ZymoGenetics 10-Q 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2008
FOR THE TRANSITION PERIOD FROM TO
Commission File Number: 0-33489
(exact name of registrant as specified in its charter)
1201 Eastlake Avenue East, Seattle, Washington 98102
(Address of principal executive offices) (Zip Code)
(Registrants telephone number, including area code)
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, and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
Common stock outstanding at July 30, 2008: 68,724,083 shares.
Quarterly Report on Form 10-Q
For the quarterly period ended June 30, 2008
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements of ZymoGenetics, Inc. (the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such rules and regulations. In the opinion of management, the financial statements reflect all normal recurring adjustments necessary to present fairly the Companys financial position and results of operations as of and for the periods indicated. Operating results for such periods are not necessarily indicative of the results that may be expected for the full year or for any future period.
These unaudited interim financial statements should be read in conjunction with the audited financial statements and related footnotes included in the Companys Annual Report filed on Form 10-K for the year ended December 31, 2007.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and that affect the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Basic and diluted net loss per share have been computed based on net loss and the weighted-average number of common shares outstanding during the applicable period. The Company has excluded 14.1 million outstanding options to purchase common stock and 620,500 restricted stock units as such potential shares are antidilutive for all periods presented.
Short-term investments consisted of the following at June 30, 2008 (in thousands):
The Companys management has concluded that unrealized losses are temporary and the Company has the ability and intent to hold the investments until at least substantially all of the cost of the investments is expected to be recovered. As of June 30, 2008, the weighted average expected maturity dates for all securities did not exceed three years.
Included in other assets is a long-term investment in common shares of BioMimetic Therapeutics, Inc. (BMTI), a company that licensed certain technologies from the Company and made certain payments in shares of common stock. These shares became publicly traded in 2006 and, as a result, are adjusted to fair value, with the unrealized gain reported as a separate component of shareholders equity. For the three months ended June 30, 2008, the unrealized gain on the investment increased by $579,000 and for the six months ended June 30, 2008, the unrealized gain on the investment decreased by $993,000. As of June 30, 2008, the unrealized gain on the investment was $922,000.
Fair value measurements
Effective January 1, 2008, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 157, Fair Value Measurements (FAS 157). FAS 157 establishes that fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price) and establishes a fair value hierarchy based on the inputs used to measure fair value. The three levels of the fair value hierarchy defined by FAS 157 are as follows:
As required by FAS 157, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Companys assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. The Companys short-term and long-term investments accounted for at fair value as of June 30, 2008 are summarized below (in thousands):
Inventory is stated at the lower of cost or market. Cost includes amounts related to materials, labor and overhead, and is determined on a specific identification basis in a manner which approximates the first-in, first-out (FIFO) method. Prior to FDA approval of RECOTHROM®, recombinant thrombin on January 17, 2008, all manufacturing related costs were expensed as research and development. The inventory balances reflect the cost of post-approval manufacturing activities. Inventory consisted of the following at June 30, 2008 (in thousands):
The Company has entered into a purchase and sale agreement, which expires August 18, 2008, to sell land located near its corporate headquarters. The sale is subject to various contingencies including the buyers due diligence investigations of the land. Previously, the land had been held for future expansion. The carrying cost of the land, which was $4.5 million as of June 30, 2008, is included in current assets. Assuming the sale closes pursuant to the pending agreement, the Company expects to record a gain of up to approximately $7.0 million.
In June 2008, the Company entered into a financing arrangement with Deerfield Management (Deerfield), whereby the Company can borrow up to $100.0 million in four draws of $25.0 million each until January 2010. The Company paid Deerfield a $1.0 million fee upon entering into the agreement and incurred $152,000 in other costs associated with the transaction. Interest will accrue on amounts outstanding at a rate of 4.9% per annum, compounded quarterly, and will be due, along with outstanding principal, in June 2013. Each $25.0 million draw entitles Deerfield to a royalty equal to 2% of RECOTHROM net sales in the U.S. The cumulative royalty will not exceed $45.0 million assuming the Company draws the entire $100.0 million. The cumulative limit on royalties will be lower if the Company borrows less than $100.0 million. In addition, the Company is obligated to issue Deerfield warrants to purchase 1.5 million shares of common stock at $10.34 per share at the earlier of the first draw or January 2010, and warrants to purchase 1.0 million shares each upon the second, third and fourth draws exercisable at a 25% premium to the average sale price of the Companys common stock for the 15 trading days prior to the draw. All warrants will have a six-year term and the Company is obligated to register with the Securities and Exchange Commission the common stock issuable under the warrants. The Company can repay borrowed amounts in whole or in part at any time, without penalty, and all associated interest and royalty obligations will cease.
The Company has calculated the fair value of the initial 1.5 million warrants to be $6.2 million using the Black Scholes option pricing model with the following assumptions; expected volatility of 55.2%; expected dividend yield of 0.0%; risk free rate of 3.503%; and a contractual life of six years and, as of June 30, 2008, recorded the amount as deferred financing costs and warrants issuable.
Deferred financing costs, consisting of the $1.0 million loan issuance fee, $152,000 of other costs associated with the transaction, and the $6.2 million fair value of warrants issuable, will be amortized to interest expense through June 2013.
RECOTHROM was approved by the FDA on January 17, 2008. Sales of RECOTHROM are recognized as revenue when the product is shipped and title and risk of loss have passed. Product sales are recorded net of provisions for estimated discounts, rebates, chargebacks, and returns. Prior to FDA approval, all third party manufacturing costs and an allocation of Company labor and overhead associated with the manufacturing of RECOTHROM for commercial sale were expensed as research and development costs as incurred. Subsequent to RECOTHROM approval, these costs are recorded as inventory. Costs of product sales includes the inventory and distribution costs associated with RECOTHROM product sales revenue.
In February 2008, the Company granted 620,500 restricted stock units to non-officer employees under the Companys 2001 Stock Incentive Plan. These shares will vest over a three-year period with one-third vesting on each anniversary of the grant date. The grant date fair value for the restricted stock unit awards was the closing market price of the Companys common stock on the date of grant, which was $9.26 per share. As of June 30, 2008, total unrecognized compensation costs related to nonvested restricted stock units was $5.0 million, which is expected to be recognized on a straight line basis through February 2011.
In January 2008, the Company issued a total of 57,200 unrestricted shares of common stock to employees of the Company in recognition of FDA approval of RECOTHROM. The share price used to determine compensation was $13.05, based on the closing price on the date the compensation committee of the Companys board of directors approved the distribution. Additionally, the compensation amount was increased to include payroll taxes paid on behalf of the employees. The entire $1.1 million of costs related to the issuance were expensed in January 2008.
The following table shows stock-based compensation expense by type of award for the periods presented (in thousands):
The following table shows stock-based compensation expense by expense classification for the periods presented (in thousands):
No income tax benefit has been recorded for stock option exercises as the Company has a full valuation allowance and management has concluded it is more likely than not that the net deferred tax asset will not be realized.
For the three and six months ended June 30, 2008, total comprehensive loss was $37.7 million and $80.2 million, respectively. For the three and six months ended June 30, 2007, total comprehensive loss was $37.7 million and $70.1 million, respectively. Comprehensive loss is composed of net loss and unrealized gains and losses on short-term and long-term investments. The net change in accumulated other comprehensive gain for the six months ended June 30, 2008 was a $1.9 million reduction, reflecting a $954,000 decrease in net unrealized gains on short-term investments and a decrease of $993,000 in unrealized gain on long-term investments.
Novo Nordisk owned approximately 30% and 31% of the Companys outstanding common stock at June 30, 2008 and 2007, respectively. The following table summarizes revenue earned from Novo Nordisk for the periods presented (in thousands):
The Company earned royalties in 2007 on two products marketed and sold by Novo Nordisk, recombinant insulin and recombinant glucagon. These royalties have ceased due to insulin and glucagon patent expiration.
Collaborations and Licenses
The Company has licensed rights to Novo Nordisk to commercialize the Companys IL-20 intellectual property. Novo Nordisk is responsible for all development activities and the Company has no significant continuing obligations under the license agreements. In January 2007, the Company received and recorded as revenue a milestone payment of $1.0 million for the advancement of IL-20 to development lead status within Novo Nordisk. In February 2008, the Company received and recorded as revenue a milestone payment of $2.0 million for a Novo Nordisk Investigational New Drug filing related to IL-20.
The Company has licensed rights to Novo Nordisk to commercialize the Companys IL-31 intellectual property outside of North America. The Company does not have any significant continuing obligations under the license agreement. In June 2007, the Company received a $1.0 million milestone payment for advancement to development lead status. Effective June 2008, Novo Nordisk terminated the IL-31 license agreement.
The Company has licensed rights to Novo Nordisk who will independently develop and commercialize recombinant Factor XIII on a worldwide basis. In February 2008 and May 2008, the Company received and recorded as revenue milestone payments of $2.5 million each related to Novo Nordisks achievement of certain manufacturing targets for rFactor XIII.
Amounts receivable from Novo Nordisk were approximately $312,000 at June 30, 2008.
In February 2007, the FASB issued FASB No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (FAS 159), which allows entities to measure eligible financial instruments and certain other items at fair value. FAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. FAS 159 is effective for the Companys fiscal years beginning after October 1, 2008. The Company is currently assessing the potential effect, if any, of implementing this standard on its results of operations, cash flows and financial condition.
In November 2007, the Emerging Issues Task Force (EITF) reached a final consensus on EITF Issue No. 07-1, Accounting for Collaborative Arrangements Related to the Development and Commercialization of Intellectual Property (EITF 07-1). EITF 07-1 will require the Company to disclose the nature and purpose of its collaborative arrangements in its annual financial statements, its rights and obligations under the collaborative arrangements, the stage of the underlying endeavors life cycle, the Companys accounting policies for the arrangements and the income statement classification and amount of significant financial statement amounts related to the collaborative arrangements. EITF 07-1 will be effective for fiscal years beginning after December 15, 2008 and will require the Company to apply it as a change in accounting principle through retrospective application to all prior periods for all collaborative arrangements existing as of the effective date. The Company is currently assessing the impact of EITF 07-1 on its results of operations, cash flows and financial condition.
In February 2008, the FASB issued FASB FSP 157-2, Effective Date of FASB Statement No. 157 (FSP 157-2), which delays the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. These nonfinancial items include assets and liabilities such as reporting units measured at fair value in a goodwill impairment test and nonfinancial assets acquired and liabilities assumed in a business combination. Effective January 1, 2008, the Company adopted FAS 157 for financial assets and liabilities recognized at fair value on a recurring basis. The partial adoption of FAS 157 for financial assets and liabilities did not have a material impact on the Companys results of operations, cash flows or financial condition. See Note 3 for information and related disclosures regarding our fair value measurements.
The Company has a license agreement with a third party under which the Company is obligated to pay royalties based upon the application of an agreed-upon formula, which contains certain variables that are subject to interpretation. Through June 30, 2008, the Company has recorded approximately $286,000 in royalty expense, which it believes fully satisfied its obligation under the license agreement. In the fourth quarter of 2005, the other party claimed that the Company owes a total of $1.5 million under its interpretation of the royalty formula. The Company continues to believe that its method of calculating the amount of royalties due is valid and intends to vigorously defend its position. The Company has applied SFAS No. 5, Accounting for Contingencies, to this matter and has concluded that it is not required to record a liability.
The following discussion and analysis should be read in conjunction with the financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. This report contains, in addition to historical information, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. This Act provides a safe harbor for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward-looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. Factors that could cause or contribute to such differences include, but are not limited to, risks associated with our unproven marketing and sales capabilities, preclinical and clinical development, manufacturing of products, product safety, regulatory oversight, relationships with third parties, intellectual property claims and litigation and other risks detailed in our public filings with the Securities and Exchange Commission, including those risks described in Item 1A. of our Annual Report on Form 10-K for the year ended December 31, 2007. All statements other than statements of historical fact, including statements regarding industry prospects and future results of operations or financial position, made in this Quarterly Report on Form 10-Q are forward looking. When used in this document, the words believes, expects, anticipates, intends, plans and similar expressions, are intended to identify certain of these forward-looking statements. However, these words are not the exclusive means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. The cautionary statements made in this document should be read as being applicable to all related forward-looking statements wherever they appear in this document. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise. Readers are urged to carefully review and consider the various disclosures made in this report and in our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks and other factors that may affect our business, prospects, results of operations and financial condition.
We are a biopharmaceutical company focused on discovering, developing and commercializing therapeutic protein-based products for the treatment of human diseases. The process for taking one of our discoveries to the marketplace is long, complex and very costly. It is difficult to predict the time it will take to commercialize any given product candidate, but it would not be unusual to span ten years or more and cost hundreds of millions of dollars. It is also a business of attrition; it is expected that, for the industry as a whole, less than 20% of the drug candidates entering human clinical trials will actually make it to the marketplace. For the products that do make it, particularly for those that address previously unmet medical needs, the markets can be significant, with a number of successful products selling in excess of $1 billion per year.
An important element of our strategy is that we intend to maintain a significant share of the commercial rights to our products in the U.S. For our commercial product, RECOTHROM, which was approved by the FDA on January 17, 2008, we have maintained full U.S. rights. As a result, we have paid and will continue to pay the commercialization and development costs for RECOTHROM in the U.S. A second important element of our strategy is that we are developing a broad portfolio of product candidates to give our company more opportunities to be successful. We currently have three product candidates in clinical development, and we expect to add additional product candidates to this portfolio in the future. Therefore, we are paying and expect to pay a significant portion of development costs for several potential product candidates. Assuming these product candidates progress through clinical development successfully, the costs of clinical trials are expected to increase significantly.
One of our most significant challenges is to appropriately balance the investment of our operating funds between our RECOTHROM commercial activities and the rest of our product pipeline. Our goal is to maximize the value of our RECOTHROM asset over the next several years, while developing valuable additional product candidates that will generate value for our shareholders over the long term. It can be a complex and highly subjective process to establish the appropriate balance between cash conservation and value generation. There are a number of important factors that we consider in addressing these challenges, including the following:
We expect that it will be several years before we can generate enough product-related revenues for our company to reach net income or cash flow breakeven, if ever. For the foreseeable future, we expect to continue to use significant amounts of cash to develop our business. Revenues from our existing relationships and the access to $100.0 million in debt financing obtained in June 2008 improve our overall financial position, but additional funding may still be required, the amount of which could be significant. We may decide to enter into additional product development collaborations, which would reduce our funding requirements. We may also generate funding through licensing of our patents.
In late 2006, we began preparations for the launch of rThrombin (which we now market in the U.S. as RECOTHROM), which was approved by the FDA on January 17, 2008. In June 2007, we entered into a global collaboration with Bayer for development and commercialization of rThrombin. Bayer has agreed to commercialize rThrombin in countries outside the United States and will co-promote the product with us in the United States for three years. We have hired approximately 60 field personnel and additional headquarters-based personnel to support the operations related to the commercialization of RECOTHROM. We are also incurring launch and commercialization related marketing costs to support the selling effort. In addition, we are building inventory to ensure we can meet the expected demand for the product and minimize the risk of product shortages. These launch and commercialization related activities require additional funding over and above that related to our development pipeline. We anticipate significant revenue generation from RECOTHROM sales over time; however, we cannot be certain of the rate of market penetration or when, if ever, our revenues will exceed our related costs.
We will continue to look for opportunities to raise capital, either in the form of debt, equity or equity-related capital as a means of funding our company. These opportunities may arise at any time, depending on things such as overall market conditions; dynamics in the biotechnology sector of the market; investor appetite for certain types of companies; and fundamental characteristics of our business. At other times, it may be difficult to raise capital on terms favorable to our company, if at all. Accordingly, we expect to raise capital when it is available, not when there is an immediate need. We believe this strategy is important to minimize the financial risks to our company and our shareholders.
Results of Operations
Product sales. On January 17, 2008, the FDA granted marketing approval of RECOTHROM (for the 5,000 IU vial configuration) and on May 27, 2008 granted marketing approval of the larger 20,000 IU RECOTHROM vial configuration, both with and without a spray kit. Sales of RECOTHROM are recognized as revenue when the product is shipped and title and risk of loss have passed. Product sales are recorded net of provisions for estimated discounts, rebates, chargebacks, and returns. We recognized net product sales revenue of $1.4 million and $2.4 million for the three and six-month periods ended June 30, 2008.
Royalties. Royalties decreased by $51,000 and $468,000 for the three and six-month periods ended June 30, 2008 as compared to the corresponding periods in 2007. We are no longer earning insulin and glucagon royalties from Novo Nordisk, which negatively impacted royalty revenue by $561,000 and $1.2 million for the three and six-month periods ended June 30, 2008. Increased royalties from sales of GEM 21S, a product of BioMimetic Therapeutics, Inc., and BeneFIX, a product of Wyeth Pharmaceuticals Inc., in 2008 partially offset the decrease in insulin and glucagon royalties.
Collaborations and licenses. We enter into various collaborative agreements that may generate significant license, option or other upfront fees with subsequent milestone payments earned upon completion of development milestones. Where we have no continuing performance obligations under an arrangement, we recognize such payments as revenue upon receipt, as these payments represent the culmination of a separate earnings process. Where we have continuing performance obligations under an arrangement, revenue is recognized using one of two methods. Where we are able to estimate the total amount of services under the arrangement, revenue is recognized using a proportional performance model. Costs incurred to date compared to total expected costs are used to determine proportional performance, as this is considered to be representative of the delivery of outputs under the arrangement. Revenue recognized at any point in time is limited to cash received and amounts contractually due. Changes in estimates of total expected performance are accounted for prospectively as a change in estimate. Where we cannot estimate the total amount of service that is to be provided, a time-based method is used to recognize revenue. Under the time-based method, revenue is recognized over the arrangements estimated performance period, starting with the contracts commencement, but not before the removal of any contingencies for each milestone. Proportional performance is determined based on the elapsed time compared to the total estimated performance period. Revenue recognized at any point in time is limited to the cash received and amounts contractually due. From period to period, license fees and milestone payments can fluctuate substantially based on the completion of new licensing or collaborative agreements and the achievement of development-related milestones.
License fees and milestone revenue were $9.5 million and $20.5 million for the three and six-month periods ended June 30, 2008, respectively, an increase of $7.1 million and $14.8 million as compared to the corresponding periods in 2007, respectively. The increases primarily resulted from amounts earned in 2008 for which no comparable amounts were earned in 2007. Specifically, license fees of $5.2 million and $9.6 million were earned for the three and six-month periods ended June 30, 2008, respectively, under the RECOTHROM (rThrombin) agreement with Bayer, which became effective in June 2007, and milestone revenue of $2.5 million was earned in both the first and second quarters in 2008 under the rFactor XIII license agreement with Novo Nordisk. Additionally, under an IL-20 license agreement with Novo Nordisk, we earned $2.0 million of milestone revenue for the six-month period ended June 30, 2008, an increase of $1.0 million as compared to the same period in 2007.
In September 2004, we signed a five-year strategic alliance agreement with Serono S.A. (now Merck Serono) under which Merck Serono may acquire rights and licenses to certain leads and targets from our research and development pipeline. The amount received upfront was deferred and is being recognized over the period in which we have continuing performance obligations. We recorded $784,000 and $1.6 million of revenue from this agreement in each of the three and six-month periods ended June 30, 2008 and 2007. As of June 30, 2008, $4.0 million was recorded as deferred revenue, which is being recognized at a rate of $3.1 million per year.
Costs and expenses
Costs of product sales. Prior to FDA approval of RECOTHROM in January 2008, all third party manufacturing costs and an allocation of our labor and overhead associated with the manufacturing of RECOTHROM for commercial sale were expensed as research and development costs as incurred. Subsequent to approval, third party manufacturing costs and labor and overhead associated with the commercial manufacturing of RECOTHROM are recorded as inventory. Accordingly, we expect that costs of product sales will be lower during the time we are selling product manufactured prior to approval. Costs of product sales includes the inventory and distribution costs associated with RECOTHROM product revenue. For the three and six-month periods ended June 30, 2008 we recognized $194,000 and $300,000, respectively in costs of product sales.
Research and development. Research and development expense consists primarily of salaries and benefit expenses, costs of consumables, contracted services and stock-based compensation. Our research and development activities have generally been expanding over the past several years, particularly related to our recently approved commercial product, RECOTHROM, and clinical-stage product candidates, atacicept, IL-21 and PEG-IFN-l. Research and development expense has been partially offset by cost reimbursements from collaborators for work performed on various co-development programs. These trends for the periods presented are shown in the following table (in thousands):
Salaries and benefits, consumables and facility costs, generally track with changes in our employee base from year to year; however, in February 2008, we terminated 37 research and development employees and recorded a severance related charge of $2.0 million in the first quarter of 2008. As a result, salary related costs decreased by $2.2 million in the three months ended June 30, 2008 as compared to the same period in 2007.
Contracted services include the cost of items such as contract research, contract manufacturing, clinical trials, non-clinical studies and payments to collaborators. These costs relate primarily to clinical development programs and can fluctuate substantially from period-to-period depending on the stage of our various programs. Generally, these external costs increase as a program advances toward commercialization, but there can be periods between major clinical trials or manufacturing campaigns during which costs decline. Our clinical trial costs increased by $943,000 and $3.5 million in the three and six-month periods ended June 30, 2008, respectively as compared to the corresponding periods in 2007, primarily reflecting the costs incurred for the lupus nephritis clinical trial that began in late 2007. Payments to collaborators also increased by $6.3 million and $12.4 million for the three and six-month periods ended June 30, 2008, respectively as compared to the corresponding periods in 2007, primarily reflecting our portion of atacicept development costs required by our collaboration with Merck Serono. Contract manufacturing costs decreased by approximately $3.1 million and $2.3 million for the three and six-month periods ended June 30, 2008, respectively, as compared to the corresponding periods in 2007, reflecting the discontinued expensing of pre-approval manufacturing of rThrombin bulk drug and finished product inventory after FDA approval in January 2008.
To date, our business needs have not required us to fully allocate all research and development costs among our various programs. However, we track direct labor, contracted services and certain consumable costs by program, which we monitor to ensure appropriate utilization of company resources. We also incur indirect costs that are not allocated to specific programs. These costs include indirect labor, certain consumable costs, facility costs, and depreciation and amortization, all of which benefit all of our research and development programs. The following table presents our research and development costs allocated to clinical development, preclinical and research programs, together with the unallocated costs that benefit all programs for the periods presented (in thousands):
The major trends in research and development program costs for the periods presented in the table were as follows:
Selling, general and administrative. Selling, general and administrative expense, which consists primarily of salaries and benefit expenses, professional fees and other corporate costs, increased 58% and 54% for the three and six-month periods ended June 30, 2008, respectively as compared to the corresponding periods in 2007. The increases were primarily due to increased sales and marketing activities and the hiring of sales employees in the second half of 2007 to support the launch and commercialization of RECOTHROM in 2008.
Stock-based compensation. Stock-based compensation expense increased $28,000 and $632,000 for the three and six-month periods ended June 30, 2008, respectively as compared to the corresponding periods in 2007. The increase for the six-month period in 2008 was due to unrestricted common stock grants of 100 shares awarded to each of our employees in January 2008 in recognition of the approval of RECOTHROM, which had a total fair value of $1.1 million. The following amounts of stock-based compensation expense were recorded for the periods presented (in thousands):
Other income (expense)
Investment income. Investment income is generated primarily from investment of our cash reserves in investment grade, fixed-income securities. There are three primary factors affecting the amount of investment income that we report: the amount of cash reserves invested, the effective interest rate, and the amount of realized gains or losses on investments held during the period. The following table shows how each of these factors affected investment income for the periods presented (in thousands):
Interest expense. We have accounted for a sale-leaseback transaction completed in October 2002 as a financing transaction. Under this method of accounting, an amount equal to the net proceeds of the sale is considered a long-term interest bearing liability. Rent payments under the leases are considered to be payments toward the liability and are allocated to principal and interest. Interest expense was relatively constant for the three and six-month periods ended June 30, 2008 and 2007.
Liquidity and Capital Resources
As of June 30, 2008, we had cash, cash equivalents and short-term investments of $116.9 million, which we intend to use to fund our operations and capital expenditures until we are able to generate positive cash flow. These cash reserves are held in a variety of investment-grade, fixed-income securities, including corporate bonds, commercial paper and money market instruments. In June 2008, we completed a debt financing arrangement enabling us to draw up to $100.0 million in $25.0 million increments until January 2010. Interest will accrue on amounts outstanding at a rate of 4.9% per annum, compounded quarterly, and will be due, along with outstanding principal, in June 2013. Each $25.0 million draw entitles the lender to a royalty equal to 2% of RECOTHROM net sales in the U.S. The cumulative royalty will not exceed $45.0 million assuming the Company draws the entire $100.0 million. In addition, we are obligated to issue between 1.5 million and 4.5 million in six-year warrants depending on the amount drawn. We believe that our existing cash resources, supplemented by funds we may draw under the debt financing arrangement, will be sufficient to fund our operations for at least the next 12 months. There are several factors that will significantly impact our cash requirements during this time, including the amount of revenue generated from RECOTHROM sales, proceeds from new license and collaboration transactions, and proceeds from the pending land sale. Depending on the level of success we have in these areas, our funds could last much longer. In addition, we may raise additional funds through one or more financing transactions, which would help fund our company over a longer period of time.
Cash flows from operating activities. The amount of cash used to fund our operating activities generally tracks our net losses, with the following exceptions:
Generally, with the exception of changes in deferred revenue and inventory increases relating to RECOTHROM, we do not expect these items to generate material year-to-year fluctuations in the relationship between our net loss and the amount of net cash used in operating activities. Substantial license or upfront fees may be received upon the date we enter into new licensing or collaborative agreements and be recorded as deferred revenue. For example, we received milestone payments from Bayer relating to the rThrombin collaboration of $30.0 million in July 2007 and $40.0 million in February 2008 that have been recorded as deferred revenue and are being recognized as revenue through the first quarter of 2013. For the six-month periods ended June 30, 2008 and 2007, we recognized $13.2 million and $7.0 million, respectively, of previously deferred revenue relating to Bayer and other collaborations. The timing of additional deferred revenue transactions is expected to be irregular and, accordingly, has the potential to create fluctuations in the relationship between our net loss and the amount of cash used in operating activities.
Cash flows from investing activities. Our most significant use of cash in investing activities is for capital expenditures. We expend a certain amount each year on routine items to maintain the effectiveness of our business, e.g., to adopt newly developed technologies, expand into new functional areas, adapt our facilities to changing needs and/or replace obsolete assets. In addition, we have used cash at various times to purchase land and expand facilities. Cash flows from investing activities also reflect large amounts of cash used to purchase short-term investments and receipts from the sale and maturity of short-term investments. These amounts primarily relate to shifts between cash and cash equivalents and short-term investments. Because we manage our cash usage with respect to our total cash, cash equivalents and short-term investments, we do not consider these cash flows to be important to an understanding of our liquidity and capital resources.
Cash flows from financing activities. We paid $1.2 million in costs related to the debt financing arrangement in the six-month period ended June 30, 2008 and received $472,000 and $3.7 million of proceeds from the exercise of stock options for the six-month periods ended June 30, 2008 and 2007, respectively.
We expect to incur substantial additional costs as we continue to advance and expand our product development programs, as well as continue to commercialize RECOTHROM. We expect these expenditures to increase over the next several years, particularly if the outcomes of clinical trials are successful and our product candidates continue to advance. Our plans include the internal development of selected product candidates and the co-development of product candidates with collaborators where we would assume a percentage of the overall product development costs. We also expect to incur substantial costs during the remainder of 2008 supporting the launch and commercialization of RECOTHROM.
Although we are optimistic regarding its commercial prospects and the rate of market penetration, it might be quite some time, if ever, before our RECOTHROM revenues exceed our expenses. If at any time our prospects for financing these various initiatives decline, we may decide to look for ways to reduce our ongoing investment. In such event, we might consider discontinuing our funding under existing co-development arrangements, establishing new co-development arrangements for other product candidates to provide additional funding sources or out-licensing product candidates or certain rights related to product candidates that we might otherwise develop and commercialize internally. Additionally, we could consider delaying or discontinuing development of product candidates to reduce the level of our related expenditures.
Our long-term capital requirements and the adequacy of our available funds will depend on several factors, many of which may not be fully in our control, including:
Over the next several years we expect to seek additional funding through public or private financings, including debt or equity financings, and through other arrangements, including collaborative arrangements. Poor financial results, unanticipated expenses or unanticipated opportunities that require financial commitments could give rise to additional financing requirements sooner than we expect. However, financing may be unavailable when we need it or may not be available on acceptable terms. If we raise additional funds by issuing equity or equity-based securities, the percentage ownership of our existing shareholders would be reduced, and these securities could have rights superior to those of our common stock. If we are unable to raise additional funds when we need them, we could be required to delay, scale back or eliminate expenditures for some of our development programs or expansion plans, or grant rights to third parties to develop and market product candidates that we would prefer to develop and market internally, with license terms that are not favorable to us.
At June 30, 2008, we were contractually obligated to make payments as follows (in thousands):
The building lease obligations resulted from our 2002 sale-leaseback financing transaction and run until May 2019. The operating leases relate to the office space near our corporate headquarter buildings and in March 2008, we entered into a master lease agreement which extended the lease term for all leased floors to April 2019. We have certain renewal provisions at our option, which are not reflected in the above table, for the building leases and the operating leases. RECOTHROM manufacturing contracts include the manufacture of rThrombin bulk drug and RECOTHROM finished product for commercial sale.
Our exposure to market risk is primarily limited to interest income sensitivity, which is affected by changes in the general level of United States interest rates, particularly because the majority of our investments are in short-term debt securities. The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive without significantly increasing risk. To minimize risk, we maintain our portfolio of cash, cash equivalents and short-term investments in a variety of interest-bearing instruments, which may include United States government and agency securities, high-grade United States corporate bonds, asset-backed securities, commercial paper and money market funds. Due to the nature of our short-term investments, all of which are expected to mature within three years, we believe that we are not subject to any material market risk exposure. We have no material foreign currency exposure, nor do we hold derivative financial instruments.
Our principal executive officer and principal financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report, have concluded that as of such date our disclosure controls and procedures were effective. No change in our internal control over financial reporting occurred during the quarter ended June 30, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II OTHER INFORMATION
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I., Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2007, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
We held our annual meeting of shareholders on June 18, 2008. Of the 68,693,089 shares of common stock outstanding as of the record date of the annual meeting, 58,020,834 shares, or 84.46% of the total shares eligible to vote at the annual meeting, were represented in person or by proxy. Two proposals were submitted to our shareholders and approved at the annual meeting, as follows:
The other directors with continuing terms following the annual meeting were: Bruce L.A Carter, Ph.D., David I. Hirsh, Ph.D., James A. Harper, David A. MacCallum, Kurt Anker Nielsen and Edward E. Penhoet, Ph.D.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.