<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___ TO ___
COMMISSION FILE NUMBER 000-31147
DELTAGEN, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-3260659
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1003 HAMILTON AVENUE, MENLO PARK, CA 94025
(Address of principal executive offices) (Zip code)
(650) 752-0200
(Registrant's telephone number, including area code)
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 NO X
------- -------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the the latest practicable date:
Common stock $0.001 par value 29,874,288
----------------------------- --------------------------------
Class Outstanding at September 14, 2000
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DELTAGEN, INC.
FORM 10-Q
QUARTERLY REPORT
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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PART I - FINANCIAL INFORMATION
<S> <C>
Item 1. Financial Statements
Balance Sheets (unaudited) 3
Statements of Operations (unaudited) 4
Statements of Cash Flows (unaudited) 5
Notes to Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk 12
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 2. Changes in Securities and Use of Proceeds 26
Item 3. Defaults Upon Senior Debt 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Other Information 27
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 28
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DELTAGEN, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
(Unaudited)
JUNE 30, DECEMBER 31,
2000 1999
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<S> <C> <C>
ASSETS
Current assets:
Cash & cash equivalents $ 13,339 $ 848
Accounts receivables, net 345 585
Prepaid expenses 367 205
------ ------
Total current assets 14,051 1,638
Property and equipment, net 7,292 4,973
Other assets 1,169 163
------ ------
Total assets $ 22,512 $ 6,774
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------ ------
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $2,630 $2,976
Accrued liabilities 1,850 984
Current portion of capital lease obligations 34 30
Current portion of loans payable 1,360 503
Deferred revenue 741 946
------ ------
Total current liabilities 6,615 5,439
Capital lease obligations, less current portion 22 22
Loans payable, less current portion 3,968 2,233
------ ------
Total liabilities 10,605 7,694
Commitments and Contingencies (Note 5)
Redeemable convertible preferred stock:
Authorized: 18,995,920 shares
Issued and outstanding: 10,938,777 and 18,137,486
shares at December 31, 1999 and June 30, 2000;
(Liquidation value: $14,500 at December 31, 1999 and
$37,050 at June 30, 2000) 36,807 14,447
------ ------
Stockholders' deficit:
Common Stock, $0.001 par value:
Authorized: 28,571,429 shares
Issued and Outstanding: 2,069,685 and 3,671,873 at
December 31, 1999 and June 30, 2000, respectively 4 2
Additional paid-in capital 23,726 10,695
Unearned stock-based compensation (13,212) (7,610)
Notes receivable from stockholders (805) -
Deficit accumulated during the development stage (34,613) (18,454)
------ ------
Total stockholders' deficit (24,900) (15,367)
------ ------
Total liabilities, redeemable convertible preferred
stock and stockholders' deficit $22,512 $6,774
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</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THIS QUARTERLY REPORT
3
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DELTAGEN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Contract Revenue $ 268 $ 457 $ 554 $ 678
------- ------- ------- -------
Operating expenses:
Research and development 6,840 2,418 12,467 4,654
General and administrative 2,417 635 4,462 883
------- ------- ------- -------
Total operating expenses 9,257 3,053 16,929 5,537
------- ------- ------- -------
Loss from operations (8,989) (2,596) (16,375) (4,859)
Interest income 218 81 398 179
Interest expense (93) (65) (182) (95)
------- ------- ------- -------
Net loss (8,864) (2,580) (16,159) (4,775)
Deemed dividend related to
beneficial conversion feature
of preferred stock - - 22,360 -
------- ------- ------- -------
Net loss attributable to
common stockholders $ (8,864) $ (2,580) $ (38,519) $ (4,775)
------- ------- ------- -------
------- ------- ------- -------
Net loss per common
share, basic and diluted $ (5.27) $ (2.55) $ (19.13) $ (6.02)
------- ------- ------- -------
------- ------- ------- -------
Weighted average shares
used in computing net loss per
share, basic and diluted 1,681 1,011 2,014 793
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THIS QUARTERLY REPORT
4
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DELTAGEN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
-----------------------
2000 1999
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<S> <C> <C>
Cash flows from operating activities:
Net loss $(16,159) $ (4,775)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 612 290
Amortization of warrants issued in connection
with loans 18 10
Amortization of unearned stock-based compensation
expense 6,044 607
Changes in operating assets and liabilities:
Accounts receivable 240 57
Prepaid expenses (162) (64)
Deposits (6) (150)
Other assets (1,000) (42)
Accounts payable (346) (140)
Accrued liabilities 866 424
Deferred revenue (205) (336)
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Net cash used in operating activities (10,098) (4,119)
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Cash flows from investing activities:
Acquisition of property and equipment (2,220) (795)
Leasehold improvements (711) (218)
------- ------
Net cash used in investing activities (2,931) (1,013)
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Cash flows from financing activities:
Principal payments under capital lease obligations (16) (28)
Repayment of loans payable (337) (359)
Proceeds from the issuance of debt 2,931 2,718
Proceeds from the issuance of preferred stock, net of
issuance costs 22,360 145
Proceeds from the issuance of common stock under
stock option plan, net of issuance costs and stock
repurchased 582 39
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Net cash provided by financing activities 25,520 2,515
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Net increase (decrease) in cash and cash equivalents 12,491 (2,617)
Cash and cash equivalents, beginning of period 848 8,635
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Cash and cash equivalents, end of period $ 13,339 $ 6,018
------- ------
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Supplemental disclosures of non-cash investing and financing activities:
Unearned stock-based compensation $ 11,646 $ 2,352
Issuance of notes receivable in exchange for common
stock $ 805 $ -
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THIS QUARTERLY REPORT
5
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DELTAGEN, INC.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
JUNE 30, 2000
1. FORMATION AND BUSINESS OF THE COMPANY
Deltagen, Inc., (the "Company") was incorporated in Delaware on
January 28, 1997. The Company's primary business is the determination of the
therapeutic potential of genes by using mammalian genetics to discover the IN
VIVO function of genes and the development and marketing of a database
containing these findings. Deltagen identifies novel gene targets through the
use of advanced bioinformatics. Genetically altered mice are then produced
that contain disruptions or deletions of the targeted gene and proprietary
analysis is performed on such mice to determine the potential function of the
targeted gene.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
UNAUDITED INTERIM RESULTS
The accompanying interim balance sheet as of June 30, 2000, the
statements of operations for the three and six months ended June 30, 1999 and
2000 and the statements of cash flows for the six months ended June 30, 1999
and 2000 are unaudited. The unaudited interim financial statements have been
prepared on the same basis as the annual financial statements and, in the
opinion of management, reflect all adjustments, which include only normal
recurring adjustments, necessary to present fairly the Company's financial
position and its results of operations and its cash flows for the three and
six months ended June 30, 1999 and 2000. The financial data and other
information disclosed in these notes to financial statements related to these
periods are unaudited. The results for the three and six months ended June
30, 2000 are not necessarily indicative of the results to be expected for the
year ending December 31, 2000.
These interim financial statements should be read in conjunction
with the annual audited financial statements, accounting policies and
financial notes thereto included in the Company's fiscal 1999 financial
statements that have previously been filed with the Securities and Exchange
Commission (the "SEC").
REVENUE RECOGNITION
For most contracts, revenue is recognized based on the terms of the
contract. Most of the contracts specify milestones to be met and the payments
associated with meeting each milestone. Revenue is recognized on completion
of each milestone. For these contracts, payment for the first milestone is
received in advance of completion. This payment is shown as deferred revenue
and only recognized as revenue once the first milestone has been completed.
For all subsequent milestones, payment is received upon completion of the
milestone, and revenue is recognized at that time. None of the amounts
recognized as revenue are refundable.
The amount of revenue recognized on completion of each milestone is
such that the earned revenue, as a percentage of total anticipated revenue,
approximates the costs incurred in achieving the related milestone, as a
percentage of the total anticipated costs.
Where the contract does not specify milestones and payment is upon
completion of the contract, revenue is recognized based on the
percentage-of-completion method of accounting.
The portion of payments received in advance of the completion of
milestones is reflected in deferred revenue. Where revenues are recognized on
a percentage of completion basis, but based on the terms of the contract the
receivable cannot yet be billed, these amounts are shown as unbilled
receivables.
6
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ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for stock-based employee compensation
arrangements in accordance with the provisions of Accounting Principles Board
Opinion No. 25 ("APB No. 25"), "Accounting for Stock issued to Employees" and
Financial Accounting Standards Board Interpretation No. 28 ("FIN No. 28"),
"Accounting for Stock Appreciation Rights and Other Variable Stock Option or
Award Plans" and complies with the disclosure provisions of Statements of
Financial Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for
Stock-Based Compensation."
Under APB No. 25, compensation expense is based on the difference,
if any, on the date of the grant, between the fair value of the Company's
stock and the exercise price. SFAS No. 123 defines a "fair value" based
method of accounting for an employee stock option or similar equity
investment.
The Company accounts for equity instruments issued to non-employees
in accordance with the provisions of SFAS No. 123 and Emerging Issues Task
Force Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services."
RECENT ACCOUNTING PRONOUNCEMENTS
In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44 ("FIN No. 44") "Accounting for Certain Transactions
Involving Stock Compensation," an interpretation of the Accounting Practice
Board Opinion No. 25 ("APB No. 25"). This interpretation clarifies the
definition of an employee for purposes of applying APB No. 25, "Accounting for
Stock Issued to Employees," the criteria for determining whether a plan
qualifies as a noncompensatory plan, the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and the
accounting for an exchange of stock compensation awards in a business
combination. This Interpretation is effective July 1, 2000, but certain
conclusions in this Interpretation cover specific events that occur after either
December 15, 1998, or January 12, 2000. The adoption of certain of the
provisions of FIN No. 44 prior to June 30, 2000 did not have a material effect
on the financial statements. The Company does not expect that the adoption of
the remaining provisions will have a material effect on the financial
statements.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 ("SAB No. 101"), "Revenue Recognition in
Financial Statements," which provides guidance on the recognition, presentation,
and disclosure of revenue in financial statements filed with the SEC. SAB No.
101 outlines the basic criteria that must be met to recognize revenue and
provides guidance for disclosures related to revenue recognition policies. The
Company has complied with the guidance in SAB No. 101 for all periods presented.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133 ("SFAS No. 133"), "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133 establishes new
standards of accounting and reporting for derivative instruments and hedging
activities. SFAS No. 133 requires that all derivatives be recognized at fair
value in the statement of financial position and that the corresponding gains
or losses be reported either in the statement of operations or as a component of
comprehensive income, depending on the type of relationship that exists. SFAS
No. 133 will be effective for fiscal years beginning after June 15, 2000. The
Company does not believe that the implementation of SFAS No. 133 will have any
significant impact on its financial position or results of operations.
NET LOSS PER SHARE
Basic earnings per share is calculated based on the weighted-average
number of common shares outstanding during the period. Diluted earnings per
share would give effect to the dilutive effect of common stock equivalents
consisting of stock options and warrants. Potentially dilutive securities have
been excluded from the diluted earnings per share calculations as they have an
antidilutive effect due to the Company's net losses.
A reconciliation of shares used in the calculations is as follows (in
thousands except per share data):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2000 1999 2000 1999
----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Basic and diluted:
Net loss $ (8,864) $ (2,580) $ (16,159) $ (4,775)
=========== =========== =========== ===========
Deemed dividend related to beneficial
conversion of preferred stock - - (22,360) -
----------- ----------- ----------- -----------
Net loss attributed to common
stockholders $ (8,864) $ (2,580) $ (38,519) $ (4,775)
=========== =========== =========== ===========
Weighted-average shares of common stock
outstanding 3,668 1,811 3,049 1,811
Less: Weighted-average shares subject to
repurchase (1,987) (800) (1,035) (1,018)
----------- ----------- ----------- -----------
Weighted-average shares used in basic and
diluted net loss per share 1,681 1,011 2,014 793
=========== =========== =========== ===========
</TABLE>
3. LOANS PAYABLE
In June 2000, the Company entered into a loan agreement with a
financial institution to obtain one or more loans totaling up to $6,500,000. A
corresponding amount of machinery, equipment and other property is pledged as
collateral for each loan.
7
<PAGE>
During June 2000, the Company incurred loans under the above noted
credit facility of $1,262,000 and $1,649,000 for a total financing of
$2,911,000. These loans bear respective interest rates of 12.75% and 12.49%
and are required to be repaid in 36 and 48 monthly installments,
respectively, beginning in July 2000.
4. REDEEMABLE CONVERTIBLE PREFERRED STOCK.
BENEFICIAL CONVERSION
In January 2000, the Company issued 7,198,709 of Series C redeemable
convertible preferred stock at $3.13 per share for proceeds of $22,360,000.
The issuance resulted in a beneficial conversion feature of $22,360,000,
calculated in accordance with Emerging Issues Task Force No. 98-5 ("EITF No.
98-5"), "Accounting for Convertible Securities with Beneficial Conversion
Features." The beneficial conversion feature is reflected as a preferred
dividend in the Statement of Operations for the six months ended June 30, 2000.
5. COMMITMENTS AND CONTINGENCIES
On May 24, 2000, Lexicon Genetics Incorporated filed a lawsuit
against the Company in the United States District Court for the District of
Delaware. The complaint in the lawsuit alleges that the Company's methods of
making knockout mice infringe United States Patent No. 5,789,215, under which
Lexicon claims to be an exclusive licensee. The complaint seeks a judgment
that the Company infringed this patent, a permanent injunction against
further infringement of the patent and an award of damages in an unspecified
amount that, under certain circumstances, may be tripled. The Company
believes that the patent in question is invalid and, even if the patent is
found to be valid, that the methods employed by the Company do not infringe
the patent. On June 13, 2000, the Company responded to Lexicon's complaint by
filing an answer and seeking a declaratory judgment in its favor. The
response seeks a judgment declaring the patent invalid and that the Company
has not infringed and is not infringing the patent. The Company intends to
defend the action vigorously.
The litigation is in the early stages and its outcome cannot be
predicted. If Lexicon prevails and obtains an injunction, the Company would
be required to obtain a license in order to continue to use the methods
covered by the patent. The Company may not be able to obtain this license on
favorable terms or at all. If unable to obtain a license, the Company would
be required to redesign its processes to use alternative methods of making
knockout mice and would experience a significant disruption in its ability to
generate revenue during this redesign period and as it develops a gene
function database using these new methods. This redesign and development
would involve significant time and costs, and the alternative methods
available may not be as effective as current methods. The Company estimates
that the average time from the date the Company begins to create a knockout
mouse until the date the data from that knockout mouse is added to the gene
function database is 12 months. The addition of new data points to the
Company's gene function database could be significantly delayed. If Lexicon
prevails, the Company could also incur significant financial liabilities that
could materially affect its business and operating results.
In addition, on July 13, 2000, the Company received a letter from
Lexicon stating that it believes the Company may be involved in activities
that conflict with four patents licensed to Lexicon. Lexicon's letter states
that these patents cover certain methods for producing gene targeted cells
and transgenic, or knockout, mice. The Company believes its methods do not
infringe these patents. If Lexicon asserts its rights under these patents as
the basis for a lawsuit against the Company and Lexicon prevails in any such
lawsuit, the Company would be prevented from using its methods unless it
obtained a license. The Company may be unable to obtain a license on
favorable terms or at all, or it may choose not to seek a license. The
Company believes it could use alternative methods, with which it has
experience and which it believes are as effective as its current methods.
Developing a gene function database using these alternative methods would
involve significant time and costs. An adverse determination of any lawsuit
with Lexicon involving these patents could also significantly affect the
marketing of its existing gene function database and DeltaSelect program. The
Company expects that, during the period prior to development of a comparable
gene function database using these alternative methods, it would experience a
significant disruption in its ability to generate revenue. If Lexicon
prevails in any lawsuit involving these patents, it could also incur
significant financial liabilities which could materially affect its business
and operating results.
At this time no estimate can be made of the outcome or any possible
loss which may be incurred.
8
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6. CUSTOMER AGREEMENTS
On June 27, 2000, the Company entered into its first DeltaBase-TM-
database subscription agreement with Glaxo Wellcome. Under the DeltaBase
agreement, Glaxo Wellcome has the right to access DeltaBase database
information on gene function and validated gene targets based upon knockout
mouse studies. The DeltaBase agreement also grants Glaxo Wellcome
non-exclusive, worldwide licenses to knockout mice, materials and
intellectual property rights under DeltaBase. The Company will receive
aggregate cash payments of $5,000,000 in subscription licensing fees during
each year of the three-year term. In addition, the Company may receive
additional licensing fees for access to its intellectual property and
additional payments on milestones achieved and on products developed by Glaxo
Wellcome, if any, using DeltaBase information, materials and related
intellectual property. Glaxo Wellcome may, however, terminate the agreement
for any reason within the first three months after the one year anniversary
of the effective date upon payment of a specified termination fee.
7. SUBSEQUENT EVENTS
REGISTRATION
In March 2000, the Company's Board of Directors authorized
management to file a registration statement with the Securities and Exchange
Commission to permit the Company to sell its common stock to the public. Upon
completion of the Company's initial public offering on August 2, 2000, all of
the outstanding preferred stock was converted into shares of common stock.
STOCK SPLIT
In May 2000, the board of directors approved an 8-for-7 forward
split of its preferred and common stock which was effective on July 12, 2000.
All common stock data and common stock option plan information in this report
has been restated to reflect the split. In addition, the conversion prices of
the Company's Series A, Series B and Series C convertible preferred stock
have also been adjusted to reflect the effect of the split.
INITIAL PUBLIC OFFERING
On August 2, 2000, the Company completed an initial public offering
in which it sold 7,000,000 shares of common stock at $15.00 per share for net
proceeds of approximately $96.4 million, net of underwriting discounts,
commissions and other offering costs. Upon the closing of the offering, all
the Company's redeemable convertible preferred stock converted into
18,137,486 shares of common stock. On August 30, 2000, the underwriters
exercised an over-allotment option to purchase an additional 1,025,000
shares, resulting in net proceeds of an additional $14.3 million.
9
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND
RESULTS OF OPERATIONS
The statements in this quarterly report that are not descriptions of
historical facts may be forward-looking statements that are subject to risks
and uncertainties. Actual results could differ materially from those
currently anticipated due to a number of factors, including those identified
below and in our other publicly available documents. We are under no
obligation to update any of these forward-looking statements after the filing
of this quarterly report to reflect actual results or changes in our
expectations.
The following information should be read in conjunction with the
consolidated financial statements and notes thereto included in Item 1 of
this quarterly report. We also urge readers to review and consider our
disclosures describing various factors that affect our business, including
the disclosures under Management's Discussion and Analysis of Financial
Condition and Results of Operations and Risk Factors and the audited
financial statements and notes thereto contained in our Registration
Statement on Form S-1, filed with the SEC in the form in which it became
effective on August 2, 2000.
OVERVIEW
We were formed in 1997 to discover and provide mammalian gene
function information for use by pharmaceutical and biotechnology companies to
expedite the drug discovery process. Since our inception, we have engaged
primarily in research and development efforts related to our technology which
enables us to select genes with therapeutic potential and delete, or
knockout, these genes in mice. We then use an extensive, integrated analysis
program to determine the function and potential pharmaceutical relevance of
these genes. We have a limited operating history and are at an early stage of
development. Our strategy and pricing models related to offering our products
and programs are unproven.
To date we have derived all of our revenue from the development and
analysis of knockout mice under our DeltaSelect-TM- program. As of June 30,
2000, we had an accumulated deficit of $34.6 million. We had net losses of
$8.9 million and $2.6 million for the three months ended June 30, 2000 and
1999, respectively. The net loss attributable to common stockholders for the
six months ended June 30, 2000 was $16.2 million, before deducting a deemed
dividend of $22.4 million relating to a beneficial conversion feature of our
preferred stock. Our losses have resulted primarily from costs incurred in
connection with research and development activities and from general and
administrative costs associated with our operations. Research and development
expenses consist primarily of salaries and related personnel costs, material
costs, legal expenses resulting from intellectual property filings and other
expenses related to the development of our gene function database,
DeltaSelect and our gene trap program. We expense our research and
development costs as they are incurred. General and administrative expenses
consist primarily of salaries and related expenses for executive, finance and
other administrative personnel, professional and other corporate expenses
including business development and general legal activities. In connection
with the development and expansion of our gene function database, DeltaSelect
and our gene trap program, we expect to incur increasing research and
development and general and administrative costs. As a result, we will need
to generate significantly higher revenues to achieve profitability. We expect
to report substantial net losses through the next several years. We had
DeltaSelect agreements as of June 30, 2000 with the following companies:
Glaxo Wellcome, Merck & Co., Pfizer, Inc., Roche Biosciences and
Schering-Plough Research Institute. Under these agreements, we create
knockout mice and perform phenotypic analysis of these mice when requested by
our customers. A customer compensates us based on milestones reached in the
creation and analysis of each knockout mouse it requests.
For most contracts, revenue is recognized using the contract method
of accounting. The contracts specify milestones to be met and the payments
associated with meeting each milestone. Revenue is recognized on completion
of each milestone. Where the contract does not specify milestones and payment
is for completion of the contract, revenue is recognized based on a
percentage of completion method of accounting. The portion of payments
received in advance of the completion of milestones is reflected in deferred
revenue. Where revenues are recognized on a percentage of completion basis,
but based on the terms of the contract, the receivable cannot yet be billed,
these unbilled amounts are shown as deferred revenue.
We anticipate that the majority of our future revenues will be derived
from periodic subscription fees under agreements with subscribers to our
DeltaBase-TM- gene function database. However, Glaxo Wellcome is currently our
only subscriber to DeltaBase. Our future operating results will depend upon many
factors, including the initiation and expiration of subscriptions to our gene
function database and other customer agreements and general and
industry-specific economic conditions which may affect pharmaceutical and
biotechnology companies' research and development expenditures. As a
consequence, our operating results have fluctuated in the past and are likely to
do so in the future.
We account for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board Opinion No. 25 (APB
No. 25), "Accounting for Stock issued to Employees" and Financial Accounting
Standards Board Interpretation No. 28, "Accounting for Stock Appreciation Rights
and Other Variable Stock Option or Award Plans" and comply with the disclosure
provisions of Statement of Financial Accounting Standards No. 123 (SFAS No.
123), "Accounting for Stock-Based Compensation."
Under APB No. 25, compensation expense is based on the difference, if
any, on the date of the grant, between the fair value of our stock and the
exercise price. SFAS No. 123 defines a "fair value" based method of accounting
for an employee stock option or similar equity investment.
10
<PAGE>
We account for equity instruments issued to non-employees in accordance
with the provisions of SFAS No. 123 and Emerging Issues Task Force Issue No.
96-18, "Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services."
During the three months ended June 30, 2000 and 1999, we recorded
unearned stock compensation of approximately $1.2 million and $1.4 million,
respectively. We recorded unearned stock compensation of $11.6 million and
$2.4 million for the six months ended June 30, 2000 and 1999, respectively.
These amounts are being amortized as charges to operations over the
respective vesting period of the individual stock options, generally four
years. During the three months ended June 30, 2000 and 1999, we recorded
amortization of unearned compensation of $3.3 million and $445,000,
respectively. We recorded amortization of unearned compensation of $6.0
million and $607,000 for the six months ended June 30, 2000 and 1999,
respectively.
We may incur additional stock-based compensation expense in the future
as a result of both options or other securities granted at below fair market
value and fluctuations in the market value of our stock which have a direct
impact on the value of options and warrants held by non-employees.
RESULTS OF OPERATIONS
Contract revenue decreased by $189,000 to $268,000 for the three
months ended June 30, 2000 from $457,000 in the comparable period of 1999.
Contract revenues for the six months ended June 30, 2000 and 1999 were
$554,000 and $678,000, respectively. The decrease in second quarter revenue
was related entirely to revenue associated with agreements for the
development and analysis of knockout mice. In the second quarter of 2000 and
1999, all of our revenue came from contracts with Merck, Pfizer, Roche,
Schering-Plough and Tularik. Our contract with Schering-Plough produced no
revenue in 1999. Our agreements with Roche and Tularik produced no revenues
in 2000. Our Tularik agreement expired in February 2000.
Research and development expenses increased by $4.5 million to $6.9
million for the three months ended June 30, 2000 from $2.4 million in the
comparable period of 1999. Research and development expenses for the six
months ended June 30, 2000 and 1999 were $12.5 million and $4.7 million,
respectively. The increase in second quarter research and development
expenses was attributable to continued expansion of research and development
activities, including increased personnel and laboratory supply costs to
support development of our gene function database and our DeltaSelect and
gene trap programs and higher depreciation and amortization and facilities
expenses related to the addition of a second facility in July 1999. The
amortization of unearned stock compensation represents $1.7 million of the
increase in research and development expenses in the three months ended June
30, 2000 and $3.0 million of the increase in the six months ended June 30,
2000.
General and administrative expenses increased by $1.8 million to
$2.4 million during the three months ended June 30, 2000 from $635,000 for
the comparable period of 1999. General and administrative expenses for the
six months ended June 30, 2000 and 1999 were $4.4 million and $883,000,
respectively. The increase in the second quarter related to compensation for
business development, finance and administrative personnel and legal and
business consulting fees. The amortization of unearned stock compensation
contributed to $1.2 million of the increase in general and administrative
expenses in the three months ended June 30, 2000 and $2.4 million of the
increase in the six months ended June 30, 2000.
Interest income (expense), net, increased by $109,000 to $124,000 in
the three months ended June 30, 2000 from $15,000 for the comparable period
of 1999. Interest income (expense), net, for the six months ended June 30,
2000 and 1999 was $216,000 and $84,000, respectively. This increase resulted
from increasing cash and investment balances as a result of additional
private equity financing during 2000. Interest expense was $93,000 in the
second quarter of 2000, as compared to $66,000 in the second quarter of 1999.
This increase resulted from higher average debt balances in 2000.
A dividend relating to a beneficial conversion feature of our
preferred stock of $22.4 million was recorded in the quarter ended March 31,
2000. This arose due to the issuance of 7,198,709 shares of Series C
redeemable convertible preferred stock in January 2000, for net proceeds of
$22.4 million.
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LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations from inception primarily through
private sales of common and preferred stock and contract payments to us under
our DeltaSelect agreements and equipment financing arrangements. As of June
30, 2000, we had received net proceeds of $37.5 million from issuances of
common and preferred stock. In addition, from our inception through June 30,
2000, we received $2.6 million in cash payments from our agreements for the
development and analysis of knockout mice, of which $1.8 million had been
recognized as revenues through June 30, 2000.
As of June 30, 2000, we had $13.3 million in cash and cash
equivalents, as compared with $848,000 as of December 31, 1999. We used $10.1
million for operating activities during the first six months of 2000. This
consisted of the net loss for the period of $16.2 million offset in part by
non-cash charges of $612,000 related to depreciation and amortization
expenses and $6.0 million related to the amortization of unearned stock
compensation. We used $2.9 million for capital expenditures during the first
six months of 2000. We received $25.5 million from financing activities
during the first six months of 2000, which consisted primarily of $22.9
million raised from the issuance of common and preferred stock and net
proceeds of $2.9 million from additional loans partially offset by loan
repayments of $337,000.
On August 2, 2000, our Registration Statement on Form S-1 (File No.
333-34668) was declared effective by the Securities and Exchange Commission
(the "IPO Registration Statement"). The IPO Registration Statement registered
a total of 7,000,000 shares of common stock, all of which were issued and
sold by us (the "Offering") upon the termination of the Offering in August
2000. The shares were sold at an aggregate offering price of $105 million,
with net proceeds of approximately $96.4 million after underwriting fees of
approximately $7.4 million and other offering expenses of approximately $1.2
million.
On August 30, 2000, the underwriters' exercised their over-allotment
for the purchase of approximately 1,025,000 shares. The shares were sold at
an aggregate offering price of $15.4 million, with net proceeds of
approximately $14.3 million after underwriting fees of approximately $1.1
million and other offering expenses.
Our capital requirements depend on numerous factors, including our
ability to obtain gene function database subscriptions and DeltaSelect
agreements, the amount and timing of payments under these subscriptions and
agreements, the level and timing of our research and development
expenditures, market acceptance of our product, the resources we devote to
developing and supporting our products and other factors, many of which are
outside of our control. We expect to devote substantial capital resources to
continue and expand our research and development efforts, to expand our sales
and marketing organization and for other general corporate activities. We
believe that our current cash balances, together with the $110.7 million net
proceeds of our initial public offering and the revenues we believe will be
derived from subscriptions to our gene function database and collaborative
research agreements, will be sufficient to fund our operations through 2001.
During or after this period, if cash generated by operations is insufficient
to satisfy our liquidity requirements or we make acquisitions or other
investments, we may need to sell additional equity or debt securities or
obtain additional credit arrangements. Additional financing may not be
available on terms acceptable to us or at all. The sale of additional equity
or convertible debt securities may result in additional dilution to our
stockholders. Any debt financing may have restrictive covenants that
adversely affect our operating plans and flexibility. The rights of any debt
or preferred stockholders will be senior to those of our common stockholders.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We invest our excess cash primarily in U.S. government securities
and marketable debt securities of financial institutions and corporations
with strong credit ratings. These instruments have maturities of twenty-four
months or less when acquired. We do not utilize derivative financial
instruments, derivative commodity instruments or other market risk sensitive
instruments, positions or transactions in any material fashion. Accordingly,
we believe that, while the instruments we hold are subject to changes in the
financial standing of the issuer of such securities, we are not subject to
any material risks arising from changes in interest rates, foreign currency
exchange rates, commodity prices, equity prices or other market changes that
affect market risk sensitive instruments. Therefore, no quantitative tabular
disclosure is included in this report.
To date, we have operated solely in the United States and all sales
have been made in U.S. dollars. Accordingly, we have not had any material
exposure to foreign currency rate fluctuations.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (SAB No. 101), "Revenue Recognition in Financial
Statements," which provides guidance on the recognition, presentation, and
disclosure of
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revenue in financial statements filed with the Securities and Exchange
Commission. SAB No. 101 outlines the basic criteria that must be met to
recognize revenue and provides guidance for disclosures related to revenue
recognition policies. We have complied with the guidance in SAB No. 101 for
all periods presented.
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133 (SFAS No. 133),
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
establishes new standards of accounting and reporting for derivative
instruments and hedging activities. SFAS No. 133 requires that all
derivatives be recognized at fair value in the statement of financial
position, and that the corresponding gains or losses be reported either in
the statement of operations or as a component of comprehensive income,
depending on the type of relationship that exists. SFAS No. 133 will be
effective for fiscal years beginning after June 15, 2000. We do not believe
that the implementation of SFAS No. 133 will have any significant impact on
our financial position or results of operations.
In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44 (FIN No. 44) "Accounting for Certain Transactions
Involving Stock Compensation," an interpretation of the Accounting Practice
Board Opinion No. 25 (APB No. 25). This interpretation clarifies the
definition of employee for purposes of applying APB No. 25, "Accounting for
Stock Issued to Employees," the criteria for determining whether a plan
qualifies as a noncompensatory plan, and the accounting for an exchange of
stock compensation awards in a business combination. This interpretation is
effective July 1, 2000, but certain conclusions in this interpretation cover
specific events that occur after either December 15, 1998 or January 12,
2000. The adoption of certain of the provisions of FIN No. 44 prior to June
30, 2000 did not have a material effect on the financial statements. The
Company does not expect that the adoption of the remaining provisions will
have a material effect on the financial statements.
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RISK FACTORS
WE EXPECT TO CONTINUE TO INCUR SUBSTANTIAL LOSSES AND WE MAY NEVER ACHIEVE
PROFITABILITY, WHICH IN TURN MAY HARM OUR FUTURE OPERATING PERFORMANCE AND MAY
CAUSE THE MARKET PRICE OF OUR STOCK TO DECLINE
We have had net losses every year since our inception in 1997 and,
as of June 30, 2000, had an accumulated deficit of $34.6 million. We had net
losses of $16.2 million and $4.8 million during the six months ended June 30,
2000 and 1999, respectively. The net loss for the six months ended June 30,
2000 was calculated before a deemed dividend related to the beneficial
conversion of our preferred stock of $22.4 million. Because we anticipate
significant additional expenditures for our research and development programs
and for the development, implementation and support of our gene function
database, we expect to report substantial net losses through at least the
next several years. We may never achieve profitability. If we do not become
profitable within the time frame expected by securities analysts or
investors, the market price of our stock will likely decline. If we do
achieve profitability, we may not sustain or increase profitability in the
future.
We expect that our expenditures will continue to increase, due in part
to:
- continued investment in the research and development of our
new and existing products and our technology, including
increased investment for the development, implementation and
support of our gene function database, our standard and
conditional knockout programs and our gene trap programs;
- obligations under existing and future fee-for-service
agreements; and
- our increasing investment in management and other
employees, sales and marketing programs,
customer service and operational and
financial controls.
WE ARE A DEVELOPMENT-STAGE COMPANY WITH AN UNPROVEN BUSINESS STRATEGY, AND OUR
LIMITED HISTORY OF OPERATIONS MAKES EVALUATION OF OUR BUSINESS AND PROSPECTS
DIFFICULT
We have had a limited operating history and are at an early stage of
development. Our strategy of offering a gene function database and using
knockout mice to enable our customers to pursue promising candidates for drug
target development is unproven. Additionally, our pricing models for offering
our products and services are unproven. We currently have one subscriber for our
gene function database. We have generated only limited revenues from customers
for the development and analysis of knockout mice, amounting to approximately
$1.2 million and $381,000 for the fiscal years ended 1999 and 1998,
respectively. For the six months ended June 30, 2000 and 1999, we recognized
revenues of $554,000 and $678,000, respectively. We recognized no revenue in
1997. Our success will depend upon, among other things, our ability to enter
into licensing and other agreements on favorable terms, our ability to determine
and generate information on those genes which have potential use as drug targets
and the commercialization of products using our data. Moreover, we have no
experience selling our data, and we have never provided a gene database before.
Our sales force may not succeed in marketing our database product, and our
employees may not succeed in implementing and operating our database in a manner
that is satisfactory to our subscribers. Furthermore, the plans for our gene
trap and conditional knockout programs are unproven, and we cannot be sure that
we will ever be able to develop these programs or that any program that we
develop will be commercially successful. As a result of these factors, it is
difficult to evaluate our prospects, and our future success is more uncertain
than if we had a longer or more proven history of operations.
WE CURRENTLY HAVE ONLY SIX CUSTOMERS AND WILL NOT SUCCEED UNLESS WE CAN ATTRACT
MANY MORE CUSTOMERS
We currently have only one subscriber to our DeltaBase gene function
database, and we have only six customers for our DeltaSelect knockout
program. We expect to enter into only a limited number of future DeltaSelect
agreements. To succeed we must attract customers for our database and other
programs. Our existing and future agreements may not be renewed and may be
terminated without penalty in the event either party fails to fulfill its
obligations under one of these agreements. Failure to renew or the
cancellation of these agreements by one of our customers could result in a
significant loss of revenues. In 1999, Pfizer accounted for 64% of our
revenues and two of our other current customers each accounted for greater
than 10% of our revenues. Our current customers are Merck, Pfizer, Roche
Biosciences, Schering-Plough, Glaxo Wellcome and Tularik. Our agreement with
Tularik expired in February 2000 and our agreements with Roche and Pfizer
expire in November and December 2000, respectively. In the first six months
of 2000, Schering-Plough accounted for 41% of our revenues and three other
customers accounted for the remaining 29%, 22% and 8%, respectively.
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Over the past several years, companies in the pharmaceutical
industry have undergone significant consolidation. If two or more of our
present or future customers merge, we may not be able to receive the same
fees under agreements with the combined entities that we were able to receive
under agreements with these customers prior to their merger. Moreover, if one
of our customers merges with an entity that is not a customer, the new
combined entity may prematurely terminate our agreement. Any of these
developments could harm our business or financial condition.
BECAUSE WE HAVE ONLY RECENTLY BEGUN TO OFFER OUR DATABASE, WHICH WE EXPECT TO BE
OUR PRINCIPAL PRODUCT, OUR FUTURE PROSPECTS ARE UNCERTAIN
We believe the majority of our revenues will be derived from fees
under agreements with our database users. We may also derive revenues from
royalties received from these users. We have entered into one agreement with
a subscriber to our database, however, we cannot be sure of the terms under
which we may enter into future agreements, such as fees payable to us or the
term of the agreements, if any. Our agreement which expires three years after
our first delivery of data to Glaxo Wellcome provides for termination for any
reason within the first three months after the one-year anniversary of the
effective date upon the payment of a specified termination fee.
Our database has not been tested by customers, and it may not perform
adequately or provide information in a manner that is useful for our
customers. If our database is not acceptable to our prospective customers, it
may not generate revenues and our fbusiness and financial condition will be
materially harmed.
We may not be able to comply with minimum performance levels or
restrictive provisions or other obligations that may be contained in any
agreements, such as minimum data delivery requirements. In addition, we may
experience unforeseen technical complications in the processes we use to
generate functional data for our gene database and functional genomics
resources. These complications could materially delay or limit the use of our
gene function database, substantially increase the anticipated cost of
generating data or prevent us from implementing our processes at appropriate
quality and scale levels, thereby causing our business to suffer.
NO DRUGS HAVE BEEN DEVELOPED AND COMMERCIALIZED USING GENOMICS-BASED RESEARCH
AND THEREFORE THE FUTURE OF OUR PRODUCTS AND PROGRAMS IS UNCERTAIN
None of the limited number of drugs developed to date using
genomics-based research have reached the commercial market. We cannot assure
you that genomics-based drug development efforts will ultimately be
successful. We have not proven our ability either to identify drug targets
with commercial potential or commercialize drug targets that we do identify.
We cannot assure you that a particular gene function in a mouse will have any
correlation to a patient's response to a particular drug. It is difficult to
successfully select those genes with the most potential for commercial
development. Furthermore, we do not know that any products based on genes
that are the subject of our research can be successfully developed or
commercialized. If commercial opportunities are not realized from
genomic-based research, our existing customers could stop using our products
or we could have difficulty attracting or retaining customers and, in any
event, we would not realize any product royalties.
OUR CUSTOMERS WILL CONTROL THE DEVELOPMENT AND COMMERCIALIZATION OF PRODUCTS
BASED ON GENES THAT WE IDENTIFY, WHICH MAY MEAN THAT OUR RESEARCH EFFORTS WILL
NEVER RESULT IN ANY ROYALTY PAYMENTS OR THIRD PARTY PRODUCT SALES
We intend for our agreements with our customers to provide us with
rights to obtain royalties from the commercial development of compounds or
therapeutic approaches derived from access to our database, technology or
intellectual property. We may not be able to obtain these rights under future
agreements. Our ability to obtain these rights depends in part on the
advantages and novelty of our technologies, the validity of our intellectual
property, the usefulness of our data and our negotiating position relative to
each potential customer.
We will have limited or no control over the resources that any
customer may devote to the development of compounds or therapeutic approaches
derived from our access to our database. These customers may breach or
terminate their agreements with us, and they are not obligated to conduct any
product discovery, development or commercialization activities at all.
Further, our customers may decide not to develop products arising out of our
customer agreements or may not devote sufficient resources to the
development, approval, manufacture, marketing or sale of these products. If
any of these events occurs, our customers may not develop or commercialize
any products based on our gene function research, technologies or
intellectual property, and we would not receive royalties on product sales
and our results of operations would suffer. Furthermore, our customers may
resist sharing
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revenue derived from the successful commercialization of a drug through
royalty payments or others may have competing claims to all or a portion of
such revenues.
THERE ARE A FINITE NUMBER OF GENE FAMILIES UPON WHICH PHARMACEUTICAL AND
BIOTECHNOLOGY COMPANIES FOCUS THEIR RESEARCH, WHICH LIMITS OUR POTENTIAL
REVENUE AND GROWTH
Our current and potential subscribers and customers traditionally
focus their research and development efforts on a finite number of gene
families that they view as reliable drug targets. Once we provide functional
information on these gene families, our ability to attract and retain
subscribers to our database will depend, in part, on the willingness of our
subscribers to expand their research and development activities to other gene
families. If our customers do not do this, we may lose existing subscribers
or fail to attract new subscribers for our database services, and as a
result, our business and financial condition may be harmed. In addition, we
have made and will continue to make significant investments in our database
and knockout programs which we may not recoup if we cannot find additional
target opportunities.
WE MAY FAIL TO MEET MARKET EXPECTATIONS BECAUSE OF FLUCTUATIONS IN OUR QUARTERLY
OPERATING RESULTS, WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE
The following are among the factors that could cause our operating results to
fluctuate significantly from period to period:
- changes in the demand for and pricing of our products and
services;
- the nature, pricing and timing of other products
and services provided by us or our
competitors;
- changes in the research and development budgets of our
customers;
- acquisition, licensing and other costs related to the
expansion of our operations;
- the timing of milestones, licensing and other
payments under the terms of our customer
agreements and agreements pursuant to which others
license technology to us;
- expenses related to, and the results of, patent
filings and other proceedings relating to
intellectual property rights; and
- our unpredictable revenue sources as described below.
We anticipate significant fixed expenses due in part to our need to
continue to invest in product development and potential extensive support for
our gene function database subscribers. We may be unable to adjust our
expenditures if revenues in a particular period fail to meet our
expectations, which would harm our operating results for that period.
As a result of these fluctuations, we believe that period-to-period
comparisons of our financial results will not necessarily be meaningful, and
you should not rely on these comparisons as an indication of our future
performance.
OUR REVENUES WILL BE UNPREDICTABLE AND THIS MAY HARM OUR FINANCIAL CONDITION
The amount and timing of revenues that we may have from our business
will be unpredictable because:
- the timing of our DeltaSelect program agreements, gene
function database subscriber agreements and installations
are determined by our customers and subscribers;
- whether any products are commercialized and generate
royalty payments depends on the efforts, timing and
willingness of our customers;
- we do not expect to receive any milestone or royalty
payment under licenses and other arrangements for a
substantial period of time, if ever;
- to date, we have entered into only one customer agreement
for our gene function database and may not enter into
any additional agreements;
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- the time required to complete custom orders for our
database programs can vary significantly; and
- our sales cycle is lengthy, as described below.
As a result, our revenue may significantly vary from quarter to
quarter, and our quarterly results may be below market expectations. If this
happens, the price of our common stock may decline.
WE EXPECT THAT OUR SALES CYCLE WILL BE LENGTHY, WHICH WILL CAUSE OUR REVENUES TO
BE UNPREDICTABLE AND OUR BUSINESS TO BE DIFFICULT TO MANAGE
Our ability to identify and obtain subscribers for our gene function
database product and other services depends upon whether customers believe
that our products and services can help accelerate drug discovery efforts.
Our sales cycle will be lengthy because of the need to educate potential
customers and sell the benefits of our products and services to a variety of
constituencies within potential subscriber companies. These companies are
large organizations with many different layers and types of decision-makers.
In addition, each database subscription and development program or services
agreement will involve the negotiation of unique terms and issues which will
take a significant amount of time. We may expend substantial funds and
management effort with no assurance that a subscription program or services
agreement will result. Actual or proposed mergers or acquisitions of our
prospective customers may also affect the timing and progress of our sales
efforts. Any of these developments could harm our business or financial
condition.
WE MAY HAVE CONFLICTS OR BE IN COMPETITION WITH OUR CUSTOMERS, WHICH WILL
HURT OUR BUSINESS PROSPECTS
We may pursue opportunities in fields, such as secreted proteins,
that could conflict with those of our customers. Moreover, disagreements
could arise with our customers or their partners over rights to our
intellectual property or our rights to share in any of the future revenues of
compounds or therapeutic approaches developed by our customers. These kinds
of disagreements could result in costly and time-consuming litigation and
could have a negative impact on our relationship with existing customers. Any
conflict with our customers could reduce our ability to attract additional
customers or enter into future customer agreements. Some of our customers
could also become competitors in the future. Our customers could develop
competing products, preclude us from entering into agreements with their
competitors or terminate their agreements with us prematurely.
WE EXPERIENCE INTENSE COMPETITION FROM OTHER ENTITIES ENGAGED IN THE STUDY OF
GENES, AND THIS COMPETITION COULD ADVERSELY AFFECT OUR BUSINESS
The human and mouse genomes contain a finite number of genes. The
human genome has been mapped and identified. Our competitors have identified
and will continue to identify the sequence of numerous genes in order to
obtain proprietary positions with respect to those genes. In addition, our
competitors may seek to identify and determine the biological function of
numerous genes in order to obtain intellectual property rights with respect
to specific uses of these genes, and they may accomplish this before we do.
We believe that the first company to determine the functions of commercially
relevant genes or the commercially relevant portions of the genome will have
a competitive advantage.
A number of companies, institutions and government-financed entities
are engaged in gene sequencing, gene discovery, gene expression analysis,
gene function determination and other gene-related service businesses. Many
of these companies, institutions and entities have greater financial and
human resources than we do and have been conducting research longer than we
have. In particular, a significant portion of this research is being
conducted by private companies and under the international Human Genome
Project, a multi-billion dollar program funded, in part, by the U.S.
government, which completed and released its initial rough draft of the human
genome in June of this year. Furthermore, other entities have and will
continue to discover and establish a patent position in genes or gene
sequences that we wish to study. Significant competition also arises from
entities using standard target identification approaches, traditional
knockout mouse technology and other functional genomics technologies. These
competitors may have intellectual property rights in functional or other data
which are superior to our rights. These competitors may also develop products
earlier than we do, obtain regulatory approvals faster than we can and invent
products and techniques that are more effective than ours. Furthermore, other
methods for conducting functional genomics research may ultimately prove more
advanced, in some or all respects, to the use of knockout mice. In addition,
technologies more advanced than or superior to our gene trap technology and
gene function identification technology may be developed, thereby rendering
our gene trap and gene function identification technologies obsolete. As we
expand our range of products and
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services, such as our gene trap program, we will compete with additional
companies, some of which may be our customers at that time or our potential
customers.
Some of our competitors have developed commercially available
databases containing gene sequence, gene expression, gene function, genetic
variation or other functional genomic information and are marketing or plan
to market their data to pharmaceutical and biotechnology companies.
Additional competitors may attempt to establish databases containing this
information in the future. We expect that competition in our industry will
continue to intensify. We also believe that some pharmaceutical and
biotechnology companies are discussing the possibility of working together to
discover the functions of genes and share gene function-related data among
themselves. The formation of this type of consortium could reduce the
prospective customer base for our gene function-related business. Moreover,
the pharmaceutical industry has undergone significant mergers and this trend
is expected to continue. This concentration of the industry could further
limit our potential customer base and therefore harm our business.
IF WE FAIL TO PROPERLY MANAGE OUR GROWTH, OUR BUSINESS COULD BE ADVERSELY
AFFECTED
We expect to continue to experience significant growth in the number of
our employees and the scope of our operations, including an increase in the
scale of our mouse knockout program. As of December 31, 1999, we had 113
full-time employees, and as of June 30, 2000, we had 167 full-time employees. We
expect our number of employees to continue to increase for the foreseeable
future. In addition, we have substantially increased the scale of our knockout
mouse production in the last year and expect to continue doing so for the
foreseeable future. Our overall growth and need to develop many different areas
of our company have placed, and may continue to place, a strain on our
management and operations. If we are unable to manage our growth effectively,
our losses could increase. The management of our growth will depend, among other
things, upon our ability to broaden our management team and attract, hire, train
and retain skilled employees. Our success will also depend on the ability of our
officers and key employees to continue to implement and improve our operational
and other systems. We will also be required to expend funds, which may be
substantial, to improve our operational, financial and management controls,
reporting systems and procedures.
In addition, we will have to invest in additional customer support
resources. Our current and potential database subscribers typically have
worldwide operations and may require support at multiple U.S. and foreign sites
and in multiple languages. To provide this support, we may need to open offices
in addition to our Menlo Park and San Carlos, California facilities, which will
result in additional burdens on our systems and resources and require additional
capital expenditures.
WE MAY ENGAGE IN FUTURE ACQUISITIONS, WHICH COULD ADVERSELY AFFECT YOUR
INVESTMENT IN US AS WE MAY NEVER REALIZE ANY BENEFITS FROM SUCH ACQUISITIONS,
WHICH ALSO COULD BE EXPENSIVE AND TIME CONSUMING
We intend to acquire and license additional products and programs,
if we determine that these products or programs complement our existing
technology or augment our existing information technology platforms. We
currently have no commitments or agreements with respect to any material
acquisitions. If we do undertake any transactions of this sort, the process
of integrating an acquired business, technology, service or product may
result in operating difficulties and expenditures and may absorb significant
management attention that would otherwise be available for ongoing
development of our business. Moreover, we may never realize the anticipated
benefits of any acquisition. Future acquisitions could result in potentially
dilutive issuances of equity securities, the incurrence of debt and
contingent liabilities and amortization expenses related to goodwill and
other intangible assets, which could adversely affect our results of
operations and financial condition.
WE MAY NEED TO RAISE ADDITIONAL CAPITAL THAT MAY NOT BE AVAILABLE, WHICH
COULD ADVERSELY AFFECT OUR OPERATIONS
Our products and services may not produce revenues that, together
with our existing cash and other resources, are adequate to meet our cash
needs. Initially, we plan to fund our operations with proceeds from this
offering, and we may in the future seek to raise additional funds from the
sale of stock or from debt financing. Our cash requirements depend on
numerous factors, including:
- our ability to attract and retain customers for our gene
function database and other products and services;
- unexpected expenses in connection with the development of
our gene function database, our gene trap program or
other products and services;
- expenditures in connection with license agreements and
acquisitions of and investments in complementary
technologies and businesses;
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- the need to increase research and development spending
to keep up with competing technologies and market
developments; and
- unexpected expenditures as we expand our sales, marketing and
customer service organizations and improve our management,
operational and financial systems.
If we need additional funding, we may be unable to obtain it on
favorable terms, or at all. If adequate funds are not available, we may have
to curtail operations significantly or obtain funds by entering into
arrangements requiring us to relinquish rights to certain technologies,
products or markets. In addition, if we raise funds by selling stock or
convertible securities, our existing stockholders could suffer dilution.
WE DEPEND ON KEY EMPLOYEES IN A COMPETITIVE MARKET FOR SKILLED PERSONNEL, AND
WITHOUT ADDITIONAL EMPLOYEES, WE CANNOT GROW OR ACHIEVE PROFITABILITY
We are highly dependent on the principal members of our management,
operations and scientific staff, including William Matthews, Ph.D., our
President and Chief Executive Officer, and Mark W. Moore, Ph.D., our Chief
Scientific Officer. The loss of either of their services would harm our
business.
Our future success also will depend in part on the continued service
of our key scientific, software, consultant and management personnel and our
ability to identify, hire and retain additional personnel, including customer
service, marketing and sales staff. We experience intense competition for
qualified personnel. We may be unable to attract and retain personnel
necessary for the development of our business. Moreover, our business is
located in the San Francisco Bay Area of California, where demand for
personnel with the skills we seek is extremely high and is likely to remain
high. Because of this competition, our compensation costs may increase
significantly.
WE CURRENTLY HAVE NO PATENTS, AND IF WE ARE UNABLE TO PROTECT OUR PROPRIETARY
INFORMATION, OUR BUSINESS WILL BE ADVERSELY AFFECTED
Our business and competitive position depends upon our ability to
protect and exploit our proprietary techniques, methods, compositions,
inventions, database information and software technology. However, our
strategy of obtaining such proprietary rights around as many genes as
possible is unproven. Unauthorized parties may attempt to obtain and use
information that we regard as proprietary. Although we intend for our gene
function database subscription agreements to require our potential
subscribers to control access to our database and information, policing
unauthorized use of our database information and software may be difficult.
We currently have no issued patents or registered copyrights.
Patents have issued to other entities based on claims relating to knockout
mice. In addition, many applications have been filed seeking to protect
partial human gene sequences, many of which are based primarily on gene
sequence information alone. Some of these applications have issued as
patents. Some of these may claim sequences which we have used or may use in
the future to generate knockout mice in our gene knockout program. In
addition, other applications have been filed which seek to protect methods of
using genes and gene expression products, some of which attempt to assign
biological function to the DNA sequences based on laboratory experiments,
computer predictions, mathematical algorithms and other methods. The issuance
of these applications as patents will depend, in part, upon whether practical
utility can be sufficiently established for the claimed sequences and whether
sufficient correlation exists between the experimental results predictions,
algorithms and other methods and actual functional utility. The patent
application process before the United States' Patent and Trademark Office and
other similar agencies in other countries is confidential in nature. As each
application is evaluated independently and confidentially, we cannot predict
whether applications have been filed or which, if any, will ultimately issue
as patents. However, it is probable that patents will be issued to our
competitors claiming knockout mice, partial human gene sequences and methods
of using genes and gene expression products.
Numerous applications have been filed by other entities claiming
gene sequences. Many patents have already issued and we expect more will
issue in the future. In addition, others may discover uses for genes or
proteins other than uses covered in any patents issued to us, and these other
uses may be separately patentable. We may not be able to obtain issued
patents on our patent applications because our patent applications may not
meet the requirements of the patent office. The holder of a patent covering a
particular use of a gene or a protein, isolated gene sequence or deduced
amino acid sequence could exclude us from using that gene, protein or
sequence. In addition, a number of entities make gene information, techniques
and methods publicly available, which may affect our ability to obtain
patents.
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Some of our patent applications may claim compositions, methods or
uses that may also be claimed in patent applications filed by others. In some
or all of these applications, a determination of priority of inventorship may
need to be decided in an interference proceeding before the U.S. Patent and
Trademark Office. Regardless of determined outcome, this process is
time-consuming and expensive.
Issued patents may not provide commercially-meaningful protection
against competitors. Other companies or institutions may challenge our or our
customers' patents or independently develop similar products that could result
in an interference proceeding in the U.S. Patent and Trademark Office or a legal
action. In the event any researcher or institution infringes upon our or our
customers' patent rights, enforcing these rights may be difficult and can be
time-consuming. Others may be able to design around these patents or develop
unique products providing effects similar to our products.
Our ability to use our patent rights to limit competition in the
creation and use of knockout mice, as well as our ability to obtain patent
rights, may be more limited in certain markets outside of the United States
because the protections available in other jurisdictions may not be as extensive
as those available domestically.
We pursue a policy of having our employees, consultants and advisors
execute proprietary information and invention agreements when they begin
working for us. However, these agreements may not be enforceable or may not
provide meaningful protection for our trade secrets or other proprietary
information in the event of unauthorized use or disclosure. We also cannot
prevent others from independently developing technology or software that
might be covered by copyrights issued to us, and trade secret laws do not
prevent independent development.
WE MAY BE SUBJECT TO LITIGATION AND INFRINGEMENT CLAIMS WHICH MAY BE COSTLY
AND DIVERT MANAGEMENT'S ATTENTION
The technology we use in our business may subject us to claims that we
infringe on the patents or proprietary rights of others. The risk of this
occurring will tend to increase as the genomics, biotechnology and software
industries expand, more patents are issued and other companies attempt to
discover gene function through mouse gene knockouts and engage in other
genomics-related businesses. Furthermore, many of our competitors and other
companies performing research on genes have already applied for patents covering
some of the genes upon which we perform research, and many patents have already
been issued which cover these genes, as well as genes we may wish to use in the
future.
In 1998, Lexicon Genetics Incorporated, one of our competitors,
informed us that it was a coexclusive licensee under a patent covering certain
isogenic DNA technology that may be used to modify the genome of a target cell.
On May 24, 2000, Lexicon filed a lawsuit against us in the United States
District Court for the District of Delaware. The complaint in the lawsuit
alleges that our methods of making knockout mice infringe United States Patent
No. 5,789,215, under which Lexicon claims to be an exclusive licensee. The
complaint seeks a judgment that we have infringed this patent, a permanent
injunction against further infringement of the patent and an award of damages in
an unspecified amount that, under certain circumstances, may be tripled. On June
13, 2000, we responded to Lexicon's complaint by filing an answer and seeking a
declaratory judgment in our favor. Our response seeks a judgment declaring the
patent invalid and that we have not infringed and are not infringing the patent.
We intend to defend the action vigorously.
The litigation against us is in the early stages and its outcome cannot
be predicted. If Lexicon prevails and obtains an injunction, we would be
required to obtain a license in order to continue to use the methods covered by
the patent. We may not be able to obtain this license on favorable terms or at
all. If we are unable to obtain a license, we would be required to redesign our
processes to use alternative methods of making knockout mice and expect we would
experience a significant disruption in our ability to generate revenue during
this redesign period and as we develop a gene function database using these new
methods. This redesign and development would involve significant time and costs,
and the alternative methods available to us may not be as effective as our
current methods. We estimate the average time from the date we begin to create a
knockout mouse until the date the data from that knockout mouse is added to the
gene function database to be 12 months. The addition of new data points to our
gene function database could be significantly delayed. We may fail to attract
customers for a gene function database that uses the alternative methods, and
the marketing of our existing database and DeltaSelect program may be
significantly affected. If Lexicon prevails, we could also incur significant
financial liabilities which could materially affect our business and operating
results.
In addition, on July 13, 2000, we received a letter from Lexicon
stating that they believe we may be involved in activities that conflict with
four patents licensed to Lexicon. Lexicon's letter states that these patents
cover certain methods for producing gene targeted cells and transgenic, or
knockout, mice. We believe our methods do not infringe these patents. If Lexicon
asserts its rights under these patents as the basis for a lawsuit against us and
Lexicon prevails in any such lawsuit, we
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would be prevented from using our methods unless we obtained a license. We
may be unable to obtain a license on favorable terms or at all, or we may
choose not to seek a license. We believe we could use alternative methods,
with which we have experience and which we believe are as effective as our
current methods. Developing a gene function database using these alternative
methods would involve significant time and costs. An adverse determination of
any lawsuit with Lexicon involving these patents could also significantly
affect the marketing of our existing gene function database and DeltaSelect
program. We expect that, during the period prior to development of a
comparable gene function database using these alternative methods, we would
experience a significant disruption in our ability to generate revenue. If
Lexicon prevails in any lawsuit involving these patents, we could also incur
significant financial liabilities which could materially affect our business
and operating results.
We may be involved in future lawsuits alleging patent infringement
or other intellectual property rights violations. In addition, litigation may
be necessary to:
- assert claims of infringement;
- enforce our patents, if any;
- protect our trade secrets or know-how; and
- determine the enforceability, scope and validity of the
proprietary rights of others.
We may be unsuccessful in defending or pursuing these lawsuits.
Regardless of the outcome, litigation, including our litigation with Lexicon,
can be very costly, can divert management's efforts and could materially affect
our business and operating results. An adverse determination may subject us to
significant liabilities or restrict or prohibit us from selling our products.
BECAUSE WE DO NOT HAVE ANY ISSUED PATENTS, AND BECAUSE KNOCKOUT MOUSE AND
GENE-RELATED PATENTS EVEN IF OBTAINED MAY NOT BE ENFORCEABLE, OUR INTELLECTUAL
PROPERTY MAY NOT HAVE ANY MATERIAL VALUE, WHICH WOULD DIMINISH OUR BUSINESS
PROSPECTS
One of our strategies is to obtain proprietary rights around as many
gene knockouts as possible. Although we have filed patent applications
covering the knockout mice we produce, we do not currently have any issued
patents. We rely on a combination of copyright and trademark law, trade
secrets, non-disclosure agreements and contractual provisions in our
agreements with our customers to establish and maintain intellectual property
rights. While the U.S. Patent and Trademark Office in the past has issued
patents to others covering function of genes, knockout mice, types of cells,
gene sequences and methods of testing cells, we do not know whether or how
courts may enforce those patents, if that becomes necessary. If a court finds
these types of inventions to be unpatentable, or interprets them narrowly,
the benefits of our strategy may not materialize and our business and
financial condition could be harmed.
OUR RIGHTS TO THE USE OF TECHNOLOGIES LICENSED TO US BY THIRD PARTIES ARE NOT
WITHIN OUR CONTROL, AND WITHOUT THESE TECHNOLOGIES, OUR PRODUCTS AND PROGRAMS
MAY NOT BE SUCCESSFUL AND OUR BUSINESS PROSPECTS COULD BE HARMED
We rely, in part, on licenses to use certain technologies which are
material to our business, including a secreted protein gene trap which we
license exclusively from the University of Edinburgh. We do not own the
patents that underlie these licenses. Our rights to use these technologies
and employ the inventions claimed in the licensed patents are subject to our
licensors abiding by the terms of those licenses and not terminating them. In
most cases, we do not control the prosecution or filing of the patents to
which we hold licenses. Instead we rely upon our licensors to prevent
infringement of those patents. Some of the licenses under which we have
rights, such as the license from the University of Edinburgh, provide us with
exclusive rights in specified fields, but we cannot assure you that the scope
of our rights under these and other licenses will not be subject to dispute
by our licensors or third parties.
OUR ACTIVITIES INVOLVE HAZARDOUS MATERIAL AND MAY SUBJECT US TO ENVIRONMENTAL
LIABILITY, WHICH WOULD SERIOUSLY HARM OUR FINANCIAL CONDITION
Our research and development activities involve the controlled use
of hazardous and radioactive materials and generate biological waste. We are
subject to federal, state and local laws and regulations governing the
storage, handling and disposal of these materials and waste products.
Although we believe that our safety procedures for handling and disposing of
these materials and wastes comply with legally prescribed standards, the risk
of accidental contamination or injury from these materials cannot
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be completely eliminated. We may be sued for any injury or contamination that
results from our use or the use by third parties of these materials, and our
liability may exceed our insurance coverage and our total assets. Future
environmental regulations could require us to incur significant costs.
COMPLIANCE WITH GOVERNMENTAL REGULATIONS COULD INCREASE OUR OPERATING COSTS OR
ADVERSELY AFFECT OUR CUSTOMERS' ABILITY TO OBTAIN GOVERNMENTAL APPROVAL OF GENE
BASED PRODUCTS, WHICH WOULD ADVERSELY AFFECT THE COMMERCIALIZATION OF OUR
TECHNOLOGY
The Animal Welfare Act, or AWA, is the federal law that currently
covers animals in laboratories. It applies to institutions or facilities
using any regulated live animals for research, testing, teaching or
experimentation, including diagnostic laboratories and private companies in
the pharmaceutical and biotechnology industries. The AWA currently does not
cover rats or mice. However, the United States Department of Agriculture,
which enforces the AWA, is presently considering changing the regulations
issued under the AWA to include mice within its coverage.
The Department of Agriculture is reconsidering the regulations in
response to a January 1999 petition filed by several parties requesting that
mice, rats and birds be added to the list of animals regulated under the AWA.
These parties also have a lawsuit pending which seeks the inclusion of mice,
rats, and birds in the AWA regulations.
Currently, the AWA imposes a wide variety of specific regulations
which govern the humane handling, care, treatment and transportation of
certain animals by producers and users of research animals, most notably
personnel, facilities, sanitation, cage size, feeding, watering and shipping
conditions. We cannot assure you that the USDA will not decide to include
mice in its regulations and that we will not become subject to registration,
inspections and reporting requirements. Compliance with the AWA could be
expensive, and current or future regulations could impair our research and
production efforts.
Since we develop animals containing changes in their genetic
make-up, we may become subject to a variety of laws, guidelines, regulations
and treaties specifically directed at genetically modified organisms, or
GMOs. The area of environmental releases of GMOs is rapidly evolving and is
currently subject to intense regulatory scrutiny, particularly
internationally. If we become subject to these laws we could incur
substantial compliance costs. For example, the Biosafety Protocol, or the
BSP, a recently adopted treaty, is expected to cover certain shipments from
the U.S. to countries abroad that have signed the BSP. The BSP is also
expected to cover the importation of living modified organisms, a category
that could include our animals. If our animals are not contained as described
in the BSP, our animals could be subject to the potentially extensive import
requirements of countries that are signatories to the BSP.
We also are subject to a variety of other federal, state and local
laws and regulations in the U.S. and in other countries pertaining to our
facilities, the shipment, exportation and importation of various articles,
safe working conditions, production practices, fire hazard control and other
health concerns. There can be no assurance that we will avoid incurring
significant costs to comply with these laws and regulations or that we will
be able to comply with them in the future. Failure to comply with relevant
laws and regulations may have a material adverse effect on our business,
financial condition and results of operation. Unanticipated changes in
existing legal and regulatory requirements or the adoption of new
requirements also could have a material adverse effect on us.
Drugs and diagnostic products are subject to an extensive and uncertain
regulatory approval process by the Food and Drug Administration and comparable
agencies in other countries. Regulatory requirements ultimately imposed on our
products or products developed by our customers could limit our or our
customers' ability to test, manufacture and, ultimately, commercialize products,
including products for which we are entitled to receive royalty payments.
ETHICAL AND SOCIAL ISSUES MAY LIMIT OR DISCOURAGE THE USE OF KNOCKOUT MICE OR
OTHER GENETIC PROCESSES WHICH COULD REDUCE OUR REVENUES AND ADVERSELY AFFECT OUR
BUSINESS
Governmental authorities could, for social or other purposes, limit
the use of genetic processes or prohibit the practice of our gene trap and
knockout mouse technologies. Public attitudes may be influenced by claims
that genetically engineered products are unsafe for consumption or pose a
danger to the environment. The subject of genetically modified organisms,
like knockout mice, has received negative publicity and aroused public
debate. In addition, animal rights activists could protest or make threats
against our facilities, which may result in property damage. Ethical and
other concerns about our methods, particularly our use of knockout mice,
could adversely affect our market acceptance.
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ALL OUR RESEARCH IS CONDUCTED AT TWO FACILITIES, AND A NATURAL DISASTER AT THESE
FACILITIES IS POSSIBLE AND COULD RESULT IN A PROLONGED INTERRUPTION OF OUR
BUSINESS
We conduct all our scientific and management activities at two
facilities in California. Both locations are in seismically active areas. We
have taken precautions to safeguard our mouse colony including through
insurance, storage of animals off-site at a back-up facility in Massachusetts,
the freezing of sperm and the storing of embryonic stem cells, or ES cells, to
allow for the regeneration of mice. However, a natural disaster, such as an
earthquake, fire, flood or outbreak of infectious disease, could cause
substantial delays. This could interrupt mouse breeding, cause us to incur
additional expenses and adversely affect our reputation with customers.
SECURITY RISKS IN ELECTRONIC COMMERCE OR UNFAVORABLE INTERNET REGULATIONS
MAY DETER FUTURE USE OF OUR PRODUCTS AND SERVICES
We may provide access to our gene function database on the Internet.
A fundamental requirement to conduct our business over the Internet is the
secure transmission of confidential information over public networks.
Advances in computer capabilities, new discoveries in the field of
cryptography or other developments may result in a compromise or breach of
the security measures we use to protect the content in our gene function
database. Anyone who is able to circumvent our security measures could
misappropriate our proprietary information or confidential customer
information or cause interruptions in our operations. We may be required to
incur significant costs to protect against security breaches or to alleviate
problems caused by breaches, and these efforts may not be successful.
Further, a well-publicized compromise of security could deter people from
using the Internet to conduct transactions that involve transmitting
confidential information. For example, attacks earlier this year by computer
hackers on major e-commerce web sites have heightened concerns regarding the
security and reliability of the Internet.
Because of the growth in electronic commerce, the U.S. Congress has
held hearings on whether to further regulate providers of services and
transactions in the electronic commerce market, and federal and state
authorities could enact laws, rules and regulations affecting our business
and operations. If enacted, these laws, rules and regulations could make our
business and operations more costly and burdensome as well as less efficient.
WE RELY ON THIRD-PARTY DATA SOURCES, AND WITHOUT THESE SOURCES, OUR PRODUCTS
AND PROGRAMS WOULD BE INCOMPLETE AND LESS APPEALING TO CUSTOMERS, SERIOUSLY
HARMING OUR BUSINESS PROSPECTS
We may rely on scientific and other data supplied by third parties,
and all of our gene sequence data comes from public genomics data. This data
could be defective, be improperly generated or contain errors or other
defects, which could corrupt our gene function database and our other
programs and services. In addition, we cannot guarantee that our sources
acquired this data in compliance with legal requirements. In the event of any
such defect, corruption or finding of nonconformance, our business prospects
could be adversely affected.
OUR COMMON STOCK MAY EXPERIENCE EXTREME PRICE AND VOLUME FLUCTUATIONS, WHICH
COULD LEAD TO COSTLY LITIGATION FOR US AND MAKE AN INVESTMENT IN US LESS
APPEALING
The market price of our common stock may fluctuate substantially due to a
variety of factors, including:
- announcements of technological innovations or new products
by us or our competitors;
- developments or disputes concerning patents or proprietary
rights, including announcements with respect to our
litigation with Lexicon or of infringement, interference
or other litigation against us or our licensors;
- the timing and development of our products and services;
- media reports and publications about genetics and gene-based
products;
- changes in pharmaceutical and biotechnology companies'
research and development expenditures;
- announcements concerning our competitors, or the
biotechnology or pharmaceutical industry in
general;
- changes in government regulation of genetic research
or gene-based products, and the pharmaceutical or
medical industry in general;
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- general and industry-specific economic conditions;
- actual or anticipated fluctuations in our operating results;
- changes in financial estimates or recommendations by
securities analysts;
- changes in accounting principles; and
- the loss of any of our key scientific or management personnel.
In addition, the stock market has experienced extreme price and
volume fluctuations. The market prices of the securities of biotechnology
companies, particularly companies like ours without consistent product
revenues and earnings, have been highly volatile and may continue to be
highly volatile in the future. This volatility has often been unrelated to
the operating performance of particular companies. For example, the stock
prices of many biotechnology companies, even those that would benefit from
publicly available gene sequence information, declined on news of the
announcement by President Clinton and British Prime Minister Blair that, as
their respective governments had each advocated before, gene sequence
information should be freely available in the public domain. In the past,
securities class action litigation has often been brought against companies
that experience volatility in the market price of their securities. Moreover,
market prices for stocks of biotechnology-related and technology companies,
particularly following an initial public offering, frequently reach levels
that bear no relationship to the operating performance of such companies.
These market prices generally are not sustainable and are subject to wide
variations. Whether or not meritorious, litigation brought against us could
result in substantial costs, divert management's attention and resources and
harm our financial condition and results of operations.
THE FUTURE SALE OF COMMON STOCK COULD NEGATIVELY AFFECT OUR STOCK PRICE
After the close of our public offering on August 2, 2000 we had
approximately 28,804,437 shares of common stock outstanding, and
approximately 29,829,437 shares when the underwriters' exercised their
over-allotment for approximately 1,025,000 shares. The 8,025,000 shares sold
in the offering are freely tradable without restriction or further
registration under the federal securities laws unless purchased by our
affiliates. The remaining 21,804,437 shares of common stock outstanding will
be available for sale in the public market 180 days after the effective date
of the registration statement, subject in some cases to volume and other
limitations.
The previous sentence assumes the effectiveness of the lock-up
agreements with the underwriters under which holders of substantially all of
our common stock have agreed not to sell or otherwise dispose of their shares
of common stock. Most of the shares that will be available for sale after the
expiration of the lock-up period will be subject to volume restrictions
because they are held by our affiliates. In addition, Salomon Smith Barney
Inc. may waive these lock-up restrictions prior to the expiration of the
lock-up period without prior notice. Salomon Smith Barney Inc. has informed
us that it has no current intentions of releasing any shares subject to the
lock-up agreements. Any determination by Salomon Smith Barney Inc. to release
any shares subject to the lock-up restrictions would be based on a number of
factors at the time of determination, including the market price of the
common stock, the liquidity of the trading market for the common stock, the
general market conditions, the number of shares proposed to be sold and the
timing, purpose and terms of the proposed sale.
If our common stockholders sell substantial amounts of common stock
in the public market, or the market perceives that such sales may occur, the
market price of our common stock could fall. The holders of approximately
18,180,856 shares of our common stock have rights, subject to some
conditions, to require us to file registration statements covering their
shares or to include their shares in registration statements that we may file
for ourselves or other stockholders. Furthermore, if we were to include in a
company-initiated registration statement shares held by those holders
pursuant to the exercise of their registration rights, those sales could
impair our ability to raise needed capital by depressing the price at which
we could sell our common stock. Please see "Shares Eligible for Future Sale."
OUR PRINCIPAL STOCKHOLDERS, EXECUTIVE OFFICERS AND DIRECTORS OWN A
SIGNIFICANT PERCENTAGE OF OUR STOCK, AND AS A RESULT, THE TRADING PRICE FOR
OUR SHARES MAY BE DEPRESSED AND THESE STOCKHOLDERS CAN TAKE ACTIONS THAT MAY
BE ADVERSE TO YOUR INTERESTS
Our executive officers and directors and entities affiliated with
them, in the aggregate, beneficially own approximately 67.6% of our common
stock following the offering. This significant concentration of share
ownership may adversely affect the
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trading price for our common stock because investors often perceive
disadvantages in owning stock in companies with controlling shareholders.
These stockholders, acting together, will have the ability to exert
substantial influence over all matters requiring approval by our
stockholders, including the election and removal of directors and any
proposed merger, consolidation or sale of all or substantially all of our
assets. In addition, they could dictate the management of our business and
affairs. This concentration of ownership could have the effect of delaying,
deferring or preventing a change in control, or impeding a merger or
consolidation, takeover or other business combination that could be favorable
to you.
OUR INCORPORATION DOCUMENTS AND DELAWARE LAW MAY INHIBIT A TAKEOVER THAT
STOCKHOLDERS CONSIDER FAVORABLE AND COULD ALSO LIMIT THE MARKET PRICE OF YOUR
STOCK
Our amended and restated certificate of incorporation and bylaws
contain provisions that could delay or prevent a change in control of our
company. Some of these provisions:
- authorize the issuance of preferred stock which can be created
and issued by the board of directors without prior stockholder
approval, commonly referred to as "blank check" preferred
stock, with rights senior to those of common stock;
- provide for a classified board of directors; and
- prohibit stockholder action by written consent.
In addition, we are governed by the provisions of Section 203 of
Delaware General Corporate Law. These provisions may prohibit large
stockholders, in particular those owning 15% or more of our outstanding voting
stock, from merging or combining with us. These and other provisions in our
amended and restated certificate of incorporation and bylaws and under Delaware
law could reduce the price that investors might be willing to pay for shares of
our common stock in the future and result in the market price being lower than
it would be without these provisions.
WE MAY SPEND THE NET PROCEEDS OF OUR INITIAL PUBLIC OFFERING IN WAYS WITH
WHICH YOU DO NOT AGREE AND WHICH ARE NOT BENEFICIAL TO YOUR INVESTMENT IN US
We have not designated any specific uses for the initial public
offering proceeds. Accordingly, management will have significant flexibility
in applying the net proceeds of the initial public offering. The failure of
management to apply the net proceeds effectively could have a material
adverse effect on our business, financial condition and results of operations.
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PART II. OTHER INFORMATION
ITEM 1. - LEGAL PROCEEDINGS
In 1998, Lexicon Genetics Incorporated, one of our competitors, informed us
that it was a coexclusive licensee under a patent covering certain isogenic DNA
technology that may be used to modify the genome of a target cell. On May 24,
2000, Lexicon filed a lawsuit against us in the United States District Court for
the District of Delaware. The complaint in the lawsuit alleges that our methods
of making knockout mice infringe United States Patent No. 5,789,215, under which
Lexicon claims to be an exclusive licensee. The complaint seeks a judgment that
we have infringed this patent, a permanent injunction against further
infringement of the patent and an award of damages in an unspecified amount
that, under certain circumstances, may be tripled. On June 13, 2000, we
responded to Lexicon's complaint by filing an answer and seeking a declaratory
judgment in our favor. Our response seeks a judgment declaring the patent
invalid and that we have not infringed and are not infringing the patent. We
intend to defend the action vigorously.
The litigation against us is in the early stages and its outcome cannot be
predicted. If Lexicon prevails and obtains an injunction, we would be required
to obtain a license in order to continue to use the methods covered by the
patent. We may not be able to obtain this license on favorable terms or at all.
If we are unable to obtain a license, we would be required to redesign our
processes to use alternative methods of making knockout mice and expect we would
experience a significant disruption in our ability to generate revenue during
this redesign period and as we develop a gene function database using these new
methods. This redesign and development would involve significant time and costs,
and the alternative methods available to us may not be as effective as our
current methods. We estimate the average time from the date we begin to create a
knockout mouse until the date the data from that knockout mouse is added to the
gene function database to be 12 months. The addition of new data points to our
gene function database could be significantly delayed. We may fail to attract
customers for a gene function database that uses the alternative methods, and
the marketing of our existing database and DeltaSelect program may be
significantly affected. If Lexicon prevails, we could also incur significant
financial liabilities which could materially affect our business and operating
results.
In addition, on July 13, 2000, we received a letter from Lexicon stating
that they believe we may be involved in activities that conflict with four
patents licensed to Lexicon. Lexicon's letter states that these patents cover
certain methods for producing gene targeted cells and transgenic, or
knockout, mice. We believe our methods do not infringe these patents. If
Lexicon asserts its rights under these patents as the basis for a lawsuit
against us and Lexicon prevails in any such lawsuit, we would be prevented
from using our methods unless we obtained a license. We may be unable to
obtain a license on favorable terms or at all, or we may choose not to seek a
license. We believe we could use alternative methods, with which we have
experience and which we believe are as effective as our current methods.
Developing a gene function database using these alternative methods would
involve significant time and costs. An adverse determination of any lawsuit
with Lexicon involving these patents could also significantly affect the
marketing of our existing gene function database and DeltaSelect program. We
expect that, during the period prior to development of a comparable gene
function database using these alternative methods, we would experience a
significant disruption in our ability to generate revenue. If Lexicon
prevails in any lawsuit involving these patents, we could also incur
significant financial liabilities which could materially affect our business
and operating results.
ITEM 2. - CHANGES IN SECURITIES
(a) Not applicable.
(b) Not applicable.
(c) On various dates from April 1, 2000 through June 30, 2000, the
Company issued 5,339 shares of its common stock to various officers,
employees and consultants pursuant to the exercise of options granted
under its 1998 Stock Plan. The exercise price per share ranged from
$0.31 to $7.88. The Company relied on the exemption provided by Rule
701 promulgated under the Securities Act of 1933, as amended, in
issuing these shares.
(d) On August 2, 2000, our Registration Statement on Form S-1 (File No.
333-34668) was declared effective by the Securities and Exchange
Commission. The IPO Registration Statement registered a total of
7,000,000 shares of common stock, the Offering, all of which were
issued and sold by us. The Offering was led by a group consisting of
Salomon Smith Barney Inc., FleetBoston Robertson Stephens, Inc. and
U.S. Bancorp Piper Jaffray Inc. The shares sold by us were sold at an
aggregate offering price of $105 million, netting proceeds of
approximately $96.4 million to us after underwriting fees of
approximately $7.4 million and other offering expenses of
approximately $1.2 million. None of these fees and expenses were paid
to any director, officer, or 10% or greater stockholder of the Company
or an affiliate of these persons.
On August 30, 2000, the underwriters exercised their over-allotment
for the purchase of approximately 1,025,000 shares. The shares sold
by us were sold at an aggregate offering price of $15.4 million,
netting proceeds of approximately $14.3 million to us after
underwriting fees of approximately $1.1 million and other offering
expenses. None of these fees and expenses were paid to any director,
officer, or 10% or greater stockholder of the Company or an affiliate
of these persons.
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Since the effective date of the IPO Registration Statement, the net
offering proceeds have been invested in highly liquid instruments,
which include marketable debt securities of financial institutions and
corporations with strong credit ratings with maturities of ninety days
or less when acquired.
Because all of the proceeds from the Offering and the over-allotment
exercise were generated after June 30, 2000, none of these proceeds
were used during the three month or six month periods covered by this
Report on Form 10-Q.
ITEM 3. - DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A majority of the Company's stockholders, by written consent, approved:
(i) an amendment and restatement to the Company's Certificate of
Incorporation, providing for, among other things, an 8-for-7 forward stock
split and an increase in the Company's authorized capital stock; (ii)
conditioned upon consummation of the Offering, an amendment and restatement
of the Company's Certificate of Incorporation to, among other things, set the
authorized "blank check" preferred stock at 5,000,000 shares, provided for a
classified Board of Directors, eliminate the right of stockholders to act by
written consent and provide for certain supermajority voting provisions;
(iii) conditioned upon consummation of the Offering, an amendment and
restatement of the Company's by-laws, to, among other things, eliminate the
right of stockholders to act by written consent and provide for certain
supermajority voting provisions; (iv) the adoption of the 2000 Stock
Incentive Plan; and (v) the adoption of the 2000 Employee Stock Purchase Plan.
ITEM 5. - OTHER INFORMATION
Not applicable.
ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
27.1 Financial Data Schedule
b) Reports on Form 8-K
No reports on Form 8-K were filed during the three months ended June 30,
2000.
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DELTAGEN, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DELTAGEN, INC.
Date: Sept 18, 2000 /s/ William Matthews
-------------------- ---------------------------------
William Matthews, Ph.D.
President and Chief Executive Officer
Date: Sept 18, 2000 /s/ Brian Crowley
-------------------- ---------------------------------
Brian Crowley
Director of Finance
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