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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
COMMISSION FILE NUMBER: 0-23413
INTERLEUKIN GENETICS, INC.
(NAME OF REGISTRANT IN ITS CHARTER)
DELAWARE 94-3123681
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
135 BEAVER STREET, 2ND FLOOR, WALTHAM, MA 02452
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
ISSUER'S TELEPHONE NUMBER: (781) 398-0700
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 [ ]
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-K is contained in this form, and no disclosure will be
contained, to the best of the registrant's knowledge, in a definitive proxy or
information statements incorporated by reference in Part 111 of this Form 10-K
or any amendment to this Form 10-K [ ].
As of March 20, 2001, the aggregate market value of the Registrant's Common
Stock held by non-affiliates, based upon the average bid and asked price as of
such date, was $30,311,768. There were 20,500,529 shares of the Registrant's
Common Stock issued and outstanding as of March 20, 2001
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Definitive Proxy Statement for the 2001 Annual
Meeting of Shareholders to be held on or about June 29, 2001, are incorporated
by reference in Part III hereof.
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ITEM 1. DESCRIPTION OF BUSINESS
FORWARD LOOKING STATEMENTS
THIS REPORT AND THE DOCUMENTS INCORPORATED BY REFERENCE CONTAIN CERTAIN
FORWARD-LOOKING STATEMENTS INCLUDING, WITHOUT LIMITATION, STATEMENTS CONCERNING
OUR EXPECTATIONS OF FUTURE SALES, GROSS PROFITS, RESEARCH AND DEVELOPMENT
EXPENSES, SELLING, GENERAL AND ADMINISTRATIVE EXPENSES, GENOMICS, PRODUCT
INTRODUCTIONS AND CASH REQUIREMENTS. FORWARD-LOOKING STATEMENTS OFTEN, ALTHOUGH
NOT ALWAYS INCLUDE WORDS OR PHRASES SUCH AS "WILL LIKELY RESULT", "EXPECT",
"WILL CONTINUE", "ANTICIPATE", "ESTIMATE", "INTEND", "PLAN", "PROJECT",
"OUTLOOK", OR SIMILAR EXPRESSIONS. ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE
EXPRESSED IN SUCH FORWARD LOOKING STATEMENTS. FACTORS THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER FROM EXPECTATIONS INCLUDE BUT ARE NOT LIMITED TO THOSE SET
FORTH WITHIN THE SECTION TITLED "FACTORS AFFECTING FUTURE PERFORMANCE" WITHIN
THIS REPORT AND WITHIN THE SECTION TITLED "RISK FACTORS" WITHIN THE COMPANY'S
REGISTRATION STATEMENT ON FORM S-3, FILED JANUARY 11, 2001 (FILE NO. 333-53558).
WE CANNOT BE CERTAIN THAT OUR RESULTS WILL NOT BE ADVERSELY AFFECTED BY ONE OR
MORE OF THOSE FACTORS OR BY OTHER FACTORS NOT CURRENTLY ANTICIPATED. WE DO NOT
INTEND TO UPDATE THESE FORWARD-LOOKING STATEMENTS.
THE COMPANY
OVERVIEW
Interleukin Genetics, Inc., a Delaware corporation ("ILGN" or the
"Company") is a functional genomics company focused on personalized medicine. We
believe that by identifying individuals at risk for certain diseases and
combining it with specific therapeutic interventions, better healthcare
decisions can be made, reducing costs and greatly improving patient health
outcomes. We have a growing portfolio of patents covering the genetics of many
common diseases and conditions, including cardiovascular diseases, osteoporosis,
complications of diabetes, restenosis, and periodontal disease.
We believe that one of the great challenges confronting medicine today is
to find the key to understanding why some people are more prone than others to
developing serious chronic diseases and why some people respond to medicine for
those diseases better than others. Until doctors are able to understand the
underlying causes for such variability in chronic diseases, the practice of
medicine will remain largely constrained to our current approach of prescribing
therapies based on broad, sweeping recommendations in which very large groups of
people with the same stage of disease all receive the same treatment. This
approach to medicine is, in many ways, quite impersonal and it is often
ineffective.
Until now, scientific study of chronic diseases has largely focused on
identifying factors that initiate or "cause" a disease. Common examples of such
factors include cholesterol in the case of heart disease, bacteria of the mouth
in the case of periodontal disease and reduced estrogen levels in the case of
osteoporosis. However, the mere presence of these initiating factors does not
mean a person will develop a disease. For example, everyone with a cholesterol
level considered high does not develop heart disease nor does everyone with a
normal cholesterol level avoid heart disease. Rather, the common diseases as we
know them only develop when our bodies respond to the initiating factors in a
way that results in a problem.
We believe that the recent expansion in understanding of human genetic
information coming from programs like the Human Genome Project will likely
change the impersonal way medicine is practiced forever. This is because the
response of an individual's body to the common disease initiating factors is
largely determined by their specific genes. By using the new tools of the
genomic era, scientists will be able to study how differences in a specific
individual's genetic information directs their body to respond to these disease
initiating factors in different ways. This is likely to be true both for
identifying who is most likely to develop one disease or another and who is most
likely to respond to one or another medicine. Since it is our genes that make us
unique, at least in the biologic sense, we believe that tailoring medical
therapy based on knowledge of our genetic tendencies will enable doctors to move
beyond the one size fits all approach to prescribing medicines which are more
"personalized" to each of us based upon our unique genetic make-up.
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Our first genetic test, PST(R), a test predictive of risk for periodontal
disease, is currently marketed in the United States, Europe and Israel. Other
products under development include tests predictive of risk for osteoporosis,
coronary artery disease, complications of diabetes and restenosis.
We have also developed and licensed medical research tools, including
BioFusion(R), to pharmaceutical and biotech companies. BioFusion is a computer
modeling system that integrates genetic and other sub-cellular behavior,
biological functions, and clinical symptoms to simulate complex diseases. This
system allows useful information to be derived from rapidly increasing databases
of gene expression being generated in companies and academic centers worldwide.
In August 2000, we entered into an agreement with Kenna Technologies, Inc.
("Kenna") whereby we granted Kenna a perpetual, non-exclusive license to certain
disease information system technology and to certain biological modeling
technology, including the Biofusion system mentioned above. In consideration for
these license rights, Kenna paid us a non-refundable initial licensing fee of
$80,000 and has agreed to pay royalties based upon net sales from certain of the
licensed technology, as defined, for periods ranging from five to ten years. We
are recognizing the initial licensing fee of $80,000 as revenue ratably over the
term of the agreement.
We have followed a strategy of working with strategic partners at the
fundamental discovery stage. This strategy has given us access to discoveries
while reducing up-front research expenses. Since 1994, we have had a strategic
alliance with the Department of Molecular and Genetic Medicine at Sheffield
University ("Sheffield") in the United Kingdom. Under this alliance, Sheffield
has provided us with the fundamental discovery and genetic analysis from their
research laboratories, and we have focused on product development, including
clinical trials, and the commercialization of these discoveries.
During 2000, we changed our strategy for marketing and distributing PST. We
no longer market, distribute or process PST ourselves. We now use third party
marketers and distributors from whom we earn royalties. We believe that while
this will reduce revenues in the short-term it will also improve margins and
reduce operating costs.
In December 2000, we entered into a license agreement with Hain
Diagnostika/ADS GmbH ("Hain") for the marketing, distribution and processing of
the PST test in all countries outside of North America and Japan. Hain has
extensive experience in commercializing genetic tests on its DNA-STRIP
Technology Platform in several fields as well as a specific commitment to
marketing products directly to dentists. Hain's central facility offers
excellent turnaround times, high quality laboratory operations and a sales and
technical staff to support clinical users.
In March 1999, we entered into an exclusive agreement with the Straumann
Company, a leading supplier of dental implants, to market and sell PST in the
United States and Puerto Rico. Straumann launched its PST promotional activities
in April 1999. In September 2000, we amended the Straumann agreement to be non-
exclusive and entered into an agreement with Kimball Genetics, Inc., who has
expertise in the processing and analysis of genetic tests and their results.
Under the terms of this agreement, Kimball has a co-marketing right with
Straumann and will process and analyze all PST tests in the United States and
Puerto Rico.
Our executive offices are located at 135 Beaver Street, Waltham,
Massachusetts 02452, and our telephone number is 781/398-0700. We were
incorporated in Texas in 1986 and we re-incorporated in Delaware in March 2000.
We maintain a website at www.ilgenetics.com. On March 20, 2001, the closing bid
price of the Common Stock on The Nasdaq SmallCap Market was $1.84 per share.
CURRENT FINANCIAL CONDITION
Since inception, we have incurred cumulative net losses of approximately
$26 million, including losses of approximately $5.0 million during 2000. For the
year ended December 31, 2000, we had negative cash flows from operating
activities of approximately $4.2 million and at December 31, 2000 we had cash,
cash equivalents and marketable securities of approximately $5.4 million.
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In January 2001, we sold in a private placement 1.2 million shares of
Common Stock for $2.50 per share. The purchasers of the common stock also
received warrants to purchase 600,000 shares of Common Stock exercisable at
$3.00 per share. We generated net proceeds of approximately $3.0 million from
this transaction.
In December 2000, we sold in a private placement 542,373 shares of Common
Stock at $3.69 per share. The purchasers of the common stock also received
warrants to purchase 135,593 shares of Common Stock exercisable at $4.83 per
share. We generated net proceeds of approximately $2.0 million from this
transaction. Under the terms of this private placement the Company is required
to adjust downward the price per share paid in the offering, by issuing
additional shares, to match any offering price paid in subsequent offerings
during the following 24 months. Following the January 2001 offering, described
above, we issued an additional 257,627 shares of common stock to the purchasers
in the December 2000 offering, and new warrants to purchase 264,407 shares of
Common Stock exercisable at a price of $3.13 to replace the previously issued
warrants to purchase 135,593 shares of Common Stock.
In January 2000, we sold in a private placement 832,667 shares of Common
Stock for a price of $6.00 per share in a private placement. We generated net
proceeds of approximately $4.7 million from this transaction.
In June 1999, we completed a private placement of 2.2 million shares of
Series A Preferred Stock, no par value ("Series A Preferred") for a price of
$2.50 per share in a private placement. We generated net proceeds of
approximately $4.7 million from this transaction. Following approval of this
private placement by the Company's shareholders on August 20, 1999, all of the
issued and outstanding shares of Series A Preferred converted into 11,000,000
shares of Common Stock.
We anticipate that our existing cash and cash equivalents, including the
$3.0 million generated from our January 2001 private placement, together with
anticipated revenue and interest income will be sufficient to conduct operations
as planned until approximately July 2002. However, our future capital
requirements are anticipated to be substantial, and we do not have commitments
for additional capital at this time. Such capital requirements are expected to
arise from the commercial launch of additional genetic tests, continued research
and development efforts, the protection of the intellectual property rights
(including preparing and filing of patent applications), as well as operational,
administrative, legal and accounting expenses. THERE IS NO ASSURANCE THAT WE
WILL BE ABLE TO RAISE ANY ADDITIONAL CAPITAL. IF ADDITIONAL AMOUNTS CANNOT BE
RAISED AND WE ARE UNABLE TO SUBSTANTIALLY REDUCE OUR EXPENSES, WE WOULD SUFFER
MATERIAL ADVERSE CONSEQUENCES TO OUR BUSINESS, FINANCIAL CONDITION AND RESULTS
OF OPERATIONS AND WOULD LIKELY BE REQUIRED TO SEEK OTHER ALTERNATIVES UP TO AND
INCLUDING PROTECTION UNDER THE UNITED STATES BANKRUPTCY LAWS.
STRATEGY
Our objective is to be a leading genetics research and development company
focused on the discovery and development of risk assessment tests and linking
such tests to therapeutic interventions to improve health outcomes. Our strategy
is to develop products for research and clinical use that are commercialized
through strategic collaborations. These products include tests that are
predictive of disease risk and functional biological information for use in drug
development. We believe that we will generate testing revenues, licensing fees,
research and development funding, and fee-for-service or participatory revenues
pursuant to contracts with our collaborative partners. In the long term, we
believe we will generate royalty payments from our corporate partners for new
genetic tests and therapeutic products. We believe that this strategy allows us
to generate near-term revenues and diversify risk, while building a proprietary
product portfolio with significant long-term potential. One of our core
strengths is our ability to identify genetic variations or markers which
correlate with an individual's predisposition to a wide range of common chronic
diseases.
DEVELOPMENT SYSTEM AND APPROACH
Many factors, both environmental and genetic, contribute to most common
diseases. Importantly, some genetic factors are sufficiently strong that they
influence the onset and progression of a disease despite many other variables.
These genetic factors control aspects of the biology that have high leverage on
the disease. We
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have focused our research and product development efforts on genetic factors
that significantly influence the clinical course of common, chronic diseases.
The body responds to various challenges by means of chemicals produced by
the cells. One of the first chemicals produced following any stimulus is
interleukin-1 (IL-1). IL-1 then activates multiple biochemical reactions which
lead to inflammation, wound healing, bone and tissue growth and repair, and many
other biological processes. IL-1 therefore has great leverage on other parts of
the biology. We have identified variations in the IL-1 genes that either amplify
or decrease the biological processes that are switched on by IL-1, thereby
providing ways to predict who is more susceptible to certain chronic diseases
and providing novel opportunities to select optimal drug therapy and design new
drugs.
PRODUCT PIPELINE AND PROPRIETARY POSITION
We have completed clinical trials and patent applications have been filed
or patents have been issued on the role of genetic factors in several diseases,
however, we are focusing our development efforts only in the following diseases:
- Periodontitis (patent issued)
- Osteoporosis (patent issued)
- Restenosis (patent pending)
- Coronary artery disease (patent pending)
- Diabetic retinopathy (patent pending)
Based on these discoveries, we are developing a pipeline of tests that are
predictive of disease risk. PST, a test predictive of disease risk for
periodontitis (gum disease), was introduced commercially in the U.S. in the
fourth quarter of 1997. We consider several factors in determining whether to
pursue new genetic testing programs, including projected commercial potential,
effectiveness of current therapies and the status of competitive programs,
likelihood of attracting collaborators, and anticipated development costs.
In each clinical disease field, our development program is focused on
understanding how genetic risk factors relate to overall risk for the disease
and establishing clear links to treatment. By combining genetic risk assessment
with specific therapeutic strategies, we believe improved clinical outcomes and
more cost-effective management of these common diseases can be achieved. These
genetic factors are also of value in both identifying response patterns during
clinical trials for the enhancement of existing therapeutic agents and for
developing new therapeutics directed at specific immuno-inflammatory components
of several common diseases.
We have spent $2,167,000, $3,571,000 and $2,799,000 on research and
development during the years ended December 31, 2000, 1999 and 1998,
respectively.
CLINICAL UTILITY
We believe in the advantages a genetic approach to medicine offers in the
prevention, management and treatment of disease. We believe our predictive tests
and research tools are of value to:
- Pharmaceutical companies, who may use them to speed new drug development,
to improve the efficacy of their drugs, to develop new therapeutics and
to target patients most likely to respond to their drugs.
- Payors and organizations who provide health care services, who may use
them to stratify patients by risk and more effectively allocate resources
for the greatest benefit.
- Physicians and other healthcare professionals, who may use this
information to assess the risk involved for their patients and adopt
appropriate treatments or preventive strategies.
- Patients committed to staying healthy, who may use this information to
make better choices and set priorities based on personal knowledge of
their individual risk for common diseases.
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TEST PREDICTIVE OF DISEASE RISK FOR PERIODONTAL DISEASE
Our first genetic susceptibility test, PST, identifies patients at risk for
severe gum disease (periodontitis). Periodontitis is a bacterially-induced
chronic inflammation that destroys the collagen fibers and bone that surround
and support the teeth. Untreated, periodontitis will eventually result in tooth
loss. Individuals who test positive for this genotype will normally be placed on
a more frequent recall program with their dental provider, and would be
candidates for more aggressive treatment.
The PST is the result of a scientific breakthrough in which an association
was discovered between a specific IL-1 genetic marker (i.e., a genetic variation
or polymorphism associated with increased disease incidence or severity) and
severe periodontal disease. IL-1 is a cytokine or protein that is known to play
a role in inflammation and the expression of periodontal disease. Patients with
this specific genotype have been found to progress more rapidly towards severe
periodontal disease. It has also been determined that cells with this genotype
produce as much as four times more IL-1 in response to the same bacterial
challenge. Prevention or therapeutic intervention aimed at reducing the
bacterial challenge should decrease the stimulus for IL-1 production and thereby
protect the patient against the potentially destructive effects of this
genotype. Based on clinical trials we have conducted and our experience to date,
we estimate that approximately 30% of the population will test positive for this
genotype.
We have developed PST pursuant to a project agreement between us and
Sheffield University. In November, 1997, a patent related to the detection of
genetic predisposition to periodontal disease was issued to the Company. We
initiated commercial sales of PST in October 1997. In December 1998, we entered
into an agreement with Washington Dental Service, a member of Delta Dental Plans
Association, for the purchase of 1,200 PST tests to be used in a study sponsored
by Washington Dental Service, in collaboration with the University of Washington
School of Dentistry. The study is designed to quantify the relationship between
PST genotype status and the utilization of dental services by patients in a
dental plan.
The study, which began in early 1999, will provide scientific and financial
information about PST in a reimbursement system. If patients who are at
increased risk for periodontal disease can be identified early using PST,
services can be provided which should minimize the progression of disease and
the cost and complications of its consequences. The most costly dental
procedures are usually those associated with tooth loss due to advanced disease
(i.e., bridges, partial dentures, implants, etc.). Therefore, early
identification and intervention of high-risk patients is in the patients' and
payer's best interest. We believe that the results of this study will provide
important scientific and financial data regarding the use of PST as a treatment-
planning tool to assess risk before actual damage occurs. The data from the
study may be available for analysis in mid 2001.
In October 2000, we introduced a cheek swab based PST test to replace
earlier blood and saliva based tests.
TEST PREDICTIVE OF DISEASE RISK FOR OSTEOPOROSIS
Osteoporosis, the most common bone disease, results in a decrease in the
amount of normal bone which leaves the affected individual more susceptible to
fractures. We have identified a genetic marker that in clinical trials was
associated with a more rapid loss of bone in women after menopause. In other
studies, we have shown that the IL-1 genotype predicts risk for certain types of
bone fractures due to osteoporosis.
The clinical utility of our osteoporosis susceptibility test lies in its
ability to predict a patient's future bone density trend and risk of fracture. A
genotype positive test result is a significant risk factor for accelerated bone
loss after menopause. A positive patient is more likely to exhibit low bone
mineral density and experience severe fractures compared to a genotype negative
patient. Early patient identification and appropriate intervention can alter the
rate of the disease.
Our test provides data that will allow practitioners to practice preventive
medicine. Results of this test will assist women who are approaching menopause
in deciding whether to start treatment for osteoporosis. This will enable
counseling at a sufficiently early stage in the process that significant bone
loss can be avoided through lifestyle modification and/or drug/hormone therapy.
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During 2000, we completed a large scale clinical trial on the osteoporosis
test. The data from this trial confirms that genetic factors identified by us
are associated with an increase in risk of osteoporosis in genotype-positive
persons compared to genotype negative persons.
TEST PREDICTIVE OF DISEASE RISK FOR CORONARY ARTERY DISEASE (PATENT PENDING)
Our coronary artery disease test (the "CAD test") is a genetic test capable
of detecting those individuals with a significantly higher level of
susceptibility to coronary artery disease. This genetic marker can be combined
with other risk factors to identify individuals at high risk for developing a
more rapidly progressive and severe form of coronary artery disease.
The availability of the CAD test will provide practitioners with a means of
truly practicing preventive medicine with respect to coronary artery disease.
The CAD test can be given to all individuals early in life because genetic risk
factors do not change over time. Individuals who test positive for the genotype
can be treated with more aggressive approaches to risk factor reduction. As
these individuals age, they can be provided with more regular: (i) monitoring of
cholesterol levels; (ii) early intervention to alter the level of blood lipids
(i.e., cholesterol). Such an approach allows for truly preventive medicine
through early risk factor reduction and appropriate monitoring for early
detection of any problems.
During 1999, we completed two large-scale clinical trials. The data from
these trials confirms that individuals with the IL-1 genetic marker have an
increased risk for heart disease even if such individuals do not have high
cholesterol. These findings are significant as over half of the first heart
attacks occur in individuals who cannot be identified using traditional risk
factors, such as smoking, high cholesterol, and diabetes. Genetic factors that
are independent of cholesterol may be of importance in identifying new
populations at increased risk for early heart disease. Once identified, these
individuals may reduce that risk by lowering cholesterol levels, even when the
cholesterol levels would not be considered "high" by currently accepted norms.
These factors may also provide new approaches to prevention and therapy.
TEST PREDICTIVE OF DISEASE RISK FOR RETINOPATHY IN DIABETICS (PATENT PENDING)
Another genetic susceptibility test which we are currently developing is a
test to determine susceptibility to sight-threatening retinopathy in diabetics.
This susceptibility involves a continued and increased risk of losing vision
when an individual has been diagnosed with diabetes.
Diabetes mellitus is among the most serious and common chronic diseases in
the world today. Although the name implies to many people simply a problem with
"sugar in the blood", the true health burden of diabetes is enormous. In fact,
diabetes mellitus is a serious metabolic disorder that puts people with the
disease at substantially increased risk of cardiovascular disease and specific
complications to the eyes, kidneys and nervous system. People with diabetes are
2-6 times more likely to have heart disease and 2-4 times more likely to
experience a stroke. Diabetes is the leading cause of blindness among adults
ages 20-40 and is the leading cause of end stage kidney disease leading to
dialysis. In addition, more than 56,000 people lose their foot or leg to
diabetes each year.
Along with the extensive health problems of diabetes comes a staggering
economic burden. Diabetes affects approximately 16 million people in the United
States alone, almost 6% of the population. Total costs of diabetes care in 1997
were approximately $98 billion with per capita costs for those with diabetes
nearly fourfold the costs for people without diabetes. Since the incidence of
diabetes increases with age, the continual aging of the "baby boom" population
is expected to continue to substantially expand the number of individuals with
diabetes over the coming decades. Interleukin Genetics is working with leaders
in the field of diabetes to develop a genetic test that we believe will aid in
identifying people with diabetes who are at particularly high risk of
experiencing the severe and costly complications of the disease. By identifying
these individuals earlier than we can currently, intensive therapy may be
started sooner in an effort to delay, or prevent, the complications before they
develop.
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TEST PREDICTIVE OF COMPLICATIONS FOLLOWING ANGIOPLASTY (RESTENOSIS)
Restenosis is the reclosure of the heart's arteries after an angioplasty or
coronary stent. Restenosis remains a significant clinical problem, affecting,
20-30% of patients treated with stents. Our restenosis test will be a genetic
test capable of identifying individuals at increased risk of restenosis at 6-9
months after their first procedure.
During 2000, we completed, together with collaborators from Munich, Germany
and Sheffield, England, a large scale clinical trial of 1850 patients who
underwent angioplasty and stent placement. Six months later, those patients were
examined and those who carried the IL-1 genetic markers believed to be
associated with decreased risk for restenosis had a 22% lower risk for
restenosis. Among patients under 60 years of age, the protective benefit was
37%.
TESTING PROCEDURE
Each of our genetic susceptibility tests require dentists or physicians to
follow a specific protocol. To conduct a genetic susceptibility test, the doctor
does a sample cheek swab and submits it to the laboratory of our strategic
partner. The laboratory then performs the test following our specific protocol
and informs the dentist or physician of the results. The dentist/physician in
turn, informs the patient and determines the appropriate course of action.
PRE-MARKETING TRIALS/STATUS OF PREDICTIVE TESTS
As an internal procedural standard, we conduct three categories of clinical
trials in conjunction with our genetic susceptibility tests. The first trial is
called a proof of principle trial, used to prove a laboratory finding. The
results of this trial are utilized to support the initial patent application and
therefore the trial needs to be completed before the patent application can be
filed. The second trial is a confirmatory trial. The purpose of the confirmatory
trial is to independently confirm the results of the proof of principle trial.
The third category of trial relates to clinical utility. The clinical utility
trial is conducted to learn what is the most effective utilization of the test
in actual clinical practice.
Following confirmatory studies, additional trials are completed on larger
populations to help develop broad scientific evidence supporting the clinical
utility of each of our tests. Such additional trials not only strengthen the
support for each tests' known use (i.e., detecting genetic susceptibility) but
also lead to additional practical uses of the susceptibility tests (e.g., use of
the susceptibility tests to determine a patient's responsiveness to a given
drug).
PRODUCT DEVELOPMENT
We have ongoing research to continue to identify other genetic factors that
appear to be associated with other diseases. We plan on filing additional patent
applications to cover these discoveries. It is our intent to bring these
discoveries to market in the form of tests predictive of disease risk or medical
research tools.
We have also come upon certain genetic factors that might be likely
candidates to serve as therapeutic targets. Drug agents might act upon these
genetic factors to reduce or increase biological actions to assist in the
treatment of diseases or disease symptoms. We are considering certain
collaborative long term relationships with pharmaceutical companies as a method
to provide for either the licensing of these discoveries or to assist in the
research and development of future products.
STRATEGIC ALLIANCES AND COLLABORATIONS
Our strategy is to develop products for research and clinical use and
commercialize such products through strategic alliances. We have followed a
strategy of working with strategic partners at the fundamental discovery stage.
This strategy has given us access to discoveries while reducing up-front
research expenses.
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SHEFFIELD UNIVERSITY
Since 1994, we have had a strategic alliance with the Department of
Molecular and Genetic Medicine at Sheffield University in the United Kingdom
("Sheffield"). Sheffield is a world leader in the genetic aspects of common
diseases with an inflammatory component. Under this alliance, Sheffield has
provided to us the fundamental discovery and genetic analysis from Sheffield's
research laboratories and we have focused on product development, including
clinical trials, and the commercialization of these discoveries.
In October 1999 we entered into a new arrangement with Sheffield and its
investigators replacing the research and development agreement that had been in
place with Sheffield since 1996. Pursuant to this new arrangement, we issued an
aggregate of 475,000 shares of its Common Stock to Sheffield and certain of its
investigators in exchange for the relinquishment by Sheffield of its interests
under certain previous agreements with us. In addition, this agreement requires
us to issue to Sheffield and certain of its investigators options to purchase
50,000 shares of stock at the current market price each June 30th during the
period of time the arrangement is in place. Sheffield is entitled to additional
options to purchase 10,000 shares of stock at the current market price each June
30th for each patent which is approved during the previous twelve months.
DELTA DENTAL
In December 1998, we signed an agreement with Washington Dental Service, a
member of the Delta Dental Plans Association, for the purchase of 1,200 PST
tests. The tests will be used in a study, sponsored by Washington Dental
Service, in collaboration with the University of Washington School of Dentistry
and us. The study is designed to quantify the relationship between PST genotype
status and the utilization of dental services by patients in a dental plan.
The study, began in March 1999, is expected to provide scientific and
financial information about PST in a reimbursement system. This study is also
expected to provide scientific and financial data regarding the use of PST as a
treatment-planning tool to assess risk. The data from the study may be available
for analysis in the middle of 2001.
KENNA TECHNOLOGIES, INC.
In November 2000, we licensed to Kenna Technologies, Inc a non-exclusive
license for the worldwide commercialization of our patented Biological Disease
Modeling System, BioFusion, and its user interface technologies, the Integrated
Disease Information System (IDIS). The transaction included an upfront license
fee and royalties. Currently, Kenna is offering BioFusion tools for the research
exploration of bone remodeling and metabolism (e.g. osteoporosis, periodontal
disease), middle ear infections and certain cancer related modules.
BRIGHAM AND WOMEN'S HOSPITAL
In November 2000, we entered an agreement with Brigham and Women's Hospital
("BWH") to investigate the genetic control of inflammation. The proprietary
screening platform to be used in the BWH study, the Inflammatory Response
Induction System ("IRIS"), allows the rapid evaluation of inflammatory responses
in humans with specific IL-1 genetic variations. We believe the BWH studies will
improve understanding of how IL-1 genetic variations affect their risk for
several chronic diseases and will help identify preventive and therapeutic
compounds for patients who are at increased risk. We anticipate the BWH studies
to be completed within twelve months at a total cost of approximately $278,000.
GENOME THERAPEUTICS
In November 2000, Genome Therapeutic Corp., a leading genomics company
commenced a commercial research program for us to provide DNA sequencing
information, including identifying variations in individual sections of genetic
information. This is known as Single Nucleotide Polymorphisms ("SNP") detection.
The
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program is focusing on key genes in a very specific chromosomal region known to
researchers as 2q13, which we and others have shown to be associated with risk
for inflammatory diseases, including Alzheimer's disease, asthma, cardiovascular
disease, diabetes, gastric cancer and osteoporosis. This contract is expected to
be completed in six months at a total cost of approximately $502,000.
PST COMMERCIAL PARTNERSHIPS
In December 1997, we entered into an agreement with Medicadent, A French
corporation ("Medicadent"), to market and sell PST in France. In August 1998, we
entered into an agreement with H.A. Systems, Ltd. market and sell PST in Israel.
In March 1999, we entered into an agreement with the Straumann Company to market
and sell PST in the United States and Puerto Rico. Straumann launched its PST
promotional activities in April 1999. In December 2000 we entered an agreement
with HainDiagnostika/ ADS GmbH for the marketing, distribution and processing of
PST for all countries outside of North America and Japan.
INTELLECTUAL PROPERTY
Our commercial success may depend at least in part on our ability to obtain
appropriate patent protection on our drug discovery and diagnostic products and
methods. We currently own exclusive rights in six issued U.S. patents, we've
received two Notices of Allowances (indicating that patents will shortly issue)
and have twenty two pending U.S. patent applications, which are based on novel
genes or novel associations between particular gene sequences and certain
inflammatory diseases, and disorders. Of the six issued patents, four relate to
genetic tests for periodontal disease, osteoporosis, asthma and sepsis and two
relate to BioFusion, our biologic modeling software.
We have been granted a number of corresponding foreign patents and have a
number of foreign counterparts of our U.S. patents and patent applications
pending.
We are continuing to identify novel interleukin genes and genetic markers.
We have received trademark protection for PST, our periodontal
susceptibility test. Our proprietary technology is subject to numerous risks,
which we discuss in "Factors Affecting Future Performance" beginning on page 12
of this report.
COMPETITION
Competition in our potential markets is intense. Although testing for major
genetic defects, such as Down's Syndrome, have been available for years, genetic
susceptibility testing for multi-factorial diseases is a newly emerging growth
segment. Despite this segment's relatively young age, other companies do exist
which have research programs seeking disease related genes for therapeutic and
susceptibility testing purposes, including some that involve
treatable/preventable disease. The technologies for discovering genes which
predispose individuals to major diseases and approaches for commercializing
those discoveries are new and rapidly evolving. Rapid technological developments
could result in our potential services, products, or processes becoming obsolete
before we recover a significant portion of the related research and development
costs and capital expenditures.
Our competitors in the United States and abroad are numerous and include,
among others, major pharmaceutical and diagnostic companies, specialized
biotechnology firms, universities and other research institutions, including
those receiving funding from the Human Genome Project. The following list of
companies may be considered a partial list of our potential competitors: Myriad
Genetics, Millennium Prediction Medicine, Canaissarce Pharmaceuticals, Diadexus,
Gemini, Oxagen. Myriad has a test for breast cancer and has announced research
programs for osteoporosis and coronary artery disease. Many of our potential
competitors have considerably greater financial, technical, marketing and other
resources than us, which may allow these competitors to discover important genes
or successfully commercialize these discoveries before us. If we do not discover
disease-predisposing genes, characterize their functions, develop
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genetic tests and related information services based on such discoveries, obtain
regulatory and other approvals, and launch such services or products before
competitors, we could be adversely affected.
Additionally, some of our competitors receive data and funding from the
Human Genome Project. The Human Genome Program is a federally funded program
focused on sequencing the human DNA and enriching the sequence data with
information about its biological function. To the extent our competitors receive
data and funding from the Human Genome Project at no cost to them, they may have
a competitive advantage over us.
In the case of newly introduced products requiring "change of behavior"
(such as genetic susceptibility tests) multiple competitors may accelerate
market acceptance and penetration through increasing awareness. Moreover, two
different genetic susceptibility tests for the same disease may in fact test or
measure different components, and thus actually be complementary when given in
parallel as an overall assessment of risk, rather than being competitive with
each other.
Furthermore, the primary focus of each of the above-referenced companies is
performing gene-identifying research for pharmaceutical companies for
therapeutic purposes, with genetic susceptibility testing being a secondary
goal. On the other hand, our primary business focus is developing and
commercializing genetic susceptibility tests for common diseases, with only an
ancillary drug discovery program.
GOVERNMENT REGULATION
The sampling of blood, saliva or cheek scrapings from patients and
subsequent analysis in a clinical laboratory does not, at the present time,
require Federal Drug Administration ("FDA") or regulatory authority approval
inside the U.S. for either the sampling procedure or the analysis itself. The
samples are taken in the healthcare provider's office, using standard materials
previously approved as medical devices, such as sterile lancets and swabs. The
testing procedure itself is performed in one or more registered, certified
clinical laboratories under the auspices of the Clinical Laboratory Improvement
Act of 1988 ("CLIA"), administered by the Health Care Financing Administration.
The federal regulations governing approval of the laboratory facilities and
applicable state and local regulations governing the operation of clinical
laboratories would also apply to the laboratories performing tests for us.
Changes in such regulatory schemes could require advance regulatory approval of
genetic susceptibility tests sometime in the future and could have a material
adverse effect on our business. In addition, certain billing practices require
that we, or a subsidiary, be licensed and regulated under CLIA.
In addition, while our main focus is on genetic susceptibility testing, we
may, in the future, endeavor to partner with pharmaceutical companies in the
area of drug development. Any drug products developed by us or our future
collaborative partners, prior to marketing in the United States, would be
required to undergo an extensive regulatory approval process by the FDA. The
regulatory process, which includes preclinical testing and clinical trials of
each therapeutic product in order to establish its safety and efficacy, can take
many years and requires the expenditure of substantial resources. Data obtained
from preclinical and clinical activities are susceptible to varying
interpretations which could delay, limit or prevent regulatory agency approval.
In addition, delays or rejections may be encountered during the period of
therapeutic development, including delays during the period of review of any
application. Delays in obtaining regulatory approvals could adversely affect the
marketing of any therapeutics developed by us or our collaborative partners,
impose costly procedures upon us and our collaborative partners' activities,
diminish any competitive advantages that we and our collaborative partners may
attain and adversely affect its ability to receive royalties. Once regulatory
approval of a product is granted, such approval may impose limitations on the
indicated uses for which it may be marketed. Further, even if such regulatory
approval is obtained, a marketed product and its manufacturer are subject to
continuing review. The discovery of previously unknown problems with a product
or manufacturer may result in restrictions on such product or manufacturer. Such
restriction could include withdrawal of the product from the market.
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EMPLOYEES
As of March 12, 2001, we had 13 full-time and part-time employees. Of our
employees, 7 are engaged directly in the development and commercialization of
tests and 6 are engaged in administrative or managerial activities. Our
employees are not covered by a collective bargaining agreement, and we consider
our relations with our employees to be good.
FACTORS AFFECTING FUTURE PERFORMANCE
WE HAVE NO ASSURANCE WE CAN RAISE ADDITIONAL NECESSARY CAPITAL
We anticipate that our current financial resources will be adequate to
maintain our current and planned operations until July 2002. There is no
assurance that we will be able to raise any additional capital. If additional
amounts cannot be raised prior to July 2002, we would suffer material adverse
consequences to our business, financial condition and results of operations and
would likely be required to seek protection under the United States Bankruptcy
laws.
Our future capital requirements will depend on many factors. Additional
capital may be needed for the commercial launch of additional genetic tests,
continued marketing and sales efforts, continued research and development
efforts, the protection of our intellectual property rights (including preparing
and filing of patent applications), as well as operational, administrative,
legal and accounting expenses. Our research and development activities will
require substantial additional capital from private or public sources. There is
no assurance that such capital will be available to us on acceptable terms, if
at all. The competition for equity capital from public and private sources has
intensified among the over 1,000 biotechnology companies in the United States
that are dependent on infusions of capital to fund their operations. We are also
engaged from time to time in discussions with several companies concerning the
licensing of certain of our proprietary technologies or forming strategic
alliances, which could provide additional sources of funding to us as well as a
possible source of equity capital. We are unable to predict the likelihood of
completing any such arrangements. There can be no assurance that we will be
successful in obtaining additional capital in amounts sufficient to continue to
fund our operations and product development.
WE HAVE A HISTORY OF OPERATING LOSSES, ACCUMULATED DEFICIT AND WE ARE UNCERTAIN
OF FUTURE PROFITABILITY
We incurred net operating losses of $0.8 million in fiscal year 1996, $4.5
million in 1997, $9.5 million in 1998, $6.1 million in 1999 and $5.0 million in
2000. As of December 31, 2000, our accumulated deficit was $31.0 million. Our
losses have resulted principally from expenses incurred for research and
development and selling, general and administrative activities. These expenses
have exceeded our revenues. We have yet to generate any significant revenues
from the sale of our genetic susceptibility testing services and there can be no
assurance that we will be able to generate significant revenues in the future.
We expect our operating losses to continue for the near future as our research
and development, sales and marketing activities and operations continue. Our
ability to achieve profitability depends on our ability to develop new products
and our ability to successfully market and sell our products and services. It is
uncertain when, or if, we will become profitable.
WE MAY BE CONSIDERED A NEW BUSINESS VENTURE
Although we have operated as a contract research firm since 1986, we have
limited experience and a short history of operations with respect to marketing
and selling susceptibility tests or therapeutics. We have had only minimal
revenues related to the sale of our genetic susceptibility testing services.
With the exception of our periodontal susceptibility test, the genetic
susceptibility tests anticipated to be sold by us have not yet been finally
designed, developed, tested or marketed. Therefore, there can be no assurance
that we will be able to complete development of these genetic susceptibility
tests, that those tests will be accepted in the marketplace, or that the tests
can be sold at a profit. Our business may also be affected significantly by
economic and market conditions over which we have no control.
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RELIANCE ON COLLABORATIVE PARTNERS
In July 1999, we entered into a new contractual arrangement with the
University of Sheffield ("Sheffield") replacing the research and development
agreement that had been in place since 1996. Under this new arrangement, we will
undertake the development and commercialization of certain discoveries resulting
from Sheffield's research. The agreement is non-cancelable for discoveries on
which the parties have reached a specific agreement, but may be terminated with
or without cause by either party upon six-months notice with respect to new
discoveries on which the parties have not yet reached agreement. If Sheffield
University terminated the agreement, such termination could make the discovery
and commercial introduction of new products more difficult or unlikely. This
agreement with Sheffield has a five-year term with an automatic yearly renewal.
Pursuant to this new arrangement, we issued an aggregate of 475,000 shares of
Common Stock to Sheffield and its investigators in exchange for the transfer of
certain patent rights and the relinquishment of any interest in future revenues
derived from this research held by Sheffield and its investigators under all
previous agreements. We also entered into a research and development services
agreement with Sheffield which automatically renews in one-year increments. In
connection with this new arrangement, we entered into a five-year consulting
agreement with Sheffield's key collaborator. We anticipate entering into
additional collaborative arrangements with Sheffield and other parties in the
future.
Since 1997, we have entered several agreements with strategic partners to
market and distribute PST. We now believe that through our various partners we
have adequate worldwide coverage in the sales, distribution and processing of
PST tests. In the majority of these agreements we receive a royalty for each
test sold. No assurances can be made regarding the commercial acceptance of PST.
In the future we may, in order to facilitate the sale of testing services and/or
products, enter into additional collaborative selling arrangements with one or
more other persons or companies. It is uncertain whether we will be able to
negotiate acceptable collaborative arrangements in the future or that such
collaborative arrangements will be successful. If we are unable to identify
collaborative partners to sell certain of our services and/or products, we may
be forced to develop an internal sales force to market and sell our services
and/or products in markets where we are not intending on developing a direct
selling presence. Such a process would take more time and potentially cost more.
As a result, revenues and earnings would be reduced. Where we have entered into
collaborative selling arrangements, our success depends upon the efforts of
others and may be beyond our control. Failure of any collaborative selling
arrangement could result in limited or delayed revenues and possible losses.
WE MAY NOT BE ABLE TO DEVELOP COMMERCIAL ACCEPTABLE DEVELOPING GENETIC
SUSCEPTIBILITY TESTS
It is uncertain whether we will be successful in developing and bringing to
market our current portfolio of future tests based on the genetic discoveries
made by us and our collaborators. Even when we discover a genetic marker,
additional clinical trials need to be conducted to confirm the initial
scientific discovery and to support the scientific discovery's clinical utility
in the marketplace. The results of a clinical trial could delay, reduce the
test's acceptance or cause our company to cancel a program. Such delays, reduced
acceptance or cancellations would limit or delay revenues and may result in
losses.
WE HAVE NO ASSURANCE OF INSURANCE REIMBURSEMENT
Our ability to successfully commercialize existing genetic susceptibility
tests and others that we may develop depends in part on obtaining adequate
reimbursement for such testing services and related treatments from government
and private health care insurers (including health maintenance organizations)
and other third-party payors. Physicians' and dentists' decisions to recommend
genetic susceptibility tests, as well as patients' elections to pursue testing,
are likely to be heavily influenced by the scope and extent of reimbursement for
such tests by third-party payors. Government and private third-party payors are
increasingly attempting to contain health care costs by limiting both the extent
of coverage and the reimbursement rate for new testing and treatment products
and services. In particular, services which are determined to be investigational
in nature or which are not considered "reasonable and necessary" for diagnosis
or treatment may be denied reimbursement coverage. To date, few insurers or
third-party payors have agreed to reimburse patients for genetic susceptibility
tests.
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It remains uncertain whether insurers or third-party payors will elect to
provide full reimbursement coverage for the genetic susceptibility tests in the
near future. If adequate reimbursement coverage is not available from insurers
or third-party payors, it is uncertain whether individuals will elect to
directly pay for the test. If both insurers or third-party payors and
individuals are unwilling to pay for the test, then the number of tests
performed will be significantly decreased. Such a scenario would result in
reduced revenues and possible losses.
WE MAY NOT BE ABLE TO PROTECT OUR PROPRIETARY TECHNOLOGY
Our success will partly depend on our ability to obtain patent protection,
both in the United States and in other countries, for our products and services.
In addition, our success will also depend upon our ability to preserve our trade
secrets and to operate without infringing the proprietary rights of third
parties.
We have twenty two (22) U.S. patent applications pending, including
applications covering certain of our anticipated genetic susceptibility tests.
We also have a number of corresponding foreign patent applications. There can be
no assurance that our patent applications will ever be issued as patents or that
the claims of any issued patents will afford meaningful protection for our
technology or products. Further, others may develop similar products which test
for susceptibility related to some diseases and yet avoid infringing upon, or
conflicting with, our anticipated patents. In addition, there can be no
assurance that any patents issued to us will not be challenged, and subsequently
narrowed, invalidated or circumvented.
Our testing services and/or products may also conflict with patents which
have been or may be granted to others. As the biotechnology industry expands and
more patents are filed and issued, the risk increases that our products may give
rise to a declaration of interference by the Patent and Trademark Office, or to
claims of patent infringement by other companies, institutions or individuals.
Such entities or persons could bring legal proceedings against us seeking
damages or seeking to enjoin us from testing, manufacturing or marketing our
products. Patent litigation is costly, and even if we prevail, the cost of such
litigation could have an adverse effect on us. If the other parties in any such
actions are successful, in addition to any liability for damages, we could be
required to cease the infringing activity or obtain a license. It is uncertain
whether any license required would be available to us on acceptable terms, if at
all. Failure by us to obtain a license to any technology that we may require to
commercialize our products could have a material adverse effect on our business,
financial condition, results of operations and cash flows. In addition, there is
considerable pressure on academic institutions and other entities to publish
discoveries in the genetic field. Such a publication by an academic institution
or other entity, prior to our filing of a patent application on such discovery,
may compromise our ability to obtain U.S. and foreign patent protection for the
discovery.
We also rely upon unpatented proprietary technologies. We rely on
confidentiality agreements with our employees, consultants and collaborative
partners to protect such proprietary technology. There can be no assurance that
we can adequately protect our rights in such unpatented proprietary
technologies, that others will not independently develop substantially
equivalent proprietary information or techniques, or otherwise gain access to
our proprietary technologies or disclose such technologies.
The United States Patent and Trademark Office issued new Utility Guidelines
in July 1995 that address the requirements for demonstrating utility,
particularly in inventions relating to human therapeutics. While the guidelines
do not require clinical efficacy data for issuance of patents for human
therapeutics, there can be no assurance that the Patent and Trademark Office's
interpretations of such guidelines, and any changes to such interpretations will
not delay or adversely affect our collaborators' ability to obtain patent
protection. The biotechnology patent situation outside the United States is even
more uncertain and is currently undergoing review and revision in many
countries.
TECHNOLOGICAL CHANGES MAY CAUSE OUR PRODUCTS TO BE OBSOLETE
Market acceptance and sales of our testing services could also be adversely
affected by technological change. It is uncertain whether our competitors will
succeed in developing genetic susceptibility tests that circumvent or are more
effective than our technologies or services. Further, it is uncertain whether
such developments would render our collaborators' technology or services less
competitive or obsolete. Further, our
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testing services could be rendered obsolete as a result of future innovations in
the treatment of gum disease, osteoporosis, coronary artery disease, pulmonary
fibrosis, asthma, diabetic retinopathy or other disease areas in which we have
developments. Such innovations could have a significant negative impact on our
ability to market our services effectively.
WE HAVE LIMITED MARKETING OR SALES EXPERIENCE
Our business strategy is to provide genetic susceptibility testing services
aimed at common diseases that are treatable and preventable. The commercial
introduction of the periodontal susceptibility test at the beginning of October
1997 represented our first such effort. From its commercial inception through
2000, our periodontal susceptibility test had generated revenues of
approximately $1.1 million. With respect to the periodontal susceptibility test,
we have devoted substantial human and financial resources to the establishment
and staffing of a customer service support facility and the building of a sales
and marketing infrastructure. However, we had limited experience in developing
and commercially marketing susceptibility testing services and consequently
closed the sales and marketing operations in October 2000 and implemented
marketing and distribution agreements. It is uncertain whether our customer
service support facilities and sales and marketing program will achieve
efficient, effective or successful operations. Failure to successfully market
such tests could reduce our revenues and may result in losses.
WE MAY FACE POSSIBLE NASDAQ DELISTING RESULTING IN A LIMITED PUBLIC MARKET FOR
OUR COMMON STOCK AND POSSIBLE VOLATILITY OF SECURITIES PRICES
Our common stock is currently listed on the NASDAQ SmallCap Market and the
Boston Stock Exchange. If we fail to maintain the qualification for our common
stock to trade on the NASDAQ SmallCap Market or the Boston Stock Exchange, our
common Stock could be subject to delisting. During 1999, we received several
notices from The Nasdaq Stock Market, Inc. ("NASDAQ") stating that the Company
was not in compliance with certain of the continued listing requirements of the
NASDAQ SmallCap Market. We believe that we currently comply with the continued
listing requirements of the NASDAQ SmallCap Market, but we have not been
notified by NASDAQ that our belief is correct. However, we cannot assure you
that we will maintain the qualifications for continued listing on the NASDAQ
SmallCap Market.
If our shares are not listed on the NASDAQ SmallCap Market as intended,
trading, if any, would be conducted in the over-the-counter market in the
so-called "pink sheets" or the OTC Bulletin Board, which was established for
securities that do not meet the NASDAQ SmallCap Market's listing requirements.
Consequently, selling our common stock would be more difficult because smaller
quantities of shares could be bought and sold, transactions could be delayed,
and security analysts' and news media's coverage of our company may be reduced.
These factors could result in lower prices and larger spreads in the bid and ask
prices for shares of common stock. Such NASDAQ delisting would also greatly
impair our ability to raise additional necessary capital through equity or debt
financing.
If our common stock is not listed on the NASDAQ SmallCap Market and/or the
Boston Stock Exchange, we may become subject to Rule 15g-9 under the Exchange
Act. That rule imposes additional sales practice requirements on broker-dealers
that sell low-priced securities to persons other than established customers and
institutional accredited investors. For transactions covered by this rule, a
broker-dealer must make a special suitability determination for the purchaser
and have received the purchaser's written consent to the transaction prior to
sale. Consequently, the rule may affect the ability of broker-dealers to sell
the common stock and affect the ability of holders to sell their shares of our
common stock in the secondary market.
The SEC's regulations define a "penny stock" to be any equity security that
has a market price less than $5.00 per share or with an exercise price of less
than $5.00 per share, subject to certain exceptions. The penny stock
restrictions will not apply to our shares if they are listed on the NASDAQ
SmallCap Market or the Boston Stock Exchange and we provide certain price and
volume information on a current and continuing basis, or meet required minimum
net tangible assets or average revenue criteria. There can be no assurance that
our shares of common stock will qualify for exemption from these restrictions.
If such shares were subject to the penny stock rules, the market liquidity for
the shares could be adversely affected.
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OUR STOCK PRICE HAS BEEN VOLATILE AND WILL LIKELY CONTINUE TO BE VOLATILE
Historically, our common stock has experienced low trading volumes. The
market price of our common stock also has been highly volatile and it may
continue to be highly volatile as has been the case with the securities of other
public biotechnology companies. Factors such as announcements by us or by our
competitors concerning technological innovations, new commercial products or
procedures, proposed government regulations and developments or disputes
relating to patents or proprietary rights may substantially affect the market
price of our securities. Changes in the market price of our common stock may
bear no relation to our actual operational or financial results.
WE HAVE NO ASSURANCE OF MARKET ACCEPTANCE FOR GENETIC SUSCEPTIBILITY TESTS
The commercial success of our genetic susceptibility tests and those that
we may develop will depend upon their acceptance as medically useful and
cost-effective by patients, physicians, dentists, other members of the medical
and dental community and insurers. Broad market acceptance can be achieved only
with substantial education about the benefits and limitations of such tests. It
is uncertain whether current genetic susceptibility tests or others that we may
develop will gain market acceptance on a timely basis. If patients, dentists and
physicians do not accept our tests, or take a longer time to accept than we
anticipate, then our revenues and profit margins will be reduced and may result
in additional losses.
WE ARE SUBJECT TO COMPETITION FROM COMPANIES WITH GREATER RESOURCES THAN US
Research in the field of disease predisposing genes and genetic markers is
intense and highly competitive. Genetic research is characterized by rapid
technological change. Our competitors in the United States and abroad are
numerous and include, among others, major pharmaceutical and diagnostic
companies, specialized biotechnology firms, universities and other research
institutions (including those receiving funding from the Human Genome Project).
Many of our potential competitors have considerably greater financial,
technical, marketing and other resources than us. These greater resources may
allow our competitors to discover important genes or genetic markers before us.
If we, in conjunction with the Department of Molecular and Genetic Medicine at
the University of Sheffield, U.K., do not discover disease predisposing genes or
genetic markers associated with increased disease severity, characterize their
function, develop susceptibility tests and related information services based on
such discoveries, obtain regulatory and other approvals, if needed, and launch
such services or products before competitors, then our revenues and earnings
will be reduced or eliminated. In addition, any of the susceptibility tests that
we may develop, including our periodontal susceptibility test, could be made
obsolete by less expensive or more effective tests or methods which may be
developed in the future. We expect competition to intensify in our industry as
technical advances are made and become more widely known.
WE ARE SUBJECT TO GOVERNMENT REGULATION
The sampling of blood, saliva or cheek scrapings from patients and
subsequent analysis in a clinical laboratory does not, at the present time,
require FDA or regulatory authority approval outside the U.S. for either the
sampling procedure or the analysis itself. The samples are taken in the
healthcare provider's office, using standard materials previously approved as
medical devices, such as sterile lancets and swabs. The testing procedure itself
is performed in one or more registered, certified clinical laboratories under
the auspices of the Clinical Laboratory Improvement Amendments of 1988 ("CLIA").
In general, the federal regulations promulgated pursuant to CLIA governing the
approval of laboratory facilities and applicable state and local regulations
governing the operation of clinical laboratories apply to our subsidiary which
operates a laboratory but not to Interleukin Genetics, Inc. Currently our
subsidiary operates an approved CLIA laboratory. Additionally, changes in
existing regulations could require advance regulatory approval of genetic
susceptibility tests which may result in a substantial curtailment or even
prohibition of our activities without regulatory approval if our tests ever
require regulatory approval, the costs of introduction will increase and
marketing and sales may be significantly delayed.
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Although our primary business is to develop genetic susceptibility testing
services, we may also develop or assist others to develop, drugs or other
treatments for the diseases related to our tests. The FDA and comparable
agencies in state and local jurisdictions and in foreign countries impose
substantial requirements upon the manufacturing and marketing of drug products
such as those potentially to be developed by our company or any partner. The
process of obtaining FDA and other required regulatory approvals is lengthy and
expensive. The time required for FDA approvals is uncertain and typically takes
a number of years, depending on the type, complexity and novelty of the product.
We may encounter significant delays or excessive costs in our efforts to secure
necessary approvals or licenses. Because certain of the products likely to
result from our research and development programs involve the application of new
technologies and will be based on new approaches, such products may be subject
to substantial additional review by various governmental regulatory authorities
and as a result, regulatory approvals may be obtained more slowly than for
products using more conventional technologies. There can be no assurance that
FDA approvals will be obtained in a timely manner, if at all. Any delay in
obtaining, or the failure to obtain, such approvals would adversely affect our
ability to generate product or product sales. Even if FDA approvals are
obtained, the marketing and manufacturing of drug products are subject to
continuing FDA and other regulatory review, and later discovery of previously
unknown problems with a product, manufacturer or facility may result in
restrictions on the product or manufacturer, including withdrawal of the product
from the market. Additional governmental regulations may be promulgated which
could delay regulatory approval of our potential products. We cannot predict the
impact of adverse governmental regulation which might arise from future
legislative or administrative action.
We intend to generate product revenues from sales outside of the United
States. Distribution of our testing services or products outside the United
States may be subject to extensive government regulation. These regulations,
including the requirements for approvals or clearance to market, the time
required for regulatory review and the sanctions imposed for violations, vary by
country. It is uncertain whether we will obtain regulatory approvals in such
countries or that we will be required to incur significant costs in obtaining or
maintaining our foreign regulatory approvals. Failure to obtain necessary
regulatory approvals or any other failure to comply with regulatory requirements
could result in reduced revenues and increased losses.
WE FACE PRODUCT LIABILITY EXPOSURE
Our business exposes us to potential liability risks inherent in the
testing and marketing of medical and dental related services or products. It is
uncertain whether liability claims will be asserted against us. We have product
and professional liability insurance which we believe provides coverage for the
testing and commercial introduction of our genetic susceptibility tests. It is
uncertain whether we will be able to maintain such insurance on acceptable
terms. Any insurance obtained may not provide adequate coverage against
potential liabilities. A liability claim, even one without merit, could result
in significant legal defense costs thereby increasing our expenses, lowering our
earnings and even resulting in losses.
OUR INDUSTRY HAS ETHICAL, LEGAL AND SOCIAL IMPLICATIONS
The prospect of broadly available genetic testing has raised issues which
are currently being widely discussed by the medical and scientific communities,
as well as other interested groups and organizations, regarding the appropriate
utilization and the confidentiality of information provided by such testing. The
recent movement towards discovery and commercialization of susceptibility tests
for assessing a person's likelihood of developing a chronic disease has also
focused public and legislative attention on the need to protect the privacy of
genetic assessment medical information. With the progression towards more
comprehensive record keeping by health insurers and managed care firms, this
need has led to a number of legal initiatives. The recently enacted federal
health insurance reform law (Health Insurance Portability Act of 1996)
recognizes the comparability of information obtained by genetic means to other
types of personal medical information. The law prohibits insurance companies
from refusing health insurance coverage to individuals on the basis of their
medical history, including "genetic information." This legislation also
prohibits employees from discrimination in hiring practices on the same basis.
This legislation indicates a trend to protect the privacy of patients while
allowing them to be screened for conditions which, can be prevented, reduced in
severity or cured. In the most extreme scenario, governmental authorities could,
for
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social or other purposes, limit the use of genetic testing or prohibit testing
for genetic susceptibility to certain conditions. For these reasons, we could
experience a delay or reduction in test acceptance. Such a delay or reduction
could reduce our revenues or result in losses.
We are taking a proactive stance in the ethical arena. Dr. Philip Reilly,
our Chief Executive Officer, is both an M.D. (certified specialist in clinical
genetics) and an attorney. He will advise us in the area of genetic testing and
its ethical, legal and clinical utility ramifications. Additionally, we are
currently advising doctors who administer our genetic susceptibility tests to
take special efforts to maintain the confidentiality of the test results. Our
intent is to avoid information about test results being disclosed to insurers
until issues regarding insurability have been fully analyzed and acted upon by
the appropriate legislative bodies.
WE DEPEND ON KEY PERSONNEL AND CONSULTANTS
Because of the specialized scientific nature of our business, we are highly
dependent upon our ability to attract and retain qualified management,
scientific and technical personnel. Our company will also be dependent upon the
ability to hire qualified marketing and sales personnel. Competition for
scientific, marketing and sales personnel is intense. Loss of the services of
Dr. Reilly, our Chief Executive Officer, or Dr. Kornman, our founder and Chief
Scientific Officer, could adversely affect our research and development programs
and susceptibility testing service business and could impede the achievement of
our business objectives. We do not maintain key man life insurance on any of our
personnel.
WE ARE SUBJECT TO INFLUENCE BY PRINCIPAL SHAREHOLDERS, OFFICERS AND DIRECTORS
As of March 1, 2001, our directors, executive officers and certain of their
affiliates beneficially owned approximately 20% of our outstanding Common Stock.
Accordingly, these shareholders, individually and as a group, may be able to
influence the outcome of shareholder votes, including votes concerning the
election of directors, the adoption or amendment of provisions in our
Certificate of Incorporation or By-Laws and the approval of certain mergers and
other significant corporate transactions, including a sale of substantially all
of our assets. Such control by existing shareholders could have the effect of
delaying, deferring or preventing a change in control.
WE ARE SUBJECT TO VARIOUS PROVISIONS THAT COULD DELAY OR PREVENT A CHANGE OF
CONTROL OF THE COMPANY
Our Board of Directors is authorized to issue up to 5,000,000 shares of
Preferred Stock and to determine the price, rights, preferences and privileges
of those shares without any further vote or action by our shareholders. The
rights of the holders of Common Stock will be subject to, and may be adversely
affected by, the rights of the holders of any shares of Preferred Stock that may
be issued in the future. While we have no present intention to issue shares of
Preferred Stock, such issuance, while providing desirable flexibility in
connection with possible acquisitions and other corporate purposes, could have
the effect of making it more difficult for a third party to acquire a majority
of our outstanding voting stock. In addition, such Preferred Stock may have
other rights, including economic rights, senior to the Common Stock. As a
result, the issuance of Preferred Stock could decrease the market value of the
Common Stock.
Our Articles of Incorporation provide that members of the Board of
Directors may be removed only for cause upon the affirmative vote of holders of
at least a majority of the shares of our outstanding capital stock entitled to
vote. Certain other provisions of our Amended and Restated Articles of
Incorporation could also have the effect of delaying or preventing changes of
control or in management. Such a delay or preventive effect could adversely
affect the price of our Common Stock.
ITEM 2. PROPERTIES
In 2000 we completed a move of our Corporate and Research and Development
offices from San Antonio, Texas to Waltham Massachusetts. The new offices are
located at 135 Beaver Street and contain approximately 4000 square feet.
17
19
Our former corporate headquarters and research and development offices,
located at 100 N.E. Loop 410, Suite 820, San Antonio, Texas, contain 8,131
usable square feet held under a lease expiring May 31, 2003 and has been
subleased by us until the expiration of this lease. We also lease space located
at 4400 MacArthur Boulevard, Suite 980, Newport Beach, California which contains
1,798 usable square feet and has been subleased until the expiration of the
original lease in April 2001.
ITEM 3. LEGAL PROCEEDINGS
We are not engaged in any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the year ended
December 31, 2000.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's Common Stock began trading on The NASDAQ SmallCap Market on
November 26, 1997 under the symbol "MSSI" and on the Boston Stock Exchange under
the symbol "MSI." In August 1999, the Company's Common Stock symbol changed to
"ILGN" on the NASDAQ SmallCap Market and "ILG" on the Boston Stock Exchange.
Prior to November 1997, there was no established trading market for the Common
Stock. The following table sets forth, for the periods indicated, the high and
low bid prices for the Common Stock, as reported by the NASDAQ SmallCap Market.
The quotations represent prices in the over-the-counter market between dealers
and securities, and do not include retail markup, markdown or commissions and
may not necessarily represent actual transactions.
HIGH LOW
2000: ------- ------
First Quarter........................................... $18.000 $6.060
Second Quarter.......................................... $10.563 $3.000
Third Quarter........................................... $ 6.500 $3.125
Fourth Quarter.......................................... $ 5.000 $2.250
HIGH LOW
1999: ------ ------
First Quarter............................................ $1.313 $0.406
Second Quarter........................................... $3.500 $0.781
Third Quarter............................................ $3.313 $1.500
Fourth Quarter........................................... $9.000 $1.875
NUMBER OF SHAREHOLDERS
As of March 20, 2001, there were approximately 146 record holders of the
Company's Common Stock.
DIVIDENDS
The Company has not declared any dividends to date and does not plan to
declare any dividends in the foreseeable future.
SALE OF UNREGISTERED SECURITIES
Previously reported.
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ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth financial data with respect to the Company
as of and for each of the five years ended December 31, 2000. The selected
financial data as of and for each of the five years ended December 31, 2000 have
been derived from the financial statements of the Company. The financial
statements and the reports thereon as of December 31, 2000 and 1999 and for the
years ended December 31, 2000, 1999 and 1998 are included elsewhere in this
Annual Report on Form 10-K. The information below should be read in conjunction
with the financial statements and Management's Discussion and Analysis of
Financial Condition and Results of Operations included in Item 7.
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
2000 1999 1998 1997 1996
----------- ------------ ----------- ----------- ---------
STATEMENT OF OPERATIONS DATA:
Revenue......................... 256,387 477,497 412,942 197,928 1,918,879
Cost of revenue................. 183,833 201,182 393,274 168,442 547,766
Gross Profit.................... 72,554 276,315 19,668 29,486 1,371,113
Operating Expenses:
Research and Development...... 2,167,409 3,570,845 2,799,220 1,223,468 958,249
Selling, general and
administrative............. 3,093,379 2,904,210 7,220,444 2,868,057 1,162,768
Total Operating Expenses...... 5,260,788 6,475,055 9,999,664 4,091,525 2,121,017
----------- ------------ ----------- ----------- ---------
Loss from operations............ (5,188,234) (6,198,740) (9,999,996) (4,062,039) (749,904)
Other Income (expense):
Interest income............... 280,298 107,446 379,054 53,889 8,561
Interest expense.............. (22,514) (59,189) (94,597) (485,062) (34,229)
Other income (expense)........ (48,377) 11,880 11,124 -- --
----------- ------------ ----------- ----------- ---------
Net loss........................ (4,978,827) (6,138,603) (9,704,415) (4,493,212) (775,572)
=========== ============ =========== =========== =========
Beneficial conversion
attributable to preferred
stock......................... -- (5,000,000) -- -- --
----------- ------------ ----------- ----------- ---------
Net loss applicable to common
stock......................... $(4,978,827) $(11,138,603) $(9,704,415) $(4,493,212) $(775,572)
=========== ============ =========== =========== =========
Basic and diluted net loss per
common share.................. (0.27) (1.15) (1.75) (1.19) (0.18)
Weighted average common shares
outstanding................... 18,315,320 9,720,621 5,540,895 3,773,474 4,288,436
AS OF DECEMBER 31,
--------------------------------------------------------------
2000 1999 1998 1997 1996
---------- ----------- ---------- ---------- ---------
SELECTED BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities......................... 5,448,101 2,656,116 2,432,271 1,212,772 55,966
Working capital (deficit)............ 4,457,828 1,967,943 1,462,748 11,186,863 (735,986)
Total assets......................... 5,694,511 3,176,159 3,672,890 12,823,376 311,962
Long term debt and capital lease
obligations, less current
portion............................ 46,989 99,246 604,507 580,739 200,834
Stockholders' equity (deficit)....... 4,493,805 2,153,178 1,846,348 11,286,889 (699,748)
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL OVERVIEW
Interleukin Genetics, Inc., a Delaware corporation is a functional genomics
company focused on personalized medicine. We believe that by identifying
individuals at risk for certain diseases and combining it with specific
therapeutic interventions, better healthcare decisions can be made, reducing
costs and greatly improving patient health outcomes. We have a growing portfolio
of patents covering the genetics of many common diseases and conditions,
including cardiovascular diseases, osteoporosis, complications of diabetes,
restenosis and periodontal disease.
We believe that one of the great challenges confronting medicine today is
to find the key to understanding why some people are more prone than others to
developing serious chronic diseases and why some people respond to medicine for
those diseases better than others. Until doctors are able to understand the
underlying causes for such variability in chronic diseases, the practice of
medicine will remain largely constrained to our current approach of prescribing
therapies based on broad, sweeping recommendations in which very large groups of
people with the same stage of disease all receive the same treatment. This
approach to medicine is, in many ways, quite impersonal and it is often
ineffective.
Until now, scientific study of chronic diseases has largely focused on
identifying factors that initiate or "cause" a disease. Common examples of such
factors include cholesterol in the case of heart disease, bacteria of the mouth
in the case of periodontal disease and reduced estrogen levels in the case of
osteoporosis. However, the mere presence of these initiating factors does not
mean a person will develop a disease. For example, everyone with a cholesterol
level considered high does not develop heart disease nor does everyone with a
normal cholesterol level avoid heart disease. Rather, the common diseases as we
know them only develop when our bodies respond to the initiating factors in a
way that results in a problem.
We believe that the recent expansion in understanding of human genetic
information coming from programs like the Human Genome Project will likely
change the impersonal way medicine is practiced forever. This is because the
response of an individual's body to the common disease initiating factors is
largely determined by their specific genes. By using the new tools of the
genomic era, scientists will be able to study how differences in a specific
individual's genetic information directs their body to respond to these disease
initiating factors in different ways. This is likely to be true both for
identifying who is most likely to develop one disease or another and who is most
likely to respond to one or another medicine. Since it is our genes that make us
unique, at least in the biologic sense, tailoring medical therapy based on
knowledge of our genetic tendencies will enable doctors to move beyond the one
size fits all approach to prescribing medicines and enable them to practice
medicine which is more "personalized" to each of us based upon our unique
genetic make-up.
Our first genetic test, PST(R), a test predictive of risk for periodontal
disease, is currently marketed in the United States, Europe and Israel. Other
products under development include tests predictive of risk for osteoporosis,
coronary artery disease, complications of diabetes and restenosis.
We have also developed and licensed medical research tools, including
BioFusion(R), to pharmaceutical and biotech companies. BioFusion is a computer
modeling system that integrates genetic and other sub-cellular behavior,
biological functions, and clinical symptoms to simulate complex diseases. This
system allows useful information to be derived from rapidly increasing databases
of gene expression being generated in companies and academic centers worldwide.
In August 2000, we entered into an agreement with Kenna Technologies, Inc.
("Kenna") whereby we granted Kenna a perpetual, non-exclusive license to certain
disease information system technology and to certain biological modeling
technology, including the Biofusion system mentioned above. In consideration for
these license rights, Kenna paid us a non-refundable initial licensing fee of
$80,000 and has agreed to pay royalties based upon net sales from certain of the
licensed technology, as defined, for periods ranging from five to ten years. We
are recognizing the initial licensing fee of $80,000 ratably over the term of
the agreement.
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We have followed a strategy of working with strategic partners at the
fundamental discovery stage. This strategy has given us access to discoveries
while reducing up-front research expenses. Since 1994, we have had a strategic
alliance with the Department of Molecular and Genetic Medicine at Sheffield
University ("Sheffield") in the United Kingdom. Under this alliance, Sheffield
has provided us with the fundamental discovery and genetic analysis from their
research laboratories, and we have focused on product development, including
clinical trials, and the commercialization of these discoveries. We have issued
475,000 shares of common stock to Sheffield and its investigators, which was
valued at $1,128,125 and was expensed in the third quarter of 1999. In addition,
we are required to issue Sheffield and its investigators 50,000 options to
purchase common stock each June 30th during the period of time the arrangement
is in place, and 10,000 additional options to purchase common stock each June
30th for each patent which is approved during the previous twelve months.
In December 2000, we entered into a license agreement with Hain
Diagnostika/ADS GmbH ("Hain") for the marketing, distribution and processing of
PST in all countries outside of North America and Japan. Hain has extensive
experience in commercializing genetic tests on its DNA-STRIP Technology Platform
in several fields as well as a specific commitment to marketing products
directly to dentists. Hain's central facility offers excellent turnaround times,
high quality laboratory operations and a sales and technical staff to support
clinical users.
In March 1999, we entered into an exclusive agreement with the Straumann
Company, a leading supplier of dental implants, to market and sell PST in the
United States and Puerto Rico. Straumann launched its PST promotional activities
in April 1999. In September 2000, we amended the Straumann agreement to be non-
exclusive and entered into an agreement with Kimball Genetics, Inc., who has
expertise in the processing and analysis of genetic tests and their results.
Under the terms of this agreement, Kimball has a co-marketing right with
Straumann and will process and analyze all PST tests in the United States and
Puerto Rico. We believe that through our various partners we have adequate
coverage in the sales, distribution and processing of PST. In the majority of
these agreements we receive a royalty for each test sold. Revenue for PST sales
has been $237,000, $457,000 and $390,000 for the years ended December 31, 2000,
1999 and 1998 respectively.
During 2000, we changed our strategy for marketing and distributing PST. We
no longer market, distribute or process the PST tests ourselves. We now use
third party marketers and distributors from whom we earn royalties. We believe
that while this will reduce revenues in the short-term it will also improve
margins and reduce operating costs.
RESULTS OF OPERATIONS
Comparison of Year Ended December 31, 2000 to Year Ended December 31, 1999
Revenue for the year ended December 31, 2000 was $256,387 as compared to
$477,497 for the year ended December 31, 1999, representing a decrease of
$221,110 or 46%. In June 1999 we received an up-front payment of $150,000 from
Dumex-Alpharma A/S for the rights to distribute our genetic susceptibility test
for periodontal disease PST(R) in nine European countries. We recognized $85,000
of this payment as revenue during 1999 and no revenue from this source during
2000. The decrease in revenue is also the result of an October 2000 change of
our method of distributing PST. Since October, we license the marketing rights
for PST and collect only royalties. This has reduced our per test revenue and
cost of revenues per test.
Cost of revenues was $183,833 for the year ended December 31, 2000 as
compared to $201,182 for the same period in 1999, representing a decrease of
$17,349 or 9%. This decrease is primarily the result of the decrease in revenue
discussed above. Gross margin decreased to 28% in 2000 from 58% in 1999
primarily as a result of the fee from Dumex-Alpharma A/S recognized in 1999
mentioned above.
For the year ended December 31, 2000, we had research and development
expenses of $2,167,409 as compared to $3,570,845 for 1999, a decrease of
$1,403,436 or 39%. This decrease was primarily due to $1,128,125 of non-cash
expense in 1999 associated with issuance of 475,000 shares of common stock to
the University of Sheffield and its investigators in conjunction with the new
arrangement entered into in October 1999. We expect clinical trial related
expenses to increase during 2000 and future periods.
21
23
For the year ended December 31, 2000, we had selling, general and
administrative expenses of $3,093,379 as compared to $2,904,210 for 1999, an
increase of $189,169 or 6%. The increase is primarily the result of costs of
approximately $200,000 associated with our relocation to Waltham, Massachusetts.
Interest income increased to $280,298 in 2000 from $107,446 in 1999, an
increase of $172,852 or 161%. This increase is attributable to the increase in
cash and investments resulting from the completion of private placements in
January and December 2000. The reduction in our debt obligations is the primary
reason for the decrease in interest expense from $59,189 in 1999 to $22,514 in
2000, a decrease of $36,675 or 62%.
Net loss applicable to common stock was $4,978,827 in 2000 compared to
$11,138,603 in 1999, a decrease of $6,159,776 or 55%. The decrease is due
primarily to a $5,000,000 charge in 1999 for the beneficial conversion feature
of preferred stock issued in our June 1999 Private Placement. Upon Shareholder
approval of the Private Placement in August 1999 all of the preferred stock
converted to common stock.
Comparison of Year Ended December 31, 1999 to Year Ended December 31, 1998
Revenue for the year ended December 31, 1999 was $477,497 as compared to
$412,942 for the year ended December 31, 1998, representing an increase of
$64,555 or 16%. The increase in revenue is primarily attributable to higher
average selling price for PST.
Cost of revenues was $201,182 for the year ended December 31, 1999 as
compared to $216,284 for the same period in 1998, representing a decrease of
$15,102 or 7%. This decrease was primarily attributable to lower laboratory
costs for processing PST tests. Gross margin improved to 58% from 48% due to the
higher average selling price of PST and the lower processing costs.
For the year ended December 31, 1999, we had research and development
expenses of $3,570,845 as compared to $2,799,220 for 1998, an increase of
$771,625 or 28%. This increase was due to $1,128,125 of non-cash expense
associated with issuance of 475,000 shares of common stock to the University of
Sheffield and its investigators in conjunction with the new arrangement entered
into in October 1999.
Selling, general and administrative expenses decreased for 1999 to
$2,904,210 from $7,200,444 in 1998, a decrease of $4,296,234 or 60%. The
decrease reflects the reduction in personnel, infrastructure and related costs
as we shifted from an internal sales staff to the use of outside distributors to
sell its PST tests.
Interest income decreased to $107,446 in 1999 from $379,054 in 1998. This
decrease is attributable to lower levels of cash and investments due to losses
from operations and a $585,992 reduction in our debt obligation. The reduction
in the debt obligation is also the primary reason for the interest expense
decreasing from $94,597 in 1998 to $59,189 in 1999, a decrease of $35,408 or
37%.
Net loss applicable to common stock increased to $11,138,603 in 2000 from
$9,508,275, an increase of $1,630,328, or 17% due to a $5,000,000 charge for the
beneficial conversion feature of preferred stock as discussed above.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2000, we had cash, cash equivalents and marketable
securities of $5,390,601. Cash, cash equivalents and marketable securities
generated interest income of $280,298 for the year ended December 31, 2000. In
January 2001, we sold in a private placement 1.2 million shares of Common Stock
for $2.50 per share and we issued to the purchasers warrants to purchase 600,000
shares of Common Stock exercisable at $3.00 per share. Approximately $3.0
million of net proceeds was received from issuance of common stock and warrants.
Net cash used in operating activities was $4,182,050 during the year ended
December 31, 2000 as compared to $4,662,099 used during 1999. Cash was used to
fund operating losses and was partially offset by increases in accounts payable
and accrued expenses and by non-cash charges from the issuance of stock and
stock options for services rendered.
22
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Investing activities used cash of $1,044,746 in 2000 and $1,510,184 in
1999. During the years ended December 31, 2000 and 1999, we used cash to
purchase marketable securities as we shifted excess cash from cash and cash
equivalents into marketable securities to earn a preferred interest rate.
Financing activities provided cash of $6,949,741 for the year ended
December 31, 2000 and $4,408,628 for the year ended December 31, 1999. During
2000, we received $7,010,103 in net proceeds from the issuance of common stock
and warrants, net of expenses. During 1999, we received $4,706,927 in net
proceeds from the issuance of convertible preferred stock and $380,545 in net
proceeds from the issuance of common stock. We made capital lease payments of
$67,474 in 2000 and $103,540 in 1999.
We currently do not have any commitments for material capital expenditures.
Our obligations at December 31, 2000 for capital lease obligations totaled
$95,649, of which $46,989 is classified as long-term and $48,660 is classified
as current. These capital lease obligations have mature through August 2003 at
various interest rates. We have entered into research agreements with Brigham
and Women's Hospital and Genome Therapeutics Corp. under which we have future
cash commitments of $210,000 and $502,000, respectively, at December 31, 2000.
We anticipate that our existing cash and cash equivalents, together with
anticipated interest income and revenue, will be sufficient to conduct
operations as planned until July 2002. However, our future capital requirements
are anticipated to be substantial, and we do not have commitments for additional
capital at this time. Such capital requirements are expected to arise from the
commercial launch of additional genetic tests, continued research and
development efforts, the protection of our intellectual property rights
(including preparing and filing of patent applications), as well as operational,
administrative, legal and accounting expenses. We plan to raise capital through
equity and/or debt issuance when, and if, such capital is available to us. THERE
IS NO ASSURANCE THAT WE WILL BE ABLE TO RAISE ANY ADDITIONAL CAPITAL. IF
ADDITIONAL AMOUNTS CANNOT BE RAISED AND WE ARE UNABLE TO SUBSTANTIALLY REDUCE
OUR EXPENSES, WE WOULD SUFFER MATERIAL ADVERSE CONSEQUENCES TO OUR BUSINESS,
FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND WOULD LIKELY BE REQUIRED TO
SEEK OTHER ALTERNATIVES UP TO AND INCLUDING PROTECTION UNDER THE UNITED STATES
BANKRUPTCY LAWS.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We maintain an investment portfolio consisting of securities of U.S
Treasury Notes. The securities held in our investment portfolio are short-term
and subject to minimal interest rate risk. Changes in interest rates affect the
fair market value of these securities. After a review of our marketable
securities as of December 31, 2000, we have determined that in the event of a
hypothetical ten percent increase in interest rates, the resulting decrease in
fair market value of our marketable investment securities would be insignificant
to the financial statements as a whole.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Company, together with the
Independent Auditors Report appears on pages F-2 through F-18 of this report.
See the "Index to Financial Statements" on page F-1 of this report.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
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PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
Information required under this Item will be contained in the Company's
Proxy Statement for its 2001 Annual Meeting, which is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
Information required under this Item will be contained in the Company's
Proxy Statement for its 2001 Annual Meeting, which is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required under this Item will be contained in the Company's
Proxy Statement for its 2001 Annual Meeting, which is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required under this Item will be contained in the Company's
Proxy Statement for its 2001 Annual Meeting, which is incorporated herein by
reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents Filed as Part of Report
1. Financial Statements:
The Consolidated Financial Statements of the Company and the related report
of the Company's independent public accountants thereon have been filed under
Item 8 hereof.
2. Financial Statement Schedules:
The information required by this item is not applicable.
3. Exhibits:
The exhibits listed below are filed as part of or incorporated by reference
in this report. Where such filing is incorporated by reference to a previously
filed document, such document is identified in parentheses. See the Index of
Exhibits included with the Exhibits filed as a part of this report.
EXHIBIT
NO. IDENTIFICATION OF EXHIBIT
- ------- -------------------------
2.1 Plan of Reorganization and Merger dated July 12, 2000 by and
between Interleukin Genetics, Inc., a Texas Corporation, and
Interleukin Genetics, Inc., a Delaware Corporation.
(incorporated herein by reference to Exhibit 2.1 of the
Company's Quarterly Report on Form 10-Q filed August 14,
2000).
3.1 Articles of Incorporation of the Company, as amended
(incorporated herein by reference to Exhibit 3.1 the
Company's Quarterly Report on Form 10-Q filed August 14,
2000).
3.2 Bylaws of the Company, as adopted on June 5, 2000
(incorporated herein by reference to Exhibit 3.2 the
Company's Quarterly Report on Form 10-Q filed August 14,
2000).
4.1 Form of Stock Certificate representing Common Stock, $.001
par value, of the Company (incorporated herein by reference
to Exhibit 4.1 the Company's Quarterly Report on Form 10-Q
filed August 14, 2000).
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EXHIBIT
NO. IDENTIFICATION OF EXHIBIT
- ------- -------------------------
4.2 Form of Representative's Warrant (incorporated herein by
reference to Exhibit 4.2 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
4.4 Form of Warrant Agreement (incorporated herein by reference
to Exhibit 4.5 of the Company's Registration Statement No.
333-37441 on Form SB-2 filed October 8, 1997).
4.5 Form of Warrant Certificate (incorporated herein by
reference to Exhibit 4.6 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
4.6 Warrant dated June 15, 1999, granted to Fine Equities, Inc.
(incorporated herein by reference to Exhibit 4.2 of the
company's Quarterly Report on Form 10-QSB field August 16,
1999).
10.1 Lease Agreement dated March 21, 1996, between the Company
and Koll Center Newport Number 9 (incorporated herein by
reference to Exhibit 10.14 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
10.2 Interleukin Genetics, Inc. 1996 Equity Incentive Plan
(incorporated herein by reference to Exhibit 10.17 of the
Company's Registration Statement No. 333-37441 on Form SB-2
filed October 8, 1997).
10.3 Amendment to the Interleukin Genetics, Inc. 1996 Equity
Incentive Plan (incorporated herein by reference to Exhibit
10.18 of the Company's Registration Statement No. 333- 37441
on Form SB-2 filed October 8, 1997).
10.4 Form of Stock Option Agreement (incorporated herein by
reference to Exhibit 10.19 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
10.5 Stock Option Exercise Agreement (incorporated herein by
reference to Exhibit 10.20 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
10.6+ Exclusive Independent Representative Agreement dated
December 1, 1997, between the Company and Medicadent, a
French corporation (incorporated herein by reference to
Exhibit 10.21 of the Company's Annual Report on Form 10-KSB
filed March 31, 1998).
10.7+ Distribution Agreement between the Company and The Straumann
Company dated March 25, 1999 (incorporated herein by
reference to Exhibit 10.2 of the company's Quarterly Report
on Form 10-QSB filed May 17, 1999).
10.8 Non-Qualified Stock Option Agreement dated June 1, 1999,
between the Company and Philip R. Reilly (incorporated
herein by reference to Exhibit 10.2 of the Company's
Quarterly Report on Form 10-QSB filed August 16, 1999).
10.9 Research and Technology Transfer Agreement dated effective
July 1, 1999, between the Company and the University of
Sheffield (incorporated herein by reference to Exhibit 10.1
of the Company's Quarterly Report on Form 10-QSB filed
November 15, 1999).
10.10+ Research Support Agreement dated effective July 1, 1999,
between the Company and the University of Sheffield
(incorporated herein by reference to Exhibit 10.2 of the
Company's Quarterly Report on Form 10-QSB filed November 15,
1999).
10.11+ Consulting Agreement dated effective July 1, 1999, between
the Company and Gordon Duff, PhD, FRCP (incorporated herein
by reference to Exhibit 10.3 of the Company's Quarterly
Report on Form 10-QSB filed November 15, 1999).
10.15 Non-Qualified Stock Option Agreement dated November 30, 1999
between the Company and Philip R. Reilly (incorporated
herein by reference to Exhibit 4.5 to the Company's
Registration Statement No. 333-32538 on Form S-8 filed March
15, 2000).
10.16 Employment Agreement dated December 1, 1999 between the
Company and Kenneth S. Kornman. (incorporated herein by
reference to Exhibit 10.25 of the Company's Annual Report on
Form 10-K filed April 15, 2000).
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EXHIBIT
NO. IDENTIFICATION OF EXHIBIT
- ------- -------------------------
10.17 Employment Agreement dated April 1, 2000 between the Company
and Philip R. Reilly. (incorporated herein by reference to
Exhibit 10.26 of the Company's Annual Report on Form 10-K
filed on April 15, 2000)
10.18 Lease Agreement between the Company and Clematis LLC.
(incorporated herein by reference to Exhibit 10.1 of the
Company's Quarterly Report on Form 10-QSB filed August 14,
2000).
10.19 First Amendment to a Commercial Lease Between the Company
and Clematis LLC. (incorporated herein by reference to
Exhibit 10.2 of the Company's Quarterly Report on Form
10-QSB filed August 14, 2000).
10.20 2000 Employee Stock Compensation Plan for the Company
(incorporated herein by reference to Exhibit 10.3 of the
Company's Quarterly Report on Form 10-QSB filed August 14,
2000).
10.21 Form of Nonqualified Stock Option Grant (incorporated herein
by reference to Exhibit 10.4 of the Company's Quarterly
Report on Form 10-QSB filed August 14, 2000).
10.22 Form of Incentive Stock Option Grant (incorporated herein by
reference to Exhibit 10.5 of the Company's Quarterly Report
on Form 10-QSB filed August 14, 2000).
10.23 Employment Agreement dated June 18, 2000 between the Company
and Fenel Eloi. (incorporated herein by reference to Exhibit
10.6 of the Company's Quarterly Report on Form 10-QSB filed
August 14, 2000).
10.24* Employment Agreement dated November 20, 2000 between the
Company and Paul Martha.
10.25 Purchase Agreement dated December 5, 2000 (incorporated
herein by reference to Exhibit 10.1 of the Company's
Registration Statement on Form 8-K filed March 7, 2001).
10.26 Registration Rights Agreement dated December 5, 2000
(incorporated herein by reference to Exhibit 10.2 of the
Company's Registration Statement on Form 8-K filed March 7,
2001).
10.27 Purchase Agreement dated January 26, 2001 (incorporated
herein by reference to Exhibit 10.3 of the Company's
Registration Statement on Form 8-K filed March 7, 2001).
10.28 Registration Rights Agreement dated January 26, 2001
(incorporated herein by reference to Exhibit 10.4 of the
Company's Registration Statement on Form 8-K filed March 7,
2001).
10.29 Consent, Waiver and Amendment Agreement dated January 26,
2001 (incorporated herein by reference to Exhibit 10.7 of
the Company's Registration Statement on Form 8-K filed March
7, 2001).
10.30 Warrant to purchase 330,000 shares dated January 26, 2001
(incorporated herein by reference to Exhibit 10.6 of the
Company's Registration Statement on Form 8-K filed March 7,
2001).
10.31 Warrant to purchase 160,000 shares dated January 26, 2001
(incorporated herein by reference to Exhibit 10.7 of the
Company's Registration Statement on Form 8-K filed March 7,
2001).
10.32 Warrant to purchase 110,000 shares dated January 26, 2001
(incorporated herein by reference to Exhibit 10.8 of the
Company's Registration Statement on Form 8-K filed March 7,
2001).
10.33 Warrant to purchase 264,407 shares dated January 26, 2001
(incorporated herein by reference to Exhibit 10.9 of the
Company's Registration Statement on Form 8-K filed March 7,
2001).
21.1 Subsidiaries of the Company
NAMES UNDER
WHICH SUBSIDIARY
NAME INCORPORATED DOES BUSINESS
- ---- ------------ ----------------
Medical Science Systems France E.U. ............. France N/A
Interleukin Genetics Laboratory Services,
Inc. .......................................... Delaware N/A
Interleukin Genetics, Inc. ...................... Delaware N/A
26
28
23.1* Consent of Arthur Andersen LLP
- ---------------
* Filed herewith.
+ Confidential treatment has been requested with respect to certain portions of
this exhibit. Omitted portions have been filed separately with the Securities
and Exchange Commission.
(b) Reports on Form 8-K
The Company filed a report on Form 8-K March 5, 2001 to report the
completion of two Private Placements of Common Stock completed on December 5,
2000 and January 26, 2001.
27
29
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INTERLEUKIN GENETICS, INC.
By: /s/ FENEL ELOI
--------------------------------------
Fenel Eloi
Chief Operating Officer, Chief
Financial Officer, Secretary and
Treasurer
Date: March 23, 2001
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the date indicated.
SIGNATURES TITLE DATE SIGNED
---------- ----- -----------
/s/ PHILIP R. REILLY Chairman of the Board of March 23, 2001
- -------------------------------------------------------- Directors and Chief
Philip R. Reilly Executive Officer
/s/ KENNETH S. KORNMAN President and Director March 23, 2001
- --------------------------------------------------------
Kenneth S. Kornman
/s/ FENEL ELOI Chief Financial Officer, March 23, 2001
- -------------------------------------------------------- Secretary & Treasurer
Fenel Eloi (PRINCIPAL FINANCIAL AND
ACCOUNTING OFFICER)
Director
- --------------------------------------------------------
Thomas A. Moore
/s/ EDWARD M. BLAIR, JR. Director March 23, 2001
- --------------------------------------------------------
Edward M. Blair, Jr.
Director
- --------------------------------------------------------
Gary L. Crocker
/s/ JOHN GAROFALO Director March 23, 2001
- --------------------------------------------------------
John Garofalo
28
30
INTERLEUKIN GENETICS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Operations....................... F-4
Consolidated Statement of Stockholders' Equity and
Comprehensive Loss........................................ F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
31
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Interleukin Genetics, Inc.:
We have audited the accompanying consolidated balance sheets of Interleukin
Genetics, Inc. (a Delaware corporation), as of December 31, 1999 and 2000, and
the related consolidated statements of operations, stockholders' equity and
comprehensive loss and cash flows for the three years in the period ended
December 31, 2000. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Interleukin Genetics, Inc.,
and subsidiaries as of December 31, 1999 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000 in conformity with accounting principles generally accepted in
the United States.
/s/ ARTHUR ANDERSEN LLP
--------------------------------------
Boston, Massachusetts
February 14, 2001
F-2
32
INTERLEUKIN GENETICS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
----------------------------
2000 1999
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 2,391,561 $ 668,616
Marketable securities..................................... 2,999,040 1,987,500
Accounts receivable, net of allowance for doubtful
accounts of $77,000 and $55,000 in 2000 and 1999,
respectively........................................... 46,870 103,002
Prepaid expenses and other current assets................. 174,074 132,560
------------ ------------
Total current assets.............................. 5,611,545 2,891,678
FIXED ASSETS, NET........................................... 68,853 284,481
OTHER ASSETS................................................ 14,113 --
------------ ------------
TOTAL ASSETS...................................... $ 5,694,511 $ 3,176,159
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 297,178 $ 134,968
Accrued expenses.......................................... 603,072 402,077
Deferred revenue.......................................... 204,807 322,812
Current portion of capital lease obligations.............. 48,660 63,877
------------ ------------
Total current liabilities......................... 1,153,717 923,734
CAPITAL LEASE OBLIGATIONS, LESS CURRENT PORTION............. 46,989 99,246
------------ ------------
Total liabilities................................. 1,200,706 1,022,980
------------ ------------
Commitments and contingencies (Note 11)..................... -- --
STOCKHOLDERS' EQUITY:
Preferred stock, no par value -- 5,000,000 shares
authorized; none issued or outstanding................. -- --
Common stock, $0.001 par value -- 50,000,000 shares
authorized; 19,067,427 and 17,223,302 shares issued and
19,042,800 and 17,223,302 outstanding in 2000 and 1999,
respectively........................................... 19,067 17,223
Treasury stock -- 24,627 shares in 2000 at cost........... (250,119) --
Additional paid-in capital................................ 35,702,628 28,160,643
Accumulated deficit....................................... (30,991,015) (26,012,188)
Other comprehensive income (loss)......................... 13,244 (12,499)
------------ ------------
Total stockholders' equity........................ 4,493,805 2,153,179
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........ $ 5,694,511 $ 3,176,159
============ ============
The accompanying notes are an integral part of these consolidated financial
statements
F-3
33
INTERLEUKIN GENETICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------
2000 1999 1998
----------- ------------ -----------
REVENUE............................................ $ 256,387 $ 477,497 $ 412,942
COST OF REVENUE.................................... 183,833 201,182 216,284
----------- ------------ -----------
GROSS PROFIT..................................... 72,554 276,315 196,658
----------- ------------ -----------
OPERATING EXPENSES:
Research and development......................... 2,167,409 3,570,845 2,799,220
Selling, general and administrative.............. 3,093,379 2,904,210 7,200,444
----------- ------------ -----------
Total operating expenses................. 5,260,788 6,475,055 9,999,664
----------- ------------ -----------
LOSS FROM OPERATIONS............................. (5,188,234) (6,198,740) (9,803,006)
----------- ------------ -----------
OTHER INCOME (EXPENSE):
Interest income.................................. 280,298 107,446 379,054
Interest expense................................. (22,514) (59,189) (94,597)
Other income (expense)........................... (48,377) 11,880 10,274
----------- ------------ -----------
Total other income....................... 209,407 60,137 294,731
----------- ------------ -----------
NET LOSS......................................... (4,978,827) (6,138,603) (9,508,275)
Beneficial conversion attributable to preferred
stock......................................... -- (5,000,000) --
----------- ------------ -----------
NET LOSS APPLICABLE TO COMMON STOCK.............. $(4,978,827) $(11,138,603) $(9,508,275)
=========== ============ ===========
BASIC AND DILUTED NET LOSS PER SHARE............... $ (0.27) $ (1.15) $ (1.72)
=========== ============ ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING......... 18,315,320 9,720,621 5,540,895
=========== ============ ===========
The accompanying notes are an integral part of these consolidated financial
statements
F-4
34
INTERLEUKIN GENETICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
PREFERRED STOCK COMMON STOCK ADDITIONAL
------------------------ ----------------------------- PAID-IN
SHARES AMOUNT SHARES $0.001 PAR VALUE CAPITAL
---------- ----------- ---------- ---------------- ---------------
BALANCE AS OF DECEMBER 31,
1997.......................... $ -- 5,540,895 $ 5,541 $16,646,658
Net loss........................ -- -- -- -- --
Common stock issued under
employee stock purchase
plan.......................... -- -- 7,575 7 5,726
Stock options issued for
services rendered............. -- -- -- -- 62,000
---------- ----------- ---------- ------- -----------
BALANCE AS OF DECEMBER 31,
1998.......................... -- -- 5,548,470 5,548 16,714,384
Net loss........................ -- -- -- -- --
Unrealized loss on securities... -- -- -- -- --
Comprehensive loss.............. -- -- -- -- --
Preferred stock issued in
private placement............. 2,200,000 4,706,927 -- -- --
Common stock issued:
Preferred stock conversion.... (2,200,000) (4,706,927) 11,000,000 11,000 9,695,927
For services rendered......... -- -- 475,000 475 1,127,650
Exercise of employee stock
options..................... -- -- 199,314 199 379,746
Employee stock purchase
plan........................ -- -- 518 1 599
Stock options issued for
services rendered............. -- -- -- -- 242,337
---------- ----------- ---------- ------- -----------
BALANCE AS OF DECEMBER 31,
1999.......................... -- -- 17,223,302 17,223 28,160,643
Net loss........................ -- -- -- -- --
Unrealized gain on securities... -- -- -- -- --
Comprehensive loss.............. -- -- -- -- --
Common stock issued:
Private placements............ -- -- 1,375,040 1,375 6,681,397
Cashless exercise of
warrants.................... -- -- 140,691 141 (141)
Exercise of employee stock
options..................... -- -- 326,835 327 577,691
Employee stock purchase
plan........................ -- -- 1,559 1 8,339
Employee stock option
compensation
for services rendered......... -- -- -- -- 274,699
Purchase of treasury stock...... -- -- -- -- --
---------- ----------- ---------- ------- -----------
BALANCE AS OF DECEMBER 31,
2000.......................... -- $ -- 19,067,427 $19,067 $35,702,628
========== =========== ========== ======= ===========
TREASURY STOCK OTHER
----------------------- ACCUMULATED COMPREHENSIVE
SHARES AMOUNT DEFICIT INCOME (LOSS) TOTAL
--------- ----------- ------------ ------------- -----------
BALANCE AS OF DECEMBER 31,
1997.......................... -- $ -- $ (5,365,310) $ -- $11,286,889
Net loss........................ -- -- (9,508,275) -- (9,508,275)
Common stock issued under
employee stock purchase
plan.......................... -- -- -- -- 5,733
Stock options issued for
services rendered............. -- -- -- -- 62,000
--------- ----------- ------------ -------- -----------
BALANCE AS OF DECEMBER 31,
1998.......................... -- -- (14,873,585) -- 1,846,347
Net loss........................ -- -- (6,138,603) -- (6,138,603)
Unrealized loss on securities... -- -- -- (12,499) (12,499)
-----------
Comprehensive loss.............. -- -- -- -- (6,151,102)
Preferred stock issued in
private placement............. -- -- -- -- 4,706,927
Common stock issued:
Preferred stock conversion.... -- -- (5,000,000) -- --
For services rendered......... -- -- -- -- 1,128,125
Exercise of employee stock
options..................... -- -- -- -- 379,945
Employee stock purchase
plan........................ -- -- -- -- 600
Stock options issued for
services rendered............. -- -- -- -- 242,337
--------- ----------- ------------ -------- -----------
BALANCE AS OF DECEMBER 31,
1999.......................... -- -- (26,012,188) (12,499) 2,153,179
Net loss........................ -- -- (4,978,827) -- (4,978,827)
Unrealized gain on securities... -- -- -- 25,743 25,743
-----------
Comprehensive loss.............. -- -- -- -- (4,953,084)
Common stock issued:
Private placements............ -- -- -- -- 6,682,772
Cashless exercise of
warrants.................... -- -- -- -- --
Exercise of employee stock
options..................... -- -- -- -- 578,018
Employee stock purchase
plan........................ -- -- -- -- 8,340
Employee stock option
compensation
for services rendered......... -- -- -- -- 274,699
Purchase of treasury stock...... (24,627) (250,119) -- -- (250,119)
--------- ----------- ------------ -------- -----------
BALANCE AS OF DECEMBER 31,
2000.......................... (24,627) $ (250,119) $(30,991,015) $ 13,244 $ 4,493,805
========= =========== ============ ======== ===========
F-5
35
INTERLEUKIN GENETICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------
2000 1999 1998
----------- ----------- -----------
CASH FLOW FROM OPERATING ACTIVITIES
Net loss.................................................. $(4,978,827) $(6,138,603) $(9,508,275)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 159,736 194,611 178,283
Unrealized gain (loss) on securities.................... 25,743 24,375 (219,082)
Issuance of stock options for services rendered......... 274,699 242,335 62,000
Issuance of stock for services rendered................. -- 1,128,125 --
Write down of patents................................... -- -- 886,534
Loss on disposal of fixed assets........................ 74,986 -- --
Other noncash expenses.................................. -- -- 31,272
(Increase) decrease in:
Account receivable, net................................. 56,131 22,084 (87,971)
Inventories............................................. -- -- 50,212
Prepaid expenses and other current assets............... (41,514) (5,134) (84,914)
Increase (decrease) in:
Accounts payable........................................ 162,210 (143,805) (271,414)
Accrued expenses........................................ 202,791 (33,578) 306,177
Deferred and prepaid revenue............................ (118,005) 47,491 202,320
----------- ----------- -----------
Net cash used in operating activities..................... (4,182,050) (4,662,099) (8,454,858)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of fixed assets................................. (19,093) (15,810) (216,597)
Increase in patents....................................... -- -- (443,520)
Increase in other assets.................................. (14,113) -- --
Purchases of marketable securities........................ (3,955,246) (4,024,374) --
Proceeds from maturity of investments..................... 2,943,706 2,530,000 5,696,795
----------- ----------- -----------
Net cash (used in) provided by investing activities....... (1,044,746) (1,510,184) 5,036,678
----------- ----------- -----------
CASH FLOW FROM FINANCING ACTIVITIES
Proceeds from private placements of common stock.......... 6,682,772 -- --
Proceeds from exercise of employee stock options.......... 578,018 379,945 5,734
Proceeds from sale of preferred stock..................... -- 4,706,927 --
Proceeds from employee stock purchase plan................ 8,340 600 --
Payments for shares returned to treasury stock............ (250,119)
Principal payments of notes payable....................... (1,797) 10,688 617,813
Principal payments of long-term debt...................... -- (585,992) (673,012)
Principal payments of capitalized lease obligations,
net..................................................... (67,473) (103,540) (105,143)
----------- ----------- -----------
Net cash provided by (used in) financing activities....... 6,949,741 4,408,628 (154,608)
----------- ----------- -----------
Net increase (decrease) in cash and equivalents............. 1,722,945 (1,763,655) (3,572,788)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 668,616 2,432,271 6,005,059
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 2,391,561 $ 668,616 $ 2,432,271
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest.................................... $ 22,514 $ 59,189 $ 94,597
Cash paid for income taxes................................ -- -- 1,660
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE ON NONCASH INVESTING AND FINANCING
ACTIVITY:
Cashless exercise of warrants............................. $ 61,840 $ -- $ --
=========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements
F-6
36
NOTE 1 -- COMPANY BACKGROUND AND UNCERTAINTIES
Organization and Line of Business
In August 1999, Medical Science Systems, Inc, was renamed Interleukin
Genetics, Inc. ("the Company").
The Company develops genetic diagnostic tests and medical research tools.
As of December 31, 2000, the Company has commercially introduced one such
product and is in various stages of development for several others.
Additionally, the Company provides research services under contract to
pharmaceutical companies. Such research services contributed less than 10% of
total revenue to the Company in 2000, 1999 and 1998.
The Company is subject to a number of risks and uncertainties, including
the need to raise additional capital to fund operations, research and
development efforts and commercialize its products. Since its inception, the
Company has incurred cumulative net losses of approximately $26.0 million,
including losses of approximately $5.0 million during 2000, $6.1 million during
1999 and $9.5 million during 1998.
During 2000, the Company raised approximately $7.0 million from two private
placements of common stock, warrants and stock option exercises. In January
2001, the Company completed a private placement of common stock and warrants
which raised an additional $3.0 million (see Note 7). The Company believes that
its current cash resources are more than adequate to fund operations through the
end of fiscal year 2001; however, absent additional equity or debt financing,
the Company also believes that these resources will be depleted in July 2002.
Commercial success of genetic susceptibility tests will depend upon their
acceptance as medically useful and cost-effective by patients, physicians,
dentists, other members of the medical and dental community, and third-party
payers. It is uncertain whether current genetic susceptibility tests or others
that the Company may develop will gain commercial acceptance on a timely basis.
Research in the field of disease predisposing genes and genetic markers is
intense and highly competitive. The Company has many competitors in the United
States and abroad that have considerably greater financial, technical,
marketing, and other resources available. If the Company does not discover
disease predisposing genes or genetic markers and develop susceptibility tests
and launch such services or products before their competitors, then revenues may
be reduced or eliminated.
The Company's ability to successfully commercialize genetic susceptibility
tests depends on obtaining adequate reimbursement for such products and related
treatment from government and private health care insurers and other third-party
payers. Doctors' decisions to recommend genetic susceptibility tests will be
influenced by the scope and reimbursement for such tests by third-party payers.
If both third-party payers and individuals are unwilling to pay for the test,
then the number of tests performed will significantly decrease, therefore
resulting in a reduction of revenues.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All material intercompany accounts and
transactions have been eliminated.
Management Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of revenues and expenses during the
reported periods. Actual results could differ from those estimates.
F-7
37
Revenue Recognition
Staff Accounting Bulletin No. 101 (SAB No. 101), Revenue Recognition, was
issued in December 1999. SAB No. 101 requires companies to recognize certain
up-front non-refundable fees and milestone payments over the life of the related
alliances when such fees are received in conjunction with alliances that have
multiple elements. The Company's adoption of this new accounting principle in
fiscal 2000 had no impact on the Company's consolidated financial statements.
Revenue from genetic susceptibility tests is recognized when the tests have
been completed and the results reported to the doctors. To the extent test kits
have been purchased but not yet submitted for test results, the Company defers
recognition of revenue. This amount is presented as deferred revenue in the
accompanying consolidated balance sheets. Contract revenues are recognized
ratably as services are provided based on a fixed contract price or on
negotiated hourly rates. Provision for anticipated losses on fixed-price
contracts is made in the period such losses are identified.
The Company has entered into agreements for the distribution of genetic
susceptibility tests, both domestically and internationally. Distributor fees
are received based on the terms of each agreement and are recognized ratably
over the applicable agreement period. Distributor fees received in advance
totaled $74,000 and $65,000 at December 31, 2000 and 1999, respectively.
Fees for the sale or licensing of product rights are recorded as deferred
revenue upon receipt and recognized as revenue on a straight line basis over the
period that the related products or services are delivered or obligations as
defined in the agreement are performed.
Revenue from milestone or other contingent payments is recognized as earned
in accordance with the terms of the related agreement. Royalties are recognized
as earned under the Company's royalty agreements when amounts are determinable
and payment is reasonably assured.
Research and Development
Research and development costs are expensed as incurred.
Basic and Diluted Net Loss per Common Share
The Company applies Statement of Financial Accounting Standards No. 128,
Earnings per Share ("SFAS 128"), which establishes standards for computing and
presenting earnings per share. Basic and diluted net loss per share was
determined by dividing net loss applicable to common stockholders by the
weighted average number of shares of common stock outstanding during the period.
Diluted loss per share is the same as basic loss per share for all the periods
presented, as the effect of the potential common stock equivalents is
antidilutive. Potential common stock excluded from the calculation of diluted
net loss per share consists of stock options and warrants as described in the
table below:
2000 1999 1998
--------- --------- ---------
Options outstanding............................... 1,826,943 1,722,130 1,174,383
Warrants outstanding.............................. 1,492,138 1,536,545 536,545
--------- --------- ---------
Total............................................. 3,319,081 3,258,675 1,710,928
========= ========= =========
Comprehensive Income (Loss)
Comprehensive income (loss) is defined as the change in equity of a
business enterprise during a period from transactions and other events and
circumstances from nonowner sources. Other than the reported net loss, the
Company had one item of comprehensive income (loss), which was unrealized
holding gains (losses) on marketable securities. Comprehensive income (loss) is
disclosed in the accompanying consolidated statements of shareholders' equity
and comprehensive loss.
F-8
38
Fair Value of Financial Instruments
The estimated fair values of financial instruments have been determined by
the Company using available market information and appropriate valuation
methodologies. The estimated fair values of cash and cash equivalents, accounts
receivable and accounts payable approximate fair value due to the short-term
nature of these instruments. Marketable securities are carried at fair market
value, as determined by current market values. The carrying amounts of the
Company's lease obligations also approximate fair value.
Cash Equivalents and Marketable Securities
Cash equivalents consist of short-term, highly liquid investments purchased
with remaining maturities of 90 days or less. Investments with an original
maturity of greater than 90 days are classified as marketable securities.
Marketable securities have been designated as available-for-sale and are stated
at market value with any unrealized holding gains or losses included as a
component of shareholders' equity and any realized gains or losses recorded in
the statement of operations in the period in which the securities are sold. The
amortized cost, unrealized gains (losses) and the fair value of marketable
securities available-for-sale as of December 31, 2000 and 1999 with maturity
dates ranging up to 12 months are as follows:
AS OF DECEMBER 31, 2000
UNREALIZED
SECURITY MATURITY COST GAIN (LOSS) FAIR VALUE
- -------- --------- ---------- ----------- ----------
U.S. Treasury Note......................... 6/30/2001 $1,987,500 $12,500 $2,000,000
U.S. Treasury Bill......................... 1/4/2001 998,296 744 999,040
---------- ------- ----------
Total...................................... $2,985,796 $13,244 $2,999,040
========== ======= ==========
AS OF DECEMBER 31, 1999
UNREALIZED
SECURITY MATURITY COST GAIN (LOSS) FAIR VALUE
- -------- --------- ---------- ----------- ----------
U.S. Treasury Note......................... 6/30/2001 $1,999,999 $(12,499) $1,987,500
Fixed Assets
Fixed assets are stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization are provided using the straight-line
method over the estimated useful lives of three to five years. Leasehold
improvements are amortized over the life of the lease or the estimated useful
life of the asset, whichever is shorter (see Note 5).
Long-Lived Assets
The Company applies the provisions of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
SFAS No. 121 requires that long-lived assets be reviewed for impairment by
comparing the undiscounted future cash flows of the assets with their carrying
amount. Any write-downs are to be treated as permanent reductions in the
carrying amount of the assets. The Company evaluates its long-lived assets for
impairment whenever events or changes in circumstances indicate that carrying
amounts of such assets may not be recoverable. Recoverability of assets to be
held and used is measured by a comparison of the carrying amount of an asset to
the future undiscounted net cash flows expected to be generated by the asset.
Based on such review, no impairment exists related to the Company's long-lived
assets at December 31, 2000.
Patents
The Company expenses patent costs as incurred as their realizability is
uncertain.
F-9
39
Stock-Based Compensation
Stock options issued to employees under the Company's stock option and
purchase plans are accounted for under Accounting Principles Board Opinion No.
25 (APB 25), Accounting for Stock Issued to Employees. All stock-based awards to
non-employees are accounted for at their fair value in accordance with SFAS No.
123, Accounting for Stock-Based Compensation, and Emerging Issues Task Force
(EITF) Issue No. 96-18, Accounting for Equity Instruments that are Issued to
Other than Employees.
Reclassifications
Certain amounts in the prior years have been reclassified to conform to the
current year's presentation.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) released SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No.
133 establishes standards for reporting and accounting for derivative
instruments, including derivative instruments embedded in other contracts, and
for hedging activities. It requires an entity to recognize all derivatives as
either assets or liabilities in its balance sheet and measure those instruments
at fair value. Pursuant to SFAS No. 137, Accounting for Derivative Instruments
and Hedging Activities-Deferral of the Effective Date of FASB Statement No. 133,
SFAS No. 133 is effective for all quarters of fiscal years beginning after June
15, 2000. The Company does not anticipate the adoption of SFAS No. 133 will have
a material impact on the Company's consolidated financial statements.
In March 2000, the FASB issued FASB Interpretation No. 44, Accounting for
Certain Transactions Involving Stock Compensation -- An Interpretation of APB
Opinion No. 25. The interpretation clarifies the application of APB Opinion No.
25 in specified events, as defined. The interpretation is effective July 1, 2000
but covers certain events occurring during the period after December 15, 1998,
but before the effective date. The adoption of this interpretation did not have
a material impact on the Company's consolidated financial statements.
NOTE 3 -- SHEFFIELD UNIVERSITY MASTER AGREEMENT
In July 1999, the Company entered into an agreement with Sheffield
University (Sheffield), whereby the Company will undertake the development and
commercialization of certain discoveries resulting from the Sheffield's
research. The agreement is non-cancelable for discoveries for which the parties
have reached a specific agreement, but may be terminated with or without cause
by either party upon six-months' notice with respect to new discoveries on which
the parties have not yet reached agreement. If Sheffield terminates the
agreement, such termination could make the discovery and commercial introduction
of new products more difficult or unlikely.
The agreement with Sheffield is a five-year agreement with an automatic
yearly renewal. In accordance with this agreement, the Company issued 275,000
shares of common stock to Sheffield for transferring all rights and title of
patents. The value of the common stock of $653,125 was expensed in the third
quarter of 1999. Additionally, each year beginning July 1, 2000, Sheffield will
receive 25,000 fully vested options to purchase common stock at the then current
market price, plus 10,000 fully vested options to purchase common stock for each
new patent application filed in the previous 12 months. During the year ended
December 31, 2000, 35,000 fully vested options to purchase common stock were
granted under this agreement and the Company recorded an expense of
approximately $114,000 based upon the value of the options using the
Black-Scholes option pricing model. These options have a five-year exercise
period. The Company signed another agreement to fund research with Sheffield for
research and development services which automatically renews in one-year
increments. The estimated cost of this agreement is approximately $111,000 per
year. Both agreements can be canceled if a certain key collaborator leaves
Sheffield.
In September 1999, a five-year consulting agreement was entered into with
Sheffield's key collaborator. In accordance with the consulting agreement, the
key collaborator received 200,000 shares of common stock for relinquishing
interests in previous research agreements. The value of the common stock of
$475,000 was
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40
expensed in the third quarter of 1999. The key collaborator will also receive 1%
of the first $4 million of net sales under the PST Technology and 2% for sales
above $4 million. During 2000, this collaborator received $3,925 in royalty
payments for sales of PST. On July 1, 2000, in consideration for future
services, the key collaborator received 25,000 fully vested options to purchase
common stock at the then current market price. These options have a five-year
exercise period from the date of grant. During 2000, the Company expensed
approximately $82,000 related to the issuance of these options based upon the
value using the Black-Scholes option pricing model. This collaborator will
continue to receive 25,000 fully vested options to purchase common stock each
July 1 during the period when this agreement is in effect.
NOTE 4 -- ACCOUNTS RECEIVABLE
The changes in the allowance for doubtful accounts consisted of the
following:
YEAR ENDED DECEMBER 31,
------------------------
2000 1999
---------- ----------
Beginning of year...................................... $ 55,000 $ 21,000
Provision charged to expense........................... 33,000 48,000
Accounts written off, net of recoveries................ (11,000) (14,000)
-------- --------
End of year............................................ $ 77,000 $ 55,000
======== ========
NOTE 5 -- FIXED ASSETS
The fixed assets' useful lives and balances at December 31, 2000 and 1999
consisted of the following:
USEFUL
LIFE 2000 1999
------------ -------- --------
Computer equipment............................... 3 years $ 44,898 $299,004
Lab equipment.................................... 5 years 6,578 6,578
Furniture and fixtures........................... 5 years 10,233 32,304
Office equipment................................. 3 years 7,259 37,769
Leasehold improvements........................... 5 years -- 60,310
Equipment under capital leases................... 3 to 5 years 173,563 377,627
-------- --------
242,531 813,592
Less -- Accumulated depreciation and
amortization................................... 173,678 529,111
-------- --------
TOTAL.................................. $ 68,853 $284,481
======== ========
During the 12 months ended December 31, 2000, fixed assets with a net book
value of approximately $75,000 were disposed of and written off. Most of the
write-off was in connection with assets which were not moved when the Company
relocated its operations to Waltham, Massachusetts.
NOTE 6 -- INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes, which requires the recognition of taxes payable or
refundable for the current year and deferred tax liabilities and assets for the
future tax consequences of events that have been recognized in the financial
statements or tax returns. The measurement of current and deferred tax
liabilities and assets is based on provisions of the enacted tax law; the
effects of future changes in tax laws or rates are not anticipated.
As of December 31, 2000, the Company had net operating loss (NOL) and
research tax credit carryforwards of approximately $23,300,000 and $317,000,
respectively, for federal income tax purposes, expiring in varying amounts
through the year 2020. The Company's ability to use its NOL and credit
carryforwards to reduce future taxes is subject to the restrictions provided by
Section 382 of the Internal Revenue Code of 1986 (the "Code"). These
restrictions provide for limitations on the Company's utilization
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41
of its NOL and credit carryforwards following a greater than 50% ownership
change during the prescribed testing period. As of December 31, 2000, the
Company had one such change. As a result, approximately $15,619,000 of the
Company's NOL carryforwards are limited in utilization to approximately $825,000
annually. The annual limitation will result in the expiration of certain of the
carryforwards prior to utilization.
As of December 31, 2000 and 1999, the approximate income tax effect of the
Company's deferred tax assets (liabilities) consisted of the following:
2000 1999
----------- -----------
Net operating loss carryforwards.................. $ 7,932,000 $ 6,374,000
Research tax credit carryforwards................. 317,000 187,000
Accrual to cash adjustments....................... 315,000 212,000
Stock options..................................... 157,000 90,000
Depreciation...................................... 33,000 22,000
Patents........................................... 39,000 61,000
----------- -----------
Total deferred tax assets............... 8,793,000 6,946,000
Valuation allowance............................... (8,793,000) (6,946,000)
----------- -----------
Net deferred tax assets........................... $ -- $ --
=========== ===========
Due to the uncertainty regarding the timing and realization of the
Company's net deferred tax asset, a full valuation allowance has been
established against the Company's deferred tax assets.
NOTE 7 -- CAPITAL STOCK
Authorized Common and Preferred Stock
At December 31, 2000, the Company had authorized 5,000,000 shares of
undesignated preferred stock of which none are outstanding. At December 31,
2000, the Company had authorized 50,000,000 shares of $0.001 par value common
stock of which 19,042,800 shares were outstanding and approximately 2.9 million
shares were reserved for the exercise of authorized and outstanding stock
options, approximately 1.3 million shares were reserved for the exercise of
authorized and outstanding warrants to purchase common stock and approximately
500,000 shares were reserved for the exercise of rights held under the Employee
Stock Purchase Plan.
Private Placements of Common Stock
In January 2001, the Company sold in a private placement 1.2 million shares
of common stock for $2.50 per share. The purchasers of common stock also
received warrants to purchase 600,000 shares of common stock exercisable at
$3.00 per share. The Company generated net proceeds of approximately $3.0
million from this transaction.
In December 2000, the Company sold in a private placement 542,373 shares of
common stock for $3.69 per share. The purchasers of common stock also received
warrants to purchase 135,593 shares of common stock exercisable at $4.83 per
share. The Company generated net proceeds of approximately $2.0 million from
this transaction. Under the terms of this private placement, the Company is
required to adjust the price per share paid in this offering, by issuing
additional shares, to match any offering price paid in subsequent financings
during the following 24 months. Following the January 2001 offering described
above, the Company issued an additional 257,627 shares of common stock to the
purchasers in the December 2000 private placement, and a new warrant to purchase
264,407 shares of common stock exercisable at a price of $3.13 to replace the
previously issued warrant to buy 135,593 shares of common stock.
In January 2000, the Company sold in a private placement 832,667 shares of
common stock, which generated net proceeds of approximately $4.7 million.
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42
Private Placement of Preferred Stock
Pursuant to a private placement that occurred in June 1999, the Company
issued 2,200,000 shares of its Series A Preferred Stock, no par value (Series A
Stock), for $5.0 million. In conjunction with this offering, the placement agent
received 200,000 shares of Series A Stock and a warrant to purchase 1,000,000
shares of common stock at an exercise price of $0.50 per share. This warrant
expires on June 16, 2004. Each share of the Series A Stock was automatically
converted into five shares of the Company's common stock at a conversion price
of $0.50 per share upon the approval of the private placement by the Company's
shareholders on August 20, 1999. On the closing date of the private placement,
the conversion price of the Series A Stock was less than the market price of the
common stock, which resulted in a beneficial conversion of $5 million which has
been recorded as a dividend to the preferred stockholders.
Employee Stock Purchase Plan
Effective October 14, 1998, the Company's Board of Directors approved an
Employee Stock Purchase Plan for qualified employees of the Company. Under the
terms of the Employee Stock Purchase Plan, an employee may purchase up to
$25,000 per calendar year of the Company's stock at a price equal to 85% of the
fair market value of the stock (as quoted on the NASDAQ national quotation
system) on either the first or last day of a calendar quarter. The Company has
reserved 500,000 shares of common stock for purchases to be made under the
Employee Stock Purchase Plan. During the years ended December 31, 2000 and 1999,
1,559 and 518 shares were purchased under the Employee Stock Purchase Plan at a
price of approximately $5.35 and $1.16 respectively, per share.
NOTE 8 -- STOCK OPTION PLAN
In June 2000, the Company's shareholders approved the adoption of the
Interleukin Genetics, Inc. 2000 Employee Stock Compensation Plan (the "2000
Plan"). The 2000 Plan provides for the award of nonqualified and incentive stock
options, restricted stock, and stock bonuses to employees, directors, officers,
and consultants of the Company. A total of 2,000,000 shares of the Company's
common stock have been reserved for award under the 2000 Plan of which
approximately 1,460,000 are available for grant at December 31, 2000.
In June 1996, the Company's shareholders approved the adoption of the
Medical Science Systems, Inc. 1996 Equity Incentive Plan (the "1996 Plan"). The
1996 Plan provides for the award of nonqualified and incentive stock options,
restricted stock and stock bonuses to employees, directors, officers and
consultants of the Company. A total of 1,300,000 shares of the Company's common
stock have been reserved for award under the 1996 Plan of which approximately
150,000 are available for grant at December 31, 2000.
Nonqualified and incentive stock options with a life of 10 years are
generally granted at exercise prices equal to the fair market value of the
common stock on the date of grant. Options generally vest over a period of four
to six years.
On October 14, 1998, the Company's Board of Directors voted to reduce the
exercise price for all outstanding options granted under the 1996 Plan to one
half of the previous price per share, but not to a price below $1.85 per share.
The close of the Company's common stock on the previous day was $1.25 per share.
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43
A summary of the status of the Company's stock options, issued both under
the 1996 and 2000 Plans and outside of these plans, at December 31, 2000, 1999
and 1998, and changes during these years is presented in the table and narrative
below:
The following table details activity under all option plans:
2000 1999 1998
-------------------------- -------------------------- --------------------------
WEIGHTED AVG WEIGHTED AVG WEIGHTED AVG
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
--------- -------------- --------- -------------- --------- --------------
Outstanding, beginning of
year.................... 1,722,130 $2.11 1,174,383 $2.20 792,640 $4.37
Granted................. 600,000 4.23 1,061,781 2.05 1,188,783 2.31
Exercised............... (326,835) 1.95 (199,314) 1.98 (--) --
Canceled................ (168,352) 2.12 (314,720) 2.15 (807,040) 4.37
--------- ----- --------- ----- --------- -----
Outstanding, end of
year.................... 1,826,943 $2.83 1,722,130 $2.11 1,174,383 $2.20
========= ===== ========= ===== ========= =====
Exercisable, end of
year.................... 1,108,684 $1.44 889,852 $1.99 387,502 $2.12
========= ===== ========= ===== ========= =====
The following table details further information regarding stock options
outstanding and exercisable at December 31, 2000:
STOCK OPTIONS OUTSTANDING
--------------------------------------------- STOCK OPTIONS EXERCISABLE
WEIGHTED AVG --------------------------
REMAINING WEIGHTED AVG WEIGHTED AVG
CONTRACTUAL LIFE EXERCISE EXERCISE
RANGE OF EXERCISE PRICE: SHARES (YEARS) PRICE SHARES PRICE
- ------------------------ --------- ---------------- -------------- --------- --------------
$0.50 - $0.99 275,398 9.41 $0.53 182,398 $0.55
$1.00 - $1.49 16,000 8.90 1.25 50,000 1.25
$1.50 - $1.99 134,145 7.26 1.81 132,200 1.81
$2.00 - $2.49 107,100 9.03 2.31 94,300 2.32
$2.50 - high end of range 1,294,300 9.78 3.48 649,786 3.30
--------- ---- ----- --------- -----
1,826,943 9.49 $2.83 1,108,684 $1.44
========= ==== ===== ========= =====
The Company applies the disclosure-only alternative of SFAS No. 123,
"Accounting for Stock-Based Compensation" (SFAS 123), which defines a
fair-value-based method of accounting for employee stock options or similar
equity instruments. Under the fair-value-based method, compensation cost is
measured at the grant date based on the value of the award and is recognized
over the service period of the award, which is usually the vesting period.
However, SFAS 123 also allows entities to continue to measure compensation costs
for employee stock compensation plans using the intrinsic value method of
accounting prescribed in APB 25. The Company has elected to continue to follow
the accounting prescribed by APB 25 and has made the required disclosures
prescribed by SFAS 123.
Had compensation cost for the Company's employee stock options been
determined consistent with SFAS 123, the Company's net loss applicable to common
stock and net loss per share would have been changed to the following pro forma
amounts.
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44
YEARS ENDED DECEMBER 31,
------------------------------------------
2000 1999 1998
----------- ------------ -----------
Net loss applicable to common stock
As Reported............................ $(4,978,827) $(11,138,603) $(9,508,275)
=========== ============ ===========
Pro Forma.............................. $(6,579,648) $(12,024,156) $(9,855,915)
=========== ============ ===========
Basic and diluted net
Loss per share
As Reported............................ $ (0.27) $ (1.15) $ (1.72)
Pro Forma.............................. (0.36) (1.24) (1.78)
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model, for a stock that does not pay dividends
with the following assumptions.
YEARS ENDED DECEMBER 31,
---------------------------------
2000 1999 1998
------- ----------- -------
Risk free interest rate............................. 5.17% 4.7% - 6.2% 5.5%
Expected life....................................... 7 years 7 years 7 years
Expected volatility................................. 242% 156% 143%
Using these assumptions, the weighted average grant date fair value of
options granted in 2000, 1999 and 1998 was $4.28, $2.48 and $1.39, respectively.
Because the SFAS 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years.
During 1998, the Company awarded nonqualified stock options to outside
consultants for services rendered. As a result, the Company recognized $62,000
in selling, general and administrative expense for the issuance of these
options. This amount represents the then fair market value of the services
rendered to the Company based on the consultants' usual and customary charges
for the services rendered.
NOTE 9 -- EMPLOYEE BENEFIT PLAN
In 1988, the Company adopted a profit sharing plan covering substantially
all of its employees. Under the profit sharing plan, the Company may, at the
discretion of the Board of Directors, contribute a portion of the Company's
current or accumulated earnings. In September 1998, the Company amended and
restated the profit sharing plan to include provisions for Section 401(k) of the
Internal Revenue Code, which allowed for pre-tax employee contributions to the
plan. Under the amended and restated plan, the Company may, at the discretion of
the Board of Directors, match a portion of the participant contributions.
Company contributions, if any, are credited to the participant's account and
vest over a period of four years based on the participant's initial service date
with the Company. During the year ended December 31, 2000, $10,726 was
contributed to the plan. During the years ended December 31,1999 and 1998, no
contributions were made to the plan.
NOTE 10 -- WARRANTS
In December 2000, in association with a private placement of common stock,
a warrant to purchase 135,593 shares of common stock exercisable at $4.83 was
issued. This warrant was canceled in January 2001 and replaced with a warrant to
purchase 264,407 shares of common stock exercisable at $3.13 (see Note 7).
In June 1999, in association with a private placement of preferred stock
(see Note 7), warrants to purchase 1,000,000 shares of common stock at $0.50 a
share were issued. Warrants to purchase 125,000 shares of common stock have been
exercised to date and warrants to purchase 875,000 shares remain outstanding.
In November 1997, in association with the Company's initial public offering
warrant to purchase 180,000 shares of common stock at $14.85 was issued. This
warrant remains outstanding.
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45
In August and September 1997, warrants to purchase 356,545 shares of common
stock at $5.50 were issued. Warrants to purchase 55,000 shares have been
exercised to date and warrants to purchase 301,545 shares remain outstanding.
NOTE 11 -- COMMITMENTS AND CONTINGENCIES
In July, 2000, the Company completed a move of its corporate and research
and development offices from San Antonio, Texas, to Waltham, Massachusetts. The
Company leases its office space under non-cancelable operating leases expiring
June 2005.
The Company's former corporate headquarters and research and development
offices, located in San Antonio, Texas, are held under a lease expiring May 31,
2003 and have been subleased by the Company until the expiration of this lease.
The Company's also leases space in Newport Beach, California, which has been
subleased by the Company until the expiration of the Company's original lease in
April 2001. The sublease income is aggregated with the net rent expense and
included in other income and expense in the consolidated statements of
operations.
The Company also leases certain office furniture and equipment under
capital lease obligations. Future minimum rental commitments, net of sublease
income, under lease agreements with initial or remaining terms of one year or
more at December 31, 2000, are as follows:
OPERATING CAPITAL
YEAR ENDING DECEMBER 31, LEASES LEASES
- ------------------------ --------- --------
2001................................................. $298,575 $ 64,041
2002................................................. 286,754 39,011
2003................................................. 189,011 14,795
2004................................................. 122,100 --
2005................................................. 61,050 --
-------- --------
$957,490 117,847
========
Less -- Amount representing interest................... 22,198
--------
Less -- Current portion................................ 48,660
--------
Long-term portion............................ $ 46,989
========
Included in furniture and equipment is capital leased equipment of $173,563
with accumulated depreciation of $135,814 at December 31, 2000.
Rent expense, net of sublease income, was $138,064, $199,346 and $220,587
for the years ended December 31, 2000, 1999 and 1998, respectively.
Employment Agreements
The Company has entered into employment agreements with certain key
employees of the Company which range from one to five years and provide for
severance ranging from three months to one year upon termination of employment.
NOTE 12 -- SEGMENT INFORMATION
The Company follows SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS 131) which establishes standards for
reporting information about operating segments in annual and interim financial
statements, and requires that companies report financial and descriptive
information about its reportable segments based on a management approach. SFAS
131 also establishes standards for related disclosures about products and
services, geographic areas and major customers. In applying the requirements of
this statement, each of the Company's geographic areas described below was
determined to be an operating segment as defined by the statement, but have been
aggregated as allowed by
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46
the statement for reporting purposes. As a result, the Company continues to have
one reportable segment, which is the development of genetic susceptibility tests
and therapeutic targets for common diseases.
During 2000, the Company closed its foreign operations. Therefore, the
Company no longer derives or reports any revenue or expense from outside of the
United States. As of December 31, 2000 and December 31, 1999, substantially all
of the assets of the Company were located in the United States.
The following table presents information about the Company by geographic
area:
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------
2000 1999 1998
----------- ----------- -----------
Total Revenues:
United States............................. $ 256,387 $ 281,239 $ 319,145
France.................................... -- 38,846 23,730
Other foreign............................. -- 157,412 70,067
----------- ----------- -----------
Total............................. $ 256,387 $ 477,497 $ 412,942
=========== =========== ===========
Operating Loss:
United States............................. $(5,188,234) $(3,650,968) $(7,576,319)
France.................................... -- (504,288) (563,337)
Other foreign............................. -- (2,043,484) (1,663,350)
----------- ----------- -----------
Total............................. $(5,188,234) $(6,198,740) $(9,803,006)
=========== =========== ===========
Concentrations of Risk
The Company sells products and provides contract services for customers
primarily in the United States and Europe and extends credit based on an
evaluation of the customer's financial condition, generally without requiring
collateral. The Company monitors its exposure for credit losses and maintains
allowances for anticipated losses. As of December 31, 2000 and December 31,
1999, no single customer accounted for more than 10% of the total accounts
receivable.
During the years ended December 31, 2000, 1999 and 1998, no one customer
accounted for more than 10% of total revenues. During the year ended December
31, 2000, the Company obtained lab services for its genetic susceptibility tests
from two companies whose services comprised approximately 29% and 24% of cost of
sales, respectively.
NOTE 13 -- ACCRUED EXPENSES
Accrued expenses consist of the following:
DECEMBER 31,
--------------------
2000 1999
-------- --------
Legal.................................................. $ 90,000 $ 90,000
Vacation............................................... 68,270 54,216
Other.................................................. 444,802 257,861
-------- --------
Total........................................ $603,072 $402,077
======== ========
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NOTE 14 -- SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following are selected quarterly financial data for the years ended
December 31, 2000 and 1999.
QUARTER ENDED
-----------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
2000 2000 2000 2000
----------- ----------- ------------- ------------
Revenue............................... $ 85,830 $ 82,119 $ 38,141 $ 50,297
Loss from operations.................. $(1,279,641) $(1,385,537) $(1,214,476) $(1,308,580)
Net loss.............................. $(1,246,036) $ (1289,637) $(1,130,255) $(1,312,899)
Basic and diluted net loss per
share............................... $ (0.07) $ (0.07) $ (0.06) $ (0.07)
QUARTER ENDED
-----------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1999 1999 1999 1999
----------- ----------- ------------- ------------
Revenues.............................. $ 92,738 $ 129,335 $ 140,179 $ 115,245
Loss from operations.................. $(1,204,450) $(1,153,108) $(2,640,745) $(1,200,437)
Net loss.............................. $(1,205,125) $(1,141,688) $(2,612,781) $(1,179,009)
Basic and diluted net loss per
share............................... $ (0.22) $ (0.43) $ (0.60) $ (0.07)
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