ITEM 1. BUSINESS
THE COMPANY
LeukoSite is a leader in the discovery and development of therapeutics based upon the biology of leukocytes. Therapeutics developed using LeukoSite technology may be used to treat cancer and inflammatory, autoimmune and viral diseases. The Company's technologies and expertise in leukocyte biology facilitate the discovery and development of novel and proprietary drugs that destroy or selectively block the disease-promoting actions of leukocytes. LeukoSite has completed enrollment and dosing in a pivotal clinical trial of CAMPATH-Registered Trademark-. The Company has begun human clinical trials of three monoclonal antibody product candidates. In addition, LeukoSite has nine small molecule drug discovery programs underway with three corporate partners.
BACKGROUND
OVERVIEW OF LEUKOCYTE AND IMMUNE SYSTEM BIOLOGY
The human immune system protects the body against infection by bacteria, viruses and parasites. Leukocytes are formed in the bone marrow, mature in lymphatic tissue and are transported throughout the body by the bloodstream. Endothelial cells, which comprise the inner lining of blood vessels, act as gatekeepers allowing circulating leukocytes to enter surrounding tissue when needed. Leukocytes, in a healthy immune response, eliminate pathogens without damaging host cells.
LEUKOCYTE MATURATION. Hematopoietic (blood-forming) stem cells in the bone marrow produce precursor cells that mature into circulating leukocytes. Neutrophils, eosinophils and basophils, which are types of mature leukocytes, are normally formed only in the bone marrow and are stored there until they are needed. The other types of leukocytes (lymphocytes and monocytes) mature in other organs, including the lymph nodes, spleen, thymus, tonsils and gut. During the process of maturation and storage, leukocytes differentiate into defined functional subtypes, after which they are released into the circulatory system. As they mature, leukocytes undergo complex changes including the appearance and disappearance of molecules or receptors on their outer membrane. Proteins and other biomolecules produced in the body bind to these receptors which in turn signal the leukocytes to respond in specific ways. If the leukocyte maturation process does not occur normally, uncontrolled and rapid proliferation of certain types of leukocytes may lead to malignant diseases such as leukemias and lymphomas.
LEUKOCYTE RECRUITMENT. Circulating leukocytes leave the bloodstream and migrate into tissues via a complex set of pathways and molecular interactions. This process is a fundamental part of the human immune system and provides a way for leukocytes to be recruited to areas of infection or damaged tissue. The sequential steps that lead to the recruitment of leukocytes from the blood vessel into tissues begin when selectins, expressed by endothelial cells, momentarily tether passing leukocytes causing them to roll along the vessel wall. If the leukocytes encounter chemokines, a type of chemical signal emanating from an inflammation site, receptors on the surface of the tethered leukocytes will then bind to the chemokines, initiating a series of changes within the leukocytes. Among the changes is the enhanced activity of adhesion receptors called integrins. In the final step, the integrins on the surface of the leukocytes bind to complementary structures called adhesion molecules located on the vessel wall. Once attached, the leukocytes change shape, squeeze through the vessel wall and migrate to the area of increased chemokine concentration at the site of inflammation.
CHEMOKINES AND CHEMOKINE RECEPTORS. Chemokines are a family of proteins produced in many different tissues. The expression of chemokines is increased in response to infection or very early stages of inflammation. Chemokine receptors are members of the G protein-coupled family of receptors located on the outer membrane of the cell and translate a variety of signals from the outside to the inside of the cell.
Chemokines bind to chemokine receptors and cause leukocytes to migrate toward the source of the chemokine molecule (that is, movement out of the bloodstream and into tissues). Each subset of leukocytes (for example, eosinophils, monocytes, lymphocytes and neutrophils) has distinct types of chemokine receptors that respond preferentially to certain chemokines. Through this discriminating mechanism, the body can control and selectively recruit certain types of leukocytes to mediate an inflammatory process. In addition, certain viruses, such as HIV-1, may use chemokine receptors as a homing mechanism to bind to and infect leukocytes.
INTEGRINS AND ADHESION MOLECULES. Integrins and adhesion molecules provide another degree of control over leukocyte recruitment pathways. Integrins are a family of proteins that bind to distinct receptors, called adhesion molecules, found on endothelial and other types of cells. Adhesion molecules attract only those leukocytes that have matching integrin molecules and allow for the selective migration of these leukocytes through the endothelial layer into tissues. A subset of adhesion molecules called addressins is expressed only on certain tissues in response to infection or damage.
LEUKOSITE'S DRUG DEVELOPMENT PROGRAMS
LeukoSite currently has four drugs in human clinical development. These monoclonal antibody programs are based on leukocyte selectivity and tissue specificity.
CAMPATH-REGISTERED TRADEMARK-
LeukoSite's lead product candidate, CAMPATH-Registered Trademark-, which was referred to as LPD03 before LeukoSite was granted this registered trademark ("CAMPATH-Registered Trademark-"), is a humanized monoclonal antibody to the leukocyte antigen CD52, which the Company is developing jointly with ILEX Oncology, Inc. ("ILEX") for the treatment of chronic lymphocytic leukemia ("CLL"). The Company licensed CAMPATH-Registered Trademark- from the British Technology Group ("BTG") after reviewing data from Phase I and II clinical trials conducted by Burroughs Wellcome ("BW") showing activity in the treatment of patients with CLL. CAMPATH-Registered Trademark- combats CLL by selectively depleting lymphocytes while sparing hematopoietic stem cells. This selective depletion permits the body to retain needed hematopoietic stem cells that are the precursors to, and repopulate the blood with, leukocytes and preserve normal immune function. CAMPATH-Registered Trademark- binds to the antigen CD52, which is expressed almost exclusively on mature lymphocytes, not stem cells, and destroys the lymphocytes. CAMPATH-Registered Trademark- is more selective than currently approved drugs for lymphomas and leukemias which indiscriminately deplete rapidly-dividing cells, including both lymphocytes and hematopoietic stem cells. LeukoSite has received an orphan product designation from the Food and Drug Administration (the "FDA") for CAMPATH-Registered Trademark- for CLL. If CAMPATH-Registered Trademark- is the first FDA approved application for CLL, LeukoSite would receive seven years of marketing exclusivity.
CLL patients are presently treated with chlorambucil and fludarabine as first-line or second-line therapy. Despite this course of treatment, all patients not dying of other causes eventually relapse. No approved therapy is available to treat patients who fail therapy with fludarabine. The median survival time for fludarabine-resistant patients is six months. Based on the data from the clinical trials, the Company believes that CAMPATH-Registered Trademark- may be effective for symptomatic CLL patients who have failed the current standard of care and second line therapies.
LeukoSite entered into a joint venture with ILEX, a drug development company with expertise in the clinical development and registration of oncology drugs, for the clinical development and commercialization of CAMPATH-Registered Trademark-. The joint venture has entered into an agreement with Boehringer Ingleheim for the manufacture of CAMPATH-Registered Trademark- to be used for clinical trials and sales following approval by the FDA. See "Collaboration Agreements--ILEX."
LeukoSite and ILEX, through the joint venture, have completed a single, noncomparative, multi-center pivotal clinical trial in 94 previously treated CLL patients who have failed treatment with fludarabine to support a BLA filing with the FDA. Patient responses were evaluated based on the National
Cancer Institute criteria and other parameters defined by LeukoSite. LeukoSite and ILEX believe that the data from the clinical trial is consistent with the earlier BW clinical trials. LeukoSite and ILEX have held a pre-BLA meeting with the FDA and intend to file a BLA with the FDA in mid-1999. However, there can be no assurance that the FDA will approve the BLA for CAMPATH-Registered Trademark-.
LDP-02 (ANTI-A4B7 MAB)
LeukoSite is developing LDP-02, a humanized monoclonal antibody to the A4B7 integrin receptor on leukocytes. LDP-02 is being evaluated for the treatment of inflammatory bowel disease, which includes ulcerative colitis and Crohn's disease, chronic disorders characterized by inflammation and ulceration of the gastrointestinal tract.
Preclinical studies in non-human primates have implicated leukoctyes expressing the A4B7 integrin as major contributors to the process of inflammatory bowel disease. The Company evaluated the murine homologue of LDP-02 before it was humanized and demonstrated pharmacologic activity in three non-human primate models of inflammatory bowel disease, including the colitic cotton-top tamarin monkey. The Company believes that this model represents the most clinically useful model of ulcerative colitis. In this model, the murine homologue of LDP-02 was found to be effective in rapidly resolving diarrhea and in inhibiting the localization of leukocytes to the colonic mucosa.
LeukoSite is developing intravenous and subcutaneous formulations of LDP-02 for the treatment and management of severe exacerbations of inflammatory bowel disease. The Company completed a Phase I study in the United Kingdom in 1998 and recently initiated two Phase I/IIa studies of LDP-02 in ulcerative colitis to evaluate the appropriate therapeutic dose while also measuring LDP-02's ability to block A4B7 thereby preventing inflammation. If Phase II studies in the United Kingdom and Canada in ulcerative colitis are supportive, LeukoSite plans to pursue further clinical studies.
In December 1997, LeukoSite entered into a collaboration agreement with Genentech, Inc. ("Genentech") to develop and commercialize LDP-02 for the treatment of inflammatory bowel disease. Under the terms of the collaboration agreement, LeukoSite is to develop LDP-02 through successful Phase II human clinical trials, after which, Genentech will conduct Phase III clinical studies which may lead to registration for future product sales. See "Collaboration Agreements--Genentech."
LDP-01 (ANTI-B2 MAB)
LeukoSite is developing LDP-01, a humanized monoclonal antibody to the B2 integrin on leukocytes for the prevention of post-ischemic reperfusion injury such as that resulting from organ transplantation, stroke and myocardial infarction. The Company believes that LDP-01 blocks the attachment of B2 integrins to their adhesion molecules and limits the recruitment of leukocytes involved in the inflammatory process. The B2 integrin receptor on the surface of leukocytes interacts with specific adhesion molecules on the surface of endothelial cells lining blood vessels. This interaction is essential for leukocytes to migrate into tissues and organs.
Methods that inhibit leukocyte recruitment following ischemic injury, such as the blockade of B2 integrins, could be therapeutically beneficial to patients injured by ischemic/reperfusion for example. The use of LDP-01 in the treatment of kidney transplant patients may result in a reduction in the time for the transplanted graft to function and may enhance graft survival. The Company initiated a Phase I/IIa clinical trial in October 1997 in the United Kingdom to determine the safety, efficacy and pharmacokinetics of LDP-01 for the reduction of post-ischemic reperfusion injury and delayed graft function in patients receiving cadaver kidney transplants.
In a similar fashion, Stroke is the irreversible loss of brain cells following ischemia, the interruption of blood flow depriving the brain of blood and oxygen. Further damage to brain cells occurs as the result of reperfusion injury by leukocytes when blood flow is reestablished. By inhibiting the recruitment of
leukocytes, LDP-01 may decrease the degree of reperfusion tissue damage and the extent of the disability, and could significantly reduce the inpatient and rehabilitation costs associated with stroke. The Company filed an IND in January 1999 in the United States to initiate a Phase I/IIa study to determine the safety, efficacy and pharmacokinetics of LDP-01 for the reduction of reperfusion tissue damage associated with ischemic stroke.
LDP-977
LeukoSite is developing LDP-977, an orally active, small molecule compound designed to selectively inhibit the production of leukotrienes, a class of molecules that plays an important role in bronchial asthma. Asthma is a chronic, inflammatory lung disease in which the airways of the lungs become either narrowed or completely blocked, impeding normal breathing, due to constriction of the muscles surrounding the airways, inflammation and swelling of the airways, or increased mucus production which clogs the airways. Leukotrienes have been shown to be produced by activated, inflammatory leukocytes (eosinophils, basophils and mast cells) known to be present in the airways of patients with asthma. LDP-977 is designed to block the production of leukotrienes, and studies indicate that antileukotriene drugs may inhibit the constriction of the airways of the lungs and have anti-inflammatory effects. A Phase I trial has been completed for LDP-977, and the Company intends, subject to the receipt of regulatory approvals, to begin a Phase IIa trial during 1999 to determine the safety, efficacy and pharmacokinetics of LDP-977.
LEUKOSITE RESEARCH AND DRUG DISCOVERY PROGRAMS
LeukoSite currently has nine partner-funded research and discovery programs. These chemokine and integrin targeted programs are based on the selective blockade of specific chemokine, chemokine receptor or integrin controlled leukocyte pathways or functions.
CCR3 RECEPTOR ANTAGONIST
LeukoSite is engaged in the discovery and development of an orally available, small molecule antagonist to block eosinophil recruitment and function for the treatment of asthma and allergies. Data in animal models and in humans suggest that eosinophils, and their recruitment to the lung and other tissues and organs, play a significant role in the pathogenesis of asthma and other allergies. The Company, in connection with several of its academic collaborators, has identified the principal eosinophil chemokine receptor, CCR3, filed a patent application on the gene that encodes for the receptor and the therapeutic applications of it and has developed a program to discover an antagonist to block the CCR3 receptor and the recruitment of eosinophils to respiratory tract tissue. The Company believes that a drug which blocks the detrimental effects of eosinophil recruitment will reduce the inflammation that contributes to asthma and allergies.
In July 1996, LeukoSite entered into an agreement with Roche Bioscience for the Company's CCR3 antagonist program. Roche Bioscience and the Company, have identified lead compounds and are in the process of optimizing these compounds. See "Collaboration Agreements--Roche Bioscience."
CCR2 RECEPTOR ANTAGONIST (MCP-1)
LeukoSite is engaged in the discovery and development of an orally available, small molecule antagonist to the CCR2 chemokine receptor for the treatment of chronic inflammatory and autoimmune diseases. The chemokine MCP-1 recruits monocytes and T cells from the bloodstream to tissues. MCP-1 activates monocytes and T cells by binding to the CCR2 receptor on the leukocyte cell membranes, often resulting in damage to surrounding tissues and irretrievable loss of normal function. The blockade of the MCP-1 interaction with the CCR2 receptor may be an effective approach for the treatment of chronic inflammatory and autoimmune diseases in which monocytes and T cells play key roles. In preclinical
studies, LeukoSite and others have shown that MCP-1 is associated with the inflammatory processes exhibited in rheumatoid arthritis and atherosclerosis.
LeukoSite entered into a collaboration agreement with Warner-Lambert Company ("Warner-- Lambert") in September 1994 to discover and develop small molecule antagonists to MCP-1 and the CCR2 receptor. This collaborative effort has identified inhibitors to the CCR2 receptor which have demonstrated pharmacological activity in animal models of inflammatory disease. This collaboration entered into a second contractual stage in April 1996 with the objective of optimizing the pharmacological profile of these inhibitors and identifying a clinical development candidate. In October 1997, Kyowa Hakko Kogyo, Ltd. ("Kyowa") joined the collaboration on MCP-1. See "Collaboration Agreements--Warner-Lambert/ Kyowa."
CXCR-1,2 RECEPTOR ANTAGONIST (IL-8)
LeukoSite is engaged in the discovery and development of an orally available, small molecule antagonist to the CXCR-1,2 chemokine receptors for the treatment of diseases involving tissue injury that result from post-ischemic reperfusion injury. Myocardial infarction results when blood flow to a region of the heart is blocked as a result of a coronary artery becoming occluded. This blockage results in injury to and death of heart tissue in the affected region. A significant portion of the tissue injury and death is thought to be caused by neutrophil-mediated inflammatory damage. IL-8 is a potent and selective chemokine protein that causes the recruitment and activation of neutrophils, which are responsible for subsequent inflammation and post-ischemic reperfusion injury. The Company's program is directed at the discovery and development of drugs which inhibit the binding of IL-8 to its receptors in order to block the recruitment of neutrophils and to prevent the resulting inflammation and reperfusion injury. LeukoSite currently intends to pursue an IL-8 receptor antagonist for post-ischemic reperfusion tissue injury resulting from myocardial infarction.
In July 1995, LeukoSite entered into a collaboration agreement with Warner-Lambert to discover and optimize lead candidates using LeukoSite's IL-8 receptor-based technology by screening Warner-Lambert's compound library. In October 1997, Kyowa joined the collaboration on IL-8. See "Collaboration Agreements--Warner-Lambert/Kyowa."
CXCR3 RECEPTOR ANTAGONIST AND CCR1 RECEPTOR ANTAGONIST
LeukoSite is engaged in the discovery and development of orally available, small molecule antagonists and monoclonal antibodies to block the leukocyte recruitment pathways controlled by chemokine receptors CXCR3 and CCR1. Ligands for the receptors, specifically the chemokines IP-10 and RANTES, play key roles in recruiting T cells and monocytes to sites of inflammation. LeukoSite is studying the role these receptors play in inflammation with a combination of tools including monoclonal antibodies. Based upon knowledge of the cells which express these receptors, small molecule antagonists may be of therapeutic value in the treatment of chronic inflammatory and autoimmune disease.
In April 1997, LeukoSite entered into a collaboration agreement with Kyowa to discover small molecule antagonists and monoclonal antibody drugs that block these chemokine receptors. In October 1997, Warner-Lambert joined the collaboration on CXCR3 and CCR1. See "Collaboration Agreements--Warner-Lambert/Kyowa."
CCR5/CXCR4 RECEPTOR ANTAGONIST
LeukoSite is engaged in the discovery and development of a small molecule antagonist to the chemokine receptors CCR5 and CXCR4. Such a drug may be useful in the treatment of patients infected with HIV and as a therapy for certain inflammatory and autoimmune diseases. The CCR5 receptor is found on lymphocytes and macrophages. Reports of people who are resistant to HIV link a deletion in the CCR5 gene and a lack of CCR5 expression to their resistance to the disease. LeukoSite and its
collaborators have reported on the molecular mechanism by which the virus binds to the CCR5 receptor and facilitates the entry of HIV-1 into leukocytes.
In November 1996, LeukoSite entered into a collaboration agreement with Warner-Lambert to discover and optimize small molecule lead candidates using LeukoSite's CCR5 receptor-based technology by screening Warner-Lambert's compound library. In January 1998, LeukoSite and Warner-Lambert announced the extension of the collaboration and its expansion to include the CXCR4 chemokine receptor. See "Collaboration Agreements--Warner-Lambert."
Outside its collaboration with Warner-Lambert, the Company has generated monoclonal antibodies to the CCR5 receptor. These antibodies block strains of HIV from binding to and infecting human leukocytes. The Company is currently evaluating these antibodies in preclinical studies to determine future clinical plans.
A4B7 INTEGRIN RECEPTOR SMALL MOLECULE ANTAGONIST
LeukoSite is engaged in the discovery and development of a small molecule antagonist to the A4B7 integrin receptor present on gut-homing T lymphocytes. The goal of this program is to identify a potent orally-active agent for patients with inflammatory bowel disease. In contrast to LDP-02, which is intended to treat acute flares of inflammatory bowel disease, daily administration of the oral A4B7 integrin receptor antagonist is intended for patients with mild to moderate inflammatory bowel disease in need of chronic therapy.
In December 1998, LeukoSite entered into a collaboration agreement with Warner-Lambert to discover and optimize small molecule lead candidates using LeukoSite's AE4B7 integrin receptor-based technology by screening Warner-Lambert's compound library. See "Collaboration Agreements--Warner- Lambert."
AEB7 INTEGRIN RECEPTOR SMALL MOLECULE ANTAGONIST
LeukoSite is engaged in the discovery and development of a small molecule antagonist to the AEB7 integrin receptor, which was a product of the AEB7 integrin receptor program. The goal of this program is to identify a potent orally-active agent for patients with asthma or inflammatory bowel disease.
In December 1998, LeukoSite entered into a collaboration agreement with Warner-Lambert to discover and optimize small molecule lead candidates using LeukoSite's A4B7 integrin receptor-based technology by screening Warner-Lambert's compound library. See "Collaboration Agreements--Warner- Lambert."
COLLABORATION AGREEMENTS
LeukoSite has existing collaboration agreements with several pharmaceutical companies, contract manufacturers and medical research institutions, and intends to continue to seek collaboration agreements with additional third parties. The Company structures its collaborations around specified targets, such as chemokines and chemokine receptors or integrins and adhesion molecules, or around targeted objectives, such as the manufacture of a certain monoclonal antibody or small molecule. This approach enables LeukoSite to exploit its drug discovery technologies while retaining flexibility to pursue additional collaborations. As of December 31, 1998, LeukoSite had received $21.4 million under these collaborations for research funding and license fees.
LeukoSite's principal existing collaborations are as follows:
WARNER-LAMBERT/KYOWA
In October 1997, LeukoSite amended its collaboration agreements with Warner-Lambert and Kyowa to combine the research and development efforts of the three companies around the targets MCP-1, IL-8, CCR1 and CXCR3. Under the terms of the joint research and development agreements, Kyowa becomes the primary marketer of products developed during the collaboration in Asia, and Warner-Lambert is to be the primary marketer of these products in the rest of the world. LeukoSite will receive royalties on product sales, in addition to licensing fees, research funding and milestone payments.
During the term of the collaboration, Warner-Lambert and Kyowa may become obligated to make milestone payments to the Company. The collaboration agreements with Warner-Lambert may be terminated by either party at any time and for any reason upon six months' written notice. In the event of termination, each party would retain a non-exclusive license to use all technology arising from the respective collaboration, and an exclusive royalty-free license to make and sell products incorporating such technology. Warner-Lambert will receive a credit against royalties payable to LeukoSite of approximately $3.9 million. Under the collaboration agreement with Kyowa, Kyowa is obligated to provide the Company with research funding payments and an additional payment if Kyowa elects to extend the term of the agreement beyond its initial two year term. Kyowa may terminate its obligation upon 60 days' notice, upon which Kyowa's funding obligation to the Company would also terminate.
WARNER-LAMBERT
In November 1996, LeukoSite and Warner-Lambert entered into a one-year exclusive drug discovery collaboration to screen and characterize antagonists to the CCR5 chemokine receptor (the "CCR5 Agreement"). The CCR5 Agreement contemplates two phases: the initial research phase, and a second phase which would involve the negotiation of a new collaboration agreement similar to the MCP-1 and IL-8 Agreements described above. In January 1998, LeukoSite and Warner-Lambert announced the extension of their collaboration and its expansion to include the CXCR4 chemokine receptor. In December 1998, LeukoSite and Warner-Lambert entered into an exclusive drug discovery collaboration to screen and characterize antagonists to the A4B7 Integrin Receptor and the AEB7 INTEGRIN RECEPTOR. Warner-Lambert has the worldwide, exclusive right under the collaboration agreements to develop and commercialize products derived from the collaboration. LeukoSite will be entitled to receive payments upon the achievement of milestones.
ROCHE BIOSCIENCE
In April 1996, LeukoSite entered into a two-year collaboration agreement with Roche Bioscience to research and discover small molecule antagonists and/or monoclonal antibodies to the CCR3 receptor and other eosinophil recruitment mechanisms (the "CCR3 Agreement"). Roche Bioscience is obligated under the CCR3 Agreement to provide funding to the Company to support (i) a team of scientist-employees of the Company, (ii) humanization of monoclonal antibodies to CCR3 and (iii) additional research if the parties mutually agree to extend the CCR3 Agreement to a third year. In conjunction with the CCR3 Agreement, the parties also entered into a license agreement (the "CCR3 License Agreement"), whereby Roche Bioscience is granted the exclusive right to make and sell products developed under the collaboration in exchange for a noncreditable license fee. The CCR3 License Agreement also provides that milestone payments shall be made by Roche to LeukoSite and that LeukoSite is entitled to receive royalties on product sales.
ILEX
In May 1997, LeukoSite and ILEX entered into a joint venture whereby the parties formed a limited partnership to develop CAMPATH-Registered Trademark- for the treatment of chronic lymphocytic leukemia, pursuant to an agreement of limited partnership and a license agreement between the LeukoSite/ILEX partnership and LeukoSite. The partners are required to make contributions each time the partnership requires working capital. The development and commercialization activities of the joint venture will be managed with equal control by each party. LeukoSite and ILEX will generally share equally in profits from the sales of CAMPATH-Registered Trademark- and in all research, development, clinical and commercialization costs. The joint venture expires in 2017, but provides for either partner, after the earlier of a change in control (as defined therein) of the other partner or October 2, 2000, to purchase the other partner's ownership of the joint venture in the event of an unresolved deadlock. In addition, in the event that one party is unable or unwilling to fulfill its funding obligations to the joint venture, then, in certain circumstances, the party that funds the joint venture shall gain control of the management of the joint venture, subject to certain catch-up rights of the other party.
GENENTECH
In December 1997, LeukoSite entered into a collaboration agreement with Genentech to develop and commercialize LDP-02 for the treatment of inflammatory bowel disease (the "LDP-02 Agreement"). Under the terms of the LDP-02 Agreement, LeukoSite is to develop LDP-02 through Phase II clinical trials. If the Phase II clinical trials are successful, Genentech will complete the development of the product and will receive exclusive worldwide rights to market LDP-02. If a product is successfully developed, LeukoSite is entitled to receive milestone payments and royalties on product sales. In addition, Genentech has agreed to provide two credit facilities. The first credit facility will be for approximately $15 million and will fund development through the completion of Phase II. The second credit facility will be available to LeukoSite if it agrees to fund 25% of the Phase III development costs in return for a share of profits on U.S. sales. If LeukoSite elects to share in the funding of the Phase III development costs, it will receive a share of the profits of LDP-02 rather than receiving royalties on sales.
The two credit facilities can be either repaid by the Company or converted into shares of Common Stock at the then market value of the Common Stock. The credit facilities are repayable at the earlier of 7 years or upon the approval of a BLA for LDP-02. If the size of the loan exceeds 50% of LeukoSite's market capitalization, Genentech has the right to convert all of the loan or the portion of the outstanding loan that is in excess of 50% of LeukoSite's market capitalization into shares of Common Stock at the then current market price. In addition, in the event that any such conversion would require LeukoSite and Genentech to file notification pursuant to the Hart-Scott-Rodino Act, Genentech may require LeukoSite to convert part or all of the loan into shares of Convertible Preferred Stock instead of into Common Stock. The Convertible Preferred Stock will have a liquidation preference of $.01 per share and no voting rights, and will be junior to any other class of Preferred Stock. In addition, the Convertible Preferred Stock will be convertible into shares of Common Stock on a one-for-one basis, subject to adjustment for stock splits, stock dividends and recapitalization.
The LDP-02 Agreement may be terminated by Genentech at any time upon nine months prior written notice. Upon termination by Genentech, all rights to LDP-02 shall revert to LeukoSite, and LeukoSite shall receive a non-exclusive license to certain Genentech technology. In addition, upon optional termination of the LDP-02 Agreement by Genentech, the credit facilities shall continue to be repaid in accordance with their terms, and the warrant issued to Genentech, to the extent not previously exercised, shall terminate.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
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(1) Computed as described in Note 2(f) of Notes to Consolidated Financial Statements.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains certain forward-looking statements within the meaning of Section 27A of the securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934, including but not limited, (i) statements about the adequacy of the Company's capital resources, interest income and revenues from its collaboration agreements to fund its operating expenses and capital requirements into 2000, (ii) statements about the amount of capital expenditures that the Company expects to incur in 1999 and (iii) certain statements identified or qualified by words such as "anticipate," "plan," "believe," "estimate," "expect" and similar expressions. Investors are cautioned that forward-looking statements are inherently uncertain and that the Company's actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Factors that could cause or contribute to such differences include those discussed under the caption "Risk Factors" in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998.
OVERVIEW
The Company is a leader in the discovery and development of therapeutics based upon the biology of leukocytes. Therapeutics developed using its technology may be used to treat cancer, and inflammatory, autoimmune and viral diseases. The Company has been funded to date primarily through proceeds from the sale of equity securities and funding from collaboration agreements. To date, the Company has not received any revenue from the sale of products. The Company has experienced operating losses since its inception and expects that the activities required to develop and commercialize its products will result in further operating losses for the next several years. As of December 31, 1998, the Company had an accumulated deficit of approximately $47 million.
In 1994, 1995 and 1996, the Company signed agreements with Warner-Lambert for the discovery and development of drugs that are intended to antagonize the MCP-1, IL-8 and CCR5 and CXCR4 receptors found on certain classes of leukocytes. In December 1998 the Company and Warner-Lambert signed an agreement related to the A4B7 and AEB7 integrin targets implicated in asthma and inflammatory bowel disease. In July 1996 the Company signed an agreement with Roche Bioscience for the discovery and development of monoclonal antibodies and small molecule antagonists to the CCR3 receptor found on a certain class of leukocytes. In April 1997 the Company signed an agreement with Kyowa for the discovery and development of small molecule antagonists to the CXCR3 and CCR1 receptors found on certain classes of leukocytes. In May 1997 the Company entered into a joint venture with Ilex for the development of CAMPATH-Registered Trademark- for the treatment of chronic lymphocyctic leukemia. In October 1997 the Company, Warner-Lambert and Kyowa agreed to jointly pursue research and development of antagonists that target MCP-1, IL-8, CCR1 and CXCR3. In December 1997 the Company entered into a collaboration agreement with Genentech for the development of a monoclonal antibody intended as therapy for inflammatory bowel disease. In August 1998 the Company entered into a collaboration agreement with MorphoSys AG for the discovery of therapeutic monoclonal antibodies for inflammatory and autoimmune disorders. On February 11, 1999, the Company acquired all of the issued and outstanding capital stock of CytoMed, Inc. (CytoMed) through the issuance of the Company's Series A Convertible Preferred Stock.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998 AND 1997
REVENUES. Revenues were $12,072,000 in 1998 compared to $5,726,000 in 1997. Revenues in 1998 resulted from research funding and a non-refundable technology access fee from the collaboration agreements with Warner-Lambert, research funding from the collaboration agreements with Kyowa and Roche Biosciences, revenue from the joint venture with Ilex and government grants. Revenues in 1997
resulted from the collaboration agreements with Warner-Lambert, Roche Bioscience and Kyowa and from government grants. The increase of $6,346,000 was primarily due to the technology access fee payment and research funding from Warner-Lambert, increased research funding from Kyowa, and billings to L&I Partners, L.P. for the reimbursement of expenses incurred by the Company on behalf of the joint venture to develop CAMPATH-Registered Trademark-.
RESEARCH AND DEVELOPMENT. Research and development expenses were $21,141,000 in 1998 compared to $11,980,000 in 1997. The increase of $9,161,000 was primarily due to external costs associated with the manufacture of clinical trial material and ongoing clinical trials for the Company's LDP-02 and LDP-01 programs and increased staffing and related costs associated with the Company's drug discovery programs. The Company expects that research and development expenses will increase in the future as the Company further expands its discovery and development programs.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were $2,625,000 in 1998 compared to $1,758,000 in 1997. The increase of $867,000 was primarily due to an increase in expenses associated with operating as a public company as well as costs associated with managing the growth of the Company. General and administrative expenses will increase in future periods to support the projected growth of the Company.
INTEREST INCOME (EXPENSE), NET. Interest income, net was $1,205,000 in 1998 and $719,000 in 1997. The increase was primarily due to interest earned on higher average cash balances available for investment during 1998. These higher cash balances resulted from the receipt of proceeds from the Company's initial public offering of common stock completed in August 1997, and the sale of common stock associated with a collaboration with Genentech completed late in 1997 and from the private placement in July 1998.
EQUITY IN OPERATIONS OF JOINT VENTURE. Equity in operations of joint venture was a loss of $3,858,000 in 1998 compared to a loss of $3,358,000 in 1997. The increase of $500,000 was primarily due to increased joint venture activity in 1998 including manufacturing, data analysis, regulatory submissions and the conduct of a pivotal clinical study of CAMPATH-Registered Trademark-.
NET LOSS. The net loss was $14,347,000 for 1998 and $10,651,000 for 1997. The increase of $3,696,000 in the net loss for 1998 was primarily due to the manufacture of clinical trial material and clinical research related to the Company's LDP-02 and LDP-01 programs and greater research and development expenses related to the Company's drug discovery programs. Higher overall expenses were offset in part by increased revenue generated from research collaborations and interest income.
YEARS ENDED DECEMBER 31, 1997 AND 1996
REVENUES. Revenues were $5,726,000 in 1997 compared to $3,674,000 in 1996. Revenues in 1997 resulted from the collaboration agreements with Warner-Lambert, Roche Bioscience and Kyowa and from SBIR grants. Revenues in 1996 were the result of a license fee from Roche Bioscience and funding from Warner-Lambert, Roche Bioscience and Small Business Innovation Research ("SBIR") grants. The increase of $2,052,000 was principally due to the receipt of funding associated with the Company's collaboration with Kyowa.
RESEARCH AND DEVELOPMENT. Research and development expenses were $11,980,000 in 1997 compared to $8,502,000 in 1996. The increase of $3,478,000 was primarily due to development, preclinical and clinical activities related to the Company's LDP-01 and LDP-02 programs. To a lesser extent, the increase was the result of a larger research staff and the laboratory supplies associated with the Company's small molecule drug discovery programs. The Company expects that research and development expenses will increase over the next several years as the Company further expands its discovery and development programs and incurs expenses on behalf of the joint venture with Ilex.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were $1,758,000 in 1997 compared to $1,371,000 in 1996. The increase of $387,000 was primarily due to an increase in staffing and other expenses associated with becoming a public company during the year. General and administrative expenses will likely increase in future periods to support the projected growth of the Company.
INTEREST INCOME (EXPENSE), NET. Interest income, net was $719,000 in 1997 and $177,000 in 1996. The increase of $542,000 was primarily due to interest earned on higher average cash balances during the year. These higher cash balances resulted from the receipt of proceeds from the Company's sale of preferred stock in late 1996 and early 1997, the Company's initial public offering of common stock completed in August 1997, and the sale of common stock associated with a collaboration with Genentech completed late in 1997.
EQUITY IN OPERATIONS OF JOINT VENTURE. For 1997, a loss of $3,358,000 from the joint venture with Ilex was recorded under equity in operations of joint venture. As the joint venture was formed in May 1997, there was no loss for 1996. Joint venture expenses in 1997 were primarily related to the manufacture of CAMPATH-Registered Trademark- by a third party for use in future clinical trials and to a lesser extent activities related to data analysis, regulatory submissions and preparations related to upcoming clinical trials.
NET LOSS. The net loss was $10,651,000 for 1997 and $6,022,000 for 1996. The increase of $4,626,000 in the net loss for 1997 was primarily due to greater research and development expenses related to the Company's small molecule and monoclonal antibody programs as well as its joint venture with Ilex for the development of CAMPATH-Registered Trademark-. Increased expenses were partially offset by increases in revenues and interest income.
YEARS ENDED DECEMBER 31, 1996 AND 1995
REVENUES. Revenues were $3,674,000 in 1996 compared to $450,000 in 1995. Revenues in 1996 resulted from the collaboration agreements with Warner-Lambert and Roche Bioscience and from SBIR grants. Revenues in 1995 were the result of a license fee from Warner-Lambert and SBIR funding.
RESEARCH AND DEVELOPMENT. Research and development expenses were $8,502,000 in 1996 and $7,051,000 in 1995. The increase of $1,451,000 in research and development expenses was primarily due to an increase in staffing and supplies and preclinical development expenditures.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were $1,371,000 in 1996 and $866,000 in 1995. The increase of $505,000 was primarily due to an increase in financing activities as well as an increase in staffing and expenses associated with corporate partnering activities.
INTEREST INCOME (EXPENSE), NET. Interest income (expense), net was $177,000 in 1996 and an expense of $10,000 in 1995. This change was primarily due to greater cash balances available for investment generating greater interest income in 1996 combined with a comparable level of interest expense in both years.
NET LOSS. The net loss was $6,022,000 for 1996 and $7,477,000 for 1995. The decrease of $1,455,000 was primarily due to revenues generated from corporate partners increased in 1996.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company's operations have been funded primarily through proceeds from the sale of equity securities, which have raised approximately $64.6 million, license fees and sponsored research, which have generated approximately $20.4 million, and capital lease obligations, which have raised approximately $5.1 million. The Company has used cash to fund operating losses of approximately $46.3 million, the investment of approximately $3.0 million in equipment and leasehold improvements and the repayment of approximately $3.3 million of capital lease obligations. The Company had no significant
commitments as of December 31, 1998 for capital expenditures. At December 31, 1998, the Company had on hand cash, cash equivalents and marketable securities of approximately $23.3 million.
The Company has entered into sponsored research and consulting agreements with certain hospitals, academic institutions and consultants, requiring periodic payments by the Company. Aggregate minimum funding obligations under these agreements, which include certain cancellation provisions, total approximately $2.1 million, of which approximately $1.8 million will be paid in 1999. The Company has also entered into an agreement to contribute $3.0 million towards funding the Therapeutic Antibody Centre at the University of Oxford in England. As of December 31, 1998 the Company has a remaining total commitment of $500,000 to provide funding in semi-annual installments through 1999.
In May 1997, the Company and Ilex entered into a joint venture whereby the parties formed a limited partnership to develop and commercialize CAMPATH-Registered Trademark- for the treatment of chronic lymphocytic leukemia and other diseases. The Company and Ilex are required to make contributions each time the joint venture requires working capital. LeukoSite and Ilex will generally share equally in profits from the sales of CAMPATH-Registered Trademark- and in research, development, and clinical expenses. The capital requirements of the joint venture consist of clinical development and commercialization expenses.
On February 11, 1999, the Company acquired all of the issued and outstanding capital stock of CytoMed through the issuance of the Company's Series A Convertible Preferred Stock. The total purchase price was approximately $16,100,000 and the net assets acquired were approximately $14,500,000, of which approximately $8,500,000 was cash and $6,000,000 was a receivable from UCB Pharma, expected to be paid in October of 1999.
The Company believes that its existing capital resources, interest income and revenue from the collaboration agreements will be sufficient to fund its planned operating expenses and capital requirements through into 2001. However, there can be no assurance that such funds will be sufficient to meet the Company's operating expenses and capital requirements during such period. The Company's actual cash requirements may vary materially from those now planned and will depend upon numerous factors, including the results of the Company's research and development and collaboration programs, the timing and results of preclinical and clinical trials, the timing and costs of obtaining regulatory approvals, the progress of the milestone and royalty producing activities of the Company's collaborative partners, the level of resources that the Company commits to the development of manufacturing, marketing, and sales capabilities, the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights, the ability of the Company to maintain existing and establish new collaboration agreements with other companies, the technological advances and activities of competitors and other factors.
The Company expects to incur substantial additional expenses, including expenses related to ongoing research and development activities, expenditures for preclinical and clinical trials and the expansion of its laboratory and administrative activities. Therefore, the Company will need to raise substantial additional capital. The Company intends to seek such additional funding through public or private financing or collaboration or other arrangements with collaborative partners. There can be no assurance, however, that additional financing will be available from any sources or, if available, will be available on acceptable terms.
YEAR 2000 ISSUES
The Company is reviewing its information systems to assess what steps are required to achieve full Year 2000 compliance. The Company relies upon microprocessor-based personal computers and commercially available applications software. The Company is currently discussing Year 2000 readiness with its supply and service vendors. The Company intends to continue to assess its exposure to Year 2000 noncompliance on the part of any of its vendors and there can be no assurance that their systems will be Year 2000 compliant. The Company does not anticipate that it will incur material expenses to make its internal computer software and operating systems Year 2000 compliant. The Company believes that the
Year 2000 issue will not pose significant problems for the Company's systems. The Company currently does not have any contingency plan in the event Year 2000 compliance cannot be achieved in a timely manner.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The statements contained in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" which are not historical are "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, amended. These forward-looking statements represent the Company's present expectations or beliefs concerning future events. The Company cautions that such statements are qualified by important factors that could cause actual results to differ materially from those in the forward looking statements including those factors identified in "Risk Factors." Results actually achieved thus may differ materially from expected results included in these statements.
QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company owns financial instruments that are sensitive to market risks as part of its investment portfolio. The investment portfolio is used to preserve the Company's capital until it is required to fund operations, including the Company's research and development activities. All of these market-risk sensitive instruments are classified as held-to-maturity and are not held for trading purposes. The Company does not own derivative financial instruments in its investment portfolio. The investment portfolio contains instruments that are subject to the risk of a decline in interest rates.
Interest Rate Risk--The Company's investment portfolio includes investment grade debt instruments. These bonds are subject to interest rate risk, and could decline in value if interest rates fluctuate. Due to the short duration and conservative nature of these instruments, the Company does not believe that it has a material exposure to interest rate risk.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See pages through attached to this report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to Directors and compliance with Section 16(a) of the Securities Exchange Act may be found in the sections captioned "PROPOSAL NO. 1--ELECTION OF DIRECTORS", "EXECUTIVE COMPENSATION" and "SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE" appearing in the definitive Proxy Statement to be delivered to Stockholders in connection with the Annual Meeting of Stockholders to be held on May 25, 1999. Such information is incorporated herein by reference. Information with respect to Executive Officers may be found under the section captioned "Executive Officers of the Registrant" in Part I of this Annual Report on Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required with respect to this item may be found in the sections captioned "EXECUTIVE COMPENSATION" appearing in the definitive Proxy Statement to be delivered to Stockholders in connection with the Annual Meeting of Stockholders to be held on May 25, 1999. Such information is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required with respect to this item may be found in the section captioned "PRINCIPAL STOCKHOLDERS" and "PROPOSAL NO. 1--ELECTION OF DIRECTORS" appearing in the definitive Proxy Statement to be delivered to Stockholders in connection with the Annual Meeting of Stockholders to be held on May 25, 1999. Such information is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Information required with respect to this item may be found in the section captioned "CERTAIN TRANSACTIONS" appearing in the definitive Proxy Statement to be delivered to Stockholders in connection with the Annual Meeting of Stockholders to be held on May 25, 1999. Such information is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) DOCUMENTS FILED AS PART OF FORM 10-K
1. FINANCIAL STATEMENTS.
The following financial statements and supplementary data are included in Part II Item 8 filed as part of this report:
LEUKOSITE, INC.
- Report of Independent Public Accountants
- Balance Sheets as of December 31, 1997 and 1998
- Statements of Operations for the years ended December 31, 1996, 1997 and
- Statements of Stockholders' Equity for the years ended December 31, 1996, 1997 and 1998
- Statements of Cash Flows for the years ended December 31, 1996, 1997 and
- Notes to Financial Statements
L&I PARTNERS, L.P.
- Report of Independent Public Accountants
- Balance Sheets as of December 31, 1997 and 1998
- Statements of Operations for the year ended December 31, 1998, the period ended December 31, 1997 and the period from inception to December 31, 1998
- Statements of Partner's Capital from inception to December 31, 1998
- Statements of Cash Flows for the year ended December 31, 1998, the period ended December 31, 1997 and the period from inception to December 31, 1998
- Notes to Financial Statements
2. FINANCIAL STATEMENT SCHEDULES.
None.
Schedules not listed above have been omitted because they are not applicable, not required or the information required is shown in the financial statements or the notes thereto.
3. LIST OF EXHIBITS.
- ------------------------
* Incorporated by reference from the Company's Registration Statement on Form S-1 (Registration No. 333-6795).
** Incorporated by reference from the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997.
*** Incorporated by reference from the Company's Current Report on Form 8-K dated January 26, 1998.
****Incorporated by reference from the Company "s Quarterly Report on Form 10-Q for the quarter ended September 30, 1998.
+ Confidential Treatment requested as to certain portions.
(B) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the quarter for which this report is filed.
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.
LEUKOSITE, INC.
BY: /S/ CHRISTOPHER K. MIRABELLI, PH.D. ----------------------------------------- Christopher K. Mirabelli, Ph.D. CHAIRMAN OF THE BOARD OF DIRECTORS, PRESIDENT AND CHIEF EXECUTIVE OFFICER
Date: March 31, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on its behalf of the registration and in the capacities on the dates indicated.
SIGNATURE TITLE DATE - ------------------------------ --------------------------- ------------------- /s/ CHRISTOPHER K. MIRABELLI, Chairman of the Board of March 31, 1999 PH.D. Directors, President and - ------------------------------ Chief Executive Officer Christopher K. Mirabelli, (Principal Executive Ph.D. Officer)
/s/ AUGUSTINE LAWLOR Vice President, Corporate March 31, 1999 - ------------------------------ Development and Chief Augustine Lawlor Financial Officer (Principal Financial and Accounting Officer)
/s/ CATHERINE BINGHAM Director March 31, 1999 - ------------------------------ Catherine Bingham
/s/ YASUNORI KANEKO, M.D. Director March 31, 1999 - ------------------------------ Yasunori Kaneko, M.D.
/s/ JAMES H. CAVANAUGH Director March 31, 1999 - ------------------------------ James H. Cavanaugh
/s/ MARTIN PERETZ, PH.D. Director March 31, 1999 - ------------------------------ Martin Peretz, Ph.D.
/s/ MARK SKALETSKY Director March 31, 1999 - ------------------------------ Mark Skaletsky
/s/ TIMOTHY A. SPRINGER, Director March 31, 1999 PH.D. - ------------------------------ Timothy A. Springer, Ph.D.
/s/ CHRISTOPHER T. WALSH, Director March 31, 1999 PH.D. - ------------------------------ Christopher T. Walsh, Ph.D.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To LeukoSite, Inc.:
We have audited the accompanying consolidated balance sheets of LeukoSite, Inc. (a Delaware corporation) and subsidiary as of December 31, 1997 and 1998, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of LeukoSite, Inc. and subsidiary as of December 31, 1997 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Boston, Massachusetts January 29, 1999
LEUKOSITE, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
LEUKOSITE, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
LEUKOSITE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
LEUKOSITE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
LEUKOSITE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) THE COMPANY
LeukoSite, Inc. (the Company) was incorporated on May 1, 1992. The Company is engaged in the development of small molecule and monoclonal antibody therapeutics with potential applications in inflammatory, autoimmune, and viral diseases and cancer.
The Company was considered to be in the development stage for financial reporting purposes until December 1998. During 1998, the Company experienced significant revenue growth, including revenue from its joint venture with Ilex (as discussed in Note 7), entered into several new collaboration agreements (see Note 4 and Note 9) and subsequent to year-end acquired all of the issued and outstanding capital stock of CytoMed, Inc. (see Note 21). As such, the Company no longer reports cumulative results from inception as required for development stage enterprises.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. All material intercompany accounts and transactions have been eliminated in consolidation.
(B) DEPRECIATION AND AMORTIZATION
The Company provides for depreciation and amortization using the straight-line method by charges to operations in amounts estimated to allocate the cost of property and equipment over their estimated useful lives as follows:
(C) REVENUE RECOGNITION
All of the Company's revenues are non-refundable and are substantially derived from corporate collaborative research arrangements, government grants and amounts billed to the Company's joint venture with Ilex, as discussed in Note 7. Corporate collaboration revenues and government grants, which are not subject to achieving development milestones, are recognized on a straight-line basis over the period of the contract, which approximates when work is performed and costs are incurred. Revenues that are earned upon the achievement of development milestones are recognized when the milestones are achieved and payment is due. License fee revenue represents technology transfer fees received for rights to certain technology of the Company. License fees are recognized as revenue when all obligations as defined in the
LEUKOSITE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) individual agreements are fulfilled by the Company and there is no risk of refund. Deferred revenue represents payments received in advance of revenue recognition.
(D) RESEARCH AND DEVELOPMENT
All research and development costs are expensed as incurred. Funding commitments are recorded as a liability when they become contractually due. Research and development expenses in the accompanying consolidated statements of operations include funded and unfunded expenses.
(E) DISCLOSURE OF FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist mainly of cash and cash equivalents, marketable securities and accounts payable. The carrying amounts of these financial instruments approximate fair value due to the short-term nature of these instruments.
(F) NET LOSS PER COMMON SHARE
In March 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 128, EARNINGS PER SHARE. The Company adopted SFAS No. 128 effective December 15, 1997. Basic net loss is based on the weighted average number of common shares outstanding. The 1997 net loss available to common stockholders has been adjusted to include $610,000 of dividends attributable to redeemable convertible preferred stock. Diluted net loss per share is the same as basic net loss per share as the inclusion of stock options and warrants would be antidilutive.
(3) CASH EQUIVALENTS AND MARKETABLE SECURITIES
Cash equivalents are highly liquid investments with original maturities of less than three months. Marketable securities consist of securities with original maturities of greater than three months. The Company accounts for cash equivalents and marketable securities in accordance SFAS No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES. In accordance with SFAS No. 115, the Company has classified its investments as held-to-maturity. The investments that the Company has the positive intent
LEUKOSITE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) CASH EQUIVALENTS AND MARKETABLE SECURITIES (CONTINUED) and ability to hold to maturity are reported at amortized cost, which approximates fair market value. As of December 31, 1998, there were no material unrealized gains or losses on investments. Cash and cash equivalents and marketable securities consisted of the following:
Taxable auction securities have maturities of either seven, twenty-eight, or thirty-five days and the yields on these instruments are reset upon maturity by utilizing the Dutch Auction or remarketing mechanisms. New and existing investors reset the rates through a competitive bidding process that reflects factors such as the current interest rate environment, comparable yields available in alternative short-term cash instruments and the credit quality of the issuer.
(4) WARNER-LAMBERT AGREEMENTS
The Company and Warner-Lambert Company (Warner) have entered into research, development and marketing agreements to share expertise in the discovery and development of compounds that antagonize the MCP-1, IL-8, CCR5 and CXCR4 receptors and A4B7 and AEB7 integrins and to market therapeutic drugs that result from the collaboration.
The Company and Warner signed an agreement related to MCP-1 in September 1994 that was amended in July 1995 and October 1997 (the MCP-1 Agreement). Under the MCP-1 Agreement, the Company and Warner are working to screen and select compounds for further development. In conjunction with the MCP-1 Agreement, Warner agreed to purchase preferred stock at a predetermined share price and to fund a portion of the Company's research expenses. Warner purchased $3,000,000 of Series C convertible preferred stock in 1995 and $5,000,000 of Series E convertible preferred stock in 1996.
The Company and Warner signed an agreement related to IL-8 in July 1995 that was amended in October 1997 (the IL-8 Agreement). Under the IL-8 Agreement, the Company and Warner are working to screen and select compounds for further development. In connection with the IL-8 Agreement, Warner paid the Company $250,000 for the grant of a license to the technology and made a $1,000,000 equity investment in the Series G preferred stock in March 1997.
LEUKOSITE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) WARNER-LAMBERT AGREEMENTS (CONTINUED) The Company and Warner signed an agreement related to CCR5 and CXCR4 in October 1996 (the CCR5 and CXCR4 Agreement). Under the CCR5 and CXCR4 Agreement, the Company and Warner are working to discover and develop small molecule antagonists to AIDS chemokine co-receptors CCR5 and CXCR4 for the treatment of HIV infection. This agreement was extended in January 1998, at which time Warner made a nonrefundable $1,000,000 payment related to the achievement of certain milestones.
Under the terms of the October 1997 amendment to the MCP-1 and IL-8 agreements, the Company, Warner and Kyowa Hakko Kogyo (Kyowa) have agreed to jointly pursue research and development of antagonists that target MCP-1, IL-8, CCR1 and CXCR3.
The Company and Warner signed an agreement related to A4B7 and AEB7 in December 1998 (the A4B7 and AEB7 Agreement). Under the A4B7 and AEB7 Agreement, the Company and Warner are working to discover and develop small molecule atagonists to the A4B7 and AEB7 integrin targets implicated in asthma and inflammatory bowel disease. In connection with the A4B7 and AEB7 Agreement, Warner made a nonrefundable $2,500,000 payment for the grant of a license to the technology and agreed to provide research funding.
The Company received quarterly research funding under the MCP-1 and IL-8 Agreements and the A4B7 and AEB7 Agreement. Through December 31, 1998, the Company had received $3,831,250 in research support. Revenue recognized for research support during the years ended December 31, 1996, 1997 and 1998 was $690,000, $1,035,000 and $1,021,667, respectively, and as of December 31, 1998, the Company has deferred recognizing $834,583 as revenue. The MCP-1, IL-8, CCR5 and CXCR4, and A4B7 and AEB7 Agreements (the Warner Agreements) also contain milestone payments payable to the Company beginning upon the designation of a product candidate for development. In addition, under the Warner Agreements, Warner will pay royalties as a percentage of sales, as defined, for certain products developed under the agreements. Warner waived its antidilution rights relating to the Series C, E and G preferred stock, which was converted into common stock in August 1997, in exchange for a credit against future royalties, if any become payable, under the MCP-1 and IL-8 Agreements and the Kyowa Agreement discussed in Note 6. The approximate amount of such credit is $3,900,000. The Warner Agreements can be terminated by either party with six months' written notice or for cause, as defined.
(5) ROCHE BIOSCIENCE AGREEMENT
The Company signed an agreement with Roche Bioscience (Roche) for the development of a drug to block the binding of eotoxin in July 1996. Under the terms of this agreement, Roche will make payments to the Company in the form of licensing fees, research support and milestone payments and royalties on worldwide sales of products resulting from the collaboration. Through December 31, 1998, the Company had received $7,062,500 in licensing and research support payments from Roche. Revenue recognized for the years ended December 31, 1996, 1997 and 1998 was $2,900,000, $2,100,000 and $1,925,000, respectively, and as of December 31, 1998, the Company has deferred recognizing $137,500 as revenue. Roche is responsible for preclinical and clinical development of products and has worldwide exclusive rights to market products.
(6) KYOWA HAKKO KOGYO AGREEMENT
The Company signed an agreement with Kyowa to discover and develop small molecule antagonists and monoclonal antibody drugs to CXCR3 and CCR1 in April 1997. The agreement was amended in October 1997. Under the terms of the amended agreement, Kyowa has primary rights to market products
LEUKOSITE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) KYOWA HAKKO KOGYO AGREEMENT (CONTINUED) in Japan and Asia resulting from the collaboration. Furthermore, the amended agreement calls for the Company, together with Warner and Kyowa to jointly develop antagonists that target MCP-1, IL-8, CXCR3 and CCR1. The Company is entitled to receive research support and milestone payments, as well as royalties based on net sales, as defined. Through December 31, 1998, the Company had received $7,000,000 of research funding from Kyowa. Revenue recognized for the years ended December 31, 1997 and 1998 was $2,100,000 and $3,300,000, respectively, and as of December 31, 1998, the Company has deferred recognizing $1,200,000 as revenue.
(7) ILEX AGREEMENT
In May 1997, the Company and Ilex Oncology, Inc. (Ilex) entered into a joint venture agreement that established a limited partnership for the purpose of developing CAMPATH-Registered Trademark-. Under the terms of the partnership, the Company is required to fund 50% of the partnership's working capital requirements. The joint venture expires in 2017, but provides for either partner under certain circumstances to purchase the other partner's ownership position of the joint venture after October 2000. Should either party fail to fulfill its funding obligations, control of the joint venture may change.
The Company accounts for its investment in the joint venture under the equity method of accounting and records its share of the income of loss in other income (expense). The Company is reimbursed by the joint venture for certain costs incurred on behalf of the joint venture. The joint venture has sublicensed the rights to CAMPATH-Registered Trademark- from the Company. For the years ended December 31, 1997 and 1998, the Company's share of the joint venture's recorded loss was $3,357,916 and $3,857,640, respectively, and the Company had a funding liability of $203,445 to the joint venture as of December 31, 1998. The Company charged the joint venture $1,235,185 and $250,106 for costs incurred by the Company on behalf of the joint venture for the year ended December 31, 1998 and December 31, 1997, respectively, which has been recorded as revenue by the Company. During 1998, the joint venture made a nonrefundable $25,000 payment to the Company for the license to the rights of CAMPATH-Registered Trademark-, which has been recorded as revenue by the Company.
(8) GENENTECH
The Company entered into an agreement with Genentech, Inc. (Genentech) in December 1997 to develop and commercialize LDP-02, a humanized monoclonal antibody for the treatment of inflammatory bowel disease (IBD). Under the terms of the agreement Genentech will have exclusive worldwide rights to market LDP-02. In connection with the agreement, Genentech made a $4,000,000 equity investment in the Company and was issued warrants to purchase 250,000 shares of common stock at an exercise price of $16.22 per share. The agreement calls for payments to be made to the Company for the achievement of certain milestones as well as future royalty payments based upon the sale of products developed under the collaboration. In addition, Genentech will provide two credit facilities. The first facility will be for approximately $15 million and will fund development of products through completion of Phase II clinical trials. The second facility will be available to the Company if it agrees to fund 25% of the Phase III clinical trial development costs in return for a specified share of profits on U.S. sales of any products developed under the agreement, as defined. If the Company elects this option, it will also receive royalties on products sold outside of the U.S. The two credit facilities can be repaid by the Company or converted into shares of common stock under certain circumstances, at the option of the Company or Genentech, at the market value of the common stock at the date of conversion. No funds have been drawn against the credit facilities for the years ended December 31, 1997 and 1998.
LEUKOSITE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) MORPHOSYS
The Company entered into a two-year collaboration agreement with MorphoSys AG (MorphoSys) in August 1998 to discover and develop therapeutic monoclonal antibodies for inflammatory and autoimmune disorders. Under the terms of the agreement, the Company received exclusive worldwide rights to develop and commercialize antibody therapeutics resulting from the collaboration. The Company made a technology access fee payment in August 1998 of $750,000, which has been included in research and development expense. The agreement calls for payments to be made to MorphoSys for funded research, the achievement of certain milestones as well as future royalties, based upon commercial sales of products developed under the collaboration.
(10) CAPITAL LEASE
In 1993, the Company entered into a master lease agreement for the sale and leaseback or lease of up to $2,250,000 of laboratory and office equipment and leasehold improvements. At December 31, 1998, the Company had acquired approximately $2,130,000 of laboratory and office equipment and leasehold improvements under the lease agreement. The Company also has an obligation to purchase $750,000 of leasehold improvements at the expiration of the lease term for 15% of its original cost. The Company issued warrants for the purchase of 210,000 shares of Series A redeemable convertible preferred stock at an exercise price of $1.00 per share to the lessors under the master lease agreement (see Note 13(b)).
In 1994, the Company entered into a second master equipment lease agreement for the lease of up to $750,000 of laboratory and office equipment. At December 31, 1998, the Company had acquired approximately $730,000 of equipment under the lease. The leased equipment reverts back to the lessor at the end of the lease term or the Company may purchase all of the equipment for fair market value, which will not be less than 10% or more than 20% of the cost of the equipment. On January 18, 1996, this agreement was amended to provide an additional $300,000 of lease availability.
On March 14, 1997, the Company entered into another lease agreement for the lease of up to $1,200,000 of laboratory and office equipment, of which $450,000 may be utilized for leasehold improvements. The leased equipment reverts back to the lessor at the end of the lease term or the Company may purchase all of the equipment for fair market value, which will not be less than 10% or more than 20% of the cost of the equipment. On May 7, 1998, this agreement was amended to provide an additional $1,200,000 of lease availability. As of December 31, 1998, $1,010,000 is available under this lease commitment.
On March 26, 1998, the Company entered into another lease agreement for the lease of up to $500,000 of laboratory and office equipment. The leased equipment reverts back to the lessor at the end of the lease term or the Company may purchase all of the equipment for fair market value, which will not be less than 10% or more than 15% of the cost of the equipment. As of December 31, 1998, $500,000 is available under this lease commitment.
On June 12, 1998, the Company entered into another lease agreement for the lease of up to $1,300,000 of laboratory and office equipment, of which $455,000 may be utilized for leasehold improvements. The leased equipment reverts back to the lessor at the end of the lease term or the Company may purchase all of the equipment for fair market value, which will not be less than 10% or more than 20% of the cost of the equipment. As of December 31, 1998, $620,000 is available under this lease commitment.
LEUKOSITE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(10) CAPITAL LEASE (CONTINUED) Future minimum lease payments under these lease agreements at December 31, 1998 are as follows:
(11) CAPITAL STOCK
(A) STOCK SPLIT AND AMENDMENT TO CHARTER
On August 8, 1997, the Company amended its Restated Certificate of Incorporation, which included a 1-for-4.10 reverse stock split of the Company's common stock and a change in the par value of the Company's common stock to $.01 per share. Accordingly, all share and per share amounts of common stock for all periods presented have been retroactively adjusted to reflect the reverse stock split and change in par value. The Company is authorized to issue 25,000,000 shares of common stock, $.01 par value, and 5,000,000 shares of preferred stock, $.01 par value.
(B) INITIAL PUBLIC OFFERING
On August 15, 1997, the Company completed the initial public offering of 2,875,000 shares of its common stock at $6 per share, for total net proceeds of $15.3 million after underwriting discounts and expenses of the offering. In connection with the public offering, all outstanding shares of redeemable convertible preferred stock and convertible preferred stock were automatically converted into 5,535,607 shares of common stock.
LEUKOSITE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) PREFERRED STOCK
(A) REDEEMABLE CONVERTIBLE PREFERRED STOCK
Redeemable convertible preferred stock activity for the two years in the period ended December 31, 1997 is as follows:
As discussed in Note 11(b), upon completion of the Company's initial public offering, all outstanding shares of redeemable convertible preferred stock were automatically converted into 4,986,827 shares of common stock.
The Company also had a separate agreement with certain Series G shareholders whereby their shares were converted into common stock based upon a specific rate of return on their original investment, as defined. The Company recorded the value attributed to the guaranteed rate of return (based on an original investments of $3,000,000, an annual rate of return of 33% and an estimated period of approximately 7.5 months before conversion into common stock) as additional paid-in capital and accreted it as a preferred stock dividend over the estimated period that the stock was outstanding. The Company recorded $610,000 of such accretion through December 31, 1997.
(13) STOCK OPTIONS AND WARRANTS
(A) STOCK OPTIONS
The Company has adopted the 1993 Stock Option Plan (the Plan) under which it may grant both incentive stock options and nonstatutory stock options. The Plan provides for the granting of options to purchase up to 2,125,000 shares of common stock. As of December 31, 1998, 352,720 shares are available for future grant under the Plan. To date, all options granted have been issued with an exercise price equal to the fair market value at the time of issuance.
LEUKOSITE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(13) STOCK OPTIONS AND WARRANTS (CONTINUED) The Company's 1997 Employee Stock Purchase Plan authorizes a total of up to 150,000 shares of the Company's common stock to be sold to participating employees. Participating employees may purchase shares of common stock at 85% of its fair market value at the beginning or end of an offering period, whichever is lower, through payroll deductions in an amount not to exceed 8% of an employee's base compensation.
During 1993, the Company granted a stock option to purchase 135,000 shares of Series A redeemable convertible preferred stock at $1.00 per share pursuant to a stock restriction agreement with a consultant. Upon conversion of the Series A redeemable convertible preferred stock into common stock as discussed in Note 11(b), the option holder is now entitled to purchase 32,927 shares of common stock at an exercise price of $4.10 per share. This option expires on August 15, 2002.
The Company had the following common stock option activity for the three years end December 31, 1998:
LEUKOSITE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(13) STOCK OPTIONS AND WARRANTS (CONTINUED)
In October 1995, the FASB issued SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. SFAS No. 123 requires the measurement of the fair value of stock options or warrants granted to employees to be included in the statement of operations or disclosed in the notes to financial statements. The Company has determined that it will continue to account for stock-based compensation for employees under Accounting Principles Board Opinion No. 25 and elect the disclosure-only alternative under SFAS No. 123. The Company has computed the pro forma disclosures required under SFAS No. 123 for options granted in 1996, 1997 and 1998 using the Black-Scholes option pricing model prescribed by SFAS No. 123. The assumptions used for the years ended December 31, 1996, 1997 and 1998 are as follows:
The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions including expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
The total value of the options granted during the years ended 1996, 1997 and 1998 was computed as approximately $867,000, $3,561,000 and $2,338,000, respectively. Of these amounts, approximately $99,000, $458,000 and $1,179,000 would be charged to operations for the years ended December 31, 1996, 1997 and 1998, respectively. The remaining amount would be amortized over the related vesting periods. The resulting pro forma compensation expense may not be representative of the amount to be expected in future years, as pro forma compensation expense may vary based upon the number of options granted and the assumptions used in valuing these options.
The pro forma net loss and pro forma net loss per common share presented below have been computed assuming no tax benefit. The effect of a tax benefit has not been considered since a substantial
LEUKOSITE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(13) STOCK OPTIONS AND WARRANTS (CONTINUED) portion of the stock options granted are incentive stock options and the Company does not anticipate a future deduction associated with the exercise of these stock options. The pro forma effect of SFAS No. 123 for the years ended December 31, 1996, 1997 and 1998 is as follows:
(B) WARRANTS
In connection with the issuance of the Company's Series G redeemable convertible preferred stock, the Company granted warrants to purchase shares of common stock. The total number of shares issuable upon exercise of the warrants and the exercise price will be determined once the Company completes its first firm commitment underwritten public offering in which the net proceeds to the Company are at least $17,500,000 (the Designated Public Offering). The warrants shall become exercisable only if the Designated Public Offering occurs after December 20, 2000. If the Designated Public Offering occurs on or prior to December 20, 2000, the warrants shall become null and void. The warrants are exercisable beginning on the later of (i) the date of the closing of the Designated Public Offering after December 20, 2000 or (ii) the date of closing in connection with, or expiration of, the underwriters' overallotment option in connection with the Designated Public Offering. The warrants expire on the earlier of (i) the date of closing of the Designated Public Offering provided the closing occurs on or prior to December 20, 2000 or (ii) December 20, 2003.
In conjunction with the Company's master lease agreement (see Note 10), the Company issued warrants for the purchase of 210,000 shares of Series A redeemable convertible preferred stock at an exercise price of $1.00 per share. Upon conversion of the Series A redeemable convertible preferred stock into common stock as discussed in Note 11(b), the warrantholder became entitled to purchase 51,220 shares of common stock at an exercise price of $4.10 per share. The warrants are fully exercisable and expire on August 15, 2002. The value assigned to the warrants, $90,500, is being accounted for as debt discount and is being amortized over the lease period.
In conjunction with the Company's agreement with Genentech (see Note 8), the Company issued warrants to purchase 250,000 shares of common stock at an exercise price of $16.22 per share. The warrants are exercisable on December 18, 1999 and expire on December 18, 2007.
LEUKOSITE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(14) OPERATING LEASE
In December 1994, the Company entered into an operating lease for its office and research facilities. The lease expires in December 1999 with an option to renew for two additional five-year terms. On September 1, 1998, the term of the lease was extended for an additional period commencing as of December 1, 1999 and expiring as of November 30, 2004. The Company has received certain rent concessions during the initial term of the lease. Rent expense is being recognized ratably over the term of the lease. Deferred rent included in the accompanying consolidated balance sheet represents the difference between cash paid to date and rent expense recognized to date. Rent expense for 1996, 1997 and 1998 amounted to approximately $459,000, $459,000 and $741,000 respectively.
Future minimum rental payments at December 31, 1998 are as follows:
(15) INCOME TAXES
The Company follows the provisions of SFAS No. 109, ACCOUNTING FOR INCOME TAXES, whereby a deferred tax asset or liability is measured by the enacted tax rates that would be in effect when any differences between the financial statement and tax bases of assets or liabilities reverse. The Company has elected to defer the deduction of certain research and development costs, as defined in the Internal Revenue Code. As of December 31, 1998, the Company has available deferred research and development costs of approximately $29,105,000, net operating loss carryforwards of approximately $13,800,000 and research and development credit carryforwards of approximately $1,300,000 to reduce future federal income taxes, if any. The net operating loss and credit carryforwards expire beginning in the year 2007 and are subject to review and possible adjustment by the Internal Revenue Service. Because of the uncertainty
LEUKOSITE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(15) INCOME TAXES (CONTINUED) of the realization of future tax return benefits of the deferred tax assets, a full valuation allowance has been provided.
The United States Tax Reform Act of 1986 contains provisions that may limit the Company's net operating loss and credit carryforwards available to be used in any given year in the event of significant changes in the ownership interests of significant stockholders. The Company has completed numerous financings since its inception and has incurred ownership changes, as defined in the Tax Reform Act of 1986. The Company believes that the ownership changes will not significantly impact its ability to utilize its net operating loss and tax credit carryforwards.
(16) COMMITMENTS
(A) RESEARCH, LICENSE AND CONSULTING AGREEMENTS
The Company has entered into various research, license and consulting agreements to support its research and development activities. These agreements generally expire over several years. Certain of such agreements contain provisions for future royalties to be paid on sales of products developed under the agreements. The Company also has commitments to fund research and development under arrangements discussed in Notes 7 and 16(b).
Future minimum commitments under research, license and consulting agreements, excluding any funding related to the Ilex joint venture discussed in Note 7, at December 31, 1998 are approximately as follows:
(B) LEUKOSITE (U.K.) LIMITED
The Company has a wholly owned subsidiary, LeukoSite (UK) Limited (LeukoSite UK). LeukoSite UK was incorporated for the purpose of entering into a research agreement to fund research activity in the United Kingdom. An agreement has been established whereby LeukoSite UK will contribute $3,000,000
LEUKOSITE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(16) COMMITMENTS (CONTINUED) toward funding the construction, equipping and the operations of a research center in the UK. The Company has paid and charged to operations $2,500,000 of such commitment as of December 31, 1998, and the balance will be paid in six-month intervals of $250,000 each. It is expected that the Company will fund most of the cash requirements of LeukoSite UK.
(17) ACCRUED EXPENSES
Accrued expenses in the accompanying consolidated balance sheets consist of the following:
(18) PROFIT SHARING PLAN
The Company maintains a profit sharing plan (the Plan) that provides for tax deferred employee benefits under Section 401(k) of the Internal Revenue Code. The Plan allows employees to make contributions, a portion of which will be matched by the Company, up to 25% of the lesser of 6% of an employee's salary or an employee's contributions. The Company's contributions are 100% vested. There were no Company matching contributions during the years ended December 31, 1996 and 1997. The Company has made matching contributions to the Plan of approximately $52,000 for the year ended December 31, 1998. The Company pays the administrative costs of the Plan.
(19) COMPREHENSIVE INCOME
In June 1997, the FASB issued SFAS No. 130, REPORTING COMPREHENSIVE INCOME. The statement established standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. This statement is effective for fiscal years beginning after December 15, 1997. The Company has adopted this statement for the year ended December 31, 1998 with no material impact on the Company's financial statements as there are no material differences between comprehensive income and reported.
(20) SEGMENT REPORTING
In June 1997, the FASB issued SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. This statement established standards for the way that public business enterprises report information about operating segments in annual financial statements and require that enterprises report selected information about operating segments in interim financial reports issued to stockholders.
LEUKOSITE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(20) SEGMENT REPORTING (CONTINUED) The Company has adopted this statement for the fiscal year ending December 31, 1998. In accordance with SFAS No. 131, the Company has one operating segment. Additional disclosure of revenue information about products and services is, therefore, not required.
(21) SUBSEQUENT EVENT
On February 11, 1999, the Company acquired all of the issued and outstanding capital stock of CytoMed Inc. (CytoMed) through the issuance of 935,625 shares of the Company's Series A Convertible Preferred Stock, par value $.01 per share, to CytoMed shareholders. The Series A Convertible Preferred Stock is convertible into common stock on a one-to-one basis upon required approval by Company shareholders. The Company will issue another 631,313 common shares to CytoMed shareholders upon receipt of a $6,000,000 payment to CytoMed from UCB Pharma which is required to be paid in October 1999. In addition, CytoMed shareholders may receive up to $23,000,000 in cash and 84,000 shares of the Company's common stock which is required upon the achievement of clinical development and regulatory milestones related to CytoMed's product candidates. The total purchase price, including shares issued, shares to be issued and transaction costs, was approximately $16,100,000 and the net assets acquired were approximately $14,500,000. The transaction will be accounted for as a purchase in accordance with Accounting Principles Board Opinion No. 16, BUSINESS COMBINATIONS.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the General Partners of L&I Partners, L.P.:
We have audited the accompanying balance sheets of L&I Partners, L.P. (a Delaware Limited Partnership in the development stage), as of December 31, 1998 and 1997, and the related statements of operations, partners' capital and cash flows for the year ended December 31, 1998, and for the period from inception (May 2, 1997) through December 31, 1997, and cumulative from inception (May 2, 1997) through December 31, 1998. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. 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 L&I Partners, L.P., as of December 31, 1998 and 1997, and the results of its operations and its cash flows for the year ended December 31, 1998, and for the period from inception through December 31, 1997, and cumulative from inception through December 31, 1998, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
San Antonio, Texas January 29, 1999
L&I PARTNERS, L.P.
(A DEVELOPMENT STAGE COMPANY)
BALANCE SHEETS
(IN THOUSANDS)
The accompanying notes are an integral part of these financial statements.
L&I PARTNERS, L.P.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
The accompanying notes are an integral part of these financial statements.
L&I PARTNERS, L.P.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF PARTNERS' CAPITAL
(IN THOUSANDS)
The accompanying notes are an integral part of these financial statements.
L&I PARTNERS, L.P.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
The accompanying notes are an integral part of these financial statements.
L&I PARTNERS, L.P. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
(AMOUNTS IN THOUSANDS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
ORGANIZATION AND CONTROL
L&I Partners, L.P. (L&I), was founded in May 1997 as a joint venture between Ilex Oncology, Inc. (Ilex), and Leukosite, Inc. (Leukosite). L&I was formed to develop and commercialize a monoclonal antibody (CAMPATH-Registered Trademark-) initially for the treatment of chronic lymphocytic leukemia, pursuant to an agreement of limited partnership and a license agreement between Leukosite, Ilex and L&I. The development and commercialization activities of L&I are jointly managed by Leukosite and Ilex who will generally share equally in profits and losses. The joint venture expires in 2017, but provides for either partner to purchase the other partner's ownership interest in the joint venture in the event of an unresolved deadlock (relating to the activities of the partnership) after the earlier of a change in control (as defined therein) of the other party or October 31, 2000. In addition, in the event that one party is unable or unwilling to fulfill its funding obligations to the joint venture, then in certain circumstances, the party that funds the joint venture shall gain control of the management of the joint venture, subject to certain catch-up rights of the other party.
L&I is in the development stage and has not yet generated operating revenues nor is there any assurance of future revenues. Since inception, L&I has received significant support from Leukosite and Ilex. Although its affiliation with Leukosite and Ilex puts it in a preferred position to develop and commercialize a product, L&I continues to be subject to the risks and challenges associated with other companies in a comparable stage of development including the ability to obtain adequate financing to fund operations and development, dependence on key individuals and entities, competition from larger companies and successful marketing of its products. Accordingly, L&I's future success is uncertain.
During the period from inception (May 2, 1997) through December 31, 1998, L&I incurred a net loss of approximately $14.5 million and, at December 31, 1998, had a negative working capital of approximately $.7 million and negative partners' capital of approximately $.7 million. The ability of L&I to continue as a going concern is dependent upon the ongoing support of its partners. The general and limited partners have committed to making additional capital contributions in order to fund the obligations and operations of L&I through fiscal 1999.
Under the partnership structure, Ilex and Leukosite each hold a 49.5 percent limited partner interest and L&I LLC holds a 1 percent general partner interest in L&I. Ilex and Leukosite each hold a 50 percent interest in L&I LLC.
BASIS OF PRESENTATION
The accompanying financial statements have been prepared in accordance with generally accepted accounting principles and are not the basis for reporting taxable income to the partners. The financial statements include the accounts of L&I only.
ESTIMATES IN FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and
L&I PARTNERS, L.P. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
(AMOUNTS IN THOUSANDS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates.
STATEMENT OF CASH FLOWS
L&I considers all highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents.
INCOME TAXES
Income and deductions of L&I for federal income tax purposes are includable in the tax returns of the individual partners. Accordingly, no recognition has been given to federal income taxes in the accompanying financial statements of L&I.
PRICE RISK MANAGEMENT ACTIVITIES
L&I may enter into exchange traded futures and options contracts, forward contracts, swaps and other financial instruments with third parties to hedge foreign currency commitments.
ALLOCATION OF NET INCOME (LOSS) AND CASH DISTRIBUTIONS
Net income (loss) is allocated to partners based on their effective ownership interest in the operating results of L&I. L&I is not required to and has not made any cash distributions.
2. RELATED-PARTY TRANSACTIONS:
L&I utilizes services extensively from both its limited partners. These services include contract research, development, scientific expertise, business development services and general management. The limited partners also provide certain general management services free of charge to L&I, however, the fair value of such services is immaterial to the results of operations of L&I for the period from inception (May 2, 1997) through December 31, 1998. During the year ended December 31, 1998 and for the period from May 2, 1997, through December 31, 1997, L&I incurred the following related party expenses for contract research services (in thousands):
3. LICENSING AGREEMENTS:
L&I has sublicensed the rights to CAMPATH-Registered Trademark- from Leukosite. The licensing agreement grants L&I the right to develop and market the product and to license the rights to the compound to other third parties. Under terms of the agreement, L&I is required to pay certain fees and royalties to Leukosite as defined in the agreement. No such payments were required for the period from inception through December 31, 1998.