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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

or

Commission File No. 0-19222

GENELABS TECHNOLOGIES, INC.

Registrant’s telephone number, including area code: (650) 369-9500

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 [   ]

There were 53,163,833 shares of the Registrant’s Common Stock issued and outstanding on August 9, 2002.

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FORWARD-LOOKING STATEMENTS

     This Quarterly Report on Form 10-Q contains or incorporates by reference certain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, referred to as the Exchange Act, including those identified by the words “may,” “will,” “anticipates,” “intends,” “believes,” “expects,” “plans,” “potential” and similar expressions. These forward-looking statements include, among others, statements regarding:

	•		potential FDA actions with respect to our NDA for Aslera, including whether or not the Aslera NDA ultimately will receive marketing approval and the timing of any such action;
	•		if the NDA for Aslera is ultimately approved, our plans and ability to successfully commercialize Aslera for systemic lupus erythematosus;
	•		our expectations with respect to our ability to obtain additional funding for our business plans;
	•		our ability to secure and defend intellectual property rights important to our business; and
	•		the potential success of our research efforts, including our ability to identify compounds for preclinical development.

     All statements in this Quarterly Report on Form 10-Q that are not historical are forward-looking statements. Actual results could differ materially from those expressed or implied in these statements as a result of a number of risks and uncertainties, including those set forth in the Business Risks section at the end of Item 2 and the other documents filed with the SEC, including our Annual Report on Form-10-K. All forward-looking statements included in this Quarterly Report on Form 10-Q are made as of the date hereof. We assume no obligation to update any such forward-looking statement for subsequent events or any reason why actual results might differ except as required by the Exchange Act.

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

GENELABS TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)

See notes to condensed consolidated financial statements.

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GENELABS TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)

See notes to condensed consolidated financial statements.

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GENELABS TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(increase/(decrease) in cash and cash equivalents)
(in thousands)
(Unaudited)

See notes to condensed consolidated financial statements.

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GENELABS TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2002

1. Significant Accounting Policies

     Basis of Presentation

     The condensed consolidated financial statements include the accounts of Genelabs Technologies, Inc. and its wholly owned subsidiaries, Accelerated Clinical Research Organization, Inc. and Genelabs Diagnostic, Inc. Genelabs Technologies, Inc. and its subsidiaries are collectively referred to as Genelabs or the Company. All intercompany accounts and transactions have been eliminated. The Company operates in one business segment, the discovery and development of pharmaceutical products. Genelabs accounts for its diagnostics operation, Genelabs Diagnostics Pte. Ltd., as a discontinued operation.

     The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. It is possible that actual amounts will differ from those estimates.

     Genelabs is a biopharmaceutical company focused on the discovery and development of novel pharmaceutical products to improve human health. We have built drug discovery and clinical development capabilities that can support various research and development projects. We are concentrating our capabilities on three core programs: developing a late-stage product for lupus, discovering novel antimicrobial lead compounds that target DNA, and discovering novel lead compounds that selectively inhibit replication of the hepatitis C virus.

     These financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three month and six month periods ended June 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002.

     These unaudited condensed consolidated financial statements are meant to be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001.

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GENELABS TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2002

2. Recent Pronouncements

     We adopted Statement of Financial Accounting Standards No. 144 (FAS 144), Accounting for the Impairment or Disposal of Long-Lived Assets, on January 1, 2002. FAS 144 supersedes Financial Accounting Standards No. 121 (FAS 121), Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and certain accounting and reporting provisions of Accounting Principles Board Opinion No. 30, Reporting the Results of Operations. The primary objectives of FAS 144 are to develop one accounting model based on the framework established in FAS 121 for long-lived assets to be disposed of by sale, and to address significant implementation issues. Our adoption of FAS 144 did not have a material impact on our financial position or results of operations for the three month and six month periods ended June 30, 2002.

3. Comprehensive Loss

     During the three months ended June 30, 2002 and 2001, the Company’s comprehensive loss amounted to $4,232,000 and $3,646,000, respectively. During the six months ended June 30, 2002 and 2001, the Company’s comprehensive loss amounted to $7,799,000 and $6,507,000, respectively.

4. Subsequent Event

     On July 9, 2002, Genelabs sold 3.1 million shares of its common stock at a price of $2.05 per share for gross proceeds of approximately $6.4 million. Net proceeds after the placement agent commission and estimated legal, Nasdaq registration and other expenses were approximately $6.0 million. The following pro forma balance sheet treats this sale of common stock as if it had occurred on June 30, 2002 and states all amounts in thousands of dollars.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     All statements in this Quarterly Report on Form 10-Q that are not historical are forward-looking statements. Actual results could differ materially from those expressed or implied in these statements as a result of a number of risks and uncertainties, including those set forth in the Business Risks section at the end of Item 2 and the other documents filed with the SEC, including our Annual Report on Form-10-K. All forward-looking statements included in this Quarterly Report on Form 10-Q are made as of the date hereof. We assume no obligation to update any such forward-looking statement for subsequent events or any reason why actual results might differ except as required by the Exchange Act.

     Genelabs Technologies, Inc., referred to as Genelabs or the Company, is a biopharmaceutical company focused on discovering and developing pharmaceutical products. We have an investigational drug, Aslera™, for which the U.S. Food and Drug Administration, referred to as the FDA, is reviewing our New Drug Application, or NDA. Aslera is a potential new treatment for systemic lupus erythematosus, referred to as SLE or lupus, a disease for which current therapies are not adequate. After licensing Aslera from Stanford, Genelabs designed and conducted two large, well-controlled Phase III clinical trials of Aslera in women with SLE and a third Phase III clinical trial in men with SLE, begun in 1997, is ongoing. Upon completion of the second Phase III trial in 1999, Genelabs prepared an NDA for Aslera to treat women with lupus, which was submitted to the FDA on a rolling basis under fast-track designation in 2000. We subsequently received priority review designation from the FDA and licensed North American marketing rights to Watson Pharmaceuticals, Inc., referred to as Watson. The FDA Arthritis Advisory Committee reviewed the NDA in April 2001 and in June 2001 the FDA sent us a letter stating that the Aslera NDA was not approvable, listing deficiencies that must be addressed before the NDA can be approved. The NDA review process has actively continued since our receipt of the FDA’s June 2001 not-approvable letter as we work within the FDA’s regulatory framework toward resolution of the issues raised in the letter. In May 2002 we learned that the FDA has classified submissions of additional clinical data and analyses to the agency as a proposed treatment of women with SLE to limit bone loss while on low-dose glucocorticoids. We currently expect a new action on our NDA no later than the end of August 2002.

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     We believe there is a range of possible outcomes from our current discussions with the FDA, from the FDA approving our NDA to the FDA stating that the NDA could only be approved with an additional large, well-controlled Phase III clinical trial with positive results or other potentially costly and time-consuming contingencies. The decisions regarding whether deficiencies in the June 2001 not-approvable letter are sufficiently resolved to support approval of Aslera rest with the FDA and cannot be reasonably estimated before they are made. Our near-term drug development goal is to reach agreement with the FDA on the steps necessary for approval.

     In the event that we cannot reach agreement with the FDA on the steps necessary for approval of Aslera, we will evaluate the feasibility of any additional requirements requested by the FDA in order to determine how to proceed with the development of Aslera. Factors in our evaluation would include the potential complexity and expense of a particular clinical trial design requested by the FDA, our ability to accrue sufficient patients in a timely manner in a clinical trial, if required, and our financial position, including whether it would be possible to secure sufficient funding through financings or collaborations to satisfy any such requirements. If we determine that it is not feasible for us to satisfy one or more requirements requested by the FDA, we currently plan to continue to work with the FDA to find an acceptable alternative or seek assistance from collaborators with resources greater than ours. Even if we reach agreement with the FDA, we anticipate that there will still be issues that must be resolved before the FDA can approve Aslera for marketing. We cannot predict what these requirements will be, whether we will be successful in resolving any of the issues or whether there will be additional substantial obstacles to, or delays in, our development of Aslera for lupus.

     Our near-term drug discovery research goals are to continue to synthesize novel DNA-targeted compounds and to screen, test and optimize our lead compounds, including the antibacterial and antifungal lead compounds identified in 2001, with the goal of selecting one or more for preclinical development. As we advance our DNA-targeted research program, we have evaluated several potential new targets that complement both our current drug discovery capabilities and our DNA-binding program, with the goal of building a balanced pipeline of pharmaceutical candidates. As a result of this evaluation we selected one of the potential new targets as a new research project and have expanded our drug discovery efforts to include studies to discover new treatments for chronic hepatitis C virus, or HCV, infection directed toward critical viral gene replication targets. The ultimate objective of our drug discovery research is to discover novel chemical compounds that can be developed into drugs to treat human disease.

     Since 1995, our strategy has been to build drug discovery and clinical development capabilities that can support various research and development projects while focusing our resources and efforts on two potentially groundbreaking programs: developing Aslera for lupus and pursuing small molecule drug discovery research targeting DNA. If approved by the FDA, Aslera will be the first new drug approved in the United States for this debilitating disease in more than 40 years. We utilize established medicinal chemistry principles in our small molecule synthesis to target DNA, which is not a customary pharmaceutical target such as enzymes, proteins and receptors. Because DNA is not a common target, there are currently fewer scientific publications and established processes to guide our research efforts but also fewer potential competitors currently focus their research efforts in this area. Our HCV-targeted research program is focused on discovery and development of small molecule antiviral drug candidates which are potent, specific inhibitors of HCV viral replication. We believe that these high-risk, potentially high reward programs focus our research and development expertise in areas where we have the opportunity to be scientific pioneers and, if successful, we believe that these programs will yield products that will address diseases for which current therapies are inadequate. At the same time, our established capabilities can be utilized as we diversify our research and development programs.

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Results of Operations — Second Quarter 2002 Compared to Second Quarter 2001

     Our net loss was $4.2 million for the three months ended June 30, 2002 compared to a loss of $3.7 million for the same period in 2001.

     We recorded contract revenues of $1.0 million in the second quarter of 2002, the largest component of which represents the recognition into income of a previously received up-front license payment from Watson. This up-front license payment from Watson is being deferred and recognized as revenue over the term that our management estimates that we have significant obligations to Watson. Our current estimate of the term we have significant obligations to Watson is over the longer of the periods incorporating FDA consideration of approval of Aslera, Genelabs’ transfer of technology to Watson, and Genelabs’ fulfillment of supply obligations to Watson, the longest of which is currently estimated to be approximately three and one-half years from the signing of the agreements with Watson in November 2000.

     Our management considers the amortization period for the up-front payment from Watson a critical accounting estimate which is based on our current estimate of the period we have significant obligations to Watson. The estimated period for amortization has a noteworthy impact on the revenue recognized, and, in turn, the net loss reported in Genelabs’ financial statements. For example, if a longer term were estimated instead of the current three and one-half years, our revenue would be lower and the net loss would be higher. Conversely, if a shorter amortization term were estimated, Genelabs’ revenue would be greater and the net loss would be lower. We have assessed the remaining term over which the up-front payment from Watson is being recognized into the income statement, and believe it is the most appropriate term based on the facts known to us as of the date of the filing of this Quarterly Report on Form 10-Q. However, actions taken by the FDA, including the new action currently expected no later than the end of August 2002, or other changes in circumstances after the filing of this Quarterly Report on Form 10-Q may either reduce or lengthen the remaining period over which we record the up-front revenue from Watson.

     The contract revenue of $1.0 million in the second quarter 2002 compares to $1.1 million for the second quarter of 2001. For both periods the amortization of the up-front payment received from Watson was $0.8 million.

     Operating expenses were $5.5 million in the second quarter of 2002 compared to $5.2 million in the second quarter of 2001. Research and development expenses represented 72% of operating expenses in the 2002 period compared to 67% of operating expenses for the same period in 2001. Research and development expenses were $4.0 million and $3.5 million for the three months ended June 30, 2002 and June 30, 2001. The increase in research and development costs for the second quarter 2002 compared to the second quarter 2001 was mostly attributable to initiation of a new drug discovery project targeting HCV viral replication. General and administrative expenses were $1.6 million in the second quarter of 2002 compared to $1.7 million in the second quarter of 2001.

     Interest income was $0.1 million in the three months ended June 30, 2002 compared to $0.5 million for the same period in 2001. The decrease in interest income was a result of both lower interest rates and lower cash and short-term investments in the second quarter of 2002.

     During the second quarter of 2002, income from Genelabs Diagnostics Pte. Ltd., which we call GLD, was $0.2 million. This subsidiary is accounted for as a discontinued operation because management is pursuing the sale of GLD and expects to complete its divestment in 2002.

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Results of Operations — First Six Months of 2002 Compared to First Six Months of 2001

     Our net loss was $7.8 million for the six months ended June 30, 2002 compared to a net loss of $6.5 million for the same period in 2001.

     We recorded contract revenue of $2.0 million in the first half of 2002 compared to $2.6 million for the first half of 2001. The decrease in contract revenue was primarily due to the scheduled expiration of the U.S. Defense Advanced Research Projects Agency, or DARPA, grant to us in early 2001. For both periods the amortization of the previously received up-front payment from Watson was $1.5 million. Contract revenues recognized in the future will be dependent upon the continuation of existing corporate collaborations, achievement of milestones under these collaborations, and establishment of new research, development and/or licensing agreements.

     Operating expenses were $10.3 million in the first six months of 2002 and $10.2 million in the first six months of 2001. Research and development expenses represented 71% of operating expenses in the 2002 period compared to 68% of operating expenses for the same period in 2001. Research and development expenses were $7.3 million for the six months ended June 30, 2002 and $6.9 million for the six months ended June 30, 2001. Our research and development is focused on discovering and developing pharmaceutical products. In drug discovery research, costs increased in the first half of 2002 compared to the first half of 2002 due to initiation in the second quarter of a new drug discovery research project targeting HCV viral replication. General and administrative expenses were $2.9 million in the first half of 2002 compared to $3.3 million in the first half of 2001.

     Interest income decreased to $0.2 million in the six months ended June 30, 2002 compared to $1.0 million for the same period in 2001 as a result of both lower interest rates and lower cash and short-term investments during the first six months of 2002.

     During the first six months of 2002, income from the discontinued operations of GLD was $0.3 million.

Liquidity and Capital Resources

     We had cash, cash equivalents and short-term investment balances totaling $10.0 million at June 30, 2002 compared to $19.0 million at December 31, 2001. The $9.0 million decrease in cash, cash equivalents and short-term investments was primarily attributable to cash used in operations which was approximately $4.6 million in the first quarter of 2002 and approximately $4.0 million in the second quarter of 2002. The cash used in operations funded our development of Aslera for lupus, the continued optimization of the antifungal and antibacterial lead compounds from our DNA-targeted drug discovery program and the commencement of our HCV drug discovery program. Subsequent to the end of the second quarter, we sold 3.1 million shares of newly issued common stock for net proceeds of approximately $6.0 million.

     Our liquidity and capital resources will potentially be materially impacted by FDA actions with respect to our NDA for Aslera, including the new action currently expected no later than the end of August 2002. If Aslera is ultimately approved for marketing in the U.S., we believe that the most important impact of the Watson collaboration on our liquidity and capital resources is the significant royalties we are entitled to receive on net sales of Aslera. During the first three quarters after product launch, a separate royalty schedule applies to support the product launch. In addition to royalties, we may receive a milestone payment of up to $45 million in the event of FDA approval of Aslera. Any decision by the FDA that would enable us to move forward with marketing plans for Aslera will materially improve our liquidity and capital resources. This improvement may occur through receipt

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of a milestone payment from Watson, revenue from product royalties, increased interest from potential collaborators in Europe and Japan and/or improved access to capital markets. We estimate that if Aslera is approved by the FDA, our resources will be sufficient to fund operations for more than two years prior to consideration of royalties on net sales of Aslera.

     If Aslera is not approved by the FDA in 2002 or the first half of 2003, we estimate that our cash, short-term investments and committed funding sources will be sufficient to fund our operations into the third quarter of 2003. Prior to this time, we plan to seek additional funds which may include the sale of equity, sale of long-term investments, establishment of corporate partnerships, funding under government grants, licensing of our clinical data or intellectual property, royalty-sharing and/or other arrangements. It is possible that none of these efforts to seek additional funds will be successful. The following are illustrations of potential impediments to our ability to successfully secure additional funds. Our research programs are in an early stage, therefore there are fewer opportunities to enter into collaborations with other companies and up-front payments for early-stage pharmaceutical research collaborations are generally smaller for projects that are further from potential marketability. Our ability to successfully complete an equity financing would be negatively impacted if we should become unable to meet Nasdaq’s listing requirements. We believe that securing funding from sales of equity would be more difficult in the event that the FDA requires significant additional studies before it will approve Aslera than if the NDA for Aslera is deemed approvable by the FDA without such requirements. We plan to evaluate the feasibility of any additional requirements requested by the FDA and expect that the details of any such requirements will have an impact on the range of possible funding sources, the amount and terms of funding available and our ability to successfully secure such funding.

     If we are not successful in securing any new sources of funding and we do not alter our plans to spend at the currently planned rate, we expect our cash and short-term investments to decrease to approximately $11 million to $12 million at the end of the third quarter 2002, and to approximately $7 million to $8 million at December 31, 2002. Since our inception, we have operated at a loss and have funded operations primarily through public and private offerings of equity securities and, to a lesser extent, contract revenues. We expect to incur substantial additional costs, including research costs for drug discovery and development costs for Aslera. The amount of additional costs in our business plans will depend on numerous factors including any FDA actions, progress of our research and development programs and the status of corporate partnership agreements.

     Additional funds for our research and development activities may not be available on acceptable terms, if at all. The unavailability of additional funds could delay or prevent the development, approval or marketing of some or all of our products and technologies, which would have a material adverse effect on our business, financial condition and results of operations.

Commitments and Contingencies

     We have commitments of $0.4 million due for the remainder of 2002 under the operating lease for our principal research, clinical development and office facilities. The lease expires on November 30, 2002. We are in discussions with our landlord regarding renewal terms and anticipate staying in the same location.

     In connection with the Active Pharmaceutical Ingredient and Finished Product Supply Agreement with Watson, as of June 30, 2002, we had outstanding orders with third party suppliers totaling $0.3 million.

     There are currently no additional contractual obligations.

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Business Risks

     The following discussion summarizes business risks which our management believes are particularly relevant at this time. It is not possible to comprehensively address all risks that exist, but there is more detailed information about these risks and additional risks under the caption “Risk Factors” in our 2001 Annual Report on Form 10-K, which shareholders and prospective investors are encouraged to review.

IF THE FDA DOES NOT APPROVE ASLERA™, OUR DRUG CANDIDATE FOR SYSTEMIC LUPUS ERYTHEMATOSUS, FOR MARKETING IN THE UNITED STATES, OUR BUSINESS PROSPECTS WILL SUFFER BECAUSE WE HAVE NO OTHER NEAR-TERM SOURCE OF POTENTIAL REVENUE.

     We have focused our development efforts to date on conducting clinical trials for an investigational new drug, Aslera, also referred to as GL701, for the treatment of women with systemic lupus erythematosus, or lupus. Lupus is a severe, chronic and debilitating autoimmune disease that can affect the lungs, heart, kidneys, skin, joints and musculoskeletal and nervous systems. Aslera is a pharmaceutical formulation containing highly purified prasterone, the synthetic equivalent of dehydroepiandrosterone or DHEA, a naturally occurring hormone.

     Before our North American partner, Watson Pharmaceuticals, can market Aslera in the United States, the FDA must review and approve a New Drug Application, or NDA, submitted by us. We submitted an NDA for Aslera to the FDA in 2000 and received a not-approvable letter in June 2001. We currently expect a new action on our NDA no later than the end of August 2002. Our business plans depend on FDA approval of Aslera in the United States. If the FDA does not approve the new drug application in a timely manner, our business would suffer because we have no other near-term source of potential revenue.

     In the event that we cannot reach agreement with the FDA on the steps necessary for approval of Aslera, we will evaluate the feasibility of any additional requirements requested by the FDA in order to determine how to proceed with the development of Aslera. Factors in our evaluation would include the potential complexity and expense of a particular clinical trial design requested by the FDA, our ability to accrue sufficient patients in a timely manner in a clinical trial, if required, and our financial position, including whether it would be possible to secure sufficient funding through financings or collaborations to satisfy any such requirements. If we determine that it is not feasible for us to satisfy one or more requirements requested by the FDA, we currently plan to continue to work with the FDA to find an acceptable alternative or seek assistance from collaborators with resources greater than ours. However, if we fail to find an acceptable alternative or assistance should these circumstances arise, we could be forced to abandon the development of Aslera for SLE. Even if we reach agreement with the FDA, we anticipate that there will still be issues that must be resolved before the FDA can approve Aslera for marketing. We cannot predict what these requirements will be, whether we will be successful in resolving any of the issues or whether there will be additional substantial obstacles to, or delays in, our development of Aslera for lupus.

     Other countries have similar regulatory requirements. We have not conducted any clinical trials for Aslera for lupus in other countries. We plan to enter into collaborations or licensing agreements regarding marketing Aslera in other countries with pharmaceutical companies with resources greater than ours. If we do not enter into these agreements, we may not be able to sell, or might face delays related to commercial introduction of, Aslera in other countries, because we lack the necessary resources.

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OUR OUTSIDE SUPPLIERS AND MANUFACTURERS FOR ASLERA ARE SUBJECT TO REGULATION, INCLUDING BY THE FDA, AND IF THEY DO NOT MEET THEIR COMMITMENTS, WE WOULD HAVE TO FIND SUBSTITUTE SUPPLIERS OR MANUFACTURERS WHICH COULD DELAY SUPPLY OF PRODUCT TO THE MARKET.

     Regulatory requirements applicable to pharmaceutical products tend to make the substitution of suppliers and manufacturers costly and time consuming. We rely on suppliers of prasterone, the active ingredient in Aslera, for production of Aslera. The disqualification of these suppliers through their failure to comply with regulatory requirements could negatively impact our business because of delays and costs in obtaining and qualifying alternate suppliers. We have no internal manufacturing capabilities for pharmaceutical products and are entirely dependent on contract manufacturers and suppliers for the manufacture of Aslera as a finished product and for its active ingredient.

     To date, we have relied on a single manufacturer, Schering Plough, to manufacture Aslera as a finished product for clinical trials and had intended to rely on Schering Plough for commercial sales of Aslera; however, we and Schering Plough plan to work together to transition the manufacturing of the finished product to other manu