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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
FOR THE FISCAL YEAR ENDED: AUGUST 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED].
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 0-10824
GENOME THERAPEUTICS CORP.
(Exact name of registrant as specified in its charter)
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<S> <C>
MASSACHUSETTS 04-2297484
(State or other jurisdiction of incorporation or (IRS employer identification number)
organization)
100 BEAVER STREET, WALTHAM, MASSACHUSETTS 02453
(Address of principal executive offices) (Zip Code)
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REGISTRANT'S TELEPHONE NUMBER: (781) 398-2300
SECURITIES REGISTERED PURSUANT TO SECTION 12 (B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12 (G) OF THE ACT:
COMMON STOCK, $.10 PAR VALUE
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [X]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of November 19, 1999 was approximately $65,061,842.
The number of shares outstanding of the registrant's common stock as of
November 19, 1999 was 19,264,408.
Documents Incorporated By Reference
Portions of the registrant's proxy statement for use at its Annual Meeting
to be held on February 28, 2000 are incorporated by reference into Part III.
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PART I
ITEM 1. BUSINESS
OVERVIEW
Genome Therapeutics Corp. ("GTC" or the "Company") is a leader in the field
of genomics-based drug target discovery -- the identification and functional
characterization of genes associated with infectious and human diseases. The
Company has over ten years of experience in genomic research. Having served as
one of the initial research institutions under genome programs sponsored by the
United States government, GTC has developed numerous techniques and tools that
are widely used in the field of genomics. GTC's commercial strategy capitalizes
on its pioneering work in genomics by applying its integrated platform
technologies of high-throughput sequencing, bioinformatics, disease gene
identification, and functional genomics to identify and validate novel drug
targets. The two areas of scientific focus are the discovery and
characterization of novel targets in (i) pathogens that are responsible for many
serious diseases and (ii) human diseases. The Company believes that its genomic
discoveries will lead to the development of novel therapeutics, vaccines, and
diagnostic products by it and its strategic partners. The Company has several
corporate collaborations in connection with its pathogen and human gene
discovery programs.
SCIENTIFIC BACKGROUND
A variety of factors cause human diseases, including genetic defects,
pathogens and environmental factors, with many of the most common life
threatening and chronic diseases believed to have a genetic component. Genes,
which define the inherited characteristics of an organism, are found in all
living cells (e.g., human, animal and pathogen). Each gene is responsible for a
specific protein that performs a specific biological function in the body, such
as the production of insulin. Genetic defects in humans, a defective gene, or
absence of a critical gene may lead to overproduction, underproduction, improper
function, or absence of a protein resulting in disease or an undesirable
physical condition. Genetic defects can be inherited or can arise from
environmental factors during the lifetime of an individual. Human diseases
caused by pathogens may also have a genetic foundation in that specific genes in
the pathogen are required for that organism to both infect and survive in the
human host.
The genetic content of an organism consists of DNA, a chemically complex
material comprised of four different nucleotides (adenine, guanine, cytosine,
and thymine) that are the building blocks of DNA. The sequence in which these
nucleotides are linked together in a molecule of DNA determines the
informational content of genes. The entire genetic content of an organism,
including humans, is referred to as its genome.
The human genome consists of 23 pairs of chromosomes. These chromosomes
contain approximately 150,000 human genes distributed over approximately three
billion nucleotides. Human genes are found in the chromosomes as coding regions
of DNA ("exons") interrupted by non-coding regions of DNA ("introns"). The
number of exons found in human genes can be quite large, as can be the distance
between exons. The function of the majority of human genes is unknown. The DNA
sequence of a human gene is transcribed into a messenger RNA molecule ("mRNA")
which is subsequently processed to remove the introns. The mature mRNA molecule,
containing only the sequences present in the exons is then translated into a
protein product.
Genomes of bacterial pathogens are significantly less complex than the
human genome and generally consist of a single chromosome containing several
thousand genes distributed over millions of nucleotides. The majority of DNA in
bacterial pathogens typically is comprised of genes as uninterrupted DNA
sequences. The number of chromosomes in fungal genomes varies from species to
species. The structure of fungal genes may be organized as uninterrupted
sequences or as coding regions ("introns") interrupted by non-coding regions
("exons") that must be processed to produce the mature mRNA.
Proteins, expressed by genes, are the targets of most current drugs.
Therefore, the identification of human disease genes and the protein product of
these genes may lead to new therapeutics and diagnostic tests. In the case of
diseases caused by pathogens, the identification of the biologically important
genes of the pathogen may lead to the development of new drugs and vaccines to
combat the pathogen. Moreover, because of the
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simpler nature of the genomes of pathogens relative to the human genome, efforts
to identify and characterize pathogen genes may lead to product development
candidates more quickly than human gene discovery efforts. The Company's
integrated platform technologies currently are being used to discover validated
drug targets.
High-Throughput Sequencing
Sequencing is the process of identifying genes through the determination of
the order or sequence of nucleotides in DNA fragments. In recent years,
high-throughput sequencing procedures have been developed that enable sequencing
performance on a larger scale, with greater speed than was previously possible,
higher quality, and lower cost.
There are generally two ways of applying high-throughput sequencing to
discover genes: random and targeted discovery. In random discovery,
high-throughput sequencing is used to identify the genes in a genome without
regard to the function of the genes. In targeted discovery, high-throughput
sequencing is used to identify the genes in a specific chromosomal region or
tissue after the cell tissue containing the same DNA has been identified in, or
associated with, a specific disease.
High-throughput sequencing offers a practical way of randomly identifying
all of the genes in most pathogens because the genomes of such pathogens consist
of relatively small numbers of uninterrupted gene sequences. In contrast, the
human genome is very large with only small portions of the DNA containing genes
that are present as interrupted DNA sequences. Publicly funded projects (in
which the Company is a participant) are undertaking sequencing of the human
genome using mapped, large insert Bacterial Artificial Chromosome (BAC) clones
covering the entire genome. In addition to this approach, several groups are
randomly discovering large numbers of human genes by sequencing expressed copies
of genes that contain only exons, called cDNA, which they synthesize from mature
mRNA.
Targeted gene discovery by high-throughput sequencing of human DNA
typically is applied as part of disease gene identification (described below)
after a specific chromosomal region has been identified which is believed to
contain a gene associated with the disease. In this targeted gene discovery
technique, the entire chromosomal region is sequenced in an effort to identify,
from all the genes present in that region, the one gene that is responsible for
causing the specific disease.
Another type of targeted gene discovery involves the use of high-throughput
sequencing of cDNA to identify genes believed to cause or perpetuate a
particular disease. In this procedure, which is referred to as "comparative gene
expression", mRNA present in healthy and diseased tissues is converted into cDNA
and then sequenced to identify the gene that are expressed in both healthy and
diseased tissues. Comparing which genes are expressing or producing protein
product, and at what level this expression is occurring in both the healthy and
diseased tissue, identifies candidate genes responsible for causing or
maintaining the disease.
Disease Gene Identification
Disease gene identification is the analysis of disease inheritance patterns
to identify the genes responsible for causing human disease. The first step in
this process is to identify individual families or genetically homogeneous
populations in which the occurrence of a specific disease in these individuals
is substantially higher than in the general population. Blood samples are
collected from these individuals to provide DNA for use in identifying the
region on a particular chromosome where the disease-causing gene is located.
This process is referred to as "genetic linkage mapping".
In genetic linkage mapping, DNA markers that detect variations between
individuals are used to track the inheritance of the disease state. The position
of these genetic markers on a chromosome, as detected by the DNA probes,
constitutes a genetic linkage map of the chromosome. The chromosomal regions,
which are initially examined, are those regions identified as containing genes
that are likely candidates for causing or predisposing an individual to the
disease. Because only a limited number of human genes have been mapped to date,
genetic mapping is done genome-wide with a set of DNA probes that span the
genome. By following the inheritance patterns of genetic markers and looking for
the coinheritance of genetic markers and the disease, the gene responsible for
causing or predisposing an individual to that disease can be located within a
specific
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chromosomal region. Using additional DNA markers, the chromosomal region
containing the targeted disease gene can be narrowed to a region.
Next, libraries comprised of large DNA fragments are examined to find those
fragments that contain pieces of DNA from the relevant chromosomal region. The
aligning of these DNA fragments so that the resulting order represents how these
DNA fragments are related to each other in the relevant chromosomal region is
called physical mapping. The physical map of the relevant chromosomal region can
then be used to identify the genes that are contained within the region. These
genes can be identified in two ways. First, "direct selection" and "exon
trapping" are used, whereby individual exons within this chromosomal region can
be isolated and then used to obtain a complete copy of the gene from a cDNA
library. Secondly, or in combination with the above tools, the DNA of the
chromosomal region can be sequenced and, using special computer software, the
exons contained within the chromosomal region can be predicted. This sequencing
information then is used to search cDNA libraries for DNA fragments, which
contain these presumed exons.
Each gene identified through this process is a candidate for causing the
disease. By determining the sequence of these genes in individuals with the
disease and comparing it to the sequence of that gene from healthy individuals,
the gene involved in the disease can be identified. The DNA sequence
differences, which are found only in individuals who have inherited the disease,
identify the gene that is believed to be responsible for causing the disease.
TECHNOLOGY PLATFORMS -- THE COMPANY
The Company applies its technologies and expertise in high-throughput
sequencing, disease gene identification, bioinformatics, and functional genomics
for use in its gene discovery programs. In its pathogen programs, the Company
uses its high-throughput sequencing capabilities to sequence pathogen genomes.
In its human gene discovery programs, the Company combines its disease gene
identification capabilities with its high-throughput sequencing capabilities to
identify human genes associated with disease. Both the Company's pathogen and
human genomics programs utilize substantial bioinformatics skills to identify
genes, tentatively assign them a likely function, and select genes as targets
for drug, vaccine and diagnostic development. The Company has fully developed
its functional genomics and drug discovery skills, including drug discovery
target identification and validation and high-throughput drug discovery assay
development.
High-Throughput Sequencing and Finishing
GTC has an automated process using DNA sequencers and computers to sequence
and analyze genes in its discovery research programs. Using its technology, the
Company has randomly sequenced the genomes of several pathogens and various
chromosomal regions of the human genome. GTC's current sequencing production
capacity is approximately 6.5 million nucleotides of raw sequence daily.
Improvements in overall quality, throughput, and cost have been implemented
through introduction of proprietary and non-proprietary technologies into the
sequencing process.
Finishing is the last step of high-throughput sequencing. It is the final
step to complete the genome once the high-throughput shotgun process has
generated the majority of the sequence. Finishing is necessary because shotgun
sequencing is a random process; the individual clones that are sequenced contain
small randomly selected fragments of the complete genome. These fragments are
assembled using sophisticated computer software that identifies overlapping
regions of sequence and arranges the fragments into large contiguous sequence
regions called "contigs". As more sequence is generated, the fragments assemble
into larger contigs covering more of the genome. At an appropriate point in a
sequencing project, the process moves from a random to a directed sequencing
approach in order to specifically target and obtain sequence for the missing
regions and, thereby, "finish" the genome sequence.
The Company has developed a proprietary control process to assure a
high-quality sequenced genome. Sequence quality is expressed in terms of the
probability of error at any given base location in the sequence. The integrated
computational and biochemical techniques used in the finishing process - when
coupled with the sequence quality measurements generated by the high-throughput
sequencing process - allow the Company to specify the required quality of the
end-product sequence and then direct the process to achieve
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the desired quality level. The Company has developed a proprietary finishing
platform that couples the computational and biochemical techniques utilized in
finishing to provide the highest quality representation of the finished product.
Finishing is also very important in the later stages of human gene
discovery where the identification of disease-associated mutations requires gene
sequences of much higher quality than in the early stages of gene
identification. The quality of the sequence must be such as to allow the
detection of two different nucleotides in a given position. The Company has a
well-established sequence based mutation and variation detection program in
place, which is essential for our gene discovery projects.
Disease Gene Identification
The Company has over 10 years of experience in various aspects of human
disease gene identification, including expertise in statistical genetics. GTC
was a pioneer in the use of genetic linkage mapping and developed numerous
techniques and tools that are widely used in the disease gene identification
field. GTC has considerable experience in identifying genetic markers for
specific chromosomal regions. This ability is needed when additional genetic
markers are required to narrow the size of the chromosomal region believed to
contain the disease gene. The Company also has several libraries of large DNA
fragments arranged in a format that facilitates the isolation of DNA fragments
from a specific chromosomal region. These libraries are used to develop physical
maps of chromosomal regions believed to contain disease genes. In addition, the
Company uses other specialized tools to identify exons present in large DNA
fragments. These tools identify and isolate genes present in chromosomal regions
believed to contain disease genes.
Bioinformatics
Identifying and characterizing genes generates vast amounts of data that
must be organized, managed, and analyzed for biological significance. Such data
results from DNA sequencing, genetic linkage analysis, physical mapping, gene
expression studies and other genomic technologies employed by the Company. The
use of computers, software, and databases to track, process, store, retrieve and
analyze data generated by genomic research is referred to as bioinformatics, and
is a key capability of any participant in the field. Because of its early work
in large-scale genetic linkage analysis, GTC was one of the first companies to
develop a significant bioinformatics capability.
The Company's efforts in bioinformatics are focused in four areas: 1)
development and application of genomic data mining and visualization software to
strengthen the gene and drug discovery programs at GTC; 2) integration and
enhancement of laboratory automation systems for high-throughput genomic
sequencing and analysis; 3) ongoing development and customer support for the
PathoGenome(TM) database, and 4) support and improvement of the information
infrastructure, including systems, networks and user support. The Company
continues to expand its bioinformatics capabilities as it develops new tools and
processes focused at discovery and validation of drug targets.
Functional Genomics (Infectious Diseases) Target Identification and Validation
After the genome of a pathogen has been sequenced, the Company uses its
bioinformatics expertise together with the information in its proprietary and
public databases to identify and locate the genes within the genome and assign
features to the genes that help identify their likely function. Relying on these
assigned features and using the criteria for the product to be developed (drug
or vaccine; narrow or broad spectrum), the Company examines various pathogen
sequences in its proprietary databases and in public databases. It then compares
these sequences against mammalian sequences to select potential pathogen gene
targets for drug or vaccine development.
The criteria used for selecting gene targets against which small molecules
(drugs) will be developed include such features as essentiality, uniqueness, and
assayability. The gene should be essential for the survival of the organism. The
gene or its protein product should have novel biochemistry or special
characteristics to make it unique to the organism(s) against which the drug is
to be active. In order to reduce possible side
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effects, such genes should be absent or have little homology to genes found in
humans. The gene or its protein product should have general features that make
it possible to construct high-throughput screening assays.
If the objective is to develop protein or polypeptide vaccines, then the
criteria used for selecting gene targets include such features as whether the
protein product is likely to be secreted or found on the cell surface or in the
membrane of the organism, or shows homology to a major antigen in other
organisms.
For small molecule targets, the transition from bioinformatics to
functional genomics begins by demonstrating that the gene is essential for the
viability or virulence of the organism. That is, the gene must be required for
the survival of the organism on a culture plate (in vitro) or in an animal model
(in vivo). To determine the essentiality of a gene, the Company has developed
high-throughput techniques for directly or randomly inactivating (i.e.
"knocking-out") specific genes within the genome of a pathogen.
Assay Development
After validation of targets for their biological relevance, the Company
then develops screening assays for these targets. These assays include
conventional biochemical assays in which the gene target is over-expressed in a
recombinant host, and then the protein product is purified and used to develop a
non-cellular, high-throughput assay. Assay systems for validated target genes
with either no known function or no biochemical assay include cell-based assays
or the development of surrogate ligand binding assays.
For vaccine targets, functional genomics begins with the demonstration that
the gene product is not subject to significant antigenic variation between
strains or under different growth conditions. Gene targets are then
over-expressed in a recombinant host, and the resulting protein product is
purified for testing in an appropriate animal model.
Functional Genomics (Human Diseases)
In many cases, the protein products of a gene or genes causing a human
disease are pharmaceutically not suitable as drug discovery targets. Therefore,
new targets require identification based on a thorough understanding of the gene
function, including interaction with other proteins and genes. The Company has
developed and is continuing to improve its technologies to accelerate the
functional analysis of important disease genes, including high-throughput
signaling pathway analyses in mammalian and non-mammalian systems, gene
knock-outs and transgenics. These technologies bridge the gap between gene
discovery and drug discovery for validated targets. High-throughput drug
discovery assay development skills complement this effort.
Other multiple technology platforms support the Company's integrated
approach to gene function and signal pathway analysis. These include:
Rapid analysis of differential gene expression profiles
GTC has a proprietary process to perform rapid analysis of differential
gene expression profiles. Such analysis applies to identifying genes
differentially expressed in normal vs. disease tissues or, using cellular model
systems developed by the Company, identifying genes differentially expressed in
response to conditional and controlled expression of specific disease genes.
High-throughput protein-protein interaction screening
GTC has a proprietary high-throughput process to identify critical protein
interactions that is used to identify regulators of disease gene-encoded protein
products and their downstream signaling mediators. The Company employs various
in vitro and cell-based technologies to identify physiologically relevant and
novel protein-protein interactions. These include yeast and mammalian cell-based
screening assays. The Company's high-throughput DNA sequencing, automation, and
bioinformatics capabilities provide critical support to the gene identification
process, data analysis and management, and the development of signal pathway
databases.
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Functional expression cloning and analysis
GTC has high-throughput processes for cloning and analyzing molecules
associated with and regulating specific metabolic pathways. This approach
employs cell biological technology in the discovery and validation of drug
discovery targets.
The identification of novel molecules, regulating metabolic pathways,
represents a critical step towards the selection of novel candidate targets.
Validation of candidate targets result from multiple approaches, including
antisense and gene "knock-out" technologies. High-throughput drug discovery
assay development skills, already resident in the Company's pathogen programs,
validate targets for the identification of novel therapeutic agents.
THE COMPANY -- BUSINESS OVERVIEW
The Company's business strategy is to use its genomics and related
proprietary technologies to identify and validate gene targets and, together
with its partners, develop novel therapeutic, vaccine and diagnostic products.
In order to achieve this objective, the Company forms exclusive and
non-exclusive strategic collaborations with pharmaceutical and biotechnology
companies that can provide both financial and scientific resources necessary for
drug discovery and clinical development. The Company also packages and markets
outputs from its genetic research. One such product is a non-exclusive genetic
database, PathoGenome(TM), which provides subscribers with genetic information
to identify gene targets for use in developing novel therapeutics. One of the
Company's core strengths is its ability to sequence genomic data quickly and
accurately. Therefore, it recently formed the GTC Sequencing Center to provide
high quality genomic sequencing information to pharmaceutical companies,
governmental agencies, and academic institutions.
The Company is one of the primary researchers under genomic programs
sponsored by the United States government. These programs serve to strengthen
the Company's genomics technology base, increasing the number and enhancing the
expertise of its scientific personnel. From January 1991 through August 1999,
the United States government awarded the Company grants and contracts providing
for aggregate payments over the contract terms of approximately $52 million. In
October 1999, the National Human Genome Sequencing Network named the Company as
a pilot center to the Mouse Genome Sequencing Network, thereby increasing the
aggregated awards to approximately $65 million.
COMPANY PROGRAMS
The Company conducts research to identify small molecules directed at
microbial and fungal infections and human diseases. The Company considers
several factors in determining whether to pursue new programs that include: 1)
the projected commercial potential, 2) the effectiveness of current therapies
and the status of competitive programs, 3) the likelihood of attracting a
pharmaceutical or biotechnology company as a collaborator, and 4) anticipated
development costs.
MICROBIAL AND FUNGAL INFECTIONS
Over the past five years, a significant portion of GTC's resources have
been devoted to sequencing the genomes of many disease-causing pathogens and
fungi. The Company will continue to identify and characterize genes of these and
other pathogens that it believes will provide new or improved therapeutic,
vaccine or diagnostic products that represent a significant commercial
opportunity. In particular, the Company will focus its efforts on pathogens,
where the incidence of antibiotic resistance or other factors limit the use or
efficacy of currently available therapies, thereby creating a need for new and
novel antibiotics and vaccines.
Antibiotics are the recognized standard therapy for bacterial and fungal
infections. Each year, approximately 300 million prescriptions for antibiotics
are written in the United States for such infections and approximately $8.5
billion was expended in the United States for oral and injectable antibiotics.
The approximately 100 antibiotics in wide use in the United States today are
primarily variations of a small number of original antibiotic compounds directed
to a few bacterial targets. In the past decade, a growing number of infections
have been caused by pathogens, which are becoming resistant to an increasing
number of
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currently available antibiotics. The growing resistance to antibiotics is
particularly problematic in the approximately 6,500 acute care hospitals in the
United States in which approximately 2.1 million patients each year develop
nosocomial (hospital acquired) infections. Examples of pathogens that have
exhibited resistance to a number of current antibiotics include Staphylococcus
aureus, Mycobacterium tuberculosis, Streptococcus pneumonia, and Enterococcus
faecium and faecalis. To date, the modification of existing antibiotics has been
the primary response of pharmaceutical companies to this resistance problem.
However, in many cases, the pathogens that are the targets of these antibiotics
have further mutated and thereby developed resistance even to the modified
antibiotics. The Company believes that using genomic information to identify new
pathogen targets will enable the development of novel antibiotics and vaccines
that avoid existing resistance mechanisms.
Helicobacter pylori
H. pylori is the pathogen believed responsible for 90% of duodenal peptic
ulcers, the most common type of ulcer, and approximately 80% of gastric peptic
ulcers. Peptic ulcer disease is a chronic inflammatory condition of the stomach
and duodenum. Although frequently asymptomatic, all persons infected by H.
pylori have chronic gastric inflammation (gastritis). The Company estimates that
approximately 4.5 million people suffer from active peptic ulcers each year and
there are approximately 500,000 new cases diagnosed annually in the United
States. Approximately 600,000 patients are hospitalized each year in the United
States for peptic ulcer disease. Serious complications occur in approximately
one-third of these cases, including intestinal obstruction, upper
gastrointestinal hemorrhage and perforation. Further, each year over 6,000
deaths in the United States are caused directly by ulcer disease, and peptic
ulcers are a contributing factor in an additional 11,000 deaths. Approximately
10% of the population in the United States will develop peptic ulcer disease
during their lifetimes. Studies have also linked H. pylori with the development
of certain stomach cancers and coronary heart disease.
The most common medications for treating peptic ulcers are anti-secretory
drugs, such as H2 antagonists (e.g., Tagamet(R) and Zantac(R)), and proton pump
inhibitors (e.g., Prilosec(R)). Although anti-secretory drugs reduce ulcer
symptoms by inhibiting gastric acid secretion, they do not eradicate the H.
pylori,which is the primary cause of the disease. Industry sources estimate the
market for such drugs to treat ulcers exceeds $10 billion worldwide. An approach
being developed to treat recurrent peptic ulcer disease recognizes the role of
H. pylori and involves the administration of antibiotics, often in combination
with bismuth or anti-secretory drugs. The most effective current antibiotic
treatments are complicated by the need to treat for prolonged periods with
multiple drugs, by side effects and problems with patient compliance, by
relapses if treatment is interrupted, and by the development of
antibiotic-resistant strains of the bacteria.
Using its sequencing technology, the Company completed the random
sequencing of the genome of a clinical isolate of H. pylori. Under its agreement
with Astra, the Company has identified genes critical to the survival of H.
pylori and proteins on the surface of the bacterium that are believed to be
likely targets for therapeutic products and vaccines, respectively. (See
"Collaborative Agreements -- Pharmaceutical Company Collaborations")
Staphylococcus aureus
Staphylococcus aureus is the most common cause of skin, wound and blood
infections. S. aureus infections are typically treated with antibiotics. The
percentage of S. aureus strains isolated from infected patients (isolates)
resistant to penicillin, methicillin, and certain other antibiotics has risen in
recent decades. Today, industry reports indicate that 11% of S. aureus
infections in the U.S. exhibit resistance to methicillin. Moreover, clinical
isolates of S. aureus exist that are resistant to all known antibiotics other
than vancomycin. Vancomycin resistance has appeared in Enterococcus, which has
raised the possibility that such resistance may be transferred to S. aureus as
has been demonstrated to occur in the laboratory. Vancomycin resistance in S.
aureus would make such strains untreatable and cases have already been
identified in Japan and in the U.S. Using its high-throughput sequencing
capabilities, the Company has sequenced the genome of a clinical isolate of
methicillin-resistant S. aureus. Under its agreement with Schering-Plough, the
Company has used the sequence of S. aureus to identify and validate gene targets
for the development of new small molecules to
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treat S. aureus and other bacterial infections of pathogens that have become
resistant to current antibiotics. (See "Collaborative Agreements --
Pharmaceutical Company Collaborations")
Fungal infections
According to the Centers for Disease Control's National Nosocomial
Surveillance System, the rate of hospital-associated fungal infections nearly
doubled in the latest reported period. Most of this increase was the result of
opportunistic infections in the growing number of people with compromised immune
systems. Such infections are mainly seen in patients infected with HIV or having
AIDS; are receiving chemotherapy; having undergone transplants; having
debilitating diseases or severe injuries; having been hospitalized long-term or
treated long-term with corticosteroids or antibacterial drugs. Currently, there
are a limited number of anti-fungals available for use in such infections and
the products currently on the market have serious side effects. In addition,
resistance to these agents is increasing. Under its agreement with
Schering-Plough, the Company is using its experience and high-throughput
sequencing capabilities with genomic tools to identify new, validated fungal
targets and to create assays for the development of new small molecules to treat
these fungal pathogens. (See "Collaborative Agreements -- Pharmaceutical Company
Collaborations")
HUMAN GENETIC DISEASES
In the human disease area, the Company is building on its many years of
experience and knowledge in disease gene identification, genotyping,
high-throughput sequencing and bioinformatics capabilities by obtaining
exclusive rights to collections of DNA samples from relevant family resources in
order to map, identify and characterize genes responsible for selected human
diseases. It currently has focused programs in Asthma and Osteoporosis.
Asthma
Asthma is a significant health problem that affects approximately 5% of the
U.S. population. Both twin and family studies suggest a strong genetic component
in the etiology of the disease. Despite a clear genetic contribution to the
disease, no consistent mode of inheritance has been observed, suggesting that
multiple genetic factors as well as environmental influences play a role in the
disease. The Company, in collaboration with Schering-Plough, has a research
program to use disease gene identification strategies to identify genes involved
in the etiology of asthma. Newly identified asthma genes will facilitate the
development of superior diagnostics and novel therapeutic agents. This program
is being conducted in collaboration with a leading academic asthma research
center, which provides access to appropriate family resources and clinical
insight to asthma pathophysiology. (See "Collaborative Agreements --
Pharmaceutical Company Collaborations")
Osteoporosis
Osteoporosis is a major health problem that affects roughly 50% of
post-menopausal women and nearly 25% of elderly men. In the U.S. alone, there
are more than 1.3 million bone fractures per year due to osteoporosis. As
defined by low bone mineral density, both twin and family studies suggest a
strong genetic component to the disease. The Company has conducted research to
identify genes involved in the etiology of osteoporosis. Given the complex
nature of this disorder, and the lack of information about biochemical defects
involved, the Company's multi-faceted approach consists of genetic and
comparative gene expression strategies to identify osteoporosis genes. The
Company believes the identification of genes regulating bone density and disease
progression will significantly influence the development of diagnostic tests and
the discovery of novel therapeutic agents. The genetics program is in
collaboration with Creighton University, a leading academic bone research
center, which provides access to appropriate family resources and clinical
insight and osteoporosis pathophysiology.
PHARMACOGENOMICS
The Company has developed a platform that uses its existing sequencing
capabilities to detect genetic variation affecting individual drug response in
diverse populations. These proprietary techniques provide GTC
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with the ability to meet the current needs of the pharmaceutical industry for
identifying ideal targets for drug intervention, selecting the best leads for
drug development and accurately predicting response to treatment in various
sub-populations. This effort is best described as effectively using genetics to
accelerate drug discovery and development in a cost-efficient manner.
COLLABORATIVE AGREEMENTS
The most significant aspect of the Company's commercialization strategy is
to pursue research collaborations with pharmaceutical and biotechnology
companies for the development and commercialization of products resulting from
the Company's genomic discoveries. The Company also seeks government grants and
contracts related to its technology and research objectives, specifically
focusing on its gene sequencing capability.
PHARMACEUTICAL COMPANY COLLABORATIONS
The Company seeks strategic collaborations with pharmaceutical and
biotechnology companies for the development and commercialization of products
based on the Company's genomic discoveries. This strategy provides the Company
access to the scientific and product development expertise of its partners and
permits the Company to benefit financially from the commercialization of
products based on the Company's gene discoveries, without incurring the
substantial costs required for pharmaceutical product development and
commercialization. The Company generally expects to license (either exclusively
or non-exclusively) to its partners most rights to therapeutic products and
vaccines and, depending upon the gene, diagnostic products that may be developed
by a collaborator from the particular genetic information licensed from the
Company. In exchange, the Company receives a combination of up-front license
fees, research funding, milestone payments, and royalty payments on product
sales. Through September 1999, the Company has entered into five research
collaborations, four of which relate to pathogens and one of which relates to
asthma genetics. The first pathogen collaboration is with AstraZeneca PLC
("Astra"), formerly Astra Hassle AB, or the development of therapeutic,
diagnostic and vaccine products effective against gastrointestinal infections
and other diseases caused by H. pylori. Two other pathogen collaborations are
with Schering Corporation and Schering-Plough Ltd. (collectively
"Schering-Plough") and provide for the use by Schering-Plough of the genomic
sequence of S. aureus and two fungal pathogens, Candida albicans and Aspergillus
fumigatus, to identify new gene targets for the development of antibiotics and
vaccines effective against drug resistant infectious organisms. The Company has
a third collaboration with Schering-Plough to identify genes and associated
proteins for Schering-Plough's use in developing new pharmaceuticals for asthma.
The final collaboration is with bioMerieux, a strategic alliance to develop,
manufacture, and sell in vitro pathogen diagnostic products for human clinical
and industrial applications.
ASTRA (H. Pylori)
In 1995, the Company entered into a collaboration agreement with Astra to
develop pharmaceutical, vaccine, and diagnostic products effective against
gastrointestinal infections 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 expertise working with H. pylori. The agreement provided
for a four-year research collaboration to further develop and annotate the
Company's H. pylori genomic sequence database, with the objective of identifying
therapeutic and vaccine targets and developing appropriate biological assays. In
August 1999, GTC's portion of the research collaboration concluded and the
program transitioned into Astra's pipeline. The research collaboration resulted
in the identification and validation of a number of undisclosed targets by GTC.
These targets, as well as screening assays, were delivered to Astra for
high-throughput drug candidate screening. The Company is entitled to future
milestone payments and royalties based upon successful development of any
products arising from the research collaboration.
Under this agreement, Astra agreed to pay the Company 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
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milestone payments. The Company received approximately $13.5 million in license
fees, expense allowances, milestone payments and research funding under the
Astra agreement through August 31, 1999. For the Company's fiscal years ended
August 31, 1997, 1998 and 1999, revenue recognized by the Company under its
agreement with Astra accounted for approximately 17%, 9% and 4%, respectively,
of the Company's total revenue.
The Company is also entitled to receive royalties on Astra's sale of any
products (i) protected by the claims of patents licensed exclusively to Astra by
the Company pursuant to the agreement, or (ii) resulting from the discovery
enabled by the genomic database licensed to Astra. GTC has the right, under
certain circumstances, to convert Astra's exclusive license to a nonexclusive
license in the event Astra is not actively pursuing commercialization of the
licensed technology.
Schering-Plough (S. aureus)
In 1995, the Company entered into a collaboration and license agreement
with Schering-Plough providing for the use by Schering-Plough of the genomic
sequence of S. aureus to identify 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 the
Company's proprietary S. aureus genomic sequence database. The Company also
granted Schering-Plough a non-exclusive 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 for use by
Schering-Plough in screening natural product and compound libraries for the
purpose of identifying 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 two and a half years with options to extend. In
March 1998, Schering-Plough elected to extend the research program through March
31, 2000. Under the agreement, Schering-Plough 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 company has achieved all of the scientific milestones scheduled to date
under this agreement. Several undisclosed novel targets, identified and
validated by GTC, and screening assays have been delivered to Schering-Plough
for high-throughput drug candidate screening. The Company has received
approximately $17.6 million in up-front license fee, research funding, and
milestone payments through August 31, 1999. For the Company's fiscal years ended
August 31, 1997, 1998 and 1999, revenue recognized by the Company under this
agreement with Schering-Plough accounted for approximately 20%, 18% and 10%,
respectively, of the Company's total revenue.
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 the technology
developed during the course of the research program. GTC also granted
Schering-Plough a right of first negotiation if, during the term of the research
plan, GTC desires to enter into a collaboration with a third party with respect
to the development or sale of any compounds which are targeted against, as their
primary indication, the pathogen that is the principal subject of the Company's
agreement with Schering-Plough. The Company will be entitled to receive
royalties on Schering-Plough's sale of therapeutic products and vaccines
developed using the technology licensed by the Company. Subject to certain
limitations, GTC retains the rights to make, use, and sell diagnostic products
developed utilizing the Company's genomic database licensed to Schering-Plough
or the technology developed during the course of the research program.
Schering-Plough (Asthma)
In 1996, the Company established its second research collaboration and
license agreement with Schering-Plough. This agreement calls for the use of
genomics to discover new therapeutics for treating asthma. As part of the
agreement, the Company will employ its high-throughput disease gene
identification, bioinformatics,
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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 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. GTC
retains the rights to diagnostic products.
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 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 upon sales of therapeutic products developed from this
collaboration. If the Company meets all the milestones, total payments to the
Company will be approximately $68 million, excluding royalties.
The Company has achieved all the scientific milestones scheduled to date
under this agreement. In September 1998, Schering-Plough authorized an
acceleration of the program resulting in a significant increase in funded
research for 1999. Of the total potential payments, approximately $23.5 million
represents license fees and research payments, and $44.5 million represents
milestone payments based on achievement of research and product development
objectives. The company received approximately $21.7 million in up-front license
fee, research funding, and expense allowances through August 31, 1999. For the
Company's fiscal years ended August 31, 1997, 1998 and 1999, revenue recognized
under this agreement with Schering-Plough accounted for approximately 28%, 37%
and 41%, respectively, of the Company's total revenue.
Schering-Plough (Fungal)
In September 1997, the Company established its third research collaboration
and license agreement with Schering-Plough for use of genomics to discover and
develop new pharmaceutical products to treat fungal infection(s). Under the
agreement, the Company will utilize 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 genomics 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 during the course of
the research program. In return, Schering-Plough agreed to fund a research
program for a minimum of two and a half 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. The
Company received approximately $7.5 million in research funding and milestone
payments through August 31, 1999. For the Company's fiscal year ended August 31,
1999, revenue recognized under this agreement with Schering-Plough accounted for
approximately 13% and 20%, respectively, of the Company's total revenue.
bioMerieux -- Infectious Disease Diagnostics
In September 1999, the Company entered into a strategic alliance with
bioMerieux to develop, manufacture and sell in vitro pathogen diagnostics for
human clinical and industrial applications. Under this collaboration, bioMerieux
will fund research for four years. The Company will receive future milestone
payments and royalties based upon successful commercialization of diagnostic
products.
BIOTECHNOLOGY COMPANY COLLABORATION
In order to maximize the commercial utilization of novel drug discovery
targets derived from GTC's genomics approach, the Company's pharmaceutical
company alliance strategy is being complemented with internal drug discovery
programs. This internal drug discovery effort focuses in both pathogen and human
genetics. The non-exclusive marketing strategy of the PathoGenome(TM) database
allows GTC to choose its own drug discovery targets from the database. The
Company's internal programs include drug discovery target validation through
gene knockouts, protein expression and purification, development of
high-throughput
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assays, and -- via external collaborations -- lead compound identification and
lead optimization. In human genetics, the Company is using its genomic tools to
identify selected novel molecular targets, which are useful in drug discovery.
As of August 1999, the Company has one drug discovery partnership, which relates
to infectious diseases.
The Company has a collaboration with ArQule, Inc. to screen the Company's
unique bacterial and fungal disease targets against ArQule's proprietary
chemical libraries to identify and optimize small molecule anti-infectives. At
of the end of the fiscal year, there were several validated targets in
high-throughput screening under this collaboration.
DATABASE PRODUCT
In 1997, the Company introduced to the market a database titled
PathoGenome(TM), consisting of genetic information from over thirty microbial
organisms. This database is available through non-exclusive subscriptions to
pharmaceutical and other drug discovery companies. It is one of the most
comprehensive commercial sources of microbial genomic information available. It
provides subscribers with a large volume of highly organized and functionally
annotated sequence information related to some of the most medically important
microbial organisms and fungi. The design of the non-exclusive database is for
use at the client site using proprietary bioinformatics software developed at
Genome Therapeutics. It offers a user-friendly graphic interface and enables
researchers to search for new genes among multiple pathogens and
cross-referenced genomic information for the development of new anti-infective
products. As of October 1999, the Company had six customer subscriptions to the
PathoGenome(TM) database. These are Bayer AG (original subscription expired),
bioMerieux, Bristol-Myers Squibb, Hoechst Marion Roussel, Schering-Plough, and
Scriptgen Pharmaceuticals. For all subscriptions, the Company may receive
royalties from future product sales, if developed resulting from information
provided by the database.
GOVERNMENT GRANTS AND CONTRACTS
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 disease gene identification projects. These programs
strengthened the Company's genomics technology base and increased the number and
enhanced the expertise of its scientific personnel.
Under these research contracts, the government has ownership rights to the
data, clones, genes and other material derived from the material furnished to
the Company by the government, and the Company has ownership rights in other
inventions developed solely by the Company under the contracts. The government
also retains certain rights, described below under the caption "Patents and
Proprietary Technology", to the inventions first reduced to practice by the
Company under the government grants and contracts.
In July 1999, the Company was named as one of the nationally funded DNA
sequencing centers of the international Human Genome Project. The Company will
participate in an international consortium in a full-scale effort to sequence
the human genome. The Company will receive funding from the National Human
Genome Research Institute (NHGRI) of up to $15.6 million over a three-year
period of which $5 million is guaranteed for the initial twelve months. In
October 1999, subsequent to year end, the Company was named as one of the pilot
centers in the Mouse Genome Sequencing Network. The Company will participate in
deciphering the genetic makeup of the mouse. The Company will receive funding
from the NHGRI of up to $12.9 million over a three-year period of which $2.4
million is guaranteed the initial seven months. As of October 1999, the Company
had approximately $28.1 million of government research grants and contracts
outstanding under which services were not yet performed. These grants and
contracts call for services to be performed over the next 35 months. These
programs are subject to annual appropriations by the government based upon the
availability of government funds and the achievement by the Company of certain
scientific milestones. Funding may be discontinued or reduced at any time.
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PATENTS AND PROPRIETARY TECHNOLOGY
The Company's commercial success ultimately depends, in part, on its
ability to obtain patent protection on methods, technologies, genes, proteins
encoded by genes, patentable human Single Nucleotide Polymorphism (SNPs) or
products based on genes or proprietary gene technology, discovered by it. The
current criteria for obtaining patent protection for partially sequenced genes
and for genes are unclear. The Company's current strategy is to apply for patent
protection upon the identification of a novel gene or novel gene fragment and
pursue claims to these gene sequences as well as equivalent sequences, such as
substantially homologous or orthologous sequences. If at the time of filing a
patent application the biological function of a gene or gene fragment has not
been characterized, the Company supplements such patent filing as soon as
additional biological function information of such gene or gene fragment becomes
available. However, there can be no assurance that the Company will be able to
obtain patent protection on such genes or gene fragments, proteins, or SNPs and
even if such patents are issued, the scope of the coverage or protection
provided by any such patents is uncertain. In addition, there can be no
assurance that any patents, if issued, will provide protection against any
competitors, will provide the Company with competitive advantages, will provide
protection for any therapeutic, vaccine or diagnostic products based on the
Company's gene discoveries or will not be successfully challenged by others.
Furthermore, others may have filed patent applications that have yet to be
published or issued covering genes or protein sequences similar or identical to
the Company's. No assurance can be given that any such patent application will
not have priority over patent applications filed by the Company or that any
patent applications filed by the Company will result in issued patents.
There have been, and continue to be, intensive discussions on the scope of
patent protection for both gene fragments, SNPs, and full-length genes. In 1996,
the U.S. PTO issued guidelines limiting the number of nucleic acid sequences
that can be examined in a single application. This requires the Company to
assess continually its patent applications to determine those that it can
support for prosecution. In addition, the U.S. Courts continue to redefine and
narrow the scope of the claims to genes, gene fragments, and proteins that are
enforceable. There can be no assurance that there will not be changes in, or
interpretations of the patent laws, which will adversely affect the Company's
patent position.
The PTO also issued new Utility Guidelines that address the requirements
for demonstrating utility, particularly in inventions relating to human
therapeutics. While the guidelines do not require clinical efficacy data for
issuance of patents for human therapeutics, the guidelines have been in effect
for only a short period of time and there can be no assurance that the PTO's
interpretations of such guidelines, and any changes to such interpretations will
not delay or adversely affect the Company's or its collaborators' ability to
obtain patent protection. The biotechnology patent situation outside the United
States is even more uncertain and is currently undergoing review and revision in
many countries.
The Company has filed patent applications and will continue to do so with
respect to a number of full-length genes and corresponding proteins and partial
genes resulting from its pathogens program. The Company with its collaborators
files foreign counterparts of these U.S. applications within the appropriate
time frames. These applications seek to protect these full length and partial
gene sequences and corresponding proteins, as well as equivalent sequences, such
as substantially homologous or orthologous sequences, and products derived
therefrom and uses therefore. These applications also identify possible
biological functions for the genes and gene fragments based, in part, on a
comparison to genes or gene fragments included in public databases but do not
contain any laboratory or clinical data with respect to such biological
functions.
The Company is free to apply for patents on the results of its research
conducted with government funds. Under the government grants, the Company has,
subject to certain rights of the government described below, exclusive ownership
rights to any commercial applications of inventions first reduced to practice
under the grants, including all gene discoveries and technology improvements
created or discovered. The Company is under obligation, under certain of the
government grants, to submit sequencing data resulting from the research to
public databases within 24 hours from the date such data and materials are
generated. However, it is restricted from applying for blanket patents on large
numbers of human or mouse genes. Under the Company's government grants and
contracts, the government has a statutory right to practice or have practiced,
and, under certain circumstances (including inaction on the part of the Company
or its licensees to
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achieve practical application of the invention or a need to alleviate public
health or safety concerns not reasonably satisfied by the Company or its
licensees), to grant to other parties licenses under any inventions first
reduced to practice under the government grants and contracts. In addition,
under the Company's government research contracts, the government has ownership
rights in the data, clones, genes and other material derived from the material
furnished to the Company by the government, and the Company has ownership rights
in other technology developed solely by the Company under the contracts.
The Company also relies on trade secret protection for its confidential and
proprietary information. There can be no assurance that the Company can maintain
adequate protection for its trade secrets or other proprietary information. In
addition, while the Company has entered into proprietary information agreements
with its employees, consultants and advisors, there can be no assurance that
these agreements will provide meaningful protection for the Company's
proprietary information in the event of unauthorized use or disclosure of such
information. Moreover, there can be no assurance that others will not
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to the Company's trade secrets or disclose
such technology, or that the Company can meaningfully protect its trade secrets.
COMPETITION
The Company faces intense competition with respect to its human genetics
and pathogen genetics and drug discovery programs. There is a finite number of
genes in the human genome and the Company believes virtually all of such genes
will be identified albeit largely without known function. The Company also
believes that the primary genes that cause or predispose individuals to most
common diseases will eventually be identified and characterized.
Competitors of the Company include pharmaceutical and biotechnology
companies both in the United States and abroad. In addition, significant
research to identify and sequence genes is being conducted by universities,
other non-profit research institutions and United States and foreign
government-sponsored entities. A number of commercial, scientific and
governmental entities are attempting to sequence human genes and the genomes of
other organisms. Other entities are utilizing positional cloning to identify and
characterize human disease genes. Certain of the Company's competitors' human
gene programs are more advanced than the Company's and any one of these
companies or other entities may discover and establish a competitive advantage
in one or more pathogen development programs which the Company has commenced.
The Company also faces competition in its human gene discovery programs in
gaining access to family DNA samples for use in disease gene identification.
The Company believes that its ability to compete is dependent, in part,
upon its ability to create and maintain advanced technology, the speed with
which it can identify and characterize the genes involved in human diseases, the
Company's ability to rapidly sequence the genomes of selected pathogens, its
collaborators' ability to develop and commercialize therapeutic, vaccine and
diagnostic products based upon the Company's gene discoveries, as well as its
ability to attract and retain qualified personnel, obtain patent protection or
otherwise develop proprietary technology or processes and secure sufficient
capital resources for the expected substantial time period between technological
conception and commercial sales of products based upon the Company's gene
discoveries.
Many of the Company's competitors have greater research and product
development capabilities and financial, scientific, marketing and human
resources than the Company. These competitors may succeed in identifying or
sequencing genes or developing products earlier than the Company or its
collaborators, obtaining authorization from the FDA for such products more
rapidly than the Company or its collaborators or developing products that are
more effective than those proposed to be developed by the Company or its
collaborators. Any potential products based on genes identified by the Company
will face competition both from companies developing gene-based products and
from companies developing other forms of diagnosis or treatment for the
particular diseases targeted by the Company. There can be no assurance that
products developed by others will not render the products, which the Company or
its collaborators may seek to develop, obsolete or uneconomical or will result
in diagnoses, treatments or cures superior to any products developed by
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the Company or its collaborators, or that any product developed by the Company
or its strategic collaboration partners will be preferred to any existing or
newly developed technologies.
GOVERNMENT REGULATION
Regulation by governmental entities in the United States and other
countries will be a significant factor in the development, manufacturing, and
marketing of any products, which may be developed by the Company or its
collaborators. The nature and the extent to which such regulation may apply to
the Company or its collaborators will vary depending on the nature of any such
products. Virtually all of the Company's or its collaborators' pharmaceutical
products will require regulatory approval by governmental agencies prior to
commercialization. In particular, human therapeutic and vaccine products are
subject to rigorous preclinical and clinical testing and other approval
procedures by the FDA in the United States and similar health authorities in
foreign countries. Various federal and, in some cases, state statutes and
regulations also govern or influence the manufacturing, safety, labeling,
storage, record keeping and marketing of such products. The process of obtaining
these approvals and the subsequent compliance with appropriate federal and
foreign statutes and regulations are time consuming and require the expenditure
of substantial resources.
The FDA regulates human therapeutic products in one of three broad
categories: drugs, biologics, or medical devices. Products based on the
Company's technologies could potentially fall into all three categories.
Generally, in order to gain FDA pre-market approval of a new drug or biological
product, a company first must conduct pre-clinical studies in the laboratory and
in animal model systems to gain preliminary information on an agent's efficacy
and to identify any safety problems. The results of these studies are submitted
as a part of an investigational new drug application ("IND"), which the FDA must
review before human clinical trials of a drug or biologic can commence. In order
to commercialize any products, the Company or its collaborators will be required
to sponsor and file an IND and will be responsible for initiating and overseeing
the clinical studies to demonstrate the safety, efficacy and potency that are
necessary to obtain FDA approval of any such products. Clinical trials are
normally done in three phases and are likely to take a number of years to
complete. After completion of clinical trials of a new product, FDA marketing
approval must be obtained. If the product is classified as a new drug, the
Company or its collaborators will be required to file a New Drug Application
("NDA") and receive approval before commercial marketing of the drug. If the
product is classified as a biologic (e.g., a vaccine), the Company or its
collaborator will be required to file a product license application and an
establishment license application ("ELA") and receive approval of both before
commercial marketing of the product can take place. The testing and approval
processes require substantial time and effort and there can be no assurance that
any approvals will be granted on a timely basis, if at all.
Even if FDA regulatory clearances are obtained, a marketed product is
subject to continual review, and later discovery of previously unknown problems
or failure to comply with the applicable regulatory requirements may result in
restrictions on the marketing of a product or withdrawal of the product from the
market as well as possible civil or criminal sanctions. In addition, biologic
products may be subject to batch certification and lot release requirements. To
the extent that any of the Company's products involve recombinant DNA
technology, additional layers of government regulation and review are possible.
For marketing outside the United States, the Company will also be subject to FDA
export regulations and foreign regulatory requirements governing human clinical
trials and marketing approval for pharmaceutical products. The requirements
governing the conduct of clinical trials, product licensing, pricing and
reimbursement vary widely from country to country.
The Company or its collaborators may also develop diagnostic products based
upon the human or pathogen genes that the Company identifies. The Company
believes that the diagnostic products to be developed by the Company or its
collaborators are likely to be regulated by the FDA as devices rather than drugs
or biologics. The nature of the FDA requirements applicable to such diagnostic
devices depends on their classification by the FDA. A diagnostic device
developed by the Company or a collaborator would most likely be classified as a
Class III device, requiring pre-market approval. Obtaining pre-market approval
involves the costly and time-consuming process, comparable to that for new drugs
or biologics, of conducting pre-clinical studies, obtaining an investigational
device exemption to conduct clinical tests, filing a pre-market approval
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application, and obtaining FDA approval. Again, there can be no assurance that
any approval will be granted on a timely basis, if at all.
The Company's research and development activities involve the controlled
use of hazardous materials, chemicals, and various radioactive materials. The
Company is subject to federal, state and local laws and regulations governing
the use, storage, handling and disposal of such materials and certain waste
products. Although the Company believes that its safety procedures for handling
and disposing of such materials comply with the standards prescribed by state,
federal and local laws and regulations, the risk of accidental contamination or
injury from these materials cannot be completely eliminated. In the event of
such an accident, the Company could be held liable for any damages that result
and any liability could exceed the resources of the Company.
MANUFACTURING AND MARKETING
The Company does not generally expect to directly manufacture or market
pharmaceutical products in the near term. However, the Company, in the future,
may consider taking such actions if it believes they are appropriate under the
circumstances. The Company has no recent experience in developing pharmaceutical
products or in manufacturing or marketing pharmaceutical products. The Company
may not have the resources to develop or manufacture or market by itself any
products based on genes identified by it. In the event the Company decides to
establish a manufacturing facility, the Company will require substantial
additional funds and will need to hire and train significant additional
personnel and will need to comply with the extensive "good manufacturing
practice" regulations applicable to such a facility. In addition, if any
products produced at the Company's facilities were regulated as biologics, the
Company will need to file and obtain approval of an ELA for its facilities.
YEAR 2000 COMPLIANCE
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. Therefore, 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 a Y2K Task Force, using both internal and external
resources, to develop a comprehensive compliance program that will identify
potential issues, costs, and solutions to address Year 2000 concerns. The
compliance program incorporates best practices from such sources as the General
Services Administration and the Government Accounting Office (www.y2k.gov). The
comprehensive program includes an extensive inventory and assessment of its
electronic equipment, computer systems, software applications, and genomic
database storage and retrieval systems used both internally and sold to its
customers. The program includes identifying and testing of all mission critical
systems, as well as developing contingency plans for critical aspects of the
Company's systems and operations to address problems that may arise despite our
Year 2000 compliance effort.
To date, the Company has completed an extensive inventory and assessment of
its electronic equipment, computer systems, software applications, and
bioinformatics applications. The Company has identified and completed testing of
all mission critical systems. All mission critical systems not found compliant
were repaired, modified, or replaced. For vendors, the Company solicited and
continues to obtain compliance certificates for third-party software and
equipment as well as statements of readiness from its major suppliers.
The Company has developed contingency plans for critical aspects for its
systems and operations to address problems that may arise despite our Year 2000
compliance efforts. The Company is currently conducting 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 continue to modify as
appropriate its contingency plans to address situations in which further systems
of the Company, or of third parties are not yet Year 2000 compliant or who have
become Year 2000 compliant.
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FACTORS THAT MAY AFFECT RESULTS
This Annual Report on Form 10-K contains forward-looking statements. For
this purpose, any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Without limiting
the foregoing, the words "believes," "anticipates," "plans," "expects,"
"intends," and similar expressions are intended to identify forward-looking
statements. There are a number of important factors that could cause the
Company's actual results to differ materially from those indicated by such
forward-looking statements. Those factors include, without limitation, those set
forth throughout this Annual Report on Form 10-K.
HUMAN RESOURCES
As of October 31, 1999, the Company had 163 full-time equivalent employees,
of whom 143 were engaged in research and development activities, and 20 in
general and administrative functions. Thirty-eight of the Company's employees
hold Ph.D. degrees and 49 others hold other advanced degrees.
None of the Company's employees is covered by a collective bargaining
agreement, and the Company considers its relations with its employees to be
good.
FACILITIES
The Company's executive offices and laboratories are located at 100 Beaver
Street, Waltham Massachusetts, where the Company has leased approximately 80,000
square feet of space expiring November 15, 2006 with options to extend for two
consecutive five-year periods.
During fiscal 1999, the Company incurred aggregate rental costs, excluding
maintenance, taxes and utilities, for all facilities of approximately $899,000.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
The Company's common stock is traded on the Nasdaq National Market System
(ticker symbol "GENE"). The table below sets forth the range of high and low
quotations for each fiscal quarter of the Company during 1999 and 1998 as
furnished by the National Association of Securities Dealers Quotation System.
<TABLE>
<CAPTION>
1999 1998
---------- ---------
HIGH LOW HIGH LOW
---- ---- ---- ---
<S> <C> <C> <C> <C>
First Quarter............................................... 3 7/8 1 3/4 9 7/8 7 1/4
Second Quarter.............................................. 3 7/8 2 1/8 9 6
Third Quarter............................................... 4 5/16 3 9 1/2 6 1/2
Fourth Quarter.............................................. 4 3/4 2 21/32 6 3/4 2 1/8
</TABLE>
As of November 10, 1999, there were approximately 1,219 shareholders of
record of the Company's Common Stock.
The Company has not paid any dividends since its inception and presently
anticipates that all earnings, if any, will be retained for development of the
Company's business and that no dividends on its Common Stock
17
<PAGE> 19
will be declared in the foreseeable future. Any future dividends will be subject
to the discretion of the Company's Board of Directors and will depend upon,
among other things, future earnings, the operating and financial condition of
the Company, its capital requirements and general business conditions.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
FOR THE YEAR ENDED AUGUST 31,
---------------------------------------------------------------------
1995 1996 1997 1998 1999
----------- ----------- ------------ ------------ -----------
<S> <C> <C> <C> <C> <C>
Revenues:
Contract research, licenses,
subscription fees........ $10,884,900 $19,344,117 $ 16,005,614 $ 19,196,558 $23,992,047
Royalties................... 90,541 127,112 647,150 20,574 26,118
----------- ----------- ------------ ------------ -----------
Total....................... $10,975,441 $19,471,229 $ 16,652,764 $ 19,217,132 $24,018,165
Net income (loss)............. $ 585,204 $ 1,920,710 $(11,302,391) $(15,813,383) $(6,328,095)
Net income (loss) per common
share....................... $ 0.05 $ 0.11 $ (0.64) $ (0.87) $ (0.34)
Weighted average common and
common equivalent shares.... 12,961,734 18,129,794 17,617,614 18,212,365 18,382,707
AS OF AUGUST 31,
---------------------------------------------------------------------
Cash, cash equivalents,
restricted cash and long and
short-term marketable
securities.................. $ 9,011,247 $53,768,562 $ 47,843,597 $ 34,177,269 $25,062,392
Working capital............... 5,498,782 25,904,641 35,708,618 20,823,316 15,641,304
Total assets.................. 11,528,674 63,279,017 60,688,379 51,464,691 39,484,997
Shareholders' equity.......... 7,238,503 54,312,758 43,946,197 29,247,800 23,411,092
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Genome Therapeutics Corp. ("GTC" or the "Company") is a leader in the field
of genomics-based drug target discovery -- the identification and functional
characterization of genes associated with infectious and human diseases. The
Company has over ten years of experience in genomic research. Having served as
one of the initial research institutions under genome programs sponsored by the
United States government, GTC has developed numerous techniques and tools that
are widely used in the field of genomics. GTC's commercial strategy capitalizes
on its pioneering work in genomics by applying its integrated platform
technologies of high-throughput sequencing, bioinformatics, disease gene
identification, and functional genomics to identify and validate novel drug
targets. The two areas of scientific focus are the discovery and
characterization of novel targets in (i) pathogens that are responsible for many
serious diseases and (ii) human diseases. The Company believes that its genomic
discoveries will lead to the development of novel therapeutics, vaccines, and
diagnostic products by it and its strategic partners. The Company has several
corporate collaborations in connection with its infectious disease and human
disease 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 license 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 sells non-exclusive licenses to access its proprietary
PathoGenome(TM) database. The sale of this database generates subscription
revenue over the term of the subscription with the potential for royalty
payments to the Company from future product sales. The expectations of these
collaborations are to result in the discovery and commercialization of novel
therapeutics, vaccines, and diagnostics. 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, manufacture,
18
<PAGE> 20
sell, and distribute the product. Accordingly, the Company does not expect to
receive royalties based upon product revenues for many years. Additionally, the
Company sells, as a contract service business, its core competency in providing
high quality genomic sequencing information to pharmaceutical companies,
governmental agencies, and academic institutions.
The Company's primary sources of revenue are collaborative agreements with
pharmaceutical company partners, subscription agreements to the Company's
PathoGenome(TM) database and government research grants and contracts. As of
October 1999, the Company had five collaborative research agreements and sold
six subscriptions to its PathoGenome(TM) database. The Company entered into a
corporate collaboration with AstraZeneca PLC, formerly Astra Hassle AB,
("Astra") to develop pharmaceutical, vaccine and diagnostic products effective
against gastrointestinal infections or any other disease caused by H. pylori. In
August 1999, the Company's portion of the research collaboration concluded and
the program transitioned into Astra's pipeline. The Company is entitled to
receive additional milestone payments and royalties based upon the development
by Astra of any products from the research collaboration. The Company entered
into a corporate collaboration with Schering Corporation and Schering-Plough,
Ltd. (collectively, "Schering-Plough") in December 1995 providing for the use by
Schering-Plough of the Company's S. 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
established its third research collaboration with Schering-Plough to use
genomics to discover and develop new pharmaceutical products to treat fungal
infections. In September 1999, after the end of the fiscal year, the Company
entered into a strategic alliance with bioMerieux to develop, manufacture and
sell in vitro pathogen diagnostic products for human clinical and industrial
applications. As part of the collaboration, bioMerieux had purchased a
subscription to the Company's PathoGenome(TM) database and made an equity
investment.
In May 1997, the Company introduced its proprietary PathoGenome(TM)
database and sold its first subscription. Since that date, the Company has sold
five additional subscriptions. Under these agreements, the subscribers will
receive a non-exclusive license to access 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 related to the
government genomics programs. The scope of the research covered by grants and
contracts encompasses technology development, sequencing production, technology
automation, and disease gene identification. These programs strengthen the
Company's genomics technology base, increase the number, and enhance the
expertise of its scientific personnel. In July 1999, the Company was named as
one of the nationally funded DNA sequencing centers of the international Human
Genome Project. The Company will participate in an international consortium in a
full-scale effort to sequence the human genome. The Company will receive funding
from the National Human Genome Research Institute (NHGRI) of up to $15.6 million
over a three-year period of which $5 million is guaranteed over the initial
twelve months. In October 1999, the Company was named as one of the pilot
centers in the Mouse Genome Sequencing Network. The Company will participate in
deciphering the genetic makeup of the mouse. The Company will receive funding
from the NHGRI of up to $12.9 million over a three-year period of which $2.4
million is guaranteed over the initial seven months. These programs are subject
to annual appropriations by the government based upon the availability of
government funds and the achievement by the Company of certain scientific
milestones.
The Company has incurred significant losses, since inception, with an
accumulated deficit of approximately $66,697,000 at August 31, 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
19
<PAGE> 21
personnel, uncertainty of regulatory approval, uncertainty of pharmaceutical
pricing, healthcare reform and related matters, product liability exposure, and
volatility of the Company's stock price.
RESULTS OF OPERATIONS
Revenue
Total revenues increased 25% from $19,217,000 in fiscal 1998 to $24,018,000
in fiscal 1999 and increased 15% from $16,653,000 in fiscal 1997 to $19,217,000
in fiscal 1998. Contract research, licenses and subscription fees increased 25%
from $19,197,000 in fiscal 1998 to $23,992,000 in fiscal 1999 and increased 20%
from $16,006,000 in fiscal 1997 to $19,197,000 in fiscal 1998. The increase in
contract research, licenses and subscription fees in both fiscal year 1999 and
1998 was primarily attributable to increased revenue recognized under the
Company's collaborative research agreements with Schering-Plough, as well as
increased subscription fees earned under the Company's subscription agreements
to the PathoGenome(TM) database.
The Company had royalty revenue of $647,000, $21,000 and $26,000 in fiscal
1997, 1998 and 1999, respectively. The royalty revenue in fiscal 1997 was
derived from the Company's rennin patent, which was assigned to Pfizer, Inc. for
$671,000 in October 1996. No further royalties will be received under this
patent.
Costs and Expenses
Total costs and expenses decreased 15% from $36,270,000 in fiscal 1998 to
$30,979,000 in fiscal 1999 and increased 20% from $30,290,000 in fiscal 1997 to
$36,270,000 in fiscal 1998. Research and development expense, which includes
GTC-sponsored research and development and research funded pursuant to
arrangements with the Company's corporate collaborators and U.S. Government,
decreased 17% from $31,977,000 in fiscal 1998 to $26,700,000 in fiscal 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 decrease from fiscal 1998 to fiscal 1999 consisted
primarily of decreases in payroll and related expenses, laboratory supplies and
overhead expenses. Research and development expenses increased 21% from
$26,524,000 in fiscal 1997 to $31,977,000 in fiscal 1998 due primarily to
increases in both personnel and laboratory expenses associated with the
Company's expansion of its microbial genetics, human gene discovery and
functional genomics research programs, as described above.
Selling, general and administrative expenses decreased slightly from
$4,292,000 in fiscal 1998 to $4,279,000 in fiscal 1999 and increased 14% from
$3,766,000 in fiscal 1997 to $4,292,000 in fiscal 1998. The increase in selling,
general and administrative expenses from fiscal 1997 to fiscal 1998 was
primarily due to increases in payroll and related expenses.
Interest Income and Expense
Interest income decreased 34% from $2,387,000 in fiscal 1998 to $1,587,000
in fiscal 1999 and decreased 20% from $2,966,000 in fiscal 1997 to $2,387,000 in
fiscal 1998. The decrease in interest income in both fiscal 1999 and 1998 was
due to the decrease in funds available for investment as a result of cash being
utilized to fund the Company's operations.
Interest expense decreased 17% from $1,147,000 in fiscal 1998 to $954,000
in fiscal 1999 due to the decrease in the Company's outstanding balances under
long-term obligations. Interest expense increased 82% from $631,000 in fiscal
1997 to $1,147,000 in fiscal 1998 due to an increase in the Company's
outstanding balance under its capital financing arrangements. The increase was
due to the consolidation of its operations into its Beaver Street facility.
20
<PAGE> 22
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
contracts, borrowings under equipment lending facilities and capital leases and
proceeds from sale of equity securities.
The Company received payments of $19,705,000 and $21,255,000 in fiscal 1998
and 1999, respectively, from its collaborative partners consisting of sponsored
research funding, subscription fees, milestone payments and expense
reimbursement, all of which are included in research funding. In fiscal 1997,
the Company received payments of $13,496,000 from its collaborative partners
consisting of an up-front license fee, sponsored research funding, subscription
fee, milestone payments and expense reimbursement, all of which are included in
research funding.
As of August 31, 1999, the Company had cash, cash equivalents, restricted
cash and short-term marketable securities of approximately $25,062,000. 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, minimum
cash level, debt service coverage and minimum restricted cash balances. The
Company has an aggregate of approximately $9,860,000 outstanding under its
borrowing arrangement at August 31, 1999, which is repayable over the three-year
period ending June 2002. At August 31, 1999, the Company had approximately
$2,325,000 available under these arrangements for future borrowings.
The Company's operating activities used cash of approximately $3,184,000,
$9,279,000 and $4,757,00 in fiscal 1999, 1998 and 1997, respectively. The
Company primarily used cash during each period to fund the Company's operations.
The Company's investing activities provided cash of approximately
$10,241,000, $10,898,000 and $2,257,000 in fiscal 1999, 1998 and 1997,
respectively, through the conversion of its marketable securities to cash and
cash equivalents, partially offset by the purchase of equipment and additions to
leasehold improvements. In addition to these purchases, the Company financed
$1,348,000, $3,573,000 and $5,843,000 of other property and equipment in fiscal
1999, 1998 and 1997, respectively, under equipment financing arrangements.
Capital expenditures totaled $2,182,000 during fiscal 1999 consisting of
leasehold improvements and purchases of laboratory, computer, and office
equipment. The Company utilized existing capital lease and equipment financing
arrangements to finance the majority of these capital expenditures. The Company
currently estimates that it will acquire approximately $3,500,000 in capital
equipment in fiscal 2000 consisting of primarily computer and laboratory
equipment, which it intends to finance under existing and new equipment
financing arrangements, yet to be negotiated. The Company is currently in
discussions with several potential sources of equipment financing.
Financing activities used cash of approximately $5,233,000 in fiscal 1999
primarily for payments of long-term obligations, partially offset by the
exercise of stock options. Financing activities provided cash of approximately
$756,000, and $422,000 in fiscal 1998 and 1997, respectively, from proceeds
received from long-term obligations and the exercise of stock options, net of
payments of long-term obligations.
At August 31, 1999, the Company had net operating loss and tax credits
(investment and research) carryforwards of approximately $63,785,000 and
$3,137,000, respectively. These net-operating losses and tax credits will expire
annually beginning in fiscal year 2000. (See Note 3 of "Notes to Consolidated
Financial Statements") These losses and tax credits are available to reduce
federal taxable income and federal income taxes, respectively, in future years,
if any. The losses and tax credits 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 has not 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.
21
<PAGE> 23
The Company believes that its existing capital resources are adequate to
meet its cash requirements for at least two years. 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. (See Note 2 to "Consolidated
Financial Statements")
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 a Y2K Task Force, using both internal and external
resources, to develop a comprehensive compliance program that will identify
potential issues, costs, and solutions to address Year 2000 concerns. The
compliance program incorporates best practices from such sources as the General
Services Administration and the Government Accounting Office (www.y2k.gov). The
comprehensive program includes an extensive inventory and assessment of its
electronic equipment, computer systems, software applications, and genomic
database storage and retrieval systems used both internally and sold to its
customers. The program includes identifying and testing of all mission critical
systems, as well as developing contingency plans for critical aspects of the
Company's systems and operations to address problems that may arise despite our
Year 2000 compliance effort.
To date, the Company has completed an extensive inventory and assessment of
its electronic equipment, computer systems, software applications, and
bioinformatics applications. The Company has identified and completed testing of
all mission critical systems. All mission critical systems not found compliant
have been repaired, modified, or replaced. 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 has developed contingency plans for critical aspects for its
systems and operations to address problems that may arise despite our Year 2000
compliance efforts. The Company continues to conduct 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 continue to modify as
appropriate its contingency plans to address situations in which further systems
of the Company, or of third parties are not yet Year 2000 compliant or who has
become Year 2000 compliant.
At this time, since the Company's 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 $450,000 to date on the Year 2000
initiative consisting of labor and outside contracting. Absent of a significant
Year 2000 compliance deficiency, management currently estimates that total costs
for its Year 2000 compliance programs will be between $475,000 to $525,000.
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
22
<PAGE> 24
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. If there are unidentified
dependencies on systems to operate the business, or if any further 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. The Company's research and development
efforts may 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.
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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements and supplementary data required by Item 8 are set
forth at the pages indicated in Item 14((a) below.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
Pursuant to General Instruction G(3) to Form 10K, the information required
for Part III (Items 10, 11, 12, and 13) is incorporated herein by reference from
the Company's proxy statement for the Annual Meeting of Shareholders to be held
on February 28, 2000.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8K
(a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES (1) AND (2) See
"Index to Consolidated Financial Statements and Financial Statement Schedules"
appearing on page F-1.
(3) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
<C> <S>
3 Restated Articles of Organization and By laws(1)
3.1 Amendment dated January 5, 1982 to Restated Articles of
Organization(2)
3.2 Amendment dated January 24, 1983 to Restated Articles of
Organization(3)
3.3 Amendment dated January 17, 1984 to Restated Articles of
Organization(4)
3.4 Amendment dated October 20, 1987 to the By-laws(8)
3.5 Amendment dated December 9, 1987 to Restated Articles of
Organization(9)
3.6 Amendment dated October 16, 1989 to the By-laws(11)
3.7 Amendment dated January 24, 1994 to Articles Restated
Articles of Organization(14)
3.8 Amendment dated August 31, 1994 to Restated of
Organization(14)
4.0 Series B Restricted Stock Purchase Plan(3)
</TABLE>
23
<PAGE> 25
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
<C> <S>
10.3 1981 Amended Stock Option Plan and Form of Stock Option
Certificate(1)
10.4 Incentive Stock Option Plan and Form of Stock Option
Certificate(1)
10.5 1984 Stock Option Plan and Form of Stock Option
Certificate(5)
10.6 Genome Therapeutics Corp. (f/k/a Collaborative Research)
Incentive Savings Plan(6)
10.7 Amendment dated November 4, 1986 to the Genome Therapeutics
Corp. (f/k/a Collaborative Research) Incentive Savings Plan
dated March 1, 1985(7)
10.9 Form of Amendment to the 1981 Incentive Stock Option Plan(8)
10.11 1988 Stock Option Plan and Form of Stock Option
Certificate(10)
10.14 1991 Stock Option Plan and Form of Stock Option
Certificate(12)
10.15 Lease dated November 17, 1992 relating to certain property
in Waltham, Massachusetts(13)
10.16 Lease dated June 3, 1993 relating to certain property in
Waltham, Massachusetts(13)
10.19 Employment Agreement with Robert J. Hennessey(13)
10.22 Lease Amendment dated August 1, 1994 relating to certain
property in Waltham, MA(14)
10.24 1993 Stock Option Plan and Form of Stock Option
Certificate(14)
10.25 Stock and Warrant Purchase Agreement among the Company and
certain purchasers named therein dated March 20, 1995(15)
10.26 Registration Rights Agreement among the Company and certain
purchasers named therein dated March 20, 1995(15)
10.27 Form of Warrant Certificate issued pursuant to the Stock and
Warrant Purchase Agreement(15)
10.28 Agreement between the Company and AstraZeneca PLC (f/k/a
Astra Hassle AB) dated August 31, 1995.(16)*
10.29 Collaboration and License Agreement between the Company,
Schering Corporation and Schering-Plough Ltd., dated as of
December 6, 1995.(18)*
10.30 Form of director Stock Option Agreement and schedule of
director options granted(17)
10.37 Lease amendment dated November 15, 1996 to certain property
in Waltham, MA.(19)
10.38 Collaboration and License Agreement between the Company,
Schering Corporation and Schering-Plough Ltd., dated as of
December 20, 1996.(20)*
10.39 Credit agreement between the Company and Fleet National Bank
dated February 28, 1997.(21)
10.40 Credit agreement between the Company and U S Trust (f/k/a
Sumitomo Bank, Limited) dated July 31, 1997.(22)
10.41 Collaboration and License Agreement between the Company and
Schering Corporation, dated September 22, 1997.(23)*
10.42 Collaboration and License Agreement between the Company and
Schering-Plough Ltd. dated September 22, 1997.(23)*
10.43 Credit modification agreement between the Company and Fleet
National Bank, dated March 9, 1998.(24)
10.44 1997 Directors' Deferred Stock Plan.(25)
10.45 1997 Stock Option Plan.(25)
10.46 Amended Employment Agreement with Robert J. Hennessey.(26)
23. Consent of Arthur Andersen LLP Independent Public
Accounts.(27)
27. Financial Data Schedule.(27)
</TABLE>
- ---------------
* Confidential treatment requested with respect to a portion of this Exhibit.
FOOTNOTES
(1) Filed as exhibits to the Company's Registration Statement on Form S-1 (No.
2-75230) and incorporated herein by reference.
(2) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the
quarter ended February 27, 1982 and incorporated herein by reference.
24
<PAGE> 26
(3) Filed as exhibits to the Company's Quarterly Report on Form 10-Q for the
quarter ended February 26, 1983 and incorporated herein by reference.
(4) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the
quarter ended February 25, 1984 and incorporated herein by reference.
(5) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1984 and incorporated herein by reference.
(6) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1985 and incorporated herein by reference.
(7) (4) Filed as exhibits to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1986 and incorporated herein by reference.
(8) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1987 and incorporated herein by reference.
(9) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the
quarter ended November 28, 1987 and incorporated herein by reference.
(10) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1988 and incorporated herein by reference.
(11) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1989 and incorporated herein by reference.
(12) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1992 and incorporated herein by reference.
(13) Filed as exhibits to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1993 and incorporated herein by reference.
(14) Filed as exhibits of the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1994 and incorporated herein by reference.
(15) Filed as exhibits to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1995 and incorporated herein by reference.
(16) Filed as an exhibit to the Company's Annual Report on Form 10-K/A3 for the
year ended August 31, 1995 and incorporated herein by reference.
(17) Filed as an exhibit to the Company Registration Statement on Forms S-8
(File No. 33-61191) and incorporated herein by reference.
(18) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the
quarter ended November 25, 1995 and incorporated herein by reference.
(19) Filed as an exhibit to the Company's 10-K for fiscal year ended August 31,
1996.
(20) Filed as an exhibit to the Company's 10-Q/A for the quarter ended March 1,
1997.
(21) Filed as an exhibit to the Company's 10-Q for the quarter ended May 31,
1997.
(22) Filed as an exhibit to the Company's 10-K for fiscal year ended August 31,
1997.
(23) Filed as exhibits to the Company's 10-Q for the quarter ended February 28,
1998.
(24) Filed as an exhibit to the Company's 10-Q for the quarter ended May 30,
1998.
(25) Filed as exhibits to the Company's Registration Statement on Forms S-8
(333-49069).
(26) Filed as an exhibit to the Company's 10-K for fiscal year ended August 31,
1998.
(27) Filed herewith.
25
<PAGE> 27
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheets as of August 31, 1998 and
1999...................................................... F-3
Consolidated Statements of Operations for the Years Ended
August 31, 1997, 1998 and 1999............................ F-4
Consolidated Statements of Shareholders' Equity for the
Years Ended August 31, 1997, 1998 and 1999................ F-5
Consolidated Statements of Cash Flows for the Years Ended
August 31, 1997, 1998 and 1999............................ F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
F-1
<PAGE> 28
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Genome Therapeutics Corp.:
We have audited the accompanying consolidated balance sheets of Genome
Therapeutics Corp. and subsidiaries (a Massachusetts corporation) as of August
31, 1998 and 1999, and the related consolidated statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended August 31, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Genome Therapeutics Corp.
and subsidiaries as of August 31, 1998 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
August 31, 1999, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Boston, Massachusetts
October 6, 1999
F-2
<PAGE> 29
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AUGUST 31,
----------------------------
1998 1999
------------ ------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents............................... $ 10,978,176 $ 12,802,162
Marketable securities................................... 21,969,524 12,060,230
Interest receivable..................................... 742,411 448,192
Unbilled costs and fees................................. 150,299 35,328
Prepaid expenses and other current assets............... 721,239 324,211
Note receivable from former officer..................... -- 120,000
------------ ------------
Total current assets............................... 34,561,649 25,790,123
------------ ------------
Equipment and Leasehold Improvements, at cost:
Laboratory and scientific equipment..................... 14,434,808 15,844,262
Leasehold improvements.................................. 7,913,570 8,205,701
Equipment and furniture................................. 1,334,268 1,344,703
------------ ------------
23,682,646 25,394,666
Less--Accumulated depreciation.......................... 8,579,440 12,173,500
------------ ------------
15,103,206 13,221,166
Restricted Cash............................................. 200,000 200,000
Long-term Marketable Securities............................. 1,029,569 --
Note Receivable from Former Officer......................... 160,000 --
Other Assets................................................ 410,267 273,708
------------ ------------
$ 51,464,691 $ 39,484,997
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term obligations............. $ 5,611,186 $ 3,934,547
Accounts payable........................................ 977,610 987,958
Accrued expenses........................................ 2,450,400 2,322,780
Deferred revenue........................................ 4,699,137 2,903,534
------------ ------------
Total current liabilities.......................... 13,738,333 10,148,819
------------ ------------
Long-term Obligations, net of current maturities............ 8,478,558 5,925,086
------------ ------------
Commitments and Contingencies (Note 4) Shareholders' Equity:
Common stock, $.10 par value-
Authorized--34,375,000 shares Issued and
outstanding--18,312,589 and 18,542,146 shares at
August 31, 1998 and 1999, respectively............... 1,831,259 1,854,214
Series B restricted stock, $.10 par value-
Authorized--625,000 shares Issued and
outstanding--none.................................... -- --
Additional paid-in capital.............................. 87,964,523 88,285,619
Accumulated deficit..................................... (60,369,289) (66,697,384)
Deferred compensation................................... (178,693) (31,357)
------------ ------------
Total shareholders' equity......................... 29,247,800 23,411,092
------------ ------------
$ 51,464,691 $ 39,484,997
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 30
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED AUGUST 31,
-------------------------------------------
1997 1998 1999
------------ ------------ -----------
<S> <C> <C> <C>
Revenues:
Contract research, licenses and subscription
fees....................................... $ 16,005,614 $ 19,196,558 $23,992,047
Royalties.................................... 647,150 20,574 26,118
------------ ------------ -----------
Total revenues.......................... 16,652,764 19,217,132 24,018,165
------------ ------------ -----------
Costs and Expenses:
Research and development..................... 26,523,824 31,977,381 26,699,910
Selling, general and administrative.......... 3,765,755 4,292,471 4,279,480
------------ ------------ -----------
Total costs and expenses................ 30,289,579 36,269,852 30,979,390
------------ ------------ -----------
Interest income.............................. 2,965,866 2,386,523 1,586,798
Interest expense............................. (631,442) (1,147,186) (953,668)
------------ ------------ -----------
Net interest income..................... 2,334,424 1,239,337 633,130
------------ ------------ -----------
Net loss................................ $(11,302,391) $(15,813,383) $(6,328,095)
============ ============ ===========
Net Loss per Common Share:
Basic and diluted............................ $ (.64) $ (.87) $ (.34)
============ ============ ===========
Weighted Average Common Equivalent Shares
Outstanding:
Basic and diluted............................ 17,617,614 18,212,365 18,382,707
============ ============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 31
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK
----------------------- ADDITIONAL TOTAL
$.10 PAID-IN ACCUMULATED DEFERRED SHAREHOLDERS'
SHARES PAR VALUE CAPITAL DEFICIT COMPENSATION EQUITY
---------- ---------- ----------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, August 31, 1996...... 17,460,966 $1,746,097 $86,067,176 $(33,253,515) $(247,000) $54,312,758
Exercise of stock
options................. 321,963 32,196 824,264 -- -- 856,460
Deferred compensation from
grant of stock
options................. -- -- 50,594 -- (50,594) --
Amortization of deferred
compensation and other
compensation expense.... -- -- -- -- 79,370 79,370
Net loss.................. -- -- -- (11,302,391) -- (11,302,391)
---------- ---------- ----------- ------------ --------- -----------
Balance, August 31, 1997...... 17,782,929 1,778,293 86,942,034 (44,555,906) (218,224) 43,946,197
Exercise of stock
options................. 529,660 52,966 930,615 -- -- 983,581
Deferred compensation from
grant of stock
options................. -- -- 91,874 -- (91,874) --
Amortization of deferred
compensation and other
compensation expense.... -- -- -- -- 131,405 131,405
Net loss.................. -- -- -- (15,813,383) -- (15,813,383)
---------- ---------- ----------- ------------ --------- -----------
Balance, August 31, 1998...... 18,312,589 1,831,259 87,964,523 (60,369,289) (178,693) 29,247,800
Exercise of stock
options................. 228,757 22,875 322,121 -- -- 344,996
Issuance of stock under
directors deferred stock
plan.................... 800 80 -- -- -- 80
Deferred compensation from
grant of stock
options................. -- -- 60,006 -- (60,006) --
Amortization of deferred
compensation and other
compensation expense.... -- -- -- -- 142,847 142,847
Compensation expense
related to grant of
stock options........... -- -- 3,464 -- -- 3,464
Reversal of deferred
compensation related to
termination of stock
options................. -- -- (64,495) -- 64,495 --
Net loss.................. -- -- -- (6,328,095) -- (6,328,095)
---------- ---------- ----------- ------------ --------- -----------
Balance, August 31, 1999...... 18,542,146 $1,854,214 $88,285,619 $(66,697,384) $ (31,357) $23,411,092
========== ========== =========== ============ ========= ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 32
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED AUGUST 31,
-----------------------------------------
1997 1998 1999
------------ ------------ -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(11,302,391) $(15,813,383) $(6,328,095)
Adjustments to reconcile net loss to net cash used in
operating activities-
Depreciation and amortization........................... 2,382,286 3,714,383 4,063,977
Loss on disposal of fixed assets........................ 227,864 288,979 --
Deferred compensation................................... 79,370 131,405 146,311
Common stock issued for services rendered............... -- -- 80
Changes in assets and liabilities-
Accounts receivable................................... 1,283,276 29,460 (15,554)
Interest receivable................................... 16,046 538,200 294,219
Unbilled costs and fees............................... 205,453 (9,979) 114,971
Prepaid expenses and other current assets............. 144,663 (287,317) 412,582
Loan to former officer................................ (160,000) -- 40,000
Accounts payable...................................... 424,112 (310,781) 10,348
Accrued expenses...................................... 642,568 76,612 (127,620)
Deferred revenue...................................... 1,300,191 2,363,442 (1,795,603)
------------ ------------ -----------
Total adjustments.................................. 6,545,829 6,534,404 3,143,711
------------ ------------ -----------
Net cash used in operating activities.............. (4,756,562) (9,278,979) (3,184,384)
------------ ------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities........................ (20,575,625) (30,820,944) (21,858,137)
Proceeds from sale of marketable securities............... 24,530,000 46,761,250 32,797,000
Purchases of equipment and leasehold improvements......... (1,370,028) (5,162,311) (834,351)
(Increase) decrease in restricted cash.................... (106,000) 101,500 --
(Increase) decrease in other assets....................... (220,850) 18,722 136,559
------------ ------------ -----------
Net cash provided by investing activities.......... 2,257,497 10,898,217 10,241,071
------------ ------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options................... 856,460 983,581 344,996
Proceeds from long-term obligations....................... 2,500,000 4,011,000 --
Payments on long-term obligations......................... (2,933,984) (4,238,341) (5,577,697)
------------ ------------ -----------
Net cash provided (used in) by financing
activities....................................... 422,476 756,240 (5,232,701)
------------ ------------ -----------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS........ (2,076,589) 2,375,478 1,823,986
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 10,679,287 8,602,698 10,978,176
------------ ------------ -----------
CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 8,602,698 $ 10,978,176 $12,802,162
============ ============ ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid during the year............................. $ 631,442 $ 1,147,186 $ 953,668
============ ============ ===========
Income taxes paid during the year......................... $ 36,612 $ 24,700 $ 33,019
============ ============ ===========
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING
ACTIVITIES:
Equipment acquired under capital leases................... $ 5,843,037 $ 3,572,777 $ 1,347,586
============ ============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 33
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Genome Therapeutics Corp. (GTC or the Company) is a leader in the field of
genomics-based drug discovery--the identification and functional
characterization of genes associated with infectious and human diseases. The
Company has over ten years of experience in genomic research. Having served as
one of the initial research institutions under genome programs sponsored by the
United States government, GTC has developed numerous techniques and tools that
are widely used in the field of genomics. GTC's commercial strategy capitalizes
on its pioneering work in genomics by applying its high-throughput sequencing,
bioinformatics, disease gene identification, and functional genomics to identify
and validate novel drug targets. The two areas of focus are the discovery and
characterization of novel targets in (i) pathogens that are responsible for many
serious diseases and (ii) human diseases.
The accompanying consolidated financial statements reflect the application
of certain accounting policies described in this note and elsewhere in the
accompanying notes to the consolidated financial statements.
(a) Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All material intercompany
accounts and transactions have been eliminated in consolidation.
(b) Revenue Recognition
Revenues are from contract research and licenses derived from collaborative
agreements with pharmaceutical companies and from government grants and
contracts. Subscription fees from the PathoGenome(TM) database are recognized
ratably over the life of the subscription. Milestone payments from collaborative
research and development agreements are recognized when they are achieved.
Royalties from the Company's pro licensed technologies are recognized as earned.
Unbilled costs and fees represent revenue recognized prior to billing.
Deferred revenue represents amounts received prior to revenue recognition.
(c) Equipment and Leasehold Improvements
Equipment and leasehold improvements are depreciated over their estimated
useful lives using the straight-line method. The estimated useful life for
leasehold improvements is the lesser of the term of the lease or the estimated
useful life of the assets. Equipment and all other depreciable assets' useful
lives vary from three to seven years. The majority of the Company's equipment
and leaseholds are financed through bank lines of credit.
(d) Net Loss per Common and Common Equivalent Share
The Company applies Statement of Financial Accounting Standards (SFAS) No.
128, Earnings per Share, which establishes standards for computing and
presenting earnings per share. Basic and diluted earnings per share were
determined by dividing net loss by the weighted average common shares
outstanding during the period. Diluted loss per share is the same as basic loss
per share for all periods presented as the effect of the potential common stock
is antidilutive. Antidilutive securities which consist of stock options and
warrants that are not included in diluted net loss per common share were
4,869,938, 4,089,226 and 3,301,008 at August 31, 1997, 1998 and 1999,
respectively.
F-7
<PAGE> 34
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(e) Concentration of Credit Risk
SFAS No. 105, Disclosure of Information about Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit
Risk, requires disclosure of any significant off-balance-sheet and credit risk
concentrations. The Company has no significant off-balance-sheet or
concentrations of credit risk such as foreign exchange contracts, options
contracts or other foreign hedging arrangements. The Company maintains its cash,
cash equivalents and marketable securities balances with several nonaffiliated
institutions.
The Company had revenues from the following significant customers:
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF TOTAL REVENUES
SIGNIFICANT -----------------
CUSTOMERS A B C
----------- --- --- ---
<S> <C> <C> <C> <C>
Year ended August 31,
1997............................................... 3 17% 27% 48%
1998............................................... 3 9 9 71
1999............................................... 3 4 4 75
</TABLE>
(f) 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.
(g) Financial Instruments
The estimated fair value of the Company's financial instruments, which
include cash equivalents, marketable securities, accounts receivable, accounts
payable and long-term debt, approximates carrying value.
(h) Comprehensive Loss
The Company has adopted 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 nonowner sources. Comprehensive loss is the same
as net loss for all periods presented.
(i) Segment Reporting
The Company applies SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. SFAS No. 131 establishes standards for
reporting information regarding operating segments in annual financial
statements and requires selected information for those segments to be presented
in interim financial reports issued to stockholders. SFAS No. 131 also
establishes standards for related disclosures about products and services and
geographic areas. Operating segments are identified as components of an
enterprise about which separate discrete financial information is available for
evaluation by the chief operating decision maker, or decision making group, in
making decisions how to allocate resources and assess performance. The Company's
chief decision-makers, as defined under SFAS No. 131, are the chief executive
officer and chief financial officer. To date, the Company has viewed its
operations and manages its business as principally one operating segment. As a
result, the financial information disclosed herein, represents all of the
material
F-8
<PAGE> 35
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
financial information related to the Company's principal operating segment. All
of the Company's revenues are generated in the United States and substantially
all assets are located in the United States.
(j) Reclassifications
The Company has reclassified certain prior year information to conform with
the current year's presentation.
(2) CASH EQUIVALENTS AND MARKETABLE SECURITIES
The Company applies SFAS No. 115, Accounting for Certain Investments in
Debt and Equity Securities. At August 31, 1999, 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 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 and consist of commercial paper
and U.S. government debt securities. The Company has not recorded any realized
gains or losses on its marketable securities.
The aggregate fair values and costs of the investments at August 31, 1998
and 1999 were as follows:
<TABLE>
<CAPTION>
1998 1999
------------------------- -------------------------
AMORTIZED MARKET AMORTIZED MARKET
MATURITY COST VALUE COST VALUE
-------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Less than one year-
Corporate and other debt securities... $21,969,524 $21,958,963 $12,060,230 $12,043,522
=========== =========== =========== ===========
Greater than one year-
Corporate and other debt securities
(average maturity of 1 year in
1998).............................. $ 1,029,569 $ 1,029,687 -- --
=========== =========== =========== ===========
</TABLE>
The Company has $200,000 in restricted cash at August 31, 1998 and 1999 in
connection with certain capital lease obligations (see Note 5).
(3) INCOME TAXES
The Company applies SFAS No. 109, Accounting for Income Taxes, which
requires the Company to recognize deferred tax assets and liabilities for
expected future tax consequences of events that have been recognized in the
financial statements or tax returns. Under this method, deferred tax assets and
liabilities are determined based on the difference between the financial
statement and tax bases of assets and liabilities using the enacted tax rates in
effect for the year in which the differences are expected to reverse. SFAS No.
109 requires deferred tax assets and liabilities to be adjusted when the tax
rates or other provisions of the income tax laws change.
At August 31, 1999, the Company had net operating loss and tax credit
carryforwards of approximately $63,785,000 and $3,137,000, respectively,
available to reduce federal taxable income and federal income taxes,
respectively, if any. Net operating loss carryforwards and credits are subject
to review and possible adjustment by the Internal Revenue Service and may be
limited in the event of certain cumulative changes in the ownership interest of
significant shareholders over a three-year period in excess of 50%.
F-9
<PAGE> 36
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The net operating loss carryforwards and tax credits expire approximately
as follows:
<TABLE>
<CAPTION>
NET OPERATING RESEARCH INVESTMENT TAX
LOSS TAX CREDIT CREDIT
EXPIRATION DATE CARRYFORWARDS CARRYFORWARDS CARRYFORWARDS
--------------- ------------- ------------- --------------
<S> <C> <C> <C>
2000........................................... $ 5,039,000 $ 273,000 $143,000
2001........................................... 3,829,000 84,000 75,000
2002........................................... 4,811,000 24,000 3,000
2003........................................... 2,254,000 -- --
2004-2019...................................... 47,852,000 2,498,000 37,000
----------- ---------- --------
$63,785,000 $2,879,000 $258,000
=========== ========== ========
</TABLE>
The components of the deferred tax assets at the respective dates are as
follows:
<TABLE>
<CAPTION>
AUGUST 31,
-------------------------
1998 1999
----------- -----------
<S> <C> <C>
Net operating loss carryforwards............................ $23,154,000 $24,237,000
Research and development credits............................ 1,310,000 2,879,000
Investment tax credits...................................... 347,000 258,000
Other, net.................................................. 1,856,000 2,318,000
----------- -----------
26,667,000 29,692,000
Valuation allowance......................................... (26,667,000) (29,692,000)
----------- -----------
$ -- $ --
=========== ===========
</TABLE>
The valuation allowance has been provided due to the uncertainty
surrounding the realization of the deferred tax assets.
(4) COMMITMENTS
(a) Lease Commitments
At August 31, 1999, the Company has operating leases for office and
laboratory facilities, the last of which expires on November 15, 2006. Minimum
lease payments and facilities charges under the leases at August 31, 1999 are as
follows:
<TABLE>
<CAPTION>
YEAR ENDING AUGUST 31,
----------------------
<S> <C>
2000........................................................ $ 917,488
2001................................................... 949,138
2002................................................... 1,179,393
2003................................................... 1,138,797
2004................................................... 1,115,653
Thereafter............................................. 2,603,526
----------
$7,903,995
==========
</TABLE>
Rental expense was approximately $949,000, $1,085,000 and $899,000 in the
years ended August 31, 1997, 1998 and 1999, respectively.
(b) Employment Agreement
The Company has an employment agreement with its chief executive officer
that provides for bonuses and severance benefits upon termination of employment,
as defined.
F-10
<PAGE> 37
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(c) Loan to Former Officer
On December 6, 1996, the Company loaned $160,000 to a former officer of the
Company. The loan bears interest at prime plus 1% and has been amended to be due
on June 30, 2000. The Company forgave and expensed $40,000 of the loan during
the year ended August 31, 1999.
(5) LONG-TERM OBLIGATIONS
On February 28, 1997, the Company entered into an equipment lease line of
credit 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 LIBOR (5.375% as of August 31, 1999)
plus 2%. On March 9, 1998, the Company increased the equipment lease line of
credit by $4,300,000 to $10,300,000. The additional borrowings under the
equipment lease line of credit will be utilized to finance laboratory, computer
and office equipment. Borrowings under the new credit line are payable in 15
quarterly installments commencing March 31, 1999, at a variable rate of LIBOR
plus 1.75%. 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 2).
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 $2,325,000 available under the modified
line of credit at August 31, 1999.
On July 31, 1997, the Company entered into a financing arrangement 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 commencing on July 1, 1998. 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
August 31, 1999.
The Company has entered into other capital lease line arrangements under
which it financed approximately $9,725,000 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 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 August 31,
1999.
Payments under long-term obligations at August 31, 1999 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING AUGUST 31,
- ----------------------
<S> <C>
2000................................................... $ 4,596,401
2001................................................... 3,975,585
2002................................................... 2,154,381
2003................................................... 261,087
-----------
Total minimum lease payments...................... 10,987,454
Less--Amount representing interest..................... 1,127,821
-----------
Present value of total minimum lease payments..... 9,859,633
Less--Current portion.................................. 3,934,547
-----------
$ 5,925,086
===========
</TABLE>
F-11
<PAGE> 38
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) SHAREHOLDERS' EQUITY
(a) Stock Options
The Company has granted stock options to key employees and consultants
under its 1988, 1991, 1993, 1995 and 1998 Stock Option Plans. The purchase price
and vesting schedule applicable to each option grant are determined by the stock
option and compensation committee of the Board of Directors. In addition, under
separate agreements not covered by any plan, the Company has granted certain key
employees and certain directors of the Company, options to purchase common
stock.
The Company granted nonqualified stock options for the purchase of 65,000
and 10,000 shares of common stock to consultants in the years ended August 31,
1997 and 1999, respectively. The options were granted with an exercise price
equal to the fair market value price at the date of grant and vest ratably over
the contract period, as defined. In accordance with Emerging Issues Task Force
(EITF) No. 96-18, Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling Goods or Services,
the Company will measure the value of options as they vest using the
Black-Scholes option pricing model. The Company has charged $5,720, 12,648 and
$16,113 to operations for the year ended August 31, 1997, 1998 and 1999,
respectively.
The Company records deferred compensation when stock options are granted at
an exercise price per share that is less than the fair market value on the date
of the grant. Deferred compensation is recorded in an amount equal to the excess
of the fair market value per share over the exercise price times the number of
options granted. Deferred compensation is being recognized as an expense over
the estimated vesting period of the underlying options. In 1997, 1998 and 1999,
the Company recorded $50,594, $91,874 and $60,006, respectively, of deferred
compensation. The Company recorded compensation expense of approximately
$79,000, $131,000 and $146,000 for the years ended August 31, 1997, 1998 and
1999, respectively. During fiscal 1999, in connection with the termination of
two employees, the Company reversed $64,495 of unamortized deferred compensation
due to the cancelation of the options.
In November 1998, the Board of Directors authorized a Stock Option
Repricing Program (the Program). Under the terms of the program, all current
employees excluding the chairman, president and CEO had the option to request
that the Company cancel their existing options and replace them with a new
option to purchase 85%-90% of the original number of shares of common stock
granted, at the new option exercise price and vesting schedule. The new exercise
price was calculated using the Black-Scholes option pricing model, which was
greater than the fair market value on the date of grant. The repriced shares
cannot be exercised for 12 months from the date of reissuance. These repriced
options are reflected as grants and cancellations in the stock activity below.
There were 1,130,118 common shares available for future grant at August 31,
1999. The following is a summary of all stock option activity:
<TABLE>
<CAPTION>
NUMBER OF EXERCISE WEIGHTED
SHARES PRICE RANGE AVERAGE PRICE
---------- ----------- -------------
<S> <C> <C> <C>
Outstanding, August 31, 1996................. 4,348,214 $ .20-14.50 $3.85
Granted................................. 797,950 6.19- 9.69 8.58
Exercised............................... (321,963) .88- 7.25 2.66
Cancelled............................... (178,513) 1.56-14.50 6.86
---------- ----------- -----
Outstanding, August 31, 1997................. 4,645,688 .20-14.50 4.63
Granted................................. 468,900 4.88- 9.50 6.30
Exercised............................... (529,660) 1.31- 8.31 1.86
Cancelled............................... (719,952) 2.03-14.50 7.77
---------- ----------- -----
</TABLE>
F-12
<PAGE> 39
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
NUMBER OF EXERCISE WEIGHTED
SHARES PRICE RANGE AVERAGE PRICE
---------- ----------- -------------
<S> <C> <C> <C>
Outstanding, August 31, 1998................. 3,864,976 $ .20-14.50 $4.63
Granted................................. 1,016,379 2.31- 4.23 3.95
Exercised............................... (228,757) .20- 2.62 1.51
Cancelled............................... (1,351,590) .20-14.50 7.22
---------- ----------- -----
Outstanding, August 31, 1999................. 3,301,008 $1.53-14.50 $3.57
========== =========== =====
Exercisable, August 31, 1999................. 2,426,749 $1.53-14.50 $3.16
========== =========== =====
Exercisable, August 31, 1998................. 2,674,323 $ .20-14.50 $3.43
========== =========== =====
Exercisable, August 31, 1997................. 2,795,938 $ .20-14.50 $2.78
========== =========== =====
</TABLE>
The range of exercise prices for options outstanding and options
exercisable at August 31, 1999 are as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE OPTIONS OUTSTANDING OPTIONS EXERCISABLE
REMAINING -------------------- --------------------
CONTRACTUAL LIFE WEIGHTED WEIGHTED
OF OPTIONS AVERAGE AVERAGE
RANGE OF OUTSTANDING EXERCISE EXERCISE
EXERCISE PRICES (IN YEARS) NUMBER PRICE NUMBER PRICE
- --------------- ---------------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C>
$1.53-2.25 3.72 1,543,102 $1.70 1,522,102 $1.70
$2.31-3.41 7.15 488,900 2.79 241,500 2.38
$3.52-5.00 9.12 626,068 4.31 184,354 4.33
$5.31-7.50 6.82 330,213 7.04 296,063 7.08
$8.31-9.50 6.50 312,225 8.86 182,355 8.86
$14.50 6.46 500 14.50 375 14.50
---- --------- ----- --------- -----
Total 5.82 3,301,008 $3.57 2,426,749 $3.16
==== ========= ===== ========= =====
</TABLE>
(b) Pro Forma Disclosure of Stock-Based Compensation
The Company applies SFAS No. 123, Accounting for Stock-Based Compensation,
which requires the measurement of the fair value of stock options or warrants
granted to employees to be included in the consolidated statement of operations
or, alternatively, disclosed in the notes to consolidated financial statements.
The Company has determined that it will continue to account for stock-based
compensation for employees and nonemployee directors under Accounting Principles
Board Opinion No. 25 and elect the disclosure-only alternative under SFAS No.
123. The Company has computed the pro forma disclosures required under SFAS No.
123 for stock options granted in 1997, 1998 and 1999 using the Black-Scholes
option pricing model. The weighted average assumptions used for 1997, 1998 and
1999 are as follows:
<TABLE>
<CAPTION>
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Risk-free interest rate....................... 6.20%-6.73% 5.36%-6.20% 4.46%-6.15%
Expected dividend yield....................... -- -- --
Expected life................................. 7 years 7 years 7 years
Expected volatility........................... 65% 65% 65%
Weighted average fair market value at grant
date........................................ $4.93 $3.61 $4.21
</TABLE>
F-13
<PAGE> 40
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The total value of the options granted to employees during 1997, 1998 and
1999 was computed as $3,857,026, $1,635,318 and $1,255,868, respectively. Of
these amounts, $2,951,660, $652,668 and $966,309 would be charged to operations
for the years ended August 31, 1997, 1998 and 1999, respectively. The remaining
amount, approximately $1,407,072, would be amortized over the remaining vesting
periods. The pro forma effect of these option grants for the years ended August
31, 1997, 1998 and 1999 is as follows:
<TABLE>
<CAPTION>
1997 1998 1999
--------------------------- --------------------------- -------------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA AS REPORTED PRO FORMA
------------ ------------ ------------ ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Net loss............. $(11,302,391) $(14,254,051) $(15,813,383) $(16,466,051) $(6,328,095) $(7,294,404)
============ ============ ============ ============ =========== ===========
Net loss per share... $ (0.64) $ (0.81) $ (0.87) $ (0.90) $ (0.34) $ (0.40)
============ ============ ============ ============ =========== ===========
</TABLE>
The resulting pro forma compensation expense may not be representative of
the amount to be expected in future years, as the pro forma expense may vary
based on the number of options granted. The Black-Scholes option pricing model
was developed for use in estimating the fair value of traded options that have
no vesting restrictions and are fully transferable. In addition, option pricing
models require the input of highly subjective assumptions, including expected
stock price volatility. Because the Company's employee stock options have
characteristics significantly different from those of traded options and because
changes in the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
(c) 1997 Directors Deferred Stock Plan
In January 1998, the Company's stockholders approved the 1997 Directors
Deferred Stock Plan (the 1997 Directors Plan) covering 150,000 shares of common
stock. The stock will be issued ratably for services provided by members of the
Company's Board of Directors. As of August 31, 1999, 800 shares of common stock
were issued under the 1997 Directors Plan.
(d) Warrants
In connection with the Company's public offering in 1996, the Company
issued two-year warrants to its underwriters for the purchase of 224,250 shares
of common stock at $15.60 per share. These warrants expired during the fiscal
year ended August 31, 1999.
(7) INCENTIVE SAVINGS PLAN 401(K)
The Company maintains an incentive savings plan (the Plan) for the benefit
of all employees. On October 1, 1996, the Company changed its matching
contribution from 50% of the first 2% of salary and 25% of the next 4% of
salary, limited to the first $50,000 of annual salary to 100% of the first 2% of
salary and 50% of the next 2% of salary, limited to the first $100,000 of annual
salary. The Company contributed $165,778, $229,460 and $241,587 to the Plan for
the years ended August 31, 1997, 1998 and 1999, respectively.
(8) COLLABORATION AGREEMENTS
(a) Astra
In August 1995, the Company entered into a collaboration agreement with
AstraZeneca PLC (Astra), formerly Astra Hassle AB, 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,
F-14
<PAGE> 41
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 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.
The Company has recognized $2,859,262, $1,653,623 and $909,870 in revenue
under the agreement in the years ended August 31, 1997, 1998 and 1999,
respectively, which consisted of milestone payments and collaborative research
revenues.
(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 Staphylococcus aureus to identify 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 the
Company's proprietary S. aureus genomic sequence database. 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 of two-and-a-half 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,
as their primary indication, the pathogen that is the principal subject of the
Company's agreement with Schering-Plough. The Company will be entitled to
receive royalties on Schering-Plough's sale
F-15
<PAGE> 42
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
Under the December 1995 agreement, the Company has recognized $3,364,810,
$3,435,807 and $2,490,802 in revenue in the years ended August 31, 1997, 1998
and 1999, respectively, under this collaborative agreement, which consisted of a
license fee, collaborative research revenue 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 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 based on the
rights to develop and commercialize diagnostic products that may result from
this collaboration.
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 $68 million, excluding royalties. Of the total
potential payments, approximately $23.5 million represents license fees and
research payments, and $44.5 million represents milestone payments based on
achievement of research and product development milestones.
Under this second agreement, the Company has recognized $4,603,805,
$7,099,911 and $9,926,776 in revenue in the years ended August 31, 1997, 1998
and 1999, respectively, under this agreement, which consisted of a license fee,
expense allowance and collaborative research revenues.
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 $11.0 million represents license
fees and 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 PathoGenome(TM)
database (see Note 9).
F-16
<PAGE> 43
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Under the third agreement, the Company has recognized $2,432,005 and
$4,831,870 in revenue for the years ended August 31, 1998 and 1999,
respectively, which consisted of research funding and milestone payments.
(c) National Human Genome Research Institute
In July 1999, the Company was named as one of the nationally funded DNA
sequencing centers of the international Human Genome Project. The Company will
participate in an international consortium in a full scale effort to sequence
the human genome. The Company is entitled to receive research and development
funding from the National Human Genome Research Institute (NHGRI) of up to $15.6
million over a three year period of which $5 million will be received over the
initial 12 months as the Company performs research under the project. As of
August 31, 1999, the Company has recognized approximately $340,000 in connection
with the international Human Genome Project.
(9) DATABASE SUBSCRIPTIONS
The Company has entered into PathoGenome(TM) database subscriptions with
Bayer AG, Bristol-Meyers Squibbs, Scriptgen Pharmaceuticals, Inc.,
Schering-Plough (see Note 8) and Hoechst Marion Roussel. The database
subscription provides nonexclusive access to the Company's genome sequence
database, PathoGenome(TM) 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 $666,667, $2,766,671 and $4,845,832 in revenue
under these agreements in the years ended August 31, 1997, 1998 and 1999,
respectively, consisting of license and subscription fees.
(10) ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
AUGUST 31,
-----------------------
1998 1999
---------- ----------
<S> <C> <C>
Payroll and related expenses...................... $1,109,626 $1,065,311
Facilities........................................ 469,932 438,453
Professional fees................................. 285,058 269,553
License and other fees............................ 185,434 160,434
Employee relocation............................... 162,519 143,843
All other......................................... 237,831 245,186
---------- ----------
$2,450,400 $2,322,780
========== ==========
</TABLE>
(11) SUBSEQUENT EVENTS
(a) bioMerieux Alliance
In September 1999, the Company entered into strategic alliance with
bioMerieux to develop, manufacture and sell in vitro diagnostic products for
human clinical and industrial applications. As part of the alliance, bioMerieux
purchased a subscription to the Company's PathoGenome(TM) database, agreed to
fund a research program for at least four years and pay royalties on future
products. In addition, bioMerieux purchased $3.75 million of the Company's
common stock at $5.53 per share. The total amount of guaranteed research
F-17
<PAGE> 44
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
and development funding and PathoGenome(TM) database subscription for the first
year, and the proceeds from the sale of the common stock, approximates $6.2
million.
(b) Mouse Genome Sequencing Network
In October 1999, the NHGRI named the Company as a pilot center to the Mouse
Genome Sequencing Network. The Mouse Genome Sequencing Network will be composed
of several facilities that will be responsible for deciphering the genetic
makeup of the mouse. The Company is entitled to receive $12.9 million in funding
over the next three years with respect to this agreement of which the Company
will to receive $2.4 million during the first fiscal period, which ends April
30, 2000 as the Company performs research under the project.
F-18
<PAGE> 45
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, Genome Therapeutics Corp. has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, on
November 24, 1999.
GENOME THERAPEUTICS CORP.
/s/ ROBERT J. HENNESSEY
------------------------------------
Robert J. Hennessey
Chief Executive Officer
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated as of November 24, 1999.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>
/s/ ROBERT J. HENNESSEY Chairman, President, Chief Executive Officer
- ---------------------------------------------
ROBERT J. HENNESSEY
/s/ MANNY BOUGOULAS Controller, Principal Accounting Officer
- ---------------------------------------------
MANNY BOUGOULAS
/s/ PHILIP V. HOLBERTON Chief Financial Officer, Principal Financial
- --------------------------------------------- Officer
PHILIP V. HOLBERTON
/s/ MARC GARNICK Director
- ---------------------------------------------
MARC GARNICK
/s/ PHILIP LEDER Director
- ---------------------------------------------
PHILIP LEDER
/s/ LAWRENCE LEVY Director
- ---------------------------------------------
LAWRENCE LEVY
/s/ STEVEN M. RAUSCHER Director
- ---------------------------------------------
STEVEN M. RAUSCHER
/s/ NORBERT REIDEL Director
- ---------------------------------------------
NORBERT REIDEL
</TABLE>
<PAGE> 1
Exhibit 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report included in this Form 10-K, into the Company's previously filed Form S-8
Registration Statements No. 2-77846, No. 2-81123, No. 2-95446, No. 33-12633, No.
33-27885, No. 33-45432, No. 0-10824, No. 03-361191, No. 333-30617, No. 333-15935
and No. 333-49069.
/s/ ARTHUR ANDERSEN LLP
Boston, Massachusetts
November 24, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000356830
<NAME> GENOME THERAPEUTICS CORP.
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> AUG-31-1999
<PERIOD-START> SEP-01-1998
<PERIOD-END> AUG-31-1999
<EXCHANGE-RATE> 1
<CASH> 12,802
<SECURITIES> 12,060
<RECEIVABLES> 484
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 25,790
<PP&E> 25,395
<DEPRECIATION> 12,174
<TOTAL-ASSETS> 39,485
<CURRENT-LIABILITIES> 10,149
<BONDS> 0
0
0
<COMMON> 1,854
<OTHER-SE> 21,557
<TOTAL-LIABILITY-AND-EQUITY> 39,485
<SALES> 0
<TOTAL-REVENUES> 24,018
<CGS> 0
<TOTAL-COSTS> 30,979
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 954
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,328)
<EPS-BASIC> (.34)
<EPS-DILUTED> (.34)
</TABLE>
