<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For Quarter Ended: FEBRUARY 27, 1999
Commission File No: 0-10824
GENOME THERAPEUTICS CORP.
------------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MASSACHUSETTS 04-2297484
- --------------------------------- -------------------
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
100 BEAVER STREET; WALTHAM, MASSACHUSETTS 02453
- ----------------------------------------- -------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER: (781) 398-2300
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
COMMON STOCK 18,357,421
-------------- --------------------------
$.10 PAR VALUE Outstanding April 12, 1999
<PAGE> 2
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
Index to Financial Information (Unaudited) and Other Information
Page
----
PART I
Financial Information (Unaudited) :
Consolidated Condensed Balance Sheets as of 3
August 31, 1998 and February 27, 1999
Consolidated Condensed Statements of Operations 4
for the 26 week periods ended February 28, 1998
and February 27,1999
Consolidated Statements of Cash Flows for the 5
26 week periods ended February 28, 1998
and February 27,1999
Notes to Consolidated Condensed Financial 6-11
Statements for the 26 week periods ended
February 28, 1998 and February 27, 1999
Management's Discussion and Analysis of Financial 12-18
Conditions and Results of Operations
PART II
Other Information:
Other Information 19
Signature 20
2
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GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
August 31, February 27,
1998 1999
(Unaudited)
- --------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents $10,978,176 $16,303,106
Marketable securities 21,969,524 14,526,250
Interest receivable 742,411 518,594
Unbilled costs and fees 150,299 109,886
Prepaid expenses and other current assets 721,239 548,697
----------- -----------
Total current assets 34,561,649 32,006,533
Equipment and leasehold improvements, at cost:
Laboratory and scientific equipment 14,434,808 15,186,577
Leasehold improvements 7,872,336 7,999,780
Equipment and furniture 1,334,268 1,333,698
Construction-in-progress 41,234 138,060
----------- -----------
23,682,646 24,658,115
Less accumulated depreciation and amortization 8,579,440 10,394,522
----------- -----------
15,103,206 14,263,593
Restricted cash 200,000 200,000
Long-term marketable securities 1,029,569 0
Note receivable from officer 160,000 160,000
Other assets 410,267 386,277
----------- -----------
Total assets $51,464,691 $47,016,403
=========== ===========
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable $ 977,610 $ 862,020
Accrued expenses 2,450,400 2,418,441
Deferred revenue 4,699,137 5,973,400
Current maturities of long-term obligations 5,611,186 4,707,893
----------- -----------
Total current liabilities 13,738,333 13,961,754
Long-term obligations, net of current maturities 8,478,558 7,336,027
Shareholders' equity 29,247,800 25,718,622
----------- -----------
Total liabilities and shareholders' equity $51,464,691 $47,016,403
=========== ===========
</TABLE>
See Notes to Consolidated Condensed Financial Statements.
3
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GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
Thirteen Weeks Ended Twenty-six Weeks Ended
February 28, February 27, February 28, February 27,
1998 1999 1998 1999
(Unaudited) (Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues:
Collaborative research, licenses, subscription
fees and royalties $ 3,861,532 $ 6,301,218 $ 7,857,474 $11,138,227
Government research 202,232 101,525 463,603 374,773
----------- ----------- ----------- -----------
Total revenues 4,063,764 6,402,743 8,321,077 11,513,000
----------- ----------- ----------- -----------
Costs and Expenses:
Research and development 7,840,057 6,571,140 14,470,972 13,110,894
Cost of government research 202,232 101,525 463,603 374,773
Selling, general and administrative 1,112,809 1,151,871 2,134,946 2,062,423
----------- ----------- ----------- -----------
Total costs and expenses 9,155,098 7,824,536 17,069,521 15,548,090
----------- ----------- ----------- -----------
Interest income 649,495 462,405 1,328,986 874,405
Interest expense (289,376) (258,715) (538,987) (529,060)
----------- ----------- ----------- -----------
Net interest income 360,119 203,690 789,999 345,345
----------- ----------- ----------- -----------
Net loss $(4,731,215) $(1,218,103) $(7,958,445) $(3,689,745)
=========== =========== =========== ===========
Basic/diluted net loss per common share $ (0.26) $ (0.07) $ (0.44) $ (0.20)
=========== =========== =========== ===========
Basic/diluted weighted average number of
common and common equivalent shares outstanding: 18,215,285 18,352,272 18,135,581 18,335,058
=========== =========== =========== ===========
</TABLE>
See Notes to Consolidated Condensed Financial Statements.
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GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
Twenty-six Weeks Ended
February 28, February 27,
1998 1999
(Unaudited)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net loss $ (7,958,445) $ (3,689,745)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depreciation and amortization 1,582,412 2,048,147
Loss on disposal of fixed assets 94,309 0
Deferred compensation 58,220 86,575
Changes in assets and liabilities:
Interest receivable 149,244 223,817
Unbilled costs and fees (44,079) 40,413
Prepaid expenses and other current assets (167,622) 172,542
Accounts payable (80,542) (115,590)
Accrued expenses 250,323 (31,959)
Deferred revenue 1,732,606 1,274,263
------------ ------------
Total adjustments 3,574,871 3,698,208
------------ ------------
Net cash (used in) provided by operating activities (4,383,574) 8,463
------------ ------------
Cash Flows from Investing Activities:
Purchases of marketable securities (14,528,524) (11,135,157)
Proceeds from sale of marketable securities 25,276,125 19,608,000
Purchases of equipment and leasehold improvements (4,553,714) (424,997)
(Increase) / decrease in other assets (21,872) 23,990
------------ ------------
Net cash provided by investing activities 6,172,015 8,071,836
------------ ------------
Cash Flows from Financing Activities:
Proceeds from exercise of stock options 852,851 73,992
Proceeds from long-term obligations 3,500,000 0
Payments on long-term obligations (1,894,760) (2,829,361)
------------ ------------
Net cash provided by (used in) financing activities 2,458,091 (2,755,369)
------------ ------------
Net Increase in Cash and Cash Equivalents 4,246,532 5,324,930
Cash and Cash Equivalents, at beginning of period 8,602,698 10,978,176
------------ ------------
Cash and Cash Equivalents, at end of period $ 12,849,230 $ 16,303,106
============ ============
Supplemental Disclosure of Cash Flow Information:
Taxes paid during period $ 13,500 $ 11,700
============ ============
Interest paid during period $ 538,988 $ 529,060
============ ============
Supplemental Disclosure of Non-cash Investing Activities:
Property and equipment acquired under capital lease obligations $ 1,770,943 $ 783,537
============ ============
</TABLE>
See Notes to Consolidated Condensed Financial Statements.
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NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The consolidated condensed financial statements included herein have
been prepared by the Company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. In the opinion of
management, the unaudited consolidated condensed financial statements have been
prepared on the same basis as the audited consolidated financial statements and
include all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of interim period results. Certain information
and footnote disclosures normally included in the financial statements prepared
in accordance with generally accepted accounting principles have been condensed
or omitted pursuant to such rules and regulations. The Company believes,
however, that its disclosures are adequate to make the information presented not
misleading. The results of operations for the 26 week period ended February 27,
1999 are not necessarily indicative of the results to be expected for the full
fiscal year. The accompanying consolidated condensed financial statements should
be read in conjunction with the Company's Form 10-K which was filed with the
Securities and Exchange Commission on November 25, 1998.
2. REVENUE RECOGNITION
Research revenues are derived from collaborative agreements with
pharmaceutical companies as well as government grants and contract arrangements.
Research revenues are recognized as earned under government grants, which
consist of cost-plus fixed-fee contracts and fixed-price contracts. Revenues are
recognized under collaborative agreements as earned. Milestone payments from
collaborative research and development arrangements are recognized when they are
achieved. Subscription fee revenue from the PathoGenome(TM) database is
recognized ratably over the life of the subscription. License fees and royalties
from collaborative agreements are recognized as earned. Unbilled costs and fees
represent revenue recognized prior to billing. Deferred revenue represents
amounts received prior to revenue recognition.
3. NET LOSS PER COMMON SHARE
The Company applies SFAS No. 128, Earnings per Share. This statement
established standards for computing and presenting earnings per share and
applies to entities with publicly held common stock or potential common stock.
Basic earnings per share was determined by dividing net loss by the weighted
average common shares outstanding during the period. Diluted earnings per share
was determined by dividing net loss by diluted weighted average shares
outstanding. Diluted weighted average shares reflects the dilutive effect, if
any, of potential common stock, which include common stock options and warrants,
based on the treasury stock method. Diluted loss per share is the same as basic
loss per share for the periods ended February 28, 1998 and February 27, 1999 as
the effect of the potential common stock is antidilutive. Potential common
stock of 4,581,048 and 3,719,869 was excluded from diluted loss per share at
February 28, 1998 and February 27, 1999, respectively.
4. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES
The Company applies SFAS No. 115, Accounting for Certain Investments in
Debt and Equity Securities. At February 27, 1999 and August 31, 1998, the
Company's cash equivalents and marketable securities are classified as
held-to-maturity, as the Company has the positive intent and ability to hold
these securities to maturity. Cash equivalents are short-term, highly liquid
investments with original maturities of less than three months. Marketable
securities are investment securities with original maturities of greater than
three months. Cash equivalents are
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carried at cost, which approximates market value, and consist of money market
funds, repurchase agreements and debt securities. Marketable securities are
recorded at amortized cost, which approximates market value. The Company has not
recorded any realized gains or losses on its marketable securities. Marketable
securities consist of commercial paper and U.S. government debt securities. The
Company has $200,000 in restricted cash at August 31, 1998 and February 27, 1999
in connection with certain long-term obligations (see Note 7).
5. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
6. COMPREHENSIVE INCOME
The Company applies SFAS No. 130, Reporting Comprehensive Income. SFAS
No. 130 requires disclosure of all components of comprehensive income on an
annual and interim basis. Comprehensive income is defined as the change in
equity of a business enterprise during a period from transactions and other
events and circumstances from non-owner sources. The Company's total
comprehensive net loss for the six month periods ended February 28, 1998 and
February 27, 1999 were the same as reported net loss for those periods.
7. LONG-TERM OBLIGATIONS
On February 28, 1997, the Company entered into an equipment lease line
of credit with a certain financial institution under which it financed
$6,000,000 of laboratory, computer and office equipment. The lease is payable in
48 monthly installments from the point of takedown, at a variable interest rate
of prime (7.75% as of February 27, 1999) plus 1/4 of 1%. On March 9, 1998, the
Company increased the amount available under the equipment lease line of credit
by $4,300,000 to $10,300,000. The additional borrowings under the equipment
lease line of credit have been and will continue to be utilized to finance
laboratory, computer and office equipment and are payable in 16 quarterly
installments commencing March 31, 1999 at a variable interest rate of prime. At
any time during the term of this agreement, the Company may elect to convert to
a fixed rate loan at the prevailing interest rate. The Company is required to
maintain certain restricted cash balances, as defined (see Note 4). In addition,
the Company is required to maintain certain financial ratios pertaining to
minimum cash balances, tangible net worth and debt service coverage. The Company
had approximately $2,889,000 available under the modified line of credit at
February 27, 1999.
On July 31, 1997, the Company entered into a financing arrangement with
another financial institution under which it financed $6,000,000 of laboratory
and office renovations at its Beaver Street facility. The principal amount of
the loan will be repaid over 48 consecutive months. The interest rates range
from 7.19% to 8.16%. The Company is required to maintain certain financial
ratios pertaining to minimum cash balances, debt to net worth and tangible net
worth. The Company has no additional availability under this financing
arrangement at February 27, 1999.
The Company entered into other capital lease line arrangements under
which it financed approximately $9,750,000 of certain laboratory, computer and
office equipment. These leases are payable in 36 monthly installments. The
interest rates range from 7.52% to 10.29%. The
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Company is required to maintain certain financial ratios pertaining to minimum
cash balances, tangible net worth, debt to tangible net worth and debt service
coverage. The Company has no additional borrowing capacity under these capital
lease agreements at February 27, 1999.
8. COLLABORATIVE AGREEMENTS
(a) Astra Hassle AB
In August 1995, the Company entered into a collaboration agreement with
Astra Hassle AB (Astra) to develop pharmaceutical, vaccine and diagnostic
products effective against gastrointestinal infection or any other disease
caused by H. pylori. The Company granted Astra exclusive access to the Company's
H. pylori genomic sequence database and exclusive worldwide rights to make, use
and sell products based on the Company's H. pylori technology. The agreement
also provides for a four-year research collaboration to further develop and
annotate the Company's H. pylori genomic sequence database, identify therapeutic
and vaccine targets and develop appropriate biological assays. This research is
being directed by a Joint Management Committee and a Joint Research Committee,
each consisting of representatives from both parties.
Under this agreement, Astra agreed to pay an initial license fee,
expense allowance, milestone payments, and fund a research program for a minimum
of two and a half years with an option to extend. On June 4, 1998, Astra
exercised its option to extend the research program for a second time which will
carry the agreement through at least August 1999. Under this agreement as
extended, Astra agreed to pay the Company a minimum of approximately $13.4
million and, subject to the achievement of certain product development
milestones, up to approximately $23 million (and possibly a greater amount if
more than one product is developed under the agreement) in license fees, expense
allowances, research funding and milestone payments. Of such fees, $500,000 are
creditable against any future royalties payable to the Company by Astra under
the agreement.
The Company will also be entitled to receive royalties on Astra's sale
of products (i) protected by the claims of patents licensed exclusively to Astra
by the Company pursuant to the agreement, or (ii) the discovery of which was
enabled in a significant manner by the genomic database licensed to Astra by the
Company. The Company has the right, under certain circumstances, to convert
Astra's license to a nonexclusive license in the event Astra is not actively
pursuing commercialization of the technology.
For the 13 week periods ended February 27, 1999 and February 28, 1998,
the Company recorded revenue of $172,000 and $359,000, respectively, under this
agreement, which consisted of sponsored research funding.
For the 26 week period ended February 27, 1999, the Company recorded
revenue of $423,000 under this agreement, which consisted of sponsored research
funding. For the 26 week period ended February 28, 1998, the Company recorded
revenue of $1,069,000 under this agreement, which consisted of sponsored
research funding and a milestone payment.
(b) Schering-Plough
In December 1995, the Company entered into a collaboration and license
agreement with Schering Corporation and Schering-Plough Ltd. (collectively
Schering-Plough) providing for the use by Schering-Plough of the genomic
sequence of Staph. aureus. The Company is identifying
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new gene targets for development of antibiotics effective against drug-resistant
infectious organisms. As part of this agreement, the Company granted
Schering-Plough exclusive access to certain of the Company's genomic sequence
databases. The Company also granted Schering-Plough a nonexclusive license to
use the Company's bioinformatics systems for Schering-Plough's internal use in
connection with the genomic databases licensed to Schering-Plough under the
agreement and other genomic databases Schering-Plough develops or acquires. The
Company also agreed to undertake certain research efforts to identify
bacteria-specific genes essential to microbial survival and to develop
biological assays to be used by Schering-Plough in screening natural product and
compound libraries to identify antibiotics with new mechanisms of action.
Under this agreement, Schering-Plough agreed to pay an initial license
fee and fund a research program for a minimum number of years with an option to
extend. On March 4, 1998, Schering-Plough elected to extend the research program
to the full term of the agreement which expires on March 31, 2000. Under the
agreement as extended, Schering-Plough has agreed to pay the Company a minimum
of $18.5 million in an up-front license fee, research funding and milestone
payments. Subject to the achievement of additional product development
milestones, Schering-Plough has agreed to pay the Company up to an additional
$24 million in milestone payments.
The agreement grants Schering-Plough exclusive worldwide rights to
make, use and sell pharmaceutical and vaccine products based on the genomic
sequence databases licensed to Schering-Plough by the Company and on the
technology developed in the course of the research program. The Company has also
granted Schering-Plough a right of first negotiation if during the term of the
research plan the Company desires to enter into a collaboration with a third
party with respect to the development or sale of any compounds that are targeted
against Staph. aureus, as their primary indication. The Company will be entitled
to receive royalties on Schering-Plough's sale of therapeutic products and
vaccines developed using the technology licensed from the Company. Subject to
certain limitations, the Company retained the rights to make, use and sell
diagnostic products developed based on the Company's genomic database licensed
to Schering-Plough or the technology developed in the course of the research
program.
For the 13 week periods ended February 27, 1999 and February 28, 1998,
the Company recorded revenue of $621,000 and $575,000, respectively, under this
agreement, which consisted of sponsored research funding.
For the 26 week period ended February 27, 1999, the Company recorded
revenue of $1,332,000 under this agreement, which consisted of sponsored
research funding. For the 26 week period ended February 28, 1998, the Company
recorded revenue of $1,912,000 under this agreement, which consisted of
sponsored research funding and milestone payments.
In December 1996, the Company entered into its second research
collaboration and license agreement with Schering-Plough. This agreement calls
for the use of genomics to discover new genes to be used as targets in the
development of therapeutics for treating asthma. As part of the agreement, the
Company will employ its high-throughput positional cloning, bioinformatics, and
genomics sequencing capabilities to identify genes and associated proteins that
can be utilized by Schering-Plough to develop new pharmaceuticals. Under this
agreement, the Company has granted Schering-Plough exclusive access to (i)
certain gene sequence databases made available under this research program, (ii)
information made available to the Company under certain third-party research
agreements, (iii) an exclusive worldwide right and license to make, use and sell
pharmaceutical and vaccine products that may result from this collaboration.
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Under this agreement, Schering-Plough agreed to pay an initial license
fee and an expense allowance to the Company. Schering-Plough is also required to
fund a research program for a minimum number of years with an option to extend.
In July 1998, Schering-Plough amended the original agreement in order to
accelerate the research effort being undertaken. In addition, upon completion of
certain scientific developments, Schering-Plough will make milestone payments to
the Company, as well as pay royalties to the Company based on sales of
therapeutics products developed from this collaboration. If all milestones are
met and the research program continues for its full term, total payments to the
Company will approximate $67 million, excluding royalties. Of the total
potential payments, approximately $22.5 million represents license fees and
research payments, and $44.5 million represents milestone payments based on
achievement of research and product development milestones.
For the 13 week periods ended February 27, 1999 and February 28, 1998,
the Company recorded revenue of $2,841,000 and $1,799,000, respectively, under
this agreement, which consisted of sponsored research funding, subcontract
activity and milestone payments.
For the 26 week periods ended February 27, 1999 and February 28, 1998,
the Company recorded revenue of $4,785,000 and $2,951,000, respectively, under
this agreement, which consisted of sponsored research funding, subcontract
activity and milestone payments.
On September 24, 1997, the Company entered into a third research
collaboration and license agreement with Schering-Plough to use genomics to
discover and develop new pharmaceutical products to treat fungal infection.
Under the agreement, the Company will employ its bioinformatics,
high-throughput sequencing and functional genomics capabilities to identify and
validate genes and associated proteins as drug discovery targets that can be
utilized by Schering-Plough to develop novel antifungal treatments.
Schering-Plough will receive exclusive access to the genomic information
developed in the collaboration related to two fungal pathogens, Candida albicans
and Aspergillus fumigatus. Schering-Plough will also receive exclusive worldwide
right to make, use and sell products based on the technology developed in the
course of the research program. In return, Schering-Plough has agreed to fund a
research program for a minimum number of years with an option to extend. If all
milestones are met and the research program continues for its full term, total
payments to the Company will approximate $34 million, excluding royalties. Of
the total potential payments, approximately $11 million represents research
payments and $23 million represents milestone payments based on achievement of
research and product development milestones. Additionally, the Company entered
into a subscription agreement with Schering-Plough to provide Schering-Plough
with nonexclusive access to the Company's proprietary PathoGenome(TM) database
and associated information relating to microbial organisms (see Note 9).
For the 13 week period ended February 27, 1999, the Company recorded
revenue of $1,336,000 under this agreement, which consisted of sponsored
research funding and a milestone payment. For the 13 week period ended February
28, 1998, the Company recorded revenue of $570,000 under this agreement, which
consisted of sponsored research funding.
For the 26 week period ended February 27, 1999, the Company recorded
revenue of $2,025,000 under this agreement, which consisted of sponsored
research funding and a milestone payment. For the 26 week period ended February
28, 1998, the Company recorded revenue of $1,007,000 under this agreement, which
consisted of sponsored research funding.
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(9) DATABASE SUBSCRIPTIONS
The Company has entered into PathoGenome(TM) database subscriptions
with Bayer AG, Bristol-Meyers Squibb, Scriptgen Pharmaceuticals, Inc., Hoechst
Marion Roussel and Schering-Plough (see Note 8). The database subscription
provides nonexclusive access to the Company's proprietary PathoGenome(TM)
database and associated information relating to microbial organisms. The
subscription agreement calls for the Company to provide periodic data updates,
analysis tools and software support. Under the subscription agreements, the
customer has agreed to pay an annual subscription fee and royalties on any
molecules developed as a result of access to the information provided by
PathoGenome(TM) database. The Company retains all rights associated with protein
therapeutic, diagnostic and vaccine use of bacterial genes or gene products.
The Company has recognized $1,312,000 and $543,000 in revenue under
these subscription agreements for the 13 week periods ended February 27, 1999
and February 28, 1998, respectively.
The Company has recognized $2,554,000 and $918,000 in revenue under
these subscription agreements for the 26 week periods ended February 27, 1999
and February 28, 1998, respectively.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a leader in the field of genomics-based drug targets
discovery -- the identification and functional characterization of genes. The
Company has over ten years of experience in the field of genomics, having served
as one of the primary researchers under genome programs sponsored by the United
States government, and has developed numerous techniques and tools that are
widely used in the field. The Company's commercial gene discovery strategy
capitalizes on its pioneering work in genomics by applying its high-throughput
sequencing technology and positional cloning, its experience and skills in
functional genomics and its bioinformatics capabilities. The two areas of focus
are: the discovery and characterization of (i) genes of pathogens that are
responsible for many serious diseases and (ii) human disease genes. The Company
believes that its genomic discoveries may lead to the development of novel
therapeutics, vaccines and diagnostic products by it and its strategic partners.
The Company has entered into numerous corporate collaborations in connection
with its pathogen and human gene discovery programs.
The Company does not anticipate revenues on a sustained basis until
such time that therapeutic, vaccine and diagnostic products based on the
Company's research efforts are commercialized, if at all. The Company's product
development strategy is to form collaborations with pharmaceutical and
biotechnology companies accessing drug discovery and clinical development
capabilities that currently do not exist at the Company. In the pharmaceutical
alliances, the Company generates revenues from licensing fees, sponsored
research and milestone payments during the term of the collaboration. Once a
product resulting from the research collaboration is commercialized, the Company
is entitled to receive royalty payments based upon product revenues.
Additionally, the Company will sell nonexclusive access to its proprietary
PathoGenome(TM) database. These collaborations are expected to result in the
discovery and commercialization of novel therapeutics, vaccines and diagnostics.
The sale of the genetic database generates subscription revenue over the term of
the subscription and royalty payments to the Company from product sales
downstream. In order for a product to be commercialized based on the Company's
research, it will be necessary for the collaborators to conduct preclinical
tests and clinical trials, obtain regulatory clearances and make manufacturing,
distribution and marketing arrangements. Accordingly, the Company does not
expect to receive royalties based upon product revenues for many years.
The Company's primary sources of revenue are collaborative agreements
with pharmaceutical company partners, subscription agreements to the Company's
proprietary PathoGenome(TM) database and government research grants and
contracts. As of February 27, 1999, the Company had four collaborative research
agreements and five subscribers to its proprietary PathoGenome(TM) database. The
Company entered into corporate collaborations with Astra Hassle AB ("Astra")
relating to H. Pylori in August 1995 and with Schering Corporation and
Schering-Plough, Ltd. (collectively, "Schering-Plough") in December 1995
providing for the use by Schering-Plough of the Company's Staph. aureus genomic
database to identify new gene targets for the development of novel antibiotics.
In December 1996, the Company entered into its second research collaboration
with Schering-Plough to identify genes and associated proteins that can be
utilized by Schering-Plough to develop new pharmaceuticals for treating asthma.
In September 1997, the Company entered into its third research collaboration
with Schering-Plough to use genomics to discover and develop new pharmaceutical
products to treat fungal infections.
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In May 1997, the Company introduced its proprietary PathoGenome(TM)
database and sold its first subscription to Bayer AG ("Bayer"). In September
1997, the Company sold subscriptions to Bristol-Myers Squibb and
Schering-Plough. In May 1998, the Company sold a subscription to Scriptgen
Pharmaceuticals, Inc. ("Scriptgen"). In September 1998, the Company sold a
subscription to Hoechst Marion Roussel ("HMR"). Under these agreements, the
subscribers will receive nonexclusive access to the Company's PathoGenome(TM)
database and associated information relating to microbial organisms.
Since 1989, the Company has been awarded a number of research grants
and contracts by various agencies of the United States government pursuant to
the government genomics programs. The scope of the research covered by grants
and contracts encompasses technology development, sequencing production,
technology automation projects and positional cloning projects. These programs
strengthened the Company's genomics technology base and increased the number and
enhanced the expertise of its scientific personnel. From January 1991 through
February 27 1999, the United States government awarded the Company grants and
contracts providing for the aggregate payments over their terms of approximately
$37 million. However, over the last two years, the Company has substantially
reduced its reliance on government research grants and contracts as the Company
focuses its resources more toward drug discovery in collaboration with
pharmaceutical partners.
The Company has incurred significant losses, since inception, with an
accumulated deficit of approximately $64,059,000 at February 27, 1999. The
Company's results of operations have fluctuated from period to period and may
continue to fluctuate in the future based upon the timing and composition of
funding under existing and new collaborative agreements and government research
grants and contracts. The Company is subject to risks common to companies in its
industry including unproven technology and business strategy, availability of,
and competition for, family resources, reliance upon collaborative partners and
others, history of operating losses, need for future capital, competition,
patent and proprietary rights, dependence on key personnel, uncertainty of
regulatory approval, uncertainty of pharmaceutical pricing, health care reform
and related matters, product liability exposure, and volatility of the Company's
stock price.
RESULTS OF OPERATIONS
THIRTEEN WEEK PERIOD ENDED FEBRUARY 28, 1998 AND FEBRUARY 27, 1999
REVENUE
Total revenues increased 58% from $4,064,000 for the 13 week period
ended February 28, 1998 to $6,403,000 for the 13 week period ended February 27,
1999. Collaborative research, licenses, subscription fees and royalties
increased 63% from $3,862,000 for the 13 week period ended February 28, 1998 to
$6,301,000 for the 13 week period ended February 27, 1999. The increase in
collaborative research, licenses, subscription fees and royalties was primarily
attributable to increased revenue recognized under the Company's collaborative
research agreements with Schering-Plough, consisting of milestone payments and
sponsored research, as well as increased subscription fees earned in fiscal 1999
under the Company's subscription agreements with Bayer, Scriptgen and HMR to
access the Company's proprietary PathoGenome(TM) database.
13
<PAGE> 14
COST AND EXPENSES
Total cost and expenses decreased 15% from $9,155,000 for the 13 week
period ended February 28, 1998 to $7,825,000 for the 13 week period ended
February 27, 1999. Research and development expense, which includes
company-sponsored research and development and research funded pursuant to
arrangements with the Company's corporate collaborators decreased by 16% from
$7,840,000 for the 13 week period ended February 28, 1998 to $6,571,000 for the
13 week period ended February 27, 1999. The reduction in research and
development expenses was primarily attributable to the Company's expenses
returning to more historical levels after being elevated for much of fiscal 1998
as new research programs and capabilities were being established specifically in
the area of microbial genetics, human gene discovery and functional genomics.
The reduction consisted primarily of decreases in payroll and related expenses,
laboratory supplies and overhead expenses.
Selling, general and administrative expenses increased slightly by 4%
from $1,113,000 for the 13 week period ended February 28, 1998 to $1,152,000 for
the 13 week period ended February 27, 1999. The increase in selling, general and
administrative expenses was primarily due to increased legal fees.
INTEREST INCOME AND EXPENSE
Interest income decreased 29% from $649,000 for the 13 week period
ended February 28, 1998 to $462,000 for the 13 week period ended February 27,
1999 reflecting a decrease in funds available for investment during fiscal 1999
as a result of cash being utilized to fund operations.
Interest expense decreased 10% from $289,000 for the 13 week period
ended February 28, 1998 to $259,000 for the 13 week period ended February 27,
1999. The decrease in interest expense was attributable to the scheduled
repayment of the Company's long-term obligations.
TWENTY-SIX WEEK PERIOD ENDED FEBRUARY 28, 1998 AND FEBRUARY 27, 1999
REVENUE
Total revenues increased 38% from $8,321,000 for the 26 week period
ended February 28, 1998 to $11,513,000 for the 13 week period ended February 27,
1999. Collaborative research, licenses, subscription fees and royalties
increased 42% from $7,857,000 for the 26 week period ended February 28, 1998 to
$11,138,000 for the 26 week period ended February 27, 1999. The increase in
collaborative research, licenses, subscription fees and royalties was primarily
attributable to increased revenue recognized under the Company's collaborative
research agreements with Schering-Plough as well as increased subscription fees
earned in fiscal 1999 under the Company's subscription agreements with Bayer,
Bristol-Myers Squibb, Schering-Plough, Scriptgen and HMR to access the Company's
proprietary PathoGenome(TM) database.
<PAGE> 15
COST AND EXPENSES
Total cost and expenses decreased 9% from $17,070,000 for the 26 week
period ended February 28, 1998 to $15,548,000 for the 26 week period ended
February 27, 1999. Research and development expense, which includes
company-sponsored research and development and research funded pursuant to
arrangements with the Company's corporate collaborators decreased by 9% from
$14,471,000 for the 26 week period ended February 28, 1998 to $13,111,000 for
the 26 week period ended February 27, 1999. The reduction in research and
development expenses was primarily attributable to the Company's expenses
returning to more historical levels after being elevated for much of fiscal 1998
as new research programs and capabilities were being established specifically in
the area of microbial genetics, human gene discovery and functional genomics.
The reduction consisted primarily of decreases in payroll and related expenses,
laboratory supplies and overhead expenses.
Selling, general and administrative expenses decreased slightly by 3%
from $2,135,000 for the 26 week period ended February 28, 1998 to $2,062,000 for
the 26 week period ended February 27, 1999.
INTEREST INCOME AND EXPENSE
Interest income decreased 34% from $1,329,000 for the 26 week period
ended February 28, 1998 to $874,000 for the 26 week period ended February 27,
1999 reflecting a decrease in funds available for investment during fiscal 1999
as a result of cash being utilized to fund operations.
Interest expense decreased slightly by 2% from $539,000 for the 26 week
period ended February 28, 1998 to $529,000 for the 26 week period ended February
27, 1999.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of cash have been revenue from
collaborative research agreements and subscription fees, revenue from government
grants and contract, borrowings under equipment lending facilities and capital
leases and proceeds from sale of equity securities.
As of February 27, 1999, the Company had cash, cash equivalents,
restricted cash and long and short-term marketable securities of approximately
$31,029,000. The Company has various arrangements under which it can finance
certain office and laboratory equipment and leasehold improvements. Under these
arrangements, the Company is required to maintain certain financial ratios,
including minimum levels of tangible net worth, total indebtedness to tangible
net worth, maximum loss, debt service coverage and minimum restricted cash
balances. At February 27, 1999, the Company had approximately $2,889,000
available under these arrangements for future borrowings. At February 27, 1999,
the Company had an aggregate of approximately $12,044,000 outstanding under its
borrowing arrangements which is repayable over the next 46 months, of which
$4,708,000 is repayable within the next 12 months.
The Company's operating activities used cash of approximately
$4,384,000 for the 26 week period ended February 28, 1998 to fund the Company's
operating loss which was partially offset by increases in deferred revenue and
accrued liabilities. The Company's operating activities provided cash of
approximately $8,000 for the 26 week period ended February 27, 1999.
15
<PAGE> 16
For the 26 week periods ending February 28, 1998 and February 27, 1999,
the Company's investing activities provided cash of approximately $6,172,000 and
$8,072,000, respectively, from the sale of marketable securities, partially
offset by the purchases of equipment and leasehold improvements.
Capital expenditures, including property and equipment acquired under capital
leases, totaled $1,209,000 for the 26 week period ended February 27, 1999
consisting primarily of laboratory, computer and office equipment. The Company
currently estimates that it will acquire an additional $770,000 in capital
equipment in fiscal 1999 consisting of primarily computer and laboratory
equipment which it intends to finance under existing equipment financing
arrangements.
The Company's financing activities provided cash of approximately
$2,458,000 for the 26 week period ended February 28, 1998 primarily from
proceeds from long-term obligations, exercise of stock options, net of payments
of long-term obligations. Financing activities used cash of approximately
$2,755,000 for the 26 week period ended February 27, 1999 primarily for payments
of long-term obligations.
At August 31, 1998, the Company had net operating loss and tax credit
carryforwards of approximately $62,908,000 and $1,658,000, respectively, and
certain of these net operating losses will expire in the next few years. These
net operating losses and tax credits are available to reduce federal taxable
income and federal income taxes, respectively, in future years, if any, are
subject to review and possible adjustment by the Internal Revenue Service and
may be limited in the event of certain cumulative changes in ownership interests
of significant shareholders over a three-year period in excess of 50%. The
Company does not believe it has experienced a cumulative ownership change in
excess of 50%. However, there can be no assurance that ownership changes will
not occur in future periods which will limit the Company's ability to utilize
the losses and tax credits.
The Company believes that its existing capital resources are adequate
to meet its cash requirements for at least two years under its current rate of
investment in research and development. There is no assurance, however, that
changes in the Company's plans or events affecting the Company's operations will
not result in accelerated or unexpected expenditures.
The Company may seek additional funding through public or private
financing and expects additional funding through collaborative or other
arrangements with corporate partners. There can be no assurance, however, that
additional financing will be available from any of these sources or will be
available on terms acceptable to the Company.
The Company does not use derivative financial instruments in its
investment portfolio. The Company places its investments in instruments that
meet high credit quality standards, as specified in the Company's investment
policy guidelines; the policy also limits the amount of credit exposure to any
one issue, issuer, and type of instrument. The Company does not expect any
material loss with respect to its investment portfolio.
16
<PAGE> 17
IMPACT OF YEAR 2000
Many currently installed computer systems and software applications are
designed to accept only two-digit entries in the date code field used to
identify years. These date code fields require modification to recognize
twenty-first century years. As a result, computer systems and software
applications used by many companies may need to be upgraded to comply with the
Year 2000 requirements. Significant uncertainty exists concerning the potential
effects of failure to comply with such requirements.
The Company has performed an extensive inventory and initial testing of
its electronic equipment, computer systems, software applications, and genomic
database storage and retrieval systems used both internally and sold to its
customers, to identify which systems may be impacted by Year 2000. The Company
formed a Y2K Task Force with Coordinators from every Department, which
identified the Company's mission-critical systems. The Company is completing its
assessment and developing a comprehensive compliance program, using internal and
external resources to address Year 2000 issues. The compliance program
incorporates best practices from such sources as the General Services
Administration and the Government Accounting Office (see www.y2k.gov). The
program includes an evaluation of its internally developed operating systems and
internally used financial and administration systems. Externally, the program
has solicited and continues to obtain compliance certificates from third-party
software and equipment vendors as well as statements of readiness from major
suppliers. The Company estimates that its mission critical systems will be
compliant by September 1999.
At this time, given that the Company's internal financial,
administrative, and scientific systems have been installed within the last few
years and the internally developed software-based systems are not generally date
sensitive, the Company does not expect the cost of addressing the Year 2000
Issue to have a material impact on the Company's business, results of operations
or financial condition. The Company has incurred approximately $50,000 to date
on the year 2000 initiative consisting of labor and outside contracting. The
Company has not had to defer any other projects, and does not anticipate having
to do so.
If such modifications, conversions, and/or replacements are not
completed in a timely manner, or if any of the Company's suppliers or
collaborators do not successfully deal with the Year 2000 Issue, the Year 2000
Issue could have a material impact on the operations of the Company. The
Company's research and development efforts could be significantly interrupted
resulting in delays in meeting its scientific obligations to existing
collaborations, delays in progress of its internal drug discovery programs and,
consequently, delays in attracting new collaborative partners. However, the
Company expects cash inflow from its existing corporate partners to be
unaffected by Year 2000 issues for at least the first two months of 2000 since
the first quarterly research payments of 2000 will be made prior to the start of
2000.
The Company's reasonable worst case internal scenario includes greater
date sensitivity than presently indicated, which may require additional
remediation and/or porting of software and databases to compliant platforms,
user interface modifications preventing erroneous date entry, and redefining
internal file-naming conventions. The Company's reasonable worst case external
scenario includes a) prolonged loss of electrical power which could compromise
critical biological samples, and b) vendor fixes that are either unavailable or
delayed, which would require the purchase of replacement systems or force a
delay in the Company's compliance schedule.
After periodic reviews of its internal compliance efforts as well as
the compliance efforts of third parties with which the Company does business,
the Company will modify as appropriate its
17
<PAGE> 18
present contingency plans to address situations in which various systems of the
Company, or of third parties are not yet Year 2000 compliant. Contingency plans
for each Department will be incorporated into a Company-wide contingency plan.
Some Departments already stockpile one month's supply of consumables, and the
existing emergency power generator has a one-day fuel supply. If there are
unidentified dependencies on systems to operate the business, or if any required
modifications are not completed on a timely basis or are more costly to
implement than anticipated, the Company's business, financial condition or
results of operations could be materially affected.
Statements in this Form 10K that are not strictly historical are
"forward looking" statements as defined in the Private Securities Litigation
Reform Act of 1995. The actual results may differ from those projected in the
forward looking statement due to risks and uncertainties that exist in the
Company's operations and business environment.
<PAGE> 19
PART II
Item 1. LEGAL PROCEEDINGS
None
Item 2. CHANGES IN SECURITIES
None
Item 3. DEFAULTS UPON SENIOR SECURITIES
None
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Special Meeting in lieu of an Annual Meeting was held on
February 22, 1999. At the meeting, shareholders took the following actions:
1) Election of Directors
<TABLE>
<CAPTION>
Name of Nominee Shares Voted For Withhold Authority
--------------- ---------------- ------------------
<S> <C> <C>
Marc Garnick 17,184,448 239,682
Robert J. Hennessey 14,904,532 2,519,598
Philip J. Leder 17,263,641 160,489
Lawrence Levy 14,850,832 2,573,298
Steven M. Rauscher 14,994,299 2,429,831
Norbert Riedel 17,269,441 154,689
</TABLE>
2) To ratify the selection of Arthur Andersen LLP as the Company's auditors
for the fiscal year ending August 31, 1999.
For Against Abstain
--- ------- -------
17,343,982 56,573 23,575
Item 5. OTHER INFORMATION
None.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
a) EXHIBITS:
None.
b) REPORTS ON FORM 8-K
None.
19
<PAGE> 20
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned
thereunto duly authorized who also serves in the capacity of principal financial
officer.
Genome Therapeutics Corp.
/s/ Fenel M. Eloi
--------------------------------
Fenel M. Eloi
(Principal Financial Officer)
Date: April 13, 1999
20
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