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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F/A-1
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission File No. 0-28550
VISIBLE GENETICS INC.
(Exact name of Registrant as specified in its charter and translation of
Registrant's name into English)
ONTARIO
(Jurisdiction of incorporation or organization)
700 BAY STREET, TORONTO, ONTARIO, CANADA M5G
1Z6 (Address of principal executive
offices)
Securities registered or to be registered pursuant to Section
12(b) of the Act:
None
Securities registered or to be registered pursuant to Section
12(g) of the Act:
COMMON SHARES, NO PAR VALUE
(Title of Class)
Securities for which there is a reporting obligation pursuant to
Section 15(d) of the Act:
None
Indicate the number of outstanding shares of each of the Registrant's classes
of capital or common stock as of the close of the period covered by the
annual report:
As of December 31, 1998, the Registrant had outstanding
9,248,233 Common Shares.
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period
that the Registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days:
Yes |X| No |_|
Indicate by check mark which financial statement item the Registrant
has elected to follow:
Item 17 |_| Item 18 |X|
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Visible Genetics Inc.
ANNUAL REPORT ON FORM 20-F
For the Fiscal Year Ended December 31, 1998
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TABLE OF CONTENTS
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PART I
Item 1. Description of Business.......................................................2
Item 2. Description of Property......................................................35
Item 3. Legal Proceedings............................................................36
Item 4. Control of Registrant........................................................36
Item 5. Nature of Trading Market.....................................................37
Item 6. Exchange Controls and Other Limitations Affecting Security Holders...........37
Item 7. Taxation.....................................................................38
Item 8. Selected Financial Data......................................................44
Item 9. Management's Discussion and Analysis of Financial Condition and Results of
Operations..............................................................45
Item 9A. Quantitative and Qualitative Disclosures About Market Risk...................52
Item 10. Directors and Officers of Registrant.........................................53
Item 11. Compensation of Directors and Officers.......................................55
Item 12. Options to Purchase Securities from Registrant or Subsidiaries...............56
Item 13. Interest of Management in Certain Transactions...............................56
PART II
Item 14. Description of Securities to Be Registered...................................57
PART III
Item 15. Defaults Upon Senior Securities..............................................57
Item 16. Changes in Securities and Changes in Security for Registered Securities......57
PART IV
Item 17. Financial Statements.........................................................57
Item 18. Financial Statements.........................................................57
Item 19. Financial Statements and Exhibits............................................57
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PART I
THIS ANNUAL REPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE
KNOWN AND UNKNOWN RISKS AND UNCERTAINTIES. THESE STATEMENTS RELATE TO OUR PLANS,
OBJECTIVES, EXPECTATIONS AND INTENTIONS. OUR ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE DISCUSSED IN THESE STATEMENTS. FACTORS THAT COULD
CONTRIBUTE TO THESE DIFFERENCES INCLUDE THOSE DISCUSSED IN "DESCRIPTION OF
BUSINESS-RISK FACTORS" AND ELSEWHERE IN THIS ANNUAL REPORT.
ITEM 1. DESCRIPTION OF BUSINESS.
OVERVIEW
We develop, manufacture and sell integrated DNA sequencing systems that
analyze genetic information to improve the treatment of selected diseases. Our
proprietary DNA sequencing system, called the OpenGene System, is designed to
identify mutations, or changes, in the DNA of genes associated with some
infectious diseases, cancers and other medical conditions. We believe that our
DNA sequencing systems will enable clinicians to monitor and customize the
treatment of diseases, initially for Human Immunodeficiency Virus, or HIV, and
later for other selected diseases.
DNA sequencing is generally considered the most thorough and accurate
method for genotyping diseases, such as cancer and certain viruses, including
HIV, which have high rates of mutation or numerous strains. Genotyping is the
act of selecting and reading certain components of the sequence of a specific
strand of DNA in order to understand how mutations in the DNA may influence the
onset and treatment of some diseases and medical conditions. Most existing DNA
sequencers have been developed to meet the needs of the research market and
typically do not address the needs of the clinical diagnostic market. We have
designed our OpenGene System to meet the needs of the clinical diagnostic
market.
Our OpenGene System consists of automated DNA sequencers, disposable
gel cassettes, related equipment and software and disease-specific GeneKits. Our
GeneKits contain the necessary chemicals, reagents, third-party licenses and
other consumables and materials required for sequencing specific
disease-associated genes. We have developed GeneKits for HIV, HLA (used for
tissue typing, for example, in organ transplants) and the p53 gene (associated
with many cancers). We are developing GeneKits for human papillomavirus (an
infection associated with cervical cancer), hepatitis B, hepatitis C and
tuberculosis. We began selling our OpenGene System to the research and clinical
research markets in the third quarter of 1996 and began selling GeneKits in the
third quarter of 1997. More than 600 of our DNA sequencers are installed in over
150 laboratories.
The first clinical diagnostic application we are targeting is HIV. We
have developed our HIV GeneKit to enable clinicians to genotype the major HIV
species infecting patients in order to improve the management of patient
treatment. HIV is a highly variable virus with high rates of mutations, which
may lead to drug resistance. One of the central challenges in maintaining HIV
patients on long-term drug therapy is to adjust each patient's medication as
drug-resistant strains of the virus emerge. Two initial clinical trials,
including one which we conducted, have shown that patients whose drug therapy is
managed using HIV genotyping had greater reductions in viral load than HIV
patients who were not genotyped.
We plan to apply to the U.S. Food and Drug Administration, or FDA, for
approval to sell our HIV OpenGene System to the clinical diagnostic market. In
December 1998, the FDA allowed us to initiate human clinical trials of our HIV
OpenGene System under an Investigational Device Exemption application, or IDE.
We intend to use the results of our clinical trials, as well as the results of a
clinical trial conducted by others, in support of our proposed FDA application.
SCIENTIFIC BACKGROUND
DNA. All cells contain DNA, a complex material that stores the genetic
blueprint, or makeup, of an organism. DNA is composed of four chemical building
blocks called nucleotides. Each nucleotide consists of,
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among other things, one of four chemical bases: adenine (A), thymine (T),
guanine (G) and cytosine (C). These four bases are the genetic alphabet that is
used to write messages and instructions which direct the synthesis or expression
of the proteins inside the cell, required to make the cell function. A sequence
is the particular order of the nucleotides in the DNA. Changes in the DNA
sequence, also called mutations, may occur from time to time. These mutations
may alter the function of the cell proteins and affect cell functions.
GENOTYPING. Genotyping is the act of selecting and reading the sequence
of nucleotides in a specific strand of DNA in order to understand how changes in
the DNA may influence the onset and treatment of some diseases and medical
conditions.
Genotyping is used by scientists, researchers and clinicians to
identify:
o genes as potential targets for therapeutic intervention;
o mutations in a gene that may predispose an individual to a
particular disease;
o genetic variation among individuals that may cause different
reactions to drug treatment; and
o mutations in the genes of infectious organisms (such as
viruses and bacteria) and tumors that may result in drug
resistance, thereby influencing treatment methods.
Genotyping is performed using tests that rely on either DNA probe or
DNA sequencing technologies.
DNA PROBES. A DNA probe is a single-stranded piece of DNA made to be
complementary to the unique base sequence of the target gene. These probes are
based on the principle that single strands of DNA seek out complementary strands
to form a chemical bond. The DNA probes are placed into prepared samples which
may include the target gene. If the target gene is present, the probe will bind
to the target, indicating its presence.
DNA probes are highly specific, target single mutations, and require
advance knowledge of the target mutation. Probes are susceptible to producing
erroneous results because they are affected by variations in the sequence
immediately surrounding their targeted mutation. As a result, DNA probes are
effective in detecting diseases only when the disease-associated mutation is at
a fixed, known location within a gene or when the sequence within a particular
gene is stable. However, in other diseases, where the mutation causing the
disease is not known, probe-based technology is not as effective. Probes also
may not effectively provide genotypes for infectious pathogens, such as viruses,
in which the DNA sequence is highly variable or where mutations occur to evade
immune responses or to develop drug resistance.
DNA SEQUENCING. DNA sequencing identifies all the chemical bases of the
DNA strand to be examined, one-by-one, readily detecting variations or new
mutations within the DNA sequence. Unlike DNA probes, sequencing reads long
segments of DNA and can therefore detect new mutations, multiple mutations and
insertions and deletions of DNA within a sequence. DNA sequencing is also less
sensitive than probes to surrounding variations in the sequence being examined.
As a result, sequencing is generally considered the most thorough and accurate
method for genotyping diseases, such as cancer, and certain viruses, such as
HIV, which have high rates of mutation or numerous strains. DNA sequencing is
also used to assess predisposition to many diseases and for tissue typing.
The DNA sequencing process involves several steps, some of which must
be performed manually and are labor intensive. DNA first must be extracted from
the sample, which usually is blood, other body fluid or tissue. After the DNA is
extracted, it is amplified, or copied, in order to provide enough DNA so that
the DNA sequence can be easily detected. This process of extraction and
amplification typically requires the use of various reagents, primers and other
chemicals, as well as proprietary processes and technologies, some of which must
be licensed from third parties. Some laboratories prepare and use their own
homebrew reagents and chemicals which usually are not subject to standardized
procedures or quality control processes necessary to ensure reliable results.
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Once the DNA is extracted and amplified, a process called gel
electrophoresis is performed. This process involves placing the DNA on a gel
substance and running an electrical current through it. This separates the DNA
so that the DNA sequence can be read. While historically many scientists
performed the entire DNA sequencing process manually, automated DNA sequencers
using a number of disposable products have been developed which simplify and
expedite parts of this process.
DNA SEQUENCING MARKETS. DNA sequencing is an important tool for the
research, clinical research and clinical diagnostic markets.
THE RESEARCH MARKET. The research market includes academic
institutions, hospitals, governmental agencies, life science companies and
pharmaceutical companies performing molecular genetics and molecular biology
research. Researchers generally use DNA sequencing equipment for gene discovery
and other large scale research projects which typically must analyze large
numbers of samples and sequence long DNA segments.
THE CLINICAL RESEARCH MARKET. The clinical research market includes
hospitals, life science companies, pharmaceutical companies, academic
institutions and clinical reference laboratories engaged in developing new
diagnostic tests, conducting clinical trials, developing drugs and researching
targeted therapeutics. Researchers in this sector often work both with DNA
probes and DNA sequencing. Researchers typically rely on repetitive sequencing
of relatively short DNA strands of targeted gene segments, for which sequencing
systems that are smaller in scale than those used in the research market are
generally considered most efficient.
THE CLINICAL DIAGNOSTIC MARKET. The clinical diagnostic market consists
of life science companies, hospitals, reference laboratories, medical clinics
and doctors offices which use clinical molecular genetic tests for the diagnosis
and management of diseases and for tissue typing. Current tests typically rely
on DNA probe-based and other technology including homebrew DNA sequencing tests.
We are not aware of any FDA approved DNA sequencing tests for the clinical
diagnostic market. Unlike the research market, genotyping for clinical
diagnostic purposes generally relies on the sequencing of relatively short DNA
strands with high degrees of accuracy. DNA sequencers and related
instrumentation used for diagnostic purposes should enable clinicians to rapidly
and accurately sequence and analyze a high volume of patient samples at
relatively low costs, and fit within the space constraints of a typical clinical
laboratory.
EXISTING DNA SEQUENCING PRODUCTS. Historically, automated DNA
sequencers and related products used for genotyping have been developed
primarily to meet the needs of the research and clinical research markets. As a
result, these DNA sequencing products typically do not address the needs of the
clinical diagnostic market because:
o existing DNA sequencers are too large for most clinical
laboratories;
o existing DNA sequencers cannot sequence DNA strands quickly
enough to satisfy diagnostic turnaround times;
o existing DNA sequencers are designed to sequence long DNA
segments and therefore may not be efficient for sequencing
shorter DNA segments typical in clinical diagnostic testing;
o existing DNA sequencers are expensive;
o gel preparation is usually a manual and time consuming process
and may result in exposure to dangerous chemicals;
o homebrew tests, reagents, chemicals and protocols are not
typically subject to the standardized procedures or quality
control processes necessary for reliable results;
o homebrew tests may not include some of the necessary
proprietary chemicals, technology and licenses; and
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o we are not aware of any available DNA sequencing products or
methods which are approved by the FDA to be marketed for
clinical diagnostic use.
Two initial clinical trials, one of which we conducted, suggest that
DNA sequencing can be a useful tool in managing the treatment of certain
diseases. We believe there is an emerging and potentially significant demand for
DNA sequencing products in the clinical diagnostic market. However, currently
available DNA sequencing products are not designed to meet the needs of the
clinical diagnostic market and we are not aware of any DNA sequencing products
that have been approved by the FDA for clinical diagnostic purposes. We believe
that for DNA sequencing to become an accepted diagnostic tool for which
third-party payors may provide reimbursement, DNA sequencing instrumentation and
technology must be easy to use, cost effective and capable of sequencing patient
samples quickly and efficiently. In addition, standardized tests for specific
diseases must be used to ensure accurate, reliable results.
THE VGI SOLUTION
Our OpenGene integrated gene sequencing and analysis system has been
designed expressly to meet the needs of the clinical diagnostic market. We
believe our OpenGene System is suitable for the clinical diagnostic market
because:
o our OpenGene DNA sequencers are small and lightweight;
o our OpenGene DNA sequencers read DNA strands faster than
existing sequencers designed for the research market;
o our OpenGene System is designed to efficiently read and
analyze the shorter DNA strands typically used for clinical
diagnosis;
o our OpenGene DNA sequencers are significantly less expensive
than comparable sequencers designed for the research market;
o our OpenGene System uses our proprietary preassembled
disposable gel cassettes which a technician fills with gel
through easy-to-use, disposable syringe cartridges that
minimize exposure to chemicals;
o our OpenGene System includes our proprietary software package
designed for DNA analysis and patient data management;
o our GeneKits include the reagents, primers and other
chemicals, third-party licenses, software and other materials
required to conduct tests for specific disease-associated
genes;
o our GeneKits are standardized, validated and undergo quality
control testing to provide reliable, reproducible results; and
o we intend to conduct the necessary clinical trials to support
an application to the FDA for authorization to sell our
OpenGene System for clinical diagnostic use, initially for
HIV, in the United States and to seek regulatory approval in
selected markets outside of the United States. In December
1998, the FDA allowed us to initiate human clinical trials of
our HIV OpenGene System under our IDE application.
We believe that our integrated OpenGene System will provide a cost
effective and efficient clinical diagnostic solution that will make DNA
sequencing a viable diagnostic tool for the management of selected diseases
and medical conditions. We must obtain approval from the FDA and comparable
foreign regulatory authorities prior to selling our products for clinical
diagnostic use. See "Risk Factors-We may not receive FDA approval for our HIV
OpenGene System and, in the future, other HIV products," "Risk Factors-We may
not receive regulatory approval for our other products," "Risk Factors-The
clinical diagnostic market for genotyping products is new and genotyping may
not become an accepted method of managing drug treatment" and "-Regulation by
the FDA and Other Government Agencies."
While our OpenGene System and GeneKits are designed to serve the
clinical diagnostic market, they also fulfill many important requirements within
the research and clinical research markets. Researchers in the clinical
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research market also work with short DNA strands, rely on a repetitive
sequencing of gene segments and need quick and efficient sequencing systems. In
the research market, our products complement existing instruments by performing
tasks such as primer labeling, chemistry verification, short sample sequencing
and other preparatory and supportive functions for which speed, cost and
efficiency are a premium. We also have developed a sequencer that is able to
read longer segments required for some research applications.
To date, a substantial portion of our revenue has been generated from
sales to the research and clinical research markets. We expect to continue to
sell to both of these markets even if we receive FDA approval for clinical
diagnostic use of our HIV OpenGene System and other products.
OUR BUSINESS STRATEGY
Our objective is to be the leading worldwide provider of genotyping
solutions for the clinical management of selected diseases and other medical
conditions. Our goal is to enable clinicians to use genetic information to
monitor and customize treatment of diseases, initially for HIV and later for
other diseases. Key elements of our business strategy are to:
PROVIDE AN INTEGRATED GENOTYPING SOLUTION FOR THE CLINICAL DIAGNOSTIC
MARKET. We are developing an integrated genotyping solution designed to meet the
needs of the clinical diagnostic market. We are not aware of any existing FDA
approved DNA sequencing tests for this market. While our products are currently
used for research and clinical research purposes only, we believe that if FDA
approval is received, our OpenGene System and GeneKits will enable clinicians to
use genotyping to manage and customize patient treatment on an ongoing basis.
TARGET THE HIV GENOTYPING MARKET. We are focusing initially on the
HIV market because there is clinical evidence to suggest that genotyping may
be effective in managing the treatment of this disease. We believe that there
is a large HIV infected patient population in the United States and
throughout the world that would benefit from HIV genotyping. By identifying
mutations in the virus through genotyping and consistently countering these
mutations with appropriate drug therapy, we believe drug treatment can be
administered and monitored more effectively. We intend to seek approval from
the FDA and other regulatory authorities to sell our HIV OpenGene System for
clinical diagnostic use in the United States and elsewhere. See "Risk
Factors-We may not receive FDA approval for our HIV OpenGene System and, in
the future, other HIV products," "Risk Factors-The results of our proposed
HIV clinical trials are uncertain" and "Risk Factors-Certain of our products
are subject to government regulation."
LEVERAGE OUR OPENGENE SYSTEM FOR ADDITIONAL APPLICATIONS. We are
developing other disease-specific GeneKits that we believe have the potential to
eliminate or reduce more time consuming and/or expensive tests and that may
enable clinicians to better monitor and manage patient treatment. In addition to
our HIV GeneKit, we have developed GeneKits for HLA (used for tissue typing, for
example, in organ transplants) and p53 (associated with many cancers), and are
developing GeneKits for HPV (implicated in cervical cancer), hepatitis B,
hepatitis C, tuberculosis and other species of HIV not tested for in our current
HIV GeneKit. Each of these GeneKits will contain the necessary chemicals,
reagents, third-party licenses and other consumables and materials for
sequencing DNA and is designed to be used with the DNA sequencers, gel
cassettes, and other equipment comprising the rest of our OpenGene System. We
also offer a wide range of testing and sequencing services at our accredited
reference testing laboratories including genotyping for HIV, hepatitis B,
hepatitis C, other infectious diseases and various genes associated with cancer.
TAILOR OUR MARKETING EFFORTS TO LOCAL MARKETS. We have established and
are expanding our sales and marketing force in the United States, Canada,
selected European countries and in other areas where we believe that the size of
the market and our familiarity with regulatory and other local conditions
justify the development of our own sales force. Our in-house sales force
includes 20 field representatives and technical support staff who provide
ongoing support to customers after sales are made. In selected geographic and
product markets where we believe that regulatory and other market factors make
it more prudent to rely on a third-party local sales and marketing effort, we
seek to enter into distribution and marketing arrangements with leading
distributors. For example, we have granted exclusive rights for the distribution
of our OpenGene System and GeneKits in the clinical diagnostic
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market to Roche Diagnostics SL in Spain and Portugal, Roche Diagnostics K.K. in
Japan, Organon Teknika in Brazil, and others. We plan to enter into similar
arrangements with other leading companies in selected markets. We have also
granted Amersham International plc the exclusive worldwide license to sell our
Seq4x4 sequencer and related products used and sold with the sequencer, which is
designed for the research market.
MAINTAIN OUR TECHNOLOGICAL LEADERSHIP IN GENOTYPING. We plan to
continue to invest significant resources in research and development so that we
may continue to provide customers with advanced genotyping technologies and
products. Where we believe it is cost effective or otherwise appropriate, we
will continue to license and acquire technologies and products to include in our
OpenGene System and GeneKits. We will also seek to continue to collaborate with
hospitals, academic institutions, pharmaceutical companies and life science
companies to develop additional GeneKits and other products.
THE HIV GENOTYPING MARKET
HIV OVERVIEW. HIV is a virus that attacks the cells in the human immune
system. Without effective treatment, HIV significantly weakens the immune
system, which results in opportunistic infections, neurological dysfunctions,
malignant tumors and eventually death. HIV infected patients may develop
Acquired Immune Deficiency Syndrome, or AIDS, which is a syndrome of infections,
diseases and medical conditions resulting from a weakened immune system. Since
the early 1980's, when the HIV epidemic was first identified, it is estimated
that more than 14 million people worldwide have died as a result of
complications from AIDS. Approximately 900,000 people in North America, 750,000
in Europe and Central Asia and a total of 33 million people worldwide are
infected with HIV. In 1998 alone, there were approximately 5.8 million new HIV
infections, including 44,000 in North America, and 2.5 million deaths as a
result of complications from AIDS.
HIV is a highly variable virus with a high rate of mutations. Because
of HIV's high mutation rate, drugs used to treat the virus, while generally
effective for a period of time, often result in the survival of a virus with
mutations that confer resistance to those drugs. Today, there are more than 140
known HIV mutations associated with drug resistance.
Currently, there are 15 approved anti-HIV drugs. These drugs
specifically target the protease and reverse transcriptase enzymes to interfere
with and reduce HIV replication. Mutations in the genetic information of the
virus that codes for these two enzymes can result in the development of drug
resistance. Current drug therapy usually relies on the use of drug cocktails of
two or more antiviral drugs, targeting different stages of the HIV life cycle. A
number of studies have shown that drugs given in various combinations reduce the
viral load in most patients and can significantly improve these patients'
overall health. Viral load is a generally used measurement of the concentration
of virus in a patient's blood. HIV patients fail drug therapy in many cases
either because the virus mutates and develops resistance to drugs, or because
the side effects of drugs or the strict dosing regimens are intolerable, leading
patients to skip doses or discontinue using the drugs.
One of the central challenges in maintaining HIV patients on long-term
drug therapy is to adjust each patient's medication as drug-resistant strains of
the virus emerge. Because they rely only on viral load, current disease
management methods usually provide a warning that the drugs are no longer
working only after the drug-resistant virus has asserted itself and viral load
has increased. These methods usually do not tell clinicians which drugs are
failing due to emerging resistance or to which drugs the patient should be
switched. As a result, there is a need to provide doctors and clinicians with
information about HIV drug resistance to enable clinicians to better manage HIV
drug therapy.
GENOTYPING AND HIV. Genotyping HIV enables clinicians to identify
mutations in the genetic material in the virus. Two initial clinical trials, one
of which we conducted, suggest that by sequencing the patient's HIV, clinicians
may be able to detect early in the process that a resistant mutant has emerged
and make appropriate changes in medication to manage viral load. Sustaining a
low viral load is believed to be a key factor in prolonging the life of an HIV
patient. Achieving and maintaining low viral loads may also significantly reduce
medical costs because patients with low or undetectable viral loads have fewer
opportunistic infections and other symptoms and, therefore, require fewer and
shorter hospital stays and fewer other medical services.
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To test the clinical usefulness of genotyping HIV to manage a patient's
drug therapy, the Community Programs for Clinical Research on AIDS, in
conjunction with several universities, conducted a 12-week prospective trial in
the United States of 100 HIV positive patients. This trial, completed in
December 1998, is known as GART, which stands for Genotypic Antiretroviral
Resistance Testing. To be eligible, each patient had to have a minimum viral
load of 10,000 copies per milliliter. The patients were randomly split into two
groups. One group received accepted standard of care treatment, but did not
undergo HIV genotyping. The other group received accepted standard of care
treatment plus HIV genotyping. Physicians of patients in the genotyping group
were able, at their discretion, to adjust medication in response to the
genotyping results. The study results showed that the patients treated in the
genotyping group had a mean decrease in viral load of approximately 93% at the
end of eight weeks, compared to an approximately 76% decrease in patients in the
non-genotyping group. This difference was found to be statistically significant.
OUR HIV OPENGENE SYSTEM
We developed our HIV OpenGene System to enable physicians to genotype
the major HIV species infecting patients and to diagnose and treat HIV based
upon the mutations present in the virus. Our GeneKit contains all of the
reagents, chemicals, third-party licenses and other materials required to
sequence the DNA from the protease and reverse transcriptase regions of the
virus, which are known to develop mutations that make the virus resistant to
drugs. We initiated the sale of our HIV GeneKit, which we call the TruGene HIV-1
Assay, for use in the clinical research market in March 1998. We have a patent
application pending in the United States and in some foreign countries covering
various aspects of our HIV GeneKit.
FDA ALLOWANCE AND CLINICAL TRIALS. Under FDA regulations, we believe
that our HIV OpenGene System will be considered a Class III medical device. This
means that in order to sell our HIV system in the United States for clinical
diagnostic purposes, we will need to obtain FDA approval. In order to obtain FDA
approval for this device, we must submit a Premarket Approval application,
commonly known as a PMA application. To be considered by the FDA, our PMA
application must be supported by extensive human clinical data demonstrating the
utility of HIV genotyping using our OpenGene System to manage a patient's drug
treatment to reduce viral load. We must also demonstrate the reliability and
performance of our HIV GeneKit and OpenGene System. In June 1999, we completed a
clinical trial in Europe called VIRADAPT, which demonstrated that patients who
received standard of care treatment and whose drug treatments were selected
using periodic genotyping had lower viral loads than patients who received
standard of care treatment but whose drug treatments were selected without the
use of genotyping. This trial was not part of our IDE, but results from this
trial will be submitted to support our PMA application. In December 1998, the
FDA allowed us to initiate human clinical trials of our HIV OpenGene System
under our IDE application. In June 1999, we initiated a trial called SEARCH to
test the clinical utility of our HIV OpenGene System in genotyping HIV infected
patients. We intend to commence our proficiency trials in the third quarter of
1999. We also plan to begin, in the third quarter of 1999, a large-scale trial
called Vigilance II which will be an open label, HIV genotyping study conducted
under our IDE. The purpose of this trial is to collect important HIV genotyping
data. It will also serve to recover some of the costs of conducting trials to
support our PMA application.
The following is a summary of each of these trials:
o VIRADAPT. In March 1997, prior to our IDE allowance, we sponsored a
prospective trial in Europe called VIRADAPT to determine the usefulness
of genotyping in managing the treatment of HIV infected patients. The
VIRADAPT trial involved 108 HIV infected patients and was scheduled to
last 12 months. To be eligible, each patient had to have a minimum
viral load of 10,000 copies per milliliter. The patients were randomly
split into two groups. The control group received standard of care
treatment, but did not undergo periodic genotyping. The genotyping
group received standard of care treatment and underwent periodic
genotyping allowing the physicians, at their discretion, to adjust
medication in response to the genotyping results. Genotypes were done
using either homebrew DNA testing methods or an early version of our
HIV GeneKit. At the end of six months, interim results showed that
patients treated in the genotyping group of
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the study had a mean decrease in their viral loads of approximately 93%
(32% of patients in the genotyping group had undetectable viral loads),
as compared to an approximately 79% decrease in viral loads in the
non-genotyping group (14% of patients in the non-genotyping group had
undetectable viral loads). This difference was found to be
statistically significant. In January 1999, on the recommendation of
the data safety management committee for the VIRADAPT trial, the
control group was stopped on ethical grounds. The committee decision
was based in part on the interim results of the VIRADAPT trial and in
part on the release of the results of the GART trial in December 1998
which showed decreases in viral loads for the genotyping patients
consistent with the VIRADAPT trial. As a result, beginning in January
1999, all patients received standard of care treatment and underwent
periodic genotyping. At the end of 12 months, results showed that 28.4%
of patients in the original genotyping arm had undetectable viral
loads. The mean viral loads for this group were maintained at
substantially the same level as after six months. The data also showed
that of those patients who were switched from standard of care
treatment only to standard of care treatment and genotyping, 26% had
undetectable viral loans as compared to 14% of patients in this group
at the end of six months before the treatment was switched. We plan to
reanalyze the samples collected in the GART and the VIRADAPT trials
using our HIV GeneKit and OpenGene System and include those results in
support of our PMA application.
o SEARCH. The SEARCH trial will test whether patients whose doctors rely
on genotyping using our HIV OpenGene System will experience greater
reductions in viral load than those patients whose doctors rely only on
standard of care treatment. This trial is intended to demonstrate the
clinical utility of our system which is required by the FDA. SEARCH
will be a one year study, involving 300 patients, with interim analysis
at six months. To be eligible, each patient will have to have a minimum
viral load of 1,000 copies per milliliter. Like GART and VIRADAPT, the
patients will be randomly split into two groups. The control group will
receive standard of care treatment without genotyping, and the
genotyping arm will receive standard of care treatment plus genotyping.
We have completed training the technicians at the trial's three U.S.
testing sites that will perform the testing and genotyping using the
HIV OpenGene System.
o PROFICIENCY TRIAL. The proficiency trial is intended to demonstrate the
reliability and performance characteristics of our HIV GeneKits and
OpenGene System, which is required by the FDA. We are in the process of
developing a test panel of approximately 500 plasma samples. We plan to
genotype the samples using our HIV OpenGene System at our subsidiary,
Applied Sciences, and at three other U.S. sites where we are currently
in the process of training and certifying technicians. To demonstrate
the reproducibility of results produced using our GeneKits, samples
from the same patients will be tested at multiple sites. Multiple
technicians will test the same samples and multiple batches of our
GeneKits will be used to test the same samples. In addition, various
interfering drugs or chemical agents will be introduced to a series of
samples to test the effect of those drugs and agents on the results
produced with our GeneKits. We intend to commence this trial as soon as
we complete the certification of the testing sites and expect this
trial to last approximately six weeks.
o VIGILANCE II. Vigilance II will be a one-year, prospective, open label,
trial with a target enrollment of 30,000 patients located throughout
the United States. Testing will be performed at approximately 25 to 30
sites. All patients will undergo HIV genotyping and the genotyping
results will be provided to their physicians. Doctors who choose not to
change drug treatment based on the genotyping results will be required
to so inform us, and results on these patients will be separately
recorded. The information collected from Vigilance II will be submitted
in support of our PMA application. We also plan to use the data
collected in Vigilance II in two ways. First, we hope to compile data
showing the prevalence of certain mutations in patients from different
areas of the country. We believe that this data may be useful in
directing doctors in a particular region to use certain drugs because
of the prevalence of certain mutations identified in that region.
Second, we intend to create a database of the results from changes made
in drug therapy, including information on viral loads, mutations and
drug resistance, which we can make available via the Internet to
doctors who treat HIV, patients with HIV and drug companies involved in
HIV research and development. Under our IDE, we intend to charge
patients for the use of our HIV OpenGene System to recover the costs of
this conducting trial.
We may also conduct additional clinical trials, the results of which
may be submitted in support of our PMA application.
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MARKETING OF THE HIV OPENGENE SYSTEM. Our marketing strategy for the
HIV OpenGene System consists of several components. In the United States, should
we obtain FDA approval, we intend to establish relationships with leading
doctors, laboratories and healthcare providers in the HIV diagnostics market and
train them to use our products. We believe that the use of our products by these
industry leaders will facilitate our marketing efforts in the rest of the HIV
clinical diagnostic market. In addition, we believe that these industry leaders
will help shape reimbursement policies of insurance companies and other
third-party payors for HIV genotyping.
We have begun to establish a dedicated team to work closely with
insurance companies and other third-party payors who will determine whether to
reimburse users of HIV GeneKits and related products in the management of their
drug therapies. We are also forming a dedicated sales force to sell our HIV
OpenGene System to major pharmaceutical companies engaged in research and
development of HIV drugs and treatments.
Outside North America, some European countries and other selected
areas, we seek to enter into distribution arrangements with leading distributors
of HIV products to sell our HIV OpenGene System for clinical diagnostic
purposes. If government approval is required for sales in those markets, we
typically rely on our local partners to obtain the required authorizations.
We intend to continue to market and sell our HIV OpenGene System to
hospitals, pharmaceutical companies, academic institutions and clinical
reference laboratories for research and clinical research purposes. We expect to
continue to service this market regardless of whether the FDA authorizes us to
sell our HIV products for clinical diagnostic purposes.
You should keep in mind that we cannot assure approval by the FDA or
foreign governmental agencies for the sale of our HIV OpenGene System to the
clinical diagnostics market on a timely basis or at all.
For a discussion of risks relating to our HIV OpenGene System, see
"Risk Factors-We may not receive FDA approval for our HIV OpenGene System
and, in the future, other HIV products," "Risk Factors-The results of our
proposed HIV clinical trials are uncertain," "Risk Factors-Each time we make
substantial alterations to any FDA approved products, we will need to seek
additional FDA approval," "Risk Factors-The clinical diagnostic market for
genotyping products is new and genotyping may not become an accepted method
of managing drug treatment," "Risk Factors-Our OpenGene System may not be
accepted by the clinical diagnostic market," "Risk Factors-Insurance
companies and other third-party payors may not reimburse doctors and patients
for our products," "Risk Factors-We do not have any marketing experience in
the clinical diagnostic market, and rely on other companies to sell our
products in some markets" and "Risk Factors-Certain of our products are
subject to government regulations."
OTHER APPLICATIONS FOR OUR PRODUCTS
ADDITIONAL GENEKITS THAT WE CURRENTLY SELL
In addition to our HIV GeneKit, we have developed and sell a series of
GeneKits that assist in identifying other disease-associated genetic mutations
and gene sequences. These kits currently are sold only to the research and
clinical research markets. As in our HIV GeneKit, each of these GeneKits
includes the materials necessary to perform tests for a specific
disease-associated gene including various reagents, primers and other chemicals,
licenses, test materials, software and other materials.
HLA. Successful transplants of bone marrow, tissue and organs generally
require that the human leukocyte antigens, known as HLA, of the donor and the
recipient be matched as precisely as possible. HLAs are proteins that exist on
the surface of the cell and are vital for determining whether a transplant will
be accepted or rejected. In 1997, there were approximately 18,000 organ
transplants in the United States and approximately 1,300 bone marrow
transplants. DNA sequencing of HLA is increasingly being recognized as the most
reliable method of HLA matching. For example, recent statistics show
approximately 500,000 potential bone marrow donors are genotyped every month
worldwide. By sequencing the particular genes in the multi-gene HLA complex, a
clinician can determine whether the donor's and recipient's HLA match. It is
widely believed that matching significantly
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increases the chances of success of the transplant. We have developed four
GeneKits for research use only for the A, B and C loci for Class I and for DRB1
for Class II genes. We began selling these kits for research purposes in October
1997. We have a U.S. patent covering various aspects of this GeneKit. See
"-Proprietary Rights."
P53. Mutations in the p53 gene are associated with many cancers,
including approximately 50% of colorectal cancers, 56% of lung cancers and 22%
of breast cancer cases. There are approximately 1.2 million new cancer cases in
the United States each year. Research has shown that some tumors displaying p53
mutations are significantly less sensitive to chemotherapy and are more
aggressive than tumors that do not display p53 mutations. Using DNA sequencing
to detect p53 mutations in tumors, patients can be identified for specific
radiation and chemotherapy regimens. Screening of the p53 gene for mutations may
assist clinicians in evaluating patient risk for early tumor recurrence and
death, customizing drug therapy and improving treatment outcomes. We began
selling these kits for research purposes in April 1999. We have a U.S. patent
covering various aspects of this GeneKit. See "-Proprietary Rights."
ADDITIONAL GENEKITS THAT WE ARE DEVELOPING
We are also developing GeneKits for the diseases listed below.
Genotyping currently is not used widely to manage drug treatment of these
diseases. However, we believe that due to the characteristics of these diseases,
genotyping may be useful to improve the management of drug therapy for infected
patients.
HPV. Human Papillomavirus, or HPV, is a viral infection. There are a
large number of sub-types of HPV that are associated with a high risk of
cervical cancer. Scientific studies estimate that at least 50% of adult women in
the United States have been exposed to HPV. There are an estimated 12,800 cases
of cervical cancer in the United States each year, resulting in approximately
4,800 deaths per year. Genotyping is believed to be a reliable method of
determining the link between specific HPV subtypes and increased risk for
cervical cancer. We have developed and are currently testing a clinical HPV
GeneKit that uses a single nucleotide DNA sequencing method to provide accurate
sub-type determination of an HPV infection.
HEPATITIS B. Hepatitis is an inflammation of the liver. Hepatitis B is
one type of virus that causes this inflammation. There are more than 350 million
people worldwide that are chronically infected with hepatitis B, of which
approximately one million are located in the United States. Hepatitis B is
treated with interferon, drugs or certain protease inhibitors. Genotyping may be
used to identify the type of hepatitis virus present (e.g., B or C) and to
detect mutations in the virus that cause the disease to become resistant to
anti-viral drugs. We have developed and are currently testing our Hepatitis B
GeneKit.
HEPATITIS C. Hepatitis C is a second type of virus that causes
inflammation of the liver. There are approximately 175 million people worldwide
that are chronically infected with hepatitis C, of which approximately 3.2
million are in the United States. Unlike hepatitis B, interferon drugs work with
only certain hepatitis C genotypes. We have developed and are currently testing
a Hepatitis C GeneKit that can be used to identify the genotypes of the virus,
so that the appropriate drug treatment may be prescribed. Protease inhibitors
are also being used experimentally to treat hepatitis C. Our Hepatitis C GeneKit
can also be used to detect mutations that may confer resistance to these
anti-viral drugs.
TUBERCULOSIS. Tuberculosis, commonly known as TB, is a highly
contagious bacterial disease of the respiratory system. There are approximately
three million deaths per year worldwide caused by TB and eight million new
infections per year worldwide. In addition, there is an increase in the number
of TB infections which are multi-drug resistant. In order to be infected with
TB, a patient must carry a certain mycobacterium. People who test positive for
non-TB mycobacterium can be treated at home with certain drugs. Due to the
highly contagious nature of TB, people who test positive for TB mycobacterium
must be kept in isolation during the early stage of treatment. Current testing
methods can take from several days to several weeks to identify whether a
patient's mycobacterium is TB or non-TB, forcing hospitals to quarantine both TB
and non-TB patients during this period. Quarantining patients for any prolonged
period uses significant medical resources. We are developing and currently
testing a TB GeneKit designed to genotype the genetic material in the
mycobacterium within approximately one day to identify the presence of TB or
non-TB mycobacterium. Our TB GeneKit can also be used to detect mutations that
confer resistance to drugs used to treat TB. We intend to market and sell our TB
GeneKit in those geographic areas where TB poses significant health threats,
including Asia, Central Europe, parts of the former Soviet Union and Africa.
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OTHER HIV. We are developing additional HIV GeneKits for HIV species
not covered by our existing HIV GeneKit.
OUR INTEGRATED OPENGENE SYSTEM
We have developed an integrated DNA sequencing and testing system known
as the OpenGene System that provides a complete platform for genotyping
analysis. Our integrated system is comprised of the following components which
are described below:
SEQUENCING SYSTEMS. Sequencing systems consist of automated DNA
sequencers and related equipment, and our proprietary DNA analysis and data
management software.
GENEKITS AND OTHER CONSUMABLES. GeneKits consist of various reagents,
enzymes, primers and other chemicals, and other consumables consist of
disposable gel cassettes, acrylamide and other materials.
SEQUENCING SYSTEMS.
CLIPPER. The Clipper automated DNA sequencer is our second-generation
two-dye automated DNA sequencer which, using our proprietary MicroCel cassettes,
can read 400 bases in approximately 30 minutes with high accuracy, suitable for
clinical diagnostic applications. The Clipper can read 16 lanes and test up to 8
patient samples per gel cassette, and can be networked so that multiple units
can run from a single workstation, thereby allowing for a significantly greater
number of patient samples to be tested simultaneously. The Clipper is relatively
small (35 cm x 40 cm x 26 cm) and lightweight. Competitive sequencers are
typically at least twice as large and significantly heavier than the Clipper.
The Clipper sells at retail prices significantly below comparable automated DNA
sequencers. The Clipper can be connected to almost any computer network and may
also be supported over the Internet. The Clipper has no moving parts and
consumes only 300 watts of power.
LONG-READ TOWER AUTOMATED DNA SEQUENCER. This sequencer is a two-dye
automated sequencer that can perform all of the applications of the Clipper
sequencer, and can also read longer DNA sequences used in some research
applications. Using Long-Read MicroCel cassettes, the Long-Read Tower can read
1,000 bases with high accuracy. The Long-Read Tower may be networked with other
Long-Read Towers or Clippers, providing a high degree of flexibility and
capacity. The Long-Read Tower is small (51cm x 40cm x 26cm) and lightweight
relative to competitive instruments, and sells at retail prices significantly
below comparable automated DNA sequencers.
SEQ4X4. The Seq4x4 automated DNA sequencer is marketed by Amersham as
the Amersham Pharmacia Biotech Seq4x4(TM) built to Amersham's specification to
work with Amersham's one color Cy 5.5 terminator chemistry and
ThermoSequenase(TM) Kits. The Seq4x4 is a less expensive version of the Clipper
that includes many of the features of the Clipper; however, it is a 16 lane
one-dye sequencer, and cannot be networked with other sequencers. The Seq4x4 is
sold to the research market where it can be used to complement or replace
significantly slower manual DNA sequencing methods and to complement currently
available, more expensive automated DNA sequencers. See "-Sales and Marketing."
GEL TOASTER. The Gel Toaster is a compact (33 cm x 11.4 cm x 30.5 cm),
lightweight device that uses ultraviolet light to polymerize, or cure, liquid
acrylamide that has been injected into the MicroCel. The acrylamide gel is the
medium through which the DNA is separated for sequencing. We also sell a toaster
for use with the Long-Read Tower which can accommodate both the MicroCel and the
Long-Read MicroCel cassettes. This toaster's dimensions are 47 cm x 39 cm x 26
cm.
GENEOBJECTS. GeneObjects is our DNA analysis and data management
software package which we have designed for molecular diagnostics laboratories.
It automates portions of the test process and facilitates analysis and
diagnosis. It also automates certain laboratory management tasks. GeneObjects
software is able to sort, analyze and store data by patient (regardless of the
test or gel source from which the data is derived) or by the test performed.
GeneObjects can also be used to control multiple sequencers over the network
from a single workstation. It can use existing microcomputers and sequencers, or
be installed as a turnkey system with state-of-the-art hardware.
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GENEKITS AND OTHER CONSUMABLES
GENEKITS. We sell to the research and clinical research markets a
series of GeneKits which assist in identifying disease-associated genetic
mutations and gene sequences. Our HIV GeneKit is described earlier in this
annual report in the section entitled "-Our HIV OpenGene System." Other GeneKits
which we sell or are developing are described in the section entitled "-Other
Applications For Our Products."
GENEKIT TECHNOLOGIES. We developed and are developing GeneKits with
features designed to make our GeneKits suitable for the clinical diagnostic
market. We use certain technologies proprietary to VGI, and other technologies
licensed by VGI, to ensure that our GeneKits will meet the needs of this market.
These technologies include our stratified matrix testing method, CLIP and CAS
technology, polymerase chain reaction technology, or PCR, and an extraction
technology referred to as Boom technology. We have U.S. patents covering our
standard matrix testing method and CLIP technology. We license the PCR
technology from Roche Molecular Systems, Inc. and F. Hoffmann-LaRoche Ltd., the
CAS technology from BIOS Laboratories, Inc. and the Boom technology from Organon
Teknika. See "-Proprietary Rights."
Our proprietary CLIP technology enables DNA samples to be prepared in a
single test-tube, single-step process that replaces the multiple individual
steps currently required to prepare a sample for DNA sequencing. This technology
saves time and reduces the cost of DNA sequence-based diagnostic testing, which
is important to the clinical diagnostic market. Our CLIP technology is also more
sensitive than traditional techniques, which is especially useful for managing
viral diseases because it permits the genotyping of patients with very low viral
loads that other methods cannot detect. As a result, using CLIP, HIV patients
with low viral loads can be genotyped and treated before drug resistance
develops and their viral loads increase. Our exclusive license from BIOS
Laboratories, Inc. permits us to use CAS technology solely for diagnostic
applications. CAS technology performs similar functions to CLIP technology,
using different enzyme chemistry on DNA.
PCR is a powerful laboratory technique that can detect, copy and
amplify specific DNA sequences. Amplifying the DNA is an essential part of DNA
sequencing because it allows the technician to start with minute amounts of DNA
and finish with at least a million-fold increase in the number of DNA molecules,
ensuring that a sufficient amount of DNA is available to obtain the sequence.
Boom technology enables sensitive, reproducible and accurate
extractions of RNA and DNA from blood plasma samples, and from sterile body
fluids such as semen and cerebral spinal fluid. The Boom method is especially
valuable in HIV genotyping for patients with low viral load. In connection with
obtaining the Boom technology license, we granted Organon Teknika a right of
first refusal to certain improvements we may develop to DNA sequencing and
extraction technology and to some of our reagents and uses of our CLIP
technology.
MICROCEL CASSETTE. The MicroCel Cassette is a disposable,
polyacrylamide electrophoretic gel cassette which acts as the detection medium
for the Clipper, Long-Read Tower and the Seq4x4. The gel is injected into the
cassette. After the cassette is cured, it is placed into the sequencer for DNA
sequencing and other tests. The cassette is comprised of two small (14 cm x 14
cm for the Clipper and Seq4x4, and 14 cm x 28 cm for the Long Read Tower) glass
plates, has a 50 micron gap and can be filled with acrylamide and cured in three
minutes through a semi-automated process which uses our Gel Toaster and SureFill
products. Competitive sequencers typically use significantly thicker (200-500
micron gap) gel systems which are assembled manually by technicians and must be
disassembled and cleaned after use. See "-Proprietary Rights."
SUREFILL CARTRIDGE. The acrylamide injected into the MicroCel cassettes
is supplied in a 10 cm long disposable syringe-based SureFill cartridge that
contains necessary ingredients to fill 10 MicroCels. SureFill protects the
technician from directly handling potentially dangerous chemicals and simplifies
the gel preparation process.
TESTING, SEQUENCING AND OTHER SERVICES
We provide DNA testing, sequencing and other services for HIV,
hepatitis B, hepatitis C, HPV and other infectious diseases as well as for
certain cancers.
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We operate an accredited reference testing laboratory in Norcross,
Georgia, that specializes in high resolution genotyping of HIV and other viruses
associated with secondary opportunistic infections of patients with AIDS. This
facility also provides high resolution DNA sequencing of hepatitis B,
cytomegalovirus and other viruses that commonly infect AIDS patients. Our
facility in Evry, France, carries out DNA diagnostic testing and sequencing
services in Europe, including genotyping tests for HIV, hepatitis C, HPV, p53,
BRCA1, BRCA2 and other tests.
We also maintain a library of cultures of HIV strains with known drug
resistant mutations and a patient database on viral drug resistance and high
resolution DNA sequencing data. This data may be used to screen new drugs for
possible viral resistance and to identify patterns of cross resistance to new
drugs as well as for the development of new AIDS treatment strategies.
SALES AND MARKETING
We market our OpenGene System in North America and in many European
countries to the research and clinical research markets through our direct sales
force. We have a sales and marketing force of 40 people. Many members of our
sales force have scientific backgrounds. Our marketing force includes a team of
trained application specialists who provide intensive on-site training,
after-sales support and site-by-site trouble shooting. We offer service
contracts to our customers on our sequencers, certain equipment and software. We
have established a toll-free telephone number in North America for customer
service. The members of our internal sales force are compensated on a commission
and a salary basis.
For other areas of the world and in selected product markets, our
strategy is to establish relationships with leading distributors to market
and sell our products. We granted Amersham the exclusive worldwide license to
use and sell the Seq4x4 and related products used and sold with the
sequencer, which is designed for the research market. During 1998
approximately 30% of our revenues were derived from sales of sequencers and
other products to Amersham. See "Risk Factors-We have limited marketing
experience in the research and clinical research markets and we rely on
Amersham."
In addition, beginning in 1999, we have granted exclusive rights to
distribute our GeneKits and OpenGene System in the clinical diagnostic market to
Organon Teknika in Brazil, to Roche Diagnostics K.K. in Japan and to Roche
Diagnostics S.L. in Spain and Portugal. We also have granted exclusive
distribution rights to Werfen Medical S.A. in Argentina and Diagnostic
Technology Pty Ltd. in Australia and New Zealand. We have agreed to terminate
our initial agreement with Roche Diagnostics S.L. and we are negotiating the
terms of a new agreement with Roche Diagnostics S.L. for these territories. The
other agreements expire at various times from April 2000 through April 2003, and
in each case, are subject to renewal. Certain of the agreements may also be
terminated by either party upon specified notice periods and may require us to
make termination payments under certain circumstances. Certain of the agreements
also provide for minimum annual purchases for specified periods.
For a description of our marketing plans for the HIV Open Gene System
if we receive FDA approval, see "Our HIV OpenGene System-Marketing of the HIV
OpenGene System." See also "Risk Factors-We do not have any marketing
experience in the clinical diagnostic market and we rely on other companies
to sell our products in some markets," "Risk Factors-We have limited
marketing experience in the research and clinical research markets and we
rely on Amersham" and "Risk Factors-We face risks relating to our
international operations."
Our marketing efforts also include product advertisement and
participation in trade shows and product seminars.
RESEARCH AND DEVELOPMENT
We currently conduct research and development through our own staff and
through collaborations with researchers at scientific and academic institutions
and hospitals. Our current research and development activities are focused on:
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o developing additional GeneKits, including additional HIV GeneKits for
different HIV species, and GeneKits for HPV, hepatitis B, hepatitis C
and tuberculosis;
o developing new technology for our sequencers and related equipment and
software;
o refining existing proprietary, disposable gel cassette technology in
order to improve performance of our sequencers; and
o exploring new technologies for future commercial products.
As of May 31, 1999, our research and development staff consists of 59
people. This includes a team of software developers who have developed our
GeneObjects software. Our software developers are working on an advanced version
of our GeneObjects software as well as additional software applications for the
clinical diagnostic market.
We incurred $6.3 million of research and development expenses in 1998,
$4.1 million in 1997 and $2.3 million in 1996. We have five facilities in the
United States and Canada where we conduct research and development. See
"-Description of Property."
MANUFACTURING
We assemble our DNA sequencers and related equipment at a
manufacturing facility in Toronto, Canada. Component parts are manufactured
by third parties to meet our design specifications. We manufacture our
disposable gel cassettes at our second manufacturing facility in Toronto. We
make GeneKits in our Pittsburgh, Pennsylvania facility and we are
establishing a second facility for making GeneKits in Mississauga, Canada. We
manufacture certain chemicals and other components included in the GeneKits.
Other GeneKits components are manufactured by, or licensed from, third
parties. See "-Description of Property."
We have documented and installed design and production practices in our
Toronto facilities to comply with the standards established by ISO 9001 and the
FDA's quality system regulations. We are in the process of documenting and
installing design and production practices in our Pittsburgh facility to comply
with the FDA's quality system regulations. We have implemented a quality
management system at these manufacturing facilities in order to ensure product
performance, reliability and quality. We are seeking certification of compliance
to ISO 9001 for our Toronto facilities. In addition to adhering to ISO goals and
FDA quality standards, we have implemented our own quality control and quality
assurance standards and programs.
We provide one year warranty coverage for product defects on the
instrument component of our sequencers. All product repairs are performed by
VGI's employees at one of our manufacturing facilities.
In connection with our GeneKits, sequencers and related equipment, we
use certain dyes and custom-designed component parts supplied by third parties.
We believe that some dyes supplied by Amersham under our exclusive worldwide
license to use and sell Amersham dyes within our GeneKits, may not be available
from other suppliers, although our customers might be able to purchase some, but
not all, dyes directly from Amersham. In addition, certain reagents and other
chemicals which we use and include in our GeneKits are available only under
license from their manufacturers. While we believe that alternative reagents and
chemicals are available, alternate supplies may not be as effective as certain
of the products which we presently use. In addition, we believe that there are
alternative suppliers for our custom-designed DNA sequencer parts, but that we
would incur costs in switching to alternative suppliers and would likely
experience delays in production of the products that use any of these parts
until such time as we were able to locate alternate suppliers or parts.
See "Risk Factors-Each time we make substantial alterations to any
FDA approved products, we will need to seek additional FDA approval," "Risk
Factors-We have limited manufacturing experience" and "Risk Factors-Certain
supplies and parts that we need are available limited sources."
PROPRIETARY RIGHTS
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We rely on patents, licenses from third parties, trade secrets,
trademarks, copyright registrations and non-disclosure agreements to establish
and protect our proprietary rights in our technologies and products.
We own or jointly own 23 U.S patents. We have an additional 35 U.S.
patent applications pending, of which three have been allowed. We also have
foreign applications presently pending as PCT applications designating
intergovernmental agencies and multiple countries including the European Patent
Office, Canada and Japan. Our issued and allowed patents and patent applications
cover various aspects of our products and technologies, including viral load
testing, several of our GeneKits and various DNA sequencing and GeneKit
technologies, including the umbrella stratified matrix testing technology and
the CLIP technology.
Our competitive position is also dependent upon unpatented trade
secrets. We are developing a substantial database of information concerning our
research and development and have taken security measures to protect our data.
However, trade secrets are difficult to protect. In an effort to protect our
trade secrets, we have a policy of requiring our employees, consultants and
advisors to execute non-disclosure agreements. These agreements provide that
confidential information developed or made known to an individual during the
course of their relationship with us must be kept confidential, and may not be
used, except in specified circumstances.
For a discussion of various risks relating to our intellectual
property, see "Risk Factors-We may not be able to obtain and protect
necessary patents and proprietary rights."
COMPETITION
The biotechnology industry is highly competitive. We compete with
entities in the United States and abroad that are engaged in the development and
production of products that analyze genetic information. They include:
biotechnology, pharmaceutical, chemical and other companies; academic and
scientific institutions; governmental agencies; and public and private research
organizations.
Some of our major competitors include:
o manufacturers and distributors of DNA sequencers such as the PE
Biosystems Group, Amersham and its Molecular Dynamics subsidiary,
LI-COR, Inc., Hitachi, Ltd. and Molecular and Genetic BioSystems, Inc.;
o manufacturers and distributors of DNA probe-based diagnostic systems
such as Abbott Laboratories, Chiron Corp., Hoffmann-La Roche Inc., Gene
Probe Inc., Digene Corporation and Johnson & Johnson; and
o manufacturers of new technologies used to analyze genetic information,
such as chip-based and assay-based technologies, including, Hyseq Inc.,
Affymetrix Inc., ChemCore Inc., CuraGen Corp. and Nanogen, Inc.
Many of these companies and many of our other competitors have much
greater financial, technical and research and development resources and
production and marketing capabilities than we do.
Our GeneKits also compete with homebrew genetic tests for HIV and other
diseases designed by laboratories and some of the companies listed above.
Homebrew tests include a variety of small-scale genotyping tests which typically
have not undergone clinical validation and have not been approved by the FDA or
other regulatory agencies.
We believe that we are able to compete primarily on the basis of the
following:
o our ability to provide an integrated DNA sequencing system;
o ease of use;
o speed of sequencing;
o cost-effectiveness;
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o clinical data with respect to the HIV market; and
o with respect to the HIV market, FDA approval of our HIV GeneKit and
related equipment, if and when we obtain it.
For a discussion of various risks related to our competitive
industry, see "Risk Factors-Our industry is highly competitive."
REGULATION BY THE FDA AND OTHER GOVERNMENT AGENCIES
We currently sell our products for research and clinical research
purposes. In the future, we intend to sell products for clinical diagnostic
purposes. We do not believe we need authorization from the FDA or health
authorities in foreign countries to sell our products for research purposes, as
long as they are properly labeled. We will, however, need to get authorization
to sell our products for clinical diagnostic purposes.
FDA APPROVAL PROCESS. Products that are used to diagnose diseases in
people are considered medical devices, which are regulated by the FDA. To obtain
FDA authorization for a new medical device, a company may have to submit data
relating to safety and efficacy based on extensive testing. This testing, and
the preparation of necessary applications and the processing of those
applications by the FDA, are expensive and may take several years to complete.
The following describes several important aspects of the FDA authorization
process.
The FDA has three classes for medical devices:
o Class I devices (for example, bandages, manual wheelchairs and ice
bags) are the least regulated, but they must still comply with the
FDA's labeling, manufacturing, recordkeeping, and other basic
requirements.
o Class II devices (for example, portable oxygen generators and
hypodermic needles) may be subject to additional regulatory controls,
such as performance standards and postmarket surveillance.
o Class III devices (for example, cardiac pacemakers) require specific
FDA approval prior to marketing and distribution, and are, as well,
subject to the FDA's basic requirements.
To sell a medical device, a company must first either submit a
notification to the FDA showing that the device is similar to a device already
on the market, or get specific approval for the device by submitting a PMA
application. A company may have to include test data in the notification,
including human test data. It will almost always have to include such test data
in a PMA application.
If human test data are required for either a notification or a PMA
application, and if the device presents a significant risk, the manufacturer
must first file an Investigational Device Exemption submission, or IDE, with the
FDA. The IDE must contain data, such as animal and laboratory testing, showing
that the device is safe for human testing. If the IDE is granted, human testing
may begin.
Generally, a notification to the FDA that a new device is similar to an
existing device requires less data and takes less time for the FDA to process
than a PMA. By contrast, a PMA application must be supported by more extensive
data to prove the safety and efficacy of the device, and review of a PMA
application involves a lengthier FDA process. The FDA conducts a preliminary
review of the PMA application. If complete, the PMA application is filed by the
FDA. Officially, the FDA then has 180 days to review the PMA application,
however, as a practical matter, PMA reviews usually take much longer, up to
one-and-a-half years or more from filing. The FDA may grant expedited
(fast-track) review of a PMA application if certain criteria relating to public
health importance are met, but that decision is within the FDA's discretion and
affects only the timing of the review process, not the outcome.
NEED FOR FDA APPROVAL OF SOME OF OUR PRODUCTS. We intend to market some
of our products in the U.S. for clinical diagnostic purposes, and therefore we
will have to obtain prior FDA authorization, as described above. We believe our
HIV GeneKit will be considered by the FDA as a Class III medical device and
therefore require a PMA. We believe that some of our other products will be
regulated as Class II or Class III medical devices. You should be aware of the
following possibilities:
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o it may be more expensive and time-consuming than we anticipate to
develop the test data needed for an IDE, or for a notification or a
PMA;
o the FDA may disagree with us that the data are adequate, and we may
therefore have to do additional testing;
o the testing may show that our device does not work at all or is not
safe enough, and therefore cannot be authorized by the FDA, or the
testing may show that the device does not work as well as it needs to
for successful marketing, even if marketing is authorized by the FDA;
o the testing may be too costly to carry out, either because we lack
adequate funds or because the market potential for the device does not
justify the costs; and
o there may be significant delays in the FDA review process, and the FDA
may refuse to authorize the marketing of our product despite our best
efforts.
You should also be aware that the FDA may approve products we submit
under a notification or PMA, but with conditions that could make it more
difficult or expensive to sell the product, or limit the market for the product.
Further, keep in mind that the FDA can revoke marketing authorization for our
products for a variety of reasons, such as our failure to comply with the FDA's
device requirements or poor product performance in terms of safety and
effectiveness.
Finally, with respect to our patented technologies, you should take
into account the fact that delays in getting FDA marketing authorization for
products that use those technologies may significantly reduce the value of our
patents. See "-Proprietary Rights."
For a discussion of the trials we are conducting under our IDE
allowance in order to obtain a PMA, see "-Our HIV OpenGene System."
OTHER FDA REQUIREMENTS. In addition to government requirements relating
to marketing authorization for medical device products, we will also be subject
to other FDA requirements. We will have to be registered as a medical device
manufacturer with the FDA. We will be inspected on a routine basis by the FDA
for compliance with the FDA's quality system regulations, which prescribe
standards for manufacturing, testing, distribution, storage, design control and
service activities. In addition, because we will manufacture some of our
products in Canada, the FDA, in conjunction with the U.S. Customs Service, could
impose a ban on our products if the FDA were to conclude that the products
appeared to be in violation of the FDA's regulatory requirements, including
restrictions that apply to the sale of research-use only products. Also, the
FDA's medical device reporting regulation will require us to provide information
to the FDA on deaths or serious injuries associated with the use of our devices,
as well as product malfunctions that are likely to cause or contribute to death
or serious injury if the malfunction were to recur.
Finally, the FDA prohibits promoting a device for unauthorized uses and
reviews company labeling for accuracy. The FDA has become aware that certain
products being sold by other companies for research purposes only, were in fact
being used by some customers for clinical diagnostic purposes. The FDA recently
issued a policy statement describing the conditions under which companies may
sell research-use only products. These conditions may restrict our ability to
sell research-use only products in the United States. We do not believe these
conditions will have any negative effect on our sale of GeneKits for legitimate
scientific research.
REGULATORY APPROVAL OUTSIDE THE UNITED STATES. We plan to market our
products outside the United States, initially in Canada, Japan and countries in
Europe. Government authorization requirements similar to the FDA's exist in some
of these and many other foreign countries. Therefore, for us to get
authorization to sell our products for clinical diagnostic purposes in Canada,
Japan and Europe may also require lengthy and costly testing procedures. In
addition, the regulatory bodies in other countries may be affected or influenced
by significantly different criteria than those used by the FDA. Sale of our
products in these areas may be materially affected by the policies of these
regulatory bodies or the domestic politics of the countries involved.
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OTHER GOVERNMENT REGULATIONS. We are or may become subject to various
federal, state, provincial and local laws, regulations and recommendations,
including those relating to workers compensation, safe working conditions, and
laboratory and manufacturing practices used in connection with our research and
development activities.
In addition, our reference laboratory in Norcross, Georgia, is subject
to regulation under the Clinical Laboratory Improvement Amendments of 1988,
known as CLIA. Under CLIA, laboratories must meet various requirements,
including requirements relating to the validation of tests, training of
personnel, and quality assurance procedures. The laboratory must also be
certified by a government agency. Our Norcross laboratory performs high
complexity tests, and is therefore subject to the most stringent level of
regulation under CLIA. This laboratory is certified under CLIA and by the state
of Georgia. Our failure to comply with state or CLIA requirements can result in
various penalties, including loss of certification. The imposition of such
penalties could have an adverse impact on us. In addition, some states regulate
out-of-state laboratories. The failure to comply with these state requirements
could also adversely affect us.
We are also subject to various laws and regulations in Canada, the
United States and Europe concerning the use and disposal of hazardous or
potentially hazardous substances including infectious disease agents and toxic
chemicals.
We are unable to predict the extent of future government regulations
or industry standards. Existing or future regulations or industry standards
may have an adverse effect on our operations, including the cost of complying
with regulations or standards or obtaining permits, delays or fines resulting
from loss of permits or failure to comply with regulations. See "Risk
Factors-We may not receive FDA approval for our HIV OpenGene System and, in
the future, other HIV products," "Risk Factors-We may not receive regulatory
approval for our other products," "Risk Factors-The results of our proposed
HIV clinical trials are uncertain," "Risk Factors-Each time we make
substantial alterations to any FDA approved products, we will need to seek
additional FDA approval" and "Risk Factors-Certain of our products are
subject to government regulation."
EMPLOYEES
As of May 31, 1999, we employ 201 full-time employees (including
executive officers) and 39 independent contractors, of whom:
o 59 are engaged in research and development;
o 40 are involved in sales and marketing activities;
o 91 in manufacturing and operations; and
o 50 are involved in finance, legal and administrative functions.
Our employees are not represented by a union or other collective
bargaining unit and we have never experienced a work stoppage. We believe that
our employee relations are good.
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RISK FACTORS
WE ARE IN THE EARLY STAGES OF COMMERCIAL MANUFACTURING AND SALE OF OUR PRODUCTS
Although we began operations in 1993, we are only in the early stages
of commercially manufacturing and marketing our products. Until 1996, we devoted
much of our time to the research and development of our technology and products.
In late 1996, we began manufacturing and selling to the research and clinical
research markets, the initial versions of our automated DNA sequencers and
related products and certain GeneKits. Our limited operating history makes it
difficult to evaluate our business and our prospects for future profitability.
Our prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in their early stages of
commercial manufacturing and marketing. Sales for our 1998 fiscal year were
$10.9 million. In the future, sales may not increase or they may decrease, and
we may never become profitable.
WE HAVE A HISTORY OF LOSSES AND ANTICIPATE FUTURE LOSSES
We incurred a net loss of $14.9 million in the year ended December 31,
1998. As of December 31, 1998, our accumulated deficit was $34.2 million. Our
losses have resulted principally from expenses incurred in research and
development of our technology and products, including clinical trials, and from
selling, general and administrative expenses that we have incurred while
building our business infrastructure and in connection with our operations. We
expect to continue to incur significant operating losses in the future as we
continue our research and development efforts and expand our sales and marketing
force and business infrastructure, in an effort to achieve greater sales and
expand our business. It is uncertain when, if ever, we will become profitable.
Our ability to become profitable will depend on many factors including:
- whether we obtain regulatory approval to sell our HIV OpenGene
System and, in the future, OpenGene Systems for other
diseases, to the clinical diagnostic market in the United
States and abroad;
- if we obtain regulatory approval, the acceptance of our HIV
OpenGene System and, in the future, OpenGene Systems for other
diseases, within the clinical diagnostic market;
- our ability to successfully market and sell our HIV OpenGene
System and, in the future, OpenGene Systems for other
diseases, to the clinical diagnostic market;
- the decision of third party payors to reimburse clinicians and
patients for use of our HIV GeneKit and, in the future, other
products;
- the acceptance of genotyping as a valid method of managing
disease therapy for the diseases and genes we currently target
and intend to target in the future;
- our ability to increase sales of our products to the research
and clinical research markets;
- our ability to effectively manage the growth of our business;
- our ability to attract and retain qualified personnel;
- our ability to continue to develop advanced versions of our
products and technologies and new products and technologies in
a timely manner; and
- our ability to obtain, and the costs of obtaining, patents and
licenses for certain products and technologies.
WE MAY NEED ADDITIONAL CAPITAL
Since we began operations we have obtained operating funds primarily by
selling shares of our company and borrowing money from investors, banks and
institutional lenders. Since late 1996, a small portion of our operating funds
have come from sales of our products. At this time, funds from operations are
not sufficient to meet our operating needs and other anticipated financial
requirements, including repayment to our institutional lenders of a $1.0 million
loan plus interest by the earlier of July 22, 1999, the completion of our
proposed $5.0 million credit facility and the completion of the proposed Warburg
Pincus financing (described below), and a $7.0 million loan plus interest on
December 31, 1999.
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We have signed a letter of intent with E.M. Warburg, Pincus & Co., LLC
under which certain funds affiliated with Warburg Pincus would invest $30.0
million in our company. We refer to this proposed financing as the "Warburg
Pincus financing." The terms of the proposed Warburg Pincus financing are
described in the section of this Annual Report entitled "Management's Discussion
and Analysis of Financial Condition and Results of Operations-Liquidity and
Capital Resources-PROPOSED WARBURG PINCUS FINANCING." In addition, we and our
institutional lenders agreed that, concurrently with the completion of the
proposed Warburg Pincus financing, we would repay $4.1 million principal amount
and interest of their loan to us, the institutional lenders would convert the
remaining $3.9 million of that loan into Series A convertible preferred shares
and we would grant the institutional lenders 144,760 warrants to purchase our
common shares. The Series A preferred shares and warrants will have the same
terms as those granted to Warburg Pincus. Completion of the proposed Warburg
Pincus financing is subject to the satisfaction of various closing conditions
and finalization of definitive documents. We are in the process of completing
those agreements. However, we cannot guarantee that the Warburg Pincus financing
will be completed in a timely manner or at all.
We have also received a commitment from a financial institution to
provide a $5.0 million credit facility to our subsidiary, Visible Genetics
Corp., or VGC, subject to certain conditions, including completion of the
lender's due diligence review of our company. We are in the process of
negotiating the definitive loan documents under which this loan would be made.
However, we cannot guarantee that we will be able to finalize the loan in a
timely manner, or at all.
If we are able to complete the proposed equity financing and concurrent
conversion of institutional loans to equity, as well as the $5.0 million credit
facility, we believe, based on our current plans, that our cash on hand,
anticipated funds from operations, proceeds from the contemplated equity
financing and anticipated borrowings under the proposed credit facility would be
sufficient to enable us to repay our remaining obligations to our institutional
lenders and meet our operating needs for the next 12 months. If we are able to
complete only the proposed credit facility, but not the proposed equity
financing and concurrent conversion of debt, we would need to raise significant
additional financing to continue to meet our operating needs and repay the loan
to our institutional lenders due on December 31, 1999. We have no commitment for
additional financing at this time, and cannot guarantee that we would be able to
obtain such financing in a timely manner, on acceptable terms or at all. If we
are unable to complete any of the proposed equity financing, concurrent
conversion of debt or the proposed credit facility or other substitute financing
when needed, we would likely default under our obligation to our institutional
lenders, we would be unable to meet many of our other obligations and our
business and future prospects would be materially adversely affected.
The assumptions described above are based on our current plans and
expectations during the next 12 months. However, the actual amount of funds that
we will need during the next 12 months will be determined by many factors, some
of which are beyond control. These factors include:
- our ability to obtain the Warburg Pincus financing, or
substitute financing on reasonable terms;
- our success in selling our products in the research and
clinical research markets during this period;
- our ability to obtain FDA approval to sell our HIV GeneKit and
related equipment for clinical diagnostic purposes;
- if we obtain FDA approval, the acceptance of our HIV products
by the clinical diagnostic market;
- the decision of third-party payors to reimburse clinicians and
patients for use of our HIV products;
- the success of our distribution partners in marketing and
selling our products in selected markets;
- progress with research and development;
- our success in introducing new products during the period;
- our ability to manage growth;
- our incurring significant fixed overhead and other expenses
prior to increasing our revenues;
- the costs of acquiring and integrating any new business or
technologies during the period;
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- the results of any other strategic relationships into which we
may enter during the period;
- the costs and timing of obtaining new patent rights;
- regulatory changes;
- competition; and
- technological developments in the market.
We may need funds sooner or in greater amounts than we currently
anticipate and we may need to obtain additional funds at the end of this 12
month period. If we need to obtain funds at the end of 12 months or earlier,
potential sources of financing may include strategic relationships, public or
private sales of our shares or debt or other arrangements. We do not have any
other committed sources of financing at this time and it is uncertain whether
additional funding will be available when needed or on acceptable terms or at
all. If the Warburg Pincus financing is completed or if we raise funds by
selling additional common shares or other securities convertible into common
shares, the ownership interest of our existing shareholders will be diluted. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources."
If we wish to issue equity securities or obtain additional financing
after the proposed Warburg Pincus financing is completed, we may need the
consent of the Series A preferred shareholders. We will be required to obtain
the consent of the holders of a majority of the then outstanding Series A
preferred shares prior to issuing any equity security that has rights as to
dividends and liquidation that are senior or equal to those of the Series A
preferred shares. We will also be required to obtain the consent of the holders
of a majority of the then outstanding Series A preferred shares if we wish to
borrow money and at such time or as a result of such loans, the total principal
amount of our indebtedness and capitalized lease obligations exceeds $15.0
million. Our proposed credit facility would also impose limitations on our
ability to incur additional indebtedness under certain circumstances. As a
result, we may be delayed in, or prohibited from, obtaining certain types of
financing.
OUR RESULTS TEND TO FLUCTUATE FROM QUARTER TO QUARTER
Our operating results have varied on a quarterly basis in the past and
may fluctuate significantly in the future as a result of a variety of factors,
many of which are outside our control. Factors that may affect our quarterly
operating results include:
- the announcement or introduction of new products, services,
technologies or strategic relationships by us or by our
competitors;
- decisions by the FDA and foreign regulatory agencies with
respect to our HIV OpenGene System or other products;
- the acceptance of our HIV OpenGene System and other products
in the clinical diagnostic market, should we obtain required
government authorizations;
- unanticipated costs or delays in carrying out our clinical
trials;
- decisions of third party payors with respect to reimbursement
for our HIV GeneKit and other products;
- the proposal or implementation of regulatory changes in the
United States or abroad that affect our products or our
business;
- the amount and timing of operating costs and capital
expenditures relating to research and development and the
expansion of our business, operations and infrastructure;
- the amount and timing of royalties accrued for licensing of
products and technologies;
- the availability and pricing of raw materials and components
from suppliers;
- our decision to increase or decrease sales of bundled
equipment, GeneKits and other consumables at reduced prices;
our decision to reduce prices;
- our products in response to price reductions by competitors;
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- our ability to successfully sell our products;
- the costs associated with, and the success of, any future
acquisitions of businesses, technologies or products, or any
strategic investments or relationships into which we may
enter;
- the cost and timing of obtaining new patent rights or licenses
from third parties;
- our ability to attract and retain personnel; and
- general economic conditions, as well as economic conditions
specific to the biotechnology industry.
Due to these and other factors, our quarterly revenues and operating
results are difficult to forecast. We believe that period-to-period comparisons
of our operating results may not be meaningful and you should not rely on any
such comparisons as an indication of our future performance. In addition, it is
likely that in one or more future quarters our operating results will fall below
the expectations of securities analysts and investors. In such event, the
trading price of our common shares could be materially adversely effected.
WE MAY NOT RECEIVE FDA APPROVAL FOR OUR HIV OPENGENE SYSTEM AND, IN THE FUTURE,
OTHER HIV PRODUCTS
We intend to seek FDA approval to sell our HIV OpenGene System for
clinical diagnostic purposes in the United States. In the future, we may seek
FDA approval to sell other HIV products for clinical diagnostic purposes in the
United States. Under FDA regulations, we believe that our HIV OpenGene System is
a Class III medical device. This means that in order to sell our HIV OpenGene
System in the United States for clinical diagnostic purposes, we will need to
obtain FDA approval. In order to get FDA approval for this device, we must
submit a Premarket Approval application, commonly known as a PMA application. To
be considered by the FDA, our PMA must be supported by extensive human clinical
data demonstrating the utility, reliability and performance of our HIV GeneKit
and OpenGene System. In December 1998, the FDA allowed us to initiate human
clinical trials of our HIV OpenGene System under our IDE application. We have
conducted one, and are continuing to conduct several additional, clinical
trials, the results of which will be submitted with our PMA application to the
FDA. In addition, for us to obtain FDA approval of our HIV OpenGene System, the
FDA must also confirm that we maintain good laboratory, clinical and
manufacturing practices. We may never obtain approval from the FDA to sell our
HIV products to the clinical diagnostic market. The clinical data from our
trials may not support the utility, reliability or performance of our products,
or our facilities may not be in compliance with the FDA's regulations. In
addition, we may choose or be required to discontinue our trials for a number of
reasons, including unanticipated interim trial reports, changes in regulations
or the adoption of new regulations, or unexpected technological developments by
our competitors. If we fail to receive FDA approval, we will be unable to carry
out our business plan to sell our HIV OpenGene System for clinical diagnostic
use in the United States and our business, financial condition and results of
operations will be materially harmed.
We also may be required to obtain approval from some foreign regulatory
authorities to sell our HIV products to the clinical diagnostic market outside
of the United States. In some cases, we will face an approval process similar to
that required by the FDA. We cannot be certain that we will obtain the necessary
approvals to sell our HIV products to the clinical diagnostic market in these
countries. In some cases, the failure to obtain any of these approvals could
materially harm our business, financial condition and results of operations. See
"-We may not receive regulatory approval for our other products," "-The results
of our proposed HIV clinical trails are uncertain," "-Certain of our products
are subject to government regulation," "Description of Business-Our HIV OpenGene
System-FDA ALLOWANCE AND CLINICAL TRIALS" and " Description of
Business-Manufacturing."
WE MAY NOT RECEIVE REGULATORY APPROVAL FOR OUR OTHER PRODUCTS
In addition to our HIV OpenGene System, we have also developed and are
continuing to develop GeneKits for other clinical diagnostic applications. In
order to sell these GeneKits to the clinical diagnostic market, we may be
required to obtain the approval of the FDA and of foreign regulatory
authorities. We may be required to conduct extensive testing and clinical trials
to support the utility, reliability and performance of our products. We may also
be required to show that our testing and manufacturing facilities comply with
applicable practices and standards. The approval process for each additional
GeneKit may be lengthy and costly and we may not be able to obtain the required
approval for each GeneKit in each country in which we desire to sell to the
clinical diagnostic market. Our failure to obtain necessary approvals to sell
our products for clinical diagnostic use in one or more significant markets
could cause material harm to our business, financial condition and results of
operations.
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THE RESULTS OF OUR PROPOSED HIV CLINICAL TRIALS ARE UNCERTAIN
To support our PMA, we are required to demonstrate through human
clinical trials the utility, reliability and performance of our HIV OpenGene
System. We conducted one trial in Europe which demonstrated that HIV patients
whose drug treatments were selected using periodic genotyping had lower viral
loads than patients whose drug treatments were selected without the use of
genotyping. That trial corroborated the results of another clinical trial
conducted in the United States in which we did not participate. We have
commenced one clinical trial in the United States to test the clinical utility
of our HIV OpenGene System and we are preparing to start a second trial in the
United States to test the reliability and performance of our HIV GeneKits. We
are also planning a third, large-scale clinical trial with the goal of
collecting additional HIV genotyping data in support of our PMA application.
The results from the clinical trials already completed may not
accurately predict the results that will be obtained from the clinical trials we
plan to conduct in the future. In addition, there can be no assurance that any
clinical trials we conduct will demonstrate the utility, reliability and
performance of our HIV OpenGene System. If the new trials are unable to
demonstrate the utility, reliability and performance of our HIV OpenGene System,
we may not obtain FDA approval. In that event, our business, financial condition
and results of operations would be materially harmed. A number of companies in
the biotechnology and pharmaceutical industries have suffered significant
setbacks in advanced clinical trials, even after obtaining promising results in
earlier trials.
The completion of clinical trials for our HIV OpenGene System and, in
the future, any clinical trials of our other products, may be terminated or
delayed by many factors and there can be no assurance that delays or
terminations will not occur. For example, the rate of enrollment of patients in
our trials may affect the amount of time it takes to complete our trials.
Enrollment rates may vary throughout the course of a clinical trial and will
depend on a number of factors including: the size of the patient population, the
number of clinical trial sites, the proximity of patients to clinical trial
sites, the eligibility criteria for the trial and the existence of competitive
clinical trials. We cannot control the rate at which patients present themselves
for enrollment, and we cannot guarantee that the rate of patient enrollment will
be consistent with our expectations or be sufficient to enable clinical trials
of our products to be completed in a timely manner. In addition, certain
clinical trials are conducted with patients having the most advanced stages of
disease. During the course of treatment, these patients may die or suffer other
adverse medical effects for reasons that may not be related to the drug
treatment selections. These events could delay our trials, as well as adversely
affect the statistical analysis of clinical trial results. Any significant
delays in, or termination of, clinical trials of any of our products could
materially harm our business, financial condition and results of operations. See
"-We may not receive FDA approval for our HIV OpenGene System and, in the
future, other HIV products," "-We may not receive regulatory approval for our
other products," "-Certain of our products are subject to government
regulation," "Description of Business-Our HIV OpenGene System-FDA ALLOWANCE AND
CLINICAL TRIALS" and "Description of Business -Regulation by the FDA and Other
Government Agencies."
EACH TIME WE MAKE SUBSTANTIAL ALTERATIONS TO ANY FDA APPROVED PRODUCTS, WE WILL
NEED TO SEEK ADDITIONAL FDA APPROVAL
If we obtain FDA approval for our HIV OpenGene System or any other
product, we will need to seek additional FDA approval each time we make
substantial changes to the product specifically approved by the FDA. For
example, we are seeking FDA approval to sell our HIV OpenGene System to the
clinical diagnostic market. Our HIV GeneKit, as submitted to the FDA, contains
specific reagents, dyes, enzymes, chemicals, software and other materials. If
this kit is approved, the FDA would require that we obtain additional approval
for any change to the kit's components that substantially alters the performance
of the kit, such as changing certain enzymes or reagents. To obtain additional
approval, we may have to conduct additional human clinical trials to demonstrate
that the altered GeneKit will produce at least the same results as the approved
GeneKit. Obtaining additional FDA approval is likely to be time consuming and
costly and we may experience delays in bringing these upgraded or new products
to market.
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THE CLINICAL DIAGNOSTIC MARKET FOR GENOTYPING PRODUCTS IS NEW AND GENOTYPING MAY
NOT BECOME AN ACCEPTED METHOD OF MANAGING DRUG TREATMENT
An important part of our business strategy is our plan to sell our
products to the clinical diagnostic market if we obtain FDA and other required
regulatory approvals. Our ability to do so will depend on the widespread
acceptance and use by doctors and clinicians of genotyping to manage the
treatment of certain diseases. The use of genotyping by doctors and clinicians
for this purpose is new. Existing DNA sequencing systems have been designed
primarily for research purposes and we are not aware of any DNA sequencing
products that have been approved by the FDA for clinical diagnostic purposes.
The demand for, and acceptance by doctors and clinicians of, DNA sequencing
systems designed for the clinical diagnostic market, such as our HIV OpenGene
System, is uncertain. Factors that may influence the acceptance of genotyping by
this market include the availability of FDA approved genotyping products and the
willingness of insurance companies and other third-party payors to reimburse
doctors and patients for use of these products. If genotyping is not accepted by
this market, we will not be able to carry out our business plan and our
business, financial condition and results of operations will be materially
harmed.
OUR OPENGENE SYSTEM MAY NOT BE ACCEPTED BY THE CLINICAL DIAGNOSTIC MARKET
Even if genotyping becomes widely accepted in the clinical diagnostic
market, we cannot predict the extent to which doctors and clinicians may be
willing to utilize our OpenGene System to manage drug treatment of selected
diseases or other medical conditions. Factors that will influence the use of our
products in this market include:
- our ability to obtain FDA approval in the United States and
other required regulatory approvals in other countries;
- whether major third-party payors decide to reimburse doctors
and patients for use of our products;
- the outcomes of any current or future clinical trials testing
the utility, reliability and performance of our OpenGene
System in managing drug treatment for selected diseases or
other medical conditions; and
- the development of competing technologies and products that
can be used for the same purposes as our products.
If our products are not accepted by the clinical diagnostic market to
manage the treatment of selected diseases and other medical conditions, our
business, financial condition and results of operations will be materially
harmed. See "-We may not receive FDA approval for our HIV OpenGene System and,
in the future, other HIV products," "-We may not receive regulatory approval for
our other products," "-The results of our proposed HIV clinical trials are
uncertain," "-Insurance companies and other third-party payors may not reimburse
doctors and patients for our products" and "-Certain of our products are subject
to government regulation."
INSURANCE COMPANIES AND OTHER THIRD-PARTY PAYORS MAY NOT REIMBURSE DOCTORS AND
PATIENTS FOR OUR PRODUCTS
Our ability to sell our HIV GeneKit and other GeneKits to the clinical
diagnostic market will depend partly on the willingness of insurance companies
and other third-party payors to reimburse doctors and patients for use of our
products. If we obtain regulatory approval to sell our products, we will seek
reimbursement from government and private health care insurers (including health
maintenance organizations) and other third-party payors. Physicians'
recommendations to use genotyping, as well as decisions by patients to pursue
genotyping, are likely to be influenced by the availability of reimbursement for
genotyping by insurance companies or other third-party payors. Government and
private third-party payors are increasingly attempting to contain health care
costs by limiting both the extent of coverage and the reimbursement rate for
testing and treatment products and services. In particular, services which are
determined to be investigational in nature or which are not considered
"reasonable and necessary" for diagnosis or treatment may be denied
reimbursement coverage. We cannot guarantee that insurers and other third-party
payors will elect to provide full or partial reimbursement coverage for our HIV
GeneKit and other GeneKits. If adequate reimbursement coverage is not available
from insurers or other third-party payors, it is uncertain whether patients will
elect to directly pay for genotyping. If insurers or other third-party payors
and patients are unwilling to pay for genotyping, our anticipated revenues would
be substantially reduced, our ability to achieve profitability would be
significantly impaired and our business, financial condition and results of
operations would be materially harmed.
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WE DO NOT HAVE ANY MARKETING EXPERIENCE IN THE CLINICAL DIAGNOSTIC MARKET AND WE
RELY ON OTHER COMPANIES TO SELL OUR PRODUCTS IN SOME MARKETS
We have no experience marketing products to the clinical diagnostic
market. If the FDA approves the sale of our HIV OpenGene System and, in the
future, other products, to the clinical diagnostic market in the United States,
we intend to expand our internal sales force. It will take significant time,
money and resources to expand our sales force. We may not be able to hire, train
and retain qualified personnel with experience in the clinical diagnostic
market. We cannot be certain that we will be able to develop the marketing
capabilities necessary to successfully market and sell our products to the
clinical diagnostic market. See "-We may not receive FDA approval for our HIV
OpenGene System and, in the future, other HIV products," "-We may not receive
regulatory approval for our other products," "-The results of our proposed HIV
clinical trials are uncertain" and "-Certain of our products are subject to
government regulation."
In selected geographic markets outside North America and certain
European countries, we seek to enter into distribution and marketing
arrangements with leading distributors to sell our products to the clinical
diagnostic market. In March 1999, we entered into a series of exclusive
distribution agreements. We granted Roche Diagnostics S.L. and Roche Diagnostics
K.K. exclusive rights to distribute our OpenGene System and GeneKits to the
clinical diagnostic markets in Spain and Portugal and Japan, respectively. We
also granted Organon Teknika the exclusive right to distribute our OpenGene
System and GeneKits to the clinical diagnostic market in Brazil. We granted
exclusive distribution rights to Werfen Medical S.A. in Argentina and Diagnostic
Technology Pty Ltd. in Australia and New Zealand. We have agreed to terminate
our initial agreement with Roche Diagnostics S.L. and we are negotiating the
terms of a new agreement with Roche Diagnostics S.L. for these territories. The
other agreements expire at various times from April 2000 through April 2003, and
in each case, are subject to renewal. Certain of the agreements may also be
terminated by either party upon specified notice periods and may require us to
make termination payments under certain circumstances.
Our ability to successfully sell products to the clinical diagnostic
market in countries in which we rely on distribution agreements will depend to a
great extent on the efforts of the distributors. Should these distributors be
unwilling to sell our products or if they are unsuccessful in their efforts, our
ability to sell to these markets will be adversely affected. Failure to
successfully market our products will likely impede our ability to generate
significant revenues and become profitable.
In addition, any of our distribution agreements may be terminated
before they expire, or, when they expire, they may not be renewed on favorable
terms or at all. If these agreements are discontinued, our business, financial
condition and results of operations may be materially harmed if we could not
find other suitable distributors to sell these products. See "-Certain supplies
and parts that we need are available from limited sources."
WE HAVE LIMITED MARKETING EXPERIENCE IN THE RESEARCH AND CLINICAL RESEARCH
MARKETS AND WE RELY ON AMERSHAM
We have limited experience in marketing products to the research and
clinical research markets. We have developed our own sales and marketing staff
and infrastructure which sells our products in North America and certain
countries in Europe. We have only been engaged in marketing our products since
late 1996. It is uncertain whether our sales and marketing staff will be able to
achieve our sales objectives in a timely and cost-effective manner. In February
1996, we granted Amersham an exclusive worldwide license to use and sell the
Seq4x4(TM) DNA sequencer and related products used and sold with the sequencer,
which is designed for the research market. Our agreement with Amersham expires
in February 2000 and is renewable each year unless either party notifies the
other at least six months in advance of renewal that it wishes to terminate the
agreement. During 1998, approximately 30% of our revenues resulted from sales of
sequencers and other products to Amersham. For 1999, we anticipate that Amersham
will account for a smaller percentage of our sales, but sales to Amersham may
continue to be significant. We cannot be certain that Amersham will be
successful in selling these products. In addition, we cannot be certain that the
agreement will not be terminated before expiration or that, upon expiration, it
will be renewed on favorable terms or at all.
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WE NEED TO CONTINUE DEVELOPING ADVANCED TECHNOLOGY AND VERSIONS OF OUR PRODUCTS
AND NEW PRODUCTS
We believe that if we are to become and remain profitable, we must
develop advanced technology, advanced versions of our current products and new
products. New technology and products must be developed and introduced to the
market in a timely and cost-effective manner to meet both changing customer
needs and technological developments. We cannot assure you that we will be able
to successfully or timely develop any technology or products, or that any new
technology or products will achieve acceptance in the market. It is also
possible that we will not have sufficient financing to develop new technology or
products. If we are unable to successfully develop technology or products in the
future, our ability to generate significant revenues will be significantly
impaired, we could experience additional significant losses and our business,
financial condition and results of operations would be materially harmed.
WE HAVE LIMITED MANUFACTURING EXPERIENCE
We have limited experience in large-scale assembly and manufacturing of
our products. We assemble our DNA sequencers, certain related equipment, and our
GeneKits. We also manufacture our MicroCel cassettes, certain of the components
included in our GeneKits and other products. Since we started assembling and
manufacturing operations in 1996, we have experienced delays, quality control
problems and capacity constraints from time to time. As production increases and
we begin manufacturing and assembling new products, additional problems may
arise. These may include technological, engineering, quality control and other
production difficulties. If we experience these problems, we could be delayed in
filling orders, shipping existing products and introducing new products to the
marketplace. These problems could also adversely affect customer satisfaction
and the market acceptance of our products.
WE MAY NOT BE ABLE TO OBTAIN AND PROTECT NECESSARY PATENTS AND PROPRIETARY
RIGHTS
Our success will partly depend on our ability to obtain patents, obtain
licenses from third parties and protect our trade secrets. We own or jointly own
23 U.S. patents. We have an additional 35 U.S. patent applications pending, of
which three have been allowed. A patent allowance is granted by the U.S. Patent
and Trademark Office if, after examination, it finds the patent application
allowable. After a patent is allowed, generally, the patent is issued as soon as
possible after payment of an issuance fee by the applicant. However, because of
the substantial backlog of patent applications in the U.S. Patent and Trademark
Office, the issuance of the patent is often delayed. Until an allowed patent is
actually issued, the U.S. Patent and Trademark Office may reverse its decision
or delay the issuance of the patent. We also have filed foreign patent
applications presently pending as PCT applications designating intergovernmental
agencies and multiple countries including the European Patent Office, Canada and
Japan. We cannot assure you that our remaining patent applications will result
in patents being issued in the United States or foreign countries. Nor can we
assure you that any technologies or products that we may develop in the future
will be patentable. In addition, we cannot guarantee that patents which have
been or will be issued will afford meaningful protection for our technology and
products. Competitors may develop products similar to ours which do not conflict
with our patents. Others may challenge our patents and, as a result, our patents
could be narrowed or invalidated. The patent position of biotechnology firms
generally is highly uncertain, involves complex legal and factual questions, and
has recently been the subject of much litigation. No consistent policy has
emerged from the U.S. Patent and Trademark Office or the courts regarding the
breadth of claims allowed or the degree of protection afforded under
biotechnology patents. In addition, there is a substantial backlog of
biotechnology patent applications at the U.S. Patent and Trademark Office and
the decisions whether to approve or reject patents may take several years.
Our success will also depend partly on our ability to operate without
infringing upon the proprietary rights of others, as well as our ability to
prevent others from infringing on our proprietary rights. We may be required at
times to take legal action in order to protect our proprietary rights. Also,
despite our best efforts, we may be sued for infringing on the patent rights of
others. Patent litigation is costly, and, even if we prevail, the cost of such
litigation could harm us. If we do not prevail, in addition to any damages we
might have to pay, we could be required to stop the infringing activity or
obtain a license. We cannot be certain that any required license would be
available to us on acceptable terms, or at all. If we fail to obtain a license,
or if the terms of a license are burdensome to us, our business, financial
condition and results of operations could be materially harmed.
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To help protect our proprietary rights in unpatented trade secrets, we
require our employees, consultants and advisors to sign confidentiality
agreements. However, we cannot guarantee that these agreements will provide us
with adequate protection if confidential information is used or disclosed
improperly. In addition, in some situations, these agreements may conflict with,
or be limited by, the rights of third parties with whom our employees,
consultants or advisors have prior employment or consulting relationships.
Further, others may independently develop similar proprietary information and
techniques, or otherwise gain access to our trade secrets. See "Description of
Business -Proprietary Rights."
CERTAIN OF OUR PRODUCTS ARE SUBJECT TO GOVERNMENT REGULATION
In the United States, the FDA regulates medical products. Similar
agencies exist in Canada, Japan, European countries and elsewhere.
Our products can be used in two ways. First, they can be used in
scientific research, to discover new information or develop better ways to
manage the treatment of disease. Second, they can be used in the medical care of
specific patients. In that case, they are called diagnostic medical devices.
We currently sell our products for research and clinical research
purposes. In the future, we intend to sell products for clinical diagnostic
purposes. We do not believe we need authorization from the FDA or health
authorities in foreign countries to sell our products for research purposes, as
long as they are properly labeled. We will, however, need authorization to sell
our products for clinical diagnostic purposes.
To obtain FDA authorization for a new medical device, a company may
have to submit data relating to safety and efficacy based on extensive testing.
This testing, the preparation of necessary applications and the processing of
those applications by the FDA, are expensive and may take several years to
complete. For a more complete description of the FDA approval process, see
"Description of Business -Regulation by the FDA and Other Government
Agencies-FDA APPROVAL PROCESS."
We cannot assure you that the FDA will approve any of our products for
clinical diagnostic purposes, or do so in a timely manner. First, the tests may
fail to prove that a particular product is safe and effective. Second, it may be
too expensive for us to conduct all the necessary tests. Third, there may be
delays, or disagreements between us and the FDA about whether the tests are
adequate. Because of these and other uncertainties, you should assume that we
may experience delays in obtaining FDA approval, or that we may not receive FDA
approval to sell our products for clinical diagnostic purposes.
Our HIV GeneKit will, and, in the future, other GeneKits may, be
regulated by the FDA as Class III medical devices. We believe that our other
GeneKits and products will be regulated as either Class II or Class III medical
devices. Since our HIV OpenGene System will be regulated as a Class III medical
device we must submit a Premarket Approval application, commonly known as a PMA
application, in order to sell our HIV OpenGene System in the United States for
clinical diagnostic purposes. To be considered by the FDA, our PMA application
must be supported by extensive human clinical data. In December 1998, the FDA
allowed us to initiate human clinical trials of our HIV OpenGene System under
our IDE application. We have conducted one, and are continuing to conduct
several additional, clinical trials, the results of which will be submitted with
our PMA application to the FDA. For a discussion of these trials, see
"Description of Business -Our HIV OpenGene System."
We also plan to market products outside the United States, initially in
Canada, Japan and selected countries in Europe. Government authorization
requirements similar to the FDA's exist in some of these and many other foreign
countries. Therefore, for us to get authorization to sell our products for
clinical diagnostic purposes in Canada, Japan, and Europe may also require
lengthy and costly testing procedures. In addition, the regulatory bodies in
other countries may be affected or influenced by significantly different
criteria than those used by the FDA. Sale of our products in these areas may be
materially affected by the policies of these bodies or the domestic politics of
the countries involved.
We are or may become subject to various federal, state, foreign,
provincial and local laws and regulations, covering a broad range of topics
including:
- worker compensation;
- safe working conditions;
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- laboratory and manufacturing practices;
- use and disposal of hazardous chemicals or infectious disease
agents and toxic chemicals; and
- product emissions.
In addition, our reference laboratory in Norcross, Georgia, is subject
to regulation under the Clinical Laboratory Improvement Amendments of 1988,
known as CLIA. Under CLIA, laboratories must meet various requirements,
including requirements relating to the validation of tests, training of
personnel, and quality assurance procedures. The laboratory must also be
certified by a government agency. Our Norcross laboratory performs high
complexity tests, and is therefore subject to the most stringent level of
regulation under CLIA. This laboratory is certified under CLIA and by the state
of Georgia. Our failure to comply with state or CLIA requirements can result in
various penalties, including loss of certification. The imposition of such
penalties could have an adverse impact on us. In addition, some states regulate
out-of-state laboratories. The failure to comply with these state requirements
could also adversely affect us.
We are unable to predict the extent of future government regulations or
industry standards. You should assume that in the future there may be more
government regulations or industry standards affecting genetic diagnostic
testing than there are now. Existing or future regulations or industry standards
may have a material adverse effect on our operations, including the cost of
complying with regulations or standards or obtaining permits, delays or fines
resulting from loss of permits or failure to comply with regulations.
CERTAIN SUPPLIES AND PARTS THAT WE NEED ARE AVAILABLE FROM LIMITED SOURCES
We use dyes, reagents and other chemicals supplied by third parties in
our GeneKits. We believe that some dyes supplied by Amersham under our exclusive
worldwide license to use and sell Amersham dyes within our GeneKits, may not be
available from other suppliers, although our customers might be able to purchase
some, but not all, of these dyes directly from Amersham. In addition, certain
reagents and other chemicals which we use and include in our GeneKits are
available only under license from their manufacturers. We cannot be certain that
we will be able to renew these licenses upon expiration, on favorable terms or
at all. While we believe that alternative dyes, chemicals and reagents are
available, alternate products may not be as effective as certain of the products
which we presently use. If we switched to an alternative dye, chemical or
reagent, we may also have to adapt the GeneKit's analysis software to the new
product, which could take time. If the GeneKit is FDA approved, we may also be
required to seek FDA approval for the altered GeneKit if the alternative product
were to substantially alter the performance of the GeneKit. This could cause
delays in production and in bringing the changed GeneKit to market. See "-Each
time we make substantial alterations to any FDA approved products, we will need
to seek additional FDA approval."
We also use certain custom-designed components supplied by third
parties in our sequencers and other equipment. We believe that there are
alternative suppliers for these custom-designed parts. However, we would incur
costs in switching to alternative suppliers and would likely experience delays
in production of the products that use any of these parts until such time as we
were able to locate alternate suppliers or parts on acceptable terms.
We license the polymerase chain reaction technology that we use in our
GeneKits from Roche Molecular Systems, Inc. and F. Hoffmann La Roche Ltd. This
license is not exclusive, and, therefore, may be granted by the Roche companies
to our competitors and others. We are required to pay royalties to the Roche
companies for the license. The license is for the life of the patents included
within the licensing agreement, which expire at various times commencing July
2004. The termination of this license would have a material adverse effect on
our ability to produce and sell GeneKits. Consequently, we could experience a
deterioration of anticipated future sales of our GeneKits and further losses.
See "Description of Business -Our Integrated OpenGene System-GeneKits and Other
Consumables-GENEKIT TECHNOLOGIES."
WE MAY BE UNABLE TO MANAGE OUR GROWTH
If we are successful in increasing sales and expanding our markets,
there will be additional demands on our management, marketing, distribution,
customer support and other operational and administrative resources and systems.
To accommodate future growth, we may have to hire a substantial number of
additional management personnel and other employees in the United States and
abroad. We may also have to add information and other systems. We cannot
guarantee that we will be able to do so. In addition, our current and future
expense levels are
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based largely on our investment plans and estimates of future revenues and are,
to a large extent, fixed. We may be unable to adjust spending in a timely manner
to compensate for any unexpected revenue shortfall. Therefore, any significant
shortfall in revenues as compared to our planned expenditures would materially
harm our business, financial condition, and results of operations. We are not
certain whether our current staff, systems and infrastructure will be adequate
to support and effectively monitor future growth. If we are unable to manage our
growth, we may not be able to implement our business plan and our business,
financial condition and results of operations would be materially harmed.
OUR FUTURE ACQUISITIONS MAY BE DIFFICULT AND DISRUPTIVE, AND WE MAY NOT REALIZE
EXPECTED BENEFITS
We have made and in the future may make acquisitions of complementary
businesses, products, services or technologies. We have limited experience in
integrating newly acquired organizations into our operations.
Acquisitions expose us to many risks, including:
- difficulty in assimilating technologies, products, personnel
and operations;
- diversion of management's attention from other business
concerns;
- large write-offs and amortization expenses related to goodwill
and other intangible assets;
- entering markets in which we have no or limited experience;
and
- incurrence of debt or assumption of other liabilities.
The occurrence of one or more of these factors could materially harm
our business, financial condition and results of operations.
OUR INDUSTRY IS HIGHLY COMPETITIVE
The biotechnology industry is highly competitive. We compete with
entities in the United States and abroad that are engaged in the development and
production of products that analyze genetic information. They include:
- biotechnology, pharmaceutical, chemical and other companies;
- academic and scientific institutions;
- governmental agencies; and
- public and private research organizations.
Some of our major competitors include:
- manufacturers and distributors of DNA sequencers such as the
PE Biosystems Group, Amersham and its Molecular Dynamics
subsidiary, LI-COR, Inc., Hitachi, Ltd. and Molecular and
Genetic BioSystems, Inc.;
- manufacturers and distributors of DNA probe-based diagnostic
systems such as Abbott Laboratories, Chiron Corp., Hoffmann-La
Roche Inc., Gene Probe Inc., Digene Corporation and Johnson &
Johnson; and
- manufacturers of new technologies used to analyze genetic
information, such as chip-based and assay-based technologies,
including, Hyseq Inc., Affymetrix Inc., ChemCore Inc., CuraGen
Corp. and Nanogen, Inc.
Many of these companies and many of our other competitors have much
greater financial, technical and research and development resources and
production and marketing capabilities than we do. Smaller companies may also
prove to be significant competitors, particularly through collaborative
arrangements with large pharmaceutical and biotechnology companies. If any of
our competitors were to devote significant resources to developing an integrated
solution for genotyping, we would experience significantly more competitive
pressure. We cannot predict whether we could successfully compete with these
pressures and our revenues could suffer.
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Our GeneKits also compete with homebrew genetic tests for HIV and other
diseases. Homebrew tests include a variety of small-scale genotyping tests which
typically have not undergone clinical validation and have not been approved by
the FDA or other regulatory agencies. See "Description of Business-Competition."
WE DEPEND ON QUALIFIED SCIENTIFIC, TECHNICAL AND MANAGEMENT PERSONNEL
Because of the specialized scientific nature of our business, we are
highly dependent upon our ability to attract and retain qualified scientific and
technical personnel. We also must hire additional qualified management and sales
and marketing personnel as our business expands. Competition in our industry for
scientific, sales and marketing and management personnel is intense. Loss of the
services of our key personnel in these areas could adversely affect our research
and development and sales and marketing programs and could impede the
achievement of our goals. We do not maintain key man life insurance on any of
our personnel.
WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS
The testing, manufacturing, sale and marketing of our products exposes
us to the risk of product liability claims. Although we have obtained product
liability insurance coverage, we cannot guarantee that product liability
insurance will continue to be available to us on acceptable terms or that our
coverage will be sufficient to protect against all claims against us. A product
liability claim, even one without merit or for which we have substantial
coverage, could result in significant legal defense costs, thereby increasing
our expenses, lowering our earnings and, depending on revenues, potentially
resulting in additional losses.
WE MAY BE SUBJECT TO LIABILITY CLAIMS BASED ON ERRORS IN OUR TESTING SERVICES
We provide DNA testing, sequencing and other services for HIV,
hepatitis B, hepatitis C, HPV and other infectious diseases, as well as for
certain cancers. These services may be used in the future by clinicians to
diagnose or treat their patients. Clinicians, patients and others may at times
seek damages for the misdiagnosis of a patient's disease based on testing
errors, for the erroneous recommendation of drug treatment based on a
technician's misreading of the sequencing results, mishandling of patient
samples or similar claims. Although we have obtained liability insurance
coverage, we cannot guarantee that liability insurance will continue to be
available to us on acceptable terms or that our coverage will be sufficient to
protect us against all claims that may be brought against us. In addition, our
existing insurance coverage may not cover certain claims against our employees
arising from misdiagnosis of a patient's disease, erroneous recommendations of
drug treatment, mishandling of patient samples or similar claims based on
employee error rather than product defects. A liability claim, even one without
merit or for which we have substantial coverage, could result in significant
legal defense costs, thereby increasing our expenses, lowering our earnings and,
depending on revenues, potentially resulting in additional losses.
WE FACE RISKS RELATING TO OUR INTERNATIONAL OPERATIONS
We sell our products in Europe, Asia and South America and operate
offices in Europe. Therefore, we are subject to certain risks that are inherent
in an international business. These include:
- varying regulatory restrictions on sales of our products to
certain markets and unexpected changes in regulatory
requirements;
- tariffs, customs, duties and other trade barriers;
- difficulties in managing foreign operations and foreign
distribution partners;
- longer payment cycles and problems in collecting accounts
receivable;
- political risks;
- fluctuations in currency exchange rates;
- foreign exchange controls which may restrict or prohibit
repatriation of funds;
- export and import restrictions or prohibitions, and delays
from customs brokers or government agencies;
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- seasonal reductions in business activity in certain parts of
the world; and
- potentially adverse tax consequences resulting from operating
in multiple jurisdictions with differing tax laws.
Depending on the countries involved, any or all of the foregoing factors could
materially harm our business, financial condition and results of operations.
U.S. INVESTORS IN OUR COMPANY COULD SUFFER ADVERSE TAX CONSEQUENCES IF WE ARE
CHARACTERIZED AS A PASSIVE FOREIGN INVESTMENT COMPANY
Although we do not believe that we were a passive foreign investment
company (or PFIC) for United States federal income tax purposes during 1998,
there can be no assurance that we will not be treated as a PFIC in 1999 or
thereafter. We would be a PFIC if 75% or more of our gross income in a taxable
year is passive income. We would also be a PFIC if at least 50% of our assets
averaged over the taxable year produce, or are held for the production of,
passive income. Passive income includes, among other items, interest, dividends,
royalties, rents and annuities. If we are or become a PFIC, shareholders in our
company will be subject to the following adverse tax consequences:
- shareholders will be taxed at the highest ordinary income tax
rates in effect during their holding period on certain
distributions on our common shares, and gain from the sale or
other disposition of our common shares;
- shareholders will be required to pay interest on taxes
allocable to prior periods; and
- the tax basis of our common shares will not be increased to
fair market value at the date of a shareholder's death.
If we are or become a PFIC, our shareholders can avoid these tax
consequences by making a qualified electing fund election or a mark-to-market
election (a mark-to-market election, however, will not provide for an increase
in the tax basis of our common shares to fair market value at the date of a
shareholder's death). These elections would need to be in effect for all taxable
years during which we were a PFIC and during which a shareholder has held our
common shares. If a shareholder makes a qualified electing fund election, he
will be taxed currently on his ordinary income and net capital gain (unless a
deferral election is in effect). If a shareholder makes a mark-to-market
election, he will include as ordinary income each year an amount equal to the
excess of the fair market value of our common shares over his adjusted tax basis
as of the close of each year (with certain adjustments for prior years).
If we are or become a PFIC, our shareholders will generally be unable
to exchange our common shares for common shares of an acquiring corporation on a
tax-deferred basis under the reorganization rules of the Internal Revenue Code,
and many other nonrecognition provisions of the Internal Revenue Code will not
apply to transfers of our common shares. In addition, if we are or become a
PFIC, pledges of our common shares will be treated as sales for federal income
tax purposes. Our shareholders should note that state and local taxes may also
apply if amounts are included in federal taxable income under the PFIC rules of
the Internal Revenue Code. The PFIC rules are very complex. If you buy common
shares of our company, you are strongly encouraged to consult with your tax
advisor concerning all of the tax consequences of investing in our common shares
and the possible benefits of making a tax election given your circumstances. See
"Taxation-U.S. Federal Income Tax Considerations-TAX STATUS OF THE COMPANY."
MANAGEMENT OWNS A LARGE PERCENTAGE OF OUR OUTSTANDING SHARES
Our directors and executive officers own, together, approximately 15%
of our outstanding common shares. Another company, of which one of our directors
is a principal shareholder, officer and director, owns approximately 20% of our
common shares. If they act together, these shareholders may be able to
effectively control our management and company policies, including matters
requiring shareholder approval, such as the election of directors, the approval
of certain mergers and other significant corporate transactions and a sale of
substantially all of our assets. Control by these shareholders could have the
effect of delaying or preventing a change in control or sale of our company. See
"Control of Registrant."
OUR UNLIMITED PREFERRED SHARES AND CLASSIFIED BOARD OF DIRECTORS COULD PREVENT
OR DELAY TAKEOVERS AND, IF WE COMPLETE OUR PROPOSED EQUITY FINANCING, WE WILL
ISSUE PREFERRED SHARES WITH PREFERENCES OVER OUR COMMON SHARES
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Our authorized capital consists of an unlimited number of common shares
and an unlimited number of preferred shares. The Board of Directors, without any
further vote by the shareholders, has the authority to issue preferred shares
and to determine the price, preferences, rights and restrictions, including
voting and dividend rights, of these shares. The rights of the holders of common
shares are subject to the rights of holders of any preferred shares that the
Board of Directors may issue in the future. That means, for example, that we can
issue preferred shares with more voting rights, higher dividend payments or more
favorable rights upon dissolution, than the common shares. If we issued certain
types of preferred shares in the future, it may also be more difficult for a
third party to acquire a majority of our outstanding voting shares.
If we complete the proposed Warburg Pincus financing, we would issue
Series A preferred shares that would entitle the holders to certain preferences
over common shares, including the following:
- we would not be able to issue any securities that rank senior
to, or in parity with, the Series A preferred shares without
obtaining the approval of the holders of the majority of the
Series A preferred shares;
- we would not be able to issue dividends to holders of common
shares until all accrued and unpaid dividends on the Series A
preferred shares were paid in full; and
- if we liquidate or wind-up our company or if we sell our
company or in certain other circumstances, holders of Series A
preferred shares would be entitled to receive an amount equal
to $1,000 per Series A preferred share, or approximately $34.0
million in the aggregate, plus accrued and unpaid dividends,
before holders of common shares would be entitled to receive
any distribution.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Liquidity and Capital Resources."
In addition, we have a "classified" Board of Directors, which means
that only one-third of our directors are eligible for election each year.
Therefore, if shareholders wish to change the composition of the Board of
Directors it would take at least two years to remove a majority of the existing
directors, and three years to change all directors. Having a classified Board of
Directors may, in some circumstances, deter or delay mergers, tender offers or
other possible transactions which may be favored by some or a majority of our
shareholders.
THE VOLATILITY OF THE STOCK MARKET COULD DRIVE DOWN THE PRICE OF OUR COMMON
SHARES
The market prices for securities of life sciences companies,
particularly those that are not profitable, have been highly volatile,
especially recently. Publicized events and announcements may have a significant
impact on the market price of our common shares. For example, announcements that
may have the effect of temporarily or permanently driving down the price of our
common shares include:
- failure to obtain FDA approval for our HIV OpenGene System;
- publicizing poor quarterly financial results;
- biological or medical discoveries by competitors;
- failed technological innovations;
- unfavorable domestic or foreign regulatory developments; and
- unfavorable developments concerning patents or other
proprietary rights.
In addition, the stock market from time to time experiences extreme
price and volume fluctuations which particularly affect the market prices for
emerging and life sciences companies, such as ours, and which are often
unrelated to the operating performance of the affected companies. These broad
market fluctuations may make it difficult for a shareholder to sell shares at a
price equal to or above the price at which the shares were purchased.
WE FACE FOREIGN CURRENCY EXCHANGE RISKS
Our financial statements are prepared in U.S. dollars and much of our
business is conducted in U.S. dollars. However, we do incur expenses in Canadian
dollars and in other foreign currencies. We also sell products to customers in
foreign countries and bill those customers in local currencies at predetermined
exchange rates. As our
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business expands, we anticipate that we will increasingly incur expenses and
bill and receive payments in local currencies at prevailing exchange rates. As a
result, we are exposed, and will continue to be exposed, to risks due to
fluctuations in the exchange rates between the U.S. dollar and the Canadian
dollar and the U.S. dollar and the currencies of such other countries. We
currently engage in limited foreign exchange hedging activities by purchasing
Canadian funds before they are actually required to protect ourselves against
the risk of losses due to fluctuations in exchange rates. We do not currently
engage in hedging activities for any other foreign currencies. We may suffer
losses as a result of fluctuations in the exchange rates between the U.S. dollar
and foreign currencies.
WE FACE RISKS RELATING TO YEAR 2000 ISSUES
Beginning on January 1, 2000, some computer systems and software will
produce erroneous results or fail unless they have been modified or upgraded to
process date information correctly. We have conducted a comprehensive
examination of our information technology systems, software applications and
software applications sold with our products to determine compliance with the
year 2000. Based on our examination, we believe that these systems and software
applications are year 2000 compliant.
We are in the process of contacting our material customers, suppliers
and third-party service providers to identify year 2000 problems and provide
solutions to prevent any disruption of business activities. At present, we do
not have complete information regarding the extent of year 2000 compliance by
our customers, suppliers and third-party service providers. We expect to
complete review of the compliance efforts by these parties in the third quarter
of 1999. Based on the information we have received so far, our most significant
year 2000 risk would involve disruption of our material supply and distribution
channels, and in particular the supply of certain instrument parts and supplies
from single-source suppliers. This would likely lead to material interruption in
product development and sales of our products. In addition, we could encounter
significant expenses in remedying any problems or switching to year 2000
compliant vendors and suppliers. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
FORWARD-LOOKING STATEMENTS
This annual report includes forward-looking statements. You can
identify these forward-looking statements when you see us using words such as
"expect," "anticipate," "estimate," "believe," "intend," "may," "predict,"
and other similar expressions. These forward-looking statements cover, among
other items:
- acceptance of our products in the clinical diagnostic market;
- acceptance of genotyping in the clinical diagnostic market;
- our marketing and sales plans;
- our expectations about the markets for our products;
- the performance of our products;
- our intention to introduce new products;
- our future capital needs;
- FDA and other regulatory approval for certain of our products;
- our proposed clinical trials;
- reimbursement of our products by insurance companies and
other third-party payors;
- our ability to compete in the research, clinical research and
clinical diagnostic markets;
- our patent applications; and
- the status of year 2000 compliance efforts of our company,
and our material customers and suppliers.
We have based these forward-looking statements largely on our current
expectations. However, forward-looking statements are subject to a number of
risks and uncertainties, certain of which are beyond our control. Actual
results could differ materially from those anticipated as a result of the
factors described under "Risk Factors" including, among others:
- the timing of our future capital needs or our inability to
raise additional capital when needed;
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- delays in obtaining, or our inability to obtain, approval by
the FDA and other regulatory authorities for our HIV OpenGene
System and, in the future, certain of our other products for
the clinical diagnostic market;
- refusal of insurance companies and other third-party payors to
reimburse patients and clinicians for our products;
- uncertainty of acceptance of genotyping, in general, and of
our products, in particular, in the clinical diagnostic
market;
- problems, delays and expenses we may face with our proposed
clinical trials;
- problems that we may face in manufacturing, marketing and
distributing our products;
- delays in the issuance of, or the failure to obtain, patents
or licenses for certain of our products and technologies;
- problems with important suppliers and business partners; and
- delays in developing, or the failure to develop, new products
and enhanced versions of existing products.
We do not undertake any obligation to publicly update or revise any
forward-looking statements contained in this annual report, whether as a result
of new information, future events or otherwise. Because of these risks and
uncertainties, the forward-looking statements and circumstances discussed in
this annual report might not transpire.
ITEM 2. DESCRIPTION OF PROPERTY.
The table below lists the locations of our facilities and summarizes
certain information about each location.
<TABLE>
<CAPTION>
Square
feet
Location Use (Approximate) Term of Lease
-------- --- ------------- -------------
<S> <C> <C> <C> <C>
1. Bay Street Research, sales and administrative offices 20,643 June 1995 -
Toronto, Canada May 2000
2. Etobicoke MicroCel manufacturing 8,482 June 1996 -
Toronto, Canada May 2001
3. Etobicoke Sequencer manufacturing 10,500 September 1998 -
Toronto, Canada August 2003
4. Oakville Research and development 8,000 September 1998 -
Ontario, Canada August 2003
5. University of September 1997 -
Pittsburgh August 2000
Applied Research Kit manufacturing, research and
Center, Pittsburgh, development 8,171
Pennsylvania
6. Technology Park Research and development 7,313 March 1998 -
Norcross, Georgia February 2003
7. Meyerside Drive* May 1999-
Mississauga, Kit development 3,100 April 2004
Canada
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8. Kestrel Road* May 1999-
Mississauga, Kit manufacturing 22,600 April 2004
Canada
9. Evry Europe head office 6,000 March 1999 -
France February 2001
</TABLE>
-----------------
* These facilities are not yet operating.
We believe that additional facilities will be available at reasonable
market rates to meet any future needs we may have for additional space.
ITEM 3. LEGAL PROCEEDINGS.
We are not a party to any material legal proceedings.
ITEM 4. CONTROL OF REGISTRANT.
The following table sets forth certain information regarding the
beneficial ownership of our outstanding common shares as of July 12, 1999, for
(i) all shareholders known to beneficially own or exercise control or direction
over more than 10% of our common shares, and (ii) all directors and executive
officers as a group (15 persons):
<TABLE>
<CAPTION>
Number of Company Shares
beneficially owned(1) or
over which control or Percentage of
Name direction is exercised Class
- - ---- ---------------------- -----
<S> <C> <C>
GeneVest Inc. (2).................................. 1,927,134 20.1%
Hilal Capital Management LLC(3).................... 1,160,000 11.3%
Oracle Partners.................................... 1,008,361 10.5%
All directors and executive officers as a group
(15 persons)(4).................................... 1,591,588 15.2%
</TABLE>
- - ------------------
(1) The information in this table is based on our records, information
provided to us by officers, directors and key employees and a review of
Schedules 13D and 13G filed by our shareholders with the Securities and
Exchange Commission. Beneficial ownership is determined in accordance
with rules of the Securities and Exchange Commission and includes
common shares over which the indicated beneficial owner exercises
voting and/or investment power. Our common shares subject to options
currently exercisable or exercisable within 60 days are deemed
outstanding for computing the percentage ownership of the person
holding the options but are not deemed outstanding for computing the
percentage ownership of any other person. This information is based on
9,569,988 common shares outstanding on July 12, 1999.
(2) GeneVest Inc. is a Canadian company incorporated pursuant to the laws
of Alberta, Canada. Mr. Sheldon Inwentash, one of our Directors, is the
President and Chief Executive Officer of GeneVest and, together with
his affiliates, beneficially owns approximately 45% of GeneVest's
issued and outstanding common shares.
(3) Represents common shares owned by various funds for which Hilal Capital
Management LLC serves as investment advisor or management company. Also
includes an aggregate of 680,000 common shares subject to warrants,
exercisable within 60 days from July 12, 1999, held by such funds.
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(4) Includes an aggregate of 893,110 common shares subject to options,
exercisable within 60 days from July 12, 1999, held by certain
directors and executive officers. Also includes 36,540 common shares
held in trust for the wife of a director and officer and 36,540 common
shares held by a corporation owned by the wife of that director and
officer and over which he has voting control.
ITEM 5. NATURE OF TRADING MARKET.
Our common shares are traded on the Nasdaq National Market under the
symbol "VGIN." Our common shares are not listed or quoted for trading on
securities markets outside of the United States. The following table sets forth,
for the periods indicated, high and low sale prices of our common shares as
reported on the Nasdaq National Market.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED DECEMBER 31, 1997 High Low
<S> <C> <C>
First Quarter......................................... $9.75 $2.38
Second Quarter........................................ $7.00 $2.50
Third Quarter......................................... $10.50 $4.75
Fourth Quarter........................................ $14.25 $6.63
FISCAL YEAR ENDED DECEMBER 31, 1998
First Quarter......................................... $9.75 $6.00
Second Quarter........................................ $11.38 $7.50
Third Quarter......................................... $13.06 $7.00
Fourth Quarter........................................ $14.00 $9.25
FISCAL YEAR ENDED DECEMBER 31, 1999
First Quarter......................................... $21.75 $10.00
Second Quarter........................................ $21.81 $15.31
</TABLE>
On July 13, 1999, the last sale price of our common shares on the
Nasdaq National Market was $10.875. As of July 13, 1999, there were 82 holders
of record of the common shares. This number does not include an indeterminable
number of beneficial holders of these securities whose common shares are held by
financial institutions in "street name."
ITEM 6. EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITY HOLDERS.
There is no law, government decree or regulation in Canada restricting
the export or import of capital or affecting the remittance of dividends,
interest or other payments to a nonresident holder of common shares, other than
withholding tax requirements. See "Taxation-Canadian Federal Income Tax
Considerations-NONRESIDENTS OF CANADA."
There is no limitation imposed by Canadian law or by our articles or
other charter documents on the right of a nonresident to hold or vote common
shares or preference shares with voting rights (collectively, "Voting Shares"),
other than as provided in the Investment Canada Act (the "Investment Act"), as
amended by the World Trade Organization Agreement Implementation Act (the "WTOA
Act"). The Investment Act generally prohibits implementation of a reviewable
investment by an individual, government or agency thereof, corporation,
partnership, trust or joint venture that is not a "Canadian," as defined in the
Investment Act (a "non-Canadian"), unless, after review, the minister
responsible for the Investment Act is satisfied that the investment is likely to
be a net benefit to Canada. An investment in Voting Shares by a non-Canadian
(other than a "WTO Investor," as defined below) would be reviewable under the
Investment Act if it were an investment to acquire direct control of our
company, and the value of the assets of our company were Cdn$5.0 million or
more. An investment in Voting Shares by a WTO Investor would be reviewable under
the Investment Act if it were an investment to acquire direct
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<PAGE>
control of our company, and the value of the assets of our company equaled or
exceeded Cdn$184.0 million. A non-Canadian, whether a WTO Investor or otherwise,
would acquire control of our company for purposes of the Investment Act if he or
she acquired a majority of the Voting Shares. The acquisition of less than a
majority, but at least one-third of our Voting Shares, would be presumed to be
an acquisition of control of our Company, unless it could be established that we
were not controlled in fact by the acquirer through the ownership of Voting
Shares. In general, an individual is a WTO Investor if he or she is a "national"
of a country (other than Canada) that is a member of the World Trade
Organization ("WTO Member") or has a right of permanent residence in a WTO
Member. A corporation or other entity will be a "WTO Investor" if it is a "WTO
investor-controlled entity" pursuant to detailed rules set out in the Investment
Act. The United States is a WTO Member.
Certain transactions involving Voting Shares would be exempt from the
Investment Act, including: (a) an acquisition of Voting Shares if the
acquisition were made in connection with the person's business as a trader or
dealer in securities; (b) an acquisition of control of our company in connection
with the realization of a security interest granted for a loan or other
financial assistance and not for any purpose related to the provisions of the
Investment Act; and (c) an acquisition of control of our company by reason of an
amalgamation, merger, consolidation or corporate reorganization, following which
the ultimate direct or indirect control in fact of our company, through the
ownership of voting interests, remains unchanged.
ITEM 7. TAXATION.
CANADIAN FEDERAL INCOME TAX CONSIDERATIONS
The following summary describes certain material Canadian federal
income tax consequences generally applicable to a holder of common shares, and
who, for purposes of the Income Tax Act (Canada) (the "ITA"), (i) holds such
shares as capital property and (ii) deals at arm's length with our company.
Generally, common shares will be considered to be capital property to a holder
provided that such holder does not hold such securities in the course of
carrying on a business, has not acquired such securities in a transaction or
transactions considered to be an adventure in the nature of trade, or the holder
of the shares is not a financial institution subject to the rules whereby gains
and losses on securities are recorded on a mark-to-market basis.
This summary is based upon the current provisions of the ITA and the
regulations thereunder and on an understanding of the published administrative
practices of Revenue Canada. This summary does not take into account or
anticipate any possible changes in law, or the administration thereof, whether
by legislative, governmental or judicial action, except proposals for specific
amendment thereto which have been publicly announced by the Canadian Minister of
Finance prior to the date hereof.
This summary does not address all aspects of Canadian federal income
tax law that may be relevant to shareholders based upon their particular
circumstances, and does not deal with provincial, territorial or foreign income
tax consequences, which might differ significantly from the consequences under
Canadian federal income tax law.
Shareholders are advised to consult their tax advisors regarding the
application of the Canadian federal income tax law to their particular
circumstances, as well as any provincial, territorial and other tax consequences
of the acquisition, ownership and disposition of their common shares.
NONRESIDENTS OF CANADA
TAXATION OF DIVIDENDS. A holder of a common share who is not resident
in Canada for purposes of the ITA (a "NonResident") will be subject to Canadian
withholding tax on dividends paid or credited, or deemed under the ITA to be
paid or credited, to the holder of the common shares. The rate of withholding
tax under the ITA on dividends is 25% of the amount of the dividend. Such rate
may be reduced under the provisions of an applicable international tax treaty to
which Canada is a party. Pursuant to the tax treaty that Canada has entered into
with the United States (the "U.S. Treaty"), the rate of Canadian withholding tax
applicable in respect of dividends paid or
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<PAGE>
credited by a Canadian corporation to a shareholder resident in the United
States, is generally reduced to 15% or 5% in the case of a corporate holder
which owns 10% or more of the voting stock. Moreover, pursuant to Article XXI of
the U.S. Treaty, an exemption from Canadian withholding tax generally is
available in respect of dividends received by certain trusts, companies and
other organizations whose income is exempt from tax under the laws of the United
States. A foreign tax credit for the tax withheld may be available to a holder
resident in the United States against U.S. federal income taxes.
DISPOSITION OF COMMON SHARES. A NonResident holder of a common share
will not be subject to tax under the ITA in respect of a capital gain realized
on the disposition of a common share unless the common share constitutes or is
deemed to constitute "taxable Canadian property" (as defined in the ITA). Shares
of a corporation that are listed on a prescribed stock exchange (which includes
shares traded on a U.S. stock exchange and the National Association of
Securities Dealers Automated Quotation System) are generally not considered to
be taxable Canadian property. However, shares that trade on a prescribed
Canadian or prescribed foreign exchange (including those noted above in the
United States) can be taxable Canadian property since the definition of taxable
Canadian property also includes any common share held by a NonResident if, at
any time during the five year period immediately preceding its disposition, not
less than 25% of the issued shares of any class or series of shares of our
company belong to the NonResident, to persons with whom the NonResident did not
deal at arm's length or to any combination thereof.
For the purposes of determining whether a property is a taxable
Canadian property, a person holding an option to acquire common shares or other
securities convertible into or exchangeable for common shares, or otherwise
having an interest in common shares, will be considered to own the common shares
that could be acquired upon the exercise of the option, the conversion or
exchange rights or in which there is such interest. Taxable Canadian property
also includes any common share held by a NonResident if the NonResident used the
common share in carrying on a business (other than an insurance business) in
Canada, or, if the NonResident is a NonResident insurer, any common share that
is its "designated insurance property" for the year. A common share will also
constitute taxable Canadian property of a former Canadian resident who made an
election under section 128.1 of the ITA in respect of such shares on ceasing to
be resident in Canada. The aforementioned rules can apply to any class of
shares.
A NonResident whose common shares constitute or are deemed to
constitute taxable Canadian property is referred to the discussion below under
"Canadian Residents -- Disposition of Common Shares" for information regarding
the treatment of the disposition under the ITA.
Even if the common shares constitute or are deemed to constitute
taxable Canadian property to a NonResident holder and their disposition would
give rise to a capital gain, an exemption from tax under the ITA may be
available under the terms of an applicable international tax treaty to which
Canada is a party. A holder resident in the United States for purposes of the
U.S. Treaty will generally be exempt from Canadian tax in respect of a gain on
the disposition of common shares provided that the value of the common shares is
not derived principally from real property situated in Canada. Article XIII
paragraph 5 of the U.S. Treaty provides that the treaty provision which normally
exempts U.S. residents from Canadian tax on the sale of property (paragraph 4)
such as shares does not apply where the U.S. resident was a Canadian resident
for 120 months during any period of twenty consecutive years preceding the time
of the sale and the individual was resident in Canada at any time during the ten
years immediately preceding the sale. If the exemption from Canadian tax in
respect of such gain is not available under the U.S. Treaty, nonresidents are
advised to consult their tax advisers with regard to other tax relief that may
be available in their circumstances.
As discussed below under "Canadian Residents -- Disposition of Common
Shares", a purchase of common shares by our company (other than a purchase of
common shares by our company on the open market in a manner in which shares
would normally be purchased by any member of the public in the open market) will
give rise to a deemed dividend under the ITA. Any such dividend deemed to have
been received by a nonresident holder will be subject to nonresident withholding
tax as described above. The amount of any such deemed dividend will reduce the
proceeds of disposition of the common share to the nonresident holder for the
purpose of computing the amount of the nonresident holder's capital gain or loss
under the ITA.
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<PAGE>
CANADIAN RESIDENTS
TAXATION OF DIVIDENDS. Dividends received on a common share will be
subject to taxation as taxable dividends received from a taxable Canadian
corporation. Under Part I of the ITA, normal grossup and dividend tax credit
rules will apply to dividends received by an individual and dividends received
by a corporation normally will be deductible in computing its taxable income.
Certain corporations may be liable to pay a 33 1/3% refundable tax under Part IV
of the ITA on such dividends.
DISPOSITION OF COMMON SHARES. Upon the disposition or deemed
disposition of a common share, a holder will realize a capital gain (or a
capital loss) to the extent that the proceeds of disposition are greater than
(or less than) the aggregate of the adjusted cost base to a holder of a common
share and any reasonable costs of disposition.
Three-quarters of any capital gain realized by a holder (a taxable
capital gain) will be included in computing the holder's income. Three-quarters
of any capital loss realized by a holder may, subject to certain restrictions
applicable to holders that are corporations, normally be deducted from the
holder's taxable capital gains realized in the year of disposition, the three
preceding taxation years or any subsequent taxation years, subject to detailed
rules contained in the ITA.
A purchase of common shares by our company (other than a purchase of
common shares by our company on the open market in a manner in which shares
would normally be purchased by any member of the public in the open market) will
give rise to a deemed dividend (except to the extent that such dividend may be
regarded under the ITA as proceeds of disposition or a capital gain and not as a
dividend for shareholders that are corporations) under the ITA equal to the
difference between the amount paid by our company on the purchase and the paidup
capital of such shares determined in accordance with the ITA. The paid up
capital of such shares may be less than the shareholder's cost of such shares.
The amount of any such deemed dividend will reduce the proceeds of disposition
of the common shares to the shareholders for the purpose of computing the amount
of the shareholder's capital gain or loss under the ITA.
A capital gain or taxable dividend can result in the application of the
alternative minimum tax rules contained in the ITA.
U.S. FEDERAL INCOME TAX CONSIDERATIONS
The following summary describes material United States federal income
tax consequences arising from the purchase, ownership and sale of common shares.
This summary is based on the provisions of the Internal Revenue Code of 1986, as
amended (the "Code"), final, temporary and proposed United States Treasury
Regulations promulgated thereunder, and the administrative and judicial
interpretations thereof, all as in effect as of the date of this Annual Report
and all of which are subject to change, possibly on a retroactive basis. The
consequences to any particular investor may differ from those described below by
reason of that investor's particular circumstances. This summary does not
address the considerations that may be applicable to any particular taxpayer
based on such taxpayer's particular circumstances (including potential
application of the alternative minimum tax), to particular classes of taxpayers
(including financial institutions, broker-dealers, insurance companies,
taxpayers who have elected mark-to-market accounting, tax-exempt organizations,
taxpayers who hold ordinary shares as part of a straddle, "hedge" or "conversion
transaction" with other investments, investors who own (directly, indirectly or
through attribution) 10% or more of our company's outstanding voting stock,
taxpayers whose functional currency is not the U.S. dollar, persons who are not
citizens or residents of the United States, or persons which are foreign
corporations, foreign partnerships or foreign estates or trusts as to the United
States) or any aspect of state, local or non-United States tax laws.
Additionally, the discussion does not consider the tax treatment of persons who
hold common shares through a partnership or other pass-through entity or the
possible application of United States federal gift or estate tax. This summary
is addressed only to a holder of common shares who is (i) a citizen or resident
of the United States who owns less than 10% of our company's outstanding voting
stock, (ii) a corporation organized in the United States or under the laws of
the United States or any state thereof, (iii) an estate, the income of which is
includable in gross income for United States federal income tax purposes
regardless of source, or (iv) a
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trust, if a court within the United States is able to exercise primary
supervision over the administration of the trust and one or more U.S. persons
have the authority to control all substantial decisions of the trust (a "U.S.
Holder"). This summary is for general information purposes only and does not
purport to be a comprehensive description of all of the tax considerations that
may be relevant to a decision to purchase common shares. This summary generally
considers only U.S. Holders that will own their common shares as capital assets.
Each shareholder should consult with such shareholder's own tax advisor
as to the particular tax consequences to such shareholder of the purchase,
ownership and sale of their common shares including the effects of applicable
state, local, foreign or other tax laws and possible changes in the tax laws.
TREATMENT OF DIVIDEND DISTRIBUTIONS
Subject to the discussion below under "TAX STATUS OF THE COMPANY --
PASSIVE FOREIGN INVESTMENt Companies," a distribution by our company to a U.S.
Holder in respect of the common shares (including the amount of any Canadian
taxes withheld thereon) will generally be treated for United States federal
income tax purposes as a dividend to the extent of our company's current and
accumulated earnings and profits, as determined under United States federal
income tax principles. To the extent, if any, that the amount of any such
distribution exceeds our company's current and accumulated earnings and profits,
as so computed, it will first reduce the U.S. Holder's tax basis in the common
shares owned by him, and to the extent it exceeds such tax basis, it will be
treated as capital gain from the sale of common shares.
While it is not anticipated that our company will pay dividends in the
foreseeable future, the gross amount of any distribution from our company
received by a U.S. Holder which is treated as a dividend for United States
federal income tax purposes (before reduction for any Canadian tax withheld at
source) will be included in such U.S. Holder's gross income, will be subject to
tax at the rates applicable to ordinary income and generally will not qualify
for the dividends received deduction applicable in certain cases to United
States corporations. For United States federal income tax purposes, the amount
of any dividend paid in Canadian dollars by our company to a U.S. Holder will
equal the U.S. dollar value of the amount of the dividend paid in Canadian
dollars, at the exchange rate in effect on the date of the distribution,
regardless of whether the Canadian dollars are actually converted into United
States dollars at that time. Canadian dollars received by a U.S. Holder will
have a tax basis equal to the U.S. dollar value thereof determined at the
exchange rate on the date of the distribution. Currency exchange gain or loss,
if any, recognized by a U.S. Holder on the conversion of Canadian dollars into
U.S. dollars will generally be treated as U.S. source ordinary income or loss to
such holder. U.S. Holders should consult their own tax advisors concerning the
treatment of foreign currency gain or loss, if any, on any Canadian dollars
received which are converted into dollars subsequent to distribution.
A U.S. Holder generally will be entitled to deduct any Canadian taxes
withheld from dividends in computing United States taxable income, or to credit
such withheld taxes against the United States federal income tax imposed on such
U.S. Holder's dividend income. No deduction for Canadian taxes may be claimed,
however, by a noncorporate U.S. Holder that does not itemize deductions. The
amount of foreign taxes for which a U.S. Holder may claim a credit in any year
is subject to complex limitations and restrictions, which must be determined on
an individual basis by each shareholder. Distributions with respect to common
shares that are taxable as dividends will generally constitute foreign source
income for purposes of the foreign tax credit limitation. The limitation on
foreign taxes eligible for credit is calculated separately with respect to
specific classes of income. For this purpose, dividends distributed by our
company with respect to the common shares will generally constitute "passive
income." Foreign income taxes exceeding a shareholder's credit limitation for
the year of payment or accrual of such tax can be carried back for two taxable
years and forward for five taxable years, subject to the credit limitation
applicable in each of such years. Additionally, the foreign tax credit in any
taxable year may not offset more than 90% of a shareholder's liability for
United States individual or corporate alternative minimum tax. The total amount
of allowable foreign tax credits in any year generally cannot exceed regular
U.S. tax liability for the year attributable to foreign source taxable income. A
U.S. Holder will be denied a foreign tax credit with respect to Canadian income
tax withheld from dividends received on the common shares to the extent such
U.S. Holder has not held the ordinary shares for at least 16 days of the 30-day
period beginning on the date which is 15 days before the ex-dividend date or to
the extent such U.S. Holder is under an obligation to make certain related
payments with
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<PAGE>
respect to substantially similar or related property. Any days during which a
U.S. Holder has substantially diminished its risk of loss on the common shares
are not counted toward meeting the 16 day holding period required by the
statute.
SALE OR EXCHANGE OF A COMMON SHARE
Subject to the discussion below under "TAX STATUS OF THE COMPANY --
PASSIVE FOREIGN INVESTMENt Companies," the sale or exchange by a U.S. Holder of
a common share generally will result in the recognition of gain or loss by the
U.S. Holder in an amount equal to the difference between the amount realized and
the U.S. Holder's basis in the common share sold. Such gain or loss will be
capital gain or loss provided that the common share is a capital asset in the
hands of the holder. The gain or loss realized by a noncorporate U.S. Holder on
the sale or exchange of a common share will be long-term capital gain or loss
subject to tax at a maximum tax rate of 20% if the common share had been held
for more than one year. If the common share had been held by such noncorporate
U.S. Holder for not more than one year, such gain will be short-term capital
gain subject to tax at a maximum rate of 39.6%. Finally, gain realized by a
noncorporate U.S. Holder with respect to common shares acquired after December
31, 2000 and held for more than five years, shall be taxed at a maximum rate of
18%. Gain realized by a corporate U.S. Holder will be subject to tax at a
maximum rate of 35%. Gains recognized by a U.S. Holder on a sale, exchange or
other disposition of common shares generally will be treated as United States
source income for United States foreign tax credit purposes. A loss recognized
by a U.S. Holder on the sale, exchange or other disposition of common shares
generally is allocated to U.S. source income under recently finalized
regulations. However, those regulations require such loss to be allocated to
foreign source income to the extent certain dividends were received by the
taxpayer within the 24-month period preceding the date on which the taxpayer
recognized the loss. The deductibility of a capital loss recognized on the sale,
exchange or other disposition of common shares is subject to limitations. A U.S.
Holder that receives foreign currency upon disposition of common shares and
subsequently converts the foreign currency into U.S. dollars generally will have
foreign exchange gain or loss based on any appreciation or depreciation in the
value of the foreign currency against the U.S. dollar. U.S. Holders should
consult their own tax advisors regarding treatment of any foreign currency gain
or loss on any Canadian dollars received in respect of the sale, exchange or
other disposition of common shares.
TAX STATUS OF THE COMPANY
PERSONAL HOLDING COMPANIES. A non-U.S. corporation may be classified as
a personal holding company (a "PHC") for United States federal income tax
purposes if both of the following two tests are satisfied: (i) if at any time
during the last half of the company's taxable year, five or fewer individuals
(without regard to their citizenship or residency) own or are deemed to own
(under certain attribution rules) more than 50% of the stock of the corporation
by value and (ii) 60% or more of such non-U.S. corporation's gross income
derived from U.S. sources or effectively connected with a U.S. trade or
business, as specifically adjusted, is from certain passive sources such as
dividends and royalty payments. Such a corporation generally is taxed (currently
at a rate of 39.6% of "undistributed personal holding company income") on the
amounts of such passive source income, after making adjustments such as
deducting dividends paid and income taxes, that are not distributed to
shareholders. We believe that our company is not currently a PHC. However, no
assurance can be given that either test will not be satisfied in the future.
FOREIGN PERSONAL HOLDING COMPANIES. A non-U.S. corporation will be
classified as a foreign personal holding company (an "FPHC") for United States
federal income tax purposes if both of the two following tests are satisfied:
(i) five or fewer individuals who are United States citizens or residents own or
are deemed to own (under certain attribution rules) more than 50% of all classes
of the corporation's stock measured by voting power or value and (ii) the
corporation receives at least 60% (50% if previously an FPHC) of its gross
income (regardless of source), as specifically adjusted, from certain passive
sources. If such a corporation is classified as a FPHC, a portion of its
"undistributed foreign personal holding company income" (as defined for United
States federal income tax purposes) would be imputed to all of its shareholders
who are U.S. Holders on the last taxable day of the corporation's taxable year,
or, if earlier, the last day on which it is classifiable as a FPHC. Such income
would be taxable as a dividend, even if no cash dividend is actually paid. U.S.
Holders who dispose of their shares prior to
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such date would not be subject to tax under these rules. We believe that our
company is not currently a FPHC. However, no assurance can be given that our
company will not qualify as a FPHC in the future.
PASSIVE FOREIGN INVESTMENT COMPANIES. A company will be a passive
foreign investment company ("PFIC") if 75% or more of its gross income
(including the pro rata share of the gross income of any company (United States
or foreign) in which the company is considered to own 25% or more of the shares
(determined by market value)) in a taxable year is passive income.
Alternatively, the company will be considered to be a PFIC if at least 50% of
the value of the company's assets (averaged over the year) (including the pro
rata share of the value of the assets of any company in which the company is
considered to own 25% or more of the shares (determined by market value)) in a
taxable year are held for the production of, or produce, passive income. Passive
income generally includes, among others, interest, dividends, royalties, rents
and annuities.
If our company is a PFIC for any taxable year, a U.S. Holders, in the
absence of an election by such U.S. Holder to treat our company as a "qualified
electing fund" (a "QEF election"), as discussed below, would, upon certain
distributions by our company and upon disposition of the common shares at a
gain, be liable to pay tax at the highest tax rate on ordinary income in effect
for each period to which the income is allocated, plus interest on the tax, as
if the distribution or gain had been recognized ratably over the days in the
U.S. Holder's holding period for the common shares during which our company was
a PFIC. Additionally, were our company a PFIC, U.S. Holders who acquire ordinary
shares from decedents would be denied the normally available step-up of the
income tax basis for such common shares to fair market value at the date of
death and instead would have a tax basis equal to the decedent's basis, if
lower.
If our company is treated as a PFIC for any taxable year, U.S. Holders
should consider whether to make a QEF Election for United States federal income
tax purposes. If a U.S. Holder has a QEF Election in effect for all taxable
years that such U.S. Holder has held the common shares and our company was a
PFIC, distributions and gain will not be recognized ratably over the U.S.
Holder's holding period or subject to an interest charge, gain on the sale of
common shares will be characterized as capital gain and the denial of basis
step-up at death described above would not apply. Instead, each such U.S. Holder
is required for each taxable year that our company is a qualified electing fund
to include in income a pro rata share of the undistributed ordinary earnings of
our company as ordinary income and a pro rata share of the undistributed net
capital gain of our company as long-term capital gain, subject to a separate
election to defer payment of taxes, which deferral is subject to an interest
charge. Consequently, in order to comply with the requirements of a QEF
Election, a U.S. Holder must receive from our company certain information. We
intend to supply U.S. Holders with the information needed to report income and
gain pursuant to a QEF Election in the event our company is classified as a
PFIC. The QEF Election is made on a shareholder-by-shareholder basis and can be
revoked only with the consent of the Internal Revenue Service (the "IRS"). A
shareholder makes a QEF Election by attaching a completed IRS Form 8621
(including the PFIC annual information statement) to a timely filed United
States federal income tax return and by filing such form with the IRS Service
Center in Philadelphia, Pennsylvania. Even if a QEF Election is not made, a
shareholder in a PFIC who is a U.S. Holder must file a completed IRS Form 8621
every year.
As an alternative to making a QEF Election, a U.S. Holder may elect to
make a mark-to-market election (the "Mark-to-Market Election") with respect to
the common shares owned by him. If the Mark-to-Market Election were made, then
the rules set forth above would not apply for periods covered by the election.
Under such election, a U.S. Holder includes in income each year an amount equal
to fair market value of the common shares owned by such U.S. Holder as of the
close of the taxable year over the U.S. Holder's adjusted basis in such shares.
The U.S. Holder would be entitled to a deduction for the excess, if any, of such
U.S. Holder's adjusted basis in his common shares over the fair market value of
such shares as of the close of the taxable year; provided however, that such
deduction would be limited to the extent of any net mark-to-market gains with
respect to the common shares included by the U.S. Holder under the election for
prior taxable years. The U.S. Holder's basis in his common shares is adjusted to
reflect the amounts included or deducted pursuant to this election. Amounts
included in income pursuant to the Mark-to-Market Election, as well as gain on
the sale or exchange of the common shares, will be treated as ordinary income.
Ordinary loss treatment applies to the deductible portion of any mark-to-market
loss, as well as to any loss realized on the actual sale or exchange of the
common shares to the extent that the amount of such loss does not exceed the net
mark-to-market gains previously included with respect to such common shares.
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The Mark-to-Market election applies to the tax year for which the election is
made and all later tax years, unless the common shares cease to be marketable or
the IRS consents to the revocation of the election.
We do not believe our company was a PFIC during 1998. However, there
can be no assurance that our company will not be classified as a PFIC in 1999 or
thereafter because the tests for determining PFIC status are applied annually
and it is difficult to make accurate predictions of future income and assets,
which are relevant to this determination. U.S. Holders who hold common shares
during a period when our company is a PFIC will be subject to the foregoing
rules, even if our company ceases to be a PFIC, subject to certain exceptions
for U.S. Holders who made a QEF election. U.S. Holders are urged to consult with
their own tax advisors about making a QEF Election or Mark-to-Market Election
and other aspects of the PFIC rules.
BACK-UP WITHHOLDING AND INFORMATION REPORTING
U.S. Holders generally are subject to information reporting
requirements with respect to dividends paid in the United States on common
shares. Under existing regulations, such dividends are not subject to back-up
withholding. U.S. Holders generally are subject to information reporting and
back-up withholding at a rate of 31% on proceeds paid from the disposition of
common shares unless the U.S. Holder provides IRS Form W-9 or otherwise
establishes an exemption.
Treasury regulations generally effective January 1, 2001 may alter the
rules regarding information reporting and back-up withholding. In particular,
those regulations would impose back-up withholding on dividends paid in the
United States on common shares unless the U.S. Holder provides IRS Form W-9 or
otherwise establishes an exemption. Prospective investors should consult their
tax advisors concerning the effect, if any, of these Treasury regulations on an
investment in common shares. The amount of any back-up withholding will be
allowed as a credit against a U.S. or Non-U.S. Holder's United States federal
income tax liability and may entitle such Holder to a refund, provided that
certain required information is furnished to the IRS.
ITEM 8. SELECTED FINANCIAL DATA.
The following selected consolidated financial data set forth below
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and our Consolidated Financial
Statements and the Notes thereto included elsewhere in this annual report.
The Consolidated Statement of Operations set forth below for fiscal years
1996, 1997 and 1998 and the Consolidated Balance Sheets data set forth below
for fiscal years 1997 and 1998 have been derived from our Consolidated
Financial Statements included elsewhere in this annual report, which have
been audited by PricewaterhouseCoopers LLP, Chartered Accountants in Canada,
whose report with respect to such financial statements appears elsewhere in
this annual report. The Consolidated Statement of Operations set forth below
for fiscal years 1994 and 1995 and the Consolidated Balance Sheets data set
forth below for fiscal years 1994, 1995 and 1996 have been derived from
audited consolidated financial statements not included in this annual report.
SELECTED CONSOLIDATED FINANCIAL INFORMATION
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------
STATEMENT OF OPERATIONS 1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Sales........................ $ - $ - $ 978 $ 3,033 $ 10,875
Cost of sales................ - - 561 1,995 6,674
Gross margin................. - - 417 1,038 4,201
--------- --------- --------- ------- --------
Expenses:
Sales, general and
administrative........... 450 1,476 3,377 7,448 11,516
Research and development 483 1,241 2,744 4,123 6,289
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Acquired research and
development.............. - - - 655 420
--------- --------- --------- ------- --------
Loss from operations before
interest................... (933) (2,717) (5,704) (11,188) (14,024)
Interest income.............. 9 12 609 774 264
Interest and financing
expense.................... - (19) (69) (3) (1,132)
--------- --------- --------- ------- --------
Net (loss)................... $(924) $(2,729) $(5,164) $(10,417) $(14,892)
========= ========= ========= ======= ========
Net (loss) per share......... $(0.32) $(0.65) $(0.89) $(1.48) $(1.91)
========= ========= ========= ======= ========
Weighted average number of
common shares outstanding.... 2,902,735 4,181,594 5,791,367 7,059,578 7,782,094
</TABLE>
<TABLE>
<CAPTION>
AS AT DECEMBER 31,
-----------------------------------------------------------------------------
BALANCE SHEET DATA 1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Cash and short-term investments........... $ 633 $ 403 $18,928 $7,588 $11,274
Working capital........................... 869 418 20,061 9,561 8,432
Indebtedness.............................. - 500 - - 7,495
Total assets.............................. 1,217 1,791 22,606 13,936 27,782
Shareholders' equity...................... 1,040 841 21,795 12,610 14,579
</TABLE>
ITEM 9. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS IN CONJUNCTION
WITH ITEM 8 -"SELECTED CONSOLIDATED FINANCIAL DATA" AND OUR CONSOLIDATED
FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED ELSEWHERE IN THIS ANNUAL REPORT.
IN ADDITION TO HISTORICAL INFORMATION, THE FOLLOWING DISCUSSION CONTAINS CERTAIN
FORWARD-LOOKING STATEMENTS THAT INVOLVE KNOWN AND UNKNOWN RISKS AND
UNCERTAINTIES, SUCH AS STATEMENTS OF OUR PLANS, OBJECTIVES, EXPECTATIONS AND
INTENTIONS. See "Description of Business-Forward-Looking Statements."
OVERVIEW
We began operations in 1993. Until 1996, we devoted substantially all
of our resources to the research and development of our technology and products.
In late 1996, we began manufacturing and selling our products to the research
and clinical research markets.
Our products and services are comprised of the following:
o SEQUENCING SYSTEMS. Sequencing systems consist of automated
DNA sequencers and related equipment, and our proprietary DNA
analysis and data management software.
o GENEKITS AND OTHER CONSUMABLES. GeneKits consist of various
reagents, enzymes, primers and other chemicals, and other
consumables consist of disposable gel cassettes, acrylamide
and other materials.
o TESTING, SEQUENCING AND OTHER SERVICES. We provide services,
such as viral load testing, genotyping and other molecular
services, through our wholly-owned subsidiaries, Applied
Sciences, Inc., which we acquired in 1997, and ACT Gene S.A.,
which we acquired in 1998.
During 1996 and 1997, we generated revenues primarily by selling
sequencing systems. During this period, our business strategy focused on
installing our DNA sequencers and related equipment in research and clinical
research facilities. During 1998, we began to shift our strategy to target the
clinical diagnostic market and to place greater emphasis on generating recurring
revenues from sales of GeneKits and other consumables initially to the research
and clinical research markets and, subject to FDA approval, to the clinical
diagnostic market. As part of this
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strategy, we may sell DNA sequencers at reduced prices, or sell bundles of
sequencers and GeneKits, to customers who commit to purchase significant
quantities of GeneKits and other consumables. This strategy may result,
initially, in reduced gross margins and additional losses as we attempt to
expand our installed base of DNA sequencers. However, we believe that this
strategy, over the long term, will help us maximize recurring sales of our HIV
GeneKit and other GeneKits to the clinical diagnostic market, should we receive
FDA approval.
OUR OPERATIONS
SALES. Sales consist of revenues from the sale of sequencing systems,
GeneKits and other consumables as well as from the sale of testing, sequencing
and other services. Sales include shipping charges, but exclude sales and excise
taxes. Revenue from the sale of our products generally is recognized when
shipment occurs, title passes to the customer and there is a reasonable
assurance of collectibility. Revenue from the sale of testing, sequencing and
other services is recognized when the service is provided and there is a
reasonable assurance of collectibility. Sales of bundled sequencing systems and
GeneKits are recognized proportionately as the components of the bundle are
shipped to customers. The total sales price of the bundle is allocated to the
components proportionately based on the prices typically charged for such
components if they were sold individually rather than as part of the bundle. For
an analysis of sales by product segment and geographic market, see Note 13 to
our Consolidated Financial Statements.
COST OF SALES. Cost of sales consists of manufacturing costs including
materials, labor and overhead chargeable to inventory. The gross margin from
sales of our products and services varies depending on product category,
distribution channel and geographic market. Gross margin is calculated by
subtracting cost of sales from sales. We sell our products in North America,
Europe, Asia, Australia and South America. In the United States, Canada and many
countries in Europe, we sell our products directly through our own sales force.
In selected geographic and product markets, we seek to sell our products through
distribution and marketing agreements with leading distributors.
SALES, GENERAL AND ADMINISTRATIVE EXPENSES. Sales, general and
administrative expenses consist primarily of salaries and related expenses,
occupancy costs, utilities, professional fees, consulting fees, travel costs,
capital taxes, depreciation of fixed assets and amortization of costs paid to
patent counsel.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
consist primarily of salaries and related expenses for employees engaged in
research and development, occupancy costs, consulting fees, travel costs,
depreciation and amortization of fixed assets and the cost of equipment and
materials provided to clinical trial partners.
INTEREST INCOME. Interest income consists of income earned on cash,
cash equivalents and marketable securities.
INTEREST AND FINANCING EXPENSE. Interest and financing expense consists
of interest paid or accrued, and amortization of warrant costs and other
financing expenses.
Our Consolidated Financial Statements are presented in U.S. dollars and
are prepared in accordance with generally accepted accounting principles in the
United States.
RESULTS OF OPERATIONS
COMPARISON OF FISCAL YEAR ENDED DECEMBER 31, 1998 TO FISCAL YEAR ENDED DECEMBER
31, 1997
SALES. Sales increased 259% to $10.9 million in 1998 from $3.0
million in 1997. This increase resulted from increased sales of our automated
DNA sequencing systems, GeneKits and other consumables and testing,
sequencing and other services. In 1998, 412 automated DNA sequencing systems
were sold, an increase of 353% from the 91 systems sold in 1997. In 1998,
automated DNA sequencing systems accounted for 74% of sales, compared to 90%
of sales in 1997. GeneKits and other consumables accounted for 13% of sales
in 1998, compared to 8% in 1997. Testing services accounted for 13% of sales
in 1998 compared to 2% of sales in 1997 as a result of our acquisition in
1998 of a DNA diagnostic testing company. Sales during 1998 in North America,
Europe, and Asia and South America were $7.4 million, $3.0 million and $0.5
million, respectively, as compared to $2.8 million, $0.2 million and $0.05
million, respectively, during 1997. During 1998, one customer accounted for
30% of sales,
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of which 29% comprised DNA sequencing systems and 1% comprised GeneKits and
other consumables. The sales to this customer were made on the same general
terms and conditions as the majority of other sales during the year. During
1997, no customer accounted for more than 10% of sales.
COST OF SALES. Cost of sales increased to $6.7 million in 1998 from
$2.0 million in 1997. In 1998, cost of sales aggregated 61% of sales, a decrease
from 66% of sales in 1997. Cost of sales decreased in 1998 as a percentage of
sales due to improvements in our manufacturing processes, as well as economies
of scale as production of automated DNA sequencing systems, GeneKits and other
consumables increased compared to the previous year.
SALES, GENERAL AND ADMINISTRATIVE EXPENSES. Sales, general and
administrative expenses increased 55% to $11.5 million in 1998 from $7.4 million
in 1997. This increase resulted primarily from increased payroll and personnel
costs due to the growth of our business, establishment of quality control and
regulatory departments and development of a sales force in North America and in
certain countries in Europe. Sales and marketing expenses included in sales,
general and administrative expenses increased 72% to $6.2 million in 1998 from
$3.6 million in 1997.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased 53% to $6.3 million in 1998 from $4.1 million in 1997. This increase
in research and development expenses resulted from increased payroll and
personnel costs along with increased purchases of laboratory supplies as we
continued to develop GeneKits and expanded our research programs.
In April 1998, we acquired 100% of the shares of ACT Gene S.A., a
DNA diagnostic testing company, for 85,000 common shares and cash payable of
$0.7 million. This acquisition was accounted for as a purchase, and resulted
in the recording of an excess of purchase price over tangible net assets of
$0.5 million, of which $0.4 million was determined to be in-process research
and development, and reflected as an expense in 1998. The in-process research
and development related to the cost and time pertaining to the development of
a test kit and research clinical samples necessary for the development of
several kits designed for use with DNA sequencing systems. As of April, 1998,
the test kit was approximately 80% completed and was expected to be completed
during 1999. We currently expect the test kit to be completed during 2000. At
the date of acquisition, the test kit had not yet reached technological
feasibility and had no alternative future uses in the clinical diagnostic
market.
INTEREST INCOME. Interest income declined to $0.3 million in 1998 from
$0.8 million in 1997.
INTEREST AND FINANCING EXPENSE. Interest and financing expense
increased to $1.1 million in 1998 from nil in 1997 due to interest paid or
accrued and the amortization of costs attributable to warrants issued in
connection with term loans entered into in April and September 1998.
COMPARISON OF FISCAL YEAR ENDED DECEMBER 31, 1997 TO FISCAL YEAR ENDED DECEMBER
31, 1996
SALES. Sales increased 210% to $3.0 million in 1997 from $1.0 million
in 1996. This increase resulted from increased sales of our automated DNA
sequencing systems and from the commencement in 1997 of sales of GeneKits and
other consumables. In 1997, 91 automated DNA sequencing systems were sold, an
increase of 112% from the 43 systems sold in 1996. In 1997, automated DNA
sequencing systems accounted for 90% of total sales, compared to 95% of total
sales in 1996. GeneKits and other consumables accounted for 8% of total sales in
1997, compared to 5% of total sales in 1996. Sales during 1997 in North America,
Europe, and Asia and South America were $2.8 million, $0.2 million and $0.05
million, respectively, as compared to $0.8 million, $0.1 million and nil,
respectively, during 1996. During 1997, no customer accounted for more than 10%
of sales. During 1996, two customers each accounted for approximately 15% of
sales, all of which were comprised of DNA sequencing systems. The sales to these
two customers were on the same general terms and conditions as the majority of
other sales during the year.
COST OF SALES. Cost of sales increased to $2.0 million in 1997 from
$0.6 million in 1996. In 1997, cost of sales aggregated 66% of sales as compared
to 57% of sales in 1996. Cost of sales increased in 1997 as a percentage of
sales due to capacity constraints and various manufacturing challenges as
production increased to meet demand.
SALES, GENERAL AND ADMINISTRATIVE EXPENSES. Sales, general and
administrative expenses increased 121% to $7.4 million in 1997 from $3.4 million
in 1996. This increase primarily resulted from increased payroll and personnel
costs as we hired additional selling, marketing, administrative and management
personnel due to our growth, and the costs of developing a sales force in North
America and certain countries in Europe. Sales and marketing costs included in
sales, general and administrative expenses increased to $3.6 million in 1997
from $0.7 million in 1996.
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RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased 50% to $4.1 million in 1997 from $2.7 million in 1996. This increase
resulted from increased payroll and personnel costs along with increased
purchases of laboratory supplies as we established a research facility in
Pittsburgh, the continued development of GeneKits at our main lab in Toronto and
with outside researchers and increased design and development costs associated
with our OpenGene System.
Effective October 1997, we acquired Applied Sciences, Inc., a
Georgia-based diagnostics company specializing in HIV genotyping. This
acquisition was accounted for as a purchase and resulted in the recording of
an excess of purchase price over tangible assets of $0.7 million. This amount
was determined to be in-process research and development and was reflected as
an expense in 1997. The in-process research and development relates to the
cost and time pertaining to the development of certain test kits designed for
use with DNA sequencing systems. As of October 1997, these kits were
approximately 20% to 50% completed. Development of one kit was completed in
the fourth quarter of 1998, and the remaining kits are expected to be
completed during 2000. At the date of acquisition, the test kits had not yet
reached technological feasibility and had no alternative future uses in the
clinical diagnostic market.
INTEREST INCOME. Interest income increased to $0.8 million in 1997 from
$0.6 million in 1996. This increase resulted because in 1996 we earned only six
months' interest following our initial public offering in June 1996.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations primarily through
private placements of equity and an initial public offering in June 1996. We
have also borrowed funds from institutional lenders and in the past utilized a
bank credit facility.
BANK CREDIT FACILITY. In 1997, we obtained a bank line of credit for up
to $1.1 million from the Royal Bank of Canada. The loan was secured by a lien on
our accounts receivable, inventory and fixed assets. In April 1998, the bank
line was repaid and the line was cancelled.
INSTITUTIONAL LOANS. On April 30, 1998, our subsidiary, Visible
Genetics Corp., or VGC, borrowed $7.0 million from various funds for which Hilal
Capital Management LLC serves as general partners, investment advisor or
management company. We refer to these funds in this Annual Report as our
"institutional lenders" or the "Hilal funds." In September 1998, VGC borrowed an
additional $1.0 million from these lenders. Proceeds of both loans may be used
by us and our subsidiaries. The loans bear interest at 10% per year. Interest
and principal on the $7.0 million loan were payable on or about April 29, 1999,
and, on the $1.0 million loan, were payable on December 28, 1999.
On April 30, 1999, we and the institutional lenders agreed to delay the
payment date of the $7.0 million loan to December 31, 1999, and to move up the
payment date of the $1.0 million loan to July 1, 1999. The institutional lenders
later extended the payment date to the earlier of July 22, 1999, the completion
of our proposed $5.0 million credit facility and the completion of the Warburg
Pincus financing. In addition, the institutional lenders agreed to permit us to
borrow up to an additional $5.0 million of loans from other lenders which would
be senior to the $7.0 million loan and junior to the $1.0 million loan.
We guaranteed VGC's obligations under both loans. We gave the
institutional lenders a security interest in most of our assets to secure our
obligations under the guaranty, including a pledge of the outstanding stock of
VGC. Both the loan agreements and the guaranty impose certain restrictions on us
and our subsidiaries, including limitations on loans and other obligations which
we may incur.
As part of the loan arrangements, we granted the institutional
lenders warrants to purchase our common shares. Initially, we granted the
institutional lenders warrants to purchase 420,000 common shares which may be
exercised until April 2003, at a price of $10.00 per share. When we borrowed
an additional $1.0 million from the institutional lenders in September 1998,
we granted them warrants for an additional 120,000 common shares which may be
exercised until September 2003, at a price of $10.00 per share. The warrants
were valued using the Black-Scholes option valuation model. The total
proceeds received from the institutional lenders were allocated between the
warrants and term loans based on the relative fair value of each component,
resulting in $0.9 million and $0.2 million of the total proceeds from the
April 1998 and September 1998 term loans, respectively, being allocated to
warrants. The value of the term loans were to be increased to their face
value at their respective maturity dates, resulting in a charge to financing
expense and warrants, by their pro rata share, over the remaining term of the
loans. As a result, non-cash charges of $0.6 million were recorded as
financing expenses in 1998. The remaining $0.4 million will to be recorded as
non-cash financing expenses in 1999.
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On April 30, 1999, we granted the institutional lenders warrants to
purchase an additional 140,000 common shares which may be exercised until April
30, 2006, at a price of $17.00 per share. The warrants were valued using the
Black-Scholes option valuation model, resulting in a value being attributed to
these warrants of $0.9 million. This amount was recorded as a deferred charge on
the balance sheet and was to be amortized to financing expense over the
remaining term of the loan maturing on December 31, 1999. As a result, the
entire amount will be recorded as a non-cash charge to financing expense in
1999.
On July 8, 1999, we and the institutional lenders agreed that,
concurrently with the completion of the proposed Warburg Pincus financing, we
would repay $4.1 million principal amount and interest of the loan, the
institutional lenders would convert the remaining $3.9 million principal amount
and interest into Series A convertible preferred shares and we would grant the
institutional lenders 144,760 warrants to purchase our common shares. The Series
A preferred shares and warrants have the same terms as those granted to Warburg
Pincus. The warrants were valued using the Black-Scholes option valuation model.
The value of the net proceeds is to be allocated between convertible preferred
shares and warrants based on the relative fair value of each instrument. The
total amount allocated to warrants and preferred shares, will be $0.9 million
and $3.0 million, respectively. The value of the warrants is treated as a
discount to the preferred shares and will be charged directly to retained
earnings over seven years, the time period when redemption of the preferred
shares first becomes mandatory.
PROPOSED WARBURG PINCUS FINANCING. On July 9, 1999, E.M. Warburg,
Pincus & Co., LLC, signed a letter of intent on behalf of certain affiliated
funds to invest $30.0 million in our company. In consideration for this
investment, we will issue to the Warburg Pincus funds 30,000 Series A preferred
shares convertible at the holders' option into common shares at $11.00 per
share, and warrants to purchase 1,100,000 common shares exercisable for four
years at a purchase price of $12.60 per share. The warrants were valued using
the Black-Scholes option valuation model. The value of the net proceeds will be
allocated between convertible preferred shares and warrants based on the
relative fair value of each instrument. The total amount allocated to warrants
and preferred shares will be $6.4 million and $22.8 million, respectively. The
value of the warrants is treated as a discount to the preferred shares and will
be charged directly to retained earnings over seven years, the time period when
redemption of the preferred shares first becomes mandatory. The preferred shares
and the warrants will contain provisions under which the conversion price and
exercise price, respectively, would be reduced on a weighted average basis if we
issue shares, options or certain other securities at prices lower than the
conversion price or exercise price (subject to certain exceptions), and would
also be adjusted upon the issuance of certain other securities, certain
recapitalization events and in certain other circumstances to protect the
holders against the dilutive effect of those events. We have agreed to file a
registration statement by October 30, 1999, registering the common shares
underlying the Series A preferred shares and the warrants, and we also will
grant certain other registration rights to the preferred shareholders and
warrantholders.
Dividends on the preferred shares will accrue at the rate of 9% per
year during the first three years after issuance, and 4% per year thereafter.
Dividends will not be payable for the first three years. After three years, at
our option, we may pay dividends in cash. If dividends are not paid in cash,
they will continue to accrue and will be convertible into additional common
shares upon conversion of the preferred shares. After the third anniversary and
prior to the seventh anniversary of the date of issuance of the preferred
shares, we would have the right to redeem the outstanding preferred shares at a
price, which we call the redemption price, equal to $1,000 per share, plus
accrued but unpaid dividends, provided that the price of our common shares on
the Nasdaq National Market equals or exceeds 150% of the conversion price for 20
trading days during a consecutive 30-day period ending within 10 days before we
notify shareholders of the redemption. We will be required to redeem one-third
of any remaining outstanding preferred shares on each of the seventh, eighth and
ninth anniversaries of the date of issuance at the redemption price, and we will
be permitted to redeem the preferred shares at any time beginning on the seventh
anniversary after issuance. If we fail to redeem the shares as required, holders
may appoint a majority of our Board of Directors, who will continue to serve
until we have redeemed the preferred shares as required.
Upon completion of the Warburg Pincus financing, the Warburg Pincus
funds would own 27.8% of our common shares (after conversion of the Series A
preferred shares and exercise of the warrants) and would have the right to
acquire additional common shares as dividends accrue on the Series A preferred
shares, or if we issued other securities on terms that trigger the anti-dilution
provisions of the Series A preferred shares or warrants.
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The holders of Series A preferred shares will be entitled to vote as a
group with the holders of common shares on all matters except that holders of
Series A preferred shares will be entitled to vote separately for one director
and will not be entitled to participate in the vote for any other directors of
our company. Our agreements with the holders of Series A preferred shares will
provide that we will be prohibited from declaring or issuing any dividends to
holders of our common shares before paying all unpaid dividends on the Series A
preferred shares. We will also be prohibited from issuing any equity securities
that are senior or equal in rank to the Series A preferred shares without
approval of the holders of a majority of the Series A preferred shares. If our
company were to be liquidated or sold or under certain other circumstances,
holders of Series A preferred shares would be entitled to receive an amount
equal to $1,000 per share, plus accrued dividends, before holders of our common
shares would be entitled to any distributions. Holders of Series A preferred
shares would also be entitled to certain other rights, including the right to
participate, on a pro rata basis, in future company financings, subject to
certain exceptions. We also would be prohibited from incurring indebtedness for
borrowed money and capital lease obligations in excess of $15.0 million
outstanding at any one time, without first obtaining approval of the holders of
a majority of the Series A preferred shares.
We have received an opinion from Hambrecht & Quist LLC that the Warburg
Pincus financing is fair from a financial point of view to our company.
Completion of the proposed Warburg Pincus financing is subject to the
satisfaction of various closing conditions and finalization of definitive
documents. We are in the process of completing those agreements. However, we
cannot guarantee that the Warburg Pincus financing will be completed.
CAPITAL EXPENDITURES. Additions to fixed assets were approximately $0.8
million, $1.1 million and $3.3 million for the years ended December 31, 1996,
1997 and 1998, respectively. We expect capital expenditures to increase over the
next several years as we expand our facilities and acquire additional
manufacturing and scientific equipment.
CURRENT AND FUTURE FINANCING NEEDS. We have incurred negative cash flow
from operations since we started our business. We have spent, and expect to
continue to spend, substantial amounts to complete our planned product
development efforts, expand our sales and marketing activities, conduct our
clinical trials, conduct research, build our business infrastructure and expand
our manufacturing capabilities. At this time, funds from operations are not
sufficient to meet our operating needs and other anticipated financial
requirements, including repayment to our institutional lenders of a $1.0 million
loan plus interest by the earlier of July 22, 1999, the completion of our
proposed $5.0 million credit facility and the completion of the proposed Warburg
Pincus financing, and a $7.0 million loan plus interest on December 31, 1999.
We are in the process of negotiating various financings which, if
completed in a timely manner, would provide us with SUFFICIENT capital to meet
our anticipated needs for the next 12 months. We have signed a letter of intent
with Warburg Pincus under which certain Warburg Pincus funds would invest $30.0
million in our company on the terms described in "PROPOSED WARBURG PINCUS
FINANCING" above. We are in the process of completing the definitive agreements
for the proposed Warburg Pincus financing. However, we cannot guarantee the
agreements or this investment will be completed in a timely manner, or at all.
In addition, our institutional lenders have agreed that, if we complete the
Warburg Pincus financing, they will convert $3.9 million principal amount plus
interest of our outstanding loan into Series A preferred shares and warrants on
the same basis as the Warburg Pincus financing. We will repay the remaining $4.1
million principal plus interest from proceeds received from the Warburg Pincus
financing.
We have also received a commitment from a financial institution to
provide a $5.0 million credit facility to VGC, subject to certain conditions,
including completion of the lender's due diligence review of our company. We are
in the process of negotiating the definitive loan documents under which this
loan would be made. However, we cannot guarantee that we will be able to
finalize the loan in a timely manner, or at all. The credit facility would be
comprised of a one-year renewable $2.5 million revolving credit facility and a
three-year $2.5 million term loan. The loans would be secured by a security
interest in substantially all of VGC's assets. We and our subsidiaries would be
required to guarantee the loan and secure our guaranties by granting the lenders
a security interest in substantially all of our assets. The agreements would
impose certain restrictions on us and our subsidiaries, including limitation on
loans and other obligations which we may incur.
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If we are able to complete the proposed equity financing and concurrent
conversion of institutional loans to equity, as well as the $5.0 million credit
facility, we believe, based on our current plans, that our cash on hand,
anticipated funds from operations, proceeds from the contemplated equity
financing and anticipated borrowings under the proposed credit facility would be
sufficient to enable us to repay our remaining obligations to our institutional
lenders and meet our operating needs for the next 12 months. If we are able to
complete only the proposed credit facility, but not the proposed equity
financing and concurrent conversion of debt, we would need to raise significant
additional financing to continue to meet our operating needs and in order to
repay the loan to our institutional lenders due on December 31, 1999. We have no
commitment for additional financing at this time, and cannot guarantee that we
would be able to obtain such financing in a timely manner, on acceptable terms
or at all. If we are unable to complete any of the proposed equity financing,
concurrent conversion of debt or the proposed bank facility or other substitute
financing when needed, we would likely default under our obligation to our
institutional lenders, we would be unable to meet many of our other obligations
and our business and future prospects would be materially adversely affected.
The assumptions described above are based on our current plans and
expectations during the next 12 months. However, the actual amount of funds that
we will need during the next 12 months will be determined by many factors, some
of which are beyond our control. Therefore, we may need funds sooner or in
greater amounts than we currently anticipate. If we need to obtain funds at the
end of 12 months or earlier, potential sources of financing may include
strategic relationships, public or private sales of our shares or debt or other
arrangements. We do not have any other committed sources of financing at this
time and it is uncertain whether additional funding will be available when
needed or on acceptable terms or at all.
If we wish to issue equity securities or obtain additional financing
after the proposed Warburg Pincus financing is completed, we may need the
consent of the Series A preferred shareholders. We will be required to obtain
the consent of the holders of a majority of the then outstanding Series A
preferred shares prior to issuing any equity security that has rights as to
dividends and liquidation that are senior or equal to those of the Series A
preferred shares. We will also be required to obtain the consent of the holders
of a majority of the then outstanding Series A preferred shares if we wish to
borrow money and at such time or as a result of such loans, the total principal
amount of our indebtedness and capitalized lease obligations exceeds $15.0
million. Our proposed credit facility would also impose limitations on our
ability to incur additional indebtedness under certain circumstances. As a
result, we may be delayed in, or prohibited from, obtaining certain types of
financing.
If the Warburg Pincus financing is completed or if we raise
funds by selling additional common shares or other securities convertible into
common shares, the ownership interest of our existing shareholders will be
diluted.
See "Risk Factors-We may need additional capital."
YEAR 2000
As the year 2000 approaches, an issue exists for companies that rely on
computers as a result of the computer industry's past practice of using two
digits rather than four digits to identify the applicable year. Consequently,
many software applications and programs may not properly recognize calendar
dates beginning in the year 2000. If not corrected, these applications and
programs could fail or create erroneous results.
We have conducted a comprehensive examination of our information
technology systems and the software applications sold with our products to
determine year 2000 compliance. Based on our examination, we believe that these
systems and software applications are year 2000 compliant.
We do not expect that the costs associated with achieving year 2000
compliance will have a material adverse effect on our future results of
operations, liquidity or capital resources. We estimate that the cost of our
year 2000 compliance efforts will be approximately $470,000, of which $450,000
represents the cost of a new enterprise system purchased in 1998. While we did
not purchase the new system specifically in response to year 2000 issues,
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our efforts at compliance accelerated the timetable for purchasing the system.
We believe that the costs to be incurred in reviewing our non-information
technology systems will be immaterial.
We are in the process of contacting our significant customers,
suppliers and third-party service providers to identify year 2000 problems and
provide solutions to prevent the disruption of business activities. At present,
we are compiling information regarding the extent of year 2000 compliance by our
significant customers, suppliers and third-party service providers. We expect to
complete review of the compliance efforts by these parties in the third quarter
of 1999.
Until we gain a better understanding of the readiness and plans of
our significant customers, suppliers and third-party service providers, we
will not have a basis for determining, or developing a response to, a worst
case scenario resulting from their failure to be year 2000 compliant. At
present, we anticipate that a likely worst case scenario would involve
disruption of our material supply and distribution channels, and in
particular the supply of certain instrument parts and supplies from
single-source suppliers. This would likely lead to material interruption in
product development and sales of our products. At the completion of our
review of significant customers, suppliers and third-party service providers,
we intend to assess worst case scenarios and to develop one or more
contingency plans that may be necessary, such as securing alternative
suppliers. See "Risk Factors-We face risks relating to year 2000."
EURO CONVERSION
Effective January 1, 1999, 11 of the 15 member countries of the
European Union adopted the euro as their common legal currency and each
participant established fixed conversion rates between their sovereign, or
legacy, currencies and the common euro currency. The legacy currencies of the
individual countries are scheduled to remain legal tender as denominations of
the euro until January 1, 2002, when euro-denominated bills and coins will be
introduced. During this transition period, public and private parties may choose
to pay for goods and services using either the euro or the participating
country's legacy currency. By July 1, 2002, the legacy currencies will be phased
out entirely as legal tender.
We currently conduct business operations in U.S. and Canadian dollars
and several other currencies. Since our information systems and processes
generally accommodate multiple currencies, we anticipate that any necessary
modification to our information systems, equipment and processes to accommodate
euro transactions will be made on a timely basis and do not expect any failures
that would have a material adverse effect on our financial position or results
of operations.
ITEM 9A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not own and have not issued any market risk sensitive instruments
about which disclosure is required to be provided pursuant to this Item.
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ITEM 10. DIRECTORS AND OFFICERS OF REGISTRANT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
The following table sets forth certain information with respect to our
directors, executive officers and key employees. This information is supplied
based upon our records and information furnished by directors and officers.
<TABLE>
<CAPTION>
Director's
Year Term
Name Age Position with Company Appointed Expires
- - ---- --- --------------------- --------- -------
<S> <C> <C> <C> <C>
Dr. John K. Stevens(1) 52 Chairman of the Board 1993 2002
President, Chief Executive Officer and
Richard T. Daly 49 Director 1998 2001
Vice President, Finance and Chief Financial
Jeffrey D. Sherman 43 Officer 1994
Dr. Richard J. Carroll 53 Vice President, Business Development 1997
Dr. James M. Dunn 45 Vice President, Technology 1994
Robert J. Griffin 55 Vice President, Manufacturing 1998
Dr. Chalom Sayada 34 Vice President, European Business Development 1998
Vice President of Regulatory and Clinical
Dr. Dean L. Winslow 46 Affairs 1999
Samuel Schwartz(2) 53 Secretary and Director 1995 2000
Michael A. Cardiff 40 Director 1999 2000
Sheldon Inwentash(1)(2)(3) 43 Director 1994 2002
Dr. Thomas C. Merigan, Jr. 65 Director 1999 2001
Dr. J. Robert S. Prichard(3) 50 Director 1999 2002
Dr. Lloyd M. Smith(2)(3) 44 Director 1995 2001
Dr. Konrad M. Weis(1) 70 Director 1997 2001
</TABLE>
- - ----------------------
(1) Member of Executive Committee
(2) Member of Audit Committee
(3) Member of Compensation Committee
The following is the business experience of each of the directors,
executive officers and key employees of Visible Genetics for at least the last
five years:
DR. JOHN K. STEVENS is the founder of our company, and has been the
Chairman of the Board since June 1993. Dr. Stevens served as President and Chief
Executive Officer of our company from June 1993 until July 1999. From 1991 until
1995, Dr. Stevens served as the executive director of the Eye Research Institute
of Canada, a not-for-profit organization. Prior to 1991, Dr. Stevens formed or
managed several high technology companies. In 1990, he formed Amacrine
International, an electron microscopy products manufacturing company, where he
served as Chief Executive Officer until the sale of that company to Ted Pella,
Inc. in 1994. Dr. Stevens has held appointments as an assistant professor at the
University of Pennsylvania, and as a professor in the Playfair Neuroscience Unit
of the University of Toronto. Dr. Stevens is listed as an inventor on a number
of U.S. patent applications relating to various software algorithms and
computer-related hardware.
RICHARD T. DALY has been President and Chief Executive Officer since
July 1999, and a Director of our company since June 1998. Mr. Daly served as
Executive Vice President of our company from March 1999 to June 1999. Prior to
joining Visible Genetics, Mr. Daly founded, and, from March 1989 through July
1998, served as
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Chairman and Chief Executive Officer of Clinical Partners, Inc., a San
Francisco-based company providing comprehensive, therapy-specific management of
HIV and AIDS patients for employers and managed health-care organizations. Prior
to founding Clinical Partners, Mr. Daly spent over 15 years in the healthcare
industry with several companies in a variety of executive positions in sales,
marketing and general management, including serving as the President of Baxter
Canada for a period of four years, and President of the Health Data Institute.
JEFFREY D. SHERMAN has been Vice President, Finance and the Chief
Financial Officer of our company since December 1994. From May 1994 to December
1994, Mr. Sherman served as the Senior Vice President, Operations of Pinetree
Capital Inc., a venture capital firm. From October 1987 to April 1994, Mr.
Sherman held a variety of senior positions in treasury, credit, and audit with
the Toronto Dominion Bank. Mr. Sherman is also an adjunct professor at York
University in Toronto. Mr. Sherman is a Chartered Accountant, a Certified
Investment Manager, and a Fellow of the Canadian Securities Institute. Mr.
Sherman received a bachelor of commerce from the University of Toronto and an
MBA from York University.
DR. RICHARD J. CARROLL has been the Vice President, Business
Development of our company since January 1998. From April 1996 to December 1997,
Dr. Carroll was a scientific consultant at Organon Teknika Corp. where he was
responsible for introducing NASBA gene amplification technology for
determination of HIV viral load to the U.S. pharmaceutical and reference
laboratory market. From 1987 to 1996, Dr. Carroll was with Becton Dickinson
VACUTAINER Systems where he was responsible for product development, clinical
trials and FDA filings for its cell separation business. Dr. Carroll holds U.S.
patents that cover blood cell separation and has published numerous scientific
papers related to blood components and HIV detection.
DR. JAMES M. DUNN has been Vice President, Technology of our company
since June 1998 and was our Director of Molecular Test Development from January
1994 to June 1998. Prior to joining our company, Dr. Dunn was a research
consultant to the Hospital for Sick Children from August 1993 to January 1994
and a National Cancer Institute of Canada research fellow at the Division of
Biology, California Institute of Technology from 1990 to 1993. Dr. Dunn received
a B.Sc. in chemistry from the University of British Columbia and a Ph.D. from
the University of Toronto.
ROBERT J. GRIFFIN has been Vice President, Manufacturing of our company
since 1998. From 1996 to 1998, Mr. Griffin provided consulting services to
companies in the areas of operations, quality assurance, product development and
manufacturability. From 1990 to 1996, Mr. Griffin was President of Heritage
Information Technologies, Inc., a company involved in developing a new,
microprocessor-controlled, interactive information system for museums and art
galleries.
DR. CHALOM SAYADA has been Vice President, European Business
Development of our company since February 1998. Since October 1996, he has been
the Chief Executive Officer of ACT Gene S.A., a subsidiary which we acquired in
1998. From May 1993 until October 1996, Dr. Sayada served as Amplicor Scientific
and Marketing Manager for Roche France where he developed clinical trials in
Europe and the U.S. From May 1989 until May 1993 he was a medical doctor at
Hospital Robert Debre in Paris. Dr. Sayada holds an M.D. from Creteil Medical
University Hospital, France and a Ph.D. from Paris XII Chatenay Malabry
University, France.
DR. DEAN L. WINSLOW has been Vice President, Regulatory and Clinical
Affairs of our company since May 1999. From 1997 to May 1999, Dr. Winslow was
Director, Antiviral Research for Gilead Sciences. From 1988 to May 1999, Dr.
Winslow was Clinical Professor of Medicine at Stanford University School of
Medicine. Dr. Winslow is currently a consultant in infectious diseases to the
Surgeon General, United States Air Force and Chairman of the Virology
Subcommittee for the Inter-Company Collaboration for AIDS Drug Development.
SAMUEL SCHWARTZ has been a Director and the Secretary of our company
since 1995. Since 1987, Mr. Schwartz has been a Senior Partner of the law firm
Goldman, Spring, Schwartz & Kichler, Canadian counsel to the Company. Mr.
Schwartz is a member of both the Ontario and Alberta Bars.
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MICHAEL A. CARDIFF has been a Director of our company since June 1999.
Mr. Cardiff has been Executive Vice President, Financial Services of EDS Canada
since October 1996. From November 1994 to September 1996, Mr. Cardiff was Senior
Vice President of Sales and Marketing of EDS Canada and from 1989 to 1994, he
held several positions with Stratus Computer Corp. Mr. Cardiff presently is a
member of the boards of directors of Visible Decisions Inc. (which company is
not related to our company), SOLCORP Insurance Software Solutions Corp. and
Spectra Securities Software Inc.
SHELDON INWENTASH has been a Director of our company since April 1994.
Since November 1993, Mr. Inwentash has been the President and Chief Executive
Officer of GeneVest Inc. (formerly known as Gene Screen Inc.), a Canadian
company which is a principal shareholder of our company. Since February 1992,
Mr. Inwentash has been the Chairman and Chief Executive Officer of Pinetree
Capital Corp., a venture capital firm.
DR. THOMAS C. MERIGAN, JR., was elected as a director of our company in
May 1999. Dr. Merigan has been the George E. and Lucy Becker Professor of
Medicine at Stanford University School of Medicine since 1980. From 1966 to
1992, Dr. Merigan was the head of the Division of Infectious Diseases at
Stanford University School of Medicine. Dr. Merigan is currently a member of the
Scientific Advisory Board of Calydon Corp., and the boards of directors of
Hollis Eden Inc. and Beacon Diagnostics. Dr. Merigan is listed as one of the
inventors of numerous U.S. patents.
PROF. J. ROBERT S. PRICHARD was elected as a director of our company in
May 1999. Prof. Prichard has been President of the University of Toronto since
1990. From 1984 to 1990, Prof. Prichard was Dean of the Faculty of Law at the
University of Toronto. Prof. Prichard is currently Chairman of the Council of
Ontario Universities, a member of the Executive Committee of the Association of
American Universities and a Director of the Association of Universities and
Colleges of Canada and the International Association of Universities. Prof.
Prichard presently serves as a Director of the Toronto Hospital, Onex
Corporation, Imasco Ltd., Moore Corporation, Four Seasons Hotels Inc. and Tesma
International Inc.
DR. LLOYD M. SMITH has been a Director of our company since March 1995.
Since June 1994, Dr. Smith has been Romnes Professor of Chemistry at the
University of Wisconsin-Madison. Dr. Smith has been involved in the development
of fluorescence-based automated DNA sequencers for over 15 years, has written
numerous scientific papers and is a named inventor on a number of U.S. patents.
Dr. Smith is a member of the National Institutes of Health National Human Genome
Research Institute Study Section and the Department of Energy, Biotechnology
Consortium. He also serves, or has served, on the editorial boards of GENOME
RESEARCH, DNA SEQUENCE GENETIC ANALYSIS: TECHNIQUES AND APPLICATIONS and JOURNAL
OF CAPILLARY ELECTROPHORESIS and was a member of the scientific advisory boards
of Fotodyne Incorporated and Boehringer Mannheim Corp. Dr. Smith is co-founder
of Third-Wave Technologies, Inc., a biotechnology company.
DR. KONRAD M. WEIS has been a Director of our company since 1997. Dr.
Weis has been the honorary Chairman of Bayer Corporation since 1991. He was
President and Chief Executive Officer of the company that later became Bayer
Corporation from 1974 until his retirement in 1991. He presently is a member of
the boards of Michael Baker Corporation and Titan Pharmaceuticals, Inc.
Under Canadian law, a majority of the Board of Directors must be
residents of Canada. It is anticipated that, if the proposed Warburg Pincus
transaction is completed, Dr. Merigan would resign as a director so as to create
a vacancy on the Board for a representative of the Warburg Pincus funds. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources-PROPOSED WARBURG PINCUS FINANCING."
ITEM 11. COMPENSATION OF DIRECTORS AND OFFICERS.
All of our directors who are not employees or officers receive a $2,500
fee for each Board of Directors or committee meeting they attended, up to
$10,000 per year. Directors who are not our employees are also eligible to
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participate in our Director Option Plan. All directors are reimbursed for
reasonable out-of-pocket travel expenses incurred by them in attending meetings
of the Board of Directors or committee meetings.
The aggregate amount of compensation paid by us to (or earned by) all
of our directors and officers as a group (13 persons) in 1998 was approximately
$877,438 for services in such capacities, of which, approximately $450,245 was
paid as bonuses. These amounts do not include compensation we paid to firms with
which a director is associated.
ITEM 12. OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT OR SUBSIDIARIES.
As of July 12, 1999 there were options and warrants outstanding to
purchase an aggregate of 2,542,794 common shares, including options to purchase
893,110 common shares held by directors and officers as a group. The options
held by directors and officers as a group have exercise prices ranging from
$1.00 to $11.50 per share and expire at various times between 2004 and 2009. The
other options and warrants have exercise prices ranging from $1.37 to $17.00 per
share, and expire at various times between 2002 and 2009.
ITEM 13. INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS.
In July 1996, we loaned Dr. Stevens $323,405. Interest accrued on the
outstanding principal amount of the loan at the annual rate of 6% and was
payable annually on December 31. The principal amount was payable $17,967 on or
before December 31, 1997 and the balance in nine equal annual installments
ending on December 31, 2007. In 1998, we amended the loan arrangement to
eliminate all required interest payments and to provide that the principal is
repayable in full on or before December 31, 2006. In addition, during 1997, we
loaned Dr. Stevens $50,000 which is payable, together with accrued interest at
the rate of 6% per year, on December 31, 1999. The largest aggregate amount of
indebtedness owed by Dr. Stevens was $379,769 during 1999.
In June 1998, Richard Daly was appointed as one of our directors to
fill a vacancy on the Board. During 1998, we paid an aggregate $280,000 in
consulting fees to Clinical Partners, Inc. in connection with clinical studies
performed by Clinical Partners, Inc. for us. Mr. Daly is the founder and was
previously the Chairman and President of Clinical Partners.
Mr. Samuel Schwartz, one of our directors and officers, is a senior
partner of a law firm to which we paid legal fees in 1998.
In March 1999, we entered into a Letter of Understanding with Dr.
Thomas C. Merigan, Jr., which sets forth the terms and conditions under which we
will be entitled to acquire certain assets and intellecutual property from him
and an entity affiliated with him. It is anticipated that the transactions
contemplated by the Letter of Understanding will be effected pursuant to a
definitive agreement to be entered into by Dr. Merigan and our company or one of
our subsidiaries. This agreement has not yet been entered into. Provided that
all terms and conditions of the Letter of Understanding and the definitive
agreement are met, Dr. Merigan will be entitled to receive 50,000 common shares,
which will vest at the rate of 12,500 common shares a year for four years. It is
contemplated that Dr. Merigan will provide part time consulting services to us.
The transactions contemplated by the Letter of Understanding are contingent upon
the approval of our Board of Directors. Dr. Merigan began performing part time
services for us in March 1999, for which he is compensated by us at the rate of
$75,000 a year. Dr. Merigan joined our Board of Directors in May 1999 and was
granted options to purchase 15,000 of our common shares.
In 1998, VGC borrowed an aggregate of $8.0 million in principal from
the Hilal funds. Hilal Capital Management LLC, which advises or manages the
Hilal funds, beneficially owns 11.3% of our common shares. For a description of
these loans and the proposed conversion of a portion of these loans to equity by
the Hilal funds, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations-Liquidity and Capital
Resources-INSTITUTIONAL LOANS".
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PART II
ITEM 14. DESCRIPTION OF SECURITIES TO BE REGISTERED.
Not applicable.
PART III
ITEM 15. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 16. CHANGES IN SECURITIES AND CHANGES IN SECURITY FOR REGISTERED
SECURITIES.
None.
PART IV
ITEM 17. FINANCIAL STATEMENTS.
Not applicable.
ITEM 18. FINANCIAL STATEMENTS
Attached. See Item 19(a).
ITEM 19. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements:
<TABLE>
<CAPTION>
Page
----
<S> <C>
Auditors' Report............................................................................... F-1
Consolidated Balance Sheets as at December 31, 1997 and 1998................................... F-2
Consolidated Statements of Operations for the years ended December 31, 1996, 1997 and 1998..... F-3
Consolidated Statements of Comprehensive Loss for the years ended December 31, 1996, 1997
and 1998....................................................................................... F-4
Consolidated Statements of Deficit for the years ended December 31, 1996, 1997 and 1998........ F-4
Consolidated Statements of Cash Flow for the years ended December 31, 1996, 1997 and 1998...... F-5
Notes to Consolidated Financial Statements..................................................... F-6
</TABLE>
(b) Exhibits:
The following exhibits are being filed herewith:
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3.1 Term Loan Agreement, dated as of April 30, 1998, by and among
Visible Genetics Corp., Hilal Capital, L.P., Hilal Capital QP,
LP, Hilal Capital International, Ltd., Highbridge
International LLC, C.J. Partners L.P. and Hilal Capital
Management LLC, as adviser for Leo Holdings, Inc.
3.2 Form of Warrant Agreement, attached as Exhibit C to Exhibit
3.1.
3.3 General Security Agreement, dated as of April 30, 1998,
between Visible Genetics Inc. and Hilal Capital Management
LLC, attached as Exhibit D to Exhibit 3.1.
3.4 Registration Rights Agreement, dated April 30, 1998, by and
among Visible Genetics Inc. and the Initial Holders specified
on the signature page thereto, attached as Exhibit E to
Exhibit 3.1.
3.5 Guarantee, dated as of April 30, 1998, by and among Visible
Genetics Inc., Hilal Capital, L.P., Hilal Capital QP, LP,
Hilal Capital International, Ltd., Highbridge International
LLC, C.J. Partners L.P. and Hilal Capital Management LLC, as
adviser for Leo Holdings, Inc., attached as Exhibit G to
Exhibit 3.1.
3.6 Amendment No. 1 to Term Loan Agreement, dated as of September
29, 1998, by and among Visible Genetics Corp., Hilal Capital,
L.P., Hilal Capital QP, LP, Hilal Capital International, Ltd.,
Highbridge International LLC, C.J. Partners L.P. and Hilal
Capital Management LLC, as adviser for Leo Holdings, Inc.
3.7 Common Shares Purchase Agreement, dated November 20, 1998,
between Visible Genetics Inc. and each of the Investors who
are signatories thereto.
3.8 Registration Rights Agreement, dated November 20, 1998, by and
among Visible Genetics Inc. and the Investors to that certain
Common Shares Purchase Agreement.
3.9 Stock Purchase Agreement, dated April 7, 1998, between Visible
Genetics Inc., Mr. Chalom Sayada, Mr. Jean Marc Feryn and Mr.
Philippe Halfon. (THIS AGREEMENT IS IN FRENCH, THEREFORE AN
ENGLISH VERSION OF THE AGREEMENT HAS ALSO BEEN FILED.)
3.10 Agreement and Plan of Merger, dated as of September 10, 1997,
by and among Visible Genetics Inc., VGI Acquisition, Inc.,
Applied Sciences, Inc. and the Shareholders of Applied
Sciences, Inc.
3.11 PCR Diagnostic License Agreement, dated August 18, 1997, by
and between Roche Molecular Systems, Inc., F. Hoffmann-La
Roche Ltd. and Visible Genetics Inc. (THIS AGREEMENT IS FILED
IN REDACTED FORM AS IT IS SUBJECT TO A REQUEST FOR
CONFIDENTIAL TREATMENT SUBMITTED TO THE SEC.)
23.1 Consent of PricewaterhouseCoopers LLP
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SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange
Act of 1934, the Registrant certifies that it meets all of the requirements for
filing on Form 20-F and has duly caused this Annual Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
VISIBLE GENETICS INC.
By: /s/ RICHARD T. DALY
-------------------------------------
Richard T. Daly
President and Chief Executive Officer
Date: January 10, 2000
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AUDITORS' REPORT
TO THE SHAREHOLDERS OF VISIBLE GENETICS INC.
We have audited the consolidated balance sheets of Visible Genetics
Inc. as at December 31, 1998 and 1997 and the consolidated statements of
operations, deficit, comprehensive loss, and cash flows for the years ended
December 31, 1998, 1997 and 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
In our opinion, these financial statements present fairly, in all
material respects, the financial position of the Company as at December 31, 1998
and 1997 and the results of its operations and the changes in its cash flows for
the years ended December 31, 1998, 1997 and 1996 in accordance with generally
accepted accounting principles in the United States of America.
/s/ PricewaterhouseCoopers LLP
Chartered Accountants
Toronto, Canada
February 19, 1999
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31
-----------
ASSETS 1998 1997
------------ ------------
<S> <C> <C>
Current assets
Cash and cash equivalents ............................... $ 6,165,924 $1,866,679
Short-term investments .................................. 5,108,254 5,721,222
Trade receivables (net of allowance for doubtful accounts
Of $470,926; 1997 - $179,000) ........................... 4,770,796 2,066,685
Other receivables (Note 3) .............................. 1,445,820 244,285
Prepaid and deposits .................................... 233,072 215,993
Inventory (Note 4) ...................................... 3,912,336 772,514
------------ ------------
Total current assets ........................................... 21,636,202 10,887,378
------------ ------------
Fixed assets (Note 5) .......................................... 3,877,163 1,450,980
Patents and licenses (Note 6) .................................. 2,269,170 1,598,014
------------ ------------
$ 27,782,535 $ 13,936,372
============ ============
LIABILITIES
Current liabilities
Notes payable (Note 7) .................................. $ 7,494,877 $ --
Accounts payable ........................................ 3,985,103 1,111,912
Accrued liabilities (Note 8) ............................ 1,723,840 214,728
------------ ------------
Total current liabilities ...................................... 13,203,820 1,326,640
------------ ------------
SHAREHOLDERS' EQUITY
Share capital (Note 9) ......................................... 46,412,685 31,281,622
Other equity (Note 9) .......................................... 2,232,465 616,061
Cumulative translation adjustment .............................. 84,822 (27,655)
Deficit ........................................................ (34,151,257) (19,260,296)
------------ ------------
14,578,715 12,609,732
$ 27,782,535 $ 13,936,372
============ ============
</TABLE>
COMMITMENTS (NOTE 13)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-2
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years ended December 31
----------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Sales
Products ............................. $ 9,421,933 $ 2,967,695 $ 978,139
Services ............................. 1,453,415 65,041 --
------------ ------------ ------------
10,875,348 3,032,736 978,139
------------ ------------ ------------
Costs of sales
Products ............................. 5,995,869 1,963,312 561,021
Services .............................. 677,712 31,520 --
------------ ------------ ------------
6,673,581 1,994,832 561,021
------------ ------------ ------------
Gross margin ........................... 4,201,767 1,037,904 417,118
Expenses:
Sales, general and administrative 11,515,757 7,447,861 3,377,356
Research and development ......... 6,289,032 4,122,916 2,744,345
Acquired research and development
(Note 10) ........................ 420,043 654,621 --
------------ ------------ ------------
18,224,832 12,225,398 6,121,701
------------ ------------ ------------
Loss from operations before interest ... (14,023,065) (11,187,494) (5,704,583)
Interest income ........................ 264,195 774,462 608,858
Interest and financing expense (Note 7) (1,132,091) (2,714) (68,959)
------------ ------------ ------------
Net loss for the year .................. $(14,890,961) $(10,415,746) $ (5,164,684)
============ ============ ============
Weighted average number of common shares
Outstanding ...................... 7,782,094 7,059,578 5,791,367
Basic and fully diluted loss per share . $ (1.91) $ (1.48) $ (0.89)
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-3
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
<TABLE>
<CAPTION>
Years ended December 31
----------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net loss for the year ........................ $(14,890,961) $(10,415,746) $ (5,164,684)
Other comprehensive income:
Foreign currency translation adjustments 112,477 -- (29,440)
------------ ------------ ------------
Comprehensive loss for the year .............. $(14,778,484) $(10,415,746) $ (5,194,124)
============ ============ ============
</TABLE>
CONSOLIDATED STATEMENTS OF DEFICIT
<TABLE>
<CAPTION>
Years ended December 31
----------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Deficit, beginning of year .. $(19,260,296) $ (8,844,550) $ (3,679,866)
Net loss for the year ....... (14,890,961) (10,415,746) (5,164,684)
------------ ------------ ------------
Deficit, end of year ........ $(34,151,257) $(19,260,296) $ (8,844,550)
============ ============ ============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-4
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
Years ended December 31
----------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cash provided by (used in)
Operating activities
Net loss for the year ...................................... $(14,890,961) $(10,415,746) $ (5,164,684)
Add: Items not involving cash -
Depreciation ......................................... 1,081,957 510,676 219,687
Amortization ......................................... 206,640 135,631 30,749
Deferred compensation cost related to options granted 77,469 250,067 33,841
Non cash financing expense related to warrants granted 580,981 -- --
Foreign exchange loss ................................ 28,453 37,067 --
In-process research and development acquired ......... 420,043 654,621 --
Increase (decrease) from changes in -
Trade receivables .................................... (2,250,576) (1,215,297) (851,388)
Other receivables .................................... (851,666) (140,274) (54,302)
Prepaids and deposits ................................ 26,006 (90,515) (31,282)
Inventory ............................................ (3,094,367) (427,321) (329,368)
Refundable investment tax credits .................... -- 496,993 267,407
Accounts Payable ..................................... 2,531,331 443,622 395,235
Accrued liabilities .................................. 1,180,556 92,542 (16,533)
------------ ------------ ------------
(14,954,134) (9,667,934) (5,194,638)
============ ============ ============
Investing activities
Purchase of fixed assets ................................... (3,313,626) (1,114,197) (823,957)
Licenses and patents acquired .............................. (877,796) (845,929) (504,870)
Purchase of short-term investments ......................... (13,728,066) (3,052,467) (12,090,863)
Redemption of short-term investments ....................... 14,616,777 7,432,233 1,989,875
Acquisitions of ACT Gene S.A ............................... (536,929) -- --
------------ ------------ ------------
(3,839,640) 2,419,640 (11,429,815)
============ ============ ============
Financing activities
Common shares issued, net of expenses ...................... 14,640,188 419,167 25,796,443
Warrants issued in connection with private placement ....... 444,572
Issuance of notes payable .................................. 6,817,559 -- --
Warrants issued in connection with notes payable ........... 1,182,441
Receipt of bridge financing ................................ -- -- 1,250,000
Repayment of bridge financing .............................. -- -- (1,250,000)
Repayment of note payable .................................. -- -- (500,000)
Other equity ............................................... 8,259 38,392 74,579
Capital lease obligation ................................... -- (169,188) --
Loan to officer to purchase shares ......................... -- -- (323,405)
------------ ------------ ------------
23,093,019 288,371 25,047,617
============ ============ ============
Increase (decrease) in cash during the year ....................... 4,299,245 (6,959,923) 8,423,164
Cash beginning of year ..................................... 1,866,679 8,826,602 403,438
------------ ------------ ------------
Cash, end of year .......................................... $ 6,165,924 $ 1,866,679 $ 8,826,602
============ ============ ============
Supplemental information
Interest paid .............................................. $ 48,073 $ 2,714 $ 68,959
Income taxes paid .......................................... $ -- $ -- $ --
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-5
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - NATURE OF OPERATIONS
Visible Genetics Inc. (the "Company') has developed a proprietary
integrated genetic diagnostic system and related proprietary application-based
products. The Company is in the early stages of commercial manufacturing and
marketing of its products. The Company's products are at present intended for
research and clinical purposes. Prior to marketing any products for diagnostic
use, the Company will require appropriate regulatory approvals.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
These financial statements have been prepared in United States dollars,
in accordance with the accounting principles generally accepted in the United
States. The principal accounting policies of the Company, which have been
consistently applied, are summarized as follows:
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements of the Company
include the following wholly owned subsidiaries: Visible Genetics Corp., Visible
Genetics B.V., Applied Sciences, Inc. Gene Foundry Inc., and ACT Gene S.A. All
intercompany accounts and transactions have been eliminated upon consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
Revenue from the sale of the Company's products is recognized when
shipment occurs and title passes to the customer. Revenue for sale of service is
recognized when the service is provided and there is reasonable assurance of
collectability. A provision is made for estimated warranty costs at the time of
the sale. Revenue from extended warranty contracts is recognized over the life
of the contract. Sales of bundled sequencing systems and testing kits are
recognized pro rata as the components of the bundle are shipped to customers.
F-6
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - CONTINUED
FINANCIAL INSTRUMENTS
Cash equivalents and short-term investments consist of high-quality
interest-bearing notes and similar instruments with remaining maturities up to
12 months. They are held to maturity and are recorded at amortized cost which,
due to their short-term nature, approximates market value. As required under
Statement of Financial Accounting Standards (SFAS) No. 95, cash equivalents
consist of short-term investments that are highly liquid and have initial terms
to maturity of three months or less. Other investments are reported as
short-term investments. Receivables, accounts payable, and notes payable are all
carried at cost or accreted cost which, due to their short-term nature,
approximates market value.
CONCENTRATION OF CREDIT RISK
The Company's financial instruments that are exposed to concentration
of credit risk consist primarily of cash and cash equivalents, short-term
investments, and receivables. The Company maintains its accounts for cash and
cash equivalents and short-term investments with a number of large
low-credit-risk financial institutions in Canada and the United States in order
to reduce its exposure. In addition, the Company limits its maximum investment
to any one counterparty to limit its credit exposure.
INVENTORY
Inventory is stated at the lower of cost and estimated realizable
value. Cost is determined by the first-in first-out method, and includes
material, labor, and an allocation of overhead.
FIXED ASSETS
Fixed assets are recorded at cost. Depreciation is provided on a
straight-line basis over the estimated useful lives of the assets, as follows:
Laboratory and computer equipment 3 to 5 years
Leasehold improvements term of the lease
PATENTS AND LICENSES
External costs of patents and licenses are recorded at cost and
amortized over their estimated useful lives, which are generally up to ten
years. If the carrying amount of a patent or license is no longer recoverable,
the related unamortized cost is written down to fair value.
FOREIGN CURRENCY TRANSLATION
Monetary assets and liabilities denominated in foreign currencies are
translated into United States dollars at the exchange rate prevailing at the
balance sheet date. Other assets, liabilities and operating items are translated
at exchange rates prevailing at the respective transaction dates. Resulting
translation adjustments are included in the consolidated statement of
operations. Assets and liabilities of subsidiaries with functional currencies
other than United States dollars are translated at the exchange rate prevailing
at the balance sheet date, and the results of their operations are translated at
average exchange rates for the year. The resulting translation adjustments are
reflected in the cumulative translation adjustment account. Other exchange gains
or losses are included in the consolidated statement of operations.
F-7
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - CONTINUED
INCOME TAXES
The Company provides for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes," which prescribes an asset and liability approach
that results in the recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been recognized in the
consolidated financial statements or tax returns.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development costs are expensed in the period incurred. The
Company is entitled to certain Canadian federal and provincial tax incentives
for qualified research and development. They are accounted for as a reduction of
the related expenditure for current expenses and a reduction of the related
asset for capital assets when it is more likely than not that the credit will be
realized. The Company is entitled to federal investment tax credits at a rate of
20% on eligible current and capital expenditures, claimable against income taxes
otherwise payable.
STOCK OPTIONS
The Company follows SFAS No. 123 which permits the use of APB No. 25 to
account for stock options issued to employees. Under that method, the Company
uses the intrinsic value method to measure the cost associated with the granting
of stock options to employees. The amount by which the market price of the
underlying shares exceeds the exercise price of the options is accounted for as
compensation expense over the periods in which services are rendered. Options
issued to consultants are recorded at their fair market value at the date of the
grant. This amount is charged to operations over the periods in which services
are rendered.
LOSS PER SHARE
The company follows SFAS No. 128 "Earnings per share" to calculate
basic and fully diluted loss per share. Basic loss per share is calculated by
dividing loss available to common shareholders by the weighted average number of
common shares outstanding during the year. The options and warrants outstanding
at the end of the year would be included in the calculation of fully diluted
loss per share using the treasury stock method if the impact was not
anti-dilutive.
NOTE 3 - OTHER RECEIVABLES
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------------
1998 1997
---------- ----------
<S> <C> <C>
Refundable taxes ................... $ 616,214 $ 102,892
Other .............................. 829,606 141,393
---------- ----------
$1,445,820 $ 244,285
========== ==========
</TABLE>
F-8
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - INVENTORY
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------
1998 1997
---------- ----------
<S> <C> <C>
Raw materials .................................. $2,231,994 $ 500,341
Work in process ................................ 339,109 135,988
Finished goods ................................. 1,341,233 136,185
---------- ----------
$3,912,336 $ 772,514
========== ==========
</TABLE>
NOTE 5 - FIXED ASSETS
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------
1998 1997
---------- ----------
<S> <C> <C>
COST
Laboratory and computer equipment ....... $4,581,794 $1,929,925
Leasehold improvements .................. 1,198,488 342,216
---------- ----------
5,780,282 2,272,141
---------- ----------
ACCUMULATED DEPRECIATION AND AMORTIZATION
Laboratory and computer equipment ....... 1,650,840 720,874
Leasehold improvements .................. 252,279 100,287
---------- ----------
1,903,119 821,161
---------- ----------
$3,877,163 $1,450,980
========== ==========
</TABLE>
NOTE 6 - PATENTS AND LICENSES
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------
1998 1997
---------- ----------
<S> <C> <C>
COST
Patents ................................ $1,050,276 $ 699,868
Licenses ............................... 1,616,032 1,088,644
---------- ----------
2,666,308 1,788,512
---------- ----------
ACCUMULATED AMORTIZATION
Patents ................................ 166,548 104,406
Licenses ............................... 230,590 86,092
---------- ----------
397,138 190,498
---------- ----------
$2,269,170 $1,598,014
========== ==========
</TABLE>
F-9
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - NOTES PAYABLE
On April 30, 1998, the Company, through its subsidiary, Visible
Genetics Corp., borrowed $7,000,000 under a term loan agreement with certain
institutional investors. The loan bears interest at 10% per annum, and interest
and principal are payable in full on or about April 29, 1999. The loan is
secured by a security interest in substantially all of the assets of the
Company, and it imposes certain restrictive covenants, including a limit on the
total indebtedness the Company may incur. In connection with the loan, the
Company issued warrants to the lenders to purchase an aggregate of 420,000
common shares at an exercise price of $ 10.00 per share. On September 28, 1998,
the term loan facility was extended under similar terms and the Company borrowed
an additional $1,000,000 under the expanded loan facility. The additional loan
will be due on December 28, 1999. In connection with the additional loan, the
Company issued warrants to the lenders to acquire 120,000 common shares at an
exercise price of $10.00 per share. The fair market value of the warrants is
estimated at the date of grant using the Black-Scholes option valuation model
based upon the following assumptions: dividend yield - nil, risk-free interest
rate - 5.0%, average expected volatility - 65%, expected term - 2 years.
For the April 30, 1998 portion of the term loan, the Company has
allocated $944,636 of the proceeds to warrants, of which $817,110 is a discount
to the term loan that will be amortized to income over the 12 month term of the
loan. For the September 28, 1998 portion of the term loan, the Company allocated
$237,805 of the proceeds to warrants, of which $181,207 is a discount to the
term loan that will be amortized to income over the 15 month term of the loan.
As a result, in 1998, $580,981 was recorded as financing expense in the
consolidated statement of operations.
NOTE 8 - ACCRUED LIABILITIES
<TABLE>
<CAPTION>
DECEMBER 31
------------------------------
1998 1997
---------- ----------
<S> <C> <C>
Warranty provision ..................... $ 90,107 $ 54,545
Salaries and benefits .................. 79,640 69,930
Professional fees ...................... 161,251 70,438
Interest ............................... 503,037 --
Value added taxes ...................... 335,944 --
Other .................................. 553,861 19,815
---------- ----------
$1,723,840 $ 214,728
========== ==========
</TABLE>
NOTE 9 - SHARE CAPITAL
In May, 1996, the Company's shares were consolidated on the basis of
0.7308 new shares for each old share. The number of shares, options and warrants
and the issue price and option price per share have been adjusted to reflect
this on a retroactive basis.
F-10
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - CONTINUED
(a) AUTHORIZED AND ISSUED SHARE CAPITAL
Authorized capital consists of an unlimited number of common shares,
without par value, and an unlimited number of preferred shares, without par
value. No preferred shares have been issued.
<TABLE>
<CAPTION>
NUMBER OF AVERAGE
COMMON SHARES ISSUE PRICE AMOUNT
------------- ----------- ------
<S> <C> <C> <C>
BALANCE, DECEMBER 31, 1995.............................. 4,437,198 $ 4,312,262
Issued on initial public offering, net of issue
costs............................................... 2,500,000 $ 11.50 25,796,443
Issued for technology license....................... 25,000 $ 9.25 231,250
--------- ------- ----------
BALANCE, DECEMBER 31, 1996.............................. 6,962,198 30,339,955
========= ==========
Issued for cash under stock option
arrangements........................................ 191,498 $ 2.19 419,167
Issued for acquisition of Applied Sciences, Inc..... 95,000 $ 5.50 522,500
--------- ------- ----------
BALANCE, DECEMBER 31, 1997.............................. 7,248,696 31,281,622
========= ==========
Issued for cash under stock option
arrangements........................................ 385,548 $ 2.39 921,395
Issued for acquisition of ACT Gene S.A.............. 85,000 $ 5.78 490,875
Issued for private placement offering, net of
issue costs......................................... 1,528,989 $ 9.88 13,718,793
--------- ------- ----------
BALANCE, DECEMBER 31, 1998.............................. 9,248,233 $46,412,685
========= ==========
</TABLE>
The value of the warrants issued in connection with the private
placement (Note 9(e)) in the amount of $444,572 has been recorded as a reduction
of the proceeds of issue and an increase to warrants included in Other equity
(Note 9(b)). The fair market value of the warrants is estimated at the date of
grant using the Black-Scholes option valuation model based upon the following
assumptions: dividend yield - nil, risk-free interest rate - 4.0%, average
expected volatility - 65%, expected term - 2.5 years.
(b) OTHER EQUITY
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Deferred compensation costs ......... $ -- $ (77,469) $ (354,786)
Options ............................. 922,714 922,714 949,964
Warrants ............................ 1,610,791 80,115 80,115
Contributed surplus ................. 61,250 61,250 61,250
Loan to an officer to purchase shares (323,405) (323,405) (323,405)
Employee share purchase loans ....... (38,885) (47,144) (85,536)
----------- ----------- -----------
$ 2,232,465 $ 616,061 $ 327,602
=========== =========== ===========
</TABLE>
F-11
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - CONTINUED
Employee share purchase loans are non-recourse, repayable in November,
1999, and secured only by the shares themselves. The loan to an officer was made
in July 1996 to purchase shares of the Company and is with recourse. The loan is
interest free and is repayable in 2006.
(c) DEFERRED COMPENSATION COSTS
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Balance, beginning of year ........... $ (77,469) $(354,786) $(307,781)
Options granted less cancellation .... -- 27,250 (386,846)
Charged to expense during the year ... 77,469 250,067 339,841
--------- --------- ---------
BALANCE, END OF YEAR ................. $ -- $ (77,469) $(354,786)
========= ========= =========
</TABLE>
(d) OPTIONS
The Company has incentive plans under which options to purchase common
shares may be granted to its employees, consultants or directors at the
discretion of the Board of Directors. Options for an aggregate of 2,260,901
shares may be granted, subject to shareholder ratification. Under the plans,
each option is for the purchase of one common share, expires up to ten years
from the date of issue, and is generally earned over a three year period. There
are no repurchase features. Options issued to employees may be cancelled if
employment is terminated within three years. The number of options that may be
cancelled is reduced in stages over that period. Options issued to employees
after May, 1996 must be exercised within 90 days of the termination of
employment.
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
NUMBER EXERCISE PRICE
---------- ----------------
<S> <C> <C>
BALANCE, DECEMBER 31, 1995 ................... 623,436 $1.61
Granted at $2.01 to $11.50 .............. 612,189 $5.55
---------- -----
BALANCE, DECEMBER 31, 1996 ................... 1,235,625 $3.56
========== =====
Granted at $3.50 to $11.50 .............. 527,580 $5.25
Exercised ............................... (191,498) $2.19
Cancelled ............................... (20,237) $3.50
---------- -----
BALANCE, DECEMBER 31, 1997 ................... 1,551,470 $4.32
========== =====
Granted at $7.70 to $10.98 .............. 580,364 $8.26
Exercised ............................... (387,881) $2.41
Cancelled ............................... (45,902) $4.01
---------- -----
BALANCE, DECEMBER 31, 1998 ................... 1,698,051 $6.11
========== =====
</TABLE>
The fair market value of employee options granted in 1998 was
approximately $2,397,000 (1997 - $1,342,000; 1996 - $1,741,000). If employee
options granted had been recorded at their fair market value, the pro forma net
loss in 1998 would have been $16,753,000 or $(2.15) per share (1997 -
$(11,443,000) or $(1.62) per share; 1996 - $(5,744,000) or $(0.99) per share).
F-12
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - CONTINUED
The fair market value of each option is estimated at the date of grant
using the Black-Scholes option valuation model based upon the following
assumptions: dividend yield - nil, risk-free interest rate (for four-year zero
coupon bond) - 5.0%, average expected volatility - 65%, expected average option
term - 4 years. The weighted average fair value for options granted in 1998 was
$4.13 (1997 - $2.63; 1996 - $2.78).
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's stock option plans have characteristics
significantly different from those of traded options, and because change in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
<TABLE>
<CAPTION>
NUMBER WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
OUTSTANDING AT EXERCISE PRICE OF EXERCISABLE AT EXERCISE PRICE
RANGE OF EXERCISE DECEMBER 31, OUTSTANDING WEIGHTED AVERAGE DECEMBER 31, OF EXERCISABLE
PRICES 1998 OPTIONS REMAINING LIFE 1998 OPTIONS
----------------- ------------ -------------- -------------- ------------- ---------------
<S> <C> <C> <C> <C> <C>
Cdn$1.37-3.42 276,114 Cdn$2.41 6.3 years 273,069 Cdn$2.41
US$3.50 485,111 US$3.50 7.8 years 358,623 US$3.50
$4.45-$6.07 32,400 $5.85 8.7 years 11,800 $5.73
$7.12-$7.84 390,429 $7.79 9.1 years 181,961 $7.77
$8.00-$9.35 319,167 $9.11 9.5 years 133,084 $8.08
$10.00-$11.50 194,830 $11.20 9.3 years 167,080 $11.46
--------- ------ ---------
1,698,051 $6.19 1,125,617
========= ====== =========
</TABLE>
(e) WARRANTS
During 1998, 540,000 warrants were issued at $10.00 per share in
connection with a term loan financing (Note 7). 420,000 of the warrants are
exercisable until April 30, 2003 and 120,000 are exercisable until September 29,
2003.
Also during 1998, 121,951 warrants were issued at $12.81 per share in
connection with a private placement of common shares. The warrants are
exercisable until November 19, 2003. During 1996, 76,734 warrants were issued at
$6.90 per share in connection with bridge financing that was subsequently
repaid. The warrants are exercisable until March 7, 2001. All warrants remain
outstanding at December 31, 1998.
F-13
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - ACQUISITIONS
Effective April, 1998, the Company acquired 100% of the shares of
ACT Gene S.A., a DNA diagnostic testing company, for 85,000 common shares of
the Company, and cash payable of $650,000. The acquisition was accounted for
as a purchase, and resulted in the recording of an excess of purchase price
over tangible net assets of $488,000, of which $420,043 was recorded as
in-process research and development, and reflected as an expense in 1998. The
nature of the acquired research and development relates to the cost and time
pertaining to the development of a test kit and research clinical samples
necessary for the development of several kits designed for use with DNA
sequencing systems. As of April, 1998 the kit was approximately 80% completed
and was expected to be completed during 1999. Projected incremental cash
flows of these projects were discounted using discounts rates ranging from
60% to 70%. The primary risk factor affecting the commercialization of each
of these products is the receipt of FDA and foreign regulatory agency
approvals for use in the clinical diagnostic market.
Effective October, 1997, the Company acquired 100% of the shares of
Applied Sciences, Inc., a DNA diagnostic testing company, for 95,000 common
shares of the Company, and the assumption of all liabilities (including
$90,000 which was repaid to the former shareholders of Applied Sciences,
Inc.), as well as a deficit of $132,000. The acquisition was accounted for as
a purchase, and resulted in the recording of an excess of purchase price over
tangible net assets of $654,621 which was recorded as in-process research and
development, and reflected as an expense in 1997. The nature of the acquired
research and development relates to the cost and time pertaining to the
development of certain test kits designed for use with DNA sequencing
systems. As of October 1997, these kits were approximately 20 to 50%
completed. Development of one kit was completed in the fourth quarter of
1998, and the remaining kits are expected to be completed during 2000.
Projected incremental cash flows of these projects were discounted using
discount rates ranging from 60% to 70%. The primary risk factor affecting the
commercialization of each of these products is the receipt of FDA and foreign
regulatory agency approvals for use in the clinical diagnostic market.
NOTE 11 - INCOME TAXES
The Company's income tax provision has been determined as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net loss for the period comprised of:
Domestic ........................... $ (6,195,350) $ (8,472,572) $ (5,164,684)
Foreign ............................ (8,695,611) (1,943,174) _
------------ ------------ ------------
$(14,890,961) $(10,415,746) $ (5,164,684)
Income taxes at 44.6% ................ $ (6,641,369) $ (4,645,423) $ (2,287,955)
Decrease resulting from permanent non-
tax deductible expense ........... 52,182 412,842 113,000
Decrease resulting from foreign rate
differences ...................... 114,856 -- --
Increase in valuation allowance ...... 6,474,331 4,232,581 2,174,955
------------ ------------ ------------
$ -- $ -- $ --
============ ============ ============
</TABLE>
F-14
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - CONTINUED
As at December 31, 1998, the Company has available losses of
approximately $10,600,000 that may be used to reduce taxable income in Canada in
future years. These losses will expire $453,000 in 2001, $1,393,000 in 2002,
$2,679,000 in 2003, $4,340,000 in 2004, and $1,735,000 in 2005. As of December
31, 1998, the Company has available losses of approximately $6,994,000 that may
be used to reduce taxable income in the United States of America, which expire
$1,655,000 in 2012 and $5,339,000 in 2013. As of December 31, 1998, the Company
has available losses of approximately $1,499,000 that may be used to reduce
taxable income in the Netherlands, which can be carried forward indefinitely.
Certain scientific research and development expenditures eligible for
tax purposes, incurred by the Company, may be deferred and deducted in future
years. These unclaimed deductions, which can be carried forward indefinitely,
amounted to approximately $9,200,000 at December 31, 1998. In addition, the
Company has earned non-refundable investment tax credits amounting to
approximately $2,013,000 that can be applied to reduce future income taxes
payable. These expire $474,000 in 2006, $701,000 in 2007 and $838,000 in 2008.
The benefit of these losses, unclaimed deductions and non-refundable
investment tax credits has not been reflected in these financial statements.
The deferred tax balances are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
DEFERRED TAX ASSETS
Research expenses ........................ 4,122,100 2,274,300
Non-capital losses ....................... 8,483,100 5,987,800
Investment tax credits ................... 1,114,700 642,200
Fixed assets ............................. 239,000 149,700
Warranty and other provisions ............ 25,600 27,500
------------ ------------
13,984,500 9,081,500
Valuation allowance ...................... (13,984,500) (9,081,500)
------------ ------------
Net deferred tax asset (liability) ....... $ -- $ --
============ ============
</TABLE>
The valuation allowance increased by $4,903,000 during 1998 (1997 -
$5,334,200). Realization of the future tax benefits related to the deferred tax
assets is dependent upon many factors, including the Company's ability to
generate taxable income within the loss carryforward periods.
NOTE 12 - SEGMENTED INFORMATION
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." This replaced the previous industry
segment approach with disclosure based upon the internal organization used by
management for making operating decisions and assessing performance. SFAS No.
131 also requires disclosures as to products and services, geographic areas and
major customers. The adoption of SFAS No. 131 did not affect results of
operations or financial position, but did affect the disclosure of segment
information. The Company's reportable segments are Sequencing Systems, GeneKits
and other Consumables, and Testing services. The accounting policies of the
segments are the same as those described above in Note 2, "Summary of
significant accounting policies."
F-15
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - CONTINUED
<TABLE>
<CAPTION>
1998
SEQUENCING GENEKITS AND OTHER RECONCILING
SYSTEMS CONSUMABLES TESTING SERVICES ITEMS TOTAL
------------ --------------- ---------------- -------------- ------------
<S> <C> <C> <C> <C> <C>
Revenues $ 8,042,421 $ 1,379,512 $ 1,453,415 -- $ 10,875,348
Depreciation and
Amortization (388,708) (666,061) (233,828) -- (1,288,597)
Profit (loss)
from operations
before interest (10,879,023) (3,023,804) 299,805 $ (420,043)(1) (14,023,065)
Additions to
Fixed assets 1,164,681 1,137,904 1,011,041 3,313,626
Total assets 8,859,003 5,281,294 2,368,161 11,274,077 (2) 27,782,535
RECONCILING ITEMS CONSIST OF: (1) ACQUIRED RESEARCH AND DEVELOPMENT (NOTE 10)
(2) CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
</TABLE>
<TABLE>
<CAPTION>
1997
SEQUENCING GENEKITS AND OTHER RECONCILING
SYSTEMS CONSUMABLES TESTING SERVICES ITEMS TOTAL
------------ --------------- ---------------- -------------- ------------
<S> <C> <C> <C> <C> <C>
Revenues $ 2,720,843 $ 246,851 $ 65,041 -- $ 3,032,735
Depreciation and
Amortization (252,020) (362,688) (31,599) -- (646,307)
Profit (loss)
from operations
before interest (9,592,047) (874,149) (66,677) $ (654,621)(3) (11,187,494)
Additions to
Fixed assets 405,799 504,142 204,256 1,114,197
Total assets 4,126,088 2,002,571 199,812 7,607,901(4) 13,936,372
RECONCILING ITEMS CONSIST OF: (3) ACQUIRED RESEARCH AND DEVELOPMENT (NOTE 10)
(4) CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
</TABLE>
In 1996, the Company only operated in the Sequencing Systems segment.
Total assets for that segment at December 31, 1996 were $3,678,056, which
excludes Cash, cash equivalents and short-term investments of $18,927,590.
F-16
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - CONTINUED
<TABLE>
<CAPTION>
GEOGRAPHIC INFORMATION - YEARS ENDED DECEMBER 31
REVENUES, BY CUSTOMER LOCATION 1998 1997 1996
------------------------------ ----------- ----------- -----------
<S> <C> <C> <C>
NORTH AMERICA
Canada $ 844,863 $ 542,716 $ 87,471
United States 6,554,232 2,278,246 741,823
----------- ----------- -----------
7,399,095 2,820,962 829,294
EUROPE
France 1,616,788 -- --
Other Europe 1,375,417 161,837 148,845
----------- ----------- -----------
2,992,205 161,837 148,845
ASIA AND LATIN AMERICA 484,048 49,937 --
----------- ----------- -----------
$10,875,348 $ 3,032,736 $ 978,139
=========== =========== ===========
GEOGRAPHIC INFORMATION - YEARS ENDED DECEMBER 31
FIXED ASSETS 1998 1997
------------ ----------- -----------
Canada $ 2,346,394 $ 928,350
United States 1,083,788 459,983
France 446,981 62,647
----------- -----------
$ 3,877,163 $ 1,450,980
=========== ===========
</TABLE>
In 1996, substantially all of the Company's fixed assets were located
in Canada.
In 1998, one customer accounted for 30% of sales, of which 29%
comprised Sequencing Systems and 1% comprised GeneKits and other Consumables
(1997 - no customer accounted for more than 10% of sales; 1996 - two customers
each accounted for approximately 15% of sales, of which the entire amounts
comprised Sequencing Systems).
NOTE 13 - COMMITMENTS
The Company has entered into operating leases for premises and
equipment as follows:
<TABLE>
<S> <C>
1999 $ 960,981
2000 718,162
2001 336,460
2002 224,584
2003 55,532
-----------
$ 2,295,719
===========
</TABLE>
The Company is committed to make a payment under a license agreement of
$350,000 in 1999. The Company has collaborative arrangements with certain third
parties that provide for royalty payments. To date, commitments under such
arrangements have not been material. Rent expense was $554,497 in 1998 (1997 -
$284,396; 1996 - $ 71,530).
F-17
<PAGE>
VISIBLE GENETICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 - RELATED PARTY TRANSACTIONS
During 1998, the Company incurred legal fees to a law firm, in which a
partner is a director of the Company, of $164,624 (1997 - $183,627; 1996 -
$321,518). During 1998, the Company incurred consulting fees to a firm, of which
the president was a director of the Company, of $280,000 (1997 - nil; 1996-nil).
Other receivables include a loan and unpaid interest due from a Company officer
and director aggregating $55,614 (1997 - $72,018; 1996 - nil).
NOTE 15 - COMPARATIVE FIGURES
Certain comparative figures have been reclassified to conform to the
financial statement presentation adopted in the current year.
F-18
