<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 1999
or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________ to
Commission File Number: 0-23930
-------
TARGETED GENETICS CORPORATION
-----------------------------
(Exact name of registrant as specified in its charter)
Washington 91-1549568
---------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1100 Olive Way, Suite 100, Seattle, Washington 98101
-------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(206) 623-7612
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Common Stock, $.01 par value 33,999,168
- ---------------------------- ---------------------------------
(Class) (Outstanding at November 1, 1999)
1
<PAGE>
TARGETED GENETICS CORPORATION
Quarterly Report on Form 10-Q
For the quarter ended September 30, 1999
TABLE OF CONTENTS
Page No.
--------
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
a) Condensed Balance Sheets - September 30, 1999 and 3
December 31, 1998
b) Condensed Statements of Operations - for the three and nine 4
months ended September 30, 1999 and 1998
c) Condensed Statements of Cash Flows - for the nine months 5
ended September 30, 1999 and 1998
d) Notes to Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 7
Item 3. Quantitative and Qualitative Disclosure About Market Risk *
PART II OTHER INFORMATION
Item 1. Legal Proceedings *
Item 2. Changes in Securities *
Item 3. Defaults Upon Senior Securities *
Item 4. Submission of Matters to a Vote of Security Holders *
Item 5. Other Information *
Item 6. Exhibits and Reports on Form 8-K 11
SIGNATURES 11
* No information is provided due to inapplicability of the item.
2
<PAGE>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
TARGETED GENETICS CORPORATION
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------ -----------
ASSETS (Unaudited)
- ------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 4,976,358 $ 1,870,841
Securities available for sale 3,576,912 10,085,955
Accounts receivable 1,342,558 102,359
Prepaid expenses and other 125,894 387,408
------------- ------------
Total current assets 10,021,722 12,446,563
Property, plant and equipment, net 3,716,868 3,299,253
Other assets 441,067 458,267
------------- ------------
$ 14,179,657 $ 16,204,083
============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable $ 1,694,377 $ 1,664,074
Accrued payroll and other liabilities 275,976 486,206
Current portion of long-term obligations 1,240,912 1,171,836
------------- ------------
Total current liabilities 3,211,265 3,322,116
Long-term obligations 1,132,515 900,208
Shareholders' equity:
Series A Preferred stock, $.01 par value; 6,000,000
shares authorized, none outstanding -- --
Series B Convertible Exchangeable Preferred stock,
$.001 par value; 12,015 shares authorized, 12,015 and
no shares issued and outstanding at September 30, 1999
and December 31, 1998, respectively 12,178,602 --
Common stock (33,999,168 and 30,652,375 shares
outstanding at September 30, 1999 and December 31,
1998, respectively) 98,088,077 88,455,138
Accumulated deficit (100,416,658) (76,501,784)
Accumulated other comprehensive income (loss) (14,144) 28,405
------------- ------------
Total shareholders' equity 9,835,877 11,981,759
------------- ------------
$ 14,179,657 $ 16,204,083
============= ============
</TABLE>
The accompanying notes are an integral part of this statement.
3
<PAGE>
TARGETED GENETICS CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
--------------------------- ----------------------------
1999 1998 1999 1998
------------- ------------ ------------- -------------
<S> <C> <C> <C> <C>
Revenue:
Collaborative agreements $ 1,364,545 $ 111,629 $ 3,987,662 $ 119,968
Other - 14,473 - 318,204
------------ ----------- ------------ ------------
Total revenue 1,364,545 126,102 3,987,662 438,172
Operating expenses:
Research and development 3,636,415 2,898,981 10,296,869 8,733,860
Technology license fee - - 3,200,000 -
General and administrative 967,624 651,300 2,408,474 2,091,860
------------ ----------- ------------ ------------
Total operating expenses 4,604,039 3,550,281 15,905,343 10,825,720
------------ ----------- ------------ ------------
Loss from operations (3,239,494) (3,424,179) (11,917,681) (10,387,548)
Equity in loss of joint venture (12,015,000) - (12,015,000) -
Investment income 123,589 136,133 344,744 313,457
Interest expense (57,632) (64,833) (163,335) (209,497)
------------ ----------- ------------ ------------
Net loss (15,188,537) (3,352,879) (23,751,272) (10,283,588)
Accretion of dividend on preferred stock (163,602) - (163,602) -
------------ ----------- ------------ ------------
Net loss applicable to common stock $(15,352,139) $(3,352,879) $(23,914,874) $(10,283,588)
============ =========== ============ ============
Basic and diluted net loss
per common share $ (0.46) $ (0.12) $ (0.76) $ (0.40)
============ =========== ============ ============
Shares used in computation of basic and
diluted net loss per common share 33,190,783 28,974,741 31,559,622 25,529,296
============ =========== ============ ============
</TABLE>
The accompanying notes are an integral part of this statement.
4
<PAGE>
TARGETED GENETICS CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine months ended
September 30,
-----------------
1999 1998
-------------- -------------
<S> <C> <C>
Operating activities:
- --------------------
Net loss $(23,914,874) $(10,283,588)
Adjustments to reconcile net loss to net cash
used in operating activities:
Equity in loss of joint venture 12,015,000 -
Technology fee paid with common stock and warrants 3,200,000 -
Depreciation and amortization 1,133,704 1,240,331
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable (1,240,199) 24,258
Decrease (increase) in other assets 206,317 (69,830)
Decrease in accounts payable
and accrued liabilities (143,322) (28,508)
Decrease (increase) in accrued interest on
securities available for sale 79,531 (59,099)
------------ ------------
Net cash used in operating activities (8,663,843) (9,176,436)
Investing activities:
- --------------------
Sales of securities available for sale 6,881,277 10,495,650
Purchases of property, plant and equipment (1,379,568) (150,995)
Purchases of securities available for sale (494,314) (12,569,056)
Increase in other assets - (15,000)
------------ ------------
Net cash provided by (used in) investing activities 5,007,395 (2,239,401)
Financing activities:
- --------------------
Net proceeds from issuance of equity securities 6,575,208 12,813,844
Proceeds from equipment financing 960,283 -
Payments under capital leases and installment loans (794,859) (798,895)
Net proceeds from stock option exercises 21,333 82,643
------------ ------------
Net cash provided by financing activities 6,761,965 12,097,592
------------ ------------
Net increase in cash and cash equivalents 3,105,517 681,755
Cash and cash equivalents, beginning of period 1,870,841 1,011,845
------------ ------------
Cash and cash equivalents, end of period $ 4,976,358 $ 1,693,600
============ ============
Supplemental disclosure of noncash investing and financing activities:
Investment in joint venture $ 12,015,000 $ -
Equipment financed through capital lease 153,677 594,983
Interest paid on capital lease and installment loans 153,525 209,497
</TABLE>
The accompanying notes are an integral part of this statement.
5
<PAGE>
TARGETED GENETICS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
The condensed financial statements included herein have been prepared by
Targeted Genetics Corporation (the "Company") without audit, according to the
rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
omitted pursuant to such rules and regulations. The financial statements
reflect, in the opinion of management, all adjustments (which consist solely of
normal recurring adjustments) necessary to present fairly the financial position
and results of operations as of and for the periods indicated.
The results of operations for the three months and nine months ended
September 30, 1999, are not necessarily indicative of the results to be expected
for the full year.
Note 2. Revenue Recognition
Revenue under collaborative agreements is recognized as defined under the
terms of the respective collaborative agreements. Nonrefundable signing or
licensing fees that are not dependent on future performance are recognized as
revenue when received. Milestone revenue is recognized upon the achievement of
the related milestone and when collection is probable. Revenue earned from the
performance of research and development is recognized ratably over the period in
which the related work is performed. Advance payments received in excess of
amounts earned are classified as deferred revenue. Revenue from the cystic
fibrosis collaboration with Medeva PLC comprised substantially all of total
Company revenue during the third quarter and nine months ended September 30,
1999.
Note 3. Strategic Alliance
On July 21, 1999, the Company and Elan Corporation, plc ("Elan") formed a
joint venture to develop enhanced gene delivery technology and products
utilizing the Company's gene therapy expertise and Elan's drug delivery
expertise. This joint venture, Emerald Gene Systems, Ltd. ("Emerald"), a Bermuda
limited company, is initially owned 80.1% by the Company and 19.9% by Elan.
Emerald will subcontract research and development efforts mainly to the joint
venturers. Under the terms of related agreements, Emerald paid $15 million to
Elan for a license giving Emerald exclusive rights to use Elan drug delivery
technologies, as defined, within the gene delivery field.
In a related transaction, Elan purchased $12,015,000 of Targeted Genetics
Series B convertible exchangeable preferred stock on July 21, 1999. This
preferred stock bears a dividend of 7%, accrued semi-annually and added to
principal, and is convertible, at Elan's option, to Targeted Genetics common
stock at a price equivalent to $3.32 per share until July 21, 2005.
6
<PAGE>
Additionally, Elan has an option to exchange this preferred stock for a 30.1%
interest in Emerald, increasing Elan's ownership in Emerald to 50%. This
exchange option is exercisable up to 6 months after the completion of a research
and development program that is currently anticipated to be 36 to 48 months in
length. This exchange right will terminate if the preferred stock is converted
into Targeted Genetics common stock unless this conversion occurs as a result of
a liquidation or certain transactions involving a change of control of the
Company. Targeted Genetics used the proceeds of the convertible exchangeable
preferred stock sale to purchase 6,000 shares of Emerald common stock and 3,612
shares of Emerald preferred stock to fund the company's share of Emerald's
initial capitalization.
Elan will also loan Targeted Genetics up to $12 million to support its
share of the joint venture's research and development costs pursuant to a
convertible promissory note issued by the Company to Elan. The note has a six
year term, will accrue interest at 12% per annum, and is convertible into
Targeted Genetics' common stock at conversion prices set at 150% of the average
closing price of the Company's common stock for the 60 trading days ending two
business days prior to the time the Company draws loan proceeds. The agreement
includes provisions allowing Targeted Genetics to convert this debt into
Targeted Genetics common stock at the current market price at its option.
Also, the Company entered into an agreement with Elan that requires Elan to
purchase up to $10 million of Targeted Genetics common stock at a premium to the
market price. Elan purchased $5 million in connection with closing of the joint
venture transaction, representing 2,148,899 shares of common stock, and will
purchase an additional $5 million at the Company's option, one year from closing
of the joint venture transaction at 120% of the market price at that time.
While Targeted Genetics owns 80.1% of the outstanding common stock of
Emerald, Elan and its subsidiaries have retained significant minority investor
rights that are considered "participating rights" as defined in EITF 96-16.
Accordingly, Targeted Genetics will not consolidate the financial statements of
Emerald, but will instead account for its investment in Emerald under the equity
method of accounting. During the quarter ended September 30, 1999, the Company
recognized no contract revenues for research and development activity performed
for Emerald.
Emerald Gene Systems' for the quarter ended September 30, 1999 had a net
loss of $15,000,000 reflecting a charge to research and development expense of
$15 million for a license fee paid by Emerald to Elan for exclusive access to
Elan drug delivery technologies for use in the area of gene delivery.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
7
<PAGE>
Risks and Uncertainties
This discussion contains forward-looking statements that are subject to
certain risks and uncertainties that could cause actual results to differ
materially from those projected. Our future cash requirements and expense
levels will depend on numerous factors, including continued scientific progress
in our research and development programs; the results of research and
development activities; preclinical studies and clinical trials; joint venture
activity; acquisition of products or technology, if any; relationships with
existing and future corporate collaborators, if any; competing technological and
market developments; the time and costs involved in obtaining regulatory
approvals; the costs involved in filing, prosecuting and enforcing patent
claims; the time and costs of manufacturing scale-up and commercialization
activities; and other factors. Please refer to our Annual Report on Form 10-K
for a more detailed description of such factors. Readers are cautioned not to
place undue reliance on these forward-looking statements, which speak only as of
the date of this report. We undertake no obligation to publicly release the
results of any revisions to these forward-looking statements that may be made to
reflect events or circumstances after the date of this report or to reflect the
occurrence of unanticipated events.
Results of Operations
Revenue for the quarter ended September 30, 1999 was $1.4 million, compared
to $126,000 in the third quarter of 1998. Revenue for the nine-month period
ended September 30, 1999 was $4.0 million, compared to $438,000 in the same
period in 1998. The increase in 1999 revenue primarily results from our
collaboration with Medeva PLC to develop tgAAV-CF, our potential cystic fibrosis
gene therapy product. This collaboration, which began in the fourth quarter of
1998, contributed substantially all of our third quarter and year to date 1999
revenue.
Research and development expenses increased to $3.6 million and $10.3
million for the three and nine months ended September 30, 1999, respectively,
compared to $2.9 million and $8.7 million in the same periods in 1998. These
increases were attributable to the hiring of additional scientists to support
our Medeva collaboration, as well as increased process development costs
associated with tgAAV-CF product development. We expect to see continued modest
quarter-to-quarter increases in costs associated with developing our cystic
fibrosis product and providing research services to Emerald Gene Systems, our
joint venture collaboration with Elan Corporation plc. Our costs will also vary
based on clinical trial activity occurring in each quarter.
Technology license fees for the first nine months of 1999 were attributable
to a $3.2 million non-cash charge related to the issuance of stock and warrants
to Alkermes, Inc. in exchange for an exclusive sub-license to a patent for the
manufacture of Adeno-Associated Viral (AAV) vectors, which are used in our
tgAAV-CF cystic fibrosis program. We issued 500,000 shares of our common stock
and warrants to purchase up to 2,000,000 additional shares in exchange for this
technology license.
General and administrative expenses for the third quarter of 1999 and 1998
were $968,000 and $651,000, respectively. General and administrative expenses
for the first nine months of 1999 increased by $317,000 to $2.4 million compared
to $2.1 million in the first nine months of 1998. Both periods reflect increases
from Medeva collaboration support costs and
8
<PAGE>
costs associated with initiating the Emerald joint venture. Results for the
first three quarters of 1998 included costs associated with a first quarter 1998
reduction in force and second quarter 1998 non-recurring corporate development
costs.
Investment income for the third quarter ended September 30, 1999 was
$124,000, compared to $136,000 in the third quarter of 1998 as average cash
balances in last year's third quarter were higher resulting from a private
placement of securities early in the second quarter of 1998. Investment income
for the first nine months of 1999 was $345,000, compared to $313,000 for the
same period in 1998 due to higher average balances in the 1999 period.
Interest expense decreased to $58,000 for the quarter ending September 30,
1999 from $65,000 for the quarter ended September 30, 1998. Interest expense
was $163,000 and $209,000 for the nine months ended September 30, 1999 and 1998,
respectively. The decreases in both periods were primarily due to lower average
principal balances as compared to the prior year.
Financial Condition
As of September 30, 1999, we had $8.6 million in cash, cash equivalents and
securities available for sale and working capital of $6.8 million. By
comparison, we had a total of $12.0 million of cash, cash equivalents and
securities at December 31, 1998 and working capital of $9.1 million. The
decreases in cash and working capital are attributable to operating losses,
investments in capital equipment and principal payments on capital lease
obligations. The decrease was offset by net proceeds of $6.5 million from the
sale of our common stock ($5.0 million connected to the Emerald joint venture).
We currently fund substantially all of our equipment purchases with capital
leases.
In conjunction with the Emerald joint venture, Elan agreed to loan us up to
$12 million in the form of convertible debt bearing 12% interest per annum to
fund our share of Emerald's research and development costs. As of September 30,
1999, we have not drawn any proceeds on this convertible debt.
Since we began operations, our primary sources of revenue have been from
license fees and research funding under collaborative agreements and income
earned from investments. These sources have covered less than twenty percent of
our expenses since we started business. Gene and cell therapy products are
subject to long development timelines and the risks of failure inherent in the
development of products based on innovative technologies. Although our
technology appears promising, it is unknown whether any commercially viable
products will result from our research and development activities. Since we do
not anticipate that we will have any product-related revenue for a number of
years, we expect to incur substantial additional losses over the next several
years.
We currently estimate that based on established sources of cash flow
(predominantly our cystic fibrosis partnership and our newly formed joint
venture with Elan) and our current planned rate of spending, that our existing
cash, cash equivalents and securities available for sale, together with the
funding expected to be provided by our collaborative partners, will be
sufficient to meet our operating and capital requirements into the second
quarter of 2001. There can be no
9
<PAGE>
assurance that the underlying assumed levels of revenue and expense will prove
to be accurate. Whether or not these assumptions prove to be accurate, we will
need to raise substantial additional capital. We intend to seek additional
funding through more collaborative arrangements and may seek additional funding
through government grants, public or private equity or debt financing. There can
be no assurance, however, that adequate funds will be available when needed or
on terms favorable to us, if at all.
Impact of Year 2000
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of our computer
programs or hardware that have date-sensitive software or embedded computer
chips may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions or engage in normal business activity.
We addressed three potential areas of impact for review and remediation
with respect to the Year 2000 Issue: (1) information technology including
computer hardware, networked equipment, PC based software applications and
financial systems (IT systems), (2) operating equipment including research and
development and manufacturing equipment with embedded chips and software
(operations equipment) and (3) third party vendors, suppliers and subcontractors
(external agents). We have completed all stages of these processes with respect
to our information technology and operating equipment and they are now Year 2000
compliant.
We have queried all significant external agents regarding the status of
their IT systems with respect to the Year 2000 Issue. Responses have not
indicated any external agent with a Year 2000 compliance issue that would
materially impact our operations. To the extent any external agents have Year
2000 issues, we have no means of ensuring that such issues will be identified
and communicated on a timely basis or that external agents will achieve Year
2000 readiness. We have identified certain external agents as key to our
processes and identified "most reasonably likely worst case Year 2000 scenarios"
and how those identified scenarios will be handled. The inability of external
agents to complete their Year 2000 resolution process in a timely fashion could
materially impact our operations.
The total estimated cost of our Year 2000 remediation project was less than
$100,000 and was expensed as incurred. If we encounter significant unforeseen
Year 2000 problems actual remediation costs could be significant. All parts of
the company were involved in the Year 2000 effort.
As noted above, while we believe that we have completed all necessary
phases of the Year 2000 program, there may be unforeseen Year 2000 problems that
generate additional remediation work during the fourth quarter of 1999 and after
January 1, 2000. In the event that we do not complete any additional work
required, our research and development activities may be adversely impacted. The
significance of any such potential impact cannot be reasonably estimated at this
time.
10
<PAGE>
PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed as part of this report.
Exhibit No. Description
- ---------- -----------
27.1 Financial Data Schedule
(b) Reports filed on Form 8-K during the quarter ended September 30, 1999.
On July 23, 1999 the Company filed a Form 8-K with respect to the
formation of Emerald Gene Systems, a joint venture with Elan Corporation,
plc.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TARGETED GENETICS CORPORATION
-----------------------------
(Registrant)
Date: November 10, 1999 /s/ H. Stewart Parker
----------------- ------------------------------------
H. Stewart Parker, Chief Executive Officer
(Principal Executive Officer)
Date: November 10, 1999 /s/ James A. Johnson
----------------- ------------------------------------
James A. Johnson, Chief Financial Officer
(Principal Financial and Accounting Officer)
11
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 4,976,358
<SECURITIES> 3,576,912
<RECEIVABLES> 1,342,558
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 10,021,722
<PP&E> 10,334,826
<DEPRECIATION> (6,617,958)
<TOTAL-ASSETS> 14,179,657
<CURRENT-LIABILITIES> 3,211,265
<BONDS> 0
0
12,178,602
<COMMON> 98,088,077
<OTHER-SE> (100,430,802)
<TOTAL-LIABILITY-AND-EQUITY> 14,179,657
<SALES> 3,987,662
<TOTAL-REVENUES> 3,987,662
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 28,083,945
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 163,335
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> (23,914,874)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (23,914,874)
<EPS-BASIC> (.76)
<EPS-DILUTED> (.76)
</TABLE>
