Item 1 of this Quarterly Report. If our patents are successfully opposed in either of these two proceedings or third parties decline to take licenses to our Queen patents, our future revenues would be adversely affected. For example, if the opponents in the proceeding regarding our '216 Patent are successful, our ability to collect royalties on European sales of antibodies humanized by others would depend on: (i) the scope and validity of our '040 Patent; and (ii) whether the antibodies are manufactured in a country outside of Europe where they are covered by one or more of our patents and, if so, on the terms of our license agreements.
In addition, until the opposition proceedings are resolved, we may be limited in our ability to collect royalties or to negotiate future license agreements based on our Queen patents. An adverse decision by the Opposition Division could encourage challenges to our related Queen patents in other jurisdictions, including the United States. Such a decision may lead some of our licensees to stop making royalty payments or lead potential licensees not to take a license, either of which might result in us initiating formal legal proceedings to enforce our rights under our Queen patents. In such a situation, a likely defensive strategy to our action would be to challenge our patents in that jurisdiction. During the opposition process with respect to our '216 Patent, if we were to commence an infringement action in Europe to enforce that patent, such an action would likely be stayed until the opposition is decided by the European Patent Office. As a result, we may not be able to successfully enforce our rights under our European or related U.S. patents.
Although we intend to vigorously defend the European patents in these two proceedings, we may not prevail in either of these opposition proceedings or any litigation contesting the validity of these patents. For example, our Japanese humanization patent, which was issued in September 1998, was opposed and eventually revoked by the Japanese Patent Office in March 2001. Although we appealed the Japanese Patent Office's revocation of this patent, the Tokyo High Court upheld the revocation of the patent and, in December 2004, the Japanese Supreme Court denied our petition for review of the Tokyo High Court's decision. The decision by the Japanese Supreme Court concluded the proceedings in the matter and the Japanese Patent Office's decision to revoke our patent is final and nonappealable.
If the outcome of either of the European opposition proceedings or any litigation involving our antibody humanization patents were to be unfavorable, our ability to collect royalties on existing licensed products and to license our patents relating to humanized antibodies may be materially harmed. In addition, these proceedings or any other litigation to protect our intellectual property rights or defend against infringement claims by others could result in substantial costs and diversion of management's time and attention, which could harm our business and financial condition.
Our ability to maintain and increase our revenues from licensing our Queen patents is dependent upon third parties entering into new patent licensing arrangements, exercising rights under existing patent rights agreements, paying royalties under existing patent licenses with us and not terminating those existing licenses with us. To date, with the exception of Alexion Pharmaceuticals, Inc. (Alexion), we have succeeded in obtaining and maintaining such licensing arrangements, and in receiving royalties
on product sales, from parties whose products may be covered by our patents. However, there can be no assurance that we will continue to succeed in our licensing efforts in the future. In the past, we have experienced challenges in our licensing efforts, such as the disagreement we had with Genentech in 2003 over whether its Xolair antibody was covered under our humanization patents. Although we subsequently reached an amicable settlement with Genentech that is intended to resolve such disagreements, Genentech or other companies may, in the future not enter into or terminate their licensing agreements with us, or seek to challenge our U.S. patents through litigation or patent office proceedings, such as re-examinations or interferences. More recently, in March 2007, the FDA approved Alexion's Soliris™ (eculizumab) humanized antibody product for marketing and we filed a lawsuit against Alexion seeking monetary damages for infringement of certain of certain claims of our Queen patents and other relief. In June 2007, Alexion filed an answer denying that its Soliris product infringes our patents, asserting certain defenses and counterclaiming for non-infringement and invalidity, and thereafter amended its answer to include a defense of unenforceability. In July 2007, the discovery stage of this litigation began and discovery is ongoing. We intend to vigorously assert our rights under the patents-in-suit and defend against Alexion's counterclaims. If we experience difficulty in enforcing our patent rights through licenses, or if our licensees, or prospective licensees, challenge our antibody humanization patents, our revenues and financial condition could be adversely affected, and we could be required to undertake additional actions, including litigation, to enforce our rights. Such efforts would increase our expenses and could be unsuccessful.
The amount of royalty revenues we receive depends on, among other things, the efforts and successes of our licensees.
The amount and timing of any royalties we may receive from our licensees will depend, in part, on the product development and marketing efforts and successes of our licensees. Our licensees may not successfully complete the product development, regulatory and marketing efforts required to sell royalty-bearing products. Competition from other products or therapies could adversely affect sales of our licensees' products. In addition, even if a licensee receives regulatory approval to sell a drug on which we would receive royalties, the licensee or a regulatory agency, such as the FDA, could terminate or suspend the marketing of the drug as a result of safety or other events. For example, in February 2005, Biogen Idec and Elan announced that they had voluntarily suspended the marketing and commercial distribution of the Tysabri antibody, a drug approved to treat MS and which is licensed under our humanization patents, because Biogen Idec and Elan had received reports of cases of progressive multifocal leukoencephalopathy (PML), a rare and frequently fatal, demyelinating disease of the central nervous system, in certain patients treated with Tysabri antibody. In July 2006, Biogen Idec and Elan reintroduced the Tysabri antibody, however, the Tysabri antibody's label now includes prominent warnings regarding the Tysabri antibody's risks and Biogen Idec and Elan implemented a risk management plan to inform physicians and patients of the benefits and risks of Tysabri antibody treatment and to minimize the risk of PML potentially associated with Tysabri antibody monotherapy.
We must protect our patent and other intellectual property rights to succeed.
Our success is dependent in significant part on our ability to develop and protect patent and other intellectual property rights and operate without infringing the intellectual property rights of others.
Our pending patent applications may not result in the issuance of valid patents or the claims and claim scope of our issued patents may not provide competitive advantages. Also, our patent protection may not prevent others from developing competitive products using related or other technology that does not infringe our patent rights. A number of companies, universities and research institutions have filed patent applications or received patents in the areas of antibodies and other fields relating to our programs. Some of these applications or patents may be competitive with our applications or have claims that could prevent the issuance of patents to us or result in a significant reduction in the claim
scope of our issued patents. In addition, patent applications are confidential for a period of time after filing. We therefore may not know that a competitor has filed a patent application covering subject matter similar to subject matter in one of our patent applications or that we were the first to invent the innovation we seek to patent. This may lead to disputes including interference proceeding or litigation to determine rights to patentable subject matter. These disputes are often expensive and may result in our being unable to patent an innovation.
The scope, enforceability and effective term of patents can be highly uncertain and often involve complex legal and factual questions and proceedings. No consistent policy has emerged regarding the breadth of claims in biotechnology patents, so that even issued patents may later be modified or revoked by the relevant patent authorities or courts. These proceedings could be expensive, last several years and either prevent issuance of additional patents to us relating to humanization of antibodies or result in a significant reduction in the scope or invalidation of our patents. Any limitation in claim scope could reduce our ability to negotiate or collect royalties or to negotiate future collaborative research and development agreements based on these patents. Moreover, the issuance of a patent in one country does not assure the issuance of a patent with similar claim scope in another country, and claim interpretation and infringement laws vary among countries, so we are unable to predict the extent of patent protection in any country.
In addition to seeking the protection of patents and licenses, we also rely upon trade secrets, know-how and continuing technological innovation that we seek to protect, in part, by confidentiality agreements with employees, consultants, suppliers and licensees. If these agreements are not honored, we might not have adequate remedies for any breach. Additionally, our trade secrets might otherwise become known or patented by our competitors.
We may need to obtain patent licenses from others in order to manufacture or sell our potential products and we may not be able to obtain these licenses on terms acceptable to us or at all.
Other companies, universities and research institutions may obtain patents that could limit our ability to use, import, manufacture, market or sell our products or impair our competitive position. As a result, we may need to obtain licenses from others before we could continue using, importing, manufacturing, marketing, or selling our products. We may not be able to obtain required licenses on terms acceptable to us, if at all. If we do not obtain required licenses, we may encounter significant delays in product development while we redesign potentially infringing products or methods or we may not be able to market our products at all.
For example, the European Patent Office (EPO) granted Celltech Therapeutics Limited (Celltech), which UCB Group acquired, a patent covering humanized antibodies, which we have opposed. At an oral hearing in January 2005, the Opposition Division of the European Patent Office revoked this patent. Celltech has appealed this decision. The appeal was dismissed by the Technical Board of Appeal of the European Patent Office at an oral hearing in March 2008 and the patent remains revoked. Also, we do not know whether the EPO will grant Celltech a patent on a pending divisional application with claims broad enough to generally cover humanized antibodies. Celltech has also been issued a corresponding U.S. patent that contains claims that may be considered broader in scope than its European patent. In addition, Celltech was recently issued a second U.S. patent with claims that may be considered broader than its first U.S. patent. We have entered into an agreement with Celltech providing each company with the right to obtain nonexclusive licenses for up to three antibody targets under the other company's humanization patents, which rights may be exercised under the agreement through December 2014. Notwithstanding this agreement, if our humanized antibodies were covered by Celltech's European or U.S. patents and if we need more than the three licenses under those patents currently available to us under the agreement, we would need to negotiate additional licenses under those patents or significantly alter our processes or products. We might not be able to successfully alter
our processes or products to avoid conflict with these patents or to obtain the required additional licenses on commercially reasonable terms, if at all.
In addition, if a Celltech U.S. patent application conflicts with our U.S. patents or patent applications, we may become involved in proceedings to determine which company was the first to invent the products or processes contained in the conflicting patents. These proceedings could be expensive, last several years and either prevent issuance of additional patents to us relating to humanization of antibodies or result in a significant reduction in the scope or invalidation of our patents. Any limitation would reduce our ability to negotiate or collect royalties or to negotiate future collaborative research and development agreements based on these patents.
We do not have a license to an issued U.S. patent assigned to Stanford University and Columbia University, which may cover a process we use to produce our potential products. We have been advised that an exclusive license has been previously granted to a third party, Centocor, under this patent. If our processes were found to be covered by either of these patents, we might need to obtain licenses or to significantly alter our processes or products. We might not be able to successfully alter our processes or products to avoid conflicts with these patents or to obtain licenses on acceptable terms or at all.
We do not have licenses to issued U.S. patents which may cover one of our development-stage products. If we successfully develop this product, we might need to obtain licenses to these patents to commercialize the product. In the event that we need to obtain licenses to these patents, we may not be able to do so on acceptable terms or at all.
If our collaborations are not successful or are terminated by our partners, we may not effectively develop and market some of our products.
We have agreements with pharmaceutical and other companies to develop, manufacture and market certain of our potential products. In some cases, we rely on our partners to manufacture such products and essential components for those products, design and conduct clinical trials, compile and analyze the data received from these trials, obtain regulatory approvals and, if approved, market these licensed products. As a result, we may have limited or no control over the manufacturing, development and marketing of these potential products and little or no opportunity to review the clinical data prior to or following public announcement. In addition, the design of the clinical studies may not be sufficient or appropriate for regulatory review and approval and we may have to conduct further studies in order to facilitate approval.
In September 2005, we entered into a collaboration agreement with Biogen Idec under which Biogen Idec became our partner on the development of daclizumab in certain indications, including MS, and volociximab (M200) in all indications. This agreement is particularly important to us. The collaboration agreement provides significant combined resources for the development, manufacture and potential commercialization of covered products. We and Biogen Idec each assume certain responsibilities and share expenses. Because of the broad scope of the collaborations, we are particularly dependent upon the performance by Biogen Idec of their obligations under the agreement. The failure of Biogen Idec to perform their obligations, our failure to perform our obligations, our failure to effectively manage the relationship, or a material contractual dispute between us and Biogen Idec would have a material adverse effect on our prospects or financial results. Moreover, our financial results depend in substantial part upon our efforts and related expenses for these programs. Our revenues and expenses recognized under the collaboration will vary depending on the work performed by us and Biogen Idec in any particular reporting period.
The arrangement with Roche pursuant to which we were co-developing daclizumab for asthma and transplant maintenance was also particularly important to us. In 2006, however, Roche decided to first discontinue its involvement in the co-development of daclizumab in treating asthma and then later to
discontinue its co-development of daclizumab in transplant maintenance and terminate the Roche Co-Development Agreement effective in May 2007.
We rely on other collaborators, such as clinical research organizations, medical institutions and clinical investigators, including physician sponsors, to conduct nearly all of our clinical trials, including recruiting and enrolling patients in the trials. If these parties do not successfully carry out their contractual duties or meet expected deadlines, we may be delayed or may not obtain regulatory approval for or commercialize our product candidates. If any of the third parties upon whom we rely to conduct our clinical trials do not comply with applicable laws, successfully carry out their obligations or meet expected deadlines, our clinical trials may be extended, delayed or terminated.
If the quality or accuracy of the clinical data obtained by third party contractors is compromised due to their failure to adhere to applicable laws, our clinical protocols or for other reasons, we may not obtain regulatory approval for or successfully commercialize any of our product candidates. If our relationships with any of these organizations or individuals terminates, we believe that we would be able to enter into arrangements with alternative third parties. However, replacing any of these third parties could delay our clinical trials and could jeopardize our ability to obtain regulatory approvals and commercialize our product candidates on a timely basis, if at all.
Our partners can terminate our collaborative agreements under certain conditions, and in some cases on short notice. A partner may terminate its agreement with us or separately pursue alternative products, therapeutic approaches or technologies as a means of developing treatments for the diseases targeted by us, or our collaborative effort. For example, in August 2006, following a portfolio review at Roche, Roche elected to discontinue its involvement in the development of daclizumab in treating asthma and other respiratory diseases in accordance with the terms of the collaboration agreement we had with Roche, and in November 2006, Roche elected to terminate the entire collaboration agreement. Even if a partner continues to contribute to the arrangement, it may nevertheless decide not to actively pursue the development or commercialization of any resulting products. In these circumstances, our ability to pursue potential products could be severely limited.
Continued funding and participation by partners will depend on the continued timely achievement of our research and development objectives, the retention of key personnel performing work under those agreements and on each partner's own financial, competitive, marketing and strategic capabilities and priorities. These considerations include:
•the commitment of each partner's management to the continued development of the licensed products or technology;
•the relationships among the individuals responsible for the implementation and maintenance of the development efforts; and
•the relative advantages of alternative products or technology being marketed or developed by each partner or by others, including their relative patent and proprietary technology positions, and their ability to manufacture potential products successfully.
Our ability to enter into new relationships and the willingness of our existing partners to continue development of our potential products depends upon, among other things, our patent position with respect to such products. If we are unable to successfully maintain our patents we may be unable to collect royalties on existing licensed products or enter into additional agreements.
In addition, our collaborative partners may independently develop products that are competitive with products that we have licensed to them. This could reduce our revenues under our agreements with these partners.
If our research and development efforts are not successful, we may not be able to effectively develop new products.
We are engaged in research activities intended to, among other things, identify antibody product candidates that we may progress into clinical development. These research activities include efforts to discover and validate new targets for antibodies in our areas of therapeutic focus. We obtain new targets through our own drug discovery efforts and through in-licensing targets from institutions or other biotechnology or pharmaceutical companies. Our success in identifying new antibody product candidates depends upon our ability to discover and validate new targets, either through our own research efforts, or through in-licensing or collaborative arrangements. In order to increase the possibilities of identifying antibodies with a reasonable chance for success in clinical studies, part of our business strategy is to identify a higher number of potential targets than we expect to be able to progress through clinical development.
Our antibody product candidates are in various stages of development and many are in an early development stage. If we are unsuccessful in our research efforts to identify and obtain rights to new targets and generate antibody product candidates that lead to the required regulatory approvals and the successful commercialization of products, our ability to develop new products could be harmed.
To supplement our own research efforts, from time to time we may in-license or otherwise acquire from others rights to products in-development or early-stage technology. Acquiring rights to products in this manner poses risks, including because we may not be unable to successfully integrate the research, development and commercialization capabilities necessary to bring these products to market.
The failure to gain market acceptance of our product candidates among the medical community would adversely affect our revenue.
Even if approved, our product candidates may not gain market acceptance among physicians, patients, third-party payers and the medical community. We may not achieve market acceptance even if clinical trials demonstrate safety and efficacy and we obtain the necessary regulatory and reimbursement approvals. The degree of market acceptance of any product candidates that we develop will depend on a number of factors, including:
•establishment and demonstration of clinical efficacy and safety;
•cost-effectiveness of our product candidates;
•their potential advantage over alternative treatment methods;
•reimbursement policies of government and third-party payers; and
•marketing and distribution support for our product candidates, including the efforts of our collaborators where they have marketing and distribution responsibilities.
Physicians will not recommend our products until clinical data or other factors demonstrate the safety and efficacy of our product as compared to conventional drug and other treatments. Even if we establish the clinical safety and efficacy of our product candidates, physicians may elect not to use our product for any number of other reasons, including whether the mode of administration of our products is effective for certain indications. Antibody products, including our product candidates as they would be used for certain disease indications, are typically administered by infusion or injection, which requires substantial cost and inconvenience to patients. Our product candidates, if successfully developed, may compete with a number of drugs and therapies that may be administered more easily. The failure of our product candidates to achieve significant market acceptance would materially harm our business, financial condition and results of operations.
The clinical development of drug products is inherently uncertain and expensive and subject to extensive government regulation.
Our future success depends in large part upon the success of our clinical development efforts. Clinical development, however, is a lengthy, time-consuming and expensive process and subject to significant risks of failure. In addition, we must expend significant amounts to comply with extensive government regulation of the clinical development process.
Before obtaining regulatory approvals for the commercial sale of any products, we must demonstrate through preclinical testing and clinical trials that our product candidates are safe and effective for their intended use in humans. We have incurred and will continue to incur substantial expense for, and we have devoted and expect to continue to devote a significant amount of time to, preclinical testing and clinical trials. Despite the time and expense incurred, our clinical trials may not adequately demonstrate the safety and effectiveness of our product candidates.
Completion of clinical development generally takes several years or more. The length of time necessary to complete clinical trials and submit an application for marketing and manufacturing approvals varies significantly according to the type, complexity and intended use of the product candidate and is difficult to predict. Further, we, the FDA, European Medicines Agency (EMEA), investigational review boards or data safety monitoring boards may decide to temporarily suspend or permanently terminate ongoing trials. Failure to comply with extensive regulations may result in unanticipated delay, suspension or cancellation of a trial or the FDA's or EMEA's refusal to accept test results. As a result of these factors, we cannot predict the actual expenses that we will incur with respect to preclinical or clinical trials for any of our potential products, and we expect that our expense levels will fluctuate unexpectedly in the future. Despite the time and expense incurred, we cannot guarantee that we will successfully develop commercially viable products that will achieve FDA or EMEA approval or market acceptance, and failure to do so would materially harm our business, financial condition and results of operations.
Early clinical trials such as phase 1 and 2 trials generally are designed to gather information to determine whether further trials are appropriate and, if so, how such trials should be designed. As a result, data gathered in these trials may indicate that the endpoints selected for these trials are not the most relevant for purposes of assessing the product or the design of future trials. Moreover, success or failure in meeting such early clinical trial endpoints may not be dispositive of whether further trials are appropriate and, if so, how such trials should be designed. We may decide, or the FDA may require us, to make changes in our plans and protocols. Such changes may relate, for example, to changes in the standard of care for a particular disease indication, comparability of efficacy and toxicity of potential drug product where a change in the manufacturing process or manufacturing site is proposed, or competitive developments foreclosing the availability of expedited approval procedures. We may be required to support proposed changes with additional preclinical or clinical testing, which could delay the expected time line for concluding clinical trials.
Larger or later stage clinical trials may not produce the same results as earlier trials. Many companies in the pharmaceutical and biotechnology industries, including our Company, have suffered significant setbacks in clinical trials, including advanced clinical trials, even after promising results had been obtained in earlier trials. For example, in August 2007, we announced that we would terminate the phase 3 program of our Nuvion® (visilizumab) antibody in intravenous steroid-refractory ulcerative colitis because data from treated patients showed insufficient efficacy and an inferior safety profile in the visilizumab arm compared to IV steroids alone.
Even when a drug candidate shows evidence of efficacy in a clinical trial, it may be impossible to further develop or receive regulatory approval for the drug if it causes an unacceptable incidence or severity of side effects, or further development may be slowed down by the need to find dosing regimens that do not cause such side effects.
In addition, we may not be able to successfully commence and complete all of our planned clinical trials without significant additional resources and expertise because we have a relatively large number of potential products in clinical development. The approval process takes many years, requires the expenditure of substantial resources, and may involve post-marketing surveillance and requirements for post-marketing studies. The approval of a product candidate may depend on the acceptability to the FDA of data from our clinical trials. Regulatory requirements are subject to frequent change. Delays in obtaining regulatory approvals may:
•adversely affect the successful commercialization of any drugs that we develop;
•impose costly procedures on us;
•diminish any competitive advantages that we may attain; and
•adversely affect our receipt of revenues or royalties.
In addition, we may encounter regulatory delays or failures of our clinical trials as a result of many factors, all of which may increase the costs and expense associated with the trial, including:
•changes in regulatory policy during the period of product development;
•delays in obtaining sufficient supply of materials to enroll and complete clinical studies according to planned timelines;
•delays in obtaining regulatory approvals to commence a study;
•delays in identifying and reaching agreement on acceptable terms with prospective clinical trial sites;
•delays in the enrollment of patients;
•lack of efficacy during clinical trials; or
•unforeseen safety issues.
Regulatory review of our clinical trial protocols may cause us in some cases to delay or abandon our planned clinical trials. Our potential inability to commence or continue clinical trials, to complete the clinical trials on a timely basis or to demonstrate the safety and efficacy of our potential products, further adds to the uncertainty of regulatory approval for our potential products.
The "fast track" designation for development of any of our products may not lead to a faster development or regulatory review or approval process and it does not increase the likelihood the product will receive regulatory approval.
If a drug is intended for the treatment of a serious or life-threatening condition and the drug demonstrates the potential to address unmet medical needs for this condition, the drug sponsor may apply for FDA "fast track" designation for a particular indication. Marketing applications filed by sponsors of products in fast track development may qualify for priority review under the policies and procedures offered by the FDA, but the fast track designation does not assure any such qualification. If we obtain a fast track designation from the FDA for any of our development stage products, this designation may not result in a faster development process, review or approval compared to drugs considered for approval under conventional FDA procedures. In addition, the FDA may withdraw any fast track designation it has granted at any time which could delay the approval process. In addition, our fast track designation does not guarantee that we will qualify for or be able to take advantage of the expedited review procedures and does not increase the likelihood that a product will receive regulatory approval.
We may be unable to enroll a sufficient number of patients in a timely manner in order to complete our clinical trials.
The rate of completion of clinical trials is significantly dependent upon the rate of patient enrollment. Patient enrollment is a function of many factors, including:
•the size of the patient population;
•perceived risks and benefits of the drug under study;
•availability of competing therapies, including those in clinical development;
•availability of clinical drug supply;
•availability of clinical trial sites;
•design of the protocol;
•proximity of and access by patients to clinical sites;
•patient referral practices of physicians;
•eligibility criteria for the study in question; and
•efforts of the sponsor of and clinical sites involved in the trial to facilitate timely enrollment.
We may have difficulty obtaining sufficient patient enrollment or clinician support to conduct our clinical trials as planned, and we may need to expend substantial additional funds to obtain access to resources or delay or modify our plans significantly. These considerations may result in our being unable to successfully achieve our projected development timelines, or potentially even lead us to consider the termination of ongoing clinical trials or development of a product for a particular indication.
We must attract and retain key employees in order to succeed.
To be successful, we must attract and retain qualified clinical, scientific, management and other personnel and we face significant competition for experienced personnel. If we are unsuccessful in attracting and retaining qualified personnel, particularly at the management level, our business could be impaired. The uncertainty caused by the strategic review and asset sales processes and restructuring we have recently undertaken has created anxiety among our employees. We believe this has caused attrition to increase because of employees' uncertainty regarding the continuation of employment. We have put in place certain severance and retention programs in an effort to mitigate the number of voluntary terminations, however, our programs may not provide effective incentive to employees to stay with us.
The uncertainly may also make the recruitment of key personnel more difficult. We are currently engaged in a search for a new Chief Executive Officer, and the disruption and uncertainty caused by our restructuring may make such recruitment more difficult. The failure to recruit a new Chief Executive Officer could adversely impact our future performance.
Pursuant to rules adopted under the Sarbanes-Oxley Act of 2002, we must evaluate the effectiveness of our disclosure controls and internal control over financial reporting on a periodic basis, publicly disclose the results of these evaluations and publicly disclose whether we have implemented any changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Our management is required to periodically evaluate the effectiveness of our disclosure controls and procedures and our internal control over financial reporting and our independent registered public
accounting firm must attest to the effectiveness of our internal control over financial reporting as of the end of each fiscal year. We are also required to disclose in our periodic reports with the SEC any changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Our evaluation of our disclosure controls and procedures may reveal material weaknesses in our internal control over financial reporting. If we identify a material weakness we would be required to conclude that our internal control over financial reporting is ineffective and disclose this conclusion, which could adversely affect the market price of our common stock. For example, we disclosed we had material weaknesses in our quarterly reports on Form 10-Q for the periods ended September 30, 2005, June 30, 2007 and September 30, 2007 and our annual report on Form 10-K for the year ended December 31, 2007.
In addition, the rules governing the standards that must be met for management to assess the effectiveness of our internal control over financial reporting are complex and require significant documentation, testing and possible remediation. Compliance with these rules has resulted in increased expenses and the devotion of significant management resources and we expect that the expenses for this process will continue to increase modestly.
We rely on sole source, third-party contract manufacturers to manufacture our products.
Assuming we successfully sell our Manufacturing Assets to Genmab, we will not have the capability to manufacture any of our development-stage products. We have entered into a supply agreement with Genmab that would become effective upon the closing of the sale of our Manufacturing Assets to Genmab, which would have an initial term of two years. If we experience supply problems with Genmab, there may not be sufficient supplies of our development-stage products for us to meet clinical trial demand, in which case our operations and results could suffer.
Our products must be manufactured in FDA-approved facilities and the process for qualifying and obtaining approval for a manufacturing facility is time-consuming. The manufacturing facilities on which we rely will be subject to ongoing, periodic unannounced inspection by the FDA and state agencies to ensure compliance with good manufacturing practices.
Assuming we successfully sell our Manufacturing Assets to Genmab, if our relationship with Genmab was to terminate unexpectedly or on short notice or expire without being renewed, our ability to meet clinical trial demand for our development-stage products could be adversely affected while we qualify a new manufacturer for that product and our operations and future results could suffer. In addition, we would need to expend significant amounts to qualify a new manufacturer and transfer technology from Genmab to the new manufacturer which would also adversely affect our results of operations.
Product supply interruptions, whether as a result of regulatory action or the termination of a relationship with a manufacturer, could significantly delay clinical development of our potential products, reduce third-party or clinical researcher interest and support of proposed clinical trials, and possibly delay commercialization and sales of these products.
Our ability to file for, and to obtain, regulatory approvals for our products, as well as the timing of such filings, will depend on the abilities of the contract manufacturers we engage. We or our contract manufacturers may encounter problems with the following:
•production yields;
•quality control and assurance;
•availability of qualified personnel;
•availability of raw materials;
•adequate training of new and existing personnel;
•on-going compliance with standard operating procedures;
•on-going compliance with FDA regulations;
•production costs; and
•development of advanced manufacturing techniques and process controls.
Manufacturing changes may result in delays in obtaining regulatory approval or marketing for our products.
If we make changes in the manufacturing process, we may be required to demonstrate to the FDA and corresponding foreign authorities that the changes have not caused the resulting drug material to differ significantly from the drug material previously produced. Further, any significant manufacturing changes for the production of our product candidates could result in delays in development or regulatory approval or in the reduction or interruption of commercial sales of our product candidates. Our or our contract manufacturers' inability to maintain manufacturing operations in compliance with applicable regulations within our planned time and cost parameters could materially harm our business, financial condition and results of operations.
We have made manufacturing changes and are likely to make additional manufacturing changes for the production of our products currently in clinical development. These manufacturing changes or an inability to immediately show comparability between the older material and the newer material after making manufacturing changes could result in delays in development or regulatory approvals or in reduction or interruption of commercial sales and could impair our competitive position.
Our business may be harmed if we cannot obtain sufficient quantities of raw materials.
We depend on outside vendors for the supply of raw materials used to produce our product candidates for use in clinical trials. Once a supplier's materials have been selected for use in the manufacturing process, the supplier in effect becomes a sole or limited source of that raw material due to regulatory compliance procedures. If the third-party suppliers were to cease production or otherwise fail to supply us with quality raw materials and we were unable to contract on acceptable terms for these services with alternative suppliers, our ability to produce our products and to conduct preclinical testing and clinical trials of product candidates would be adversely affected. This could impair our competitive position.
We must comply with extensive government regulations and laws.
We are subject, directly or through our customers, to extensive regulation by federal government, state governments, and the foreign countries in which we conduct our business.
In particular, we are subject to extensive and rigorous government regulation as a developer of drug products. For example, the FDA regulates, among other things, the development, testing, research, manufacture, safety, efficacy, record-keeping, labeling, storage, approval, quality control, adverse event reporting, advertising, promotions, sale and distribution of biopharmaceutical products. Our product candidates and any future products may also be subject to extensive regulation by foreign governments. The regulatory review and approval process, which includes preclinical studies and clinical trials of each product candidate, is lengthy, expensive and uncertain.
We must rely on our contract manufacturers and third-party suppliers for regulatory compliance and adhering to the FDA's current Good Manufacturing Practices (cGMP) requirements. If these
manufacturers or suppliers fail to comply with applicable regulations, including FDA pre-or post-approval inspections and cGMP requirements, then the FDA could sanction us. These sanctions could include fines, injunctions, civil penalties, failure of regulatory authorities to grant marketing approval of our products, delay, suspension or withdrawal of approvals, license revocation, product seizures or recalls, operational restrictions or criminal prosecutions, any of which could significantly and adversely affect our business.
Laws that may directly or indirectly affect our ability to operate our business include, but are not limited, to the following:
•the federal Anti-Kickback Law, which prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in cash or in kind, to induce either the referral of an individual, or furnishing or arranging for a good or service, for which payment may be made under federal healthcare programs such as the Medicare and Medicaid programs;
•the federal False Claims Act, which imposes civil and criminal liability on individuals and entities who submit, or cause to be submitted, false or fraudulent claims for payment to the government;
•the federal False Statements Statute, which prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false statement in connection with the delivery of or payment for healthcare benefits, items or services;
•the federal Foreign Corrupt Practices Act, which prohibits corporations and individuals from engaging in certain activities to obtain or retain business or to influence a person working in an official capacity; and
•state law equivalents to the Anti-Kickback Law and False Claims Act, which may not be limited to government reimbursed items.
If our operations are found to violate any applicable law or other governmental regulations, we may be subject to civil and criminal penalties, damages and fines, including exclusion from the Medicare and Medicaid programs and the curtailment or restructuring of our operations. Similarly, if the hospitals, physicians or other providers or entities with which we do business are found non-compliant with applicable laws, they may be subject to sanctions, which could also have a negative impact on us. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations, and additional legal or regulatory change. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses, divert our management's attention from the operation of our business and damage our reputation.
We expend a significant amount on compliance efforts and the expenses have been, and may in the future be unpredictable, and adversely affect our results. Changing laws, regulations and standards may also create uncertainty and increase insurance costs. We are committed to compliance and maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest all reasonably necessary resources to comply with evolving standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities.
We may be unable to obtain or maintain regulatory approval for our products.
Even if the FDA grants us marketing approval for a product, the FDA may impose post-marketing requirements, such as:
•labeling and advertising requirements, restrictions or limitations, such as the inclusion of warnings, precautions, contra-indications or use limitations that could have a material impact on the future profitability of our product candidates;
•adverse event reporting;
•testing and surveillance to monitor our product candidates and their continued compliance with regulatory requirements; and
•inspection of products and manufacturing operations and, if any inspection reveals that the product or operation is not in compliance, prohibiting the sale of all products, suspending manufacturing or withdrawing market clearance.
The discovery of previously unknown problems with our product candidates, including adverse events of unanticipated severity or frequency, may result in restrictions of the products, including withdrawal from manufacture. Additionally, certain material changes affecting an approved product such as manufacturing changes or additional labeling claims are subject to further FDA review and approval. The FDA may revisit and change its prior determination with regard to the safety or efficacy of our products and withdraw any required approvals after we obtain them. Even prior to any formal regulatory action requiring labeling changes or affecting manufacturing, we could voluntarily decide to cease the distribution and sale or recall any of our future products if concerns about their safety and efficacy develop.
As part of the regulatory approval process, we or our contractors must demonstrate the ability to manufacture the pharmaceutical product to be approved. Accordingly, the manufacturing process and quality control procedures are required to comply with the applicable FDA cGMP regulations and other regulatory requirements. Good manufacturing practice regulations include requirements relating to quality control and quality assurance as well as the corresponding maintenance of records and documentation. Manufacturing facilities must pass an inspection by the FDA before initiating commercial manufacturing of any product. Pharmaceutical product manufacturing establishments are also subject to inspections by state and local authorities as well as inspections by authorities of other countries. To supply pharmaceutical products for use in the United States, foreign manufacturing establishments must comply with these FDA approved guidelines. These foreign manufacturing establishments are subject to periodic inspection by the FDA or by corresponding regulatory agencies in these countries under reciprocal agreements with the FDA. The FDA enforces post-marketing regulatory requirements, such as cGMP requirements, through periodic unannounced inspections. Failure to pass an inspection could disrupt, delay or shut down our manufacturing operations. We expect to consummate the sale of our Manufacturing Assets and, although we do not have currently marketed products, the foregoing considerations would be important to our future selection of contract manufacturers.
Our collaborative partners, licensees and we also are subject to foreign regulatory requirements regarding the manufacture, development, marketing and sale of pharmaceutical products and, if the particular product is manufactured in the United States, FDA and other U.S. export provisions. These requirements vary widely in different countries. Difficulties or unanticipated costs or price controls may be encountered by us or our licensees or marketing partners in our respective efforts to secure necessary governmental approvals. This could delay or prevent us, our licensees or our marketing partners from marketing potential pharmaceutical products.
Further, regulatory approvals may be withdrawn if we do not comply with regulatory standards or if problems with our products occur. In addition, under a BLA, the manufacturer continues to be subject to facility inspection and the applicant must assume responsibility for compliance with applicable pharmaceutical product and establishment standards. If we fail to comply with applicable FDA and other regulatory requirements at any stage during the regulatory process, we may be subject to sanctions, including:
•delays;
•warning letters;
•fines;
•clinical holds;
•product recalls or seizures;
•changes to advertising;
•injunctions;
•refusal of the FDA to review pending market approval applications or supplements to approval applications;
•total or partial suspension of product manufacturing, distribution, marketing and sales;
•civil penalties;
•withdrawals of previously approved marketing applications; and
•criminal prosecutions.
We may incur significant costs in order to comply with environmental regulations or to defend claims arising from accidents involving the use of hazardous materials.
We are subject to federal, state and local laws and regulations governing the use, discharge, handling and disposal of materials and wastes used in our operations. As a result, we may be required to incur significant costs to comply with these laws and regulations. We cannot eliminate the risk of accidental contamination or injury from these materials. In the event of such an accident, we could be held liable for any resulting damages and incur liabilities, which exceed our resources. In addition, we cannot predict the extent of the adverse effect on our business or the financial and other costs that might result from any new government requirements arising out of future legislative, administrative or judicial actions.
We may be subject to product liability claims, and our insurance coverage may not be adequate to cover these claims.
We face an inherent business risk of exposure to product liability claims in the event that the use of products during research and development efforts or after commercialization results in adverse effects. This risk exists even with respect to any products that receive regulatory approval for commercial sale. While we maintain liability insurance for our products, it may not be sufficient to satisfy any or all liabilities that may arise. Also, adequate insurance coverage may not be available in the future at acceptable cost, if at all.
Increased leverage as a result of our sale of notes in 2003 and 2005 may harm our financial condition and results of operations.
At December 31, 2007, we had $684.6 million in total liabilities outstanding, including $250.0 million in principal that remains outstanding under our 2.00% Convertible Senior Notes due February 15, 2012 (the 2005 Notes) and $250.0 million in principal that remains outstanding under our unsecured 2.75% Convertible Subordinated Notes due 2023 (the 2003 Notes). The 2003 and 2005 Notes do not restrict our future incurrence of indebtedness and we may incur additional indebtedness in the future. Our level of indebtedness will significantly affect our future operations because:
•we will have additional cash requirements in order to support the payment of interest on our outstanding indebtedness;
•increases in our outstanding indebtedness and leverage will increase our vulnerability to adverse changes in general economic and industry conditions, as well as to competitive pressure; and
•the levels of our outstanding debt could limit our ability to obtain additional financing for working capital, capital expenditures, general corporate and other purposes.
Our ability to make payments of principal and interest on our indebtedness depends upon our future performance, which will be subject to general economic conditions, industry cycles and financial, business and other factors affecting our operations, many of which we cannot control. Our ability to generate sufficient cash flow from operations in the future to service our debt may require us to, among other things:
•seek additional financing in the debt or equity markets;
•refinance or restructure all or a portion of our indebtedness, including the 2005 Notes or the 2003 Notes;
•sell selected assets;
•reduce or delay planned capital expenditures; or
•reduce or delay planned operating expenditures, such as clinical trials.
Such measures might not be sufficient to enable us to service our debt. In addition, any such financing, refinancing or sale of assets might not be available on economically favorable terms.
We may not have the ability to raise the funds to repurchase the 2003 Notes on the repurchase date or to finance any repurchase offer required by the indenture.
In August 2010, August 2013 and August 2018, respectively, holders of the 2003 Notes may require us to repurchase all or a portion of their 2003 Notes at 100% of their principal amount, plus any unpaid interest. For 2003 Notes to be repurchased in August 2010, we must pay for the repurchase in cash, and we may pay for the repurchase of 2003 Notes to be repurchased in August 2013 and August 2018, at our option, in cash, shares of our common stock or a combination of cash and shares of our common stock. In addition, if a repurchase event occurs (as defined in the indenture), each holder of the 2003 Notes may require us to repurchase all or a portion of the holder's 2003 Notes. We may not have sufficient funds available for any required repurchases of these securities. In addition, the terms of any agreements related to borrowing which we may enter into from time to time may prohibit or limit our repurchase of 2003 Notes or make our repurchase of 2003 Notes an event of default under certain circumstances. If a repurchase event occurs at a time when a credit agreement prohibits us from purchasing the 2003 Notes, we could seek the consent of the lender to purchase the 2003 Notes or could attempt to refinance the debt covered by the credit agreement. If we do not obtain a consent, we may not repurchase the 2003 Notes. Our failure to repurchase tendered 2003 Notes would constitute an event of default under the indenture for the 2003 Notes, which might also constitute a default under
the terms of our other debt, including the 2005 Notes. In such circumstances, our financial condition and the value of our securities could be materially harmed.
We may not have sufficient cash to purchase the 2005 Notes, if required, upon a fundamental change.
Holders of the 2005 Notes may require us to purchase all or any portion of their 2005 Notes upon a fundamental change, which generally is defined as the occurrence of any of the following: (1) our common stock is not traded on a national securities exchange or listed on The Nasdaq Global Select Market; (2) any person acquires more than 50% of the total voting power of all shares of our capital stock; (3) certain mergers, consolidations, sales or transfers involving us occur; or (4) our Board of Directors does not consist of continuing directors. In certain situations, holders of the 2005 Notes will not have a repurchase right even if a fundamental change has occurred. In addition, we may not have sufficient cash funds to repurchase the 2005 Notes upon such a fundamental change. Although there are currently no restrictions on our ability to pay the purchase price, future debt agreements may prohibit us from repaying the purchase price. If we are prohibited from repurchasing the 2005 Notes, we could seek consent from our lenders at the time to repurchase the 2005 Notes. If we are unable to obtain their consent, we could attempt to refinance their debt. If we were unable to obtain consent or refinance the debt, we would be prohibited from repurchasing the 2005 Notes upon a fundamental change. If we were unable to purchase the 2005 Notes upon a fundamental change, it would result in an event of default under the indenture. An event of default under the indenture could result in a further event of default under our other then-existing debt. In addition, the occurrence of the fundamental change may be an event of default under our other debt, which could have a significant adverse affect on our financial condition.
The conversion of any of the outstanding 2003 Notes or 2005 Notes into shares of our common stock would have a dilutive effect, which could cause our stock price to go down.
The 2003 Notes and 2005 Notes are convertible, at the option of the holder, into shares of our common stock at varying conversion prices. We have reserved shares of our authorized common stock for issuance upon conversion of the 2003 Notes and 2005 Notes. If any or all of the 2003 Notes or 2005 Notes are converted into shares of our common stock, our existing stockholders will experience immediate dilution and our common stock price may be subject to downward pressure. If any or all of the 2003 Notes or 2005 Notes are not converted into shares of our common stock before their respective maturity dates, we will have to pay the holders of such notes the full aggregate principal amount of the 2003 Notes or 2005 Notes, respectively, then outstanding. Such payments could have a material adverse effect on our cash position.
Failure to achieve revenue targets or raise additional funds in the future may require us to reduce the scope of or eliminate one or more of our planned activities.
While we believe we have sufficient funds for our anticipated operations, we will need to generate significantly greater revenues to achieve and then maintain profitability on an annual basis. The product development, including clinical trials, manufacturing and regulatory approvals of product candidates currently in development, and the acquisition and development of additional product candidates by us will require a commitment of substantial funds. Our future funding requirements, which may be significantly greater than we expect, depend upon many factors, including:
•the progress, level and timing of research and development activities related to clinical trials we are conducting or that are being conducting in collaboration with our partners, including clinical trials with respect to daclizumab and volociximab;
•the cost and outcomes of regulatory submissions and reviews;
•the continuation or termination of third party manufacturing or sales and marketing arrangements;
•the status of competitive products;
•our ability to defend and enforce our intellectual property rights; and
•our ability to extend the patent protection of our currently marketed products; and
•the establishment of additional strategic or licensing arrangements with other companies, or acquisitions.
Our common stock price is highly volatile and an investment in our Company could decline in value.
Market prices for securities of biotechnology companies, including ourselves, have been highly volatile, and we expect such volatility to continue for the foreseeable future, so that investment in our securities involves substantial risk. For example, during the period from January 1, 2007 to December 31, 2007, our common stock closed as high as $27.70 per share and as low as $16.51 per share. Additionally, the stock market from time to time has experienced significant price and volume fluctuations unrelated to the operating performance of particular companies. The following are some of the factors that may have a significant effect on the market price of our common stock:
•developments or disputes as to patent or other proprietary rights;
•approval or introduction of competing products and technologies;
•disappointing sales of products from which we receive royalties or withdrawal from the market of an approved product from which we receive royalties;
•a change in the mix of U.S.-based Sales and ex-U.S.-based Sales in connection with our master patent license agreement with Genentech;
•results of clinical trials;
•failures or unexpected delays in timelines for our potential products in development, including the obtaining of regulatory approvals;
•delays in manufacturing or clinical trial plans;
•fluctuations in our operating results;
•market reaction to announcements by other biotechnology or pharmaceutical companies, including market reaction to various announcements regarding products licensed under our technology;
•initiation, termination or modification of agreements with our collaborative partners or disputes or disagreements with collaborative partners;
•loss of key personnel;
•litigation or the threat of litigation;
•public concern as to the safety of drugs developed by us;
•sales of our common stock held by collaborative partners or insiders; and
•comments and expectations of results made by securities analysts.
If any of these factors causes us to fail to meet the expectations of securities analysts or investors, or if adverse conditions prevail or are perceived to prevail with respect to our business, the price of the common stock would likely drop significantly. A significant drop in the price of a company's common stock often leads to the filing of securities class action litigation against the company. This type of litigation against us could result in substantial costs and a diversion of management's attention and resources.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
The following table identifies the location and general character of each of our principal facilities as of December 31, 2007:
We began moving our corporate headquarters to Redwood City, California in September 2007 and completed the move by the end of 2007. In October 2007, we closed on the sale of property that we had owned in Fremont, California, which was part of our former corporate headquarters and leased this property back through the end of 2007. We had vacated all facilities in Fremont as of December 31, 2007, and we do not plan to renew or extend the remaining leases for such property, all of which will have terminated by March 31, 2008. In addition, of the 75,000 square footage in Plymouth, Minnesota, we had vacated approximately 70,000 square feet as of December 31, 2007. In connection with our sale of our Manufacturing Assets, Genmab would assume our obligations under certain of these leases for approximately 30,000 square feet of the Plymouth, Minnesota space.
In February 2008, we announced the sale of our Minnesota manufacturing facility and related operations to Genmab, for total cash proceeds of $240 million. Under the terms of this agreement, Genmab would acquire our manufacturing facilities in Brooklyn Park, Minnesota.
In relation to our new Redwood City premises, we have options to extend the terms of our leases for up to ten years to December 2031. We also have a right of first refusal to lease space in two other buildings on the corporate office campus in which our two leased buildings in Redwood City are located.
In connection with our restructuring plan initiated in an effort to reduce operating costs to a level we believe is consistent with a biotechnology company focused solely on antibody discovery and development, we may sublease excess capacity in the future.
We own substantially all of the equipment used in our facilities. (See Note 11 to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report for additional information.)
ITEM 3. LEGAL PROCEEDINGS
European Patent Oppositions
Two humanization patents based on the Queen technology were issued to us by the European Patent Office, European Patent No. 0 451 216 (the '216 Patent) and European Patent No. 0 682 040 (the '040 Patent). Eighteen notices of opposition to our '216 Patent and eight notices of opposition to our '040 Patent were filed by major pharmaceutical and biotechnology companies, among others, and we are currently in two separate opposition proceedings with respect to these two patents. Six opponents, including Genentech, have withdrawn from the opposition proceedings with respect to the opposition to our '216 Patent leaving 12 remaining opponents. A description of these two proceedings is set forth below.
Opposition to '216 Patent
In November 2003, in an appeal proceeding of a prior action of the Opposition Division of the European Patent Office, the Technical Board of Appeal of the European Patent Office ordered that certain claims in our '216 Patent be remitted to the Opposition Division for further prosecution and consideration of issues of patentability (entitlement to priority, novelty, enablement and inventive step). The claims remitted cover the production of humanized antibody light chains that contain amino acid substitutions made under our antibody humanization technology. In April 2007, at an oral proceeding the Opposition Division upheld claims that are virtually identical to the claims remitted by the Technical Board of Appeal to the Opposition Division. The opponents in this opposition have the right to appeal this decision of the Opposition Divisions. If any of the opponents appeal the decision to the Technical Board of Appeal, the '216 Patent would continue to be enforceable during the appeal process. Two notices of appeal have since been filed by Boehringer Ingelheim GmbH and Celltech R&D Limited.
Until the opposition is resolved, we may be limited in our ability to collect royalties or to negotiate future licensing or collaborative research and development arrangements based on this and our other humanization patents. Moreover, if the opposition is eventually successful, our ability to collect royalties on European sales of antibodies humanized by others would depend on the scope and validity of our '040 Patent, which is also being opposed, whether the antibodies are manufactured in a country outside of Europe where they are covered by one of our patents, and in that case the terms of our license agreements with respect to that situation. Also, if the Opposition Division rules against us, that decision could encourage challenges of our related patents in other jurisdictions, including the United States. Such a decision may also lead some of our licensees to stop making royalty payments or lead potential licensees not to take a license, either of which might result in us initiating formal legal actions to enforce our rights under our humanization patents. In such a situation, a likely defensive strategy to our action would be to challenge our patents in that jurisdiction. During the opposition process with respect to our '216 Patent, if we were to commence an infringement action to enforce that patent, such an action would likely be stayed until the opposition is decided by the European Patent Office. As a result, we may not be able to successfully enforce our rights under our European or related U.S. patents.
Opposition to '040 Patent
At an oral hearing in February 2005, the Opposition Division decided to revoke the claims in our '040 Patent. The Opposition Division based its decision on formal issues and did not consider substantive issues of patentability. We appealed the decision to the Technical Board of Appeal. The appeal suspended the legal effect of the decision of the Opposition Division during the appeal process.
The Technical Board of Appeal has not scheduled a date for the appeal hearing with respect to the '040 Patent.
We intend to continue to vigorously defend our two European Queen patents in these two proceedings. We may not prevail in either of the opposition proceedings or any litigation contesting the validity of these patents. If the outcome of either of the opposition proceedings or any litigation involving our antibody humanization patents were to be unfavorable, our ability to collect royalties on existing licensed products and to license our patents relating to humanized antibodies may be materially harmed. In addition, these proceedings or any other litigation to protect our intellectual property rights or defend against infringement claims by others could result in substantial costs and diversion of management's time and attention, which could harm our business and financial condition.
Patent Infringement Suit against Alexion
In March 2007, after the FDA's market approval of Alexion Pharmaceuticals, Inc.'s (Alexion) Soliris™ (eculizumab) humanized antibody product, we filed a lawsuit against Alexion in the United States District Court for the District of Delaware for infringement of certain claims of United States Patent Number 5,693,761, United States Patent Number 5,693,762 and United States Patent Number 6,180,370 (collectively, the patents-in-suit), which are three of our antibody humanization patents, commonly referred to as the Queen patents. We are seeking monetary damages and other relief. In June 2007, Alexion filed an answer denying that its Soliris product infringes the patents-in-suit, asserting certain defenses and counterclaiming for non-infringement and invalidity, and thereafter amended its answer to include a defense of unenforceability. In July 2007, the discovery stage of this litigation began and discovery is ongoing. We intend to vigorously assert our rights under the patents-in-suit and defend against Alexion's counterclaims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock trades on the Nasdaq Global Select Market under the symbol "PDLI." Prices indicated below are the high and low bid prices as reported by the Nasdaq National Market System for the periods indicated. We have never paid any cash dividends on our capital stock. In conjunction with the announcement of the cessation of the process to sell our Company in March 2008, we also announced that we intend to distribute to our stockholders at least $500 million of the initial proceeds from the sale of the Commercial and Cardiovascular Assets and Manufacturing Assets, pending the close of all of the transactions, in a form and at a time to be determined. In addition, we announced that we are actively evaluating several alternative structures that would, if completed, result in the distribution to our stockholders of 50% or more of the value of future antibody humanization royalties that would be received from currently marketed products.
As of February 21, 2008, we had approximately 253 common stockholders of record. Most of our outstanding shares of common stock are held of record by one stockholder, Cede & Co., a nominee for Depository Trust Company. Many brokers, banks and other institutions hold shares as nominees for beneficial owners, which deposit these shares in participant accounts at the Depository Trust Company. The actual number of beneficial owners of our stock is likely significantly greater than the number of stockholders of record, however, we are unable to reasonably estimate the total number of beneficial holders.
COMPARISON OF STOCKHOLDER RETURNS
The line graph below compares the cumulative total stockholder return on our common stock between December 31, 2002 and December 31, 2007 with the cumulative total return of (i) the Nasdaq Biotechnology Index and (ii) the Nasdaq Composite Index over the same period. This graph assumes that $100.00 was invested on January 1, 2002, in our common stock at the closing sale price for our common stock on December 31, 2001 and at the closing sales price for each index on that date and that all dividends were reinvested. No cash dividends have been declared on our common stock. Stockholder returns over the indicated period should not be considered indicative of future stockholder returns and are not intended to be a forecast.
The information under this heading "Comparison of Stockholder Returns" shall not be deemed to be "soliciting material" or to be "filed" with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that we specifically incorporate it by reference in such filing.
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth information regarding all of our existing equity compensation plans under which we are authorized to issue shares of our common stock as of December 31, 2007.
(1)Includes 523,989 shares of common stock available for future issuance under our 1993 Employee Stock Purchase Plan.
(2)See Note 3, "Stock-Based Compensation," in the Notes to Consolidated Financial Statements of Part II, Item 8 of this Annual Report for a description of our 1999 Nonstatutory Stock Option Plan.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial information has been derived from our audited consolidated financial statements. The information below is not necessarily indicative of the results of future operations and should be read in conjunction with Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Item 1A, "Risk Factors," of this Form 10-K, and the consolidated financial statements and related notes thereto included in Item 8 of this Form 10-K, in order to fully understand factors that may affect the comparability of the information presented below.
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
CONSOLIDATED BALANCE SHEET DATA:
(1)In 2007, total costs and expenses included restructuring charges of $6.7 million and asset impairment charges of $5.5 million, and in 2006, total costs and expenses included asset impairment charges of $0.9 million. In 2005, total costs and expenses included a $15.8 million impairment charge relating to a reversion right asset which was acquired from Roche in 2003. In 2003, total costs and expenses included $86.0 million in acquired in-process research and development charges related to the acquisition of Eos Biotechnology, Inc. (Eos) and certain daclizumab rights from Roche.
In addition, total costs and expenses in 2007 and 2006 included employee stock based compensation costs of $20.5 million and $23.4 million, net of tax, respectively, due to our adoption of Statement of Financial Accounting Standards No. 123(R), "Share-Based Payment," on a modified prospective basis on January 1, 2006.
(2)In 2003, interest and other income and interest expense, net, included $6.5 million of debt extinguishment charges related to the redemption of our $150 million 5.50% convertible subordinated notes in November 2003.
(3)The financial results relating to our Commercial and Cardiovascular Operations have been presented as discontinued operations and the related assets are classified as "held for sale" on our Consolidated Balance Sheet. See Note 6 to the Consolidated Financial Statements for further details. In addition to the presentation of our Commercial and Cardiovascular Operations as discontinued operations discussed above, we have reclassified previously reported clinical affairs costs from research and development to general and administrative to conform to the presentation in the Consolidated Statement of Operations for the year ended December 31, 2006.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. All statements other than statements of historical facts are "forward looking statements" for purposes of these provisions, including any projections of earnings, revenues or other financial items, any statements of the plans and objectives of management for future operations, any statements concerning proposed new products or licensing or collaborative arrangements, any statements regarding future economic conditions or performance, and any statement of assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as "may," "will," "expects," "plans," "anticipates," "estimates," "potential," or "continue" or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained in this report are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including but not limited to the risk factors set forth below, and for the reasons described elsewhere in this report. All forward-looking statements and reasons why results may differ included in this report are made as of the date hereof, and we assume no obligation to update these forward-looking statements or reasons why actual results might differ.
OVERVIEW
We are a biopharmaceutical company focused on the discovery and development of novel antibodies in oncology and immunologic diseases. We receive royalties and other revenues through licensing agreements with numerous biotechnology and pharmaceutical companies based on our proprietary antibody humanization technology platform. These licensing agreements have contributed to the development by our licensees of nine marketed products. We currently have several investigational compounds in clinical development for severe or life-threatening diseases, two of which we are developing in collaboration with Biogen Idec MA, Inc. (Biogen Idec). Our research platform is focused on the discovery of novel antibodies for the treatment of cancer and immunologic diseases.
During the period from March 2005 through March 2008, we marketed and sold acute-care products in the hospital setting in the United States and Canada. We acquired three of these products,
Cardene IV, Retavase and IV Busulfex, which are small-molecule-based products, in connection with our acquisitions of ESP Pharma, Inc. and the rights to Retavase in March 2005. We acquired the rights to Cardene SR in September 2007. As discussed below, these products and the related operations were fully divested during the first quarter of 2008.
On August 28, 2007, in connection with a months-long evaluation of strategic alternatives that our management and Board of Directors conducted, we announced our intent to sell our Commercial and Cardiovascular Assets, which were comprised of our Cardene, Retavase and IV Busulfex commercial products and our ularitide development-stage cardiovascular product (together, the Commercial and Cardiovascular Assets). The decision to pursue a sale of these assets was related to a significant strategic change to focus the Company on the discovery and development of novel antibodies in oncology and immunologic diseases. Given the change in our strategic direction and the current timing of our pipeline products, we determined that our commercial products and cardiovascular development programs, which are not antibody-based products, were no longer a strategic fit. We subsequently announced on October 1, 2007 that we were seeking the sale of our entire Company or of our key assets, which decision was in connection with our ongoing evaluation of strategic alternatives and objective of maximizing stockholder value.
In December 2007, we entered into an asset purchase agreement with Otsuka Pharmaceutical Co., Ltd. (Otsuka) under which we agreed to sell the rights to IV Busulfex ®, including trademarks, patents, intellectual property and related assets, for $200 million in cash, plus additional consideration for the sale of our IV Busulfex inventories, all to be paid at closing. In addition, in February 2008, we entered into an asset purchase agreement with EKR Therapeutics, Inc. (EKR) for the sale of our Cardene and Retavase commercial products, as well as for ularitide, our development-stage product (together, the Cardiovascular Assets). The consideration for the Cardiovascular Assets, which includes all trademarks, patents, intellectual property, inventories and related assets, consisted of an upfront payment of $85 million, up to $85 million in development and sales milestone payments, as well as royalties on certain future Cardene and ularitide product sales. In March 2008, we closed these transactions, completing the sale of the Commercial and Cardiovascular Assets.
We did not recognize any asset impairment charges related to the Commercial and Cardiovascular Assets as of December 31, 2007, since their respective fair values exceeded their carrying values at this date. Our assessment of the fair value of the Commercial and Cardiovascular Assets included a probability-weighted and discounted measurement of the contingent consideration, which relates to future milestones and royalties under the terms of the sale of the Cardiovascular Assets. However, as we will not be recognizing the contingent consideration until the milestones and royalties are earned, we expect to recognize a loss of approximately $65 million effective upon the sales of the Commercial and Cardiovascular Assets in March 2008.
In February 2008, we entered into an asset purchase agreement with GMN, Inc. (Genmab), a wholly owned subsidiary of Genmab A/S, for the sale of our Minnesota manufacturing facility and related operations for $240 million. Under the terms of this agreement, Genmab would acquire our manufacturing and related administrative facilities in Brooklyn Park, Minnesota, and all assets therein, as well as certain of our lease obligations related to our facilities in Plymouth, Minnesota (together, the Manufacturing Assets). In addition, Genmab plans to retain the approximately 170 employees currently working at the manufacturing facility. In connection with this transaction, Genmab would produce clinical material to supply certain of our pipeline products for our investigational studies under a clinical supply agreement. We expect to close this transaction during the first quarter of 2008, and expect to recognize a gain of approximately $50 million at that time.
In March 2008, we announced that we had ended the sale process for the Company or our biotechnology discovery and development assets and that we would focus on the discovery and development of innovative new antibodies for cancer and immunologic diseases. While we had actively
pursued a sale of the entire Company or our key assets since we announced our intent to do so in October 2007, we had not received any firm offers for the Company as a whole or for our biotechnology assets.
We also announced in March 2008 that we intend to distribute to our stockholders at least $500 million of the initial proceeds from the sale of the Commercial and Cardiovascular Assets and Manufacturing Assets, pending the close of all of the transactions, in a form and at a time yet to be determined. In addition, we announced that we are actively evaluating several alternative structures that, if completed, would result in the distribution to our stockholders of 50 percent or more of the value of future antibody humanization royalties that would be received from currently marketed products, net of any applicable corporate-level taxes. We are carefully evaluating numerous factors, including tax implications, structural considerations, and market conditions, in order to select the alternative that would maximize the value of the humanization royalties for our stockholders. The structures being evaluated include, among others, a sale of the right to receive future royalties, a securitization of future royalties or a distribution to stockholders of securities related to the royalty stream.
In an effort to reduce operating costs to a level more consistent with a biotechnology company focused solely on antibody discovery and development, in March 2008 we commenced a restructuring effort pursuant to which we intend to eliminate approximately 250 employment positions over approximately one year and undertake other substantial cost cutting measures. This reduction is in addition to previously planned reductions of approximately 335 positions resulting from the sales of the Commercial and Cardiovascular Assets and Manufacturing Assets. Subsequent to the transition period, we expect that our workforce will consist of approximately 300 employees. We anticipate a transition period of approximately 12 months before planned expense reductions and transition services related to the Commercial and Cardiovascular Assets and Manufacturing Assets sales transactions are fully implemented or completed. We have offered retention bonuses and other incentives to the transition employees, as well as to the employees that we expect to retain after the restructuring, to encourage these employees to stay with the Company. In connection with this restructuring effort, we expect to incur significant transition-related expenses over the next 12-month period, a portion of which would be recorded as restructuring charges.
We were organized as a Delaware corporation in 1986 under the name Protein Design Labs, Inc. In 2006, we changed our name to PDL BioPharma, Inc.
SUMMARY OF 2007 FINANCIAL RESULTS
During the fourth quarter of 2007, based on the significant interest in and the offers we received for our Commercial and Cardiovascular Assets, we elected to proceed with the sale of these assets separate from the sale of the entire Company. As a result, in accordance with the applicable accounting guidance, we classified our Commercial and Cardiovascular Assets, including product rights intangible assets and related fixed assets, as "held for sale" on the Consolidated Balance Sheet. In addition, since we expect to have no significant or direct involvement in the future operations related to these assets after the closing date of the sales in March 2008, the results of the Commercial and Cardiovascular Operations segment, which was comprised almost entirely of those operations related to the Commercial and Cardiovascular Assets, have been presented as discontinued operations for all periods presented. Discontinued operations are reported as a separate component within the Consolidated Statement of Operations outside of income (loss) from continuing operations. As a result, we no longer report net product sales, cost of product sales, or selling and marketing expenses, all of which related to the Commercial and Cardiovascular Operations, separately in the Consolidated Statements of Operations.
Our total revenues from continuing operations for 2007 were $258.9 million, a 4% increase from $249.1 million in 2006. This revenue growth was driven by increases in royalties from our licensees and was partially offset by a decrease in license, collaboration and other revenues. Of the total revenues from continuing operations that we generated in 2007, 85% were from royalty payments we received and 15% were from license, collaboration and other revenues, compared to 74% and 26%, respectively, in 2006. During 2007, royalty revenues from our antibody humanization technology licenses grew 20% from the previous year, which reflects the growing importance of antibody therapeutics in the treatment of diverse diseases, such as cancer, viral infections, asthma and eye disorders. During the year ended December 31, 2007, we received royalties on eight marketed products, with approximately 90% of our royalty revenues derived from the Herceptin, Avastin and Lucentis antibody products marketed by Genentech and the Synagis antibody product marketed by MedImmune. The decrease in license, collaboration and other revenues was principally due to the recognition of $20.5 million in 2006 as a result of the discontinuation of our co-development collaborations with Roche for daclizumab in the asthma transplant maintenance indications and a decrease in revenue recognized from our collaboration with Biogen Idec.
Our total costs and expenses related to continuing operations in 2007 were $283.7 million, an increase of $20.2 million from 2006. This increase was primarily driven from restructuring and idle facility charges of $6.7 million as well as asset impairment charges of $5.5 million that we recognized during 2007, and higher legal and consulting expenses related to the efforts to sell the Company and our key assets during the year.
Our net loss for 2007 was $21.1 million, compared to $130.0 million in 2006. Of these amounts, net losses of $19.4 million and $10.8 million for 2007 and 2006, respectively, were attributable to our continuing operations. Net cash provided by operating activities in 2007 was $67.0 million compared to $78.8 million in 2006. At December 31, 2007, we had cash, cash equivalents, marketable securities and restricted cash and investments of $440.8 million, compared to $426.3 million at December 31, 2006. In 2007, we incurred capital expenditures of $94.7 million, principally related to the development and construction of our new corporate headquarters, an increase from $36.5 million in 2006. As of December 31, 2007, we had $684.6 million in total liabilities outstanding, which included $500.0 million in convertible notes, $250.0 million of which are callable at our option in each of 2008 and 2010 and due in 2023 and 2012, respectively.
RECENT DEVELOPMENTS
In addition to our announcements in the second half of 2007 and on March 4, 2008 related to our intent to solicit offers for our Commercial and Cardiovascular Assets as well as the potential future sale of our entire Company or of its key assets, and the termination of that process and our related restructuring plans, the events noted below affected our financial results and operations during 2007 and early 2008 or otherwise affected our business prospects:
•In August 2007, we announced our termination of the Nuvion phase 3 development program in intravenous steroid-refractory ulcerative colitis due to insufficient efficacy and an inferior safety profile in the Nuvion arm compared to IV steroids.
•In September 2007, the Board of Directors formally approved a workforce reduction related to our manufacturing operations. In early October 2007, we notified the 104 individuals affected by this workforce reduction, and all impacted employees were provided 60 days advance notice of the date their employment would terminate. We recognized an aggregate of $3.6 million in restructuring charges during 2007 related to this reduction in force.
•In October 2007, we completed the sale of two buildings that comprised part of our prior corporate headquarters in Fremont, California for $13.2 million in net proceeds.
•In November 2007, we received a $5 million milestone payment from Biogen Idec upon the datalock of the current phase 2 trial of daclizumab in multiple sclerosis.
•In the fourth quarter of 2007, we completed the move of our corporate headquarters from Fremont, California to Redwood City, California. During the year, we incurred $94.7 million in total capital expenditures which principally related to the development and construction of the new headquarters.
•In December 2007, we announced the agreement to sell the rights to Busulfex and, in February 2008, we announced the agreements to sell the Cardiovascular Assets and the Manufacturing Assets.
•In March 2008, we announced the closing of the sales of the Commercial and Cardiovascular Assets and announced the cost reduction and other operational and strategic decisions described above.
ECONOMIC AND INDUSTRY-WIDE FACTORS
Various economic and industry-wide factors are relevant to us and could affect our business, including the factors set forth below.
•Our business will depend in significant part on our ability to successfully develop innovative new drugs. Drug development, however, is highly uncertain and very expensive, typically requiring tens to hundreds of millions invested in research, development and manufacturing elements. Identifying drug candidates to study in clinical trials requires significant investment and may take several years. In addition, the clinical trial process for drug candidates is usually lengthy, expensive and subject to high rates of failure throughout the development process. As a result, a majority of the clinical trial programs for drug candidates are terminated prior to applying for regulatory approval. Even if a drug receives FDA or other regulatory approval, such approval could be conditioned on the need to conduct additional trials, or we could be required to or voluntarily decide to suspend marketing of a drug as a result of safety or other events.
•Our industry is subject to extensive government regulation, and we must make significant expenditures to comply with these regulations. For example, the FDA regulates, among other things, the development, testing, research, manufacture, safety, efficacy, record-keeping, labeling, storage, approval, quality control, adverse event reporting, advertising, promotions, sale and distribution of our products. The development of our products outside of the United States is subject to similar extensive regulation by foreign governments, which regulations are not harmonized with the regulations of the United States.
•The manufacture of antibodies for use as therapeutics in compliance with regulatory requirements is complex, time-consuming and expensive. If these products or product candidates are not manufactured in accordance with FDA and European good manufacturing practices, we may not be able to obtain regulatory approval for our products. Given the pending sale of our Manufacturing Assets to Genmab, which we expect to close in the first quarter of 2008, we do not have either facilities or resources to manufacture our potential products. Accordingly, we will be completely reliant on third-party manufacturers for the supply of all of our development products.
•Our business success is dependent in significant part on our success in establishing intellectual property rights, either internally or through in-license of third-party intellectual property rights, and protecting our intellectual property rights. If we are unable to protect our intellectual property, we may not be able to compete successfully and our sales and royalty revenues and operating results would be adversely affected. Our pending patent applications may not result in the issuance of valid patents or our issued patents may not provide competitive advantages or may be reduced in scope. Proceedings to our protect intellectual property rights are expensive,
can, and have, continued over many years and could result in a significant reduction in the scope or invalidation of our patents, which could adversely affect our results of operations.
•To be successful, we must retain qualified clinical, scientific, marketing, administrative and management personnel. We face significant competition for experienced personnel and have experienced significant attrition in late 2007 and early 2008 as a result of the uncertainty created by the strategic initiatives we undertook during this period. We also implemented a restructuring in March 2008, which includes a significant reduction in force, and we expect to continue to face challenges in retaining qualified personnel as we transition to a more streamlined organization.
See also Item 1A
ITEM 1A. RISK FACTORS
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2.
ITEM 2. PROPERTIES
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PDL BIOPHARMA, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except per share data)
PDL BIOPHARMA, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)
PDL BIOPHARMA, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
PDL BIOPHARMA, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands, except share data)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ITEM 9B.
ITEM 9B. OTHER INFORMATION
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (In thousands)
SIGNATURES