10-Q 1 d10q.txt FORM 10-Q FOR QUARTERLY PERIOD ENDED JUNE 30, 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 June 30, 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 44,114,727 ------------------------------------- ---------------------------------- (Class) (Outstanding at July 31, 2001) TARGETED GENETICS CORPORATION Quarterly Report on Form 10-Q For the quarter ended June 30, 2001 TABLE OF CONTENTS
Page No. -------- PART I FINANCIAL INFORMATION Item 1. Financial Statements a) Condensed Consolidated Balance Sheets at June 30, 2001 and December 31, 2000 3 b) Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2001 and 2000 4 c) Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 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. Qualitative and Quantitative 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 18 Item 5. Other Information * Item 6. Exhibits and Reports on Form 8-K 18 SIGNATURES 19
* 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
June 30, December 31, 2001 2000 ------------ -------------- ASSETS (Unaudited) ------ Current assets: Cash and cash equivalents $ 26,581,827 $ 38,630,216 Accounts receivable 2,312,424 3,086,534 Receivable from joint venture 240,299 177,088 Prepaid expenses and other 1,030,239 291,435 ------------- ------------- Total current assets 30,164,789 42,185,273 Property, plant and equipment, net 8,635,463 6,206,276 Goodwill and other purchased intangibles, net 34,786,364 37,821,059 Other assets 1,513,634 1,761,434 ------------- ------------- $ 75,100,250 $ 87,974,042 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Current liabilities: Accounts payable $ 1,765,752 $ 4,000,084 Payable to joint venture 359,965 261,743 Accrued payroll and other liabilities 1,016,423 679,739 Deferred revenue 6,752,363 6,906,174 Current portion of long-term obligations 970,174 838,245 ------------- ------------- Total current liabilities 10,864,677 12,685,985 Long-term obligations 2,344,538 947,508 Long-term note payable 1,512,766 1,498,566 Deferred revenue 6,206,758 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 June 30, 2001 and at December 31, 2000 13,736,932 13,275,778 Common stock, $.01 par value, 80,000,000 shares authorized, 44,108,727 and 42,608,943 shares issued and outstanding at June 30, 2001 and December 31, 2000, respectively 203,354,853 200,968,429 Accumulated deficit (162,920,274) (150,812,610) ------------- ------------- Total shareholders' equity 54,171,511 63,431,597 ------------- ------------- $ 75,100,250 $ 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 Six months ended June 30, June 30, -------------------------- ---------------------------- 2001 2000 2001 2000 ----------- ----------- ------------ ------------ Revenue: (restated) (restated) Collaborative agreements $ 3,609,210 $ 1,835,697 $ 6,737,229 $ 4,123,322 Collaborative agreements with affiliates 729,346 441,799 1,406,700 854,060 ----------- ----------- ------------ ------------ Total revenue 4,338,556 2,277,496 8,143,929 4,977,382 Operating expenses: Research and development 6,637,568 4,538,044 13,030,924 8,255,800 Amortization of acquisition-related intangibles 1,517,346 - 3,034,695 - General and administrative 1,441,681 1,091,622 3,468,559 2,198,573 ----------- ----------- ------------ ------------ Total expenses 9,596,595 5,629,666 19,534,178 10,454,373 ----------- ----------- ------------ ------------ Loss from operations (5,258,039) (3,352,170) (11,390,249) (5,476,991) Equity in loss of joint venture (1,018,721) (607,537) (1,866,939) (1,171,531) Investment income 477,352 463,503 1,279,257 679,257 Interest expense (65,536) (64,344) (129,733) (128,465) ----------- ----------- ------------ ------------ Loss before cumulative effect of change in accounting principle (5,864,944) (3,560,548) (12,107,664) (6,097,730) Cumulative effect of change in accounting principle - - - (3,681,687) ----------- ----------- ------------ ------------ Net loss (5,864,944) (3,560,548) (12,107,664) (9,779,417) Accretion of dividend on preferred stock (232,548) (216,025) (461,154) (432,553) ----------- ----------- ------------ ------------ Net loss applicable to common shareholders $(6,097,492) $(3,776,573) $(12,568,818) $(10,211,970) =========== =========== ============ ============ Basic and diluted net loss per share: Loss before cumulative effect of change in accounting principle $ (0.14) $ (0.10) $ (0.29) $ (0.19) Cumulative effect of change in accounting principle - - - (0.10) ----------- ----------- ------------ ------------ Net loss applicable to common shareholders $ (0.14) $ (0.10) $ (0.29) $ (0.29) =========== =========== ============ ============ Shares used in computation of basic and diluted net loss per share 43,977,218 36,415,401 43,748,479 35,619,386 =========== =========== ============ ============
The accompanying notes are an integral part of this statement. 4 TARGETED GENETICS CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Six months ended June 30, ------------------------------------- 2001 2000 ------------ ------------ Operating activities: (restated) --------------------- Net loss $(12,107,664) $($9,779,417) Adjustments to reconcile net loss to net cash used in operating activities: Cumulative effect adjustment of change in accounting principle - 3,681,687 Amortization of intangibles 3,034,695 - Depreciation and amortization 1,883,585 730,501 Equity in loss of unconsolidated joint venture 1,866,939 1,171,531 Noncash equity issuances 80,466 - Changes in operating assets and liabilities: Decrease in deferred revenue (3,357,439) (664,856) Increase (decrease) in accounts payable and accrued liabilities (1,947,648) 67,345 Decrease in accounts receivable 1,014,409 192,226 Increase in other assets (766,103) (262,017) Decrease (increase) in accounts receivable from joint venture (63,211) 289,958 Increase in accrued interest on securities available for sale - 12,691 ------------ ------------ Net cash used in operating activities (10,361,971) (4,560,351) Investing activities: --------------------- Purchases of property, plant and equipment (4,112,052) (388,867) Investment in unconsolidated joint venture (1,768,717) (1,535,074) Maturities and sales of securities available for sale - 1,520,112 ------------ ------------ Net cash used in investing activities (5,880,769) (403,829) Financing activities: --------------------- Net proceeds from sale of capital stock 2,767,112 28,772,407 Proceeds from leasehold improvement and equipment financing 1,938,516 671,594 Payments under capital leases and installment loans (511,277) (640,095) ------------ ------------ Net cash provided by financing activities 4,194,351 28,803,906 ------------ ------------ Net increase (decrease) in cash and cash equivalents (12,048,389) 23,839,726 Cash and cash equivalents, beginning of period 38,630,216 4,100,798 ------------ ------------ Cash and cash equivalents, end of period $ 26,581,827 $ 27,940,524 ============ ============ Supplemental disclosure of noncash investing and financing activities: Preferred stock dividend $ 461,154 $ 432,553 Equipment financed through capital lease 101,720 82,241 Interest paid on capital lease and installment loans 76,993 89,088
The accompanying notes are an integral part of this statement. 5 TARGETED GENETICS CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 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"). 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. In the opinion of our management, the financial statements reflect 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 and six months ended June 30, 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 ------------------------------ In the fourth quarter of 2000, we adopted the Securities and Exchange Commission's Staff Accounting Bulletin No. 101, 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 has been recorded as deferred revenue that will be recognized as revenue over the remaining term of the research and development collaboration agreements. The results for the three-month period and the six- month period ended June 30, 2000 were restated to reflect the effects of the accounting change. For the three-month period ended June 30, 2000, as a result of the change in accounting principle, net loss decreased by $525,000, or $0.01 per share, reflecting the related deferred revenue that was recognized as revenue during the period. For the six-month period ended June 30, 2000, as a result of the change in accounting principle, net loss increased by $2.6 million, or $0.07 per share, reflecting the $3.7 million, or $0.10 per share, cumulative effect of the change, net of $1.1 million, or $0.03 per share, of the related deferred revenue that was recognized as revenue during the six-month period ended June 30, 2000. We recognized $1.6 million, or $0.04 per share, of deferred revenue for the three-month period ended June 30, 2001 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. We recognized $3.2 million, or $0.07 per share of deferred revenue for the six- month period ended June 30, 2001, including $2.1 million 6 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 $1.1 million of revenue related to the cumulative effect adjustment. 3. Earnings Per Share ------------------ Basic net loss per share is computed based upon the weighted average number of common shares outstanding during the period. Targeted Genetics' diluted net loss per share is the same as its basic net loss per share because all stock options, warrants and other potentially dilutive securities are antidilutive and are therefore excluded from the calculation of diluted net loss per share. 4. New Accounting Pronouncements ----------------------------- In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 141 (SFAS 141), Business Combinations. SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of- interests method. We do not believe that the adoption of SFAS 141 will have an impact on our financial statements. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible Assets, which is effective January 1, 2002. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS 142 also requires us to complete a transitional goodwill impairment test six months from the date of adoption. We are currently assessing but have not yet determined the impact of SFAS 142 on our financial position and results of operations. 5. Matters Associated With Genovo Acquisition ------------------------------------------ In connection with our acquisition of Genovo, we established an escrow of 550,872 shares of Targeted Genetics common stock held for the benefit of former Genovo stockholders, subject to the fulfillment of specified representations and warranties in the merger agreement. Included in these representations and warranties is our collection of a receivable of $2.0 million for pre-acquisition contractual matters related to Genovo. During the quarter ended June 30, 2001 the party associated with this receivable communicated its intent to dispute payment. Because we have not yet reviewed the facts connected to the matter nor determined our course of action, we cannot yet assess to what extent this receivable will be collectible. According to the terms of the merger agreement, in the event that we are unable to collect this receivable, we would reduce the share balance in the escrow account and reflect that change as a reduction in the Genovo purchase price. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements -------------------------- This quarterly report on Form 10-Q contains forward-looking statements, which involve current expectations, forecasts of future events and other statements that are not historical facts. Inaccurate assumptions and known and unknown risks and uncertainties can affect the accuracy of forward-looking statements. Our actual results could differ materially from our expectations for a number of reasons, including the risks described in the section below entitled "Factors Affecting Our Operating Results, Our Business and Our Stock." You should not unduly rely on these forward-looking statements, which speak only as of the date of this report. We undertake no duty to update any forward- looking statements to reflect new information, circumstances or events after the date of this report. 7 Results of Operations --------------------- Revenue. Revenue for the three-month period ended June 30, 2001 increased to $4.3 million from $2.3 million for the three-month period ended June 30, 2000. Revenue for the six months ended June 30, 2001 increased to $8.1 million from $5.0 million for the same period in 2000. The increases in revenue for both the three-month period and the six-month period ended June 30, 2001 were 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. Increases in revenue from the addition of the hemophilia research and development activities were offset by decreases in revenue from our cystic fibrosis product development collaboration with Celltech Group plc for both the three-month period and the six-month period ended June 30, 2001 compared to the same periods in 2000, 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 three-month period ended June 30, 2001 increased to $6.6 million from $4.5 million for the three-month period ended June 30, 2000. Research and development expenses for the six-month period ended June 30, 2001 increased to $13.0 million from $8.3 million for the same period in 2000 . The year-to-year increases in research and development expenses for both the three-month period and the six-month period ended June 30 reflect increased 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 our Emerald Gene Systems joint venture; hiring additional clinical and regulatory personnel to design and administer our cystic fibrosis and cancer clinical trials; and increased costs associated with expanding our manufacturing facilities. Expenses for 2001 also reflect increased activity within our majority-owned cell therapy business subsidiary, CellExSys, Inc., 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, hemophilia and AIDS and providing research and development services to Emerald. This trend of quarterly increases in research and development costs 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. Goodwill Amortization. Amortization of goodwill for the second quarter of 2001 and six-month period ended June 30, 2001 reflect 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 six-month period ended June 30, 2000. General and Administrative Expenses. General and administrative expenses for the second quarter of 2001 increased to $1.4 million from $1.1 million for the same period in 2000. General and administrative expenses for the six months ended June 30, 2001 increased to $3.5 million from $2.2 million for the same period in 2000. The year-to-year increases in both periods 8 reflect 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 losses of $1.0 million for the second quarter of 2001 and losses of $1.9 million for the six-month period ended June 30, 2001 for our 80.1% equity share in the losses of Emerald Gene Systems. Our equity losses in Emerald were $608,000 for the second quarter of 2000 and $1.2 million for the six-month period ended June 30, 2000. Investment Income. Investment income for the second quarter of 2001 of $477,000 was approximately equal to that of the same period in 2000, because increases in average investment balances during the three-month period ended June 30, 2001 were offset by slightly lower interest rates. Investment income for the six months ended June 30, 2001 increased to $1.3 million from $679,000 for the same period in 2000, due primarily to an increase in the value per share of our short-term bond mutual fund in the first quarter. Interest Expense. Interest expense for the second quarter of 2001 increased to $66,000 from $64,000 for the same period in 2000. Interest expense for the six-month period ended June 30, 2001 increased to $130,000 from $128,000 for the same period in 2000. The year-to-year increases in both periods were primarily due to higher average outstanding principal balances in the second quarter of 2001 and added amortization for a discount note, partially offset by lower average principal balances in the first quarter of 2001. 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 change in accounting principle in the second quarter of 2001 and $525,000 of amortized deferred revenue in the second quarter of 2000. We recognized $3.2 million of amortized deferred revenue related to this change in accounting principle in the six-month period ended June 30, 2001 and $1.1 million of amortized deferred revenue in the six-month period ended June 30, 2000. Amortized deferred revenue in second quarter of 2001 included $1.1 million of deferred revenue related to up-front payments received in the second half of 2000 when we initiated collaborations with Biogen and Genetics Institute and $525,000 of deferred revenue related to the cumulative effect adjustment. Amortized deferred revenue in the six-month period ended June 30, 2001 included $2.1 million of deferred revenue related to up-front payments received in the second half of 2000 when we initiated collaborations with Biogen, Inc. and Genetics Institute and $1.1 million of deferred revenue related to the cumulative effect adjustment. Amortized deferred revenue in 2000 consisted entirely of deferred revenue related to the cumulative effect adjustment. 9 Financial Condition ------------------- As of June 30, 2001, we had $26.6 million in cash and cash equivalents, compared with $38.6 million in cash and cash equivalents as of December 31, 2000. In addition, we had $19.3 million in working capital compared with $29.5 million in working capital as of December 31, 2000. These decreases reflect operating losses for the first half of 2001, investments in leasehold improvements and capital equipment for the expanded clinical manufacturing facility 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, 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 in April 2003. Genzyme Corporation also has an option, exercisable in August 2001, to purchase 311,295 shares of our common stock at a purchase price of $12.8495 per share for an aggregate purchase price of $4.0 million. In connection with our acquisition of Genovo, we established an escrow of 550,872 shares of Targeted Genetics common stock held for the benefit of former Genovo stockholders, subject to the fulfillment of specified representations and warranties in the merger agreement. Included in these representations and warranties is our collection of a receivable of $2.0 million under a contractual obligation with a third party for pre-acquisition Genovo matters. Recently, we were advised that the third party disputes payment of this receivable. Failure to collect this receivable would reduce our working capital. 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 10 expect that we will need to raise substantial additional funds to continue developing and commercializing our products. 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 June 30, 2001, we have incurred cumulative losses of $163.3 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. 11 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 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, we will be unable to generate product revenue and may be unable 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. 12 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 rights 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 nonexclusive license. The United States Patent and Trademark Office has declared an 13 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. 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 14 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. If we do not attract and retain qualified personnel, we will be unable to successfully and timely develop our potential products. 15 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. 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 16 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 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. We were recently advised that a third party disputes payment of a $2.0 million contractual receivable related to fulfillment of representations and warranties connected with our acquisition of Genovo. If we are unable to collect this receivable, our operating capital will be reduced. 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. 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 June 30, 2001, we held $26.6 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. 17 PART II OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders We held an annual meeting of our shareholders on May 8, 2001. Of the 43,757,050 shares outstanding as of the record date for the annual meeting, 36,580,187 shares, or 84% of the total shares eligible to vote at the annual meeting, were represented in person or by proxy. The following matters were approved by our shareholders at the annual meeting: 1) The election of Jack L. Bowman and Jeremy L. Curnock Cook to serve as Class I members of our board of directors, with terms expiring in 2004 and the election of Joseph M. Davie to serve as a class II member of our board of directors, with a term expiring in 2002 . Our shareholders cast greater than 97% of the votes cast in favor of each nominee. 2) The amendment of the Targeted Genetics Corporation 1999 Stock Option Plan to increase the number of shares of common stock issuable under the Plan from 1,500,000 to 3,500,000 shares. Our shareholders cast 20,413,458 votes in favor of the proposal and 6,044,896 votes against. In addition, there were 37,142 abstentions and 10,084,691 broker non-votes. 3) The adoption of the Targeted Genetics Corporation 2000 Genovo Rollover Stock Option Plan. Our shareholders cast 21,650,444 votes in favor of this proposal, and 4,806,385 votes against. In addition, there were 38,667 abstentions and 10,084,691 broker non- votes. Item 6. Exhibits and Reports on Form 8-K (a) See the Index to Exhibits included in this quarterly report. (b) We did not file any current reports on Form 8-K during the quarter ended June 30, 2001. 18 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) Date: August 14, 2001 /s/ H. Stewart Parker ---------------------- ------------------------------------- H. Stewart Parker, President and Chief Executive Officer (Principal Executive Officer) Date: August 14, 2001 /s/ David J. Poston ---------------------- ------------------------------------- David J. Poston, Senior Director, Finance, Assistant Secretary (Interim Principal Financial and Accounting Officer) 19 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 First Lease Amendment, dated May 12, 1997, between Targeted Genetics and Benaroya Capital Company, LLC 10.2 Second Lease Amendment, dated February 25, 2000, between Targeted Genetics and Benaroya Capital Company, LLC 10.3 Third Lease Amendment, dated April 19, 2000, between Targeted Genetics and Benaroya Capital Company, LLC 10.4 Fourth Lease Amendment, dated March 28, 2001, between Targeted Genetics and Benaroya Capital Company, LLC
_______ (A) Incorporated by reference to Targeted Genetics' Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, filed on August 11, 2000. (B) Incorporated by reference to the designated exhibit included with Targeted Genetics' Registration Statement on Form 8-A, filed on 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. 20