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ORE PHARMACEUTICAL HOLDINGS INC. 10-K 2007 UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
Commission
File Number: 0-23317
GENE
LOGIC INC.
(Exact
name of registrant as specified in its charter)
50
West Watkins Mill Road
Gaithersburg,
Maryland 20878
(Address
of Principal Executive Offices)
Registrant’s
phone number, including area code: (301)
987-1700
Securities
registered pursuant to Section 12(b) of the Act: None
Securities
registered pursuant to Section 12(g) of the Act:
COMMON
STOCK, $.01 PAR VALUE
(Title
of Class)
Indicate
by check mark if the Registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act: YES ¨
NO
x
Indicate
by check mark if the Registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act: YES ¨
NO
x
Indicate
by check mark whether the Registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days: YES x
NO
¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of the Registrant’s knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K: YES x
NO
¨
Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act): YES ¨
NO
x
Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. (Rule 12b-2 of the Exchange
Act):
Large
accelerated filer ¨
Accelerated
filer x
Non-accelerated
filer ¨
The
aggregate market value of the voting stock (which consists solely of shares
of
Common Stock) held by non-affiliates of the Registrant as of June 30, 2006
was
approximately $41,881,719.60, based on the closing price on that date of Common
Stock on The NASDAQ Stock Market.*
The
number
of shares outstanding of the Registrant’s Common Stock, $.01 par value, was
31,820,273 as of March 1, 2007.
*
Excludes 786,135 shares of Common Stock held by directors and executive
officers and stockholders whose beneficial ownership exceeds 10% of the shares
outstanding on June 30, 2006. Exclusion of shares held by any person should
not
be construed to indicate that such person possesses the power, direct or
indirect, to direct or cause the direction of the management or policies of
the
Registrant, or that such person is controlled by or under common control with
the Registrant.
1
TABLE
OF CONTENTS
2
This
Annual Report on Form 10-K (“Form 10-K”) contains forward-looking statements
regarding future events and the future results of Gene Logic Inc. (“Gene Logic”)
that are based on current expectations, estimates, forecasts and projections
about the industries in which Gene Logic operates and its business and the
beliefs and assumptions of the management of Gene Logic. Words such as
“expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,”
“believes,” “seeks,” “estimates,” variations of such words, and similar
expressions are intended to identify such forward-looking statements. These
forward-looking statements are only predictions and are subject to risks,
uncertainties and assumptions that are difficult to predict. Therefore, actual
results may differ materially and adversely from those expressed in any
forward-looking statements. Factors that might cause or contribute to such
differences include those discussed in this Form 10-K under the section entitled
“Risk Factors”. Gene Logic undertakes no obligation to revise or update publicly
any forward-looking statements to reflect any change in management’s
expectations with regard thereto or any change in events, conditions, or
circumstances on which any such statements are based.
Unless
the
context otherwise requires, references in this Form 10-K to “Gene Logic,” “Gene
Logic Laboratories Inc.,” “Gene Logic Ltd.,” “Gene Logic K.K.,” the “Company,”
“we,” “us,” and “our” refer to Gene Logic Inc. and its wholly owned
subsidiaries. Gene Logic®,
BioExpress®,
ToxExpress®,
ASCENTA®
and
Genesis Enterprise System®
are
registered trademarks of Gene Logic. ToxShield™ is a trademark of Gene Logic.
GeneChip®
is a
registered trademark of Affymetrix, Inc. Viagra®
is a
registered trademark of Pfizer, Inc. Evista®
is a
registered trademark of Eli Lilly & Co. Hytrin®
is a
registered trademark of Abbott Laboratories.
CORPORATE
HISTORY
Gene
Logic
Inc. was incorporated in September 1994 as a Delaware corporation and commenced
operations in 1996. In 1997, we completed our initial public offering. Our
stock
is traded on The NASDAQ Stock Market under the symbol “GLGC”. In 1998, we
purchased Oncormed, Inc., which brought us new expertise in tissue sample
management and use of microarray technologies. In 2003, we purchased TherImmune
Research Corporation, renamed it Gene Logic Laboratories Inc. and subsequently
referred to it in our SEC filings as our Preclinical Division. We sold Gene
Logic Laboratories on December 15, 2006, to a privately held company. In 2004,
we acquired certain technologies from Millennium Pharmaceuticals, Inc., which,
in combination with our genomics databases and proprietary software, are the
basis for our current pharmaceutical development business.
We
are
headquartered in Gaithersburg, Maryland. Our principal executive offices are
located at 50 West Watkins Mill Road, Gaithersburg, Maryland 20878, and our
telephone number is (301) 987-1700. Our Internet site is www.genelogic.com.
Material
contained on our Internet site is not incorporated by reference into this Form
10-K.
OVERVIEW
In
2004,
Gene Logic created a pharmaceutical development division (known as our Drug
Repositioning division) within the Company to identify and develop new or
expanded uses for small molecule therapeutics. Based on advances in our
pharmaceutical development division and changes in our Genomics business, and
after recently concluding a comprehensive review of our strategy, we have
decided to focus our resources on becoming a pharmaceutical development company.
We are now building a therapeutic pipeline by applying our proprietary drug
indication discovery platform to find new and expanded uses for drug candidates
supplied by major pharmaceutical companies with whom we have drug development
partnerships. We believe this strategy is the best way to create value for
shareholders.
In
2005
and 2006, we entered into drug repositioning and development (“drug
development”) partnerships with Pfizer, F. Hoffmann-La Roche Ltd, Eli Lilly and
Co., and NV Organon. Our partners provide us with drug candidates that have
already been assessed as safe in human clinical trials, and whose development
for their original indications has been discontinued. Our drug development
partnerships are generally structured to provide us with milestone payments
for
repositioned drug candidates that our partners return to clinical development
for indications that we have identified, and long-term value in the form of
royalties or other co-ownership positions.
3
We
apply,
at our own expense, our drug indication discovery platform to identify new
uses
for these clinical-stage drug candidates. This platform consists of genomics
databases and bioinformatics software developed by Gene Logic over the past
10
years, and biological screening technologies acquired from Millennium
Pharmaceuticals and which subsequently have undergone further development.
In
2006, we began evaluating more than 40 drug candidates for our drug development
partners. Based on our experience to date, we have been able to develop
alternative indication hypotheses for 25%-33% of the candidates for which
evaluation is complete. Some of the candidates for which we have found new
indications have or will progress to in
vivo
efficacy
models to evaluate and support their suitability for re-entering clinical trials
for the proposed new indications. For the candidates that will shortly begin
in
vivo
efficacy
studies, our partners have agreed to fund a portion of the costs associated
with
these studies. We expect that some portion of the drug candidates will have
successful outcomes in the in
vivo
tests and
will be selected by our partners to re-enter clinical trials, but we do not
yet
have sufficient data to estimate the rate of clinical trial re-entry. We do
not
expect any of these drug candidates to re-enter clinical trials, if at all,
until after 2007.
In
the
event that a partner chooses not to pursue development of a candidate for which
we find a new indication, we may seek to acquire the repositioned candidate
and
may choose to further develop it ourselves or outlicense it to third parties.
For example, in 2006, we acquired certain rights from Millennium Pharmaceuticals
to a drug candidate for which we have identified potential new indications.
From
1996
through 2006, our business was primarily devoted to developing and
commercializing proprietary genomic and toxicogenomic databases, toxicogenomic
services, software tools and other services. The Genomics services we provide
enable customers worldwide to discover and prioritize drug targets, identify
biomarkers, predict toxicity and understand mechanisms of toxicity, and
understand mechanisms of action of specific compounds.
In
2006,
we began to redirect our Genomics Division in response to our customers’
shifting their research activities from early-stage drug discovery into
later-stage development and validation efforts and a resulting decline in sales
of our Genomics licenses. In August, we took steps to reduce the staffing and
expense levels in this business. We examined the business for new avenues to
create value and concluded that our commercially demonstrated expertise in
biomarker discovery and validation could be used as a potential new platform
for
molecular diagnostics development. As
a
result, we have engaged outside financial advisors to identify strategic
alternatives for our Genomics business. We continue to serve new and existing
Genomics customers.
In
December 2006, we sold our Preclinical Division. The Preclinical Division
provided contract research services to assess the safety and pharmacologic
effects of compounds to support regulatory submissions for human clinical
trials. We decided to sell the Preclinical Division because the business
provided insufficient strategic or synergistic advantage to our pharmaceutical
development, genomics or molecular diagnostic efforts. The sale included four
of
our leased facilities and the transfer of approximately 200 employees.
The
Drug Discovery and Development Process
The
process of drug development is expensive, time consuming and risky. On average
it takes 13 years from the beginning of the discovery effort to get a drug
to
market and, while research and development costs have been doubling every five
years, success rates for getting drugs to market have been flat or declining.
Today,
drug discovery and development in the United States generally consists of the
following steps:
4
Drug
Repositioning
A
significant number of drug candidates are halted at some point in the discovery
and development process. Candidates may have toxicity issues, lack efficacy
in
the targeted therapeutic application, be difficult to manufacture, have a narrow
market, or be inferior to competitive products, among other issues. Drug
repositioning is generally defined by the industry as either (i) finding new
uses for drug candidates discontinued during the clinical phases or (ii) finding
uses for marketed drugs in additional therapeutic applications.
Biological
Function and Genomics
The
cells
of all living organisms contain a blueprint or set of instructions for how
each
cell-type should work. This blueprint is passed from one generation to the
next
and is encoded in a set of molecules called deoxyribonucleic acid (“DNA”). These
DNA molecules are organized into long strands that bind to each other in a
twisted double helix structure. DNA molecules can be organized in a vast number
of different ways, leading to the production of millions of different protein
molecules. These protein
molecules
are the
basic building blocks of all living organisms.
Protein
molecules are produced from DNA utilizing an intermediate molecule called
messenger ribonucleic acid (“mRNA”),
which
translates DNA into protein form. The specific sequence of DNA that produces
a
particular protein is called a gene.
In
humans, every cell contains three billion base pairs of DNA molecules, referred
to collectively as the human
genome.
Only a
small percentage of the genome actively produces proteins.
Cells
are
very different from each other in structure and function despite the fact that
they share the same genetic blueprint. For example, a brain cell and a muscle
cell, although very different, contain exactly the same DNA code. The reason
for
the difference in structure and function is that not all genes are active in
any
cell. The type of cell and its function are determined by which genes are
actively producing protein and the amount of protein they are producing. In
fact, almost any change in the activity of a cell, whether normal or diseased,
is reflected in a change in the genes that are producing protein. This pattern
of gene activity is called gene
expression.
The
determination of patterns of gene expression is a broad measure of the function
of a cell.
Microarray
technology
has
accelerated the process of measuring gene expression. Microarray technology
uses
millions of DNA sequences attached to a solid surface in a dense matrix. Samples
of cells and tissues from humans or animals are prepared, and the resulting
mRNA
is then labeled and exposed to the surface of the microarray. The labeled mRNA
adheres to its counterpart DNA on the microarray, resulting in information
which
can then be analyzed to determine the level and pattern of gene expression
within that tissue or cell.
While
the
biology of different normal and diseased cells can be evaluated by analyzing
gene expressions patterns, there are also variations of the gene sequence for
similar genes from individual to individual. These individual variations in
gene
sequence, known as SNPs, account for similar proteins working more or less
effectively. These differences in protein function lead to individual variations
in the effectiveness of drugs, susceptibility to disease, and toxicity of
compounds. There may be hundreds or thousands of variations within any gene
from
one individual to another. There are thought to be about three million
significant SNPs in the human genome, although not all of them have yet been
discovered and the function for most is not known. These variations are
determined by various methods and machines that allow a DNA sequence to be
analyzed.
5
Different
patterns of gene expression are associated with normal and diseased cells,
as
well as either the toxic or therapeutic effect that drugs can have on cells.
For
example, a cancerous tissue can be compared to normal tissue to find aberrant
gene activity that is associated with the cancer, and that information can
be
used to identify biomarkers (a molecular marker associated with a biological
function) and targets and to develop drugs to treat the disease. Using
information about the human genome to develop drugs is called pharmacogenomics.
Normal
cells can also be compared to cells that have been treated with a specific
compound, to determine if that compound has a toxic effect on cells. Using
information about how gene expression patterns vary when chemicals are toxic
to
tissues is called toxicogenomics.
The
amount
of information that is generated from sequencing three billion base pairs of
DNA
and using microarrays to look at gene expression patterns in tens of thousands
of biological tissues and processes could not be stored and analyzed if it
were
not for advances in information technology that occurred with the development
of
computers and the internet. The science of using computers to capture and
understand biology is known as bioinformatics.
Besides
gene expression data, there are other methods to look at biological function.
In
addition to the traditional methods, new methods are being developed. Some
of
these include:
Gene
expression and other methods of looking at biological functions are critical
to
pharmaceutical companies’ drug development processes. The current model for drug
development is based on developing a systematic understanding of biology.
Pharmaceutical companies develop drugs by seeking specific proteins that could
be therapeutic targets. These companies then seek chemical compounds that could
modulate or manipulate the targets in a way that would have a therapeutic
effect. Scientists have the ability to screen large libraries of compounds
using
high-throughput automated systems against biological targets to identify
potential therapeutic compounds that will modulate these targets. But, first,
scientists must identify the targets, from among the 3,000 to 5,000 human genes
that might produce proteins. One efficient way to identify these targets is
using gene expression data produced from normal and diseased human tissues
as
well as from animal models and cell lines.
Molecular
Diagnostics
encompass
a variety of technologies and methods for utilizing profiles of DNA and RNA
changes in individual patients to facilitate determining what condition a
patient has (diagnosis), the likely outcome (prognosis), response to therapy
(monitoring), and the best responders to various treatments (personalized
medicine). Traditional clinical diagnostic processes involve physicians
analyzing patient body fluids or tissues to assess biological functions, usually
by analysis of proteins and tissues. Over the past few years, the growth of
molecular diagnostics has increased the use of RNA and DNA analysis to assess
biological function.
Development
of new types of molecular markers requires a process of discovery followed
by
validation in carefully selected patient populations in carefully controlled
clinical trials. Such clinical trials may take weeks or years to conduct and
results are generally published in peer-reviewed medical journals. Once enough
studies are conducted to demonstrate the validity of a new diagnostic, the
tests
can be offered through laboratories licensed through a state and federal process
certified by the Clinical Laboratory Improvement Advisory Committee (“CLIA”).
Alternatively, manufacturers of the reagents and systems that are required
to
perform the diagnostic assay can submit an application to the FDA (510K or
PMA)
which, if approved, allows them to market products to laboratories and doctors
who are licensed to conduct clinical analysis on tests ordered by doctors.
In
2007, the FDA published draft recommendations suggesting new regulations on
any
genetic test that utilizes multiple markers and requires an algorithm to produce
a result. While these draft recommendations have not been finalized, if they
are, then the FDA would require approval for all tests in this
category.
6
OUR
BUSINESS
We
currently conduct our operations through two business segments: the Drug
Repositioning Division and the Genomics Division. We are focusing primarily
on
our Drug Repositioning business and continue to serve new and existing Genomics
customers while seeking strategic alternatives for that business.
Drug
Repositioning Division
Gene
Logic’s drug repositioning platform provides an efficient and cost-effective
approach for systematically uncovering a drug candidate’s biological activity
and identifying possible new indications for drug candidates for which
development has otherwise been discontinued.
The
pharmaceutical development process is expensive, time-consuming and risky,
with
a high failure rate. See “Scientific and Industry Background” above. Billions of
dollars are spent annually to identify and develop biologically active compounds
that do not ultimately succeed for various reasons, including (i) insufficient
effectiveness in treating the disease or condition for which they were designed;
(ii) safety and toxicity issues; (iii) patient variability in responding to
a
drug candidate; and (iv) insufficient potential economic return for the company
developing the drug candidate.
Pharmaceutical
companies have traditionally relied on two mainstream approaches to establish
a
product pipeline - internal development and product in-licensing. The first
approach continues to be time-consuming and expensive while the latter is
limited by increased competition between pharmaceutical companies to in-license
a finite number of quality drug candidates. Furthermore, in traditional drug
development, development of a drug candidate that is determined to have limited
effectiveness in human clinical trials for a selected indication will be
stopped, even though the compound could be effective in treating
other
medical
conditions. Until now, any alternative uses were most often discovered by
serendipity, such as in the cases of Pfizer’s Viagra®,
Eli
Lilly & Co.’s Evista®,
and
Abbott’s Hytrin®.
Drug
repositioning offers pharmaceutical companies a third approach to expanding
their drug development pipelines. Gene Logic has the ability to evaluate a
drug
candidate in less than one year using our drug indication discovery platform,
allowing us to quickly and efficiently discover possible new indications for
a
drug candidate. Following confirmation of the potential new use via in
vivo
efficacy
tests, we believe that some of these candidates will be found suitable for
re-entry into clinical development for a new indication. Our Drug Repositioning
Division uses a technology platform that integrates technologies acquired from
Millennium Pharmaceuticals in 2004 (which we continue to improve) with our
core
genomic and toxicogenomic capabilities (see below).
We
have
developed partnerships with four pharmaceutical partners in 2005 and 2006,
Pfizer, Inc., F. Hoffmann-La Roche Ltd, Eli Lilly and Co., and NV
Organon.
Our
agreement with Organon involves co-ownership and co-development of repositioned
drug candidates, and it therefore differs substantially from our other
agreements. Our other drug repositioning and development agreements vary
somewhat as to specific terms (see “Contractual Arrangements” earlier), but
generally conform to the following:
7
In
most
cases, if our partner decides not to take the drug candidate back into
development, we have development rights that would entitle our partner to
receive milestone payments and royalties on sales.
We may
choose to license such candidates to a third party for development, or we may
invest in further development to increase a particular candidate’s value prior
to outlicensing. We have acquired certain rights from Millennium Pharmaceuticals
to a drug candidate for which we have identified potential new
indications.
We
believe
that no single technology is adequate to assess the effect of a drug candidate
across complex biological processes. Our multi-platform solution allows us
to
systematically and efficiently evaluate a range of biological activity that
potentially may be affected by a drug candidate, including its potential effect
on a wide variety of diseases, without requiring a prior disease-specific
hypothesis. The technologies we use to develop hypotheses about which diseases
a
drug candidate may be used to treat include in
vivo (in
life),
in
vitro (in
dish),
in
silico (in
computer data), and ex
vivo (outside
organism) assessments of a drug candidate at the DNA, RNA, protein, pathway,
and
cellular levels.
The
technologies include:
Real-Time
In Vivo
Imaging
- We are
using in-licensed technology in conjunction with proprietary protocols and
procedures to create an optimal imaging program that allows the pharmacological
action of a compound in organs and tissues to be visualized non-invasively
using
genetically engineered mice. This technology allows us to determine which organs
are affected by the compound, timing of the response, and biological pathway
information.
Ex
Vivo
Multiplex
Bioanalytics -
Using
sophisticated laboratory automation and proprietary targeted separation and
analysis techniques, we can simultaneously measure levels of biomolecules in
certain biological fluids collected from a compound-treated animal. By comparing
the levels of biomolecules in treated animals to those in normal animals, we
can
identify activity caused by the compound which may signal potential alternative
disease indications.
In
Vitro
Molecular
Pharmacology
- Powered
by sophisticated robotics and software, part of our technology platform allows
us to apply a compound to a large number of cell types to identify pathways
that
may be activated or repressed by the compound. Another technology enables us
to
apply a compound to cells in a broad panel of cellular assays, each of which
represents one or more relevant diseases, to measure the effect of the compound
on the diseases.
In
Silico
Biology
- Our
existing genomics capabilities enable us to find close relatives of the target
protein in the genome, major and minor sites of expression of the target in
the
body, disease conditions that alter the expression of the target, and a host
of
additional drug target parameters. We use the BioExpress®
System
and our proprietary algorithms and biostatistical expertise to identify pathways
and cell regulatory patterns to understand a compound’s mechanism of activity in
any organ of interest.
Potential
alternative therapeutic uses can then be validated through a study, using an
animal model related to the new disease indication, performed either in our
laboratories or those of a third-party service provider or by our pharmaceutical
partners.
In
2006,
we began evaluating more than 40 drug candidates for our drug development
partners. Based on our experience to date, we have a success rate of 25%-33%
in
developing new hypotheses. Some of these candidates for which we have found
new
indications have or will progress to in
vivo
efficacy
models to evaluate and support their suitability for re-entering clinical trials
for the proposed new indications. For the candidates that will shortly begin
in
vivo
efficacy
studies, our partners have agreed to fund a portion of the costs associated
with
these studies. We expect that some portion of the drug candidates will have
successful outcomes in the in
vivo
tests and
re-enter clinical trials, but we do not yet have sufficient data to estimate
the
rate of clinical trial re-entry. We do not expect any of these drug candidates
to re-enter clinical trials, and we do not expect to derive significant revenue
from milestones or royalties from our drug development partnerships, until
after
2007.
Genomics
Division
Our
Genomics Division includes proprietary gene expression and toxicogenomics
databases, toxicogenomics services, software tools, microarray data generation
and analysis services (for gene expression and SNP genotyping), and other
professional services. These services assist researchers in identifying and
characterizing drug targets and biomarkers and can help predict potential human
toxicity of drug candidates. Gene expression patterns and biological pathways
in
disease, genetic abnormalities, and mechanisms involved in drug efficacy and
toxicity all help researchers make better informed decisions.
8
Our
genomics data are based on gene expression results and clinical data from a
collection of over 35,000 diseased and normal human and animal model tissues,
as
well as primary cells and cell cultures. These samples, together with relevant
pathology and clinical data are collected from clinical centers, teaching
hospitals, academic medical centers, standard toxicology animal lab studies
and,
in some instances, commercial providers. The samples in our BioExpress System
represent more than 400 separate clinical disease indications with focused
collection programs in critical therapeutic areas of greatest market interest,
including oncology, cardiovascular, central nervous system, inflammatory and
metabolic diseases. The samples in our ToxExpress®
System
are primarily derived from animal liver, the primary toxicity response site,
as
well as animal heart and kidney.
We
isolate
and prepare the genetic material from these tissue samples and then analyze
the
genetic material through a high throughput, automated process using microarrays
to determine gene expression. The results of this analysis and the corresponding
pathology and clinical or experimental information for each sample are compiled
using our software and bioinformatics capabilities, resulting in reference
databases and software tools that are the foundation of our Genomics
Division.
Our
Genomics Division currently offers the following services:
BioExpress
System and Related Products and Services -
The
BioExpress System is a database that enables drug development researchers to
use
our data to: (i) investigate human disease and disease progression by
identifying and prioritizing disease-associated gene targets through an
understanding of gene expression patterns, genetic abnormalities, disease
pathways and disease mechanisms of action, (ii) examine the interrelationship
between the human genome, disease mechanisms and related individual clinical
parameters, and (iii) identify potential disease biomarkers. The database
comprises gene expression data derived from normal and diseased human and animal
tissues and related pathology and clinical or experimental information about
those samples. BioExpress Suites and Custom Suites consist of subsets of
BioExpress System data. The ASCENTA®
System is
a Web-based analysis system that contains selected, curated gene expression
data
sets from the BioExpress System.
Microarray
Data Generation and Analysis Services -
We offer
a growing portfolio of services that enable customers to outsource to us the
generation and analysis of gene expression and SNP genotyping information,
primarily from customer-supplied biological samples. Our services are designed
to deliver high quality, reproducible data in the customer’s preferred format.
To provide these services, we use automation, state-of-the-art facilities and
our expertise in sample handling, preparation and processing and data analysis.
Customers use this information to help make better decisions throughout their
drug discovery and development process.
ToxExpress
System and Related Services -
The
ToxExpress System is a database consisting of gene expression profiles and
associated experimental data from rat and canine tissues as well as rat and
human primary hepatocytes. These samples include both normal samples and treated
samples (i.e., samples that have been exposed to specific compounds with known
toxicity). The information for each treated sample includes a “toxicity
profile”, containing time-course, dose and other classical toxicology study
information, supplemented with data from studies on primary human liver tissues
and cells and other animal model tissues. The ToxExpress System data can be
used
to develop predictive models and to undertake mechanistic studies on acute
and
chronic human toxicity. Customers compare our data to theirs to develop risk
assessment/management strategies, and to prioritize leads in development.
ToxExpress also includes the following related offerings: ToxSuite Datasets,
Molecular Mechanism of Toxicity Services, ToxShieldTM
Suites,
and Custom ToxExpress Services.
Genesis
Enterprise System®
Software -
The
Genesis Enterprise System Software is our enterprise-wide bioinformatics
solution. It is a sophisticated and comprehensive software platform for
warehousing, comparing, mining, analyzing and visualizing gene expression and
clinical information. This software enables drug development researchers to
compile and rapidly assess large data sets (including our proprietary data,
customer-derived data and publicly available research data), and contains
various tools for conducting sophisticated analyses of gene expression
data.
In
2006,
in response to our customers’ shifting their research activities from
early-stage drug discovery into later-stage development and validation efforts,
we examined our Genomics Division for new avenues to create value. We concluded
that our commercially demonstrated expertise in biomarker discovery and
validation could be used as a potential new platform for molecular diagnostics
development. We believe that the following capabilities could serve as the
basis
for more rapid development of biomarker diagnostic products: (i) our substantial
clinical network of hospitals and other research institutions with which we
have
agreements for human sample accrual; (ii) our Biorepository containing more
than
17,000 human clinical samples from more than 400 different diseases; (iii)
our
BioExpress database and related software enabling biomarker prototyping, proof
of concept, and specificity testing; and (iv) our GLP data generation capacity
to undertake clinical validation studies. As
a
result, we have engaged outside financial advisors to identify strategic
alternatives for our Genomics business. We continue to serve new and existing
Genomics customers while we explore this opportunity.
9
CUSTOMERS,
SALES, MARKETING AND CUSTOMER SUPPORT
During
2006, three Genomics Division customers each accounted for 10% or more of our
total revenue.
The
following table sets forth information on the composition of our total revenue
by geographic region for each of the last three fiscal years:
We
market
and sell the services of our Genomics Division primarily to pharmaceutical
and
biotechnology companies based in North America, Japan and Europe. A
company
in Japan assists us, for a fee, in making sales in Japan and provides marketing
advice and support in connection with our Genomics Division. We
also
maintain customer service support representation in Japan and the United
Kingdom. We provide pre- and post-sales support activities to our Genomics
customers through our genomics services and software support group, including
technical demonstrations, planning and implementation of initial deployment
and
new and ongoing training, content updates, software upgrades, on-going support
and follow-on training.
We
market
and sell the capabilities of our Drug Repositioning Division to pharmaceutical
companies based in North America, Japan and Europe. We have a team of business
development professionals with diverse pharmaceutical and consulting experience
who lead contract negotiations with potential pharmaceutical partners. Once
a
contract is signed, members of both the technology and business development
groups interact with each pharmaceutical partner as required.
RESEARCH
& DEVELOPMENT
Research
and development expenses for the years ended 2006, 2005 and 2004 were $9.9
million, $6.8 million and $2.4 million, respectively. Most of our research
and
development expenses consist of costs associated with our Drug Repositioning
Division and are for the evaluation of customer-supplied drug candidates and
ongoing development of our drug indication discovery platform.
A
smaller
portion of our research and development expense consists of general technology
and process improvements related to our Genomics Division. This portion of
our
research and development is focused on developing new applications and licensing
or acquiring technologies to serve as platforms for molecular diagnostics,
and
for the development of new gene expression, SNP genotyping, and other
molecular-based solutions. We continue to research methods to improve the
production of our gene expression data and decrease the size requirements for
tissue samples.
10
Drug
Repositioning Division
We
have
drug development partnerships to identify new indications for discontinued
clinical-stage drug candidates from our pharmaceutical partners. Under these
agreements, we do not receive up-front revenue. We are entitled to receive
milestone payments in the event that a drug candidate for which we have found
a
new indication is returned to a partners’ development pipeline at its election.
If our partner begins commercial sales of the repositioned drug, we would be
entitled to a percentage of royalties based on actual sales or other
compensation. Each partner has agreed to provide a specific number of drug
candidates during the term of the applicable agreement, from which we can select
those to be introduced into our drug repositioning pipeline. We will evaluate
those drug candidates at our expense and will inform our partners of any new
possible indications we identify for these drug candidates. In some instances,
our partners have the right to elect to have us conduct mutually agreed upon
in
vivo
model
validation studies based on our hypotheses, which may be partially or entirely
at our or our partners’ expense. Drug candidates with new indications would then
be returned to a partner’s pipeline at its sole election. If a partner elects
not to pursue a new use we identify, we may, in some instances, have the option
to develop, license and commercialize such use, subject to payments of
success-based milestones and royalties to our partner. Unlike our other
agreements, under the agreement with Organon, both companies are equal owners
of
drug candidates for which we find new uses and may decide to jointly develop
and
commercialize the drug candidate. If we acquire development rights as to a
given
drug candidate, we could elect to either (i) out-license the development rights
to such drug candidate without further development on our part, or (ii) continue
to develop the drug candidate, either through our own resources or with a
development partner, to a point where we can more effectively out-license the
drug candidate to a third-party for final development and commercialization.
We
do not
expect to derive any significant revenue from milestones or royalties under
these agreements until after 2007.
Genomics
Division
We
expect
that approximately half of our Genomics Division revenue in 2007 will continue
to be derived from subscription agreements. Our customers enter into multi-year
or perpetual license agreements for our larger databases (and annual,
multi-year, or perpetual license agreements for certain of our smaller
databases) to obtain non-exclusive access to all or parts of our gene expression
and toxicogenomics databases. These agreements may be for a full database or
a
portion of a database tailored to a customer’s needs and most relevant to their
drug development strategy. One of our subscription agreements contains
requirements for the addition of certain data that, if not met, could result
in
a reduction in license fees. Pricing for these subscriptions is generally
dependent upon such factors as the database solution being offered, the term
of
the license, the extent and type of use by the customer, the number of users
at
the customer site, the scope of installation at the customer’s site,
requirements for customization, any content requirements and whether we provide
any custom analysis or data management services. Contracts under these
subscription agreements may be terminated by either party if the other party
breaches the agreement and fails to cure such breach within any applicable
cure
period or in the event of a bankruptcy of either party.
In
certain
circumstances, customers may acquire a perpetual license to use certain
information from our databases. Pricing for perpetual licenses to data is
generally dependent upon such factors as the data solution being offered, the
extent and type of use by the customer and the number of users at the customer
site. Some of our customers purchasing perpetual licenses continue as customers
purchasing additional services, including licenses to other databases and
microarray data generation and analysis services.
We
expect
that approximately half of our revenue will be derived from a combination of
microarray data generation and analysis and other professional services and
solutions. The particular type and scope of the services we provide are based
on
the customer’s needs. Pricing for these services is generally dependent upon
such factors as the number of samples or compounds analyzed, the type of
analysis performed, the starting material provided by the customer, the type
and
source of GeneChip®
microarray used for the services and requirements for customization. Generally,
contracts for services may be terminated by either party if the other party
breaches the agreement and fails to cure such breach within any applicable
cure
period or in the event of a bankruptcy of either party.
COMPETITION
Drug
Repositioning Division
Currently,
an increasing number of pharmaceutical and biotechnology companies are
evaluating whether to implement internal repositioning programs for their own
drug candidates. In addition, there are companies attempting to reposition
drug
candidates on behalf of drug development partners, including Melior, KineMed,
Perlegen Sciences, Inc., Vanda Pharmaceuticals Inc. and CombinatoRX Inc. We
are
not aware of any existing competitor that has developed, or is in the process
of
developing, a comparable suite of technologies to that employed by us. Other
companies, some of whom are not doing repositioning work, have individual
technologies that could directly compete with components of our drug
repositioning technology platform.
11
Genomics
Division
Our
Genomics Division competes with internal capabilities of pharmaceutical and
biotechnology companies and universities worldwide which may choose to use
genomics technologies to generate for their own use similar sets of gene
expression or SNP data. To a lesser extent, we also compete with commercial
providers who offer less extensive and, in at least one instance,
population-specific data (deCODE genetics, Inc.). In addition, at least one
privately held company that we know of (Iconix Pharmaceuticals, Inc.) licenses
an alternative toxicogenomics database and provides predictive toxicogenomics
services that compete with our toxicogenomics services. In addition, we face
increasing competition from a variety of public and private companies in the
area of microarray data generation and analysis services, including Expression
Analysis, Inc. and Clinical Data, Inc. However, we currently believe there
are
no commercially available gene expression databases of comparable size and
scale
to that of our BioExpress and ToxExpress System databases. Our services compete
on the basis of: scope and quality of services offered; price; speed of delivery
of specific services; strength of reputation; size of our databases; alternative
technologies; expertise and experience in specific technological and scientific
areas; subject focus of genomics and toxicogenomics data sets and technologies;
our ability to acquire, handle, process, store, analyze and present complex
gene
expression data and clinical annotation information in a timely, quality
controlled and accurate manner; and, our ability to integrate proprietary gene
expression data with publicly available and other third-party generated data
sets.
SUPPLIERS
Drug
Repositioning Division
In
our
Drug Repositioning Division, we have a non-exclusive license and sublicense
from
Promega Corporation (the “Promega License”) to use the luminescence technology
we use in our real-time in
vivo
imaging.
The term of the agreement is for the life of the relevant patents, unless
earlier terminated upon breach by either party, bankruptcy or termination of
Promega’s rights by an academic institution that holds certain rights to a
portion of the technology (in which case we would seek separate licenses from
Promega for its technology and directly from the institution). Under the terms
of the agreement, we paid Promega an initial fee and we pay Promega an annual
license maintenance fee and royalties on luminescent assay reagents we use
that
are not purchased from Promega. We also have a non-exclusive license with
Xenogen Corporation (the “Xenogen License”), for which we pay an annual license
fee to use the Xenogen Imaging Technology and certain related software in
connection with our use of certain imaging equipment we purchased from Xenogen
for use in performing real-time in
vivo
imaging.
The term of the Xenogen license ends in 2008, with a three year renewal option,
subject to earlier termination if we fail to make timely payment or otherwise
breach the terms of the agreement, and we have agreed to indemnify Xenogen
and
certain other persons and entities for liability resulting from our use of
the
technology.
To
build
our genomics and toxicogenomics databases that are the basis of our Genomics
Division, we enter into collaboration agreements from time to time with
institutions or individuals (including a few commercial providers), to obtain
specific tissues, blood samples and cell lines and associated experimental
or
clinical data. We pay fees under these agreements and, in the case of
non-commercial providers, we may provide access to software and to certain
gene
expression data and financial support for the collaborator’s research.
Non-commercial collaboration agreements typically have a term of two to three
years, subject to automatic renewal unless earlier terminated by either party.
Since we’ve already compiled a broad base of general data, our efforts are
currently focused on the procurement of special, high-value, difficult-to-obtain
and rare samples. We continue to believe that none of these collaboration
agreements are individually material to our operations because any one can
be
replaced on comparable terms with another provider.
To
generate the gene expression data in our genomics and toxicogenomics databases
and to provide microarray data generation and analysis and other services and
solutions as part of our Genomics Division, we use Affymetrix, Inc.
(“Affymetrix”) microarrays, reagents, instrumentation and software. Our 2006
supply and license agreement with Affymetrix expired on December 31, 2006.
On
January 9, 2007, but effective January 1, 2007, we entered into (a) a new
three-year Biotech Access Agreement governing our purchase and use of Affymetrix
microarrays and related products for internal research and to generate data
for
databases and (b) a new two-year Service Provider Agreement governing the
purchase and use by us of microarrays to provide data generation and analysis
and other services and solutions to individual customers. Under terms of the
new
agreements, we are obligated to grant to Affymetrix a non-exclusive,
royalty-free license to certain inventions we make related to their microarray
technology and, under certain circumstances, to offer to negotiate with them
a
non-exclusive, royalty-bearing license for certain inventions we make related
to
sample processing. The Biotech Access Agreement requires payment of an annual
access fee of $50,000, subject to waiver for any year in which we are an
Affymetrix Service Provider, and sets prices for the products, reagents and
instrumentation we purchase from Affymetrix. The Service Provider Agreement
(but
not the BioTech Access Agreement) is terminable by either party if the other
party defaults under the agreement and, after written notice from the
non-defaulting party, fails to cure the default during the applicable cure
period.
12
In
the
past, we also purchased from Affymetrix a reagent made by Enzo BioChem,
Inc. (“Enzo”). As first reported in 2004, in late 2003 Enzo terminated its
distribution agreement with Affymetrix and filed suit against Affymetrix
alleging in part that Affymetrix had agreements with us and other named
customers to supply the reagent for use in potential violation of their rights.
Subsequently, Affymetrix denied Enzo’s claims, filed counterclaims and also
introduced a new alternative reagent, which we are using. The lawsuit is
currently in the discovery and pretrial hearing stage.
INTELLECTUAL
PROPERTY RIGHTS
As
of
December 31, 2006, in our Genomics Division, we have exclusive ownership or
license rights to 58 issued patents, 26 of which are United States patents,
and
98 patent applications, 47 of which are United States utility (non-provisional)
or provisional patent applications. As of December 31, 2006, in our Drug
Repositioning Division, we have exclusive ownership or license rights to 8
issued patents, all of which are United States patents, and 25 patent
applications, 11 of which are United States utility (non-provisional) or
provisional patent applications; except for one application, all of these
patents and applications relate to either of two compounds or their potential
uses. We do not at this time believe that any single patent or application
is
individually material to our business.
With
respect to proprietary know-how and products and processes for which patents
are
of questionable value or are difficult or impossible to obtain or enforce,
we
rely on confidentiality agreements and other trade secret protection measures
to
protect our interests. We take security measures to protect our proprietary
know-how and technologies and confidential data, including requiring all
employees, consultants and customers to enter into confidentiality agreements.
In arrangements with our customers or suppliers that require the sharing of
processes and data, our policy is to make available only such data as is
relevant to our agreements with such customers and suppliers, subject to
appropriate contractual restrictions, including requirements for them to
maintain confidentiality and use such processes and data solely for our benefit.
However, such measures may not adequately protect our data.
In
the
areas of genomics, toxicogenomics and bioinformatics technologies related to
these capabilities, we seek patent rights primarily to protect our freedom
to
operate, and to obtain whatever exclusivity may be available under a given
patent that relates to our main service offerings. We apply for patent
protection on methods of obtaining and using genomic information and on
databases, software, and user interface tools relating to the management and
use
of such information. Our applications may also contain claims to methods of
identifying and using gene expression profiles and genetic markers, claims
to
novel genes and gene fragments, and claims to novel uses for known genes or
gene
fragments. We also actively file patent applications on technologies and
methodologies we have developed in the field of toxicogenomics. Our
toxicogenomics patent applications contain claims that cover methods of
predicting toxicity, toxicity markers, statistical models, and other inventions
related to our toxicogenomics program.
We
have a
worldwide, nonexclusive, fully paid, non-transferable license for the life
of
certain patents from Incyte Corporation (“Incyte”) (formerly Incyte Genomics,
Inc.), obtained in connection with the settlement of certain litigation in
2001,
to use i) a process that Affymetrix recommends we use in the preparation of
samples for use with the Affymetrix GeneChip platform; and ii) certain patent
rights related to the development and use of certain types of databases. The
samples and process may only be used to generate gene expression data for use
in
research and development. The license may be terminated by Incyte under certain
limited circumstances if we: i) use certain patents outside of the permitted
field of use, or induce another party to do so; ii) violate certain agreements
regarding any future disputes between the parties involving these patents;
or
iii) violate the confidentiality provisions of the agreement. If Incyte were
to
terminate the license agreement on the grounds that we materially breached
such
agreement and if we dispute such claim, the party in whose favor the court
finds
would be entitled to an agreed-upon payment from the losing party. Likewise,
if
we claim Incyte has materially breached the License Agreement and if Incyte
disputes such claim, the party in whose favor the court finds would be entitled
to an agreed-upon payment from the losing party.
Under
the
terms of our supply agreement with Affymetrix described above under “Suppliers,”
we have the right to use Affymetrix products, software, systems and database
patent rights to generate and use databases, license the data in such databases
to third parties and provide sample processing services to generate and analyze
data for a customer’s internal use for research and development. In addition, we
are obligated to grant to Affymetrix a non-exclusive, royalty-free license
to
certain inventions we make related to their microarray technology and, under
certain circumstances, to offer to negotiate with them a non-exclusive,
royalty-bearing license for certain inventions we make related to sample
processing.
13
For
our
Drug Repositioning Division, we have acquired or obtained licenses to use
certain intellectual property rights and technologies from Millennium, Xenogen,
Promega and others, and we will, from time to time, continue to acquire and
obtain licenses to use intellectual property rights and technologies as needed
for our Drug Repositioning Division. We will also pursue patents, where
appropriate, on new enabling technology used in our Drug Repositioning Division.
Certain agreements with partners having rights to known drugs, under which
our
Drug Repositioning Division seeks new therapeutic uses for such compounds,
provide us with certain intellectual property rights to those new uses. Where
such agreements permit, we will pursue broad patent protection for selected
new
uses that we have found for known drugs.
GOVERNMENT
REGULATION
Drug
Repositioning Division
Our
Drug
Repositioning Division operations in our Cambridge, Massachusetts facilities
are
subject to a
variety
of national, state and local laws and regulations, including the Animal Welfare
Act and the rules and regulations promulgated thereunder by the United States
Department of Agriculture (“USDA”). These regulations establish the standards
for the humane treatment, care, use and handling of animals by research
facilities. In addition, our Cambridge facilities are registered with the United
States National Institutes of Health Office of Protection for Research Risks
(“OPRR”) and comply with The Office of Laboratory Animal Welfare (“OLAW”)
regulations. Our Cambridge, Mass. facilities maintain standard operating
procedures and the documentation necessary to comply with such
regulations. Our
Cambridge, facility is subject to regulation under the Ordinance for the use
of
Laboratory Animals for the City of Cambridge which is enforced by the
Commissioner of Laboratory Animals. Under this ordinance we maintain standard
operating procedures and the documentation necessary to comply with such
regulations.
Genomics
Division
Our
Genomics Division depends upon our continued access to and use of tissue samples
and related clinical data, which are affected by regulations governing
disclosure of confidential personal data, such as regulations governing the
disclosure of medical information, issued by the Department of Health and Human
Services under the Health Insurance Portability and Accountability Act of 1996
(“HIPAA”), and applicable regulations of Canada and the European Union. We
monitor our procedures to ensure that such procedures comply with applicable
privacy regulations. We also perform certain experiments in our Genomics
Division which comply with applicable laboratory standards as prescribed by
the
Good Laboratory Practice (“GLP”) regulations promulgated by the FDA. The
acquisition and use of human tissue by us is generally subject to regulations
imposed by the Internal Review Boards of the organizations providing such
materials and to the requirements for patient informed consent.
General
All
of our
laboratories are subject to licensing and regulation under federal, state and
local laws relating to hazard communication and employee right-to-know
regulations, the handling, storage and disposal of medical specimens, laboratory
materials and hazardous waste and radioactive materials and the safety and
health of laboratory employees.
The
Occupational Safety and Health Administration (“OSHA”) has established extensive
requirements relating to workplace safety, which require us follow certain
procedures including providing ongoing training and proper equipment for
employees working in our facilities. Our employees receive initial and periodic
training focusing on compliance with applicable hazardous materials regulations
and health and safety guidelines.
The
use of
controlled substances in our laboratory testing facilities is regulated in
the
United States by the United States Drug Enforcement Administration (“DEA”) and
relevant state and local agencies. All of our laboratories using controlled
substances for testing purposes are subject to licensure by the DEA and
applicable state agencies.
The
regulations of the United States Department of Transportation and the United
States Postal Service apply to the transportation of laboratory specimens via
surface and air.
14
SEASONALITY
Customer
purchasing patterns do not show significant predictable seasonal
variation.
HUMAN
RESOURCES
As
of
December 31, 2006, we had 151 employees, consisting of 150 within the United
States, and 1 who resides in Japan. Most of our employees are engaged directly
in research, development, production and marketing and sales activities. None
of
our employees are covered by collective bargaining agreements, and management
considers relations with our employees to be good.
AVAILABLE
INFORMATION
We
maintain a Web site at www.genelogic.com.
However,
material contained on our Internet site is not incorporated by reference into
this Form 10-K. We make available free of charge on or through our Web site
our
SEC filings, including our Annual Report on Form 10-K, Quarterly Reports on
Form
10-Q, Current Reports on Form 8-K and amendments to those reports we file or
furnish pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934 as soon as reasonably practicable after such reports are electronically
filed with, or furnished to, the Securities and Exchange Commission
(SEC).
15
We
operate
in a rapidly changing environment that involves a number of risks, some of
which
are beyond our control. Set forth below are risks and uncertainties we have
identified as material that could cause actual results to differ materially
from
the results contemplated by the forward-looking statements contained in this
Form 10-K and that could have material adverse effects on our business, results
of operations, financial condition and cash flows.
Risks
Related to Our Drug Repositioning Division
Our
platform may
not yield sufficient new indications and thus measurable successes to
gain market acceptance.
We
may not
succeed in achieving significant market acceptance of any of our technologies
used in drug repositioning activities because the technologies we use and our
approach to drug repositioning may fail to generate sufficient new indications
that are accepted for clinical trial re-entry or that are of sufficient
commercial value to interest our partners. This outcome would have a material
adverse effect on our business, financial condition, results of operations
and
market valuation.
Others
are developing and could provide drug repositioning research and services that
could compete with us and jeopardize our business and financial
objectives.
Pharmaceutical
companies and other companies and research organizations are developing
technologies for better understanding the complex biological processes affected
by compounds and selecting, purposing and repurposing compounds. These parties
may elect to use such technologies internally, in lieu of using our services,
or
may successfully offer such services based on their technologies in competition
against us. While we have license rights related to certain of the technologies
that comprise the technology platform for our Drug Repositioning Division,
we do
not currently have issued patents to any of the technologies we use other than
our genomics databases and software and our license rights to the other
technologies are generally non-exclusive. We will seek patents or other
protection on other elements of the technologies we use to find new indications
for drug candidates. We may not be able to obtain adequate protection for these
technologies or the technologies may become obsolete. Competition for our
services could cause us to be unable to get sufficient compounds to achieve
our
business objectives, and could otherwise jeopardize our ability to achieve
our
financial objectives, in drug development.
The
time required to present and negotiate our drug repositioning agreements is
lengthy; we may spend considerable resources on unsuccessful sales efforts
or
may not be able to negotiate and enter into drug development partnership
agreements on the schedule we anticipate.
Our
drug
development business strategy depends upon our ability to establish
collaborative arrangements with pharmaceutical partners to reposition candidates
that have been assessed as safe in human clinical trials but for which
development for the original indication has been discontinued. If we are unable
to establish partnerships with a sufficient number of pharmaceutical companies,
we may not be able to obtain enough drug candidates to meet our business
objectives.
Our
ability to obtain new drug development partnerships depends upon our ability
to
convince them that our drug indication discovery platform can increase
productivity for their drug development efforts. Intentional repurposing of
candidates is a relatively new activity. Pharmaceutical companies need to be
persuaded of the potential of this approach. In addition, pharmaceutical
companies do not generally have specific individuals responsible for managing
discontinued candidates. The time required to present our proposals for drug
repositioning and negotiate agreements is substantial (often 12 months or more)
and we may expend substantial effort with no assurance that a new agreement
will
result on terms acceptable to us or that provide sufficient opportunities for
us. Consolidations of pharmaceutical and biotechnology companies could also
affect the timing and progress of our Drug Repositioning Division sales efforts.
We
may be unable to obtain access to sufficient numbers of acceptable candidates
for evaluation by our platform to meet our business
objectives
Our
business plan is dependent on having sufficient acceptable compounds available
to evaluate, to provide us with sufficient opportunities to find compounds
with
alternative indications that are appealing to our partners or to us for further
development. At present, we can only obtain access to these compounds through
our partners. There are challenges to obtaining new drug development partnership
agreements, as described above. Further, even after we enter into an agreement
with a partner, it may take time for that partner to identify acceptable
candidates it is willing to make available to us which may further limit the
numbers, or timely availability, of compounds we can use to meet our business
and financial objectives. At present, while we have the capacity to evaluate
greater numbers of compounds, such compounds are not available under existing
agreements. Our achievement of our business objectives will continue to be
limited by the numbers of acceptable candidate compounds available for
evaluation for alternative indications.
16
We
may be required to invest significant resources in identifying alternative
uses
for our partners’ candidates. We will not receive any revenue from our partners
unless they decide to return candidates to their pipeline and our ability to
earn revenue under our drug development agreements is based in part on factors
over which we may have little or no control.
Under
our
drug development partnership agreements we typically have agreed to perform
evaluations of candidates at our expense. Accordingly, we may need to invest
significant resources in seeking alternative uses for one or more partners’ drug
candidates using our drug indication discovery platform, and we may find no
new
or alternative uses for these candidates. If we identify new or alternative
uses
for a given candidate, we may not be able to realize any value from the
identification of such alternative use until our partner determines, if ever,
that the use makes the candidate sufficiently desirable to warrant further
development and commercialization. We do not control when, on what schedule,
or
whether, a partner will accept a drug candidate for redevelopment or at what
pace, if at all, the partner will conduct further development efforts of such
repositioned drug candidate. Such decisions may be affected by factors of which
we may not be aware and over which we will have no influence.
In
the
event that a partner declined to develop a candidate for an indication we had
found, we could, in some instances and with the agreement of our partner,
acquire rights to develop that candidate for particular indications and, if
we
were to elect to pursue development of any such candidate, any such development
would require that we promptly find a partner and/or that we invest substantial
financial and other resources to develop the product to a stage where we could
license it out to a third-party for final development and commercialization.
We
have not engaged in drug development to date and there can be no assurance
that
we would be successful in conducting such development or in identifying a
licensing partner to continue such development on terms that would be profitable
to us.
If
we find
new uses for candidates, we may not realize sufficient return from such
discoveries. The indications we find may not be sufficiently attractive for
development by our partners or us due to factors such as: difficulties in
obtaining adequate patent protection for the new indication, the existence
or
discovery of alternate drug candidates that may equally or more effectively
address the therapeutic need or the internal requirements of our pharmaceutical
partners. Even if a candidate reenters a partner's pipeline, our milestone
revenue depends on whether further development of the candidate is successful
and our royalty revenue will depend on whether the candidate is commercially
successful, all of which is outside of our control.
These
factors may limit our ability to earn significant revenue under any of our
agreements.
The
drug indication discovery platform for our Drug Repositioning Division currently
relies in part on inventions of third parties that may not always be available
to us.
Our
drug
indication discovery platform currently relies in part on inventions to which
third parties have obtained or are obtaining patent or other rights and, in
the
process of further developing the platform we may need to license rights to
use
other such inventions. We may not be able to retain or to obtain license rights
needed for one or more of these technologies on terms acceptable to us. We
currently license certain technology in connection with certain products
purchased from Xenogen Corporation and we also purchase and license the right
to
use Luciferase from Promega Corporation. The Xenogen license is for a term
ending in 2008 with an option to renew for an additional three years. The
Promega license is for a period ending on the expiration or abandonment of
the
last of the valid claims of the licensed patent rights. Each of these licenses
is terminable if we breach the agreement and fail to cure such breach within
the
applicable cure period. In addition, the Promega license includes a sublicense
to rights owned by an academic institution and the license from Promega would
terminate if the license to Promega from the academic institution terminated.
If
either of these agreements were to terminate while the relevant patent claims
were enforceable and if we were not able to obtain new licenses, we would have
to abandon or substantially revise one of the key technologies used in our
drug
repositioning process.
Risks
Related to Our Genomics Division
The
Genomics Division is currently our sole source of revenue and, to continue
to
derive revenue from this division in the short term and to achieve our strategic
objectives, we need to maintain the existing business.
17
While
we
seek new uses for our Genomics assets, our strategy depends, in part, on
maintaining revenue from and controlling costs in our Genomics Division. To
maintain revenue, we must extend existing subscriptions, find new subscribers
and obtain new orders from existing customers and find new customers for our
data generation and other services. All of our remaining long-term subscriptions
are due to expire by their terms in 2008 and there is no assurance that any
of
them will be renewed or extended. While we currently expect to continue to
reduce our dependence on large, multi-year subscription agreements, and increase
revenue from data generation services, if we fail to achieve our revenue
objectives, our Genomics Division segment could experience further losses,
which
also could have an adverse effect on our ability to develop an alternative
strategy for the Genomics assets and our entire business could materially
suffer. It is also possible that we could eventually be forced to further reduce
the size of our business or to further dispose of some or all of the Genomics
assets.
We
may not be able to identify or implement a business strategy that will achieve
our objectives.
While
we
believe that our expertise in biomarker discovery and validation could be used
as a potential new platform for molecular diagnostics development and we have
engaged outside financial advisors who are actively assisting us in determining
the value of our competencies and assets in this area, it is possible that
we
will be unable to identify a strategic alternative that would provide
significant value from the further development of these assets. Further, in
the
process of determining the long-term prospects and value of the business, we
may
conclude that the fair value of the Genomics business is less than its carrying
value, which may require us to take one or more impairment charges.
As
a result of uncertainty about our long-term Genomics business strategy and
as a
result of restructuring our operations, we may have difficulty attracting and
retaining customers and employees.
We
have
significantly restructured our Genomics Division to reduce future operating
expenses and have changed the strategic focus of the Company. We are also
contemplating strategic alternatives that could have a material impact on our
business as it is presently conducted, none of which may be successful. These
factors create uncertainty, which could cause customers and employees to have
concerns about our future or, in the case of employees, their future, and they
may be hesitant to commit to a long-term relationship with us and existing
employees may be distracted from their job responsibilities and seek other
employment. We may also find it difficult to recruit new employees due to
uncertainty over our future. If customers do not believe that we will continue
to support, enhance or update our services, they could be less willing to
purchase those services. While we believe our personnel reductions have targeted
areas not necessary to our ability to serve customers, there can be no assurance
that these changes will not have a negative impact on our ability to keep
retained staff or provide adequate services to our customers, which, in turn,
may have an adverse impact on our ability to retain and hire employees and
to
retain existing customers and obtain new customers.
Our
genomics and toxicogenomics databases may require upgrading and expansion to
keep existing and find new customers, but such upgrading and expansion may
be
difficult or expensive.
In
the
past, we have invested in new database content, upgraded our databases and
developed new versions of our software tools due to customer demand and changes
in the microarray platforms. In recent years we have reduced the amount of
content added each year to our database and focused on data from samples of
particular interest to our customers. Specific tissue and blood samples that
we
believe will enhance the content of our databases may be difficult to obtain
or
may not be available on terms acceptable to us. Future investments will be
limited as we continue the transformation of Gene Logic into a biopharmaceutical
company. However, if we choose not to make such changes, it could affect our
ability to keep existing or find new customers.
The
sales cycle for our Genomics Division is lengthy; we may spend considerable
resources on unsuccessful sales efforts or may not be able to complete deals
on
the schedule we anticipate.
The
sales
cycle for multi-year subscriptions to our BioExpress and ToxExpress System
databases is estimated at nine to 15 months; the sales cycle for our other
services, including toxicogenomics reports, microarray data generation and
analysis and other professional services and solutions requires at least several
months. The lengthy sales cycle is caused by a number of factors, including
our
need to educate our existing and potential customers and sell the benefits
of
the services of our Genomics Division to a variety of groups within such
companies and the possible negotiation of unique terms. We may expend
substantial effort with no assurance that a new or extended subscription or
other agreement will result or that it can be completed in a timely manner.
Actual and proposed consolidations of pharmaceutical and biotechnology companies
have affected, and may in the future affect, our Genomics Division sales
efforts.
We
rely on microarrays and other products supplied by Affymetrix to maintain and
add to the underlying genomics and toxicogenomics data of our databases and
to
provide our microarray data generation and analysis and other
services.
18
Our
continuing ability to maintain and add to the gene expression data that is
the
foundation of our databases depends in part on the ability of Affymetrix to
supply us with adequate quantities of high quality microarrays and other
products and to make available licenses of technologies to use such products.
We
also rely on Affymetrix microarrays to provide our microarray data generation
and analysis services and on a new line of SNP-based microarrays to provide
our
SNP genotyping services. Affymetrix provides us with microarrays, reagents,
instrumentation and software under two agreements that expire on December 31,
2008 and 2009 respectively. There is no assurance that we can renew such
agreements on terms comparable to, or as favorable to us as, the current
agreements. One of the agreements is also specifically terminable if we breach
the agreement and fail to cure any breach within the applicable cure period.
If
Affymetrix is unable or unwilling to supply us with the products and licenses
we
require on acceptable terms or if the microarrays are unavailable or defective
or otherwise unreliable, we may incur additional database production costs
and
we may need to obtain alternative technologies. Alternative technologies may
not
be available to us, or may only be available to us on unfavorable terms.
Restricted or curtailed access to such products could cause our Genomics
Division to suffer by preventing or delaying our ability to provide our
databases and services or increasing the cost to generate additional or
replacement content for our databases.
Other
Risks
We
have a history of operating losses that are likely to continue for some time.
We
have
incurred operating losses in each year since our inception, including losses
of
$54.7 million in 2006, $48.3 million in 2005, and $28.5 million in 2004. At
December 31, 2006, we had an accumulated deficit of $315.7 million. Our losses
have resulted principally from costs incurred in the development, marketing
and
sale of services from our Genomics and former Preclinical Divisions, development
of the Drug Repositioning Division, the impairment of goodwill of our former
Preclinical Division, and acquisitions of research and development. These costs
have exceeded our revenue and we expect to incur additional losses in the
future, including losses relating to the ongoing development of our Drug
Repositioning Division.
Our
ability to use our Federal Net Operating Loss carryforwards may be
limited.
We
intend
to utilize our Federal Net Operating Loss carryforwards (“NOLs”) to reduce any
potential future United States income tax liability. These NOLs begin to expire
in 2008. Based on a Section 382 analysis performed in the fourth quarter of
2006
(that excluded NOLs obtained through acquisitions), we do not believe we are
currently subject to any current material limitations on the use of our NOLs
to
offset our potential future income tax liability, although such limitations
could occur in the future. However, we may not generate sufficient taxable
income to utilize our NOLs prior to their expiration.
Our
ability to retain and recruit and retain qualified personnel may be adversely
affected by the substantial changes we are undergoing.
In
2006,
we sold our Preclinical Division and restructured our Genomics workforce and
supporting staff. We are now in the process of trying to develop new uses and
find strategic alternatives for our Genomics assets and capabilities and
continuing to develop our Drug Repositioning Business. These changes and the
uncertainty of our future may make it difficult to retain and to recruit
qualified personnel.
We
may not be able to obtain necessary funding as required to develop and operate
our Drug Repositioning Business and our Genomics Business.
We
do not
expect to begin to generate any significant revenue in our Drug Repositioning
business until at least after 2007 and our Genomics business is currently
operating at a loss. We are seeking strategic alternatives for our Genomics
business to provide funding to develop the potential of this business for human
molecular diagnostics. We may also need additional financing for our Drug
Repositioning business. If we are unable to find an acceptable strategic
alternative for our Genomics Division or to obtain necessary financing, or
financing on favorable terms, when needed for our Drug Repositioning Division,
our business would materially suffer. If additional financing is obtained
through the issuance of equity securities or debt convertible to equity, our
existing stockholders could experience significant dilution.
Our
revenue is derived primarily from, and is subject to risks faced by, the
pharmaceutical and biotechnology industries in the United States, Japan and
Europe; our revenue is also subject to foreign currency risk.
We
expect
that our revenue will continue to be derived primarily from agreements with
pharmaceutical and biotechnology companies. As a consequence, our results of
operations may fluctuate substantially due to fluctuations or delays in our
customers’ research and development expenditures and other factors affecting
their purchasing decisions. These factors include:
19
In
addition, beginning in 2005, contracts with our Japanese customers began to
be
payable in Japanese Yen and are subject to fluctuations due to changes in
currency exchange rates.
None
of
these factors is within our control.
We
sold our Preclinical Division in December 2006, but are still subject to certain
risks from that sale.
In
December 2006, we sold our Preclinical Division. Under the terms of that sale,
there was to be a post-closing reconciliation of working capital that could
result in a purchase price adjustment. In accordance with the terms of the
agreement, the buyer has raised the possibility that an adjustment is required,
requiring us to make an additional payment to the buyer. We are in the process
of resolving the matter as provided in the agreement. In addition, $1.5 million
of the purchase price was placed in escrow until December 15, 2007 to cover
our
potential liability for any breaches of our representations, warranties and
agreements in the stock purchase agreement, including as to certain retained
liabilities. Claims for breaches of warranty relating to payment of taxes and
environmental and certain other matters can exceed the escrow amount. If we
concluded that the buyer is entitled to a purchase price adjustment under the
terms of the agreement or the buyer makes valid claims against the escrow fund
or under other indemnification provisions in the purchase agreement that are
not
subject to the escrow fund limitations, we could experience further costs
associated with the sale of the business and may be required to further adjust
the impairment charge associated with the sale of the Preclinical
Division.
We
also
guarantee two leases of facilities to our former Preclinical Division. Buyer
is
required to either substitute itself as guarantor or indemnify us for any claims
made against our guarantees. If the former Preclinical Division defaults under
such leases and claims are made against our guarantees and buyer fails to
substitute itself as guarantor or adequately indemnify us, we could suffer
additional losses.
Certain
investments made by the Company may fluctuate in value and may create an adverse
impact on our financial performance; the value of certain of our intangibles
and
long-term investments creates risk to our financial
performance.
We’ve
previously recorded value for goodwill and other intangible assets, including
licenses to technologies or data, patent costs and software development and
database upgrade costs which, at December 31, 2006, had an aggregate value
of
$12.7 million. Whether or not these intangible assets are impaired involves
significant judgment, including the following: (i) whether our licenses and
internally developed intellectual property may not provide valid and economical
competitive advantage; and (ii) whether our services we provide may become
obsolete before we recover the costs incurred in connection with their
development. Under Statement of Financial Accounting Standards No. 142,
“Goodwill and Other Intangible Assets”, we are required to perform periodic
reviews of our intangible assets and we may be required to reduce the value
of
these assets if circumstances change.
In
addition, we have an investment in Xceed Molecular (formerly named MetriGenix,
Inc.) with a book value as of December 31, 2006 of $3.0 million. This investment
is subject to periodic evaluation for impairment. Since Xceed is an independent
company in which we are a minority stockholder, the factors affecting an
impairment analysis, which include potential revenue, cost of capital and fair
market value of the entity, are not within our control. There is no guarantee
that, in the future, this investment might not be subject to an impairment
charge.
We
may not be able to obtain adequate patent protection for new technologies and
methods required for achieving our business objectives.
Our
success will depend in part on our ability to protect confidential information
and to obtain intellectual property rights and licenses sufficient to provide
adequate exclusivity and to preserve our freedom to operate.
We
rely on
confidentiality agreements and other trade secret protective measures to protect
our interests in proprietary know-how and technology that are not patentable
or
for which patents are difficult to enforce. We have taken security measures
to
protect our proprietary know-how and confidential data and continue to explore
further methods of protection. While we require all employees, consultants
and
customers with access to our trade secrets to enter into confidentiality
agreements, we cannot be certain that we will be able to protect our trade
secrets. We also rely on confidentiality procedures to prevent public disclosure
of patentable proprietary technology prior to filing patents. Any material
leak
of confidential information into the public domain, or to third parties, could
cause our business, financial condition and results of operations to suffer
adverse consequences, including possible loss of patent rights.
20
Our
patent
position involves complex legal and factual questions. Legal standards relating
to the validity and scope of claims in the genomics technology field are still
evolving. Therefore, the degree of exclusivity that future patent protection
may
provide for our proprietary technologies in this field is uncertain. Likewise,
legal standards relating to validity of claims to new methods of using known
drugs are still evolving. Hence, the likelihood of patenting potential new
therapeutic uses of drug repositioning candidates also is
uncertain.
Specific
risks and uncertainties that we face in the area of patent exclusivity
include:
We
may need to initiate patent enforcement litigation or be subject to future
infringement claims.
In
addition, other organizations, including companies, academic and non-profit
institutions and governmental organizations are developing technologies in
the
genomics and drug repositioning fields. Many of these technologies are subject
to the same evolving legal standards and related uncertainties about patent
protection as our proprietary technologies. Therefore, it may be necessary
for
us to initiate litigation to protect and enforce our intellectual property
rights.
We
also
face risks that patents issued to other organizations may restrict our ability
to do business, and that we may be unable to obtain or maintain licenses
providing freedom to operate on acceptable terms. Thus, the technologies that
we
use to develop our services, and those that we incorporate in our services,
may
be subject to claims that they infringe the patents or proprietary rights of
others. In particular, we are aware of a number of patents and patent
applications owned by others relating to genetic markers and to the analysis
of
gene expression or the manufacture and use of microarrays and related materials.
Therefore, we could be sued by parties alleging patent
infringement.
The
risk
of involvement in patent litigation may increase as the genomics, biotechnology
and software industries and drug repositioning businesses expand, more patents
are issued and other organizations engage in our business fields. We could
incur
substantial litigation costs to defend ourselves in patent infringement suits
brought by other parties or to initiate such suits. In addition, patent
litigation could cause disruption in our business activities and divert
management’s time and attention from the operation of our business. In that
regard, in the past we purchased reagents made by Enzo from Affymetrix, and
also
directly from Enzo. In late 2003, Enzo sued Affymetrix, alleging, among other
things, that Affymetrix had agreements with Gene Logic and other named customers
to supply the Enzo reagent for use by such customers in potential violation
of
Enzo’s rights. That suit continues, but we have not been made a party to that
suit. It is possible that Enzo could in the future make claims or initiate
litigation against us in connection with our prior use of their
reagent.
Our
activities involve hazardous materials and may subject us to environmental
liability.
Certain
activities of our businesses involve the controlled use of limited quantities
of
hazardous and radioactive materials and may generate biological and/or hazardous
waste. We are subject to federal, state and local laws and regulations governing
the use, manufacture, storage, handling and disposal of these materials and
certain waste products. Although we believe that our safety procedures for
handling and disposing of these materials comply with prescribed standards,
we
cannot completely eliminate the risk of accidental contamination or injury
from
these materials. In the event of an accident or if we otherwise fail to comply
with applicable regulations, we could lose our permits and/or approvals or
be
held liable for damages or penalized with fines.
We
believe
that we comply in all material respects with currently applicable environmental
laws and regulations and do not expect near term material additional capital
expenditures for environmental control facilities. However, we may have to
incur
significant costs in the future to comply with environmental laws and
regulations. At present, we also believe we have appropriate insurance coverage
against hazardous materials claims.
If
we are unable to maintain compliance with NASDAQ’s listing requirements, our
stock could be delisted which would negatively impact our liquidity and our
stockholders’ ability to sell shares.
21
Our
listing on the NASDAQ Global Market is conditioned upon our continued compliance
with the NASDAQ Marketplace Rules, including a rule that requires that the
minimum bid price per share for our common stock not be less than $1.00 for
30
consecutive trading days. Given the recent price levels for our common stock,
we
cannot assure that we will be able to continue to comply with such rules. If
we
fail to comply and cannot remedy our noncompliance during any applicable notice
or grace periods, our common stock could be delisted from the NASDAQ Global
Market. The delisting of our common stock would likely have a material
adverse effect on the trading price, volume and marketability of our common
stock.
Upon
a
delisting from the NASDAQ Global Market, our common stock would become subject
to the penny stock rules of the SEC, in which event it is possible that the
price of our common stock would further decline and likely that our stockholders
would find it more difficult to sell their shares.
None.
22
The
following table sets forth information regarding the principal facilities we
own
or lease, the location and approximate size of each such facility or the size
of
the space leased at such property, and their designated use. We believe that
these facilities are in good condition, enable us to serve our customers
efficiently and are sufficient to meet our business needs for the foreseeable
future.
*
As of
December 31, 2006, we had subleased a portion of this property to unrelated
third parties, resulting in $0.4 million in future sublease payments to us
during 2007.
We
are not
currently a party to any legal proceedings that would have a material adverse
effect on our financial condition or results of operations.
None.
23
EXECUTIVE
OFFICERS
The
following table sets forth, as of March 1, 2007, information regarding the
names
and ages of all our executive officers and their respective positions and
offices with us.
Mark
D. Gessler
has
served as Chief Executive Officer since June 2000 and as President since prior
to March 2000. Since March 2000, Mr. Gessler has been a member of our Board
of
Directors and from April 2001 to November 2004, he served as Chairman of the
Board of Directors. Mr. Gessler holds an M.B.A. from the University of
Tennessee.
Philip
L. Rohrer, Jr.
has
served as Chief Financial Officer since prior to March 2000. Mr. Rohrer holds
a
B.A. in biology from Hood College and an M.S.M. from Frostburg State
University.
F.
Dudley Staples, Jr.
has
served as our Senior Vice President, Secretary and General Counsel since May
2002. From prior to March 2000 to May 2001, Mr. Staples served as General
Counsel of Online Office Supplies Company, an online seller of office supplies
and subsidiary of eCommerce Industries, Inc., and then as Associate General
Counsel of eCommerce Industries, Inc. Mr. Staples holds a J.D. degree from
the
University of Virginia School of Law.
Louis
A. Tartaglia, Ph.D.
was
appointed Chief Scientific Officer in February 2007. Prior to that appointment,
he served as Senior Vice President and General Manager, Drug Repositioning
and
Selection beginning in January 2005. Dr. Tartaglia joined Gene Logic in July
2004 following Gene Logic's acquisition of certain technologies from Millennium
Pharmaceuticals, Inc. From 2002 to 2004, Dr. Tartaglia served as Vice President
of New Ventures at Millennium Pharmaceuticals, Inc. From 1999 to 2002, he served
as Vice President of Metabolic Diseases. Dr. Tartaglia holds a Ph.D. in
Biochemistry from the University of California, Berkeley.
Larry
Tiffany
has
served as Senior Vice President, General Manager, Genomics since June 2006.
Prior to returning to Gene Logic, Mr. Tiffany was President and Chief Business
Officer of Genetraks, an Australian-based veterinary molecular diagnostics
firm,
from 2004-2006. Prior to joining Genetraks, Mr. Tiffany was VP, Worldwide
Business Development for Gene Logic. Mr. Tiffany holds a J.D. degree from
Franklin Pierce Law Center; a M.S. in Biotechnology from The Johns Hopkins
University; and a B.S. in Chemistry from Nazareth College.
24
ITEM
5.
MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS
AND ISSUER PURCHASES
OF EQUITY SECURITIES
Our
Common
Stock is traded on the NASDAQ Stock Market under the symbol GLGC. The following
table sets forth information regarding the high and low closing prices for
our
Common Stock, for the periods indicated.
Holders
On
March
1, 2007, the last reported sale price of our Common Stock on the NASDAQ Stock
Market was $1.74. As of March 1, 2007, there were approximately 326 registered
holders of record of our Common Stock, including one company, Cede & Co.,
which is the Registered Nominee for the Depository Trust Company, acting as
holder of record for beneficial holders whose stock is held in street
name.
Dividend
Policy
Since
we
became a public company, we have not paid dividends on our Common Stock.
Currently, we intend to retain future earnings, if any, to finance the growth
and development of our business and do not anticipate paying cash dividends
for
the foreseeable future.
 25
The
selected consolidated financial data set forth below with respect to our
consolidated statements of operations for the years ended December 31, 2006,
2005 and 2004 and with respect to the consolidated balance sheets as of December
31, 2006 and 2005 have been derived from audited consolidated financial
statements included as part of this Form 10-K. The statements of operations
data
for the years ended December 31, 2003 and 2002 and the balance sheet data as
of
December 31, 2004, 2003 and 2002 are derived from audited financial statements
not included in this Form 10-K. The following selected consolidated financial
data includes, for 2006, through 2003 only, the results for our Preclinical
Division (resulting from the April 1, 2003 acquisition of TherImmune Research
Corporation, which was subsequently sold December 15, 2006) and for 2006, 2005
and 2004 only, the results for our Drug Repositioning Division (resulting from
the July 2004 acquisition of technologies from Millennium Pharmaceuticals,
Inc.)
and should be read in conjunction with the consolidated financial statements
and
notes thereto included elsewhere in this Form 10-K.
For
2006,
2005 and 2004, respectively, $3.7 million, $4.2 million, and $2.2 million in
costs previously allocated to the Preclinical Division have been re-allocated
to
the Genomics and Drug Repositioning Divisions. These amounts represent costs
that the Company has now determined will not be eliminated as a result of the
sale of its Preclinical Division.
(1)
Includes $10.9 million loss on disposal for the Preclinical
Division.
(2)
Includes $32.8 million impairment charge associated with the impairment of
goodwill for the Preclinical Division.
26
We
currently conduct our operations through two business segments:
In
2004,
Gene Logic created a pharmaceutical development division (known as our Drug
Repositioning Division) within the Company to identify and develop new or
expanded uses for small molecule therapeutics. Based on advances in our
pharmaceutical development division and changes in our Genomics business,
and
after concluding a comprehensive review of our strategy, we have decided
to
focus our resources on becoming a pharmaceutical development company. We
are now
building a therapeutic pipeline by applying our proprietary drug indication
discovery platform to find new and expanded uses for drug candidates supplied
by
major pharmaceutical companies with whom we have drug development partnerships.
We believe this strategy is the best way to create value for shareholders.
In
2005
and 2006, we entered into drug development partnerships with Pfizer, Inc.,
F.
Hoffmann-La Roche Ltd, Eli Lilly and Company and NV Organon. In 2006, we
began
evaluating more than 40 drug candidates for our drug development partners.
We
have been able to develop alternative indication hypotheses for 25%-33% of
these
candidates for which evaluation is complete. Some of the candidates for which
we
have found new indications have or will progress to in
vivo
efficacy
models to evaluate and support their suitability for re-entering clinical
trials
for the proposed new indications. We expect that some portion of the drug
candidates will have successful outcomes in the in
vivo
tests and
re-enter clinical trials, but we do not yet have sufficient data to estimate
the
rate of clinical trial re-entry. We do not expect any of these drug candidates
to re-enter clinical trials until after 2007.
Early
in
2006, it began to become apparent that our customers had begun to shift their
emphasis away from research on early stage drug discovery where many of our
Genomics services have been targeted, to later stage development and validation
efforts. In response to the declining sales and financial performance that
resulted from this change in emphasis, we restructured the Division and also
began to explore new avenues of value for our Genomics Division, including
capitalizing on our commercially demonstrated expertise in biomarker development
as a potential platform for molecular diagnostics development. We engaged
outside financial advisors to consider strategic alternatives for our Genomics
business. We continue to serve new and existing Genomics customers while
we
explore these alternatives.
Also
in
2006, we announced the closing of the sale of Gene Logic Laboratories, Inc.
to
Bridge Pharmaceuticals, Inc. (“Bridge”) for a sales price of $15.0 million,
including $13.5 million paid at closing less transaction costs of $1.4 million
and $1.5 million held in escrow for 12 months to guarantee certain obligations
under the agreement. The purchase price remains subject to adjustment for
certain changes in working capital and the assumption of certain liabilities
associated with the business. In addition, we provide certain transition
services under and an agreement with Bridge and our guarantees of two leases
continue in effect pending their assignment to and assumption by Bridge.
If the
guarantees are not assumed by Bridge, then Bridge will indemnify us with
respect
to such guarantees. The Preclinical Division provided contract research services
enabling customers to assess the safety and pharmacologic effects of compounds.
We decided to sell the Preclinical Division because the business provided
insufficient strategic or synergistic advantage to our pharmaceutical
development, genomics or molecular diagnostics efforts.
Currently,
most of our revenue comes from our Genomics Division. Historically, we have
derived a majority of our Genomics Division revenue from licenses to our
databases in the form of multi-year subscriptions and annual subscriptions
to
our smaller databases or a subset of our larger databases. We have also granted
perpetual licenses to our data and/or software tools. We also generate revenue
from providing other services, including various toxicogenomics reports,
microarray data generation and analysis and other professional services.
Fees
are payable ratably over the life of the agreement for multi-year agreements,
ratably or up-front for shorter-term agreements and, in the case of perpetual
licenses, upon delivery of the data or software. Generally, our Genomics
Division contracts may be terminated in the event of breach by either party
not
cured within any applicable cure period. In the past, we have invested in
new
database content, upgraded our databases and developed new versions of our
software tools. Future investments will be limited as we continue the
transformation of Gene Logic into a biopharmaceutical company.
27
We
have
developed partnerships with four pharmaceutical partners in 2005 and 2006:
Pfizer, Inc., F. Hoffmann-La Roche Ltd, Eli Lilly and Company, and NV
Organon.
Our
agreement with NV Organon involves co-ownership and co-development of
repositioned drug candidates, and it therefore differs substantially from
our
other agreements. Our other drug repositioning and development agreements
vary
somewhat as to specific terms (see “Contractual Arrangements” earlier), but
generally conform to the following:
In
most
cases, if our partner decides not to take the drug candidate back into
development, we have development rights that would entitle our partner to
receive milestone payments and royalties on sales.
We may
choose to license such candidates to a third party for development, or we
may
invest in further development to increase a particular candidate’s value prior
to outlicensing. We have acquired certain rights from Millennium Pharmaceuticals
to a drug candidate for which we have identified potential new
indications.
We
have
incurred net losses in each year since our inception, including losses of
$54.7
million in 2006, $48.3 million in 2005 and $28.5 million in 2004. At December
31, 2006, we had an accumulated deficit of $315.7 million. Our losses have
resulted principally from costs incurred in the development, marketing and
sale
of services from our Genomics and Preclinical Divisions, development of the
Drug
Repositioning Division, the impairment of our Preclinical Division goodwill
and
acquisitions of research and development. These costs have exceeded our revenue
and we expect to incur additional losses in the future.
Revenue.
We
primarily derive our revenue from our Genomics Division services. To date,
we
have recorded no meaningful revenue from our Drug Repositioning Division.
Revenue from continuing operations decreased $32.8 million, or 57%, to $24.3
million in 2006 from $57.2 million in 2005. During 2006, three customers
each
accounted for greater than 10% of our total revenue. During 2005, two customers
accounted for greater than 10% of our total revenue. The 2006 decrease in
revenue resulted from declining subscription revenue, the absence of anticipated
sales of perpetual licenses to database products and slower than anticipated
sales growth for microarray data generation and analysis services. These
changes
were caused primarily by our customers’ having shifted their emphasis from
research on early stage drug development, for which many of our Genomics
Division services are targeted, into later-stage development and validation
efforts. The 2006 results reflect the absence of $28.6 million in subscription
fees from expired agreements, $2.7 million less for perpetual license fees
and
reduced revenue of $2.4 million from certain agreements with existing customers
renegotiated at reduced service levels, partially offset by higher revenue
of
$2.8 million from increased microarray data generation and analysis services
in
2006.
In
2006,
long-term subscription agreements with five customers were to expire by their
terms and two agreements allowed for early termination at the customer’s
election. These agreements accounted for 38% of our Genomics services revenue
in
2006, of which 16% consisted of revenue from the sale of perpetual licenses
to
data and software. As to the two agreements that were subject to early
termination at the customer’s election, one customer terminated its agreement
early and one customer elected to continue its agreement. As to the remaining
five agreements, four agreements have expired by their terms and one was
terminated by mutual agreement. Three of these customers purchased perpetual
licenses to data and software in connection with their respective terminations.
28
Our
remaining long-term subscriptions are due to expire by their terms in 2008.
For
2007, we expect to continue to derive more revenue from our other services
and
reduce our revenue from large, multi-year subscription agreements.
Database
Production Expense.
Database
production expenses, which consist primarily of costs to provide microarray
data
generation and analysis services and costs related to the acquisition and
processing of tissues and overhead expenses needed to generate the content
for
the BioExpress and ToxExpress System databases, decreased to $27.4 million
for
2006 from $31.7 million for 2005. The decrease consisted primarily of a
$4.2 million
reduction in database production expenses, including lower costs for agreements
with third parties, partially offset by $1.0 million increase in inventory
reserves in 2006. For 2007, we expect database production expenses to decrease
due to the restructuring of the Genomics Division and increased customer
demand
for microarray data generation and analysis services.
Research
and Development Expense.
Research
and development expenses, which consist primarily of costs associated with
the
evaluation of customer-supplied drug candidates and ongoing development of
our
drug indication discovery platform, increased to $9.9 million for 2006 from
$6.8
million for 2005. The increase was primarily the result of large numbers
of
evaluations of drug candidates begun under the terms of our drug discovery
partnerships. For 2007, we expect research and development expenses to increase
modestly, as we continue to evaluate drug candidates supplied by our drug
discovery partners and further develop our indication discovery platform.
In
addition, we may incur additional expenses if we decide to pursue further
development of a drug candidate for which we acquired certain rights from
Millennium in 2006.
Selling,
General and Administrative Expense.
Selling,
general and administrative expenses from continuing operations, which consist
primarily of sales, marketing, accounting, legal, human resources and other
general corporate expenses, decreased to $22.4 million for 2006 from $26.8
million for 2005. The decrease is largely due a reduction of $2.0 million
in
costs under the terms of our 2006 annual employee incentive compensation
plan
and lower payroll expense for Genomics Division and Corporate staff. For
2007,
we expect selling, general and administrative expenses to decrease, primarily
due to the restructuring of the Genomics Division.
Genomics
Division Restructuring Expense.
During
2006, we initiated a restructuring of our Genomics Division, which is expected
to be substantially completed by December 31, 2007. This restructuring included
the termination of 70 employees, which resulted in severance costs of $1.5
million; the acceleration of future costs of $2.4 million for certain
laboratory and office facilities that were no longer needed for continuing
operations and were either abandoned or for which we have entered into sublease
arrangements; and the impairment of certain intangible assets of $1.3 million,
primarily patent and license costs, which we determined would no longer be
utilized by our Genomics Division. Once fully implemented, we estimate that
the
staff reductions will reduce our annual salary and fringe benefits costs
by
approximately $8.0 million and we expect to realize additional savings in
certain non-employee costs in connection with this restructuring.
Net
Interest Income. Net
interest income increased to $2.7 million for 2006 from $2.6 million for
2005,
due to increases in our rates of return on investments, largely offset by
a
decline in the balance of our cash and cash equivalents and marketable
securities available-for-sale.
Other
(Income) Expense. Other
(income) expense was an expense of $0.1 million for 2006 compared to income
of
$0.8 million for 2005, due to foreign currency transaction losses and gains
in
each period, respectively, relating to our subscription agreements with our
Japanese customers. Beginning in 2005, as a result of changing our distribution
arrangements in Japan, our agreements with our Japanese customers are now
denominated in Japanese Yen.
Write-down
of Other-than-Temporary Decline in the Value of Marketable Securities
Available-for-Sale. In
2005,
we recorded a $0.7 million write-down of our investment in Avalon
Pharmaceuticals, Inc., due to an other-than-temporary decline in its estimated
market value.
Write-down
of Equity Investment.
In
connection with our investment in Xceed Molecular (“Xceed”, formerly MetriGenix
Corporation) in 2003, we had entered into a subscription agreement granting
Xceed a license to use our BioExpress System and had been issued a warrant
to
enable us to maintain our 15% equity ownership in Xceed, which would terminate
upon termination of the subscription agreement. In 2006, we terminated the
subscription agreement by mutual agreement and the warrant was therefore
terminated. As a result, we recorded a $0.3 million write-down of the fair
value
of this warrant during 2006. At December 31, 2006, the remaining book value
of
our investment in Xceed was $3.0 million, which we believe approximates fair
value.
29
Revenue.
Revenue
from continuing operations increased $5.0 million, or 10%, to $57.2 million
in
2005 from $52.2 million in 2004. During 2005, two customers each accounted
for
greater than 10% of our total revenue. During 2004, one customer accounted
for
greater than 10% of our total revenue. The increase in 2005 reflected $11.7
million in additional revenue from sales to several existing customers of
perpetual licenses for certain data and software, partially offset by $4.2
million less revenue from certain agreement extensions at reduced service
levels
and the absence of $3.9 million in subscription fees from agreements that
expired.
Database
Production Expense.
Database
production expenses, which consisted primarily of costs related to the
acquisition and processing of tissues and overhead expenses needed to generate
additional content for the BioExpress and ToxExpress System databases, decreased
to $31.7 million for 2005 from $41.9 million for 2004. The decrease consisted
primarily of a $7.6 million reduction in database production expenses, including
lower costs for acquiring tissues and certain agreements with third parties,
and
a decrease of $3.1 million in depreciation and amortization expense.
Research
and Development Expense.
Research
and development expenses, associated primarily with our Drug Repositioning
Division, increased to $6.8 million for 2005 from $2.4 million for 2004.
The
increase was primarily a result of further development of the biological
screening technologies acquired from Millennium in 2004.
Selling,
General and Administrative Expense.
Selling,
general and administrative expenses, which consist primarily of sales,
marketing, accounting, legal, human resources and other general corporate
expenses, increased to $26.8 million for 2005 from $19.2 million for 2004.
The
increase is largely due to an increase of $4.4 million in our investment
in our
Drug Repositioning Division and increased costs under our 2005 annual employee
incentive compensation plan.
Purchased
Research and Development.
During
2004, we incurred a one-time expense of $8.8 million for the write-off of
purchased in-process research and development associated with the acquisition
of
biological screening technologies acquired from Millennium.
Net
Interest Income. Net
interest income increased to $2.6 million for 2005 from $1.4 million for
2004,
due to increases in our rates of return on investments, partially offset
by a
decline in the balance of our cash and cash equivalents and marketable
securities available-for-sale.
Other
(Income) Expense. Other
(income) expense increased to $0.8 million for 2005 from zero for 2004, due
to
foreign currency transaction gains relating to our Japanese customers. Beginning
in 2005, as a result of changing our Japanese distribution arrangements,
our
agreements with our Japanese customers are denominated in Japanese
Yen.
Write-down
of Other-than-Temporary Decline in the Value of Marketable Securities
Available-for-Sale. In
2005,
we recorded a $0.7 million write-down of our investment in Avalon
Pharmaceuticals, Inc., due to an other-than-temporary decline in its estimated
market value.
LIQUIDITY
AND CAPITAL RESOURCES
From
inception through December 31, 2006, we have financed our operations and
acquisitions through the issuance and sale of equity securities and payments
from customers. As of December 31, 2006, we had approximately $50.1 million
in
cash, cash equivalents and marketable securities available-for-sale, compared
to
$82.1 million as of December 31, 2005.
Net
cash
from operating activities from continuing operations decreased to a negative
$34.0 million for 2006 from a positive $6.1 million for 2005,
primarily due to our increased net loss from continuing operations for
2006, the timing of customer payments (including prepayments) for our
services in 2005 and payments in 2006 to Millennium and under our compensation
and retention plans. We presently anticipate that our use of cash for 2007
will
be lower due to an anticipated lower net loss from continuing operations.
During
2006 and 2005, our investing activities consisted primarily of purchases,
sales
and maturities of available-for-sale securities, capital expenditures and
software development and database upgrade costs. Capital expenditures for
2006
and 2005 were $2.0 million and $9.9 million, respectively. The decrease in
capital expenditures was primarily due to the completion in 2005 of a
significant facility renovation. For 2007, we do not expect the level of
capital
expenditures to be significant.
We
have
capitalized software development costs of $1.0 million and $2.1 million for
2006
and 2005, respectively. These costs related to efforts to enhance the software
platform of our BioExpress and ToxExpress System databases. Also, we have
incurred database upgrade costs of $2.6 million and $4.2 million for 2006
and
2005, respectively, enhancing the content of our databases using new versions
of
microarrays from Affymetrix. Future investments in upgrades and new versions
of
our software tools are being evaluated as part of our overall strategy for
the
Genomics Division.
In
2006,
we announced the closing of the sale of our Preclinical Division to Bridge
for a
sales price of $15.0 million, including $13.5 million paid at closing less
transaction costs of $1.4 million and $1.5 million held in escrow for 12
months
to guarantee certain obligations under the
agreement.
30
Our
financing activities, other than the repayment of an equipment loan, have
primarily consisted of the exercise of stock options.
In
July
2004, we purchased and licensed certain biological screening technologies
utilized by our Drug Repositioning Division and hired a research team from
Millennium. During 2006, we paid Millennium $3.5 million in cash representing
the final installment of the purchase price. In connection with the purchase,
we
also contractually agreed to, and subsequently met, a commitment to spend
an
aggregate of $14.5 million to further develop and commercialize these
technologies.
To
generate our gene expression data, we use Affymetrix microarrays,
instrumentation and software. Under the terms of our current supply and license
agreements with Affymetrix, we do not have a purchase commitment. In 2006,
under
the prior agreement, we agreed to purchase a minimum of $7.1 million in products
and services from Affymetrix in 2006. As of December 31, 2006, we had met
this
commitment.
Specific
future financial commitments from continuing operations as of December 31,
2006
are set forth in the following table:
We
believe
that existing cash, cash equivalents and marketable securities
available-for-sale and anticipated payments from customers will be sufficient
to
support our operations for the foreseeable future. These estimates are
forward-looking statements that involve risks and uncertainties. Our actual
future capital requirements and the adequacy of our available funds will
depend
on many factors, including those discussed under “Risks Related to Our Business
and Industry” elsewhere in this Report.
Our
consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States, which require management
to
make estimates and assumptions that affect the reported amounts of assets
and
liabilities at the date of the financial statements and the reported amounts
of
revenue and expenses during the reporting period. Actual results could differ
from these estimates. The following discussion highlights what we believe
to be
the critical accounting policies and judgments made in the preparation of
these
consolidated financial statements.
Revenue
is
recognized in accordance with the SEC’s Staff Accounting Bulletin No. 104,
“Revenue Recognition” (“SAB 104”). SAB 104 requires that four basic criteria be
met before revenue can be recognized: 1) persuasive evidence of an arrangement
exists; 2) delivery has occurred or services rendered; 3) the fee is fixed
and
determinable; and 4) collectability is reasonably assured. As to 1), our
business practices require that our services be performed pursuant to contracts
with our customers. As to 2), we recognize revenue when services are rendered
to
our customers. Determination of 3) and 4) are based on management’s judgments
regarding the fixed nature of our arrangements taking into account termination
provisions and the collectability of fees under our arrangements. Should
changes
in conditions cause management to determine these criteria are not met for
certain future arrangements, revenue recognized for any reporting period
would
be adjusted and could be adversely affected.
In
accordance with Emerging Issues Task Force Issue No. 00-21, “Revenue
Arrangements with Multiple Deliverables”, revenue recognized for any
multiple-element contract is allocated to each element of the arrangement
based
on the relative fair value of the element. The determination of fair value
of
each element is based on our analysis of objective evidence from comparable
internal or third-parties’ sales of the individual element. If we are unable to
determine evidence of fair value for an undelivered element of the arrangement,
revenue for the arrangement is deferred and recognized using the revenue
recognition method appropriate to the predominant undelivered
element.
Genomics
Services Revenue.
Through
2006, the majority of Genomics services revenue consists of fees earned under
subscription agreements for all or parts of our gene expression databases,
the
BioExpress System and ToxExpress System, which are typically for a specific
multi-year term for the larger databases and annual terms for smaller parts
of
the databases. We have also granted to some customers perpetual licenses
to
certain data from our BioExpress and ToxExpress System databases and software
tools. In addition, we have generated a smaller, but growing percentage of
revenue from providing other services, including various toxicogenomics reports,
microarray data generation and analysis and other professional services.
Revenue
from subscription agreements is recognized ratably over the period during
which
the customer has access to the database. Certain subscription agreements
have
included a right of early termination (which, in some instances, is subject
to
conditions) by the customer, without penalty, on a specified date prior to
the
normal expiration of the term. If any agreement has a right of early
termination, revenue is recognized ratably over the subscription term up
to the
possible date of early termination, based on subscription fees earned under
the
agreement through the possible date of early termination. If such early
termination does not occur, the balance of the subscription fees earned under
the agreement is recognized as revenue ratably over the remaining term of
the
agreement. Revenue from perpetual licenses to data and software for which
the
Company is not obligated to provide continuing support or services is recognized
when the data and/or software has been delivered. Revenue from perpetual
licenses for which the Company is obligated to provide continuing support
or
services is recognized during the period such support or services are provided.
Revenue from other services is recognized when the services are performed.
Our
agreements generally provide for termination in the event of a breach of
the
agreement by either party or a bankruptcy or insolvency of either
party.
31
Periodically,
we enter into contractual arrangements with multiple deliverables. If we
are
unable to determine objectively and reliably the fair value of individual
undelivered elements, we recognize all revenue using the revenue recognition
method appropriate to the predominant undelivered element. We also defer
the
direct and incremental expenses associated with the delivery of services
for
which revenue has been deferred and recognize these expenses as we recognize
the
related revenue. The timing of revenue recognition associated with agreements
we
enter into in future periods may also be dependent on our ability to objectively
and reliably determine the fair value of deliverables included in those
agreements.
Under
Statement of Financial Accounting Standards No. 142, “Goodwill and Other
Intangible Assets”, we are required to perform an annual impairment test of our
goodwill and periodic reviews of our other intangible assets. In addition,
we
are required to test for impairment at any point we have an indication that
impairment may exist. We have elected to perform our annual impairment test
of
goodwill as of October 1. The goodwill impairment test that we have historically
selected consisted of a ten-year discounted cash flow analysis, including
the
determination of a terminal value, and required management to make various
judgments and assumptions, including revenue growth rates and discount rates,
which management believed to be reasonable.
In
conjunction with our review of assets held for sale of the Preclinical Division,
we determined that the remaining value of the goodwill that resulted from
the
acquisition of TherImmune (later renamed Gene Logic Laboratories Inc., our
former Preclinical Division) was likely impaired, due to our assessment of
the
possible indications of fair value resulting from our decision to consider
the
sale of the division. As a result, we recorded a non-cash expense of $10.2
million which was included in the $11.0 million impairment charge in the
third quarter of 2006 representing the implied impairment of goodwill of
our
Preclinical Division. During the third quarter of 2005, we recorded a non-cash
expense of $32.8 million representing the implied impairment of goodwill
of our
Preclinical Division. These non-cash expenses are included in the loss from
discontinued operations of our Preclinical Division for the respective periods.
As
part of
our annual testing of goodwill, we determined that no impairment existed
in the
carrying value of goodwill of our Genomics Division. However, due to the
restructuring of our Genomics Division, we recorded impairment charges of
$1.3
million in the third quarter of 2006 for certain intangible assets which
we
determined would no longer be utilized by our Genomics Division.
Our
assessment of the fair value of our divisions is dependent on subjective
estimates we make of inherently uncertain future net cash flows including
estimates of terminal values. Accordingly, our estimates for future periods
of
net cash flows may change as market conditions and circumstances dictate.
Future
impairment tests of goodwill for our Genomics Division and other intangibles
may
result in additional impairment charges based on these changing estimates.
ACCOUNTS
RECEIVABLE AND UNBILLED SERVICES
Our
ability to collect outstanding receivables and unbilled services from our
customers is critical to our operating performance and cash flows. Typically,
arrangements with our customers require that the payments for our services
be
made in advance, based upon the achievement of milestones or in accordance
with
predetermined payment schedules. We have an allowance for doubtful accounts
based on our estimate of accounts receivable that are at risk of collection.
If
the financial condition of our customers were to deteriorate, resulting in
an
impairment of their ability to make payments, an increase in the allowance
for
doubtful accounts may be required.
32
INVENTORY
We
maintain an inventory of tissue samples collected from various commercial
and
academic sites that are used to expand the content of our databases. We assess
the quality and supply of samples in excess of our current requirements in
determining appropriate reserves. Our methods for calculating these reserves
are
based both on historical performance and management estimates. Inventory
reserves are reviewed for adjustment on an ongoing basis. Changes in tissue
quality and/or our requirements for their use could potentially cause
adjustments to these reserves in future periods.
We
also
maintain an inventory of microarrays and reagents used to generate genomic
data
for our databases and for services in our Genomics Division. This inventory
is
valued at the lower of cost or market. Certain items in inventory may be
considered impaired, obsolete, or excessive and as such, we may establish
an
allowance to reduce the carrying value of these items to their net realizable
value. Based on certain estimates, assumptions and judgments made from
information available at the time, we determine the appropriate amount of
any
such inventory allowance. If these estimates or assumptions or the market
for
the use of our microarrays and reagents change, we may be required to record
additional reserves.
Following
the write-down of $0.3 million in 2006, we hold an equity investment in one
company (Xceed Molecular, formerly MetriGenix) with a remaining book value
of
$3.0 million as of December 31, 2006. We record an investment impairment
charge
when it is believed that an investment has experienced a decline in value
that
is other-than-temporary. Future adverse changes in market conditions or poor
operating results of the underlying investee could result in our inability
to
recover the carrying value of this investment that may not be reflected in
such
an investment’s current carrying value, thereby possibly requiring an impairment
charge in the future.
STOCK-BASED
COMPENSATION
In
the
first quarter of 2006, we adopted Statement of Financial Accounting Standards
No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”). SFAS 123R requires
us to expense the fair value of stock-based compensation awards of our various
stock-based compensation programs over the requisite service period of the
award. We estimate the fair value of our stock-based compensation using fair
value pricing models which require the use of significant assumptions for
expected volatility of our common stock, life of stock options and risk-free
interest rate. Future adverse changes in such assumptions could result in
us
recording increased stock-based compensation expenses for stock-based
compensation awards granted/issued in the future.
In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards No. 157, “Fair Value Measurements”
(“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring
fair value under generally accepted accounting principles and expands
disclosures about fair value measurements. SFAS 157 emphasizes that fair
value
is a market-based measurement, not an entity-specific measurement, and states
that a fair value measurement should be determined based on the assumptions
that
market participants would use in pricing the asset or liability. This Statement
applies under other accounting pronouncements that require or permit fair
value
measurements, for which the FASB previously concluded in such accounting
pronouncements that fair value is the relevant measurement attribute.
Accordingly, this Statement does not require any new fair value measurements.
SFAS 157 is effective for fiscal years beginning after November 15, 2007,
which
we intend to adopt on January 1, 2008. We are currently evaluating the impact,
if any, that SFAS 157 will have on our financial position, results of operations
and cash flows, but do not believe the effect will be material.
In
July
2006, the Financial Accounting Standards Board issued Interpretation No.
48,
"Accounting for Uncertainty in Income Taxes" ("FIN 48") which clarifies the
accounting for income taxes by prescribing the minimum recognition threshold
a
tax position is required to meet before being recognized in the financial
statements. FIN 48 also provides guidance on derecognition, measurement,
classification, interest and penalties, accounting in interim periods,
disclosure and transition. FIN 48 is effective for fiscal years beginning
after
December 15, 2006. We do not expect the adoption of this Interpretation to
have
a material impact on our financial statements.
33
Effective
January 1, 2006, we adopted the fair value recognition provisions of SFAS
123R,
using the modified prospective transition method, and therefore have not
restated results for prior periods. Under this method, we recognize compensation
expense for all share-based payments granted after January 1, 2006 and for
those
that were granted prior to, but have not yet vested as of, January 1, 2006,
in
accordance with SFAS 123R. For 2006, stock-based compensation awards consisted
of options awarded under the 1997 Equity Incentive Plan and the 1997
Non-Employee Directors’ Stock Option Plan. Under the fair value recognition
provisions of SFAS 123R, we recognize stock-based compensation net of an
estimated forfeiture rate and recognize the compensation cost for those shares
expected to vest on a straight-line basis over the requisite service period
of
the award. Prior to SFAS 123R adoption, we accounted for share-based payments
under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued
to Employees” and accordingly, were required to recognize compensation expense
only to the extent that the fair value of the underlying stock on the date
of
grant exceeded the exercise or acquisition price of the stock or stock-based
award. Since stock options granted by us in the last several years have been
granted with an exercise price equal to the fair value on the grant date,
we did
not recognize any expense for such options prior to our adoption of SFAS
123R.
Our net
loss from continuing operations and total net loss for 2006 were impacted
by the recognition of $0.6 million and $0.8 million, respectively, in
non-cash expense related to the fair value of our stock-based compensation
awards. The impact of stock compensation expense in future periods will be
dependent on the number and type of share-based payments issued to employees
and
non-employee directors.
ITEM
7A. QUANTITATIVE AND
QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We
have
exposure to financial market risks, including changes in interest rates.
At
December 31, 2006, we had cash and cash equivalents of approximately $25.7
million and marketable securities available-for-sale of an additional $24.4
million. We invest our excess cash primarily in money market funds, obligations
of the U.S. Government and its agencies and marketable debt securities of
companies with strong credit ratings. These instruments have maturities of
twenty-four months or less when purchased. We do not utilize derivative
financial instruments, derivative commodity instruments or other market risk
sensitive instruments, positions or transactions in any material fashion.
Accordingly, we believe that, while the instruments we hold are subject to
changes in the financial standing of the issuer of such securities, we are
not
subject to any material risks arising from changes in foreign currency exchange
rates, commodity prices, equity prices or other market changes that affect
market risk sensitive instruments. Based on our cash and cash equivalents
and
marketable securities available-for-sale balances at December 31, 2006, a
hypothetical 100 basis point adverse movement in interest rates would have
resulted in an increase in the net loss of approximately $0.5 million for
the
year ended December 31, 2006. Actual changes in rates may differ from the
hypothetical assumptions used in computing this exposure.
Since
the
beginning of 2005 and as a result of changing our distribution arrangements
in
Japan, we have been subject to risk from changes in foreign exchange rates
relating to revenue with our Japanese customers, as such agreements are now
denominated in Japanese Yen. Such changes could result in foreign currency
exchange gains or losses. As a policy, we convert our customer payments made
in
Japanese Yen to United States dollars upon receipt of such payments. Revenue
derived from the Pacific Rim as a percentage of total revenue was 39% for
the
year ended December 31, 2006 and was primarily derived from our customers
in
Japan. Exchange rate fluctuations between the United States dollar and Japan
could result in positive or negative fluctuations in the amounts relating
to
revenue reported in our consolidated financial statements. A hypothetical
10%
adverse change in average foreign currency movements would have resulted
in an
increase in the net loss of approximately $0.7 million for the year ended
December 31, 2006. There can be no assurance that losses related to this
currency risk will not occur.
ITEM
8. FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA
Our
Consolidated Financial Statements and notes thereto, together with the Reports
of Independent Registered Public Accounting Firm, appear on pages F-1 through
F-22 of this Annual Report on Form 10-K and are incorporated herein by
reference.
ITEM
9. CHANGES IN AND
DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM
9A. CONTROLS AND PROCEDURES
Attached
as exhibits to this Form 10-K are certifications of our Chief Executive Officer
(CEO) and Chief Financial Officer (CFO), which are required in accordance
with
Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the Exchange
Act). This “Controls and Procedures” section includes information concerning the
controls and controls evaluation referred to in the certifications. Part
II,
Item 8 of this Form 10-K sets forth the report of Ernst & Young LLP, our
independent registered public accounting firm, regarding its audit of our
internal control over financial reporting and of management’s assessment of
internal control over financial reporting set forth below in this section.
This
section should be read in conjunction with the certifications and the Ernst
& Young LLP report for a more complete understanding of the topics
presented.
34
As
of
December 31, 2006, under the supervision and with the participation of our
management, including the Chief Executive Officer (“CEO”) and Chief Financial
Officer (“CFO”), an evaluation was performed of the effectiveness of the design
and operation of our “disclosure controls and procedures” (“Disclosure
Controls”). These are controls and procedures designed to reasonably assure that
information required to be disclosed in our reports filed under the Exchange
Act, such as this Form 10-K, is recorded, processed, summarized and reported
within the time periods specified in the rules and forms of the United States
Securities and Exchange Commission (“SEC”). Disclosure Controls are also
designed to reasonably assure that such information is accumulated and
communicated to our management, including the CEO and CFO as appropriate,
to
allow timely decisions regarding required disclosure. Based on that evaluation,
our CEO and CFO have concluded that, as of December 31, 2006, our disclosure
controls and procedures were effective to provide reasonable assurance that
information required to be disclosed in our Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified by the
SEC,
and that material information relating to us is made known to management,
including the CEO and CFO, particularly during the period when our periodic
reports are being prepared.
Our
management, including the CEO and CFO, does not expect that our Disclosure
Controls or our internal control over financial reporting will prevent or
detect
all errors and all instances of fraud. A control system, no matter how well
designed and operated, can provide only reasonable, not absolute, assurance
that
the control system’s objectives will be met. The design of a control system must
reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Further, because of
the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that misstatements due to error or fraud will
not
occur or that all control issues and instances of fraud, if any, within the
Company have been detected. These inherent limitations include the realities
that judgments in decision-making can be faulty and that breakdowns can occur
because of simple error or mistake. Controls can also be circumvented by
the
individual acts of some persons, by collusion of two or more people, or by
management override of the controls. The design of any system of controls
is
based, in part, on certain assumptions about the likelihood of future events
and
there can be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions. Projections of any evaluation
of
the effectiveness of controls to future periods are subject to risks. Over
time,
controls may become inadequate because of changes in conditions or deterioration
in the degree of compliance with policies or procedures.
MANAGEMENT'S
REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our
management is responsible for establishing and maintaining adequate “internal
control over financial reporting” to provide reasonable assurance regarding the
reliability of our financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles. Internal control over financial reporting includes
those
policies and procedures that (i) pertain to the maintenance of records that
in
reasonable detail accurately and fairly reflect the transactions and
dispositions of the assets of the company; (ii) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and
that
receipts and expenditures of the company are being made only in accordance
with
authorizations of management and directors of the company; and (iii) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the company’s assets that could have a
material effect on the financial statements.
Under
the
supervision and with the participation of our management, including our CEO
and
CFO, we conducted an evaluation of the effectiveness of our internal control
over financial reporting as of December 31, 2006 based on the framework in
Internal
Control--Integrated Framework
issued by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Based on that evaluation, our management concluded that our internal control
over financial reporting was effective as of December 31, 2006 to provide
reasonable assurance regarding the reliability of financial reporting and
the
preparation of financial statements for external reporting purposes in
accordance with generally accepted accounting principles.
Management’s
assessment of the effectiveness of our internal control over financial reporting
as of December 31, 2006 has been audited by Ernst & Young LLP, an
independent registered public accounting firm. Ernst & Young LLP has issued
an attestation report concurring with management’s assessment, which is included
in Part II, Item 8 of this Form 10-K.
There
were
no changes in our internal controls over financial reporting during the fourth
quarter of 2006 that materially affected or are reasonably likely to materially
affect our internal controls over financial reporting.
35
ITEM
9B. OTHER
INFORMATION
None.
ITEM
10.
DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT
IDENTIFICATION
OF DIRECTORS
The
information required by this item is incorporated by reference to the
information set forth in the section entitled “Election of Directors,” contained
in the Company’s definitive Proxy Statement for the 2007 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission within
120
days following the Company’s fiscal year ended December 31, 2006 (the “Proxy
Statement”).
The
information required by this item is incorporated by reference to the
information set forth in the section entitled “Executive Officers” in Part I,
following Item 4 of this Annual Report on Form 10-K.
The
information required by this item is incorporated by reference to the
information set forth in the section entitled “Section 16(a) Beneficial
Ownership Reporting Compliance,” contained in the Proxy Statement.
The
information required by this item is incorporated by reference to the
information set forth in the section entitled “Corporate Governance,” contained
in the Proxy Statement.
The
information required by this item is incorporated by reference to the
information set forth in the section entitled “Executive Compensation,”
contained in the Proxy Statement.
ITEM
12. SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED MATTERS
The
information required by this item is incorporated by reference to the
information set forth in the section entitled “Security Ownership of Certain
Beneficial Owners and Management,” contained in the Proxy
Statement.
The
information required by this item is incorporated by reference to the
information set forth in the section entitled “Certain Transactions,” contained
in the Proxy Statement.
The
information required by this item is incorporated by reference to the
information set forth in the section entitled “Principal Accountant Fees and
Services,” contained in the Proxy Statement.
36
ITEM
15.
EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES
(a)
1. Financial Statements
(a)
2. Financial Statement Schedules
All
other
schedules for which provision is made in the applicable accounting regulations
of the SEC are not required under the related instruction or are inapplicable
and therefore have been omitted.
37
_____________________
38
39
40
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of
1934, the Registrant has duly caused this report to be signed on its behalf
by
the undersigned, thereunto duly authorized, on the 16th
day of
March, 2007.
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed below by the following persons on behalf of the Registrant and in
the
capacities and on the dates indicated.
41
Gene
Logic Inc.
Index
to Consolidated Financial Statements
F-1
Internal
Control Over Financial Reporting
The
Board
of Directors and Stockholders of Gene Logic Inc.
We
have
audited management’s assessment, included in the accompanying Management’s
Report on Internal Controls Over Financial Reporting listed as Item 9A, that
Gene Logic Inc. maintained effective internal control over financial reporting
as of December 31, 2006, based on criteria established in Internal
Control-Integrated Framework
issued by
the Committee of Sponsoring Organizations of the Treadway Commission (the COSO
criteria). Gene Logic Inc.’s management is responsible for maintaining effective
internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility
is to express an opinion on management’s assessment and an opinion on the
effectiveness of the company’s internal control over financial reporting based
on our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control
over
financial reporting, evaluating management’s assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing
such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain
to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors
of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial statements.
Because
of
its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In
our
opinion, management’s assessment that Gene Logic Inc. maintained effective
internal control over financial reporting as of December 31, 2006 is fairly
stated, in all material respects, based on the COSO criteria. Also, in our
opinion, Gene Logic Inc. maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2006, based on
the
COSO criteria.
We
also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Gene Logic
Inc. as of December 31, 2006 and 2005, and the related consolidated statements
of operations, stockholders’ equity, and cash flows for each of the three years
in the period ended December 31, 2006, and our report dated March 14, 2007
expressed an unqualified opinion thereon.
/s/
ERNST
& YOUNG LLP
Baltimore,
Maryland
March
14,
2007
F-2
Consolidated
Financial Statements
The
Board
of Directors and Stockholders Gene Logic Inc.
We
have
audited the accompanying consolidated balance sheets of Gene Logic Inc. as
of
December 31, 2006 and 2005, and the related consolidated statements of
operations, stockholders’ equity, and cash flows for each of the three years in
the period ended December 31, 2006. Our audits also included the financial
statement schedule listed in the Index at Item 15(a). These financial statements
and schedule are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In
our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Gene Logic Inc. at
December 31, 2006 and 2005, and the consolidated results of its operations
and
its cash flows for each of the three years in the period ended December 31,
2006
in conformity with U.S. generally accepted accounting principles. Also, in
our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
As
discussed in Note 1 to the consolidated financial statements, in 2006, the
Company changed its method of accounting for stock-based compensation upon
the
adoption of Statement of Financial Accounting Standard No. 123(R), “Shared-Based
Payments”.
We
also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of Gene Logic Inc.’s internal
control over financial reporting as of December 31, 2006, based on criteria
established in Internal
Control-Integrated Framework
issued by
the Committee of Sponsoring Organizations of the Treadway Commission and our
report dated March 14, 2007 expressed an unqualified opinion thereon.
/s/
ERNST
& YOUNG LLP
Baltimore,
Maryland
March
14,
2007
F-3
Consolidated
Balance Sheets
as
of December 31, 2006 and 2005
(in
thousands, except share data)
F-4
Consolidated
Statements of Operations
For
the Years Ended December 31, 2006, 2005 and 2004
(in
thousands, except per share data)
F-5
Consolidated
Statements of Stockholders’ Equity
For
the Years Ended December 31, 2004, 2005 and 2006
(in
thousands, except number of shares)
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