UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
/ X / Annual Report pursuant to Section 13 or 15(d) of the Securities
--- Exchange Act of 1934.
For the fiscal year ended December 31, 1998, or
/ / Transition report pursuant to Section 13 or 15(d) of the Securities
--- Exchange Act of 1934.
For the transition period from to .
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Commission file number: 0-21088
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VICAL INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 93-0948554
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
9373 TOWNE CENTRE DRIVE, SUITE 100, SAN DIEGO, CA 92121
Address of principal executive offices
(619) 453-9900
Registrant's telephone number including area code
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, Par Value $0.01
Preferred Stock Purchase Rights, Par Value $0.01
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the Common Stock held by non-affiliates of the
registrant, based upon the last sale price of the Common Stock reported on
the National Association of Securities Dealers Automated Quotation National
Market System on March 15, 1999, was $166,432,000.
The number of shares of Common Stock outstanding as of March 15, 1999, was
16,190,313.
1
DOCUMENTS INCORPORATED BY REFERENCE
(To the Extent Indicated Herein)
Registrant's Proxy Statement to be filed with the Securities and Exchange
Commission in connection with the solicitation of proxies for the
Registrant's 1999 Annual Meeting of Stockholders to be held on May 27, 1999,
is incorporated by reference in Part III, Items 10 (as to directors), 11, 12
and 13 of this Form 10-K.
2
PART I
ITEM 1. BUSINESS
OVERVIEW
Vical is developing gene-based pharmaceutical products for human
therapy. Our patented naked DNA gene delivery technology and proprietary
lipids are designed to deliver selected genes into some cells in the body.
These genes have been shown in clinical trials to cause the cells to produce
desired proteins which may prevent or treat infectious and malignant diseases
and other disorders. Vical is developing cancer product candidates internally
while developing vaccines for infectious diseases and gene-based delivery of
therapeutic proteins for other disorders primarily in collaboration with
corporate partners.
The key discovery leading to Vical's proprietary direct gene
transfer technology was that some muscle tissues can absorb genetic material
directly and subsequently express a desired protein for periods ranging from
weeks to several months. In addition, we are developing other technologies to
deliver DNA directly into some non-muscle tissues, including the use of lipid
molecules that facilitate direct absorption of DNA into cells. The active
ingredients of products under development at Vical consist of highly
purified, well-defined gene sequences produced by conventional fermentation
processes.
Our gene-based therapy approach may offer safer and more
cost-effective treatments for many diseases as well as novel treatment
alternatives for diseases that are currently poorly addressed. The broad
applicability, ease of manufacturing and potential low cost of our gene-based
approach may provide competitive advantages for commercialization.
Some of the matters discussed in this Annual Report on Form 10-K are
forward-looking statements that involve risks and uncertainties, including
the timely and successful development of candidate products, receipt of
necessary regulatory approvals and commercial acceptance of products, the
attainment of patent protection for any of these products, the impact of
competitive products and pricing and reimbursement policies, changing market
conditions and the other risks detailed throughout this Form 10-K. Actual
results may differ materially from those projected. These forward-looking
statements represent our judgment as of the date of the filing of this Form
10-K. We disclaim, however, any intent or obligation to update these
forward-looking statements.
GENE TRANSFER TECHNOLOGY
Gene transfer is an approach to the treatment and prevention of
diseases in which genes are introduced into cells to direct the production of
specific proteins needed to correct or control diseases. A typical human cell
contains thousands of different proteins essential to cellular structure,
growth and function. Proteins are produced by the cell according to a set of
genetic instructions encoded by DNA, which contains all the information
necessary to control the cell's biological processes.
DNA is organized into segments called genes, with each gene
containing the information required to produce a specific protein. Production
of the protein encoded by a particular gene is known as gene expression. The
improper expression of even a single gene can severely alter a cell's normal
function, frequently resulting in a disease.
Gene transfer approaches include the use of (1) cells genetically
altered EX VIVO (outside the body) using viruses or other gene transfer
methods, (2) viruses that have been genetically disabled so that they cannot
reproduce and infect other cells and that are delivered IN VIVO to the
patient, and (3) non-viral or synthetic formulations of DNA that are
delivered IN VIVO to the patient. EX VIVO cell-based therapies are cumbersome
and expensive relative to IN VIVO therapies since individual products must be
designed and manufactured for each patient.
3
Gene transfer product candidates in development rely primarily on IN
VIVO delivery. IN VIVO approaches using viruses suffer several drawbacks that
may limit their widespread usefulness, including adverse immune responses and
inflammation that may inhibit the activity of the virus-based therapy and
prevent repeated administration. In addition, viruses can induce permanent
changes in the patient's genetic makeup, which may cause malignant
transformation of cells leading to cancer. IN VIVO methods using non-viral
DNA formulations may offer safer and more effective gene transfer.
Vical has developed core technologies that allow the IN VIVO
delivery of non-viral DNA formulations, or naked DNA. The discovery that led
to Vical's naked DNA gene transfer approach was that some muscle tissues are
able to directly absorb genetic material into cells and subsequently express
the desired protein for periods ranging from weeks to several months. In
addition, we have developed proprietary methods to allow the delivery of
genes directly into some non-muscle tissues, including the use of lipid
molecules that facilitate absorption into cells.
Vical's naked DNA gene transfer approach involves the design and
construction of plasmids, DNA segments whose ends are attached together to
form a highly stable closed loop. These plasmids contain the gene encoding
the protein of interest as well as short segments of DNA that control the
rate and location of protein expression.
The potential benefits of Vical's gene transfer technology may include:
- CONVENIENCE. Vical's gene-based drug therapy is intended to be directly
administered like conventional pharmaceuticals.
- SAFETY. Vical's anticipated products will contain no viral components
that may cause an unwanted immune response or infection.
- EASE OF MANUFACTURING. Vical's product candidates are manufactured
using conventional fermentation techniques and standard purification
procedures.
- COST-EFFECTIVENESS. Vical's gene transfer technology may prove more
cost-effective than systems requiring EX VIVO manipulation of cells on a
patient-by-patient basis. In some situations, administering DNA encoding a
particular protein may be more cost-effective than administering the
protein itself. This is because the DNA, once introduced into the body, is
intended to stimulate the production of a therapeutic protein over a
prolonged period of time.
CLINICAL TRIALS
U.S. Food and Drug Administration ("FDA") approval is required prior
to marketing a pharmaceutical product in the United States. To obtain this
approval the FDA requires clinical trials to demonstrate the safety,
efficacy, and potency of the product candidates. Clinical trials are the
means by which experimental drugs or treatments are tested in humans. New
therapies typically advance from laboratory (research) testing through animal
(preclinical) testing and finally through several phases of clinical (human)
testing. Upon successful completion of clinical trials, approval to market
the therapy for a particular patient population may be requested from the FDA
in the United States and/or its counterparts in other countries.
Clinical trials are normally done in three phases. In Phase I,
trials are conducted with a small number of patients or healthy volunteers to
determine the safety profile, the pattern of drug distribution and metabolism
and early evidence on effectiveness. In Phase II, trials are conducted with a
larger group of patients afflicted with a target disease in order to
determine preliminary efficacy, optimal dosages and expanded evidence of
safety. In Phase III, large scale, multi-center, comparative trials are
conducted with patients afflicted with a target disease in order to provide
enough data for the statistical proof of safety, efficacy, and potency
required by the FDA and other regulatory authorities. For life-threatening
diseases, initial human testing generally is done in patients rather than
healthy volunteers. Such studies may provide results traditionally obtained
in Phase II trials. Such trials are referred to as "Phase I/II" trials.
4
CANCER PRODUCT DEVELOPMENT PROGRAMS
Vical is developing cancer product candidates internally while
developing vaccines for infectious diseases and gene-based delivery of
therapeutic proteins for other disorders primarily in collaboration with
corporate partners.
CANCER
Cancer is a group of diseases in which certain cells grow
uncontrolled by the body's normal self-regulatory mechanisms. Traditional
chemotherapy seeks to control cancer by killing rapidly dividing cells.
However, a number of non-malignant cells in the body, such as intestinal
epithelium and bone marrow cells, also rapidly divide and are highly
susceptible to chemotherapy. Thus, doses sufficient to eradicate the cancer
often cannot be administered without life-threatening side effects.
A therapeutic approach that selectively kills tumor cells would be
far superior to currently available therapies. One approach would be to
generate a specific immune response targeting cancer cells without damaging
other normal tissues. It is generally believed that the immune system is
capable of selectively recognizing cancer cells as abnormal and destroying
them. However, the vast majority of cancers arise spontaneously in patients
with an otherwise normal immune system. This observation suggests that cancer
cells somehow escape the normal immune defense mechanisms or that the
cytotoxic T lymphocyte (CTL), or killer T-cell, response produced by cancer
patients is not powerful enough to kill all of the abnormal cells. A variety
of methods have been used to augment the immune response against tumor cells,
including the systemic administration of natural immune-enhancing proteins
such as interleukin 2 (IL-2), either alone or in combination with other
agents. These methods have shown encouraging results in some patients with
some tumor types but also cause serious side effects.
Vical scientists are developing novel gene-based cancer
immunotherapies to address the shortcomings, including adverse side effects
of existing therapies. Vical is focusing on some types of cancer including
melanoma, head and neck cancer, kidney cancer, prostate cancer and B-cell
lymphoma.
Current U.S. market data for these cancers and Vical's product candidates are
summarized below.
- --------------------------------------------------------------------------------------------------------------------
1998 1998 1998 INCREASE IN
TYPE OF PRIMARY NEW CURRENT ESTIMATED DEATHS
CANCER CASES CASES DEATHS 1974-1994 PRODUCT CANDIDATE
- --------------------------------------------------------------------------------------------------------------------
Melanoma 41,600 476,000 7,300 79% ALLOVECTIN 7 & GP100
- --------------------------------------------------------------------------------------------------------------------
Head & Neck 41,400 342,000 12,300 6% ALLOVECTIN 7
- --------------------------------------------------------------------------------------------------------------------
Kidney 29,900 201,000 11,600 62% LEUVECTIN
- --------------------------------------------------------------------------------------------------------------------
Prostate 184,500 1,000,000 39,200 82% LEUVECTIN
- --------------------------------------------------------------------------------------------------------------------
B-cell Lymphoma 55,400 296,000 24,900 105% VAXID
- --------------------------------------------------------------------------------------------------------------------
Sources: American Cancer Society, SEER Cancer Statistics
MELANOMA. This is a skin cancer found predominantly in Caucasians,
particularly fair-skinned individuals who have experienced repeated sunburn.
If detected when the disease is still limited to one site (stage I and II) it
usually can be treated successfully by surgery. If untreated, the disease
spreads to the lymph glands, lungs, liver, brain and other organs. Stage III
is defined as metastatic (spread) disease limited to one region and is
treated with a combination of surgery and chemotherapy. Stage IV disease
involves advanced regional or any distant tumors and it is usually treated
with some combination of chemotherapy, radiotherapy, and surgery. The
five-year survival of patients with stage III and stage IV disease is 60% and
15%, respectively. In patients whose disease continues to progress after they
have received all available treatments, the median survival is 6 to 8 months.
HEAD AND NECK CANCER. This describes any of several localized tumors
affecting the oral cavity, the pharynx or larynx. Head and neck cancers are
found more frequently in men than in women, and most often in men over age
40. Risk factors vary with the particular location, but can include use of
tobacco and excessive consumption of alcohol.
5
Most head and neck cancers are treated by surgical removal and/or
localized radiation therapy, with widely ranging degrees of success depending
on the number of tumors, their size, and their specific location. In advanced
disease, standard treatment may be preceded by systemic chemotherapy to
improve treatability, or followed by systemic chemotherapy to address
remaining cancer cells, most often with a combination of agents. The
five-year survival rate for head and neck cancer patients, if treated, varies
from more than 90 percent for localized, accessible disease to less than 5
percent for widespread malignancies not curable by surgery.
KIDNEY CANCER. The most common type of kidney cancer, renal cell
carcinoma, is more prevalent in males than females, predominantly in people
over 35. The greatest single risk factor is cigarette smoking. Other risk
factors include exposure to asbestos, cadmium, or gasoline, and the use of
some pain medications containing phenacetin.
Kidney cancer frequently spreads to adjacent tissues and ultimately
to other internal organs, most often the lungs, bone, brain or liver. About
30 percent of patients have metastatic disease when first diagnosed.
Treatment of regional metastatic kidney cancer involves surgical removal of
the affected kidney and surrounding tissue, frequently combined with
radiation therapy to alleviate pain. The five-year survival rate for
metastatic disease where surgery cannot be curative is less than 10 percent
with very few treatment alternatives.
PROSTATE CANCER. The most frequently diagnosed type of cancer, and
second leading cause of cancer fatalities among men in the United States, is
prostate cancer. African Americans are at significantly greater risk than
Caucasians, and men over age 65 account for over 80 percent of all diagnoses.
Early detection has been increasing the number of annual diagnoses
and improving overall survival rates. Most patients are diagnosed while the
disease is confined to the prostate gland, with a five-year survival rate of
99 percent. If the disease is discovered after it spreads to connective
tissue, lymph nodes, or other internal organs, survival rates decline.
Treatment options include "watchful waiting" for older patients with no
symptoms or with other more serious illnesses, radiation therapy, and
surgical removal of the prostate gland and/or affected lymph nodes. Symptoms
may also be relieved by hormone therapy or surgery.
B-CELL LYMPHOMA. Non-Hodgkin's B-cell lymphoma is a disease in which
cells in the lymph nodes or other lymphatic tissue grow abnormally. They
divide too rapidly and grow without any order or control. Too much tissue is
formed and tumors, usually cancerous, begin to grow. Low-grade non-Hodgkin's
B-cell lymphoma is a less aggressive form of the disease. This disease is
characterized by a slow growth rate and excellent initial response to current
treatments; however, a regular pattern of relapse to a widespread, aggressive
lymphoma occurs for which no curative therapy has been identified.
CANCER PRODUCT CANDIDATES
ALLOVECTIN-7 (MELANOMA AND HEAD AND NECK CANCER). We are developing
a product candidate, ALLOVECTIN-7, for treatment of various solid tumors.
ALLOVECTIN-7 is a DNA/lipid complex containing the gene encoding the HLA-B7
antigen. ALLOVECTIN-7 is designed to be injected directly into a tumor, where
malignant cells take it in and display the HLA-B7 antigen on their surface.
This antigen alerts the immune system to the presence of foreign tissue,
inducing the type of powerful immune response seen in organ transplant
rejection.
LEUVECTIN (KIDNEY AND PROSTATE CANCERS). Our second oncology product
candidate, LEUVECTIN, is another DNA/lipid complex designed for direct
injection into a tumor. LEUVECTIN contains the gene encoding IL-2. Systemic
IL-2 protein therapy is approved as a treatment for kidney cancer and
melanoma, but can cause severe side effects. We expect that LEUVECTIN, when
injected into tumors, will cause the malignant cells to produce IL-2. Local
expression of IL-2 may stimulate the patient's immune system to attack and
destroy the tumor cells. Because LEUVECTIN delivers IL-2 locally, it may
provide efficacy comparable to the protein treatment with fewer side effects.
GP100 (MELANOMA). In collaboration with the National Cancer
Institute, we are using an experimental DNA vaccine containing a gene which
may cause cells at the injection site to produce a modified gp100 melanoma
antigen (melanoma-related protein). The antigen is expected to trigger an
immune response against melanoma tumor cells. In earlier studies, the
National Cancer Institute tested a vaccine using peptides (portions of the
modified antigen) in combination with IL-2 protein therapy. A DNA vaccine may
be more generally applicable and may provide advantages in manufacturing and
administration.
6
VAXID (B-CELL LYMPHOMA). In collaboration with Stanford University
Medical Center, we are developing a naked DNA vaccine, VAXID, against
low-grade non-Hodgkin's B-cell lymphoma. VAXID contains a gene that encodes
the patient-specific idiotype (characteristic feature) of cancerous B-cells.
Preclinical studies showed that the injection into mice of a B-cell lymphoma
idiotype DNA vaccine resulted in strong anti-idiotype immune responses and
significant protection against tumor challenge. We believe that immunization
of post-chemotherapy patients with VAXID could result in the elimination of
residual disease and the prevention of the relapse of disease.
CANCER CLINICAL TRIALS
ALLOVECTIN-7 (MELANOMA). Ninety patients with advanced melanoma have
received treatment with ALLOVECTIN-7 during two phase II clinical trials.
Four (17%) of 23 evaluable patients with disease limited to the skin, lymph
nodes, or lung achieved clinical responses. There were one complete response
and three partial responses. Of the 73 evaluable patients in the two trials,
19 patients (26%) appeared to derive clinical benefit from treatment. Current
treatments for melanoma frequently result in grade 3 adverse events which
require hospitalization and grade 4 events which are considered
life-threatening. There were no grade 3 or 4 adverse events caused by
ALLOVECTIN-7. We believe ALLOVECTIN-7's minimal side effects will provide a
much safer and better tolerated treatment than available treatments. As a
result of these promising data, additional studies are underway. Two studies
are recruiting in 50 centers across the United States, one involving
end-stage patients in a single-agent trial and one comparing dacarbazine (the
only FDA approved chemotherapeutic agent for metastatic melanoma) to a
combination of dacarbazine plus ALLOVECTIN-7. Positive results from either or
both of these trials could allow us to apply to the FDA for approval to
market the drug candidate.
ALLOVECTIN-7 (HEAD AND NECK CANCER). In a phase I/II and an early
phase II study in advanced or recurrent squamous cell cancer of the head and
neck, 39 patients were treated. Of 32 evaluable patients, five (16%)
responded, two of whom were complete responders and three of whom were
partial responders. A multi-center phase II study is now ongoing.
LEUVECTIN (KIDNEY CANCER). IL-2 is the only FDA approved drug for
the treatment of metastatic kidney disease but its administration is
associated with serious toxicity in the majority of patients. The goal of the
LEUVECTIN kidney cancer program is to match IL-2's efficacy without major
adverse events.
Initial results from the phase I/II trial in kidney cancer suggested
that LEUVECTIN had a favorable risk-benefit profile in these patients. To
date there has been only one grade 3 adverse event and no grade 4 adverse
events caused by LEUVECTIN out of over 130 patients treated. A multi-center
study is ongoing.
LEUVECTIN (PROSTATE CANCER). We released initial data in 1998 from a
Phase I/II pilot trial in patients with prostate cancer. The data indicated
that the treatment was safe and well-tolerated, that it may stimulate an
immune response against the disease, and that it may result in an increased
time to disease progression. On the basis of these data, we intend to pursue
further clinical development.
GP100 (MELANOMA). The National Cancer Institute published data from
a previous clinical trial indicating a 42% response rate in end-stage
melanoma patients after treatment with systemic IL-2 and the gp100 protein.
This study is being repeated (Phase I/II) with a gp100 naked DNA vaccine from
Vical.
VAXID (B-CELL LYMPHOMA). An initial phase I/II study is now ongoing
in collaboration with Stanford University Medical Center.
INFECTIOUS DISEASE VACCINE DEVELOPMENT PROGRAMS
According to the World Health Organization, of a global total of
52.2 million deaths in 1997, 17.3 million were due to infectious and
parasitic diseases making it the leading category. Most deaths from
infectious diseases were caused by acute lower respiratory infections,
tuberculosis, diarrhea, human immunodeficiency virus (HIV) and malaria.
NAKED DNA VACCINE TECHNOLOGY
Vical's naked DNA technology may address two deficiencies of
traditional preventive vaccine approaches: (1) the inability to predict the
random changes in the strains of various infectious agents and (2) the need
for safe formulations (adjuvants) that boost an antibody response or that
cause sufficient killer T-cell responses. We believe our potential vaccine
products should be simpler to manufacture than vaccines that are made using
cumbersome and labor-intensive techniques involving difficult tissue culture
procedures and live viruses.
7
Vical scientists have shown in animal experiments that the
intramuscular injection of a plasmid encoding a protein common to all strains
of the influenza virus stimulates both antibody and killer T-cell responses
against the virus itself and the virus-infected cells. The immune response is
potent, specific and requires no adjuvant formulation. For over a year
following vaccination, treated animals demonstrated higher survival rates
than untreated control animals when challenged with various strains of
inhaled influenza virus. This observed cross-strain protection, if
reproducible in humans, will offer a key advantage compared with conventional
vaccines. Thus, Vical's direct gene transfer technology may be universal, not
requiring frequent re-design or product modification for each new viral
strain.
Only a few years ago, DNA vaccines were an unproven novelty with
limited acceptance in the scientific community. Today, more than 700
scientific publications have documented the efficacy of DNA vaccines in
providing protective immunity against viruses, bacteria and parasites in
dozens of species from fish to primates. Additional studies have extended
these findings to other models of infectious diseases for which there are no
approved vaccines, such as HIV, herpes and malaria.
NAKED DNA VACCINE LICENSES
Vical has licensed its naked DNA gene delivery technology to Merck
for a total of seven preventive vaccines: influenza, HIV, herpes, hepatitis B
virus (HBV), hepatitis C virus (HCV), human papilloma virus (HPV) and
tuberculosis and three therapeutic vaccines: HPV, HIV and HBV. We also have a
license and option agreement with Pasteur Merieux Connaught (PMC) for a total
of six preventive vaccines: cytomegalovirus (CMV), respiratory syncytial
virus (RSV), Lyme disease, helicobacter pylori, malaria and herpes zoster.
Vical also has an option agreement with Merial, the joint venture between
Merck's animal health business and Rhone Merieux, for veterinary vaccines.
Because of the large-scale development programs, manufacturing capacity and
distribution channels required to successfully market a vaccine, we believe
collaborations with major pharmaceutical companies are the most effective way
to apply our patented technology in the emerging DNA vaccine field. See
"--Collaboration and Licensing Agreements--Corporate Partners--Merck & Co.,
Inc.," "--Pasteur Merieux Connaught," "--Merial" and "--Collaboration and
Licensing Agreements--Research Institutions--Office of Naval Research."
MALARIA. We are collaborating with PMC and the U.S. Naval Medical
Research Center (NMRC) to develop a DNA vaccine against malaria. There is no
effective vaccine against malaria. This is a severe infectious disease
characterized by fever, headache and joint pain, which if untreated can lead
to death. Infection normally occurs when the parasite enters a victim's
bloodstream during a mosquito bite. An estimated 300 million people are
affected by malaria worldwide, with more than one million deaths each year.
In July 1997, Vical and PMC began a Phase I trial of an experimental
vaccine against the parasite that causes malaria. NMRC conducted the clinical
trial with approximately twenty volunteers. Trial results, reported in an
October 1998 issue of SCIENCE, indicated that subjects immunized with a
potential malaria DNA vaccine developed dose-related killer T-cell immune
responses. As a result of these encouraging data, further clinical
development is planned.
GENE-BASED THERAPEUTIC PROTEIN DELIVERY
Vical's direct gene transfer technology may permit the development
of alternatives to therapeutic protein administration for other diseases.
Major shortcomings of some therapeutic proteins include their short duration
of action and the potential side effects associated with high levels of
circulating protein after intravenous administration. We believe that direct
injection into muscles of genes that encode for the protein of interest may
enable the muscle to act as a protein factory causing a sustained release of
low levels of the therapeutic proteins and reducing side effects and the need
for repeated dosing. Vical's technology may be most suitable for the delivery
of proteins that are required in small amounts over prolonged periods of time.
Much attention is being focused on the emerging field of
angiogenesis, which involves inducing the growth of new blood vessels to
replace those blocked by disease. Gene-based delivery of growth factors has
been successfully demonstrated in human trials. Other potential applications,
still being tested in animal models, could involve the delivery of proteins
that maintain nerve cell function for treating certain neurodegenerative
diseases, or the delivery of biologically active compounds such as insulin to
treat diabetes or erythropoeitin to treat certain forms of anemia.
8
In 1997, Vical licensed its patented naked DNA technology to Merck
for the delivery of certain angiogenic growth factors that may be useful in
cardiovascular applications such as coronary artery disease and peripheral
vascular disease. Coronary artery disease, a narrowing of the blood vessels
supplying the heart, can lead to severe chest pain and heart attack. Coronary
artery disease is the single largest cause of death in the United States.
Peripheral vascular disease affects the blood vessels in the limbs, most
commonly narrowing of the blood vessels of the lower extremities for which
therapy is very limited. In September 1998, we licensed our catheter-based
intravascular gene delivery technology to Boston Scientific Corporation.
We licensed our gene delivery technology to Rhone-Poulenc Rorer
(RPR) in 1997 for the delivery of neurologically active proteins that may be
applicable in treating neurodegenerative diseases such as Alzheimer's,
Parkinson's and Lou Gehrig's diseases. In early 1999, Vical licensed its gene
delivery technologies to Pfizer Inc. for potential use in delivering
therapeutic proteins for animal health applications. See "--Collaboration and
Licensing Agreements--Corporate Partners--Merck & Co., Inc.,"
"--Rhone-Poulenc Rorer," "--Boston Scientific Corporation" and "--Pfizer Inc."
9
Vical's product development programs are summarized in the following
table:
MCaption
- ---------------------------------- --------------------------- ------------------------------ ------------------------------
Project Target Indication(s) Development Status(1) Development Rights(2)
- ---------------------------------- --------------------------- ------------------------------ ------------------------------
CANCER
ALLOVECTIN-7 Melanoma, Phase III Vical
Head and neck cancer Phase II Vical
LEUVECTIN Renal cell carcinoma Phase II Vical
Prostate cancer Phase I/II Vical
VAXID B-cell lymphoma Phase I/II Vical
gp100 Melanoma Phase I/II Vical (3)
Therapeutic DNA vaccines Various cancers Preclinical/Phase I Centocor
INFECTIOUS DISEASES
Preventive DNA vaccines Influenza Phase I Merck
Malaria Phase I Pasteur Merieux Connaught
HIV, herpes, hepatitis B Research/preclinical Merck
and C, tuberculosis,
papilloma
CMV, RSV, Lyme, H.pylori, Research/preclinical Pasteur Merieux Connaught
herpes zoster
Chlamydia Research/preclinical Vical
Therapeutic DNA vaccines Hepatitis B, HIV, Research/preclinical Merck
papilloma
Veterinary DNA vaccines Various Research Merial
OTHER DISEASES
Therapeutic protein DNA Cardiovascular diseases Research/preclinical Merck
Therapeutic protein DNA Neurodegenerative Diseases Research/preclinical Rhone-Poulenc Rorer
Catheter-based DNA therapy Cardiovascular diseases Research/preclinical Boston Scientific
Therapeutic protein DNA Animal Health Research Pfizer
- ---------------------------------- --------------------------- ------------------------------ ------------------------------
(1) As denoted in the table, "Research" indicates research related to
identification and synthesis of lead compounds. "Preclinical Development"
indicates that a specific compound is undergoing toxicology testing and
manufacturing scale-up, among other things, in preparation for filing an
application for an investigational new drug (IND). In Phase I, trials are
conducted with a small number of healthy volunteers to determine the safety
profile, the pattern of drug distribution and metabolism. In Phase II,
trials are conducted with a larger group of patients afflicted with a
target disease in order to determine preliminary efficacy, optimal dosages
and expanded evidence of safety. In the case of products for
life-threatening diseases, the initial human testing is generally done in
patients rather than in healthy volunteers. Since these patients are
already afflicted with the target disease, it is possible that such studies
may provide results traditionally obtained in Phase II trials. Such trials
are frequently referred to as "Phase I/II" trials. See "--Clinical Trials."
(2) See "--Collaboration and Licensing Agreements--Corporate Partners."
(3) Vical owns the rights to any inventions developed solely by Vical employees
under a Cooperative Research and Development Agreement (CRADA) with the
National Cancer Institute (NCI) and has the option to obtain a license for
inventions developed jointly with NCI or solely by NCI under the CRADA.
10
COLLABORATION AND LICENSING AGREEMENTS
Vical has entered into various arrangements with corporate, academic
and government collaborators, licensors, licensees and others. Our success is
partially dependent upon the subsequent success of these outside parties in
performing their responsibilities. We believe these parties have an economic
incentive to perform their contractual responsibilities. However, the
progress of these activities is not controlled by us. The parties may not
perform their obligations and we may not derive any revenue from such
arrangements. In addition, the collaborators may pursue alternative
technologies.
We have entered into, and expect to enter into, research
collaborations, licensing agreements and corporate collaborations. In
addition to the agreements summarized below, we conduct ongoing negotiations
with potential corporate partners. However, we may not be able to negotiate
additional acceptable collaborative agreements.
CORPORATE PARTNERS
MERCK & CO., INC. In May 1991, we entered into a research
collaboration and license agreement with Merck to develop vaccines utilizing
Vical's intramuscular delivery technology to prevent infection and/or disease
in humans. In connection with the 1991 agreement, we granted Merck a
worldwide exclusive license to preventive vaccines using our technology
against seven human infectious diseases: influenza, HIV, herpes simplex, HBV,
HCV, HPV and tuberculosis.
In addition, Merck has rights to therapeutic uses of preventive
vaccines developed under the 1991 agreement. In December 1995 and November
1997, Merck acquired additional rights to develop and market therapeutic
vaccines against HPV, HIV and HBV. Under the November 1997 amendment, Merck
made an investment of $5.0 million for approximately 262,000 shares of
Vical's common stock.
In September 1997, we also entered into an option and license
agreement granting Merck the rights to use Vical's naked DNA technology to
deliver certain growth factors as potential treatments for cardiovascular
applications. The agreement resulted in an initial payment to Vical of $2.0
million.
In connection with these agreements, Merck has paid Vical $19.1
million as of December 31, 1998. Merck is obligated to pay additional fees if
research milestones are achieved with respect to the products developed under
the various Merck agreements and royalties on net sales by Merck of products,
if any products are developed and marketed. For some indications Vical has an
opportunity to co-promote product sales.
PASTEUR MERIEUX CONNAUGHT. In September 1994, Vical entered into a
collaborative agreement with the vaccine manufacturer PMC covering the use of
Vical's proprietary gene delivery and technologies for developing vaccines
against CMV, RSV, Lyme disease, helicobacter pylori and malaria. In April
1996, herpes zoster was added. PMC is obligated to make milestone and royalty
payments to Vical if any products are developed and marketed. In July 1997,
PMC paid us $1.0 million as a milestone payment upon initiation of a Phase I
trial of an experimental vaccine against the parasite that causes malaria.
Through December 31, 1998, Vical had received $7.8 million under this
agreement.
RHONE-POULENC RORER PHARMACEUTICALS, INC. In October 1997, Vical and
Rhone-Poulenc Rorer Pharmaceuticals, Inc. ("RPR") entered into an agreement
granting RPR an exclusive worldwide license to use our naked DNA gene
delivery technology to deliver certain neurologically active proteins for
potential treatment of neurodegenerative diseases. Under the terms of the
agreement, we received $1.0 million in 1997. This agreement provides for us
to receive additional payments based upon achievement of milestones and
royalty payments on product sales.
CENTOCOR, INC. In February 1998, Vical entered into a license
agreement allowing Centocor, Inc. to use our naked DNA technology to develop
and market certain gene-based vaccines for the potential treatment of some
types of cancer. We received an initial payment of $2.0 million plus
reimbursement of $200,000 of patent costs. We may receive additional payments
based upon achievement of milestones and royalty payments on product sales.
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MERIAL. Vical entered into a corporate alliance in March 1995
relating to DNA vaccines in the animal health area with Merial (a joint
venture between Merck and Rhone Merieux). Merial has options to take
exclusive licenses to Vical's gene delivery technologies to develop and
commercialize gene-based vaccines to prevent infectious diseases in
domesticated animals. Through December 31, 1998, Vical had received $2.1
million under this agreement. If Merial exercises its license options and
markets these vaccines, cash payments and royalties on sales would be due to
Vical.
PFIZER INC. In January 1999, Vical and Pfizer entered into a
collaborative license and option agreement to develop and market gene-based
delivery of therapeutic proteins for animal health applications. Under the
agreement, Pfizer made an investment of $6.0 million for approximately
318,000 shares of Vical common stock. Pfizer also paid Vical a $1.0 million
upfront license fee, and is obligated to pay Vical $1.5 million for research
and development over the first three years of the agreement.
BOSTON SCIENTIFIC CORPORATION. In September 1998, Vical and Boston
Scientific Corporation entered into a license and option agreement for the
development of catheter-based intravascular gene delivery technology. We
received $1.1 million in October 1998 under this agreement. The agreement
provides for us to receive royalty payments on any related product sales.
GENZYME CORPORATION. In October 1993, Vical entered into a
collaborative research and option agreement with Genzyme to evaluate the use
of our proprietary lipids to deliver genes for the treatment of cystic
fibrosis. In 1996, Genzyme exercised its option to use Vical's lipid
technology in cystic fibrosis. Through December 31, 1998, Vical had received
$2.3 million from Genzyme under this agreement. The license agreement
includes provisions for research, milestone and royalty payments to Vical.
Under the Merck, PMC, Merial, RPR, Centocor and Pfizer agreements,
if Vical were to receive milestone or royalty payments, Vical would be
required to pay 10 percent of some of these payments to Wisconsin Alumni
Research Foundation. See "--Research Institutions--Wisconsin Alumni Research
Foundation."
RESEARCH INSTITUTIONS
OFFICE OF NAVAL RESEARCH. Vical entered into an agreement in
September 1998 with the Office of Naval Research for the development work on
a potential multi-gene DNA vaccine to prevent malaria. The agreement may
provide funding up to $2.7 million through 2000.
THE UNIVERSITY OF MICHIGAN. In October 1992, Vical entered into a
license agreement with the University of Michigan and obtained the exclusive
license to products using technology for delivering gene-based products into
cancer cells and blood vessels by catheters. Michigan retained the right to
grant non-exclusive, non-royalty bearing licenses to the United States
government and the Howard Hughes Medical Institute. In April 1997, Vical
entered into a sublicense agreement with Cardiogene Therapeutics, Inc. with
respect to certain cardiovascular applications of this technology. Cardiogene
subsequently was acquired by Boston Scientific Corporation which then entered
into an agreement with Vical in September 1998 for the development of
intravascular gene delivery technology.
WISCONSIN ALUMNI RESEARCH FOUNDATION (WARF). Under a 1989 research
agreement, scientists at the University of Wisconsin, Madison, and at Vical
co-invented a core technology related to intramuscular naked DNA
administration. In 1991, Vical licensed WARF's interest in that technology,
except as to the U.S. government which may hold non-exclusive licenses to
technology developed with government funds. Vical paid WARF an initial
license fee and agreed to pay WARF a royalty on sales of any products
incorporating the licensed technology and a percentage of up-front license
payments from third parties.
ACCESS TO PROPRIETARY GENES AND PROTEINS
A number of the genetic sequences or proteins encoded by those
sequences that Vical is currently using or may use in its gene-based product
candidates are, or may become, patented by others. As a result, we may be
required to obtain licenses to conduct certain research, to manufacture or to
market products that contain proprietary genetic sequences. Licenses may not
be available on commercially reasonable terms, or at all.
12
PATENTS AND PROPRIETARY RIGHTS
Patents and other proprietary rights are important to our business.
We file patent applications to protect our technology, inventions, and
improvements to our inventions that are considered important to the
development of our business.
Vical also relies upon trade secrets, know-how, continuing
technological innovations and licensing opportunities to develop and maintain
its competitive position. We have filed or participated as licensee in the
filing of more than 300 patent applications in the United States and in
foreign countries relating to our technology. We have filed a series of
patent applications seeking to cover naked DNA gene transfer for immunization
and for delivering therapeutic proteins to patients, specific gene sequences
and formulations of gene-based product candidates, methods for producing
pharmaceutical-grade DNA and the composition of matter of several families of
lipid molecules and their uses in gene delivery. Some of these patents have
been issued by the U.S. Patent and Trademark Office ("PTO"). Several other
applications are still pending in the United States, and corresponding
foreign applications have been filed. The claims may not issue in their
present form, if at all, and patents, if issued, may be challenged,
invalidated or circumvented and the rights granted may not provide
proprietary protection or commercial advantage to Vical. See "--Risk
Factors--Uncertainty Regarding Our Intellectual Property Rights."
As of December 31, 1998, Vical or its exclusive licensors had
received fifteen U.S. patents covering various aspects of its proprietary
technology. These patents are described below:
TECHNOLOGY COVERED
Direct administration of lipid-complexed DNA for immunization
Method to deliver a protein by injecting DNA into cardiac muscle
Plasmids expressing IL-2
Direct administration of naked DNA for immunization
Direct administration of naked DNA for protein expression
Process to reduce RNA during DNA production
Process to manufacture pharmaceutical-grade DNA
Use of cationic lipids to deliver genes IN VIVO
Catheter to facilitate intravascular gene transfer
Cationic lipid compositions to facilitate gene transfer IN VIVO
Improved purification of DNA using polyethylene glycol (PEG)
Method to transfect cells surrounding a blood vessel by catheter
Direct administration of naked DNA to transfect vascular wall
Compositions and methods for Lyme Disease DNA vaccine
Lipids to facilitate gene delivery
In addition to these issued U.S. patents, Vical's core DNA delivery
technology is covered by a patent issued in Europe. According to European
patent procedures, issued patents may be opposed by parties interested in
challenging the scope or validity of the issued claims. Vical's European
patent is currently being opposed by several companies pursuant to these
procedures. We intend to overcome the oppositions and defend our patent
position in these proceedings. An unfavorable result in these opposition
proceedings could adversely affect us.
The patent positions of pharmaceutical and biotechnology firms,
including Vical, are uncertain and involve complex legal and factual
questions which are largely unresolved. In addition, the coverage claimed in
a patent application can be significantly reduced before a patent is issued.
Consequently, we do not know whether any patent applications will result in
the issuance of patents or, if any patents are issued, whether those patents
will provide significant proprietary protection or will be circumvented or
invalidated. Since patent applications in the United States are maintained in
secrecy until patents issue or foreign counterparts, if any, publish, and,
since publication of discoveries in the scientific or patent literature often
lag behind actual discoveries, we cannot be certain that Vical or any
licensor was the first creator of inventions covered by pending patent
applications or was the first to file patent applications for such
inventions. Moreover, we might have to participate in interference
proceedings declared by the PTO to determine priority of invention, which
could result in substantial cost to us, even if we were to prevail. Our
patents, if issued, may not be held to be valid or enforceable by a court or
a competitor's technology or product may be found to not infringe such
patents.
13
A number of pharmaceutical and biotechnology companies, and research
and academic institutions have developed technologies, filed patent
applications or received patents on various technologies that may be related
to our business. Some of these technologies, applications or patents may
conflict with our technologies or patent applications. Such conflict could
limit the scope of the patents, if any, that we may be able to obtain or
result in the denial of our patent applications. In addition, if patents that
cover Vical's activities are issued to other companies, we might not be able
to obtain licenses to these patents at a reasonable cost or be able to
develop or obtain alternative technologies.
In addition to patent protection, we also rely upon trade secret
protection for our confidential and proprietary information. Others may
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to our trade secrets or disclose such
technology. We may not be able to meaningfully protect our trade secrets.
We require our employees, consultants, and parties to collaborative
agreements to execute confidentiality agreements upon the commencement of
employment, consulting relationships, or a collaboration with us. These
agreements provide that all confidential information developed or made known
during the course of the relationship with Vical is to be kept confidential
and not disclosed to third parties except in specific circumstances. In the
case of employees, the agreements provide that all inventions resulting from
work performed for Vical, utilizing property of Vical or relating to Vical's
business and conceived or completed by the individual during employment,
shall be the exclusive property of Vical to the extent permitted by
applicable law. These agreements may not provide meaningful protection of our
trade secrets or adequate remedies in the event of unauthorized use or
disclosure of such information. See "--Risk Factors--Uncertainty Regarding
Our Intellectual Property Rights May Harm Us."
COMMERCIALIZATION AND MANUFACTURING
Because of the broad potential applications of our technology, we
intend to develop and commercialize products both on our own and through
corporate partners. We intend to develop and market products to well-defined
specialty markets, such as oncology, infectious diseases and metabolic
disorders. Where appropriate, we will rely on strategic marketing and
distribution partners for manufacturing and marketing products addressing
diseases treated by primary care physicians. We may not be able to reach
satisfactory arrangements with such distribution partners or such
arrangements may not be successful.
We believe our DNA plasmids can be produced in commercial
quantities in bacterial cells through traditional fermentation and
purification techniques. The separation and purification of plasmid DNA is a
relatively straightforward procedure because of the inherent biochemical
differences between plasmid DNA and the majority of other bacterial
components. In addition, our lipid formulations consist of components that
are synthesized chemically using traditional, readily scaleable, organic
synthesis procedures.
We produce supplies of product for all of our clinical trials and
intend to produce sufficient supplies for additional clinical investigations.
We may also choose to have outside organizations manufacture our product
candidates for expanded clinical trials under close supervision utilizing our
proprietary processes. We may not be able to contract for manufacturing
capabilities on acceptable terms.
COMPETITION
The field of gene-based drug development is new and rapidly
evolving, and it is expected to continue to undergo significant and rapid
technological change. Rapid technological development could result in Vical's
potential products or technologies becoming obsolete before we recover a
significant portion of our related research, development and capital
expenditures. We may experience competition both from other companies in the
field and from companies which have other forms of treatment for the diseases
we are targeting. We are aware of several development-stage and established
enterprises, including major pharmaceutical and biotechnology firms, which
are exploring gene-based drugs or are actively engaged in gene transfer
research and development. We may also experience competition from companies
that have acquired or may acquire technology from companies, universities and
other research institutions. As these companies develop their technologies,
they may develop proprietary positions which may materially and adversely
affect Vical. See "--Risk Factors--Uncertainty Regarding Our Intellectual
Property Rights May Harm Us."
14
Some competitors and potential competitors have substantially
greater product development capabilities and financial, scientific, marketing
and human resources than Vical. Other companies may develop products earlier,
obtain FDA approvals for products more rapidly, or develop products that are
more effective than those under development by Vical. We will seek to expand
our technological capabilities to remain competitive, however, research and
development by others may render our technology or products obsolete or
noncompetitive or result in treatments or cures superior to ours.
Our competitive position will be affected by the disease indications
addressed by our potential products and those of our competitors, the timing
of market introduction for these potential products and the stage of
development of other technologies to address these disease indications. For
Vical and its competitors, proprietary positions, the ability to complete
clinical trials on a timely basis and the ability to obtain timely regulatory
approvals to market these potential products are likely to be significant
competitive factors. Other important competitive factors will include the
efficacy, safety, reliability, availability and price of potential products
and the ability to secure sufficient capital resources for the
often-substantial period between technological conception and commercial
sales. See "--Risk Factors--The Effect of Competition and Technological
Change May Hurt Us."
GOVERNMENT REGULATION
Any products we develop will require regulatory clearances prior to
clinical trials and additional regulatory clearances prior to
commercialization. New human gene therapy products are expected to be subject
to extensive regulation by the FDA and comparable agencies in other
countries. The precise regulatory requirements with which we will have to
comply are uncertain at this time due to the novelty of the human gene
products and therapies currently under development. We believe that our
potential products will be regulated either as biological products or as
drugs. Drugs are subject to regulation under the Federal Food, Drug and
Cosmetic Act, and biological products, in addition to being subject to
certain provisions of that Act, are regulated under the Public Health Service
Act. Both statutes and related regulations govern, among other things, the
testing, manufacturing, safety, efficacy, labeling, storage, record keeping,
advertising and other promotional practices. FDA approval or other clearances
must be obtained before clinical testing, and before manufacturing and
marketing of biologics or drugs.
Obtaining FDA approval historically has been a costly and
time-consuming process. Generally, in order to gain FDA premarket approval,
preclinical studies must be conducted in the laboratory and in animal model
systems to gain preliminary information on an agent's efficacy and to
identify any major safety concerns. The results of these studies are
submitted as a part of an application for an investigational new drug (IND),
which the FDA must review and allow before human clinical trials can start.
The IND includes a detailed description of the clinical investigations.
A company must sponsor and file an IND for each proposed
product and must conduct clinical studies to demonstrate the safety, efficacy
and potency that are necessary to obtain FDA approval. The FDA receives
reports on the progress of each phase of clinical testing, and it may require
the modification, suspension, or termination of clinical trials if an
unwarranted risk is presented to patients. Human gene therapy products are a
new category of therapeutics, and the clinical trial period may be lengthy or
the number of patients may be numerous in order to establish safety, efficacy
and potency.
After completion of clinical trials of a new product, FDA marketing
approval must be obtained. If the product is regulated as a biologic, a
Biologic License Application (BLA) is required. If the product is classified
as a new drug, a New Drug Application (NDA) is required. The NDA or BLA must
include results of product development activities, preclinical studies and
clinical trials in addition to detailed manufacturing information.
15
Applications submitted to the FDA can take typically two to five
years to receive approval after filing. If questions arise during the FDA
review process, approval can take more than five years. The FDA may
ultimately decide that the application does not satisfy its criteria for
approval or require additional preclinical or clinical studies. Even if FDA
regulatory clearances are obtained, a marketed product is subject to
continual review, and later discovery of previously unknown problems or
failure to comply with the applicable regulatory requirements may result in
restrictions on the marketing of a product or withdrawal of the product from
the market as well as possible civil or criminal sanctions. Before marketing
clearance is secured, the manufacturing facility will be inspected for
current Good Manufacturing Practices (GMP) compliance by FDA inspectors. The
manufacturing facility must satisfy current GMP requirements prior to
marketing clearance. In addition, after marketing clearance is secured, the
manufacturing facility will be inspected periodically for GMP compliance by
FDA inspectors, and, if the facility is located in California, by inspectors
from the Food and Drug Branch of the California Department of Health Services.
In addition to the FDA requirements, the National Institutes of
Health ("NIH") has established guidelines for research involving recombinant
DNA molecules. These guidelines apply to all recombinant DNA research which
is conducted at or supported by the NIH, including proposals to conduct
clinical research involving gene therapy. The NIH review of clinical trial
proposals is a public process and usually involves review and approval by the
Recombinant DNA Advisory Committee of the NIH.
In both domestic and foreign markets, sales of any approved products
will depend on reimbursement from third party payors, such as government and
private insurance plans. Third party payors are increasingly challenging the
prices charged for medical products and services. If we succeed in bringing
one or more products to market, these products may not be considered
cost-effective, reimbursement may not be available, or reimbursement policies
may adversely affect our ability to sell our products on a profitable basis.
We also are subject to various federal, state and local laws,
regulations and recommendations relating to safe working conditions,
laboratory and manufacturing practices, the experimental use of animals and
the use and disposal of hazardous or potentially hazardous substances,
including radioactive compounds and infectious disease agents, used in
connection with our research. The extent of government regulation which might
result from any future legislation or administrative action cannot be
accurately predicted.
HUMAN RESOURCES
As of March 15, 1999, Vical had 101 full-time employees, 20 of whom
hold degrees at the doctorate level. Of these employees, 78 are engaged in,
or directly support, research and development activities, and 23 are in
administrative and business development positions. A significant number of
our management and professional employees have prior experience with
pharmaceutical and biotechnology companies. None of our employees is covered
by collective bargaining agreements, and management considers relations with
its employees to be good.
PRODUCT LIABILITY EXPOSURE
The use of any products we produce could expose us to product liability
claims. We currently carry insurance against such claims for clinical trials
only. We may not have sufficient coverage, or sufficient coverage may not be
available at a reasonable cost. An inability to obtain product liability
insurance at acceptable cost or to otherwise protect against potential
product liability claims could prevent or inhibit the commercialization of
products developed by Vical. A product liability claim or recall could have a
material adverse effect on our business or financial condition.
16
RISK FACTORS
You should carefully consider the following risk factors when
evaluating Vical and its prospects as presented in this report or elsewhere
by management.
UNCERTAINTY CONCERNING OUR POTENTIAL PRODUCTS AND TECHNOLOGY MAY
ADVERSELY AFFECT US
Very little data exists regarding the safety and efficacy of gene
therapy. Moreover, existing studies do not necessarily predict that some
therapy will be safe or effective in humans. This is significant because all
of our potential products are either in research or development. A failure to
successfully develop and commercialize products will materially adversely
affect us. We must conduct a substantial amount of additional research and
development before any U.S. or foreign regulatory authority will approve any
of our products. This research and development may indicate that our
potential products are unsafe or ineffective, in which case, regulatory
authorities may not approve them. Even if approved, our products may not be
commercially successful.
OUR LOSSES
We have not sold any products and do not expect to sell any products
for the next several years. We have incurred cumulative losses totaling
approximately $37.7 million through December 31, 1998. Moreover, we expect
that our negative cash flow and losses from operations will continue and
increase for the foreseeable future. Indeed, we may never generate sufficient
product revenue to become profitable. We also expect to have
quarter-to-quarter fluctuations in revenues, expenses and losses, some of
which could be significant.
OUR ADDITIONAL FINANCING REQUIREMENTS AND LACK OF ACCESS TO CAPITAL
COULD ADVERSELY AFFECT US
We will need to raise more money to continue the research and
development necessary to bring products to market and to establish
manufacturing and marketing capabilities. If we cannot obtain more money we
will be materially and adversely affected. The amount of money we will need
will depend on many factors, including:
- the progress of our research and development programs
- the scope and results of our preclinical studies and clinical
trials
- the time and costs involved in:
- obtaining necessary regulatory approvals
- filing, prosecuting and enforcing patent claims
- scaling up our manufacturing capabilities
- competing technological and market developments
- the commercial arrangements we may establish
- other factors not within our control
We intend to seek additional funds through public and private stock
offerings, arrangements with corporate collaborators or other sources.
However, we may be unable to obtain the money we need on acceptable terms. If
this happens, we may have to eliminate or scale back some or all of our
research and development programs or license others to develop products
and/or technologies that we otherwise would seek to develop ourselves.
THE REGULATORY APPROVAL PROCESS IS EXPENSIVE, TIME CONSUMING AND
UNCERTAIN WHICH MAY ADVERSELY AFFECT US
The regulations governing gene therapy products are evolving and
uncertain; seeking to comply with them is expensive and time consuming.
Failure to obtain FDA approval of our products will materially and adversely
affect us. For example, the FDA has not established guidelines concerning the
length of the clinical trial period required for gene therapy products. Nor
has that agency indicated how many patients it will require to be enrolled in
clinical trials to establish the safety, efficacy and potency of gene therapy
products. Furthermore, existing regulations are subject to substantial review
by various governmental agencies. Therefore, future U.S. or foreign
regulations could prevent or delay regulatory approval of our products or
affect adversely our ability to develop, test, manufacture and market our
products.
We believe that the FDA and comparable foreign regulatory bodies will
regulate the commercial use of any of our products as either biologics or
drugs. These agencies are likely to regulate each product containing a
particular gene
17
as a separate biologic or drug depending on its intended use and evolving
policy. Presently, to commercialize any product we must sponsor and file a
regulatory application for each proposed product. We then must conduct
clinical studies to demonstrate the safety, efficacy and potency of the
product necessary to obtain FDA approval.
The NIH also has established guidelines for research involving
recombinant DNA molecules which is conducted at or supported by the NIH. We
must comply with these guidelines because we and certain of our collaborators
use recombinant DNA molecules in our research and we have received grants
from the NIH. Under current guidelines, we must submit for review to the NIH
and the Recombinant DNA Advisory Committee each of our proposals to conduct
clinical research.
We may be unable to obtain the necessary approvals for clinical
trials or for the manufacturing or marketing of our products. Even if we do
obtain regulatory clearance, marketed products remain subject to continual
review by U.S. regulators. If regulators discover a previously unknown
problem with one of our products, or if we fail to comply with applicable
regulations, regulators may:
- restrict marketing of the product
- withdraw the product from the market
- impose civil or criminal sanctions
In addition, many other companies and academic institutions are conducting
research in the gene therapy field using a variety of approaches and
technologies. If any of these researchers were to obtain adverse results in
preclinical or clinical studies this could adversely affect the regulatory
environment for gene therapy products in general, possibly leading to delays
in the approval process for our potential products.
UNCERTAINTY REGARDING OUR INTELLECTUAL PROPERTY RIGHTS MAY HARM US
Patents may not issue from any of our applications. Moreover, if
patents do issue, governmental authorities may not allow claims in such
patents sufficient to protect our technology. Finally, others may challenge
or seek to circumvent or invalidate patents that are issued to us or to
licensors of our technology. In that event, the rights granted under patents
may be inadequate to protect our proprietary technology or to provide any
commercial advantage.
Our success will depend in part on our ability to obtain patent
protection for our products and processes both in the United States and in
other countries. The patent positions of biotechnology and pharmaceutical
companies, however, can be highly uncertain and involve complex legal and
factual questions. Therefore, it is difficult to predict the breadth of
claims allowed in the biotechnology and pharmaceutical fields. We also seek
to protect our proprietary technology through confidentiality agreements with
corporate collaborators, employees, consultants and contractors. Others may
breach these agreements and we may not have a remedy that is adequate to
protect our rights.
Protecting intellectual property rights can also be very expensive.
Litigation may be necessary to enforce a patent or to determine the scope and
validity of third-party proprietary rights. Moreover, if a competitor were to
file a patent application claiming technology also invented by us, we would
have to participate in an interference proceeding before the U.S. Patent and
Trademark Office or in a foreign counterpart to determine the priority of the
invention.
Our success also will depend in part on our ability to keep from
infringing upon patents issued to competitors and breaching the technology
licenses that might cover technology used in our products. We do not know
whether any patents held by others will require us to alter our products or
processes, obtain licenses, or stop activities. A number of genetic sequences
or proteins encoded by genetic sequences that we are investigating are, or
may become, patented by others. As a result, we may have to obtain licenses
to test, use or market these products. Our business may suffer if we cannot
obtain licenses, or if we can obtain them only on terms that are commercially
unfavorable.
OUR DEPENDENCE ON OTHERS MAY ADVERSELY AFFECT US
Our strategy for the research, development and commercialization of
our products requires us to enter into contractual arrangements with
corporate collaborators, licensors, licensees and others. Our success depends
upon the performance by these persons of their responsibilities under these
arrangements. We cannot control the timing of their
18
performance or the amount of resources they will devote to these activities.
Some persons may not perform their obligations as we expect or we may not
derive any revenue from these arrangements.
We have collaborative agreements with several pharmaceutical
companies. We do not know whether these companies will successfully develop
and market any products under their respective agreements. Moreover, some of
our collaborators are also researching competing technologies to treat the
diseases targeted by our collaborative programs. We may be unsuccessful in
entering into other collaborative arrangements to develop and commercialize
our products.
THE EFFECT OF COMPETITION AND TECHNOLOGICAL CHANGE MAY HURT US
Gene therapy is a new and rapidly evolving field. We expect that the
field will continue to undergo significant and rapid technological change.
Such change could render our products or technologies obsolete.
We compete with companies in the field of gene therapy and with
companies pursuing other forms of treatment or prevention for the diseases we
have targeted. Several development stage and established entities, including
major pharmaceutical and biotechnology firms, are exploring the field of
human gene therapy or are actively engaged in research and development in
areas related to gene therapy. We also may experience competition from
companies that have acquired or may acquire technology from universities and
other research institutions. As these companies develop their technologies,
they may develop proprietary positions in aspects of gene therapy which may
materially and adversely affect our business.
Some of our competitors and potential competitors have substantially
greater product development capabilities and financial, scientific, marketing
and human resources than we do. Other companies may succeed in developing
products earlier than we do, obtaining FDA approval for products more rapidly
than we do, or developing products that are more effective than those we
propose to develop. While we will seek to expand our technological
capabilities to remain competitive, research and development by others might
render our technology or products obsolete or noncompetitive or result in
treatments or cures superior to any therapy developed by us. Additionally,
consumers may not prefer therapies developed by us over existing or newly
developed therapies.
WE CANNOT MANUFACTURE OR MARKET PRODUCTS ON A COMMERCIAL SCALE WHICH
MAY HURT US
We have neither the resources nor the capability to manufacture or
market our proposed products on a commercial scale. We may be dependent
initially on corporate partners, licensees or others to manufacture and
market our products commercially. If we decide to establish a
commercial-scale manufacturing facility, we will require substantial
additional funds and personnel. We also will be required to comply with
extensive regulations applicable to a manufacturing facility. We may be
unable to enter into any arrangement for the manufacture or marketing of our
products. We also may be unable to obtain additional capital to perform these
activities ourselves.
THERE IS UNCERTAINTY CONCERNING INSURANCE COVERAGE AND REIMBURSEMENT
FOR OUR POTENTIAL PRODUCTS WHICH MAY ADVERSELY AFFECT US
As with many health care products and services, the commercial
viability of our gene therapy products and related treatments may depend in
part on whether their costs are covered by health insurers. These insurers
include:
- government health administration authorities
- private health coverage insurers
- managed care organizations
- other similar organizations
Whenever a new health care product is approved by the regulatory
authorities it is always uncertain whether insurers will cover the product.
We do not know whether or to what extent insurers will cover our potential
products. If purchasers or users of our potential products are not entitled
to adequate reimbursement for the cost of using our potential products, they
may decide not to use them or to limit their use. This could harm our
business.
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OUR USE OF HAZARDOUS MATERIALS COULD ADVERSELY AFFECT US
Although we do not manufacture commercial quantities of our potential
products we do produce limited quantities of our potential products for
clinical trials. Our research and development processes involve the
controlled storage, use and disposal of hazardous materials, biological
hazardous materials and radioactive compounds. We are subject to federal,
state and local regulations governing the use, manufacture, storage, handling
and disposal of materials and waste products. There is a risk of accidental
contamination or injury from these materials. In the event of an accident, we
could be held liable for any damages that result, and any liability could
exceed our resources. We could be required to incur significant costs to
comply with current or future environmental laws and regulations. This could
materially or adversely affect our operations, business or assets.
VOLATILITY OF STOCK PRICE AND ABSENCE OF DIVIDENDS
The market price of our common stock, like that of many other life
sciences companies, has been highly volatile and is likely to continue to be
highly volatile. The following factors, among others, could have a
significant adverse impact on the market price of our common stock:
- the results of our preclinical studies and clinical trials or
those of one of our collaborators or competitors
- other evidence of the safety or efficacy of our potential
products or the products of our competitors
- the announcement by us or one of our competitors of technological
innovations or new products
- governmental regulatory actions
- developments with our collaborators
- developments concerning our patent or other proprietary rights or
those of one of our competitors (including litigation)
- concern as to the safety of our potential products
- period to period fluctuations in our operating results
- market conditions for life science stocks in general
- other factors not within our control
We have never paid cash dividends on our common stock and do not anticipate
paying any cash dividends in the foreseeable future.
YEAR 2000 ISSUES
We are unable to control whether our current and future strategic
partners' computer systems are Year 2000 compliant. Any of the following
events could affect our operations:
- if a strategic partner were unable to purchase our clinical
materials or services
- if a strategic partner were unable to manage its clinical trials
or research and development activities
- if a strategic partner were unable to pay its invoices owed to us
- if a supplier were unable to manufacture and ship materials to us
or provide requested contract services
Failure of systems maintained by our strategic partners or suppliers
could cause us to incur significant expenses to remedy any problems, or
otherwise seriously damage our business.
20
EXECUTIVE OFFICERS
The executive officers of Vical are as follows:
NAME AGE POSITION
- ---- --- --------
Alain B. Schreiber, M.D. 43 President, Chief Executive Officer and Director
Deirdre Y. Gillespie, M.D. 42 Executive Vice President and Chief Business Officer
Martha J. Demski 46 Vice President, Chief Financial Officer, Treasurer and
Secretary
George J. Gray 52 Vice President, Operations
Jon A. Norman, Ph.D. 50 Vice President, Research
Robert H. Zaugg, Ph.D. 49 Vice President, Business Development
ALAIN B. SCHREIBER, M.D., has been President, Chief Executive Officer and a
director of Vical since May 1992. Prior to joining Vical, Dr. Schreiber held
various executive level positions at Rhone-Poulenc Rorer Inc. from July 1985
to April 1992, most recently as Senior Vice President of Discovery Research.
From October 1982 to June 1985, Dr. Schreiber served as Biochemistry
Department Head at Syntex Corp. He received his undergraduate degree and M.D.
from the Free University of Brussels, after which he was awarded a fellowship
in immunology at the Weizmann Institute. Dr. Schreiber serves on the Board of
Spiros Development Corporation and is an appointed Advisor for Foreign Trade
for Belgium.
DEIRDRE Y. GILLESPIE, M.D., joined Vical as Executive Vice President and
Chief Business Officer in March 1998. Dr. Gillespie served as Vice President
of Business Development for 3-Dimensional Pharmaceuticals, Inc. in
Pennsylvania from 1997 until joining Vical. From 1991 to 1996, she held
various management positions with DuPont Merck Pharmaceutical Co. in England
and Delaware. From 1986 to 1990, Dr. Gillespie directed clinical research
activities for Sandoz Pharma AG in Switzerland and England. Dr. Gillespie
received a B.Sc. in Pharmacology and Therapeutics and an M.D. from London
University. She has MRCP certification (equivalent to internal medicine
boards in the U.S.). Dr. Gillespie received her M.B.A. from the London
Business School with a specialization in marketing and international
management.
MARTHA J. DEMSKI joined Vical as Chief Financial Officer in December 1988 and
serves as Vice President, Chief Financial Officer, Treasurer and Secretary.
From August 1977 until joining Vical, Ms. Demski held various positions with
Bank of America, lastly as Vice President/Section Head of the Technology
Section. She also served as an adviser to Bank of America on a statewide
basis regarding the biotechnology industry in California. Ms. Demski received
a B.A. from Michigan State University and an M.B.A. in Finance and Accounting
from The University of Chicago Graduate School of Business.
JON A. NORMAN, PH.D., joined Vical in January 1993 as Vice President,
Research. From 1986 until joining Vical, Dr. Norman was the Group
Leader/Section Head for the Departments of Pharmacology and Biochemistry at
Bristol-Myers Squibb Corporation. He was a Senior Research Scientist at
Ciba-Geigy Corporation, from 1981 to 1986. Dr. Norman received his B.A. and
M.A. from the University of California at Santa Barbara and his Ph.D. in
Biochemistry from the University of Calgary, after which he was awarded a
fellowship at the Friedrich Miescher Institute in Basel, Switzerland.
GEORGE J. GRAY joined Vical in October 1992 as Vice President, Operations.
Prior to that time he was at Rhone-Poulenc Rorer Inc. where he held various
positions since 1975, lastly as Director, Discovery Research Ventures,
U.S./U.K. from January 1990 to October 1992, and prior to that as Director,
Project Management from January 1988 to December 1989. Mr. Gray received a
B.A. from George Washington University.
21
ROBERT H. ZAUGG, PH.D., joined Vical in July 1991 as the Senior Director,
Business Development and has served as the Vice President of Business
Development since January 1994. Prior to joining Vical, Dr. Zaugg served as
Director of Business Development & Licensing for Triton Biosciences from 1988
to 1991 and in various business development positions with Sandoz
Pharmaceuticals Corporation from 1982 to 1988. He holds a B.A. from the
University of California at Los Angeles, a Ph.D. in Biochemistry from
Northwestern University and an M.B.A. from New York University. He was
awarded a post-doctoral fellowship in immunology at the Massachusetts
Institute of Technology.
The executive officers are elected annually by the Board of
Directors.
ITEM 2. PROPERTIES
Vical currently leases approximately 38,000 square feet of
laboratory and office space in San Diego, California at three sites and with
three leases. The leases terminate in 1999 and 2001 and contain varying
renewal options. Total current monthly rental on the facilities, including
common area maintenance costs, is approximately $95,000.
ITEM 3. LEGAL PROCEEDINGS
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Vical's common stock is traded on the Nasdaq National Market under
the symbol "VICL." The following table presents quarterly information on the
price range of high and low sales prices for the common stock on the Nasdaq
National Market for the periods indicated since January 1, 1997.
1997 HIGH LOW
- ---- ---- ---
First Quarter $18.25 $14.00
Second Quarter 15.75 9.25
Third Quarter 15.00 10.625
Fourth Quarter 17.25 11.00
1998
- ----
First Quarter $18.00 $12.00
Second Quarter 19.00 14.00
Third Quarter 17.875 7.188
Fourth Quarter 18.00 8.00
As of March 15, 1999, there were approximately 553 stockholders of
record of Vical common stock with 16,190,313 shares outstanding. We have
never declared or paid any dividends and do not expect to pay any dividends
in the foreseeable future.
In January 1999, Vical and Pfizer Inc. ("Pfizer") entered into a
license and option agreement, and a stock purchase agreement under which
Pfizer made an investment of $6.0 million for approximately 318,000 shares of
Vical common stock. For this sale of stock, we relied on the exemption from
registration under Section 4(2) of the Securities Act of 1933.
22
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------- -------------- --------------- -------------- ---------------
(in thousands, except per share and share amounts)
STATEMENT OF OPERATIONS DATA:
Revenues:
Contract revenue.............. $ 876 $ 1,326 $ 1,061 $ 900 $ 1,005
License/royalty revenue....... 5,044 6,477 5,679 5,402 4,509
----------- ----------- ----------- ----------- -----------
5,920 7,803 6,740 6,302 5,514
Expenses:
Research and development... 12,054 11,936 11,318 8,997 8,336
General and administrative. 3,650 3,733 3,168 2,902 2,615
----------- ----------- ----------- ----------- -----------
Loss from operations.............. (9,784) (7,866) (7,746) (5,597) (5,437)
Interest income................... 2,465 2,447 2,773 1,687 1,159
Interest expense.................. 162 192 108 73 80
----------- ----------- ----------- ----------- -----------
Net loss.......................... $ (7,481) $ (5,611) $ (5,081) $ (3,983) $ (4,358)
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Net loss per share (basic and
diluted) ..................... $ (.47) $ (.36) $ (.33) $ (.29) $ (.34)
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Shares used in per share
calculation................... 15,797,585 15,484,952 15,382,848 13,504,790 12,831,585
AS OF DECEMBER 31,
---------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------- -------------- --------------- -------------- ---------------
(in thousands)
BALANCE SHEET DATA:
Cash, cash equivalents and
marketable securities......... $ 40,184 $ 45,555 $ 46,846 $ 52,528 $ 27,339
Working capital................... 38,398 44,856 46,315 51,541 25,956
Total assets...................... 44,844 50,691 52,440 55,118 30,324
Long-term obligations............. 801 1,232 1,617 339 527
Stockholders' equity.............. 40,824 47,194 48,365 53,264 27,852
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Vical was incorporated in April 1987 and since that time has devoted
substantially all of its resources to its research and development programs.
We are focusing our resources on the development of our direct gene transfer
and related technologies. To date, we have not received revenues from the
sale of products. We cannot assure that we will be able to generate
sufficient product revenue to become profitable at all or on a sustained
basis. As of December 31, 1998, our accumulated deficit was approximately
$37.7 million.
Vical expects to incur substantial operating losses for at least the
next several years due to significant increases in research and development
expenses. The increases are expected to result from costs of preclinical
studies and clinical trials for our product candidates, increased patent and
regulatory costs, and associated increases in personnel, laboratory supplies,
contract services and facilities. Losses may fluctuate from quarter to
quarter as a result of differences in the timing of expenses incurred and the
revenues received from collaborative agreements. Such fluctuations may be
significant.
23
When used in this discussion, the words "expects," "anticipated" and
similar expressions are intended to identify forward-looking statements.
These statements are subject to risks and uncertainties which could cause
actual results to differ materially from those projected. 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
publicly release the result of any revisions to these forward-looking
statements which may be made to reflect events or circumstances after the
date of this report to reflect the occurrence of unanticipated events.
RESULTS OF OPERATIONS
Vical had revenues of $5.9 million for the year ended December 31,
1998, compared with $7.8 million in 1997 and $6.7 million in 1996. License
revenues in 1998 consisted of $2.2 million from Centocor, Inc. for an
agreement covering technology for the potential treatment of some types of
cancer, $1.1 million from an agreement with Boston Scientific Corporation for
the development of catheter-based vascular gene therapy, recognition of $.9
million of deferred license fees from a further extension of the license and
option agreement with Merial, royalty revenues of $.7 million and $.2 million
of other license revenue. Contract revenues in 1998 consisted principally of
$.7 million from an agreement with the Office of Naval Research for the
development work on a potential DNA vaccine to prevent malaria. This
agreement is a multi-year agreement which could provide up to an additional
$2.0 million in revenues through 2000. Contract revenue in 1998 also included
$.2 million of reimbursements from PMC and other sources.
Vical had revenues of $7.8 million for the year ended December 31,
1997, compared with $6.7 million in 1996. Revenues in 1997 were composed of
research and license revenue from a 1997 Merck agreement covering certain
growth factors ($2.0 million); the equity premium on the investment Merck
made in 1997 in Vical common stock under an amendment to the 1991
collaborative agreement ($1.0 million); the PMC collaboration ($2.4 million);
a 1997 collaborative agreement with RPR for neurodegenerative disease targets
($1.0 million); and other agreements which totaled $1.4 million. In November
1997, Vical and Merck amended the 1991 agreement and granted Merck rights to
develop and market therapeutic vaccines against HIV and HBV. Under the
November 1997 amendment, Merck made an investment of $5.0 million for
approximately 262,000 shares of Vical common stock. The price per share
reflected a twenty-five percent premium over the trading price of the common
stock. The premium on the investment was reflected in revenue in 1997. The
PMC revenue represented contract revenue of $1.1 million as payment for
clinical and preclinical work and license revenue of $1.3 million, of which
$1.0 million was for a milestone payment for the start of the malaria
clinical trial and the balance was the recognition of deferred license fees.
Revenues in 1996 resulted from research and license revenue from: the PMC
collaboration in the amount of $2.7 million, the 1991 Merck agreement in the
amount of $1.5 million, the Genzyme collaboration in the amount of $1.3
million, and several other agreements in the amount of $1.2 million. Revenue
from the PMC agreement in 1996 was primarily the result of PMC's payment of
licensing and option fees, and the addition of a new option, as well as the
payment of fees for Vical's performance of clinical and preclinical work. The
Merck revenue resulted from milestone payments due under the 1991 Merck
agreement. The Genzyme collaboration income was the result of Genzyme
exercising its option to license our technology for the treatment of cystic
fibrosis as well as payments for our performance of research and preclinical
work.
Research and development expense increased to $12.1 million in 1998
from $11.9 million in 1997 and $11.3 million in 1996. The increases in
research and development expense were generally due to expansion of our
research and development activities. The increase in 1998 principally was due
to increased clinical trial costs and additional royalty expense for license
agreements. The increase in expenses in 1997 compared to 1996 included
increased clinical and preclinical efforts which resulted in increases to
staffing, increased facilities related costs and increased expenditures on
laboratory supplies. Clinical trials expense increased to $1.9 million during
1998 from $1.6 million in 1997. This increase was due to the commencement of
the Phase II and Phase III clinical trials of ALLOVECTIN 7 for melanoma.
Clinical trials expense increased to $1.6 million during 1997 from $1.2
million in 1996 primarily due to the commencement of the malaria clinical
trial and increased clinical trials activity on LEUVECTIN. During 1996, we
incurred expenses of approximately $1.2 million with the commencement and
progression of the multi-center Phase I/II and Phase II clinical trials of
LEUVECTIN and ALLOVECTIN-7 respectively. Research and development expense is
expected to increase in 1999 and thereafter as our preclinical and clinical
trial activities increase.
24
General and administrative expense decreased to $3.6 million in 1998
from $3.7 million in 1997 due to lower insurance and facilities expenses. The
increase to $3.7 million in 1997 from $3.2 million during 1996 was due
primarily to additional staffing and related expenses. General and
administrative expenses are expected to continue to increase as research and
development activities expand.
Interest income increased to $2.5 million in 1998 from $2.4 million
in 1997 due to higher rates of return on investments. Interest income of $2.4
million during 1997 declined from the $2.8 million in 1996, due to lower
investment balances as we redeemed investments to fund operating expenses.
Interest expense decreased during 1998 due to lower capital lease
obligations, lower balance of bank note payable and lower interest rates on
the newer capital lease obligations. Interest expense increased in 1997
compared to the previous year due to increased capital lease obligations to
finance equipment needs and the addition of a debt instrument in 1996.
YEAR 2000 ISSUES
The Year 2000 problem is due to many computer systems using only two
digits rather than four to designate a specific year. As a result, many of
these systems may fail to function properly if a date beyond 1999 is entered.
We have completed our assessment of any potential Year 2000 issues for our
internal computer applications, including embedded control systems in
equipment, to determine whether they will function for the year 2000 and
beyond and what modifications, if any, would be required to ensure their
continuing functionality. We plan to upgrade our existing business
applications software to the latest Year 2000 compliant release of the
software by June 1, 1999. We also plan to implement a new financial and
accounting system and related hardware to meet our growing needs into the
near future. This new system will be Year 2000 compliant and implemented
prior to yearend. Given the relatively small size of our systems and the
predominantly new hardware, software and operating systems, we do not
anticipate any significant delays in becoming Year 2000 compliant. To date
our costs for Year 2000 compliance have been immaterial and we expect our
costs to finish becoming Year 2000 compliant to be immaterial.
We are unable to control whether our current and future strategic
partners' systems are Year 2000 compliant. The failure of systems maintained
by our strategic partners or suppliers could cause us to incur significant
expenses to remedy any problems, or otherwise seriously damage our business.
We are communicating with strategic partners to assess the risk of Year 2000
issues. We have not completed the inquiries of the strategic partners.
However, we are not aware, at this time, of any material Year 2000 issues
regarding our dealings with our strategic partners. We anticipate that our
assessment will be completed by July 31, 1999.
At this time, we have no reason to believe that Year 2000 changes
will have a material impact on Vical's business, financial condition or
results of operations. Since no significant issues have been identified, we
do not have a comprehensive contingency plan to address any material Year
2000 issues. A contingency plan, if required, will be developed for all
applications and systems that affect core business functions upon completion
of our assessment of Year 2000 issues. We do plan to perform backups of the
existing and upgraded versions of the computer system so that in the event
our planned new financial and accounting system and related hardware do not
function properly we can continue to operate under the old system. Vical has
not identified what it believes would be a reasonably likely worst case
scenario with respect to Year 2000 failures.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, Vical has financed its operations primarily
through private placements of common stock and preferred stock, three public
offerings of common stock, and revenues from collaborative agreements. As of
December 31, 1998, we had working capital of approximately $38.4 million
compared with $44.9 million at December 31, 1997. Cash and marketable
securities totaled approximately $40.2 million at December 31, 1998, compared
with $45.6 million at December 31, 1997.
We expect to incur substantial additional research and development
expense and general and administrative expense. Our future capital
requirements will depend on many factors, including the rate of scientific
progress in our research and development programs, the scope and results of
preclinical testing and clinical trials, the time and costs involved in
obtaining regulatory approvals, the costs involved in filing, prosecuting and
enforcing patent claims, competing technological and market developments, the
cost of manufacturing scale-up, commercialization activities and arrangements
and other factors not within our control. We intend to seek additional
funding through research and development relationships with suitable
potential corporate collaborators and/or through public or private
financings. We cannot assure that additional financing will be available on
favorable terms, if at all.
25
If additional financing is not available, Vical anticipates that our
available cash and existing sources of funding will be adequate to satisfy
our operating needs through at least 2000.
ITEM 7.a QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Vical's investment portfolio is maintained in accordance with our investment
policy which defines allowable investments, specifies credit quality
standards and limits the credit exposure of any single issuer. No investments
in equity securities are made. At December 31, 1998, 96 percent of the
investments would mature within two years, none would mature beyond three
years, and the average maturity was nine months. Our investments are all
classified as available-for-sale securities. We are subject to interest rate
risk. We projected an ending fair value of our cash equivalents and
marketable securities using a twelve-month time horizon, a nine-month average
maturity and assuming a 150-basis-point increase in interest rates. The
decrease in fair value assuming a 150-basis-point increase in interest rates
compared with fair value with no change in interest rates was not material.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and supplementary data of
Vical required by this item are set forth at the pages indicated in Item
14(a)(1).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
DIRECTORS
The directors of Vical are as follows:
NAME AFFILIATION
- ---- -----------
Alain B. Schreiber, M.D. Vical Incorporated
Robert C. Bellas, Jr. Morgenthaler Ventures
M. Blake Ingle Canji, Inc. (retired)
Patrick F. Latterell Venrock Associates
Fred A. Middleton Sanderling Ventures
Dale A. Smith Baxter International Inc. (retired)
Philip M. Young U.S. Venture Partners
Gary A. Lyons Neurocrine Biosciences, Inc.
The information required by this item (with respect to Directors) is
incorporated by reference from the information under the caption "Election of
Directors" contained in Vical's Proxy Statement to be filed with the
Securities and Exchange Commission in connection with the solicitation of
proxies for Vical's 1999 Annual Meeting of Stockholders to be held on May 27,
1999 ("Proxy Statement").
The required information concerning Executive Officers of Vical is
contained in Part I of this Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from
the information under the caption "Executive Compensation" contained in the
Proxy Statement.
26
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from
the information under the caption "Security Ownership of Certain Beneficial
Owners and Management" contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from
the information contained under the caption "Certain Transactions" contained
in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K
(a) (1) FINANCIAL STATEMENTS
The financial statements required by this item are submitted in a
separate section beginning on page F-1 of this report.
FINANCIAL STATEMENTS
Report of Independent Public Accountants F-1
Balance Sheets at December 31, 1998 and 1997 F-2
Statements of Operations for the three years F-3
ended December 31, 1998
Statements of Stockholders' Equity F-4
for the three years ended December 31, 1998
Statements of Cash Flows for the three years F-5
ended December 31, 1998
Notes to Financial Statements F-6
(2) FINANCIAL STATEMENT SCHEDULES
Schedules have been omitted because of the absence of conditions
under which they are required or because the required information is included
in the financial statements or the notes thereto.
(3) Exhibits with each management contract or compensatory plan or
arrangement required to be filed are identified. See paragraph (c) below.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the quarter ended December 31,
1998.
27
(c) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
3.1(i)(10) Restated Certificate of Incorporation.
3.1(ii)(10) Amended and Restated Bylaws of the Company.
3.2(i)(2) Certificate of Designation, Rights and Preferences of
Series A Participating Preferred Stock of Vical
Incorporated.
4.1(10) Specimen Common Stock Certificate.
4.2(2) Rights Agreement dated as of March 20, 1995, between
the Company and First Interstate Bank of California.
4.3(11) Stock Purchase Agreement dated November 3, 1997,
between the Company and Merck & Co., Inc.
10.1(4)# Stock Incentive Plan of Vical Incorporated.
10.2(5)# 1992 Directors' Stock Option Plan of Vical
Incorporated.
10.3(3) Form of Indemnity Agreement between the Company and
its directors and officers.
10.5(3)# Employment Agreement dated August 20, 1992, between
the Company and Mr. George J. Gray.
10.6(3)# Employment Agreement dated November 2, 1992, between
the Company and Dr. Jon A. Norman.
10.7(3) Stock Purchase Agreement dated February 20, 1992.
10.8(3) Lease dated December 4, 1987, between the Company and
Nexus/GADCo.-UTC, a California Joint Venture, as
amended.
10.9(6)* Research Collaboration and License Agreement dated May
31, 1991, between the Company and Merck & Co., Inc.
10.12(1)* License Agreement dated January 1, 1991, between the
Company and Wisconsin Alumni Research Foundation.
10.14(1)* License Agreement dated October 23, 1992, between the
Company and the Regents of University of Michigan.
10.16(7) Research, Option and License Agreement dated September
29, 1994, between the Company and Pasteur Merieux
Serums & Vaccins.
10.17(8) Amendment dated April 27, 1994, to Research
Collaboration and License Agreement dated May 31,
1991, between the Company and Merck & Co., Inc.
10.18(9)* Agreement between Merck & Co., Inc. and the Company
dated September 12, 1997.
10.19(11)* Amendment dated November 3, 1997, to Research
Collaboration and License Agreement dated May 31,
1991, between the Company and Merck & Co., Inc.
23.1 Consent of Arthur Andersen LLP.
24 Power of Attorney (see page 30).
27 Financial Data Schedule
- -----------
(1) Incorporated by reference to the Company's Registration
Statement on Form S-1 (No. 33-56830) filed on January 7, 1993.
(2) Incorporated by reference to the exhibit of the same number to
the Company's Report on Form 10-K for the Fiscal Year ended
December 31, 1994 (No. 0-21088).
(3) Incorporated by reference to the Exhibits of the same number
filed with the Company's Registration Statement on Form S-1 (No.
33-56830) filed on January 7, 1993.
(4) Incorporated by reference to Exhibit A filed with the Company's
Schedule 14A Definitive Proxy Statement on Form DEF 14A filed on
April 14, 1998.
(5) Incorporated by reference to Exhibit 10.1 filed with the
Company's Registration Statement on Form S-8 (No. 33-87972)
filed on December 29, 1994.
(6) Incorporated by reference to Exhibit 10.9 of the Company's
Quarterly Report on Form 10-Q for the quarter ended September
30, 1994 (No. 0-21088).
(7) Incorporated by reference to Exhibit A of the Company's
Quarterly Report on Form 10-Q for the quarter ended September
30, 1994.
(8) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1994 (No. 0-21088).
28
(9) Incorporated by reference to the exhibit of the same number to
the Company's Quarterly Report on the Form 10-Q for the quarter
ended September 30, 1997, as amended by Form 10-Q/A filed
January 30, 1998.
(10) Incorporated by reference to the exhibit of the same number
filed with the Company's Registration Statement on Form S-3 (No.
33-95812) filed on August 15, 1995.
(11) Incorporated by reference to the exhibit of the same number to
the Company's Annual Report on Form 10-K for the year ended
December 31, 1997, filed on March 30, 1998.
* The Company has received confidential treatment of certain portions
of these agreements.
# Indicates management contract or compensatory plan or arrangement.
(d) FINANCIAL STATEMENT SCHEDULES
The financial statement schedules of Vical Incorporated required by
this item are set forth at the pages indicated in Item 14(a)(2).
29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized on March 30, 1999.
VICAL INCORPORATED
By: /s/ ALAIN B. SCHREIBER, M.D.
--------------------------------------------
Alain B. Schreiber, M.D.
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Alain B. Schreiber and Martha J. Demski, and
each of them, his or her attorneys-in-fact, each with full power of
substitution, for him or her in any and all capacities, to sign any
amendments to this Report and to file the same, with exhibits thereto and
other documents in connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that each said
attorneys-in-fact, or substitute or substitutes, may do or cause to be done
by virtue hereof.
/s/ ALAIN B. SCHREIBER, M.D. President, March 30, 1999
- ------------------------------------------ Chief Executive Officer
Alain B. Schreiber, M.D. and Director
/s/ MARTHA J. DEMSKI Vice President, Finance March 30, 1999
- ------------------------------------------ Chief Financial Officer
Martha J. Demski Secretary and Treasurer
/s/ ROBERT C. BELLAS, Jr. Director March 30, 1999
- ------------------------------------------
Robert C. Bellas, Jr.
/s/ FRED A. MIDDLETON Director March 30, 1999
- ------------------------------------------
Fred A. Middleton
/s/ PHILIP M. YOUNG Director March 30, 1999
- ------------------------------------------
Philip M. Young
/s/ PATRICK F. LATTERELL Director March 30, 1999
- ------------------------------------------
Patrick F. Latterell
/s/ DALE A. SMITH Director March 30, 1999
- ------------------------------------------
Dale A. Smith
/s/ M. BLAKE INGLE Director March 30, 1999
- ------------------------------------------
M. Blake Ingle
/s/ GARY A. LYONS Director March 30, 1999
- ------------------------------------------
Gary A. Lyons
30
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Vical Incorporated:
We have audited the accompanying balance sheets of Vical Incorporated, a
Delaware corporation, as of December 31, 1998 and 1997, and the related
statements of operations, stockholders' equity, and cash flows for each of
the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Vical Incorporated as of
December 31, 1998 and 1997, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
San Diego, California
February 8, 1999
F-1
VICAL INCORPORATED
BALANCE SHEETS
December 31,
1998 1997
---------------- ----------------
ASSETS
Current Assets:
Cash and cash equivalents (Note 2) $ 13,567,817 $ 12,157,149
Marketable securities - available-for-sale (Note 2) 26,615,939 33,397,482
Receivables and other 1,432,711 1,566,532
---------------- ----------------
Total current assets 41,616,467 47,121,163
---------------- ----------------
Property and Equipment (Note 5):
Equipment 5,139,944 4,966,955
Leasehold improvements 1,558,554 1,587,554
---------------- ----------------
6,698,498 6,554,509
Less--accumulated depreciation and amortization (4,992,121) (4,334,224)
---------------- ----------------
1,706,377 2,220,285
---------------- ----------------
Patent costs, net of accumulated amortization of $126,638 and
$74,063 (Note 1) 1,387,936 1,247,059
Other assets 133,385 102,500
---------------- ----------------
$ 44,844,165 $ 50,691,007
---------------- ----------------
---------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued expenses (Note 4) $ 2,281,252 $ 1,424,603
Current portion of capital lease obligations (Note 5) 473,466 448,261
Current portion of notes payable (Note 5) 213,773 213,773
Deferred revenue (Note 3) 250,000 178,261
---------------- ----------------
Total current liabilities 3,218,491 2,264,898
---------------- ----------------
Long-Term Obligations:
Long-term obligations under capital leases (Note 5) 747,807 911,794
Notes payable (Note 5) 53,443 320,660
---------------- ----------------
Total long-term obligations 801,250 1,232,454
---------------- ----------------
Commitments (Note 5)
Stockholders' Equity (Note 6):
Preferred stock, $.01 par value--5,000,000 shares authorized--
none outstanding - -
Common stock, $.01 par value--40,000,000 shares authorized-- 158,665 157,313
15,866,544 and 15,731,316 shares issued and outstanding
in 1998 and 1997, respectively
Additional paid-in capital 78,332,483 77,267,971
Accumulated other comprehensive income (Note 2) 69,440 24,028
Accumulated deficit (37,736,164) (30,255,657)
---------------- ----------------
Total stockholders' equity 40,824,424 47,193,655
---------------- ----------------
$ 44,844,165 $ 50,691,007
---------------- ----------------
---------------- ----------------
See accompanying notes.
F-2
VICAL INCORPORATED
STATEMENTS OF OPERATIONS
Year ended December 31,
1998 1997 1996
---------------- ---------------- ----------------
Revenues (Note 3):
Contract revenue $ 875,773 $ 1,325,925 $ 1,060,557
License/Royalty revenue 5,044,607 6,477,244 5,679,542
---------------- ---------------- ----------------
5,920,380 7,803,169 6,740,099
---------------- ---------------- ----------------
Expenses:
Research and development 12,054,367 11,936,068 11,317,908
General and administrative 3,649,841 3,733,290 3,168,331
---------------- ---------------- ----------------
15,704,208 15,669,358 14,486,239
---------------- ---------------- ----------------
Loss from operations (9,783,828) (7,866,189) (7,746,140)
Other income (expense):
Interest income 2,465,545 2,447,139 2,772,845
Interest expense (162,224) (192,181) (107,296)
---------------- ---------------- ----------------
Net loss $ (7,480,507) $ (5,611,231) $ (5,080,591)
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Net loss per share (basic and diluted--Note 1) $ (0.47) $ (0.36) $ (0.33)
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Weighted average shares used in computing net
loss per share 15,797,585 15,484,952 15,382,848
---------------- ---------------- ----------------
---------------- ---------------- ----------------
See accompanying notes.
F-3
VICAL INCORPORATED
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE THREE YEARS ENDED DECEMBER 31, 1998
Accumulated
Additional Other Total Total
Common Stock Paid-in Deferred Comprehensive Accumulated Stockholders' Comprehensive
Shares Amount Capital Compensation Income Deficit Equity Loss
---------- --------- ------------ ------------ ------------- -------------- ------------- -------------
BALANCE, December 31, 1995 15,364,265 $ 153,643 $ 72,728,484 $ (158,427) $ 104,176 $ (19,563,835) $ 53,264,041
Stock option exercises 32,317 323 175,988 - - - 176,311
Deferred compensation - - - 158,427 - - 158,427
Unrealized loss on
marketable securities
arising during
holding period $ (136,199)
Reclassification of
realized gain
included in net loss (16,762)
-------------
Unrealized gain (loss)
on marketable
securities - - - - (152,961) - (152,961) (152,961)
Net loss - - - - - (5,080,591) (5,080,591) (5,080,591)
---------- --------- ------------ ------------ ------------- -------------- ------------- -------------
BALANCE, December 31, 1996 15,396,582 153,966 72,904,472 - (48,785) (24,644,426) 48,365,227 (5,233,552)
-------------
-------------
Issuance of common stock
at $15.28 per share
(Note 3) 261,812 2,618 3,992,143 - - - 3,994,761
Stock option exercises 72,922 729 371,356 - - - 372,085
Unrealized gain on
marketable securities
arising during holding
period 87,763
Reclassification of
realized loss included
in net loss (14,950)
-------------
Unrealized gain (loss) on
marketable securities - - - - 72,813 - 72,813 72,813
Net loss - - - - - (5,611,231) (5,611,231) (5,611,231)
---------- --------- ------------ ------------ ------------- -------------- ------------- -------------
BALANCE, December 31, 1997 15,731,316 157,313 77,267,971 - 24,028 (30,255,657) 47,193,655 (5,538,418)
-------------
-------------
Stock option exercises 135,228 1,352 1,064,512 - - - 1,065,864
Unrealized gain on
marketable securities
arising during holding
period 57,041
Reclassification of
realized gain included
in net loss (11,629)
-------------
Unrealized gain (loss)
on marketable
securities - - - - 45,412 - 45,412 45,412
Net loss - - - - - (7,480,507) (7,480,507) (7,480,507)
---------- --------- ------------ ------------ ------------- -------------- ------------- -------------
BALANCE, December 31, 1998 15,866,544 $ 158,665 $ 78,332,483 $ - $ 69,440 $ (37,736,164) $ 40,824,424 $ (7,435,095)
---------- --------- ------------ ------------ ------------- -------------- ------------- -------------
---------- --------- ------------ ------------ ------------- -------------- ------------- -------------
See accompanying notes.
F-4
VICAL INCORPORATED
STATEMENTS OF CASH FLOWS
Year ended December 31,
1998 1997 1996
---------------- ---------------- ----------------
OPERATING ACTIVITIES:
Net loss $ (7,480,507) $ (5,611,231) $ (5,080,591)
Adjustments to reconcile net loss to net cash provided
from (used in) operating activities:
Depreciation and amortization 920,695 939,956 620,033
Compensation expense related to stock purchases - - 158,427
Write-off of abandoned patent application costs 94,800 80,994 3,247
Changes in operating assets and liabilities:
Receivables and other 133,821 359,463 (1,397,906)
Accounts payable and accrued expenses 856,649 614,219 282,087
Deferred revenue 71,739 (1,013,043) 512,137
---------------- ---------------- ----------------
Net cash used in operating activities (5,402,803) (4,629,642) (4,902,566)
---------------- ---------------- ----------------
INVESTING ACTIVITIES:
Marketable securities 6,826,955 912,645 10,963,363
Capital expenditures (34,292) (418,507) (980,709)
Other assets (1,885) 210,400 221,288
Patent expenditures (288,252) (280,778) (269,682)
---------------- ---------------- ----------------
Net cash provided from (used in) investing activities 6,502,526 423,760 9,934,260
---------------- ---------------- ----------------
FINANCING ACTIVITIES:
Principal payments under capital lease obligations (487,702) (506,205) (414,176)
Proceeds from (payments on) notes payable (267,217) (106,887) 641,320
Issuance of common stock, net 1,065,864 4,366,846 176,311
---------------- ---------------- ----------------
Net cash provided from financing activities 310,945 3,753,754 403,455
---------------- ---------------- ----------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,410,668 (452,128) 5,435,149
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 12,157,149 12,609,277 7,174,128
---------------- ---------------- ----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 13,567,817 $ 12,157,149 $ 12,609,277
---------------- ---------------- ----------------
---------------- ---------------- ----------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest Paid $ 167,622 $ 184,191 $ 107,296
NONCASH INVESTING AND FINANCING ACTIVITIES:
Equipment acquired under capital leases $ 348,920 $ 434,416 $ 1,200,022
See accompanying notes.
F-5
VICAL INCORPORATED
NOTES TO FINANCIAL STATEMENTS
December 31, 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS ACTIVITY
Vical Incorporated (the "Company"), a Delaware corporation, was incorporated
in 1987 and has devoted substantially all of its resources since that time to
its research and development programs. The Company is focusing its resources
on the development of its direct gene transfer and related technologies.
All of the Company's potential products are in research and development. No
revenues have been generated from the sale of any of such products, nor are
any such revenues expected for at least the next several years. The products
currently under development by the Company will require significant
additional research and development efforts, including extensive preclinical
and clinical testing and regulatory approval, prior to commercial use. There
can be no assurance that the Company's research and development efforts will
be successful and that any of the Company's potential products will prove to
be safe and effective in clinical trials. Even if developed, these products
may not receive regulatory approval or be successfully introduced and
marketed at prices that would permit the Company to operate profitably. The
Company expects to continue to incur substantial losses and not generate
positive cash flow from operations for at least the next several years. No
assurance can be given that the Company can generate sufficient product
revenue to become profitable or generate positive cash flow from operations
at all or on a sustained basis.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period.
Actual results could differ from those estimates.
PROPERTY AND EQUIPMENT
Equipment is stated at cost and depreciated over the estimated useful lives
of the assets (3-5 years) using the straight-line method. Leasehold
improvements are stated at cost and amortized over the shorter of the life of
the lease or the remaining useful life of the asset using the straight-line
method.
PATENT COSTS
The Company capitalizes certain costs related to patent applications.
Accumulated costs are amortized over the estimated economic lives of the
patents using the straight-line method, commencing at the time the patents
are issued. Costs related to patent applications are written off to expense
at the time such costs are deemed to have no continuing value.
RESEARCH AND DEVELOPMENT COSTS
All research and development costs are expensed as incurred.
REVENUE UNDER COLLABORATIVE AGREEMENTS
Revenue under collaborative agreements is generally recognized over the term
of the agreement or on the achievement of certain milestones. Advance
payments received in excess of amounts earned are classified as deferred
revenue.
NET LOSS PER SHARE
Basic and diluted net loss per share for each of the three years in the
period ended December 31, 1998, has been computed using the weighted average
number of shares of common stock outstanding during the periods pursuant to
Statement of Financial Accounting Standards No. 128, "Earnings Per Share."
Diluted loss per share does not include any stock options as the effect would
be antidilutive. See Note 6 for information on the number of options
outstanding and the weighted average exercise price at December 31, 1998,
1997 and 1996.
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income
Taxes."
F-6
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments such as accounts receivable,
accounts payable and accrued expenses reasonably approximate fair value
because of the short maturity of these items. The Company believes the
carrying amounts of the Company's notes payable and obligations under capital
leases approximate fair value because the interest rates on these instruments
change with, or approximate, market interest rates.
COMPREHENSIVE INCOME
The Company has implemented Statement of Financial Accounting Standards No.
130 ("SFAS 130"), "Reporting Comprehensive Income." This statement requires
that all items that are required to be recognized under accounting standards
as components of comprehensive income be reported in a financial statement
that is displayed with the same prominence as other financial statements.
Accordingly, in addition to reporting net income (loss) under the current
rules, the Company was required to display the impact of any unrealized gain
or loss on marketable securities as a component of comprehensive income and
to display an amount representing total comprehensive income for each period
presented. The Company has presented the required information in the
Statements of Stockholders' Equity.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the Accounting Standards Executive Committee issued AICPA
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use" ("SOP 98-1"). This statement provides
guidance on accounting for the costs of computer software developed or
obtained for internal use. The statement identifies characteristics of
internal use software and assists in determining when computer software is
for internal use. SOP 98-1 is effective for fiscal years beginning after
December 15, 1998, with earlier application permitted. The Company has not
determined the impact of the adoption of SOP 98-1 as this is highly dependent
upon the nature, timing and extent of future internal use software
development.
The Company has adopted Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" and,
has determined that it operates in one business segment dedicated to research
in gene delivery technology.
2. CASH EQUIVALENTS AND MARKETABLE SECURITIES
The Company invests its excess cash in debt instruments of financial
institutions, corporations with strong credit ratings, and in U.S. government
obligations. The Company has established guidelines relative to
diversification and maturities that maintain safety and liquidity. These
guidelines are periodically reviewed and modified to take advantage of trends
in yields and interest rates. Cash equivalents are short-term, highly liquid
investments with original maturities of less than three months. Cash
equivalents at December 31, 1998 and 1997, consist primarily of $11,671,743
and $12,080,473, respectively, in commercial paper, federal agency discount
notes and money market funds.
The Company has adopted Statement of Financial Accounting Standards No. 115
("SFAS 115"), "Accounting for Certain Investments in Debt and Equity
Securities," which requires that the Company's marketable securities be
classified as available-for-sale and that unrealized holding gains or losses
are recorded as a separate component of stockholders' equity. Realized gains
or losses, calculated based on the specific identification method, were not
material for the years ended December 31, 1998, 1997 and 1996.
At December 31, 1998, marketable securities consisted of the following:
Amortized Cost Market Value Unrealized Gain
-------------- ------------ ---------------
U.S. Government Obligations $ 5,508,897 $ 5,529,915 $21,018
Commercial Paper 21,037,602 21,086,024 48,422
----------- ----------- -------
Total Marketable Securities $26,546,499 $26,615,939 $69,440
=========== =========== =======
Approximately 60%, 36% and 4% of these securities mature within one, two and
three years, respectively, of December 31, 1998.
F-7
At December 31, 1997, marketable securities consisted of the following:
Amortized Cost Market Value Unrealized Gain
-------------- ------------ ---------------
U.S. Government Obligations $12,978,062 $12,982,090 $ 4,028
Commercial Paper 20,395,392 20,415,392 20,000
----------- ----------- -------
Total Marketable Securities $33,373,454 $33,397,482 $24,028
----------- ----------- -------
----------- ----------- -------
3. SIGNIFICANT CONTRACTS AND LICENSE AGREEMENTS
MERCK & CO., INC.
The Company has entered into three separate agreements with Merck & Co., Inc.
("Merck") which provide Merck with certain exclusive rights to develop and
commercialize vaccines using the Company's "naked" DNA technology for certain
disease targets. The 1991 and 1997 agreements are for human vaccine targets
and the 1992 agreement is for animal vaccine targets. Prior to 1996, Merck
exercised its options to seven preventive human infectious disease vaccines
using the Company's naked DNA technology pursuant to the 1991 agreement. In
1996, the Company received a $1,000,000 payment from Merck upon the
initiation of a Phase I clinical trial of an experimental DNA vaccine against
influenza virus, one of the seven infectious disease targets covered by the
agreement. Also in 1996, Vical accrued a $500,000 payment from Merck in
conjunction with the issuance of the patent technology covering the
agreement. The payment was subsequently received in 1997. In November 1997,
the Company and Merck amended the 1991 agreement and granted Merck certain
rights to develop and market therapeutic vaccines against the human
immunodeficiency virus (HIV) and hepatitis B virus (HBV). Under the amended
agreement, Merck made an investment of $5,000,000 for approximately 262,000
shares of the Company's common stock including a twenty-five percent premium
over the average per share closing price for the twenty trading days prior to
the date of the agreement. The premium of $1,000,000 on the investment was
reflected in revenue in 1997 and the balance of the investment, net of costs
to issue the shares of stock, was reflected in common stock and additional
paid-in capital.
The September 1997 agreement between the Company and Merck granted Merck the
rights to use the Company's naked DNA technology to deliver certain growth
factors as potential treatments for a range of applications including
revascularization. The agreement resulted in an initial payment to the
Company of $2,000,000. Through December 31, 1998, the Company had received a
total of $19,130,000 (including the payment for the investment for common
stock) under these agreements of which $0, $3,000,000, and $1,500,000 was
recognized as revenue in 1998, 1997, and 1996, respectively. All three
agreements provide for the Company to receive additional payments based upon
achievement of certain defined milestones and royalty payments based on net
product sales.
PASTEUR MERIEUX CONNAUGHT
In September 1994, the Company entered into an agreement with Pasteur Merieux
Connaught ("PMC") that includes a research collaboration and options for PMC
to take exclusive licenses to Vical's naked DNA vaccine technology for each
of five vaccine targets. In order to maintain the options, PMC will be
required to pay Vical option fees as specified in the agreement. In addition,
Vical was paid an annual research fee through September 1997 by PMC for
expenses incurred in performing certain preclinical work as defined in the
agreement. PMC renewed options and exercised an option in 1995. In 1996, PMC
exercised three options, extended one option, and added a new option. In
1997, PMC paid the Company $1,000,000 as a milestone payment under the
agreement because the Company and PMC began a Phase I clinical trial of an
experimental vaccine against the parasite that causes malaria. The Company
and PMC are sponsoring the trial which is being conducted by the U.S. Naval
Medical Research Institute and the U.S. Army Medical Research Institute of
Infectious Diseases. Through December 31, 1998, Vical has received $7,816,000
of which $239,000, $2,399,000, and $2,746,000, was recognized as revenue in
1998, 1997, and 1996, respectively. The agreement provides for the Company to
receive additional payments based upon achievement of certain defined
milestones and royalty payments based on net product sales.
RHONE-POULENC RORER PHARMACEUTICALS, INC.
In October 1997, the Company and Rhone-Poulenc Rorer Pharmaceuticals. Inc.
("RPR") entered into an agreement granting RPR an exclusive worldwide license
to use the Company's naked DNA gene delivery technology to develop certain
gene therapy products for potential treatment of neurodegenerative diseases.
Under the terms of the agreement, the Company received $1,000,000 which was
recognized as revenue in 1997. This agreement provides for the Company to
receive additional payments based upon achievement of certain defined
milestones and royalty payments based on net product sales.
CENTOCOR, INC.
In February 1998, the Company signed an agreement allowing Centocor, Inc.
("Centocor") to use Vical's naked DNA technology to develop and market
gene-based vaccines for the potential treatment of certain types of cancer.
The agreement
F-8
resulted in a payment to Vical of $2,200,000, which was recognized as revenue
in 1998. The payment represented an initial payment of $2,000,000 under the
license agreement and reimbursement of $200,000 of patent costs. The Company
may receive further payments plus royalties if Centocor successfully develops
products using the Vical technology. The agreement grants to Centocor
exclusive worldwide licenses and options to license Vical's naked DNA
technology to deliver certain antigens to induce immune responses against the
associated cancer cells.
BOSTON SCIENTIFIC CORPORATION
In September 1998, the Company and Boston Scientific Corporation entered into
a license and option agreement for the development of catheter-based
intravascular gene delivery technology. The Company received $1,100,000 which
was recognized as revenue in 1998. The agreement also provides for the
Company to receive royalty payments on net product sales.
NAVAL MEDICAL RESEARCH INSTITUTE
In September 1998, the Company signed a cooperative agreement with the Office
of Naval Research for funding of up to $2,700,000 to develop a multi-gene
malaria DNA vaccine and test its ability to protect humans against malaria.
The Company recognized $697,000 of contract revenue under this agreement in
1998.
OTHER RESEARCH AND LICENSING AGREEMENTS
The Company also received revenue under research and licensing agreements
with other entities including the U.S. government of which approximately
$1,585,000, $1,404,000, and $2,494,000, was recognized as revenue during the
years ended December 31, 1998, 1997, and 1996, respectively. Included in
these amounts is revenue recognized for a corporate alliance entered into in
March 1995 relating to DNA vaccines in the animal health area with Merial (a
joint venture between Merck and Rhone Merieux), a leading manufacturer and
marketer of animal health products worldwide. The agreement includes options
for Merial to take exclusive licenses to Vical's naked DNA vaccine technology
and the cytofectin technology to develop and commercialize certain gene-based
products for use in the prevention of infectious diseases in domesticated
animals. In 1996, the agreement was extended to March 1998. In 1997, a patent
milestone payment was made to the Company pursuant to the agreement. In 1998
a payment was made to the Company and the agreement was extended to March
1999. If Merial exercises its license options, cash payments and royalties on
net sales would be due to the Company.
In 1996, the Company received $1,100,000 and recognized revenue of
$1,300,000, under a 1993 agreement with Genzyme Corporation . This agreement
was for the exercise of an option to obtain exclusive worldwide license
rights related to the use of the Company's lipid technology in the treatment
of cystic fibrosis. No cash was received and no revenue was recognized under
this agreement in 1998 or 1997. Under a U.S. government agreement that
commenced in the first quarter of 1996 and ended June 30, 1997, the Company
and the Naval Medical Research Institute were awarded a grant that provided
$1,000,000 to support further development of a malaria vaccine based on
Vical's naked DNA vaccine technology. In December 1996, the Company also
recognized $92,000 of revenue under an agreement which expired in December
1996 with Baxter International, Inc.
Under separate agreements, the Company is obligated to pay third parties 10
percent of certain payments received by the Company under the Merck, PMC,
RPR, Merial, Centocor, Boston Scientific Corporation and Pfizer, Inc. (see
"Note 10-Subsequent Event") agreements.
4. OTHER FINANCIAL DATA
Accounts payable and accrued expenses consisted of the following at December
31, 1998 and 1997:
1998 1997
---- ----
Employee compensation $692,716 $678,588
Accounts payable 768,796 327,617
Accrued clinical trials costs 492,914 310,891
Other accrued liabilities 326,826 107,507
---------- ----------
$2,281,252 $1,424,603
---------- ----------
---------- ----------
F-9
5. COMMITMENTS
LEASES
The Company leases its office and research facilities and certain equipment
under operating and capital leases. The minimum annual rents on the office
and research facilities are subject to increases based on changes in the
Consumer Price Index subject to certain minimum and maximum annual increases.
The Company is also required to pay taxes, insurance and operating costs
under the facilities leases. The equipment capital leases are secured by
substantially all equipment of the Company.
Operating Leases Capital Leases
---------------- --------------
Years ended December 31,
1999 $1,076,700 $566,014
2000 460,788 538,482
2001 116,241 186,781
2002 - 84,896
2003 - -
---------------- --------------
Total minimum lease payments $1,653,729 1,376,173
----------------
----------------
Less amount representing
interest (154,900)
--------------
Present value of capital
lease payments 1,221,273
Less current portion (473,466)
--------------
Long-term obligations under
capital leases $747,807
--------------
--------------
Rent expense for the years ended December 31, 1998, 1997, and 1996, was
$998,195, $969,899, and $807,713, respectively.
Cost and accumulated depreciation of equipment under capital leases were as
follows:
Accumulated
Cost Depreciation Net
---- ------------ ---
December 31, 1998 $2,163,877 $1,109,781 $1,054,096
December 31, 1997 2,312,876 1,066,488 1,246,388
NOTES PAYABLE
The Company has a term loan which bears interest at the bank's prime rate
(8.25% at December 31, 1998) plus .5%, or the Company may alternatively
choose to have its borrowings bear interest at the LIBOR rate plus 3.25%. The
term loan is secured by any Company deposits at the bank, however, the
Company is not required to, and does not, maintain any deposits at the bank.
The term loan has a fifteen-month remaining amortization period. At December
31, 1998, the loan balance was $267,216, including $213,773 reflected in
current liabilities.
RESEARCH AND LICENSE AGREEMENTS
In 1998 and 1997, the Company continued research and exclusive license
agreements with various universities for continuing research and license
rights to technology related to gene therapy. The agreements generally grant
the Company the right to commercialize any product derived from specified
technology. Fees paid and future obligations on these agreements are not
significant.
F-10
6. STOCKHOLDERS' EQUITY
PREFERRED STOCK
The Company's certificate of incorporation, as amended, authorizes the
issuance of up to 5,000,000 preferred shares. No shares of preferred stock
were outstanding at December 31, 1998 or 1997.
COMMON STOCK
The Company's certificate of incorporation, as amended, authorizes the
issuance of up to 40,000,000 common shares. Common stock shares totaling
15,866,544, and 15,731,316 were outstanding at December 31, 1998 and 1997,
respectively.
STOCK PLAN AND DIRECTORS OPTION PLAN
The Company has a stock plan ("Stock Incentive Plan of Vical Incorporated")
under which 2,450,000 shares of common stock are reserved for issuance to
employees, non-employee directors and consultants of the Company. The plan
provides for the grant of incentive and nonstatutory stock options and the
direct award or sale of shares. The exercise price of stock options must
equal at least the fair market value on the date of grant. The maximum term
of options granted under the plan is ten years. Except for annual grants to
directors which vest at the next annual meeting, options generally vest 25%
on the first anniversary of the date of grant, with the balance vesting
quarterly over the remaining three years. The plan has also limited the
number of options that may be granted to any plan participant in a single
calendar year to 300,000 shares.
The Company also has a directors stock option plan ("Directors Plan") that
provides for the issuance to non-employee directors of up to 210,000 shares
of the Company's common stock, of which options for 202,500 shares have been
granted. The initial grant to a director of options under this plan generally
vests 25% on the first anniversary of the date of grant, with the balance
vesting quarterly over the remaining three years. In 1997, the stockholders
approved an amendment to the Stock Incentive Plan of Vical Incorporated
allowing non-employee directors to receive grants under that plan and,
accordingly, it is not anticipated that there will be any future grants under
the Directors Plan.
F-11
The following table summarizes stock option transactions for the Company's
stock option plans for the years ended December 31, 1998, 1997 and 1996:
Weighted Ave. Weighted Ave.
Shares Exercise Price Fair Value of Grants
------ -------------- ---------------------
Outstanding,
December 31, 1995 749,912 $7.60
Granted 456,350 $15.99 $11.95
Exercised (32,317) $5.48
Forfeited (14,264) $10.97
---------
Outstanding,
December 31, 1996 1,159,681 $10.92
Granted 403,845 $14.14 $10.17
Exercised (72,922) $ 5.10
Forfeited (48,106) $13.25
---------
Outstanding,
December 31, 1997 1,442,498 $12.04
Granted 580,875 $15.56 $11.12
Exercised (135,228) 7.88
Forfeited (73,100) 13.99
---------
Outstanding,
December 31, 1998 1,815,045 $13.39
--------- ------
--------- ------
The following table summarizes information about stock options outstanding
under the Company's stock option plans at December 31, 1998:
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------------- ------------------------------------
Weighted Weighted
Number Average Average Number Weighted
Range of Outstanding Remaining Exercise Exercisable Average
Exercise Prices As of 12/31/98 Contractual Life Price As of 12/31/98 Exercise Price
- ------------------------------------------------------------------------------- ------------------------------------
$0.1600 - $13.2500 457,284 6.1 $7.50 376,850 $6.75
$13.3750 - $15.0000 455,050 7.8 $14.00 241,363 $13.82
$15.1875 - $15.5000 582,238 9.1 $15.36 96,838 $15.20
$15.6250 - $20.5000 320,473 8.5 $17.40 129,778 $18.39
--------------- -----------------
$0.1600 - $20.5000 1,815,045 7.9 $13.39 844,829 $11.53
The number of shares and weighted average price of options exercisable at
December 31, 1998, 1997 and 1996 were 844,829 shares at $11.53, 688,126
shares at $9.90, and 487,750 shares at $6.82, respectively.
F-12
The Company has adopted the disclosure-only provisions of SFAS 123.
Accordingly, no compensation cost has been recognized for the stock option
plans. Had compensation cost for the Company's stock option plans been
determined consistent with the provisions of SFAS 123, the Company's net loss
and loss per share would have increased to the pro forma amounts indicated
below:
1998 1997 1996
---- ---- ----
Net loss - as reported $7,480,507 $5,611,231 $5,080,591
Net loss - pro forma $11,645,607 $8,878,712 $6,497,447
Net loss per share - as reported $.47 $.36 $.33
Net loss per share - pro forma $.74 $.57 $.42
The fair value of each option grant was estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants: risk free interest rates of 5.09% (1998), 5.99%
(1997) and 6.57% (1996) and, expected volatility of 71% (1998), 70% (1997)
and 74% (1996). An expected option life of 5 years and a dividend rate of
zero is assumed for all years presented.
Because SFAS 123 has not been applied to options granted prior to January 1,
1995, the resulting pro forma compensation cost may not be representative of
that to be expected in future years.
7. RELATED PARTIES
Included in other assets at December 31, 1998 and 1997, is the long-term
portion of notes receivable, representing amounts due from certain officers
and employees of the Company. Imputed interest is applied at the applicable
federal rate. The loan agreements allow for the notes to be forgiven under
certain circumstances over the next three years. The long-term portion is
$60,000 and $25,000 at December 31, 1998 and 1997, respectively. The current
portion, included in receivables and other, is $55,000 and $25,000 at
December 31, 1998 and 1997, respectively.
8. INCOME TAXES
As of December 31, 1998, the Company has available net operating loss
carryforwards of approximately $36,700,000 and research and development
credit carryforwards of approximately $1,700,000 to reduce future federal
income taxes, if any. These carryforwards expire through 2018 and are subject
to review and possible adjustment by the Internal Revenue Service.
The Tax Reform Act of 1986 limits a company's ability to utilize certain net
operating loss and tax carryforwards in the event of cumulative change in
ownership in excess of 50%, as defined. The Company has completed numerous
financings that have resulted in a change in ownership in excess of 50%, as
defined. The utilization of net operating loss and tax credit carryforwards
may be limited due to these ownership changes.
The Company has a deferred tax asset of approximately $17,400,000 related
primarily to its net operating loss and tax credit carryforwards. A valuation
allowance has been recognized to offset the entire amount of the deferred tax
asset as realization of such asset is uncertain.
9. EMPLOYEE BENEFIT PLANS
The Company has a defined contribution savings plan under section 401(k) of
the Internal Revenue Code. The plan covers substantially all employees. The
Company matches employee contributions made to the plan according to a
specified formula. The Company's matching contributions totaled approximately
$95,000, $94,000, and $78,000, in 1998, 1997, and 1996, respectively.
10. SUBSEQUENT EVENT
In January 1999, Pfizer Inc. entered into a license and option agreement and
a stock purchase agreement with the Company. Under the terms of the
agreements Pfizer Inc. paid the Company $1,000,000 in license fees and
$6,000,000 for the purchase of approximately 318,000 shares of common stock
at $18.87 per share, reflecting a 25% premium. The license fee and the
$1,200,000 premium on the purchase of stock will be recognized as revenue in
1999, and the balance of the common stock investment, net of any cost to
issue the shares of stock, will be reflected in common stock and additional
paid-in capital in 1999.
F-13
11. SUMMARY OF UNAUDITED QUARTERLY FINANCIAL INFORMATION
The following is a summary of the unaudited quarterly results of operations
for the years ended December 31, 1998 and 1997 (in thousands, except per
share amounts):
Quarter Ended
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
1998
Revenues $ 2,732 $ 560 $ 1,696 $ 932
Research and development costs 3,095 3,058 3,158 2,743
Total operating costs and
expenses 4,062 4,072 4,012 3,558
Net loss (721) (2,935) (1,750) (2,075)
Net loss per common
share (basic and diluted) (.05) (.19) (.11) (.13)
Shares used in per share
calculation 15,753 15,789 15,817 15,892
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
1997
Revenues $ 1,126 $ 867 $ 3,480 $ 2,330
Research and development costs 2,794 2,797 3,319 3,026
Total operating costs and
expenses 3,691 3,678 4,247 4,054
Net loss (2,002) (2,267) (225) (1,117)
Net loss per common
share (basic and diluted) (.13) (.15) (.01) (.07)
Shares used in per share
calculation 15,423 15,448 15,458 15,609
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