Back to GetFilings.com
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
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, 2001
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, WALTHAM, MA 02452
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER:
(781) 398-0700
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceeding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained in this form and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ]
As of March 18, 2002, the aggregate market value of the Registrant's Common
Stock held by non-affiliates, based upon the average bid and asked price of
$0.91 as of such date, was $17,032,039. Exclusion of shares held by any person
should not be construed to indicate that such person possesses the power, direct
or indirect to direct or cause the direction of management or policies of the
Registrant, or that this person is controlled by or under common control with
the Registrant. There were 21,427,699 shares of the Registrant's Common Stock
issued and outstanding as of March 18, 2002.
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 17, 2002, are incorporated
by reference in Part III hereof.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
ITEM 1: DESCRIPTION OF BUSINESS:
FORWARD LOOKING STATEMENTS
THIS REPORT ON FORM 10-K AND THE DOCUMENTS INCORPORATED BY REFERENCE WITHIN
THIS DOCUMENT CONTAIN CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT AND SECTION 21E OF THE SECURITIES EXCHANGE
ACT. STATEMENTS CONTAINED IN THIS REPORT THAT ARE NOT STATEMENTS OF HISTORICAL
FACT MAY BE DEEMED TO BE FORWARD-LOOKING STATEMENTS. WORDS OR PHRASES SUCH AS
"WILL LIKELY RESULT", "EXPECT", "WILL CONTINUE", "ANTICIPATE", "ESTIMATE",
"INTEND", "PLAN", "PROJECT", "OUTLOOK", OR SIMILAR EXPRESSIONS ARE INTENDED TO
IDENTIFY FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS ADDRESS OR MAY
ADDRESS THE FOLLOWING SUBJECTS:
- THE SUFFICIENCY OF OUR CURRENT CASH RESOURCES TO FUND OPERATIONS UNTIL
SEPTEMBER 2002;
- OUR EXPECTATION OF THE BENEFITS THAT WILL RESULT FROM THE ONGOING
RESEARCH PROGRAMS THAT OUTSIDE PARTIES ARE CONDUCTING ON OUR BEHALF;
- ANY EXPECTATION WE MAY HAVE REGARDING THE SUCCESS OF DEVELOPING PRODUCTS,
THE TIMING OF RELEASING PRODUCTS FOR SALE OR THE SUCCESS OF THESE
PRODUCTS WHEN THEY ARE RELEASED;
- OUR EXPECTATION OF THE BENEFITS THAT WILL RESULT FROM THE ONGOING
RESEARCH WE ARE FUNDING AT SHEFFIELD UNIVERSITY;
- OUR EXPECTATION THAT WE WILL CONTINUE TO EXPERIENCE LOSSES UNTIL OUR
GENETIC TESTING REVENUES GROW SUBSTANTIALLY FROM CURRENT LEVELS.
ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE EXPRESSED IN FORWARD-LOOKING
STATEMENTS. FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER FROM EXPECTATIONS
INCLUDE BUT ARE NOT LIMITED TO; RISKS RELATED TO MARKET ACCEPTANCE OF GENETIC
RISK ASSESSMENT TESTS IN GENERAL AND OUR PRODUCTS IN PARTICULAR, RISKS RELATED
TO TECHNOLOGY AND PRODUCT OBSOLESCENCE, DELAYS IN DEVELOPMENT OF PRODUCTS,
DEPENDENCE ON THIRD PARTIES, OUR ABILITY TO OBTAIN ADEQUATE CAPITAL, COMPETITIVE
RISKS AND THOSE RISKS SET FORTH WITHIN THE SECTION TITLED "FACTORS AFFECTING
FUTURE PERFORMANCE" BEGINNING ON PAGE 12 WITHIN THIS REPORT. WE CANNOT BE
CERTAIN THAT OUR RESULTS WILL NOT BE ADVERSELY AFFECTED BY ONE OR MORE OF THESE
FACTORS OR BY OTHER FACTORS NOT CURRENTLY ANTICIPATED. ALL INFORMATION SET FORTH
IN THIS FORM 10-K IS AS OF THE DATE OF THIS FORM 10-K. UNLESS REQUIRED BY LAW WE
ACCEPT NO RESPONSIBILITY TO UPDATE THIS INFORMATION.
GENERAL OVERVIEW
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 this knowledge 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
a number of common diseases and conditions.
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 differently 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 the 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.
1
However, the mere presence of these initiating factors does not always 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. 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 for identifying both who is
most likely to develop one disease or another but also for who is most likely to
respond to one or another medicine. It has long been recognized that individual
responses to most drugs vary from person to person in ways that may be
clinically very important yet are usually unpredictable. While one person may
receive great benefit from a drug at one dose, a second person may require 2-3
times that dose, while yet another may be unable to tolerate treatment due to
side effects even at the lowest dose. Until recently, the tools to unravel the
biological basis for this wide variability in drug response have been very
limited. In fact, doctors and their patients have been forced to accept that a
simple "trial and error" approach was the only effective way to select the most
appropriate therapy. However, because the ways that our bodies respond to drugs
are ultimately determined by our genes, a better understanding of the
interactions between our genes and the drugs we use holds the promise of ending
this non-specific way of prescribing medicines. 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.
Our first genetic test, PST(R), a test predictive of risk for periodontal
disease, is currently marketed in the United States and Europe. Other products
under development include tests predictive of risk for osteoporosis, coronary
artery disease and a test to determine the best drug treatment for advanced
cases of rheumatoid arthritis.
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.
We are currently developing new medical research tools which we hope will
contain detailed information regarding variations in the Interleukin-1 (IL-1)
gene cluster and the Tumor Necrosis Factor Alpha (TNF(alpha)) as they relate to
human inflammatory processes and diseases.
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 our Biofusion system. 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 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.
In December 2000, we entered into an exclusive seven-year 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
2
sales and technical staff to support clinical users. We can terminate this
agreement if certain minimum sales levels are not met.
In March 1999, we had 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. In September 2000, we amended this
agreement to be non-exclusive and we entered an agreement with Kimball Genetics,
Inc. for Kimball to process and analyze all PST tests in the United States and
Puerto Rico. In December 2001, the agreement with Straumann expired and was not
renewed. Kimball is now our sole marketing partner within the United States. We
believe that through our partners we have adequate coverage in the sales,
distribution and processing of PST. We do not expect the expiration of the
Straumann contract to have any impact on sales levels.
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 has reduced revenues in the short-term it has also improved margins and
reduced operating costs.
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. The information contained on our
website is not incorporated by reference into this Form 10-K. We have included
our website address only as an inactive textual reference and do not intend it
to be an active link to our website.
CURRENT FINANCIAL CONDITION
Since inception, we have incurred cumulative net losses of approximately
$30.5 million, including losses of approximately $4.5 million during 2001. For
the year ended December 31, 2001, we had negative cash flows from operating
activities of approximately $4.5 million and at December 31, 2001 we had cash
and cash equivalents of approximately $3.9 million.
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 $2.9 million from
this transaction. Under the terms of this private placement we are 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.
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 $1.9 million from this
transaction. Under the terms of this private placement we are 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.
We anticipate that our existing cash and cash equivalents, together with
anticipated revenue and interest income will be sufficient to conduct operations
as planned only until approximately September 2002. As a result, there is
significant doubt about our ability to continue as a going concern. 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
3
expenses. THERE IS NO ASSURANCE THAT WE WILL BE ABLE TO RAISE ADDITIONAL CAPITAL
ON TERMS ACCEPTIBLE TO US, IF AT ALL. 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 and risk
stratification tests and to improve health outcomes by linking these tests to
therapeutic interventions. We are also focused on developing genetic tests that
help identify patients most likely to respond to a specific drug. Our strategy
is to develop products for research and clinical use and to commercialize these
products through strategic collaborations. These products will include tests
that are predictive of disease risk and that identify patients' response to
therapy and functional biological information for use in drug development. We
intend to 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, and correlate them to
clinical utility in 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 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 IL-1.
It then activates multiple biochemical reactions that 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
GENETIC TESTING
Risk Assessment Tests
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, in the short-term we are focusing our development efforts only in the
areas of cardiovascular disease and osteoporosis. We introduced PST, a test
predictive of disease risk for severe gum diseases (periodontitis), commercially
in the U.S. in the fourth quarter of 1997. Clinical trials are ongoing in the
area of cardiovascular disease and osteoporosis. We expect one or more of these
studies will be completed by the end of 2002.
Risk Stratification Tests
A second area that we believe has great promise is the area of stratifying
the risk among patients with a particular disease or condition to predict which
patients will develop complications from their condition and
4
which will not. We are currently developing a test that we believe will allow
physicians to determine which diabetic patients are at high risk of developing
complications associated with cardiovascular disease.
Pharmacogenetics Tests
Pharmacogenetics is the linking of specific therapies to specifics in
genetic code. We believe that Pharmacogenetics represents the future of
medicine. With Pharmacogenetics, in the future, instead of all patients at a
specific stage of disease receiving the same treatment, a patient may be able to
first receive a genetic test to predict which treatment will be most effective.
We are currently developing a test to determine the best treatment for
patients in advanced stages of rheumatoid arthritis. We intend to do the
development work with a large health management organization and other academic
institutions during 2002 and a portion of 2003. We expect clinical trials to
begin early in 2002.
THERAPEUTICS
We are very interested in the prospect of developing therapeutics that will
be effective in the treatment of persons of a particular genotype. We are
actively investigating possible candidate compounds for those that may be most
promising to bring to market. These compounds may come from several sources,
including, (i) off-patent drugs that can be re-patented as a treatment for a
specific genotype, (ii) drugs that have failed their Phase III clinical trials
because they did not prove efficacious for the general population but might gain
approval if we were able to identify the specific patients for whom it will work
or (iii) new chemical entities which our greater understanding of genetics may
allow us to develop.
PHARMACOGENETIC TOOLS
We believe that the knowledge we have developed over the past several years
regarding the IL-1 gene cluster and other gene clusters can be developed into a
tool for researchers involved in study of inflammation and genetics and how they
relate to risk of disease and drug responses. We have developed and licensed
medical research tools, including our proprietary BioFusion system, to
pharmaceutical and biotech companies. We are currently receiving license and
royalty revenues from the sale of BioFusion. We are also developing a computer
model containing detailed structure, function and variation information of the
IL-1 gene cluster as they relate to human inflammatory processes and diseases.
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 $2,687,000, $2,167,000 and $3,571,000 on research and
development during the years ended December 31, 2001, 2000 and 1999,
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, that 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 that provide health care services, which 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.
5
- 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.
PRODUCT ON THE MARKET
TEST PREDICTIVE OF DISEASE RISK FOR PERIODONTAL DISEASE
Our first genetic susceptibility test, PST, identifies patients at risk for
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.
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 could
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 under the terms of a project agreement with 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, was completed during 2001.
The data from this study are currently being analyzed. It is hoped this data
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 could 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, we believe 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.
We are currently evaluating the use of PST as a tool to determine which
patients with gingivitis or early periodontitis should increase their frequency
of dental visits. We believe that not all patients with early signs of disease
will develop the full level of periodontitis in a short period of time. We
believe that PST can identify the patients most likely to have a high trajectory
of the disease.
PRODUCTS UNDER DEVELOPMENT
TEST PREDICTIVE OF DISEASE RISK FOR OSTEOPOROSIS
Osteoporosis, the most common age-related bone disease, results in a
decrease in the strength of the bone that leaves the affected individual more
susceptible to fractures. According to the National Institute of Health, 10
million Americans suffer from the disease and another 18 million have low bone
mass, placing them at increased risk for the disease. Although, osteoporosis
occurs in both men and women, it begins earlier and progresses more rapidly in
women, after menopause. The consequences of osteoporosis can be both physical
and financial. Hip and vertebral fractures, which are commonly associated with
osteoporosis, have a profound
6
impact on quality of life. Direct financial expenditures for the treatment for
osteoporotic fractures are estimated at $10 to $15 billion annually in the
United States alone.
We have conducted several collaborative research projects with major
osteoporosis epidemiologic centers. Results of these studies have indicated a
number of small variations in the IL-1 gene cluster, referred to as
polymorphisms, are associated with a more rapid rate of bone loss and an
increased risk of fracture in post-menopausal women. Currently, we are
confirming these results by additional, focused studies with national and
international osteoporosis epidemiologic study centers, with the ultimate
objective of developing a genetic predisposition test to determine a woman's
risk for vertebral fracture.
A genetic predisposition test could identify women at elevated risk for
developing osteoporosis-related vertebral fracture early in the course of the
disease and allow these women and their physicians to practice preventive
medicine. This will enable therapeutic intervention or recommendations for
changes in lifestyle or diet at an early stage, so that bone loss and fracture
is minimized or prevented.
We have completed extensive market research analyses, involving women's
focus groups, physician's and consumer's surveys which show there is enthusiasm
for such a test.
By the end of 2002, we anticipate completing one or more clinical studies
to confirm our initial results of association of polymorphisms in the IL-1 gene
cluster with signs and symptoms of osteoporosis.
TEST PREDICTIVE OF DISEASE RISK FOR COMPLICATIONS FROM DIABETES
Another genetic susceptibility test we are currently developing is a test
to determine susceptibility to complications from diabetes. These complications
include increased risk of cardiovascular disease, susceptibility to
sight-threatening retinopathy, kidney disease, and neuropathy, a nerve disease
that can result in the need to amputate a foot or leg.
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. According to the American
Diabetes Association, people with diabetes are 2-4 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. The American Diabetes Association
reports that total costs of diabetes care in 1997 were approximately $98 billion
with per capita health 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. We are 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, better-targeted therapy may be started sooner in an effort to
delay, or prevent, the complications before they develop.
If our diabetes program is successful we expect to have a test predictive
of cardiovascular complications from diabetes on the market early in 2003.
TEST TO DETERMINE THE MOST EFFECTIVE TREATMENT FOR RHEUMATOID ARTHRITIS
Rheumatoid Arthritis is a disease that affects approximately 2.1 million
Americans. The most common sufferers are women between the ages of 25 and 40
years old. According to the Arthritis Foundation 50% of people with rheumatoid
arthritis are on disability within ten years of the conditions onset. The final
drug treatments that are usually prescribed by physicians for patients with RA
are anticytokine treatments.
7
We are currently developing a test that we believe may help rheumatologists
select the best anticytokine therapy for each rheumatoid patient. Different
anticytokine therapies act very differently on a patient's biology. Two of the
three anticytokine therapies used to treat Rheumatoid Arthritis are anti-TNFa
drugs; the other affects the IL-1 gene. We believe that depending upon the
specific genetics of individual patients, it can be predicted which class of
drug would be most effective. Neither class of drug works for all individuals
and the cost of prescribing the incorrect drug is very high in terms of both
pain and suffering for the patient and increased cost of medical intervention.
We believe this test represents an excellent example of what the future of
personalized medicine may look like, with physicians first conducting genetic
tests to determine the best course of treatment before prescribing expensive,
invasive therapies that often may not be fully effective.
KNOWLEDGE DATABASE
We believe that the proprietary information and knowledge base we have
developed over the past several years regarding the IL-1 gene cluster and other
gene clusters can be developed into a tool for researchers involved in study of
inflammation, genetics and how these relate to risk of disease and to drug
responses. We are developing a user-friendly, web-based knowledge tool
containing detailed structure, function and variation information of the IL-1
gene cluster and other genes critical to the range of human inflammatory
processes. This tool, as we are developing it, will combine our extensive
proprietary database with selected non-proprietary data to create a
comprehensive base of knowledge. We plan to continue to develop this knowledge
base on the IL-1 and other regions of genetic code during 2002. We plan to begin
marketing access to this knowledge base to academic researchers, pharmaceutical
and biotechnology companies, drug manufacturers and nutraceutical companies as a
research tool in the near future.
TESTING PROCEDURE
Each of our genetic susceptibility tests requires 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 test's 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.
8
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.
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 our 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 an
aggregate of 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 that is filed on our behalf 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 were used be used in a study, sponsored by Washington Dental
Service, in collaboration with the University of Washington School of Dentistry
and us. The study was 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 and was completed in July 2001. It 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 are currently being analyzed.
KENNA TECHNOLOGIES, INC.
In November 2000, we issued 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 based upon sales of the product. 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
cancers.
KAISER PERMANENTE
In December 2001, we entered into a research collaboration with Kaiser
Permanente's Center for Health Research to study genetic risk factors for
chronic diseases that are affected by inflammation. We believe that
9
knowledge resulting from this work will enable us to develop new diagnostic
tools that physicians and health care organizations can use to assess their
patients' genetic risk for many diseases. The first product to be developed
under this collaboration will be a test to assess the risk of cardiovascular
complications from diabetes. We expect this program to be completed by the end
of 2002. We expect that we will be performing additional studies with Kaiser
during 2002.
PST COMMERCIAL PARTNERSHIPS
In December 2000, we entered into an exclusive seven-year 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. We can terminate this agreement if
certain minimum sales levels are not met.
In March 1999, we had 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. In September 2000, we amended this
agreement to be non-exclusive and we entered an agreement with Kimball Genetics,
Inc. to process and analyze all PST tests in the United States and Puerto Rico.
In December 2001, the agreement with Straumann expired and was not renewed.
Kimball is now our sole marketing partner within the United States. We believe
that through our partners we have adequate coverage in the sales, distribution
and processing of PST. We do not expect the expiration of the Straumann contract
to have any impact on sales levels.
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 nine issued U.S. patents, which
have projected expiration dates between 2015 and 2018 and have 20 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 nine issued patents, six relate to genetic tests for
periodontal disease, osteoporosis, asthma, coronary artery disease, sepsis and
disease associated with IL-1 inflammatory haplotypes and three 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 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
The genetics field is broad with diverse business segments. The field may
be generally segmented into: a) services, including sequencing, informatics,
etc.; b) technology platforms, including chip makers, genotyping equipment,
etc.; c) drug target and drug development companies; d) diagnostic companies
that will distribute DNA tests, and e) content companies that will discover
genes and gene variations that influence diseases and drug responses.
We are involved in the discovery and commercialization of genetic
variations that influence inflammatory diseases and the therapeutic responses to
these diseases. 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
10
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 Predictive Medicine, Genaissance Pharmaceuticals,
Variagenics and 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 genetic tests and related information services based on such
discoveries, obtain regulatory and other approvals, and launch these 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 Project 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-identification research for pharmaceutical companies for
therapeutic purposes, with genetic susceptibility testing being a secondary
goal. In contrast, 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 central 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 collected 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
11
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 our ability to receive royalties. Once
regulatory approval of a product is granted, the 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.
EMPLOYEES
As of March 18, 2002, we had 20 full-time and part-time employees. Of our
employees, 13 are engaged directly in the research, development and
commercialization of tests and 7 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
IF WE FAIL TO OBTAIN ADDITIONAL CAPITAL, OR OBTAIN IT ON UNFAVORABLE TERMS,
THEN WE MAY HAVE TO END OUR RESEARCH AND DEVELOPMENT PROGRAMS AND OTHER
OPERATIONS
We anticipate that our current financial resources are adequate to maintain
our current and planned operations through September 2002. If we cannot raise
additional capital prior to September 2002, we will be unable to fund our
business operations and will be required to seek other strategic alternatives or
we will be required to declare bankruptcy.
Our future capital needs depend on many factors. We will need capital for
the commercial launch of additional genetic tests, continued research and
development efforts, obtaining and protecting patents and administrative
expenses. Additional financing may not be available when needed, or, if
available, it may not be available on favorable terms. If we cannot obtain
additional funding on acceptable terms when needed, we may have to discontinue
operations, or, at a minimum, curtail one or more of our research and
development programs.
WE HAVE A HISTORY OF OPERATING LOSSES AND EXPECT THESE LOSSES TO CONTINUE IN
THE FUTURE
We have experienced significant operating losses since our inception and
expect these losses to continue for the foreseeable future. We incurred losses
from operations of $6.2 million in 1999, $5.2 million in 2000 and $4.8 million
in 2001. As of December 31, 2001, our accumulated deficit was $35.5 million. Our
losses result primarily from research and development and selling, general and
administrative expenses. We have not generated significant revenues from product
sales, and we do not know if we will ever generate significant revenues from
product sales. We will need to generate significant revenues to continue our
research and development programs and achieve profitability. We cannot predict
when, if ever, we will achieve profitability.
THE MARKET FOR GENETIC SUSCEPTIBILITY TESTS IS UNPROVEN
The market for genetic susceptibility tests is at an early stage of
development and may not continue to grow. Both we and the general scientific
community have only a limited understanding of the role of genes in predicting
disease. When we identify a gene or genetic marker that may predict disease, we
conduct clinical trials to confirm the initial scientific discovery and to
establish the scientific discovery's clinical utility in the marketplace. The
results of these clinical trials could limit or delay our ability to bring the
test to market, reduce the test's acceptance by our customers or cause us to
cancel the program, any of which limit or delay sales and cause additional
losses. The only genetic susceptibility test we currently market is PST, and it
has produced only minimal revenues to date. The marketplace may never accept our
products, and we may never
12
be able to sell our products at a profit. We may not complete development of or
commercialize our other genetic susceptibility tests.
The success of our 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 by third-party
payors, such as insurance companies and the government. We can achieve broad
market acceptance only with substantial education about the benefits and
limitations of genetic susceptibility tests. Our tests may not gain market
acceptance on a timely basis, if at all. If patients, dentists and physicians do
not accept our tests, or take a longer time to accept them than we anticipate,
then it will reduce our sales, resulting in additional losses.
WE RELY HEAVILY ON THIRD PARTIES TO PERFORM SALES, MARKETING AND DISTRIBUTION
FUNCTIONS ON OUR BEHALF, WHICH COULD LIMIT OUR EFFORTS TO SUCCESSFULLY MARKET
PRODUCTS
We have limited experience and capabilities with respect to distributing,
marketing and selling genetic susceptibility tests. We have relied and plan to
continue to rely significantly on sales, marketing and distribution arrangements
with third parties, over which we have limited influence. If these third parties
do not successfully market our products, it will reduce our sales and increase
our losses. If we are unable to negotiate acceptable marketing and distribution
agreements with future third parties, or if in the future we elect to perform
sales, marketing and distribution functions ourselves, we will incur significant
costs and face a number of additional risks, including the need to recruit
experienced marketing and sales personnel.
WE RELY HEAVILY ON THIRD PARTIES TO PERFORM RESEARCH AND DEVELOPMENT ON OUR
BEHALF, WHICH COULD LIMIT OUR EFFORTS TO SUCCESSFULLY DEVELOP PRODUCTS
We have limited research and development capabilities. In July 1999, we
entered into a new contractual arrangement with the University of Sheffield,
replacing the research and development agreement that had been in place since
1996. Under our arrangement with Sheffield, we will undertake the business
development and commercialization of discoveries resulting from Sheffield's
research. The agreement is non-cancelable for those discoveries on which
Sheffield and we have reached a specific business development agreement, but
otherwise either party can end the arrangement upon six months' notice. This
agreement with Sheffield has a five-year term with an automatic yearly renewal.
As part of this arrangement, we issued an aggregate of 475,000 shares of our
common stock to Sheffield and its researchers in exchange for patent rights and
other interests held by Sheffield and its researchers under our previous project
agreements. Our agreement with Sheffield requires us to fund agreed upon
research and development activities at the University of Sheffield on our behalf
based upon annual budgets. We also entered into a five-year consulting agreement
with Sheffield's key collaborator, Dr. Gordon Duff.
Reliance on third-party research and development entails risks we would not
be subject to if we performed this function ourselves. These risks include
reliance on the third party for regulatory compliance and quality assurance, the
possibility of breach of agreements by third parties because of factors beyond
our control and the possibility of terminations or nonrenewals of agreements by
third parties, based on their own business priorities, at times that are costly
or inconvenient for us. We may in the future elect to perform all research and
development ourselves, which will require us to raise substantial additional
funds and recruit additional qualified personnel.
IF WE ARE UNSUCCESSFUL IN ESTABLISHING ADDITIONAL STRATEGIC ALLIANCES, OUR
ABILITY TO DEVELOP AND MARKET PRODUCTS AND SERVICES WILL BE DAMAGED
Entering into strategic alliances for the development and commercialization
of products and services based on our discoveries is an important element of our
business strategy. We anticipate entering into additional collaborative
arrangements with Sheffield and other parties in the future. We face significant
competition in seeking appropriate collaborators. In addition, these alliance
arrangements are complex to
13
negotiate and time-consuming to document. If we fail to maintain existing
alliances or establish additional strategic alliances or other alternative
arrangements, then our ability to develop and market products and services will
be damaged. In addition, the terms of any future strategic alliances may be
unfavorable to us or these strategic alliances may be unsuccessful.
IF WE FAIL TO OBTAIN AN ADEQUATE LEVEL OF REIMBURSEMENT FOR OUR PRODUCTS OR
SERVICES BY THIRD-PARTY PAYORS, THEN OUR PRODUCTS AND SERVICES WILL NOT BE
COMMERCIALLY VIABLE
The availability and levels of reimbursement by governmental and other
third-party payors affect the market for any healthcare service. These
third-party payors continually attempt to contain or reduce the costs of
healthcare by challenging the prices charged for medical products and services.
Our ability to successfully commercialize our existing genetic susceptibility
test and others that we may develop depends on obtaining adequate reimbursement
from third-party payors. The extent of third-party payor reimbursement will
likely heavily influence physicians' and dentists' decisions to recommend
genetic susceptibility tests, as well as patients' elections to pursue testing.
If reimbursement is unavailable or limited in scope or amount, then we cannot
sell our products and services profitably. In particular, third-party payors
tend to deny reimbursement for services which they determine to be
investigational in nature or which are not considered "reasonable and necessary"
for diagnosis or treatment. To date, few third-party payors have agreed to
reimburse patients for genetic susceptibility tests, and we do not know if
third-party payors will, in the future, provide full reimbursement coverage for
these genetic tests. If third-party payors do not provide adequate reimbursement
coverage, then individuals may choose to directly pay for the test. If both
third-party payors and individuals are unwilling to pay for the tests, then the
number of tests we can sell will be significantly decreased, resulting in
reduced revenues and additional losses.
IF WE FAIL TO OBTAIN PATENT PROTECTION FOR OUR PRODUCTS AND PRESERVE OUR TRADE
SECRETS, THEN COMPETITORS MAY DEVELOP COMPETING PRODUCTS AND SERVICES, WHICH
WILL DECREASE OUR SALES AND MARKET SHARE
Our success will partly depend on our ability to obtain patent protection,
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 upon the proprietary rights of third
parties.
We own exclusive rights in nine issued U.S. patents and have 20 U.S. patent
applications pending. We have also been granted a number of corresponding
foreign patents and have a number of foreign counterparts of our U.S. patents
and patent applications pending. Our patent positions, and those of other
pharmaceutical and biotechnology companies, are generally uncertain and involve
complex legal, scientific and factual questions. Our ability to develop and
commercialize products and services depends on our ability to:
- Obtain patents;
- Obtain licenses to the proprietary rights of others;
- Prevent others from infringing on our proprietary rights; and
- Protect trade secrets.
Our pending patent applications may not result in issued patents or any
issued patents may never afford meaningful protection for our technology or
products. Further, others may develop competing products which avoid legally
infringing upon, or conflicting with, our patents. In addition, competitors may
challenge any patents issued to us, and these patents may subsequently be
narrowed, invalidated or circumvented.
We also rely on trade secrets and proprietary know-how that we seek to
protect, in part, by confidentiality agreements. The third parties we contract
with may breach these agreements, and we might not have adequate remedies for
any breach. Additionally, our competitors may discover or independently develop
our trade secrets.
14
THIRD PARTIES MAY OWN OR CONTROL PATENTS OR PATENT APPLICATIONS AND REQUIRE US
TO SEEK LICENSES, WHICH COULD INCREASE OUR COSTS OR PREVENT US FROM DEVELOPING
OR MARKETING OUR PRODUCTS OR SERVICES
We may not have rights under patents or patent applications which are
related to our current or proposed products. Third parties may own or control
these patents and patent applications in the United States and abroad.
Therefore, in some cases, to develop or sell any proposed products or services,
with patent rights controlled by third parties, our collaborators or we may
seek, or may be required to seek, licenses under third-party patents and patent
applications. If this occurs, we will pay license fees or royalties or both to
the licensor. If licenses are not available to us on acceptable terms, we or our
collaborators may be prohibited from developing or selling our products or
services.
If third parties believe our products or services infringe upon their
patents, they could bring legal proceedings against us seeking damages or
seeking to enjoin us from testing, manufacturing or marketing our products or
services. Any litigation could result in substantial expenses to us and
significant diversion of attention by our technical and management personnel.
Even if we prevail, the time, cost and diversion of resources of patent
litigation would likely damage our business. If the other parties in any patent
litigation brought against us are successful, in addition to any liability for
damages, we may have to cease the infringing activity or obtain a license.
TECHNOLOGICAL CHANGES MAY CAUSE OUR PRODUCTS AND SERVICES TO BE OBSOLETE
Our competitors may develop susceptibility tests that are more effective
than our technologies or that make our technologies obsolete. Innovations in the
treatment of the diseases in which we have products or product candidates could
make our products obsolete. These innovations could prevent us from selling, and
significantly reduce or eliminate the markets for, our products.
WE MAY BE DELISTED FROM NASDAQ RESULTING IN A LIMITED PUBLIC MARKET FOR OUR
COMMON STOCK AND VOLATILITY IN OUR STOCK PRICE
Our common stock is currently listed on the Nasdaq SmallCap Market and the
Boston Stock Exchange. During 1999, we received several notices from Nasdaq
stating that we were not in compliance with their continued listing
requirements. In addition, the price of our common stock has been extremely
volatile and has at times fallen below Nasdaq's $1.00 minimum bid price
requirement. If our stock price is below the minimum bid price requirement for
30 consecutive trading days, we would have 180 days to regain compliance with
this requirement or face delisting. Accordingly, we may not be able to maintain
our continued listing on the Nasdaq or the Boston Stock Exchange.
If Nasdaq or the Boston Stock Exchange delists our shares, then trading
would be conducted in the over-the-counter market in the so-called "pink sheets"
or the OTC Bulletin Board. Selling our common stock will be more difficult
because of reduced trading volume and transaction size, transactions could be
delayed, and security analysts' and news media's coverage, if any, of ILGN will
be reduced. These factors may result in lower prices and larger spreads in the
bid and ask prices for our shares. The delisting of our shares would also
greatly impair our ability to raise additional necessary capital through equity
or debt financing.
Historically, our common stock has experienced low trading volumes. The
market price of our common stock 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 are likely to affect the market price
of our common stock. Changes in the market price of our common stock may bear no
relation to our actual operational or financial results.
15
WE HAVE COMPLETED FINANCIAL TRANSACTIONS THAT MAY REQUIRE US TO ISSUE MORE
SHARES TO EXISTING SHAREHOLDERS WHICH WILL DILUTE THE VALUE OF THE STOCK
In December 2000 and January 2001 we sold in private placements a total of
2 million shares of our common stock for $2.50 per share and warrants to
purchase 864,407 shares of common stock exercisable at $3.00 and $3.13. Under
the terms of these private placements we are required to adjust downward the
price per share in the offering, by issuing additional shares, to match any
offering price paid in subsequent offerings during a 24-month period following
completion of the private placements. The price of our common stock has been
volatile and has recently been trading at or below $1.00 per share. This low
share price will make it very difficult to raise additional capital at a price
matching that of the private placements. Therefore, it is likely that we will
need to issue additional shares to the purchasers in these offerings, if we are
to raise additional capital. This might significantly dilute the value of the
outstanding common stock.
WE MAY BE PROHIBITED FROM FULLY USING OUR NET OPERATING LOSS CARRYFORWARDS,
WHICH COULD AFFECT OUR FINANCIAL PERFORMANCE
As a result of the losses incurred since inception, we have not recorded a
federal income tax provision and have recorded a valuation allowance against all
future tax benefits. As of December 31, 2001, we had net operating loss
carryforwards of approximately $27.9 million for federal and state income tax
purposes, expiring in varying amounts through the year 2021. We also had a
research tax credit of approximately $397,000 at December 31, 2001, that expires
in varying amounts through the year 2021. Our ability to use these net operating
loss and credit carryforwards is subject to restrictions contained in the
Internal Revenue Code which provide for limitations on our utilization of our
net operating loss and credit carryforwards following a greater than 50%
ownership change during the prescribed testing period. We experienced a change
in ownership interest in June 1999. As a result, approximately $15.6 million of
our net operating loss carryforwards are limited in utilization to approximately
$825,000 annually. The annual limitation may result in the expiration of the
carryforwards prior to utilization. In addition, in order to realize the future
tax benefits of our net operating loss and tax credit carryforwards, we must
generate taxable income, of which there is no assurance.
WE ARE SUBJECT TO INTENSE COMPETITION FROM COMPANIES, WHICH MAY DAMAGE OUR
BUSINESS
Our industry is highly competitive. Our competitors in the United States
and abroad are numerous and include 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 competitors have considerably greater financial resources, research
and development staffs, facilities, technical personnel, marketing and other
resources than we do. Furthermore, many of these competitors are more
experienced than we are in discovering, commercializing and marketing products.
These greater resources may allow our competitors to discover important genes or
genetic markers before we do. If we, in conjunction with the University of
Sheffield, do not discover disease predisposing genes and commercialize these
discoveries before our competitors, then our ability to generate sales and
revenues will be reduced or eliminated, and could make our products obsolete. We
expect competition to intensify in our industry as technical advances are made
and become more widely known.
WE ARE SUBJECT TO GOVERNMENT REGULATION WHICH MAY SIGNIFICANTLY INCREASE OUR
COSTS AND DELAY INTRODUCTION OF FUTURE PRODUCTS
The sale, performance or analysis of our genetic tests do not currently
require FDA or other federal regulatory authority approval. Changes in existing
regulations could require advance regulatory approval of genetic susceptibility
tests, resulting in a substantial curtailment or even prohibition of our
activities without regulatory approval. If our genetic tests ever require
regulatory approval, on either a state or federal level, then the costs of
introduction will increase and marketing and sales of products may be
significantly delayed.
16
WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS THAT ARE COSTLY TO DEFEND AND
THAT COULD LIMIT OUR ABILITY TO USE SOME TECHNOLOGIES IN THE FUTURE
The design, development, manufacture and use of our genetic susceptibility
tests involve an inherent risk of product liability claims and associated
adverse publicity. Producers of medical products face substantial liability for
damages in the event of product failure or allegations that the product caused
harm. We currently maintain product liability insurance, but it is expensive and
difficult to obtain, may not be available in the future on economically
acceptable terms and may not be adequate to fully protect us against all claims.
We may become subject to product liability claims that, even if they are without
merit, could result in significant legal defense costs. We could be held liable
for damages in excess of the limits of our insurance coverage, and any claim or
resulting product recall could create significant adverse publicity.
ETHICAL, LEGAL AND SOCIAL ISSUES RELATED TO GENETIC TESTING MAY REDUCE DEMAND
FOR OUR PRODUCTS
Genetic testing has raised issues regarding the appropriate utilization and
the confidentiality of information provided by genetic testing. Genetic tests
for assessing a person's likelihood of developing a chronic disease have focused
public attention on the need to protect the privacy of genetic assessment
medical information. For example, concerns have been expressed that insurance
carriers and employers may use these tests to discriminate on the basis of
genetic information, resulting in barriers to the acceptance of genetic tests by
consumers. This could lead to governmental authorities prohibiting genetic
testing or calling for limits on or regulating the use of genetic testing,
particularly for diseases for which there is no known cure. Any of these
scenarios would decrease demand for our products and result in substantial
losses.
OUR DEPENDENCE ON KEY EXECUTIVES AND SCIENTISTS COULD ADVERSELY IMPACT THE
DEVELOPMENT AND MANAGEMENT OF OUR BUSINESS
Our success substantially depends on the ability, experience and
performance of our senior management and other key personnel. If we lose one or
more of the members of our senior management or other key employees, it could
damage our development programs and our business. In addition, our success
depends on our ability to continue to hire, train, retain and motivate skilled
managerial and scientific personnel. The pool of personnel with the skill that
we require is limited. Competition to hire from this limited pool is intense. We
compete with numerous pharmaceutical and health care companies, as well as
universities and nonprofit research organizations in the highly competitive
Boston, Massachusetts business area. Loss of the services of Dr. Philip R.
Reilly, our Chairman and CEO, Dr. Kenneth Kornman, our President, or Dr. Paul M.
Martha, our Chief Medical Officer, could delay our research and development
programs and damage our business. We have entered into employment agreements
with three to five year terms with Drs. Reilly, Kornman and Martha. Any of these
employees can terminate his employment upon 30 days notice. We do not maintain
key man life insurance on any of our personnel.
BECAUSE OUR PRINCIPAL SHAREHOLDERS, OFFICERS AND DIRECTORS CONTROL A LARGE
PERCENTAGE OF OUR VOTING POWER, OTHER STOCKHOLDERS' VOTING POWER MAY BE
LIMITED
As of February 28, 2002, our directors, executive officers and certain of
their affiliates beneficially owned approximately 18% 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. These shareholders may make decisions that are adverse to other
shareholders' interests. This ownership concentration may also adversely affect
the market price of our common stock.
17
WE DO NOT EXPECT TO PAY DIVIDENDS FOR THE FORESEEABLE FUTURE AND YOU SHOULD
NOT EXPECT TO RECEIVE ANY FUNDS WITHOUT SELLING YOUR SHARES, WHICH YOU MAY
ONLY BE ABLE TO DO AT A LOSS
We have never declared or paid any cash dividends on our capital stock. We
currently intend to retain any earnings for use in the operation and expansion
of our business and do not anticipate paying any cash dividends on our common
stock in the foreseeable future. Therefore, you should not expect to receive any
funds without selling your shares, which you may only be able to do at a loss.
ITEM 2. PROPERTIES
In 2000 we completed a move of our Corporate and Research and Development
offices from San Antonio, Texas to Waltham, Massachusetts. Our offices are
located at 135 Beaver Street and contain approximately 6,000 square feet of
space. Our lease on this space expires in June 2006.
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.
ITEM 3. LEGAL PROCEEDINGS
We are not currently a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the year ended December 31, 2001.
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.
HIGH LOW
------ ------
2001:
First Quarter............................................. $3.594 $1.344
Second Quarter............................................ $3.150 $1.125
Third Quarter............................................. $3.100 $1.390
Fourth Quarter............................................ $2.250 $1.100
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
18
NUMBER OF SHAREHOLDERS
As of March 18, 2002, there were approximately 140 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 on its common stock in the foreseeable future.
SALE OF UNREGISTERED SECURITIES
On July 1, 2001, the Company issued an option to purchase 35,000 shares of
common stock, $.001 par value (the "Sheffield Option"), at a per share exercise
price of $2.85 to the University of Sheffield, U.K. ("Sheffield") and an option
to purchase 25,000 shares of common stock, $.001 par value (the "Duff Option"),
at a per share exercise price of $2.85 to Sheffield's key investigator, Dr.
Gordon Duff. The Sheffield Option was issued pursuant to the Company's
collaborative arrangement with Sheffield and the Duff Option was issued pursuant
to a consulting agreement between the Company and Dr. Duff. Under the terms of
the arrangement with Sheffield, the Company is to grant to Sheffield on each
July 1 during the term of the arrangement options to purchase 25,000 shares of
common stock of the Company and options to purchase an additional 10,000 shares
of common stock of the Company for each patent application filed during the
preceding 12 months. Under the terms of the consulting agreement with Dr. Duff,
the Company is obligated to grant Dr. Duff on each July 1 during the term of the
agreement options to purchase 25,000 shares of common stock of the Company. The
Sheffield Option and the Duff Option are exercisable for a period of five years
from the date of grant. The Sheffield Option and Duff Option were not registered
under the Securities Act of 1933, as amended (the "Securities Act"), pursuant to
Section 4(2) of the Securities Act and Regulation D promulgated thereunder, and
pursuant to Rule 903 and Rule 904 of regulation S. The Company relied on certain
representations and warranties of Sheffield and Dr. Duff, including among other
things, their ability to evaluate the merits and risks of an investment in the
Company's securities, their status as "accredited investors" (as that term is
defined in Rule 501 (a) of Regulation D), that their residence, domicile and/or
principal corporate office is Sheffield, England and the securities were
acquired solely for their own account for investment and not with a view to
distribution..
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, 2001. The selected
financial data as of and for each of the five years ended December 31, 2001 have
been derived from the financial statements of the Company. The financial
statements and the related reports as of December 31, 2001 and 2000 and for the
years ended December 31, 2001, 2000 and 1999 are included elsewhere in this
Annual Report on Form 10-K. The information below should be read
19
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,
--------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ----------- ------------ ----------- -----------
STATEMENT OF OPERATIONS
DATA:
Revenue.................... $ 202,942 $ 256,387 $ 477,497 $ 412,942 $ 197,928
Cost of Revenue............ 48,674 183,833 201,182 216,284 168,442
----------- ----------- ------------ ----------- -----------
Gross Profit............... 154,268 72,554 276,315 196,658 29,486
Operating Expenses:
Research and
development........... 2,686,621 2,167,409 3,570,845 2,799,220 1,223,468
Selling, general and
administrative........ 2,244,274 3,093,379 2,904,210 7,220,444 2,868,057
----------- ----------- ------------ ----------- -----------
Total operating
expenses.............. 4,930,895 5,260,788 6,475,055 9,999,664 4,091,525
----------- ----------- ------------ ----------- -----------
Loss from operations....... (4,776,627) (5,188,234) (6,198,740) (9,803,006) (4,062,039)
Other income (expense):
Interest income.......... 263,435 280,298 107,446 379,054 53,889
Interest expense......... (9,818) (22,514) (59,189) (94,597) (485,062)
Other income (expense)... 304 (48,377) 11,880 10,274 --
----------- ----------- ------------ ----------- -----------
Net loss................... $(4,522,706) $(4,978,827) $ (6,138,603) $(9,508,275) $(4,493,212)
=========== =========== ============ =========== ===========
Beneficial conversion
attributable to preferred
stock.................... -- -- (5,000,000) -- --
----------- ----------- ------------ ----------- -----------
Net loss applicable to
common stock............. $(4,522,706) $(4,978,827) $(11,138,603) $(9,704,415) $(4,493,212)
=========== =========== ============ =========== ===========
Basic and diluted net loss
per common share......... $ (0.21) $ (0.27) $ (1.15) $ (1.75) $ (1.19)
=========== =========== ============ =========== ===========
Weighted average common
shares outstanding....... 21,049,437 18,315,320 9,720,621 5,540,895 3,773,474
=========== =========== ============ =========== ===========
AS OF DECEMBER 31,
--------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
SELECTED BALANCE SHEET DATA:
Cash, cash equivalents and
marketable securities.......... $3,922,736 $5,390,601 $2,656,116 $2,432,271 $1,212,772
Working capital.................. 3,270,667 4,457,828 1,967,943 1,462,748 11,186,863
Total assets..................... 4,393,126 5,694,511 3,176,159 3,672,890 12,823,376
Long term debt and capital lease
obligations, less current
portion........................ 11,091 46,989 99,246 604,507 580,739
Stockholders' equity............. 3,550,548 4,493,805 2,153,178 1,846,348 11,286,889
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL 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
20
certain diseases and combining this knowledge 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 a number of common diseases and conditions.
Our first genetic test, PST(R), a test predictive of risk for periodontal
disease, is currently marketed in the United States and Europe. Other products
under development include tests predictive of risk for osteoporosis, coronary
artery disease and a test to determine the best drug treatment for advanced
cases of rheumatoid arthritis.
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.
We are currently developing new medical research tools which we hope will
contain detailed information regarding variations in the Interleukin-1 (IL-1)
gene cluster and the Tumor Necrosis Factor Alpha (TNF(alpha)) as they relate to
human inflammatory processes and diseases.
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 our Biofusion system. 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. We have issued
475,000 shares of common stock to Sheffield and its investigators, which was
valued at $1,128,125 and was charged to research and development expense 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 an exclusive seven-year 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. We can terminate this agreement if
certain minimum sales levels are not met.
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. In September 2000, we amended this agreement to
be non-exclusive and we entered an agreement with Kimball Genetics, Inc. for
Kimball to process and analyze all PST tests in the United States and Puerto
Rico. In December 2001 the agreement with Straumann expired and was not renewed.
Kimball is now our sole marketing partner within the United States. We believe
that through our partners we have adequate coverage in the sales, distribution
and processing of PST. We do not expect the expiration of the Straumann contract
to significantly decrease sales levels. Revenue for PST sales has been $186,000,
$237,000 and $457,000 for the years ended December 31, 2001, 2000 and 1999
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
21
we earn royalties. We believe that while this has reduced revenues in the
short-term it has also improved margins and reduced operating costs.
RESULTS OF OPERATIONS
COMPARISON OF YEAR ENDED DECEMBER 31, 2001 TO YEAR ENDED DECEMBER 31, 2000
Revenue for the year ended December 31, 2001 was $202,942 as compared to
$256,387 for the year ended December 31, 2000, representing a decrease of
$53,445 or 21%. In the year ended December 31, 2001, the Company recorded
revenue based on 4,012 PST tests processed compared to 1,209 PST tests processed
during the year ended December 31, 2000. Gross profit margin in 2001 was 76%
compared to 28% for the year earlier period.
The decrease in revenue and cost of revenue and the improvement in gross
margin was the result of a change in our strategy for marketing, distributing
and processing PST in 2000. We no longer market, distribute or process PST tests
ourselves. We now use third parties to perform these functions on our behalf and
we earn a royalty on end-user sales. The decrease in revenue was partially
offset by revenue produced by a study of PST that was conducted by Washington
Dental University. The number of processed tests associated with this study was
1,150. This study ended in July 2001 and revenue from this source has not
continued after that time.
For the year ended December 31, 2001, the Company had research and
development expenses of $2,686,621 compared with $2,167,409 for the same period
in 2000, representing an increase of $519,212 or 24%. The increase was due to
increases in personnel costs and increases in the cost of outside research
projects. The 2001 expense included approximately $597,000 for outside research
projects. These projects related to DNA sequencing and an investigation of the
genetic control of inflammatory responses. The total compares to approximately
$354,000 for outside research projects during the same period of 2000.
We have recently completed a research project with Genome Therapeutics,
Inc. to provide us with DNA sequencing information, including identifying SNP
(Single Nucleotide Polymorphism) variations in the region of the IL-1 genes. The
program focused on those key genes in this very specific chromosomal region that
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.
We have begun a new research project with Genome Therapeutics to provide
DNA sequencing information within the TNF) (Tumor Necrosis Factor alpha) gene.
We believe that the understanding of variations within this gene group will
further our understanding of how a small area of genetic code, which primarily
relates to diseases of inflammation, affects individual risk of specific common
diseases. It is expected that this study will be completed within the first half
of 2002.
We are also funding research at Sheffield University in support of several
research projects including the following: A study to determine the haplotypes,
or sets of genetic variations that are inherited together, that exist within the
IL-1 gene cluster; A study to discover novel drug targets for inflammatory
diseases by discovering genes involved in the responses of cells after they have
been activated by IL-1; the development of a system that measures the net IL-1
biologic activity of blood or any tissue fluid and the discovery of the genetic
variations that control patient to patient differences in inflammatory
mechanisms. We believe that the completion of these studies will greatly enhance
our understanding of the IL-1 gene cluster and the relationship of this gene
cluster to inflammatory responses and disease risk. During 2001, we funded
$244,000 for research completed at Sheffield, including related payments to
collaborators at Sheffield, compared to $273,000 in 2000.
During 2001, we substantially completed the physical construction of our
new research laboratory located at our corporate offices at 135 Beaver Street in
Waltham, Massachusetts. The lab became operational during February of 2002. The
cost of construction of the laboratory was approximately $250,000. We plan to
undertake the following research activities within the laboratory:
- Identification of functional SNPs: A project to determine which of the
SNPs within the IL-1 gene cluster leads to an alteration in the
expression of the IL-1 genes.
22
- Create IL-1 genotype and haplotype specific cell models that can be used
for studying drug responses. These models will be critical proprietary
reagents for the analyses of genotype related drug response for use in
future partnerships and collaborative projects for the development of new
drugs.
- Investigate IL-1 genotype and haplotype influences on the expression of
inflammatory response genes derived from tissues of individuals with
diseases that we are studying clinically.
During the calendar year 2002 we anticipate undertaking additional research
projects in the areas of rheumatoid arthritis, osteoporosis, complications from
Diabetes and Alzheimer's disease. We anticipate total research and development
expenses, including clinical costs, to be between $4 and $5 million for the
calendar year 2002. Actual costs may vary from this estimate as a result of
changes in technology, the success of current and future research projects, the
success or failure of our current or future strategic alliances and
collaborations, the identification of new business opportunities and our ability
to raise additional capital. We have not made an attempt to finalize an estimate
of our research and development expenses for beyond 2002 due to the factors
listed above.
Selling, general and administrative expenses were $2,244,274 during the
year ended December 31, 2001 compared to $3,093,379 during the same period last
year, a decrease of $849,105 or 27%. The decrease was primarily the result of a
reduction in administrative, sales and marketing expense related to the sale and
distribution of PST. As mentioned above, we no longer market, sell, distribute
or process PST directly. We now use third parties to perform these activities on
our behalf. This has significantly reduced our operating expenses as they relate
to PST.
Interest income during 2001 was $263,435 compared to $280,298 during 2000.
This decrease was due entirely to the lower interest rates in 2001 in comparison
with 2000. Interest expense of $9,818 was incurred during the year ended
December 31, 2001, compared to $22,514 during 2000.
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 2000, we license the marketing
rights for PST and collect only royalties. This has reduced our revenue and cost
of revenues per test but has increased our gross profit margin.
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.
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%.
23
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.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2001, we had cash and cash equivalents of $3,922,736.
Cash, cash equivalents and marketable securities generated interest income of
$263,435 for the year ended December 31, 2001. Net cash used in operating
activities was $4,545,967 during the year ended December 31, 2001 as compared to
$4,182,050 used during 2000. Cash was used primarily to fund operating losses.
Investing activities provided cash of $2,736,973 in 2001 and used cash of
$1,044,746 in 2000. During the year ended December 31, 2001 cash was provided
from the maturity of marketable securities. During 2000 we used cash to purchase
marketable securities as we shifted excess cash from cash and cash equivalents
into marketable securities to earn a higher interest rate.
Financing activities provided cash of $3,340,169 for the year ended
December 31, 2001 and $6,949,741 for the year ended December 31, 2000. During
2001, we received $2,911,267 in net proceeds from the issuance of common stock
and warrants, net of expenses and $476,199 from the exercise of warrants and
employee stock options. During 2000, we received $6,682,772 in net proceeds from
the issuance of common stock and warrants, net of expenses and $578,018 from the
exercise of warrants and employee stock options. We made capital lease payments
of $54,342 in 2001 and $67,473 in 2000.
We currently do not have any commitments for material capital expenditures.
Our obligations at December 31, 2001 for capital lease payments totaled $41,307,
of which $11,091 is classified as long-term and $30,216 is classified as
current. These capital lease obligations mature through August 2003 at various
interest rates.
We anticipate that our existing cash and cash equivalents, together with
anticipated interest income and revenue, will be sufficient to conduct
operations as planned only until September 2002. As a result, there is
significant doubt about our ability to continue as a going concern. We are
actively pursuing additional capital investment; 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 ADDITIONAL CAPITAL ON TERMS
ACCEPTABLE TO US, OR AT ALL. 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.
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are described in Note 2 to the
consolidated financial statements included in this report. We believe our most
critical accounting policies are in the areas of revenue recognition, cost
estimations of certain ongoing research contracts and our decision to expense
all patent related costs as incurred.
REVENUE RECOGNITION:
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
24
results, we defer recognition of revenue. This amount is presented on our
balance sheet as deferred revenue. Contract revenues are recognized ratably as
services are provided based on a fixed contract price or on negotiated hourly
rates. 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.
COST ESTIMATES:
Much of our research and development is done on contract by outside
parties. It is not unusual that at the end of an accounting period we need to
estimate both the total cost of these projects and the percent of that project
which was completed as of the accounting date. We then need to adjust those
estimates when actual final invoices are received. To date, these adjustments
have not been material to our financial statements, and we believe that the
estimates that we made as of December 31, 2001 are reflective of the actual
expenses incurred as of that date. However, readers should be cautioned that the
possibility exists that certain research projects might cost more than we have
estimated and that these higher costs will be reflected in future periods.
PATENT EXPENSES:
We have made the decision to expense patent expenses as incurred due to the
possibility that we will never be able to derive any benefits from our patents.
As noted in the section titled Intellectual Property on page 10 of this report
we have exclusive rights in nine issued U.S. patents and have twenty pending
U.S. patents applications. We have also been granted a number of corresponding
foreign patents and we have a number of foreign counterparts of our U.S. patents
and patent applications pending. Since inception we have expensed close to $2
million in the effort to obtain patent protection for our intellectual property
including $300,000 during the year ended December 2001. If we had decided to
record the costs of developing patent protection as an intangible asset on the
balance sheet it would have had a material effect on the presentation of our
financial statements. In future periods we may decide to change this
presentation as the realizability of return on this investment becomes more
certain.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
As of December 31, 2001, the only financial instruments we carried were
cash and cash equivalents. We believe the market risk arising from holding these
financial instruments is not material.
Some of our sales occur outside the United States and are transacted in
foreign currencies. Accordingly, we are subject to exposure from adverse
movements in foreign currency exchange rates. At this time we do not believe
this risk is material and we do not currently use derivative financial
instruments to manage foreign currency fluctuation risk. However, if foreign
sales increase and the risk of foreign currency exchange rate fluctuation
increases, we may in the future consider utilizing derivative instruments to
mitigate these risks.
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.
25
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 2002 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 2002 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 2002 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 2002 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).
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).
26
EXHIBIT
NO. IDENTIFICATION OF EXHIBIT
- ------- -------------------------
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+ 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).
10.7@ 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).
10.8 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).
10.9+ 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).
10.10+ 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).
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).
27
EXHIBIT
NO. IDENTIFICATION OF EXHIBIT
- ------- -------------------------
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. (incorporated herein by reference
to Exhibit 10.24 of the Company's Annual Report on Form 10-K
filed March 26, 2001).
10.25 Purchase Agreement dated December 5, 2000 (incorporated
herein by reference to Exhibit 10.1 of the Company's Current
Report 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 Current Report 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 Current
Report 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 Current Report 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 Current Report 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 Current Report 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 Current Report 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 Current Report 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 Current Report on Form 8-K filed March 7, 2001).
10.34* Amendment to the Lease Agreement between the Company and
Clematis LLC.
21.1* Identification of Exhibit Subsidiaries of the Company.
23.1* Consent of Arthur Andersen LLP.
99.1* Letter to Commission pursuant to Temporary Note 3t.
- ---------------
* Filed herewith.
+ The Securities and Exchange Commission with respect to certain portions of
this exhibit has previously granted confidential treatment. Omitted
portions have been filed separately with the Securities and Exchange
Commission.
@ Management contract or compensatory plan, contract or arrangement
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the fourth
quarter of the fiscal year ended December 31, 2001.
28
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
INTERLEUKIN GENETICS, INC.
By: /s/ FENEL M. ELOI
------------------------------------
Fenel M. Eloi
Chief Operating Officer, Chief
Financial Officer, Secretary and
Treasurer
Date: March 26, 2002
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the date indicated.
SIGNATURES TITLE DATE SIGNED
---------- ----- -----------
/s/ PHILIP R. REILLY Chairman of the Board of Directors March 26, 2002
------------------------------------------------ and Chief Executive Officer
Philip R. Reilly (Principal Executive Officer)
/s/ KENNETH S. KORNMAN President and Director March 26, 2002
------------------------------------------------
Kenneth S. Kornman
/s/ FENEL M. ELOI Chief Financial Officer, Secretary March 26, 2002
------------------------------------------------ & Treasurer
Fenel M. Eloi (Principal Financial and
Accounting Officer)
Director
------------------------------------------------
Thomas A. Moore
/s/ EDWARD M. BLAIR, JR. Director March 26, 2002
------------------------------------------------
Edward M. Blair, Jr.
/s/ GARY L. CROCKER Director March 26, 2002
------------------------------------------------
Gary L. Crocker
/s/ JOHN GAROFALO Director March 26, 2002
------------------------------------------------
John Garofalo
29
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 Statements of Stockholders' Equity and
Comprehensive Loss........................................ F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
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, 2000 and 2001, and
the related consolidated statements of operations, stockholders' equity and
comprehensive loss and cash flows for each of the three years in the period
ended December 31, 2001. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the 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, 2000 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001 in conformity with accounting principles generally accepted in
the United States.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the financial statements, the Company has suffered recurring losses from
operations and believes that its existing cash resources, absent additional debt
or equity financing, will be depleted by September 2002. These factors raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 1. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ ARTHUR ANDERSEN LLP
--------------------------------------
Boston, Massachusetts
February 14, 2002
F-2
INTERLEUKIN GENETICS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
---------------------------
2001 2000
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 3,922,736 $ 2,391,561
Marketable securities..................................... -- 2,999,040
Accounts receivable, net of allowance for doubtful
accounts of $14,000 and $77,000 in 2001 and 2000,
respectively........................................... 75,982 46,870
Prepaid expenses and other current assets................. 103,436 174,074
------------ ------------
Total current assets.............................. 4,102,154 5,611,545
FIXED ASSETS, NET........................................... 178,904 68,853
OTHER ASSETS................................................ 112,068 14,113
------------ ------------
TOTAL ASSETS...................................... $ 4,393,126 $ 5,694,511
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 181,554 $ 297,178
Accrued expenses.......................................... 477,368 603,072
Deferred revenue.......................................... 142,349 204,807
Current portion of capital lease obligations.............. 30,216 48,660
------------ ------------
Total current liabilities......................... 831,487 1,153,717
CAPITAL LEASE OBLIGATIONS, LESS CURRENT PORTION............. 11,091 46,989
------------ ------------
Total liabilities................................. 842,578 1,200,706
------------ ------------
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; 21,452,326 and 19,067,427 shares issued and
21,427,699 and 19,042,800 outstanding in 2001 and 2000,
respectively........................................... 21,452 19,067
Additional paid-in capital................................ 39,292,936 35,702,628
Treasury stock -- 24,627 shares in 2001 and 2000, at
cost................................................... (250,119) (250,119)
Accumulated deficit....................................... (35,513,721) (30,991,015)
Other comprehensive income................................ -- 13,244
------------ ------------
Total stockholders' equity........................ 3,550,548 4,493,805
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........ $ 4,393,126 $ 5,694,511
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
INTERLEUKIN GENETICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------
2001 2000 1999
----------- ----------- ------------
REVENUE.............................................. $ 202,942 $ 256,387 $ 477,497
COST OF REVENUE...................................... 48,674 183,833 201,182
----------- ----------- ------------
GROSS PROFIT....................................... 154,268 72,554 276,315
----------- ----------- ------------
EXPENSES:
Research and development........................... 2,686,621 2,167,409 3,570,845
Selling, general and administrative................ 2,244,274 3,093,379 2,904,210
----------- ----------- ------------
Total operating expenses................... 4,930,895 5,260,788 6,475,055
----------- ----------- ------------
LOSS FROM OPERATIONS............................... (4,776,627) (5,188,234) (6,198,740)
----------- ----------- ------------
OTHER INCOME (EXPENSE):
Interest income.................................... 263,435 280,298 107,446
Interest expense................................... (9,818) (22,514) (59,189)
Other income (expense)............................. 304 (48,377) 11,880
----------- ----------- ------------
Total other income......................... 253,921 209,407 60,137
----------- ----------- ------------
NET LOSS........................................... (4,522,706) (4,978,827) (6,138,603)
Beneficial conversion feature attributable to
preferred stock................................. -- -- (5,000,000)
----------- ----------- ------------
NET LOSS APPLICABLE TO COMMON STOCK................ $(4,522,706) $(4,978,827) $(11,138,603)
=========== =========== ============
BASIC AND DILUTED NET LOSS PER SHARE................. $ (0.21) $ (0.27) $ (1.15)
=========== =========== ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING........... 21,049,437 18,315,320 9,720,621
=========== =========== ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
INTERLEUKIN GENETICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE LOSS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
PREFERRED STOCK COMMON STOCK TREASURY STOCK
------------------------ ----------------------- ADDITIONAL -------------------
$0.001 PAID-IN
SHARES AMOUNT SHARES PAR VALUE CAPITAL SHARES AMOUNT
---------- ----------- ---------- ---------- ----------- ------- ---------
BALANCE AS OF DECEMBER 31, 1998....... -- -- 5,548,470 $ 5,548 $16,714,384 -- $ --
Net loss.............................. -- -- -- -- -- -- --
Unrealized loss on marketable
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 to non-employees
for services rendered................ -- -- -- -- 242,337 -- --
---------- ----------- ---------- ---------- ----------- ------- ---------
BALANCE AS OF DECEMBER 31, 1999....... -- -- 17,223,302 17,223 28,160,643 -- --
Net loss.............................. -- -- -- -- -- -- --
Unrealized gain on marketable
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 -- --
Stock options issued to non-employees
for services rendered................ -- -- -- -- 274,699 -- --
Purchase of treasury stock............ -- -- -- (24,627) (250,119)
---------- ----------- ---------- ---------- ----------- ------- ---------
BALANCE AS OF DECEMBER 31, 2000....... -- -- 19,067,427 19,067 35,702,628 (24,627) (250,119)
Net loss.............................. -- -- -- -- -- -- --
Unrealized loss on marketable
securities...........................
Comprehensive loss....................
Common stock issued:
Private placements................... -- -- 1,457,627 1,458 2,909,809 -- --
Exercise of warrants................. -- -- 875,000 875 436,625 -- --
Exercise of employee stock options... -- -- 46,964 47 38,652 -- --
Employee stock purchase plan......... -- -- 5,308 5 7,040 -- --
Stock options issued to non-employees
for services rendered................ -- -- -- -- 198,182 -- --
---------- ----------- ---------- ---------- ----------- ------- ---------
BALANCE AS OF DECEMBER 31, 2001....... -- $ -- 21,452,326 $ 21,452 $39,292,936 (24,627) $(250,119)
========== =========== ========== ========== =========== ======= =========
OTHER
ACCUMULATED COMPREHENSIVE
DEFICIT INCOME (LOSS) TOTAL
------------ ------------- ----------
BALANCE AS OF DECEMBER 31, 1998....... $(14,873,585) -- $1,846,347
Net loss.............................. (6,138,603) -- (6,138,603)
Unrealized loss on marketable
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 to non-employees
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 marketable
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
Stock options issued to non-employees
for services rendered................ -- -- 274,699
Purchase of treasury stock............ -- -- (250,119)
------------ -------- ----------
BALANCE AS OF DECEMBER 31, 2000....... (30,991,015) 13,244 4,493,805
Net loss.............................. (4,522,706) -- (4,522,706)
Unrealized loss on marketable
securities........................... (13,244) (13,244)
Comprehensive loss.................... (4,535,950)
Common stock issued:
Private placements................... -- -- 2,911,267
Exercise of warrants................. -- -- 437,500
Exercise of employee stock options... -- -- 38,699
Employee stock purchase plan......... -- -- 7,045
Stock options issued to non-employees
for services rendered................ -- -- 198,182
------------ -------- ----------
BALANCE AS OF DECEMBER 31, 2001....... $(35,513,721) $ -- $3,550,548
============ ======== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
INTERLEUKIN GENETICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------
2001 2000 1999
----------- ----------- -----------
CASH FLOW FROM OPERATING ACTIVITIES
Net loss.................................................. $(4,522,706) $(4,978,827) $(6,138,603)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 57,416 159,736 194,611
Unrealized gain (loss) on marketable securities......... (13,244) 25,743 24,375
Issuance of stock options to non-employees for services
rendered.............................................. 198,182 274,699 242,335
Issuance of stock to non-employees for services
rendered.............................................. -- -- 1,128,125
(Gain) loss on disposal of fixed assets................. (3,355) 74,986 --
Account receivable, net................................. (29,112) 56,131 22,084
Prepaid expenses and other current assets............... 70,638 (41,514) (5,134)
Accounts payable........................................ (115,624) 162,210 (143,805)
Accrued expenses........................................ (125,704) 202,791 (33,578)
Deferred revenue........................................ (62,458) (118,005) 47,491
----------- ----------- -----------
Net cash used in operating activities..................... (4,545,967) (4,182,050) (4,662,099)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of fixed assets................................. (164,112) (19,093) (15,810)
Increase in other assets.................................. (97,955) (14,113) --
Purchases of marketable securities........................ -- (3,955,246) (4,024,374)
Proceeds from maturity of marketable securities........... 2,999,040 2,943,706 2,530,000
----------- ----------- -----------
Net cash provided by (used in) investing activities....... 2,736,973 (1,044,746) (1,510,184)
----------- ----------- -----------
CASH FLOW FROM FINANCING ACTIVITIES
Proceeds from private placements of common stock.......... 2,911,267 6,682,772 --
Proceeds from exercise warrants and employee stock
options................................................. 476,199 578,018 379,945
Proceeds from sale of preferred stock..................... -- -- 4,706,927
Proceeds from employee stock purchase plan................ 7,045 8,340 600
Purchase of treasury stock................................ -- (250,119)
Increases in (payments of) notes payable, net............. -- (1,797) 10,688
Principal payments of long-term debt...................... -- -- (585,992)
Principal payments of capitalized lease obligations,
net..................................................... (54,342) (67,473) (103,540)
----------- ----------- -----------
Net cash provided by financing activities................. 3,340,169 6,949,741 4,408,628
----------- ----------- -----------
Net increase (decrease) in cash and equivalents............. 1,531,175 1,722,945 (1,763,655)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 2,391,561 668,616 2,432,271
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 3,922,736 $ 2,391,561 $ 668,616
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest.................................... $ 9,818 $ 22,514 $ 59,189
=========== =========== ===========
Cash paid for income taxes................................ $ -- $ -- $ --
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE ON NONCASH INVESTING AND FINANCING
ACTIVITY:
Cashless exercise of warrants............................. $ -- $ 61,840 $ --
=========== =========== ===========
Conversion of preferred stock to common stock............. $ -- $ -- $ 9,706,927
=========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
INTERLEUKIN GENETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- COMPANY BACKGROUND AND UNCERTAINTIES
ORGANIZATION AND LINE OF BUSINESS
The Company develops genetic diagnostic tests and medical research tools.
As of December 31, 2001, 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 2001, 2000 and 1999.
The Company is subject to numerous 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 $30.5 million including losses
of approximately $4.5 million during 2001, $5.0 million during 2000 and $6.1
million during 1999. The Company believes that it current cash resources, absent
additional equity or debt financing, will be depleted by September 2002. These
factors raise substantial doubt about the Company's ability to continue as a
going concern. Management is actively pursuing several sources of additional
financing to address this uncertainty. There can be no assurances that
management can secure additional financing under terms that are acceptable to
the Company or at all. These financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
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,
if at all.
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.
The Company was incorporated in Texas in 1986 and re-incorporated in
Delaware in March 2000.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Interleukin Genetics, Inc., and its wholly-owned subsidiaries, Medical Science
Systems France E.U. and Interleukin Genetics Laboratory Services, Inc. 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
F-7
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
those estimates. The Company's most critical accounting policies are in the area
of revenue recognition, cost estimations of certain ongoing research contracts
and the Company's decision to expense all patent related costs as incurred.
These critical accounting policies are more fully discussed in these notes to
financial statements and in the section of the Company's Form 10-K entitled
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
REVENUE RECOGNITION
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 and paid for but not yet submitted for test results, the
Company defers recognition of all related revenue. These amounts are 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 with outside parties 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 $0 and $74,000 at December 31, 2001
and 2000, 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 when
earned in accordance with the terms of the related agreement. Royalties are
recognized when earned under the Company's royalty agreements when amounts are
fixed or determinable and payment is reasonably assured.
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 agreements 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.
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 ("SFAS")
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 due to the loss in each period. 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:
2001 2000 1999
--------- --------- ---------
Options outstanding............................... 2,652,069 1,826,943 1,722,130
Warrants outstanding.............................. 1,345,952 1,492,138 1,536,545
--------- --------- ---------
Total............................................. 3,998,021 3,319,081 3,258,675
========= ========= =========
F-8
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
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 stockholders' equity
and comprehensive loss.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company using available market information has determined the estimated
fair values of financial instruments. 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 capital lease obligations also approximate fair value.
CASH EQUIVALENTS AND MARKETABLE SECURITIES
Cash equivalents consist of short-term, highly liquid investments purchased
with original 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 fair market value with any unrealized holding gains or losses included as a
component of stockholders' equity and any realized gains or losses recorded in
the statement of operations in the period in which the securities are sold. The
Company held no marketable securities as of December 31, 2001. The amortized
cost, unrealized gains and the fair value of marketable securities as of
December 31, 2000 with maturity dates ranging up to 6 months are as follows:
UNREALIZED
SECURITY MATURITY COST GAIN 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
========== ========== ==========
FIXED ASSETS
Fixed assets are stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization are provided using the straight-line
method over 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 the Company evaluate 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.
Any write-downs, based on fair value, are to be treated as permanent reductions
in the carrying amount of the assets. The Company believes that no impairment
exists related to the Company's long-lived assets at December 31, 2001.
F-9
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
PATENTS
The Company expenses patent costs as incurred as their realizability is
uncertain.
STOCK-BASED COMPENSATION
Stock options issued to employees under the Company's stock option and
stock 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.
NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141, Business Combinations, which applies to all business combinations
initiated after June 30, 2001. This statement requires that all business
combinations be accounted for by the purchase method and defines the criteria
used to identify intangible assets to be recognized apart from goodwill.
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets, which is effective for fiscal years beginning after December 15, 2001,
except for goodwill and intangible assets acquired after June 30, 2001, which
are subject immediately to the non-amortization and amortization provisions of
this statement. Under the new rules, goodwill and intangible assets deemed to
have indefinite lives will no longer be amortized but will be subject to annual
impairment tests in accordance with the statement. Other intangible assets will
continue to be amortized over their estimated useful lives.
In August 2001, the FASB issued SFAS No. 143 Accounting for Asset
Retirement Obligations, effective for fiscal years beginning after June 15,
2002. This statement addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
retirement costs.
In October 2001, the FASB issued SFAS No. 144 Accounting for the Impairment
or Disposal of Long-lived Assets, effective for fiscal years beginning after
December 15, 2001. This statement addresses financial accounting and reporting
for the impairment or disposal of long-lived assets.
The Company does not expect the effect of complying with these new
accounting pronouncements to have a material impact on its 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 Sheffield's research.
For certain of the discoveries, the parties have reached a specific
non-cancelable agreement of development and commercialization. However, for new
discoveries on which the parties have not yet reached specific agreement, the
agreement may be terminated with or without cause by either party upon six
months' notice. 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. During 1999, in accordance with this agreement, the Company
issued 275,000 shares of common stock to Sheffield for transferring all rights
and title of certain patents. The value of the common stock of $653,125 was
charged to research and development expense 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,
2001, 35,000 fully vested options to purchase common stock were granted under
this agreement and the Company charged approximately $69,000 to research and
development expense based upon the fair value of the options determined using
the Black-Sholes
F-10
NOTE 3 -- SHEFFIELD UNIVERSITY MASTER AGREEMENT -- (CONTINUED)
option-pricing model. These options have a five-year exercise period. In 1999,
the Company signed another research agreement with Sheffield that automatically
renews in one-year increments. This agreement requires the Company to pay the
cost of agreed upon research projects conducted at Sheffield. For the year ended
December 31, 2001 the Company funded and expensed approximately $244,000 for
research conducted at Sheffield. This includes funding to the University and to
collaborators at the University. Both agreements with Sheffield 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 charged to research and development expense 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 2001,
this collaborator received $2,213 in royalty payments for sales of PST. On July
1, 2000 and 2001, 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 2001, the Company charged to research and development
expense approximately $50,000 related to the issuance of these options based
upon the fair value determined using the Black-Sholes option-pricing model. This
collaborator will continue to receive 25,000 fully vested options to purchase
common stock each July 1 during the period that 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,
------------------------------
2001 2000 1999
-------- -------- --------
Beginning of year................................... $ 77,000 55,000 $ 21,000
Provision charged to expense........................ 9,000 33,000 48,000
Accounts written off, net of recoveries............. (72,000) (11,000) (14,000)
-------- -------- --------
End of year......................................... $ 14,000 $ 77,000 $ 55,000
======== ======== ========
NOTE 5 -- FIXED ASSETS
The fixed assets' useful lives and balances at December 31, 2001 and 2000
consisted of the following:
USEFUL LIFE 2001 2000
------------ -------- -------
Computer and office equipment....................... 3 years $ 83,889 $52,157
Lab equipment....................................... 5 years 120,281 6,578
Furniture and fixtures.............................. 5 years 10,233 10,233
Leasehold improvements.............................. 5 years 12,098 --
Equipment under capital leases...................... 3 to 5 years 149,042 173,563
-------- -------
375,543 242,531
Less -- Accumulated depreciation and amortization... 196,639 173,678
-------- -------
Total..................................... $178,904 $68,853
======== =======
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
F-11
NOTE 6 -- INCOME TAXES -- (CONTINUED)
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, 2001, the Company had net operating loss (NOL) and
research tax credit carryforwards of approximately $27,900,000 and $397,000,
respectively, for federal and state income tax purposes, expiring in varying
amounts through the year 2021. The Company's ability to use its NOL and tax
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 of its NOL and
tax credit carryforwards following a greater than 50% ownership change during
the prescribed testing period. As of December 31, 2001, the Company has 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 may result in the expiration of certain of the carryforwards
prior to utilization.
As of December 31, 2001 and 2000, the approximate income tax effect of the
Company's deferred tax assets (liabilities) consisted of the following:
2001 2000
------------ -----------
Net operating loss carryforwards.......................... $ 9,417,000 $ 7,892,000
Research tax credit carryforwards......................... 397,000 337,000
Accrual to cash adjustments............................... 286,000 301,000
Disqualifying dispositions and non-qualified stock option
exercises............................................... 157,000 117,000
Loss on sale of assets.................................... (50,000) (50,000)
Depreciation.............................................. 67,000 38,000
Patents................................................... 16,000 50,000
------------ -----------
Total deferred tax assets....................... 10,290,000 8,685,000
Valuation allowance....................................... (10,290,000) (8,685,000)
------------ -----------
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, 2001, the Company had authorized 5,000,000 shares of
undesignated preferred stock of which none are outstanding. At December 31,
2001, the Company had authorized 50,000,000 shares of $0.001 par value common
stock of which 21,427,699 shares were outstanding and approximately 3.5 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
493,000 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 $2.9
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, if lower, in
subsequent financings during the following 24 months.
F-12
NOTE 7 -- CAPITAL STOCK -- (CONTINUED)
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 $1.9 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, if lower, 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.
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, 2001, 2000 and
1999, 5,206, 1,559 and 518 shares were purchased under the Employee Stock
Purchase Plan at an average purchase price of approximately $1.28, $5.35 and
$1.16 respectively, per share.
PREFERRED STOCK
In June 1999, the Company issued 2,200,000 shares of preferred stock in a
private placement for total proceeds of $4,706,927. Each share of preferred
stock was convertible into five shares of common stock at the option of the
holder. Because the fair value of the common stock into which the preferred
stock was convertible exceeded the purchase price paid by the preferred
stockholders, the Company recorded a beneficial conversion in the amount of
$5,000,000. In August 1999, the preferred stockholders exercised their right to
convert their preferred stock into a total of 11,000,000 shares of common stock
with an aggregate fair value of $9,706,927
NOTE 8 -- STOCK OPTION PLANS
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 awards 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 680,000 were available for future issuance at December 31, 2001.
In June 1996, the Company's shareholders approved the adoption of the 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 170,000 were available for grant at
December 31, 2001.
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 three
to four years.
F-13
NOTE 8 -- STOCK OPTION PLANS -- (CONTINUED)
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, 2001, 2000
and 1999, and changes during these years is presented in the tables below:
The following table details all stock option activity:
2001 2000 1999
-------------------------- -------------------------- --------------------------
WEIGHTED AVG WEIGHTED AVG WEIGHTED AVG
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
--------- -------------- --------- -------------- --------- --------------
Outstanding, beginning
of year............. 1,826,943 $2.83 1,722,130 $2.11 1,174,383 $2.20
Granted............. 904,798 1.68 600,000 4.23 1,061,781 2.05
Exercised........... (46,964) 0.85 (326.835) 1.95 (199,314) 1.98
Canceled............ (32,708) 4.34 (168,352) 2.15 (314,720) 2.15
--------- ----- --------- ----- --------- -----
Outstanding, end of
year................ 2,652,069 $2.47 1,826,943 $2.83 1,722,130 $2.11
========= ===== ========= ===== ========= =====
Exercisable, end of
year................ 1,457,126 $2.55 1,108,684 $2.44 889,852 $1.99
========= ===== ========= ===== ========= =====
The following table details further information regarding stock options
outstanding and exercisable at December 31, 2001:
STOCK OPTIONS OUTSTANDING STOCK OPTIONS EXERCISABLE
--------------------------------------------- --------------------------
WEIGHTED AVG
REMAINING
CONTRACTUAL WEIGHTED AVG WEIGHTED AVG
RANGE OF EXERCISE PRICE: SHARES LIFE (YEARS) EXERCISE PRICE SHARES EXERCISE PRICE
- ------------------------ --------- ---------------- -------------- --------- --------------
$0.50 - $0.99........... 244,921 7.40 $0.52 244,921 $0.52
$1.00 - $1.49........... 546,000 8.98 1.22 16,000 1.25
$1.50 - $1.99........... 172,435 5.85 1.81 138,435 1.82
$2.00 - $2.49........... 198,100 7.69 2.23 112,450 2.28
$2.50 - $4.72........... 1,490,613 7.62 3.35 945,320 3.23
--------- ---- ----- --------- -----
2,652,069 7.77 $2.47 1,457,126 $2.55
========= ==== ===== ========= =====
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.
F-14
NOTE 8 -- STOCK OPTION PLANS -- (CONTINUED)
Had compensation cost for the Company's employee stock awards been
determined consistent with SFAS 123, the Company's net loss applicable to common
stock and net loss per share would have been as follows:
YEARS ENDED DECEMBER 31,
----------------------------------------
2001 2000 1999
----------- ----------- ------------
Net loss applicable to common stock
As reported................................ $(4,522,706) $(4,978,827) $(11,138,603)
=========== =========== ============
Pro forma.................................. $(6,255,848) $(6,579,648) $(12,024,156)
=========== =========== ============
Basic and diluted net loss per share
As reported................................ $ (0.21) $ (0.27) $ (1.15)
Pro forma.................................. $ (0.30) (0.36) (1.24)
The fair value of each option grant is estimated on the date of grant using
the Black-Sholes option-pricing model, for a stock that does not pay dividends
with the following assumptions.
YEARS ENDED DECEMBER 31,
-------------------------------------
2001 2000 1999
------------- ------- -----------
Risk free interest rate......................... 4.56% - 5.41% 5.17% 4.7% - 6.2%
Expected life................................... 7 years 7 years 7 years
Expected volatility............................. 100% 242% 156%
Using these assumptions, the weighted average grant date fair value of
options granted in 2001, 2000 and 1999 was $1.31, $4.28 and $2.48, respectively.
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 participants' accounts and
vest over a period of four years based on the participants' 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, 2001 and 1999, no
contributions were made to the plan.
NOTE 10 -- WARRANTS
In January 2001, in association with a private placement of common stock, a
warrant to purchase 600,000 shares of common stock exercisable at $3.00 per
share was issued (see Note 7). This warrant remains outstanding.
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 per
share 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 per
share (see Note 7). This warrant remains outstanding.
In June 1999, in association with a private placement of preferred stock
warrants to purchase 1,000,000 shares of common stock exercisable at $0.50 per
share were issued. All of these warrants to purchase common stock have been
exercised.
In November 1997, in association with the Company's initial public
offering, a warrant to purchase 180,000 shares of common stock exercisable at
$14.85 per share was issued. This warrant remains outstanding.
F-15
NOTE 10 -- WARRANTS -- (CONTINUED)
In August and September 1997, warrants to purchase 356,545 shares of common
stock exercisable at $5.50 per share were issued. Warrants to purchase 55,000
shares have been exercised to date and warrants to purchase 301,545 shares
remain outstanding.
In accordance with EITF Issue No. 00-19 Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company's Own Stock, the
Company has determined that each of the warrants described above should be
classified as permanent equity in the financial statements and should not be
marked to market over the life of the warrant.
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 a non-cancelable operating lease expiring
June 2006.
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 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 lease commitments, net of sublease
income, under lease agreements with initial or remaining terms of one year or
more at December 31, 2001, are as follows:
OPERATING CAPITAL
YEAR ENDING DECEMBER 31, LEASES LEASES
- ------------------------ ---------- -------
2002........................................................ $ 436,372 $34,564
2003........................................................ 340,519 14,796
2004........................................................ 271,331 --
2005........................................................ 267,320 --
2006........................................................ 132,192 --
---------- -------
$1,447,734 49,360
==========
Less -- Amount representing interest........................ 8,053
-------
Less -- Current portion..................................... 30,216
-------
Long-term portion................................... $11,091
=======
Rent expense, net of sublease income, was $190,163, $138,064 and $199,346
for the years ended December 31, 2001, 2000 and 1999, 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
F-16
NOTE 12 -- SEGMENT INFORMATION -- (CONTINUED)
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 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, 2001 and December 31, 2000, 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,
---------------------------------------
2001 2000 1999
----------- ----------- -----------
Total Revenues:
United States............................... $ 202,942 $ 256,387 $ 281,239
France...................................... -- -- 38,846
Other foreign............................... -- -- 157,412
----------- ----------- -----------
Total............................... $ 202,942 $ 256,387 $ 477,497
=========== =========== ===========
Operating Loss:
United States............................... $(4,776,627) $(5,188,234) $(3,650,968)
France...................................... -- -- (504,288)
Other foreign............................... -- -- (2,043,484)
----------- ----------- -----------
Total.................................... $(4,776,627) $(5,188,234) $(6,198,740)
=========== =========== ===========
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, 2001, a single customer
accounted for 91% of the total accounts receivable. As of December 31, 2000, no
single customer accounted for more than 10% of the total accounts receivable.
During the year ended December 31, 2001, one customer accounted for 56% of
total revenue and another accounted for 22% of total revenue. During the years
ended December 31, 2000 and 1999, no one customer accounted for more than 10% of
total revenues. The increase in concentration of risk is the result of our
change in strategy in selling PST. We no longer market PST directly; we now sell
to a few large distributors who market PST to individual physicians and
patients.
NOTE 13 -- ACCRUED EXPENSES
Accrued expenses consist of the following:
DECEMBER 31,
-------------------
2001 2000
-------- --------
Legal....................................................... $ 50,000 $ 90,000
Vacation.................................................... 100,282 68,270
Other....................................................... 327,086 444,802
-------- --------
Total............................................. $477,368 $603,072
======== ========
F-17
NOTE 14 -- SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following are selected quarterly financial data for the years ended
December 31, 2001 and 2000.
QUARTER ENDED
--------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
2001 2001 2001 2001
----------- ----------- ------------- ------------
Revenue.......................... $ 40,291 $ 118,654 $ 24,978 $ 19,019
Loss from operations............. $(1,244,381) $(1,223,685) $(1,183,294) $(1,125,267)
Net loss......................... $(1,140,043) $(1,146,149) $(1,135,880) $(1,100,636)
Basic and diluted net loss per
share.......................... $ (0.06) $ (0.05) $ (0.05) $ (0.05)
QUARTER ENDED
----------------------------------------------------------
MARCH 31, SEPTEMBER 30, DECEMBER 31,
2000 JUNE 30, 2000 2000 2000
----------- ------------- ------------- ------------
Revenues......................... $ 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)
F-18