10-Q 1 a10-q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------- FORM 10-Q ----------- (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____ to ____ Commission File Number: 000-30289 PRAECIS PHARMACEUTICALS INCORPORATED ------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 04-3200305 ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) One Hampshire Street, Cambridge, MA 02139-1572 ---------------------------------------------------- (Address of principal executive offices and zip code) (617) 494-8400 ----------------- (Registrant's 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 (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 [ ] As of July 31, 2000, there were 41,867,686 shares of the registrant's common stock, $.01 par value, outstanding. PRAECIS PHARMACEUTICALS INCORPORATED FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2000 INDEX

PAGE NUMBER ------ PART I. FINANCIAL INFORMATION 3 Item 1. Financial Statements Condensed Consolidated Balance Sheets - June 30, 2000 3 (unaudited) and December 31, 1999 Condensed Consolidated Statements of Operations (unaudited) 4 - three and six months ended June 30, 2000 and 1999 Condensed Consolidated Statements of Cash Flows (unaudited) 5 - six months ended June 30, 2000 and 1999 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition 10 and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk 25 PART II. OTHER INFORMATION 26 Item 2. Changes in Securities and Use of Proceeds 26 Item 6. Exhibits and Reports on Form 8-K 27 SIGNATURE 28 EXHIBIT INDEX 29

2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. PRAECIS PHARMACEUTICALS INCORPORATED Condensed Consolidated Balance Sheets (In thousands, except share and per share data)

JUNE 30, DECEMBER 31, 2000 1999 ---------- ------------ (unaudited) ASSETS Current assets: Cash and cash equivalents ................................................ $ 167,931 $ 94,525 Accounts receivable ...................................................... 3,460 8,121 Unbilled revenue ......................................................... 2,915 4,259 Materials inventory ...................................................... 29,957 21,100 Prepaid expenses and other assets ........................................ 2,994 708 Deferred income taxes .................................................... 5,575 5,575 --------- --------- Total current assets ............................................... 212,832 134,288 Property and equipment, net ................................................ 6,427 6,043 Other assets ............................................................... 2,180 -- --------- --------- Total assets ....................................................... $ 221,439 $ 140,331 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ......................................................... $ 6,320 $ 9,878 Accrued expenses ......................................................... 7,944 6,859 Deferred revenue ......................................................... 5,391 5,501 Advance payments ......................................................... 29,957 21,100 Income taxes payable ..................................................... -- 4,672 Current portion of capital lease obligations ............................. 19 58 --------- --------- Total current liabilities .......................................... 49,631 48,068 Deferred revenue ........................................................... 2,273 4,547 Commitments and contingencies Stockholders' equity: Preferred Stock, $0.01 par value; 10,000,000 shares authorized; no shares issued and outstanding .................................................... -- -- Series A, B, C, D, E Convertible Preferred Stock, $0.01 par value; 3,750,000 shares authorized; no shares in 2000 and 3,417,300 shares in 1999 issued and outstanding ........................................................... -- 35 Common Stock, $0.01 par value; 200,000,000 shares in 2000 and 60,000,000 shares in 1999 authorized; 41,867,320 shares in 2000 and 6,358,684 shares in 1999 issued and outstanding ............................................ 419 64 Additional paid-in capital ................................................. 174,736 88,710 Accumulated deficit ........................................................ (5,620) (1,093) --------- --------- Total stockholders' equity ......................................... 169,535 87,716 --------- --------- Total liabilities and stockholders' equity ................... $ 221,439 $ 140,331 ========= =========

SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 3 PRAECIS PHARMACEUTICALS INCORPORATED Condensed Consolidated Statements of Operations (In thousands, except share and per share data) (unaudited)

Three Months Ended Six Months Ended June 30, June 30, ---------------------------- ---------------------------- 2000 1999 2000 1999 ----------- ----------- ----------- ----------- Revenues: Corporate collaborations.................... $ 9,972 $ 39,202 $ 18,973 $ 40,345 ----------- ----------- ----------- ----------- Total revenues........................... 9,972 39,202 18,973 40,345 Costs and expenses: Research and development.................... 12,389 17,328 23,665 28,459 General and administrative.................. 1,783 2,510 3,177 3,427 ----------- ----------- ----------- ----------- Total costs and expenses.................. 14,172 19,838 26,842 31,886 ----------- ----------- ----------- ----------- Operating income (loss)....................... (4,200) 19,364 (7,869) 8,459 Interest income, net.......................... 2,148 1,057 3,442 2,033 ----------- ----------- ----------- ----------- Income (loss) before income taxes............. (2,052) 20,421 (4,427) 10,492 Provision for income taxes.................... -- 1,600 100 1,700 ----------- ----------- ----------- ----------- Net income (loss)............................. $ (2,052) $ 18,821 $ (4,527) $ 8,792 =========== =========== =========== =========== Net income (loss) per share: Basic....................................... $ (0.07) $ 3.08 $ (0.25) $ 1.45 =========== =========== =========== =========== Diluted..................................... $ (0.07) $ 0.50 $ (0.25) $ 0.24 =========== =========== =========== =========== Weighted average number of common shares: Basic....................................... 29,990,086 6,100,933 18,400,705 6,044,368 Diluted..................................... 29,990,086 37,322,095 18,400,705 37,124,602 Pro forma net income (loss) per share: Basic....................................... $ (0.05) $ 0.59 $ (0.13) $ 0.28 =========== =========== =========== =========== Diluted..................................... $ (0.05) $ 0.50 $ (0.13) $ 0.24 =========== =========== =========== =========== Pro forma weighted average number of common shares: Basic....................................... 38,713,639 31,708,783 35,566,406 31,652,218 Diluted..................................... 38,713,639 37,322,095 35,566,406 37,124,602

SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 4 PRAECIS PHARMACEUTICALS INCORPORATED Condensed Consolidated Statements of Cash Flows (In thousands) (unaudited)

Six Months Ended June 30, ---------------------------- 2000 1999 ----------- ----------- OPERATING ACTIVITIES: Net income (loss)................................................................. $ (4,527) $ 8,792 Adjustments to reconcile net income (loss) to cash (used in) provided by operating activities: Depreciation and amortization................................................... 1,293 553 Deferred income taxes........................................................... -- (2,648) Stock compensation.............................................................. 1,238 -- Changes in operating assets and liabilities: Accounts receivable........................................................... 4,661 (4,902) Unbilled revenue.............................................................. 1,344 (8,728) Materials inventory........................................................... (8,857) (1,324) Prepaid expenses and other assets............................................. (2,286) (850) Other assets.................................................................. (2,180) -- Accounts payable.............................................................. (3,558) 4,713 Accrued expenses.............................................................. 1,085 3,904 Deferred revenue.............................................................. (2,384) 8,481 Advance payments.............................................................. 8,857 1,324 Income taxes payable.......................................................... (4,672) 2,960 ----------- ----------- Net cash (used in) provided by operating activities............................... (9,986) 12,275 INVESTING ACTIVITIES: Purchase of property and equipment................................................ (1,677) (1,945) ----------- ----------- Net cash used in investing activities............................................. (1,677) (1,945) FINANCING ACTIVITIES: Principal repayments of capital lease obligations................................. (39) (144) Initial public offering proceeds (net of offering costs).......................... 84,263 -- Proceeds from exercises of common stock options .................................. 845 41 ----------- ----------- Net cash provided by (used in) financing activities............................... 85,069 (103) ----------- ----------- Net increase in cash and cash equivalents......................................... 73,406 10,227 Cash and cash equivalents, beginning of period.................................... 94,525 85,298 ----------- ----------- Cash and cash equivalents, end of period.......................................... $ 167,931 $ 95,525 =========== ===========

SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 5 PRAECIS PHARMACEUTICALS INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION The accompanying condensed consolidated financial statements have been prepared by PRAECIS PHARMACEUTICALS INCORPORATED (the "Company") in accordance with generally accepted accounting principles and pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. It is suggested that the financial statements be read in conjunction with the audited financial statements and the accompanying notes included in the Company's Registration Statement on Form S-1 (File No. 333-96351) (the "Registration Statement"), which was declared effective by the SEC on April 26, 2000. The information furnished reflects all adjustments which, in the opinion of management, are considered necessary for a fair presentation of results for the interim periods. Such adjustments consist only of normal recurring items. It should also be noted that results for the interim periods are not necessarily indicative of the results expected for the full year or any future period. The preparation of these 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 disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES (SFAS No. 133), which is effective for fiscal year 2001. SFAS No. 133 requires all derivatives to be carried on the balance sheet as assets or liabilities at fair value. The accounting for changes in fair value would depend on the hedging relationship and would be reported in the income statement or as a component of comprehensive income. The Company believes that the adoption of this new accounting standard will not have a material impact on the Company's financial statements. In December 1999, the SEC issued Staff Accounting Bulletin 101 ("SAB 101"), REVENUE RECOGNITION IN FINANCIAL STATEMENTS. SAB 101 clarifies the SEC staff's views on applying generally accepted accounting principles to revenue recognition in financial statements. In March 2000, the SEC issued an amendment, SAB 101A, which deferred the effective date of SAB 101. In June 2000, the SEC issued an amendment, SAB 101B, which again deferred the effective date of SAB 101. The Company will adopt SAB 101 in the fourth quarter of 2000 in accordance with SAB 101B. The Company believes its revenue recognition policies are in compliance with SAB 101. In March 2000, the FASB issued Interpretation No. 44, ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK COMPENSATION (the "Interpretation"). This Interpretation clarifies how companies should apply the Accounting Principles Board's Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. The Interpretation will be applied prospectively to new awards, modifications to outstanding awards, and changes in employee status on or after July 1, 2000, except as follows: the definition of an employee applies to awards granted after December 15, 1998; the Interpretation applies to modifications that reduce the exercise price of an award after December 15, 1998; and the Interpretation applies to modifications that add a reload feature to an award made after January 12, 2000. The Company believes that there are no awards that would result in an adjustment at July 1, 2000 as a result of this Interpretation. PRINCIPLES OF CONSOLIDATION The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, 830 Winter Street LLC ("830 Winter Street"), a single purpose Delaware limited liability company, that was formed by the Company on June 8, 2000 in connection with the purchase of the Company's new facility in Waltham, Massachusetts. All material intercompany balances and transactions have been eliminated in consolidation. 6 NET INCOME (LOSS) PER SHARE Basic net income (loss) per share is based on the weighted average number of common shares outstanding. Diluted net income (loss) per share is calculated using the weighted average number of common shares outstanding plus the dilutive effect of outstanding stock options and warrants using the treasury stock method, and the effect of the convertible preferred stock using the if-converted method. For the three and six months ended June 30, 2000, diluted net income (loss) per common share is the same as basic net income (loss) per common share as the inclusion of weighted average shares of common stock issuable upon exercise of stock options and warrants would be antidilutive. For the three and six months ended June 30, 1999, the difference between basic and diluted shares used in the computation of net income (loss) per share is 31.2 million and 31.1 million weighted-average common equivalent shares, respectively, resulting from outstanding convertible preferred stock, common stock options and warrants. Pro forma net income (loss) per share has been computed as described above and also gives effect, under SEC guidance, to the conversion of preferred shares not included above that automatically converted to common shares upon the closing of the Company's initial public offering in May 2000 (See Note 5), using the if-converted method. The reconciliation of the denominators of the historical and pro forma, basic and diluted net income (loss) per share calculations is as follows:

Three Months Ended Six Months Ended June 30, June 30, ------------------- ------------------ 2000 1999 2000 1999 ---- ---- ---- ---- Historical: Weighted average number of common shares outstanding used in computing basic net income (loss) per share .................. 29,990,086 6,100,933 18,400,705 6,044,368 Net effect of common stock options, warrants and convertible preferred -- 31,221,162 -- 31,080,234 stock .................................... ---------- ---------- ---------- ---------- Weighted average number of common shares outstanding used in computing diluted net 29,990,086 37,322,095 18,400,705 37,124,602 income (loss) per share .................. ========== ========== ========== ========== Pro forma: Weighted average number of common shares used in computing basic net income (loss) per share (from above) ................... 29,990,086 6,100,933 18,400,705 6,044,368 Adjustment to reflect the effect of the assumed conversion of preferred stock from 8,723,553 25,607,850 17,165,701 25,607,850 the date of issuance ..................... ---------- ---------- ---------- ---------- Weighted average number of common shares outstanding used in computing pro forma basic net income (loss) per 38,713,639 31,708,783 35,566,406 31,652,218 share .................................... ========== ========== ========== ========== Weighted average number of common shares used in computing diluted net income (loss) per share (from above) ............ 29,990,086 37,322,095 18,400,705 37,124,602 Adjustment to reflect the effect of the assumed conversion of preferred stock from 8,723,553 -- 17,165,701 -- the date of issuance ..................... ---------- ---------- ---------- ---------- Weighted average number of common shares used in computing pro-forma diluted net 38,713,639 37,322,095 35,566,406 37,124,602 income (loss) per share .................. ========== ========== ========== ==========

7 3. STOCK BASED COMPENSATION Options granted to non-employee consultants to purchase 62,500 shares of common stock at June 30, 2000 are accounted for at fair value in accordance with SFAS 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. During the three and six months ended June 30, 2000, $0.8 million and $1.2 million, respectively, were charged to compensation expense in connection with these options. 4. STOCK SPLIT On March 8, 2000, the Company effected a two-for-one stock split of its common stock, par value $.01 per share ("Common Stock"), in the form of a 100% stock dividend. All common share and per share data in the accompanying condensed consolidated financial statements have been retroactively adjusted to reflect the stock split. 5. INITIAL PUBLIC OFFERING On April 26, 2000, the Company's Registration Statement was declared effective by the SEC. Pursuant to the Registration Statement, on May 2, 2000, the Company sold 8,000,000 shares of its Common Stock at $10 per share and on May 8, 2000, the Company sold an additional 1,200,000 shares of Common Stock at $10 per share pursuant to the underwriters' exercise in full of their over-allotment option. The Company received net proceeds of approximately $84.3 million from its initial public offering (including the net proceeds from the sale of shares pursuant to the exercise by the underwriters of the over-allotment option), after payment of underwriting discounts and commissions and estimated offering expenses. Upon the closing of the Company's initial public offering on May 2, 2000, all of the outstanding shares of the Company's convertible preferred stock, par value $.01 per share (the "Preferred Stock"), automatically converted into 25,607,850 shares of Common Stock. Immediately following the automatic conversion of the Preferred Stock, the Company filed an amended and restated certificate of incorporation. Under the amended and restated certificate of incorporation, the Company is authorized to issue 200,000,000 shares of Common Stock and 10,000,000 shares of Preferred Stock. There currently are no shares of Preferred Stock issued and outstanding. 6. SUBSEQUENT EVENTS BUILDING AND RELATED MORTGAGE FINANCING On July 11, 2000, the Company purchased, for $41.3 million, through its subsidiary 830 Winter Street, land and a building to be used as its principal headquarters and research facility. In connection with obtaining first mortgage financing to purchase this facility, the Company formed 830 Winter Street and assigned to 830 Winter Street all of its rights and obligations under the related Purchase and Sale Agreement (the "Purchase and Sale Agreement"). On July 11, 2000, 830 Winter Street executed an Acquisition and Construction Loan Agreement (the "Loan Agreement") providing for up to $33.0 million in first mortgage financing. Under the terms of the Loan Agreement, advances are available primarily to pay for the acquisition of and improvements to the Company's new facility. In connection with the purchase of the new facility, an initial advance of $24.0 million was made on July 11, 2000. Advances bear interest at a rate equal to the 30-day LIBOR plus 2.0% (8.64% at July 11, 2000). Interest is payable monthly in arrears commencing July 1, 2000. Principal is due and payable in full on July 30, 2003, subject to two, one-year extension options. The loan is secured by the new facility, together with all fixtures, equipment, improvements and other items related thereto, and by all rents, income or profits received by 830 Winter Street. As a condition of the 8 financing, the Company executed certain unconditional guaranties of all of 830 Winter Street's obligations under the Loan Agreement and related loan documents. In connection with the first mortgage financing, in July 2000 830 Winter Street entered into an interest rate cap agreement (the "Interest Rate Cap"), in order to manage fluctuation in cash flows resulting from interest rate risk. Under the terms of the Interest Rate Cap, the Company has hedged its exposure to the underlying interest rate index to a maximum of 30-day LIBOR plus 1.25% (7.88% at July 10, 2000). The term of the Interest Rate Cap is the three-year period ending July 10, 2003. The Company expects to occupy the new facility during the first quarter of 2001 and intends to sublet a portion of the facility at that time. In connection with the decision to relocate its principal operations to the new facility, the Company may incur approximately $1.0 million of incremental cash and non-cash operating costs during the approximate 12-month transition period. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND ACCOMPANYING NOTES TO THOSE STATEMENTS INCLUDED ELSEWHERE IN THIS FORM 10-Q. THIS FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, THAT INVOLVE RISKS AND UNCERTAINTIES. ALL STATEMENTS OTHER THAN STATEMENTS OF HISTORICAL INFORMATION PROVIDED HEREIN ARE FORWARD-LOOKING STATEMENTS AND MAY CONTAIN INFORMATION ABOUT FINANCIAL RESULTS, ECONOMIC CONDITIONS, TRENDS AND KNOWN UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF A NUMBER OF FACTORS, WHICH INCLUDE THOSE DISCUSSED IN THIS SECTION AND ELSEWHERE IN THIS REPORT AND THE RISKS DISCUSSED IN PRAECIS' OTHER FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH REFLECT MANAGEMENT'S ANALYSIS, JUDGMENT, BELIEF OR EXPECTATION ONLY AS OF THE DATE HEREOF. PRAECIS UNDERTAKES NO OBLIGATION TO PUBLICLY REISSUE OR MODIFY THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES THAT ARISE AFTER THE DATE HEREOF. OVERVIEW Since our inception, we have been engaged in developing drugs for the treatment of a variety of human diseases. Our lead program is the development of abarelix, a drug to treat diseases that respond to the lowering of hormone levels. We have entered into collaborations with Amgen Inc. and Sanofi-Synthelabo S.A. to further develop and commercialize our abarelix products. Since our inception, we have had no revenues from product sales. We have received revenues in the form of signing, performance-based, cost sharing and contract services payments from corporate collaborations. These revenues enabled us to achieve profitability and positive cash flow before any financing activity for fiscal 1997, 1998 and 1999. From inception through June 30, 2000, we recognized approximately $138.7 million in revenues under these collaboration agreements. Under these agreements, we could receive additional non-refundable performance-based payments and reimbursement for ongoing development costs, as well as a percentage of future product profits. For the next several years, we expect that our sources of revenue, if any, will consist primarily of interest income and payments from our corporate collaborators. We expect reimbursement for ongoing development costs under our corporate collaborations to diminish over the next several years. Our accumulated deficit as of June 30, 2000 was approximately $5.6 million. Substantially all of our expenditures to date have been for drug development activities and for general and administrative expenses. Due to the high costs associated with preparing to launch our first product, as well as other research and development and general and administrative expenses, we expect to have net operating losses for fiscal 2000 and the following several years. We do not expect to generate operating income until several years after abarelix is approved for marketing by the FDA for the treatment of prostate cancer. We will require regulatory approval to market all of our future products. In August 1996, we entered into a collaboration and license agreement with Boehringer Ingelheim International GmbH. Under this agreement, Boehringer paid us approximately $5.4 million over approximately two years. These payments consisted of an initial signing payment and additional payments for 10 the screening of Boehringer compounds and reimbursement of personnel and related materials expenses. We also are entitled to receive royalties on the net sales of any product containing a Boehringer compound which we screened if Boehringer develops and commercializes the product. In May 1997, we entered into an agreement with Sanofi-Synthelabo for the development and commercialization of abarelix products in Europe, Latin America, the Middle East and various countries in Africa. Under our agreement with Sanofi-Synthelabo, we could receive up to approximately $69.6 million in non-refundable fees and performance-based payments. For supply of product to Sanofi-Synthelabo, we receive a transfer price that varies based on sales price and volume. Additionally, we are entitled to receive reimbursement for ongoing development costs. To date, we have received a total of approximately $31.5 million in non-refundable fees, performance-based payments and reimbursement for ongoing development costs under the Sanofi-Synthelabo agreement. In 1997 and 1998, we entered into agreements with Roche Products Inc. for the research, development and commercialization of abarelix products in all countries outside of the Sanofi-Synthelabo territory. In December 1998, we and Roche mutually terminated the agreement. During the term of the agreement, Roche paid to us approximately $28.2 million in performance-based and cost-sharing payments. Roche retains no rights to the abarelix program and has no equity interest in us. Effective March 1999, we entered into an agreement with Amgen for the development and commercialization of abarelix products in the countries not covered by the Sanofi-Synthelabo agreement. Under the agreement, we could receive up to $25.0 million in signing and performance-based fees. Of this $25.0 million, we have received $10.0 million to date, which is the minimum amount payable under the agreement. The remaining $15.0 million is payable upon FDA approval of a new drug application (NDA), relating to abarelix. Amgen will pay the first $175.0 million of all authorized costs and expenses associated with the research, development and commercialization of abarelix products in the United States. We expect Amgen's $175.0 million funding commitment to be fulfilled during the third quarter of 2000. Following these expenditures, in general we will share with Amgen all subsequent United States research and development costs for abarelix products through the launch period and we will reimburse Amgen for our share of the costs associated with establishing a sales and marketing infrastructure in the United States, as set forth in the Amgen agreement. In general, we will receive a transfer price and royalty based on a sharing of the resulting profits on sales of abarelix products in the United States. All program expenses in Amgen's licensed territory outside the United States will be borne by Amgen, and we will receive a royalty on net sales of abarelix products in those territories. We have granted Amgen exclusive manufacturing and commercialization rights for abarelix products for all indications in the licensed territories. During the second quarter of 2000, Amgen assumed manufacturing responsibility for abarelix products, with the exception of the depot formulation, pursuant to the terms of the Amgen agreement. Under the Amgen agreement, we have retained manufacturing responsibility for the depot formulation of abarelix, subject to the terms of the agreement. RESULTS OF OPERATIONS THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THREE MONTHS ENDED JUNE 30, 1999 Revenues for the three months ended June 30, 2000 decreased 75% to approximately $10.0 million, from approximately $39.2 million for the corresponding period in 1999. The decrease in revenues was the result of a decrease in reimbursable abarelix expenses. In addition, incremental reimbursement revenues were recognized during the three months ended June 30, 1999 which related to reimbursable expenses incurred prior to the signing of the Amgen agreement and recognized as revenue in accordance with the terms therein. We anticipate revenues to continue to decrease due to the expected completion of Amgen's initial funding commitment and the decline in our abarelix development expenses, which will be subject to a reduced rate of 11 reimbursement under our corporate collaborations. Research and development expenses for the three months ended June 30, 2000 decreased 29% to approximately $12.4 million, from approximately $17.3 million for the corresponding period in 1999. The decrease in expenses was primarily the result of decreased spending on our abarelix/prostate cancer clinical development program. This decrease was partially offset by increased spending related to our abarelix/endometriosis, Latranal and Apan clinical development programs, as well as discovery research initiatives. We expect Amgen's initial funding commitment will be completed during the third quarter of 2000. Following these expenditiures, in general we will share with Amgen all subsequent United States research and development costs for abarelix products through the launch period. General and administrative expenses for the three months ended June 30, 2000 decreased 29% to approximately $1.8 million, from approximately $2.5 million for the corresponding period in 1999. The decrease in expenses was due primarily to sales and marketing costs incurred during the corresponding period in 1999 that are currently being assumed by our corporate partner, Amgen, in order to establish a sales and marketing infrastructure in the United States for abarelix products. The decrease in expenses was partially offset by an increase in personnel and compensation costs, an increased use of consultants and external contractors, and other costs associated with being a public company. We expect that general and administrative expenses will increase as we hire additional administrative personnel to support continued growth of our research and development initiatives and incur additional costs related to being a public company, including directors' and officers insurance, investor relations programs and printing and legal costs. In addition, following the expected completion of Amgen's initial funding commitment during the third quarter of 2000, we will reimburse Amgen for our share of the costs associated with establishing a sales and marketing infrastructure in the United States, as set forth in the Amgen agreement. Net interest income for the three months ended June 30, 2000 increased 103% to approximately $2.1 million, from approximately $1.1 million for the corresponding period in 1999. The increase in interest income was due to higher average cash and investment balances from our initial public offering in May 2000 and an increase in average interest rates from the same period last year. The provision for income taxes for the three months ended June 30, 2000 and 1999 was zero and $1.6 million, respectively. Our effective tax rate was approximately 16.3% during 1999. SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO SIX MONTHS ENDED JUNE 30, 1999 Revenues for the six months ended June 30, 2000 decreased 53% to approximately $19.0 million, from approximately $40.3 million for the corresponding period in 1999. The decrease in revenues was the result of a decrease in reimbursable abarelix expenses. In addition, incremental revenues were recognized during the six months ended June 30, 1999 which related to reimbursable abarelix expenses incurred prior to the signing of the Amgen agreement and recognized as revenue in accordance with the terms therein. We anticipate revenues to continue to decrease due to the expected completion of Amgen's initial funding commitment and the decline in our abarelix development expenses, which will be subject to a reduced rate of reimbursement under our corporate collaborations. Research and development expenses for the six months ended June 30, 2000 decreased 17% to approximately $23.7 million, from approximately $28.5 million for the corresponding period in 1999. The decrease in expenses was primarily the result of decreased spending on our abarelix/prostate cancer clinical development program. This decrease was partially offset by increased spending related to our abarelix/endometriosis, Latranal and Apan clinical development programs, as well as discovery research initiatives. We expect Amgen's initial funding commitment will be completed during the third quarter of 2000. Following these expenditiures, in general we will share with Amgen all subsequent United States research and development costs for abarelix products through the launch period. 12 General and administrative expenses for the six months ended June 30, 2000 decreased 7% to approximately $3.2 million, from approximately $3.4 million for the corresponding period in 1999. The decrease in expenses for the sixth-month period was due primarily to sales and marketing costs incurred during the corresponding period in 1999 that are currently being assumed by our corporate partner, Amgen, in order to establish a sales and marketing infrastructure in the United States for abarelix products. The decrease in expenses was partially offset by an increase in personnel and compensation costs, an increased use of consultants and external contractors, and other costs associated with being a public company. We expect that general and administrative expenses will increase as we hire additional administrative personnel to support continued growth of our research and development initiatives and incur additional costs related to being a public company, including directors' and officers insurance, investor relations programs and printing and legal costs. In addition, following the expected completion of Amgen's initial funding commitment during the third quarter of 2000, we will reimburse Amgen for our share of the costs associated with establishing a sales and marketing infrastructure in the United States, as set forth in the Amgen agreement. Net interest income for the six months ended June 30, 2000 increased 69% to approximately $3.4 million, from approximately $2.0 million for the corresponding period in 1999. The increase in interest income was due to increased cash and investment balances from our initial public offering in May 2000 and an increase in average interest rates from the same period last year. The provision for income taxes for the six months ended June 30, 2000 and 1999 was $0.1 million and $1.7 million, respectively. Our effective tax rate was approximately 16.3% during 1999. The provision for income taxes during 2000 was primarily for state income taxes. LIQUIDITY AND CAPITAL RESOURCES We have financed our operations since inception principally through private placements of equity securities and our initial public offering. Prior to our initial public offering, we had received net proceeds of approximately $10.5 million from the private placement of our common stock, $0.5 million from the private placement of warrants to purchase common stock and $78.5 million from the private placement of convertible preferred stock. Additionally, we have received a total of approximately $176.0 million for one-time signing payments and performance-based payments, cost reimbursements and contract service payments under our collaboration agreements. We also have received $14.3 million from interest on invested cash balances and paid $0.4 million in interest expense associated with equipment leasing. On May 2, 2000, we completed our initial public offering, selling 8,000,000 shares of common stock at a price of $10 per share, raising a total of approximately $73.1 million in net proceeds after payment of underwriting discounts and commissions and estimated offering expenses. On May 3, 2000, the underwriters of our initial public offering exercised their right to purchase additional shares of common stock to cover over-allotments. Accordingly, on May 8, 2000, we sold an additional 1,200,000 shares of common stock at a price of $10 per share, resulting in an additional $11.2 million in net proceeds after payment of underwriting discounts and commissions. We sold a total of 9,200,000 shares (including the over-allotment shares) of common stock in our initial public offering for a total of approximately $84.3 million, net of underwriting discounts and commissions and estimated offering expenses. At June 30, 2000, we had cash and cash equivalents of $167.9 million and working capital of $163.2 million, compared to $94.5 million and $86.2 million, respectively, at December 31, 1999. Based upon our existing capital resources, together with the net proceeds of the initial public offering, interest income and payments under our collaboration agreements, we anticipate that we will be able to maintain currently planned operations for at least the next several years. For the six months ended June 30, 2000, net cash of $10.0 million was 13 used in operating activities, compared to $12.3 million provided by operating activities in the corresponding period in 1999. During the six months ended June 30, 2000, our use of cash in operations was principally due to our net loss coupled with our payment of 1999 income taxes, as well as an increase in our prepaid expenses and other assets and a decrease in accounts payable, partially offset by decreases in accounts receivable and unbilled revenues. Our investing activities for the six months ended June 30, 2000 were limited to the purchase of property and equipment in the amount of approximately $1.7 million. Our financing activities for the six months ended June 30, 2000 consisted principally of the proceeds of our initial public offering, as well as proceeds received from the exercise of common stock options. On July 11, 2000, we purchased, for $41.3 million, through our wholly owned subsidiary, 830 Winter Street LLC, a single purpose Delaware limited liability company, land and a building of approximately 175,000 square feet located in Waltham, Massachusetts. We will use this building as our principal headquarters and research facility. In connection with obtaining first mortgage financing to purchase this facility, we formed 830 Winter Street and assigned all of our rights and obligations under the related purchase and sale agreement to that entity. 830 Winter Street executed an acquisition and construction loan agreement providing for up to $33.0 million in financing for the acquisition of and improvements to the new facility. Under the terms of the loan agreement, advances are available primarily to pay for the acquisition of and improvements to the new facility. In connection with the purchase of the new facility, an initial advance of $24.0 million was made on July 11, 2000. The remaining $9.0 million of the loan will be made available following the expenditure by 830 Winter Street of not less than $4.5 million for renovation costs, and will be subject to various other terms and conditions under the loan documents. Advances bear interest at a rate equal to the 30-day LIBOR plus 2.0% (8.64% at July 11, 2000). Interest is payable monthly in arrears commencing July 1, 2000. Principal is due and payable in full on July 30, 2003, subject to two, one-year extension options. The loan is secured by the new facility, together with all fixtures, equipment, improvements and other items related thereto, and by all rents, income or profits received by 830 Winter Street. In addition, as a condition of the financing, we executed certain unconditional guaranties of all of 830 Winter Street's obligations under the loan agreement and related loan documents. We expect to occupy the new facility during the first quarter of 2001 and intend to sublet a portion of the facility at that time. Under our agreement with Amgen, Amgen will provide us with a line of credit not to exceed $150.0 million through 2002. Under the line of credit, subject to various conditions each year, we are permitted to draw down a maximum of $25.0 million in 2000, $75.0 million in 2001, and in 2002, the remaining balance of the line of credit available after all previous drawdowns. For each drawdown in 2002, we must demonstrate a cash flow need reasonably acceptable to Amgen and meet various other specified conditions, including conditions relating to the commercial sale of abarelix. Borrowings 14 will bear interest at market rates and will be secured by various receivables relating to abarelix products. In addition, all borrowings under the line of credit must be repaid by 2008. We anticipate making drawdowns under the loan beginning this year, subject to the conditions set forth in the Amgen agreement. We expect our funding requirements to increase over the next several years as we continue with current clinical trials for abarelix, initiate clinical trials for additional products, prepare for a potential commercial launch of abarelix products, improve and move into our new facility and continue to expand our research and development initiatives. Our expenditure requirements will depend on numerous factors, including: - the progress of our research and development activities; - the scope and results of preclinical testing and clinical trials; - the cost, timing and outcomes of regulatory reviews; - the rate of technological advances; - determinations as to the commercial potential of our products under development; - the status of competitive products; - our ability to defend and enforce our intellectual property rights; - the continued viability and duration of our corporate collaboration agreements or other licensing agreements; - the establishment, continuation or termination of third-party manufacturing or sales and marketing arrangements; - the development of sales and marketing resources; - the establishment of additional strategic or licensing arrangements with other companies or acquisitions; - our ability to sublease our current facility and part of our new facility; and - the availability of other financing. At December 31, 1999, we had provided a valuation allowance of $3.6 million for our deferred tax assets. The valuation allowance represents the excess of the deferred tax asset over the benefit from future losses that could be carried back if, and when, they occur. Due to anticipated operating losses in the future, we believe that it is more likely than not that we will not realize a portion of the net deferred tax assets in the future and we have provided an appropriate valuation allowance. YEAR 2000 CONSIDERATIONS We, our corporate collaborators, suppliers and other third parties we rely upon use a wide variety of information technologies, computer systems and scientific equipment containing computer chips dedicated to a specific task. As of July 31, 2000, neither we, nor to our knowledge, any of the third parties we depend upon, have experienced any material problems associated with the year 2000 issue. If we or these third parties experience problems in the future as a result of any year 2000-related issues, we could experience an interruption of our research programs. We currently are unable to estimate the duration and extent of any potential interruption, or estimate the effect that 15 any interruption may have on our future revenue. However, we believe that the impact of any residual year 2000-related issues on our research operations will be limited to the ongoing execution of new experiments, and we do not expect that any historical data would be affected. Costs to ensure that our systems and networks are year 2000 compliant have not been, nor do we expect them to be, material. ADDITIONAL RISK FACTORS THAT MAY AFFECT FUTURE RESULTS THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY ONES THAT WE FACE. ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY KNOWN TO US OR THAT ARE CURRENTLY DEEMED IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS. IF ANY OF THESE RISKS ACTUALLY OCCUR, OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY ADVERSELY AFFECTED. BECAUSE WE HAVE NOT YET MARKETED OR SOLD ANY OF OUR PRODUCTS AND ANTICIPATE SIGNIFICANT INCREASES IN OUR OPERATING EXPENSES OVER THE NEXT SEVERAL YEARS, WE MAY NOT BE PROFITABLE IN THE FUTURE. We cannot assure you that we will be profitable in the future or, if we are profitable, that it will be sustainable. All of our potential products are in the research or development stage. We have not yet marketed or sold any of our products, and we may not succeed in developing and marketing any product in the future. To date, we have derived substantially all of our revenues from payments under our collaboration and license agreements and will continue to do so for at least the next several years. In addition, we expect to continue to spend significant amounts to continue clinical studies, obtain regulatory approval for our product candidates and expand our facilities. We also intend to spend substantial amounts to fund additional research and development for other products, enhance our core technologies, and for general and administrative purposes. As of June 30, 2000, we had an accumulated deficit of approximately $5.6 million. We expect that our operating expenses will increase significantly in the near term, resulting in significant operating losses for fiscal 2000 and the next several years. IF OUR CLINICAL TRIALS ARE NOT SUCCESSFUL, OR IF WE ARE OTHERWISE UNABLE TO OBTAIN AND MAINTAIN THE REGULATORY APPROVAL REQUIRED TO MARKET AND SELL OUR PRODUCTS, WE WOULD INCUR ADDITIONAL OPERATING LOSSES. The development and sale of our products is subject to extensive regulation by governmental authorities. Obtaining and maintaining regulatory approval typically is costly and takes many years. Regulatory authorities have substantial discretion to terminate clinical trials, delay or withhold registration and marketing approval, and mandate product recalls. Failure to comply with regulatory requirements may result in criminal prosecution, civil penalties, recall or seizure of products, total or partial suspension of production or injunction, as well as other action against our potential products or us. Outside the United States, we can market a product only if we receive a marketing authorization from the appropriate regulatory authorities. This foreign regulatory approval process includes all of, and in some cases, additional, risks associated with the FDA approval process we describe above. To gain regulatory approval from the FDA and foreign regulatory authorities for the commercial sale of any product, we must demonstrate the safety and efficacy of the product in clinical trials. If we develop a product to treat a long-lasting disease, such as cancer or Alzheimer's Disease, we must gather data over an extended period of time. There are many risks associated with our clinical trials. For example, we may be unable to achieve the same level of success in later trials as we did in earlier ones. Additionally, data we obtain from preclinical and clinical activities are susceptible to varying interpretations that could impede regulatory approval. Further, some patients in our prostate cancer and Alzheimer's Disease programs have a high risk of death, age-related disease or other adverse medical events not related to our products. These events may effect the statistical analysis of the safety and efficacy of our products. 16 In addition, many factors could delay or terminate our ongoing or future clinical trials. For example, a clinical trial may experience slow patient enrollment or lack of sufficient drug supplies. Patients may experience adverse medical events or side effects, and there may be a real or perceived lack of effectiveness of the drug we are testing. Future governmental action or changes in FDA policy may also result in delays or rejection. Accordingly, we may not be able to obtain product registration or marketing approval for abarelix depot, our drug candidate for the treatment of prostate cancer and endometriosis, or for any of our other products, based on the results of our clinical trials. If we obtain regulatory approval for a product, the approval will be limited to those diseases for which our clinical trials demonstrate the product is safe and effective. To date, none of our products have received regulatory approval for commercial sale. If we are delayed in obtaining or are unable to obtain regulatory approval to market our products, we may exhaust our available resources, including the proceeds from our initial public offering, which was completed in May 2000, significantly sooner than we had planned. If this happened, we would need to raise additional funds to complete commercialization of our lead products and continue our research and development programs. We cannot assure you that we would be able to obtain these additional funds on favorable terms, if at all. EVEN IF WE RECEIVE APPROVAL FOR THE MARKETING AND SALE OF OUR PRODUCTS, THEY MAY FAIL TO ACHIEVE MARKET ACCEPTANCE AND, ACCORDINGLY, MAY NEVER BE COMMERCIALLY SUCCESSFUL. Many factors may affect the market acceptance and commercial success of any of our potential products, including: - the timing of market entry as compared to competitive products; - the effectiveness of our products, including any potential side effects, as compared to alternative treatment methods; - the rate of adoption of our products by doctors and nurses and acceptance by the target population; - the product labeling or product insert required by the FDA for each of our products; - the competitive features of our products as compared to other products, including the frequency of administration of abarelix as compared to other products, and doctor and patient acceptance of these features; - the cost-effectiveness of our products and the availability of insurance or other third-party reimbursement, in particular Medicare, for patients using our products; - the extent and success of our marketing efforts and those of our collaborators; and - unfavorable publicity concerning our products or any similar products. If our products are not commercially successful, we may never become profitable. IF OUR STRATEGIC PARTNERS REDUCE, DELAY OR TERMINATE THEIR FINANCIAL SUPPORT, WE MAY BE UNABLE TO SUCCESSFULLY DEVELOP, MARKET, DISTRIBUTE AND SELL OUR PRODUCTS. We depend upon our corporate collaborators, in particular Amgen and Sanofi-Synthelabo, to provide substantial financial support for developing our products. We also will rely on them in some instances to help us obtain 17 regulatory approval for our products and to manufacture, market, distribute or sell our products. Despite our dependence, we have limited control over the amount and timing of resources that our corporate collaborators devote to our programs or potential products. Also, our corporate collaborators may terminate our collaboration agreements in various circumstances. For example, in December 1998, we and Roche Products Inc. mutually terminated our agreement. We and each of Amgen and Sanofi-Synthelabo may mutually terminate our agreement, and, in addition: - Amgen and Sanofi-Synthelabo each may terminate its agreement with us if the results of any clinical trial of abarelix materially harms the product's commercial prospects; - Amgen may terminate its agreement with us at any time upon 90 days prior written notice; and - Sanofi-Synthelabo may terminate its agreement with us if specified adverse events occur relating to our European patent applications or the related patents which may be issued covering abarelix or our Rel-Ease(TM) technology. We cannot assure you that any of our present or future collaborators will meet their obligations to us under the collaboration agreements. If a collaborator terminates its agreement with us or fails to perform its obligations, it may delay the development or commercialization of the potential product or research program. As a result, we could have to devote unforeseen additional resources to development and commercialization or to terminate one or more of our drug development programs. Due to increased operating costs and lost revenue associated with the termination of a collaboration agreement, we could have to seek funds in addition to the net proceeds of our initial public offering, which was completed in May 2000, to meet our capital requirements. We cannot assure you that we would be able to raise the necessary funds or negotiate additional corporate collaborations on acceptable terms, if at all, and we may have to curtail or cease operations. For instance, if, following the termination of our agreement with Roche, we had been unable to enter into an alternative collaboration for the development and commercialization of our abarelix products in a timely manner, we likely would have needed to delay or cut back our programs for the development of abarelix or other drugs and to raise additional funds through one or more equity financings prior to the time we had planned to do so and possibly on less than favorable terms. WE COULD EXPERIENCE DELAYS IN THE RESEARCH, DEVELOPMENT OR COMMERCIALIZATION OF OUR PRODUCTS AS A RESULT OF CONFLICTS WITH OUR CORPORATE COLLABORATORS OR COMPETITION FROM THEM. An important part of our strategy involves conducting proprietary research programs. We may pursue opportunities that conflict with our collaborators' businesses. Disagreements with our collaborators could develop over rights to intellectual property, including the ownership of technology co-developed with our collaborators. Our current or future collaborators could develop products in the future that compete with our products. This could diminish our collaborators' commitment to us, and reduce the resources they devote to developing and commercializing our products. Conflicts or disputes with our collaborators, and competition from them, could harm our relationships with our other collaborators, restrict our ability to enter future collaboration agreements and delay the research, development or commercialization of our products. BECAUSE WE DEPEND ON THIRD PARTIES TO CONDUCT LABORATORY TESTING AND HUMAN CLINICAL STUDIES AND ASSIST US WITH REGULATORY COMPLIANCE, WE MAY ENCOUNTER DELAYS IN PRODUCT DEVELOPMENT AND COMMERCIALIZATION. We have contracts with a limited number of research organizations to design and conduct our laboratory testing and human clinical studies. If we cannot contract for testing activities on acceptable terms, or at all, we may not complete our product development efforts in a timely manner. To the extent 18 we rely on third parties for laboratory testing and human clinical studies, we may lose some control over these activities. For example, third parties may not complete testing activities on schedule or when we request. In addition, these third parties may not conduct our clinical trials in accordance with regulatory requirements. The failure of these third parties to carry out their contractual duties could delay or prevent the development and commercialization of our products. IF WE FAIL TO DEVELOP AND MAINTAIN OUR RELATIONSHIPS WITH THIRD-PARTY MANUFACTURERS, OR IF THESE MANUFACTURERS FAIL TO PERFORM ADEQUATELY, WE MAY BE UNABLE TO COMMERCIALIZE OUR PRODUCTS. Our capacity to conduct clinical trials and commercialize our products will depend in part on our ability to manufacture our products on a large scale, at a competitive cost and in accordance with regulatory requirements. We must establish and maintain a commercial scale formulation and manufacturing process for all of our potential products to complete clinical trials. We, our collaborators or third-party manufacturers may encounter difficulties with these processes at any time that could result in delays in clinical trials, regulatory submissions or in the commercialization of potential products. We have no experience in large-scale product manufacturing, nor do we have the resources or facilities to manufacture products on a commercial scale. We will continue to rely upon contract manufacturers to produce abarelix and other compounds for preclinical, clinical and commercial purposes for a significant period of time. If our supply agreements are not satisfactory, we may not be able to develop or commercialize potential products as planned. The manufacture of our potential products will be subject to current good manufacturing practices regulations. Third-party manufacturers are subject to regulatory review and may fail to comply with these good manufacturing practices regulations. If we need to replace our current third-party manufacturers, or contract with additional manufacturers, we must conduct new product testing and facility compliance inspections. This testing and inspection is costly and time-consuming. Any of these factors could prevent, or cause delays in, obtaining regulatory approvals for, and the manufacturing, marketing or selling of, our products and could also result in significantly higher operating expenses. For example, Oread Pharmaceutical Manufacturing, Inc., the supplier of abarelix depot powder in finished vials, advised us that its lease for possession and use of the facility where it conducted its manufacturing operations pursuant to its agreement with us had been terminated, effective June 30, 2000, that it would be unable to continue operations in the leased premises and that it must terminate its agreement with us. Although we were able to make alternative arrangements for this step in the manufacture of abarelix depot in a timely manner, the use of a different manufacturer may require us to undergo additional regulatory review and compliance procedures which could result in additional expenses and delay the regulatory approval and commercialization of abarelix depot for the treatment of prostate cancer. If we fail to meet our manufacturing and supply obligations under our agreements with either Amgen or Sanofi-Synthelabo, they may assume manufacturing responsibility under their agreements. In addition, if this occurs, we must pay Sanofi-Synthelabo its incremental costs of assuming manufacturing responsibility. ALTERNATIVE TREATMENTS ARE AVAILABLE WHICH MAY IMPAIR OUR ABILITY TO CAPTURE MARKET SHARE FOR OUR PRODUCTS. Alternative products exist or are under development to treat the diseases for which we are developing drugs. For example, the FDA has approved several drugs for the treatment of prostate cancer that responds to changes in hormone levels. Even if the FDA approves abarelix depot for commercialization for the treatment of prostate cancer, it may not compete favorably with existing treatments that already have an established market share. If abarelix depot does not achieve broad market acceptance as a drug for the treatment of 19 prostate cancer, we may not become profitable. MANY OF OUR COMPETITORS HAVE SUBSTANTIALLY GREATER RESOURCES THAN WE DO AND MAY BE ABLE TO DEVELOP AND COMMERCIALIZE PRODUCTS THAT MAKE OUR PRODUCTS AND TECHNOLOGIES OBSOLETE AND NON-COMPETITIVE. A biotechnology company such as ours must keep pace with rapid technological change and faces intense competition. We compete with biotechnology and pharmaceutical companies for funding, access to new technology, research personnel and in product research and development. Many of these companies have greater financial resources and more experience than we do in developing drugs, obtaining regulatory approvals, manufacturing and marketing. We also face competition from academic and research institutions and government agencies pursuing competitive alternatives to our products and technologies. We expect that all of our products under development will face intense competition from existing or future drugs. Our competitors may: - successfully identify drug candidates or develop products earlier than we do; - obtain approvals from the FDA or foreign regulatory bodies more rapidly than we do; - develop products that are more effective, have fewer side effects or cost less than our products; or - successfully market products that compete with our products. IF WE ARE UNABLE TO OBTAIN AND ENFORCE VALID PATENTS, WE COULD LOSE OUR COMPETITIVE ADVANTAGE. Our success will depend in part on our ability to obtain patents and maintain adequate protection of our technologies and products. If we do not adequately protect our intellectual property, competitors may be able to use our technologies and erode our competitive advantage. For example, if we lost our patent protection for abarelix, another party could produce and market abarelix in direct competition with us. Some foreign countries lack rules and methods for defending intellectual property rights and do not protect proprietary rights to the same extent as the United States. Many companies have had difficulty protecting their proprietary rights in these foreign countries. Patent positions are sometimes uncertain and usually involve complex legal and factual questions. We can protect our proprietary rights from unauthorized use by third parties only to the extent that our proprietary technologies are covered by valid and enforceable patents or are effectively maintained as trade secrets. To date, we own or exclusively license eight issued United States patents. We have applied, and will continue to apply, for patents covering both our technologies and products as we deem appropriate. Others may challenge our patent applications or our patent applications may not result in issued patents. Moreover, any issued patents on our own inventions, or those licensed from third parties, may not provide us with adequate protection, or others may challenge, circumvent or narrow our patents. Third-party patents may impair or block our ability to conduct our business. Additionally, third parties may independently develop products similar to our products, duplicate our unpatented products, or design around any patented products we develop. IF WE ARE UNABLE TO PROTECT OUR TRADE SECRETS AND PROPRIETARY INFORMATION, WE COULD LOSE OUR COMPETITIVE ADVANTAGE IN THE MARKET. In addition to patents, we rely on a combination of trade secrets, confidentiality, nondisclosure and other contractual provisions, and security measures to protect our confidential and proprietary information. These measures may not adequately protect our trade secrets or other proprietary information. If they do not adequately protect our rights, third parties could 20 use our technology, and we could lose any competitive advantage we may have. In addition, others may independently develop similar proprietary information or techniques or otherwise gain access to our trade secrets, which could impair any competitive advantage we may have. IF OUR POTENTIAL PRODUCTS CONFLICT WITH THE PATENTS OF COMPETITORS, UNIVERSITIES OR OTHERS, WE COULD HAVE TO ENGAGE IN COSTLY LITIGATION AND BE UNABLE TO COMMERCIALIZE THOSE PRODUCTS. Our potential products may give rise to claims that they infringe other patents. A third party could force us to pay damages or to stop our manufacturing and marketing of the affected products by bringing a legal action against us for any infringement. In addition, a third party could require us to obtain a license to continue to manufacture or market the affected products, and we may not be able to do so. We believe that significant litigation will continue in our industry regarding patent and other intellectual property rights. If we become involved in litigation, it could consume a substantial portion of our resources. Even if legal actions were meritless, defending a lawsuit could take significant time, be expensive and divert management's attention from other business concerns. IF THIRD PARTIES TERMINATE OUR LICENSES, WE COULD EXPERIENCE DELAYS OR BE UNABLE TO COMPLETE THE DEVELOPMENT AND COMMERCIALIZATION OF OUR PRODUCTS. We license some of our technology from third parties. Termination of our licenses could force us to delay or discontinue some of our development and commercialization programs. For example, if Advanced Research and Technology Institutes, Inc., the assignee of Indiana University Foundation, terminated our abarelix license, we could have to discontinue development and commercialization of our abarelix products. We cannot assure you that we would be able to license substitute technology in the future. Our inability to do so could impair our ability to conduct our business because we may lack the technology necessary to develop and commercialize our potential products. DUE TO OUR INEXPERIENCE AND OUR LIMITED SALES AND MARKETING STAFF, WE WILL DEPEND ON THIRD PARTIES TO SELL AND MARKET OUR PRODUCTS. We have no experience in marketing or selling pharmaceutical products and have a limited marketing and sales staff. To achieve commercial success for any approved product, we must either develop a marketing and sales force or enter into arrangements with third parties to market and sell our products. We have granted Amgen and Sanofi-Synthelabo exclusive commercialization rights for abarelix products in defined geographic locations. Our marketing and distribution arrangements with Amgen and Sanofi-Synthelabo may not be successful and we may not receive any revenues from these arrangements. We cannot assure you that we will be able to enter into marketing and sales agreements on acceptable terms, if at all, for any other products. OUR REVENUES WILL DIMINISH IF WE FAIL TO OBTAIN ACCEPTABLE PRICES OR ADEQUATE REIMBURSEMENT FOR OUR PRODUCTS FROM THIRD-PARTY PAYORS. The continuing efforts of government and third-party payors to contain or reduce the costs of health care may limit our commercial opportunity. If government and other third-party payors do not provide adequate coverage and reimbursement for our products, physicians may not prescribe them. If we are unable to offer physicians comparable or superior financial motivation to use our products, we may not be able to generate significant revenues. For example, in some foreign markets, pricing and profitability of prescription pharmaceuticals are subject to government control. In the United States, we expect that there will continue to be federal and state proposals for similar controls. In addition, increasing emphasis on managed care in the United States will continue to put pressure on the pricing of pharmaceutical products. Cost control initiatives could decrease the price that any of our collaborators or we receive for any products in the future. Further, cost 21 control initiatives could impair our collaborators' ability to commercialize our products, and our ability to earn revenues from this commercialization. Our ability to commercialize pharmaceutical products, alone or with collaborators, may depend in part on the availability of reimbursement for our products from: - government and health administration authorities; - private health insurers; and - other third-party payors, including Medicare. We cannot predict the availability of reimbursement for newly approved health care products. Third-party payors, including Medicare, are challenging the prices charged for medical products and services. Government and other third-party payors increasingly are limiting both coverage and the level of reimbursement for new drugs and refusing, in some cases, to provide coverage for a patient's use of an approved drug for purposes not approved by the FDA. Third-party insurance coverage may not be available to patients for any of our products. WE MAY BE UNABLE TO SUB-LEASE OUR CURRENT FACILITY OR FIND SUITABLE TENANTS FOR A PORTION OF OUR NEW FACILITY. We have exceeded the capacity of our current facilities, and recently purchased, through our wholly owned subsidiary, 830 Winter Street LLC, a new facility in Waltham, Massachusetts. In July 2000, we executed a 15-year lease with 830 Winter Street for our new facility. We intend to sub-lease a portion of our new facility to third-parties and to sub-lease our current facility. We may not be able to find suitable sub-tenants to occupy these spaces in a timely manner, if at all. IF WE LOSE OUR KEY PERSONNEL OR ARE UNABLE TO ATTRACT AND RETAIN ADDITIONAL SKILLED PERSONNEL, WE MAY BE UNABLE TO PURSUE OUR PRODUCT DEVELOPMENT AND COMMERCIALIZATION EFFORTS. We depend substantially on the principal members of our management and scientific staff, including Malcolm L. Gefter, Ph.D., our Chief Executive Officer, President and Chairman of the Board. We do not have employment agreements with any of our executive officers. Any officer or employee can terminate his or her relationship with us at any time and work for one of our competitors. The loss of these key individuals could result in competitive harm because we could experience delays in our product research, development and commercialization efforts without their expertise. Recruiting and retaining qualified scientific personnel to perform future research and development work also will be critical to our success. Competition for skilled personnel is intense and the turnover rate can be high. We compete with numerous companies and academic and other research institutions for experienced scientists. This competition may limit our ability to recruit and retain qualified personnel on acceptable terms. Failure to attract and retain personnel would prevent us from successfully developing our products or core technologies and launching our products commercially. Our planned activities may require the addition of new personnel, including management, and the development of additional expertise by existing management personnel. The inability to acquire these services or to develop this expertise could result in delays in the research, development and commercialization of our products. WE MAY HAVE SUBSTANTIAL EXPOSURE TO PRODUCT LIABILITY CLAIMS AND MAY NOT HAVE ADEQUATE INSURANCE TO COVER THOSE CLAIMS. We may be held liable if any product we develop, or any product made by others using our technologies, causes injury. We have only limited product liability insurance coverage for our clinical trials. We intend to obtain product liability insurance to cover our products approved for marketing and 22 sale. This insurance may be prohibitively expensive or may not fully cover our potential liabilities. Our inability to obtain adequate insurance coverage and at an acceptable cost could prevent or inhibit the commercialization of our products. If a third party sues us for any injury caused by products made by us or using our technologies, our liability could exceed our total assets. WE USE HAZARDOUS CHEMICALS AND RADIOACTIVE AND BIOLOGICAL MATERIALS IN OUR BUSINESS AND POTENTIAL CLAIMS RELATING TO IMPROPER HANDLING, STORAGE OR DISPOSAL OF THESE MATERIALS COULD BE TIME CONSUMING AND COSTLY. Our research and development processes involve the controlled use of hazardous materials, including chemicals and radioactive and biological materials. The health risks associated with accidental exposure to abarelix include temporary impotence or infertility and harmful effects on pregnant women. Our operations also produce hazardous waste products. We cannot eliminate the risk of accidental contamination or discharge from hazardous materials and any resultant injury. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of hazardous materials. Compliance with environmental laws and regulations may be expensive. Current or future environmental regulations may impair our research, development or production efforts. We might have to pay civil damages in the event of an improper or unauthorized release of, or exposure of individuals to, hazardous materials. Some of our collaborators also work with hazardous materials in connection with our collaborations. We have agreed to indemnify our collaborators in some circumstances against damages and other liabilities arising out of development activities or products produced in connection with these collaborations. IF WE ENGAGE IN AN ACQUISITION, WE WILL INCUR A VARIETY OF COSTS AND MAY NEVER REALIZE THE ANTICIPATED BENEFITS OF THE ACQUISITION. If appropriate opportunities become available, we may attempt to acquire businesses, products or technologies that we believe are a strategic fit with our business. We currently have no commitments or agreements for any acquisitions. If we do undertake any transaction of this sort, the process of integrating an acquired business, product or technology may result in unforeseen operating difficulties and expenditures and may absorb significant management attention that would otherwise be available for ongoing development of our business. Moreover, we may fail to realize the anticipated benefits of any acquisition. Future acquisitions could dilute your ownership interest in us and could cause us to incur debt, expose us to future liabilities and result in amortization expenses related to goodwill and other intangible assets. THE MARKET PRICE OF OUR COMMON STOCK MAY EXPERIENCE EXTREME PRICE AND VOLUME FLUCTUATIONS. The market price of the common stock may fluctuate substantially due to a variety of factors, including: - announcements of technological innovations or new products by us or our competitors; - announcement of FDA approval or disapproval of our products; - the success rate of our discovery efforts and clinical trials leading to performance-based payments and revenues under our collaborations; - developments or disputes concerning patents or proprietary rights, including announcements of infringement, interference or other litigation against us or our licensors; - the willingness of collaborators to commercialize our products and the timing of commercialization; 23 - announcements concerning our competitors, or the biotechnology or pharmaceutical industry in general; - public concerns as to the safety of our products or our competitors' products; - changes in government regulation of the pharmaceutical or medical industry; - changes in the reimbursement policies of third-party insurance companies or government agencies; - actual or anticipated fluctuations in our operating results; - changes in financial estimates or recommendations by securities analysts; - loss of corporate collaborators; - changes in accounting principles; and - the loss of any of our key scientific or management personnel. In addition, the stock market has experienced extreme price and volume fluctuations. The market prices of the securities of biotechnology companies, particularly companies like ours without consistent product revenues and earnings, have been highly volatile, and may continue to be highly volatile in the future. This volatility has often been unrelated to the operating performance of particular companies. In the past, securities class action litigation has often been brought against companies that experience volatility in the market price of their securities. Whether or not meritorious, litigation brought against us could result in substantial costs and a diversion of management's attention and resources. WE EXPECT THAT OUR QUARTERLY RESULTS OF OPERATIONS WILL FLUCTUATE, AND THIS FLUCTUATION COULD CAUSE OUR STOCK PRICE TO DECLINE. Our quarterly operating results have fluctuated in the past and are likely to do so in the future. These fluctuations could cause our stock price to decline. Some of the factors that could cause our operating results to fluctuate include: - the failure of any of our corporate collaborators to meet their payment obligations, or termination of any of our agreements with them; - the timing of development and commercialization of our abarelix products leading to performance-based payments and revenues under our agreements with our corporate collaborators; and - the timing of our commercialization of other products resulting in revenues. Due to the possibility of fluctuations in our revenues and expenses, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. CONCENTRATION OF OWNERSHIP AMONG OUR EXISTING EXECUTIVE OFFICERS, DIRECTORS AND PRINCIPAL STOCKHOLDERS MAY PREVENT NEW STOCKHOLDERS FROM INFLUENCING SIGNIFICANT CORPORATE DECISIONS. After giving effect to our initial public offering, our officers, directors and stockholders affiliated with them control, based on their beneficial ownership as of July 31, 2000, a significant percentage of our outstanding common stock, and will until at least 180 days after our initial 24 public offering. As a result, these stockholders, acting together, will be able to significantly influence all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. The interests of this group of stockholders may not always coincide with our interests or the interests of other stockholders. ANTI-TAKEOVER PROVISIONS IN OUR CHARTER, BY-LAWS AND UNDER DELAWARE LAW MAY MAKE AN ACQUISITION OF US MORE DIFFICULT, EVEN IF AN ACQUISITION WOULD BE BENEFICIAL TO OUR STOCKHOLDERS. Provisions in our certificate of incorporation and by-laws may delay or prevent an acquisition of us or a change in our management. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporate Law. These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us. These provisions in our charter, by-laws and under Delaware law could reduce the price that investors might be willing to pay for shares of our common stock in the future and result in the market price being lower that it would be without these provisions. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we invest in may have market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with an interest rate fixed at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline. We believe that a 10% decline in the average yield of our investments would adversely impact our net interest income. We do not believe, however, that such a 10% decline would have a material adverse effect on our overall results of operations or cash flows. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds and government and non-government debt securities. The average duration of all of our investments in 1999 and during the six months ended June 30, 2000 was less than one year. Due to the short-term nature of these investments, we believe we have no material exposure to interest rate risk arising from our investments. In connection with the purchase of our new facility in July 2000, 830 Winter Street, our wholly owned subsidiary, executed an acquisition and construction loan agreement that provides for up to $33.0 million in borrowings at a floating interest rate indexed to the 30-day LIBOR. Concurrent with that transaction, 830 Winter Street also entered into an interest rate cap agreement which limits exposure to interest rate increases to 30-day LIBOR plus 1.25%. With regard to borrowings under the loan agreement, we believe that we have mitigated our risk to significant adverse fluctuations in interest rates and we do not believe that a 10% change in interest rates would have a material impact on our results of operations or cash flows. Accordingly, we do not believe that there is any material market risk exposure with respect to derivative or other financial instruments that would require quantitative tabular disclosure under this item. 25 PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. On March 8, 2000, we filed an amendment to our amended and restated certificate of incorporation, as amended, effecting a two-for-one split of our common stock, par value $.01 per share. The common stock share amounts and the option exercise prices set forth below give effect to the 2-for-1 stock split of the common stock. (c) During the period covered by this report on Form 10-Q, we issued the securities set forth below that were not registered under the Securities Act of 1933, as amended. On April 5, 2000, we issued 6,100 shares of common stock upon the exercise of options for aggregate consideration of $38,887.50. The issuance of common stock upon the exercise of options was exempt from registration under the Securities Act either pursuant to Rule 701 under the Securities Act, as a transaction pursuant to a compensatory benefit plan, or pursuant to Section 4(2) of the Securities Act, as a transaction not involving a public offering. The foregoing securities are deemed restricted securities for the purposes of the Securities Act. (d) On February 8, 2000, we filed a Registration Statement on Form S-1 (Registration No. 333-96351) with the Securities and Exchange Commission to register under the Securities Act 8,000,000 shares of our common stock (plus an additional 1,200,000 shares subject to an over-allotment option granted to the underwriters). The Registration Statement was declared effective by the Securities and Exchange Commission on April 26, 2000. The managing underwriters for the offering were Salomon Smith Barney Inc., CIBC World Markets Corp. and Credit Suisse First Boston Corporation. On May 2, 2000, upon the closing of the sale of 8,000,000 shares of common stock to the underwriters in our initial public offering, all of the outstanding shares of our convertible preferred stock automatically converted into 25,607,850 shares of common stock. The offering was terminated on May 8, 2000, after we had sold all of the 9,200,000 shares of common stock registered under the Registration Statement, including 1,200,000 shares sold pursuant to the exercise of the underwriters' over-allotment option. The initial public offering price was $10.00 per share. The aggregate proceeds of the offering (including the over-allotment option) were $92,000,000. In connection with the offering, we paid an aggregate of $6,440,000 in underwriting discounts and commissions and incurred approximately $1,300,000 in other offering expenses. We did not pay any finders' fees in connection with our initial public offering. We received net offering proceeds of approximately $84,260,000, after deducting underwriting discounts and commissions and other offering related expenses. From April 26, 2000 through June 30, 2000, we had not used any of the net proceeds from our initial public offering. We expect to use approximately $28.0 million of the net proceeds of the offering for the purchase of our new facility and related improvements. Pending use of these proceeds, we have invested these funds in short-term, interest-bearing, investment-grade securities. No direct or indirect payments were made by PRAECIS for offering expenses or from the net offering proceeds to any director, officer, person owning ten percent or more of any class of equity securities of PRAECIS, general partner of PRAECIS or their associates or to any affiliate of PRAECIS. We have not determined the specific allocation of the remaining proceeds of the offering. While we cannot specify with certainty the particular uses for such proceeds, we currently intend to use the remaining 26 proceeds over time for: (i) the production of abarelix drug products; (ii) clinical trial expenses related to abarelix and other clinical and preclinical testing and expansion of research and development initiatives; (iii) sales and marketing expenses associated with the commercial launch of abarelix; and (iv) working capital and general corporate purposes. Our management will continue to have broad discretion over the actual use of these proceeds. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits EXHIBIT NUMBER EXHIBIT ------- ------- 3.1 Amended and Restated Certificate of Incorporation (1) 3.2 Amended and Restated By-Laws (1) 4.1 Specimen certificate representing shares of common stock (2) 4.2 Warrant to purchase Series A Convertible Preferred Stock dated as of August 12, 1998 held by Comdisco, Inc. (2) 4.3 Warrant to purchase Series A Convertible Preferred Stock dated as of August 12, 1998 held by Gregory Stento (2) 4.4 Warrant to purchase Common Stock dated as of May 13, 1997 (2) 10.1 Second Amended and Restated 1995 Stock Plan 10.2 Acquisition and Construction Loan Agreement dated as of July 11, 2000 between 830 Winter Street LLC and Anglo Irish Bank Corporation plc and related Loan and Security Agreements 10.3 Guaranty of Costs and Completion dated as of July 11, 2000 10.4 Guaranty of Non-Recourse Exceptions dated as of July 11, 2000 10.5 Environmental Compliance and Indemnity Agreement dated as of July 11, 2000 executed by 830 Winter Street LLC and the Registrant 10.6 Lease Agreement dated as of July 11, 2000 between 830 Winter Street LLC, as landlord, and the Registrant, as tenant 10.7 Letter Amendment, effective as of March 1, 2000, to Lease dated as of August 19, 1998 by and between the Registrant and BDG Piscataway, LLC 27 Financial Data Schedule ---------------- (1) Incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended March 31, 2000 filed with the Securities and Exchange Commission on June 7, 2000. (2) Incorporated by reference to Registration Statement on Form S-1 (Registration No. 333-96351) initially filed with the Securities and Exchange Commission on February 8, 2000 and declared effective on April 26, 2000. (b) Reports Submitted on Form 8-K The Registrant did not file any reports on Form 8-K during the quarter ended June 30, 2000. 27 SIGNATURE 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 hereunto duly authorized. PRAECIS PHARMACEUTICALS INCORPORATED Date: August 14, 2000 By /s/ KEVIN F. McLAUGHLIN ------------------------- Kevin F. McLaughlin Chief Financial Officer, Senior Vice President, Treasurer and Secretary (Duly Authorized Officer and Principal Financial and Accounting Officer) EXHIBIT INDEX EXHIBIT NUMBER EXHIBIT ------- ------- 3.1 Amended and Restated Certificate of Incorporation (1) 3.2 Amended and Restated By-Laws (1) 4.1 Specimen certificate representing shares of common stock (2) 4.2 Warrant to purchase Series A Convertible Preferred Stock dated as of August 12, 1998 held by Comdisco, Inc. (2) 4.3 Warrant to purchase Series A Convertible Preferred Stock dated as of August 12, 1998 held by Gregory Stento (2) 4.4 Warrant to purchase Common Stock dated as of May 13, 1997 (2) 10.1 Second Amended and Restated 1995 Stock Plan 10.2 Acquisition and Construction Loan Agreement dated as of July 11, 2000 between 830 Winter Street LLC and Anglo Irish Bank Corporation plc and related Loan and Security Agreements 10.3 Guaranty of Costs and Completion dated as of July 11, 2000 10.4 Guaranty of Non-Recourse Exceptions dated as of July 11, 2000 10.5 Environmental Compliance and Indemnity Agreement dated as of July 11, 2000 executed by 830 Winter Street LLC and the Registrant 10.6 Lease Agreement dated as of July 11, 2000 between 830 Winter Street LLC, as landlord, and the Registrant, as tenant 10.7 Letter Amendment, effective as of March 1, 2000, to Lease dated as of August 19, 1998 by and between the Registrant and BDG Piscataway, LLC 27 Financial Data Schedule ---------------- (1) Incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended March 31, 2000 filed with the Securities and Exchange Commission on June 7, 2000. (2) Incorporated by reference to Registration Statement on Form S-1 (Registration No. 333-96351) initially filed with the Securities and Exchange Commission on February 8, 2000 and declared effective on April 26, 2000.