-----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, GLjUuhQfPvt6cL3FC9t2tMCRZwUCa7nndBPrWS25CUR/Poj7jvhNPJzUuC3RxabV ZswG7hay3ifzOQMWBkcmsw== 0001032210-01-500538.txt : 20010514 0001032210-01-500538.hdr.sgml : 20010514 ACCESSION NUMBER: 0001032210-01-500538 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20010331 FILED AS OF DATE: 20010511 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TARGETED GENETICS CORP /WA/ CENTRAL INDEX KEY: 0000921114 STANDARD INDUSTRIAL CLASSIFICATION: BIOLOGICAL PRODUCTS (NO DIAGNOSTIC SUBSTANCES) [2836] IRS NUMBER: 911549568 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-23930 FILM NUMBER: 1631022 BUSINESS ADDRESS: STREET 1: 1100 OLIVE WAY STREET 2: STE 100 CITY: SEATTLE STATE: WA ZIP: 98101 BUSINESS PHONE: 2066237612 MAIL ADDRESS: STREET 1: 1100 OLIVE WAY STREET 2: STE 100 CITY: SEATTLE STATE: WA ZIP: 98101 10-Q 1 d10q.txt FORM 10-Q FOR THE PERIOD ENDED MARCH 31, 2001 SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q (Mark One) [x] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2001 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to ----------- Commission File Number:0-23930 ------- TARGETED GENETICS CORPORATION ----------------------------- (Exact name of registrant as specified in its charter) Washington 91-1549568 ----------------------------------- -------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 1100 Olive Way, Suite 100, Seattle, Washington 98101 ---------------------------------------------------- (Address of principal executive offices) (Zip code) (206) 623-7612 -------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock, $.01 par value 43,887,161 -------------------------------- ---------------------------- (Class) (Outstanding at May 1, 2001) TARGETED GENETICS CORPORATION Quarterly Report on Form 10-Q For the quarter ended March 31, 2001 TABLE OF CONTENTS
Page No. -------- PART I FINANCIAL INFORMATION Item 1. Financial Statements a) Condensed Consolidated Balance Sheets - March 31, 2001 and December 31, 2000 3 b) Condensed Consolidated Statements of Operations for the three months ended March 31, 2001 and 2000 4 c) Condensed Consolidated Statements of Cash Flows for the three months March 31, 2001 and 2000 5 d) Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7 Item 3. Quantitative and Qualitative Disclosure About Market Risk 17 PART II OTHER INFORMATION Item 1. Legal Proceedings * Item 2. Changes in Securities * Item 3. Defaults Upon Senior Securities * Item 4. Submission of Matters to a Vote of Security Holders * Item 5. Other Information * Item 6. Exhibits and Reports on Form 8-K 17 SIGNATURES 17
* No information is provided due to inapplicability of the item. 2 PART I FINANCIAL INFORMATION Item 1. Financial Statements TARGETED GENETICS CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31, 2001 2000 ------------- ------------- ASSETS (Unaudited) - ------ Current assets: Cash and cash equivalents $ 34,034,268 $ 38,630,216 Accounts receivable 2,788,363 3,086,534 Receivable from joint venture 854,442 177,088 Prepaid expenses and other 529,685 291,435 ------------- ------------- Total current assets 38,206,758 42,185,273 Property, plant and equipment, net 7,321,107 6,206,276 Goodwill and other purchased intangibles, net 36,303,710 37,821,059 Other assets 1,479,034 1,761,434 ------------- ------------- $ 83,310,609 $ 87,974,042 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY - ------------------------------------ Current liabilities: Accounts payable $ 3,877,789 $ 4,000,084 Payable to joint venture 1,098,747 261,743 Accrued payroll and other liabilities 815,738 679,739 Deferred revenue 7,578,281 6,906,174 Current portion of long-term obligations 812,661 838,245 ------------- ------------- Total current liabilities 14,183,216 12,685,985 Long-term obligations, less current portion 819,736 947,508 Long-term note payable 1,505,616 1,498,566 Deferred revenue 7,314,758 9,410,386 Shareholders' equity: Preferred stock, 6,000,000 shares authorized Series A preferred stock, $.01 par value; 400,000 shares authorized, none outstanding - - Series B convertible exchangeable preferred stock, $.001 par value; 12,015 shares authorized, issued and outstanding at March 31, 2001 and at December 31, 2000 13,504,384 13,275,778 Common stock $.01 par value, 80,000,000 shares authorized, 43,761,050 and 42,608,943 shares issued and outstanding at March 31, 2001 and December 31, 2000, respectively 203,038,229 200,968,429 Accumulated deficit (157,055,330) (150,812,610) ------------- ------------- Total shareholders' equity 59,487,283 63,431,597 ------------- ------------- $ 83,310,609 $ 87,974,042 ============= =============
The accompanying notes are an integral part of this statement. 3 TARGETED GENETICS CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three months ended March 31, ------------------------------ 2001 2000 ----------- ----------- Revenue: (restated) Collaborative agreements $ 3,128,019 $ 2,287,625 Collaborative agreements with affiliates 677,354 412,261 ----------- ----------- Total revenue 3,805,373 2,699,886 Operating expenses: Research and development 6,393,356 3,717,756 Amortization of acquisition-related intangibles 1,517,346 - General and administrative 2,026,881 1,106,951 ----------- ----------- Total operating expenses 9,937,583 4,824,707 ----------- ----------- Loss from operations (6,132,210) (2,124,821) Equity in loss of joint venture (848,218) (563,994) Investment income 801,905 215,754 Interest expense (64,197) (64,121) ----------- ----------- Loss before cumulative effect of change in accounting principle (6,242,720) (2,537,182) Cumulative effect of change in accounting principle - (3,681,687) ----------- ----------- Net loss (6,242,720) (6,218,869) Dividend on preferred stock (228,606) (216,528) ----------- ----------- Net loss applicable to common shareholders $(6,471,326) $(6,435,397) =========== =========== Basic and diluted net loss per share: Loss before cumulative effect of change in accounting principle $(0.15) $ (0.08) Cumulative effect of change in accounting principle $ - $ (0.10) ----------- ----------- Net loss applicable to common shareholders $(0.15) $ (0.18) =========== =========== Shares used in computation of basic and diluted net loss per share 43,517,198 34,823,371 =========== ===========
The accompanying notes are an integral part of this statement. 4 TARGETED GENETICS CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three months ended March 31, ---------------------------- 2001 2000 ----------- ----------- Operating activities: (restated) - --------------------- Net loss $ (6,242,720) $ (6,218,869) Adjustments to reconcile net loss to net cash used in operating activities: Cumulative effect adjustment of change in accounting principle - 3,681,687 Equity in loss of joint venture 848,218 563,994 Depreciation and amortization 693,605 352,875 Amortization of intangibles 1,517,349 - Noncash equity variances 80,466 - Decrease in deferred revenue (1,423,521) (198,334) Decrease (increase) in accounts receivable from joint venture (677,354) 294,124 Decrease (increase) in accounts receivable 298,171 (431,966) Increase (decrease) in current liabilities 142,281 (122,705) Decrease in prepaid expenses and other 61,750 38,475 Decrease in accounts payable and accrued liabilities (172,295) (653,991) Decrease (increase) in other assets (35,000) 13,438 ------------ ------------ Net cash used in operating activities (4,909,050) (2,681,272) Investing activities: - --------------------- Purchases of property, plant and equipment (1,689,248) (362,825) Investment in joint venture (11,214) (563,994) Maturities and sales of securities available for sale - 10,920 ------------ ------------ Net cash used in investing activities (1,700,462) (915,889) Financing activities: - --------------------- Net proceeds from sale of capital stock 2,217,940 28,681,742 Payments under capital leases and installment loans (204,376) (305,712) Proceeds from leasehold improvement and equipment financing - 456,182 ------------ ------------ Net cash provided by financing activities 2,013,564 28,832,212 ------------ ------------ Net increase (decrease) in cash and cash equivalents (4,595,948) 25,235,041 Cash and cash equivalents, beginning of period 38,630,216 4,100,798 ------------ ------------ Cash and cash equivalents, end of period $ 34,034,268 $ 29,335,839 ============ ============ Supplemental disclosure of noncash investing and financing activities: Preferred stock dividend $ 228,606 $ 216,528 Equipment financed through capital lease 51,020 45,599 Interest paid on capital lease and installment loans 36,377 44,543
The accompanying notes are an integral part of this statement. 5 TARGETED GENETICS CORPORATION NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) Note 1. Basis of Presentation - ------------------------------ The condensed consolidated financial statements included in this quarterly report have been prepared by Targeted Genetics Corporation without audit, according to the rules and regulations of the Securities and Exchange Commission ("SEC"). The consolidated financial statements include the accounts of Targeted Genetics and its wholly-owned subsidiaries Genovo, Inc., TGCF Manufacturing Corporation and CellExSys, Inc. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such rules and regulations. The financial statements reflect, in the opinion of management, all adjustments (which consist solely of normal recurring adjustments) necessary to present fairly the financial position and results of operations as of and for the periods indicated. The results of operations for the three months ended March 31, 2001, are not necessarily indicative of the results to be expected for the full year. The unaudited consolidated financial statements included in this quarterly report should be read in conjunction with the audited consolidated financial statements and related footnotes for the year ended December 31, 2000, included in Targeted Genetics'annual report on Form 10-K for the year ended December 31, 2000. 2. Change in Accounting Principle ------------------------------ We adopted the Securities and Exchange Commission's Staff Accounting Bulletin No. 101., in the fourth quarter of 2000, effective January 1, 2000, and recorded a $3.7 million charge as a cumulative effect of the change in accounting principle. We previously recognized nonrefundable, up-front license fees as revenue when the technology was transferred and when all of its significant contractual obligations relating to the fees had been fulfilled. The cumulative effect was initially recorded as deferred revenue that will be recognized as revenue over the remaining term of the research and development collaboration agreements, as appropriate. The results for the first quarter of 2000 were restated to reflect the effects of the accounting change. For the quarter ended March 31, 2000, the impact of the change in accounting principle was to increase net loss by $3.2 million, or $0.09 per share, comprised of the $3.7 million cumulative effect of the change ($0.10 per share), net of $0.5 million of the related deferred revenue that was recognized as revenue during the quarter ended March 31, 2000 ($0.01 per share). For the quarter ended March 31, 2001, we recognized $1.6 million of deferred revenue including $1.1 million of revenue related to up-front payments received in the second half of 2000 when we initiated collaborations with Biogen, Inc. and Genetics Institute and $525,000 of revenue related to the cumulative effect adjustment. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements - -------------------------- This quarterly report contains forward-looking statements, which involve current expectations or forecasts of future events and other statements that are not historical facts. Inaccurate assumptions and known or unknown risks and uncertainties can affect the accuracy of forward-looking statements. Our actual results could differ materially from those expressed in the forward-looking statements for a number of reasons, including the factors described in the section below entitled "Factors Affecting Our Operating Results, Our Business and Our Stock Price". You should not unduly rely on these forward-looking statements which speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect new information, circumstances or events after the future date of this report. Results of Operations - --------------------- Revenue. Revenue for the quarter ended March 31, 2001 increased to $3.8 million from $2.7 million for the first quarter of 2000, primarily due to increased revenue associated with the initiation in the second half of 2000 of a multiple product development collaboration with Biogen, Inc. and a hemophilia product development collaboration with Genetics Institute. The increase in revenue from the addition of the hemophilia research and development activities to our business base, was offset by a decrease in revenue from our Celltech Group plc cystic fibrosis product development collaboration in the first quarter 2001 compared to the same period last year, which resulted primarily from vector manufacturing revenue recognized last year as we were preparing for the current Phase II cystic fibrosis clinical trial. Research and Development Expenses. Research and development expenses for the quarter ended March 31, 2001 increased to $6.4 million from $3.7 million for the first quarter of 2000. This increase reflects expenses related to the research and development operations assumed from the acquisition of Genovo, hiring additional research scientists to support our Genetics Institute and International AIDS Vaccine Initiative (IAVI) product development collaborations and Emerald Gene Systems joint venture, and hiring additional clinical and regulatory personnel to design and administer our cystic fibrosis and cancer clinical trials. Current quarter expenses also reflect increased activity within our majority-owned CellExSys, Inc. cell therapy business subsidiary and increased research and development efforts in our cancer and arthritis programs. We expect to see continued increases in quarterly costs associated with developing our gene therapy product candidates for cancer and hemophilia and providing research and development services to Emerald. This trend of quarter to quarter research and development cost increases should be partially offset in the second half of 2001 by the anticipated spin-off of CellExSys. Our costs will vary depending on the level of clinical trial activity occurring in each quarter. 7 Amortization of Acquisition-Related Intangibles. Amortization of acquisition-related intangibles for the quarter ended March 31, 2001 reflects amortization expense for goodwill, noncompetition agreements and work force know-how that we acquired when we purchased Genovo. We had no expenses related to amortization of acquired intangibles in the first quarter of 2000. General and Administrative Expenses. General and administrative expenses for the quarter ended March 31, 2001 increased to $2.0 million from $1.1 million for the first quarter of 2000. The increase reflects the addition of Genovo operating costs, greater investments in business development, costs associated with spinning off our CellExSys cell therapy subsidiary and increased administrative support for our growing number of collaborative partnerships. Equity in Loss of Joint Venture. We recognized a $848,000 loss in the first quarter of 2001 for our 80.1% equity share in the losses of Emerald Gene Systems. Our equity losses in Emerald were $564,000 in the first quarter of 2000. Investment Income. Investment income for the first quarter ended March 31, 2001 increased to $802,000 from $216,000 for the first quarter of 2000. The increase resulted from higher average cash balances in 2001 and an increase in the value per share of our short-term bond mutual fund. Interest Expense. Interest expense for the quarter ended March 31, 2001 remained unchanged at $64,000 in comparison to the first quarter of 2000. Lower average principal balances in 2001 and an addition of amortization for a discount note, offset each other to keep interest expense the same as compared to the first quarter of 2000. Accounting Change. In accordance with SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, effective January 1, 2000 we changed our method of accounting for nonrefundable up-front license fees to recognize these fees on a straight-line basis over the term of the related research and development collaboration arrangements. As of January 1, 2000, we recognized a $3.7 million noncash cumulative effect adjustment to reflect this change in accounting principle. We recorded the cumulative effect adjustment as deferred revenue that will be recognized as revenue over the remaining term of the research and development collaboration agreements. We recognized $1.6 million of amortized deferred revenue related to this accounting principle in the first quarter of 2001 and $525,000 of amortized deferred revenue in the first quarter of 2000. Amortized deferred revenue in 2001 included $1.1 million of revenue related to up-front payments received in the second half of 2000 when we initiated collaborations with Biogen, Inc. and Genetics Institute and $525,000 of revenue related to the cumulative effect adjustment. Amortized deferred revenue in 2000 consisted entirely of revenue related to the cumulative effect adjustment. 8 Financial Condition - ------------------- As of March 31, 2001, we had $34.0 million in cash and cash equivalents compared to $38.6 million in cash and cash equivalents as of December 31, 2000. In addition, we had $24.0 million in working capital compared to $29.5 million in working capital as of December 31, 2000. These decreases reflect operating losses for the first quarter, investments in leasehold improvements and capital equipment and principal payments on capital lease obligations. We have financed our operations through private and public offerings of our equity securities, research funding under collaborative agreements, license fees, capital and operating lease transactions, equipment financing arrangements and investment income. Although we expect our expenses to continue to increase in 2001, we expect cash generated from our collaborations with Genetics Institute, Biogen, Emerald and IAVI to increase as well, partially offsetting our expense increases. We also have contractual commitments for the following cash resources: . a $10.0 million equity investment by Biogen; . a $10.0 million loan agreement with Biogen; . funds available under a $12.0 million convertible loan with Elan Corporation plc, our partner in the Emerald joint venture; and . an additional $1.0 million of proceeds under our loan agreement with Celltech. We also have warrants outstanding for 3.3 million shares of common stock, which would provide us with proceeds of $6.7 million if exercised. These warrants expire April 2003. Genzyme Corporation also has an option, exercisable in August 2001, to purchase 311,295 shares of our common stock at an aggregate purchase price of $4.0 million. Gene therapy products are subject to long development timelines and the risks of failure inherent in the development of products based on innovative technologies. Although our technology appears promising, we do not know whether any commercially viable products will result from our research and development activities. Because we do not anticipate having any product-related revenue for at least the next several years, we expect to generate substantial additional losses in the future. We currently estimate that, based on our current planned rate of spending, our existing cash and cash equivalents together with the funding we expect our existing collaborative partners to provide, will be sufficient to meet our operating and capital requirements until mid-2003. The assumed levels of revenue and expense underlying our estimates, however, may not be accurate. Our business strategy includes entering into additional collaborative relationships with corporate partners to generate license fees, milestone payments, research and development funding and, potentially, equity investments, all of which would be used to fund our ongoing operations. We may be unsuccessful in establishing additional collaborative relationships or in maintaining our existing ones. Over the long term, regardless of our partnering success, we expect that we will need to raise substantial additional funds to continue developing and commercializing our products. 9 Factors Affecting Our Operating Results, Our Business and Our Stock Price - ------------------------------------------------------------------------- In addition to the other information contained in this quarterly report, you should read and consider the following risk factors. If any of these risks actually occur, our business, operating results or financial condition could be harmed and the trading price of our stock could decline. If we are unable to secure financing on terms acceptable to us for future capital needs, we will be unable to fund continuing operations. Developing and commercializing our potential products will require substantial additional financial resources. Because internally generated cash flow will not fund development and commercialization of our products, we will look to outside sources for funding. These sources could involve one or more of the following types of transactions: . product development and funding collaborations; . technology sales; . technology licenses; . issuing debt; or . issuing equity. If we cannot obtain additional financing when needed or on acceptable terms, we will be unable to fund continuing operations. We have a history of losses and may never become profitable, which could result in a decline in the value of our common stock and a loss of your investment. We have generated small amounts of revenue and incurred significant net losses since we began business. As of March 31, 2001, we have incurred cumulative losses of $157.2 million. We expect to continue to incur substantial additional losses in the future, primarily due to the following factors: . all of our products are in a testing phase and have not received regulatory approval; and . we will spend significant amounts on operating expenses. We may never generate profits, and if we do become profitable, we may be unable to sustain or increase profitability on a quarterly or annual basis. As a result, the trading price of our stock could decline and you could lose all or part of your investment. If our preclinical and clinical trials are unsuccessful or we do not receive regulatory approval for our products, most of which are in the early stage of product development, we may be unable to generate sufficient revenue to maintain our business. Almost all of our potential products are in research and development or in early-stage clinical trials. We cannot apply for regulatory approval of our potential products until we have 10 performed additional research and development and testing, both in preclinical and clinical trials. Our trials may not demonstrate the safety and efficacy of any potential product, and we may encounter unacceptable side effects or other problems. Should this occur, we may have to delay or discontinue development of the potential product. After a successful clinical trial, we cannot market any product in the United States or abroad until we receive regulatory approval from the Food and Drug Administration (FDA) and applicable state and foreign regulators. If we are unable to gain regulatory approval of any product after successful clinical trials, we may be unable to generate sufficient product revenue to maintain our business. Delays or unexpected costs in obtaining approval of our potential products or complying with governmental regulatory requirements could make it more difficult to maintain or improve our financial condition. The regulatory process in the gene therapy industry is costly, time consuming and subject to unpredictable delays, and regulatory requirements governing gene and cell therapy products frequently change. In addition, the requirements of the FDA, National Institutes of Health (NIH) and other agencies for clinical trials and the criteria regulators use to determine safety and efficacy of a product candidate vary among trials and potential products. Accordingly, we cannot predict how long it will take or how much it will cost to obtain regulatory approvals for clinical trials or for manufacturing or marketing our potential products. Delays in bringing a potential product to market or unexpected costs in obtaining regulatory approval could decrease our ability to generate product sales revenue. In addition, all manufacturing operations are subject on an ongoing basis to the current Good Manufacturing Practices requirements of the FDA, as well as to other federal, state and local regulations. While we currently anticipate that we will be able to manufacture products that meet these requirements, we may be unable to attain or maintain compliance with current or future regulatory requirements. If we discover previously unknown problems after we receive regulatory approval of a potential product or fail to comply with applicable requirements, we may suffer restrictions on our ability to market the product, including mandatory withdrawal of the product from the market. This, or an unexpected increase in the cost of compliance, could make it more difficult to maintain or improve our financial condition. Failure to recruit patients could delay or prevent clinical trials of our potential products, which could cause a delay or inability to develop our potential products. Identifying and qualifying patients to participate in testing our potential products is critical to our near-term success. The timing of our clinical trials depends on the speed at which we can recruit patients to participate in testing our products. Delays in recruiting or enrolling patients to test our products could result in increased costs, delays in advancing our product development, delays in proving the effectiveness of our technology or termination of the clinical trials altogether. Any of these could delay or prevent the development of our product candidates. Our business will not succeed if our technology and products fail to achieve market acceptance. 11 Even if our potential products or those of our corporate partners succeed in clinical trials and are approved for marketing, these products may never achieve market acceptance. Competing gene delivery products or alternative treatment methods, including more traditional approaches to treating disease, may be more effective or may be more economically feasible than our products. Moreover, doctors, patients, the medical community in general or the public may never accept or use any products based on gene delivery or other technologies that we or our corporate partners develop. We may be unable to adequately protect our proprietary rights, which may limit our ability to compete effectively. Our success depends in part on our ability to protect our proprietary rights. We own or exclusively license patents and patent applications for a number of genes, processes, practices and techniques critical to our present and potential products. If we fail to obtain and maintain patent or other intellectual-property protection for this technology, our competitors could market competing products using those genes, processes, practices and techniques. The failure of our licensors to obtain and maintain patent protection for technology they license to us could similarly harm our business. Patent applications and patent positions in the field of biotechnology are highly uncertain and involve complex legal, scientific and factual questions. Our patent applications may not result in issued patents and the scope of the patent may be reduced both before and after the patent is issued. Even if we secure a patent, the patent may not provide significant protection and may be circumvented or invalidated. We also rely on unpatented proprietary technology and technology that we have licensed on a nonexclusive basis. While we take precautions to protect our proprietary unpatented technology, we may be unable to meaningfully protect this technology from unauthorized use or misappropriation by a third party. In any event, other companies may independently develop substantially equivalent proprietary information and techniques. Intellectual property claims and litigation could subject us to significant liability for damages and invalidation of our proprietary right and could divert our resources. As the biotechnology industry expands, the risk increases that other companies may claim that our processes and potential products infringe on their patents. In addition, litigation may be necessary to enforce our intellectual property rights or determine the rights of others. Defending these claims, regardless of their merit, would be costly and would likely divert management's attention and resources away from our operations. If we infringe on another company's patented processes or technology, we may have to pay damages. We may also be required to obtain a license, or develop or obtain alternative technology, in order to continue manufacturing or marketing the affected product or using the affected process. If we are unable to obtain a license on acceptable terms or obtain or develop alternative technology, we may be unable to develop or commercialize some or all of our product candidates and our business could be harmed. Our potential tgAAV-CF product uses our proprietary adeno-associated virus (AAV) delivery technology to deliver a normal copy of a CFTR gene to which we have rights under a 12 nonexclusive license. The United States Patent and Trademark Office has declared an interference proceeding to determine the priority of invention of this gene. If the eventual outcome does not favor our licensor, we will have to pay increased license fees to the prevailing party to secure and maintain access to the CFTR gene to continue with development of tgAAV-CF. The costs of licensing the CFTR gene could be substantial. If we cannot maintain access to the CFTR gene, we may be unable to develop or deliver our potential tgAAV-CF product, which could result in decreased ability to generate revenue and difficulty in obtaining additional financing to fund our operations. We may be unable to develop and commercialize some of our potential products if our relationships with scientific collaborators and corporate partners are not successful. Our success depends on the continued availability of outside scientific and corporate collaborators to perform research and develop processes to advance and augment our internal efforts and to fund our development programs. Competition for collaborators in gene therapy is intense. If we are unsuccessful in recruiting or maintaining our relationships with scientific collaborators and other corporate partners, we could experience delays in our research and development or loss of access to important enabling technology. Even if we maintain our current or establish new scientific collaborations or other partnerships, however, they may never result in the successful development of product candidates. The development and commercialization of many of our potential products, and therefore the success of our business, substantially depends on the performance of our collaborators. If our corporate partners do not commit sufficient financial and technical resources to our research and development programs or the commercialization of our products, the preclinical or clinical development related to the collaboration could be delayed or terminated. Our current or future collaborators may develop, market or provide funding for competing products or alternative technologies. In addition, disputes may arise with respect to ownership of technology or product candidates developed under our collaborations. Moreover, our corporate partners may terminate any existing partnerships, and we may be unable to enter into additional collaborations on acceptable terms, or at all. If we are unable to license necessary technology from third parties, we may be unable to successfully develop and commercialize our potential products. We have entered into various license agreements, both exclusive and nonexclusive, that give us and our partners rights to use technologies owned or licensed by commercial and academic organizations in the research, development and commercialization of our potential products and those of our partners. Our success depends on our ability to obtain and maintain these kinds of licensing arrangements. Disputes may arise regarding rights to inventions and know-how resulting from the joint creation or use of intellectual property by our licensors and us and or scientific collaborators. In addition, many of our in- licensing agreements contain milestone-based termination provisions. If we or any of our corporate partners fail to meet agreed milestones, the licensor could terminate the relevant agreement. 13 If we are unable to maintain our current licenses and obtain additional licenses in the future on acceptable terms, we and our corporate partners may be required to expend significant time and resources to develop or in-license replacement technology. If we are unable to develop alternative technology or obtain a replacement license on acceptable terms, we may be unable to develop or commercialize some or all of our potential products and our business may suffer. If we or our business partners are unable to successfully market and distribute any potential product, our business will be harmed. We have no experience in sales and marketing. To market any products that may result from our development programs, we will need to develop marketing and sales capabilities, either on our own or with others. We intend to enter into collaborations with corporate partners to utilize the mature marketing and distribution capabilities of our partners. While we believe that these collaborative partners will be motivated to market and distribute our potential products, our current and potential future partners may not commit sufficient resources to commercializing our technology on a timely basis. If our business partners do not successfully market and distribute our products and we are unable to develop sufficient marketing and distribution capabilities on our own, our business will be harmed. The intense competition and rapid technological change in our market may result in pricing pressures and failure of our potential products to achieve market acceptance. We presently face competition from other companies and institutions developing gene therapy and cell therapy technologies and from companies using more traditional approaches to treating human diseases. We also compete with other companies to acquire products or technology from research institutions or universities. Most of our competitors have substantially more financial and infrastructure resources and experience than we do in the following areas: . research and development; . clinical trials; . obtaining FDA and other regulatory approvals; . manufacturing; and . marketing and distribution. In addition, the competitive positions of other companies may be strengthened through collaborative relationships. Consequently, our competitors may be able to commercialize and obtain regulatory approval for new products more rapidly than we do, or manufacture and market competitive products more successfully than we do. This could result in pricing pressures or our products failing to achieve market acceptance. In addition, gene therapy is a new and rapidly evolving field and is expected to continue to undergo significant and rapid technological change. Rapid technological development by our competitors, including development of technologies, products or processes that are more effective than those we have developed, could result in our actual and proposed technologies, products or processes losing market share or becoming obsolete. 14 If we do not attract and retain qualified personnel, we will be unable to successfully and timely develop our potential products. Our future success depends in large part on our ability to attract and retain key technical and management employees and scientific advisors. We have programs in place to retain personnel, including competitive compensation packages and programs to create a positive work environment. Because competition for employees in our field is intense, however, we may be unable to retain our existing personnel or attract additional qualified employees and advisors. If we experience excessive turnover or difficulties in recruiting new personnel, our research and development could be delayed and we could experience difficulties in generating sufficient revenue to maintain our business. Our limited manufacturing capability may limit our ability to successfully introduce our potential products. We currently do not have the capacity to manufacture large-scale clinical or commercial quantities of our potential products. To do so, we will need to expand our current facilities and staff or supplement them through the use of contract providers. We have recently leased a building for the purpose of developing a facility to manufacture AAV vectors for Phase III and early commercial purposes. This manufacturing facility, if successfully developed, as well as any future manufacturing facilities that we may construct, will be subject to initial and ongoing regulation by the FDA and other governmental agencies. We may be unable to obtain regulatory approval for or maintain in operation this or any other manufacturing facility. If we are unable to obtain and maintain the necessary manufacturing capabilities, either alone or through third parties, we will be unable to introduce sufficient product to sustain our business. Our use of hazardous materials to develop our potential products exposes us to liability risks and the risk of regulatory limitation of our use of these materials, either of which could reduce our ability to generate revenue and make it more difficult to fund our operations. Our research and development activities involve the controlled use of hazardous materials, including chemicals, biological materials and radioactive compounds. Although we believe that our safety procedures for handling and disposing of these materials comply with applicable laws and regulations, we cannot eliminate the risk of accidental contamination or injury from hazardous materials. If a hazardous material accident occurred, we would be liable for any resulting damages. This liability could exceed our financial resources. Additionally, hazardous materials are subject to regulatory oversight. Accidents unrelated to our operations could cause federal, state or local regulatory agencies to restrict our access to hazardous materials needed in our research and development efforts. If our access to these materials is limited, we could experience delays in our research and development programs. Paying damages or experiencing delays caused by restricted access could reduce our ability to generate revenue and make it more difficult to fund our operations. 15 The costs of product liability and other claims and product recalls could exceed the amount of our insurance, which could significantly harm our financial condition or our reputation. Our business activities expose us to the risk of liability claims or product recalls and any adverse publicity that might result from a liability claim against us. We currently have only limited amounts of liability insurance, and the amounts of claims against us may exceed our insurance coverage. Liability insurance is expensive and may not continue to be available on acceptable terms. A product liability or other claim not covered by insurance or in excess of our insurance or a product recall could significantly harm our financial condition or our reputation. In addition, a liability claim against one of our corporate partners or another gene therapy company could also harm our reputation. Our recent acquisition of Genovo and any future acquisitions could be costly, difficult to integrate and disruptive to our business. In September 2000, we acquired Genovo, a privately held biotechnology company specializing in viral gene delivery. In the future, we may acquire additional complementary companies, products or technologies. Managing the Genovo acquisition and any future acquisition may entail numerous operational and financial risks and strains, including: . difficulties in assimilating the operations, technologies, products or potential products and personnel of the acquired company; . loss of key employees of the acquired company; . disruption of our business; . diversion of management's attention from our core business; . assumption of known and unknown liabilities; . higher-than-expected acquisition and integration costs and charges against earnings; and . potentially dilutive issuances of equity securities. We may be unable to successfully integrate Genovo or any future acquisitions with our existing operations or successfully develop any acquired product candidates or technologies. We may not gain any substantial benefit from the Genovo acquisition or any products, technologies or businesses that we acquire in the future, notwithstanding the expenditure of a significant amount of time and financial, personnel and other resources. Market fluctuations or volatility could cause the market price of our common stock to decline. In recent years the stock market in general and the market for biotechnology-related companies in particular have experienced extreme price and volume fluctuations, often unrelated to the operating performance of the affected companies. Our common stock has experienced, and is likely to continue to experience, these fluctuations in price, regardless of our performance. These fluctuations could cause the market price of our common stock to decline. 16 Item 3. Qualitative and Quantitative Disclosure About Market Risk Because of the short-term nature of our investments, we believe that our exposure to market rate fluctuations on those investments is nominal. At present, we do not employ any derivative or other financial instruments or derivative commodity instruments to hedge any market risks and we do not currently plan to employ them in the future. At March 31, 2001, we held $34.0 million in cash and cash equivalents, primarily invested in a short-term bond fund owning securities that, on the average, mature in less than one year. PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) See the Index to Exhibits included in this quarterly report. (b) Reports on Form 8-K. On February 21, 2001, we filed a current report on Form 8-K reporting our November 9, 2000 agreement with Genetics Institute, Inc., the biotechnology research division of Wyeth-Ayerst, a division of American Home Products Corporation to collaborate on the development of gene therapy products for the treatment of hemophilia. SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. TARGETED GENETICS CORPORATION ----------------------------- (Registrant) Signature Date --------- ---- /s/ H. Stewart Parker May 11, 2001 --------------------- ------------ H. Stewart Parker President and Chief Executive Officer (Principal Executive Officer) /s/ David J. Poston May 11, 2001 ------------------- ------------ David J. Poston Senior Director, Finance; Assistant Secretary (Interim Principal Financial and Accounting Officer) 17 Targeted Genetics Corporation INDEX TO EXHIBITS Exhibit No. Description Note 3.1 Restated Articles of Incorporation (A) 3.2 Amended and Restated Bylaws (Exhibit 3.2) (C) 4.1 Rights Agreement, dated as of October 17, 1996, between Targeted Genetics and (B) ChaseMellon Shareholder Services, L.L.C. (Exhibit 2.1) 4.2 First Amendment to Rights Agreement, dated July 21, 1999, between Targeted (D) Genetics and ChaseMellon Shareholder Services , L.L.C. (Exhibit 1.9) 10.1 2000 Genovo Inc. Roll-Over Stock Option Plan (Exhibit 99.1) (E) 10.2 1999 Restated Stock Option Plan, as Amended January 23, 2001
____________ (A) Incorporated by reference to Targeted Genetics' Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, filed August 11, 2000. (B) Incorporated by reference to the designated exhibit included with Targeted Genetics' Registration Statement on Form 8-A, filed October 22, 1996. (C) Incorporated by reference to the designated exhibit included with Targeted Genetics' Annual Report on Form 10-K for the year ended December 31, 1996, filed on March 12, 1997. (D) Incorporated by reference to the designated exhibit included with Targeted Genetics' Current Report on Form 8-K, filed on August 4, 1999. (E) Incorporated by reference to the designated exhibit included with Targeted Genetics' Registration Statement on Form S-8 (No. 333-48220), filed on October 19, 2000. 18 EX-10.2 2 dex102.txt 1999 STOCK OPTION PLAN Exhibit 10.2 TARGETED GENETICS CORPORATION 1999 STOCK OPTION PLAN (As restated on January 23, 2001) SECTION 1. PURPOSE The purpose of the Targeted Genetics Corporation 1999 Stock Option Plan (the "Plan") is to enhance the long-term shareholder value of Targeted Genetics Corporation, a Washington corporation (the "Company"), by offering opportunities to selected persons to participate in the Company's growth and success, and to encourage them to remain in the service of the Company and its Related Corporations (as defined in Section 2) and to acquire and maintain stock ownership in the Company. SECTION 2. DEFINITIONS For purposes of the Plan, the following terms shall be defined as set forth below: "Board" means the Board of Directors of the Company. "Cause" means dishonesty, fraud, misconduct, unauthorized use or disclosure of confidential information or trade secrets, or conviction or confession of a crime punishable by law (except minor violations), in each case as determined by the Plan Administrator, and its determination shall be conclusive and binding. "Change in Control" has the meaning set forth in Section 11.1.4. "Code" means the Internal Revenue Code of 1986, as amended from time to time. "Common Stock" means the common stock, par value $.01 per share, of the Company. "Disability," unless otherwise defined by the Plan Administrator, means a mental or physical impairment of the Optionee that is expected to result in death or that has lasted or is expected to last for a continuous period of 12 months or more and that causes the Optionee to be unable, in the opinion of the Company, to perform his or her duties for the Company or a Related Corporation and to be engaged in any substantial gainful activity. "Effective Date" means the date on which the Plan is adopted by the Board, so long as it is approved by the Company's shareholders at any time within 12 months of such adoption. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Fair Market Value" shall be as established in good faith by the Plan Administrator or (a) if the Common Stock is listed on the Nasdaq National Market, the closing selling price for the Common Stock as reported by the Nasdaq National Market for a single trading day or (b) if the Common Stock is listed on the New York Stock Exchange or the American Stock Exchange, the closing selling price for the Common Stock as such price is officially quoted in the composite tape of transactions on such exchange for a single trading day. If there is no such reported price for the -1- Common Stock for the date in question, then such price on the last preceding date for which such price exists shall be determinative of Fair Market Value. "Good Reason" means the occurrence of any of the following events or conditions and the failure of a Successor Corporation to cure such event or condition within 30 days after receipt of written notice from the Optionee: (a) a change in the Optionee's status, title, position or responsibilities (including reporting responsibilities) that, in the Optionee's reasonable judgment, represents a substantial reduction in the status, title, position or responsibilities as in effect immediately prior thereto; the assignment to the Optionee of any duties or responsibilities that, in the Optionee's reasonable judgment, are materially inconsistent with such status, title, position or responsibilities; or any removal of the Optionee from or failure to reappoint or reelect the Optionee to any of such positions, except in connection with the termination of the Optionee's employment for Cause, for Disability or as a result of his or her death, or by the Optionee other than for Good Reason; (b) a reduction in the Optionee's annual base salary; (c) the Successor Corporation's requiring the Optionee (without the Optionee's consent) to be based at any place outside a 35-mile radius of his or her place of employment prior to a Change of Control, except for reasonably required travel on the Successor Corporation's business that is not materially greater than such travel requirements prior to the Change of Control; (d) the Successor Corporation's failure to (i) continue in effect any material compensation or benefit plan (or the substantial equivalent thereof) in which the Optionee was participating at the time of a Corporate Transaction, including, but not limited to, the Plan, or (ii) provide the Optionee with compensation and benefits substantially equivalent (in terms of benefit levels and/or reward opportunities) to those provided for under each material employee benefit plan, program and practice as in effect immediately prior to the Change of Control; (e) any material breach by the Successor Corporation of its obligations to the Optionee under the Plan or any substantially equivalent plan of the Successor Corporation; or (f) any purported termination of the Optionee's employment or service relationship for Cause by the Successor Corporation that is not in accordance with the definition of Cause under the Plan. "Grant Date" means the date on which the Plan Administrator completes the corporate action relating to the grant of an Option and all conditions precedent to the grant have been satisfied, provided that conditions to the exercisability or vesting of Options shall not defer the Grant Date. "Incentive Stock Option" means an Option to purchase Common Stock granted under Section 7 with the intention that it qualify as an "incentive stock option" as that term is defined in Section 422 of the Code. "Nonqualified Stock Option" means an Option to purchase Common Stock granted under Section 7 other than an Incentive Stock Option. -2- "Option" means the right to purchase Common Stock granted under Section 7. "Option Term" has the meaning set forth in Section 7.3. "Optionee" means (a) the person to whom an Option is granted; (b) for an Optionee who has died, the personal representative of the Optionee's estate, the person(s) to whom the Optionee's rights under the Option have passed by will or by the applicable laws of descent and distribution, or the beneficiary designated in accordance with Section 10; or (c) the person(s) to whom an Option has been transferred in accordance with Section 10. "Parent," except as provided in Section 8.3 in connection with Incentive Stock Options, means any entity, whether now or hereafter existing, that directly or indirectly controls the Company. "Plan Administrator" means the Board or any committee or committees designated by the Board or any person to whom the Board has delegated authority to administer the Plan under Section 3.1. "Related Corporation" means any Parent or Subsidiary of the Company. "Retirement" means retirement as of the individual's normal retirement date under the Company's 401(k) Plan or other similar successor plan applicable to salaried employees. "Securities Act" means the Securities Act of 1933, as amended. "Subsidiary," except as provided in Section 8.3 in connection with Incentive Stock Options, means any entity that is directly or indirectly controlled by the Company. "Successor Corporation" has the meaning set forth in Section 11.1.2. "Termination Date" has the meaning set forth in Section 7.6. SECTION 3. ADMINISTRATION 3.1 Plan Administrator The Plan shall be administered by the Board and/or a committee or committees (which term includes subcommittees) appointed by, and consisting of two or more members of, the Board (a "Plan Administrator"). If and so long as the Common Stock is registered under Section 12(b) or 12(g) of the Exchange Act, the Board shall consider in selecting the members of any committee acting as Plan Administrator, with respect to any persons subject or likely to become subject to Section 16 of the Exchange Act, the provisions regarding (a) "outside directors" as contemplated by Section 162(m) of the Code and (b) "nonemployee directors" as contemplated by Rule 16b-3 under the Exchange Act. The Board may delegate the responsibility for administering the Plan with respect to designated classes of eligible persons to different committees consisting of two or more members of the Board, subject to such limitations as the Board deems appropriate. Committee members shall serve for such term as the Board may determine, subject to removal by the Board at any time. To the extent consistent with applicable law, the Board may authorize a senior executive -3- officer of the Company to grant Options to specified eligible persons, within the limits specifically prescribed by the Board. 3.2 Administration and Interpretation by Plan Administrator Except for the terms and conditions explicitly set forth in the Plan, the Plan Administrator shall have exclusive authority, in its discretion, to determine all matters relating to Options under the Plan, including the selection of individuals to be granted Options, the type of Options, the number of shares of Common Stock subject to an Option, all terms, conditions, restrictions and limitations, if any, of an Option and the terms of any instrument that evidences the Option. The Plan Administrator shall also have exclusive authority to interpret the Plan and may from time to time adopt, and change, rules and regulations of general application for the Plan's administration. The Plan Administrator's interpretation of the Plan and its rules and regulations, and all actions taken and determinations made by the Plan Administrator pursuant to the Plan, shall be conclusive and binding on all parties involved or affected. The Plan Administrator may delegate administrative duties to such of the Company's officers as it so determines. SECTION 4. STOCK SUBJECT TO THE PLAN 4.1 Authorized Number of Shares Subject to adjustment from time to time as provided in Section 11, the number of shares of Common Stock that shall be available for issuance under the Plan shall be 3,500,000 shares. Shares issued under the Plan shall be drawn from authorized and unissued shares or shares now held or subsequently acquired by the Company. 4.2 Limitations Subject to adjustment from time to time as provided in Section 11, not more than 200,000 shares of Common Stock may be made subject to Options under the Plan to any individual in the aggregate in any one fiscal year of the Company, such limitation to be applied in a manner consistent with the requirements of, and only to the extent required for compliance with, the exclusion from the limitation on deductibility of compensation under Section 162(m) of the Code. 4.3 Reuse of Shares Any shares of Common Stock that have been made subject to an Option that cease to be subject to the Option (other than by reason of exercise of the Option to the extent it is exercised for shares) shall again be available for issuance in connection with future grants of Options under the Plan; provided, however, that for purposes of Section 4.2, any such shares shall be counted in accordance with the requirements of Section 162(m) of the Code. SECTION 5. ELIGIBILITY Options may be granted under the Plan to those officers, directors and employees of the Company and its Related Corporations as the Plan Administrator from time to time selects. Options may also be granted to consultants, agents, advisors and independent contractors ("consultants") who provide services to the Company and its Related Corporations; provided, however, that such -4- consultants render bona fide services not in connection with the offer and sale of the Company's securities in a capital-raising transaction. SECTION 6. ACQUIRED COMPANY OPTIONS Notwithstanding anything in the Plan to the contrary, the Plan Administrator may grant Options under the Plan in substitution for awards issued under other plans, or assume under the Plan awards issued under other plans, if the other plans are or were plans of other acquired entities ("Acquired Entities") (or the parent of the Acquired Entity) and the new Option is substituted, or the old award is assumed, by reason of a merger, consolidation, acquisition of property or of stock, reorganization or liquidation (the "Acquisition Transaction"). In the event that a written agreement pursuant to which the Acquisition Transaction is completed is approved by the Board and said agreement sets forth the terms and conditions of the substitution for or assumption of outstanding awards of the Acquired Entity, said terms and conditions shall be deemed to be the action of the Plan Administrator without any further action by the Plan Administrator, except as may be required for compliance with Rule 16b-3 under the Exchange Act, and the persons holding such awards shall be deemed to be Optionees. SECTION 7. TERMS AND CONDITIONS OF OPTIONS 7.1 Grant of Options The Plan Administrator is authorized under the Plan, in its sole discretion, to issue Options as Incentive Stock Options or as Nonqualified Stock Options, which shall be appropriately designated. 7.2 Option Exercise Price The exercise price for shares purchased under an Option shall be as determined by the Plan Administrator, but shall not be less than 100% of the Fair Market Value of the Common Stock on the Grant Date with respect to Incentive Stock Options and Nonqualified Stock Options. For Incentive Stock Options granted to a more than 10% shareholder, the option exercise price shall be as specified in Section 8.2. 7.3 Term of Options The term of each Option (the "Option Term") shall be as established by the Plan Administrator or, if not so established, shall be 10 years from the Grant Date. For Incentive Stock Options, the maximum Option Term shall be as specified in Sections 8.2 and 8.4. 7.4 Exercise of Options The Plan Administrator shall establish and set forth in each instrument that evidences an Option the time at which, or the installments in which, the Option shall vest and become exercisable, which provisions may be waived or modified by the Plan Administrator at any time. If not so established in the instrument evidencing the Option, the Option shall vest and become exercisable according to the following schedule, which may be waived or modified by the Plan Administrator at any time: -5-
Period of Optionee's Continuous Employment or Service With the Company or Its Related Percent of Total Option Corporations From the Option Grant Date That Is Vested and Exercisable - --------------------------------------------- -------------------------------------- After 3 months 6.25% Each additional 3-month period of continuous An additional 6.25% service completed thereafter After 4 years 100%
The Plan Administrator may adjust the vesting schedule of an Option held by an Optionee who works less than "full-time" as that term is defined by the Plan Administrator. To the extent that the right to purchase shares has accrued thereunder, an Option may be exercised from time to time by delivery to the Company of a written stock option exercise agreement or notice, in a form and in accordance with procedures established by the Plan Administrator, setting forth the number of shares with respect to which the Option is being exercised, the restrictions imposed on the shares purchased under such exercise agreement, if any, and such representations and agreements as may be required by the Company, accompanied by payment in full as described in Section 7.5. An Option may not be exercised as to less than a reasonable number of shares at any one time, as determined by the Plan Administrator. 7.5 Payment of Exercise Price The exercise price for shares purchased under an Option shall be paid in full to the Company by delivery of consideration equal to the product of the Option exercise price and the number of shares purchased. Such consideration must be paid in cash or by check or, unless the Plan Administrator in its sole discretion determines otherwise, either at the time the Option is granted or at any time before it is exercised, in any combination of (a) cash or check; (b) tendering (either actually or, if and so long as the Common Stock is registered under Section 12(b) or 12(g) of the Exchange Act, by attestation) shares of Common Stock already owned by the Optionee for at least six months (or any shorter period necessary to avoid a charge to the Company's earnings for financial reporting purposes) having a Fair Market Value on the day prior to the exercise date equal to the aggregate Option exercise price; (c) if and so long as the Common Stock is registered under Section 12(b) or 12(g) of the Exchange Act, delivery of a properly executed exercise notice, together with irrevocable instructions, to (i) a brokerage firm designated by the Company to deliver promptly to the Company the aggregate amount of sale or loan proceeds to pay the Option exercise price and any withholding tax obligations that may arise in connection with the exercise and (ii) the Company to deliver the certificates for such purchased shares directly to such brokerage firm, all in accordance with the regulations of the Federal Reserve Board; or -6- (d) such other consideration as the Plan Administrator may permit. In addition, to assist an Optionee (including an Optionee who is an officer or a director of the Company) in acquiring shares of Common Stock pursuant to an Option granted under the Plan, the Plan Administrator, in its sole discretion, may authorize, either at the Grant Date or at any time before the acquisition of Common Stock pursuant to the Option, (i) the payment by the Optionee of a full- recourse promissory note, (ii) the payment by the Optionee of the purchase price, if any, of the Common Stock in installments, or (iii) the guarantee by the Company of a loan obtained by the Optionee from a third party. Subject to the foregoing, the Plan Administrator shall in its sole discretion specify the terms of any loans, installment payments or loan guarantees, including the interest rate and terms of and security for repayment. 7.6 Post-Termination Exercises The Plan Administrator shall establish and set forth in each instrument that evidences an Option whether the Option shall continue to be exercisable, and the terms and conditions of such exercise, if an Optionee ceases to be employed by, or to provide services to, the Company or its Related Corporations, which provisions may be waived or modified by the Plan Administrator at any time. If not so established in the instrument evidencing the Option, the Option shall be exercisable according to the following terms and conditions, which may be waived or modified by the Plan Administrator at any time: (a) Any portion of an Option that is not vested and exercisable on the date of termination of the Optionee's employment or service relationship (the "Termination Date") shall expire on such date, unless the Plan Administrator determines otherwise. (b) Any portion of an Option that is vested and exercisable on the Termination Date shall expire upon the earliest to occur of: (i) the last day of the Option Term; (ii) if the Optionee's Termination Date occurs for reasons other than Cause, death, Disability or Retirement, the three-month anniversary of such Termination Date; and (iii) if the Optionee's Termination Date occurs by reason of death, Disability or Retirement, the one-year anniversary of such Termination Date. Notwithstanding the foregoing, if the Optionee dies after the Termination Date while the Option is otherwise exercisable, the Option shall expire upon the earlier to occur of (y) the last day of the Option Term and (z) the first anniversary of the date of death. Also notwithstanding the foregoing, in case of termination of the Optionee's employment or service relationship for Cause, the Option shall automatically expire upon first notification to the Optionee of such termination, unless the Plan Administrator determines otherwise. If an Optionee's employment or service relationship with the Company is suspended pending an investigation of whether the Optionee shall be terminated for Cause, all the Optionee's rights under any Option likewise shall be suspended during the period of investigation. -7- An Optionee's transfer of employment or service relationship between or among the Company and its Related Corporations, or a change in status from an employee to a consultant that is evidenced by a written agreement between an Optionee and the Company or a Related Corporation, shall not be considered a termination of employment or service relationship for purposes of this Section 7. Employment or service relationship shall be deemed to continue while the Optionee is on a bona fide leave of absence, if such leave was approved by the Company or a Related Corporation in writing and if continued crediting of service for purposes of this Section 7 is expressly required by the terms of such leave or by applicable law (as determined by the Company). The effect of a Company-approved leave of absence on the terms and conditions of an Option shall be determined by the Plan Administrator, in its sole discretion. 7.7 Option Repricing In no event shall any issued and outstanding option be repriced to a lower option price at any time during the term of such option without the prior affirmative vote of a majority of shares of stock of the Company present at a shareholders meeting in person or by proxy and entitled to vote thereon. Any amendment or repeal of this provision shall require the affirmative vote of a majority of shares of stock of the Company present at a shareholders meeting in person or by proxy and entitled to vote thereon. SECTION 8. INCENTIVE STOCK OPTION LIMITATIONS To the extent required by Section 422 of the Code, Incentive Stock Options shall be subject to the following additional terms and conditions: 8.1 Dollar Limitation To the extent the aggregate Fair Market Value (determined as of the Grant Date) of Common Stock with respect to which Incentive Stock Options are exercisable for the first time during any calendar year (under the Plan and all other stock option plans of the Company) exceeds $100,000, such portion in excess of $100,000 shall be treated as a Nonqualified Stock Option. In the event the Optionee holds two or more such Options that become exercisable for the first time in the same calendar year, such limitation shall be applied on the basis of the order in which such Options are granted. 8.2 More Than 10% Shareholders If an individual owns more than 10% of the total voting power of all classes of the Company's stock, then the exercise price per share of an Incentive Stock Option shall not be less than 110% of the Fair Market Value of the Common Stock on the Grant Date and the Option Term shall not exceed five years. The determination of more than 10% ownership shall be made in accordance with Section 422 of the Code. 8.3 Eligible Employees Individuals who are not employees of the Company or one of its parent corporations or subsidiary corporations may not be granted Incentive Stock Options. For purposes of this Section 8.3, "parent corporation" and "subsidiary corporation" shall have the meanings attributed to those terms for purposes of Section 422 of the Code. -8- 8.4 Term Except as provided in Section 8.2, the Option Term shall not exceed 10 years. 8.5 Exercisability An Option designated as an Incentive Stock Option shall cease to qualify for favorable tax treatment as an Incentive Stock Option to the extent it is exercised (if permitted by the terms of the Option) (a) more than three months after the Termination Date for reasons other than death or Disability, (b) more than one year after the Termination Date by reason of Disability, or (c) after the Optionee has been on leave of absence for more than 90 days, unless the Optionee's reemployment rights are guaranteed by statute or contract. For purposes of this Section 8.5, Disability shall mean "disability" as that term is defined for purposes of Section 422 of the Code. 8.6 Taxation of Incentive Stock Options In order to obtain certain tax benefits afforded to Incentive Stock Options under Section 422 of the Code, the Optionee must hold the shares issued upon the exercise of an Incentive Stock Option for two years after the Grant Date and one year from the date of exercise. An Optionee may be subject to the alternative minimum tax at the time of exercise of an Incentive Stock Option. The Optionee shall give the Company prompt notice of any disposition of shares acquired by the exercise of an Incentive Stock Option prior to the expiration of such holding periods. 8.7 Promissory Notes The amount of any promissory note delivered pursuant to Section 7.5 in connection with an Incentive Stock Option shall bear interest at a rate specified by the Plan Administrator, but in no case less than the rate required to avoid imputation of interest (taking into account any exceptions to the imputed interest rules) for federal income tax purposes. SECTION 9. WITHHOLDING The Company may require the Optionee to pay to the Company the amount of any withholding taxes that the Company is required to withhold with respect to the grant, vesting or exercise of any Option. Subject to the Plan and applicable law, the Plan Administrator may, in its sole discretion, permit the Optionee to satisfy withholding obligations, in whole or in part, (a) by paying cash, (b) by electing to have the Company withhold shares of Common Stock (up to the minimum federal tax withholding rate) or (c) by transferring to the Company shares of Common Stock (already owned by the Optionee for such period necessary to avoid a charge to the Company's earnings for financial reporting purposes), in such amounts as are equivalent to the Fair Market Value of the withholding obligation. The Company shall have the right to withhold from any shares of Common Stock issuable pursuant to an Option (up to the minimum federal tax withholding rate) or from any cash amounts otherwise due or to become due from the Company to the Optionee an amount equal to such taxes. The Company may also deduct from any Option any other amounts due from the Optionee to the Company or a Related Corporation. -9- SECTION 10. ASSIGNABILITY No Option granted under the Plan may be assigned, pledged or transferred by the Optionee and may not be made subject to attachment or similar proceedings otherwise than by will or by the applicable laws of descent and distribution, and, during the Optionee's lifetime, such Option may be exercised only by the Optionee. Notwithstanding the foregoing, and to the extent permitted by Section 422 of the Code, the Plan Administrator, in its sole discretion, may permit such assignment, transfer and exercisability and may permit an Optionee to designate a beneficiary who may exercise the Option after the Optionee's death; provided, however, that any Option so assigned or transferred shall be subject to all the same terms and conditions contained in the instrument evidencing the Option. SECTION 11. ADJUSTMENTS UPON CHANGES IN CAPITALIZATION The aggregate number and class of shares for which Options may be granted under this Plan, the limits set forth in Section 4.2, the number and class of shares covered by each outstanding Option and the exercise price per share thereof (but not the total price), and each such Option, shall all be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock of the Company resulting from a split or consolidation of shares or any like capital adjustment, or the payment of any stock dividend. 11.1 Effect of Liquidation, Reorganization or Change in Control 11.1.1 Cash, Stock or Other Property for Stock Except as provided in Section 11.1.2 or Section 11.1.3, upon a merger (other than a merger of the Company in which the holders of shares of Common Stock immediately prior to the merger have the same proportionate ownership of shares of Common Stock in the surviving corporation immediately after the merger), consolidation, acquisition of property or stock, reorganization (other than a mere reincorporation or the creation of a holding company) or liquidation of the Company, as a result of which the shareholders of the Company receive cash, stock or other property in exchange for or in connection with their shares of Common Stock, each Option shall terminate, but the Optionee shall have the right immediately prior to any such merger, consolidation, acquisition of property or stock, reorganization or liquidation to exercise such Option in whole or in part whether or not the vesting requirements set forth in the Option agreement have been satisfied. 11.1.2 Conversion of Options on Stock for Stock Exchange If the shareholders of the Company receive capital stock of another corporation ("Exchange Stock") in exchange for their shares of Common Stock in any transaction involving a merger, consolidation, acquisition of property or stock, or reorganization, all Options shall be converted into options to purchase shares of Exchange Stock unless the Company and the corporation issuing the Exchange Stock (the "Successor Corporation"), in their sole discretion, determine that any or all such Options shall not be converted into options to purchase shares of Exchange Stock but instead shall terminate in accordance with the provisions of Section 11.1.1. The amount and price of converted options shall be determined by adjusting the amount and price of the Options granted hereunder in the same proportion as used for determining the number of shares of Exchange Stock the holders of shares of the Common Stock receive in such merger, consolidation, acquisition of property or stock, or reorganization. Unless accelerated by the Plan Administrator, the vesting -10- schedule set forth in the Option agreement shall continue to apply to the options granted for the Exchange Stock. Any Options that are converted into options to purchase shares of Exchange Stock that do not otherwise accelerate at that time shall be accelerated in the event the Optionee's employment or services should subsequently terminate within two years of any transaction described in this Section 11.1.2, unless such employment or services are terminated by the Successor Corporation for Cause or by the Optionee voluntarily without Good Reason. 11.1.3 Change in Control In the event of a "Change in Control," as defined below, of the Company, unless otherwise determined by the Board prior to the occurrence of such Change in Control, the following acceleration and cash-out provisions shall apply: (a) Any Option outstanding as of the date such Change in Control is determined to have occurred that is not yet fully vested on such date shall become immediately exercisable in full and (b) Optionees shall have, as an alternative to the right to exercise any Option, the right to elect within 90 days following a Change in Control, or, if during the six months prior to the date of such Change in Control such Optionee is subject to Section 16 of the Exchange Act, then with respect to Options held by the Optionee, the period following the Change in Control during which an election may be made shall be extended for one month after the end of the six-month period required to avoid any liability under Section 16(b) of the Exchange Act, to receive in cash an amount equal to the difference between the Option exercise price and the Fair Market Value of the shares on the date of exercising this election, times the number of shares subject to the Option or portion thereof for which this election is made. The election shall be made by delivering written notice of making such election to the Company within the 90 day period. The notice shall specify the Options or portions thereof to which the election relates. The cash-out proceeds shall be paid to the Optionee or, in the event of death of an Optionee prior to full payment, to the estate of the Optionee or to a person who acquired the right to exercise the Option by designation, bequest or inheritance. 11.1.4 Definition of "Change in Control" For purposes of this Plan, a "Change in Control" shall mean: (a) A "Board Change" (for purposes of this Plan, a Board Change shall have occurred if individuals who, as of the date of the adoption of this Plan, constitute the Company's Board of Directors (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that for all purposes of this Plan any individual becoming a director subsequent to such date whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of either an actual or a threatened election contest (as such terms are used in Rule 14a-11 of Regulation 14A promulgated under the Exchange Act) or other actual or threatened solicitation of proxies or consents by or on behalf of a Person (as defined below) other than the Board); or -11- (b) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Exchange Act) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 under the Exchange Act) of (i) 20% or more of either (A) the then outstanding shares of Common Stock (the "Outstanding Company Common Stock") or (B) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"), in the case of either (A) or (B) of this clause (i), which acquisition is not approved in advance by a majority of the Incumbent Board, or (ii) 33% or more of either (A) the Outstanding Company Common Stock or (B) the Outstanding Company Voting Securities, in the case of either (A) or (B) of this clause (ii), which acquisition is approved in advance by a majority of the Incumbent Board; provided, however, that the following acquisitions shall not constitute a Change in Control: (x) any acquisition by the Company, (y) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any company controlled by the Company, or (z) any acquisition by any company pursuant to a reorganization, merger or consolidation, if, following such reorganization, merger or consolidation, the conditions described in clauses (i), (ii) and (iii) of the following subsection (c) are satisfied; or (c) Approval by the shareholders of the Company of a reorganization, merger or consolidation, in each case, unless, following such reorganization, merger or consolidation, (i) more than 60% of, respectively, the then outstanding shares of common stock of the company resulting from such reorganization, merger or consolidation and the combined voting power of the then outstanding voting securities of such company entitled to vote generally in the election of directors is then beneficially owned, directly or indirectly, by all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such reorganization, merger or consolidation in substantially the same proportions as their ownership, immediately prior to such reorganization, merger or consolidation, of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding the Company, any employee benefit plan (or related trust) of the Company or such company resulting from such reorganization, merger or consolidation and any Person beneficially owning, immediately prior to such reorganization, merger or consolidation, directly or indirectly, 33% or more of the Outstanding Company Common Stock or Outstanding Company Voting Securities, as the case may be) beneficially owns, directly or indirectly, 33% or more of, respectively, the then outstanding shares of common stock of the company resulting from such reorganization, merger or consolidation or the combined voting power of the then outstanding voting securities of such company entitled to vote generally in the election of directors, and (iii) at least a majority of the members of the board of directors of the company resulting from such reorganization, merger or consolidation were members of the Incumbent Board at the time of the execution of the initial agreement providing for such reorganization, merger or consolidation; or (d) Approval by the shareholders of the Company of (i) a complete liquidation or dissolution of the Company or (ii) the sale or other disposition of all or substantially all of the assets of the Company, other than to a company, with respect to which following such sale or other disposition, (A) more than 60% of, respectively, the then outstanding shares of common stock of such company and the combined voting power of the then outstanding voting securities of such company entitled to vote generally in the election of directors is then beneficially owned, directly or indirectly, by all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting -12- Securities immediately prior to such sale or other disposition in substantially the same proportion as their ownership, immediately prior to such sale or other disposition, of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (B) no Person (excluding the Company and any employee benefit plan (or related trust) of the Company or such company and any Person beneficially owning, immediately prior to such sale or other disposition, directly or indirectly, 33% or more of the Outstanding Company Common Stock or Outstanding Company Voting Securities, as the case may be) beneficially owns, directly or indirectly, 33% or more of, respectively, the then outstanding shares of common stock of such company and the combined voting power of the then outstanding voting securities of such company entitled to vote generally in the election of directors, and (C) at least a majority of the members of the board of directors of such company were approved by a majority of the Incumbent Board at the time of the execution of the initial agreement or action of the Board providing for such sale or other disposition of assets of the Company. 11.2 Fractional Shares In the event of any adjustment in the number of shares covered by any Option, any fractional shares resulting from such adjustment shall be disregarded and each such Option shall cover only the number of full shares resulting from such adjustment. 11.3 Determination of Board to Be Final All Section 11 adjustments, other than those made after a Change in Control pursuant to Section 11.1.3, shall be made by the Board, and its determination as to what adjustments shall be made, and the extent thereof, shall be final, binding and conclusive. Unless an Optionee agrees otherwise, any change or adjustment to an Incentive Stock Option shall be made in such a manner so as not to constitute a "modification" as defined in Code Section 424(h) and so as not to cause his or her Incentive Stock Option issued hereunder to fail to continue to qualify as an "incentive stock option" as defined in Code Section 422(b). SECTION 12. AMENDMENT AND TERMINATION OF PLAN 12.1 Amendment of Plan The Plan may be amended only by the Board in such respects as it shall deem advisable; provided, however, that to the extent required for compliance with Section 422 of the Code or any applicable law or regulation, shareholder approval shall be required for any amendment that would (a) increase the total number of shares available for issuance under the Plan, (b) modify the class of persons eligible to receive Options, or (c) otherwise require shareholder approval under any applicable law or regulation. Any amendment made to the Plan that would constitute a "modification" to Incentive Stock Options outstanding on the date of such amendment shall not, without the consent of the Optionee, be applicable to any such outstanding Incentive Stock Options but shall have prospective effect only. 12.2 Termination of Plan The Board may suspend or terminate the Plan at any time. The Plan shall have no fixed expiration date; provided, however, that no Incentive Stock Options may be granted more than ten years after the later of (a) the Plan's adoption by the Board and (b) the adoption by the Board of -13- any amendment to the Plan that constitutes the adoption of a new plan for purposes of Section 422 of the Code. 12.3 Consent of Optionee The amendment or termination of the Plan or the amendment of an outstanding Option shall not, without the Optionee's consent, impair or diminish any rights or obligations under any Option theretofore granted to the Optionee under the Plan; provided, however, that adjustments made pursuant to Section 11 shall not be subject to these restrictions. Any change or adjustment to an outstanding Incentive Stock Option shall not, without the consent of the Optionee, be made in a manner so as to constitute a "modification" that would cause such Incentive Stock Option to fail to continue to qualify as an Incentive Stock Option. SECTION 13. GENERAL 13.1 Evidence of Options Options granted under the Plan shall be evidenced by a written instrument that shall contain such terms, conditions, limitations and restrictions as the Plan Administrator shall deem advisable and that are not inconsistent with the Plan. 13.2 No Individual Rights Nothing in the Plan or any Option granted under the Plan shall be deemed to constitute an employment contract or confer or be deemed to confer on any Optionee any right to continue in the employ of, or to continue any other relationship with, the Company or any Related Corporation or limit in any way the right of the Company or any Related Corporation of the Company to terminate an Optionee's employment or other relationship at any time, with or without Cause. 13.3 Registration Notwithstanding any other provision of the Plan, the Company shall have no obligation to issue or deliver any shares of Common Stock under the Plan or make any other distribution of benefits under the Plan unless such issuance, delivery or distribution would comply with all applicable laws (including, without limitation, the requirements of the Securities Act), and the applicable requirements of any securities exchange or similar entity. The Company shall be under no obligation to any Optionee to register for offering or resale or to qualify for exemption under the Securities Act, or to register or qualify under state securities laws, any shares of Common Stock, security or interest in a security paid or issued under, or created by, the Plan, or to continue in effect any such registrations or qualifications if made. The Company may issue certificates for shares with such legends and subject to such restrictions on transfer and stop-transfer instructions as counsel for the Company deems necessary or desirable for compliance by the Company with federal and state securities laws. To the extent that the Plan or any instrument evidencing an Option provides for issuance of stock certificates to reflect the issuance of shares of Common Stock, the issuance may be effected on a noncertificated basis, to the extent not prohibited by applicable law or the applicable rules of any stock exchange. -14- 13.4 No Rights as a Shareholder No Option shall entitle the Optionee to any cash dividend, voting or other right of a shareholder unless and until the date of issuance under the Plan of the shares that are the subject of such Option. 13.5 Compliance With Laws and Regulations Notwithstanding anything in the Plan to the contrary, the Plan Administrator, in its sole discretion, may bifurcate the Plan so as to restrict, limit or condition the use of any provision of the Plan to Optionees who are officers or directors subject to Section 16 of the Exchange Act without so restricting, limiting or conditioning the Plan with respect to other Optionees. Additionally, in interpreting and applying the provisions of the Plan, any Option granted as an Incentive Stock Option pursuant to the Plan shall, to the extent permitted by law, be construed as an "incentive stock option" within the meaning of Section 422 of the Code. 13.6 Optionees in Foreign Countries The Plan Administrator shall have the authority to adopt such modifications, procedures and subplans as may be necessary or desirable to comply with provisions of the laws of foreign countries in which the Company or its Related Corporations may operate to assure the viability of the benefits from Options granted to Optionees employed in such countries and to meet the objectives of the Plan. 13.7 No Trust or Fund The Plan is intended to constitute an "unfunded" plan. Nothing contained herein shall require the Company to segregate any monies or other property, or shares of Common Stock, or to create any trusts, or to make any special deposits for any immediate or deferred amounts payable to any Optionee, and no Optionee shall have any rights that are greater than those of a general unsecured creditor of the Company. 13.8 Severability If any provision of the Plan or any Option is determined to be invalid, illegal or unenforceable in any jurisdiction, or as to any person, or would disqualify the Plan or any Option under any law deemed applicable by the Plan Administrator, such provision shall be construed or deemed amended to conform to applicable laws, or, if it cannot be so construed or deemed amended without, in the Plan Administrator's determination, materially altering the intent of the Plan or the Option, such provision shall be stricken as to such jurisdiction, person or Option, and the remainder of the Plan and any such Option shall remain in full force and effect. 13.9 Choice of Law The Plan and all determinations made and actions taken pursuant hereto, to the extent not otherwise governed by the laws of the United States, shall be governed by the laws of the State of Washington without giving effect to principles of conflicts of laws. -15- SECTION 14. EFFECTIVE DATE The Effective Date is the date on which the Plan is adopted by the Board, so long as it is approved by the Company's shareholders at any time within 12 months of such adoption. Adopted by the Board on January 21, 1999 and approved by the Company's shareholders on May 5, 1999; amended by the Board on January 23, 2001 and approved by the shareholders on May 8, 2001. -16- PLAN ADOPTION AND AMENDMENTS/ADJUSTMENTS SUMMARY PAGE
Section/Effect of Date of Shareholder Date of Board Action Action Amendment Approval - -------------------- ---------------------- ----------------- ------------------- January 21, 1999 Initial Plan Adoption May 5, 1999 January 23, 2001 Increase shares Section 4.1 May 8, 2001 available from 1,500,000 to 3,500,000
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