ITEM 1. BUSINESS
OVERVIEW
GenVec is an emerging late stage biopharmaceutical company focused on the development and commercialization of TNFerade™ for the treatment of cancer. The Company is conducting a Phase II/III trial for the use of TNFerade to treat locally advanced, unresectable pancreatic cancer. TNFerade is also in Phase II trials for rectal cancer and metastatic melanoma. The core technology used for TNFerade has broad application. It is currently being used in five funded collaborations, three for the development of preventative vaccines against infectious diseases, one for the treatment of severe coronary artery disease, and one for a second-generation oncology product. As a clinical stage biopharmaceutical company, our business and our ability to realize our corporate goals and execute our strategy are subject to numerous risks and uncertainties. Material risks and uncertainties relating to our business and our industry are described in Item 1A
ITEM 1A. RISK FACTORS
This Form 10-K contains forward-looking information based on our current expectations. Because our actual results may differ materially from any forward-looking statements made by GenVec, this section includes a discussion of important factors that could affect our actual future results, including, but not limited to, our product development programs, contract revenues, expenses, net loss and earnings per share.
RISKS RELATED TO OUR BUSINESS
We have a history of losses and anticipate future losses.
We have incurred net losses in each year since our inception in December 1992, including a net loss of $14.0 million for the year ended December 31, 2005. As of December 31, 2005, we had an accumulated deficit of approximately $150.0 million. We are unsure if or when we will become profitable. The size of our net losses will depend, in part, on the growth rate of our revenues and the level of our expenses.
We derive substantially all of our revenues from payments from collaborations with corporations and government entities, and will continue to do so for the foreseeable future. We expect that it will be several years, if ever, before we will recognize revenue from product candidate sales or royalties. A large portion of our expenses is fixed, including expenses related to facilities, equipment and personnel. In addition, we expect to spend significant amounts to fund research and development and to enhance our core technologies. We also expect to incur substantial costs to manufacture our product candidates. As a result, we expect that our operating expenses will increase significantly over the next several years and, consequently, we will need to generate significant additional revenue to achieve profitability. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a consistent basis.
We will have no product revenues in the near term and may need to raise additional capital to operate our business.
We are focused on clinical product development. Until, and unless, we receive approval from the FDA and other regulatory authorities for our product candidates, we cannot sell these products and will not have product revenues. We will require substantial funds to conduct research and development activities, preclinical studies, clinical trials and other activities prior to the commercialization of any potential products. We anticipate that such funds will be obtained from external sources and intend to seek additional equity, debt or lease financing or collaborative agreements with corporate, governmental or academic collaborators to fund future operations. Our actual capital requirements will depend on many factors. If we experience unanticipated cash requirements, we may need to seek additional sources of funding, which may not be available on favorable terms, if at all. Such additional funding may only be available on terms that may cause dilution to common stockholders, have liquidation preferences and/or pre-emptive rights. In the past, we have secured funding on terms that included pre-emptive rights. For example, pursuant to an Investor Rights Agreement between GenVec and HealthCare Ventures V, L.P. dated December 21, 2001, HealthCare Ventures V and VI have the right to purchase shares of GenVec common that we may propose to sell in the future to prevent dilution of their interest in the company. If we do not succeed in raising additional funds on acceptable terms, we may be unable to complete planned preclinical studies and clinical trials or obtain approval of our product candidates from the FDA and other regulatory authorities. In addition, we could be forced to discontinue product development, reduce or forego sales and marketing efforts and attractive business opportunities or discontinue operations.
Our ability to develop, obtain regulatory approval of and commercialize our potential products depends, in part, on collaborations with other companies. If we are unable to find collaborators, we may not be able to develop, test and commercialize our products.
To date, we only have entered into collaborative agreements with a limited number of companies, and some of those are no longer in effect. The success of our business strategy depends, in part, on our ability to enter into and sustain collaborations with other companies for the development and commercialization of our product candidates. Unless we are able to enter into and sustain collaboration agreements, we will need to raise additional funds for the development, testing, and commercialization of our product candidates. If collaborations or other funding is not available, we may have to delay or curtail the development and commercialization of certain product candidates.
We have experienced, and may continue to experience, delays in conducting our clinical trials.
Clinical trials for the product candidates we are developing may be delayed by many factors, including that potential appropriate patients for studies are limited in number and may be difficult to recruit. Following the release of our TNFerade clinical trails from clinical hold in 2005, we have experienced delays in enrolling patients into our TNFerade clinical trials and may have additional delays as we seek to expand enrollment. Our ability to enroll appropriate patients for any of our clinical trials also may be adversely affected by trials being conducted by our competitors for similar disease indications. The failure of any clinical trials to meet applicable regulatory standards or the standards of the relevant reviewing bodies could cause such trials to be delayed or terminated, which could further delay the development of any of our product candidates. Any such delays increase our product development costs, with the possibility that we could run out of funding. Delays in one clinical trial also can adversely affect our ability to launch clinical trials for similar or different indications. Consequently, if such delays are significant they could negatively affect our financial results and the commercial prospects for our products.
We cannot be sure that our collaborators will perform as expected, and collaborations might produce conflicts that could delay or prevent the development or commercialization of our potential product candidates and negatively impact our business and financial condition.
We cannot control the resources that any collaborator may devote to our products. Our present or future collaborators may not perform their obligations as expected. These collaborators may breach or terminate their agreements with us or otherwise fail to conduct their collaborative activities successfully and in a timely manner. In addition, our collaborators may elect not to develop products arising out of our collaborative arrangements or to devote sufficient resources to the development, regulatory approval, manufacture, marketing or sale of these products. If any of these events occur, we may not be able to develop our technologies or commercialize our products.
An important part of our strategy involves conducting multiple product development programs. We may pursue opportunities in fields that conflict with those of our collaborators. In addition, disagreements with our collaborators could develop over rights to our intellectual property. The resolution of such conflicts and disagreements may require us to relinquish rights to our intellectual property that we believe we are entitled to. In addition, any disagreement or conflict with our collaborators could reduce our ability to obtain future collaboration agreements and negatively impact our relationship with existing collaborators. Such a conflict or disagreement could also lead to delays in collaborative research, development, regulatory approval or commercialization of various products or could require or result in litigation or arbitration, which would be time consuming and expensive and could have a significant negative impact on our business, financial condition and results of operations.
Our collaboration agreements may prohibit us from conducting research in areas that may compete with our collaboration products, while our collaborators may not be limited to the same extent. This could negatively affect our ability to develop products and, ultimately, prevent us from achieving a continuing source of revenues.
We anticipate that some of our corporate or academic collaborators will be conducting multiple product development efforts within each disease area that is the subject of its collaboration with us. We generally have agreed not to conduct independently, or with any third party, certain research that is competitive with the research conducted under our collaborations. Therefore, our collaborations may have the effect of limiting the areas of research that we may pursue, either alone or with others. Some of our collaborators, however, may develop, either alone or with others, products in related fields that are competitive with the products or potential products that are the subject of their collaborations with us. In addition, competing products, either developed by the collaborators or to which the collaborators have rights, may result in their withdrawing support for our product candidates.
Generally under our academic collaborations, we retain the right to exclusively license any technologies developed using funding we provided. If we elect to not license a particular technology, the academic collaborator is typically free to use the technology for any purpose, including the development and commercialization of products that might compete with our products.
We are an early stage company deploying unproven technologies, and we may never be able to develop, get regulatory approval of, or market any of our product candidates.
Gene-based products are new and rapidly evolving medical approaches, which have not been shown to be effective on a widespread basis. Biotechnology and pharmaceutical companies have successfully developed and commercialized only a limited number of gene-based products to date. In addition, no gene therapy product has received regulatory approval in the United States. To date, none of our product candidates has been approved for sale in the United States or elsewhere. We may be unable to develop products or delivery systems that:
•
prove to be safe and effective;
•
meet applicable regulatory standards;
•
are capable of being manufactured at reasonable costs;
•
do not infringe the intellectual property rights of third parties;
•
are superior to products offered by third parties; or
•
can be marketed successfully.
Gene-based products may be susceptible to various risks, including undesirable and unintended side effects from genes or the delivery systems, unintended immune responses, inadequate therapeutic efficacy or other characteristics that may prevent or limit their approval or commercial use. Successful products require significant development and investment, including a lengthy and uncertain period of testing to show their safety and effectiveness before their regulatory approval or commercialization. We have not proven our ability to develop, obtain regulatory approval of or commercialize gene-based medicines or cell transplantation products. We may be unable to successfully select those genes or cells with the most potential for commercial development.
If we fail to adequately show the safety and efficacy of our product candidates, we will not be able to obtain FDA approval of our product candidates.
We face the risk of failure involved in developing therapies based on new technologies. While certain of our product candidates are in clinical trials, there are others for which we have not yet initiated clinical trials. For those product candidates not yet in clinical trials, we will need to conduct significant additional research and animal testing, referred to as preclinical testing, before any of these product candidates can advance to clinical trials. In addition, we will need to conduct further clinical testing of those product candidates currently in clinical trials. It may take us many years to complete preclinical testing or trials, and failure could occur at any stage of testing. Acceptable results in early testing or trials might not be repeated later. Not all products in preclinical testing or early stage clinical trials will become approved products. Before we can file applications with the FDA for product approval, we must show that a particular product candidate is safe and effective. Even with respect to those product candidates currently in clinical trials, we must demonstrate the safety and efficacy of those product candidates before we can secure FDA approval. Our failure to adequately show the safety and effectiveness of our product candidates would prevent FDA approval of our products. Our product development costs will increase if we experience delays in testing or regulatory approvals or if we need to perform more or larger clinical trials than planned. If the delays are significant, they could negatively affect our financial results and the commercial prospects for our product candidates.
Because we or our collaborators must obtain regulatory approval to market our products in the United States and in non-U.S. jurisdictions, we cannot predict whether or when we will be permitted to commercialize our products; failure to comply with applicable regulations can also harm our business and operations.
•
The pharmaceutical industry is subject to stringent regulation by a wide range of authorities. We cannot predict whether we or our collaborators will obtain regulatory approval for any product we develop. No one can market a pharmaceutical product in the United States until it has completed rigorous preclinical testing and clinical trials of the product and an extensive regulatory approval process implemented by the FDA. To date, the FDA has not approved a gene therapy product for sale in the United States. Satisfaction of regulatory requirements typically takes many years, is dependent upon the type, complexity and novelty of the product and requires the expenditure of substantial resources. Of particular significance are the requirements covering research and development, testing, manufacturing, quality control, labeling and promotion of drugs for human use. Before commencing clinical trials, we must submit to the FDA and receive approval from the FDA of an Investigational New Drug application (“IND”). Clinical trials are subject to oversight by Institutional Review Boards and the FDA. Clinical trials are also subject to:
•
informed consent;
•
good clinical practices (GCP);
•
continuing FDA oversight;
•
potentially large numbers of test subjects; and
•
potential suspension by us, our collaborators or the FDA at any time if it is believed that the subjects participating in these trials are being exposed to unacceptable health risks or if the FDA finds deficiencies in the Investigational New Drug application or the conduct of these trials.
We may encounter delays or rejections in the regulatory approval process because of additional government regulation from future legislation or administrative action or changes in FDA policy during the period of product development, clinical trials and FDA regulatory review. Failure to comply with applicable FDA or other applicable regulatory requirements may result in criminal prosecution, civil penalties, recall or seizure of products, total or partial suspension of production or injunction, as well as other regulatory action against our product candidates or us. If regulatory approval of a product is granted, this approval will be limited to those disease indications for which the product has shown through clinical trials to be safe and effective. The FDA also strictly regulates promotion and labeling after approval. Outside the United States, our ability to market a product is contingent upon receiving clearances from the appropriate regulatory authorities. This non-U.S. regulatory approval process includes risks similar to those associated with FDA clearance described above.
If we or our collaborators are unable to manufacture our products in sufficient quantities or are unable to obtain regulatory approvals for a manufacturing facility for our products, we may experience delays, and be unable to meet demand, and may lose potential revenues.
Completion of our clinical trials and commercialization of our product candidates require access to, or development of, facilities to manufacture a sufficient supply of our product candidates. We have limited experience manufacturing any of our gene-based products in the volumes that will be necessary to support large-scale clinical trials or commercial sales. We do not yet know the extent to which we will be able to develop our Gaithersburg manufacturing facilities and processes to the manufacture of gene therapy product candidates. Efforts to establish capabilities, if pursued, may not meet initial expectations as to scheduling, reproducibility, yield, purity, cost, potency or quality.
If we or our collaborators are unable to manufacture our product candidates in clinical quantities or, when necessary, commercial quantities, then we will need to rely on third parties to manufacture compounds for clinical and commercial purposes. These third-party manufacturers must receive FDA approval before they can produce clinical material or commercial products. Our products may be in competition with other products for access to these facilities and may be subject to delays in manufacture if third parties give other products greater priority. In addition, we may not be able to enter into any necessary third-party manufacturing arrangements on acceptable terms, or on a timely basis. There are very few contract manufacturers who currently have the capability to produce our proposed products, and the inability of any of these contract manufacturers to deliver our required quantities of product candidates on a timely basis and at commercially reasonable prices would negatively affect our operations.
Before we or our collaborators can begin commercial manufacturing of any of our product candidates, we or our collaborators must obtain regulatory approval of the manufacturing facility and process. Manufacturing of our proposed products must comply with the FDA’s current Good Manufacturing Practices requirements, commonly known as cGMP, and non-U.S. regulatory requirements. The cGMP requirements govern quality control and documentation policies and procedures. In complying with cGMP and non-U.S. regulatory requirements, we will be obligated to expend time, money and effort in production, record keeping and quality control to assure that the product meets applicable specifications and other requirements. We or our collaborators must also pass a pre-approval inspection before FDA approval. If we or our collaborators fail to comply with these requirements, our product candidates would not be approved. If we or our collaborators fail to comply with these requirements after approval, we would be subject to possible regulatory action and may be limited in the jurisdictions in which we are permitted to sell our products. The FDA and non-U.S. regulatory authorities also have the authority to perform unannounced periodic inspections of our manufacturing facility to ensure compliance with cGMP and non-U.S. regulatory requirements.
If successful large-scale manufacturing of gene-based medicines is not possible, we may be unable to manufacture enough of our product candidates to achieve regulatory approval or market our products.
Very few companies have shown successful large-scale manufacturing of gene-based medicines, and there are significant uncertainties and risks associated with the scale up of our manufacturing processes to commercial levels. There are a limited number of contract manufacturers qualified to perform large-scale manufacturing of gene-based medicines. We may be unable to manufacture commercial-scale quantities of gene-base medicines, or receive appropriate government approvals, on a timely basis or at all. Failure to successfully manufacture or obtain appropriate government approvals on a timely basis or at all would prevent us from achieving our business objectives.
We may experience difficulties or delays in product manufacturing, which are beyond our control and could harm our business, because we rely on third-party manufacturers.
We currently expect to produce our product candidates through third-party manufacturers. Problems with any manufacturing processes could result in product defects, which could require us to delay shipment of products or recall products previously shipped. In addition, any prolonged interruption in the operations of our or a third party’s manufacturing facilities could result in the cancellation of shipments. A number of factors could cause interruptions, including equipment malfunctions or process failures, or damage to a facility due to natural disasters or otherwise. Because our manufacturing processes are or are expected to be highly complex and subject to a lengthy FDA approval process, alternative qualified production capacity may not be available on a timely basis or at all.
Difficulties or delays in our manufacturing could increase our costs and damage our reputation. The manufacture of pharmaceutical products can be an expensive, time-consuming, and complex process. Manufacturers often encounter difficulties in scaling-up production of new products, including problems involving the transfer of manufacturing technology, production yields, quality control and assurance, and shortages of personnel. Delays in scale-up to commercial quantities could result in additional expense and delays in our clinical trials, regulatory submissions and commercialization.
We rely on a limited number of suppliers for some of our manufacturing materials. Any problems experienced by any of these suppliers could negatively affect our operations.
We rely on third-party suppliers and vendors for some of the materials used in the manufacture of our product candidates. Some of these materials are available from only one supplier or vendor. For supply of early clinical trial materials, we rely on one supplier, Invitrogen Corporation, for its cell culture medium and Cambrex for custom buffers. The cell culture medium is used to grow the cells within which our product candidates are produced. For supply of late-stage clinical trial materials, we currently are planning to use purification resins from the Applied Biosystems Group of Applera Corporation and the BioSepra S.A. Process Division of Pall Corporation. We do not currently have supply agreements with any of these suppliers. Any significant problem experienced by one of our suppliers could result in a delay or interruption in the supply of materials to us until such supplier resolves the problem or an alternative source of supply is located. We have limited experience with alternative sources of raw materials. Any delay or interruption would likely lead to a delay or interruption of manufacturing operations, which could negatively affect our operations.
We have limited marketing capabilities, and if we are unable to enter into collaborations with marketing partners or develop our own sales and marketing capability, we may not be successful in commercializing our products.
We currently have limited sales, marketing and distribution capabilities. As a result, we will depend on collaborations with third parties that have established distribution systems and direct sales forces. To the extent that we enter into co-promotion or other licensing arrangements, our revenues will depend upon the efforts of third parties, over which we may have little or no control. If we are unable to reach and maintain agreements with one or more pharmaceutical companies or collaborators, we may be required to market our products directly. In any case we may elect to establish our own specialized sales force and marketing organization to market our products to physicians. In order to do this, we would have to develop a marketing and sales force with technical expertise and with supporting distribution capability. Developing a marketing and sales force is expensive and time consuming and could delay a product launch. We cannot be certain that we will be able to attract and retain qualified sales personnel or otherwise develop this capability.
We face substantial competition from other companies and research institutions that are developing products to treat the same diseases that our product candidate’s target, and we may not be able to compete successfully.
We compete with pharmaceutical and biotechnology companies that are pursuing other forms of treatment for the diseases that our product candidates target. We may also face competition from companies that may develop competing technology internally or acquire it from universities and other research institutions. As these companies develop their technologies, they may develop proprietary positions, which may prevent or limit our product commercialization efforts.
Some of our competitors are established companies with greater financial and other resources than we have. We expect that competition in our business will intensify. Our competitors may succeed in:
•
identifying important genes or delivery mechanisms before us;
•
developing products or product candidates earlier than we do;
•
forming collaborations before we do, or precluding us from forming collaborations with others;
•
obtaining approvals from the FDA or other regulatory agencies for such products more rapidly than we do;
•
developing and validating manufacturing processes more rapidly than we do;
•
obtaining patent protection to other intellectual property rights that would limit or preclude our ability to use our technologies or develop products; or
•
developing products that are safer or more effective than those we develop or propose to develop.
While we seek to expand our technological capabilities to remain competitive, research and development by others may render our technology or product candidates obsolete or noncompetitive or result in treatments or cures superior to any therapy developed by us.
RISKS RELATED TO OUR INDUSTRY
If we are unable to adequately protect our intellectual property rights, our competitors may be able to take advantage of our research and development efforts to compete with us.
Our commercial success will depend in part on obtaining patent protection for our products and other technologies and successfully defending these patents against third party challenges. Our patent position, like that of other biotechnology firms, is highly uncertain and involves complex legal and factual questions. The biotechnology patent situation in the United States and other countries is uncertain and is currently undergoing review and revision. Changes in, or different interpretations of, patent laws in the United States and other countries might allow others to use our discoveries or to develop and commercialize our products without any compensation to us.
Our ability to develop and protect a proprietary position based on biotechnological innovations and technologies involving genes and gene therapy, delivery systems, production, formulations and the like, is particularly uncertain. The U.S. Patent and Trademark Office, as well as the patent offices in other countries, have often required that patent applications concerning biotechnology-related inventions be limited or narrowed substantially. Our disclosures in our patent applications may not be sufficient to meet the statutory requirements for patentability in all cases. In addition, other companies or institutions possess issued patents and have filed and will file patent applications that cover or attempt to cover genes, vectors, cell lines, and methods of making and using gene therapy products that are the same as or similar to the subject matter of our patent applications. For example, while we have pending patent applications pertaining to particular adenovectors that cannot reproduce themselves, and adenovectors modified to alter cell binding characteristics, we are aware of issued patents and pending patent applications of other companies and institutions relating to the same subject matter. Patents and patent applications of third parties may have priority over our issued patents and our pending or yet to be filed patent applications. Proceedings before the U.S. Patent and Trademark Office and other patent offices to determine who properly lays claim to inventions are costly and time consuming, and we may not win in any such proceedings.
The issued patents we already have or may obtain in the future may not provide commercially meaningful protection against competitors. Other companies or institutions may challenge our or our collaborators’ patents in the United States and other countries. In the event a company, institution or researcher infringes upon our or our collaborators’ patent rights, enforcing these rights may be difficult and can be expensive and time consuming, with no guarantee that our or our collaborators’ patent rights will be upheld. Others may be able to design around these patents or develop unique products providing effects similar to our products. In addition, our competitors may legally challenge our patents and they may be held to be invalid. In addition, various components used in developing gene therapy products, such as particular genes, vectors, promoters, cell lines and construction methods, used by others and us, are available to the public. As a result, we are unable to obtain patent protection with respect to such components, and third parties can freely use such components. Third parties may develop products using such components that compete with our potential products. Also, with respect to some of our patentable inventions, we or our collaborators have decided not to pursue patent protection outside the United States. Accordingly, our competitors could develop, and receive non-U.S. patent protection for, gene therapies or technologies for which we or our collaborators have or are seeking U.S. patent protection. Our competitors may be free to use these gene therapies or technologies outside the United States in the absence of patent protection.
Where we believe patent protection is not appropriate we rely to a limited extent on trade secrets to protect our technology. However, trade secrets are difficult to protect. While we have entered into confidentiality agreements with employees and collaborators, we may not be able to prevent the disclosure or use of our trade secrets. In addition, other companies or institutions may independently develop substantially equivalent information and techniques.
If our potential products conflict with intellectual property rights of competitors, universities or others, then we may be prevented from developing those product candidates.
Other companies and institutions have issued patents and have filed and will file patent applications that may issue into patents that cover or attempt to cover genes, vectors, cell lines and methods of making and using gene and gene-based therapy products used in or similar to our product candidates and technologies. For example, we are aware of issued patents and pending patent applications relating to the delivery, including through the use of adenovectors, of medically beneficial substances to the heart and other tissues. It could be alleged that our BIOBYPASS angiogen conflicts with these patents. We also are aware of other issued patents and pending patent applications that relate to various aspects of our other product candidates and systems, including TNFerade, and it could be alleged that our product candidates conflict with these patents. We have not conducted freedom to use patent searches on all aspects of our product candidates or potential product candidates, and we may be unaware of relevant patents and patent applications of third parties. In addition, those freedom to use patent searches that have been conducted may not have identified all relevant issued patents or all relevant pending patent applications that could issue into patents, particularly in view of the characterizations of the subject matter of issued patents and pending patent applications, as well as the fact that pending patent applications can be maintained in secrecy for a period of time and, in some circumstances, until issuance as patents.
An issued patent gives rise to a rebuttable presumption of validity under U.S. law and the laws of some other countries. The holder of a patent to which we or our collaborators do not hold a license could bring legal actions against our collaborators or us for damages or to stop us or our collaborators from using the affected technology, which could limit or preclude our ability to develop and commercialize our product candidates. If any of our potential products are found to infringe a patent of a competitor or third party, we or our collaborators may be required to pay damages and to either obtain a license in order to continue to develop and commercialize the potential products or, at the discretion of the competitor or third party, to stop development and commercialization of the potential products. Since we have concentrated our resources on developing only a limited number of products, the inability to market one of our products would disproportionately affect us as opposed to a competing company with many products in development.
We believe that there will be significant litigation in our industry regarding intellectual property rights. Many of our competitors have expended and are continuing to expend significant amounts of time, money and management resources on intellectual property litigation. If we become involved in litigation, it could consume a substantial portion of our resources and could adversely affect our business, financial condition and results of operations, even if we ultimately are successful in such litigation, in view of our limited resources.
If our right to use intellectual property we license from others is affected, our ability to develop and commercialize our product candidates may be harmed.
We rely, in part, on licenses to use some technologies that are material to our business. For example, to create our product candidates, we combine our vectors with genes intended to produce proteins. For our current product candidates, we have secured licenses to use the VEGF121, TNF - alpha, and PEDF genes. We do not own the patents or patent applications that underlie these licenses. For these genes, we do not control the enforcement of the patents. We rely upon our licensors to properly prosecute and file those patent applications and to prevent infringement of those patents.
While many of the licenses under which we have rights provide us with exclusive rights in specified fields, the scope of our rights under these and other licenses may be subject to dispute by our licensors or third parties. In addition, our rights to use these technologies and practice the inventions claimed in the licensed patents and patent applications are subject to our licensors abiding by the terms of those licenses and not terminating them. Any of our licenses may be terminated by the licensor if we are in breach of a term or condition of the license agreement, or in certain other circumstances. In addition, some of our licenses require us to achieve specific milestones.
Our product candidates and potential product candidates will require several components that may each be the subject of a license agreement. The cumulative license fees and royalties for these components may make the commercialization of these product candidates uneconomical.
Adverse events in the field of gene therapy may negatively affect regulatory approval or public perception of our products or product candidates.
In September 1999, a patient undergoing gene therapy using an adenoviral vector to deliver a therapeutic gene died as a result of an adverse reaction to the treatment. This death was widely publicized. Other patient deaths have occurred in other gene-based clinical trials. These deaths and the resulting publicity surrounding them, as well as any other serious adverse events in the field of gene therapy that may occur in the future, may result in greater governmental regulation of our product candidates and potential regulatory delays relating to the testing or approval of our product candidates. As a result of the incident in September 1999, the United States Senate held a series of hearings to determine whether additional legislation was required to protect patients who participate in clinical trials. Possibly as a consequence of these hearings, a specific division within the FDA for gene and cell therapy was established. Furthermore, extended patient follow-up for gene therapy product candidates has been recommended. Additionally, the National Institutes of Health and its advisory bodies routinely review the field of gene therapy and issue reports on the adverse events reported by investigators. The NIH has approved a proposal to establish a Gene Transfer Safety Assessment Board to review serious adverse event reports, annual reports and other safety information in order to assess toxicity and safety and report these findings at NIH Recombinant DNA Advisory Committee (RAC) meetings. Additional scrutiny cannot be ruled out. Any increased scrutiny could delay or increase the costs of our product development efforts or clinical trials.
The commercial success of our product candidates will depend in part on public acceptance of the use of gene therapies for the prevention or treatment of human disease. Public attitudes may be influenced by claims that gene therapy is unsafe, and gene therapy may not gain the acceptance of the public or the medical community. Negative public reaction to gene therapy could result in greater government regulation and stricter clinical trial oversight and commercial product labeling requirements of gene therapy products and could cause a decrease in the demand for any products we may develop.
Our product candidates involve new technologies and therapeutic approaches in the field of gene therapy, which is a new and evolving field. As discussed above, no gene therapy product has received regulatory approval in the United States, and adverse events in this field may negatively affect public perception of our product candidates. Even if our product candidates attain regulatory approval, our success will depend upon the medical community, patients and third party payors accepting gene therapy products in general, and our product candidates in particular, as medically useful, cost-effective and safe. In particular, our success will depend upon physicians specializing in the treatment of those diseases that our product candidates target prescribing treatments that involve the use of our product candidates in lieu of, or in addition to, existing treatments that they are already familiar with and for which greater clinical data may be available. Even if the clinical safety and efficacy of our product candidates is established, physicians may elect not to recommend our products for a variety of reasons, including the reimbursement policies of government and third-party payors. Further, third-party payors, such as health insurance plans, may be reluctant to authorize and pay for new forms of treatment that they may deem expensive and less-proven that existing treatments. Even if gene therapy products, and our product candidates in particular, are accepted by the medical community and third-party payors, the public in general, or patients in particular, may be uncomfortable with new therapies, including our product candidates, and it could take substantial time for them to accept gene therapy products as a viable treatment alternative, if ever. If gene therapy and our product candidates do not gain widespread acceptance, we may be unable to generate significant revenues, if any, which would adversely affect our results of operations. In addition, even if our product candidates achieve market acceptance, we may not be able to maintain that market acceptance over time if new products or technologies are introduced that are more favorably received than our product candidates or render them obsolete.
We may be sued for product liability, which could damage our reputation and expose us to unanticipated costs.
We, alone or with our collaborators, may be held liable if any product we or our collaborators develop, or any product, which is made with the use or incorporation of any of our technologies, causes injury or is found otherwise unsuitable during product testing, manufacturing, marketing or sale. Regardless of the merit or eventual outcome, product liability claims may result in:
•
withdrawal of product candidates from our clinical trials;
•
withdrawal of our products from the market; if they have been approved;
•
damage to our reputation;
•
costs of litigation;
•
substantial monetary awards to plaintiffs; and
•
decreased demand for our products or product candidates.
Although we currently have and intend to maintain product liability insurance, this insurance may become prohibitively expensive, or may not fully cover our potential liabilities. Inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could prevent or inhibit the commercialization of products developed by us or in collaboration with others. Currently, we have a total of $5 million liability coverage under a clinical trials and professional liability insurance policy. If we are sued for any injury caused by our products, our liability could exceed our total resources.
We use hazardous chemicals and radioactive and biological materials in our business; any liability or disputes relating to improper handling, storage or disposal of these materials could be time consuming and costly.
Our research and development processes involve the use of hazardous materials, including chemicals and radioactive and biological materials, and also produce hazardous waste products. Hazardous chemicals used in our processes include, but are not limited to, flammable solvents such as methanol and ethanol, toxic chemicals such as ethidium bromide and formaldehyde, and corrosive chemicals such as acetic acid and sodium hydroxide. We also use several radioactive compounds, including phosphorous-32, carbon-14, sulfur-35, phosphorous-33, iodine-125, hydrogen-3, and chromium-51.
The hazardous biological material used in our research and development activities include human and animal cell lines and viruses, such as adenoviruses, and animals infected with human viruses. Some of the biological material may be novel, including viruses with novel properties. We cannot eliminate the risk of accidental contamination or discharge or injury from these materials. Federal, state, and local laws and regulations govern the use, manufacture, storage, handling and disposal of these materials. We could be subject to civil damages in the event of an improper or unauthorized release of, or exposure of individuals to, these hazardous materials. In addition, claimants may sue us for injury or contamination that results from our use or the use by third parties of these materials, and our liability may exceed our total assets. Compliance with environmental laws and regulations may be expensive, and current or future environmental regulations may impair our research, development or production efforts.
Although we have general liability insurance, these polices contain exclusions from insurance against claims arising from pollution from chemical or radioactive materials. Our collaborators are working with these types of hazardous materials in connection with our collaborations. In the event of a lawsuit or investigation, we could be held responsible for any injury we or our collaborators cause to persons or property by exposure to, or release of, any hazardous materials. However, we believe that we are currently in compliance with all applicable environmental and occupational health and safety regulations.
If reforms in the health care industry make reimbursement for our potential products less likely, the market for our potential products will be reduced, and we will lose potential sources of revenue.
Our success may depend, in part, on the extent to which reimbursement for the costs of therapeutic products and related treatments will be available from third-party payors such as government health administration authorities, private health insurers, managed care programs, and other organizations. Over the past decade, the cost of health care has risen significantly, and there have been numerous proposals by legislators, regulators, and third-party health care payors to curb these costs. Some of these proposals have involved limitations on the amount of reimbursement for certain products. Similar federal or state health care legislation may be adopted in the future and any products that we or our collaborators seek to commercialize may not be considered cost-effective. Adequate third-party insurance coverage may not be available for us to establish and maintain price levels that are sufficient for realization of an appropriate return on our investment in product development. Moreover, the existence or threat of cost control measures could cause our corporate collaborators to be less willing or able to pursue research and development programs related to our product candidates.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
We currently lease 42,900 square feet for our corporate offices and research and development laboratories located at 65 West Watkins Mill Road in Gaithersburg, Maryland. The lease expires on November 1, 2009. We have options to extend the term of this lease for an additional fourteen years. We have additional space within our Gaithersburg, Maryland facilities that can be utilized to accommodate future growth. We currently believe that the Gaithersburg facility is sufficient to meet our present needs as well as possible growth over the next several years.
We also lease 25,000 square feet for research and development laboratories and manufacturing space located in Charlestown, Massachusetts. In conjunction with the sale of our myoblast cell therapy assets in December 2005, we subleased approximately 11,000 square feet of our Charlestown facility through September 2006. The Charlestown lease expires on October 3, 2006. We do not plan to exercise our option to extend the lease at this time.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are not currently a party to any material legal proceedings.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
There were no matters submitted by the Company during the quarter ended December 31, 2005 to a vote of security holders, through the solicitation of proxies or otherwise.
EXECUTIVE OFFICERS OF THE REGISTRANT
The Board of Directors appoints all executive officers annually. There is no family relationship between or among any of the executive officers or directors.
Paul H. Fischer, Ph.D., serves as our President and Chief Executive Officer and as a director of the Company. Dr. Fischer has served as President and Chief Executive Officer and as a director of the Company since 1996. Prior to joining GenVec, he was Executive Vice President of Research and Development with Oncologix, Inc. (now Antigenics, Inc.), a biotechnology company. Dr. Fischer’s previous experience includes Manager, Cancer Research at Pfizer, Inc., a pharmaceutical company. Dr. Fischer performed post-doctoral research in Pharmacology at Yale University School of Medicine. He was an Assistant Professor of Pharmacology at the University of Missouri School of Medicine and an Associate Professor of Human Oncology at the University of Wisconsin, prior to joining Pfizer. Dr. Fischer received his B.S. in Biology from the University of Denver and his Ph.D. in Pharmacology from the University of California at San Francisco.
Jeffrey W. Church joined the Company in August 1998 and serves as Chief Financial Officer, Treasurer and Corporate Secretary. Prior to joining the Company, he served from September 1997 to August 1998 as Executive Vice President and Chief Financial Officer of Biospherics, Inc., a telecommunications and biotechnology company. Before that Mr. Church was employed with Meridian Medical Technologies, Inc., a medical device/drug delivery company. In addition to his CFO duties at Meridian, Mr. Church was also responsible for one of the company’s three operating units. Previously, Mr. Church spent seven years with PricewaterhouseCoopers as Audit Manager. Mr. Church received his B.S. in Accounting from the University of Maryland.
Thomas A. Davis, M.D., serves as Chief Medical Officer. Dr. Davis joined GenVec in July 2005 with extensive experience in cancer drug development, having managed clinical development at the National Cancer Institute and at Medarex, Inc. At the Cancer Therapy Evaluation Program of the National Cancer Institute in Rockville, Maryland, he directed the government sponsored clinical evaluation of a broad assortment of therapeutic monoclonal antibodies as well as directing clinical development within adult hemotologic malignancies and blood and bone marrow transplantation. He also has served as head of Clinical Science at Medarex, Inc., specializing in the development of novel therapeutic human antibodies. He completed fellowship training at Stanford University, where he participated in all phases of clinical development of assorted anti-CD20 antibodies and tumor specific idiotype vaccines for the treatment of B-cell lymphomas. He received his education and training in medicine at Johns Hopkins University and Georgetown University, where he also served as chief resident in Internal Medicine.
C. Richter King, Ph.D., serves as our Senior Vice President of Research. From May 1998 to December 2004, Dr. King served as our Vice President of New Product Research, an area that he still oversees. Prior to joining GenVec in 1998, Dr. King conducted extensive research into the amplification of the erbB-2 gene, which is associated with common human cancers. Pursuing erbB-2 as a potential target for anticancer therapy, Dr. King directed an experienced research group at the Georgetown University Medical School’s Lombardi Cancer Research Center in Washington, DC, where he served as Associate Professor with the University’s Department of Biochemistry. Previously, Dr. King was the Director of Drug Discovery for Oncologix (now Antigenics, Inc.). Dr. King holds a Ph.D. in Biochemistry from the Johns Hopkins University in Baltimore, MD.
PART II
ITEM 5.
ITEM 5.
MARKET FOR THE REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Since our initial public offering of common stock on December 12, 2000, our common stock has been traded in the over-the-counter market and is included for quotation on the Nasdaq National Market under the symbol GNVC.
Set forth below is the range of high and low closing sale prices for our common stock as reported on the Nasdaq National Market for the two most recent years:
As of February 28, 2006, there were approximately 191 stockholders of record of our common stock, one of which is Cede & Co., a nominee for Depository Trust Company (or “DTC”). All of the shares of common stock held by brokerage firms, banks and other financial institutions as nominees for beneficial owners are deposited into participant accounts at DTC, and are therefore considered to be held of record by Cede & Co. as one stockholder.
We have not paid any cash dividends since our inception and we do not anticipate paying any cash dividends in the foreseeable future. We did not repurchase any of our equity securities during the last fiscal year.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth our selected financial data for each of the years in the five-year period ended December 31, 2005. The information below should be read in conjunction with our financial statements and notes thereto included elsewhere in this report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K. The historical results are not necessarily indicative of results to be expected for future periods.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Financial Statements and Notes thereto appearing elsewhere in this report. See “Business - Risks and Uncertainties” regarding certain factors known to GenVec that could cause reported financial information not to be necessarily indicative of future results, including discussions of the risks related to the development, regulatory approval, proprietary protection of our product candidates, and their market success relative to alternative products.
CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES
The discussion and analysis of GenVec’s financial condition and results of operations are based upon GenVec’s financial statements. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. On an on-going basis, GenVec evaluates its estimates using authoritative pronouncements, historical experience and other assumptions as the basis for making estimates. Actual results could differ from those estimates. Significant accounting policies are more fully described in Note 2 to GenVec’s financial statements included in this annual report on Form 10-K.
GenVec believes the following accounting policies to be critical because they require significant estimates or judgment on the part of management:
Revenue Recognition. Research and development (R & D) revenue, from cost-reimbursement and cost-plus agreements, are recognized as earned based on the performance requirements of the contract. Reimbursable costs under such contracts are subject to audit and retroactive adjustment. Contract revenues and accounts receivable reported in the financial statements are recorded at the amount expected to be received. Contract revenues are adjusted to actual upon final audit and retroactive adjustment. Non-refundable R & D fees for which no further performance obligations exist are recognized when collection is assured. Contract and upfront license payments where GenVec has continued involvement through a research or development collaboration are recognized ratably over the contract period. Revenue associated with performance milestones are recognized based on achievement of the milestones as defined in the respective agreements.
In accordance with Staff Accounting Bulletin 104, GenVec has deferred recognition of up-front contract or license payments received under its collaboration and license agreements and has amortized the related unearned revenues over the terms of the collaboration agreements, generally ranging from two to four years. GenVec’s results of operations included $2.3 million, $435,000 and $98,000 during the years ended December 31, 2005, 2004 and 2003, of amortization of these upfront contract and license fees which were received in prior years. Amortized revenues for the year ended December 31, 2005 included $1.1 million from unearned upfront contract and license fees related to the Terumo agreement, including $667,000 of accelerated amortization due to the assignment of the Terumo agreement as part of the Company’s sale of its myoblast cell therapy assets in December 2005. As of December 31, 2005 and 2004, GenVec had residual unearned revenue of $1.2 million and $2.0 million, respectively.
Clinical Trial Expenses and Research and Development Activities: The Company accrues estimated costs for clinical and pre-clinical studies based on estimates of work performed and completion of certain milestones. The Company believes that this method best aligns the expenses it records with the efforts it expends. The Company monitors the progress of the trials and their related activities to the extent possible, and adjusts, the accruals accordingly. Adjustments to accruals are charged to expense in the period in which the facts that give rise to the adjustment become known; all adjustments to-date have been inconsequential.
The expenditures that will be necessary to execute GenVec’s business plan are subject to numerous uncertainties, which may adversely affect its liquidity and capital resources. Completion of clinical trials may take several years or more, but the length of time generally varies substantially according to the type, complexity, novelty and intended use of a product candidate. GenVec estimates that clinical trials of the type GenVec generally conducts are typically completed over the following timelines:
The duration and the cost of clinical trials may vary significantly over the life of a project as a result of differences arising during the clinical trial protocol, including, among others, the following:
•
the number of patients that ultimately participate in the trial;
•
the duration of patient follow-up that seems appropriate in view of the results;
•
the number of clinical sites included in the trials; and
•
the length of time required to enroll suitable patient subjects.
GenVec tests potential product candidates in numerous pre-clinical studies to identify indications for which they may be product candidates. GenVec may conduct multiple clinical trials to cover a variety of indications for each product candidate. As GenVec obtains results from trials, GenVec may elect to discontinue clinical trials for certain product candidates or for certain indications in order to focus its resources on more promising product candidates or indications.
An element of GenVec’s business strategy is to pursue the research and development of a range of product candidates for a variety of indications. This is intended to allow GenVec to diversify the risks associated with its research and development expenditures. As a result, GenVec believes its future capital requirements and its future financial success are not substantially dependent on any one product candidate. To the extent GenVec is unable to maintain a broad range of product candidates, GenVec’s dependence on the success of one or a few product candidates would increase.
GenVec’s product candidates also have not yet received FDA regulatory approval, which is required before GenVec can market them as therapeutic products. In order to proceed to subsequent clinical trial stages and to ultimately achieve regulatory approval, the FDA must conclude that GenVec’s clinical data establish safety and efficacy. Historically, the results from pre-clinical testing and early clinical trials have often not been predictive of results obtained in later clinical trials. A number of new drugs and biologies have shown promising results in early clinical trials, but subsequently failed to establish sufficient safety and efficacy data to obtain necessary regulatory approvals.
Furthermore, GenVec’s business strategy includes the option of entering into collaborative arrangements with third parties to complete the development and commercialization of GenVec’s product candidates. In the event that third parties take over the clinical trial process for one or more of GenVec’s product candidates, the estimated completion date would largely be under the control of that third party rather than GenVec. GenVec cannot forecast with any degree of certainty which proprietary products or indications, if any, will be subject to future collaborative arrangements, in whole or in part, and how such arrangements would affect GenVec’s development plan or capital requirements. GenVec’s programs may also benefit from subsidies, grants or government or agency-sponsored studies that could reduce GenVec’s development costs.
As a result of the uncertainties discussed above, among others, GenVec is unable to estimate the duration and completion costs of its research and development projects or when, if ever, and to what extent it will receive cash inflows from the commercialization and sale of a product. GenVec’s inability to complete its research and development projects in a timely manner or its failure to enter into collaborative agreements, when appropriate, could significantly increase its capital requirements and could adversely impact its liquidity. These uncertainties could force GenVec to seek additional, external sources of financing from time to time in order to continue with its business strategy. GenVec’s inability to raise additional capital, or to do so on terms reasonably acceptable to it, would jeopardize the future success of its business.
TNFerade, GenVec’s lead cancer product candidate is currently being clinically studied in Phase II trials for the treatment of locally advanced pancreatic cancer, metastatic melanoma cancer and rectal cancer. GenVec has incurred approximately $42.1 million of expenses on the development of this product candidate since the commencement of this program in 1999, including an allocation of corporate general and administrative expenses. These costs include research, development, clinical trials and clinical supply costs, including an allocation of corporate general and administrative expenses. GenVec expects to continue to expend substantial additional amounts for the clinical development of TNFerade.
BIOBYPASS is currently being studied in a randomized, placebo-controlled Phase II trial with targeted enrollment of 129 patients with advanced heart disease in collaboration with the Cordis Corporation, a Johnson & Johnson company, to evaluate the effects of BIOBYPASS on exercise tolerance and heart function when administered with the Cordis injection catheter system. Since commencement of the research and development program of BIOBYPASS in 1996, through December 31, 2005, GenVec has incurred approximately $49.1 million in research, development and clinical costs, including an allocation of corporate general and administrative expenses. From July 1997 until July 2002, the development of BIOBYPASS was subject to a Research, Development and Collaboration Agreement with The Warner Lambert Company, a subsidiary of Pfizer, Inc., under which GenVec received approximately $62.6 million in non-refundable research and development funding, milestone payments, equity purchases and license fees. GenVec intends to seek strategic alliances with other organizations to continue the clinical development of BIOBYPASS. In January 2004, the Company entered into a research collaboration with Cordis Corporation, a Johnson & Johnson company, to conduct a randomized, double blind, placebo controlled study using BIOBYPASS in a procedure involving guided delivery of the angiogenic agent directly into targeted regions of the heart in patients with severe coronary artery disease using the Cordis NOGASTAR Mapping Catheter and MYOSTAR Injection Catheter. Clinical benefit will be assessed in a multi-center study, which is being conducted in Europe and is expected to enroll up to 129 patients with severe coronary artery disease. GenVec and Cordis will collaborate on regulatory matters and share in the clinical trial costs. GenVec will supply all clinical material and Cordis will provide the NOGASTAR and MYOSTAR mapping and injection catheters and training to the interventional cardiologists conducting the trial. GenVec retains commercial rights to BIOBYPASS and Cordis retains all commercial rights to the NOGASTAR mapping catheters and MYOSTAR injection catheters. GenVec anticipates that it will share the risks and costs of development by partnering this program, which it expects may require granting commercialization rights to collaborators.
PEDF has completed an initial Phase I trial for the treatment of advanced, wet age-related macular degeneration, a leading cause of blindness in individuals over the age of 50. GenVec is presently conducting a Phase I study to evaluate PEDF in patients with less severe macular degeneration. Patient enrollment of this trial has completed in the first quarter of 2006. Since commencement of the program in 2000 through December 31, 2005, GenVec has incurred approximately $20.8 million in research, development and clinical costs, including an allocation of corporate general and administrative expenses. GenVec intends to seek strategic alliances with other organizations to continue the clinical development of PEDF. GenVec anticipates that it will share the risks and costs of development by partnering this program, which it expects may require granting commercialization rights to its collaborators.
GenVec is also developing therapeutic vaccines for the treatment of life-threatening viruses. GenVec is currently collaborating with the U.S. Government and PATH’s Malaria Vaccine Initiative (MVI) for the development of preventative vaccines for HIV, SARS, malaria and dengue virus. Each of these vaccine candidates will be evaluated in clinical trials sponsored by the respective organizations. During 2005, we also expanded collaborative efforts to develop a vaccine for foot-and-mouth disease funded by the U.S. Government. Research and development activities performed by GenVec are subject to statements of work and approved budgets under fixed price or cost-plus fixed fee contracts. Since commencement of these vaccine development programs in 2002 through December 31, 2005, GenVec has incurred approximately $46.0 million in research and development costs, including an allocation of corporate general and administrative expenses, most of which has been funded by the various sponsors under cost-reimbursement agreements.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued a revision of Statement of Financial Accounting Standards (or “FAS”) No. 123, “Accounting for Stock-Based Compensation.” The revision is referred to as “FAS 123R - Share-Based Payment” (or “FAS 123R”), which supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” (or “APB 25”) and will require companies to recognize compensation expense, using a fair-value based method, for costs related to share-based payments including stock options and stock issued under our employee stock plans. We intend to adopt FAS 123R using the modified prospective basis on January 1, 2006. Our adoption of FAS 123R is expected to result in compensation expense that will reduce net income per share by approximately $0.02 per share for 2006. However, our estimate of future stock-based compensation expense is affected by our stock price, the number of stock-based awards our board of directors may grant in 2006, as well as a number of complex and subjective valuation assumptions and the related tax effect. These valuation assumptions include, but are not limited to, the volatility of our stock price and employee stock option exercise behaviors.
See Note 2 in our Notes to Financial Statements for information regarding other recent accounting pronouncements.
OVERVIEW
We are an emerging late stage biopharmaceutical company focused on the development and commercialization of innovative gene-based therapies to treat cancer, heart disease and vision loss, and vaccines to prevent infectious diseases. We combine our patented gene transfer technologies with proprietary therapeutic genes to create product candidates, such as TNFerade for cancer, BIOBYPASS for heart disease and PEDF for eye disease. Using the same, gene transfer technology, we are also collaborating with the U.S. Government and PATH’s Malaria Vaccine Initiative (MVI) for the development of vaccine candidates for HIV, malaria and other infectious diseases. We announced a new collaboration with the U.S. Department of Agriculture for the development of a vaccine for foot-and-mouth disease.
We will seek collaborative partners to advance the clinical development of TNFerade for the treatment of cancer, BIOBYPASS for the treatment of heart disease and PEDF for the prevention of blindness. If GenVec enters into collaborative licensing and/or funded research arrangements, operating expenses would increase commensurate with the increased revenues from such arrangements.
To date, none of our proprietary or collaborative programs has resulted in a commercial product; therefore, we have not received any revenues or royalties from the sale of products. We have funded its operations primarily through public and private placements of equity securities, payments received under collaborative programs with public and private entities and debt financings.
We have incurred operating losses each year since inception and, as of December 31, 2005, had an accumulated deficit of approximately $150.0 million. Our losses have resulted principally from costs incurred in research and development and from general and administrative activities. Research and development expenses consist primarily of salaries and related personnel costs, sponsored research costs, patent costs, technology access fees, clinical trial costs, and other expenses related to our product development and research programs. General and administrative expenses consist primarily of salaries and related expenses for executive, finance and other administrative personnel, facility costs, professional fees and other corporate expenses including business development, insurance and general legal activities.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2005 AND 2004
REVENUE
Revenue. Revenue increased 124 percent to $26.6 million in 2005 from $11.9 million in 2004 primarily as a result of an increase of $13.5 million in research activities under our funded vaccine programs with the National Institute of Health (NIH), U.S. Naval Medical Research Center (NMRC), U.S. Department of Agriculture (USDA) and the Malaria Vaccine Initiative (MVI). Revenue from our HIV vaccine development contract with NIH increased $11.4 million. This increase is due to the initiation of the one-time production of clinical grade HIV vaccine supplies for a Phase II proof-of-concept trial (“POCET trial”) to be conducted by NIH and expected to commence in the first half of 2007. Revenues in 2005 also include $667,000 in amortized revenues due to the accelerated recognition of deferred income resulting from the completion of all significant performance obligations under the Terumo License and Development Agreement. Revenues in 2006 are expected to decline to approximately $20 million as production of HIV vaccine supplies is completed and the Company transitions production to the manufacture of additional late-stage clinical material for the expanded Phase II/III pancreatic trial during the second half of 2006.
OPERATING EXPENSES
Research and development. Research and development expenses increased from $23.1 million in 2004 to $30.8 million in 2005. The increase is primarily due to expanded preparations to enable production of clinical-grade HIV vaccine stocks for the expected Phase II POCET trial noted above; the POCET trial will be conducted as part of our funded collaborative vaccine development program with The Vaccine Research Center at the National Institute of Allergy and Infectious Diseases of the National Institute of Health under our subcontract managed by SAIC-Frederick, Inc. Research and development efforts for our proprietary gene-based therapeutic product candidates were focused on the continued clinical testing of TNFerade, BIOBYPASS and PEDF. Offsetting these costs were lower levels of research and development expenditures resulting from the closure of our myoblast cell therapy operation in the fourth quarter 2005 in conjunction with the sale of these assets.
General and administrative. General and administrative expenses increased 6 percent to $8.3 million in 2005 from $7.9 million in 2004. The approximate $400,000 change is primarily a result of increases in a variety of expenditures including consulting, legal, facility and audit fees.
Loss on disposal of assets. The loss on disposal of assets primarily resulted from the $1.8 million non-cash write-off of intangible assets in conjunction with the Company’s sale of its myoblast cell therapy assets in December 2005.
OTHER INCOME (LOSS)
Other income (loss) increased from $226,000 in other income in 2004 to $484,000 in other income in 2005. Other interest income increased from $612,000 in 2004 to $908,000 in 2005. This increase was due in part to higher interest rates as well as increased investment balances resulting from the $14.0 million net proceeds realized from our September 26, 2005 equity financing. Interest expense increased from $386,000 in 2004 to $426,000 in 2005 due to a $240,000 non-cash market value adjustment of our interest rate swap agreement partially offset by lower interest charges due to debt repayments of $1.2 million during 2005.
YEARS ENDED DECEMBER 31, 2004 AND 2003
REVENUE
Revenue. Revenue increased 13 percent to $11.9 million in 2004 from $10.5 million in 2003 primarily from an increase of $1.2 million in research activities under our funded vaccine programs with the National Institute of Health (NIH) and the Malaria Vaccine Initiative (MVI) and a $641,000 increase in NIH funded research grants, which help support further development of our core technologies. These increases were partially offset by a temporary decline of approximately $800,000 under our funded vaccine development program with the Navy Medical Research Center.
OPERATING EXPENSES
Research and development. Research and development expenses decreased slightly from $23.5 million in 2003 to $23.1 million in 2004. Research and development expenditures were focused on internal product development efforts around the continuing clinical development of TNFerade and PEDF and the Company’s funded vaccine programs with The Vaccine Research Center at the National Institute of Allergy and Infectious Diseases of the National Institute of Health and PATH’s Malaria Vaccine Initiative. Offsetting these costs were lower levels of expenditures related to the BIOBYPASS Phase II trials for coronary artery disease and decreased activities conducted under our funded vaccine development program with the Navy Medical Research Center.
General and administrative. General and administrative expenses decreased 6 percent to $7.9 million in 2004 from $8.4 million in 2003. This reflects a $1.2 million decrease in severance cost incurred in April 2003 as part of our workforce reduction/cost control program, partially offset by increases during 2004 in fees related to intellectual property, recruiting and compliance with new regulations promulgated under the Sarbanes-Oxley Act of 2002.
OTHER INCOME (EXPENSE)
Other income (expense), consisting primarily of interest income and investment gains or losses offset by interest expense, increased from $81,000 in other income in 2003 to $226,000 in other income in 2004. This increase was primarily due to a $222,000 increase in interest income generated, in part, from the $11.7 million net proceeds of our equity financing completed April 16, 2004 and a $100,000 decrease in interest expense stemming from debt repayments of $1.5 million; these 2004 factors were partially offset by a $178,000 gain on sale of a security reported in 2003.
LIQUIDITY AND CAPITAL RESOURCES
To date, we have been engaged primarily in research and development activities. As a result we have experienced and expect to continue to incur operating losses for the foreseeable future until one or more of our product candidates is commercialized. As of December 31, 2005, we held $32.0 million in cash and investments as compared to approximately $33.1 million at December 31, 2004. Net cash used in operating activities was $13.5 million in 2005 compared with $16.1 million used in 2004. Net cash provided by financing activities was $13.2 million in 2005, primarily reflecting proceeds of $14.0 million from issuance of stock and $464,000 from purchases under stock incentive programs offset by debt repayments of $1.2 million. Net cash provided by investing activities was approximately $1.8 million in 2005, which consisted principally of the net proceeds of the maturity of investment securities offset by the purchase of property and equipment. As of December 31, 2005, our working capital was approximately $30.5 million compared to $26.0 million at December 31, 2004. This increase primarily reflects a $2.5 million increase in accounts receivable due to higher monthly billings under our expanded vaccine development programs; all payments due related to these receivables have been collected.
Historically, we have contracted with various academic institutions and research organizations to perform research and development activities and with clinical sites for the treatment of patients under clinical protocols. Such contracts expire at various dates and have differing renewal and expiration clauses. We utilize different financing instruments, such as debt and capital and/or operating leases, to finance various equipment and facility needs. Our financing commitments are summarized in the following table:
We expect our revenue for the next several years to consist primarily of payments under government grants and contracts and, to a lesser extent, corporate collaborations and interest income. We intend to focus our resources on our lead product candidate, TNFerade, for the treatment of cancer. We have a collaboration with Cordis Corporation to conduct further clinical studies of our cardiovascular product candidate, BIOBYPASS, under which Cordis is responsible for providing injection catheters, training the interventional cardiologist conducting the trial and sharing the clinical trial costs. With respect to our other product candidates, including PEDF, we will seek to form strategic alliances under which we will share the risks and costs of development. We also will continue to look for funded research collaborations to help offset future anticipated losses from operations. Some of these arrangements may require us to relinquish rights to certain of our existing or future technologies, product candidates or products that we would otherwise seek to develop or commercialize on our own, or to license the rights to our technologies, product candidates or products on terms that are not favorable to us.
We expect that significant additional financing will be required as we move our product candidates through clinical development, including the recent decision to advance TNFerade into a Phase II/III trial for pancreatic cancer. On March 15, 2006, we entered into a Committed Equity Financing Facility (CEFF) with Kingsbridge Capital Ltd., under which Kingsbridge has committed to purchase, at our option, up to a total of $30.0 million of the Company’s common stock over a three-year period. Due to the pricing formula, however, the actual amount of additional financing available to us under the CEFF may be substantially less than the committed amount. Net proceeds from sale of common stock under the CEFF will help defray some of the incremental costs associated with expanded clinical testing of TNFerade in locally advanced pancreatic cancer. As part of the arrangement, the Company issued a warrant to Kingsbridge to purchase 520,000 shares of the Company’s common stock at a price equal to 125% of the average closing bid prices during the five (5) days preceding the issuance date of the warrant.
We believe that our existing cash reserves, anticipated cash flow from current collaborations and funds from the CEFF will be sufficient to support our operations for approximately 2 years. Without new collaborations, government grants or contracts, or additional equity financing, we would use approximately $20 - $22 million in cash over the next twelve months, including approximately $1.5 million for capital expenditures and $2.4 million in contractual obligations reflected in the table above.
We expect that, in addition to the CEFF described above, significant additional capital will be required which we may seek through further public or private equity offerings, debt financing, additional strategic alliance and licensing arrangements or some combination of these financing alternatives. If we are successful in raising additional funds through the issuance of equity securities, investors likely will experience dilution, or the equity securities may have rights, preferences or privileges senior to those of the holders of our common stock. If we raise funds through the issuance of debt securities, those securities would have rights, preferences and privileges senior to those of our common stock. In addition, if we lack adequate funding, we may be required to delay, reduce the scope of, or eliminate one or more of our research and development or clinical programs.
As of December 31, 2005, our net operating loss carry forwards were approximately $198.5 million. If not utilized, our loss carry forwards will expire at various dates through 2025. Utilization of our net operating losses to offset future taxable income, if any, may be substantially limited due to “change of ownership” provisions in the Internal Revenue Code of 1986. We have not yet determined the extent to which limitations may have been triggered as a result of past or future financings. This annual limitation may result in the expiration of certain net operating losses before their use.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The primary objective of our investment activities is to preserve our capital until it is required to fund operations while at the same time maximizing the income we receive from our investments without significantly increasing risk. As of December 31, 2005, we had cash and cash equivalents and short-term investments of $32.0 million as follows:
Our exposure to market risk is confined to our cash and cash equivalents, which consist of commercial paper having maturities of less than one year, and our investment portfolio. We maintain an investment portfolio of investment grade government agency notes and corporate bonds. The securities in our investment portfolio are not leveraged, are classified as available-for-sale and are, due to their predominantly short-term nature, subject to minimal interest rate risk. We currently do not hedge interest rate exposure on our investment portfolio. As of December 31, 2005, securities totaling $25.2 million mature in 2006. While we do not believe that an increase in market rates of interest would have any significant negative impact on the realizable value of our investment portfolio, changes in interest rates affect the investment income we earn on our investments and, therefore, impact our cash flow and results of operations. We are headquartered in the United States where we conduct our pre-clinical research activities. Clinical trials are currently conducted in the United States and, to a lesser extent, Europe and Israel. We are evaluating clinical sites in other locations outside of the United States. All revenues to date have been received in U.S. dollars. Accordingly, we have not had any material exposure to foreign currency rate fluctuations.
At December 31, 2005, we had an outstanding industrial revenue bond payable of $2.6 million. This bond bears interest at a variable rate based on LIBOR. During 2000, we entered into an interest rate swap agreement that effectively fixed the interest rate over the life of the bond at 6.68 percent plus a remarketing fee. As of December 31, 2005, the fair value of the interest rate swap, excluding accrued interest, was a liability of $99,000. We also have outstanding loans totaling $684,000 at fixed interest rates ranging from 5.0 percent to 12.1 percent. Principal and interest on these loans is due and payable monthly. Accordingly, we had fixed interest rates on all of our debt as of December 31, 2005. An increase or decrease in interest rates would impact amounts due to us or payable under our swap agreement. However, we do not expect a change in interest rates will have any significant impact on our operations.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted in a separate section of this report. See Index to Financial Statements on Page F below for a list of the financial statements being filed herein.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Based on their evaluation as of December 31, 2005, our Chief Executive Officer and Chief Financial Officer, have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were sufficiently effective to ensure that the information required to be disclosed by us in this Annual Report on Form 10-K was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and instructions for Form 10-K.
Other Information
There were no changes in our internal controls over financial reporting during the quarter ended December 31, 2005 that have materially affected, or are reasonably likely to materially affect our internal controls over financial reporting.
Our management, including our Chief Executive Office and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitation in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within GenVec have been detected.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2005. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Our management has concluded that, as of December 31, 2005, our internal control over financial reporting is effective based on these criteria. Our independent registered public accounting firm, KPMG LLP, have issued an audit report on our assessment of our internal control over financial reporting, which is included herein.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
On March 15, 2006, GenVec, Inc. (“GenVec”) and Kingsbridge Capital Limited (“Kingsbridge”) entered into a Common Stock Purchase Agreement (the “Purchase Agreement”). Pursuant to the Purchase Agreement, Kingsbridge has committed, at GenVec’s option, to purchase up to $30 million of GenVec’s common stock, par value $0.001 per share (the “Common Stock”) within a three-year period. Due to the pricing formula, however, the actual amount of additional financing available to GenVec pursuant to the Purchase Agreement may be substantially less than the committed amount. As part of the arrangement, the Company issued a warrant to Kingsbridge to purchase 520,000 shares of Common Stock (the “Warrant”) at an exercise price equal to 125% of the average closing bid price during the five (5) days preceding the issuance date of the Warrant. The Warrant becomes exercisable on September 15, 2006 and will remain exercisable until March 15, 2011.
The transaction was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”) and Regulation D promulgated thereunder, as a transaction not involving a public offering, and in reliance on similar exemptions under applicable state laws.
As part of the transaction, pursuant to a Registration Rights Agreement dated March 15, 2006 between GenVec and Kingsbridge, GenVec agreed to register for resale under the Securities Act all of the shares of Common Stock issuable under the Purchase Agreement, as well as shares of Common Stock issuable upon exercise of the Warrant.
The foregoing description of the Purchase Agreement , the Registration Rights Agreement and the Warrant is qualified in its entirety by reference to the terms of those documents, which are filed herewith as Exhibits 10.28, 4.4 and 4.5, respectively.
For information regarding Dr. Davis’ Salary Continuation Agreement, see Item 11.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following sets forth the names and ages, as of February 28, 2006, of the members of the Board of Directors, their respective positions and offices with the Company, the period during which each has served as a director of the Company and their principal occupations or employment during the past five years.
Information concerning our Executive Officers is set for the in Part I of the Form 10-K.
Directors with Terms Expiring in 2006
Thomas H. Fraser, Ph.D., age 57, has served as a director of GenVec since August 2003. Dr. Fraser has served as the Chairman of the Board of Directors since joining the Board. Dr. Fraser served as Diacrin’s President and Chief Executive Officer and as a director from 1990 to August 2003. Dr. Fraser was previously Executive Vice President, Corporate Development, for Repligen Corporation, a biopharmaceutical company. Dr. Fraser was the founding Vice President for Research and Development at Repligen in 1981 and served as Executive Vice President from 1982 through 1990 as well as Chief Technical Officer from 1982 through 1988. Prior to joining Repligen, Dr. Fraser headed the recombinant DNA research group in Pharmaceutical Research and Development at The Upjohn Company, a pharmaceutical company. Dr. Fraser received his Ph.D. in Biochemistry from the Massachusetts Institute of Technology and was a Damon Runyon-Walter Winchell Cancer Fund Postdoctoral Fellow at The University of Colorado.
Paul H. Fischer, Ph.D., age 56, has served as President and Chief Executive Officer and as a director of GenVec since 1996. Prior to joining GenVec, he was Executive Vice President of Research and Development with Oncologix, Inc. (now Antigenics, Inc.), a biotechnology company. Previous experience included Manager, Cancer Research at Pfizer, Inc., a pharmaceutical company. Dr. Fischer received his B.S. in Biology from the University of Denver, his Ph.D. in Pharmacology from the University of California at San Francisco and performed post-doctoral research in Pharmacology at Yale University School of Medicine and was an associate Professor of Human Oncology at the University of Wisconsin.
Wayne T. Hockmeyer, Ph.D., age 61, has served as a director of GenVec since December 2000. Dr. Hockmeyer is a member of the Nominating and Corporate Governance Committee and is the Chairman of the Compensation Committee. Dr. Hockmeyer founded MedImmune, Inc. in April 1988 as President and Chief Executive Officer and was elected as a director of MedImmune in May 1988. Dr. Hockmeyer became Chairman of the Board of Directors of MedImmune in May 1993. He relinquished his position as Chief Executive Officer in October 2000 and now serves as the Chairman of the Board of Directors and President of MedImmune Ventures, Inc. Dr. Hockmeyer earned his bachelor’s degree from Purdue University and his Ph.D. from the University of Florida in 1972. Dr. Hockmeyer was recognized in 1998 by the University of Florida as a Distinguished Alumunus and in 2002, Dr. Hockmeyer was awarded a Doctor of Science honoris causa from Purdue University. Dr. Hockmeyer is a member of the Maryland Economic Development Commission and the Maryland Governor’s Workforce Investment Board (GWIB). He is also a member of the Board of Directors of Advancis Pharmaceutical Corp., Vanda Pharmaceuticals, Idenix Pharmaceuticals, Inc., and TolerRx, Inc. and serves on the boards of several educational and philanthropic organizations.
Directors with Terms Expiring in 2007
Zola P. Horovitz, Ph.D., age 71, has served as a director of GenVec since August 2003. Dr. Horovitz is a member of the Nominating and Corporate Governance Committee and is the Chairman of the Audit Committee. Dr. Horovitz served as a director of Diacrin from 1994 to August 2003. Dr. Horovitz was Vice President, Business Development and Planning at Bristol-Myers Squibb Pharmaceutical Group from 1991 until 1994 and was Vice President, Licensing from 1989 to 1991. Prior to 1989, Dr. Horovitz spent 30 years as a member of the Squibb Institute for Medical Research. Dr. Horovitz is also a director of Avigen, Inc., BioCryst Pharmaceuticals, Genaera Pharmaceuticals, Nitromed, DoV Pharmaceuticals, Immunicon and Palatin Technologies. Dr. Horovitz received his Ph.D. from the University of Pittsburgh.
William N. Kelley, M.D., age 66, has served as a director of GenVec since June 2002. Dr. Kelley is a member of the Audit Committee and is the Chairman of the Nominating and Corporate Governance Committee. Dr. Kelley brings a long history of involvement in experimental models of gene therapy to the Board. Dr. Kelley and his colleagues at the University of Michigan were the first to propose in vivo gene therapy as it is recognized today and the first to directly administer a human gene in vivo and obtain expression in an experimental animal model. In the fall of 1989, Dr. Kelley became Executive Vice President of the University of Pennsylvania with responsibilities as Chief Executive Officer for the Medical Center, Dean of the School of Medicine, and the Robert G. Dunlop Professor of Medicine and Biochemistry and Biophysics. In the national leadership arena, Dr. Kelley has served as President of the American Society for Clinical Investigation, President of the American College of Rheumatology, Chair of the American Board of Internal Medicine and Chair of the Residency Review Committee for Internal Medicine. Dr. Kelley also serves as a director of Merck & Company; Beckman Coulter; Advanced Bio-Surfaces, Inc., and Polymedix, Inc.
Harold R. Werner, age 57, has served as a director of GenVec since January 2002. Mr. Werner is a member of the Compensation Committee. Mr. Werner is a co-founder of HealthCare Ventures, a venture capital fund specializing in health care. Prior to the formation of HealthCare Ventures in 1985, Mr. Werner was Director of New Ventures for Johnson & Johnson Development Corporation. Before joining Johnson & Johnson in 1980, he was Senior Vice President of Robert S. First, Inc. Mr. Werner has served as a director for over thirty public and private companies in the health care field and has specialized in the formation of new high-science companies. Mr. Werner was elected to GenVec’s Board pursuant to the Investor Rights Agreement between GenVec and HealthCare Ventures in connection with HealthCare Ventures’ investment in GenVec in December 2001. In connection with its investment, HealthCare Ventures was granted the right to designate one individual to fill a vacancy created on the Board pursuant to the Investor Rights Agreement. Mr. Werner holds BS and MS degrees in engineering from Princeton University and an MBA from The Harvard Business School.
Directors with Terms Expiring in 2008
Barbara H. Franklin, age 65, has served as a director of GenVec since October 2002. Ms. Franklin is a member of the Audit Committee. Since January 1995, Ms. Franklin has served as the President and Chief Executive Officer of Barbara Franklin Enterprises, a private international consulting and investment firm in Washington D.C. Between January 1993 and January 1995, she was a lecturer and served as a director of various corporations and organizations. Previously, Ms. Franklin served as the 29th U.S. Secretary of Commerce. Ms. Franklin founded Franklin Associates, an internationally recognized consulting firm, and served as its President from 1984 through 1992. She was Senior Fellow of the Wharton School (1979 - 1988), one of the original Commissioners of the U.S. Consumer Product Safety Commission (1973 - 1979) and a staff assistant to the President, creating the first White House effort to recruit women for high level government jobs (1971 - 1973). Earlier she held executive positions at Citibank and the Singer Company. Ms. Franklin currently is a director of Aetna Inc.; The Dow Chemical Company; MedImmune, Inc.; and the Washington Mutual Investors Fund. She has been a director of the NASDAQ Stock Market, Inc., and the American Institute of CPA’s and has been awarded the John J. McCloy Award for contributions to audit excellence. She currently serves as a director of the National Association of Corporate Directors (NACD), a trustee of the Financial Accounting Foundation, and a member of the Public Company Accounting Oversight Board (PCAOB) Advisory Council. She has been chosen as Director of the Year by the NACD in 2000 and as Outstanding Director by Board Alert in 2003. Ms. Franklin graduated from the Pennsylvania State University and received an MBA from Harvard Business School.
Stelios Papadopoulos, Ph.D., age 57, has served as a director of GenVec since August 2003. Dr. Papadopoulos served as a director of Diacrin from 1991 to August 2003. Dr. Papadopoulos is a Vice Chairman in the investment banking division at Cowen & Co., LLC focusing on the biotechnology and pharmaceutical sectors. Prior to joining Cowen in February 2000, he spent 13 years as an investment banker at PaineWebber, where he was most recently Chairman of PaineWebber Development Corp., a PaineWebber subsidiary. Prior to becoming an investment banker he spent two years as a biotechnology analyst, first at Donaldson, Lufkin & Jenrette and subsequently at Drexel Burnham Lambert. Before coming to Wall Street in 1985, Dr. Papadopoulos was on the faculty of the Department of Cell Biology at New York University Medical Center. He continues his affiliation with NYU Medical Center as an Adjunct Associate Professor of Cell Biology. Dr. Papadopoulos holds a Ph.D. in biophysics and an MBA in finance, both from New York University. He is co-founder and Chairman of the Board of Exelixis, Inc., He is also co-founder and member of the Board of Anadys Pharmaceuticals, Inc., a director of SGX Pharmaceuticals, Inc., and is a director of several private companies in the biotechnology sector.
Joshua Ruch, age 56, has served as a director of GenVec since August 2003. Mr. Ruch is a member of the Compensation Committee. Mr. Ruch served as a director of Diacrin from March 1998 to August 2003. Mr. Ruch is the Chairman and Chief Executive Officer of Rho Capital Partners, Inc., an investment and venture capital management company, which he co-founded in 1981. Prior to founding Rho, Mr. Ruch was employed in investment banking at Salomon Brothers. Mr. Ruch received a B.S. degree in electrical engineering from the Israel Institute of Technology (Technion) and an MBA from the Harvard Business School. Mr. Ruch is also a director of a number of private companies.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 (the “1934 Act”) requires the Company’s executive officers, directors and persons who beneficially own more than 10% of a registered class of the Company’s equity securities to file with the SEC initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of the Company. Such executive officers, directors and greater than 10% beneficial owners are required by SEC regulation to furnish the Company with copies of all Section 16(a) reports filed by such reporting persons.
Except as set forth below, and based solely on the Company’s review of copies of such reports furnished to the Company and written representations that no other reports were required during fiscal 2005, the Company believes that all Section 16(a) filing requirements applicable to the Company’s executive officers, directors, and greater than 10% beneficial owners were complied with.
Thomas A. Davis, GenVec’s Chief Medical Officer, did not timely report an open market purchase of 5,000 shares of GenVec common stock on November 22, 2005. Dr. Davis subsequently filed the Form 4 with the SEC on January 5, 2006.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth a summary of all compensation paid or accrued by the Company to the Chief Executive Officer and to the next four most highly compensated executive officers whose annual compensation exceeded $100,000 for 2005 for services rendered to the Company during the years ended December 31, 2005, 2004 and 2003.
Summary Compensation Table
Option Grants in Last Fiscal Year
The following table sets forth grants of stock options made during the year ended December 31, 2005, to each of the individuals listed in the Summary Compensation Table.
(1)
One-eighth of each option grant vests six months after the date of grant and the remainder vests monthly on a pro-rata basis over the following 42 months. The options were granted under the GenVec 2002 Stock Incentive Plan.
(2)
In accordance with the rules and regulations of the Securities and Exchange Commission, such gains are based on assumed rates of annual compound stock appreciation of 5% and 10% from the date on which the options were granted over the full term of the options. The rates do not represent GenVec’s estimate or projection of future GenVec common stock prices, and no assurance can be given that these rates of annual compound stock appreciation will occur.
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values
Compensation of Directors
During 2005, each non-employee director received $2,000 per Board meeting attended, $1,000 per committee meeting attended and $3,000 per quarter as a retainer. The Company’s Chairman of the Board received $4,000 per Board meeting attended, $1,000 per committee meeting attended and $6,000 per quarter as a retainer. Directors were reimbursed for some expenses in connection with attendance at Board and committee meetings.
Under the 2002 Stock Incentive Plan, non-employee directors receive: (i) grants of options to purchase 20,000 shares of Common Stock which are exercisable ratably over a four-year period upon the effective date such non-employee director joins the Board and (ii) annual automatic grants of 15,000 options, 50% of which will be exercisable six months after the date of grant and 50% of which will be exercisable 12 months after the date of grant, except for the Chairman of the Board, who receives an annual automatic grant of 22,500 options instead of 15,000 options. The options granted to the Chairman become exercisable in the same proportion as the options granted to the other non-employee directors. Director options have an exercise price equal to the fair market value of GenVec common stock on the date of the grant and a ten-year term.
Upon completion of the Diacrin merger in August 2003, GenVec entered into a consulting agreement with Dr. Thomas Fraser, Chairman of the Board of Directors. Under the terms of the consulting agreement, Dr. Fraser will devote approximately 20% of his working time to the business and affairs of GenVec (including time spent in his capacity as a Director of GenVec). Dr. Fraser received $32,500 under the terms of the consulting agreement in 2005.
Mr. Werner has declined to accept options for service on the Board.
Employment Contracts and Termination of Employment and Change-in-Control Arrangements
The Company does not currently have employment agreements with its executive officers. Certain executive officers are party to a Salary Continuation Agreement and/or Change in Control Agreement. The material terms of these agreements are described below.
The terms of Dr. Fischer’s Salary Continuation Agreement provide that if Dr. Fischer’s employment is terminated without cause and other than by reason of death or disability, the Company will continue to pay Dr. Fischer’s salary and provide him with life insurance and health insurance for a period of 24 months from the date of his termination. In addition, the Company is required to pay Dr. Fischer an additional payment equal to the pro rata amount of his bonus for the last completed year of employment based on the number of months worked in the year of termination. Dr. Fischer’s Change in Control Agreement provides that if he is terminated or resigns for good cause in connection with a change in control of the Company, he is entitled to (i) a severance payment based on 24 months salary and bonus, (ii) an additional pro rata payment based on his highest annual salary in the past year and his highest bonus amount in the past three years, (iii) any bonus applicable to the preceding fiscal year, if not yet paid, and (iv) continuation of life and health insurance benefits for a period of 24 months. The Company is also obligated to provide a one-time payment to cover certain FICA and Medicare withholding taxes and excise taxes imposed under Section 4999 of the Internal Revenue Code of 1986, as amended due on such benefits. The Salary Continuation Agreement contains obligations on Dr. Fischer’s part regarding non-disparagement and non-competition, and both agreements provide for his nondisclosure of proprietary information. If Dr. Fischer should die while entitled to any payments or benefits under either agreement, such payments and benefits are payable to Dr. Fischer’s heirs or estate. To the extent Dr. Fischer becomes entitled to benefits under the Change of Control Agreement, the salary continuation agreement is superseded and he will not receive any benefit under such agreement.
The terms of the Company’s Salary Continuation Agreements with Mr. Church, Dr. Davis and Dr. King are identical to the terms of the Salary Continuation Agreement the Company entered into with Dr. Fischer, as described above, except that under their agreements Mr. Church, Dr. Davis and Dr. King are entitled to salary and insurance benefits for 12 months instead of 24 months.
The Company has also entered into a Change in Control Agreement with Mr. Church. The terms of this agreement are identical to the terms of the Change in Control Agreement that the Company entered into with Dr. Fischer, as described above, except that under his agreement Mr. Church’s severance payment is based on, and he is entitled to continuation of health and life insurance benefits for, 18 months instead of 24 months.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth certain information as of February 28, 2006, regarding the beneficial ownership of the Company’s Common Stock by (i) those persons known to the Company to be the beneficial owners of more than 5% of the outstanding shares of Common Stock, (ii) each of the individuals listed in the “Summary Compensation Table” below, (iii) each director of the Company, and (iv) all current directors and executive officers as a group.
Beneficial ownership is determined in accordance with the rules of the SEC for computing the number of shares of Common Stock beneficially owned by a person and the percentage ownership of that person. Shares of Common Stock subject to options currently exercisable or exercisable within 60 days after February 28, 2006 are considered outstanding for the purpose of computing the percentage ownership of the person holding such options, but are not considered outstanding when computing the percentage ownership of each other person. Except as indicated in the footnotes to this table, each stockholder named in the table below has sole voting and investment power for the shares shown as beneficially owned by them. Percentage of ownership is based on 63,675,282 shares of Common Stock outstanding on February 28, 2006.
Equity Compensation Plan Information
The following table discloses certain information about the options issued and available for issuance under all outstanding Company option plans as of December 31, 2005:
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On September 26, 2005, the Company sold 7,600,000 shares of common stock to various investors at $2.00 per share under the shelf registration. Proceeds, net of offering costs, from this sale totaled $13,990,000. SG Cowen & Co., LLC (“SG Cowen”) was engaged as the placement agent for this transaction. Stelios Papadopoulos, Ph.D., is a Vice Chairman in the investment banking division of SG Cowen and is a member of GenVec’s board of directors.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Principal Accountant Fees and Services
The following is a summary of the fees billed to GenVec by KPMG LLP for professional services rendered for the years ended December 31, 2005 and 2004:
Audit Fees
These fees consist of fees for professional services rendered for the audit of GenVec’s financial statements, review of the interim financial statements included in quarterly reports, and services in connection with statutory and regulatory filings.
Audit-Related Fees
These fees comprise assurance and related services that are reasonably related to the performance of the audit or review of the Company’s financial statements and are not reported under “Audit Fees” above. GenVec did not incur such fees during 2005 and 2004.
Tax Fees
These fees comprise tax compliance and tax preparation assistance for state and federal filings, consultations concerning tax related matters and other tax compliance projects. Less than 5% of these fees comprise consulting fees, as it is GenVec’s intent to minimize consulting services in this category.
All Other Fees
All other fees consist of fees not included in any other category. GenVec did not incur such fees during 2004 and 2005.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)
(1 )
Financial Statements - See index to Financial Statements on page F below for a list of the financial statements being filed herein.
(2 )
Financial Statement Schedules - All financial statement schedules are omitted because they are not applicable, not required under the instructions or all the information required is set forth in the financial statements or notes thereto.
(3 )
Exhibits - The Exhibits listed in the accompanying Index to Exhibits are filed or incorporated by reference as part of this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
GENVEC, INC.
By:
/s/ PAUL H. FISCHER
Paul H. Fischer, Ph.D
President, Chief Executive Officer and Director
Date:
March 15, 2006
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.
By:
* /s/ PAUL H. FISCHER, PH.D.
Paul H. Fischer, Ph.D.
Attorney-in-Fact
GENVEC, INC.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
GenVec, Inc.:
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A of this Form 10-K, that GenVec, Inc. (the Company) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). GenVec’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that GenVec, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, GenVec, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the balance sheets of GenVec, Inc. as of December 31, 2005 and 2004, and the related statements of operations, stockholders’ equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2005, and our report dated March 15, 2006 expressed an unqualified opinion on those financial statements.
/s/ KPMG LLP
McLean, Virginia
March 15, 2006
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
GenVec, Inc.:
We have audited the accompanying balance sheets of GenVec, Inc. (the Company) as of December 31, 2005 and 2004, and the related statements of operations, stockholders’ equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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 GenVec, Inc. as of December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of GenVec, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 15, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
/s/ KPMG LLP
McLean, Virginia
March 15, 2006
GENVEC, INC.
STATEMENTS OF OPERATIONS
The accompanying Notes to Financial Statements are an integral part of these statements.
GENVEC, INC.
BALANCE SHEETS
The accompanying Notes to Financial Statements are an integral part of these statements.
GENVEC, INC.
STATEMENTS OF CASH FLOWS
The accompanying Notes to Financial Statements are an integral part of these statements.
GENVEC, INC.
STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE LOSS
The accompanying Notes to Financial Statements are an integral part of these statements.
NOTES TO FINANCIAL STATEMENTS
(1) ORGANIZATION AND BUSINESS DESCRIPTION
GenVec is an emerging late stage biopharmaceutical company developing innovative gene-based therapeutics to treat cancer, heart disease and vision loss and vaccines to prevent infectious disease. The Company is focused on the development and commercialization of our lead product candidate, TNFerade, for the treatment of cancer. The Company’s advanced product candidates are:
•
TNFeradeÔ, which is currently in a Phase II/III trial for the treatment of locally advanced pancreatic cancer and Phase II trials for the treatment of rectal and melanoma cancer;
•
BIOBYPASSÒ, which is currently in a randomized, placebo-controlled Phase II trial for the treatment of severe coronary artery disease. The Company previously completed a randomized, controlled Phase II study of 67 patients with severe coronary artery disease using a cardiac surgical procedure; and
•
PEDF, which has completed enrollment in a Phase Ib trial for the treatment of wet age-related macular degeneration, a leading cause of blindness in individuals over the age of 50.
The medical use of many proteins has historically been limited by the inability to maintain sufficient concentrations of the protein at the site of the disease for a period of time long enough to provide a benefit, while minimizing side effects caused by the protein’s presence in other, non-target tissues. GenVec’s gene-based therapeutic product candidates are based on proprietary technology that uses an adenovector to deliver genes that produce proteins at the site of disease.
The Company’s gene-based product candidates have been generally well tolerated in multiple clinical trials. The Company believe results to date support the broad applicability and commercial potential of our product development programs and is working with our collaborators and customers to develop second generation vectors and new applications for our technology, such as preventative vaccines to treat HIV, malaria and other infectious diseases.
The Company is subject to various risks common to companies within the biotechnology industry. These include, but are not limited to, development by competitors of new technological innovations; dependence on key personnel; dependence on a limited number of products; risks inherent in the research and development of biotechnology products; protection of proprietary technology; acceptance of the Company’s products by the country’s regulatory agencies in which the Company may choose to sell its products, as well as the end customer; health care cost containment initiatives; and product liability and compliance with government regulations, including the U.S. Food and Drug Administration.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments with original maturities of three months or less.
(b) INVESTMENTS
The Company’s investments consist primarily of bonds, government agency notes and commercial paper. These investments are classified as available-for-sale securities, which are carried at fair value, with the unrealized holding gains and losses reported as a separate component of other comprehensive income until realized. Realized gains and losses from the sale of available-for-sale securities are determined on a specific identification basis.
A decline in the market value of any available-for-sale security below cost that is deemed to be other than temporary results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned.
(c) FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Company’s financial instruments, as reflected in the accompanying balance sheets, approximate fair value. Financial instruments consist of cash and cash equivalents, short-term investments, long-term investments, bond sinking fund, accounts receivable, accounts payable, and long-term debt. The Company has an interest rate swap agreement to manage interest rate exposure. The swap agreement has been deemed to be ineffective due to the different pricing frequencies of the swap agreement and related debt instrument; as such, changes in fair value of the swap agreement are included in interest expense.
(d) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Property and equipment is depreciated using the straight-line method over the estimated useful lives of assets, generally three to five years for equipment and seven years for furniture and fixtures. Leased property meeting certain criteria is capitalized at the lower of the present value of the future minimum lease payments or fair value at the inception of the lease. Amortization of capitalized leased assets is computed on the straight-line method over the term of the lease. Repair and maintenance costs are expensed as incurred.
(e) REVENUE RECOGNITION
The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition (“SAB 104”). Under SAB 104, we recognize revenues when a contract is executed, the contract price is fixed and determinable, delivery of the service or products has occurred, and collectibility of the contract price is considered probable. Upfront non-refundable fees are deferred and subsequently recognized over the period in which we complete performance obligations when such fees are received in conjunction with an agreement that includes such performance obligations. Revenue associated with performance milestones is recognized based on achievement of the milestones as defined in the respective agreements. Non-refundable research and development fees for which no future performance obligations exist are recognized when collection is assured. Research and development revenue from cost-reimbursement and cost-plus fixed fee agreements is recognized as earned based on the performance requirements of the contract. Revisions in revenues, costs and billing factors (e.g. indirect rate estimates) are accounted for in the period of change. Reimbursable costs under such contracts are subject to audit and retroactive adjustment. Contract revenues and accounts receivable reported in the financial statements are recorded at the amount expected to be received. Contract revenues are adjusted to actual upon final audit and retroactive adjustment.
(f) RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations as incurred. Such costs include internal research and development expenditures (such as salaries and benefits, raw materials and supplies) and contracted services (such as sponsored research, consulting and testing services) of proprietary research and development activities and similar expenses associated with collaborative research agreements.
(g) CLINICAL TRIAL EXPENSES
The Company accrues estimated costs for clinical and pre-clinical studies based on estimates of work performed and completion of certain milestones. The Company believes that this method best aligns the expenses it records with the efforts it expends. The Company monitors the progress of the trials and their related activities to the extent possible, and adjusts, the accruals accordingly. Adjustments to accruals are charged to expense in the period in which the facts that give rise to the adjustment become known.
(h) INCOME TAXES
Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.
(i) NET LOSS PER SHARE
Basic and diluted net loss per share has been computed using the weighted average number of shares of common stock outstanding during the period.
If the Company had net income, diluted earnings per share would be presented based on the shares used in the computation of basic net loss per share as well as potential common shares related to outstanding options and warrants. Total outstanding options in the amount of 57,000 were excluded from the computation of diluted earnings per shares as of December 31, 2005.
(j) COMPREHENSIVE LOSS
Comprehensive loss consists of net loss and unrealized holding gains and losses from available-for-sale securities.
(k) INTEREST RATE SWAP
The Company has an interest rate swap agreement to manage interest rate exposure. Amounts to be paid or received under this agreement are included in interest expense. The swap agreement has been deemed to be ineffective, as such, changes in the fair value of the swap agreement are included in interest expense.
(l) TECHNOLOGICAL LICENSE AND INTELLECTUAL PROPERTY
Technological license and intellectual property costs consist of payments associated with license agreements and legal costs associated with the acquisition and development of intellectual property. Costs associated with the acquisition, development and/or maintenance of intellectual property are expensed when incurred.
(m) STOCK OPTION PLANS AND EMPLOYEE STOCK PURCHASE PLAN
The Company accounts for stock-based compensation awards to employees in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations, and complies with the disclosure provisions of SFAS Nos. 123 and 148, Accounting for Stock-Based Compensation. Under APB 25, compensation expense is based on the difference, if any, on the date of grant, between the quoted market price of the Company’s stock and the exercise price. All stock-based awards to non-employees are accounted for at their fair value in accordance with the provisions of SFAS No. 123.
Option grants to employees have been issued only at fair market value prices as of the date of grant during the periods presented herein, and the Company’s policy does not recognize compensation costs for options of this type. The pro forma costs of these options granted have been calculated using the Black-Scholes option pricing model and assuming the following for each of the three years ended December 31, 2005, 2004 and 2003: expected volatility of 75 percent, 75 percent and 102.81 percent; risk free interest rate of 3.70 percent, 2.51 percent and 2.54 percent; expected lives of four years and no dividend yield. The pro forma amounts may not be representative of the effects on pro forma net earnings for future years. The weighted-average grant date fair market value of options issued was $1.10 per share in 2005, $1.64 per share in 2004 and $1.24 per share in 2003. The following table illustrates the effect on net loss and net loss per share if the fair value based method had been applied to all outstanding and unvested awards in each year (in thousands, except per share data):
The Company has a stock purchase plan that is considered to be non-compensatory under Financial Interpretation Number 44, Accounting for Certain Transaction Involving Stock Compensation; however, for disclosure purposes this plan is considered to be compensatory.
(n) USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America may require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The Company’s significant accounting estimates involve recognition of revenue from research and development agreements, accrual of clinical trial costs and valuation of intangible assets.
(o) RECENT ACCOUNTING PRONOUNCEMENTS
In May 2005, the FASB issued FASB Statement No. 154, Accounting Changes and Error Corrections. Statement 154 establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to a newly adopted accounting principle. This statement will be effective for the Company for all accounting changes and any error corrections occurring after January 1, 2006.
In March 2005, the FASB issued FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations, which requires conditional asset retirement obligations to be recognized if a legal obligation exists to perform asset retirement activities and a reasonable estimate of the fair value of the obligation can be made. FIN 47 also provides guidance as to when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The Company does not have any asset retirement obligations within the scope of this Statement.
In December 2004, the FASB issued a revision of Statement of Financial Accounting Standards (or “FAS”) No. 123, “Accounting for Stock-Based Compensation.” The revision is referred to as “FAS 123R - Share-Based Payment” (or “FAS 123R”), which supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” (or “APB 25”) and will require companies to recognize compensation expense, using a fair-value based method, for costs related to share-based payments including stock options and stock issued under our employee stock purchase plans. We intend to adopt FAS 123R using the modified prospective basis on January 1, 2006. Our adoption of FAS 123R is expected to result in compensation expense that will increase diluted net loss per share by an estimated $0.02 per share for 2006 with respect to unvested options outstanding as of December 31, 2005. However, our actual stock-based compensation expense for 2006 will be affected by changes in our stock price, the number of additional stock-based awards our board of directors may grant in 2006, as well as a number of complex and subjective valuation assumptions and the related tax effect. These valuation assumptions include, but are not limited to, the volatility of our stock price and employee stock option exercise behaviors.
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. For any VIEs that must be consolidated under FIN 46R, the assets, liabilities and noncontrolling interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R first applies may be used to measure the assets, liabilities and noncontrolling interest of the VIE. The Company does not have any financial interest within the scope of this Statement.
In May 2003, FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, was issued. This Statement establishes standards for the classification, measurement and disclosure of certain financial instruments with characteristics of both liabilities and equity. The Company does not have any financial instruments that are within the scope of this Statement.
(3) BUSINESS ACQUISITION AND DISPOSITION
(a) ACQUISITION
On August 21, 2003, the Company and Diacrin consummated the business combination that was jointly announced in April 2003 under which GenVec acquired Diacrin through an exchange of stock. Under the terms of the agreement, each share of Diacrin Common Stock was exchanged for 1.5292 shares of GenVec Common Stock in a transaction intended to qualify as a tax-free reorganization. Based on GenVec’s average closing per share price of $1.28 for a five-day period around April 15, 2003 (the date the transaction was announced), the transaction was valued at approximately $38.5 million. At the time of closing, GenVec’s existing shareholders owned approximately 45.4 percent and Diacrin’s original shareholders owned approximately 54.6 percent of the combined company. The difference between the cash and cash equivalents acquired in the acquisition of $7.3 million and the transaction costs incurred of $2.4 million is presented in the Statements of Cash Flows as cash provided by investing activities. The Company is the acquirer and the transaction was accounted for under the purchase method pursuant to SFAS No. 141, “Business Combinations”. Accordingly, results of operations of Diacrin have been included in these financial statements from August 21, 2003.
The aggregate purchase price of $38.5 million includes 27,665,392 shares of common stock issued in the exchange, valued at $35.4 million and 1,937,197 common stock options valued at $3.1 million. The value of the stock options was computed using the Black-Scholes valuation model based on the closing price on the date of the transaction. Of the $3.1 million computed value, $563,000 represents the intrinsic value of unvested in-the-money options as of the date of the transaction and has been recorded as deferred compensation, to be amortized over the remaining vesting period of the options.
The acquisition costs are summarized as follows (in thousands):
* Exclusive of $16 of registration fees charged directly against additional paid-in capital. All transaction costs were paid as of December 31, 2003.
The fair value of the assets acquired and liabilities assumed at the date of acquisition are summarized as follows (in thousands):
The excess of the acquisition costs over the fair value of the net assets acquired has been recorded as intangible assets. Management has identified such assets as pertaining to the patents related to the myoblast cell therapy program. The amortization is not deductible for tax purposes because of the tax-free nature of the business combination.
(b) DISPOSITION
On December 28, 2005, the Company completed the sale of its myoblast cell therapy assets to Mytogen, Inc. (“Mytogen”). In conjunction with the sale of these assets, the Company discontinued its cell transplantation therapy operations in Charlestown, Massachusetts and subleased a portion of the facility to Mytogen. Under the terms of the asset purchase agreement, GenVec will receive royalties on the sales of future myoblast-related products and a portion of specified milestone payments, licensing revenues and/or proceeds from the sale or transfer of key Mytogen assets, if any, that occur through December 2007. Royalty payments made to Company under this agreement will be recognized when received. In connection with the sale of the myoblast-related assets and the termination of our cell therapy operations in Charlestown, Massachusetts, the Company incurred cash charges of approximately $75,000 in staff termination costs, accrued $460,000 for continuing lease obligations for the Charlestown facility (net of expected sublease income) and recorded non-cash write-offs of $93,000 of fixed assets and leasehold improvements and $1.8 million of intangible assets.
(4) INVESTMENTS
The amortized cost, gross unrealized holding gains and fair value of available-for-sale securities by major security type at December 31, 2005 and 2004, are as follows (in thousands):
Maturities of securities classified as available-for-sale had fair values as follows at December 31 (in thousands):
(5) PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31 (in thousands):
Depreciation and amortization expense related to property and equipment were $1,558,000, $1,813,000, and $1,927,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
(6) INTANGIBLE ASSETS
Beginning January 2004, intangible assets arising from the Company’s merger with Diacrin were being amortized through December 2024 on a straight-line basis. The carrying value of the intangible assets was supported by the discounted value of milestone payments due under the Terumo License and Development Agreement, which was acquired as part of the merger. As of December 31, 2004, the carrying value of the intangible assets (net of amortization) was $1.9 million. On December 28, 2005, the Company completed the sale of the Company’s myoblast assets, which included the assignment of the Terumo License and Development Agreement, to Mytogen, Inc. As a result of the assignment, the Company has recorded a non-cash write-off of the intangible assets (net of amortization) in the amount of $1.8 million.
(7) LONG-TERM DEBT
Long-term debt consists of the following at December 31 (in thousands):
Aggregate maturities of long-term debt are as follows (in thousands):
(a) INDUSTRIAL REVENUE BOND
In June 1999, in connection with the lease of its Gaithersburg facility, the Company borrowed $5,000,000 under an Industrial Revenue Bond with the State of Maryland to fund leasehold improvements and additional equipment needs of the Company. The Bond is secured by a first priority lien on all equipment and fixtures financed, a $2,500,000 letter of credit facility guaranteed by the Maryland Industrial Development Finance Authority, and a $2,500,000 guarantee from The Warner-Lambert Company. The annual fee for the letter of credit is one percent of the outstanding balance, which totaled $27,000, $42,000 and $48,000 for the years ended December 31, 2005, 2004, and 2003, respectively. Warner-Lambert’s guarantee will remain in place as long as the outstanding principal balance on the Bond is greater than $2,500,000 and will be reduced in value dollar for dollar as the principal balance decreases below $2,500,000.
The Bond bears interest at a variable rate based on weekly market conditions and matures on June 1, 2009. The weighted-average interest rates during 2005, 2004 and 2003 were 1.72 percent, 1.62 percent and 1.12 percent, respectively. The Bond is subject to mandatory sinking fund redemption. The Company began making sinking fund payments in July 2000; the balance of the sinking fund at December 31, 2005 and 2004 was $296,000 and $276,000, respectively.
In October 2000, the Company entered into an interest rate swap agreement to reduce its exposure to adverse fluctuations in interest rates related to the Company’s outstanding bond payable. The Company does not utilize financial instruments for trading or other speculative purposes. The interest rate swap agreement entitles the Company, on a monthly basis, to receive a LIBOR-based floating rate of interest and pay a fixed rate of interest of 6.68 percent. The interest rate swap has a total notional amount of $3,645,000 and extends through the life of the outstanding bond.
The Company has determined the interest rate swap to be ineffective, as such, changes in the fair value of the swap agreement are included in interest expense. The fair value of the swap agreement was a liability of $99,000 and $239,000 at December 31, 2005 and 2004, respectively.
(b) TERM LOAN
In connection with the lease of the office and laboratory facility, the landlord loaned $858,000 for the construction of leasehold improvements in the form of a term loan. This loan is payable in monthly installments of $11,900, including interest at a fixed rate of 10.5 percent over the remaining term of the building lease.
(c) EQUIPMENT FINANCING
On December 27, 2002 the Company secured $939,000 in financing for certain assets purchased by the Company at an interest rate of 10.0 percent. The note is payable in monthly installments of $26,100 through December 2005 followed by monthly installments of $14,000 through December 2006. The equipment financed by the note secures the loan.
On April 3, 2002 the Company secured $1,564,000 in financing for certain assets purchased by the Company. The financing consists of two notes: one note for $1,054,000 at an interest rate of 9.54 percent, payable in monthly installments of $33,600 through April 2005; the second note for $507,000 at an interest rate of 9.99 percent, payable in monthly installments of $12,800 through April 2006. The equipment financed by the notes secures the loan.
(d) ECONOMIC DEVELOPMENT LOAN
On September 29, 1999, the Company entered into an economic development fund agreement with Montgomery County, Maryland (the County) and received $125,000 for the purpose of relocation and expansion related expenses. The $125,000 received was considered a loan, which accrued interest on the principal balance at 5 percent per year until we were required to commence payment as described below.
Quarterly payments of principal and interest were originally scheduled to commence on January 15, 2002. Subsequent loan payments were to be deferred or forgiven by the County if the Company achieved certain incentive provisions outlined in the loan agreement related to the hiring of new employees within the Company. As of December 31, 2003, the Company achieved certain incentive provisions related to increasing its workforce resulting in the following: On February 2004, the Department of Economic Development of Montgomery County, Maryland, converted $68,408 of the $125,000 conditional loan into a grant. Repayment of the remaining $56,592, plus accrued interest of $6,251, occurs in quarterly installments of $4,360, which commenced in April 2004 and continues through January 2008. The interest rate is fixed at 5 percent.
(8) STRATEGIC ALLIANCES AND RESEARCH CONTRACTS
The Company has established collaborations and research contracts with pharmaceutical and biotechnology companies and governmental agencies to enhance its ability to discover, evaluate, develop and commercialize multiple product opportunities. Revenue is summarized as follows (in thousands):
GenVec’s results of operations included $2.3 million, $435,000 and $98,000 during the years ended December 31, 2005, 2004 and 2003, of amortization of these upfront contract and license fees which were received in prior years. Amortized revenues for the year ended December 31, 2005 included $1.1 million from unearned upfront contract and license fees related to the Terumo agreement, including $667,000 of accelerated amortization due to the completion of our significant performance obligations under the Terumo agreement.
(a) VACCINE RESEARCH CENTER
In December 2001, the Vaccine Research Center (VRC) at the National Institute of Allergy and Infectious Diseases of the National Institutes of Health selected the Company to collaborate in the development of a worldwide preventative AIDS vaccine candidate. This collaboration was expanded to include the development of a SARS vaccine candidate (April 2003) and an influenza vaccine candidate (February 2006). The Company has a cost-plus fixed fee sub-contract, managed for the VRC through SAIC-Frederick, Inc., which became effective January 25, 2002. Under the sub-contract, the Company is responsible for constructing and producing adenovector-based vaccine candidates utilizing its proprietary cell line and second-generation adenovector technology. The program encompasses a base year and six option years. The fourth option year covering 2006 has been exercised and work is continuing under the contract.
(b) PATH/MALARIA VACCINE INITIATIVE (MVI)
In March 2004, the Company signed a two-year, $2,581,000 contract for the development, production and evaluation of vaccines against malaria. Under the contract, the Company is responsible for constructing adenovector-based vaccine candidates using its proprietary cell line and second-generation adenovector technology. The contract includes $547,000 for work to be performed under a separate Collaborative Research and Development Agreement (CRADA) with the Navy Medical Research Center (NMRC). Under the CRADA, NMRC will provide the Company with optimized malaria genes to be used in the development of the adenovector vaccines as well as provide preclinical evaluation of the vaccine candidates.
(c) US NAVAL MEDICAL RESEARCH CENTER (NMRC)
In January 2003, the Company signed a two-year, $1,900,000 fixed price contract to aid in the development of vaccines against malaria and dengue fever. Under the contract, the Company is responsible for constructing and producing adenovector-based vaccine candidates using its proprietary cell line and second-generation adenovector technology.
In January 2005, the Company signed a one-year, $1,582,000 fixed price contract for the production of vaccines against malaria. Under the contract, the Company will be responsible for producing, testing and releasing malaria vaccines under current Good Manufacturing Practices (cGMP) standards for preclinical evaluation by NMRC. In conjunction with the preclinical evaluation of the vaccine candidates, the Company will provide regulatory support to NMRC with regard to an anticipated Investigational New Drug (IND) filing with the FDA.
(d) FUSO PHARMACEUTICALS INDUSTRIES, LTD. (Fuso)
In September 1997, the Company established collaboration with Fuso to conduct research and to identify, evaluate and develop gene therapy products for the treatment of cancer. Under the terms of the contract, the Company received $750,000 annually for five years, subject to Fuso’s right to terminate the collaboration upon 90 days prior written notice. The annual payments are non-refundable. As part of the collaboration, the Company granted Fuso an exclusive, royalty-bearing license to develop and commercialize products developed under the collaboration for the treatment of cancer in Japan and, at Fuso’s option, Korea and Taiwan. Fuso will be responsible for the development and commercialization of any products in its territory. The Company will receive additional payments for the achievement by Fuso of specific product development and regulatory milestones, with the earliest of such payments not expected in the near term. The Company will also receive royalties on the sale of any such products commercialized by Fuso. The Company has retained all rights to develop and commercialize these products for the treatment of cancer in the rest of the world, and generally for all other uses worldwide, subject to certain restrictions. In connection with establishment of the collaboration, Fuso purchased $1,000,000 of the Company’s capital stock consisting of 75,329 shares of the Company’s Class E convertible preferred stock for $13.28 per share. All preferred shares were converted into common shares in December 2000 in connection with the Company’s initial public offering at a rate of 1.5 common shares to each preferred share.
In September 2002, the parties amended the collaboration agreement to increase the level of funding to $1,500,000 per year, effective April 1, 2002, and extended the agreement through December 31, 2003.
Effective January 1, 2004, the Company and Fuso established a new three-year, $4,500,000 research collaboration to identify a targeted cancer therapy product candidate designed to treat not only the primary tumor but also cancer that has spread, or metastasized to distant sites in the body.
As of December 31, 2005 and 2004, unearned revenue related to this collaboration was $0 and $42,000, respectively.
(e) TERUMO CORPORATION (Terumo)
In September 2002, Diacrin entered into a development and license agreement with Terumo Corporation, of which the Company has become a party as a result of the acquisition consummated on August 21, 2003. Under the terms of the agreement, the Company licensed to Terumo its human muscle cell transplantation technology for cardiac disease in Japan. Terumo would fund all development costs in Japan while the Company continued to independently develop its cardiac repair technology for commercialization in the U.S. and elsewhere. On October 1, 2002, the Company received an upfront non-refundable license fee of $2.0 million. The agreement also includes payments by Terumo to the Company for development milestones and a royalty on product sales. The Company recorded the upfront license fee as unearned revenue to be amortized through November 2007.
For the year-to-date period ended November 30, 2005, the Company recognized $367,000 of unearned revenue. On December 28, 2005, the Company completed the sale of its myoblast assets to Mytogen, Inc., which included the assignment of the development and license agreement with Terumo. As a result of the assignment, the Company accelerated amortization of the remaining balance of unearned revenue and recorded additional revenue of $667,000.
(f) CORDIS CORPORATION (Cordis)
In January 2004, the Company entered into a research collaboration with the Cordis Cardiology Division of Cordis Corporation, a Johnson & Johnson company, to study the clinical benefit of BIOBYPASS in a procedure involving guided delivery of the angiogenic agent directly into targeted regions of the heart in patients with severe coronary artery disease using the Cordis NOGASTAR® Mapping Catheter and MYOSTAR™ Injection Catheter.
The purpose of this collaboration is to conduct a randomized, double blind, placebo controlled study of the Company’s cardiovascular product candidate, BIOBYPASS. Clinical benefit will be assessed in the multi-center study, which will be conducted in Europe and Israel and is expected to enroll up to 129 patients with severe heart disease. GenVec and Cordis will collaborate on regulatory matters and share in the clinical trial costs. GenVec will supply all clinical material and Cordis will provide the NOGASTAR® and MYOSTAR® mapping and injection catheters and training to the interventional cardiologists conducting the trial. GenVec retains all commercial rights to BIOBYPASS and Cordis retains all commercial rights to the NOGASTAR mapping catheters and MYOSTAR injection catheters. The Company recorded a $1.0 million receivable and $1.0 million of unearned revenue as of December 31, 2003; the receivable was satisfied in January 2004 with the receipt of a $1.0 million payment from Cordis. Revenues are recognized as earned based on performance under the contract. In 2005, the Company recognized $470,000 in revenues earned under the collaboration.
(g) OTHER STRATEGIC ALLIANCES AND RESEARCH GRANTS
Revenues include $498,000 earned in 2005 under a $1.7 million extension of our foot-and-mouth vaccine development agreement with the U.S. Department of Agriculture.
(9) COMMITMENTS
(a) LEASE AGREEMENTS
The Company has non-cancelable operating leases for its Gaithersburg, MD and Charlestown, MA facilities. The Gaithersburg office and laboratory lease expires in October 2009. The agreement includes a provision for a 3 percent annual increase in base rent. The lease contains renewal options for up to fourteen years and requires the Company to pay all executory costs such as maintenance and insurance. As part of the lease, the landlord’s initial contribution of $1,300,000 in incentives is considered a reduction of rental expense that is recognized on a straight-line basis over the term of the lease. The Charlestown lease expires on October 3, 2006. Rent expense under all operating leases was approximately $1,934,000, $1,492,000 and $967,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
Future minimum lease payments under all non-cancelable operating leases are as follows (in thousands):
At December 31, 2005 and 2004, the Company had a straight-line lease liability of $745,000 and $885,000, respectively.
(b) LICENSE AGREEMENTS
In 2000, the Company entered into agreements with Public Health Service (PHS) for exclusive rights to develop and commercialize the PEDF gene for gene therapy applications in the eye. In October 2004, the Company entered into an agreement with PHS that superseded the 2000 license agreement, extending the Company’s rights to include the development and commercialization of the PEDF gene and protein for diagnostic and therapeutic applications in the eye. In December 2004, the Company entered into an agreement with PHS further expanding the Company’s rights to include the use of the PEDF gene and protein for the diagnosis, treatment and/or prevention of cancer (except cancers of the eye as covered under the October 2004 license agreement). In exchange for these licenses, the Company has committed to pay product royalties based on net sales of licensed products, net of a minimum royalty payable annually for the duration of the agreements. The Company has also committed to pay a one-time, $50,000 license fee under each of the two agreements upon the earlier of the achievement of certain commercialization milestones or stipulated anniversaries of the commencement date of the agreements.
In February 1998, the Company entered into a non-exclusive license agreement with Asahi Chemical Industry Company Limited (Asahi) for rights to gene therapy applications in the United States to its proprietary form of the TNF-alpha gene. In exchange for this license, the Company paid a $200,000 non-refundable fee to Asahi and has committed to additional payments upon the achievement of specified clinical milestones, as well as product royalties based on net sales of a licensed product. In September 2002 the Company paid $50,000 upon commencement of Phase II clinical trials involving the TNF-alpha gene.
In May 1996, the Company entered into an exclusive, worldwide license agreement with Scios, inc. (Scios) for rights to gene therapy applications of its proprietary form of the VEGF gene. Johnson & Johnson acquired Scios in April 2003. Scios will share in certain profits the Company realizes from the research, development and commercialization of products incorporating the VEGF gene. The Company has agreed to provide a minimum royalty on revenues generated from the development of these products, which is creditable against the profits to be shared. In connection with the license agreement, Scios purchased 96,852 shares of the Company’s Class D convertible preferred stock at a price of $10.33 per share. All preferred shares were converted into common shares in December 2000 in connection with the Company’s initial public offering at a rate of 1.5 common shares to each preferred share. In addition, the Company granted Scios a warrant to purchase 317,796 shares of the Company’s common stock, which vested upon the earlier of the achievement of specified product development milestone events or certain dates. All Scios warrants expired as of December 11, 2005.
The Company’s license agreements often include event based milestone payments, the timing of which is dependent upon a number of factors including final approvals by regulatory agencies and the continued enforceability of patent claims.
(c) RESEARCH AND DEVELOPMENT AND CLINICAL AGREEMENTS
The Company has agreed to provide grants for certain research projects under agreements with several universities and research organizations. Under the terms of these agreements, the Company has received rights to the resulting technology. Total grants paid by the Company were approximately $261,000, $483,000, and $1,000,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
As discussed in Note 2, the Company has agreements with clinical sites for the treatment of patients under clinical protocols. Total clinical costs were $3,154,000, $2,482,000 and $2,285,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
Additionally, certain agreements disclosed above require the Company to pay royalties upon commercial sales, if any, of specified products. The Company generally bases the royalties on a percentage of net sales or other product fees earned. Royalties will become due when sales are generated.
(10) STOCKHOLDERS’ EQUITY
(a) CAPITAL STOCK
In December 2002, the Company filed with the Securities and Exchange Commission a $25,000,000 shelf registration statement on Form S-3.
In April 2005, the Company filed with the Securities and Exchange Commission a $35,000,000 shelf registration statement on Form S-3, replacing our prior $25,000,000 shelf registration statement.
As of December 31, 2005, $19.8 million of unissued securities are registered under the shelf registration statement on Form S-3 filed in April 2005.
In September 2001, the Board of Directors of the Company declared a dividend which was issued on September 28, 2001 of one preferred stock purchase right (a “Right”) for each share of common stock outstanding. The Rights initially trade with, and are inseparable from the common stock. The Rights will become exercisable only if a person or group acquires beneficial ownership of 20 percent or more of the outstanding common stock of GenVec (an “Acquiring Person”), or announces the intention to commence a tender or exchange offer the consummation of which would result in that person or group becoming an Acquiring Person. Each Right allows its holder, other than the Acquiring Person, to purchase from the Company one one-hundredth of a share of Series A junior participating preferred stock (the “Preferred Share”), at a purchase price of $50.00, subject to adjustment. This portion of a Preferred Share gives the stockholder approximately the same dividend, voting, and liquidation rights as would one share of common stock. The Rights expire on September 7, 2011, unless redeemed earlier by the Company at a price of $0.01 per Right at any time before the Rights become exercisable.
In addition to the Common Stock reflected on the Company’s balance sheets, the following items are reflected in the capital accounts as of December 31, 2005 and 2004:
(b) STOCK OPTION GRANTS
At the Company’s Annual Meeting of Stockholders, held on June 6, 2002, the stockholders approved the adoption of the 2002 Stock Incentive Plan (“the Plan”), which replaced the 2000 Director Option Plan and the 1993 Stock Incentive Plan (collectively, “prior plans”). The Plan, which is administered by the Compensation Committee of the Board (“The Committee”), authorized for issuance 1,000,000 shares plus any shares available under the prior plans at their termination date.
Employees, non-employee directors and consultants are eligible to receive stock option grants or restricted stock under the Plan. Under the Plan, options are granted at not less than existing market prices and expire 10 years from the date of grant. The Committee has broad powers to determine eligibility and terms of all awards. Grants to employees generally vest ratably over a four-year period; grants to consultants generally vest over the terms of their contractual agreements; and grants to non-employee directors generally vest over 12 months.
Changes in stock options were as follows:
As of December 31, 2005 options covering 3,402,086 shares were exercisable at $0.70 to $9.63 per share (average $3.36 per share) and options covering 2,563,920 shares remain available to be granted.
Options outstanding at December 31, 2005 are summarized below:
For options granted to consultants, the Company recorded $0, $0 and $65,000 of gross deferred compensation for each of the three years ended December 31, 2005, and the amortization related to this and prior years deferred compensation amounted to $0, $0 and $191,000.
As a result of the merger with Diacrin in August 2003, the Company recorded deferred compensation of $563,000 for the difference between the exercise price of outstanding unvested Diacrin options and the fair value of the Company’s common stock at the date of the acquisition. The deferred compensation is being amortized over the remaining vesting period of the related options. Net amortization for 2005, 2004 and 2003 related to this and prior years deferred compensation amounted to $261,000, $229,000 and $1,542,000, respectively. The $121,000 balance as of December 31, 2005 will be fully amortized by the end of 2007. This deferred compensation is subject to reduction for any employee who terminates employment prior to the expiration of such employee’s option vesting period.
(c) EMPLOYEE STOCK PURCHASE PLAN
In December 2000, the Company adopted the 2000 Employee Stock Purchase Plan, referred to as the “Purchase Plan”. The Company reserved a total of 350,000 shares of common stock for issuance under the Purchase Plan, plus annual increases on the first day of each fiscal year beginning 2001 equal to the lesser of 350,000 shares; 2 percent of the outstanding shares as of such date; or a lesser amount determined by the Board of Directors.
Substantially all employees are eligible to participate. Participants may purchase common stock through payroll deductions of up to 15 percent of the participant’s compensation. The maximum number of shares a participant may purchase during a six-month offering period is 6,250 shares.
The price of stock purchased under the purchase plan is 85 percent of the lower of the fair market value of the common stock at the beginning of the offering period or the end of the offering period. Employees purchased 145,212 shares, 66,124 shares and 34,939 shares during 2005, 2004 and 2003 at a weighted average purchase price of $1.39, $1.75 and $1.74. The Purchase Plan will terminate on October 18, 2010, unless sooner terminated by the Board of Directors.
(d) WARRANTS
Warrants to purchase common stock were granted to organizations and institutions in conjunction with certain licensing and funding activities. The warrants vested according to a combination of time and events as prescribed in the agreements. Outstanding and vested warrants are summarized below (in thousands, except per share amounts):
(11) INCOME TAXES
A reconciliation of tax credits computed at the statutory federal tax rate on loss from operations before income taxes to the actual income tax expense is as follows (in thousands):
The valuation allowance for deferred tax assets increased approximately $6.7 million, $7.9 million and $8.3 million for the years ended December 31, 2005, 2004 and 2003.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in this assessment. Based upon the Company’s historical operating performance and the reported cumulative net losses to date, the Company presently does not have sufficient objective evidence to support the recovery of its deferred tax assets. Accordingly, the Company has provided a full valuation allowance against its deferred tax assets. Recording this valuation in no way affects the Company’s ability to utilize this asset.
Deferred income taxes reflect the net effects of net operating loss carryforwards and the temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets are as follows (in thousands):
At December 31, 2005, the Company has net operating loss carryforwards of approximately $198.5 million for federal income tax purposes of which $59.4 million expire at various dates through 2013, and $139.1 million expire at various dates through 2025. The Company has research and experimentation tax credit carryforwards of $10.4 million at December 31, 2005, of which $1.7 million expire through 2013 and $8.7 million expire through 2025. The Company also has capital loss carryforwards of $0.8 million which will expire 2008.
The Company’s NOL and tax credit carryforwards may be significantly limited under Section 382 of the Internal Revenue Code (IRC). NOL and tax credit carryforwards are limited under Section 382 when there is a significant “ownership change” as defined in the IRC. During 2005 and in prior years, the Company may have experienced such ownership changes. Diacrin might have also experienced ownership changes in prior years and/or as a result of its merger with the Company.
The limitation imposed by Section 382 would place an annual limitation on the amount of NOL and tax credit carryforwards that can be utilized. When the Company completes the necessary studies, the amount of NOL carryforwards available may be reduced significantly. However, since the valuation allowance fully reserves for all available carryforwards, the effect of the reduction would be offset by a reduction in the valuation allowance. Thus, the resolution of this matter would have no effect on the reported assets, liabilities, revenues and expenses for the periods presented.
(12) OTHER COMPREHENSIVE INCOME (LOSS)
The purpose of reporting comprehensive income (loss) is to report a measure of all changes in equity, other than transactions with stockholders. Total comprehensive income (loss) is included in the Statements of Stockholders’ Equity. The components of accumulated other comprehensive income (loss) are as follows (in thousands):
Other comprehensive income (loss) does not reflect the effect of income taxes because the Company had no income tax provision during the three years ended December 31, 2005.
(13) QUARTERLY RESULTS (UNAUDITED)
The Company’s unaudited quarterly information is as follows (in thousands, except per share data):
The loss per share was calculated for each three-month period on a stand-alone basis. As a result, the sum of the loss per share for the four quarters does not equal the loss per share for the respective twelve-month period.
(14) SUBSEQUENT EVENT (UNAUDITED)
On March 15, 2006, the Company entered into a Committed Equity Financing Facility (CEFF) with Kingsbridge Capital Ltd., under which Kingsbridge has committed to purchase up to $30.0 million of the Company’s common stock within a three-year period, subject to certain conditions and limitations. As part of the arrangement, the Company issued a warrant to Kingsbridge to purchase 520,000 shares of the Company’s common stock at a price equal to 125% of the average closing bid prices during the five (5) days preceding the issuance date of the warrant. The warrant is exercisable beginning six months after the date of grant and for a period of five years thereafter.
Under the CEFF, the Company may require Kingsbridge to purchase shares of common stock at prices between 88% and 92% of the volume weighted average price (VWAP) on each trading day during an 8-day pricing period. The value of the maximum number of shares the Company may issue in any pricing period is equal to the lesser of 1.75% of the Company’s market capitalization immediately prior to the commencement of the pricing period, or $5.0 million. The minimum VWAP for determining the purchase price at which the Company’s stock may be sold in any pricing period is the greater of $1.25, or 75% of the closing price of the Company’s common stock on the day prior to the commencement of the pricing period. The CEFF also requires the Company to file a resale registration statement with respect to the resale of shares issued pursuant to the CEFF and underlying the warrant, to use commercially reasonable efforts to have the registration statement declared effective by the SEC, and to maintain its effectiveness. The Company is obligated to sell a minimum of $2.0 million of common stock available under the CEFF within a two-year period.