-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HodlGyBVlFy5hHBIfCbSvXsPisRPWnjFc9M9tHj9npFMtObkknBL0Uk93461bbwt Q3X5hvL+T/2yMWGsCgFT/Q== 0000927016-02-001832.txt : 20020415 0000927016-02-001832.hdr.sgml : 20020415 ACCESSION NUMBER: 0000927016-02-001832 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020401 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GENOME THERAPEUTICS CORP CENTRAL INDEX KEY: 0000356830 STANDARD INDUSTRIAL CLASSIFICATION: IN VITRO & IN VIVO DIAGNOSTIC SUBSTANCES [2835] IRS NUMBER: 042297484 STATE OF INCORPORATION: MA FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-10824 FILM NUMBER: 02598009 BUSINESS ADDRESS: STREET 1: 1OO BEAVER ST CITY: WALTHAM STATE: MA ZIP: 02453 BUSINESS PHONE: 7813982300 MAIL ADDRESS: STREET 1: 100 BEAVER STREET CITY: WALTHAM STATE: MA ZIP: 02453 FORMER COMPANY: FORMER CONFORMED NAME: COLLABORATIVE RESEARCH INC DATE OF NAME CHANGE: 19920703 10-K405 1 d10k405.txt FORM 10-K =============================================================================== 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, 2001 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number: 0-10824 Genome Therapeutics Corp. (Exact name of registrant as specified in its charter) Massachusetts 04-2297484 (State or other jurisdiction (IRS employer of incorporation or organization) identification number) 100 Beaver Street, Waltham, Massachusetts 02453 (Address of principal executive offices) (Zip Code) Registrant's telephone number: (781) 398-2300 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.10 PAR VALUE (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [X] The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 27, 2002 was approximately $131,327,000. The number of shares outstanding of the registrant's common stock as of March 27, 2002 was 22,831,030. Documents Incorporated By Reference Portions of the registrant's proxy statement for use at its Annual Meeting to be held on June 25, 2002 are incorporated by reference into Part III. =============================================================================== PART I ITEM 1. Business Overview We are a biopharmaceutical company focused on the discovery and development of pharmaceutical and diagnostic products. We have eight established product development programs. Our lead product candidate, Ramoplanin, is in Phase III clinical trials for the prevention of bloodstream infections caused by vancomycin-resistant enterococci (VRE). We have six alliances with pharmaceutical companies including Schering-Plough, AstraZeneca, Wyeth-Ayerst and bioMerieux, and a joint venture with ArQule. In addition to these eight projects, we have a portfolio of earlier stage internal drug discovery programs. We also maintain an active service business, GenomeVisionTM Services, providing drug discovery services to pharmaceutical and biotechnology companies and to the National Human Genome Research Institute. BioPharmaceutical Product Discovery and Development - --------------------------------------------------- We concentrate our product discovery and development efforts in two principal areas: (i) infectious diseases caused by bacterial and fungal pathogens and (ii) human diseases believed to have a significant genetic component. In both of these fields we have built integrated discovery platforms to discover genes and characterize their function. We use these platforms to pursue the discovery of new products through strategic alliances with corporate partners and through internal research programs. We have long been a leader in the use of genomics to discover new drugs for the treatment of bacterial and fungal infections. In October 2001, we in-licensed the compound, Ramoplanin, and are developing it for the prevention of bloodstream infections caused by vancomycin-resistant enterococci (VRE). We have two ongoing discovery and development collaborations with Schering-Plough. The first is focused on new treatments for drug resistant bacterial infections, including Staph. aureus, and the second is focused on novel anti-fungals. We have partnered with AstraZeneca to develop treatments for ulcers caused by H. pylori and with bioM[eacute]rieux to develop diagnostics for bacterial infections. We have formed a joint venture with ArQule, Inc. to discover and develop new broad-spectrum antibiotics. In addition to these collaborations, we have continued to invest in internal research programs in bacterial and fungal infections. In addition to drug discovery for bacterial and fungal infections, we are leaders in the use of population genetics as a tool in discovering new therapies for the treatment of chronic human diseases. We have formed an alliance with Schering-Plough to discover new treatments for asthma and an alliance with Wyeth-Ayerst for the treatment of osteoporosis. We also continue to invest in the development of new therapies for the treatment of osteoporosis as well as neurological and psychiatric diseases. Scientific Background Infectious Disease The identification and characterization of the genes essential to the survival of a pathogen may lead to the development of innovative drugs to combat infection. We have sequenced the genomes of over 20 important pathogens and have developed a database that includes proprietary and publicly available genetic information from over thirty microbial organisms, including organisms responsible for the most prevalent bacterial infections. Our researchers have used this database to conduct cross-genome comparisons and identify genes conserved in a large number of pathogens. Then, through a series of technologies, we refer to as the PathoEssentialTM platform, we have been able to identify conserved genes that are essential for survival of the organisms, (known as essential targets). Screening assays are then developed to screen compounds for activity against these conserved essential targets. In addition, we have developed a suite of technologies that allow us to characterize, profile, determine and/or confirm mechanism of action of compounds identified in our primary high-throughput screening assays. We have built a high-throughput screening capability. In 2001, our first full year of operation, we generated over 2.2 million data points. We use biochemical and cell-based assays internally. We also collaborate with a third party, Cetek, to conduct affinity-based screening on targets of unknown function. To capitalize on this screening capability, we have built a diverse compound library from commercial sources of approximately 80,000 compounds selected based on chemical diversity and other "drug-like" properties. We have invested in our in vivo, pre-clinical capabilities and have commenced in vivo testing on several compounds. 1 Chronic Human Diseases A variety of factors cause human disease, including genetic defects, pathogens and environmental factors, with many of the most common life threatening and chronic diseases believed to have a genetic component. Consequently, the identification and characterization of genes associated with these chronic diseases may lead to new therapies and diagnostic tests. The completion of the first draft of the human genome and additional genomics initiatives such as the SNP consortium have resulted in the generation of tremendous amounts of gene sequence and polymorphism information, but new products based on this information are yet to be discovered. Identifying genes that cause or are associated with a specific disease and determining how those genes contribute to the disease is a formidable challenge. Therefore, industrialized discovery technologies that can convert this large amount of genomic data into actual drug candidates are critical to translate these early-stage discoveries into actual treatments for human disease. We have developed an integrated suite of technologies, tools and data management and analysis capabilities to bridge this gap between genomics data and drug candidates. We have developed sophisticated techniques for evaluating population resources to identify genes associated with chronic disease or rare genetic disorders. Our scientists carefully characterize human phenotypes and develop linkage maps to discover genes associated with human disease. We have designed an integrated platform of highly automated, industrial scale technologies that permits us to rapidly analyze and draw conclusions from genomic information. We believe our approach will allow our collaborators and us to effectively use genomic information to identify and validate targets that can be successfully developed into novel therapeutics and diagnostic products. Our Drug Discovery and Development Strategy Our strategy is to focus our drug discovery and development efforts on bacterial and fungal infections and chronic human diseases. We employ three pathways to discover and develop new products. Each path has a different level of internal vs external funding and different economics. The table below sets forth the typical funding and economic structure for the various pathways:
- ------------------------------------------------------------------------------------------ Pathway Funding GENE Economics - ------------------------------------------------------------------------------------------ . License fees Drug Discovery Alliances 100% funded by alliance partner . Milestone payments . Sponsored research . Royalties - ------------------------------------------------------------------------------------------ Joint Ventures 50-50 shared funding 50-50 profit split - ------------------------------------------------------------------------------------------ Internal Discovery Programs 100% funded by GENE 100% to GENE, net of 3rd & In-Licensed Products party royalties - ------------------------------------------------------------------------------------------
Drug Discovery Alliances We seek to form strategic alliances with major pharmaceutical companies to maximize the probability of success in drug discovery and development. This is particularly important for research programs that require the discovery and/or development capabilities of a major pharmaceutical company to fully exploit or that address market opportunities that would require a large, global sales and marketing infrastructure. In these alliances, typically, the alliance partner funds research efforts with us to discover genes, determine their function and develop assays to test compounds against those genes. As we successfully complete our portion of the program, the partner assumes responsibility for downstream drug discovery and development. We believe, for example, that our current alliances with Wyeth-Ayerst, Schering-Plough, AstraZeneca, and bioMerieux, all industry leaders in their fields, are providing us with the best opportunity to capitalize on our early genomics discoveries. We continue to meet or exceed our development schedule with all of our alliance partners and seek to extend or expand these alliances, when it is strategically beneficial to both parties. 2 We will continue to seek additional alliances, particularly in chronic human diseases. We believe that these diseases represent large commercial opportunities that require the resources of a major pharmaceutical company. We will seek partners that have franchises in the treatment of these major disease indications. We believe companies that have major research efforts and/or commercial products focused on a particular disease will continue to be motivated to utilize genomic information to develop novel products that will allow them to maintain or enhance their market leadership position. Joint Ventures In late 2000, we made the strategic decision to begin investing more heavily in joint ventures and internally funded programs in infectious disease. Our goal is to invest in a number of these ventures to take advantage of development synergies that certain strategic partners can offer. This should allow us to accelerate the process of drug discovery as well as capture a larger share of the program value. Our joint venture with ArQule is an example of this kind of program. This venture is funded equally by both companies and is focused on discovering new broad-spectrum anti-bacterials. It combines our gene targets, assay development, screening and anti-bacterial discovery technologies with the extensive compound libraries and medicinal chemistry capabilities of our partner. Internal Discovery Programs We continue to invest to expand our internal drug discovery capabilities in bacterial and fungal infections. During the last two years, we have built a high-throughput screening capability. In 2001, our first full year of operation, we generated over 2.2 million data points. We have built a diverse compound library of approximately 80,000 compounds derived from commercial sources. We have invested in our in vivo, pre-clinical capabilities and have commenced in vivo testing on several compounds. While we will seek to partner some of these programs with larger companies, we will also seek to develop and commercialize some of these discoveries ourselves for niche opportunities, such as hospital-acquired infections or infections in immuno-compromised patients. We continue to evaluate and invest in acquiring additional family resources (families whose members suffer from diseases with a significant inherited component) for new drug discovery programs in chronic human diseases. Additionally, we continue to invest in our platform to rapidly discover and characterize the function of genes associated with human disease. We plan to partner these programs with major pharmaceutical companies for downstream discovery, clinical development and commercialization. In-licensed compounds for Clinical and Commercial Development We seek to supplement our drug discovery efforts with an active in-licensing program. We seek to in-license products in pre-clinical and/or clinical development that will complement our internal drug discovery efforts for infectious diseases. Our first such product candidate, Ramoplanin, is in Phase III clinical trials for the prevention of bloodstream infections caused by VRE. We will also explore additional indications for this product candidate, potentially expanding and extending its value. BioPharmaceutical and Diagnostic Programs We have eight ongoing product development programs. Our lead product candidate, Ramoplanin, is in Phase III clinical trials for the prevention of bloodstream infections caused by VRE. We have six alliances with pharmaceutical companies including Schering-Plough, AstraZeneca, Wyeth-Ayerst and bioMerieux, and a joint venture with ArQule. In addition to these eight programs, we have a portfolio of earlier stage internal drug discovery programs. Ramoplanin Bacteria are commonly classified into two categories: gram-positive and gram-negative. Enterococci are a family of gram-positive bacteria that are part of the normal flora of the gastrointestinal tract. While these organisms do not normally cause infections in healthy people, they become a threat in patients that have a compromised immune system and are frequently found in hospitalized patients. Enterococci are now the second most common cause of bloodstream infections acquired in the Intensive Care Units (ICUs) of hospitals in the United States. Enterococcal bloodstream infections in the ICU have been associated with a crude mortality of over 30%. 3 For thirty years, the antibiotic of last resort for enteroccal bloodstream infections was vancomycin. However, the widespread use of vancomycin and other antibiotics such as third generation cephalosporins has increased the prevalence of resistant strains of enterococci, known as vancomycin-resistant enterococci (VRE). In 1999, more than 25% of intensive care unit enterococci infections were caused by VRE, a 47% increase from 1994. Given its rapid spread and the difficulty in treating blood-borne infections, VRE has received significant attention from both the medical and public health communities. Most VRE is not only resistant to vancomycin, but also to other common antibiotics. This provides VRE with a selective advantage over other enterococcal isolates in the gut and enables resistant pathogens to easily colonize the human gastrointestinal (GI) tract. The morbidity and mortality associated with VRE bloodstream infections is substantially higher than for enterococcal bloodstream infections caused by vancomycin-sensitive strains of enterococci. Given the high morbidity, mortality and cost of VRE bloodstream infections and the limited treatment options for active infections, a great deal of focus within the infectious disease community has been placed on infection control practices within the hospital to prevent VRE infections. Infection control has focused on screening to identify colonized patients and the use of barrier methods to avoid the spread of colonization to other patients. Typically, these require isolation of the patient in a room with negative air pressure and the "gowning and gloving" of physicians and nursing staff. Such patients are often not allowed to have family visitors. The large quantity of VRE in the gut has motivated investigators to seek to de-colonize the gut in an attempt to prevent VRE bloodstream infections. However, attempts to prevent VRE bloodstream infections have been unsuccessful in the past. Bacitracin has been tried in combination with or without gentamicin or a tetracycline. Novobiocin has also been tried. It is believed that these approaches have not been successful due to lack of potency or the inability of the antibacterials to reach high enough levels in the gut to suppress VRE effectively. In October 2001, we in-licensed Ramoplanin, a product under development as a novel antibiotic for the prevention of bloodstream infections caused by VRE, from Biosearch Italia S.p.A (Biosearch). Ramoplanin is a novel glycolipodepsipeptide antibiotic produced by fermentation of Actinoplanes species, with activity against gram-positive aerobic and anaerobic microorganisms. In preclinical studies Ramoplanin has been shown to be bactericidal for most gram-positive species, including methicillin-resistant staphylococci and VRE. Ramoplanin inhibits the bacterial cell wall peptidoglycan biosynthesis with a mechanism different from that of vancomycin, teicoplanin or other cell wall-synthesis inhibitors. No evidence of cross-resistance between Ramoplanin and other glycopeptide antibiotics has been observed. Ramoplanin has a unique profile (see Table 5) that may make it a particularly attractive compound for killing bacteria in the gastrointestinal tract. This may make the product a useful drug in the treatment of certain infections (C. Difficile) that occur in the GI tract. It may also make the compound effective in the prevention of bloodstream infections by gram positive organisms that are concentrated in the GI tract, including VRE. - -------------------------------------------------------------------------------- Table 5: Ramoplanin Profile - -------------------------------------------------------------------------------- Characteristic Potential Advantage - -------------------------------------------------------------------------------- Novel class of antibiotic . No demonstrated cross-resistance with other antibiotics. . No demonstrated resistance - -------------------------------------------------------------------------------- Orally administered, but not . Concentrates and exerts its killing absorbed into bloodstream effects in the GI tract - -------------------------------------------------------------------------------- Bactericidal . Rapid killing effect. . Less likely to develop resistance - -------------------------------------------------------------------------------- Gram Positive Spectrum . Low potency against gram negative anaerobes. . Less likely to result in overgrowth of other opportunistic organisms. . Potential value vs C. Difficile - -------------------------------------------------------------------------------- In a Phase II, multicenter, double-blind, placebo-controlled trial, oral Ramoplanin was well tolerated. In addition, after seven days of treatment, 90% of patients who were colonized with VRE at the beginning of the study had no detectable VRE in their gastrointestinal tract, while all of the placebo patients had detectable VRE ) p*0.01). Ramoplanin has been granted Fast Track status 4 by the FDA and is currently being tested in a Phase III clinical study. The ongoing Phase III study is designed to demonstrate whether oral prophylaxis with Ramoplanin reduces the incidence of VRE bloodstream infections in cancer patients known to carry VRE bacteria in their intestines. More than one-third of the planned 950 patients have been enrolled in the study at more than 40 clinical trial sites in the U.S. We expect to file a New Drug Application for Ramoplanin in 2004. The license agreement provides us with exclusive rights to develop and market oral Ramoplanin in the U.S. and Canada. Biosearch will provide the bulk material for the manufacture of the product. Under the terms of the agreement, we paid Biosearch an initial consideration of $2 million. Thereafter, we will make milestone payments of up to an additional $8 million in a combination of cash and notes convertible into our stock if certain development milestones are met. In addition to purchasing bulk material from Biosearch, we will fund the completion of clinical trials and pay a royalty on product sales. The combined total of bulk product purchases and royalties is expected to be 26% of our net product sales. The Company and Biosearch have established a joint committee to coordinate global efforts for the ongoing clinical development and future commercialization of Ramoplanin. Drug Discovery Alliances We form strategic alliances with major pharmaceutical companies to maximize our success in product discovery and development. The following table summarizes our existing product discovery and development partnerships:
- ------------------------------------------------------------------------------------------------------------------------------ Bacterial and Fungal Infections Alliances - ------------------------------------------------------------------------------------------------------------------------------ Alliance Focus Partner Status of Alliance Proceeds Received as Potential Proceeds, (Date of Agreement) of December 31, 2001 excluding royalties - ------------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------------ Contract research program completed; Ulcers AstraZeneca Program transferred to AstraZeneca; $13.5 million $23.3 million (September 1995) Currently in lead optimization. - ------------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------------ Contract research program Drug Resistant Schering-Plough substantively completed; Validated $21.4 million $45.4 million Bacterial Infections (December 1995) targets and screening assays transferred to Schering-Plough; Currently in high-throughput screening. - ------------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------------ Fungal Infections Schering-Plough Contract research program $12.2 million $33.2 million (September 1997) substantively completed; Validated targets and screening assays transferred to Schering-Plough; Currently in high-throughput screening. - ------------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------------ Infectious Disease BioMerieux PathoGenome Database delivered; $3.4 million $5.2 million Diagnostics (September 1999) identification of gene markers ongoing. - ------------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------------ Human Disease Alliances - ------------------------------------------------------------------------------------------------------------------------------ Alliance Focus Partner Status of Alliance Proceeds Received as Potential Proceeds, (Date of Agreement) of December 31, 2001 excluding royalties - ------------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------------ Wyeth-Ayerst Identified specific gene mutation Osteoporosis Division of that leads to increased bone mass; $8.1 million $118.0 million American Contract research extended through Home Products December 2002. Currently in high- (December 1999) throughput screening - ------------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------------ Asthma Schering-Plough Two genes discovered. Identification $38.5 million $81.0 million (December 1996) of candidate genes ongoing; Contract research program extended to December 2002; Currently in high throughput screening - ------------------------------------------------------------------------------------------------------------------------------
- -------------- * Assumes receipt or payment of all license fees, funded research and contingent payments for achieving milestones, after extensions 5 and/or reallocations; excludes potential royalties Bacterial and Fungal Infection Alliances - ---------------------------------------- Ulcers H. pylori infection affects an estimated 30% of the United States population, causing more than 5 million cases of peptic ulcer disease per year. Industry sources estimate that the market for ulcer disease products worldwide to be $14.5 billion in 2001. The pathogen, H. pylori, is believed to be responsible for 90% of duodenal ulcers, the most common type of ulcer, and approximately 80% of gastric peptic ulcers. The World Health Organization has estimated that H. pylori is responsible for 550,000 new cases of stomach cancer per year worldwide. Using our sequencing technology, we completed the random sequencing and finishing of the genome of H. pylori. We believe that drugs targeted at genes essential to the survival of H. pylori will provide novel treatments for peptic ulcers. In September 1995, we formed an alliance with AstraZeneca to identify genes critical to the survival of H. pylori and proteins on the surface of the bacterium that we believe to be likely targets for drugs. AstraZeneca is a leader in the field of products to treat peptic ulcer disease. Its anti-ulcer drug, Prilosec(R) was the world's biggest selling prescription drug in 2000 with sales of $6.2 billion. As of December 31, 2001, we had received payments of $13.5 million under this alliance and have rights to receive, based on attainment of milestones, an additional $9.8 million of payments in addition to potential royalties. In August 1999, we had completed our research obligations under this alliance and had turned over validated drug targets and assays to AstraZeneca for pre-clinical testing. AstraZeneca recently announced that it had begun a lead optimization program on a lead identified through the high-throughput screening program conducted using one of these targets. Drug Resistant Bacterial Infections Infectious diseases remain the world's leading cause of premature death. Each year approximately 2 million patients in the U.S. develop antibiotic resistant infections while being treated in hospitals. Antibiotic resistant organisms, many of which have multiple antibiotic resistances, cause these infections. Industry sources estimate that the pharmaceutical market for antibiotic products worldwide was more than $20 billion in 2000. The pathogen Staph. Aureus is a common cause of skin, wound and blood infections. Staph. aureus infections are typically treated with antibiotics. In recent decades, the incidence of Staph. aureus infections that are resistant to available antibiotic treatments has risen. Using our high-throughput sequencing capabilities, we have sequenced the genome of antibiotic-resistant Staph. aureus. We believe that drugs targeted at genes essential to the survival of Staph. aureus will provide novel treatments for skin, wound and blood infections contracted in hospitals. In December 1995, we formed an alliance with Schering-Plough to identify and validate gene targets for the development of drugs to treat Staph. aureus and other pathogens that have become resistant to current antibiotics. Schering-Plough is an established participant in the anti-infective market, and a leader in the utilization of genomics to discover novel anti-infective products. As of December 31, 2001, we had received payments of $21.4 million under this alliance and have rights to receive, based on attainment of milestones, an additional $24 million of payments as well as potential royalties. As of December 31, 2001, we had substantively completed our research obligations under this alliance and had turned over validated drug targets and assays to Schering-Plough for high-throughput screening. Fungal infections The past twenty years have seen dramatic changes in the pattern of fungal infections in humans. These pathogens have assumed a much greater importance because of their increasing incidence in immunocompromised patients, such as AIDS patients, transplant recipients, cancer patients and other groups of immunocompromised individuals. Increased international travel and misuse of antimicrobial agents have also contributed to this trend and the emerging resistance to certain treatments. Industry sources estimate that the global market for prescription antifungal drugs was approximately $4.8 billion in 1999, with non-prescription fungal treatments adding significantly to overall market size. Currently, there are a limited number of antifungals available for use against hospital related fungal infections, and many of the products currently on the market have serious side effects. We believe that drugs targeted at genes that are essential to the survival of fungal pathogens will provide novel and effective treatments for fungal infections. In September 1997, we formed an alliance with Schering-Plough to use our high-throughput sequencing capabilities and genomic 6 tools to identify new, validated fungal targets for the development of drugs to treat fungal infections. Schering-Plough is a leader in the field of drugs targeted against fungal infections, with market leading products such as the Lotrimin AF(R) and Tinactin(R) lines of topical antifungals. As of December 31, 2001, we had received payments of $12.2 million under this alliance and have rights to receive, based on attainment of milestones, an additional $21.0 million of payments in addition to potential royalties. As of December 31, 2001, we had substantively completed our research obligations under this alliance and had turned over validated drug targets and assays to Schering-Plough for high-throughput screening. Infectious disease diagnostics The World Health Organization estimates that more than 13 million people die of an infectious disease worldwide each year, with many of those infections acquired in hospitals. There has been a global resurgence of infectious diseases, including the identification of new pathogens, the re-emergence of old infectious agents and the rapid spread of resistance to anti-infective agents. The ability to rapidly identify the specific microorganisms involved in disease is becoming increasingly important and complex, providing challenges and opportunities for infectious disease testing. Highly sophisticated and versatile methods are needed to identify a larger and more diverse list of pathogens, including variants with drug resistant characteristics. It is anticipated that nucleic acid tests incorporating such methods will be part of the fastest growing segment of the $20 billion in vitro diagnostic global market. In September 1999, we entered into a strategic alliance with bioMerieux to develop, manufacture and sell in vitro pathogen diagnostics for human clinical and industrial applications. A privately held company based in France, bioMerieux is one of the top 10 diagnostics companies in the world and the leader in the field of microbiology. The total amount of research and development funding approximates $5.2 million for the four-year term of this agreement. As of December 31, 2001, we had received payments of $3.4 million and have rights to receive future milestone payments and royalties based upon successful commercialization of diagnostic products. Chronic Human Disease Alliances - ------------------------------- Osteoporosis Osteoporosis is a major health problem characterized by low bone mass that affects more than 200 million people worldwide and approximately one-third of post-menopausal women. In the U.S. alone, osteoporosis contributes to more than 1.5 million bone fractures per year. Estimated direct expenditures in the United States for osteoporosis and associated fractures are $13.8 billion. Twin and family studies suggest a strong genetic component to the disease. Under a collaboration with Creighton University of Omaha, Nebraska, we have gained access to data from related individuals identified by Creighton who exhibit high bone mass. We believe the identification of genes regulating bone density and disease progression will lead to the discovery of novel drugs for treating osteoporosis by increasing bone mass, as well as the development of diagnostic tests. In December 1999, we formed an alliance with Wyeth-Ayerst to develop drugs to treat osteoporosis based on our genetic research. Wyeth-Ayerst is a leader in the field of women's health with a broad array of products, including Premarin(R), a leading estrogen replacement therapy. As of December 31, 2001, we had received payments of $8.1 million under this alliance and have rights to receive, subject to the achievement of milestones, up to a total of $118.0 million in license fees, milestone payments and research support, as well as royalties on sales of any products developed. Under this alliance, we are carrying out functional studies to confirm the identity of target genes. During 2001, the research phase of this alliance was extended through December 31, 2002. This program has recently entered high-throughput screening. Asthma Asthma affects over 155 million people worldwide according to the World Health Organization and the incidence appears to be rising dramatically. In the United States, the incidence has doubled over the past two decades and affects approximately 4% to 10% of the United States population. The annual care associated with the disease exceeds $15.0 billion in direct and indirect costs. Published research suggests that multiple genetic factors as well as environmental influences play a role in the disease. We believe that the asthma genes that we have identified will facilitate the development of superior diagnostics and novel drugs. In December 1996, we formed an alliance with Schering-Plough to use our disease gene identification strategies to identify genes involved in the development of asthma. Schering-Plough has extended our alliance through December 2002. Schering-Plough is a leader in the field of allergy and respiratory care products, with products such as Afrin(R) nasal spray, the leading product in the 7 branded nasal spray market, and the Claritin(R) line of antihistamines, which generated $3.1 billion of sales in 2000. As of December 31, 2001, we had received payments of $38.5 million under this alliance and have rights to receive, based on attainment of milestones an additional $42.5 million of payments as well as potential royalties. During 2001, we used our proprietary genomics tools, bioinformatics and high-throughput sequencing to discover two genes associated with asthma. These genes have been transferred to Schering-Plough for further drug discovery efforts. This program has advanced into high-throughput screening. Arqule Joint Venture In October, 2000, we formed a new joint venture with ArQule, Inc. The joint venture, which replaced an earlier 1998 collaboration agreement, includes a significantly increased commitment of shared, dedicated scientific and technical resources from both companies and includes joint ownership rights to all lead compounds and commercial outcomes that result from this effort. The joint venture is focused on the discovery and development of novel, small molecule, broad-spectrum antibacterials. The venture combines our validated targets, assays and compound profiling capabilities with ArQule's Parallel TrackTM Drug Discovery platform. Under the terms of the agreement, we will contribute a number of proprietary validated targets and ArQule will contribute its compound libraries and medicinal chemistry capabilities. Both companies are involved in screening efforts. It is anticipated that we will develop compounds through early clinical testing and then make a decision on a potential partnership with a larger pharmaceutical company. To date, 12 targets have been screened, several chemical series are undergoing further characterization and four (4) promising lead candidates from two (2) chemoptypes have been tested in vivo. Internal Drug Discovery Bacterial and Fungal Infections We continue to invest in developing targets and downstream discovery capabilities in bacterial and fungal infections. These efforts are focused in three program areas: Essential Microbial Targets - We are seeking to discover both broad and narrow - --------------------------- spectrum anti-microbial agents. We are mining the sequence information contained in our PathoGenomeTM Database to identify genes that are conserved in a broad or narrow spectrum of pathogens. We concentrate on conserved microbial genes that have low homology with human genes to decrease risk of toxicity in man. Using our proprietary functional genomics technology, our scientists have been able to discover among these conserved genes, genes that are essential for the survival of pathogenic organisms. Thus, our gene discovery approach generates validated essential microbial targets that possess both selectivity and specificity, which are ideal attributes for drug intervention. These targets serve as the basis for our internal drug discovery efforts. In this regard, we have drawn upon our strengths in microbial genetics to develop both biochemical and cell based assays for these targets for use in our high-throughput screening platform. In addition, we continue to build internal capabilities through the acquisition of novel compound libraries. We anticipate that these efforts will lead to the further growth of our own infectious disease franchise. We may enter into alliances with other companies to engage in the development, commercialization and marketing of leads identified through this program. Biofilms - A biofilm is a structured community of bacterial cells enclosed in a - -------- self-produced polymeric matrix and adherent to an inert or living surface. Biofilms constitute a protected mode of growth that allow survival in a hostile environment. The Centers for Disease Control has estimated that up to 65% of the infections treated by physicians in the developed world are caused by organisms growing in this protected mode of growth. Bacterial biofilms are inherently resistant to antibiotics. Among the approximately 5 million Central Venous Catheter (CVCs) and pulmonary arterial catheters (Swan-Ganz) placed in the US per year, as many as 10% of these lines become infected, resulting in about 200,000 to 400,000 episodes of catheter-related bloodstream infections. Discovering how biofilm formation and detachment are controlled may open the way to new anti-microbial therapeutic strategies that may become more important than agents designed to kill bacterial cells. We are applying our microbial genomics and functional genomics platforms to identify genes involved in biofilm formation, maturation and degradation. After further validation, genes will progress to high-throughput screening to identify lead candidates for further development. Chronic Human Diseases 8 We have developed an integrated suite of technologies, tools and data management and analysis capabilities to discover genes associated with human disease. We have developed sophisticated techniques for evaluating families whose members suffer from diseases with a significant inherited component. Our scientists carefully characterize human phenotypes and develop linkage maps to discover genes associated with human disease. Our human disease drug discovery platform uses a well developed yeast-2 hybrid capability, bioinformatics and microarrays to elucidate the protein pathways of the genes we discover. This approach enables us to find multiple targets for screening. Our asthma alliance advanced into high throughput screening during the last 12 months. We plan to continue to invest in our human gene discovery program. We are evaluating a number of families who are affected by chronic diseases with a strong inherited component. By gaining access to these families and analyzing their history and their genetics, we are able to discover disease-associated genes. Additionally, we continue to invest in functional genomics technologies to help determine gene function. We plan to continue to partner all of our programs in human diseases with major pharmaceutical companies. These companies have the biological and disease expertise, the clinical development capabilities and the sales and marketing infrastructure required to discover and develop new drugs in these areas. GENOMEVISON(TM) SERVICES ------------------------ In addition to our drug discovery programs, we have built a successful service business for genomics-based research that provides industrial scale, high quality a) library construction; b) customized sequencing services; c) confirmation sequencing; d) project finishing, assembly and annotation; e) SNP discovery and screening; and, f) quality control testing & validation to pharmaceutical companies, biotechnology companies, and research institutions on a contract basis. Since the launch of these services in July 1999, we have entered into many contracts with pharmaceutical and biotechnology companies and other research institutions, in addition to our longstanding work in the United States government's genomics programs. We have extensive experience in high-throughput sequencing with a substantial production staff and a highly automated sequencing center operating twenty-four hours per day, seven days per week. The U.S. government recognized the quality of our sequencing work by naming us as one of ten U.S. centers for the Human Genome Project and one of two primary centers for the Rat Genome Sequencing Program. We were the only commercial entity selected for the Human Genome Project. National Human Genome Research Institute In July 1999, the U.S. government named us one of five NIH funded DNA sequencing centers in the U.S. for the international Human Genome Project. The government based the award on a peer review process that evaluated our industrial scale sequencing facility for production capacity, cost effectiveness and quality standards. We are the only commercial entity to have been chosen to participate in the project. We will receive funding from the NHGRI of up to $17.4 million through February 2003, of which all funds have been appropriated. In October 1999, the U.S. government named us as one of ten initial centers in the Mouse Genome Sequencing Network. The government based the award on a peer review process that evaluated our industrial scale sequencing facility for production capacity, cost effectiveness and quality standards. The NHGRI agreed to provide us with funding of up to $13.4 million through February 2003, of which all funds have been appropriated. In August 2000, we were named as one of two primary centers for the Rat Genome Sequencing Program and agreed to switch its research focus from the Mouse Program to the Rat Program. Remaining funds from the Mouse Program, as well as a portion of the remaining funds from the Human Genome Project, are being redirected to the Rat Genome Sequencing Program. Under both these research contracts, the U.S. government has ownership rights to the data, clones, genes and other material derived from material furnished to us by the government. We have ownership rights in other inventions that we develop on our own under the contracts. PathoGenome(TM) Database In 1997, we introduced to the market the PathoGenome Database, a database consisting of proprietary and publicly available genetic information from over thirty microbial organisms, including organisms responsible for the most prevalent bacterial infections. The PathoGenome Database provides subscribers with non-exclusive access to a large volume of highly organized and functionally annotated sequence information related to some of the most medically important microbial organisms and fungi. We initially designed 9 the PathoGenome Database to be accessed at the client site using our proprietary bioinformatics software. It enables researchers to search for new genes among multiple pathogens and cross-reference genomic information for the development of new anti-infective products. Our Technology We have created an integrated high quality platform of drug discovery technologies. This platform includes high quality, industrial scale gene sequencing and sequence finishing, bioinformatics, functional genomics technologies, assay development, high throughput screening and compound profiling. High-Throughput Gene Sequencing We have developed a high-quality, industrial scale process for gene sequencing. Our GenomeVision(TM) Services utilize a fully automated process that makes use of DNA sequencing instruments and computers to sequence and analyze genes. We maintain high quality standards for all steps of our sequencing process by strictly controlling the quality of the raw data generated. Using our technology, we have sequenced and continue to sequence the genomes of bacterial and fungal pathogens and various regions of the human, rat and other genomes. We were the only commercial company that participated in the Human Genome Project. Sequence Finishing Finishing is the final step to organizing the genomic data once the majority of the sequence information has been generated. Finishing is necessary because the individual clones sequenced contain small, randomly selected fragments of the complete genome. We assemble these fragments using sophisticated proprietary computer software that identifies overlapping regions and arranges the fragments into large contiguous regions. We also employ a directed sequencing approach in order to specifically target and obtain sequences for the missing regions to facilitate completion of the full genome sequence. We have developed a proprietary finishing platform that utilizes integrated computational and biochemical approaches to specify the required quality of the end-product sequence and then directs the process to achieve the desired quality level. As a result of our emphasis on quality, we currently have a finished data accuracy of 99.99%. Bioinformatics Vast amounts of data result from DNA sequencing, finishing, microarray and other genomic technologies that we employ. In order to determine the biological significance and function of the genomic data that we compile, it must be organized, managed, and analyzed. Bioinformatics involves the use of computers, software, and databases to track, process, store, retrieve and analyze data generated by genomic research. We were one of the first companies to develop a significant bioinformatics capability due to our early work in large-scale genetic linkage and sequence analysis. A central focus of our current bioinformatics program is the development of an integrated genomic and functional genomic data management platform to strengthen and accelerate our gene and drug discovery programs. The objective of our bioinformatics program is to accelerate the discovery of genes and the determination of their function. Functional Genomics Functional genomics is the process of assigning biochemical functions and disease roles to genes. In the target discovery and validation stages of our pharmaceutical and diagnostic programs, functional genomics confirms that specific gene targets are appropriate for the development of pharmaceutical, vaccine, or diagnostic products. We have developed a number of technologies to accelerate the functional analysis of important disease genes, including gene expression, micro arrays, protein-protein interaction technologies and gene knockouts. When we combine our expertise in bioinformatics with these technologies, we bridge the gap between gene discovery and drug discovery. High Throughput Screening & Compound Libraries We have built a high-throughput screening capability to test compounds against validated targets. Our screening technologies allow us to develop biochemical and cell-based screening assays and screen. The output of each screen is captured in our central database using our chemoinformatics tools. We have built a diverse compound library of over 80,000 compounds acquired from commercial sources. We use cheminformatics to select compounds based on their diversity and several "drug-like" properties. During 10 2001, our first full year of operation, we screened our libraries against multiple targets generating over 2.2 million datapoints. Patents and Proprietary Technology Our ultimate commercial success depends in part on our ability to obtain intellectual property protection on our methods, technologies and discoveries, including genes, proteins encoded by genes, patentable human single nucleotide polymorphisms (SNPs), haplotypes or products based on genes or our proprietary gene technology. To that end, our policy is to protect our proprietary technology primarily through patents, in spite of the fact that the current criteria for obtaining patent protection for partially sequenced genes and for genes are unclear. Our current strategy is to apply for patent protection upon the identification of a novel gene or novel gene fragment and pursue claims to these gene sequences as well as equivalent sequences, such as substantially homologous or orthologous sequences. If at the time of filing a patent application we have not characterized the biological function of a gene or gene fragment we supplement our patent filing as soon as additional biological function information about such gene or gene fragment becomes available. We have filed patent applications and will continue to do so with respect to a number of full-length genes and corresponding proteins and partial genes resulting from our pathogens program. Along with our collaborators, we file foreign counterparts of these U.S. applications within the appropriate time frames. Our patent applications seek to protect these full length and partial gene sequences and corresponding proteins, as well as equivalent sequences, and products derived from and uses of these sequences. There have been, and continue to be, intensive discussions on the scope of patent protection for gene fragments, single nucleotide polymorphisms, and full-length genes. In 1996, the U.S. Patent and Trademark Office issued guidelines limiting the number of nucleic acid sequences that can be covered in a single patent application. In addition, the U.S. courts continue to redefine and narrow the enforceable scope of claims to genes, gene fragments, SNPs, and proteins. The U.S. PTO also issued new Utility Guidelines that address the requirements for demonstrating utility, particularly in inventions relating to human therapeutics, and Written Description guidelines that address the amount of disclosure required to support claims to nucleotide sequences. Consequently, we continually must assess our patent applications to determine those that we can support for prosecution. While the guidelines do not require clinical efficacy data for issuance of patents for human therapeutics, the guidelines have been in effect for only a short period of time and it is possible that the U.S. PTO may interpret them in a way that could delay or adversely affect our ability or the ability of our collaborators to obtain patent protection. The biotechnology patent situation outside the United States is even more uncertain and is currently undergoing review and revision in many countries. We are free to apply for patents on the results of our research conducted with government funds. Under the government grants, subject to the limitations described below, we have exclusive ownership rights to any commercial applications of inventions that we first reduce to practice under the grants, including all gene discoveries and technology improvements created or discovered. We are under an obligation under some of the government grants to submit sequencing data resulting from the research to public databases within 24 hours from the date we generate such data and materials. The governmental grants also restrict us from applying for blanket patents on large numbers of human or mouse genes. In addition, the government has a statutory right to practice or permit others to practice inventions that we first reduce to practice under a government grant or contract. In addition, under our government research contracts, the government has ownership rights in the data, clones, genes and other material derived from the material the government furnished to us. The patent positions of biotechnology and pharmaceutical companies are generally uncertain and involve complex legal and factual issues. No assurance can be given that any patent issued to or licensed by us or our collaborators will provide protection that has commercial significance. We cannot assure that: . our patents will afford protection against competitors with similar compounds or technologies . our patent applications will issue . others will not obtain patents having claims similar to the claims in our patents or applications . the patents of others will not have an adverse effect on our ability to do business or . the patents issued to or licensed by us will not be infringed, challenged, opposed, narrowed, invalidated or circumvented 11 Moreover, we believe that obtaining foreign patents may, in some cases, be more difficult than obtaining domestic patents because of differences in patent laws. We also recognize that our patent position may generally be stronger in the U.S. than abroad. In particular, we are aware that companies have published patent applications relating to nucleic acids encoding several H. pylori proteins and, in other disease programs, relating to genes for which we have found mutations of interest. If these companies are issued patents, their patents may limit our ability and the ability of our collaborators to practice under any patents that may be issued to us. Because of this, our collaborators or we may not be able to obtain a patent with respect to the genes of H. pylori. Further, the value of certain other patents issued to us or our collaborators that are the subject of other collaborations may be limited. Also, even if a patent were issued to our collaborators, or us, the scope of coverage or protection afforded to such patent may be limited. We also rely upon trademarks, unpatented trade secrets and improvements, unpatented know-how and continuing technological innovation to develop and maintain our competitive position. We generally protect this information with confidentiality agreements that provide that all confidential information developed or made known to others during the course of the employment, consulting or business relationship shall be kept confidential except in specified circumstances. Agreements with employees provide that all inventions conceived by the individual while employed by us are our exclusive property. We cannot guarantee, however, that these agreements will be honored, that we will have adequate remedies for breach if they are not honored or that our trade secrets will not otherwise become known or be independently discovered by competitors. Competition The biotechnology industry generally, and our human genetics and pathogen genetics and drug discovery and development programs specifically, are characterized by rapidly evolving technology and intense competition. Our competitors include pharmaceutical and biotechnology companies both in the United States and abroad. In addition, universities and other non-profit research institutions and United States and foreign government-sponsored entities are conducting significant research to identify and sequence genes. These entities are becoming more aggressive in their pursuit of patent protections and licensing arrangements. Many of these institutions and other consortia, such as the SNP Consortium, are also working to make large amounts of genetic information publicly available, shrinking the pool of information available for proprietary protection. Many of our competitors have greater research and product development capabilities and financial, scientific, marketing and human resources than we do, and some competitors' human genome programs are more advanced than our program. Therefore, our competitors may succeed in identifying or sequencing genes or developing products earlier, in obtaining authorization from the FDA for products more rapidly and in developing products that are more effective than those proposed by our collaborators or us. Any potential products based on genes that we identify will face competition both from companies developing gene-based products and from companies developing other forms of diagnosis or treatment for the particular diseases. Accordingly, competition with respect to our technologies and product candidates is and will be based on, among other things: . our ability to create and maintain advanced technology . the speed with which we can identify and characterize the genes involved in human diseases . our ability to rapidly sequence the genomes of selected pathogens . our ability and our partners' ability to develop and commercialize therapeutic, vaccine and diagnostic products based upon our gene discoveries . our ability to attract and retain qualified personnel . our ability to obtain patent protection . our ability to develop proprietary technology or processes . our ability to secure sufficient capital resources to fund our research operations . our ability to successfully manage the clinical development and registration of our product 12 We also face increasing competition for strategic alliances with leading pharmaceutical and biotechnology companies. We cannot be certain that we will be able to obtain such strategic alliances in the future or that we will be able to obtain them on terms comparable with existing alliances. Competition among genetics companies is also increasing for access to unique data from related individuals that we employ to identify genes for specific human diseases. We also face increasing competition for in-licensing opportunities with leading pharmaceutical and biotechnology companies. We cannot be certain that we will be able to in-license product opportunities in the future. Our competitive position will also depend upon our ability to attract and retain qualified personnel, to obtain patent protection or otherwise develop proprietary product or processes, and to secure sufficient capital resources for the often-substantial period between technological conception and commercial sales. Competitive disadvantages in any of these areas could materially harm our business and financial condition. Government Regulation Regulation by governmental entities in the United States and other countries will be a significant factor in the development, manufacturing and marketing of any products that our collaborators or we develop. The extent to which such regulation may apply to our collaborators or us will vary depending on the nature of the product. Virtually all of our or our collaborators' pharmaceutical products will require regulatory approval by governmental agencies prior to commercialization. In particular, the FDA in the United States and similar health authorities in foreign countries subject human therapeutic and vaccine products to rigorous preclinical and clinical testing and other approval procedures. Various federal and, in some cases, state statutes and regulations also govern or influence the manufacturing, safety, labeling, storage, record keeping and marketing of human therapeutic and vaccine products. Obtaining these approvals and complying with appropriate federal and foreign statutes and regulations requires a substantial amount of time and financial resources. The FDA regulates human therapeutic products in one of three broad categories: drugs, biologics, or medical devices. Our most advanced product, Ramoplanin, will be regulated by the Center for Drug Evaluation and Research (CDER). Products discovered based on our technologies could potentially fall into all three categories. The FDA generally requires the following steps for pre-market approval of a new drug or biological product: . preclinical laboratory and animal tests . submission to the FDA of an investigational new drug application, or IND, which must become effective before clinical trials may begin . adequate and well-controlled human clinical trials to establish the safety and efficacy of the product for its intended indication . submission to the FDA of a marketing application; a new drug application, or NDA, if the FDA classifies the product as a new drug; or a biologics license application, or BLA, if the FDA classifies the product as biologic . FDA review of the marketing application and NDA or BLA in order to determine, among other things, whether the product is safe and effective for its intended uses Our collaborators or we also may develop diagnostic products based upon the human or pathogen genes that we identify. We believe that the FDA is likely to regulate these diagnostic products as devices rather than drugs or biologics. The nature of the FDA requirements applicable to diagnostic devices depends on how the FDA classifies the diagnostic devices. The FDA most likely will classify a diagnostic device that our collaborators or we develop as a Class III device, requiring pre-market approval. Obtaining pre-market approval involves the following process, which may be costly and time-consuming: . conducting pre-clinical studies . obtaining an investigational device exemption to conduct clinical tests . conducting clinical trials . filing a pre-market approval application . attaining FDA approval 13 Products on the market are subject to continual review by the FDA; therefore, subsequent discovery of previously unknown problems, or failure to comply with the applicable regulatory requirements may result in restricted marketing or withdrawal of the product from the market and possible civil or criminal sanctions. The FDA also may subject biologic products to batch certification and lot release requirements. To the extent that any of our products involve recombinant DNA technology, additional layers of government regulation and review are possible. Similarly, there are additional regulatory requirements for products marketed outside the United States governing the conduct of clinical trials, product licensing, pricing and reimbursement. Manufacturing and Marketing We do not expect to manufacture pharmaceutical products in the near term. The terms of our agreement for Ramoplanin obligate the licensor, Biosearch Italia SpA. to manufacture the bulk drug. We are responsible for the manufacture of the finished dosage form for the United States and Canada. We currently use a contract manufacturer to produce Ramoplanin for our clinical trial program. We plan to also use a contract manufacturer to produce the final dosage to support product sales. In the event we decide to establish a manufacturing facility of our own, we will require substantial additional funds and will need to hire and train significant additional personnel and will need to comply with the extensive "good manufacturing practice" regulations applicable to such a facility. In addition, if the FDA regulated any products produced at our facility as biologics, we would need to file and obtain approval of an Establishment License Application for our facility. Our current plan is to market and sell Ramoplanin through our own sales and marketing organization. We may, at a later date, determine that the commercial success of Ramoplanin will benefit from the additional resources from a pharmaceutical marketing partner would provide. We currently do not have the resources to market by ourselves, but fully expect to assemble a sales and marketing organization at the appropriate time. Factors That May Affect Results This Annual Report on Form 10-K contains forward-looking statements. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes," "anticipates," "plans," "expects," "intends," and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause our actual results to differ materially from those indicated by such forward-looking statements. Those factors include, without limitation, those set forth throughout this Annual Report on Form 10-K, including the risks detailed in Exhibit 99.1 to this Annual Report on Form 10-K. Human Resources As of December 31, 2001, we had 204 full-time equivalent employees; of which 167 of these employees engaged in research and development activities and 37 of them conducted general and administrative functions. Forty-four of our employees hold Ph.D. degrees and 50 more hold other advanced degrees. None of our employees is covered by a collective bargaining agreement, and we consider our relations with our employees to be good. Facilities Our executive offices and laboratories are located at 100 Beaver Street, Waltham, Massachusetts. We lease approximately 80,000 square feet of space and our lease expires on November 15, 2006 with options to extend for two consecutive five-year periods. During 2001, we incurred aggregate rental costs, excluding maintenance and utilities, for our facility of approximately $1,007,000. ITEM 3. Legal Proceedings None. ITEM 4. Submission Of Matters to a Vote of Security Holders None. 14 PART II ITEM 5. Market for the Registrant's Common Stock and Related Security Holder Matters Our common stock is traded on the Nasdaq National Market System (ticker symbol "GENE"). The table below sets forth the range of high and low quotations for each fiscal quarter during 2001 and 2000 as furnished by the National Association of Securities Dealers Quotation System.
2001 2000 ---- ---- High Low High Low ------ ----- ------ ----- First Quarter................................................. $ 11.690 $ 4.750 $ 75.380 $12.880 Second Quarter................................................ 16.900 4.781 39.000 12.060 Third Quarter................................................. 15.450 4.010 34.500 18.130 Fourth Quarter................................................ 8.390 5.450 21.440 6.630
As of March 27, 2002, there were approximately 1,018 shareholders of record of our common stock. We have not paid any dividends since our inception and presently anticipate that all earnings, if any, will be retained for development of our business and that no dividends on our common stock will be declared in the foreseeable future. Any future dividends will be subject to the discretion of our Board of Directors and will depend upon, among other things, future earnings, the operating and financial condition of the Company, our capital requirements and general business conditions. ITEM 6. Selected Consolidated Financial Data
For the Year Ended December 31, ------------------------------------------------------------------------- 1997 1998 1999 2000 2001 -------------- ------------- ------------- ------------- -------------- Revenues: BioPharmaceutical $ 11,132,294 $ 18,135,038 $ 18,162,056 $ 11,851,091 $ 18,438,286 GenomeVision(TM) Services 3,300,881 3,913,376 6,665,529 13,594,143 17,302,239 ------------------------------------------------------------------------- Total revenues 14,433,175 22,048,414 24,827,585 25,445,234 35,740,525 Net loss................................ (16,031,795) (12,967,676) (3,940,075) (5,846,839) (10,090,302) Net loss per common share............... (0.90) (0.71) (0.21) (0.27) (0.45) Weighted average common shares outstanding 17,771,824 18,289,644 18,627,045 21,376,685 22,572,427
As of December 31, ------------------------------------------------------------------------- Cash and cash equivalents, restricted cash, warrant and long and short-term investments............ $ 44,492,461 $ 30,816,859 $ 26,778,026 $ 73,009,887 $ 67,341,249 Working capital......................... 31,298,804 19,749,608 19,447,189 51,601,069 44,156,478 Total assets............................ 61,230,003 48,920,973 45,443,236 90,251,004 82,739,598 Shareholders' equity.................... 40,089,689 27,557,237 28,846,957 72,687,452 66,731,938
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations OVERVIEW We are a biopharmaceutical company focused on the discovery and development of pharmaceutical and diagnostic products. We have eight established product development programs. Our lead product candidate, Ramoplanin, is in Phase III clinical trials for the prevention of bloodstream infections caused by vancomycin-resistant enterococci (VRE). We have six alliances with pharmaceutical companies including Schering-Plough, AstraZeneca, Wyeth-Ayerst and bioMerieux, and a joint venture with ArQule. In addition to these eight projects, we have a portfolio of earlier stage internal drug discovery programs. We also maintain an active service business, GenomeVision(TM) Services, providing drug discovery services to pharmaceutical and biotechnology companies and to the National Human Genome Research Institute. We receive payments under our bioPharmaceutical business from our product discovery alliances based on license fees, contract 15 research and milestone payments during the term of the alliance. We also receive payments under our GenomeVision Services business from selling, as a contract service business, high quality genomic sequencing information to our customers, including pharmaceutical companies, biotechnology companies, governmental agencies, and academic institutions. In addition, under our GenomeVision Services business, subscribers to our PathoGenome(TM) Database pay access fees for the information they obtain. We anticipate that our alliances will result in the discovery and commercialization of novel pharmaceutical, vaccine and diagnostic products. In order for a product to be commercialized based on our research, it will be necessary for our product discovery partner to conduct preclinical tests and clinical trials, obtain regulatory clearances, manufacture, sell, and distribute the product. Accordingly, we do not expect to receive royalties based upon product revenues for many years, if at all. Our primary sources of revenue are from alliance agreements with pharmaceutical company partners, subscription agreements to our PathoGenome Database and government research grants and contracts. Currently, we have six product discovery alliances and one joint venture, of which we currently receive contract research funding from three of these alliances. In August 1995, we entered into an alliance with AstraZeneca to develop pharmaceutical, vaccine and diagnostic products effective against gastrointestinal infections or any other disease caused by H. pylori. In August 1999, the contract research under the alliance concluded and the program transitioned into AstraZeneca's pipeline. We are entitled to receive additional milestone payments and royalties based upon the development by AstraZeneca of any products from the research alliance. In December 1995, we entered into an alliance with Schering-Plough. Under this alliance, Schering-Plough can use our Staph. aureus genomic database to identify new gene targets for the development of novel antibiotics. As of December 31, 2001, we had substantively completed our research obligations under this alliance and had turned over validated drug targets and assays to Schering-Plough for high-throughput screening. In December 1996, we entered into our second research alliance with Schering-Plough to identify genes and associated proteins that Schering-Plough can utilize to develop new pharmaceuticals for treating asthma. In September 1997, we established our third research alliance with Schering-Plough for the development of new pharmaceutical products to treat fungal infections. As of December 31, 2001, we had substantively completed our research obligations under this alliance and had turned over validated drug targets and assays to Schering-Plough for high-throughput screening. In September 1999, we entered into a strategic alliance with bioMerieux to develop, manufacture and sell in vitro pathogen diagnostic products for human clinical and industrial applications. As part of the strategic alliance, bioMerieux has purchased a subscription to our PathoGenome Database and has made an equity investment. In December 1999, we entered into a strategic alliance with Wyeth-Ayerst to develop drugs based on our genetic research to treat osteoporosis. In September 2000, we entered into a joint venture with ArQule, Inc. to identify novel anti-infective drug compounds. In May 1997, we introduced our PathoGenome Database and sold our first subscription. Since that date, we have continued to contract with subscribers on a non-exclusive basis, and, as of December 31, 2001, we had seven subscribers. Under our agreements, the subscribers receive non-exclusive access to information relating to microbial organisms in our PathoGenome Database. Subscriptions to the database generate revenue over the term of the subscription with the potential for royalty payments to us from future product sales. We do expect to see a revenue decline in subscription fees over the next two years as subscribers substantially complete data mining of PathoGenome. Since 1989, the United States government has awarded us a number of research grants and contracts related to government genomics programs. The scope of the research covered by grants and contracts encompasses technology development, sequencing production, technology automation, and disease gene identification. These programs strengthen our genomics technology base and enhance the expertise of our scientific personnel. In July 1999, we were named as one of the nationally funded DNA sequencing centers of the international Human Genome Project. We are entitled to receive funding from the National Human Genome Research Institute (NHGRI) of up to $17.4 million through February 2003, of which all funds have been appropriated and $12.0 million had been received through December 31, 2001. In October 1999, the NHGRI named us as a pilot center to the Mouse Genome Sequencing Network. We are entitled to receive $13.4 million in funding over forty-one months with respect to this agreement, of which all funds have been appropriated and $10.4 million had been received through December 31, 2001. In August 2000, we were named one of two primary centers for the Rat Sequencing Program from NHGRI. As part of the agreement, we will use remaining funding under the mouse award, as well as a portion of the remaining funding under the human award, to participate in this rat genome initiative. In October 2001, we acquired an exclusive license in the United States and Canada for a novel antibiotic, Ramoplanin, from Biosearch Italia S.p.A (Biosearch). We will assume responsibility for the product development in the United States of Ramoplanin, currently in Phase III clinical trials. The agreement provides us with exclusive rights to develop and market oral Ramoplanin in the U.S. and Canada. Biosearch will retain all other rights to market and sell Ramoplanin. In addition, we are obligated to purchase bulk material from Biosearch and fund the completion of clinical trials, purchase bulk material, and pay a royalty on product sales. The combined total of bulk product purchases and royalties is expected to be approximately 26% of our net product sales. 16 We have incurred significant operating losses since our inception. As of December 31, 2001, we had an accumulated deficit of approximately $82.1 million. Our losses are primarily from costs associated with prior operating businesses and research and development expenses. These costs have often exceeded our revenues generated by our alliances, subscription agreements and government grants. Our results of operations have fluctuated from period to period and may continue to fluctuate in the future based upon the timing, amount and type of funding. We expect to incur additional operating losses in the future. We are subject to risks common to companies in our industry including unproven technology and business strategy, reliance upon collaborative partners and others, uncertainty of regulatory approval, uncertainty of pharmaceutical pricing, rapid technological change, history of operating losses, need for future capital, competition, patent and proprietary rights, dependence on key personnel, healthcare reform and related matters, availability of, and competition for, unique family resources, and volatility of our stock. NEW ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, Business Combinations, SFAS No. 142, Goodwill and Other Intangible Assets and SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method of accounting. SFAS No. 142 addresses how intangible assets that are acquired should be accounted for in financial statements upon their acquisition and also how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Beginning on January 1, 2002, with the adoption of SFAS No. 142, goodwill and certain purchased intangibles existing on June 30, 2001, will no longer be subject to amortization over their estimated useful life. Rather, the goodwill and certain purchased intangibles will be subject to an assessment for impairment based on fair value. The provisions of SFAS No. 142 are required to be applied starting with fiscal years beginning after December 15, 2001. SFAS No. 143 establishes accounting standards for the recognition and measurement of legal obligations associated with the retirement of tangible long-lived assets and requires recognition of a liability for an asset retirement obligation in the period in which it is occurred. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The adotption of SFAS No. 142 did not have a material impact on the Company's financial position or results of operations. The adoption of SFAS No. 143 is not expected to have a material impact on the Company's financial position or results of operations. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. This Statement supercedes FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of Accounting Principles Board (APB) Opinion No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. Under this Statement, it is required that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and it broadens the presentation of discontinued operations to include more disposal transactions. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early adoption permitted. The Company does not expect the adoption of this Statement to have a material impact on its financial position or results of operations. CRITICAL ACCOUNTING POLICIES In December 2001, the SEC requested that reporting companies discuss their most "critical accounting policies" in management's discussion and analysis of financial condition and results of operations. The SEC indicated that a "critical accounting policy" is one that is important to the portrayal of a company's financial condition and operating results and requires management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We have identified the policies below as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. For a detailed discussion on the application of this and other accounting policies, see Note 1 in the Notes to the Consolidated Financial Statements of this Annual Report on Form 10-K. The Company's preparation of this Annual Report on Form 10-K requires it to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of its financial statements, and assurance that actual results will not differ from those estimates. Revenue Recognition BioPharmaceutical revenues consist of license fees, contract research and milestone payments from alliances with pharmaceutical 17 companies. GenomeVision Services are revenues from government grants, fees received from custom gene sequencing and analysis services and subscription fees from the PathoGenome Database. Revenues from contract research, government grants, the PathoGenome Database subscription fees, and custom gene sequencing and analysis services are recognized over the respective contract periods as the services are provided. License fees and milestone payments are recognized as earned in accordance with Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition. Milestone payments will be recognized upon achievements of the milestone as long as the milestone is deemed to be substantive and we have no other performance obligations related to the milestone. Unbilled costs and fees represent revenue recognized prior to billing. Deferred revenue represents amounts received prior to revenue recognition. Clinical Trial Estimates Our clinical development trials related to Ramoplanin are primarily performed by outside parties. It is not unusual at the end of each accounting period to estimate both the total cost of the trials and the percent completed as of that accounting date. We then need to adjust our estimates when final invoices are received. To date, these adjustments have not been material to our financial statements, and we believe that the estimates that we made as of December 31, 2001 are reflective of the actual expenses incurred as of that date. However, readers should be cautioned that the possibility exists that the timing or cost of certain trials might be longer or shorter and cost more or less than we have estimated and that the associated financial adjustments would be reflected in future periods. Results of Operations Years Ended December 31, 2000 and 2001 Revenues Total revenues increased 40% from $25,445,000 in 2000 to $35,741,000 in 2001. BioPharmaceutical revenue increased 56% from $11,851,000 in 2000 to $18,438,000 in 2001 primarily due to increased milestone payments under our product discovery alliances with Wyeth-Ayerst and Schering-Plough. Revenue from GenomeVision Services increased 27% from $13,594,000 in 2000 to $17,302,000 in 2001 due to increased revenue recognized under our commercial sequencing business of approximately $935,000, as well as increased revenue recognized under our government grants with the National Human Genome Research Institute to participate in the Human Genome and Mouse (Rat) Genome sequencing projects of approximately $3,175,000. Costs and Expenses Total costs and expenses increased 45% from $33,780,000 in 2000 to $48,978,000 in 2001. Cost of services increased 39% from $11,715,000 in 2000 to $16,153,000 in 2001 primarily due to increased costs and expenses associated with the increase in GenomeVision Services revenue, as mentioned above. The increase consisted primarily of higher labor and material costs. Research and development expenses include internal research and development, research funded pursuant to arrangements with our strategic alliance partners, as well as clinical development costs and expenses. Research and development expenses increased 58% from $15,191,000 in 2000 to $24,058,000 to 2001. This planned increase was primarily due to the acquisition and clinical development of Ramoplanin of approximately $5,549,000, as well as increased investment in our internal drug discovery programs, specifically in the area of anti-infectives and chronic human diseases of $4,138,000. Selling, general and administrative expenses increased 28% from $6,875,000 in 2000 to $8,767,000 in 2001 reflecting an expansion in the areas of corporate development, sales and marketing and clinical development administrative expenses. The increase consisted of an increase in payroll and related expenses, as well as recruiting and consulting expenses. Interest Income and Expense Interest income increased 15% from $3,331,000 in 2000 to $3,839,000 in 2001 reflecting an increase in funds available for investment as a result of (i) proceeds received from the sale of common stock through a public offering in 2000 and 2001, (ii) proceeds received from the exercise of stock options, and (iii) proceeds received from our employee stock purchase plan. 18 Interest expense decreased 18% from $843,000 in 2000 to $692,000 in 2001. The decrease was due to a decrease in our outstanding balances under long-term obligations from approximately $7.8 million at December 31, 2000 to $5.6 million at December 31, 2001. Years Ended December 31, 1999 and 2000 Revenues Total revenues increased slightly by 2% from $24,828,000 in 1999 to $25,445,000 in 2000. BioPharmaceutical revenue decreased 35% from $18,162,000 in 1999 to $11,851,000 in 2000 primarily due to decreased contract research revenue and milestone payments under our product discovery alliances. Revenue from GenomeVision Services increased 104% from $6,665,000 in 1999 to $13,594,000 in 2000 primarily due to increased revenue recognized under our commercial sequencing business of approximately $691,000, as well as increased revenue recognized under our government grants with the National Human Genome Research Institute to participate in the Human Genome and Mouse (Rat) Genome sequencing projects of approximately $6,779,000. Costs and Expenses Total costs and expenses increased 15% from $29,389,000 in 1999 to $33,780,000 in 2000. Cost of services increased 157% from $4,560,000 in 1999 to $11,715,000 in 2000 primarily due to increased costs and expenses associated with the increase in GenomeVision Services revenue, as mentioned above. The increase consisted primarily of higher labor and material costs. Research and development expenses include internal research and development, research funded pursuant to arrangements with our strategic alliance partners, as well as clinical development costs and expenses. Research and development expenses decreased 25% from $20,376,000 in 1999 to $15,191,000 to 2000. This reduction in research and development expenses was primarily attributable to a decline in our internal drug discovery programs and research funded under our product discovery alliances during 2000. Selling, general and administrative expenses increased 54% from $4,453,000 in 1999 to $6,875,000 in 2000 primarily due to increases in payroll and related expenses, non-cash charges related to the issuance of stock options and restricted stock awards, as well as increased shareholder communication expenses caused by an expanded shareholder base. Interest Income and Expense Interest income increased 124% from $1,488,000 in 1999 to $3,331,000 in 2000 reflecting primarily an increase in funds available for investment as a result of (i) proceeds received from the sale of common stock through a public offering in 2000, (ii) proceeds received from the exercise of stock options, and (iii) proceeds received from our employee stock purchase plan. Interest expense decreased 3% from $867,000 in 1999 to $843,000 in 2000. The decrease was due to a decrease in our outstanding balances under long-term obligations from approximately $8.9 million at December 31, 1999 to $7.8 million at December 31, 2000. Liquidity and Capital Resources Our primary sources of cash have been payments received from product discovery alliances, subscription fees, government grants, borrowings under equipment lending facilities and capital leases and proceeds from sale of equity securities. As of December 31, 2001, we had cash, cash equivalents, restricted cash and short-term and long-term investments of approximately $67,341,000. In 2001, we sold 127,500 shares of common stock in a series of transactions through the Nasdaq National Market, resulting in proceeds received of approximately $1,706,000, net of issuance costs. In 2001, we also issued 352,950 shares of common stock related to the exercise of stock options and our employee stock purchase plan, resulting in proceeds received of approximately $1,204,000. In 2000, we sold 1,500,000 shares of common stock in a series of transactions through the Nasdaq National Market, resulting in proceeds received of approximately $44,723,000, net of issuance costs. In 2000, we issued 1,288,943 shares of common stock related to the exercise of stock options and our employee stock purchase plan, resulting in proceeds received of approximately $3,528,000. 19 In 1999, we also sold 678,610 shares of common stock to bioMerieux, a product discovery partner, resulting in proceeds received of approximately $3,732,000, net of issuance costs. In 1999, we also issued 472,459 shares of common stock related to the exercise of stock options, resulting in proceeds received of approximately $1,235,000. We received payments of approximately $18,087,000, $17,399,000 and $22,866,000 in 2001, 2000 and 1999, respectively, from our product discovery partners consisting of up-front license fees, contract research funding, subscription fee, milestone payments and expense reimbursement. We had various arrangements under which we financed certain office and laboratory equipment and leasehold improvements. We had an aggregate of approximately $5,632,000 outstanding under our borrowing arrangements at December 31, 2001. This amount is repayable over the next 34 months, of which $3,572,000 is repayable over the next 12 months. Under these arrangements, we are required to maintain certain financial ratios, including minimum levels of tangible net worth, total indebtedness to tangible net worth, minimum cash level, debt service coverage and minimum restricted cash balances. We had no additional borrowing capacity under these capital lease agreements at December 31, 2001. In February 2002, we entered into an additional line of credit for $3,500,000, of which $500,000 will be used to refinance a portion of the existing line of credit and the remaining $3,000,0000 to be used to finance office and laboratory equipment. Our operating activities used cash of approximately $3,091,000 in 2001 primarily due to an increase in our net loss and prepaid expenses and other assets, as well as a decrease in deferred revenue. These uses of cash were partially offset by a decrease in interest receivable, accounts receivable and unbilled costs and fees, as well as an increase in accounts payables and accrued liabilities. Our operating activities provided cash of approximately $3,011,000 in 2000 and used cash of approximately $1,616,000 in 1999. Our investing activities provided cash of approximately $20,017,000 in 2001 through the conversion of marketable securities to cash and cash equivalents, partially offset by purchases of marketable securities, equipment and additions to leasehold. Our investing activities used cash of approximately $45,568,000 and $2,467,000 in 2000 and 1999, respectively, to purchase marketable securities, equipment and additions to leasehold, partially offset the conversion of marketable securities to cash and cash equivalents. Capital expenditures totaled $3,706,000 during 2001 consisting of leasehold improvements and purchases of laboratory, computer, and office equipment. We utilized existing capital lease and equipment financing arrangements to finance the majority of these capital expenditures. We currently estimate that we will acquire approximately $5,000,000 in capital equipment in 2002 consisting of primarily computers, laboratory equipment, and additions to leasehold improvement, which we intend to finance the majority of theses purchases under new financing arrangements. Financing activities used cash of approximately $2,217,000 and $205,000 in 2001 and 1999, respectively, primarily for payments of long-term obligations, partially offset by proceeds received from the sale of equity securities, exercise of stock options, and employee stock purchase plan. Financing activities provided cash of approximately $43,636,000 in 2000 primarily from proceeds received from the sale of equity securities, exercise of stock options, and employee stock purchase plan, net of payments of long-term obligations. At December 31, 2001, we had net operating loss and tax credits (investment and research) carryforwards of approximately $93,767,000 and $6,642,000, respectively, available to reduce federal taxable income and federal income taxes, respectively, if any. Net operating loss carryforwards are subject to review and possible adjustment by the Internal Revenue Service and may be limited, in the event of certain cumulative changes in ownership interests of significant shareholders over a three-year period in excess of 50%. Additionally, certain of these losses are expiring due to the limitations of the carryforward period. We believe that our existing capital resources are adequate for approximately two years under our current rate of investment in research and development. There is no assurance, however, that changes in our plans or events affecting our operations will not result in accelerated, or unexpected expenditures. On March 6, 2002, we sold convertible debentures to two institutional investors in a private placement transaction, raising $15 million in gross proceeds. The debentures may be converted into shares of our common stock at the option of the holder, at a price of $8.00 per share, subject to certain adjustments. The maturity date of the debentures is December 31, 2004, provided, that if any time on or after December 31, 2003 the Company maintains a net cash balance (i.e., cash and cash equivalents less obligations for borrowed money bearing interest) of less than $35 million, then the holders of the debentures can require that all or any part of the outstanding principal balance of the notes plus all accrued but unpaid interest be repaid. Interest on the debentures accrues at 6% annually. The investors also received warrants to purchase up to 487,500 shares of common stock at an exercise price of $8.00 per share, subject to certain adjustments. The warrants only become exercisable to the extent the debentures are converted or if certain other redemptions or repayments of the debentures occur. We plan to continue to invest in our internal research and development programs, including our lead candidate, Ramoplanin, currently in Phase III clinical development. We expect to incur $15-20 million in Phase III clinical development expenditures through the end of 2002. We expect to seek additional funding in the future through public or private financing. Additional financing may not be available when needed, or if available, it may not be on terms acceptable to us. To the extent that we raise additional capital by issuing equity or convertible debt securities, ownership dilution to stockholders will result. In 2000, we entered into two separate interest-rate-swap agreements with a bank aggregating approximately $1,900,000. Under these agreements, we pay a fixed rate of 8.78% and receives a variable rate tied to the one month LIBOR rate. As of 20 December 31, 2001, the variable rate was 3.83%. These swap agreements meet the required criteria, as defined in SFAS No. 133 to use special hedge accounting, and we have recorded an unrealized loss of $30,830 at December 31, 2001, through other comprehensive income, for the change in the fair value of the swap agreements. At February 28, 2002, this debt had been paid off in its entirety and the interest-rate-swap agreements expired. We generally place our marketable security investments in high quality credit instruments, as specified in our investment policy guidelines; the policy also limits the amount of credit exposure to any one issue, issuer, and type of instrument. We do not expect any material loss from our marketable security investments and therefore believe that our potential interest rate exposure is limited. This Form 10-K and documents we have filed with the Securities and Exchange Commission contain forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements represent our management's judgment regarding future events. Forward-looking statements typically are identified by use of terms such as "may," "will," "should," "plan," "expect," "intend," "anticipate," "estimate," and similar words, although some forward-looking statements are expressed differently. All forward-looking statements, other than statements of historical fact, included in this report regarding our financial position, business strategy and plans or objectives for future operations are forward-looking statements. We cannot guarantee the accuracy of the forward-looking statements, nor do we plan to update these forward-looking statements. You should be aware that our actual results could differ materially from those contained in the forward looking statements due to a number of risks affecting our business, including our ability and the ability of our alliance partners to (i) successfully develop products based on the Company's genomics information, (ii) obtain the necessary governmental approvals, (iii) effectively commercialize any products developed before our competitors and (iv) obtain and enforce intellectual property rights, as well as the risk factors set forth in this Annual Report on Form 10-K and those set forth in other filings that we may make with the Securities and Exchange commission from time to time. ITEM 8. Financial Statements and Supplementary Data Financial statements and supplementary data required by Item 8 are set forth at the pages indicated in Item 14(a) below. ITEM 9. Disagreements on Accounting and Financial Disclosure None PART III Pursuant to General Instruction G(3) to Form 10K, the information required for Part III (Items 10, 11, 12, and 13) is incorporated herein by reference from the Company's proxy statement for the Annual Meeting of Shareholders to be held on June 25, 2002. 21 PART IV ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8K (a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES (1) AND (2) See "Index to Consolidated Financial Statements and Financial Statement Schedules" appearing on page F-1. (3) Exhibits
Exhibit No. Description - -------- ----------- 3 Restated Articles of Organization and By laws /(1)/ 3.1 Amendment dated January 5, 1982 to Restated Articles of Organization /(2)/ 3.2 Amendment dated January 24, 1983 to Restated Articles of Organization /(3)/ 3.3 Amendment dated January 17, 1984 to Restated Articles of Organization /(4)/ 3.4 Amendment dated October 20, 1987 to the By-laws /(8)/ 3.5 Amendment dated December 9, 1987 to Restated Articles of Organization /(9)/ 3.6 Amendment dated October 16, 1989 to the By-law /(11)/ 3.7 Amendment dated January 24, 1994 to Articles Restated Articles of Organization /(14)/ 3.8 Amendment dated August 31, 1994 to Restated Articles of Organization /(14)/ 3.9 Amendment dated March 15, 2001 to Restated Articles of Organization /(33)/ 3.10 By-Laws of Genome Therapeutics Corp (as amended through July 24, 2001) /(34)/ 4.2 Form of Note dated March 5, 2002 received by Smithfield Fiduciary LLC and the Tail Wind Fund, Ltd. /(35)/ 4.3 Form of Warrant received by Smithfield Fiduciary LLC and The Tail Wind Fund, Ltd. /(35)/ 10.4 Incentive Stock Option Plan and Form of Stock Option Certificate /(1)/ 10.6 Genome Therapeutics Corp. (f/k/a Collaborative Research) Incentive Savings Plan /(6)/ 10.7 Amendment dated November 4, 1986 to the Genome Therapeutics Corp. (f/k/a Collaborative Research) Incentive Savings Plan dated March 1, 1985 /(7)/ 10.14 1991 Stock Option Plan and Form of Stock Option Certificate /(12)/ 10.15 Lease dated November 17, 1992 relating to certain property in Waltham, Massachusetts /(13)/ 10.16 Lease dated June 3, 1993 relating to certain property in Waltham, Massachusetts /(13)/ 10.19 Employment Agreement with Robert J. Hennessey /(13)/ 10.22 Lease Amendment dated August 1, 1994 relating to certain property in Waltham, MA /(14)/ 10.24 1993 Stock Option Plan and Form of Stock Option Certificate /(14)/ 10.28 Agreement between the Company and AstraZeneca PLC (f/k/a Astra Hassle AB) dated August 31, 1995 /(16)/* 10.29 Collaboration and License Agreement between the Company, Schering Corporation and Schering-Plough Ltd., dated as of December 6, 1995 /(18)/* 10.30 Form of director Stock Option Agreement and schedule of director options granted /(17)/ 10.37 Lease amendment dated November 15, 1996 to certain property in Waltham, MA /(19)/ 10.38 Collaboration and License Agreement between the Company, Schering Corporation and Schering-Plough Ltd., dated as of December 20, 1996 /(20)/* 10.39 Credit agreement between the Company and Fleet National Bank dated February 28, 1997 /(21)/ 10.40 Credit agreement between the Company and U S Trust (f/k/a Sumitomo Bank, Limited) dated July 31, 1997 /(22)/ 10.41 Collaboration and License Agreement between the Company and Schering Corporation, dated September 22, 1997 /(23)/* 10.42 Collaboration and License Agreement between the Company and Schering-Plough Ltd. dated September 22, 1997 /(23)/* 10.43 Credit modification agreement between the Company and Fleet National Bank, dated March 9, 1998 /(24)/
22
10.44 1997 Directors' Deferred Stock Plan /(25)/ 10.45 1997 Stock Option Plan /(25)/ 10.46 Amended Employment Agreement with Robert J. Hennessey /(26)/ 10.47 Collaboration and License Agreement between the Company and American Home Products, Inc., acting through its Wyeth-Ayerst Division, dated December 20, 1999 /(27)/ 10.49 Collaboration and License Agreement between Genome Therapeutics Corporation and bioMerieux Incorporated dated as of September 30, 1999 /(29)/ 10.50 Registration Rights Agreement between the Company and bioMerieux Alliance sa dated September 30, 1999 /(30)/ 10.51 Compound Discovery Collaboration Agreement, dated October 17, 2000 between the Company and ArQule, Inc* /(31)/ 10.52 2001 Incentive Plan /(32)/ 10.53 Stock Option Agreements with Steven M. Rauscher /(32)/ 10.55 Employment Letter with Steven M. Rauscher /(34)/ 10.56 Employment Letter with Stephen Cohen /(34)/ 10.57 Employment Letter with Richard Labaudinere PhD /(34)/ 10.58 Purchase Agreement dated March 5, 2002 among Smithfield Fiduciary LLC, The Tail Wind Fund, Ltd. and the Company /(35)/ 10.59 Registration Rights Agreement dated March 5, 2002 among Smithfield Fiduciary LLC, The Tail Wind Fund, Ltd. and the Company /(35)/ 10.60 Employment Letter with Robert J. Hennessey /(36)/ 10.61 License and Supply Agreement between the Company and Biosearch Italia, S.P.A., dated October 8, 2001 /(36)/* 23. Consent of Arthur Andersen LLP Independent Public Accounts /(36)/ 99.1 Risk Factors /(36)/ 99.2 Letter to Commission Pursuant to Temporary Note 3T /(36)/ - ----------
* Confidential treatment requested with respect to a portion of this Exhibit. FOOTNOTES /(1)/ Filed as exhibits to the Company's Registration Statement on Form S-1 (No. 2-75230) and incorporated herein by reference. /(2)/ Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended February 27, 1982 and incorporated herein by reference. /(3)/ Filed as exhibits to the Company's Quarterly Report on Form 10-Q for the quarter ended February 26, 1983 and incorporated herein by reference. /(4)/ Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended February 25, 1984 and incorporated herein by reference. /(6)/ Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1985 and incorporated herein by reference. 23 /(7)/ Filed as exhibits to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1986 and incorporated herein by reference. /(8)/ Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended August 31, 1987 and incorporated herein by reference. /(9)/ Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended November 28, 1987 and incorporated herein by reference. /(11)/ Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1989 and incorporated herein by reference. /(12)/ Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1992 and incorporated herein by reference. /(13)/ Filed as exhibits to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference. /(14)/ Filed as exhibits of the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1994 and incorporated herein by reference. /(16)/ Filed as an exhibit to the Company's Annual Report on Form 10-K/A3 for the year ended August 31, 1995 and incorporated herein by reference. /(17)/ Filed as an exhibit to the Company Registration Statement on Forms S-8 (File No. 33-61191) and incorporated herein by reference. /(18)/ Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended November 25, 1995 and incorporated herein by reference. /(19)/ Filed as an exhibit to the Company's 10-K for fiscal year ended August 31, 1996 and incorporated herein by reference. /(20)/ Filed as an exhibit to the Company's 10-Q/A for the quarter ended March 1, 1997 and incorporated herein by reference. /(21)/ Filed as an exhibit to the Company's 10-Q for the quarter ended May 31, 1997 and incorporated herein by reference. /(22)/ Filed as an exhibit to the Company's 10-K for fiscal year ended August 31, 1997 and incorporated herein by reference. /(23)/ Filed as exhibits to the Company's 10-Q for the quarter ended February 28, 1998 and incorporated herein by reference. /(24)/ Filed as an exhibit to the Company's 10-Q for the quarter ended May 30, 1998 and incorporated herein by reference. /(25)/ Filed as exhibits to the Company's Registration Statement on Forms S-8 (333-49069) and incorporated herein by reference. /(26)/ Filed as an exhibit to the Company's 10-K for fiscal year ended August 31, 1998 and incorporated herein by reference. /(27)/ Filed as an exhibit to the Company's 8-K filed on March 8, 2000 and incorporated herein by reference. /(29)/ Filed as an exhibit to the Company's 10-Q for the quarter ended November 27, 1999 and incorporated herein by reference. /(30)/ Filed as an exhibit to the Company's Registration Statement on Form S-3 (file No 333-32614) and incorporated herein by reference. /(31)/ Filed as an exhibit to the Company's 10-Q for the quarter ended November 25, 2000 and incorporated herein by reference. /(32)/ Filed as exhibit to the Company's Registration Statement on Form S-8 (333-58274) and incorporated herein by reference.. 24 /(33)/ Filed as an exhibit to the Company's 10-Q for the quarter ended February 24, 2001 and incorporated herein by reference. /(34)/ Filed as an exhibit to the Company's 10-Q for the quarter ended September 29, 2001 and incorporated herein by reference. /(35)/ Filed as an exhibit to the Company's 8-K filed on March 6, 2002 and incorporated herein by reference. /(36)/ Filed herewith. 25 GENOME THERAPEUTICS CORP. AND SUBSIDIARY INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Report of Independent Public Accountants........................................................................ F-2 Consolidated Balance Sheets as of December 31, 2000 and 2001.................................................... F-3 Consolidated Statements of Operations for the Years Ended December 31, 1999, 2000 and 2001...................... F-4 Consolidated Statements of Shareholders' Equity and Comprehensive Income for the Years Ended December 31, 1999, 2000 and 2001....................................................................... F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 2000 and 2001...................... F-6 Notes to Consolidated Financial Statements...................................................................... F-7
F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Genome Therapeutics Corp.: We have audited the accompanying consolidated balance sheets of Genome Therapeutics Corp. and subsidiary (the Company) as of December 31, 2000 and 2001, and the related consolidated statements of operations, shareholders' equity and comprehensive income and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Genome Therapeutics Corp. and subsidiary as of December 31, 2000 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States. /s/ Arthur Andersen LLP Boston, Massachusetts February 28, 2002 F-2 GENOME THERAPEUTICS CORP. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS
December 31, --------------------------------- 2000 2001 --------------------------------- ASSETS Current Assets: Cash and cash equivalents................................................. $ 10,095,817 $ 24,805,385 Short-term investments (held-to-maturity)................................. 51,743,917 29,961,540 Interest receivable....................................................... 1,466,808 1,074,726 Accounts receivable....................................................... 827,106 513,885 Unbilled costs and fees................................................... 796,072 164,465 Prepaid expenses and other current assets................................. 900,547 1,583,320 --------------------------------- Total current assets............................................... 65,830,267 58,103,321 ================================= Property and Equipment, at cost: Laboratory and scientific equipment....................................... 18,823,063 20,918,535 Leasehold improvements.................................................... 8,302,308 8,798,842 Equipment and furniture................................................... 1,134,320 1,267,854 --------------------------------- 28,259,691 30,985,231 Less--Accumulated depreciation............................................ 15,225,148 19,091,703 --------------------------------- 13,034,543 11,893,528 Restricted Cash (Note 2).................................................... 200,000 200,000 Long-term Investments (held-to-maturity).................................... 10,970,153 11,839,045 Warrant (available-for-sale)................................................ -- 535,279 Other Assets................................................................ 216,041 168,425 --------------------------------- $ 90,251,004 $ 82,739,598 ================================= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Current maturities of long-term obligations............................... $ 4,499,696 $ 3,571,578 Accounts payable.......................................................... 1,296,511 2,092,593 Accrued expenses.......................................................... 3,712,757 4,832,713 Deferred revenue.......................................................... 4,720,234 3,449,959 --------------------------------- Total current liabilities.......................................... 14,229,198 13,946,843 Long-term Obligations, net of current maturities............................ 3,334,354 2,060,817 Commitments (Note 4) Shareholders' Equity: Common stock, $0.10 par value -- Authorized -- 50,000,000 shares Issued and outstanding -- 22,288,658 and 22,772,170 shares at December 31, 2000 and 2001, respectively.................... 2,228,866 2,277,217 Additional paid-in capital................................................ 143,018,548 146,509,995 Accumulated deficit....................................................... (71,963,333) (82,053,635) Deferred compensation and note receivable from officer (Note 6(e))........ (596,629) (506,088) Accumulated other comprehensive income.................................... -- 504,449 --------------------------------- Total shareholders' equity......................................... 72,687,452 66,731,938 --------------------------------- $ 90,251,004 $ 82,739,598 ================================= The accompanying notes are an integral part of these consolidated financial statements.
F-3 GENOME THERAPEUTICS CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, -------------------------------------------- 1999 2000 2001 -------------------------------------------- Revenues: BioPharmaceutical........................................................ $ 18,162,056 $ 11,851,091 $ 18,438,286 GenomeVision(TM) services................................................ 6,665,529 13,594,143 17,302,239 -------------------------------------------- Total revenues 24,827,585 25,445,234 35,740,525 ============================================ Costs and Expenses: Cost of services......................................................... 4,559,588 11,714,955 16,152,707 Research and development................................................. 20,376,271 15,190,531 24,057,760 Selling, general and administrative...................................... 4,453,252 6,874,579 8,767,229 -------------------------------------------- Total costs and expenses......................................... 29,389,111 33,780,065 48,977,696 -------------------------------------------- Loss from operations...................................... (4,561,526) (8,334,831) (13,237,171) ============================================ Interest Income (Expense): Interest income.......................................................... 1,488,250 3,330,625 3,839,260 Interest expense......................................................... (866,799) (842,633) (692,391) -------------------------------------------- Net interest income.............................................. 621,451 2,487,992 3,146,869 -------------------------------------------- Net loss.................................................. $ (3,940,075) $ (5,846,839) $(10,090,302) ============================================ Net Loss per Common Share: Basic and diluted........................................................ $ (0.21) $ (0.27) $ (0.45) ============================================ Weighted Average Common Shares Outstanding: Basic and diluted........................................................ 18,627,045 21,376,685 22,572,427 ============================================ The accompanying notes are an integral part of these consolidated financial statements.
F-4 GENOME THERAPEUTICS CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
Common Stock Additional $0.10 Paid-In Accumulated Shares Par Value Capital Deficit -------------------------------------------------------- Balance, December 31, 1998........... 18,348,646 $1,834,865 $88,029,084 $(62,176,419) Sale of common stock, net of issuance costs of $17,885........... 678,610 67,861 3,664,254 -- Exercise of stock options............ 472,459 47,245 1,187,509 -- Deferred compensation from grant of stock options....................... -- -- 1,366,574 -- Amortization of deferred compensation and other stock-based compensation expense................ -- -- -- -- Reversal of deferred compensation related to cancellation of stock options............................. -- -- (119,494) -- Compensation expense related to grant of stock options.............. -- -- 3,464 -- Net loss............................. -- -- -- (3,940,075) -------------------------------------------------------- Balance, December 31, 1999........... 19,499,715 1,949,971 94,131,391 (66,116,494) ======================================================== Sale of common stock, net of issuance costs of $718,066.......... 1,500,000 150,000 44,572,729 -- Exercise of stock options............ 1,280,612 128,062 3,184,327 -- Issuance of stock under employee stock purchase plan................. 8,331 833 214,723 -- Deferred compensation from grant of stock options....................... -- -- 1,377,161 -- Amortization of deferred compensation and other stock-based compensation expense................ -- -- -- -- Reversal of deferred compensation related to cancellation of stock options............................. -- -- (461,783) -- Net loss............................. -- -- -- (5,846,839) -------------------------------------------------------- Balance, December 31, 2000........... 22,288,658 2,228,866 143,018,548 (71,963,333) ======================================================== Sale of common stock, net of issuance costs of $44,622.................... 127,500 12,750 1,693,017 -- Exercise of stock options............ 251,354 25,135 736,584 -- Issuance of stock under employee stock purchase plan................. 74,596 7,460 434,410 -- Issuance of restricted common stock and loan to officer (Note 6e)....... 24,000 2,400 (2,400) -- Deferred compensation from grant of stock options....................... -- -- 647,942 -- Issuance of stock under directors deferred stock plan................. 6,062 606 (606) -- Amortization of deferred compensation and other stock based compensation expense.......... -- -- -- -- Reversal of deferred compensation related to cancellation of stock options............................. -- -- (17,500) -- Unrealized gain on long-term investment (available for sale)..... Unrealized loss on derivative instruments......................... Net loss............................. -- -- -- (10,090,302) -------------------------------------------------------- Balance, December 31, 2001........... 22,772,170 $ 2,277,217 $ 146,509,995 $ (82,053,635) ======================================================== Deferred Compensation & Note Accumulated Receivable Other Total From Comprehensive Shareholders' Comprehensive Officer Income Equity Income ------------------------------------------------------------- Balance, December 31, 1998........... $ (130,293) -- $ 27,557,237 Sale of common stock, net of issuance costs of $17,885........... -- -- 3,732,115 Exercise of stock options............ -- -- 1,234,754 Deferred compensation from grant of stock options....................... (1,366,574) -- -- Amortization of deferred compensation and other stock-based compensation expense................ 259,462 -- 259,462 Reversal of deferred compensation related to cancellation of stock options............................. 119,494 -- -- Compensation expense related to grant of stock options.............. -- -- 3,464 Net loss............................. -- -- (3,940,075) (3,940,075) ------------------------------------------------------------- Balance, December 31, 1999........... (1,117,911) -- 28,846,957 (3,940,075) ============================================================= Sale of common stock, net of issuance costs of $718,066.......... -- -- 44,722,729 Exercise of stock options............ -- -- 3,312,389 Issuance of stock under employee stock purchase plan................. -- 215,556 Deferred compensation from grant of stock options....................... (1,377,161) -- -- Amortization of deferred compensation and other stock-based compensation expense................ 1,436,660 -- 1,436,660 Reversal of deferred compensation related to cancellation of stock options............................. 461,783 -- -- Net loss............................. -- -- (5,846,839) (5,846,839) ------------------------------------------------------------- Balance, December 31, 2000........... (596,629) -- 72,687,452 (5,846,839) ============================================================= Sale of common stock, net of issuance costs of $44,622.................... -- -- 1,705,767 Exercise of stock options............ -- -- 761,719 Issuance of stock under employee stock purchase plan................. -- -- 441,870 Issuance of restricted common stock and loan to officer (Note 6e)....... (163,000) -- (163,000) Deferred compensation from grant of stock options....................... (647,942) -- -- Issuance of stock under directors deferred stock plan................. -- -- -- Amortization of deferred compensation and other stock based compensation expense.......... 883,983 -- 883,983 Reversal of deferred compensation related to cancellation of stock options............................. 17,500 -- -- Unrealized gain on long-term investment (available for sale)..... 535,279 535,279 535,279 Unrealized loss on derivative instruments......................... (30,830) (30,830) (30,830) Net loss............................. -- -- (10,090,302) $(10,090,302) ------------------------------------------------------------- Balance, December 31, 2001........... $ (506,088) $ 504,449 $ 66,731,938 $ (9,585,853) ============================================================= The accompanying notes are an integral part of these consolidated financial statements.
F-5 GENOME THERAPEUTICS CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, -------------------------------------------- 1999 2000 2001 ------------- -------------- --------------- Cash Flows from Operating Activities: Net loss................................................................ $ (3,940,075) $(5,846,839) $(10,090,302) Adjustments to reconcile net loss to net cash (used in) provided by operating activities- Depreciation and amortization......................................... 3,973,001 4,471,722 4,807,379 Loss on disposal of equipment and leasehold improvements.............. 362,534 665,207 39,355 Amortization of deferred compensation................................. 262,926 1,436,660 883,983 Changes in assets and liabilities- Interest receivable................................................. (274,095) (612,005) 392,082 Accounts receivable................................................. (806,527) (10,787) 313,221 Unbilled costs and fees............................................. (317,216) 1,220,195 631,607 Prepaid expenses and other current assets........................... (34,174) (323,730) (682,773) Accounts payable.................................................... 210,409 305,954 796,082 Accrued expenses.................................................... (46,230) 1,049,809 1,089,126 Deferred revenue.................................................... (1,006,212) 654,545 (1,270,275) -------------------------------------------- Net cash (used in) provided by operating activities.............. (1,615,659) 3,010,731 (3,090,515) -------------------------------------------- Cash Flows from Investing Activities: Purchases of investments................................................ (23,129,394) (69,013,466) (47,526,465) Proceeds from sale of investments....................................... 22,880,646 23,860,411 68,439,950 Purchases of property and equipment..................................... (2,514,394) (460,835) (944,278) Decrease in other assets................................................ 296,372 46,167 47,616 -------------------------------------------- Net cash (used in) provided by investing activities.............. (2,466,770) (45,567,723) 20,016,823 -------------------------------------------- Cash Flows from Financing Activities: Proceeds from sale of common stock...................................... 3,732,115 44,722,729 1,705,767 Proceeds from exercise of stock options................................. 1,234,754 3,312,389 761,719 Proceeds from issuance of stock under the employee stock purchase plan.. -- 215,556 441,870 Note receivable from officer............................................ (120,000) 120,000 (163,000) Payments on long-term obligations....................................... (5,052,021) (4,734,876) (4,963,096) -------------------------------------------- Net cash (used in) provided by financing activities.............. (205,152) 43,635,798 (2,216,740) -------------------------------------------- Net (Decrease) Increase in Cash and Cash Equivalents...................... (4,287,581) 1,078,806 14,709,568 Cash and Cash Equivalents, beginning of year.............................. 13,304,592 9,017,011 10,095,817 -------------------------------------------- Cash and Cash Equivalents, end of year.................................... $9,017,011 $10,095,817 $24,805,385 -------------------------------------------- Supplemental Disclosure of Cash Flow Information: Interest paid during the year........................................... $866,800 $842,633 $692,391 -------------------------------------------- Income taxes paid during the year....................................... $31,800 $8,231 $60,000 -------------------------------------------- Supplemental Disclosure of Noncash Investing and Financing Activities: Equipment acquired under capital leases................................. $1,126,597 $3,691,840 $2,761,441 -------------------------------------------- Unrealized gain on warrant.............................................. -- -- $535,279 -------------------------------------------- Unrealized loss on derivative instruments............................... -- -- (30,830) -------------------------------------------- The accompanying notes are an integral part of these consolidated financial statements.
F-6 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Genome Therapeutics Corp. and subsidiary (the Company) is a biopharmaceutical company focused on the discovery and development of pharmaceutical and diagnostic products. The Company has eight established product development programs. The Company's lead product candidate, Ramoplanin, is in Phase III clinical trials for the prevention of bloodstream infections caused by vancomycin-resistant enterococci (VRE). The Company has six alliances with pharmaceutical companies including Schering-Plough, AstraZeneca, Wyeth-Ayerst and bioMerieux, and a joint venture with ArQule. In addition to these eight projects, the Company has a portfolio of earlier stage internal drug discovery programs. The Company also maintains an active service business, GenomeVision(TM) Services, providing drug discovery services to pharmaceutical and biotechnology companies and to the National Human Genome Research Institute. The accompanying consolidated financial statements reflect the application of certain accounting policies, as described in this note and elsewhere in the accompanying notes to the consolidated financial statements. (a) Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Collaborative Securities Corp. (a Massachusetts Securities Corporation). All intercompany accounts and transactions have been eliminated in consolidation. (b) Revenue Recognition BioPharmaceutical revenues consist of license fees, contract research and milestone payments from alliances with pharmaceutical companies. GenomeVision Services are revenues from government grants, fees received from custom gene sequencing and analysis services and subscription fees from the PathoGenome(TM) Database. Revenues from contract research, government grants, the PathoGenome Database subscription fees, and custom gene sequencing and analysis services are recognized over the respective contract periods as the services are provided. License fees and milestone payments are recognized as earned in accordance with Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition. Milestone payments will be recognized upon achievements of the milestone as long as the milestone is deemed to be substantive and the Company has no other performance obligations related to the milestone. Unbilled costs and fees represent revenue recognized prior to billing. Deferred revenue represents amounts received prior to revenue recognition. (c) Property and Equipment Property and equipment, including leasehold improvements, are depreciated over their estimated useful lives using the straight-line method. The estimated useful life for leasehold improvements is the lesser of the term of the lease or the estimated useful life of the assets. The majority of the Company's equipment and leasehold improvements are financed through bank lines of credit. - ------------------------------------------------------- Estimated Useful Life - ------------------------------------------------------- Laboratory Equipment 5 Years - ------------------------------------------------------- Computer Equipment & Licenses 3 Years - ------------------------------------------------------- Office Equipment 5 Years - ------------------------------------------------------- Furniture & Fixtures 5 Years - ------------------------------------------------------- F-7 (d) Net Loss Per Share Basic and diluted earnings per share were determined by dividing net loss by the weighted average shares outstanding during the period. Diluted loss per share is the same as basic loss per share for all periods presented, as the effect of the potential common stock is antidilutive. Antidilutive securities which consist of stock options, directors' deferred stock and unvested restricted stock that are not included in diluted net loss per share were 3,762,856, 3,320,113 and 3,773,990 shares at December 31, 1999, 2000 and 2001, respectively. (e) Concentration of Credit Risk SFAS No. 105, Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk, requires disclosure of any significant off-balance-sheet and credit risk concentrations. At December 31, 2001, the Company had entered into two interest- rate-swap agreements with a bank. The Company has no other off-balance-sheet or concentrations of credit risk such as foreign exchange contracts, options contracts or other foreign hedging arrangements. The Company maintains its cash and cash equivalents and investment balances with several nonaffiliated institutions. The Company maintains reserves for the potential write-off of accounts receivable. To date, the Company has not written off any significant accounts. The following table summarizes the number of customers that individually comprise greater than 10% of total revenues and their aggregate percentage of the Company's total revenues: Number of Percentage of Significant Total Revenues Customers A B C ----------- ------ ------- ----- Year ended December 31, 1999..................... 1 71% 9% - 2000..................... 2 35% 36% - 2001..................... 3 31% 36% 18% The following table summarizes the number of customers that individually comprise greater than 10% of total accounts receivable and their aggregate percentage of the Company's total accounts receivable: Percentage of Total Accounts Receivable --------------------------------------- B D E F G H I - - - - - - - At December 31, 1999.................. - 11% 31% - - 35% 18% 2000.................. 87% - - - - - - 2001.................. - - - 37% 29% - - (f) Use of Estimates The preparation of consolidated 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 at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (g) Financial Instruments The estimated fair value of the Company's financial instruments, which includes cash and cash equivalents, short-term and long-term investments, accounts receivable, accounts payable and long-term debt, approximates the carrying values of these instruments. (h) Derivative Instruments and Hedging Activities The Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, in 2001. SFAS F-8 No. 133 establishes standards for accounting and reporting derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. To manage the Company's exposure to movements in interest rates on its variable rate debt, the Company entered into two interest-rate-swap agreements. See Note 5 for further discussion. (i) Reclassifications The Company has reclassified certain prior-year information to conform with the current year's presentation. (j) Comprehensive Income (Loss) The Company has adopted SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 requires disclosure of all components of comprehensive income (loss) on an annual and interim basis. Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. At December 31, 2001, the Company recorded approximately $535,000 to comprehensive income related to the value of a warrant and ($35,000) to comprehensive loss related to two interest-rate-swap agreements. See Notes 2 and 5 for further discussion. (k) Segment Reporting The Company adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 establishes standards for reporting information regarding operating segments in annual financial statements and requires selected information for those segments to be presented in interim financial reports issued to stockholders. SFAS No. 131 also establishes standards for related disclosures about products and services and geographic areas. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision-making group, in making decisions as to how to allocate resources and assess performance. The Company's chief decision makers, as defined under SFAS No. 131, are the chief executive officer and chief financial officer. To date, the Company has viewed its operations and manages its business as principally two operating segments: GenomeVision Services and BioPharmaceutical. As a result, the financial information disclosed herein represents all of the material financial information related to the Company's two operating segments. All of the Company's revenues are generated in the United States and all assets are located in the United States.
GenomeVision(TM) Services BioPharmaceutical Total ----------------------------------------------------------------- 1999 Revenues $ 6,665,529 $ 18,162,056 $ 24,827,585 Gross profit 2,105,941 7,083,332 9,189,273 Company-funded research & development -- 9,297,547 9,297,547 2000 Revenues $ 13,594,143 $ 11,851,091 $ 25,445,234 Gross profit 1,879,188 3,715,045 5,594,233 Company-funded research & development -- 7,054,485 7,054,485 2001 Revenues $ 17,302,239 $ 18,438,286 $ 35,740,525 Gross profit 1,149,532 11,122,807 12,272,339 Company-funded research & development -- 16,742,281 16,742,281
The Company does not allocate assets by its operating segments. (l) Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, Business Combination, SFAS No. 142, Goodwill and Other Intangible Assets and SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method of accounting. SFAS No. 142 addresses how intangible assets that are acquired should be accounted for in financial statements upon their acquisition and also how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. F-9 Beginning on January 1, 2002, with the adoption of SFAS No. 142, goodwill and certain purchased intangibles existing on June 30, 2001, will no longer be subject to amortization over their estimated useful life. Rather, the goodwill and certain purchased intangibles will be subject to an assessment for impairment based on fair value. The provisions of SFAS No. 142 are required to be applied starting with fiscal years beginning after December 15, 2001. SFAS No. 143 establishes accounting standards for the recognition and measurement of legal obligations associated with the retirement of tangible long-lived assets and requires recognition of a liability for an asset retirement obligation in the period in which it is occurred. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 142 did not have a material impact on the Company's financial position or results of operations. The adoption of SFAS No. 143 is not expected to have a material impact on the Company's financial position or results of operations. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. This Statement supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of Accounting Principles Board (APB) Opinion No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. Under this Statement, it is required that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and it broadens the presentation of discontinued operations to include more disposal transactions. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early adoption permitted. The Company does not expect the adoption of this Statement to have a material impact on its financial position or results of operations. (2) CASH EQUIVALENTS AND INVESTMENTS The Company applies the provisions of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. At December 31, 2000 and 2001, the Company's investments include short-term and long-term investments which are classified as held-to-maturity, as the Company has the positive intent and ability to hold these securities to maturity. Cash equivalents are short-term, highly liquid investments with original maturities of 90 days or less. The Company's short-term and long-term investments include marketable securities with original maturities of greater than 90 days. Cash equivalents are carried at cost, which approximates market value, and consist of debt securities. Short-term and long-term investments are recorded at amortized cost, which approximates market value and consist of commercial paper and U.S. government debt securities. The average maturity of the Company's investments is approximately 7.5 months at December 31, 2001. At December 31, 2001, the Company had an unrealized gain of approximately $442,000, which is the difference between the amortized cost and the market value of the held to maturity investments. The Company's investments also include a warrant to purchase 45,000 shares of common stock from Versicor, Inc. which was received in connection with its collaboration agreement with Versicor, Inc. dated March 10, 1997. The warrant was immediately vested and is exercisable through March 10, 2002. The Company is accounting for the warrant in accordance with SFAS No. 115 as an "available for sale security" and as a result, the warrant is record at fair value. Upon exercise, the shares received will be restricted and as a result the Company will not be able to liquidate its position in the shares for at least one year. At December 31, 2001, the Company had recorded an unrealized gain of $535,000 in other comprehensive income in its consolidated statements of shareholders' equity related to the appreciation in value of the warrant. At December 31, 2000 and 2001, the Company's cash and cash equivalents and investments consisted of the following: 2000 2001 -------------------------- Cash and Cash Equivalents: Cash............................................ $ 9,245,817 $ 21,801,201 Debt securities................................. 850,000 3,004,184 -------------------------- Total cash and cash equivalents........ $ 10,095,817 $ 24,805,385 -------------------------- Investments: Short-term investments ......................... $ 51,743,917 $ 29,961,540 Long-term investments .......................... $ 10,970,153 $ 11,839,045 Warrant -- 535,279 -------------------------- Total investments...................... $ 62,714,070 $ 42,335,864 -------------------------- The Company also has $200,000 in restricted cash at December 31, 2000 and 2001 in connection with certain capital lease obligations (see Note 5). (3) INCOME TAXES F-10 The Company applies SFAS No. 109, Accounting for Income Taxes, which requires the Company to recognize deferred tax assets and liabilities for expected future tax consequences of events that have been recognized in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using the enacted tax rates in effect for the year in which the differences are expected to reverse. SFAS No. 109 requires deferred tax assets and liabilities to be adjusted when the tax rates or other provisions of the income tax laws change. At December 31, 2001, the Company had net operating loss and tax credit carryforwards of approximately $93,767,000 and $6,642,000, respectively, available to reduce federal taxable income and federal income taxes, respectively, if any. Net operating loss and tax credit carryforwards are subject to review and possible adjustment by the Internal Revenue Service and may be limited in the event of certain cumulative changes in the ownership interest of significant shareholders over a three-year period in excess of 50%. The net operating loss and tax credit carryforwards expire approximately as follows: Investment Net Operating Research Tax Tax Loss Credit Credit Expiration Date Carryforwards Carryforwards Carryforwards - --------------- ------------- ------------- ------------- 2002............... $ 2,254,000 $ -- $ -- 2003............... 697,000 -- -- 2004............... 2,702,000 -- -- 2005............... 1,456,000 80,000 -- 2006--2021......... 86,658,000 6,525,000 37,000 --------------------------------------------- $ 93,767,000 $ 6,605,000 $ 37,000 --------------------------------------------- The components of the Company's net deferred tax asset at the respective dates are as follows: December 31, ---------------------------- 2000 2001 ------------- ------------- Net operating loss carryforwards...... $ 36,538,000 $ 37,265,000 Research and development credits...... 5,816,000 6,605,000 Investment tax credits................ 37,000 37,000 Other, net............................ 4,018,000 4,233,000 ----------------------------- 46,409,000 48,140,000 Valuation allowance................... (46,409,000) (48,140,000) ----------------------------- $ -- $ -- ----------------------------- The valuation allowance has been provided due to the uncertainty surrounding the realization of the deferred tax assets. (4) COMMITMENTS (a) Lease Commitments At December 31, 2001, the Company has operating leases for office and laboratory facilities, the last of which expires on November 15, 2006. Approximate minimum lease payments and facilities charges under the operating leases at December 31, 2001 are as follows: Year ending December 31, 2002.......................................... $ 1,028,000 2003.......................................... 946,000 2004.......................................... 1,100,000 2005.......................................... 1,107,000 2006.......................................... 1,073,000 ----------- $ 5,254,000 =========== F-11 Rental expense under these operating leases was approximately $1,009,000, $927,000 and $1,007,000 for the years ended December 31, 1999, 2000 and 2001, respectively. (b) Employment Agreements The Company has employment agreements with its executive officers, which provide for bonuses, as defined, and severance benefits upon termination of employment, as defined. (5) LONG-TERM OBLIGATIONS In February 2000, the Company entered into an equipment line of credit under which it may finance up to $4,000,000 of laboratory, computer and office equipment. In December 2000, the Company increased the line of credit by $2,712,000 to $6,712,000. The Company, at its discretion, can enter into either operating or capital leases. The borrowings under operating leases are payable in 24 monthly installments and capital leases are payable in 36 monthly installments. As of December 31, 2001, the Company had entered into $256,000 in operating leases and $6,456,000 in capital leases. The interest rates under the capital leases range from 7.55% to 10.37%. The Company had no additional borrowing capacity under this line of credit at December 31, 2001. There are no covenants related to this agreement. Over the last five years, the Company had entered into other lines of credit or capital lease arrangements under which it financed approximately $15,060,000 of laboratory, computer and office equipment, as well as facility renovations. The borrowings under these arrangements are payable in 36 to 48 monthly installments from the date of initiation. Interest rates range from 7.63% to 10.28%. The Company is required to maintain certain restricted cash balances, as defined. In addition, the Company is required to maintain certain financial ratios pertaining to minimum cash balances, tangible net worth and debt service coverage. As of December 31, 2001, the Company was in compliance with all covenants. The Company had no additional borrowing capacity under these other lines of credit or capital lease agreements at December 31, 2001. In February 2002, the Company entered into an additional line of credit for $3,500,000, of which $500,000 will be used to refinance a portion of an existing line of credit. This line of credit is payable in twelve consecutive quarterly payments at the prevailing LIBOR rate (2.08% at February 28, 2002) plus 1 1/2 %. The Company is required to maintain certain financial ratios pertaining to minimum cash balances. As of December 31, 2001, the Company was in compliance with all covenants. During 2000, the Company entered into two interest-rate-swap agreements to manage its exposure to movements in the interest rates on its variable rate debt. The swap agreements are cash flow hedges and are used to manage exposure to interest rate movement by effectively converting the variable rate to a fixed rate. Such instruments are matched with the underlying borrowings. SFAS No. 133 eliminates special hedge accounting if a swap agreement does not meet certain criteria, thus requiring the Company to reflect all changes in the fair value of the swap agreement in earnings in the period of change. The Company entered into two separate interest-rate-swap agreements with a bank aggregating approximately $1,900,000. Under these agreements, the Company pays a fixed rate of 8.78% and receives a variable rate tied to the one month LIBOR rate. As of December 31, 2001, the variable rate was 3.83%. These swap agreements meet the required criteria, as defined in SFAS No. 133 to use special hedge accounting, and the Company has recorded an unrealized loss of $30,830 at December 31, 2001, through other comprehensive income, for the change in the fair value of the swap agreements. At February 28, 2002, this debt had been paid off in its entirety and the interest-rate-swap agreements expired. Finance payments under long-term obligations at December 31, 2001 are as follows: Year ending December 31, 2002..................................................... $ 3,881,339 2003..................................................... 1,727,572 2004..................................................... 432,459 ------------- Total minimum lease payments........................ 6,041,370 Less--Amount representing interest............................ 408,975 ------------- Present value of total minimum lease payments............ 5,632,395 Less--Current portion......................................... 3,571,578 ------------- $ 2,060,817 ------------- (6) SHAREHOLDERS' EQUITY F-12 (a) Stock Options The Company has granted stock options to key employees and consultants under its 1991, 1993, 1995 and 1997 Stock Option Plans, as well as the 2001 Incentive Plan. The Stock Option and Compensation Committee of the Board of Directors determines the purchase price and vesting schedule applicable to each option grant. In addition, under separate agreements not covered by any plan, the Company has granted certain key employees and directors of the Company, options to purchase common stock. The Company granted nonqualified stock options for the purchase of 65,000 and 10,000 shares of common stock to consultants during fiscal years 1997 and 1999, respectively. The options were granted with an exercise price equal to the fair market value price at the date of grant and vest ratably over the contract period, as defined. In accordance with Emerging Issues Task Force (EITF) No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services, the Company will measure the fair value of the options as they vest using the Black-Scholes option pricing model. The Company has charged $29,750, $281,636 and $3,160 to operations for the years ended December 31, 1999, 2000 and 2001, respectively, related to the grant of these options. During 2000, the Company granted to certain employees the right to receive 154,616 shares of common stock. The employees received the common stock in two equal installments on the anniversary of the grant date. The Company recorded deferred compensation of $647,942 related to the grant of these rights to receive the common stock, which will be amortized to expense over the period the shares are earned. Since the inception of this program, employees who resigned from the Company forfeited 62,915 shares of the restricted stock. The Company records deferred compensation when stock options, restricted stock and other stock-based awards are granted at an exercise price per share that is less than the fair market value on the date of the grant. Deferred compensation is recorded in an amount equal to the excess of the fair market value per share over the exercise price times the number of options or shares granted. Deferred compensation is being recognized as an expense over the vesting period of the underlying options. During the years ended 1999, 2000 and 2001, the Company recorded $1,366,574, $1,377,161 and $647,942, respectively, of deferred compensation. The Company recorded compensation expense of approximately $262,926, $1,436,660 and $883,983 for the years ended December 31, 1999, 2000 and 2001, respectively. During 1999, 2000 and 2001, in connection with the termination of several employees, the Company reversed $119,494, $461,783 and $17,500, respectively, of unamortized deferred compensation due to the cancellation of options. There were 2,734,903 common shares available for future grant at December 31, 2001. The following is a summary of all stock option activity:
Number of Exercise Price Weighted Shares Range Average Price ----------------------------------------- Outstanding, December 31, 1998.......... 3,622,570 $0.20-14.50 $3.63 Granted............................... 1,121,479 0.00-9.25 3.60 Exercised............................. (472,459) 0.20-8.31 2.61 Cancelled............................. (632,232) 0.00-14.50 5.35 ---------------------------------------- Outstanding, December 31, 1999.......... 3,639,358 0.00-14.50 3.45 Granted............................... 1,198,004 0.00-66.00 14.89 Exercised............................. (1,280,612) 0.00-14.72 2.59 Cancelled............................. (381,769) 0.00-66.00 4.44 ---------------------------------------- Outstanding, December 31, 2000.......... 3,174,981 0.00-66.00 7.99 Granted............................... 865,640 1.80-16.08 7.87 Exercised............................. (251,354) 0.00-14.72 3.03 Cancelled............................. (143,403) 0.00-39.38 11.74 ---------------------------------------- Outstanding, December 31, 2001.......... 3,645,864 $0.00-66.00 $8.15 ---------------------------------------- Exercisable, December 31, 2001.......... 1,951,126 $0.10-66.00 $5.73 ---------------------------------------- Exercisable, December 31, 2000.......... 1,607,085 $0.00-14.72 $4.10 ----------------------------------------
F-13
----------------------------------- Exercisable, December 31, 1999................................... 2,091,258 $1.56-14.50 $2.87 -----------------------------------
The range of exercise prices for options outstanding and options exercisable at December 31, 2001 are as follows:
Weighted Average Remaining Contractual Options Outstanding Options Exercisable Life of ----------------------------- --------------------------- Options Weighted Weighted Range of Outstanding Average Average Exercise Prices (In Years) Number Exercise Price Number Exercise Price - ------------------ ------------ ----------- ---------------- ---------- --------------- $0.00-3.38........................ 2.98 994,202 $ 1.95 841,161 $ 1.81 3.52-4.88....................... 7.34 464,290 4.35 430,184 4.34 5.05-7.50....................... 8.82 400,754 6.73 71,027 7.03 7.56-9.50....................... 6.02 495,956 8.65 321,133 8.88 9.80-14.72...................... 8.96 1,186,349 13.77 261,052 14.49 15.97-66.00..................... 8.56 104,313 23.20 26,569 24.15 ------------------------------------------------------------------------ Total................... 6.69 3,645,864 $ 8.15 1,951,126 $ 5.73
(b) Sale of Common Stock In September 1999, the Company sold 678,610 shares of its common stock to bioMerieux as part of a strategic alliance agreement (see Note 8 (c)). The Company received $3,732,115 in proceeds from the sale of common stock, net of issuance costs of $17,885. In June and July of 2000, the Company sold 1,500,000 shares of its common stock in a series of transactions through the Nasdaq National Market at an average price of $31.01 per share resulting in proceeds of $44,722,729, net of issuance costs of $718,066. In June and July of 2001, the Company sold 127,500 shares of its common stock in a series of transactions through the Nasdaq National Market at an average price of $13.73 per share resulting in proceeds of $1,705,767, net of issuance costs of $44,622. (c) Pro Forma Disclosure of Stock-based Compensation SFAS No. 123, Accounting for Stock-Based Compensation requires the measurement of the fair value of stock options or warrants granted to employees to be included in the consolidated statement of operations or, alternatively, disclosed in the notes to consolidated financial statements. The Company has determined that it will continue to account for stock-based compensation for employees and nonemployee directors under APB Opinion No. 25 and elect the disclosure-only alternative under SFAS No. 123. The Company has computed the pro forma disclosures required under SFAS No. 123 for stock options granted in 1999, 2000 and 2001 using the Black-Scholes option-pricing model. The weighted average assumptions used for 1999, 2000 and 2001 and certain weighted average data are as follows:
1999 2000 2001 --------------- -------------- -------------- Risk-free interest rate....................... 5.10%-6.38% 5.36%-6.71% 4.31%-5.24% Expected dividend yield....................... -- -- -- Expected life................................. 5 years 5 years 5 years Expected volatility........................... 72% 87% 87% Weighted average fair market value at grant date................................. $3.28 $11.45 $6.25
The pro forma effect of these option grants for the years ended December 31, 1999, 2000 and 2001 is as follows:
1999 As Reported Pro Forma - ---- ------------- ------------- Net loss............................................................ $ (3,940,075) $ (4,498,680) -------------- --------------
F-14
------------------------------ Net loss per share.................................................. $ (0.21) $ (0.24) ------------------------------ 2000 - ---- Net loss............................................................ $ (5,846,839) $ (7,175,564) ------------------------------ Net loss per share.................................................. $ (0.27) $ (0.34) ------------------------------ 2001 - ---- Net loss............................................................ $(10,090,302) $(16,700,952) ----------------------------- Net loss per share.................................................. $ (0.45) $ (0.74) -----------------------------
The resulting pro forma compensation expense may not be representative of the amount to be expected in future years, as the pro forma expense may vary based on the number of options granted. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions, including expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. (d) 1997 Directors' Deferred Stock Plan In January 1998, the Company's stockholders approved the 1997 Directors' Deferred Stock Plan (the 1997 Directors' Plan) covering 150,000 shares of common stock. The shares will be granted as services are performed by members of the Company's Board of Directors. As of December 31, 2001, the Company granted 39,012 shares of restricted common stock under the 1997 Directors' Plan. These shares are issued at the end of the three-year period or earlier if the individual ceases to serve as a member of the Company's Board of Directors. As of December 31, 2001, 6,862 shares of restricted common stock were vested under the 1997 Directors' Plan. (e) Note Receivable from Officer On March 28, 2001, the Company loaned $163,000 to an officer of the Company to allow him to pay income tax liabilities associated with a restricted stock grant of 24,000 shares. The loan bears interest at 4% and is payable in full on December 31, 2004 and may be extended by either party to December 31, 2006. The loan may also be extended beyond December 31, 2006 upon mutual consent. The principal amount of the note is non-recourse as it is secured only by the 24,000 shares of restricted stock. The interest portion of the loan is full-recourse as it is secured by the officer's assets. The Company issued these shares to the officer for no consideration and as a result recorded deferred compensation of approximately $347,000, which will be amortized over the vesting period of the award, which is forty-eight months. (f) Employee Stock Purchase Plan On February 28, 2000, the Company adopted an Employee Stock Purchase Plan under which eligible employees may contribute up to 15% of their earnings toward the semi-annual purchase of the Company's common stock. The employees' purchase price will be 85% of the fair market value of the common stock at the time of grant of option or the time at which the option is deemed exercised, whichever is less. No compensation expense will be recorded in connection with the plan. As of December 31, 2001, the Company has issued 82,927 shares under this plan. (7) INCENTIVE SAVINGS 401(K) PLAN The Company maintains an incentive savings 401(k) plan (the Plan) for the benefit of all employees. In February 2002, the Company changed its match to 50% of the first 6% of salary from 100% of the first 2% of salary and 50% of the next 2% of salary, limited to the first $100,000 of annual salary. The Company contributed $229,732, $201,759 and $251,157 to the Plan for the years ended December 31, 1999, 2000 and 2001, respectively. (8) ALLIANCES - BIOPHARMACEUTICAL (A) ASTRAZENECA In August 1995, the Company entered into a strategic alliance with AstraZeneca (Astra), formerly Astra Hassle AB, to develop F-15 drugs, vaccines and diagnostic products effective against peptic ulcers or any other disease caused by H. pylori. The Company granted Astra exclusive access to the Company's H. pylori genomic sequence database and exclusive worldwide rights to make, use and sell products based on the Company's H. pylori technology. The agreement provided for a four-year research alliance (which ended in August 1999) to further develop and annotate the Company's H. pylori genomic sequence database, identify therapeutic and vaccine targets and develop appropriate biological assays. Under this agreement, Astra agreed to pay the Company, subject to the achievement of certain product development milestones, up to $23.3 million (and possibly a greater amount if more than one product is developed under the agreement) in license fees, expense allowances, research funding and milestone payments. The Company has received a total of $13.5 million in license fees, expense allowances, milestone payments and research funding under the Astra agreement through December 31, 2001. The Company will also be entitled to receive royalties on Astra's sale of products protected by the claims of patents licensed exclusively to Astra by the Company pursuant to the agreement or the discovery of which was enabled in a significant manner by the genomic database licensed to Astra by the Company. The Company has the right, under certain circumstances, to convert Astra's license to a nonexclusive license in the event that Astra is not actively pursuing commercialization of the technology. The Company recognized approximately $620,000, $6,000 and $0 in revenue under the agreement during the years ended December 31, 1999, 2000 and 2001, respectively. (b) SCHERING-PLOUGH In December 1995, the Company entered into a strategic alliance and license agreement (the December 1995 agreement) with Schering Corporation and Schering-Plough Ltd. (collectively, Schering-Plough) providing for the use by Schering-Plough of the genomic sequence of Staph. aureus to identify and validate new gene targets for development of drugs to target Staph. aureus and other pathogens that have become resistant to current antibiotics. As part of this agreement, the Company granted Schering-Plough exclusive access to the Company's proprietary Staph. aureus genomic sequence database. The Company agreed to undertake certain research efforts to identify bacteria-specific genes essential to microbial survival and to develop biological assays to be used by Schering-Plough in screening natural product and compound libraries to identify antibiotics with new mechanisms of action. Under this agreement, Schering-Plough paid an initial license fee and agreed to fund the research program through March 31, 2002. Under this agreement, Schering-Plough agreed to pay the Company a minimum of $21.4 million in an up-front license fee, research funding and milestone payments. Subject to the achievement of additional product development milestones, Schering-Plough agreed to pay the Company up to an additional $24 million in milestone payments. The agreement grants Schering-Plough exclusive worldwide rights to make, use and sell pharmaceutical and vaccine products based on the genomic sequence databases licensed to Schering-Plough and on the technology developed in the course of the research program. The Company will be entitled to receive royalties on Schering-Plough's sale of therapeutic products and vaccines developed using the technology licensed. As of December 31, 2001, the Company had substantively completed its research obligations under this alliance and had turned over validated drug targets and assays to Schering-Plough for high-throughput screening. A total of $21.4 million has been received through December 31, 2001. Under the December 1995 agreement, the Company recognized approximately $2,344,000, $1,887,000 and $1,570,000 in revenue during the years ended December 31, 1999, 2000 and 2001, respectively. In December 1996, the Company entered into its second strategic alliance and license agreement (the December 1996 agreement) with Schering-Plough. This agreement calls for the use of genomics to discover new pharmaceutical products for treating asthma. As part of the agreement, the Company will employ its high-throughput disease gene identification, bioinformatics, and genomics sequencing capabilities to identify genes and associated proteins that can be utilized by Schering-Plough to develop pharmaceuticals and vaccines for treating asthma. Under this agreement, the Company has granted Schering-Plough exclusive access to (i) certain gene sequence databases made available under this research program, (ii) information made available to the Company under certain third-party research agreements, and (iii) an exclusive worldwide right and license to make, use and sell pharmaceutical and vaccine products based on the rights to develop and commercialize diagnostic products that may result from this alliance. Under this agreement (and subsequent extensions), Schering-Plough paid an initial license fee and an expense allowance to the Company and agreed to fund the research program through at least December 2002. In addition, upon completion of certain scientific developments, Schering-Plough has made or will make milestone payments, as well as pay royalties based upon sales of therapeutics products developed from this collaboration. If all milestones are met and the research program continues for its full term, total payments to the Company will approximate $81.0 million, excluding royalties. Of the total potential payments, approximately $36.5 F-16 million represents license fees and research payments, and $44.5 million represent milestone payments based on achievement of research and product development milestones. A total of $38.5 million has been received through December 31, 2001. Under the December 1996 agreement, the Company recognized approximately $9,280,000, $4,711,000 and $8,084,000 in revenue during the years ended December 31, 1999, 2000 and 2001, respectively. In September 1997, the Company entered into a third strategic alliance and license agreement (the September 1997 agreement) with Schering-Plough to use genomics to discover and develop new pharmaceutical products to treat fungal infections. Under this agreement, the Company will employ its bioinformatics, high-throughput sequencing and functional genomics capabilities to identify and validate genes and associated proteins as drug discovery targets that can be utilized by Schering-Plough to develop novel antifungal treatments. Schering-Plough will receive exclusive access to the genomic information developed in the alliance related to two fungal pathogens, Candida albicans and Aspergillus fumigatus. Schering-Plough will also receive exclusive worldwide rights to make, use and sell products based on the technology developed during the course of the research program. In return, Schering-Plough agreed to fund a research program through March 31, 2002. If all milestones are met and the research program continues for its full term, total payments to the Company will approximate $33.2 million, excluding royalties. Of the total potential payments, approximately $10.2 million represents contract research payments and $23.0 million represents milestone payments based on achievement of research and product development milestones. As of December 31, 2001, the Company had substantively completed its research obligations under this alliance and had turned over validated drug targets and assays to Schering-Plough for high-throughput screening. A total of $12.2 million has been received through December 31, 2001. Under the September 1997 agreement, the Company recognized approximately $5,261,000, $1,912,000 and $1,137,000 in revenue for the years ended December 31, 1999, 2000 and 2001, respectively. Under certain circumstances, the Company may have an obligation to give Schering-Plough a right of first negotiation to develop with the Company certain of its asthma and infectious disease related discoveries if it decides to seek a third party collaborator to develop such discovery. (c) BIOMERIEUX ALLIANCE In September 1999, the Company entered into a strategic alliance with bioMerieux to develop, manufacture and sell in vitro diagnostic products for human clinical and industrial applications. As part of the alliance, bioMerieux purchased a subscription to the Company's PathoGenome Database (see Note 9), paid an up-front license fee, agreed to fund a research program for at least four years and pay royalties on future products. In addition, bioMerieux purchased $3.75 million of the Company's common stock. The total amount of research and development funding, excluding subscription fees, approximates $5.2 million for the four-year term of this agreement. The research and development funding will be recognized as the research services are performed over the four-year term of the agreement. Approximately $3.4 million has been received through December 31, 2001. The Company recognized approximately $232,000, $1,469,000 and $1,173,000 in revenue during the years ended December 31, 1999, 2000 and 2001, respectively, which consisted of alliance research revenue and amortization of the up-front license fees. (d) WYETH-AYERST LABORATORIES In December 1999, the Company entered into a strategic alliance with Wyeth-Ayerst Laboratories to develop novel therapeutics for the prevention and treatment of osteoporosis. The alliance will focus on developing therapeutics, utilizing targets based on the characterization of a gene associated with a unique high bone mass trait. The agreement provides for the Company to employ its established capabilities in positional cloning, bioinformatics and functional genomics in conjunction with Wyeth-Ayerst's drug discovery capabilities and its expertise in bone biology and the osteoporotic disease process to develop new pharmaceuticals. Under the terms of the agreement, Wyeth-Ayerst paid the Company an up-front license fee, and funded a multi-year research program, which includes milestone payments and royalties on sales of therapeutics products developed from this alliance. If the research program continues for its full term and substantially all of the milestone payments are met, total payments to the Company, excluding royalties, would exceed $118 million. Approximately $8.1 million has been received through December 31, 2001. The Company recognized approximately $1,640,000 and $6,485,000 in revenue during the years ended December 31, 2000 and 2001, respectively, which consisted of alliance research revenue milestone payments and amortization of the up-front license fees. F-17 (9) GENOMEVISION(TM) SERVICES GenomeVision(TM) services are revenues from government grants, fees received from custom gene sequencing and analysis and subscription fees from PathoGenome(TM) Database. (A) DATABASE SUBSCRIPTIONS The Company has entered into a number of PathoGenome Database subscriptions. The database subscriptions provide nonexclusive access to the Company's proprietary genome sequence database, PathoGenome Database, and associated information relating to microbial organisms. These agreements call for the Company to provide periodic data updates, analysis tools and software support. Under the subscription agreements, the customer pays an annual subscription fee and will pay royalties on any molecules developed as a result of access to the information provided by the PathoGenome Database. The Company retains all rights associated with protein therapeutic, diagnostic and vaccine use of bacterial genes or gene products. (B) NATIONAL HUMAN GENOME RESEARCH INSTITUTE In July 1999, the Company was named as one of the nationally funded DNA sequencing centers of the international Human Genome Project. The Company is entitled to receive funding from the National Human Genome Research Institute (NHGRI) of up to $17.4 million through February 2003, of which all funds have been appropriated. In October 1999, the NHGRI named the Company as a pilot center to the Mouse Genome Sequencing Network. The Company is entitled to receive $13.4 million in funding through February 2003 with respect to this agreement, of which all funds have been appropriated. In August 2000, the Company was named one of two primary centers for the Rat Sequencing Program from NHGRI. As part of the agreement, we will use remaining funding under the mouse award, as well as a portion of the remaining funding under the human award, to participate in this rat genome initiative. Funding under our government grants and research contracts is subject to appropriation each year by the U.S. Congress and can be discontinued or reduced at any time. In addition, we cannot be certain that we will receive additional grants or contracts in the future. (10) PRODUCT DEVELOPMENT In October 2001, the Company acquired an exclusive license in the United States and Canada for a novel antibiotic, Ramoplanin, from Biosearch Italia S.p.A (Biosearch Italia). The Company will assume responsibility for the product development in the United States of Ramoplanin, currently in Phase III clinical trials. The agreement provides the Company with exclusive rights to develop and market oral Ramoplanin in the U.S. and Canada. Biosearch Italia will provide the bulk material for manufacture of the product and will retain all other rights to market and sell Ramoplanin. Under the terms of this agreement, the Company paid Biosearch Italia an initial license fee of $2 million and is obligated to make payments of up to $8 million in a combination of cash and notes convertible into Company stock upon the achievement of specified milestones. In addition, the Company is obligated to purchase bulk material from Biosearch Italia and fund the completion of clinical trials and pay a royalty on product sales. The Company expended approximately $5,549,000 and made cash payments of approximately $4,263,000 under this agreement during the year ended December 31, 2001, which consisted of the initial license fee and clinical development expenses. (11) QUARTERLY RESULTS OF OPERATIONS The following table sets forth unaudited quarterly statement of operations data for each of the eight quarters in the period ended December 31, 2001. In the opinion of management, this information has been prepared on the same basis as the audited financial statements appearing elsewhere in this Form 10-K, and all necessary adjustments, consisting only of normal recurring adjustments, have been included in the amounts stated below to present fairly the unaudited quarterly results of operations. F-18
2000 Quarter One Quarter Two Quarter Three Quarter Four Year Revenues: BioPharmaceutical...................................... $3,341,373 $2,872,424 $2,783,478 $2,853,816 $11,851,091 GenomeVision(TM) Services.............................. 3,668,813 3,301,520 3,141,373 3,482,437 13,594,143 ------------------------------------------------------------------------- Total revenues 7,010,186 6,173,944 5,924,851 6,336,253 25,445,234 ========================================================================= Costs and Expenses: Cost of services....................................... 2,937,332 2,671,538 2,750,809 3,355,276 11,714,955 Research and development............................... 3,638,769 3,522,553 3,754,546 4,274,663 15,190,531 Selling, general and administrative.................... 1,835,662 1,198,426 1,711,451 2,129,040 6,874,579 ------------------------------------------------------------------------- Total costs and expenses........................... 8,411,763 7,392,517 8,216,806 9,758,979 33,780,065 ------------------------------------------------------------------------- Loss from operations............................... (1,401,577) (1,218,573) (2,291,955) (3,422,726) (8,334,831) ========================================================================= Interest Income (Expense): Interest income....................................... 463,209 456,593 1,180,363 1,230,460 3,330,625 Interest expense...................................... (198,607) (217,749) (210,751) (215,526) (842,633) ------------------------------------------------------------------------- Net interest income................................ 264,602 238,844 969,612 1,014,934 2,487,992 ------------------------------------------------------------------------- Net loss........................................... $(1,136,975) $(979,729) $(1,322,343) $(2,407,792) $(5,846,839) ========================================================================= Net Loss per Common Share: Basic and diluted..................................... $ (0.06) $ (0.05) $ (0.06) $ (0.11) $ (0.27) ========================================================================= Weighted Average Common Shares Outstanding: Basic and diluted..................................... 20,309,912 20,696,487 22,215,971 22,284,371 21,376,685 ========================================================================= 2001 Quarter One Quarter Two Quarter Three Quarter Four Year Revenues: BioPharmaceutical...................................... $3,557,570 $7,459,478 $2,917,389 $4,503,849 $18,438,286 Genome Vision(TM) Services............................. 4,532,678 3,930,400 4,460,646 4,378,514 17,302,239 ------------------------------------------------------------------------- Total revenues 8,090,248 11,389,879 7,378,035 8,882,363 35,740,525 ========================================================================= Costs and Expenses: Cost of services....................................... 3,680,816 3,430,803 4,633,058 4,408,030 16,152,707 Research and development............................... 3,822,329 4,438,822 5,247,912 10,548,697 24,057,760 Selling, general and administrative.................... 1,634,922 2,190,432 2,559,004 2,382,871 8,767,229 ------------------------------------------------------------------------- Total costs and expenses............................ 9,138,067 10,060,057 12,439,974 17,339,598 48,977,696 ------------------------------------------------------------------------- Loss from operations................................ (1,047,819) 1,329,822 (5,061,939) (8,457,235) (13,237,171) ========================================================================= Interest Income (Expense): Interest income........................................ 1,143,795 986,723 1,055,631 653,111 3,839,260 Interest expense....................................... (169,342) (212,123) (174,269) (136,657) (692,391) ------------------------------------------------------------------------- Net interest income................................. 974,453 774,600 881,362 516,454 3,146,869 ------------------------------------------------------------------------- Net loss............................................ $(73,366) $2,104,422 $(4,180,577) $(7,940,781) $(10,090,302) ========================================================================= Net Loss per Common Share: Basic and diluted...................................... $(0.00) $0.09 $(0.18) $(0.35) $(0.45) ========================================================================= Weighted Average Common Shares Outstanding: Basic and diluted...................................... 22,409,501 22,451,753 22,685,660 22,742,794 22,572,427 =========================================================================
F-19 (12) ACCRUED EXPENSES Accrued expenses consist of the following: December 31, ======================= 2000 2001 ======================= Payroll and related expenses.................. $1,717,108 $1,990,394 Facilities.................................... 466,678 463,279 Professional fees............................. 242,273 108,375 License and other fees........................ 435,434 183,724 Employee relocation........................... 146,936 224,543 Clinical development.......................... -- 1,286,324 Other......................................... 704,328 576,074 ------------------------ $ 3,712,757 $4,832,713 ======================== (13) SUBSEQUENT EVENT (UNAUDITED) On March 6, 2002, the Company sold convertible debentures to two institutional investors in a private placement transaction, which resulted in $15 million in gross proceeds. The debentures may be converted into shares of the Company's common stock at the option of the holder, at a price of $8.00 per share, subject to certain adjustments. The maturity date of the debentures is December 31, 2004; provided, that if any time on or after December 31, 2003 the Company maintains a net cash balance (i.e., cash and cash equivalents less obligations for borrowed money bearing interest) of less than $35 million, then the holders of the notes can require that all or any part of the outstanding principal balance of the notes plus all accrued but unpaid interest be repaid. Interest on the debentures accrues at 6% annually. The investors also received warrants to purchase up to 487,500 shares of common stock at an exercise price of $8.00 per share, subject to certain adjustments. The warrants only become exercisable to the extent the debentures are converted or if certain other redemptions or repayments of the debentures occur. The warrant was valued using the Black-Scholes Option Pricing Model and recorded as a discount to the debt in accordance with EITF 00-27. The discount will be amortized as interest expense over the term of the debt. F-20 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Genome Therapeutics Corp. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 29, 2002. GENOME THERAPEUTICS CORP. /s/ STEVEN M. RAUSCHER -------------------------------- Steven M. Rauscher Chief Executive Officer SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated as of March 29, 2002.
Signature Title --------- ----- /s/ ROBERT J. HENNESSEY Director, Chairman of the Board - -------------------------------------- Robert J. Hennessey /s/ STEVEN M. RAUSCHER Director, President and Chief Executive Officer - -------------------------------------- Steven M. Rauscher /s/ STEPHEN COHEN Senior Vice President and Chief Financial Officer; Principal Financial Officer - -------------------------------------- Stephen Cohen /s/ MARC GARNICK Director - -------------------------------------- Marc Garnick /s/ PHILIP LEDER Director - -------------------------------------- Philip Leder /s/ LAWRENCE LEVY Director - -------------------------------------- Lawrence Levy /s/ DAVID STONE Director - -------------------------------------- David Stone /s/ NORBERT RIEDEL Director - -------------------------------------- Norbert Riedel
EX-10.60 3 dex1060.txt EMPLOYMENT LETTER WITH ROBERT J. HENNESSEY Exhibit 10.60 May 9,2001 Mr. Robert J. Hennessey 4 Lauricella Lane Waltham, Massachusetts 02452 Dear Robert: This letter will confirm our offer to you of employment with Genome Therapeutics Corp. (the "Company"), under the terms and conditions that follow: 1. Position and Duties. Effective May 1, 2001, you will be employed by the Company as its Chairman of the Board. You will have all powers and duties consistent with such position, including working with the Chief Executive Officer of the Company (the "Chief Executive Officer") and other employees of the Company on business development projects. You will devote twenty-five percent (25%) of your business time and best reasonable efforts to fulfill faithfully, responsibly and to the best of your ability your duties hereunder. During your employment with the Company, the Chief Executive Officer shall semi-annually review with you your time commitment to the Company to determine whether or not it should be adjusted. Following such review, if the Chief Executive Officer and you mutually agree that your time commitment should be changed, then the Chief Executive Officer and you shall jointly make a recommendation to the Compensation Committee of the Company's Board of Directors (the "Board") to effect such change. You may devote your business time, outside of your time commitment to the Company pursuant to this Paragraph 1, to any entity or purpose that you chose, provided, that, you observe your obligations to the Company regarding confidentiality and non-competition set forth in Paragraph 3 hereof. You warrant that you are free to enter into and fully perform this agreement and are not subject to any employment, confidentiality, non-competition or other agreement which conflicts with this agreement. 2. Compensation and Benefits. During your employment, as compensation for all services performed by you for the Company and its subsidiaries, the Company will provide you the following pay and benefits: a. Base Salary. The Company will pay you a base salary at the rate of One Hundred and Forty Thousand Dollars ($140,000) per year, payable in accordance with the regular payroll practices of the Company (such base salary as adjusted from time to time in accordance with the provisions of this paragraph 2(a), the "Base Salary"). The Chief Executive Officer shall semi-annually review with you your Base Salary to determine whether or not the same should be increased or decreased in light of your duties and responsibilities. Following such review, if the Chief Executive Officer and you mutually agree that your base salary hereunder should be changed, then the Chief Executive Officer and you shall jointly make a recommendation to the Compensation Committee of the Board to effect such change. b. Expenses. The Company will reimburse you, upon proper accounting, for reasonable business expenses, including travel expenses, which you incur in the course of performing your duties under this agreement. c. Prior Option Grants. The Company acknowledges that on February 16, 1996 the Board awarded to you stock options covering an aggregate of 300,000 shares of the Company's common stock at an exercise price of $8.87 per share (the "1996 Options") and that on March 15, 1993 the Board awarded to you stock options covering an aggregate of 1,600,000 shares of the Company's common stock, 630,000 of which remain unexercised, at an exercise price of $1.625 per share (the "1993 Options" and together with the 1996 Options, the "Options"). All of the unexercised Options are fully vested. In the event that the Company terminates your employment for Cause (as defined in Paragraph 4 below, which definition shall not include any termination of your employment related to your pursuit of another opportunity that is not in violation of your obligations to the Company under Paragraph 3 hereof), you (or your estate or permitted transferees) shall have three months from the date of termination to exercise all or any portion of the unexercised Options. In the event that your employment with the Company terminates for any other reason, then you (or your estate or permitted transferees) may exercise all or any portion of the unexercised Options at any time prior to the tenth (10th) anniversary of the respective grant dates of such Options. At your option, all or any portion of the exercise price of any Option may be paid by surrendering Options for cancellation in which event you will receive credit against the exercise price of Options to be exercised in the amount of the difference between the exercise price of the Option so surrendered and the per share closing price of the shares subject to the surrendered Options on the Nasdaq National Market (or other primary exchange on which such shares are traded). d. Participation in Employee Benefit Plans. You will be entitled to participate in all employee benefit plans from time to time in effect on the same basis as other executive employees of the Company, except to the extent such plans are duplicative of benefits otherwise provided to you under this agreement. Your participation will be subject to the terms of the applicable plan documents and applicable Company policies. 3. Confidential Information and Restricted Activities. In order to induce the Company to enter into this agreement, you hereby agree as follows: a. Confidentiality. Except for and on behalf of the Company with the consent of or as directed by the Board, you shall keep confidential and shall not divulge to any other person or entity, during the term of employment or thereafter, any of the business -2- secrets or other confidential information regarding the Company and its subsidiaries which have not otherwise become public knowledge, provided, however, that nothing in this agreement shall preclude you from disclosing information (i) to parties retained to perform services for the Company or its subsidiaries, (ii) under any other circumstances to the extent such disclosure is, in your reasonable judgment, appropriate or necessary to further the best interests of the Company or its subsidiaries, or (iii) as may be required by law. b. Records. All papers, books and records of every kind and description relating to the business and affairs of the Company and its subsidiaries, whether or not prepared by you, other than personal notes and files prepared by or at your direction, shall be the sole and exclusive property of the Company, and you shall, at the expense of the Company, surrender them to the Company at any time upon request by the Board. c. Non-competition. You agree that (a) during the term of your employment hereunder, (b) for a period of twelve (12) months following the date of your termination in the event that you are discharged other than for Cause (as defined in Paragraph 4(d)) or you resign with Good Reason (as defined in Paragraph 4(e)), (c) for a period of three (3) months following the date of your termination in the event that you are discharged for Cause, and (d) for a period of twelve (12) months following the date of your termination in the event that you resign without Good Reason, you will not, directly or indirectly, (a) own, manage, operate, control or participate in any manner in the ownership, management, operation or control of, or be connected as an officer, employee, partner, director, principal, consultant, agent or otherwise with, or have any financial interest in, or aid or assist anyone else in the conduct of, any business, venture or activity which competes, directly or indirectly, with, any business, venture or activity being conducted on the date of your termination by the Company, or by any group, division or subsidiary of the Company or (b) recruit or otherwise seek to induce any employees of the Company or any of its subsidiaries to terminate their employment or violate any agreement with or duty to the Company or any of its subsidiaries. It is understood and agreed that, for the purposes of the foregoing provisions of this Paragraph 3(c), (i) no business, venture or activity shall be deemed to be a business, venture or activity conducted by the Company or any group, division or subsidiary of the Company, unless not less than 20% of the Company's consolidated assets are devoted to, such business, venture or activity; and (ii) no business, venture or activity conducted by any entity by which you are employed or in which you are interested or with which you are connected or associated shall be deemed competitive with any business, venture or activity conducted by the Company unless it is one to which 20% or more of its consolidated assets are devoted. Furthermore, ownership of stock not to exceed 2% of the voting stock of any publicly held corporation shall not, of itself, constitute a violation of this Paragraph 3(c). -3- 4. Termination of Employment; Severance. Your employment under this agreement shall continue until one party delivers to the other party a written notice of termination setting forth the reason, if any, for the termination. If you terminate your employment without Good Reason, you will give the Company two month's written notice. a. In the event of termination of your employment by the Company other than for Cause or your termination of employment for Good Reason, the Company will: (i) continue to pay you your Base Salary and provide you with the benefits set forth in Paragraph 2(d) hereof for the lesser of (x) a period of twelve (12) months from the date of termination or (y) such period of time that it takes you to find employment or consulting work that generates comparable income; (ii) pay you on the date of termination any Base Salary earned but not paid through the date of termination; and (iii) pay you any bonus to which you are entitled in accordance with Paragraph 2(b) above, prorated to the date of termination and payable at the time such bonuses are payable to Company executives generally. All severance payments will be payable in accordance with the normal payroll practices of the Company. b. In the event of termination of your employment by the Company for Cause or termination by you other than for Good Reason, the Company will have no further obligations to you other than paying you any Base Salary earned but not paid through the date of termination. c. If within two years of a Change of Control (as defined in Exhibit A hereto) of the Company, (i) you are terminated other than for Cause, or (ii) you terminate your employment with the surviving company due to the fact that the surviving company takes any action that results in a material diminution in your position, authority or duties as such position, authority or duties existed immediately prior to the Change of Control (provided, that failure to maintain your position as chairman of the board or a director of the surviving company will not constitute such a material diminution), then, in the case of either (i) or (ii), the Company will continue to pay your Base Salary (as in effect at the time of your termination) and provide you with the benefits set forth in Paragraph 2(d) above for a period of eighteen (18) months from the date of termination. The Company will also pay you on the date of termination any Base Salary earned but not paid through the date of termination. All severance payments will be payable in accordance with the normal payroll practices of the Company. If you are eligible for severance payments under this Paragraph 4(c) upon termination, then the provisions of Paragraph 4(a) above shall not apply to such termination. d. For purposes of this agreement, "Cause" shall mean: (i) your material failure to perform (other than by reason of disability), or material negligence in the performance of, your duties and responsibilities to the Company or any of its -4- subsidiaries; (ii) your material breach of this agreement or any other agreement between you and the Company or any of its subsidiaries; (iii) the commission of a felony or other crime involving an act of moral turpitude; or (iv) a material act of dishonesty or breach of trust on your part resulting or intended to result, directly or indirectly, in a personal gain or enrichment at the expense of the Company. e. For purposes of this agreement, "Good Reason" shall mean: (i) any action by the Company that results in a material diminution in your position, authority or duties with the Company, excluding any isolated, insubstantial or inadvertent action not taken in bad faith and which is promptly remedied by the Company; (ii) material failure of the Company to provide you compensation and benefits in accordance with the terms of Paragraph 2, above, for more than ten business days after notice from you specifying in reasonable detail the nature of the failure or (iii) a Change of Control. f. This agreement shall automatically terminate in the event of your death during employment. In the event you become disabled during employment and, as a result, are unable, in the reasonable judgment of the Board, to continue to perform substantially all of your duties and responsibilities under this agreement, the Company will continue to pay you your Base Salary and to provide you benefits in accordance with Paragraph 2(d) above, to the extent permitted by plan terms, for up to twenty-four (24) weeks of disability during any period of three hundred and sixty-five (365) consecutive calendar days. The obligations of the Company to make payments to you due to disability pursuant to this Paragraph 4(f) shall be reduced by the amount of any payments you receive pursuant to the Company's disability insurance policy. If you are, in the reasonable judgment of the Board, unable to return to work after twenty-four (24) weeks of disability, the Company may terminate your employment, upon notice to you. 5. Miscellaneous. This agreement sets forth the entire agreement between you and the Company and replaces all prior and contemporaneous communications, agreements and understandings, written or oral, with respect to the terms and conditions of your employment; provided, that the terms and provisions regarding the grant to you of the Options set forth in Section 6(a) of your Employment Agreement with the Company dated March 15, 1996, solely to the extent not inconsistent with the terms of this agreement, shall remain in full force and effect (other than such provisions regarding registration rights, which shall cease to be in effect). This agreement may not be modified or amended, and no breach shall be deemed to be waived, unless agreed to in writing by you and an expressly authorized representative of the Board. This agreement may be executed in two or more counterparts, each of which shall be an original and all of which together shall constitute one and the same instrument. This is a Massachusetts contract and shall be governed and construed in accordance with the laws of the Commonwealth of Massachusetts, without regard to the conflict of laws principles thereof. All payments made hereunder shall be net of any tax or other amount required to be withheld by the -5- Company by law. Neither you nor the Company may make any assignment of this agreement or any interest in it, by operation of law or otherwise, without the prior written consent of the other; provided, however, that the Company may assign its rights and obligations under this agreement without your consent to one of its subsidiaries or to any Person that acquires substantially all the assets of the Company, by means of a merger or otherwise. Your obligations to the Company under Paragraph 3 hereof (Confidential Information and Restricted Activities) shall survive any termination of this agreement. 6. Notices. Any notices provided for in this agreement shall be in writing and shall be effective when delivered in person or deposited in the United States mail, postage prepaid, and addressed to you at your last known address on the books of the Company or, in the case of the Company, to it at its principal place of business, attention of the Chief Executive Officer, or to such other address as either party may specify by notice to the other actually received. 7. Binding Effect. This agreement shall be binding upon and inure to the benefit of your heirs and representatives and the successors and assigns of the Company. The Company shall require any successor (whether direct or indirect, by purchase, merger, reorganization, consolidation, acquisition of property or stock, liquidation, or otherwise) to all or a significant portion of its assets, by agreement in form and substance satisfactory to you, expressly to assume and agree to perform this agreement in the same manner and to the same extent that the Company would be required to perform this agreement if no such succession had taken place. Regardless of whether such agreement is executed, this agreement shall be binding upon any successor of the Company in accordance with the operation of law and such successor shall be deemed the "Company" for purposes of this agreement. If the foregoing is acceptable to you, please sign this letter in the space provided and return it to me no later than May 23, 2001. At the time you sign and return it this letter will take effect as a binding agreement between you and the Company on the basis set forth above. The enclosed copy is for your records. Sincerely yours, Accepted and Agreed: Steven M. Rauscher ______________________________ Chief Executive Officer Robert J. Hennessey Date:_________________________ Norbert Riedel, Ph.D. Chairman of the Compensation Committee -6- EXHIBIT A A "Change of Control" shall be deemed to have occurred if and when: (i) the Company executes an agreement of acquisition, merger, or consolidation which contemplates that after the effective date provided for in the agreement, all or substantially all of the business and/or assets of the Company shall be controlled by another corporation or other entity; PROVIDED, HOWEVER, for purposes of this clause (i) that (A) if such an agreement requires as a condition precedent approval by the Company's shareholders of the agreement or transaction, a Change of Control shall not be deemed to have taken place unless and until such approval is secured and, (B) if immediately after such effective date the voting shareholders of such other corporation or entity shall be substantially the same as the voting shareholders of the Company immediately prior to such effective date, the execution of such agreement shall not, by itself, constitute a "Change of Control;" (ii) any "person" (as such term is used in Sections 13(d) or 14(d)(2) of the Securities Exchange Act of 1934) becomes the beneficial owner, directly or indirectly, of securities of the Company that represent 35% or more of the votes that could then be cast in an election for members of the Company's Board; or (iii) during any period of 24 consecutive months, commencing after the effective date of this agreement, individuals who at the beginning of such 24-month period were directors of the Company shall cease to constitute at least a majority of the Company's Board, unless the election of each director who was not a director at the beginning of such period has been approved in advance by directors representing at least two thirds of (A) the directors then in office who were directors at the beginning of the 24-month period, or (B) the directors specified in clause (A) plus directors whose election has been so approved by directors specified in clause (A). EX-10.61 4 dex1061.txt LICENSE AND SUPPLY AGREEMENT EXHIBIT 10.61 BIOSEARCH ITALIA, S.P.A. AND GENOME THERAPEUTICS CORPORATION LICENSE AND SUPPLY AGREEMENT THIS LICENSE AND SUPPLY AGREEMENT (the "Agreement") is made effective as of the __th day of October, 2001 (the "Effective Date") by and between GENOME THERAPEUTICS CORPORATION a Massachussetts corporation having its principal place of business at 100 Beaver Street, Waltham, MA 02453, USA ("GENE") and BIOSEARCH ITALIA, S.p.A. an Italian corporation with its principal place of business at via R. Lepetit, 34, 21040 Gerenzano, Italy ("Biosearch"). GENE and Biosearch are sometimes referred to herein individually as a "Party"and collectively as the "Parties." RECITALS A. Biosearch is a pharmaceutical company interested in the identification and development of naturally produced compounds for the treatment of infectious diseases, and the commercialization of products based upon such compounds. B. Biosearch discovered and is developing a proprietary compound, Ramoplanin, and is currently conducting clinical trials in the U.S. of an oral formulation of Ramoplanin for the prevention of infectious diseases in patients carrying Vancomycin-resistant Enterococci ("VRE") and at risk of infection following chemotherapy or transplantation, with a view to registering a new pharmaceutical product for worldwide marketing under its trademark(s) and trade name(s). C. On May 8, 1998 Biosearch had entered into an agreement with IntraBiotics Pharmaceuticals, Inc., to permit the latter to develop and commercialize in the United States and Canada, formulations other than parenteral formulations of Ramoplanin. D. Following a decision by IntraBiotics to discontinue the development activities of Licensed Products (as defined herein), an amendment to the agreement mentioned under C. above was entered into, effective June 1, 2001, whereby Biosearch agreed to reacquire from IntraBiotics all rights in and to licensed Ramoplanin formulations (other than, for a given period, *****), after a Transition Period ending August 31, 2001. From this date until the Effective Date, Biosearch has assumed responsibility for the development of Licensed Products within the Territory. E. IntraBiotics subsequently gave notice of termination of the agreements it had entered into with Clinical Research Organizations (CROs) and Vendors engaged in the clinical trial activity and transferred to Biosearch the IND application for Ramoplanin, effective July 22, 2001. F. Pursuant to the above mentioned amendment, all rights in and to the ***** of Ramoplanin shall revert to Biosearch effective April 1, 2002 if IntraBiotics does not commence clinical development activity with respect to at least one ***** topical product by March 31, 2002. G. GENE is a biotechnology company interested in the development of products useful for the treatment of infectious diseases or conditions, and is interested in completing the development activities mentioned above - --------------------------- * Confidential Treatment has been requested for the marked portions. Page 1 and commercializing oral formulations of Ramoplanin for the treatment or prevention of infectious diseases and conditions in the United States and Canada (including the territories and possessions of each such country). ARTICLE 1 DEFINITIONS The following terms shall have the following meanings as used in this Agreement: 1.1 "Affiliate" means an entity that, directly or indirectly, through one or more intermediaries, controls, is controlled by or is under common control with Biosearch or GENE. 1.2 "Biosearch Know-how" means Information which (i) Biosearch is required to disclose to GENE under this Agreement and (ii) is within the Control of Biosearch. Notwithstanding anything herein to the contrary, Biosearch Know-how shall exclude Biosearch Patents. 1.3 "Biosearch Patent" means a Patent which covers, or is used or useful in, the manufacture of Bulk Licensed Compound or the discovery, evaluation, manufacture, use, sale, offer for sale and/or importation of Licensed Products within the Field, which Patent is owned or Controlled by Biosearch, including, without limitation, Biosearch's interest in any Joint Patents. 1.4 "Bulk Licensed Compound" means the bulk form of the Licensed Compound meeting the Specifications and used to manufacture Licensed Products under this Agreement. 1.5 "Clinical Materials" shall mean supplies of Licensed Product as well as supplies of placebo, packaged and labelled and in compliance with regulatory requirements for purposes of completing clinical trials as part of Development of the Licensed Product in the Territory. 1.6 "Commercialization" shall mean *****. 1.7 "Convertible Note" means a convertible promissory note issued by GENE in the form attached hereto as Exhibit I. 1.8 "Control" means possession of the ability to grant a license or sublicense as provided for herein without violating the terms of any agreement or other arrangement with any Third Party. 1.9 "Cost of Goods Sold" means the ***** . 1.10 "Development" means all activities relating to obtaining Regulatory Approval of a Licensed Product, Licensed Product delivery systems and new indications thereof and all activities relating to developing the ability to manufacture the same. 1.11 "Drug Approval Application" means an application for Regulatory Approval required before commercial sale or use of a Licensed Product as a drug in a regulatory jurisdiction. 1.12 "Excluded Formulations" means, *****. 1.13 "Field" means the ***** . - --------------------------- * Confidential Treatment has been requested for the marked portions. Page 2 1.14 "GENE Know-how" means Information which (i) GENE is required to disclose to Biosearch under this Agreement and (ii) is within the Control of GENE. Notwithstanding anything herein to the contrary, GENE Know-how shall exclude GENE Patents. 1.15 "GENE Patent" means a Patent which covers the manufacture, use, sale, offer for sale and/or import of Licensed Products within the Field, which Patent is owned or Controlled by GENE. 1.16 "IND" (or "InvestigationaI New Drug Application") means an application as defined in the United States Food, Drug and Cosmetic Act and applicable regulations promulgated thereunder to the United States Food and Drug Administration (the "FDA"), or the equivalent application to the equivalent agency in jurisdictions outside the United States, the filing of which is necessary to commence clinical testing of Licensed Products in humans. 1.17 "Information " means (i) techniques and data within the Field relating to Bulk Licensed Compound or Licensed Products, including inventions, practices, methods, knowledge, know-how, skill, experience, test data including pharmacological, toxicological and clinical test data, analytical. and quality control data or descriptions and (ii) compounds, compositions of matter, assays and biological materials within the Field. 1.18 "Joint Patent" shall have the meaning set forth in Section 10.3. 1.19 "Know-how" means Biosearch Know-how and/or GENE Know-how. 1.20 "Licensed Compound" means the compound known as Ramoplanin, as described in IND No. 56341. 1.21 "Licensed Product" means any product including or incorporating any formulation of the Licensed Compound, other than Excluded Formulations. 1.22 "NDA" means an application as defined in the United States Food, Drug and Cosmetic Act and applicable regulations promulgated thereunder to the FDA, or the equivalent application to the equivalent agency in jurisdictions outside the United States, the filing of which is necessary to commence the commercial sale of Licensed Products. 1.23 "Net Sales" means the ***** . 1.24 "Other Licensee" means any Third Party to which Biosearch has granted a license under the Biosearch Patents and Biosearch Know-how for the development or commercialization of Licensed Products or other products containing the Licensed Compound. 1.25 "Patent" means (i) valid and enforceable patents, re-examinations, reissues, renewals, extensions, term restorations and foreign counterparts thereof, and (ii) pending (at any time during the term of this Agreement) patent applications and foreign counterparts thereof. 1.26 "Phase III Clinical Trials" means those trials on sufficient numbers of patients that are designed to establish that a drug is safe and efficacious for its intended use, and to define warnings, precautions and adverse reactions that are associated with the drug in the to be prescribed dosage range, and supporting Regulatory Approval of such drug. - --------------------------- * Confidential Treatment has been requested for the marked portions. Page 3 1.27 "Regulatory Approval" means any approvals (including pricing and reimbursement approvals, if appropriate), product and/or establishment licenses, registrations or authorizations of any federal, state or local regulatory agency, department, bureau or other governmental entity, necessary for the manufacture, use, storage, import, export or sale of Licensed Products in a regulatory jurisdiction. 1.28 "Specifications" shall have the meaning set forth in Section 7.4. 1.29 "Supply Price" shall have the meaning set forth in Section 8.2. 1.30 "Territory" means the United States and Canada and the territories and possessions of each of the foregoing countries. 1.31 "Third Party" means any entity other than Biosearch or GENE or their Affiliates. 1.32 "Transfer Price" shall have the meaning set forth in Section 7.9. 1.33 "Valid Claim" means a claim of (a) an issued patent, which claim has not lapsed, been cancelled, or become abandoned and which claim has not been declared invalid or unenforceable by a court of competent jurisdiction in a decision from which no appeal has or can be taken, or (b) a patent application, so long as such application is being prosecuted and the claim in question has not been abandoned by the owner of the application (with the period of presumed validity of a pending application not to exceed five years in countries). ARTICLE 2 DEVELOPMENT 2.1 General. GENE shall be responsible for the completion of the Development of Licensed Products in the Field and in the Territory, with support from Biosearch as provided in this Agreement. Development of products including the Licensed Compound (including without limitation Licensed Products) outside of the Territory, development of products other than Licensed Products including the Licensed Compound in the Field and in the Territory, subject to the provisions of Section 5.6 herein, shall be conducted by Biosearch and/or the Other Licensees, if any, outside the scope of this Agreement. ***** .However, in order to avoid the duplication of cost and effort, and to optimize the results of worldwide Development of Licensed Products, the Parties agree to ***** as provided in this Agreement. In particular, the Parties intend to *****. 2.2 Development of Licensed Products by GENE. (a) GENE Commitment. GENE shall have the right to utilize all relevant non-clinical and clinical data received from Biosearch prior to the Effective Date and during the term of this Agreement pursuant to Sections 2.3 and 2.4 for the sole purposes of obtaining Regulatory Approval and Commercialization of Licensed Products in the Field and in the Territory. GENE hereby agrees, subject to the terms hereof, to conduct or have conducted, at its sole expense or at the expense of any Affiliate or sublicensee as permitted under this Agreement, subsequent to the Effectve Date all non-clinical and clinical Development necessary to obtain Regulatory Approvals for Licensed Products in the Field and in the Territory. GENE shall not have any obligation to develop Licensed Products for any *****but may, at its option, develop Licensed Products for any ***** and shall, at all times during the term of this Agreement, undertake Development of Licensed Product for at least *****. (b) Diligence and monitoring. GENE shall work *****, to develop Licensed Products in the Field and in the Territory. *****. The progress of all Development activities and GENE's ***** shall be ***** - --------------------------- * Confidential Treatment has been requested for the marked portions. Page 4 by the Joint Management Committee referred to in Section 2.4 below on a continuing basis, following a regular meeting schedule. Any matter that should involve an assessment of GENE's ***** in carrying out Development activities shall be examined by the Chief Executive Officers of Biosearch and GENE, with a view to finding the most appropriate solution without jeopardizing the progress of clinical trials in the agreed time frame. If such matter cannot be resolved within sixty (60) days, it shall be dealt with in accordance with the proceedures in Section 14.2(b). (c) Delivery of Information. GENE will provide to Biosearch its Information regarding the Development of Licensed Products in the Field, as set forth in Section 2.4, for use in development and commercialization of products by Biosearch and, subject to Section 2.6, any Other Licensees outside of the Territory. Biosearch and, subject to Section 2.6, any Other Licensees shall be permitted to use and reference all such Information regarding Development of Licensed Products in (i) any Drug Approval Application filed outside the Territory and (ii) any Drug Approval Application filed within the Territory with respect to products other than Licensed Products that contain the Licensed Compound within the Field. Notwithstanding the foregoing, Biosearch agrees that it shall treat, and shall use its ***** to cause the Other Licensees to treat, all Information provided by GENE pursuant to this Section 2.2(c) as Confidential Information subject to the terms of Article 9. (d) Regulatory Matters. (i) Compliance with Regulations. GENE shall conduct its efforts hereunder in compliance with all applicable regulatory requirements. (ii) Drug Approval Applications. GENE shall, at its own expense, be responsible for preparing and filing Drug Approval Applications and seeking Regulatory Approvals for Licensed Products in the Field and in the Territory, including preparing all reports necessary for filing a Drug Approval Application for Licensed Products in the Territory. GENE shall be responsible for prosecuting all such Drug Approval Applications, and Biosearch and, subject to Section 2.6, any Other Licensees shall have the right of cross reference with respect thereto. In connection with all Drug Approval Applications being prosecuted by GENE hereunder, GENE agrees to provide Biosearch with a copy of all filings to regulatory agencies that it makes hereunder. GENE shall provide to Biosearch reports regarding the status of each pending and proposed Drug Approval Application in the Territory within thirty (30) days after each June 30th and December 31st during the term of this Agreement, until such times as no Drug Approval Applications are pending or unless otherwise agreed between the parties. In the event that any regulatory agency threatens or initiates any action to remove a Licensed Product from the market in the Territory, GENE shall promptly notify Biosearch of such communication. (e) ***** GENE shall develop or commercialize Licensed Products or Licensed Compound in the Territory only for use in the Field. 2.3 Development Obligations of Biosearch. (a) Access to Biosearch and Other Licensee Information. (i) Biosearch will, as soon as possible after the Effective Date, provide GENE with copies of all regulatory filings and the results of all clinical and non-clinical testing of Licensed Products under the Control of or performed by Biosearch or IntraBiotics prior to the Effective Date, to the extent that Biosearch is not restricted from providing any such information that is owned or Controlled by IntraBiotics and to the extent that such filings or information has not already been provided to GENE and will take all steps necessary to allow GENE to use such filings or information. - --------------------------- * Confidential Treatment has been requested for the marked portions. Page 5 (ii) During the term of this Agreement, Biosearch will provide to GENE all Information in its possession regarding Licensed Compounds in the Field (including Information it receives from any Other Licensees), as such Information becomes available, for use in GENE's Development efforts. GENE shall be permitted to use and reference all Biosearch and any Other Licensee reports provided to GENE pursuant to this Agreement in any Drug Approval Application for Licensed Products in the Territory. Notwithstanding the foregoing, GENE agrees that it shall treat all Information provided by Biosearch or any Other Licensee pursuant to this Section 2.3 as Confidential Information, subject to the terms of Article 9. (iii) Following the transfer of development responsibilites from IntraBiotics to Biosearch, but prior to the Effective Date, Biosearch entered into a number of contractual relationships with previous employees of IntraBiotics, as well as previous contractors of clinical development services to IntraBiotics, including, but not limited to Contract Research Organizations, Third-Party manufacturers, investigative sites, microbiology and clinical laboratories. These relationships were established in order to continue the development of Licensed Products within the Territory. *****. (b) Development and Regulatory Assistance. Biosearch shall (i) cooperate with GENE and applicable regulatory authorities in obtaining and maintaining Regulatory Approval for Biosearch's maufacturing process(es) and/or facilities and any Third Party process(es) and/or facilities established by Biosearch for the manufacture of Bulk Licensed Compound and (ii) provide reasonable technical assistance to GENE for Development of Licensed Products (c) Supply of Clinical Materials. Biosearch shall use *****to supply, or cause to be supplied at its expense, amounts of Bulk Licensed Compound sufficient for GENE to obtain Regulatory Approval of Licensed Products in the Field and in the Territory as set forth in Article 7. (d) Manufacturing Process; Scale Up. The Parties acknowledge that it is ***** It is agreed accordingly that Biosearch shall at all times manage the manufacturing processes of the Licensed Compound, and manufacture, or have manufactured ***** for preclinical, clinical and commercial quantities ***** expense. (e) ***** Biosearch and any Other Licensees shall develop or commercialize Licensed Products or Licensed Compound only for use in the Field. 2.4 Reports; Joint Management Committee; Project Leaders. (a) Reports. Each Party shall provide to the other Party reports summarizing such Party's development and commercialization of products containing the Licensed Compound. Such reports will be provided by each Party within thirty (30) days after the end of each calendar quarter and shall summarize such Party's efforts during the previous quarter. (b) Joint Management Committee. Each Party shall, within thirty (30) days after the Effective Date, appoint ***** members from each Party to serve on the Joint Management Committee. Each Party may send one or more additional representatives to each such meeting. The role of the Joint Management Committee shall include, without limitation, the*****. The Joint Management Committee shall meet at least*****, alternating between Biosearch's facilities in Gerenzano Italy and GENE's facilities in Waltham, MA, USA, unless otherwise agreed between the parties. Each Party shall bear all costs incurred by its representatives with respect to their attendance of such meetings. (c) Project Leaders. Additionally, each Party shall, within thirty (30) days after the Effective Date, appoint a project leader to facilitate transfer of information regarding the Licensed Compound and Licensed Products to the other Party. The project leaders shall meet on a regular basis, at least quarterly. Each Party may - --------------------------- * Confidential Treatment has been requested for the marked portions. Page 6 send one or more additional representatives to each such meeting. Each Party shall bear all costs incurred by its project leader and other representative(s) with respect to their attendance of such meetings. The site of the project leader meetings shall alternate between Biosearch's facilities in Gerenzano Italy and GENE's facilities in Waltham, MA, USA, unless otherwise agreed between the parties. 2.5 Adverse Event Reporting. Each Party agrees to report to the other, prior to or coincident to reporting to regulatory authorities, any serious adverse event which is reported to occur in connection with the use of a Licensed Product or the Licensed Compound. Each Party agrees to provide to the other copies of all reports that are made to regulatory authorities concerning material safety, efficacy or quality matters with respect to any Licensed Product or the Licensed Compound. Prior to the first Regulatory Approval for a product containing a Licensed Compound anywhere in the world, the Parties shall agree on a formal adverse event reporting protocol to conform with the respective regulatory obligations of GENE, Biosearch, and any Other Licensees throughout the world. 2.6 Other Licensees. (a) Biosearch agrees to use its ***** in order to obtain from any Other Licensees permission for Biosearch to provide to GENE any information that, if such information were owned or Controlled by Biosearch, would be Information that Biosearch must provide to GENE pursuant to Section 2.3, and shall obtain rights to Other Licensee technology relating to Licensed Products as provided in Section 5.7. Biosearch will require the Other Licensees to provide to GENE, either directly or through Biosearch, all information owned or Controlled by such Other Licensee that, if such information were owned or Controlled by Biosearch, would be Information that Biosearch must provide to GENE pursuant to Section 2.3. Biosearch may provide any Information it receives from GENE pursuant to Section 2.5 to the Other Licensees, if any, and may grant to Other Licensees a sublicense under the license granted to Biosearch in Section 5.4 with respect to Information Biosearch receives from GENE pursuant to Section 2.5. (b) Biosearch shall not provide any Information it receives from GENE pursuant to this Article 2 (other than Information relating to adverse events provided by GENE pursuant to Section 2.5) to any Other Licensee unless and until such Other Licensee permits Biosearch to provide to GENE any and all information owned or Controlled by such Other Licensee that, if such information were owned or Controlled by Biosearch, would be Information that Biosearch must provide to GENE pursuant to Section 2.3. Biosearch may not grant to any Other Licensee a sublicense under the license granted to Biosearch in Section 5.4 with respect to Information disclosed to it by GENE pursuant to this Article 2 (other than Information relating to adverse events provided by GENE pursuant to Section 2.5) to any Other Licensee that does not allow Biosearch to provide to GENE information of such Other Licensee as provided in this Section 2.6, and any such Other Licensee shall *****. ARTICLE 3 EXCLUSIVITY 3.1 Development of Licensed Compounds By Biosearch. The Parties recognize that the Licensed Compound may be useful for *****. In this regard, the Parties agree as follows: (a) Biosearch, its Affiliates and other sublicensees shall not develop or commercialize the Licensed Compound in any ***** in the Territory for use in the Field during the term of this Agreement. (b) Biosearch, its Affiliates and other sublicensees may develop and commercialize the Licensed Compound in any formulation for any use in the Field outside of the Territory, and in any Excluded Formulation - --------------------------- * Confidential Treatment has been requested for the marked portions. Page 7 for any use in the Field and in the Territory during the term of this Agreement, subject to the provisions of Sections 3.2, 3.3 and 3.4. 3.2*****. It is agreed and understood between the Parties that in the event *****does not commence clinical development activity with respect to at least ***** by March 31, 2002, then Biosearch shall notify GENE in writing and GENE shall *****. 3.3 *****. In the event that Biosearch develops a *****containing Licensed Compound, then Biosearch shall notify GENE in writing and GENE shall have a *****. 3.4 Follow-up products. In the event that Biosearch discovers, develops, licenses and/or acquires rights to any products for the same indications for which the formulations of the Licensed Compound may be developed (other than Excluded Formulations) ("Follow-up Products"), then Biosearch shall notify GENE in writing and GENE shall have***** . ARTICLE 4 LICENSING FEE; MILESTONE PAYMENTS 4.1 Licensing Fee. As partial payment for the patent licenses granted by Biosearch pursuant to Article 5 of this Agreement, and the Development Obligations of Biosearch pursuant to Article 2.3, GENE shall pay to Biosearch, within *****after the Effective Date, two million Dollars (U.S.$2,000,0000), cash by wire transfer (same value date). 4.2 Milestone Payments. GENE or its sublicensee shall make the following milestone payments to Biosearch within ***** after the first achievement of each of the following milestones with respect to Licensed Products in the Field and in the Territory: (i) *****cash by wire transfer (same value date) when all of the following conditions are met: ***** (ii) Two million Dollars (U.S.$2,000,000) payable by the issuance of a Convertible Note in such original principal amount to Bioseach effective on the same date of the U.S. NDA filing with FDA. (iii) Five million Dollars (U.S.$5,000,000) payable by the issuance of a Convertible Note in such original principal amount to Biosearch on the same date the U.S. NDA is approved by FDA. Any grant by GENE of a sublicense to a Third Party as permitted in Section 5.5 shall not affect Biosearch's right to receive milestone payments as provided in this Section 4.2. GENE shall remain responsible for the payments due to Biosearch pursuant to this Section 4.2 in the event it grants any such sublicense. The payment amounts are *****. ARTICLE 5 LICENSES - --------------------------- * Confidential Treatment has been requested for the marked portions. Page 8 5.1 Patent Licenses to GENE. Biosearch hereby grants to GENE an exclusive ***** license under the Biosearch Patents to make, have made, use, import, offer, sell, offer for sale and have sold Licensed Products in the Field and in the Territory. Such license shall additionally include the right to make or have made Bulk Licensed Compound in all instances hereunder, and to the extent that, GENE acquires the right to make or have made Bulk Licensed Compound hereunder. Such license shall be subject to the terms and conditions of this Agreement, including payment of the amounts set forth in Articles 4, 7 and 8 hereof 5.2 Patent Licenses to Biosearch. GENE hereby grants to Biosearch an ***** license under GENE Patents to make, have made, use, import, offer, sell, offer for sale and have sold (i) inside the Territory, products containing the Licensed Compound in any Excluded Formulation for any and all uses within the Field, and (ii) outside of the Territory, products containing the Licensed Compound (including without limitation Licensed Products) for any and all uses within the Field. 5.3 Know-How License to GENE. Subject to Article 9, Biosearch grants to GENE a ***** license to use Biosearch Know-how within the Territory for any purpose consistent with the rights and obligations contained in this Agreement. 5.4 Know-How License to Biosearch. Subject to Article 9, GENE grants to Biosearch a ***** license to use GENE Know-how for any purpose consistent with the rights and obligations contained in this Agreement. 5.5 Sublicensing. GENE***** grant sublicenses under this Article 5 to its Affiliates or to Third Party agents and representatives to conduct development and commercialization of Licensed Products until a first registration is obtained for a Licensed Product. Thereafter, sublicenses may be granted for *****: GENE shall in any event give prior written notice to Biosearch of any intention to grant any such sublicense and shall be responsible to Biosearch for compliance by the sublicensee of GENE's obligations hereunder. 5.6 Right of Negotiation for ***** 5.7 Third Party Technology. (a) Biosearch represents to GENE that no Third Party technology is included in the Biosearch Patents or in the Biosearch Know-how as of the Effective Date. (b) Biosearch will assist GENE in obtaining access to, and licenses under, technology relating to Licensed Products that is owned or Controlled by any Other Licensee which is developing or commercializing products containing the Licensed Compound (including without limitation Licensed Products) outside of the Territory, or products containing the Licensed Compound (including without limitation Licensed Products) within the Territory, in each case solely to the extent such technology is necessary or useful for the Development or Commercialization of Licensed Products in the Field. ARTICLE 6 COMMERCIALIZATION 6.1 General. The Commercialization of Licensed Products in the Field and in the Territory shall be conducted independently by GENE, its Affiliates, its Sublicensees and its Third Party agents and representatives. 6.2 GENE Efforts. GENE will use *****to promote, sell and distribute the Licensed Products in the Territory after it obtains Regulatory Approval therefor, *****. - --------------------------- * Confidential Treatment has been requested for the marked portions. Page 9 6.3 Commercial. ***** 6.4 Formulation, Packaging and Labeling. GENE will be responsible for formulating Bulk Licensed Compound into final dosage form and packaging the Licensed Product for sale under this Agreement, including, without limitation, designing and producing all packaging materials and product inserts, all in forms consistent with the requirements of the regulatory authorities in the Territory. 6.5 Expenses. All expenses incurred by GENE in connection with its obligations under this Article 6 will be borne solely by GENE. GENE will be responsible for appointing its own employees, agents and representatives, who will be compensated by GENE. 6.6 Restrictions on Distributors and Dealers. Subject to mandatory provisions of applicable laws, Biosearch shall not, and shall also ensure that its distributors and dealers (including its Affiliates and non-Affiliates) to whom Biosearch sells for resale products containing the Licensed Compound (including without limitation Licensed Products) for resale do not, sell the Licensed Product or any product containing Licensed Compound for any use to any customer located in the Territory, other than such sales of or for Excluded Formulations of the Licensed Compound, or products containing the Licensed Compound, for use in the Field. 6.7 Pricing. GENE shall determine, in its sole discretion, the pricing, discounting policy and other commercial terms relating to Licensed Products in the Field and in the Territory. ARTICLE 7 MANUFACTURE AND SUPPLY; TRANSFER PRICE AND SUPPLY PRICE 7.1 Manufacture and Supply of Bulk Licensed Compound by Biosearch. Subject to the terms and conditions of this Article 7, Biosearch will manufacture, or arrange for manufacture of, GENE's requirements of Bulk Licensed Compounds for Development and Commercialization of Licensed Products in the Field and in the Territory (unless GENE elects or is permitted also to manufacture Bulk Licensed Compound as permitted under this Article 7), subject to the ***** pursuant to Section 7.9 and a ***** as provided in Section 8.2. GENE, at its sole expense, will be responsible for having the Bulk Licensed Compound that is manufactured by Biosearch pursuant to this Article 7 processed into the final form. 7.2 Biosearch's Inability to Supply. The Parties intend that Biosearch shall supply to GENE and GENE shall purchase from Biosearch ***** of Bulk Licensed Compound. Notwithstanding the foregoing, and in addition to the other provisions of this Agreement, GENE shall have manufacturing rights as follows: (i) Biosearch shall provide prompt notice to GENE if Biosearch anticipates that it will be unable to meet GENE's forecasted requirements for Bulk Licensed Compound by ***** for a period exceeding *****. In this event, or if Biosearch is actually unable to meet GENE's forecasted requirements for Bulk Licensed Compound by *****, GENE shall have the right to produce or have produced through a Third Party its requirements of Bulk Licensed Compound for use in the Field and in the Territory and Biosearch shall license on a fully-paid basis and provide to GENE or such Third Party all*****. (ii) If Biosearch intends, any time during the initial term of this agreement or any renewal period, to *****, it shall provide GENE with *****. In this event GENE shall have the right to produce or have produced - --------------------------- * Confidential Treatment has been requested for the marked portions. Page 10 through a Third Party its requirements of Bulk Licensed Compound for use in the Field and in the Territory and Biosearch shall license on a fully-paid basis and provide to GENE or such Third Party all *****. (iii) Upon the occurence of the events described under clause (i) or (ii) above, Biosearch ***** only as provided in this Agreement. In regard to the foregoing, the Parties agree to cooperate to obtain all necessary assurances and cooperation from any of Biosearch's Third Party contract manufacturers to enable GENE to manufacture Bulk Licensed Compound. If GENE elects to manufacture Bulk Licensed compounds, Biosearch shall promptly provide to GENE all*****. In addition, Biosearch shall provide a right of reference and access to appropriate regulatory filings for the manufacture of such Bulk Licensed Compound to GENE. In all such events, GENE shall*****. In addition to the foregoing, Biosearch shall, as soon as practicable upon GENE's request, deliver to GENE, in accordance with Section 7.6 and Section 7.7, the Retained Amount of Bulk Licensed Compound retained by Biosearch pursuant to Section 7.11. 7.3 Process Development, Manufacturing Approvals. Biosearch will use ***** to develop a process for the manufacture of Bulk Licensed Compounds according to the Specifications therefor and to ***** GENE's anticipated requirements for clinical and commercial supply of Licensed Products. Biosearch will use ***** to make necessary filings to obtain, or to cause a Third Party manufacturer of Bulk Licensed Compounds to make necessary filings to obtain, Regulatory Approval for the manufacture of Bulk Licensed Compounds as part of the approval of a Drug Approval Application for each Licensed Product in the Field and in the Territory. Should Biosearch be *****. 7.4 Specifications. The current specifications for Bulk Licensed Compound are attached to this Agreement as Exhibit II (as such specifications may be modified pursuant to this Section, the "Specifications"). Biosearch shall ***** during the term of this Agreement make changes to the Specifications for Bulk Licensed Compound *****. Biosearch may modify Specifications if regulatory authorities within the Territory recommend or require changes thereto, or if GENE submits a proposal for changing such Specifications. Notwithstanding the previous sentence, both Parties shall use their ***** to implement changes in the Specifications which are required by the regulatory authorities within the Territory unless both Parties agree to the contrary in writing. At the request of GENE, Biosearch shall arrange for GENE's designated representatives to inspect and visit from time to time the facilities at which Bulk Licensed Compound is manufactured, stored or tested for the purpose of determining that the manufacture of Bulk Licensed Compound complies with the requirements of this Agreement. Such inspections shall occur during regular business hours upon reasonable notice. 7.5 Forecasting. *****before the end of ***** following the Effective Date, GENE will provide Biosearch with a ***** for Bulk Licensed Compound for the *****together with a rolling forecast covering the ***** following the one for which the firm order was issued. The order for the first ***** following the Effective Date will be provided within ***** of the Effective Date, and shall be subject to Biosearch's acceptance, not to be unreasonably withheld. In no event shall Biosearch be required to deliver more Bulk Licensed Compound in any given ***** than the firm order that was submitted by GENE for such ***** in the last applicable forecast. Biosearch shall use commercially reasonable efforts to supply any additional quantities requested by GENE in excess of the amounts previously forecasted by GENE, it being recognized that substantial increases in production levels may require significant advance notice. 7.6 Shipment of Bulk Licensed Compound. Biosearch shall deliver the Bulk Licensed Compound it manufactures for GENE pursuant to this Article 7 to location(s) designated by GENE by such method and carrier as GENE shall request. Unless otherwise agreed by the Parties, all shipments of Bulk Licensed Compound by Biosearch shall be ex-works Biosearch. Biosearch shall use best efforts to deliver Bulk Licensed Compound on the dates specified by GENE. Biosearch will bear all transportation expenses for the delivery of material to GENE, and shall bear all risk of loss of any material following shipment from the place of manufacture until delivered to GENE. - --------------------------- * Confidential Treatment has been requested for the marked portions. Page 11 7.7 Invoices. Biosearch will invoice GENE for each shipment of material supplied to GENE under this Article 7. GENE shall pay the relevant invoices within ninety (90) days after its receipt thereof. 7.8 Acceptance. Prior to shipment of Bulk Licensed Compound, Biosearch will ship representative samples of each batch to be shipped to GENE. Upon receipt of such sample and upon receipt of a shipment of Bulk Licensed Compound, GENE may determine whether the sample and such shipment, respectively, meet the Specifications. GENE shall notify Biosearch in writing promptly if such sample or shipment of Bulk Licensed Compound, as applicable, manufactured by Biosearch fails to meet the Specifications, therefor. If Biosearch has not received such written notice within thirty (30) days after such material has been received by GENE, then such shall be deemed to have met the Specifications. Upon receipt of any such written notice of non-conformance, Biosearch shall either acknowledge that the subject Bulk Licensed Compound does not meet the Specifications, or resample the sample, lot or batch in question and have said samples tested by an independent laboratory of its choice, acceptable to GENE. If such independent laboratory determines that such samples fail to meet the Specifications or Biosearch acknowledges that Bulk Licensed Compound is non-conforming, then Biosearch shall at GENE's option either replace the non-conforming Bulk Licensed Compound at no additional cost as soon as reasonably possible or refund any payments made by GENE for such non-conforming materials. 7.9 Transfer Price for Clinical Supply and Validation Process. Prior to receipt of Regulatory Approval of the Licensed Product in the Territory, and subject to Biosearch's obligation under Section 2.3(c) herein, GENE will purchase clinical supplies of Bulk Licensed Compound at a price (the "Transfer Price") equal to ***** of Bulk Licensed Compound. 7.10 Manufacturing Reports. The reports that Biosearch shall provide pursuant to Section 2.4(a) shall include details of Biosearch's efforts to scale up the manufacturing process for Bulk Licensed Compound at alternate sites pursuant to Section 2.3. 7.11 Retention of Back-up Supply of Bulk Licensed Compound. To help protect against interruptions in supply of Bulk Licensed Compounds pursuant to this Article 7, Biosearch shall retain under appropriate conditions a supply of Bulk Licensed Compound at all times after the parties commence production of Licensed Products for commercial launch in an amount determined pursuant to this Section. GENE shall notify Biosearch at least ninety (90) days prior to commencement of commercial scale manufacture of Licensed Product of the amount of Bulk Licensed Compound that constitutes a sufficient supply for the purpose of this Section 7.11 (the "Retained Amount"). GENE may re-establish the Retained Amount from time to time as necessary or desirable in view of its good faith estimate of its requirements for Bulk Licensed Compounds during the remainder of the term of this Agreement. 7.12 Discussions Regarding Long Term Supply Capacity. The parties acknowledge that GENE will gain knowledge regarding the potential market for Licensed Products in the Field and in the Territory as the development of Licensed Products progresses. Accordingly, it is possible that GENE's full commercial requirements for Bulk Licensed Compounds either upon commercial launch of Licensed Products or thereafter may exceed the capacity at Biosearch's manufacturing facility therefor. If at any time GENE's good faith estimate of the market for Licensed Products indicates that Biosearch's current manufacturing facility may not have sufficient capacity for manufacturing GENE's requirements for Bulk Licensed Compound over the term of this Agreement, then GENE and Biosearch shall discuss in good faith acceptable mechanisms for any such actual or potential inability of Biosearch to supply GENE' requirements, which may include without limitation for the establishment of a second manufacturing site by Biosearch. If the parties do not agree on such mechanisms for assuring sufficient supply of Bulk Licensed Compound and appropriate amendments to this Agreement implementing such mechanisms, then GENE may elect to establish a second manufacturing site. - --------------------------- * Confidential Treatment has been requested for the marked portions. Page 12 ARTICLE 8 SUPPLY PRICE AND ROYALTY; PAYMENT PROCEDURES AND RECORDS 8.1 Supply Obligation; Duration. During the term of this Agreement, GENE shall purchase ***** Bulk Licensed Compound from Biosearch, subject to Section 7. The price for commercial supply to GENE of all Bulk Licensed Compound manufactured by Biosearch shall be as provided in Section 8.2. Gene will be obligated to pay only for batches that meet all commercial and regulatory specifications and are accepted pursuant to Section 7.8. 8.2 Supply Price and Royalty. (a) In consideration of the manufacture of Bulk Licensed Compound and the grant of licenses hereunder, GENE will pay to Biosearch a supply price (the "Supply Price") and a royalty (the "Royalty") as described in the table set forth below. The Supply Price will be*****the Royalty on GENE's Net Sales will be*****. As used above, the following terms shall have the following meanings: ***** Notwithstanding the foregoing, the Parties agree to the desirability of maintaining a competitive price and competitive supply arrangements for Licensed Products in the face of increased competition. In the event that the adjustments to the total payments described in the table above are not able or are inadequate to meet GENE's needs to modify GENE's costs for Licensed Products as reasonably determined by GENE, the Parties hereby agree to negotiate in good faith to establish other mechanisms as may be deemed necessary to maintain competitiveness in the marketplace. (b) The Royalty payable by GENE hereunder shall be subject to adjustment as follows: ***** 8.3 Third Party Royalties. (a) Any royalties due to Third Parties with respect to the manufacture, use, sale, offer for sale or import of Licensed Product in the Field and in the Territory shall be borne by Biosearch. (b) Biosearch has agreed to pay IntraBiotics a royalty on Net Sales pursuant to the transfer of the rights for Ramoplanin. ***** 8.4 Sales by Sublicensees. If GENE grants a sublicense under the rights granted to it pursuant to Article 5, then such sublicense shall include an obligation for the sublicensee to account for and report its Net Sales of such Licensed Products on the same basis as if such sales were Net Sales by GENE, and GENE shall pay the Supply Price to Biosearch on such sales as if the Net Sales of the sublicensee were Net Sales of GENE. 8.5 Promotional and Marketing Contributions; Validation Material. (a) *****. (b) Biosearch has an obligation to produce ***** of Bulk Licensed Compound for validation of the Biosearch manufacturing process and facility. GENE has agreed to accept a maximum of ***** described in - --------------------------- * Confidential Treatment has been requested for the marked portions. Page 13 Section 8.5(a). GENE will pay for ***** of the material at a price of *****. Payment will be due ***** a Licensed Product in the U.S. This material will be stored at Biosearch until Gene needs to "run" the finished product manufacturing campaign. GENE shall notify Biosearch when this material must be manufactured and the material must meet the Specifications. GENE shall use such material to validate its formulation and finishing process pursuant to 2.2(a). In the event that all of the material is not required for the validation of GENE's formulation and finishing process and the remaining shelf life of the unused material does not allow for its formulation and finishing, then GENE shall not be obligated to pay for such unused material but shall return it to Biosearch. The material will be manufactured at the time indicated by GENE. In the event that the Licensed Product becomes non-exclusive in the territory, prior to the time at which Biosearch has fulfilled its obligations under this clause, the price to be paid for this material will be reduced to the TBP if the TBP is less than *****. 8.6 Supply Price Payments, Royalty Payments and Sublicense Revenue Payments. (a) Biosearch shall deliver Bulk Licensed Product and shall invoice GENE at the Supply Price. GENE shall notify Biosearch of its receipt thereof and pay such invoices within ninety (90) days after receipt of such Bulk Licensed Compound. (b) GENE will deliver to Biosearch a report showing in detail its calculation of the Net Sales and quantities of any Licensed Products sold during a given ***** following the end of ***** following the end of each calendar year for which Royalty or other royalty payments are due from GENE. GENE shall pay the Royalty or other royalty due on Net Sales or quantity of Licensed Product sold during the ***** covered by a given report under this Section 8.6(b) within ***** after GENE provides such report to Biosearch. (c) GENE will deliver a report showing in detail its calculation of the Net Sales and quantities of any Licensed Products sold by GENE's sublicensees during a ***** to Biosearch within ***** following the end of each ***** following the end of each ***** for which payments are due from GENE to Biosearch thereon. GENE shall pay the amounts due to Biosearch on Net Sales and quantities of Licensed Product sold by GENE's sublicensees pursuant to Section 8.2 and 8.3 for a given ***** covered by such reports within ***** after GENE provides such report to Biosearch. 8.7 Exchange Rate; Manner and Place of Payment. All amounts paid to Biosearch hereunder shall be paid in United States currency. Net Sales shall be accounted for on a ***** in U.S. Dollars for each month on the last banking day of such*****. All payments due to Biosearch under this Agreement shall be made by wire transfer at a bank and to an account designated by Biosearch, unless otherwise specified by Biosearch. 8.8 Late Payments. In the event that any payment due hereunder is not made when due, interest shall accrue on the late payment from the due date of such payment at the ***** as then quoted in the Wall Street Journal. The payment of such interest shall not limit any Party from exercising any other rights it may have as a consequence of the lateness of the payment. 8.9 Record Keeping. During the term of this Agreement, GENE shall keep full and accurate books and records setting forth, for the Licensed Product on which payments are due, including gross sales, all deductions allowed in arriving at Net Sales and any other information necessary and in sufficient detail to allow the calculation of payments to be paid by GENE. During the term of this Agreement and for a period of ***** thereafter, GENE shall permit Biosearch, at Biosearch's expense, by independent certified public accountants employed by Biosearch and reasonably acceptable to GENE, to examine relevant books and records at any reasonable time, not more often than once each calendar year, within ***** of any such payment. If it is determined that there was an underpayment due Biosearch of ***** or more, without prejudice to any other rights Biosearch may have, GENE shall promptly pay to Biosearch the balance of the amounts due and shall also reimburse Biosearch for the cost of such verification examination. - --------------------------- * Confidential Treatment has been requested for the marked portions. Page 14 8.10 Tax and Withholdings. Any withholding taxes levied by tax authorities in the Territory on the payments hereunder, to the extent due by Biosearch and not transferable upon GENE, shall be borne by Biosearch and deducted by GENE from the sums otherwise payable by it hereunder for payment to the proper tax authorities on behalf of Biosearch. In such event, GENE shall deliver to Biosearch evidence of the payment of such taxes. GENE agrees to cooperate with Biosearch in the event Biosearch claims exemption from such withholding or seeks deductions under any double taxation or other similar treaty or agreement from time to time in force. ARTICLE 9 CONFIDENTIALITY 9.1 Confidentiality; Exceptions. Except to the extent expressly authorized by this Agreement or otherwise agreed in writing, the Parties agree that, the receiving Party shall keep confidential and shall not publish or otherwise disclose or use for any purpose other than as provided for in this Agreement any Information and other information and materials furnished to it by the other Party pursuant to this Agreement, or any provisions of this Agreement that are the subject of an effective order of the Securities Exchange Commission granting confidential treatment pursuant to the Securities Act of 1934, as amended (collectively, "Confidential Information"), except to the extent that it can be established by the receiving Party that such Confidential Information: (a) was already known to the receiving Party, other than under an obligation of confidentiality, at the time of disclosure by the other Party; (b) was generally available to the public or otherwise part of the public domain at the time of its disclosure to the receiving Party; (c) became generally available to the public or otherwise part of the public domain after its disclosure and other than through any act or omission of the receiving Party in breach of this Agreement; or (d) was disclosed to the receiving Party, other than under an obligation of confidentiality, by a Third Party who had no obligation to the disclosing Party not to disclose such information to others. 9.2 Authorized Disclosure. Each Party may disclose Confidential Information hereunder to the extent such disclosure is reasonably necessary in filing or prosecuting patent applications, prosecuting or defending litigation, complying with applicable governmental regulations or conducting preclinical or clinical trials, provided that if a Party is required by law or regulation to make any such disclosure of the other Party's Confidential Information it will, except where impracticable for necessary disclosures (for example in the event of medical emergency), give reasonable advance notice to the other Party of such disclosure requirement and, except to the extent inappropriate in the case of patent applications, will use its reasonable efforts to secure confidential treatment of such Confidential Information required to be disclosed. In addition, each Party shall be entitled to disclose, under a binder of confidentiality containing provisions as protective as those of this Article 9, Confidential Information to any Third Party for the purpose of carrying out activities authorized under this Agreement, including disclosures to authorized sublicensees, and subject to Sections 2.5 and 2.6 disclosures by Biosearch for purposes of the development and commercialization of products other than Licensed Products anywhere in the world outside of the Field, and of Licensed Products either outside of the Field and within the Territory, or within the Field and outside of the Territory. Nothing in this Article 9 shall restrict any Party from using for any purpose any Information developed by it during the course of the collaboration hereunder. Biosearch acknowledges that if GENE files a required Securities Exchange Commission filing or registration statement covering the sale of its securities in the United States, it will be required to file a copy of this Agreement with its Page 15 public disclosure statement. GENE agrees to seek confidential treatment of at least the economic terms of this Agreement with respect to any such filing. 9.3 Publications. Except as required by law, each Party agrees that it shall not publish or present Information relating to the Licensed Compound or to products containing the Licensed Compound without providing to the other Party the opportunity for prior review of such publication or presentation. The Party desiring to publish or present such Information (the "Proposing Party") shall provide to the other Party the opportunity to review such proposed publication or presentation (including information to be presented verbally) as early as reasonably practical, but not later than twenty (20) days prior to the anticipated date of submission or disclosure to a Third Party. The Party reviewing such publication or presentation shall respond to the Proposing Party with comments thereon within ten (10) days of receiving such materials from the Proposing Party. The Proposing Party agrees, upon written request from the other Party, not to submit such abstract or manuscript for publication or to make such presentation until the other Party consents, which agreement shall not be unreasonably withheld. This Article 9 shall survive termination or expiration of this Agreement for a period of five (5) years thereafter. ARTICLE 10 OWNERSHIP OF INTELLECTUAL PROPERTY AND PATENT RIGHTS 10.1 Ownership. Each Party shall solely own, and it alone shall have the right to apply for, Patents within and outside of the Territory for any inventions made solely by that Party's employees or consultants in the course of performing work under this Agreement. Inventions made jointly by personnel of Biosearch and GENE shall be jointly owned by the Parties ("Joint Patents"), subject to the licenses granted to GENE pursuant to Article 5. 10.2 Disclosure of Patentable Inventions. Each Party shall provide to the other any patent application disclosing an invention or jointly conceived invention relating to Licensed Products within the Field arising during the term of this Agreement reasonably in advance of the intended date for submission of any patent application to a governmental patent authority. 10.3 Patent Filings. (a) Biosearch Responsibilities. Biosearch shall prepare, file, prosecute and maintain Patents to cover inventions relating to the discovery, evaluation, manufacture, use or sale of Licensed Products that are made solely by Biosearch personnel (all of which shall be included in the Biosearch Patents) or that are made jointly by personnel of Biosearch and GENE in the course of the collaboration ("Joint Patents", all of which shall be included in both the Biosearch Patents and GENE Patents). Biosearch shall keep GENE informed of the status of each such Biosearch Patent and Joint Patent and shall give reasonable consideration to any suggestions or recommendations of GENE concerning the preparation, filing, prosecution and maintenance thereof. The Parties shall cooperate reasonably in the prosecution of all Biosearch Patents and Joint Patents under this Section 10.3(a) and shall share all material Information relating thereto promptly after receipt of such Information. If, during the term of this Agreement, Biosearch intends to allow any issued Biosearch Patent or Joint Patent to which GENE has a license under this Agreement to expire for failure to make maintenance fee payments, Biosearch shall notify GENE of such intention at least sixty (60) days prior to the date upon which such issued Biosearch Patent or Joint Patent shall expire, and GENE shall thereupon have the right, but not the obligation, to assume responsibility for the maintenance thereof Page 16 (b) GENE Responsibilities. GENE shall file, prosecute and maintain Patents to cover inventions relating to the discovery, evaluation, manufacture, use or sale of Licensed Products that are made solely by GENE personnel (all of which shall be included in GENE Patents). GENE shall keep Biosearch informed of the status of each GENE Patent and shall give reasonable consideration to any suggestions or recommendations of Biosearch concerning the preparation, filing, prosecution and maintenance thereof. The Parties shall cooperate reasonably in the prosecution of all GENE Patents under this Section 10.3(b) and shall share all material Information relating thereto promptly after receipt of such Information. If, during the term of this Agreement, GENE intends to allow any issued GENE Patent to which Biosearch has a license under this Agreement to expire for failure to make maintenance fee payments, GENE shall notify Biosearch of such intention at least sixty (60) days prior to the date upon which such GENE Patent shall expire, and Biosearch shall thereupon have the right, but not the obligation, to assume responsibility for the maintenance thereof. 10.4 Third Party Patent Rights. No Party makes any warranty with respect to the validity, perfection or dominance of any Patent or other proprietary right or with respect to the absence of rights in Third Parties which may be infringed by the manufacture or sale of the Licensed Product. Each Party agrees to bring to the attention of the other Party any patent or patent application it discovers, or has discovered, and which relates to the subject matter of this Agreement. 10.5 Enforcement Rights. (a) Infringement by Third Parties. If any Biosearch Patent or GENE Patent is infringed by a Third Party in the Territory in connection with the manufacture, import, use, sale or offer for sale of a product competitive with a Licensed Product ("Competitive Product Infringement"), the Party to this Agreement first having knowledge of such infringement shall promptly notify the other in writing. The notice shall set forth the facts of that infringement in reasonable detail. GENE shall have the primary right, but not the obligation, to institute, prosecute or control any action or proceeding with respect to such infringement of a Biosearch Patent or Joint Patent within the Field and within the Territory, or of a GENE Patent anywhere in the world both within and outside of the Field, by counsel of its own choice. Biosearch shall have the right to participate in such action and to be represented by counsel of its own choice. Biosearch shall have the primary right, but not the obligation, to institute, prosecute, and control any action or proceeding with respect to such infringement of Biosearch Patents or Joint Patent occurring within the Territory that is outside of the Field, or occurring anywhere else in the world both within and outside of the Field, by counsel of its own choice. Solely within the Territory with respect to Biosearch Patents other than Joint Patents and anywhere in the World with respect to Joint Patents, GENE shall have the right to participate in such action brought by Biosearch pursuant to the foregoing sentence and to be represented by counsel of its own choice therein. If the Party primarily responsible for bringing suit under this Section 10.5(a) (the "Responsible Party") fails to bring an action or proceeding within a period of ninety (90) days after having knowledge of that infringement, then, solely with respect to infringement occurring inside the Field and inside the Territory with respect to infringement of patents, the other Party shall have the right to bring and control any such action by counsel of its own choice, and the Responsible Party shall have the right to participate in such action and be represented by counsel of its own choice. If a Responsible Party brings any such action or proceeding hereunder, the other Party agrees to be joined as a party plaintiff and to give the Responsible Party reasonable assistance and authority to control, file and prosecute the suit as necessary. The costs and expenses of the Party bringing suit under this Section (including the internal costs and expenses specifically attributable to said suit) shall be reimbursed first out of any damages or other monetary awards recovered in favor of the Parties. Any remaining damages shall be split in accordance with each Party's interest therein. No settlement or consent judgment or other voluntary final disposition of a suit under this Section 10.5(a) may be entered into without the joint consent of Biosearch and GENE. (b) Defense and SettIement of Third Party Claims against Licensed Products. If a Third Party asserts that a patent or other right owned by it is infringed by the manufacture, import, use, sale or offer for Page 17 sale of any Licensed Product, the Party first obtaining knowledge of such a claim shall immediately provide the other Party notice of such claim and the related facts in reasonable detail. Defense of any such claim in the Field and in the Territory shall be controlled by GENE; provided that Biosearch shall have the right to participate in such defense and to be represented in any such action by counsel of its selection at its sole discretion. GENE shall also have the right to control settlement of such claim with respect to a Licensed Product in the Field and in the Territory; provided, however, that no settlement shall be entered into without the written consent of Biosearch, which consent shall not be withheld unreasonably. (c) Allocation of Expenses Incurred Pursuant to Section 10.5(b). The expenses of patent defense, settlement and judgments pursuant to Section 10.5(b) with respect to the Licensed Products shall be borne solely by GENE, except as provided in Section 10.5(d). (d) Settlement of Third Party Claims for Infringement; Payment of Third Party Royalties. If a Third Party asserts that a patent or other right owned by it is infringed by the manufacture, use, sale, offer for sale or import of any Licensed Product, and as a result of settlement procedures or litigation under this Section 10.5, GENE is required to pay the Third Party a royalty or make any payment of any kind for the right to sell a Licensed Product in a particular country, such expense shall be borne by Biosearch as set forth in Section 8.3. (e) Agreement of Primarily Responsible Party. Notwithstanding the provisions of Section 10.5(a), neither Party shall file and prosecute an action for infringement of a Patent for which the other Party has the primary responsibility to file and prosecute such action, and pursuant to which that other Party having primary responsibility has commenced and is prosecuting at least one such action for infringement of said Patent, without the agreement of that other Party, which agreement shall not be unreasonably withheld. 10.6 Patent Marking. GENE shall mark Licensed Products with appropriate patent numbers or indicia as necessary to maintain the enforceability of Biosearch Patents, Joint Patents and GENE Patents. 10.7 TRADEMARKS AND TRADE NAMES. (a) Product Trademarks and Trade Names. The Parties agree to the principle and desirability of identifying and registering with the appropriate trademark authorities global trademark(s) ("Global Trademarks") and global trade name(s) ("Global Trade Names") for Licensed Products and Bulk Licensed Compound. Such Global Trademarks and Global Trade Names for Licensed Products and Licensed Compound shall at all times be the exclusive property of Biosearch. Subject to the following paragraph, Biosearch and GENE shall jointly select, prosecute applications for, register, maintain and enforce the Global Trademarks and Global Trade Names for Licensed Products in the Territory, at Biosearch's expense. All uses of trademarks or trade names to identify a Licensed Product shall comply with all applicable laws and regulations, including without limitation those laws and regulations particularly applying to the proper use and designation of trademarks and trade names. Should it be determined by GENE that a Global Trademark or Global Trade Name is unavailable or becomes the subject of an opposition in the Territory, or should the Parties be unable to reach agreement on such Global Trademark or Global Trade Name, GENE shall have the right to select, prosecute applications for, register, maintain and enforce trademarks and trade names for Licensed Products in the Territory ("Territory Trademarks" and "Territory Trade Names", respectively) at its own expense. Such Territory Trademarks and Territory Trade Names shall at all times be the exclusive property of GENE. Notwithstanding the foregoing, without limitation all branding, logos, indicia and trade dress, shall be developed by GENE in its sole discretion for use in the Territory, whether for use with a Territory Trademark or Territory Trade Name. Such branding, logos, indicia and trade dress, without limitation, shall be the exclusive property of GENE and may be licensed to Biosearch, at Biosearch's request, for the exclusive use with Licensed Products outside the Territory on a royalty-free basis. Page 18 (b) Infringement. Each Party shall notify the other Party promptly upon learning of any actual, alleged or threatened infringement of the trademark for Licensed Product in the Field and in the Territory or of any unfair trade practices, trade dress imitation, passing off of counterfeit goods or like offenses. The parties shall confer regarding the appropriate steps necessary or useful to protect, enforce and maintain such trademark. GENE shall make the final decision of whether and how to defend the trademark. (c) License. Biosearch hereby grants to GENE a fully paid license to use all Global Trademarks and Global Trade Names and any other Trademarks and Trade Names owned or Controlled by Biosearch under which Biosearch sells and markets products containing the Bulk Licensed Compound solely in connection with GENE's Development and Commercialization of Licensed Products in the Field and in the Territory pursuant to this Agreement. GENE may sublicense any rights under the Biosearch Global Trademarks and/or Global Trade Names persuant to Section 5.5 of this Agreement. GENE hereby grants to Biosearch a fully paid license to use any Territory Trademarks and Territory Trade Names solely in connection with Biosearch's Development and Commercialization of products containing Bulk Licensed Compound in the Field outside of the Territory. Biosearch may not sublicense any right under the Territory Trademark or Territory Trade Name with out the prior written consent of GENE. 10.8 Trade Secrets. The parties each acknowledge that Biosearch maintains certain technology useful for the manufacture of the Bulk Licensed Compound as a trade secret and that accordingly Biosearch has chosen not to seek patent protection on such technology. Biosearch hereby agrees that it shall use all commercially reasonable efforts to maintain such technology as a trade secret (unless and until Biosearch files a patent application claiming such technology), including without limitation (i) disclosing such technology to third parties only under an obligation of confidentiality and non-use with respect thereto comparable in scope to the confidentiality and non-use obligations set forth in Article 9 with respect to Confidential Information, (ii) not disclosing any trade secrets in any public presentation or publication and (iii) employing other mechanisms typically used in the pharmaceutical industry to protect trade secrets of similar nature. ARTICLE 11 TERM AND TERMINATION 11.1 Term. Except as otherwise provided herein, the term of this Agreement shall commence on the Effective Date and, unless earlier terminated as provided in this Agreement, shall expire ten (10) years after first commercial sale of a Licensed Product by GENE in the Field and in the Territory. In the event that at any time during the term of this Agreement, Biosearch is merged into or acquired by a Third Party or sells to a Third Party all or substantially all of the assets to which this Agreement relates, GENE shall have an option, exercisable at any time prior to the expiration of the term, to extend the agreement for an additional ***** up to a total of ***** under the same terms and conditions stated herein, and at no additional economic terms. Except as provided under Section 8.5, the terms and conditions of this Agreement will automatically renew for subsequent periods of ***** at the end of the initial ten year term, subject to either party's right not to renew, to be communicated in writing to the other party with at least ***** advance notice; provided that Biosearch's right to not renew the term of this Agreement shall, in any event, be subject to Biosearch's obligation to provide a minimum ***** notice to GENE if Biosearch should choose not to supply Bulk Licensed Compound, pursuant to Section 7.2(ii). In this event, Biosearch will supply GENE the manufacturing know-how and the most productive seed strain to enable GENE to produce or have produced the Bulk Licensed Compound. Upon termination of this Agreement pursuant to this Section 11.1, GENE's license under Article 5 shall continue in full force and effect and GENE may thereafter continue to sell Licensed Products in the Field and in the Territory on a royalty free basis. - ----------------------------------- * Confidential Treatment has been requested for the marked portions. Page 19 11.2 Termination for Cause. Either Party may terminate this Agreement upon sixty (60) days written notice upon or after the breach of any material provision of this Agreement by the other Party if the breaching Party has not cured such breach within the sixty (60) day period following written notice of termination by the other Party. 11.3 OTHER TERMINATION. (a) By GENE. GENE shall have the right to terminate this Agreement upon ninety (90) days prior written notice to Biosearch if the prospects for achieving Regulatory Approval for a Licensed Product or commercially feasible Development or Commercialization of a Licensed Product appear in GENE's reasonable judgment not to justify further support of the Licensed Product. (b) *****. 11.4 EFFECT OF TERMINATION. (a) Upon termination of this Agreement by Biosearch for GENE's material breach pursuant to Sections 11.2, or by GENE pursuant to Section 11.3, all rights and licenses granted to GENE with respect to the Licensed Product under Article 5 shall terminate. Furthermore, GENE shall pay all sums accrued hereunder which are then due (except as expressly otherwise provided in this Agreement), shall promptly assign to Biosearch all right, title and interest in and to any regulatory filings in the Territory pertaining to Licensed Products and shall deliver to Biosearch any GENE Information necessary to obtain the Regulatory Approval of Licensed Products in the Territory which has not been obtained as of the date of termination. If this Agreement is terminated by Biosearch pursuant to Section 11.2 or 11.3(b), or by GENE pursuant to Section 11.3(a), GENE shall return to Biosearch, or at Biosearch's request destroy, all Biosearch Information and any other Confidential Information relating to the Licensed Compound or Licensed Products, and any Bulk Licensed Compound supplied by Biosearch for clinical development or commercial distribution. Additionally, if Biosearch terminates this Agreement pursuant to Section 11.2 or GENE terminates this Agreement pursuant to Section 11.3, the license granted in Section 5.2 shall automatically become, without any further action by GENE, an exclusive, worldwide, royalty-free license under the GENE Patents to make, have made, use, import, offer, sell, offer for sale and have sold the Licensed Compound and pharmaceutical products containing the Licensed Compound (including without limitation Licensed Products) for any and all uses. (b) Upon termination of this Agreement by GENE for Biosearch's material breach pursuant to Section 11.2, all licenses granted to GENE shall survive. If Biosearch is supplying Licensed Bulk Compound at the time of any termination by GENE of this Agreement for Biosearch's material breach, Biosearch shall continue to provide for supply of Bulk Licensed Compound to the extent provided prior to notice of such termination until such time as GENE is able to secure an equivalent alternative commercial supply source for the Territory, as requested by GENE; and Biosearch shall take the actions described in and be obligated under Section 7.2(iii); provided, however, that GENE shall pay to Biosearch its Cost of Goods Sold for such Bulk Licensed Compound. Any additional payments for such supply shall be negotiated between the Parties at such time of termination. 11.5 Accrued Rights, Surviving Obligations. Termination of this Agreement shall not affect any accrued rights and remedies of either Party. Additionally, the terms of Articles 7 (solely to the extent required to effect the intent of Section 11.4, if applicable), 8 (solely to the extent required to effect the intent of Section 11.4, if applicable), 9, 12, 13 and 14, as well as Sections 10.2 through 10.8, 11.4, 11.5, of this Agreement shall survive any termination or expiration of this Agreement. - ------------------------------------- * Confidential Treatment has been requested for the marked portions. Page 20 ARTICLE 12 REPRESENTATIONS AND WARRANTIES 12.1 Mutual Representations and Warranties. Each Party hereby represents and warrants: (a) Corporate Power. Such Party is duly organized and validly existing under the laws of the state or country of its incorporation and has full corporate power and authority to enter into this Agreement and to carry out the provisions, hereof. (b) Due Authorization. Such Party is duly authorized to execute and deliver this Agreement and to perform its obligations hereunder. (c) Binding Agreement. This Agreement is a legal and valid obligation binding upon it and enforceable in accordance with its terms. The execution, delivery and performance of this Agreement by such Party does not conflict with any agreement, instrument or understanding, oral or written, to which it is a Party or by which it may be bound, nor violate any law or regulation of any court, governmental body or administrative or other agency having jurisdiction over it. Such Party has not, and during the term of the Agreement will not, grant any right to any Third Party with respect to its Patents or Know-how that would conflict with the rights granted to the other Party hereunder. 12.2 Representations by Biosearch Regarding Manufacture of Bulk Licensed Compounds. Biosearch hereby warrants that the Bulk Licensed Compound supplied hereunder will: (a) comply with the Specifications then in effect for Bulk Licensed Compound; (b) be manufactured, stored and shipped in compliance with all applicable regional, federal, state and local laws and governmental regulations, including without limitation the applicable current Good Manufacturing Practices regulations; (e) when shipped, will not be adulterated or misbranded within the meaning of the Federal Food, Drug & Cosmetic Act and the regulations promulgated thereunder; and (d) be manufactured in accordance with all applicable laws and governmental rules and regulations. (e) be manufactured in a manner that does not involve any infringement or unauthorized use of any intellectual property rights of any Third Party. 12.3 Other Representations by Biosearch. Biosearch further represents and warrants to GENE that: (a) to the best of Biosearch's knowledge on the Effective Date, there are no interferences or oppositions pending before any court or administrative office or agency relating the Biosearch Patents; (b) Biosearch has provided to GENE access to all clinical records which describe all adverse event reports relating to Licensed Products; and (c) Biosearch owns all right, title and interest in and to IND No. 56341 and all subsequent filings thereunder, and Biosearch owns or controls all rights necessary to grant the rights Biosearch purports to grant to GENE pursuant to this Agreement; and (d) as of the Effective Date, Biosearch has not received any notices of infringement or any written communications relating in any way to a possible infringement with respect to the Licensed Compound or Page 21 Licensed Products in the Field, and is not aware that the practice of the Biosearch Patents and Biosearch Know-how as contemplated by this Agreement will involve any infringement or unauthorized use of any intellectual property nights of any Third Party. (e) Biosearch has concluded an agreement with IntraBiotics (the IntraBiotics Agreement) under which it is obligated to pay a royalty on sales of Licensed Products in the Territory. (f) Biosearch has on-hand or will supply within sixty (60) days of the Effective Date, such clinical supplies as are necessary to complete Development of Licensed Product within the Territory. (g) Biosearch will be responsible in full for all costs of Development prior to the Effective Date. Biosearch warrants that it has entered into contractual relationships with previous employees of IntraBiotics, as well as previous contractors of clinical development services to IntraBiotics, including, but not limited to Contract Research Organizations, Third-Party manufacturers, investigative sites, microbiology and clinical laboratories, in order to continue the development of Licensed Products within the Territory. Biosearch shall provide copies of all contracts with these consultants and contractors to GENE, prior to the Effective Date and will make best efforts to work closely with GENE to transfer or assign these relationships to GENE in an orderly fashion to permit a smooth transition in accordance with Section 2.3(a)(iii). 12.4 Disclaimer of Warranties. The Parties understand that the activities to be undertaken pursuant to this Agreement will involve technologies and products that have not been approved by any regulatory authority and that neither Party guarantees the safety or usefulness of the Licensed Products. EXCEPT AS EXPRESSLY SET FORTH IN THIS AGREEMENT, NEITHER PARTY MAKES ANY REPRESENTATION OR WARRANTY TO THE OTHER PARTY OF ANY NATURE, EXPRESS OR IMPLIED, INCLUDING WITHOUT LIMITATION ANY WARRANTY OF NONINFRINGEMENT, MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. ARTICLE 13 INDEMNIFICATION 13.1 Indemnification by Biosearch. Biosearch hereby agrees to indemnify, hold harmless and defend GENE against any and all expenses, costs of defense (including without limitation attorneys' fees, witness fees, damages, judgments, fines and amounts paid in settlement) and any amounts GENE becomes legally obligated to pay because of any Third Party claim or claims against it to the extent that such claim or claims result from (i) Biosearch's negligence, (ii) Biosearch's breach or alleged breach of any representation or warranty by Biosearch or of any other provision of this Agreement; (iii) any claims of breach of the IntraBiotics Agreement which may be brought against GENE; (iv) any claims from third parties, consultants, employees and contractors concerning Development activities prior to the Effective Date, whether conducted on behalf of Biosearch, IntraBiotics or any other Third Party; or the possession, manufacture, use, handling, storage, sale or other disposition of Bulk Licensed Compound or of products containing the Licensed Compound by Biosearch, its agents or licensees or sublicensees (other than GENE), except to the extent such claim or claims arise from the negligence, recklessness or willful misconduct of GENE or any breach of any representation or warranty of GENE made pursuant to Section 12; provided that GENE provides Biosearch with prompt notice of any such claim and the exclusive ability to defend (with the reasonable cooperation of GENE) and settle any such claim. Any liability of Biosearch shall in no event extend to consequential damages. 13.2 Indemnification by GENE. GENE hereby agrees to indemnify, hold harmless and defend Biosearch against any and all expenses, costs of defense (including without limitation attorneys' fees, witness fees, damages, judgments, fines and amounts paid in settlement) and any amounts Biosearch becomes legally obligated to pay because of any Third Party claim or claims against it to the extent that such claim or claims arise out of (i) Page 22 GENE's negligence, recklessness or willful misconduct, (ii) GENE's breach or alleged breach of any representation or warranty by GENE or of any other provision of this Agreement, (iii) the possession, final manufacture, use, sale or administration of Licensed Products by GENE or GENE's Affiliates, licensees or sublicensees, except to the extent such claim or claims arise from the negligence, recklessness or willful misconduct of Biosearch or any breach of any representation or warranty of Biosearch made pursuant to Section 12; provided that Biosearch provides GENE with prompt notice of any such claim and the exclusive ability to defend (with the reasonable cooperation of Biosearch) or settle any such claim, and provided further that such indemnities shall not apply to losses resulting from Biosearch matters covered under Section 13.1 above. 13.3 Mechanics. In the event that the parties cannot agree as to the application of Sections 13.1 and 13.2 above to any particular loss or claim, the parties may conduct separate defenses of such claim. Each Party further reserves the right to claim indemnity from the other in accordance with Sections 13.1 and 13.2 above upon resolution of the underlying claim, notwithstanding the provisions of Sections 13.1 and 13.2 above requiring the indemnified Party to tender to the indemnifying Party the exclusive ability to defend such claim or suit. Page 23 ARTICLE 14 MISCELLANEOUS 14.1 ASSIGNMENT. (a) Either Party may assign any of its rights or obligations under this Agreement to any Affiliates; provided, however, that such assignment shall not relieve the assigning Party of its responsibilities for performance of its obligations under this Agreement, and further provided that if a proposed assignment would have an adverse financial impact upon the other Party (e.g., by reason of changed tax treatment of payments due under this Agreement), such assignment shall be subject to the other Party's prior written consent. (b) This Agreement shall survive any such merger or reorganization of either Party with or into another party and no consent for such merger or reorganization shall be required hereunder; provided, that in the event of such merger or reorganization, no intellectual property rights of the acquiring corporation shall be included in the technology licensed hereunder. (c) Except as set forth in subsections (a) and (b), this agreement may not be assigned by either Party without the prior consent of the other Party. This Agreement shall be binding upon and inure to the benefit of the successors and permitted assigns of the Parties. Any assignment not in accordance with this Agreement shall be void. 14.2 DISPUTE RESOLUTION. (a) The Parties recognize that disputes as to certain matters may from time to time arise during the term of this Agreement which relate to either Party's rights and/or obligations hereunder or thereunder. It is the objective of the Parties to establish procedures to facilitate the resolution of disputes arising under this Agreement in an expedient manner by mutual cooperation. To accomplish this objective, the Parties agree to follow the procedures set forth in this Articie 14 if and when a dispute arises under this Agreement. Unless otherwise specifically recited in this Agreement, disputes among the Parties will be resolved by reference first to their respective executive officers designated below or their successors, for attempted resolution by good faith negotiations within fourteen (14) days after such notice is received. Said designated officers are as follows: For GENE: Chief Executive Officer For Biosearch: Chairman of the Board / Managing Director In the event the designated executive officers are not able to resolve such dispute, either Party may at anytime after the fourteen (14) day period seek to resolve the dispute through the means provided in Section 14.2(b). (b) Any claim or controversy arising out of or related to this Agreement or any breach hereof that is not resolved by the designated officers as provided in this Agreement shall be resolved solely and exclusively by final and binding arbitration (i) if started by Biosearch, in Boston, MA, USA by a panel of three arbitrators appointed and acting according to the then existing rules of the JAMS/Endispute; and (ii) if started by GENE, in Milan, Italy, by a panel of three arbitrators appointed and acting according to the International Rules then in force of the National and International Arbitration Chamber of Milan. The arbitrator(s) selected shall have significant experience in the biotechnology or pharmaceutical industry, and shall apply the rules of law. Any arbitration proceeding conducted pursuant to this Section 14.2(b) shall be conducted in the English language. Any award made by such arbitrator(s) shall be final and binding upon the parties and a judgment of a court having jurisdiction Page 24 may be entered on such award. Notwithstanding the foregoing, disputes regarding the validity, scope or enforceability of patents shall be submitted to a court of competent jurisdiction in the country where such patent has issued. 14.3 Force Majeure. Save as provided in Section 4.2 above, neither Party shall lose any rights hereunder or be liable to the other Party for damages or losses on account of failure of performance by the defaulting Party if the fallure is occasioned by government action, war, fire, explosion, flood, strike, lockout, earthquake, embargo, act of God, or any other similar cause beyond the control of the defaulting Party, provided that the Party claiming force majeure has exerted all reasonable efforts to avoid or remedy such Force Majeure. 14.4 Compliance with Law. Each Party hereto shall comply with all applicable laws, rules, ordinances, guidelines, consent decrees and regulations of any applicable federal, state or other governmental authority. 14.5 Export Law Compliance. GENE understands and recognizes that the Licensed Product and other materials made available to it hereunder may be subject to the export administration regulations of the United States Department of Commerce and other United States government regulations related to the export of chemical compounds and medical devices. 14.6 Governing Law. This Agreement shall be governed by and construed according to the laws of New York, NY, USA. 14.7 Entire Agreement. This Agreement, including all Exhibits attached hereto, and all documents delivered concurrently herewith, set forth all the covenants, promises, agreements, warranties, representations, conditions and understandings between the Parties hereto and supersede and terminate all prior agreements and understanding between the Parties. No subsequent alteration, amendment, change or addition to this Agreement, shall be binding upon the Parties hereto unless reduced to writing and signed by the respective authorized officers of the Parties. 14.8 Relationship of the Parties. Nothing hereunder shall be deemed to authorize either Party to act for, represent or bind the other except as expressly provided in this Agreement. 14.9 Notices. All notices hereunder shall be in writing and shall be deemed given if delivered personally or by facsimile transmission (receipt verified), telexed, mailed by registered or certified mail (return receipt requested), postage prepaid, or sent by express courier service, to the Parties at the following addresses (or at such other address for a Party as shall be specified by like notice; provided, that notices of a change of address shall be effective only upon receipt thereof. If to Biosearch, addressed to: BIOSEARCH ITALIA S.p.A. Via Lepetit, 34 21040 Gerenzano, ltaly Attention: Chairman of the Board Telephone: +39.02.96474.341 Telecopy: +39.02.96474.400 If to GENE, addressed to: GENOME THERAPEUTICS CORPORATION 100 Beaver Street Waltham, MA 02453-8443, USA Attention: Chief Executive Officer Telephone: +1.781.398.2300 Telecopy: +1.781.398.8277 Page 25 14.10 Waiver. Except as specifically provided for herein, the waiver from time to time by either of the Parties of any of their rights or their failure to exercise any remedy shall not operate or be construed as a continuing waiver of same or of any other of such Party's rights or remedies provided in this Agreement. 14.11 Severability. If any term, covenant or condition of this Agreement or the application thereof to any Party or circumstance shall, to any extent, be held to be invalid or unenforceable, then (i) the remainder of this Agreement, or the application of such term, covenant or condition to Parties or circumstances other than those as to which it is held invalid or unenforceable, shall not be affected thereby and each term, covenant or condition of this Agreement shall be valid and be enforced to the fullest extent permitted by law; and (ii) the Parties hereto covenant and agree to renegotiate any such term, covenant or application thereof in good faith in order to provide a reasonably acceptable alternative to the term, covenant or condition of this Agreement or the application thereof that is invalid or unenforceable, it being the intent of the Parties that the basic purposes of this Agreement are to be effectuated. 14.12 Official Language. The official text of this Agreement and any appendices, exhibits and schedules hereto, or any notice given or accounts or statements required by this Agreement shall be in English. In the event of any dispute concerning the construction or meaning of this Agreement, reference shall be made only to this Agreement as written in English and not to any other translation into any other language. 14.13 Headings. The Section and paragraph headings contained herein are for the purposes of convenience only and are not intended to define or limit the contents of said sections or paragraphs. 14.14 Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the Parties have executed this Agreement in duplicate originals by their proper officers as of the Effective Date. GENOME THERAPEUTICS CORPORATION BIOSEARCH ITALIA, S.P.A. By: ________________________ By: ___________________________ Title: _____________________ Title: ________________________ Page 26 EXHIBIT I CONVERTIBLE NOTE THIS NOTE HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT") OR UNDER THE SECURITIES LAWS OF ANY STATE, AND MAY NOT BE SOLD OR OTHERWISE TRANSFERRED IN THE ABSENCE OF SUCH REGISTRATION OR AN EXEMPTION THEREFROM UNDER THE ACT AND ANY SUCH APPLICABLE STATE LAWS. GENOME THERAPEUTICS CORP. CONVERTIBLE NOTE DUE [INSERT DATE 60 MONTHS AFTER DATE OF ISSUE] $[Amount] [Date of Issue] FOR VALUE RECEIVED, the undersigned Genome Therapeutics Corp., a Massachusetts corporation (the "Company"), hereby promises to pay to Biosearch Italia, S.p.A., or registered assigns, at the address specified in Section 14.9 of the License and Supply Agreement (as defined below), or at such other place as the Holder of this Note shall from time to time have designated to the Company in writing, on [insert date 60 months after Date of Issue] (the "Stated Maturity Date"), [AMOUNT IN WORDS ($[Amount in numbers]) (the "Principal Amount"), with interest as provided in Section 1 hereof. 1. INTEREST. This Note shall accrue daily interest from the date hereof, computed on the basis of a year of 365 or 366 (as applicable) days and actual days elapsed, on the principal amount from time to time unpaid at a rate per annum equal to five percent (5%) (the "Applicable Rate"), said interest being payable in arrears on the last business day of the calendar month in which this Note was issued in each year (each such day, and the day that is the Stated Maturity Date, being a "Payment Date"), commencing on [insert date that is the last business day of the month in which the Note is issued, one year following the date of issue], and at the stated or any accelerated maturity hereof. All interest shall be payable in cash in the lawful money of the United States. 2. PAYMENT PROVISIONS. The Company covenants that so long as this Note is outstanding: 2.1. Payment at Maturity of Note. On the Stated Maturity Date, and on any accelerated maturity of the Notes, the Company will pay the entire principal amount of this Note then outstanding, together with all accrued and unpaid interest thereon. 2.2. Prepayments. Except as provided in Section 4.2 hereof, the Company may not prepay all or any part of the principal amount of the Notes. 3. CONVERSION OF NOTE. 3.1. Conversion by Holder. Subject to Section 3.4, the Holder of this Note may at any time convert the principal amount of this Note then outstanding into a number of shares of Common Stock equal to (x) the aggregate amount of principal of this Note divided by (y) the Conversion Price (as hereinafter defined). As used herein, the "Conversion Price" shall initially be $15.00, shall be adjusted and readjusted from time to time as provided in this Section 3 and, as so adjusted or readjusted, shall remain in effect until a further adjustment or readjustment thereof is required by Section 3 of this Note. Such conversion shall be effected by surrender of this Note to the Company at its office specified in Section 14.9 of the License and Supply Agreement, accompanied by a Conversion Notice in substantially the form attached to this Note (or a reasonable facsimile thereof) executed by such Holder, and such Holder shall thereupon be entitled to receive the number of shares of Common Stock specified in the first sentence of this Section 3.1 or the shares or other interests specified in Section 3.4 below. The conversion of this Note shall be deemed to have been effected immediately prior to the close of business on the business day on which this Note shall have been surrendered to the Company as provided in the immediately preceding sentence, and at such time the Holder shall be deemed to have become the holder of record of such shares of Common Stock. As soon as practicable after conversion of the Note, and in any event within five business days thereafter, the Company at its expense will cause to be issued in the name of and delivered to the Holder of this Note a certificate for the number of duly authorized, validly issued, fully paid and nonassessable shares of Common Stock to which such Holder shall be entitled upon such conversion. 3.2. Automatic Conversion. In the event that the Common Stock trades at or in excess of a price per share of $30.00 for a period of not less than twenty consecutive Trading Days, this Note shall automatically be converted, without any action on the part of the Holder or the Company, into a number of shares of Common Stock equal to (x) the aggregate amount of principal of this Note then outstanding divided by (y) the Conversion Price then in effect. If, pursuant to Section 3.4 below, this Note becomes convertible into other shares or other interests, this Note shall automatically be converted into such shares or other interests if the quotient obtained by dividing the aggregate fair market value of such shares or other interests (as determined in good faith by the Company (or its successor)), by the number of shares of Common Stock into which this Note was convertible immediately before the Subsequent Event (as defined below) equals or exceeds $30.00 for a period of not less than twenty consecutive Trading Days. 3.3. Adjustments of Conversion Price for Subdivisions, Stock Dividends, Combinations or Consolidation of Common Stock. In the event the outstanding shares of Common Stock shall be increased by way of stock issued as a dividend for no consideration or subdivided (by stock split or otherwise) into a greater number of shares of Common Stock, the Conversion Price then in effect shall, concurrently with the effectiveness of such increase or subdivision, be proportionately decreased. In the event the outstanding shares of Common Stock shall be combined or consolidated, by reclassification or otherwise, into a lesser number of shares of Common Stock, the Conversion Price then in effect shall, concurrently with the effectiveness of such combination or consolidation, be proportionately increased. 3.4. Subsequent Events. In the event of any recapitalization, consolidation, merger or bankruptcy or declaration of insolvency of the Company or its successor (each, a "Subsequent Event"), this Note shall thereafter be convertible into the right to receive such shares or other interests (including, without limitation, cash) as the Holder would have been entitled if this Note had been converted immediately prior to such Subsequent Event. -2- 3.5. No Impairment. The Company will not, by amendment of its charter or through any reorganization, recapitalization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by the Company, but will at all times in good faith assist in carrying out all such action as may be necessary or appropriate in order to protect the conversion rights of the Holder of this Note. 3.6. Reservation of Shares. So long as any portion of this Note shall remain outstanding, the Company shall at all times reserve and keep available, free from preemptive rights, out of its authorized capital stock, for the purpose of issuance upon conversion of this Note, the full number of shares of Common Stock then issuable upon conversion of this Note. If the Company's Common Stock shall be listed on any national stock exchange, the Company at its expense shall include in its listing application all of the shares of Common Stock reserved for issuance upon conversion of this Note (subject to issuance or notice of issuance to the exchange) and will similarly procure the listing of any further Common Stock reserved for issuance upon conversion of this Note at any subsequent time as a result of adjustments in outstanding Common Stock or otherwise. 3.7. Validity of Shares. The Company will from time to time take all such action as may be reasonably required to assure that all shares of Common Stock which may be issued upon conversion of this Note will, upon issuance, be legally and validly issued, fully paid and non-assessable and free from all taxes, liens and charges with respect to the issuance thereof; and, without limiting the generality of the foregoing, the Company agrees that it will from time to time take all such action as may be reasonably required to assure that the par value per share, if any, of the Common Stock is at all times equal to or less than the lowest quotient obtained by dividing the then current principal amount of this Note by the number of shares of Common Stock into which this Note can, from time to time, be converted. 3.8. Representations of the Holder. The Holder represents and warrants to the Company that the Holder is acquiring this Note and the shares of Common Stock issuable upon conversion of this Note for the Holder's own account for investment only and not with a view to distribution or resale of the Note or shares of Common Stock issuable upon conversion of this Note. The Holder represents that it is an "accredited investor" as such term is defined in Rule 501 under the Securities Act of 1933, as amended (the "Act"). The Holder understands that this Note and the shares of Common Stock issuable upon conversion of this Note are being issued to the Holder pursuant to an exemption from the registration requirements of the Act and, accordingly, must be held indefinitely by the Holder unless later transferred in transactions that are either registered under the Act or exempt from registration. The Holder also understands that the shares of Common Stock issuable upon conversion of this Note will bear a legend similar to the legend set forth at the top of this Note. 4. EVENTS OF DEFAULT. 4.1. Events of Default. Each of the following events is herein referred to as an "Event of Default": -3- 4.1.1. Breach of Covenant. The Company shall fail to perform or observe any other covenant, agreement or provision to be performed or observed by it under this Note and such failure shall not be rectified or cured within 30 days after actual knowledge of such failure by an executive officer of the Company. 4.1.2. Bankruptcy, etc. The Company shall: (a) commence a voluntary case under Title 11 of the United States Code as from time to time in effect, or authorize, by appropriate proceedings of its board of directors or other governing body, the commencement of such a voluntary case; (b) have filed against it a petition commencing an involuntary case under such Title 11, which petition is not dismissed within 30 days after such filing; (c) seek relief as a debtor under any applicable law, other than such Title 11, of any jurisdiction relating to the liquidation or reorganization of debtors or to the modification or alteration of the rights of creditors, or consent to or acquiesce in such relief; (d) have entered against it any order by a court of competent jurisdiction (i) finding it to be bankrupt or insolvent, (ii) ordering or approving its liquidation, reorganization or any modification or alteration of the rights of its creditors, or (iii) assuming custody of, or appointing a receiver or other custodian for, all or a substantial part of its property; or (e) make an assignment for the benefit of, or enter into a composition with, its creditors, or appoint or consent to the appointment of a receiver or other custodian for all or a substantial part of its property. 4.2. Remedies. Upon the occurrence and during the continuance of any Event of Default, the Holder may accelerate the maturity of this Note upon notice to the Company (and upon the occurrence of an Event of Default under Section 4.1.3 above, such maturity shall be automatically accelerated) and may exercise any remedies at law or in equity. 4.3. Annulment of Defaults. An Event of Default shall not be deemed to be in existence or to have occurred for any purpose of this Note until the expiration of all grace periods under this note or if the Holder shall have waived such event in writing or stated in writing that the same has been cured to its reasonable satisfaction. No waiver or statement of satisfactory cure pursuant to this Section 4.3 shall extend to or affect any subsequent or other Event of Default not specifically identified in such waiver or statement of satisfactory cure or impair any of the Holder's rights upon the occurrence thereof. 4.4. Waivers. The Company hereby waives to the extent not prohibited by applicable law which cannot be waived (a) all presentments, demands for performance, notice of nonperformance (except to the extent specifically required by the provisions hereof), (b) any requirement of diligence or promptness on the part of the Holder in the enforcement of its rights under this Note, (c) except to the extent required by other provisions of this Note, any and all notices of every kind and description which may be required to be given by any statute or rule of -4- law, and (d) any defense of any kind (other than indefeasible payment) which it may now or hereafter have with respect to its liability under this Note. 4.5. Course of Dealing. No course of dealing between the Company and its affiliates on the one hand, and the Holder, on the other hand, shall operate as a waiver of any of the Holder's rights under this Note. No delay or omission in exercising any right under this Note shall operate as a waiver of such right or any other right. A waiver on any one occasion shall not be construed as a bar to or waiver of any right or remedy on any other occasion. No waiver or statement of satisfactory cure or consent shall be binding upon the Holder unless it is in writing and signed by the Holder. 5. DEFINITIONS. As used in this Note, the following terms have the meanings set forth below: 5.1 "Common Stock" means the Company's Common Stock, $.10 par value per share, any stock into which such Common Stock shall have been changed or any stock resulting from any reclassification of such Common Stock. 5.2. "Company" has the meaning set forth in the first paragraph of this Note, such term to include any entity which shall succeed to or assume the obligations of the Company hereunder. 5.3 "Holder" means each holder from time to time of this Note. 5.4. "License and Supply Agreement" means the License and Supply Agreement dated as of September, 2001 by and between the Company and Biosearch Italia, S.p.A., as the same may be amended, restated, extended, renewed or otherwise modified from time to time. 5.5 "Trading Day" means a day on which trades may be effected through the Nasdaq National Market or any successor thereto. 6. MISCELLANEOUS. This Note shall be governed by and construed in accordance with the domestic substantive laws of The Commonwealth of Massachusetts without giving effect to any choice or conflict of laws provision or rule that would cause the application of the domestic substantive laws of any other jurisdiction. This Note shall be binding on the Company and its successors and assigns. The parties hereto, including the undersigned maker and all guarantors and endorsers, hereby waive presentment, demand, notice, protest and all other demands and notices in connection with the delivery, acceptance, performance and enforcement of this Note, except as specifically otherwise provided herein, and assent to extensions of the time of payment, or forbearance or other indulgence, without notice. GENOME THERAPEUTICS CORP. By:_____________________________ Title: -5- FORM OF CONVERSION NOTICE To Genome Therapeutics Corp., The undersigned registered holder of the within Note hereby irrevocably converts the unpaid principal- amount of this Note, and requests that the certificates for such shares be issued in the name of, and delivered to, whose address is Dated: ____________________________________ (Signature must conform in all respects to name of holder as specified on the face of Note) ____________________________________ (Street Address) ____________________________________ (City) (State) (Zip Code) -6- EXHIBIT II Bulk Licensed Compound Specifications (forse sono da rivedere) ***** __________________________ * Confidential Treatment has been requested for the marked portions. Initials:_____ _____ EX-23 5 dex23.txt CONSENT OF ARTHUR ANDERSEN LLP Exhibit 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K, into the Company's previously filed Registration Statement File No. 2-77846, No. 2-81123, No. 2-95446, No. 33-12633, No. 33-27885, No. 0-10824, No. 33-45432, No. 33-75136, No. 333-15935, No. 333-49069, No. 333-30920, No. 333-39390, No. 333-92951, No. 333-32614 and No. 333-58274. ARTHUR ANDERSEN LLP Boston, Massachusetts March 29, 2002 EX-99.1 6 dex991.txt RISK FACTORS EXHIBIT 99.1 RISK FACTORS We have a history of significant operating losses and expect these losses to continue in the future. We have experienced significant operating losses each year since our inception and expect these losses to continue for the foreseeable future. We had a net loss of approximately $10,090,000 for the fiscal year ended December 31, 2001, and, as of December 31, 2001, we had an accumulated net loss of approximately $82,054,000. The losses have resulted primarily from costs incurred in research and development and from general and administrative costs associated with our operations. These costs have exceeded our revenues which to date have been generated principally from collaborations, government grants and sequencing services. We anticipate incurring additional losses this year and in future years and cannot predict when, if ever, we will achieve profitability. These losses may increase in the near future as we expand our research and development and clinical trial activities. In addition, our partners' product development efforts which utilize our products are at an early stage and, accordingly, we do not expect our losses to be substantially mitigated by revenues from milestone payments or royalties under those agreements for a number of years, if ever. Use of genomic information to develop or commercialize products is unproven. The development of new drugs and the diagnosis of disease based on genomic information is unproven. Our business strategy is based on the assumption that identifying and characterizing genes and sequencing select human genes and the genomes of select pathogens may help scientists better understand complex disease processes and develop drugs to treat these diseases. There is limited understanding of the roles of genes in diseases. Few therapeutic vaccine or diagnostic products based on genomic information have been developed and commercialized. To date, no one has developed or commercialized any pharmaceutical, diagnostic or vaccine products based on our technologies. If we fail to identify genes useful for the discovery and development of such products, or if partners are unable to use the genomic information that we provide to them to develop such products, our current and potential customers may lose confidence in our products or their value for drug discovery, and our business may suffer as a result. We rely heavily upon existing and prospective alliance partners and licensees, and a significant portion of our revenue has been derived from one alliance partner. Our strategy for developing and commercializing therapeutic, vaccine and diagnostic products depends, in part, on strategic alliances and licensing arrangements with pharmaceutical and biotechnology partners. We currently have alliances with AstraZeneca, bioMerieux, Schering-Plough and Wyeth-Ayerst. We have received a substantial portion of our revenue from these alliances, and we expect to continue to do so. Under these arrangements, we are entitled to receive payments and royalties based on the achievement by us and our partners of certain development milestones and the successful development of products arising from the collaborations. Although we have achieved many of the scientific milestones under our agreements, we cannot assure you that we will continue these achievements in the future or that milestones dependent on our partners' development and commercialization activities will be attained. In addition, we cannot assure that we will maintain our current collaborations or establish additional collaborations. Competition among genomics companies for collaborations with pharmaceutical companies is intense. This competition is enhanced by the trend towards consolidation among large pharmaceutical companies. Consequently, we cannot be sure that we will be able to enter into new collaborations or maintain our existing ones, and any new or renewed collaborations may be on terms less favorable to us than past collaborations. Our failure to maintain existing collaborations or to enter into additional collaborations would have a material adverse effect on our business. In particular, if funding from partners were to become unavailable or were to be reduced, we would need to devote additional internal resources to our research programs or possibly scale back or terminate some programs. Since 1996, we have received a significant amount of revenues based on payments under our alliances with Schering-Plough. We have two infectious disease alliances with Schering-Plough and a third collaboration with Schering-Plough that relates to asthma genetics. The funded research phase under these agreements have been extended and is scheduled to end on March 31, 2002 (with respect to the infectious disease alliances) and December 31, 2002 (with respect to the asthma alliance). For the fiscal years ended December 31, 1999, 2000 and 2001, revenues from Schering-Plough accounted for approximately 71%, 35% and 31%, respectively, of our total revenue. If Schering-Plough fails to continue to extend one or more of these agreements, we would lose research funding, which could have a material adverse effect on us. Our strategy includes entering into multiple, concurrent alliances. We cannot assure that we will be able to manage multiple alliances successfully. The risks we face in managing multiple alliances include maintaining confidentiality among partners, avoiding conflicts between partners and avoiding conflicts between us and our partners. If we fail to manage our alliances effectively, or if any of the problems described above arise, one or more of the following could occur which could have a material adverse effect on our business: - use of significant resources to resolve conflicts, - delay in research effects, - legal claims involving significant time, - expense, - loss of reputation, - termination of one or more alliances, or - loss of capital and loss of revenues. If our partners develop products using our genomic information, we will rely on these partners for product development, regulatory approval, manufacturing and marketing of those products before we can receive some of the milestone payments, royalties and other payments to which we may be entitled under the terms of some of our alliance agreements. Our agreements with our partners typically allow the partners significant discretion in electing whether to pursue any of these activities. We cannot control the amount and timing of resources our partners may devote to our programs or potential products. As a result, we cannot assure that our partners will perform their obligations as expected. In addition, if a partner is involved in a business combination, such as a merger or acquisition, or changes its business focus, its performance under our agreement may suffer and, as a result, we may not generate any revenues from the royalty, milestone and similar payment provisions of our collaboration agreement with that partner. Development of therapeutic, diagnostic and vaccine products based on our discoveries will be subject to the high risks of failure inherent in the development or commercialization of health care products. These risks include the possibility that any such products will be found to be toxic, be found to be ineffective, fail to receive necessary regulatory approvals, be difficult or impossible to manufacture on a large scale, be uneconomical to market, fail to be developed prior to the successful marketing of similar products by competitors or infringe on proprietary rights of third parties. Our alliance partners may not be successful in developing or commercializing therapeutic, diagnostic or vaccine products under our agreements with them. We derive a substantial portion of our revenues from fees paid by pharmaceutical companies for our information, products and services. We expect that pharmaceutical and biotechnology companies will be one of our primary source of revenues for the foreseeable future. As a result, we are subject to risks and uncertainties that affect the pharmaceutical and biotechnology industries and to reductions and delays in research and development expenditures by companies in these industries. These effects on the pharmaceutical and biotechnology industries may affect our ability to conclude deals with collaborative partners. -2- In addition, our future revenues may be adversely affected by mergers and consolidations in the pharmaceutical and biotechnology industries, which will reduce the number of our potential customers. Large pharmaceutical and biotechnology customers could also decide to conduct their own genomic programs, rely on publicly available information or joint consortia or seek other providers instead of using our products or services. We may not succeed in obtaining regulatory approval for commercialization of our product candidates or maintain regulatory compliance with respect to products approved for commercial use. On October 9, 2001, we acquired a license to develop the antibiotic Ramoplanin, our first product candidate, and we intend to expand our pipeline of clinical candidates, both through internal development efforts and acquisitions. The development, manufacture and marketing of pharmaceutical products are subject to government regulation in the United States and other countries. In the United States and most foreign countries, we must complete rigorous pre-clinical testing and extensive human clinical trials that demonstrate the safety and effectiveness of a product in order to apply for regulatory approval to market the product. These processes are expensive and can take many years to complete. We may not be able to demonstrate the safety and efficacy of our products to the satisfaction of the U.S. Food and Drug Administration, commonly referred to as the FDA, or other regulatory authorities. We may also be required to demonstrate that our proposed product represents an improved form of treatment over existing therapies and we may be unable to do so without conducting further clinical studies. Negative, inconclusive or inconsistent clinical trial results could prevent regulatory approval, increase the cost and timing of regulatory approval or require additional studies or a filing for a narrower indication. In addition, regulatory approval may take longer than we expect as a result of a number of factors, including failure to qualify for priority review of our applications. Delays in obtaining regulatory approval can be extremely costly in terms of lost sales opportunities and increased clinical trial costs. Furthermore, all statutes and regulations governing the approval of our product candidates are subject to change in the future. These changes may increase the time or cost of regulatory approval, limit approval, or prevent it completely. Even if we receive regulatory approval for our product candidates, the later discovery of previously unknown problems with a product, manufacturer or facility may result in restrictions, including withdrawal of the product from the market. Approval of a product candidate may be conditioned upon certain limitations and restrictions as to the drug's use, or upon the conduct of further studies, and may be subject to continuous review. After approval of a product, we will have significant ongoing regulatory compliance obligations, and if we fail to comply with these requirements, we could be subject to penalties, including warning letters, fines, product recalls, withdrawal of regulatory approval, operating restrictions, injunctions, and criminal prosecution. Clinical studies are costly, time consuming and unpredictable, and we have limited experience conducting and managing necessary pre-clinical and clinical trials for our product candidates. Our initial product candidate, Ramoplanin, is in Phase III clinical trials for the prevention of bloodstream infections caused by vancomycin-resistant enterococci, also known as VRE. Prior clinical and pre-clinical trials for Ramoplanin were conducted by Biosearch Italia and its licensees, from whom we acquired our license to develop Ramoplanin. The speed with which we complete our clinical trials and our applications for marketing approval will depend on several factors, including the following: - the rate of patient enrollment, which is a function of many factors, including the size of the patient population, the proximity of patients to clinical sites, the eligibility criteria for the study and the nature of the protocol; - institutional review board approval of the protocol and the informed consent form; - prior regulatory agency review and approval of our applications and procedures; - analysis of data obtained from pre-clinical and clinical activities which are susceptible to varying interpretations, which interpretations could delay, limit or prevent regulatory approval; -3- - changes in the policies of regulatory authorities for drug approval during the period of product development; and - the availability of skilled and experienced staff to conduct and monitor clinical studies, to accurately collect data and to prepare the appropriate regulatory applications. In addition, the cost of human clinical trials varies dramatically based on a number of factors, including the order and timing of clinical indications pursued, the extent of development and financial support from alliance partners, the number of patients required for enrollment, the difficulty of obtaining clinical supplies of the product candidate, and the difficulty in obtaining sufficient patient populations and clinicians. We have limited experience in conducting and managing the pre-clinical and clinical trials necessary to obtain regulatory marketing approvals. We may not be able to obtain the approvals necessary to conduct clinical studies. Also, the results of our clinical trials may not be consistent with the results obtained in pre-clinical studies or the results obtained in later phases of clinical trials may not be consistent with those obtained in earlier phases. A number of companies in the biopharmaceutical industry have suffered significant setbacks in advanced clinical trials, even after experiencing promising results in early animal and human testing. If regulatory approval of a drug is granted, such approval is likely to limit the indicated uses for which it may be marketed. Furthermore, even if a product of ours gains regulatory approval, the product and the manufacturer of the product will be subject to continuing regulatory review. We may be restricted or prohibited from marketing or manufacturing a product, even after obtaining product approval, if previously unknown problems with the product or its manufacture are subsequently discovered. We will need to develop marketing and sales capabilities to successfully commercialize our product candidates. Because we have only recently acquired a license to develop our first product candidate, we currently have no marketing or sales experience. We will need to develop a marketing and sales staff to successfully commercialize our product candidates, including Ramoplanin. The development of marketing and sales capabilities will require significant expenditures, management resources and time. We may be unable to build such a sales force, the cost of establishing such a sales force may exceed any product revenues, or our marketing and sales efforts may be unsuccessful. Failure to successfully establish sales and marketing capabilities in a timely manner or find suitable sales and marketing partners may materially adversely affect our business and results of operation. Even if we are able to develop a sales force or find a suitable marketing partner, our products may not be accepted by health care providers or consumers. Health care insurers and other payers may not pay for our products or may impose limits on reimbursement. Our ability to commercialize Ramoplanin and our future products will depend, in part, on the extent to which reimbursement for such products will be available from third-party payers, such as Medicare, Medicaid, health maintenance organizations, health insurers and other public and private payers. If we succeed in bringing Ramoplanin or other products in the future to market, we cannot assure you that third-party payers will pay for Ramoplanin or other products or will establish and maintain price levels sufficient for realization of an appropriate return on our investment in product development. If adequate coverage and reimbursement levels are not provided by government and private payers for use of our products, our products may fail to achieve market acceptance and our results of operations may be materially adversely affected. Many health maintenance organizations and other third-party payers use formularies, or lists of drugs for which coverage is provided under a health care benefit plan, to control the costs of prescription drugs. Each payer that maintains a drug formulary makes its own determination as to whether a new drug will be added to the formulary and whether particular drugs in a therapeutic class will have preferred status over other drugs in the same class. This determination often involves an assessment of the clinical appropriateness of the drug and sometimes the cost of the drug in comparison to alternative products. We cannot assure you that Ramoplanin or any of our future products will be added to payer's formularies, whether our products will have preferred status to alternative -4- therapies, nor whether the formulary decisions will be conducted in a timely manner. We may also decide to enter into discount or formulary fee arrangements with payers, which could result in us receiving lower or discounted prices for Ramoplanin or future products. We currently depend and will in the future depend on third parties to manufacture our product candidates, including Ramoplanin. We do not have the internal capability to manufacture commercial quantities of pharmaceutical products under the FDA's current Good Manufacturing Practices. We have entered into an agreement with Biosearch for the manufacture of Ramoplanin and expect to enter into similar agreements with third parties for the manufacture of future product candidates. We cannot be certain that Biosearch or future manufacturers will be able to deliver commercial quantities of product candidates to us or that such deliveries will be made on a timely basis. If we are required to find additional or alternative sources of supply for Ramoplanin or other future product candidates, we may face additional cost and delay in product development and commercialization. We may not be able to enter into alternative supply arrangements at commercially acceptable rates, if at all. Also, if we change the source or location of supply or modify the manufacturing process, regulatory authorities will require us to demonstrate that the product produced by the new source or from the modified process is equivalent to the product used in any clinical trials that we had conducted. In addition, any contract manufacturers that we may use must adhere to the FDA's regulations on current Good Manufacturing Practices, which are enforced by the FDA through its facilities inspection program. These facilities are subject to periodic inspection by the FDA. The manufacture of products at these facilities will be subject to strict quality control testing and recordkeeping requirements. Moreover, while we may choose to manufacture products in the future, we have no experience in the manufacture of pharmaceutical products for clinical trials or commercial purposes. If we decide to manufacture products, we would be subject to the regulatory requirements described above. In addition, we would require substantial additional capital and would be subject to delays or difficulties encountered in manufacturing pharmaceutical products. No matter who manufactures the products, we will be subject to continuing obligations regarding the submission of safety reports and other post-market information. The genomics industry is intensely competitive and evolving. There is intense competition among entities attempting to sequence segments of the human genome and identify genes associated with specific diseases and develop products and services based on these discoveries. We face competition in these areas from genomic, pharmaceutical, biotechnology and diagnostic companies, academic and research institutions and government or other publicly-funded agencies, both in the United States and abroad. Some of our competitors are developing databases containing gene sequence, gene expression, genetic variation or other genomic information and are marketing or plan to market their data to pharmaceutical companies. Additional competitors may attempt to establish databases containing this information in the future. In addition, some entities are attempting to identify and patent randomly sequenced genes and gene fragments, while others are pursuing a gene identification, characterization and product development strategy based on positional cloning or other technologies. Numerous pharmaceutical companies also are developing genomic research programs, either alone or in partnership with our competitors. Competition among these entities to sequence genes, identify and characterize genes of interest, obtain patent protection and market this genomic information is intense and is expected to increase. In order to compete against existing and future technologies, we will need to demonstrate to potential customers that our technologies and capabilities are superior to competing technologies. Many of our competitors have substantially greater capital resources, sequencing capabilities, research and developmental staffs, facilities, manufacturing and marketing experience, distribution channels and human resources than us. These competitors may discover, characterize or develop important genes, drug targets or leads, drug discovery technologies or drugs in advance of us or our customers or which are more effective than those developed by us or our customers, or may obtain regulatory approvals of their drugs more rapidly than our customers do, any -5- of which could have a material adverse effect on any of our similar programs. Moreover, these competitors may obtain patent protection or other intellectual property rights that would limit our rights or our customers' ability to use our products to commercialize therapeutic, diagnostic or vaccine products. Future competition will come from existing competitors as well as other companies seeking to develop new technologies for drug discovery based on gene sequencing, target gene identification, bioinformatics and related technologies. In addition, certain pharmaceutical and biotechnology companies have significant needs for genomic information and may choose to develop or acquire competing technologies to meet such needs. We also face competition from providers of software. A number of companies have announced their intent to develop and market software to assist pharmaceutical companies and academic researchers in managing and analyzing their own genomic data and publicly available data. Our intellectual property protection may be inadequate to protect our proprietary rights. Our success will depend, in part, on our ability to obtain commercially valuable patent claims and protect our intellectual property. Our patent position involves complex legal and factual questions, and legal standards relating to the validity and scope of claims in our technology field are still evolving. Therefore, the degree of future protection for our proprietary rights is uncertain. The risks and uncertainties that we face with respect to our patents and other proprietary rights include the following: - the pending patent applications we have filed or to which we have exclusive rights may not result in issued patents or may take longer than we expect to result in issued patents; - the claims of any patents which are issued may be limited from those in our patent applications and may not provide meaningful protection; - we may not be able to develop additional proprietary technologies that are patentable; - the patents licensed or issued to us or our customers may not provide a competitive advantage; - other companies may challenge patents licensed or issued to us or our customers; - patents issued to other companies may harm our ability to do business; - other companies may independently develop similar or alternative technologies or duplicate our technologies; and - other companies may design around technologies we have licensed or developed. We may apply for patent protection for compositions and methods relating to gene expression and disease-specific patterns of gene expression that we identify and individual disease genes and targets that we discover. These patent applications may include claims relating to novel genes, gene fragments, single nucleotide polymorphisms (SNPs) or encoded protein and to novel uses for known genes, gene fragments, SNPs or proteins identified from the use of our genomic information and our databases. We may not be able to obtain meaningful patent protection for our discoveries. Even if patents are issued, their scope of coverage or protection is uncertain. For example, we or our collaborators have filed patent applications with respect to a number of full length genes and corresponding proteins and partial genes of H. pylori, of M. leprae and several other organisms. These applications seek to protect these full-length and partial gene sequences and corresponding proteins, as well as equivalent sequences and products and uses derived from these sequences and proteins. Some court decisions and US Patent and Trademark Office guidelines indicate that disclosure of a partial sequence may not be sufficient to support the patentability of a full-length sequence. In addition, we are aware that some companies have published patent applications relating to nucleic acids encoding several H. pylori proteins and, in other disease programs, relating to genes for which we have found mutations of interest. If these companies are issued patents, their patents may limit our ability and the ability of our collaborators to practice under any patents that may be issued to our collaborators or us. Because of this, we or our -6- collaborators may not be able to obtain patents with respect to the genes of infectious agents such as H. pylori, or the value of certain other patents issued to us or our collaborators may be limited. Also, even if a patent were issued to us, the scope of coverage or protection afforded to such patent may be limited. Our proprietary position may depend on our ability to protect trade secrets. We rely on trade secret protection for our confidential and proprietary information and procedures, including procedures related to sequencing genes and to searching and identifying important regions of genetic information. We currently protect such information and procedures as trade secrets. We protect our trade secrets through recognized practices, including access control, confidentiality agreements with employees, consultants, collaborators, and customers, and other security measures. These confidentiality agreements may be breached, however, and we may not have adequate remedies for any such breach. In addition, our trade secrets may otherwise become known or be independently developed by competition. We may infringe the intellectual property rights of third parties and may become involved in expensive intellectual property litigation. The intellectual property rights of biotechnology companies, including our company, are generally uncertain and involve complex legal, scientific and factual questions. Our success in the functional genomic field may depend, in part, on our ability to operate without infringing on the intellectual property rights of others and to prevent others from infringing on our intellectual property rights. There has been substantial litigation regarding patents and other intellectual property rights in the genomic industry. We may become party to patent litigation or proceedings at the U.S. Patent and Trademark Office or a foreign patent office to determine our patent rights with respect to third parties which may include subscribers to our database information services. Interference proceedings in the U.S. Patent and Trademark Office or opposition proceedings in a foreign patent office may be necessary to establish which party was the first to discover such intellectual property. We may become involved in patent litigation against third parties to enforce our patent rights, to invalidate patents held by such third parties, or to defend against such claims. The cost to us of any patent litigation or similar proceeding could be substantial, and it may absorb significant management time. If an infringement litigation against us is resolved unfavorably, we may be enjoined from manufacturing or selling certain of our products or services without a license from a third party. We may not be able to obtain such a license on commercially acceptable terms, or at all. We may not be able to obtain meaningful patent protection for discoveries under our government contracts. Under our government grants and contracts, the government has a statutory right to practice or have practiced any inventions developed under the government research contracts. In addition, under certain circumstances, such as inaction on the part of us or our licensees to achieve practical application of the invention or a need to alleviate public health or safety concerns not reasonably satisfied by us or our licensees, the government has the right to grant to other parties licenses to any inventions first reduced to practice under the government grants and contracts. If the government grants such a license to a third party, our patent position may be jeopardized. In addition, the government has ownership rights in the data, clones, genes and other material derived from the material furnished to us by the government, while we have ownership rights in other technology developed solely by us. We are also obligated under certain government grants to submit sequencing data and materials resulting from our research to public databases within 24 hours from the date such data and materials are developed. Our ability to obtain patent protection for our discoveries and inventions may be adversely affected by this publication. International patent protection is uncertain. Patent law outside the United States is uncertain and is currently undergoing review and revision in many countries. Further, the laws of some foreign countries may not protect our intellectual property rights to the same extent as U.S. laws. We may participate in opposition proceedings to determine the validity of our or our -7- competitors' foreign patents, which could result in substantial costs and diversion of our efforts. Finally, some of our patent protection in the United States is not available to us in foreign countries due to the laws of those countries. We expect to raise additional funds in the future. We believe that our existing cash and marketable securities together with borrowings under equipment financing arrangements and anticipated cash flow from operations will be sufficient to support our current plans for approximately two years. However, we expect to raise additional capital, subject to market conditions and strategic considerations over the course of the next 18 months. In particular, we may need additional funds to increase our research and development activities and fund our clinical trials. We may seek funding through additional public or private equity offerings, debt financings or agreements with customers. If we raise additional capital by issuing equity or convertible debt securities, the issuances may dilute share ownership of existing investors and future investors may be granted rights superior to those of current shareholders. Additional financing may not be available when needed, or, if available, may not be available on favorable terms. If we cannot obtain adequate financing on acceptable terms when such financing is required, our business will be adversely affected. We have issued $15 million of convertible notes due December 31, 2004, which contain restrictive covenants, including covenants that can cause early repayment of the Notes. On March 5, 2002, we issued convertible notes, bearing interest at 6% per annum, to two institutional investors in the aggregate principal amount of $15 million. The Notes are due on December 31, 2004, but if at any time on or after December 31, 2003, we maintain a net cash balance (i.e., cash and cash equivalents less obligations for borrowed money bearing interest) of less than $35 million, then the holders of the notes can require that all or any part of the outstanding principal balance of the notes plus all accrued but unpaid interest be repaid. If we have to repay the notes early, our cash position and ability to execute our business plan could be adversely affected. The notes also contain provisions limiting Genome Therapeutics' ability to incur debt that is senior to the notes, with an exception for certain equipment financing, and provisions that can cause the payment of a premium to the holders of the notes on a change of control transaction. The notes are convertible into our common stock at a price of $8 per share (subject to anti-dilution and other adjustments). As part of the transaction, the purchasers also received warrants to purchase up to 487,500 shares of our common stock at an exercise price of $8.00 per share (subject to anti-dilution and other adjustments), which become exercisable to the extent the notes are converted or if certain other redemptions or repayments of the notes occur. The shares underlying the notes and the warrants will be registered for re-sale and if the notes are converted and the warrants exercised, these shares could be sold into the market creating dilution of the ownership of our shareholders at that time. We rely on funding from the United States government. As of December 31, 2001, we had approximately $8.6 million of government research contracts outstanding under which we had not yet completed all of the services. Funding under our government grants and research contracts is subject to appropriation each year by the United States Congress and can be discontinued or reduced at any time. In addition, there can be no assurance that we will receive additional grants or contracts in the future. The government's failure to fund our research in this area not only would end our participation in the program, but might adversely affect the industry-wide perception of genomics and the utility of genomic information. Our research and product development depends on access to tissue samples and other biological materials from individuals. To continue to build our database products, we will need access to normal and diseased human and other tissue samples, other biological materials and related clinical and other information, which may be in limited supply. We compete with many other companies for these materials and information. We may not be able to obtain or -8- maintain access to these materials and information on acceptable terms. In addition, government regulation in the United States and foreign countries could result in restricted access to, or use of, human and other tissue samples. If we lose access to sufficient numbers or sources of tissue samples, or if tighter restrictions are imposed on our use of the information generated from tissue samples, our business may be harmed. Competition among genomics companies is also increasing for access to unique data from related individuals that we use to identify genes for specific human diseases. Ethical, legal and social issues related to the use of genetic information and genetic testing may cause less demand for our products. Genetic testing has raised issues regarding confidentiality and the appropriate uses of the resulting information. For example, consumers have expressed concerns towards insurance carriers and employers using such tests to discriminate on the basis of such information, resulting in barriers to the acceptance of such tests. This could lead to governmental authorities calling for limits on or regulation of the use of genetic testing or prohibit testing for genetic predisposition to certain diseases, particularly those that have no known cure. Any of these scenarios could reduce the potential markets for our products. We may not succeed in realizing any additional revenue from the PathoGenome Database. In 1997, we introduced the PathoGenome Database that consists of genetic information from more than thirty microbial organisms. In the past, our strategy for our database depended on entering into subscription agreements with pharmaceutical, biotechnology and other companies for the use of our database. Each of the agreements that we may have with our customers is for a specific term, and we anticipate that they may not be renewed upon expiration or may be renewed at a substantially lower price. If any agreements expire and are not renewed, our revenue would suffer. Our sales cycle is lengthy and we may spend considerable resources on unsuccessful negotiation efforts or may not be able to complete deals on the schedule anticipated. Our ability to obtain new customers for genomic information products depends on our customers' belief that we can help accelerate their drug discovery efforts. Our negotiation cycle is typically lengthy because we need to educate potential customers and sell the benefits of our products and services to a variety of constituencies within companies. In addition, each agreement involves the negotiation of unique terms. We may expend substantial funds and management effort with no assurance that an agreement will result. Actual and proposed consolidations of pharmaceutical companies have affected and may in the future affect the timing and progress of our ability to conclude deals with collaborative partners. We depend on key personnel in a highly competitive market for skilled personnel. We are highly dependent on the principal members of our senior management and key scientific and technical personnel. The loss of any of these personnel could have a material adverse effect on our ability to achieve our goals. Our future success is also dependent upon our ability to attract and retain additional qualified scientific, technical and managerial personnel. Our plan to expand our biopharmaceutical program will require us to hire a number of new personnel with expertise in the areas of clinical trials and sales and marketing. We experience intense competition for qualified personnel and may not be able to continue to attract and retain skilled personnel necessary for the development of our business. Our activities involve hazardous materials and may subject us to environmental liability. Our research and development involve the controlled use of hazardous and radioactive materials and biological waste. We are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of these materials and certain waste products. Although we believe that our safety -9- procedures for handling and disposing of these materials comply with legally prescribed standards, we cannot completely eliminate the risk of accidental contamination or injury from these materials. In the event of an accident, we could be held liable for damages or penalized with fines, and this liability could exceed our resources. We believe that we are in compliance in all material respects with applicable environmental laws and regulations and currently do not expect to make material additional capital expenditures for environmental control facilities in the near term. However, we may have to incur significant costs to comply with current or future environmental laws and regulations. We may have difficulty managing our growth. We expect to continue to experience growth in the number of our employees and customers and the scope of our operations. In particular, we plan significant growth in our service (GenomeVision) and bioPharmaceutical business. This growth may continue to place a significant strain on our management and operations. Our ability to manage this growth will depend upon our ability to broaden our management team and our ability to attract, hire and retain skilled employees. Our success will also depend on the ability of our officers and key employees to continue to implement and improve our operational and other systems, to manage multiple, concurrent customer relationships and to hire, train and manage our employees. Multiple factors beyond our control may cause fluctuations in our operating results and may cause our business to suffer. Our revenues and results of operations may fluctuate significantly, depending on a variety of factors, including the following: - our success in concluding deals for, and changes in the demand for, our products; - variations in the timing of payments from partners and customers and the recognition of these payments as revenues; - the terms we are able to negotiate in our deals; - the progress of our pre-clinical and clinical trials; - the timing of our new product introductions, if any; - changes in the research and development budgets of our customers and potential customers; - the introduction of new products and services by our competitors; - regulatory actions; - expenses related to, and the results of, litigation and other proceedings relating to intellectual property rights; - the cost and timing of our adoption of new technologies; - the cost, quality and availability of cell and tissue samples, reagents and related components and technologies, including those supplied to us pursuant to contractual arrangements; and - the lengthy nature of our sales cycle for concluding alliances and other deals. We will not be able to control many of these factors. In addition, if our revenues in a particular period do not meet expectations, we may not be able to adjust our expenditures in that period, which could cause our business to suffer. We believe that period-to-period comparisons of our financial results will not necessarily be meaningful. You should not rely on these comparisons as an indication of our future performance. If our operating results in any future period fall below the expectations of securities analysts and investors, our stock price may fall, possibly by a significant amount. Future acquisitions may absorb significant resources and may be unsuccessful. -10- As part of our strategy, we may pursue acquisitions of businesses or assets, investments and other relationships and alliances. Acquisitions may involve significant cash expenditures, debt incurrence, additional operating losses, dilutive issuances of equity securities, and expenses that could have a material adverse effect on our financial condition and results of operations. For example, to the extent that we elect to pay the purchase price for such acquisitions in shares of our stock, the issuance of additional shares of our stock will be dilutive to our stockholders. Acquisitions involve numerous other risks, including: - difficulties integrating acquired technologies and personnel into our business; - diversion of management from daily operations; - inability to obtain required financing on favorable terms; - entering new markets in which we have little or no previous experience; - potential loss of key employees or customers of acquired companies; - assumption of the liabilities and exposure to unforeseen liabilities of acquired companies; and - amortization of the intangible assets of acquired companies. It may be difficult for us to complete these types of transactions quickly and to integrate the businesses efficiently into our current business. Any acquisitions or investments by us may ultimately have a negative impact on our business and financial condition. -11- EX-99.2 7 dex992.txt LETTER TO COMMISSION PURSUANT TO TEMP. NOTE 3T EXHIBIT 99.2 GENOME THERAPEUTICS CORP. 100 Beaver Street Waltham, MA 02453 LETTER TO COMMISSION PURSUANT TO TEMPORARY NOTE 3T March 29, 2002 Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549-0408 Ladies and Gentlemen: Pursuant to Temporary Note 3T to Article 3 of Regulation S-X, Genome Therapeutics Corp. has obtained a letter of representation from Arthur Andersen LLP ("Andersen") stating that the December 31, 2001 audit was subject to their quality control system for the U.S. accounting and auditing practice to provide reasonable assurance that the engagement was conducted in compliance with professional standards, that there was appropriate continuity of Andersen personnel working on the audit and availability of national office consultation. Availability of personnel at foreign affiliates of Andersen is not relevant to this audit. Very truly yours, Genome Therapeutics Corp. /s/ Stephen Cohen Stephen Cohen Senior Vice President and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----