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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 FOR THE FISCAL YEAR ENDED: DECEMBER 31, 2000.
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER:
0-30365
PARADIGM GENETICS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 56-2047837
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
108 ALEXANDER DRIVE, RESEARCH TRIANGLE PARK, NORTH CAROLINA 27709
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (919) 425-3000
FORMER NAME, FORMER ADDRESS, AND FORMER YEAR, IF CHANGED SINCE LAST REPORT:
NOT APPLICABLE
SECURITIES REGISTERED TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
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 (Section 229.405 of this chapter) 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 [ ]
The aggregate market value of the registrant's voting stock, held by non-
affiliates of the registrant (based upon the closing sale price on the Nasdaq
National Market on March 19, 2001) was approximately $107,764,118. Exclusion of
shares held by any person should not be construed to indicate that such person
is an affiliate of the registrant.
As of March 19, 2000, there were 26,326,197 shares of common stock, $.01 per
share par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information contained in Part III of this Form 10-K is incorporated by
reference from the registrant's proxy statement, to be filed with the Securities
and Exchange Commission in connection with the solicitation of proxies for the
registrant's Annual Meeting of Stockholders to be held on May 2, 2001.
PARADIGM GENETICS, INC.
FORM 10K
FOR THE YEAR ENDED DECEMBER 31, 2000
__________________________
TABLE OF CONTENTS
PART I Page
-----
Item 1. Business....................................................................................... 3
Item 2. Properties..................................................................................... 15
Item 3. Legal Proceedings.............................................................................. 15
Item 4. Submission of Matters to a Vote of Security Holders............................................ 15
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.......................... 16
Item 6. Selected Financial Data........................................................................ 17
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations..................................................................................... 19
Item 8. Financial Statements and Supplementary Data.................................................... 29
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure..................................................................................... 29
PART III
Item 10. Directors and Executive Officers of the Registrant............................................. 30
Item 11. Executive Compensation......................................................................... 30
Item 12. Security Ownership of Certain Beneficial Owners and Management................................. 30
Item 13. Certain Relationships and Related Transactions................................................. 30
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K................................ 31
Index to Financial Statements.................................................................. F1
2
PART 1
ITEM 1. BUSINESS
BUSINESS
Overview
We have industrialized the process of determining gene function to generate
information that we believe will enable us and our commercial partners to
develop novel products in four major sectors of the global economy: human
health, nutrition, crop production, and industrial products. We have developed
an industrialized, high throughput platform, known as the GeneFunction
Factory(TM), capable of determining the function of over a hundred plant and
microbial genes per week. We are able to determine gene function at a rate far
greater than that achieved historically. We believe this gives us an advantage
in establishing intellectual property and developing new products. Because there
is homology between the genes in the plants and microbes on which we work and
genes in other target organisms, we believe that the information produced by our
GeneFunction Factory(TM) will be directly applicable to the development of new
and improved products in our target markets.
We designed our GeneFunction Factory(TM) to be an integrated, rapid, industrial
scale laboratory through which we can discover and modify genes, understand the
consequences of the modifications and reliably determine the function of those
genes. Our assembly-line approach automates the measurement of thousands of
physical and chemical characteristics of a selected organism at different times
in the organism's life cycle using the following techniques:
. gene expression profiling, a process of determining the level of activity
of genes in an organism at a specific time;
. metabolic profiling, a process of determining the identity and quantities
of chemicals in an organism at a specific time; and
. phenotypic profiling, a process of measuring the physical and chemical
characteristics of an organism at a specific time.
This process generates very large amounts of diverse data, which are then fed
into our FunctionFinder(TM) bioinformatics system. These data are then refined,
sorted and mined to definitively determine gene function.
To date, we have established commercial partnerships with Bayer and Monsanto and
a strategic alliance with Lion Bioscience. The Bayer partnership is focused on
the development of new herbicides while the Monsanto partnership is focused on
the development of crop production and nutrition products. Under these
partnerships, we have total committed funding of approximately $60 million and
have performance fees, milestone payments and payments in connection with
extension options that could generate as much as an additional $129 million. We
will also earn product development milestones and sales royalties if products
are commercialized from these alliances. The strategic alliance with Lion
Bioscience is to co-develop and co-market a new plant and fungal metabolic
profiling database that will be used for target identification and validation.
BACKGROUND
Genes
The genes of an organism, whether animal, plant or microbe, determine its
physical and chemical characteristics. The entire genetic content of an organism
is called its genome. Genes consist of organized units of molecules called
deoxyribonucleic acid, or DNA, which in turn consist of four different chemical
bases, called nucleotides. Each nucleotide pairs with its complementary
nucleotide in the double helix structure of DNA, forming what scientists call a
base pair. The precise sequence of the nucleotides in a gene determines the
physical and chemical activity that the gene produces in an organism. Each cell
of an organism contains at least one complete copy of the organism's genes, but
each cell type expresses only those genes that are necessary for the cell to
perform its role. When a gene is expressed, it acts alone or in combination with
other expressed genes to synthesize structural proteins and enzymes. The
activity of these proteins causes the cell to perform biological functions,
which may influence the physical and chemical characteristics of the organism. A
modification in a gene sequence may lead to the over- or under-production of a
protein, modifying the normal biological function of the cell, and potentially
affecting the physical and chemical characteristics of the entire organism.
3
The Industrialization of Gene Sequencing
In the early 1990s, a worldwide effort began to decipher the precise sequence of
the genomes of various organisms, including humans, microbials and plants. The
search to identify genes and their encoded proteins that are associated with
both health and disease has fueled this effort. Advances in DNA sequencing
technology and instrumentation have allowed researchers to begin to sequence
genes on an industrial scale by creating ``sequencing factories,'' instead of
sequencing genes one at a time. During the last two decades, the speed at which
scientists can sequence the building blocks of genes, or base pairs, has
increased from hundreds per week to millions per week, while the cost of
sequencing a base pair has decreased proportionately. Large sequencing centers
at universities, research institutes and private companies produce tens of
thousands of gene sequences each week. The gene sequence information that has
been discovered to date provides a vast and diverse starting point for gene
function research. However, in the absence of other information, a gene's
sequence does not provide any clues to a gene's function. Without understanding
function, researchers will have a limited ability to translate this gene
sequence data into information necessary to develop new commercial products.
DETERMINING GENE FUNCTION
Historically, gene function determination has been a slow, labor intensive and
formulaic process. It has involved working in one gene at a time by first
determining the gene's sequence and then understanding how the gene is expressed
in an organism's tissue and what proteins are produced. That same gene is then
modified and the impact in the organism of those modifications are compared to
the original data.
Individual research laboratories in different locations have conducted most of
this type of genetic research using variations on the same techniques to study
different genes, one gene at a time. Researchers have only recently developed
methods to study the function of many genes at one time and in one place, using
one or more of the following techniques, each of which is explained in the
corresponding paragraphs below:
. gene annotation and homology determination;
. gene expression profiling; and
. model organism functional genomics.
Gene Annotation and Homology Determination
Researchers can use search and alignment algorithms to determine the degree to
which a newly discovered gene sequence is similar, or homologous, to previously
known sequences. Researchers can then examine any remarks, or annotations,
written by other scientists about the characteristics, activity or function of
the previously studied sequence, and draw inferences about the function of the
new gene sequence based on its structural similarity, or homology, to the known
gene sequence. It is possible to find similarities among gene sequences from
different species, because researchers find many gene families in certain groups
of organisms, and some are even found in all organisms.
Although gene annotation and homology determination may provide insight into the
function of a newly discovered gene, researchers can infer only information with
limited value. First, even if researchers have studied a similar gene, very few
of the studied genes have reliable annotation about function. Second, of the
genes researchers have currently annotated for function, most annotations relate
to fundamental processes, such as respiration, which address only a fraction of
the potential commercial applications of functional genomics, which is the
assignment of a function to a gene. Third, genes with similar sequences often
have very different functions.
Gene Expression Profiling
A gene expression profile provides a snapshot of genes that are expressed in
specific tissues of specific organisms at specific points in time. This snapshot
tells an investigator where, when and to what extent a particular gene is
expressed in a cell, tissue or organism and what physiological pathways are
active in the cell. Gene expression technology has progressed rapidly over the
past few years. Currently, investigators use various profiling technologies such
as gene chips to analyze the expression patterns of tens of thousands of genes
at once.
Although gene expression profiling may provide clues to a gene's function in a
particular process or pathway, it does not provide sufficient information to
conclusively determine a gene's function or its commercial value. A gene
expression profile shows that a gene was expressed in a cell at the time a
certain biological function occurred in the cell. However, the profile does not
show whether the expression of the gene was causally related to the cellular
activity, or how the gene interacted with other genes that were expressed at the
same time. Also, the profile does not show the chemical and physical effects of
changes in gene expression in an organism.
4
Model Organism Functional Genomics
We believe the most reliable way to determine a gene's precise function is to
study the effects of modified, or variant, forms of the gene on an organism. The
biology and genetics of certain organisms, which we call model organisms, make
them effective tools for investigating the function of genes of other organisms
with commercial value, which we refer to as target organisms. Generally, model
organisms must be similar enough to associated target organisms to allow
meaningful comparisons. They must also be easier, faster and less costly to
investigate. Model organisms may also serve as targets for gene discovery when
there is commercial potential for the model organism itself. Researchers use
model organisms to determine the function of a gene from a target organism by
comparing the physical and chemical characteristics produced by normal and
variant forms of a comparable gene from the model organism, and extrapolating
the results to the target organism. We refer to this process as model organism
functional genomics.
Companies utilizing model organism functional genomics face several critical
challenges. First, they must choose a model organism that is relevant to target
organisms with commercial value. Second, they must choose model organisms with
physical and chemical characteristics that make them efficient research tools.
Third, they must collect large amounts of information about a small number of
genes in a model in their normal and variant states. Fourth, they must have
powerful informatics tools to manage and analyze collected data. However, even
when these challenges are met, determination of gene function using model
organisms typically occurs on a small scale, with individual investigators
studying a small number of genes at a time.
OUR APPROACH TO INDUSTRIALIZING GENE FUNCTION DISCOVERY: OUR GENEFUNCTION
FACTORY(TM)
The existing approaches to determining gene function have produced limited
results and the functions of most genes remain unknown. Historically, functional
genomics work has been conducted in a job shop or cottage industry-like manner.
This has resulted in gene function discovery being slow and expensive. We have
addressed this problem by developing our 30,000 square foot GeneFunction
Factory(TM). This is a state-of-the-art integrated, rapid, industrial scale
laboratory through which we have the capacity to definitively determine the
function of over a hundred genes per week at a unit cost much lower than
typically can be achieved using a job shop approach. We do this by discovering
and modifying genes, measuring the consequences of the modifications and
reliably determining the gene function. We control and manage this process
through an integrated laboratory information management system.
By industrializing this process we plan to determine the function of many genes
before our competition, to secure proprietary intellectual property positions on
those genes and to develop, in concert with our commercial partners, novel
products in our target markets.
Our GeneFunction Factory(TM) is organized as a series of steps. Each step
consists of one or more work stations designed to perform complex tasks rapidly,
efficiently, routinely and repetitively in an assembly-line manner. Organisms
and genetic material pass from station to station to be studied for gene
function. We can scale each step in the process to increase the number of genes
that move through our GeneFunction Factory(TM). Scalability, speed and our
proprietary processes distinguish this method of gene function determination
from other methods. Our GeneFunction Factory(TM) presently is capable of
determining the function of over 100 genes per week.
In the steps of our GeneFunction Factory(TM), we first identify genes and
produce organisms with modified forms of the genes, leading to an over- or
under-expression of the encoded protein. We then measure thousands of physical
and chemical characteristics of the variant organisms at different times of the
organisms' life using gene expression, metabolic and phenotype profiling. Next,
we organize and store the data associated with the measurements taken in the
previous step. Finally, we analyze the data to elucidate function of the genes.
Our Model and Target Organisms
We have carefully selected the organisms we study in our GeneFunction
Factory(TM). Some researchers use yeast and the bacterium Escherichia coli as
general model organisms, and others use the mouse as a model for humans. Yeast
and bacteria are efficient model organisms, but are such simple organisms that
extrapolating information about gene function to more complex target organisms
is often not meaningful. Mice are more useful for annotating genes of higher
organisms, but are expensive to maintain and study and are not conducive to high
throughput analysis. We have chosen organisms for our gene function factory that
are economical and efficient to study, have short life cycles and have direct
applicability to our target markets. These organisms are a mustard plant known
as Arabidopsis, rice, and six fungi.
5
Arabidopsis is a useful model organism because it is a dicot and, as such, it is
similar to soybeans, cotton, vegetables and oil seed crops. It is an efficient
model organism because it has a short life cycle of seven weeks and a small
genome. Although the Arabidopsis genome has been sequenced and catalogued it is
estimated that less than 10% of its genes have been experimentally investigated
for function. Furthermore, of the approximately 289 known human disease genes,
nearly 50% are found in Arabidopsis making it an important model organism for
human healthcare applications. Rice is an important target and model organism
because it is one of the world's most important grains and, as a monocot, it is
closely related to corn, wheat, barley, sugarcane, oats and rye. We are
currently studying three fungi that cause diseases in cereals, rice and
broadleaf plants. We are also studying three additional fungi that have
commercial value for fermentation, human fungal disease and natural product
discovery. We believe we can use our GeneFunction Factory(TM) to study the
function of essentially every gene in these organisms.
Gene Discovery and Variant Generation
One constraint in gene function discovery has been the time consuming nature of
constructing gene variants. In gene discovery, researchers construct libraries
of DNA fragments for an organism. The researchers sequence and alter the DNA
fragments to produce a gene variant. In plants, we produce two types of
variants: knock-out variants, in which we have modified the selected gene to
under-produce its encoded protein, and over-expression variants, in which we
have modified the selected gene to over-produce its protein. In fungi, we use
proprietary technology to activate or inactivate genes using specialized DNA
fragments that we can insert into genes to modify the gene. We then introduce
the modified gene into the fungal nucleus where it efficiently and precisely
replaces the normal gene. Using these proprietary technologies, we have modified
thousands of plant and fungal genes.
Variant Analysis
Traditionally, the process of understanding the often-subtle difference between
a variant and normal organism has required years of experimentation. We have
solved this problem by rapidly and accurately collecting large volumes of data
for many different gene modifications with our automated workstations, sample
tracking and data collection software that constitute our GeneFunction
Factory(TM). The three types of data that we collect for each variant are gene
expression profiles, metabolic profiles and phenotype profiles.
Gene Expression Profiling. Gene expression profiling provides a snapshot
of the genes expressed in an organism at a given time. By comparing gene
expression profiles of a variant organism to a normal organism, we gather
information about the function of the modified gene as well as the effect of
that gene on the expression of other normal genes. By determining how a modified
gene affects normal genes, we gain insight into biochemical pathways of an
organism.
Metabolic Profiling. Metabolic profiling provides a snapshot of the
chemicals, including vitamins, minerals and other biochemicals, in cells,
tissues, and organisms, at a given time. We detect and measure these chemicals
using mass spectroscopy, which separates molecules by electrical charge and
size, and chromatography, which separates molecules by size and chemical
properties. We have invested in state-of-the-art technologies and have
developed proprietary instrumentation and algorithms to analyze this metabolic
data.
Phenotype Profiling. Phenotype profiling is the measurement of physical
and chemical characteristics of an organism at one or more times during its life
cycle. We currently measure approximately 140 different characteristics of our
target and model organisms. These include flowering time, plant height, plant
weight, seed set, seed shape, leaf shape, color reflectance, root density,
nutrient utilization and appearance. We take measurements under standard
conditions as well as under various stress conditions. These different
measurements, when taken at specified times, produce a phenotype profile for a
variant that we can compare to a phenotype profile for a normal organism to help
understand the function of the modified gene. We have developed a proprietary
method for obtaining a phenotype profile for an organism that is an important
part of our variant analysis.
Our FunctionFinder(TM) Bioinformatics System
Data Management. Laboratory researchers typically track and collect data using
notebooks, which makes it difficult to organize, store and access the volumes of
data generated. We have addressed this issue by developing a proprietary
Laboratory Information Management System, or LIMS, using barcodes and other
automated data collection devices to track samples and store data. We have also
developed technology to improve the organization, formatting and storage of data
collected from our variant analyses. Our LIMS allows us to record and manage the
thousands of daily measurements produced by our GeneFunction Factory(TM).
Data Analysis. The challenge with the vast amounts of data that have been
collected and stored for so many genes is being able to retrieve and make sense
of relevant information to determine the function of genes. To meet this
challenge, we have developed our FunctionFinder(TM) bioinformatics system, which
incorporates information obtained from our variant analyses and from public
sources. FunctionFinder(TM) includes tools for storing, retrieving, analyzing
and mining data to create knowledge about genes. The FunctionFinder(TM)
bioinformatics system contains proprietary software that we have developed.
6
MARKET OPPORTUNITIES
By determining gene function information and developing intellectual property
around that information, we believe that we can build a sustainable competitive
advantage. We plan to develop, with our commercial partners, novel products in
our four target markets. To date, we have entered into commercial partnerships
with Bayer to develop novel herbicides and with Monsanto to develop crop outputs
and nutritional products. Our target markets are as follows:
Human Health
We are focusing our efforts in the human health sector in two areas. The first
area is the use of metabolic profiling as a platform technology for drug
discovery. Metabolic profiling analyzes the diversity and changes in low
molecular weight compounds (generally called metabolites) in cells, tissues or
organisms as a result of genetic or drug intervention. We have developed
metabolite profiling as a way to analyze gene function and the effect of gene
function in a significant number of complex human diseases such as type II
diabetes and cardiovascular diseases. Like proteomics, "metabolomics" (as this
new field is called) uses sophisticated mass spectrometers and bioinformatic
software to analyze cell extracts or fluids, but at a speed that is orders of
magnitude faster. We have invested in state-of-the-art technologies and have
developed proprietary instrumentation and algorithms for analyzing metabolite
data. Metabolic profiling can key in on the dynamic changes in the small
molecules that are the signatures of altered or diseased metabolic states. We
plan to combine data obtained using this new technology with data from our
GeneFunction Factory(TM) to augment drug and gene-based studies in areas such as
toxicogenomics and pharmacogenomics. We plan to launch a composite of
specialized services and databases to meet many of the needs of the
pharmaceutical industry in this area. To initiate this effort, in November
2000, we announced a strategic collaboration to develop software tools and
databases with LION bioscience AG. We will focus on developing content and
supplying services, while LION will develop analysis tools and software.
The second area that we are pursuing is the discovery of novel anti-fungal
targets for drug discovery. Our GeneFunction Factory(TM) is providing new anti-
fungal targets for screening chemicals. We are currently examining two human
pathogens, Apergillus fumigatus and Candida albicans. Apergillus fumigatus is
the causal agent of the invasive pulmonary aspergillosis. Candida albicans is
the causal agent of various forms of local and systemic candidiasis. Both fungal
infections generally occur in patients with impaired immune systems. In 1999,
approximately 2.7 million patients in the United States were hospitalized for
chemotherapy, organ transplants or AIDS. Of these, approximately 25% developed
serious fungal infections associated with high morbidity and mortality. The
mortality rates for Candida and Aspergillus infections have been reported to be
38% and between 65% and 95% respectively. Treatment options for serious fungal
infections remain limited. Currently the FDA has approved only two major classes
of antifungal drugs. The first class is the polyenes (amphotericin B and related
compounds). The other class is the azoles (fluconazole and itraconazole). The
polyenes generally are limited by serious side effects which include chills,
diarrhea, nausea, vomiting and metabolic and nutritional disorders. The azoles
are limited in their application because they inhibit, rather than kill fungi
and therefore are increasingly ineffective due to growing pathogen resistance.
Nevertheless, despite these limitations, these drugs generated over $1 billion
in revenues in the United States in 1998. We estimate that the total United
States market for human antifungals (covering systemic, vaginal and skin
applications) will be at least $2.0 billion by 2010.
Because the known biochemical targets for the control of human fungal pathogens
are related to gene products that are targeted for control of crops against
fungal disease, we believe that some of the validated targets and validated
assays developed in our crop fungicides program will be relevant in our human
anti-fungals program.
Nutrition
The nutrition market includes foods, beverages and food and beverage additives
that have either an enhanced nutritional content or a therapeutic effect that
reduce the risk of disease in consumers. We call these functional foods or
nutraceuticals. Because many foods and additives come from plants and microbes,
we believe that our commercial partners and we can use our GeneFunction
Factory(TM) to develop food and beverage products with improved nutritional
content. We plan to develop functional foods in two ways. The first is through
metabolic engineering. By regulating the genes that impact biochemical pathways
for known compounds, we believe we will be able to increase the volume or
quantity of beneficial compounds. The second method is through metabolic
discovery. This entails discovering novel compounds in existing or novel plants
and microbials or discovering compounds of interest in novel biochemical
pathways that give rise to therapeutic effects in consumers.
The demand for functional foods is being driven by demographics, a more highly
educated population and technology improvements. The aging "baby boomer"
population is wellness conscious and has a high average disposable income. As
members of this demographic group approach retirement they are becoming more
health and wellness conscious. For the population as a whole, there has been no
other time in our history that we have known more about the health risks
associated with emerging pathogens in our food supply or have been more
conscious of the link between diet and health. Finally, the technology now
exists, through companies like Paradigm Genetics, to understand how compounds
are produced and which ones may be efficacious in promoting good health.
7
Already, many food production companies are exploring ways to create foods with
therapeutic benefits. For example, in January 2000, DuPont's Protein
Technologies International and General Mills, Inc. announced plans to
collaborate in developing and marketing functional foods containing proprietary
soy technology consistent with the FDA approved health claim that there is an
association between consumption of soy protein and the reduced risk of coronary
heart disease. Other examples of existing functional foods include cholesterol-
reducing margarine and nutritionally enhanced breakfast cereals.
The functional foods and functional beverages markets are growing rapidly.
Datamonitor estimates that the current functional foods market is approximately
$9 billion. Nutritional Business Journal reports that the potential market size
for this segment is $250 billion or 50% of the size of the entire food market
and 250% of the size of the over-the-counter and prescription drug markets
combined. Business Communications Corporation projects that the functional foods
and functional beverages market in the United States will reach $314 billion in
2002. Estimates of market size vary considerably because there is no
universally accepted definition of functional foods or nutraceuticals. However,
we do know that the market is growing rapidly and we plan to position ourselves
to take advantage of this market growth.
Crop Production
The crop production sector consists of crop inputs and crop outputs. Herbicides,
fungicides, fertilizers and seeds are examples of crop inputs. Harvested grain,
vegetables and fiber are examples of crop outputs. We intend to utilize the
information derived from our GeneFunction Factory(TM) to develop commercial
products, independently or with commercial partners, in the following areas:
Crop Inputs
Herbicides. Herbicides are chemicals that kill weeds that cause
substantial crop loss. The herbicide market is a mature market in which
innovative products have historically been introduced only about once per
decade. In 1999, global sales of herbicides were approximately $15 billion,
with Roundup(R) being the leading product. While there are many herbicides on
the market today, there is still a need for new types of products. For
example, there is a need for a herbicide that can be applied at the same time
seeds are planted, remains active in the field for several weeks, is
environmentally friendly and kills a broad spectrum of weeds quickly.
Conventionally, researchers have discovered new herbicide products by
spraying various chemicals on weeds in the hope of finding a chemical that
kills weeds without killing crops. Once a promising chemical is discovered,
researchers use labor-intensive genetics, physiology and biochemistry
techniques to determine the protein in the weed that the chemical affects.
This conventional approach is expensive and slow and has a low success rate.
Typically, researchers must screen 80,000 chemicals to find a commercial
product.
Our GeneFunction Factory(TM) is providing new herbicide targets for
chemical screening much faster and more economically than the conventional
method. As part of our collaboration with Bayer, we are using our GeneFunction
Factory(TM) to identify Arabidopsis genes that are promising targets for new
herbicides. After we have discovered the target genes, we then produce the
proteins encoded by these promising genes in quantities that are sufficient for
large-scale high-throughput, or high volume, chemical screening for herbicides.
Finally, our assay group produces assays, or test kits, containing those
proteins that can be used to screen for new herbicides. By narrowly focusing our
discovery efforts on finding chemicals that disable specific genes within weeds,
we believe that, together with our commercial partners, we may be able to
discover environmentally friendly herbicides more efficiently than our
competition.
Fungicides. Fungal plant diseases impose greater costs upon food growers
than any other plant disease. Chemicals used to control these diseases are
called fungicides. The global market for fungicides, such as Tilt(R) and
Ridomil PC(R), was approximately $6 billion in 1999. There is a need for
better and safer fungicides, particularly those that treat currently
untreatable fungal diseases or fungal strains that become resistant to
existing fungicides.
As with herbicides, researchers conventionally have discovered fungicides
by spraying various chemicals on crops in the hope of finding a chemical that
inhibits fungal infections on crops without killing the crops themselves.
Until recently, researchers had not used an approach based upon the
determination of gene function for fungicide discovery. Our GeneFunction
Factory(TM) is providing potential new fungicide targets for screening chemicals
faster and more economically than the conventional method. We are currently
examining three filamentous fungi, including Magnaporthe grisea, a rice
pathogen, and Mycosphaerella graminicola, a wheat pathogen. We are
identifying genes in these fungi that are essential for the survival of the
fungi, but not the crop. We believe that these genes will provide promising
targets for chemical screening using assays that we, or our commercial
partners, produce.
8
Fertilizers. Fertilizers are products that are typically applied to the
soil to provide crops with the nutrients needed to produce high yields. The
primary ingredients of most fertilizers are nitrogen, potassium and
phosphorus. The global market for fertilizers in 1998 was about $50 billion.
In general, current product discovery efforts for fertilizers are focused on
blending or reformulating known fertilizer compounds and reducing production
costs. Plants are limited in their ability to utilize fertilizers. Excess
fertilizer enters the environment either as run-off or ground water seepage,
both of which are major environmental concerns. We believe that products that
enhance fertilizer utilization will dramatically improve the economics and
lessen environmental concerns of crop production because growers will be able
to use less fertilizer to produce the same yields. We believe that our
GeneFunction Factory(TM) may allow us to identify genes in crops that improve
their ability to utilize fertilizer.
Seeds. Typical commercial seeds include hybrid corn seeds, registered
wheat seeds and vegetable seeds. The global market for commercial seeds in
1999 was over $15 billion. Currently, there is a need for new commercial seeds
that can increase crop yields and improve the quality of foods and fibers. One
commercial seed that has successfully increased crop yield while reducing the
use of pesticides is the Bollgard(TM) cottonseed. Its developers inserted a
microbial gene into cottonseed that encodes a protein that kills the cotton
budworm, a significant pest of cotton. The resulting seed produces a high
yield of cotton while avoiding both the cost and negative environmental impact
of budworm pesticide.
Historically, time-consuming plant breeding techniques have dominated
research in the seed industry. Recently, the seed industry has invested
heavily in the genetic modification of crops, which has resulted in a number
of commercialized products and products in development. The seed industry now
has the technology to efficiently insert genes into seeds, and products such
as the Bollgard cottonseed have demonstrated the commercial viability of this
technology. We believe that there is a market need for a technology that can
rapidly generate information about the function of a large number of genes and
identify those genes that code for commercially valuable crop traits that the
seed industry could then breed or insert into crops. Examples of valuable crop
traits are disease resistance, vitamin content and resistance to herbicides
and fungicides.
Crop Outputs
The output side of crop production consists of harvested crops. The global
value of harvested crops in 2000 was approximately $700 billion with
additional value created through crop processing. While there are more than
170 crops grown worldwide, only a few key crops, such as corn, soybean, rice,
wheat, potatoes and tomatoes, account for most of the value. Two major market
opportunities involve improving processing and product attributes. An example
of a processing improvement is a reduction in the soluble fiber present in
wheat. Pasta made from this type of wheat would be faster drying than ordinary
pasta and therefore companies could produce and package pasta at a reduced
cost. An example of an improved product attribute is an increased amount of
oil in each ton of processed canola. We believe that our GeneFunction
Factory(TM) may allow us to quickly and efficiently identify novel genes that
control processing and product attributes.
Industrial Products
Within the industrial products sector, we are targeting the markets that utilize
plants and microbials for the development of their products. Such industries
include fermentation, fiber for paper and energy, specialty chemicals, and
enzymes. Fermentation is used in the production of many foods, drinks, vitamins,
and supplements as well as for laundry detergent, paper, and plastic. These
industries are capital intensive, and research has focused on improving current
production costs. There is an incremental need for industrial products that are
novel, effective, inexpensive and environmentally friendly. To fill this need,
companies in each of these industries are making investments in biotechnology to
improve current efficiencies and develop novel products.
Since many industrial products are derived from biological sources, we believe
that by understanding how gene function dictates product characteristics, we may
be able to develop information that will significantly reduce production costs
as well as lead to the creation of novel products. We believe that the use of
our GeneFunction Factory(TM) may lead to the discovery of gene function
information useful for the development of various industrial products,
including:
. improved or novel fermentation products, such as enzymes and specialty
chemicals;
. improved fiber products, such as wood, plastics, cotton and linen; and
. improved industrial processes, such as wastewater treatment.
9
OUR STRATEGY
Our goal is to build long term stockholder value by leading the discovery of
gene function information for the development and commercialization, on our own
and in concert with our partners, of new and improved products in the areas of
human health, nutrition, crop production and industrial products. The key
elements of our strategy are to:
Determine the Function of Genes in Our Target and Model Organisms.
Using our GeneFunction Factory(TM), we intend to determine the function of
essentially every gene in each of our target and model organisms and incorporate
this data into our FunctionFinder(TM) bioinformatics system. We intend to
establish our FunctionFinder(TM) bioinformatics system as the definitive source
of gene function information for these target and model organisms, as well as
other target organisms related to our model organisms.
Continue to Industrialize Our GeneFunction Factory(TM).
We intend to continue to industrialize and to seek process improvements in our
GeneFunction Factory(TM). Our goals are to determine the function of genes
faster, more accurately, less expensively and in higher volumes than our
competitors. By so doing, we believe that we can build an intellectual property
position and develop a stake in the commercialization of new products that will
build sustainable stockholder value.
Develop Products Through Commercial Partnerships, Joint Ventures and Internally.
We intend to establish additional commercial partnerships and joint ventures
with leading companies in human health, nutrition, crop production and
industrial products. We will endeavor to build stockholder value through a
combination of research payments, milestone payments, royalties, and product
revenues.
Pursue Intellectual Property Protection for Our GeneFunction Factory(TM) and
Gene Function Information.
We intend to continue to aggressively pursue patents for our discovery methods,
our research platform and aspects of our bioinformatics system. Additionally, we
intend to aggressively pursue patents on discoveries of novel genes and gene
functions. As of February 26, 2001, we have rights to 45 U.S. patent
applications and seven international patent applications relating to our
technologies and genes. We intend to protect and build on our existing patent
portfolio and also rely on trade secrets to protect our proprietary
technologies. Where necessary, we will seek licenses to implement aspects of our
research platform subject to ownership rights of others.
COMMERCIAL PARTNERSHIPS
As part of our business strategy, we have established commercial partnerships
with pharmaceutical and agricultural companies in the fields of herbicide
development, crop production and nutrition. To date, we have entered into
significant commercial partnerships with Bayer and Monsanto.
Bayer
In September 1998, we entered into a commercial partnership with Bayer for the
development of new chemical herbicides. Under the terms of the commercial
partnership, we have agreed to use our GeneFunction Factory(TM) to identify
Arabidopsis genes that may be targets for herbicide discovery. We are providing
exclusively to Bayer assays based on these targets for use in high throughput
screening for herbicides, as well as access to customized Arabidopsis-based
releases of FunctionFinder(TM) for use in herbicide discovery. The commercial
partnership has an initial term of three years, ending in September 2001, unless
Bayer terminates it at an earlier date because we do not achieve specific
milestones, and Bayer has the option to extend it for two additional years. The
commercial partnership provides that we are entitled to committed research
funds, additional fees based on the number of assays we deliver and our success
in delivering customized releases of FunctionFinder(TM), and milestone and
royalty payments for any products that might emerge from the commercial
partnership. Under the terms of the commercial partnership, Bayer is obligated
to pay us approximately $16.5 million in committed funding and as much as an
additional $23.4 million in performance fees, milestone payments and payments
made in connection with the exercise of options to extend the commercial
partnership. To date, we have received approximately $13.0 million of this
funding from Bayer pursuant to the commercial partnership. We will also earn
sales royalties and product milestones in the event that our commercial
partnership with Bayer yields commercial products.
10
We have achieved nine milestones in our commercial partnership with Bayer. These
milestones include the delivery of the first seven assays for high throughput
screening and the delivery of the first and second releases of a customized
FunctionFinder(TM) bioinformatics system for discovery of novel herbicide
targets.
Monsanto
In November 1999, we entered into a commercial partnership with Monsanto to
provide certain Arabidopsis-based gene function data for the development of crop
inputs and outputs. Under the terms of this commercial partnership, Monsanto is
providing us with thousands of genes from Arabidopsis and other organisms. We
are performing a functional analysis of such genes for Monsanto using our
GeneFunction Factory(TM). Monsanto will either own or have exclusive licenses to
certain patents that result from this project. The commercial partnership has an
initial term of six years, ending in November 2005, unless Monsanto terminates
it at an earlier date because we do not achieve specific milestones, and
Monsanto has the option to extend it for up to two years and nine months.
Monsanto may expand the commercial partnership either by increasing the number
of genes that we are to analyze in Arabidopsis or by requiring us to analyze
gene function in a second model, or both, for additional research and possible
milestone payments. The commercial partnership provides that we are entitled to
committed research funds, additional fees based on the number of genes analyzed
and royalty payments for any products that might emerge from the commercial
partnership. Under the terms of the commercial partnership, Monsanto is
obligated to pay us approximately $43.9 million in committed funding and as much
as an additional $105.1 million in performance fees, milestone payments and
payments made in connection with the exercise of options to extend the
commercial partnership. To date, we have received approximately $16.8 million of
this funding from Monsanto pursuant to the commercial partnership. We will also
earn sales royalties and product milestones in the event that our commercial
partnership with Monsanto yields commercial products.
LION bioscience
In November 2000, we entered into a strategic collaboration with LION bioscience
for the development and marketing of a plant and fungal based metabolic
profiling database and bioinformatics software products for analyzing that
database . The database will be used for target identification and target
validation. Approximately 50% of new drug leads are derived from natural
products from plants and fungi. We believe that by developing the metabolic
profiling database we can provide a source of drugable targets for
pharmaceutical companies and other biotechnology companies.
RESEARCH AND DEVELOPMENT
Our research and development efforts are directed towards the development of our
GeneFunction Factory(TM), including our FunctionFinder(TM) bioinformatics system
and research activities in connection with our commercial partnerships and our
government grant. We spent approximately $3.6 million in 1998, approximately
$7.6 million in 1999 and approximately $18.1 million in 2000 on our research and
development efforts.
COMPETITION
We face competition from functional genomics companies, including Exelixis,
Inc., CuraGen Corporation, Rosetta Inpharmatics, Inc. and Large Scale Biology
Corporation. We expect competition to intensify in genomics research as
technology advances are made and become widely known. Genomic technologies have
undergone and are expected to continue to undergo rapid and significant change.
Our future success will depend in large part on maintaining a competitive
position in the genomics field, and particularly in the functional genomics
field. We, or others, may make rapid technological developments, which may
result in products or technologies becoming obsolete or noncompetitive before we
recover the expenses we incur in connection with our development. Products that
we or our commercial partners offer could be made obsolete by less expensive or
more effective crop production, nutrition enhancement, human health and
industrial application product development technologies, including technologies
that may be unrelated to genomics. We may not be able to make the enhancements
to our technology necessary to compete successfully with newly emerging
technologies.
Any products that we may develop alone or in collaboration with others will
compete in highly competitive markets. In the specific markets in which we apply
or intend to apply our FunctionFinder(TM) bioinformatics system, we face
competition from plant genomics, pharmaceutical, agri-chemical and biotechnology
companies. Many of our existing and potential competitors have substantially
greater financial resources, research and development staffs, facilities,
manufacturing and marketing experience, distribution channels and human
resources than we do. Many of these competitors have achieved substantial market
penetration in our chosen markets. We have entered into commercial partnerships
with Bayer and Monsanto in the crop production and nutrition sectors, but have
not yet entered into any commercial partnerships in other markets. Moreover, our
competitors may obtain patent protection or other intellectual property rights
that could limit our rights or our commercial partners' ability to use our
technologies or commercialize products in our chosen markets.
11
Our ability to compete in the human health sector may be limited by our
exclusive use of plant and fungal model organisms. We believe that our ability
to compete in the human health sector will depend on the degree to which
information we develop on plant and fungal gene and pathway function is useful
in developing information about how similar human genes and pathways code for
human pathology. Although our models have several advantages, competing
companies that use model organisms with greater similarities to human genes,
such as mice, as well as companies that do direct studies of human populations,
may have a substantial advantage in developing products for humans. Similarly,
we believe that as it relates to industrial products, our FunctionFinder(TM)
bioinformatics system will only be useful in the development of products that
are plant or fungal based, such as enzymes and alcohol.
GOVERNMENT REGULATION
Regulation of Development and Commercialization of Agricultural Products
Federal, state, local and foreign government regulations and regulatory agencies
will govern our efforts, alone or together with our commercial partners, to
develop and commercialize genetically enhanced nutrition and crop products.
These regulations and agencies may prevent us and our commercial partners from
developing and marketing nutrition and crop product candidates in a timely
manner or under technically or commercially feasible conditions, and may impose
expenses, delays and other impediments to our efforts to develop such product
candidates.
The FDA's current policy is to apply the same regulatory standards to
genetically modified foods that it applies to foods developed through
traditional plant breeding. This means that a food or food ingredient developed
by genetic modification must meet the same rigorous safety standards under the
Federal Food, Drug, and Cosmetic Act as other food products. Under this policy,
the FDA ordinarily will require premarket review of genetically modified foods
only if they raise significant safety concerns, such as elevated levels of
toxicants or the presence of allergens, or if the FDA deems them to contain a
food additive. The FDA requires premarket approval of food additives as products
from introduced genes only if the product differs substantially in structure and
function from similar naturally occurring substances. Also, the FDA does not
currently require that genetically modified products be labeled as such, as long
as they are as safe and have the same nutritional characteristics as
conventional products.
In January 2001, the FDA issued a proposed rule and a draft guidance document
concerning food developed through biotechnology. The proposed rule, if
finalized, would require food developers to notify the FDA at least 120 days in
advance of their intent to market a food or animal food developed through
biotechnology and to provide information to demonstrate that the product is as
safe as its conventional counterpart. The proposed regulation also recommends
that the food developer participate in a presubmission consultation with the
FDA. At the end of the 120-day period, the FDA may request additional time to
evaluate the submission, disagree with the sponsor's assessment of equivalent
safety or pose no further questions, in which case the bioengineered food may be
marketed. The draft guidance document, if finalized, would provide direction to
manufacturers who wish to voluntarily label their food products as being made
with or without ingredients developed through biotechnology. If and when the
regulation is finalized, our commercial partners and we will have to provide
notice to the FDA before we may commercialize any genetically modified food
product and depending on the FDA's assessment, we may be delayed or prevented
from commercializing any such product.
The USDA prohibits genetically modified plants from being grown and transported
except pursuant to an exemption or under special controls. In general, companies
apply for an exemption to facilitate product development because the special
controls are burdensome. However, we can not guarantee that the products we
develop will qualify for such an exemption.
Regulatory policies for genetically modified nutrition and crop products vary
widely, are currently the subject of intense political controversy, and may
change substantially in the near future. Accordingly, labeling, premarket
notification or other restrictions in foreign countries where we and our
commercial partners may want to develop and/or market genetically modified
product candidates may impose additional expenses and delays on such product
candidates or may make commercialization in such countries impracticable.
Our future nutrition and crop product candidates may also be subject to other
regulations and regulatory agencies, such as the Occupational Safety and Health
Act, the Toxic Substances Control Act, the National Environmental Policy Act,
other federal water, air and environmental quality statutes, import/export
control legislation and other laws. Any product candidates relating to
pesticides will be subject to the jurisdiction of the Environmental Production
Agency.
Regulation of Drug Development and Commercialization
Prior to the marketing of any new drug developed by us or our commercial
partners, that new drug must undergo an extensive regulatory review process in
the United States and other countries. This regulatory process, which includes
preclinical studies and clinical trials, and may include post-marketing
surveillance of any compound to establish its safety and efficacy, can take many
years and require the expenditure of substantial resources. Data obtained from
preclinical studies and clinical trials are subject to varying interpretations
that could delay, limit or prevent marketing. We and our commercial partners may
also encounter delays or rejections based on changes in government agency
policies for drug review. Delays in obtaining marketing clearance could delay
the commercialization of any drugs or diagnostic products developed by us or our
commercial partners, impose costly procedures on our commercial partners'
activities, diminish any competitive advantages that our commercial partners may
attain and lessen our potential royalties.
12
Even if regulatory clearance is obtained, a marketed product and its
manufacturer are subject to continuing review. Discovery of previously unknown
problems with a product may result in withdrawal of the product from the market,
which could reduce our revenue sources and hurt our financial results.
No agency has approved any product resulting from the use of our
FunctionFinder(TM) bioinformatics system for commercialization in the United
States or elsewhere. In addition, we and our commercial partners have not
submitted any investigational new drug applications for any such product
candidate. We cannot be certain if or when we or our commercial partners will
submit an application for regulatory review, or whether we or our commercial
partners will be able to obtain marketing approval for any products on a timely
basis, if at all. If we and our commercial partners fail to obtain required
governmental approvals, it will prevent us from marketing drugs or diagnostic
products. The occurrence of any of these events may cause our business,
financial condition and results of operations to suffer.
Environmental Regulation
Our research and development activities involve the controlled use of hazardous
materials and chemicals. We are subject to federal, state and local laws and
regulations governing the use, storage, handling and disposal of such materials
and certain waste products. The risk of accidental contamination or injury from
these materials cannot be eliminated. In the event of an accident, we could be
held liable for any damages that result, and any liability could exceed our
resources.
INTELLECTUAL PROPERTY
We seek U.S. and foreign patent protection for major components of our
GeneFunction Factory(TM). We also rely on trade secret protection for certain of
our confidential and proprietary information, and we use license agreements both
to access external technologies and assets and to convey certain intellectual
property rights to others. Our commercial success will be dependent in part on
our ability to obtain commercially valuable patent claims and to protect our
intellectual property portfolio. As of February 26, 2001, we had filed 45 U.S.
patent applications and seven international patent applications, which are
subject to rights that we have granted to various collaborators and development
partners. We have filed 16 trademark applications in the United States and have
received allowances on six of them.
The patent positions of life science companies are generally uncertain and
involve complex legal and factual questions. Our business could be hurt by any
of the following:
. our pending patent applications may not result in issued patents;
. the claims of any issued patents may not provide meaningful protection;
. we may be unsuccessful in developing additional proprietary technologies
that are patentable;
. our patents may not provide a basis for commercially viable products or
provide us with any competitive advantages and may be challenged by third
parties; and
. others may have patents that relate to our technology or business.
In addition, patent law relating to the scope of claims in the technology field
in which we operate is still evolving. The extent of future patent protection is
uncertain. In particular, we are aware of several groups that are attempting to
identify and patent gene fragments and full-length genes, both characterized and
uncharacterized. There is substantial uncertainty regarding the possible patent
protection for gene fragments or genes without known function or correlation
with specific functions. Furthermore, others may independently develop similar
or alternative technologies, duplicate any of our technologies, and if patents
are licensed or issued to us, design around the patented technologies licensed
to or developed by us. In addition, we could incur substantial costs in
litigation if we are required to defend ourselves in patent suits brought by
third parties or if we initiate such suits.
We are aware of a number of U.S. patents and patent applications and related
foreign patents and patent applications owned by third parties relating to gene
sequences and the analysis of gene function. These other technologies may
provide third parties with competitive advantages over us and may hurt our
business. In addition, some third party patent applications contain broad
claims, and it is not possible to determine whether or not applicants will
narrow such claims during prosecution or whether patent offices will allow and
issue patents on such claims, even if such claims appear to cover prior art or
have other defects. An owner or licensee of a patent in the field may threaten
or file an infringement action and we may or may not prevail in any such action.
The cost of defending an infringement action may be substantial, which could
significantly increase our expenses and increase our losses. Furthermore, other
patent holders may not grant us required licenses on commercially viable terms,
if at all. Failure to obtain any required license could prevent us from
utilizing or commercializing one or more of our technologies or gene-related
products.
13
We have applied, and intend to make additional applications, for patent
protection for:
. methods relating to gene sequencing, phenotype analysis, gene expression
profiling, metabolic profiling and other methods for determination of
gene function;
. bioinformatic technologies;
. function specific patterns of gene expression we identify; and
. individual genes and targets we discover.
Such patents may include claims relating to novel genes and gene fragments and
to novel uses for known genes or gene fragments identified through our discovery
programs. We may not be able to obtain meaningful patent protection for our
discoveries; even if patents are issued, the scope of the coverage or protection
they would afford is uncertain. Failure to secure such meaningful patent
protection would endanger our competitive position.
With respect to proprietary know-how that is not patentable and for processes
for which patents are difficult to enforce, we rely on trade secret protection
and confidentiality agreements to protect our interests, including several
elements of our FunctionFinder(TM) bioinformatics system. In addition, we are
developing a proprietary index of plant and fungal gene and gene fragment
sequences which we update on an ongoing basis. We will apply for patents on some
of this data, whereas we will maintain other data as proprietary trade secret
information. We have taken security measures to protect our proprietary know-how
and technologies and confidential data and continue to explore further methods
of protection. While we require all employees, consultants and commercial
partners to enter into confidentiality agreements, we cannot be certain that
others will not disclose proprietary information, or will not independently
develop substantially equivalent proprietary information and techniques or
otherwise gain access to our trade secrets, or that we can meaningfully protect
our trade secrets. In the case of arrangements with our commercial partners that
require the sharing of data, our policy is to make available to our commercial
partners only such data as is relevant to our agreements with such commercial
partners, under controlled circumstances, and only during the contractual term
of those agreements, and subject to a duty of confidentiality on the part of our
customer. However, such measures may not adequately protect our data. Any
material leak of confidential data into the public domain or to third parties
may harm our business.
We are a party to various license agreements that give us rights to use
technologies and biological materials in our research and development processes.
We may not be able to maintain such rights on commercially reasonable terms, if
at all. Failure by us to maintain such rights could harm our business.
EMPLOYEES
As of February 26, 2001, we had 210 full-time employees, of whom 47 hold Ph.D.
degrees. Of our total workforce, 170 are engaged in research and development
activities, and 40 are engaged in business development, finance and
administration. None of our employees is represented by a collective bargaining
agreement. We believe that our relations with our employees are good.
14
ITEM 2. PROPERTIES.
We currently lease an aggregate of approximately 132,000 square feet of single-
story and multi-story office and laboratory facilities in Research Triangle
Park, North Carolina. The first building lease, for approximately 28,000 square
feet on Alexander Drive in Research Triangle Park, is on a month-to-month basis.
The second building lease, for approximately 20,000 square feet on S. Miami
Boulevard in Durham, expires August 31, 2005. The third building lease, for
approximately 84,000 square feet on Alexander Drive in Research Triangle Park
expires on November 18, 2010. We have the option to renew all leases. We also
have an option to require a real estate investment trust to develop and finance
an additional two-story laboratory and office facility covering approximately
50,000 square feet on our current site on Alexander Drive in Research Triangle
Park.
ITEM 3. LEGAL PROCEEDINGS.
We are not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not Applicable.
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Market Information
The Company's common stock, par value $.01 ("common stock") per share, is traded
on the Nasdaq National Market ("Nasdaq") under the symbol "PDGM." The following
table sets forth for the periods indicated the range of high and low sales
prices for the common stock as reported by Nasdaq from the date that the Common
Stock commenced public trading on May 5, 2000.
2000 HIGH LOW
First Quarter...................... Not traded Not traded
Second Quarter..................... $15.250 $ 7.000
Third Quarter...................... $25.125 $12.125
Fourth Quarter..................... $28.563 $ 7.375
STOCKHOLDERS
As of March 19, 2001, there were approximately 250 holders of record of the
Company's common stock and, according to the Company's estimates, approximately
4,500 beneficial owners of the Company's common stock.
DIVIDENDS
The Company has never declared or paid dividends on its capital stock and does
not anticipate paying any dividends in the foreseeable future.
USE OF PROCEEDS
In connection with our initial public offering, we sold 6,000,000 shares of
common stock at $7.00 per share for net proceeds of approximately $37.6
million, net of underwriting discounts, commissions and other offering costs. On
May 31, 2000, the underwriters exercised an over-allotment option to purchase an
additional 750,000 shares resulting in net proceeds of approximately $4.9
million. On May 5, 2000, the Securities and Exchange Commission declared our
Registration Statement on Form S-1 (File No. 333-30758) effective. The following
table sets forth our cumulative use of the net offering proceeds as of December
31, 2000:
Construction and acquisition of plant buildings, facilities, and equipment...... $ 1,860,000
Repayment of indebtedness....................................................... 423,000
General corporate purposes...................................................... 801,000
Research and development expenses............................................... 666,000
Cash and cash equivalents....................................................... 2,951,000
Temporary investments........................................................... 33,853,000
Long-term investments........................................................... 1,975,000
The foregoing use of net proceeds does not represent a material change in the
use of net proceeds described in the Registration Statement.
16
ITEM 6. SELECTED FINANCIAL DATA
The statement of operations data for December 31, 1998, 1999 and 2000 and the
balance sheet data as of December 31, 1999 and 2000 have been derived from our
audited financial statements beginning on page F-1 of this report. The statement
of operations data for the period from inception (September 9, 1997) through
December 31, 1997 and the balance sheet data as of December 31, 1997 and 1998
have been derived from audited financial statements that are not included in
this report. The historical results are not necessarily indicative of the
operating results to be expected in the future. The selected financial data
shown below should be read in conjunction with our financial statements and the
notes to those financial statements beginning on page F-1 and ``Management's
Discussion and Analysis of Financial Condition and Results of Operations''
beginning on page 19 of this report.
Period from
inception
(September
1997) to
December 31. Years Ended December 31,
- ---------------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts and shares outstanding) 1997 1998 1999 2000
- ---------------------------------------------------------------------------------------------------------------------
Statement of Operations Data:
Revenues:
Commercial partnerships...................................... $ -- $ 820 $ 2,052 $ 9,837
Grant revenue................................................ -- 51 145 500
---------- ---------- ---------- -----------
Total revenues.............................................. -- 871 2,197 10,337
Operating expenses:
Research and development (includes $0, $0, $88 and $449
respectively, of stock-based compensation)................... 71 3,641 7,615 18,115
Selling, general and administrative (includes $0, $6, $112
and $959, respectively, of stock-based compensation)......... 149 1,530 4,826 10,961
---------- ---------- ---------- -----------
Total operating expenses.................................... 220 5,171 12,441 29,076
---------- ---------- ---------- -----------
Loss from operations........................................... (220) (4,300) (10,244) (18,739)
---------- ---------- ---------- -----------
Interest income (expense), net................................. -- 10 (376) 1,015
---------- ---------- ---------- -----------
Net loss....................................................... (220) (4,290) (10,620) (17,724)
---------- ---------- ---------- -----------
Beneficial conversion of Series C Preferred
Stock.......................................................... -- -- -- (12,000)
---------- ---------- ---------- -----------
Net loss attributable to common stockholders................... $ (220) $ (4,290) $ (10,620) $ (29,724)
========== ========== ========== ===========
Net loss per share attributable to common stockholders --basic
and diluted.................................................... $ (0.19) $ (1.14) $ (2.51) $ (1.61)
========== ========== ========== ===========
Weighted average common shares outstanding--basic and
diluted........................................................ 1,160,958 3,750,036 4,236,409 18,434,804
========== ========== ========== ===========
December 31,
- ---------------------------------------------------------------------------------------------------------------------
(in thousands) 1997 1998 1999 2000
- ---------------------------------------------------------------------------------------------------------------------
Balance Sheet Data:
Cash, cash equivalents and short-term investments.............. $ 18 $ 3,455 $ 3,956 $ 36,804
Working capital................................................ (224) 1,148 (3,635) 16,808
Total assets................................................... 63 7,435 14,225 75,465
Long-term debt, net of current portion ........................ -- 3,539 8,047 10,753
Preferred stock................................................ -- 5,951 11,919 --
Accumulated deficit............................................ (253) (4,543) (15,163) (32,887)
Total stockholders' (deficit) equity........................... (216) 1,452 (2,827) 39,614
17
SELECTED QUARTERLY FINANCIAL DATA
(Unaudited)
2000
- ------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts) First Second Third Fourth Total
- ------------------------------------------------------------------------------------------------------------
Net revenues $ 593 $ 1,696 $ 3,536 $ 4,512 $ 10,337
Loss from operations (4,793) (5,136) (4,254) (4,556) (18,739)
Net loss (4,776) (4,774) (3,992) (4,182) (17,724)
Beneficial conversion of Series C Preferred Stock (12,000) - - - (12,000)
Net loss attributable to common stockholders (16,776) (4,774) (3,992) (4,182) (29,724)
Net loss per share attributable to common stockholders
- basic and diluted $ (3.11) $ (0.29) $ (0.16) $ (0.16) $ (1.61)
1999
- ------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts) First Second Third Fourth Total
- ------------------------------------------------------------------------------------------------------------
Net revenues $ 332 $ 332 $ 381 $ 1,152 $ 2,197
Loss from operations (1,991) (2,381) (2,909) (2,963) (10,244)
Net loss (2,041) (2,439) (2,993) (3,147) (10,620)
Net loss per share attributable to common stockholders
- basic and diluted $ (0.54) $ (0.63) $ (0.66) $ (0.66) $ (2.51)
18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that are based upon
current expectations. Our actual results and the timing of events could differ
materially from those anticipated in our forward-looking statements as a result
of many factors, including those set forth under "Risk Factors", "Forward-
Looking Statements'' and elsewhere in this report.
You should read the following discussion and analysis in conjunction with
"Selected Financial Data" and the financial statements and related notes
included elsewhere in this report.
OVERVIEW
We have industrialized the process of determining gene function to generate
information that we believe will enable us and our commercial partners to
develop novel products in four major sectors of the global economy: human
health, nutrition, crop production and industrial products. We have developed an
industrialized, high-throughput platform, known as the GeneFunction Factory(TM),
capable of determining the function of over a hundred plant and microbial genes
per week. We designed our GeneFunction Factory(TM) to be an integrated, rapid,
industrial scale laboratory through which we can discover and modify genes,
understand the consequences of the modifications and reliably determine the
function of those genes.
Paradigm Genetics was founded in September 1997. We currently have commercial
partnerships with Bayer AG in the area of crop production and with The Monsanto
Company in the areas of crop production and nutrition. The commercial
partnership with Bayer was signed in September 1998 and generated the majority
of our revenues for fiscal years 2000, 1999 and 1998. The commercial partnership
with Monsanto was signed in November 1999. This partnership began contributing
revenues in the second quarter of fiscal year 2000. We also generated revenues
in fiscal years 2000, 1999 and 1998 from a grant from the U.S. Department of
Energy.
We have invested heavily in developing our GeneFunction Factory(TM) and in
establishing our bioinformatics infrastructure. During the first quarter of
2001, we expanded our facilities by moving into a newly developed office and
laboratory complex, housing our new generation GeneFunction Factory(TM),
totaling approximately 84,000 square feet. We now occupy office and laboratory
space totaling approximately 132,000 square feet. Our total number of employees
increased to 193 employees at December 31, 2000 from 92 employees at December
31, 1999, and from 47 employees at December 31, 1998. Of our total number of
employees on December 31, 2000, 79% were engaged in research and development
activities. Our research and development efforts consisted of work performed
under our commercial partnerships, our federal government grant and work
advancing our own core technologies and programs.
We have incurred significant losses since our inception. As of December 31,
2000, our accumulated deficit was approximately $32.9 million and total
stockholders' equity was approximately $39.6 million. Our net loss increased to
approximately $17.7 million during the year ended December 31, 2000, compared to
approximately $10.6 million during the year ended December 31, 1999, and $4.3
million during the year ended December 31, 1998. Operating expenses including
non-cash compensation charges increased to approximately $29.1 million during
the year ended December 31, 2000, from approximately $12.4 million during the
year ended December 31, 1999, and $5.2 million during the year ended December
31, 1998. We expect to incur additional operating losses over at least the next
two years as we continue to develop our GeneFunction Factory(TM), advance our
internal research and development programs, establish the infrastructure
necessary to support our business and increase our marketing activities.
Source of Revenue and Revenue Recognition Policy
Revenues are derived from commercial partnerships and from a government grant.
Revenues related to fixed nonrefundable payments are recognized under commercial
partnerships based on progress to completion in accordance with the applicable
performance requirements of each commercial partnership. Our effort level under
these partnerships is not ratable. Refundable fees received under commercial
partnerships are initially deferred and recognized as revenues based on progress
to completion over the term of the commercial partnerships beginning at the date
that the refund right expires, which is the date on which the related
performance requirements have been met. Nonrefundable fees received at the
initiation of a commercial partnership are deferred and recognized as revenues
on a progress-to-completion basis over the term of the commercial partnership
with all other fixed nonrefundable payments received under the commercial
partnerships. This is required as we have a future performance obligation under
these partnerships which is performed as we deliver the results of our gene
analysis to our commercial partners. Progress to completion under commercial
partnerships is measured based on a comparison of the number of genes analyzed
to the total number of genes to be analyzed, on a contract-by-contract basis.
Milestone payments under commercial partnerships are recognized as revenue when
the applicable milestone has been achieved, on a percentage of completion basis,
and such achievement has been acknowledged by the other partner. Revenues from
the government grant are recognized as expenses are incurred over the period of
the grant. Cash received in excess of revenues recognized under commercial
partnerships and the government grant is recorded as deferred revenue. Payments
received under our commercial partnerships and government grant are generally
non-refundable regardless of the outcome of the future research and development
activities to be performed by us under these arrangements. As of December 31,
2000, we had deferred revenue of approximately $17.1 million.
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Results of Operations
Years Ended December 31, 2000 and 1999.
Revenues. Revenues are comprised of amounts recognized under our commercial
partnerships and a grant from the U.S. Department of Energy. Total revenues
increased 371% to approximately $10.3 million in 2000 compared to approximately
$2.2 million in 1999. This increase was primarily the result of higher
throughput in our GeneFunction Factory(TM), the successful delivery of version
2.0 of our proprietary FunctionFinder(TM) bioinformatics system and the delivery
to Bayer of a number of herbicide assays during the year.
Revenues earned under commercial partnerships increased 379% to approximately
$9.8 million in 2000 compared to approximately $2.1 million in 1999. This
increase was primarily the result of higher throughput in our GeneFunction
Factory(TM) for Bayer and to a lesser extent the result of commencement of work
for Monsanto. Revenues relating to our Bayer partnership increased to
approximately $8.6 million in 2000 from approximately $2.1 million in 1999 and
revenues relating to our Monsanto partnership increased from zero in 1999 to
approximately $1.2 million in 2000. In the future we expect more of our revenue
to come from our partnership with Monsanto than from our partnership with Bayer.
Our partnership with Bayer has an initial term of three years, ending in
September 2001, unless Bayer terminates it at an earlier date because we do not
achieve specific milestones. Bayer has the option to extend the partnership for
two additional years, and we believe that Bayer will exercise this option.
Grant revenues increased 245% to approximately $500,000 in 2000 from
approximately $145,000 in 1999. This increase was the result of our U.S.
Department of Energy grant being extended in 1999. In June 2001, this grant ends
and will no longer contribute to our revenue.
Research and Development Expenses. Research and development expenses consist
primarily of personnel costs, costs of supplies, facility costs, license fees,
the recognition of deferred compensation and depreciation of laboratory
equipment. Research and development expenses increased 138% to approximately
$18.1 million in 2000 compared to approximately $7.6 million in 1999. Of this
increase, approximately $5.1 million was due to an increased number of research
and development staff, approximately $1.3 million was due to higher supplies,
approximately $478,000 was due to higher facilities costs, approximately
$445,000 was due to additional license fees, approximately $362,000 was due to
the amortization of deferred compensation, and approximately $1.3 million was
due to depreciation of additional laboratory equipment to support our commercial
partnership agreements and develop our core technology. We expect to continue to
devote substantial resources to research and development. We also expect that
research and development expenses will continue to increase and that net losses
will continue as a result.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses consist primarily of personnel costs, professional
expenses, such as legal and accounting fees, facilities costs, business
development costs, depreciation and the recognition of deferred compensation.
Selling, general and administrative expenses increased 127% to approximately
$11.0 million in 2000 compared to approximately $4.8 million in 1999. Of this
increase, approximately $2.0 million was due to increased staffing necessary to
manage and support our growth, approximately $825,000 was due to an increase in
professional expenses, approximately $229,000 was due to higher facilities
costs, approximately $410,000 was due to increased depreciation expenses and
approximately $847,000 was due to the recognition of deferred compensation. We
expect that our selling, general and administrative expenses will continue to
increase as we expand our legal, accounting and business development staff, add
infrastructure, incur additional costs related to being a public company,
including directors' and officers' insurance premiums, investor relations
programs and increased professional fees and continue to make commission
payments related to our commercial partnerships.
Stock-Based Compensation Expense. Stock-based compensation expense represents
the amortization of deferred compensation related to stock options granted to
employees with an exercise price below the estimated fair value of our common
stock at the date of grant, as determined by our board of directors. Deferred
compensation is amortized over the vesting period of the related stock options,
which is generally four years. We recognized approximately $1.3 million in non-
cash compensation expense related to amortization of deferred compensation in
2000 as compared to approximately $200,000 in 1999.
Deferred compensation for options granted to employees has been determined as
the difference between the estimated fair value for financial reporting purposes
of our common stock on the date the options were granted and the exercise price.
Deferred compensation for options granted to consultants has been determined in
accordance with Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" as the fair value of equity instruments issued. In
connection with the grant of stock options to employees, we recorded deferred
compensation of approximately $1.3 million in 2000.
20
Other Income (Expense), Net. Other income (expense), net represents interest
earned on our cash and cash equivalents and short-term investments offset by
interest expense on long-term debt and capital leases and the recognition of a
loss on disposal of assets. Other income, net was approximately $1.0 million in
2000, as compared to other expense, net of approximately $375,000 in 1999. This
change was attributable to the interest we earned on our cash balances offset
partially by increases in interest from higher senior long-term debt and notes
payable secured by capital equipment purchases, and the recognition of a loss on
the disposal of assets. We expect a de minimus other expense, net for 2001. Our
interest earnings on cash balances may decrease as we continue to fund
operations and service our debt.
Years Ended December 31, 1999 and 1998.
Revenues. Revenues are comprised of amounts recognized under a commercial
partnership with Bayer, which was signed in September 1998, and a grant from the
U.S. Department of Energy. Total revenues increased 152% to approximately $2.2
million in 1999 compared to approximately $871,000 in 1998. This increase was
primarily the result of higher throughput in our GeneFunction Factory(TM), the
successful delivery to Bayer of version 1.0 of our proprietary
FunctionFinder(TM) bioinformatics system and the delivery to Bayer of several
herbicide assays during the year.
Revenues earned under the commercial partnership with Bayer increased 150% to
approximately $2.1 million in 1999 compared to approximately $820,000 in 1998.
This increase was primarily a result of higher throughput in our GeneFunction
Factory(TM). Substantially all of our revenues during 1999 and 1998 relate to
the commercial partnership with Bayer.
Grant revenues increased 187% to approximately $145,000 in 1999 compared to
approximately $51,000 in 1998. This increase was the result of the grant from
the U.S. Department of Energy being extended in 1999.
Research and Development Expenses. Research and development expenses consist
primarily of personnel costs, facility costs, costs of supplies, depreciation of
laboratory equipment and the recognition of deferred compensation. Research and
development expenses increased 109% to approximately $7.6 million in 1999
compared to approximately $3.6 million in 1998. Of this increase, approximately
$2.5 million was due to an increased number of research and development staff,
approximately $334,000 was due to higher facilities costs, and approximately
$885,000 was due to depreciation of additional laboratory equipment to support
our commercial partnerships and develop our core technology.
Selling, General, and Administrative Expenses. Selling, general and
administrative expenses consist primarily of personnel costs, facilities costs,
business development costs, professional expenses, such as legal and accounting
fees and the recognition of deferred compensation. Selling, general and
administrative expenses increased 215% to approximately $4.8 million in 1999
compared to approximately $1.5 million in 1998. Of this increase, approximately
$1.3 million was due to increased staffing necessary to manage and support our
growth, approximately $209,000 was due to higher facilities costs, approximately
$267,000 was due to an increase in professional expenses and approximately
$397,000 was due to increased depreciation expenses.
Stock-Based Compensation Expense. Stock-based compensation expense represents
the amortization of deferred compensation related to stock options granted to
employees with an exercise price below the estimated fair value of our common
stock at the date of grant, as determined by our board of directors. Deferred
compensation is amortized over the vesting period of the related stock options,
which is generally four years. We recognized approximately $200,000 in non-cash
compensation expense related to amortization of deferred compensation in 1999 as
compared to approximately $6,000 in 1998.
Other Income (Expense), Net. Other income (expense), net represents interest
earned on our cash and cash equivalents and short-term investments offset by
interest expense on long-term debt and capital leases. Other expense, net was
approximately $376,000 in 1999 as compared to other income, net of $11,000 in
1998. This change was attributable to increases in senior long-term debt and an
increase in notes payable secured by capital equipment purchases, partially
offset by an increase in interest income on our cash balances.
Liquidity and Capital Resources
We have historically financed our operations through the sale of common and
preferred stock, debt and capital lease financing, payments received from
commercial partnerships and a government grant. From our inception through
December 31, 2000, we have raised approximately $26.9 million in net cash
proceeds from the sale of preferred stock. On May 10, 2000, we completed an
initial public offering in which we sold 6,000,000 shares of common stock at
$7.00 per share for net proceeds of approximately $37.6 million, net of
underwriting discounts, commissions and other offering costs. On May 31, 2000,
the underwriters exercised an over-allotment option to purchase an additional
750,000 shares resulting in net proceeds of approximately $4.9 million. During
the year ended December 31, 2000, we raised approximately $6.9 million in
secured debt financing from one financial institution. In February 2001, we
signed a secured debt agreement with one lender that will allow us to access up
to $6.5 million during 2001.
21
Annual maturities of other long-term debt secured in years subsequent to 2000
are approximately $3.4 million in 2001, approximately $5.8 million in 2002,
approximately $3.0 million in 2003, and approximately $1.8 million in 2004. In
addition, we have several noncancellable operating leases pertaining to office
lease space and other equipment. Our minimum lease payments, under these
leases, are approximately $1.8 million in 2001, approximately $1.7 million in
2002, approximately $1.6 million in 2003, approximately $1.6 million in 2004,
approximately $1.9 million in 2005, and approximately $10.4 million thereafter.
We had cash, cash equivalents and short-term investments of approximately $36.8
million at December 31, 2000, approximately $4.0 million at December 31, 1999
and approximately $3.5 million at December 31, 1998. Our cash, cash equivalents,
short-term investments and long-term investments totaled approximately $45.3
million at December 31, 2000. We believe that this balance coupled with cash
from our commercial partners will be sufficient to cover our cash flow needs
into the foreseeable future. We are exposed to interest rate fluctuations on
cash equivalents, short-term investments, and long-term investment amounts
outstanding under notes payable and lines of credit. Our cash and cash
equivalents, short-term, and long-term investments are invested in financial
instruments with interest rates based on financial market conditions.
We had working capital of approximately $16.8 million at December 31, 2000, a
working capital deficit of approximately $3.6 million at December 31, 1999, and
working capital of approximately $1.1 million at December 31, 1998. The increase
in working capital between 2000 and 1999 was primarily due to proceeds from the
completion of our initial public offering in May 2000, the issuance of
convertible preferred stock in January 2000, an increase in secured debt
financing and cash received from our commercial partners during the year. The
decrease in working capital between 1998 and 1999 was primarily due to increases
in deferred revenue from our commercial partners in 1999 with which we financed
our operations, leasehold improvements and equipment purchases. These
expenditures were partially offset by proceeds from sales of preferred stock and
issuance of notes payable.
Our operating activities used cash of approximately $4.4 million in 2000,
approximately $4.4 million in 1999 and approximately $2.1 million in 1998. Cash
used in operating activities was primarily related to net operating losses.
Cash used in investing activities totaled approximately $57.2 million in 2000,
approximately $7.6 million in 1999 and approximately $6.1 million in 1998.
Investing activities consist primarily of net purchases of investments and
additions to property and equipment. Capital expenditures totaled approximately
$18.3 million in 2000, approximately $6.6 million in 1999 and approximately $3.7
million in 1998. The increase in capital expenditures was primarily a result of
our investment in our GeneFunction Factory(TM), which includes laboratory and
data processing equipment and leasehold improvements. We expect to continue to
make significant investments in the purchase of property and equipment to
support our expanding operations. A portion of our cash may be used to acquire
or invest in complementary businesses, products or technologies, or to obtain
the right to use such complementary technologies.
Financing activities provided cash of approximately $63.3 million in 2000,
approximately $11.5 million in 1999 and approximately $9.2 million in 1998. Cash
provided by financing activities resulted from the receipt of approximately
$42.5 million in net proceeds from our initial public offering in May 2000 and
the receipt of approximately $15.0 million in net proceeds from the sale of
Series C Preferred Stock in January 2000. In 1999 we received approximately $6.0
million in net proceeds from the sale of Series B Preferred Stock. In 1998 we
received approximately $6.0 million in net proceeds from the sale of Series A
Preferred Stock, including $350,000 in proceeds from bridge loans which were
converted to Series A Preferred Stock. In addition, we had net borrowings under
our notes payable for equipment financing of approximately $5.0 million in 2000,
approximately $5.5 million in 1999 which includes $2.0 million under our senior
note payable and approximately $3.6 million in 1998.
We expect to continue expanding our operations through internal growth and,
possibly, through strategic acquisitions. We expect these activities will be
funded from existing cash, cash flow from operations, and borrowings under our
credit facilities. We believe that these sources of liquidity will be
sufficient to fund our operations for the foreseeable future. From time to
time, we evaluate potential acquisitions and other growth opportunities, which
might require additional external financing, and we might seek funds from public
or private issuances of equity or debt securities.
Recently Issued Accounting Standards
In March 2000, the Financial Accounting Standards Board, or FASB, issued
Interpretation No. 44, or FIN 44, "Accounting for Certain Transactions Involving
Stock Compensation - an Interpretation of APB 25." This Interpretation
clarifies (a) the definition of employee for purposes of applying Opinion 25,
(b) the criteria for determining whether a plan qualifies as a non-compensatory
plan, (c) the accounting consequence of various modifications to the terms of a
previously fixed stock option or award, and (d) the accounting for an exchange
of stock compensation awards in a business combination. FIN 44 was effective
July 1, 2000. The adoption did not have a material impact on our results of
operations.
22
In December 1999, the SEC issued Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements," or SAB 101, which provides guidance on the
recognition, presentation, and disclosure of revenue in financial statements
filed with the SEC. SAB 101, as amended by SAB 101A and SAB 101B, outlines the
basic criteria that must be met to recognize revenue and provides guidance for
disclosures related to revenue recognition policies. We have adopted SAB 101,
and the adoption of SAB 101 did not have a significant impact on our revenue
recognition policies.
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Investments and Hedging Activities," or SFAS No.
133. SFAS No. 133 establishes accounting and reporting standards for
derivatives and hedging activities and supercedes several existing standards.
SFAS No. 133, as amended by SFAS No. 137 and SFAS No. 138, is effective for all
fiscal quarters of fiscal years beginning after June 15, 2000. The Company does
not currently, nor does it intend in the future, to use derivative instruments
and therefore, does not expect that the adoption of SFAS No. 133 will have any
impact on its financial position or the results of operations.
Potential Volatility of Quarterly Operating Results and Stock Price
Our quarterly and annual operating results have fluctuated, and we expect that
they will continue to fluctuate in the future. Factors that could cause these
fluctuations include:
. the timing of the initiation, progress or cancellation of commercial
partnerships
. the mix of work performed for our commercial partners in a particular
period
. the timing of internal expansion costs, and
. the timing and amount of costs associated with evaluating and integrating
acquisitions, if any.
Fluctuations in quarterly results or other factors beyond our control could
affect the market price of our common stock. Such factors include changes in
earnings estimates by analysts, market conditions in our industry, changes in
pharmaceutical, agri-chemical, and biotechnology industries, and general
economic conditions. Any effect on our common stock could be unrelated to our
longer-term operating performance.
FORWARD-LOOKING STATEMENTS
Our forecast of the period of time through which our financial resources will be
adequate to support our operations and other statements contained in this report
are forward-looking and involve risks and uncertainties. Actual results could
vary as a result of a number of factors. We believe that our existing cash and
investment securities and anticipated cash flow from existing partnerships
together with the net proceeds from our initial public offering will be
sufficient to support our current operating plan into the foreseeable future.
We have based this estimate on assumptions that may prove to be wrong. It is
possible that we may seek additional funding within this time frame. We may
raise additional funds through public or private financing, collaborative
relationships or other arrangements. We cannot assure you that additional
funding, if sought, will be available or, even if available, will be available
on terms favorable to us. Further, any additional equity financing may be
dilutive to stockholders, and debt financing, if available, may involve
restrictive covenants. Our failure to raise capital when needed may harm our
business and operating results. Our future capital requirements will depend on
many factors, including:
. the number, breadth and progress of our research programs
. the achievement of the milestones under certain of our existing commercial
partnerships
. our ability to establish additional and maintain current and additional
commercial partnerships
. our commercial partners' success in commercializing products developed
under our commercial partnership agreements
. our success in commercializing products to which we have retained the
rights under our commercial partnerships
. the costs incurred in enforcing and defending our patent claims and other
intellectual property rights, and
. the costs and timing of obtaining regulatory approvals for any of our
products.
This report contains other forward-looking statements, including statements
regarding: our ability to successfully develop and improve our GeneFunction
Factory(TM); database and other technologies; our ability to industrialize the
process of gene function discovery and generate information enabling the
development of novel products; our ability to establish intellectual property
protection for our gene function information, databases, processes and other
technologies; product development and commercialization efforts; our strategy;
23
anticipated increases in our revenues, and timing of revenues from commercial
partnerships; our ability to meet or exceed our milestone targets and earn
royalties under our commercial partnerships; our ability to enter into new
partnerships and alliances; our intended use of the proceeds from our initial
public offering and other financial resources; our research and development and
other expenses; our operational and legal risks; the future of the genomics
industry and the type of companies that will lead it; and building shareholder
value.
Such statements are based on management's current expectations and are subject
to a number of risks, factors and uncertainties that may cause actual results,
events and performance to differ materially from those referred to in the
forward-looking statements. These risks include, but are not limited to, our
early stage of development, history of net losses, technological and product
development uncertainties, reliance on research collaborations, uncertainty of
additional funding and ability to protect our patents and proprietary rights.
These and other risks are discussed below in Part I, Item 7 of this report,
titled "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Risk Factors."
RISK FACTORS
WE HAVE A HISTORY OF NET LOSSES. WE WILL CONTINUE TO INCUR NET LOSSES THAT MAY
DEPRESS OUR STOCK PRICE.
We have incurred net losses in each year since our inception and expect these
losses to continue. We experienced a net loss of approximately $17.7 million for
the twelve months ended December 31, 2000. As of December 31, 2000, we had an
accumulated deficit of approximately $32.9 million. To date, we have derived all
of our revenues from two commercial partnerships and a government grant. We
expect to derive revenue in the foreseeable future principally from commercial
partnerships. We expect to spend a significant amount of capital to fund
research and development and enhance our core technologies, including our
GeneFunction Factory(TM). As a result, we expect that our operating expenses
will increase significantly in the near term and, consequently, we will need to
generate significant additional revenues to become profitable. We cannot predict
when, if ever, we will become profitable.
WE MAY NEVER BECOME PROFITABLE IF WE AND OUR COMMERCIAL PARTNERS ARE UNABLE TO
DEVELOP OR COMMERCIALIZE OUR TECHNOLOGIES INTO PRODUCTS.
We have no experience in manufacturing and marketing products, and we currently
do not have the resources or capability to manufacture products on a commercial
scale. In order for us to commercialize our products on our own, we would need
to develop, or obtain through outsourcing arrangements or through acquisitions,
the capability to manufacture, market and sell products. Since we do not
currently possess the resources necessary to develop and commercialize potential
products ourselves, we must enter into commercial partnerships to develop and
commercialize products.
We have entered into only two commercial partnerships, with Bayer and Monsanto,
to fund the development of certain new products, including herbicides and plants
with improved nutritional and growth characteristics. To date, we have derived
most of our revenues from the commercial partnership with Bayer. If we are
unable to successfully achieve milestones or our commercial partners fail to
develop successful products, we will not earn the revenues contemplated under
such partnerships. In addition, we may not be able to enter into additional
commercial partnerships. We do not control the resources that our commercial
partners devote to our projects and our commercial partners may not perform
their obligations. Our commercial partnerships are subject to termination rights
by the commercial partners. If any of our commercial partners were to terminate
its relationship with us, or fail to meet its contractual obligations, it could
have a material adverse effect on our revenues and it could have a material
adverse effect on our ability to undertake research, to fund related and other
programs and to develop, manufacture and market any products that may have
resulted from the commercial partnership. Specifically, Bayer may not decide to
exercise its option to extend our commercial partnership past September 2001, in
which case our future revenues from this commercial partnership could be as much
as $17.6 million lower than if Bayer decides to exercise the extension option.
Also, we may pursue opportunities in fields that conflict with our commercial
partners or in which our commercial partners could become active competitors. In
either case, we may not be able to commercialize our products.
We may need additional financing, which may not be available, and any financings
may dilute the percentage ownership of our existing stockholders, cause us to
relinquish rights to our technologies or cause us to grant licenses on
unfavorable terms.
Our existing capital resources may not be sufficient to fund our future
operating plans and we may therefore need to raise significant additional
capital. We have expended significant resources in developing our GeneFunction
Factory(TM) and expect our capital expenditures and operating expenses to
increase over the next several years as we continue developing the GeneFunction
Factory(TM) and increase our research and development activities. The amount of
additional capital which we expect we will need to raise will depend on many
factors, including:
. the number, breadth and progress of our research programs;
. the achievement of the milestones under certain of our existing commercial
partnerships;
24
. our ability to establish additional and maintain current and additional
commercial partnerships;
. our partners' success in commercializing products developed under our
commercial partnerships;
. our success in commercializing products to which we have retained the
rights under our commercial partnerships;
. the costs incurred in enforcing and defending our patent claims and other
intellectual property rights; and
. the costs and timing of obtaining regulatory approvals for any of our
products.
We may need to raise additional capital through public or private equity
offerings, debt financings or additional commercial partnerships and licensing
arrangements. We may not be able to find additional financing when we need it or
on terms favorable to our stockholders or us. If we raise additional capital by
issuing equity securities, such an issuance will reduce the percentage ownership
of existing stockholders. Furthermore, we may need to issue securities that have
rights, preferences and privileges senior to our common stock. If we raise
additional funds through commercial partnerships and licensing arrangements, we
may be required to relinquish rights to certain of our technologies or product
candidates, or to grant licenses on unfavorable terms.
IF WE LOSE OUR KEY PERSONNEL OR ARE UNABLE TO ATTRACT AND RETAIN ADDITIONAL
PERSONNEL, OUR OPERATIONS COULD BE DISRUPTED AND OUR REVENUES COULD DECREASE.
Our success depends on the continued services and on the performance of our
senior management and scientific staff, in particular John Ryals, Ph.D., our
Chief Executive Officer and President. The loss of the services of Dr. Ryals or
any of our other senior management or scientific staff could seriously impair
our ability to operate and achieve our objectives, which could reduce our
revenues. We have $2 million of key man life insurance on Dr. Ryals. This amount
may not be sufficient to compensate us for the loss of his services. In
addition, recruiting and retaining qualified scientific personnel to perform
future research and development work will be critical to our success.
In order to achieve our business objectives, we must identify, attract, train
and motivate additional personnel with expertise in specific industries and
areas applicable to the products developed through our technologies. We compete
intensely for these personnel and we may be unable to achieve our personnel
goals. Our failure to achieve any of these goals could seriously limit our
ability to improve our operations and financial results.
IF WE WERE SUCCESSFULLY SUED FOR PRODUCT LIABILITY, WE COULD FACE SUBSTANTIAL
LIABILITIES THAT EXCEED OUR RESOURCES.
We may be held liable if any product we develop, or any product which is made
using our technologies, causes injury or is found unsuitable during product
testing, manufacturing, marketing, sale or use. For example, a genetically
modified food could, after it is sold, be found to cause illness in individuals
who eat the food. Also, like other pharmaceutical products, those produced
through genetically modified plants could be found to cause illness. These risks
are inherent in the development of chemical, agricultural and pharmaceutical
products. We currently do not have product liability insurance. If we choose to
obtain product liability insurance but cannot obtain sufficient insurance
coverage at an acceptable cost or otherwise protect against potential product
liability claims, the commercialization of products that we or our commercial
partners develop may be prevented or inhibited. If we are sued for any injury
caused by our products, our liability could exceed our total assets.
IF WE DO NOT COMPETE EFFECTIVELY, OUR LOSSES COULD INCREASE.
Our technology platform for the industrialization of gene function determination
faces competition from functional genomics technologies, which are computer
hardware and software technologies that researchers use to help them identify
the role that specific genes play within organisms, created by others, including
Exelixis, Inc., CuraGen Corporation, Rosetta Inpharmatics, Inc. and Large Scale
Biology Corporation. We expect competition to intensify in genomics research as
scientists achieve technology advances that become widely known. Genomic
technologies have undergone and are expected to continue to undergo rapid and
significant change. Our future success will depend in large part on maintaining
a competitive position in the genomics field, and particularly in the functional
genomics field. We or others may make rapid technological developments which may
result in products or technologies becoming obsolete before we recover the
expenses we incur in connection with our development. We or our commercial
partners may offer products which could be made obsolete by less expensive or
more effective crop enhancement, nutrition enhancement, drug discovery and
industrial product development technologies, including technologies that may be
unrelated to genomics. We may not be able to enhance our technology in ways
necessary to compete successfully with newly emerging technologies.
Any products that we may develop alone or in collaboration with others will
compete in highly competitive markets. In the specific markets in which we apply
or intend to apply our technology platform, we face competition from plant
genomics, pharmaceutical, agri-chemical and biotechnology companies. Many of our
existing and potential competitors have substantially greater financial
resources, research and development staffs, facilities, manufacturing and
marketing experience, distribution channels and human resources than we do. Many
of these competitors have achieved substantial market penetration in the human
health, nutrition, crop production, and industrial products markets.
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Our exclusive use of plant