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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended September 30, 2002
Commission File No. 0-14710
XOMA Ltd.
(Exact name of registrant as specified in its charter)
Bermuda 52-2154066
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2910 Seventh Street, Berkeley, CA 94710
(Address of principal executive offices) (Zip Code)
(510) 204-7200
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No ___
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common shares, US$.0005 par value 70,341,504
Class Outstanding at November 1, 2002
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XOMA Ltd.
FORM 10-Q
TABLE OF CONTENTS
Page
PART I FINANCIAL INFORMATION.................................................1
Item 1. Condensed Consolidated Financial Statements (unaudited)......1
Condensed Consolidated Balance Sheets as of September 30,
2002 and December 31, 2001...................................1
Condensed Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 2002 and 2001......2
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2002 and 2001................3
Notes to Condensed Consolidated Financial Statements.........4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................10
Item 3. Quantitative and Qualitative Disclosures About Market
Risk........................................................23
Item 4. Controls and Procedures.....................................23
PART II OTHER INFORMATION..............................................24
Item 1. Legal Proceedings...........................................24
Item 2. Changes in Securities and Use of Proceeds...................24
Items 3, 4 and 5 are either inapplicable or nonexistent and therefore
are omitted from this report................................24
Item 6. Exhibits & Reports on Form 8-K..............................24
Signatures....................................................................25
Certifications................................................................26
-i-
PART I - FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
XOMA Ltd.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
September 30, 2002 December 31, 2001
(Unaudited) (Note 1)
------------------ -----------------
ASSETS
Current Assets:
Cash and cash equivalents $ 35,861 $ 67,320
Short-term investments 332 320
Receivables 6,124 1,662
Related party receivables 394 418
Inventory 1,306 1,299
Prepaid expenses and other 733 249
----------- ----------
Total current assets 44,750 71,268
Property and equipment, net 22,095 14,645
Deposits and other 172 194
----------- ----------
Total Assets $ 67,017 $ 86,107
=========== ==========
LIABILITIES & SHAREHOLDERS' EQUITY (Net Capital Deficiency)
Current Liabilities:
Accounts payable $ 3,885 $ 3,520
Accrued liabilities 6,999 4,422
Capital lease obligations - current 943 673
Deferred revenue - current 2,812 5,017
Convertible note - current 5,112 5,013
----------- ----------
Total current liabilities 19,751 18,645
Capital lease obligations - long-term 1,496 1,393
Deferred revenue - long-term 1,165 1,470
Convertible notes - long-term 58,305 50,980
----------- ----------
Total Liabilities 80,717 72,488
Shareholders' Equity (Net Capital Deficiency) (13,700) 13,619
----------- ----------
Total Liabilities & Shareholders' Equity $ 67,017 $ 86,107
=========== ==========
Note 1 - Amounts derived from the Company's audited financial statements
appearing in the Annual Report on Form 10-K for the year ended December 31, 2001
as filed with the Securities and Exchange Commission.
See accompanying notes to condensed consolidated financial statements.
XOMA Ltd.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2002 2001 2002 2001
----------- ---------- ---------- ----------
Revenues:
License and collaborative fees $ 1,423 $ 1,316 $ 9,076 $ 3,381
Contract and other revenue 2,810 1,969 9,103 7,972
----------- ---------- ---------- ----------
Total revenues 4,233 3,285 18,179 11,353
----------- ---------- ---------- ----------
Operating Costs and Expenses:
Research and development 9,701 8,162 30,395 26,097
Marketing, general and administrative 6,416 2,002 15,114 5,707
----------- ---------- ---------- ----------
Total operating costs and expenses 16,117 10,164 45,509 31,804
----------- ---------- ---------- ----------
Loss from operations (11,884) (6,879) (27,330) (20,451)
Other Income (Expense):
Investment and other income 194 611 698 1,590
Interest and other expense (572) (551) (1,714) (2,181)
----------- ---------- ---------- ----------
Net Loss $ (12,262) $ (6,819) $ (28,346) $ (21,042)
=========== ========== ========== ==========
Basic and diluted net loss per share $ (0.17) $ (0.10) $ (0.40) $ (0.31)
=========== ========== ========== ==========
Shares used in computing basic and diluted
net loss per share 70,330 70,008 70,291 67,502
=========== ========== ========== ==========
See accompanying notes to condensed consolidated financial statements.
-2-
XOMA Ltd.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
Nine Months Ended
September 30,
---------------------------------
2002 2001
------------- --------------
Cash Flows from Operating Activities:
Net loss $ (28,346) $ (21,042)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 1,332 877
Shares contributed to 401(k) and management incentive plans 541 477
Increase in convertible notes to a collaborative partner for
cost allocation 2,050 1,438
Accrued interest on convertible notes 1,354 1,993
(Gain) on investments -- (21)
(Gain) loss on disposal/retirement of property and equipment 1 (85)
Change in assets and liabilities:
Receivables and related party receivables (4,438) (898)
Inventory (7) (714)
Prepaid expenses and other (484) 25
Deposits and other assets 22 --
Accounts payable 365 (335)
Accrued liabilities 2,577 (4)
Deferred revenue (2,510) 1,236
------------- --------------
Net cash used in operating activities (27,543) (17,053)
------------- --------------
Cash Flows from Investing Activities:
Proceeds from sale of short-term investments -- 253
Purchase of property and equipment, net of sales proceeds (8,783) (4,993)
------------- --------------
Net cash used in investing activities (8,783) (4,740)
------------- --------------
Cash Flows from Financing Activities:
Proceeds from sale and leaseback transactions 1,000 1,070
Principal payments under capital lease obligations (627) (188)
Proceeds from issuance of convertible note 4,020 2,677
Proceeds from issuance of shares and warrants 474 47,868
------------- --------------
Net cash provided by financing activities 4,867 51,427
------------- --------------
Net increase (decrease) in cash and cash equivalents (31,459) 29,634
Cash and cash equivalents at beginning of year 67,320 35,043
------------- --------------
Cash and cash equivalents at end of period $ 35,861 $ 64,677
============= ==============
See accompanying notes to condensed consolidated financial statements.
-3-
XOMA Ltd.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited, dollars in thousands)
NOTE 1 - OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
XOMA Ltd. ("XOMA" or the "Company"), a Bermuda company, is a biopharmaceutical
company that develops and manufactures products to treat cancer, immunologic and
inflammatory disorders, and infectious diseases. The Company's products are
presently in various stages of development and all are subject to regulatory
approval before the Company or its collaborators can commercially introduce any
products. There can be no assurance that any of the products under development
by the Company will be developed successfully, obtain the requisite regulatory
approval or be successfully manufactured or marketed.
Basis of Presentation
The interim information contained in this report is unaudited but, in
management's opinion, includes all normal recurring adjustments necessary for a
fair presentation of results for the periods presented. Interim results may not
be indicative of results to be expected for the full year or future periods. The
condensed consolidated balance sheet as of December 31, 2001 has been derived
from the audited consolidated financial statements included in the Company's
2001 Annual Report on Form 10-K. The unaudited condensed consolidated financial
statements should be read in conjunction with the Company's audited consolidated
financial statements for the year ended December 31, 2001 included in its Annual
Report on Form 10-K.
Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities, if any, at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ materially from those
estimates.
Concentration of Risk
Cash, cash equivalents, short-term investments and accounts receivable are
financial instruments which potentially subject the Company to concentrations of
credit risk. The Company maintains and invests excess cash in money market funds
and short-term investments which bear minimal risk. The Company has not
experienced any significant credit losses and does not generally require
collateral on receivables. For the nine months ended September 30, 2002, three
customers represented 43%, 28% and 26% of total revenues and as of September 30,
2002 billed and unbilled receivables totaled $1,725, $4,000 and $232 for these
customers, respectively. For the nine months ended September 30, 2001, two
customers represented 51% and 46% of total revenues.
-4-
XOMA Ltd.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited, dollars in thousands)
Recent Accounting Pronouncements
In July of 2001, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 141, or SFAS 141, "Business
Combinations." SFAS 141 eliminates the pooling-of-interests method of accounting
for business combinations except for qualifying business combinations that were
initiated prior to July 1, 2001. In addition, SFAS 141 further clarifies the
criteria to recognize intangible assets separately from goodwill. Specifically,
SFAS 141 requires that an intangible asset may be separately recognized only if
such an asset meets the contractual-legal criterion or the separability
criterion. The requirements of SFAS 141 are effective for any business
combination accounted for by the purchase method that is completed after June
30, 2001 (i.e., the acquisition date is July 1, 2001 or after). The adoption of
SFAS 141 on January 1, 2002 had no material impact on the Company's financial
position or results of operations.
In July of 2001, the FASB issued Statement of Financial Accounting Standards No.
142, or SFAS 142, "Goodwill and Other Intangible Assets." Under SFAS 142,
goodwill and indefinite lived intangible assets are no longer amortized but are
reviewed annually (or more frequently if impairment indicators arise) for
impairment. For intangible assets with indefinite useful lives, the impairment
review will involve a comparison of fair value to carrying value, with any
excess of carrying value over fair value being recorded as an impairment loss.
For goodwill, the impairment test shall be a two-step process, consisting of a
comparison of the fair value of a reporting unit with its carrying amount,
including the goodwill allocated to each reporting unit. If the carrying amount
is in excess of the fair value, the implied fair value of the reporting unit
goodwill is compared to the carrying amount of the reporting unit goodwill. Any
excess of the carrying value of the reporting unit goodwill over the implied
fair value of the reporting unit goodwill will be recorded as an impairment
loss. Separable intangible assets that are deemed to have a finite life will
continue to be amortized over their useful lives (but with no maximum life).
Intangible assets with finite useful lives will continue to be reviewed for
impairment in accordance with Statement of Financial Accounting Standards No.
121, or SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." The amortization provisions of SFAS 142
apply to goodwill and intangible assets acquired after June 30, 2001. The
adoption of SFAS 142 on January 1, 2002 had no material impact on the Company's
financial position or results of operations.
In August of 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, or SFAS 143, "Accounting for Asset Retirement Obligations." SFAS 143
addresses financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated retirement costs.
The adoption of SFAS 143 on January 1, 2002 had no material impact on the
Company's financial position or results of operations.
In October of 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, or SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," which supersedes SFAS 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of." SFAS 144 addresses
financial accounting and reporting for the impairment of long-lived assets and
for long-lived assets to be disposed of. However, SFAS 144 retains the
fundamental provisions of SFAS 121 for: (1) recognition and measurement of the
impairment of long-lived assets to be held and used; and (2) measurement of
long-lived assets to be disposed of by sale. SFAS 144 is effective for fiscal
years beginning after December 15, 2001. The adoption of SFAS 144 on January 1,
2002 had no material effect on the Company's financial position or results of
operations.
In April of 2002, the FASB issued Statement of Financial Accounting Standards
No. 145, or SFAS 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment
of FASB Statement No. 13, and Technical Corrections," which
-5-
XOMA Ltd.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited, dollars in thousands)
provides guidance on the classification of gains and losses from the
extinguishment of debt and on the accounting for certain specified lease
transactions. The provisions of SFAS 145 which relate to the rescission of
Statement 4 are applicable in fiscal years beginning after May 15, 2002. The
remaining provisions of SFAS 145 are effective for financial statements issued
on or after May 15, 2002. The Company does not expect the adoption of SFAS 145
will have a material impact on its financial position or results of operations.
In July of 2002, the FASB issued Statement of Financial Accounting Standards No.
146, or SFAS 146, "Accounting for Costs Associated with Exit or Disposal
Activities." SFAS 146 requires that a liability for costs associated with an
exit or disposal activity be recognized and measured initially at fair value
only when the liability is incurred. SFAS 146 addresses costs associated with
restructuring activities that are currently accounted for under Emerging Issues
Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (Including Certain
Costs Incurred in a Restructuring)." The scope of SFAS 146 also covers
termination benefits that employees who are involuntarily terminated receive
under the terms of a one-time benefit arrangement, costs related to terminating
a contract that is not a capital lease and costs to consolidate facilities. SFAS
146 is effective for exit or disposal activities that are initiated after
December 31, 2002. The Company does not expect the adoption of SFAS 146 to have
a material impact on its financial position or results of operations.
Revenue Recognition
Revenue is recognized when the related costs are incurred and the four basic
criteria of revenue recognition are met: (1) persuasive evidence of an
arrangement exists; (2) delivery has occurred or services rendered; (3) the fee
is fixed and determinable; and (4) collectibility is reasonably assured.
Determination of criteria (3) and (4) are based on management's judgments
regarding the nature of the fee charged for products or services delivered and
the collectibility of those fees.
License and Collaborative Fees
Revenue from non-refundable license or technology access payments under license
and collaborative agreements where the Company has a continuing obligation to
perform is recognized as revenue over the period of the continuing performance
obligation.
Milestone payments under collaborative arrangements are recognized as revenue
upon achievement of the milestone events, which represent the culmination of the
earnings process because the Company has no future performance obligations
related to the payment. Milestone payments that require a continuing performance
obligation on the part of the Company are recognized over the period of the
continuing performance obligation. Amounts received in advance are recorded as
deferred revenue until the related milestone is achieved.
Contract Revenue
Contract revenue for research and development involves the Company providing
research, development or manufacturing services to collaborative partners. The
Company recognizes revenue under these arrangements as the related research and
development costs are incurred and collectibility is reasonably assured.
-6-
XOMA Ltd.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited, dollars in thousands)
Product Sales
The Company recognizes product revenue upon shipment when there is persuasive
evidence that an arrangement exists, delivery has occurred, the price is fixed
and determinable and collectibility is reasonably assured. Allowances are
established for estimated uncollectible amounts, product returns, and discounts,
if any.
Research and Development
The Company expenses research and development costs as incurred. Research and
development expenses consist of direct and research-related allocated overhead
costs such as facilities costs, salaries and related personnel costs and
material and supply costs. In addition, research and development expenses
include costs related to clinical trials to validate the Company's testing
processes and procedures and related overhead expenses. The Company's research
and development expenses include costs incurred to provide services to third
parties under terms of various collaborative arrangements.
Comprehensive Income (Loss)
Unrealized gains or losses on the Company's available-for-sale securities are
included in other comprehensive income (loss). Comprehensive loss and its
components for the three and nine months ended September 30, 2002 and 2001 are
as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- -----------------------------
2002 2001 2002 2001
---------- ---------- ----------- -----------
Net loss $ (12,262) $ (6,819) $ (28,346) $ (21,042)
Unrealized gain (loss) on
securities available-for-sale 12 (17) 12 (17)
---------- ---------- ----------- -----------
Comprehensive loss $ (12,250) $ (6,836) $ (28,334) $ (21,059)
========== ========== =========== ===========
Net Loss Per Share
Basic and diluted net loss per share is based on the weighted average number of
shares outstanding during the period in accordance with the FASB's Statement of
Financial Accounting Standards No. 128. The following potentially dilutive
outstanding securities were not considered in the computation of diluted net
loss per share because they would be antidilutive for each of the periods ended
September 30:
Nine months ended September 30,
---------------------------------
2002 2001
------------ --------------
(in thousands)
Options for shares 4,661 4,201
Warrants for shares 700 700
Convertible notes and related interest 10,577 4,789
-7-
XOMA Ltd.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited, dollars in thousands)
NOTE 2 - BALANCE SHEET COMPONENTS
Inventories
Inventories are stated at the lower of standard cost (which approximates
first-in, first-out cost) or market. Inventories, which relate principally to
the Company's agreement with Baxter Healthcare Corporation, consist of the
following:
September 30 December 31,
2002 2001
----------------- ---------------------
Raw minerals $ 202 $ 195
Finished goods 1,104 1,104
----------------- ---------------------
Total $ 1,306 $ 1,299
================= =====================
Accrued Liabilities
Accrued liabilities consist of the following:
September 30, December 31,
2002 2001
------------------ ------------------
Accrued payroll expenses $ 2,765 $ 2,347
Accrued clinical trial expenses 494 445
Accrued legal fees 2,825 505
Other 915 1,125
------------------ ------------------
Total $ 6,999 $ 4,422
================== ==================
NOTE 3 - LICENSE AGREEMENT
In February of 2002, XOMA and MorphoSys AG announced cross-licensing agreements
for antibody-related technologies. Under the agreements, XOMA is entitled to
receive license payments from MorphoSys in addition to a license to use the
MorphoSys HuCAL(R) GOLD antibody library for its target discovery and research
programs. MorphoSys and its partners receive a license to use the XOMA antibody
expression technology for developing antibody products using MorphoSys' phage
display-based HuCAL(R) antibody library. MorphoSys also receives a license for
the production of antibodies under the XOMA patents. The term of this license
agreement commenced in February of 2002 and remains in effect until the
expiration of the last patent within the XOMA patent rights provided under the
terms of the agreement. Because there are no continuing performance obligations
on the part of the Company under the MorphoSys agreement, the license fee
provided for in that agreement was recognized as revenue in the first quarter of
2002. Under the terms of the agreement, the license fee was to be paid in two
installments. The first was due and paid in the first quarter of 2002, and the
second portion, which was recognized as revenue in the first quarter of 2002 in
the amount of $4,000, is due in the fourth quarter of 2002. At MorphoSys'
option, the second installment could be paid in either cash in the amount of
$4,000 or with MorphoSys shares equivalent to $4,800 at the time of MorphoSys'
election to pay the second installment in shares.
Subsequent to the end of the quarter, the Company was notified by MorphoSys of
its intention to exercise its option to pay the second installment with 363,466
of its ordinary shares, which number of shares was determined with reference to
the market price of MorphoSys shares at the time of such notice (October 23,
2002). The administrative process in Germany that is required in order for these
shares to be issued has not yet been completed. Since September 30, 2002, the
per share closing price for MorphoSys shares has ranged from approximately $8.30
to $16.17. Additionally, XOMA has applied for but not yet received an exemption
from German withholding tax on the full license fee from MorphoSys. The Company
has received an inquiry from the German federal tax authority questioning
whether the Company is entitled to the exemption. Although the Company has
responded to this inquiry, claiming it is entitled to the exemption, the German
tax authority has not yet ruled on this issue. Were the German tax authorities
to find that the claimed exemption from withholding does not apply, and were any
appeals of that decision also to fail, the license fees due from MorphoSys would
be subject to withholding at a rate of approximately 26% of the cash paid or the
market value of the shares upon issuance, as the case may be. Subject to the
risks discussed in this paragraph, the Company expects to receive the MorphoSys
shares in the fourth quarter of 2002.
The Company has not recorded a provision for these uncertainties related to
either changes in the market value of the shares MorphoSys intends to issue or
the German withholding tax. Both future market conditions for the MorphoSys
shares and the final determination by the German authorities are difficult to
predict and may vary significantly. Therefore, under the provisions of Statement
of Financial Accounting Standards No. 5, Accounting for Contingencies, the
Company has determined that the conditions related to the likelihood of the
events both probable and reasonably estimable have not been met. If either of
these uncertainties results in an unfavorable outcome for XOMA, the Company's
financial position and results of operations would be adversely impacted.
-8-
XOMA Ltd.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited, dollars in thousands)
NOTE 4 - SUBSEQUENT EVENTS
Subsequent to September 30, 2002, XOMA filed a Registration Statement on Form
S-3 to register the resale by Millennium Pharmaceuticals, Inc. and an affiliate
of up to 5,000,000 common shares that we may sell to Millennium under the terms
of our investment agreement or that we may issue upon conversion of the
convertible note held by Millennium. No such common shares may be resold by
Millennium pursuant to such registration statement until such registration
statement is declared effective by the Securities and Exchange Commission.
Additionally, the convertible note for $5,000 held by Millennium was amended to
extend the maturity date from November 26, 2002 to May 26, 2003.
In October of 2002, XOMA and Dyax Corp. announced a cross-licensing agreement
for antibody-related technologies. Under the agreement, XOMA will receive
license and royalty payments from Dyax in addition to a Dyax antibody library
and a license to Dyax's phage display patents known as the Ladner patents. Dyax
receives a license to use XOMA's antibody expression technology for developing
antibody products for itself and Dyax collaborators. Dyax also receives a
license for the production of antibodies under the XOMA patents.
-9-
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations
Revenues for the three months ended September 30, 2002 were $4.2 million, a 27%
increase compared with $3.3 million for the same period in 2001. The increase
was primarily due to higher contract revenue from Baxter Healthcare Corporation
and Onyx Pharmaceuticals, Inc. for development services. Revenues for the nine
months ended September 30, 2002 increased 60% to $18.2 million compared to $11.4
million for the same period in 2001. This increase was primarily due to
increased license fees including our agreement with MorphoSys AG entered into in
February of 2002, the recognition of revenue for certain license fees and other
payments received in the current and prior periods from Baxter, Onyx and
Genentech, Inc. and contract revenue from Baxter and Onyx.
Research and development expenses for the three months and nine months ended
September 30, 2002 increased to $9.7 million and $30.4 million, respectively, or
by 18% and 16%, respectively, from $8.2 million and $26.1 million, respectively,
for the comparable periods of 2001. Spending in 2002 reflected increased
development costs associated with Raptiva(TM) (Efalizumab, formerly
Xanelim(TM)), MLN01, CAB2 and ONYX-015. The increase was partially offset by
savings on certain preclinical development programs that were discontinued
during 2001.
Our research and development activities can be divided into earlier stage
programs, which include molecular biology, process development, pilot-scale
production and preclinical testing, and later stage programs, which include
clinical testing, regulatory affairs and manufacturing clinical supplies. The
cost associated with these programs approximate the following (in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- -------------------------
2002 2001 2002 2001
----------- ---------- ----------- ----------
Earlier stage programs $ 3.0 $ 2.9 $ 12.4 $ 11.7
Later stage programs 6.7 5.3 18.0 14.4
----------- ---------- ----------- ----------
Total $ 9.7 $ 8.2 $ 30.4 $ 26.1
=========== ========== =========== ==========
-10-
Our research and development activities also can be divided into those related
to our internal projects and those related to collaborative arrangements. The
cost related to internal projects versus collaborative arrangements approximate
the following (in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- --------------------------
2002 2001 2002 2001
----------- ---------- ----------- ----------
Internal projects $ 2.5 $ 3.7 $ 12.3 $ 15.2
Collaborative arrangements 7.2 4.5 18.1 10.9
----------- ---------- ----------- ----------
Total $ 9.7 $ 8.2 $ 30.4 $ 26.1
=========== ========== =========== ==========
For the nine months ended September 30, 2002 and 2001 one project accounted for
21% and 18%, respectively, of our total research and development costs. No other
single project was greater than 20% during these periods.
Marketing, general and administrative expenses for the three months and nine
months ended September 30, 2002 increased to $6.4 million and $15.1 million,
respectively, or 220% and 165%, respectively, from $2.0 million and $5.7
million, respectively, for the comparable periods in 2001. The most significant
component of this increase was litigation expenses related to our litigation
against Biosite Incorporated and certain shareholder litigation, which totaled
approximately $3.3 million and $7.0 million in the respective three and nine
month periods of 2002. The litigation matters to which these expenses related
have been settled or otherwise resolved. The 2002 periods also include marketing
expenses related to pre-launch activities for Raptiva(TM). These marketing
expenses are expected to continue at similar or higher levels.
Investment income for the three months and nine months ended September 30, 2002
decreased to $0.2 million and $0.7 million, respectively, or 67% and 56%,
respectively, compared to $0.6 million and $1.6 million for the same periods of
2001 due to lower interest rates and lower average cash balances. Interest
expense for the three months ended September 30, 2002 and 2001 was at the same
level of $0.6 million. Interest expense for the nine months ended September 30,
2002 decreased 23% to $1.7 million as compared to $2.2 million for the same
period of 2001. This decrease reflected lower interest rates on a higher average
outstanding balance of the convertible notes due to Genentech and Millennium.
Liquidity and Capital Resources
XOMA had $36.2 million in cash, cash equivalents and short-term investments at
September 30, 2002 compared to $67.6 million at December 31, 2001. Working
capital (current assets minus current liabilities) at September 30, 2002
decreased to $25.0 million from $52.6 million at December 31, 2001. These
decreases were primarily due to net operating losses and capital expenditures
for facility expansions, including a third 2,750-liter fermentation suite.
Net cash used in operations for the nine months ended September 30, 2002 was
$27.5 million, compared with $17.1 million for the same period of 2001. This
increase primarily reflected higher net operating losses as a result of higher
marketing, general and administrative expenses.
Net capital expenditures increased to $8.8 million for the nine months ended
September 30, 2002 from $5.0 million for the same period of 2001. Current year
spending included expenses related to the renovation and expansion of our
manufacturing and warehouse facilities.
Net cash provided by financing activities decreased to $4.9 million for the nine
months ended September 30, 2002 from $51.4 million for the same period of 2001
and $3.8 million from the exercise of warrants. The prior year period included
net proceeds of $43.3 million from a common share equity financing completed in
June 2001. In addition, for the nine months ended September 30, 2002, the
Company received $4.0 million of debt financing from Genentech for the Company's
share of Raptiva(TM) development costs compared to $2.7 million for the same
period of
-11-
2001. Proceeds received from capital leases were $1.0 million for the nine
months ended September 30, 2002 compared to $1.1 million for the same period in
2001.
For the full year 2002, the Company currently expects its net loss to be
somewhat higher than in 2001, due to increased expenses on Raptiva(TM) and on
the Millennium collaboration, expansion of the Company's development
infrastructure and higher marketing, general and administrative expenses.
Based on forecasted spending levels that reflect a reduction in legal expenses,
currently anticipated revenues that include licensing revenues from Dyax
announced in October of 2002, and debt financing provided by Genentech for
XOMA's share of Raptiva(TM) development costs, the Company estimates it has
sufficient cash resources to meet its operating needs through at least the
middle of 2004. Any significant revenue shortfalls or increases in planned
spending on internal programs could shorten this period. Any new licensing
arrangements or collaborations, any financing from Millennium under the
investment agreement between the companies, as reflected in our Registration
Statement on Form S-3 filed on November 6, 2002, or any other new equity or
other financing arrangements could extend this period. Genentech and XOMA
announced in early April of 2002 that a pharmacokinetic study comparing
XOMA-produced material and Genentech-produced material did not achieve a
pre-defined statistical definition for comparability. An additional 556 patient
Phase III efficacy study testing Genentech material has now been completed.
Genentech had anticipated filing a Biologics License Application (BLA) for
Raptiva(TM) in psoriasis by the end of 2002 pending discussions with the FDA.
Following a subsequent meeting held with the FDA, the companies continue to
anticipate that the BLA will be filed by the end of 2002.
The timeliness of this submission, subsequent review by the FDA and progress or
setbacks by potentially competing products may have an adverse effect on the
Company's ability to raise new funding on acceptable terms. A further discussion
of the risks related to our business and their effects on our cash flow and
ability to raise new funding on acceptable terms is set forth below under the
heading "Forward-Looking Statements And Cautionary Factors That May Affect
Future Results."
Subsequent to the end of the quarter, the Company was notified by MorphoSys of
its intention to exercise its option to pay the second installment of the
license fee owed to the Company under its license agreement with MorphoSys using
363,466 of its ordinary shares, which number of shares was determined with
reference to the market price of MorphoSys shares at the time of such notice
(October 23, 2002). The administrative process in Germany that is required in
order for these shares to be issued has not yet been completed. Since September
30, 2002, the per share closing price for MorphoSys shares has ranged from
approximately $8.30 to $16.17. Additionally, XOMA has applied for but not yet
received an exemption from German withholding tax on the full license fee from
MorphoSys. The Company has received an inquiry from the German federal tax
authority questioning whether the Company is entitled to the exemption. Although
the Company has responded to this inquiry, claiming it is entitled to the
exemption, the German tax authority has not yet ruled on this issue. Were the
German tax authorities to find that the claimed exemption from withholding does
not apply, and were any appeals of that decision also to fail, the license fees
due from MorphoSys would be subject to withholding at a rate of approximately
26% of the cash paid or the market value of the shares upon issuance, as the
case may be. Subject to the risks discussed in this paragraph, the Company
expects to receive the MorphoSys shares in the fourth quarter of 2002.
The Company has not recorded a provision for these uncertainties related to
either changes in the market value of the shares MorphoSys intends to issue or
the German withholding tax. Both future market conditions for the MorphoSys
shares and the final determination by the German authorities are difficult to
predict and may vary significantly. Therefore, under the provisions of Statement
of Financial Accounting Standards No. 5, Accounting for Contingencies, the
Company has determined that the conditions related to the likelihood of the
events both probable and reasonably estimable have not been met. If either of
these uncertainties results in an unfavorable outcome for XOMA, the Company's
financial position and results of operations would be adversely impacted.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities, if any, at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ materially from those
estimates.
Revenue Recognition
Revenue is recognized when the related costs are incurred and the four basic
criteria of revenue recognition are met: (1) persuasive evidence of an
arrangement exists; (2) delivery has occurred or services rendered; (3) the fee
is fixed and determinable; and (4) collectibility is reasonably assured.
Determination of criteria (3) and (4) are based on management's judgments
regarding the nature of the fee charged for products or services delivered and
the collectibility of those fees.
License and Collaborative Fees
Revenue from non-refundable license or technology access payments under license
and collaborative agreements where the Company has a continuing obligation to
perform is recognized as revenue over the period of the continuing performance
obligation.
-12-
Milestone payments under collaborative arrangements are recognized as revenue
upon achievement of the milestone events, which represent the culmination of the
earnings process because the Company has no future performance obligations
related to the payment. Milestone payments that require a continuing performance
obligation on the part of the Company are recognized over the period of the
continuing performance obligation. Amounts received in advance are recorded as
deferred revenue until the related milestone is achieved.
Contract Revenue
Contract revenue for research and development involves the Company providing
research, development or manufacturing services to collaborative partners. The
Company recognizes revenue under these arrangements as the related research and
development costs are incurred and collectibility is reasonably assured.
Product Sales
The Company recognizes product revenue upon shipment when there is persuasive
evidence that an arrangement exists, delivery has occurred, the price is fixed
and determinable and collectibility is reasonably assured. Allowances are
established for estimated uncollectible amounts, product returns, and discounts,
if any.
Change in Accounting Principle
The Company previously recognized non-refundable license fees as revenue when
received and when all significant contractual obligations of the Company
relating to the fees had been met. Effective January 1, 2000, the Company
changed its method of accounting for non-refundable initial fees to recognize
such fees over the period of continuing involvement by the Company such as the
research and development period or the manufacturing period of the agreement, as
applicable. The Company believes this accounting policy is preferable based on
guidance provided in SEC Staff Accounting Bulletin No. 101, or SAB 101, "Revenue
Recognition in Financial Statements." As of January 1, 2000, there was no
cumulative effect of an accounting change as a result of the adoption of SAB 101
and there was no pro forma effect of the adoption of SAB 101 in any period
presented. In connection with the license and supply and development agreement
with Baxter on January 25, 2000, the Company received $10.0 million as an
initial, non-refundable fee. This initial fee was deferred and is being
amortized over the period of continuing involvement, which period was estimated
to be 36 months.
Forward-Looking Statements And Cautionary Factors That May Affect Future Results
Certain statements contained herein related to the relative size of the
Company's loss for 2002, the estimated levels of its expenses and revenues for
the balance of 2002, the sufficiency of its cash resources and the BLA filing
time frame, as well as other statements related to the progress and timing of
product development and present or future licensing or collaborative
arrangements, or that otherwise relate to future periods, are forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. These statements are based
on assumptions that may not prove accurate. Actual results could differ
materially from those anticipated due to certain risks inherent in the
biotechnology industry and for companies engaged in the development of new
products in a regulated market. Among other things, the actual loss for 2002
could be higher depending on revenues from licensees and collaborators, the size
and timing of expenditures and whether there are unanticipated expenditures; the
sufficiency of cash resources could be shortened if expenditures are made
earlier or in larger amounts than anticipated or are unanticipated or if funds
are not available; and the BLA filing could be delayed by unexpected safety or
efficacy issues or additional time requirements for data analysis, BLA
preparation, discussions with the FDA, enrollment in clinical studies,
additional clinical studies or manufacturing process modifications. These and
other risks, including those related to changes in the status of
-13-
existing collaborative relationships, availability of additional licensing or
collaboration opportunities, the timing or results of pending and future
clinical trials, the ability of collaborators and other partners to meet their
obligations, market demand for products, actions by the Food and Drug
Administration or the U.S. Patent and Trademark Office, uncertainties regarding
the status of biotechnology patents, uncertainties as to the costs of protecting
intellectual property and risks associated with our status as a Bermuda company
are described in more detail in the remainder of this section.
None Of Our Pharmaceutical Products Have Received Regulatory Approval; If Our
Products Do Not Receive Regulatory Approval, Neither We Nor Our Third Party
Collaborators Will Be Able To Manufacture And Market Them
Even our most developed pharmaceutical product has yet to be submitted for
licensure. We will be unable to manufacture and market our products without
required regulatory approvals in the United States and other countries. The
United States government and governments of other countries extensively regulate
many aspects of our products, including:
o testing
o manufacturing
o promotion and marketing and
o exporting.
In the United States, the Food and Drug Administration regulates pharmaceutical
products under the Federal Food, Drug, and Cosmetic Act and other laws,
including, in the case of biologics, the Public Health Service Act. At the
present time, we believe that our products will be regulated by the FDA as
biologics. The FDA recently announced that it is consolidating its
responsibility for reviewing new pharmaceutical products into its Center for
Drug Evaluation and Research, the body that currently reviews drug products,
combining that operation with part of its biologics review operation, the Center
for Biologics Evaluation and Research. Because implementation of this plan is
not expected to begin until next year, we do not know when or how this change
will affect us. State regulations may also affect our proposed products.
The FDA has substantial discretion in both the product approval process and
manufacturing facility approval process and, as a result of this discretion and
uncertainties about outcomes of testing, we cannot predict at what point, or
whether, the FDA will be satisfied with our or our collaborators' submissions or
whether the FDA will raise questions which may be material and delay or preclude
product approval or manufacturing facility approval. As we accumulate additional
clinical data, we will submit it to the FDA, which may have a material impact on
the FDA product approval process.
Our potential products will require significant additional research and
development, extensive preclinical studies and clinical trials and regulatory
approval prior to any commercial sales. This process is lengthy, often taking a
number of years, and expensive. As clinical results are frequently susceptible
to varying interpretations that may delay, limit or prevent regulatory
approvals, the length of time necessary to complete clinical trials and to
submit an application for marketing approval for a final decision by a
regulatory authority varies significantly. As a result, it is uncertain whether:
o our future filings will be delayed
o our studies will be successful
o we will be able to provided necessary additional data
o our future results will justify further development or
o we will ultimately achieve regulatory approval for any of these
products.
-14-
For example,
o in 1996, we and Genentech began developing Raptiva(TM)(Efalizumab,
formerly Xanelim(TM)) in patients with moderate-to-severe psoriasis.
In April of 2002, we and Genentech announced that a pharmacokinetic
study conducted on Raptiva(TM)comparing XOMA-produced material and
Genentech-produced material did not achieve the pre-defined
statistical definition of comparability, and the FDA requested that
another Phase III study be completed before the filing of a Biologics
License Application for Raptiva(TM), delaying the filing of a
Biologics Licensing Application with the FDA for Raptiva(TM)beyond the
previously-planned time frame of summer 2002. In September of 2002, we
and Genentech announced the results of the additional Phase III study
which achieved its primary efficacy endpoint. Although Genentech and
we are working to file a BLA by the end of 2002, unexpected delays in
the preparation of the BLA due to further data analysis, discussions
with the FDA or similar matters may prevent us from doing so. We have
also conducted a Phase I/II study of Raptiva(TM)in kidney transplant
recipients. We do not know whether there will be follow-on studies,
and if there are such follow-on studies we do not know whether any
such studies will be sufficient for regulatory approval. We have also
announced the initiation of enrollment in a Phase II clinical study of
Raptiva(TM)in patients suffering from rheumatoid arthritis. We do not
know whether or when any such testing will demonstrate product safety
and efficacy in this patient population or result in regulatory
approval.
o in December of 1992, we began human testing of our NEUPREX(R)product,
a genetically-engineered fragment of a particular human protein, and
have licensed certain worldwide rights to Baxter. In April of 2000,
members of the FDA and representatives of XOMA and Baxter discussed
results from the Phase III trial that tested NEUPREX(R)in pediatric
patients with a potentially deadly bacterial infection principally of
children called meningococcemia, and senior representatives of the FDA
indicated that the data presented were not sufficient to support the
filing of an application for marketing approval at that time. Because
we have not generated any additional data or completed any further
analysis, we do not know whether we will be able to supply such
additional data. If we conduct an additional trial to provide the
requested additional data, we will not know whether the results will
be adequate for approval until the trial has been completed and the
resulting data reviewed by the FDA. In September of 1999, we
discontinued patient enrollment in our Phase III clinical trial
testing NEUPREX(R)in trauma patients with severe blood loss because an
independent data safety monitoring board told us that interim results
from the trial did not support continuing the trial. Baxter has
initiated a Phase II study with NEUPREX(R)in Crohn's disease patients.
Enrollment in this study has now been completed, but because we do not
know the results, we do not know whether the results will justify
further development.
Given that regulatory review is an interactive and continuous process, we
maintain a policy of limiting announcements and comments upon the specific
details of the ongoing regulatory review of our products, subject to our
obligations under the securities laws, until definitive action is taken.
Because All Of Our Products Are Still In Development, We Will Require
Substantial Funds To Continue; We Cannot Be Certain That Funds Will Be Available
And, If Not Available, We May Have To Take Actions Which Could Adversely Affect
Your Investment
If adequate funds are not available, we may have to dilute or otherwise
adversely affect the rights of existing shareholders, curtail or cease
operations or, in extreme circumstances, file for bankruptcy protection. We have
spent, and we expect to continue to spend, substantial funds in connection with:
o research and development relating to our products and production
technologies
o expansion of our production capabilities
o extensive human clinical trials and
o protection of our intellectual property.
-15-
Based on current spending levels and third party funding, we believe that we
have enough cash to meet our currently anticipated needs for operating expenses,
working capital, equipment acquisitions and current research projects through at
least the middle of 2004. However, to the extent we experience changes in the
timing or size of expenditures or unanticipated expenditures, or if our
collaborators do not meet their obligations to us or anticipated revenues
otherwise do not materialize, these funds may not be adequate for this period.
As a result, we do not know whether:
o operations will generate meaningful funds
o additional agreements for product development funding can be reached
o strategic alliances can be negotiated or
o adequate additional financing will be available for us to finance our
own development on acceptable terms, if at all.
Cash balances and operating cash flow are influenced primarily by the timing and
level of payments by our licensees and development partners, as well as by our
operating costs.
Because All Of Our Products Are Still In Development, We Have Sustained Losses
In The Past And We Expect To Sustain Losses In The Future
We have experienced significant losses and, as of September 30, 2002, we had an
accumulated deficit of approximately U.S.$536.0 million.
For the year ended December 31, 2001 and the nine months ended September 30,
2002, we had a net loss of approximately U.S.$28.0 million, or U.S.$0.41 per
common share (basic and diluted), and U.S.$28.3 million, or U.S.$.40 per common
share (basic and diluted), respectively. We expect to incur additional losses in
the future. For the full year 2002, we currently expect our net loss to be
somewhat higher than in 2001, due to increased expenses on Raptiva(TM) and on
the Millennium collaboration, the further expansion of our development
infrastructure, and marketing, general and administrative expenses.
Our ability to make profits is dependent in large part on obtaining regulatory
approval for our products and entering into agreements for product development
and commercialization, both of which are uncertain. Our ability to fund our
ongoing operations is dependent on the foregoing factors and on our ability to
secure additional funds. Because all of our products are still in development,
we do not know whether we will ever make a profit or whether cash flow from
future operations will be sufficient to meet our needs.
If Third Party Collaborators Do Not Successfully Develop And Market Our
Products, We May Not Be Able To Do So On Our Own
Our financial resources and our marketing experience and expertise are limited.
Consequently, we depend to a large extent upon securing the financial resources
and marketing capabilities of third parties with whom we collaborate.
o In April of 1996, XOMA and Genentech entered into an agreement whereby
XOMA agreed to co-develop Genentech's humanized monoclonal antibody
product Raptiva(TM). In April of 1999, the companies extended and
expanded the agreement.
o In January of 2000, we licensed the worldwide rights to all
pharmaceutical compositions containing a particular human protein for
treatment of meningococcemia and additional potential future human
clinical indications to Baxter.
o In January of 2001, we entered into a strategic process development
and manufacturing alliance with Onyx Pharmaceuticals, Inc. pursuant to
which we are scaling up production to commercial volume and will
manufacture one of Onyx's cancer products.
-16-
o In November of 2001, we entered into a collaboration with Millennium
Pharmaceuticals, Inc. to develop two of Millennium's products for
certain vascular inflammation indications.
Because our collaborators are independent third parties, they may be subject to
different risks than we are and have significant discretion in determining the
efforts and resources they will apply, we do not know whether Genentech, Baxter,
Onyx or Millennium will successfully develop or market any of the products we
are collaborating on.
Even when we have a collaboration relationship, other circumstances may prevent
it from resulting in successful development of marketable products. For example,
in June of 1999, we licensed certain genetically-engineered fragments of a
particular human protein to Allergan Inc. to treat bacterial ophthalmic
infections. In May of 2000, following successful product testing at Allergan, we
expanded the collaboration. In November of 2000, Allergan advised us that for
internal economic reasons they planned to discontinue development of ophthalmic
anti-infective products derived from this protein.
Although we continue to evaluate additional strategic alliances and potential
partnerships, we do not know whether or when any such alliances or partnerships
will be entered into.
Because We Have No History Of Profitability And Because The Biotechnology Sector
Has Been Characterized By Highly Volatile Stock Prices, Announcements We Make
And General Market Conditions For Biotechnology Stocks Could Result In A Sudden
Change In The Value Of Our Common Shares
As a biopharmaceutical company, we have experienced significant volatility in
our common shares. Fluctuations in our operating results and general market
conditions for biotechnology stocks could have a significant impact on the
volatility of our common share price. From September 30, 2001 through September
30, 2002, our share price has ranged from a high of U.S.$12.19 to a low of
U.S.$3.00. On November 1, 2002 the last reported sale price of the common shares
as reported on the Nasdaq National Market was U.S.$5.75 per share. Factors
contributing to such volatility include, but are not limited to:
o results of preclinical studies and clinical trials,
o information relating to the safety or efficacy of our products,
o developments regarding regulatory filings,
o announcements of new collaborations,
o failure to enter into collaborations,
o developments in existing collaborations,
o our funding requirements and the terms of our financing arrangements,
o announcements of technological innovations or new indications for our
therapeutic products,
o government regulations,
o developments in patent or other proprietary rights,
o the number of shares outstanding,
o the number of shares trading on an average trading day,
o announcements regarding other participants in the biotechnology and
pharmaceutical industries, and
o market speculation regarding any of the foregoing.
-17-
Because Many Of The Companies We Do Business With Are Also In The Biotechnology
Sector, The Volatility Of That Sector Can Affect Us Indirectly As Well As
Directly
The same factors that affect us directly because we are a biotechnology company
can also adversely impact us indirectly by affecting the ability of our
collaborators, partners and others we do business with to meet their obligations
to us or our ability to realize the value of the consideration provided to us by
these other companies. For example, in connection with our licensing transaction
with MorphoSys AG, MorphoSys has announced that it has exercised its option to
pay a portion of the license fee owed to us in the form of equity securities of
MorphoSys, and the value of those shares is subject both to market risks
affecting our ability to realize the value of those shares and more generally to
the business and other risks to which the issuer of those shares is subject. The
administrative process in Germany that is required in order for these shares to
be issued has not yet been completed. Since September 30, 2002, the per share
closing price for MorphoSys shares has ranged from approximately $8.30 to
$16.17, which demonstrates the volatility of these shares in the current market.
If Any Of Our Products Receives Regulatory Approval, We May Not Be Able To
Increase Existing Or Acquire New Manufacturing Capacity Sufficient To Meet
Market Demand
Because we have never commercially introduced any pharmaceutical products and
none of our products have received regulatory approval, we do not know whether
the capacity of our existing manufacturing facilities can be increased to
produce sufficient quantities of our products to meet market demand. Also, if we
need additional manufacturing facilities to meet market demand, we cannot
predict that we will successfully obtain those facilities because we do not know
whether they will be available on acceptable terms. In addition, any
manufacturing facilities acquired or used to meet market demand must meet the
FDA's quality assurance guidelines.
Because We Do Not And Cannot Currently Market Any Of Our Products For Commercial
Sale, We Do Not Know Whether There Will Be A Viable Market For Our Products
Even if we receive regulatory approval for our products and we or our third
party collaborators successfully manufacture them, our products may not be
accepted in the marketplace. For example, physicians and/or patients may not
accept a product for a particular indication because it has been biologically
derived (and not discovered and developed by more traditional means) if no
biologically-derived products are currently in widespread use in that
indication, as is currently the case with psoriasis. Consequently, we do not
know if physicians or patients will adopt or use our products for their approved
indications.
If Our And Our Partners' Patent Protection For Our Principal Products And
Processes Is Not Enforceable, We Will Not Realize Our Profit Potential
Because of the length of time and the expense associated with bringing new
products to the marketplace, we and our partners hold and are in the process of
applying for a number of patents in the United States and abroad to protect our
products and important processes and also have obtained or have the right to
obtain exclusive licenses to certain patents and applications filed by others.
However, the patent position of biotechnology companies generally is highly
uncertain and involves complex legal and factual questions, and no consistent
policy regarding the breadth of allowed claims has emerged from the actions of
the U.S. Patent and Trademark Office with respect to biotechnology patents.
Legal considerations surrounding the validity of biotechnology patents continue
to be in transition, and historical legal standards surrounding questions of
validity may not continue to be applied, and current defenses as to issued
biotechnology patents may not in fact be considered substantial in the future.
These factors have contributed to uncertainty as to:
o the degree and range of protection any patents will afford against
competitors with similar technologies
o if and when patents will issue
-18-
o whether or not others will obtain patents claiming aspects similar to
those covered by our patent applications or
o the extent to which we will be successful in avoiding infringement of
any patents granted to others.
The Patent Office has issued approximately 60 patents to us related to our
products based on human bactericidal permeability-increasing protein, which we
call BPI, including novel compositions, their manufacture, formulation, assay
and use. In addition, we are the exclusive licensee of BPI-related patents and
applications owned by New York University and Incyte Pharmaceuticals Inc. The
Patent Office has also issued nine patents to us related to our bacterial
expression technology.
If certain patents issued to others are upheld or if certain patent applications
filed by others issue and are upheld, we may require licenses from others in
order to develop and commercialize certain potential products incorporating our
technology or we may become involved in litigation to determine the proprietary
rights of others. These licenses, if required, may not be available on
acceptable terms, and any such litigation may be costly and may have other
adverse effects on our business, such as inhibiting our ability to compete in
the marketplace and absorbing significant management time.
Due to the uncertainties regarding biotechnology patents, we also have relied
and will continue to rely upon trade secrets, know-how and continuing
technological advancement to develop and maintain our competitive position. All
of our employees have signed confidentiality agreements under which they have
agreed not to use or disclose any of our proprietary information. Research and
development contracts and relationships between us and our scientific
consultants and potential customers provide access to aspects of our know-how
that are protected generally under confidentiality agreements. These
confidentiality agreements may not be honored or may not be enforced by a court.
To the extent proprietary information is divulged to competitors or to the
public generally, such disclosure may adversely affect our ability to develop or
commercialize our products by giving others a competitive advantage or by
undermining our patent position.
Protecting Our Intellectual Property Can Be Costly And Exposes Us To Risks Of
Counterclaims Against Us
We may be required to engage in litigation or other proceedings to protect our
intellectual property. The cost to us of this litigation, even if resolved in
our favor, could be substantial. Such litigation could also divert management's
attention and resources. In addition, if this litigation is resolved against us,
our patents may be declared invalid, and we could be held liable for significant
damages. In addition, if the litigation included a claim of infringement by us
of another party's patent that was resolved against us, we or our collaborators
may be enjoined from developing, manufacturing, selling or importing products,
processes or services without a license from the other party.
Other Companies May Render Some Or All Of Our Products Noncompetitive Or
Obsolete
Developments by others may render our products or technologies obsolete or
uncompetitive. Technologies developed and utilized by the biotechnology and
pharmaceutical industries are continuously and substantially changing.
Competition in the areas of genetically-engineered DNA-based and antibody-based
technologies is intense and expected to increase in the future as a number of
established biotechnology firms and large chemical and pharmaceutical companies
advance in these fields. Many of these competitors may be able to develop
products and processes competitive with or superior to our own for many reasons,
including that they may have:
o significantly greater financial resources
o larger research and development and marketing staffs
o larger production facilities
o entered into arrangements with, or acquired, biotechnology companies
to enhance their capabilities or
o extensive experience in preclinical testing and human clinical trials.
-19-
These factors may enable others to develop products and processes competitive
with or superior to our own. In addition, a significant amount of research in
biotechnology is being carried out in universities and other non-profit research
organizations. These entities are becoming increasingly interested in the
commercial value of their work and may become more aggressive in seeking patent
protection and licensing arrangements.
Without limiting the foregoing, we are aware that:
o Biogen Inc. has announced that its Amevive(R) product achieved
positive results in Phase III clinical trials in patients with
moderate-to-severe plaque psoriasis, that the FDA and the EMEA have
officially accepted Biogen's filings for approval of Amevive(R) in
psoriasis, that a FDA advisory panel voted to recommend approval of
Amevive(R) for the treatment of moderate-to-severe chronic plaque
psoriasis and that the FDA has committed to complete the review of its
Amevive(R) application by the end of the first quarter of 2003;
o Centocor Inc., a unit of Johnson & Johnson, has tested its rheumatoid
arthritis and Crohn's disease drug in psoriasis, and it has been
announced that the drug has shown clinical benefit;
o it has been announced that Immunex Corp. (recently acquired by Amgen
Inc.) has tested its rheumatoid arthritis and psoriatic arthritis drug
in psoriasis with positive results;
o MedImmune, Inc. has completed enrollment in three Phase II trials to
evaluate its anti-T cell monoclonal antibody in psoriasis;
o GenMab A/S has announced that the FDA approved its investigational new
drug filing for HuMax-CD4 for psoriasis and the initiation of a Phase
II study; and
o other companies, including Medarex, Inc., are developing monoclonal
antibody or other products for treatment of inflammatory skin
disorders.
Currently, there are several companies with marketed biologics that are approved
for treating patients with rheumatoid arthritis:
o Immunex Corp. markets Enbrel,
o Amgen Inc. gained FDA approval for Kineret and
o Centocor Inc. is approved to market Remicade to rheumatoid arthritis
patients.
In addition to approved products, a number of companies are developing drugs
with a biologic mechanism of action for the treatment of rheumatoid arthritis.
These companies include Cambridge Antibody Technology Group plc, Biogen Inc.,
Celltech Group plc and others.
A number of companies are developing monoclonal antibodies targeting cancers,
which may prove more effective than ONYX-015 or the ING-1 antibody.
It is possible that one or more other companies may be developing one or more
products based on the same human protein as our NEUPREX(R) product, and these
product(s) may prove to be more effective than NEUPREX(R) or receive regulatory
approval prior to NEUPREX(R) or any BPI-derived ophthalmic product developed by
XOMA.
As We Do More Business Internationally, We Will Be Subject To Additional
Political, Economic and Regulatory Uncertainties
We may not be able to successfully operate in any foreign market. We believe
that, because the pharmaceutical industry is global in nature, international
activities will be a significant part of our future business activities and
that, when and if we are able to generate income, a substantial portion of that
income will be derived from product sales
-20-
and other activities outside the United States. Foreign regulatory agencies
often establish standards different from those in the United States, and an
inability to obtain foreign regulatory approvals on a timely basis could put us
at a competitive disadvantage or make it uneconomical to proceed with a
product's development. International operations may be limited or disrupted by:
o imposition of government controls
o export license requirements
o political or economic instability
o trade restrictions
o changes in tariffs
o restrictions on repatriating profits
o withholding and other taxation and
o difficulties in staffing and managing international operations.
For example, we have applied for but not yet received an exemption from German
withholding tax on the full license fee owed to us by MorphoSys in connection
with our previously announced cross-licensing agreements. We have received an
inquiry from the German federal tax authority questioning whether we are
entitled to the exemption. Although we have responded to this inquiry, claiming
we are entitled to the exemption, the German tax authority has not yet ruled on
this issue. Were the German tax authority to find that the claimed exemption
from withholding does not apply, and were any appeals of that decision also to
fail, the license fees due from MorphoSys would be subject to withholding at a
rate of approximately 26% of the cash paid or the value of the shares upon
issuance, as the case may be.
Also, our financial results could be significantly affected by factors such as
fluctuations in currency exchange rates or weak economic conditions in the
foreign markets in which we or our collaborators seek to operate.
Because We Are A Relatively Small Biopharmaceutical Company With Limited
Resources, We May Not Be Able To Attract And Retain Qualified Personnel, And The
Loss Of Key Personnel Could Delay Or Prevent Achieving Our Objectives
Our success in developing marketable products and achieving a competitive
position will depend, in part, on our ability to attract and retain qualified
scientific and management personnel, particularly in areas requiring specific
technical, scientific or medical expertise. There is intense competition for
such personnel. Our research, product development and business efforts would be
adversely affected by the loss of one or more of key members of our scientific
or management staff, particularly our executive officers: John L. Castello, our
Chairman of the Board, President and Chief Executive Officer; Patrick J.
Scannon, M.D., Ph.D., our Chief Scientific and Medical Officer and Senior Vice
President; Clarence L. Dellio, our Senior Vice President, Operations; Peter B.
Davis, our Vice President, Finance and Chief Financial Officer; and Christopher
J. Margolin, our Vice President, General Counsel and Secretary. We have
employment agreements with Mr. Castello, Dr. Scannon and Mr. Davis. We currently
have no key person insurance on any of our employees.
Because We Engage In Human Testing, We Are Exposed To An Increased Risk Of
Product Liability Claims
The testing and marketing of medical products entails an inherent risk of
allegations of product liability. We believe that we currently have adequate
levels of insurance for our clinical trials; however, in the event of one or
more large, unforeseen awards, such levels may not provide adequate coverage. We
will seek to obtain additional insurance, if needed, if and when our products
are commercialized; however, because we do not know when this will occur, we do
not know whether adequate insurance coverage will be available or be available
at acceptable costs. A significant
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product liability claim for which we were not covered by insurance would have to
be paid from cash or other assets. To the extent we have sufficient insurance
coverage, such a claim would result in higher subsequent insurance rates.
We May Be Subject To Increased Risks Because We Are A Bermuda Company
Alleged abuses by certain companies that have changed their legal domicile from
jurisdictions within the United States to Bermuda have created an environment
where, notwithstanding that we changed our legal domicile in a transaction that
was approved by our shareholders and fully taxable to our company under U.S.
law, we may be exposed to various prejudicial actions, including:
o "blacklisting" of our common shares by certain pension funds
o legislation restricting certain types of transactions and
o punitive tax legislation.
We do not know whether any of these things will happen, but if implemented one
or more of them may have an adverse impact on our future operations or our share
price.
If You Were To Obtain A Judgment Against Us, It May Be Difficult To Enforce
Against Us Because We Are A Foreign Entity
We are a Bermuda company. All or a substantial portion of our assets may be
located outside the United States. As a result, it may be difficult for
shareholders and others to enforce in United States courts judgments obtained
against us. We have irrevocably agreed that we may be served with process with
respect to actions based on offers and sales of securities made in the United
States by serving Christopher J. Margolin, c/o XOMA Ltd., 2910 Seventh Street,
Berkeley, California 94710, our United States agent appointed for that purpose.
We have been advised by our Bermuda counsel, Conyers Dill & Pearman, that there
is doubt as to whether Bermuda courts would enforce judgments of United States
courts obtained in (1) actions against XOMA or our directors and officers that
are predicated upon the civil liability provisions of the U.S. securities laws
or (2) original actions brought in Bermuda against XOMA or such persons
predicated upon the U.S. securities laws. There is no treaty in effect between
the United States and Bermuda providing for such enforcement, and there are
grounds upon which Bermuda courts may not enforce judgments of United States
courts. Certain remedies available under the United States federal securities
laws may not be allowed in Bermuda courts as contrary to that nation's policy.
Our Shareholder Rights Agreement Or Bye-laws May Prevent Transactions That Could
Be Beneficial To Our Shareholders And May Insulate Our Management From Removal
Our shareholder rights agreement could make it considerably more difficult or
costly for a person or group to acquire control of XOMA in a transaction that
our board of directors opposes.
Our bye-laws:
o require certain procedures to be followed and time periods to be met
for any shareholder to propose matters to be considered at annual
meetings of shareholders, including nominating directors for election
at those meetings;
o authorize our board of directors to issue up to 1,000,000 preference
shares without shareholder approval and to set the rights, preferences
and other designations, including voting rights, of those shares as
the board of directors may determine; and
o contain provisions, similar to those contained in the Delaware General
Corporation Law, that may make business combinations with interested
shareholders more difficult.
-22-
These provisions of our shareholders rights agreement and our bye-laws, alone or
in combination with each other, may discourage transactions involving actual or
potential changes of control, including transactions that otherwise could
involve payment of a premium over prevailing market prices to holders of common
shares, could limit the ability of shareholders to approve transactions that
they may deem to be in their best interests and could make it considerably more
difficult for a potential acquiror to replace management.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk. The Company's exposure to market rate risk due to changes in
interest rates relates primarily to the Company's investment portfolio. The
Company does not use derivative financial instruments in its investment
portfolio. By policy, the Company places its investments with high quality debt
security issuers, limits the amount of credit exposure to any one issuer, limits
duration by restricting the term and holds investments to maturity except under
rare circumstances. The Company classifies its cash equivalents as fixed rate if
the rate of return on an instrument remains fixed over its term. As of September
30, 2002, all the Company's cash equivalents are classified as fixed rate.
The Company also has a long-term convertible note due to Genentech in 2005.
Interest on this note of LIBOR plus 1% is reset at the end of June and December
each year and is therefore variable.
The table below presents the amounts and related weighted interest rates of the
Company's cash equivalents and long-term convertible note at September 30, 2002:
Fair Value Average Interest
Maturity (in thousands) Rate
--------------- ------------------ ----------------
Cash equivalents, fixed rate Daily $ 35,861 1.90%
Long-term convertible note, variable rate 2005 $ 58,305 2.96%
Other Market Risk. At September 30, 2002, the Company had a long-term
convertible note outstanding which is convertible into common shares based on
the market price of the Company's common shares at the time of conversion. A 10%
decrease in the market price of the Company's common shares would increase the
number of shares issuable upon conversion of either security by approximately
11%. An increase in the market price of Company common shares of 10% would
decrease the shares issuable by approximately 9%.
Item 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
our Chairman of the Board, President and Chief Executive Officer and our Vice
President, Finance and Chief Financial Officer, we conducted an evaluation of
our disclosure controls and procedures, as such term is defined under Rule
13a-14(c) promulgated under the Securities Exchange Act of 1934, as amended,
within 90 days of the filing date of this report. Based on this evaluation, our
Chairman of the Board, President and Chief Executive Officer and our Vice
President, Finance and Chief Financial Officer concluded that our disclosure
controls and procedures are effective in timely alerting them to material
information relating to the Company and its consolidated subsidiaries required
to be included in our periodic SEC filings.
There have been no significant changes in our internal controls or in other
factors that could significantly affect these controls subsequent to the date of
the evaluation referenced above.
-23-
PART II - OTHER INFORMATION
OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
On September 13, 2002, all claims and counterclaims in XOMA's litigation with
Biosite Incorporated were dismissed with prejudice pursuant to a settlement
agreement between the parties. Other terms of the settlement included a
royalty-free license to XOMA to practice certain Biosite patents, assignment to
XOMA of Biosite's antibody expression technology that was announced earlier this
year, a royalty-free license to Biosite to utilize XOMA's bacterial cell
expression technology, an agreement pursuant to which XOMA may receive
expression libraries for up to an agreed number of targets it presents to
Biosite, termination of the existing license to Biosite from XOMA for the LBP
diagnostic assay and an exchange of releases.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company continues to use the net proceeds from its June 2001 registered
offering of common shares for general corporate purposes, including leasehold
improvements, equipment acquisitions, current research and development projects,
the development of new products or technologies, general working capital and
operating expenses. Pending application of the net proceeds as described above,
the Company has invested the remaining net proceeds of the offering in
short-term, investment-grade, interest-bearing securities.
Item 3. DEFAULTS UPON SENIOR SECURITIES
None
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
Item 5. OTHER INFORMATION
None
Item 6. EXHIBITS & REPORTS ON FORM 8-K
(a) Exhibits:
Amendment No. 1 to Convertible Subordinated Promissory Note dated
November 5, 2002 (incorporated by reference to Exhibit 10.3A to the
Company's Registration Statement on Form S-3 (No. 333-101035), filed
November 6, 2002).
(b) Reports on Form 8-K:
None
-24-
XOMA Ltd.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
XOMA Ltd.
Date: November 14, 2002 By: /s/ JOHN L. CASTELLO
--------------------
John L. Castello
Chairman of the Board, President and
Chief Executive Officer
Date: November 14, 2002 By: /s/ PETER B. DAVIS
------------------
Peter B. Davis
Vice President, Finance and
Chief Financial Officer
-25-
CERTIFICATION ACCOMPANYING PERIODIC REPORT
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.ss.1350)
Each of the undersigned officers of XOMA Ltd. (the "Company") hereby certify
that (1) the Quarterly Report of the Company on Form 10-Q for the period ended
September 30, 2002 (the "Report") fully complies with the requirements of
Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and (2) the
information contained in the Report fairly presents, in all material respects,
the financial condition and the results of operations of the Company.
XOMA Ltd.
Date: November 14, 2002 By: /s/ JOHN L. CASTELLO
--------------------
John L. Castello
Chairman of the Board, President and
Chief Executive Officer
Date: November 14, 2002 By: /s/ PETER B. DAVIS
------------------
Peter B. Davis
Vice President, Finance and
Chief Financial Officer
-26-
CERTIFICATIONS
I, JOHN L. CASTELLO, certify that:
1. I have reviewed this quarterly report on Form 10-Q of XOMA Ltd.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The Registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002 By: /s/ JOHN L. CASTELLO
--------------------
John L. Castello
Chairman of the Board, President and
Chief Executive Officer
-27-
I, PETER B. DAVIS, certify that:
1. I have reviewed this quarterly report on Form 10-Q of XOMA Ltd.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002 By: /s/ PETER B. DAVIS
------------------
Peter B. Davis
Vice President, Finance and
Chief Financial Officer
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