterly Report on Form 10-Q contains forward-looking statements, including statements about our future operating results, our drug development programs and potential strategic alliances. For this purpose, any statement that is not a statement of historical fact should be considered a forward-looking statement. We often use the words "believe," "anticipate," "plan," "expect," "intend" and similar expressions to help identify forward-looking statements. There are a number of important factors that could cause our actual results to differ materially from those indicated or implied by forward-looking statements. Factors that could cause or contribute to such differences include those discussed below, as well as those discussed elsewhere in this Form 10-Q. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. RISKS RELATED TO OUR BUSINESS WE HAVE A LIMITED OPERATING HISTORY AND HAVE INCURRED SUBSTANTIAL OPERATING LOSSES SINCE OUR INCEPTION. WE EXPECT TO CONTINUE TO INCUR LOSSES IN THE FUTURE AND MAY NEVER BECOME PROFITABLE. We have a limited operating history. You should consider our prospects in light of the risks and difficulties frequently encountered by early stage companies. In addition, we have incurred operating losses since our inception, expect to continue to incur operating losses for the foreseeable future and may never become profitable. As of June 30, 2003, we had an accumulated deficit of approximately $50.8 million. As we expand our research and development efforts, we will incur increasing losses. We may continue to incur substantial operating losses even if we begin to generate revenues from our drug candidates or technologies. We have not yet commercialized any products or technologies and cannot be sure we will ever be able to do so. Even if we commercialize one or more of our drug candidates or technologies we may not become profitable. Our ability to achieve profitability depends on a number of factors, including our ability to complete our development efforts, obtain regulatory approval for our drug candidates and successfully commercialize our drug candidates and technologies. 23 IF WE ARE UNABLE TO SUCCESSFULLY BEGIN OR COMPLETE OUR CLINICAL TRIALS OF KRX-101, OUR ABILITY TO ACHIEVE OUR CURRENT BUSINESS STRATEGY WILL BE ADVERSELY AFFECTED. Whether or not and how quickly we complete clinical trials is dependent in part upon the rate at which we are able to engage clinical trial sites and, thereafter, the rate of enrollment of patients. Patient enrollment is a function of many factors, including the size of the patient population, the proximity of patients to clinical sites, the eligibility criteria for the study and the existence of competitive clinical trials. If we experience delays in identifying and contracting with sites and/or in patient enrollment in our clinical trial program, we may incur additional costs and delay our development program for KRX-101. Additionally, we have submitted a subpart H clinical development plan to the FDA for the clinical development of KRX-101 for diabetic nephropathy. A final agreement on the specifics of our clinical program for that development plan has not been agreed to with the FDA and we cannot give any assurance that an acceptable final agreement on the specifics of such clinical program will ever be reached with the FDA. In fact, based on the FDA's comments to date, we believe that additional discussions with the FDA will be required prior to final agreement on the specifics of our subpart H accelerated approval clinical program. We cannot assure you that those discussions will take place or, if they do take place, the timing of such discussions, or that the results of such discussions will be satisfactory to us. Additionally, the FDA has stated that based on the novelty of the approach that we have discussed with them, they would want to refer our proposed approach to the Cardio-Renal Advisory Committee. Moreover, even if we are able to reach final agreement with the FDA regarding the specifics of an accelerated approval approach, no assurance can be given that we will be able to meet the requirements set forth in such agreement. The subpart H process is complex and requires flawless execution. Many companies who have been granted the right to utilize an accelerated approval approach have failed to obtain approval. The clinical timeline, scope and consequent cost for the development of KRX-101 will depend, in part, on the final outcome of our discussions with the FDA. Moreover, negative or inconclusive results from the clinical trials we hope to conduct or adverse medical events could cause us to have to repeat or terminate the clinical trials. Accordingly, we may not be able to complete the clinical trials within an acceptable time frame, if at all. OUR DRUG CANDIDATES ARE IN EARLY STAGES OF DEVELOPMENT AND MAY NEVER RECEIVE THE NECESSARY REGULATORY APPROVALS. Our drug candidates are in early stages of development. We have not received, and may never receive, regulatory approval for clinical trials for any of our drug candidates. We will need to conduct significant additional research and human testing before we can apply for product approval with the FDA or with regulatory authorities of other countries. Preclinical testing and clinical development are long, expensive and uncertain processes. Satisfaction of regulatory requirements typically depends on the nature, complexity and novelty of the product and requires the expenditure of substantial resources. Data obtained from preclinical and clinical tests can be interpreted in different ways, which could delay, limit or prevent regulatory approval. It may take us many years to complete the testing of our drug candidates and failure can occur at any stage of this process. Negative or inconclusive results or medical events during a clinical trial could cause us to delay or terminate our development efforts. Clinical trials also have a high risk of failure. A number of companies in the pharmaceutical industry, including biotechnology companies, have suffered significant setbacks in advanced clinical trials, even after achieving promising results in earlier trials. If we experience delays in the testing or approval process or if we need to perform more or larger clinical trials than originally 24 planned, our financial results and the commercial prospects for our drug candidates may be materially impaired. In addition, we have limited experience in conducting and managing the clinical trials necessary to obtain regulatory approval in the United States and abroad and, accordingly, may encounter unforeseen problems and delays in the approval process. BECAUSE WE LICENSE OUR PROPRIETARY TECHNOLOGIES, TERMINATION OF THESE AGREEMENTS WOULD PREVENT US FROM DEVELOPING OUR DRUG CANDIDATES. We do not own KRX-101 or any of our early-stage technologies. We have licensed these technologies from others. These license agreements require us to meet development or financing milestones and impose development and commercialization due diligence on us. In addition, under these agreements we must pay royalties on sales of products resulting from licensed technologies and pay the patent filing, prosecution and maintenance costs related to the licenses. If we do not meet our obligations in a timely manner or if we otherwise breach the terms of our agreements, our licensors could terminate the agreements and we would lose the rights to KRX-101 or our early-stage technologies. BECAUSE OUR REVISED BUSINESS MODEL IS BASED, IN PART, ON THE ACQUISITION OR IN-LICENSING OF ADDITIONAL CLINICAL PRODUCT CANDIDATES, IF WE FAIL TO ACQUIRE OR IN-LICENSE SUCH CLINICAL PRODUCT CANDIDATES, OUR LONG TERM BUSINESS PROSPECTS WILL BE SUBSTANTIALLY IMPAIRED. As a major part of our business strategy, we plan to acquire or in-license clinical stage product candidates. If we fail to acquire or in-license such product candidates, we may not achieve expectations of our future performance. Because we do not intend to engage in significant discovery research, we must rely on third parties to sell or license new product opportunities to us. Other companies, including some with substantially greater financial, development, marketing and sales resources, are competing with us to acquire or in-license such products or product candidates. We may not be able to acquire or in-license rights to additional products or product candidates on acceptable terms, if at all. IF WE DO NOT ESTABLISH OR MAINTAIN DRUG DEVELOPMENT AND MARKETING ARRANGEMENTS WITH THIRD PARTIES, WE MAY BE UNABLE TO COMMERCIALIZE OUR TECHNOLOGIES INTO PRODUCTS. We are an emerging company and do not possess all of the capabilities to fully commercialize our product candidates on our own. From time to time, we may need to contract with third parties to: o assist us in developing, testing and obtaining regulatory approval for and commercializing some of our compounds and technologies; and o market and distribute our drug candidates. For example, we are currently seeking third party partners to conduct further preclinical development of the KinAce platform and other early stage programs. There can be no assurance that we will be able to successfully enter into agreements with such partners on terms that are acceptable to us. If we are unable to successfully contract with third parties for these services when needed, or if existing arrangements for these services are terminated, whether or not through our actions, or if such third parties do not fully perform under these arrangements, we may have to delay, scale back or end one or more of our drug development programs or seek to develop or commercialize our technologies independently, which could result in delays. Further, such failure could result in the termination of license rights to one or more of our technologies. 25 Moreover, if these development or marketing agreements take the form of a partnership or strategic alliance, such arrangements may provide our collaborators with significant discretion in determining the efforts and resources that they will apply to the development and commercialization of products based on our technologies. Accordingly, to the extent that we rely on third parties to research, develop or commercialize products based on our technologies, we are unable to control whether such products will be scientifically or commercially successful. WE RELY ON THIRD PARTIES TO MANUFACTURE OUR PRODUCTS. IF THESE THIRD PARTIES DO NOT SUCCESSFULLY MANUFACTURE OUR PRODUCTS OUR BUSINESS WILL BE HARMED. We have no experience in manufacturing products for clinical or commercial purposes and do not have any manufacturing facilities. We intend to use third parties to manufacture our products for use in clinical trials and for future sales. We may not be able to enter into third party contract manufacturing agreements on acceptable terms, if at all. Contract manufacturers often encounter difficulties in scaling up production, including problems involving production yields, quality control and assurance, shortage of qualified personnel, compliance with FDA and foreign regulations, production costs and development of advanced manufacturing techniques and process controls. Our third party manufacturers may not perform as agreed or may not remain in the contract manufacturing business for the time required by us to successfully produce and market our drug candidates. In addition, our contract manufacturers will be subject to ongoing periodic, unannounced inspections by the FDA and corresponding foreign governmental agencies to ensure strict compliance with, among other things, current good manufacturing practices, in addition to other governmental regulations and corresponding foreign standards. We will not have control over, other than by contract, third party manufacturers' compliance with these regulations and standards. Switching or engaging multiple manufacturers may be difficult because the number of potential manufacturers is limited and, particularly in the case of KRX-101, the process by which multiple manufacturers make the drug substance must be identical at each manufacturing facility. It may be difficult for us to find and engage replacement or multiple manufacturers quickly and on terms acceptable to us if at all. Moreover, if we need to change manufacturers, the FDA and corresponding foreign regulatory agencies must approve these manufacturers in advance, which will involve testing and additional inspections to ensure compliance with these regulations and standards. If third-party manufacturers fail to deliver the required quantities of our drug candidates on a timely basis and at commercially reasonable prices, and if we fail to find replacement or multiple manufacturers on acceptable terms, our ability to develop and deliver products on a timely and competitive basis may be adversely impacted and our business, financial condition or results of operations will be materially harmed. In the event that we are unable to obtain or retain third party manufacturers, we will not be able to commercialize our products as planned. The manufacture of our products for clinical trials and commercial purposes is subject to FDA and foreign regulations. No assurance can be given that our third party manufacturers will comply with these regulations or other regulatory requirements now or in the future. While we currently have a contract manufacturing relationship for KRX-101, we do not believe that this relationship will be sufficient to meet our needs for clinical and commercial supplies. Accordingly, we are currently seeking to establish an alternative contract manufacturing relationship which we believe will be adequate to satisfy our current clinical and commercial supply needs. 26 As we seek to transition our manufacturing of KRX-101 to a new contract manufacturer, we will need to create a reproducible manufacturing process that will ensure consistent manufacture of KRX-101 across multiple batches and sources. As with all heparin-like compounds, the end product is highly sensitive to the manufacturing process utilized. Accordingly, the creation of a reproducible process will be required for the successful commercialization of KRX-101. There can be no assurance that we will be successful in this endeavor. IF WE ARE NOT ABLE TO OBTAIN THE RAW MATERIAL REQUIRED FOR THE MANUFACTURE OF OUR LEAD PRODUCT CANDIDATE, KRX-101, OUR ABILITY TO DEVELOP AND MARKET THIS PRODUCT CANDIDATE WILL BE SUBSTANTIALLY HARMED. Source materials for KRX-101, our lead product candidate, are derived from porcine intestines. Long-term supplies for KRX-101 could be affected by limitations in the supply of porcine intestines, over which we will have no control. Additionally, diseases affecting the world supply of pigs could have an actual or perceived negative impact on our ability, or the ability of our contract manufacturers, to source, make and/or sell KRX-101. Such negative impact could materially adversely affect the commercial success of KRX-101. IF OUR COMPETITORS DEVELOP AND MARKET PRODUCTS THAT ARE MORE EFFECTIVE THAN OURS, OUR COMMERCIAL OPPORTUNITY MAY BE REDUCED OR ELIMINATED. Our commercial opportunity will be reduced or eliminated if our competitors develop and market products that are more effective, have fewer side effects or are less expensive than our drug candidates. Other companies have products or drug candidates in various stages of preclinical or clinical development to treat diseases for which we are seeking to discover and develop drug candidates. Some of these potential competing drugs are further advanced in development than our drug candidates and may be commercialized earlier. Even if we are successful in developing effective drugs, our products may not compete successfully with products produced by our competitors. Our competitors include pharmaceutical companies and biotechnology companies, as well as universities and public and private research institutions. In addition, companies active in different but related fields represent substantial competition for us. Many of our competitors have significantly greater capital resources, larger research and development staffs and facilities and greater experience in drug development, regulation, manufacturing and marketing than we do. These organizations also compete with us to recruit qualified personnel, attract partners for joint ventures or other collaborations, and license technologies that are competitive with ours. As a result, our competitors may be able to more easily develop technologies and products that would render our technologies or our drug candidates obsolete or noncompetitive. IF WE LOSE OUR KEY PERSONNEL OR ARE UNABLE TO ATTRACT AND RETAIN ADDITIONAL PERSONNEL, OUR OPERATIONS COULD BE DISRUPTED AND OUR BUSINESS COULD BE HARMED. Subsequent to the current and 2002 restructurings, we currently have 15 full and part-time employees and several other persons working under research agreements or consulting agreements. To successfully develop our drug candidates, we must be able to attract and retain highly skilled personnel. In addition, if we lose the services of our current personnel, in particular, Michael S. Weiss, our Chairman and Chief Executive Officer, our ability to continue to develop our lead drug candidates could be materially impaired. In addition, while we have an employment agreement with Mr. Weiss, this agreement would not prevent him from terminating his employment with us. 27 ANY ACQUISITIONS WE MAKE MAY NOT BE SCIENTIFICALLY OR COMMERCIALLY SUCCESSFUL. As part of our business strategy, we may effect acquisitions to obtain additional businesses, products, technologies, capabilities and personnel. If we make one or more significant acquisitions in which the consideration includes stock or other securities, your equity in us may be significantly diluted. If we make one or more significant acquisitions in which the consideration includes cash, we may be required to use a substantial portion of our available cash. Acquisitions involve a number of operational risks, including: o difficulty and expense of assimilating the operations, technology and personnel of the acquired business; o inability to retain the management, key personnel and other employees of the acquired business; o inability to maintain the acquired company's relationship with key third parties, such as alliance partners; o exposure to legal claims for activities of the acquired business prior to acquisition; o diversion of management attention; and o potential impairment of substantial goodwill and write-off of in-process research and development costs, adversely affecting our reported results of operations. RISKS RELATED TO OUR FINANCIAL CONDITION IF WE ARE UNABLE TO OBTAIN ADDITIONAL FUNDS ON TERMS FAVORABLE TO US, OR AT ALL, OUR BUSINESS WOULD BE HARMED. We expect to use rather than generate funds from operations for the foreseeable future. Based on our current plans, we believe our existing cash and cash equivalents will be sufficient to fund our operating expenses and capital requirements for at least the next two years. However, the actual amount of funds that we will need prior to or after that date will be determined by many factors, some of which are beyond our control. As a result, we may need funds sooner or in different amounts than we currently anticipate. These factors include: o the progress of our development activities; o the progress of our research activities; o the number and scope of our development programs; o our ability to establish and maintain current and new licensing or acquisition arrangements; o our ability to achieve our milestones under our licensing arrangements; o the costs involved in enforcing patent claims and other intellectual property rights; and o the costs and timing of regulatory approvals. 28 If our capital resources are insufficient to meet future capital requirements, we will have to raise additional funds. If we are unable to obtain additional funds on terms favorable to us or at all, we may be required to cease or reduce our operating activities or sell or license to third parties some or all of our technology. If we raise additional funds by selling additional shares of our capital stock, the ownership interests of our stockholders will be diluted. If we raise additional funds through the sale or license of our technology, we may be unable to do so on terms favorable to us. OUR RESTRUCTURINGS MAY NOT ACHIEVE THE RESULTS WE INTEND AND MAY HARM OUR BUSINESS. Since mid-2002, we have been restructuring the company, including the current and 2002 restructurings. Our workforce reduction consisted principally of research personnel primarily involved in early-stage projects, along with certain managerial and administrative staff. The implementation of our restructurings has placed, and may continue to place, a significant strain on our managerial, operational, financial and other resources. If we are unable to implement our restructurings effectively, we may not successfully achieve our business strategy or reduce our costs. Moreover, we may be required to further reduce our headcount and/or program-specific expenditures, which could require us to further scale back or abandon any of our development activities, or license to others products or technologies we would otherwise have sought to commercialize ourselves. As of June 30, 2003, we decided, due its significantly reduced activity, to vacate the Jerusalem facility by the middle of July 2003, and to consolidate the remaining limited activities at an alternative location. Although the facility was vacated in July 2003, as of the date hereof the lease remains in effect. The remaining portion of the lease obligations relating to the Jerusalem facility amounts to $1,044,000 through the term of the lease ending December 2005. The Company could be held responsible for the remaining obligations of our subsidiaries under the lease and in certain instances damages and other charges. In September 2001, one of our Israeli subsidiaries received the status of an "Approved Enterprise," a status which grants certain tax benefits in Israel in accordance with the "Law for the Encouragement of Capital Investments, 1959". Through June 30, 2003, our Israeli subsidiary will have received tax benefits of approximately $731,000 as a result of our subsidiary's status as an "Approved Enterprise." As a result of recent cost reductions, the staff and activity of this subsidiary have been materially reduced. In January 2003, the subsidiary notified the Israeli governmental authority of reductions in its staff and operations that had formed the basis of its Approved Enterprise program, and requested that the program instituted prior to the cost reductions be approved. In February 2003, the Israeli governmental authority informed this subsidiary that it may be in non-compliance with the conditions of its Approved Enterprise program because of the indicated reductions. As part of the restructuring implemented during the first quarter of 2003, we decided to close down our Jerusalem laboratory facility. We are currently engaged in discussions with the Israeli governmental authority and at this point are uncertain as to whether or not any past benefits will need to be repaid. Accordingly, we have not recorded any charge with respect to this potential liability. It is possible that as a result of these cost reductions and the close down of the Jerusalem laboratory facility, we may be liable to repay some or all of the tax benefits received to date, which could adversely affect our cash flow and results of operations. 29 RISKS RELATED TO OUR INTELLECTUAL PROPERTY IF WE ARE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY THIRD PARTIES MAY BE ABLE TO USE OUR TECHNOLOGY, WHICH COULD ADVERSELY AFFECT OUR ABILITY TO COMPETE IN THE MARKET. Our commercial success will depend in part on our ability and the ability of our licensors to obtain and maintain patent protection on our drug products and technologies and successfully defend these patents and technologies against third-party challenges. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. No consistent policy regarding the breadth of claims allowed in biotechnology patents has emerged to date. Accordingly, the patents we use may not be sufficiently broad to prevent others from practicing our technologies or from developing competing products. Furthermore, others may independently develop similar or alternative technologies or design around our patented technologies. The patents we use may be challenged, invalidated or fail to provide us with any competitive advantage. Moreover, we rely on trade secrets to protect technology where we believe patent protection is not appropriate or obtainable. However, trade secrets are difficult to protect. While we require our employees, collaborators and consultants to enter into confidentiality agreements, this may not be sufficient to adequately protect our trade secrets or other proprietary information. In addition, we share ownership and publication rights to data relating to some of our drug candidates with our research collaborators and scientific advisors. If we cannot maintain the confidentiality of this information, our ability to receive patent protection or protect our proprietary information will be at risk. LITIGATION OR THIRD-PARTY CLAIMS OF INTELLECTUAL PROPERTY INFRINGEMENT COULD REQUIRE US TO SPEND SUBSTANTIAL TIME AND MONEY DEFENDING SUCH CLAIMS AND ADVERSELY AFFECT OUR ABILITY TO DEVELOP AND COMMERCIALIZE OUR PRODUCTS. Third parties may assert that we are using their proprietary technology without authorization. In addition, third parties may have or obtain patents in the future and claim that our technologies infringe their patents. If we are required to defend against patent suits brought by third parties, or if we sue third parties to protect our patent rights, we may be required to pay substantial litigation costs, and our management's attention may be diverted from operating our business. In addition, any legal action against our licensors or us that seeks damages or an injunction of our commercial activities relating to the affected technologies could subject us to monetary liability and require our licensors or us to obtain a license to continue to use the affected technologies. We cannot predict whether our licensors or we would prevail in any of these types of actions or that any required license would be made available on commercially acceptable terms, if at all. RISKS RELATED TO OUR COMMON STOCK CONCENTRATION OF OWNERSHIP OF OUR COMMON STOCK AMONG OUR EXISTING EXECUTIVE OFFICERS, DIRECTORS AND PRINCIPAL STOCKHOLDERS MAY PREVENT NEW INVESTORS FROM INFLUENCING SIGNIFICANT CORPORATE DECISIONS. As of June 30, 2003, our executive officers, directors and principal stockholders (including their affiliates) beneficially own, in the aggregate, approximately 34.41% of our outstanding common stock, including, for this purpose, currently exercisable options and warrants held by our executive officers, directors and principal stockholders. As a result, these persons, acting together, may have the ability to effectively determine the outcome of all matters submitted to our stockholders for approval, including the election and removal of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, such persons, acting together, may 30 have the ability to effectively control our management and affairs. Accordingly, this concentration of ownership may harm the market price of our common stock by discouraging a potential acquirer from attempting to acquire us. OUR STOCK PRICE COULD BE VOLATILE AND YOUR INVESTMENT COULD DECLINE IN VALUE. The trading price of our common stock is likely to be highly volatile and subject to wide fluctuations in price in response to various factors, many of which are beyond our control. These factors include: o developments concerning our drug candidates; o announcements of technological innovations by us or our competitors; o new products introduced or announced by us or our competitors; o changes in financial estimates by securities analysts; o actual or anticipated variations in quarterly operating results; o expiration or termination of licenses, research contracts or other collaboration agreements; o conditions or trends in the regulatory climate and the biotechnology, pharmaceutical and genomics industries; o changes in the market valuations of similar companies; and o additions or departures of key personnel. In addition, equity markets in general, and the market for biotechnology and life sciences companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of companies traded in those markets. These broad market and industry factors may materially affect the market price of our common stock, regardless of our development and operating performance. In the past, following periods of volatility in the market price of a company's securities, securities class-action litigation has often been instituted against that company. Such litigation, if instituted against us, could cause us to incur substantial costs to defend such claims and divert management's attention and resources, which could seriously harm our business. THE GENERAL BUSINESS CLIMATE IS UNCERTAIN AND WE DO NOT KNOW HOW THIS WILL IMPACT OUR BUSINESS OR OUR STOCK PRICE. Over the past several years, there have been dramatic changes in economic conditions, and the general business climate has been negatively impacted. Indices of the U.S. stock markets have fallen significantly and consumer confidence has waned. Compounding the general unease about the current business climate are the still unknown economic and political impacts of the September 11, 2001 terrorist attacks and hostilities abroad. We are unable to predict how any of these factors may affect our business or stock price. 31 ANTI-TAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW COULD MAKE A THIRD-PARTY ACQUISITION OF US DIFFICULT. THIS COULD LIMIT THE PRICE INVESTORS MIGHT BE WILLING TO PAY IN THE FUTURE FOR OUR COMMON STOCK. Provisions in our certificate of incorporation and bylaws could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, or control us. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. Our certificate of incorporation allows us to issue preferred stock with rights senior to those of the common stock without any further vote or action by the stockholders and our bylaws eliminate the right of stockholders to call a special meeting of stockholders, which could make it more difficult for stockholders to effect certain corporate actions. These provisions could also have the effect of delaying or preventing a change in control. The issuance of preferred stock could decrease the amount of earnings and assets available for distribution to the holders of our common stock or could adversely affect the rights and powers, including voting rights, of such holders. In certain circumstances, such issuance could have the effect of decreasing the market price of our common stock. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rate Risk. The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities in which we invest may have market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline. We maintain our portfolio in cash equivalents and short-term interest bearing securities, including corporate debt, money market funds and government debt securities. The average duration of all of our investments held in the first half of 2003 was less than one year. Due to the short-term nature of these investments, we believe we have no material exposure to interest rate risk arising from our investments. Foreign Currency Rate Fluctuations. While our Israeli subsidiaries transact business in New Israel Shekels or NIS, most operating expenses and commitments are linked to the US dollar. As a result, there is currently minimal exposure to foreign currency rate fluctuations. Any foreign currency revenues and expenses are translated using the daily average exchange rates prevailing during the year and any transaction gains and losses are included in net income. In the future, our subsidiaries may enter into NIS-based commitments that may expose us to foreign currency rate fluctuations. ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. Based on their evaluations as of the end of the period covered in this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Exchange Act Rules 13a, 14(c) and 15(d)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. 32 PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (d) Use of Proceeds From Registered Securities We received net proceeds (after deducting underwriting discounts and commissions and offering expenses) of $46.3 million from the sale of 5,200,000 shares of common stock in our initial public offering in July 2000. As of June 30, 2003, we have used the net proceeds of this offering as follows: o approximately $5.8 million to fund the development of KRX-101 for diabetic nephropathy; o approximately $3.9 million to fund the development of KRX-123 for hormone-resistant prostate cancer; o approximately $10.3 million to fund expansion of our KinAce platform and to further develop the compounds we have generated with it; and o approximately $15.1 million to use as working capital, in-licensing development activities and for general corporate purposes. We intend to use our current capital resources primarily to advance KRX-101 and to in-license, acquire and develop novel clinical stage compounds. The timing and amounts of our actual expenditures will depend on several factors, including the timing of our entry into collaboration agreements, the progress of our clinical trials, the progress of our research and development programs, the results of other pre-clinical and clinical studies and the timing and costs of regulatory approvals. Until we use the net proceeds, we intend to invest the funds in short and long-term, investment-grade, interest-bearing instruments. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS We held our annual meeting of stockholders on June 23, 2003. At the meeting, Lawrence J. Kessel and Peter Salomon were elected and Malcolm Hoenlein, Peter M. Kash, Lindsay A. Rosenwald, and Michael S. Weiss were reelected to our board of directors. The vote with respect to each nominee is as set forth below: Nominee Total Vote For Total Vote Withheld - ------- -------------- ------------------- Malcolm Hoenlein 12,447,179 4,400 Peter M. Kash 12,447,179 4,400 Lawrence J. Kessel 12,447,179 4,400 Lindsay A. Rosenwald 12,447,179 4,400 Peter Salomon 12,447,179 4,400 Michael S. Weiss 12,447,179 4,400 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits The exhibits listed on the Exhibit Index are included with this report. 10.1 - Employment Agreement between Keryx Biopharmaceuticals, Inc. and Ron Bentsur, dated as of June 23, 2003. 31.1 Certification of Principal Executive Officer 33 31.2 Certification of Principal Financial Officer 32.1 - Certifications pursuant to 18 U.S.C. Section 1350 32.2 - Certifications pursuant to 18 U.S.C. Section 1350 (b) Reports on Form 8-K - On August 13, 2003, the Company furnished a Current Report on Form 8-K under Item 9, containing a copy of its earnings release for the period ended June 30, 2003 (including financial statements) pursuant to Item 12 (Results of Operations and Financial Condition). SIGNATURES Pursuant to the requirements 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. KERYX BIOPHARMACEUTICALS, INC. Date: August 14, 2003 /s/ Ron Bentsur --------------------------------------------- Ron Bentsur Vice President Finance and Investor Relations (Principal Financial and Accounting Officer) 34 EXHIBIT INDEX The following exhibits are filed as part of this Quarterly Report on Form 10-Q: 10.1 - Employment Agreement between Keryx Biopharmaceuticals, Inc. and Ron Bentsur, dated as of June 23, 2003. 31.1 Certification of Principal Executive Officer 31.2 Certification of Principal Financial Officer 32.1 - Certification pursuant to 18 U.S.C. Section 1350 32.2 - Certification pursuant to 18 U.S.C. Section 1350 35