Management's Discussion and Analysis
of Financial Conditions and Results of Operations
REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements. These statements involve known and unknown
risks, uncertainties and other factors which may cause our actual results,
performance or achievements to be materially different from any future results,
performances or achievements expressed or implied by the forward-looking
statements. Forward-looking statements include, but are not limited to,
. the marketing
and sales of our products and services;
. our ability to
sustain licensing and other contract-based revenues;
. the impact of
our NIH contract on future business;
the value of, and expenses
associated with, our intellectual property;
. our future revenues and profitability, including any
revenues from milestone payments and access extension fees, under our DeltaBase
. the requirements
of pharmaceutical and biotechnology companies;
. the benefits of knockout mice programs and, in particular,
our technologies and products, to the pharmaceutical industry;
the increasing competition we face
in the field of knockout mice from both commercial and government organizations;
. failures in the drug discovery, development and approval
processes by our partners and collaborators;
. our ability to successfully execute our business plan and
to meet contractual obligations, in view of the Company's limited staff; and
In some cases, you can identify
forward-looking statements by terms such as "may," "will," "should," "could,"
"would," "expects," "plans," "anticipates," "believes," "estimates,"
"projects," "predicts," "potential" and similar expressions intended to
identify forward-looking statements. These statements reflect our current views
with respect to future events and are based on assumptions and subject to risks
and uncertainties. Given these uncertainties, you should not place undue
reliance on these forward-looking statements.
These forward-looking statements represent our estimates and assumptions
only as of the date of this report.
You should read this report completely
and with the understanding that our actual future results may be materially
different from what we expect. We qualify all of our forward-looking statements
by these cautionary statements.
YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS IN
CONJUNCTION WITH OUR FINANCIAL STATEMENTS AND THE NOTES ACCOMPANYING THE
Deltagen (or the "Company") is a
provider of research tools to the biopharmaceutical industry and to the
academic research community. Deltagen
has generated an inventory of "knockout mice" in which a single gene has been
deleted ("knocked out"). The knockout
mice have been analyzed to determine the phenotypic changes associated with
that gene deletion. This phenotypic data
has been organized in an integrated database known as DeltaBase. DeltaBase contains phenotypic data on 750
different knockout mouse lines. In
addition to those 750 knockout mouse lines, Deltagen has approximately 150
additional knockout mouse lines that have not been characterized
phenotypically. Deltagen also has
approximately 450 knockout lines at the embryonic stem (ES) cell stage.
Our customers and partners/collaborators
have included some of the world's largest pharmaceutical companies, including
GlaxoSmithKline plc, Merck & Co., Inc., Pfizer Inc., Eli Lilly and Company
and Schering-Plough Research Institute.
We generate revenue from our DeltaBase
and DeltaOne products and programs.
DeltaBase is our proprietary database
that provides information, based on knockout mouse studies, on gene function
and validated gene targets for drug discovery.
Each knockout mouse underwent a standardized, detailed and extensive
analysis in order to determine the function and role that a particular gene
plays in the mouse and that gene's suitability as a drug target.
DeltaOne offers access to our portfolio
of knockout mice and/or accompanying phenotypic data, as well as any
corresponding intellectual property, on a gene-by-gene basis.
Company has a three-year contract, expiring September 2008, with the United
States Government through the National Institutes of Health ("NIH"). Under this contract, the NIH is eligible to
order any of the approximately 750 knockout mouse lines (and related phenotypic
data) that populate DeltaBase. The NIH
is permitted to publish the phenotypic data and make the knockout mouse
materials available for licensing to academic institutions. In September 2005, the NIH placed an initial
delivery order for 129 knockout lines.
No other delivery orders have been submitted.
We derive substantially all of our
revenues from a narrow and limited range of sources. Substantially all of our revenues are derived
from the provision of knockout mouse lines and related phenotypic data to the
biopharmaceutical industry and pursuant to government contracts. Because of continuing consolidation in the
biopharmaceutical industry and the finite number of knockout lines in the
Company's inventory, significant uncertainty exists with respect to the
Company's future revenues.
Our operating results have fluctuated in
the past and are likely to do so in the future, and we do not believe that
period-to-period comparisons of our operating results are a good indication of
our future performance.
2. Critical Accounting
Policies and Estimates
The consolidated financial statements of
Deltagen for the three-month period ended June 30, 2006 are unaudited, but have
been prepared in accordance with accounting principles generally accepted in
the United States of America ("GAAP") for interim financial information. These consolidated financial statements have
been prepared so that they present fairly, in the opinion of management, the
Company's financial position and its results of operations and its cash flows
for the period presented.
Under our revenue recognition policy,
revenues are recognized when a definitive agreement with a determinable price
exists, product delivery and/or invoicing (in each case where there is
reasonable assurance of meeting customer-specified criteria) have occurred, and
collectibility is reasonably assured. A
change in our revenue recognition policy or changes in the terms of contracts
under which we recognize revenues could have an impact on the amount and timing
of our recognition of revenues.
The preparation of consolidated financial
statements in conformity with GAAP requires the Company to make estimates and
assumptions that affect the amounts that are reported in the consolidated
financial statements and accompanying disclosures. Although these estimates are based on the
Company's best knowledge of current events and actions that the Company may
undertake in the future, actual results may differ materially from the
3. Results of Operations
consolidated revenues for the three months ended June 30, 2006 totaled $3.749
million, compared to $1.882 million in the first quarter of 2006. The
second quarter revenues were attributable primarily to revenue received from
our NIH contract, under which we recognized approximately $3.2 million in the
second quarter of 2006. Of this amount,
approximately $1.3 million was received during the second quarter and
approximately $1.9 million was received early in the third quarter of
2006. No new delivery orders were placed
by the NIH in the second quarter of 2006 and there are no assurances that the
NIH will place any additional delivery orders.
The decrease in non-NIH-related revenues was attributable primarily to the
fact that the Company did not recognize any access extension fees under its
DeltaBase collaboration agreements during the second quarter of 2006. The Company recognized $0.500 million in
extended access fees in the first quarter of 2006.
The Company had
interest income of $0.087 million for the three months ended June 30, 2006.
expenses for the three months ended June 30, 2006 were $2.015 million, of which
$1.125 million were attributable to third-party royalty and commission
$0.123 million were attributable to a non-cash stock-based compensation expense
relating to stock options granted by the Company on March 30, 2006 in
accordance with Statement of Financial Standards (SFAS 123R). Other
operating expenses, which totaled $0.767 million for the three months ended
June 30, 2006, were attributable primarily to salaries and other general and
administrative expenses, and patent prosecution expenses. Total consolidated expenses for the first
quarter of 2006 were $1.555 million, of which $0.493 million were attributable
to third-party royalty and commission obligations. Other operating expenses totaled $1.062
million in the first quarter of 2006.
The increase in third-party royalty and commission obligations in the
second quarter over the first quarter was due to the increase in revenues in
the second quarter, which increased 100% over the first quarter. The decrease in other operating expenses was
due to a decrease in patent prosecution expenses and the cessation of legal
expenses associated with the administration of the Company's bankruptcy
case. Legal and administrative fees
associated with prosecution of the Company's patent portfolio were $0.201
million for the three months ended June 30, 2006, compared to $0.373 million in
the first quarter of 2006.
As of June 30, 2006,
the Company had paid to Lexicon Genetics Incorporated a cumulative total of
$1.564 million in royalties toward the $6.0 million royalty cap payable under
our February 2005 sublicense assumption and settlement agreement with Lexicon
Net income before
the provision for income taxes for the three months ended June 30, 2006 was
$1.821 million. Net income after provision for income taxes for such three-month period
was $1.483 million.
As of June 30, 2006,
the Company had $10.789 million in cash and cash equivalents.
As of June 30, 2006,
the Company had accounts receivable of $3.380 million. Of this amount, approximately $1.9 million
related to revenues recognized, but not received, in the second quarter under
our NIH contract. This amount was
received in July 2006. Approximately
$1.0 million of the accounts receivable as of June 30, 2006 related to research
investment tax credits expected to be received from the French government by Deltagen Europe, S.A.
During the quarter
ended June 30, 2006, the Company reduced the reserve allowance against the
deferred tax asset by $0.518 million. This adjustment increased the amount of
the net tax asset and reduced the income tax expense by equal amounts during
the quarter. After this adjustment, the unused tax asset carried as of June 30,
2006 was $0.598 million current and $0.400 million deferred. The Company will
continue to evaluate and adjust the recoverability of the deferred tax assets
and the level of the valuation allowance.
The balance sheet for 2005 has been audited and the
audited consolidated balance sheet will be posted on the Company's website,
together with the auditors' report and notes to the financials for such period.
consolidated financial results for the second quarter of 2006 reflect certain
adjustments to the 2005 and first quarter 2006 financials made in connection
with the audit. The adjustments are
discussed in the notes to the financials for the second quarter of 2006, which
will be made available on Deltagen's website.
The Company does not intend to update its Management's Discussion
& Analysis and Risk Factors for 2005.
4. Publications and
From time to time,
employees of Deltagen are given co-authorship credit on scientific publications
and presentations by certain of the Company's customers. Co-authorship credit of a Deltagen employee
should not be viewed as an indication that the Company and its employees are
engaged in research activities or that the Company has any rights in the
subject matter of such publications or presentations. As mentioned previously, the Company is not
currently engaged in any research activities, either alone or in collaboration
with any of its customers.
Risk Factors Affecting Future Operating Results
There are numerous
risks and uncertainties related to both our business and our industry that
could cause actual results or events to differ materially from those indicated
by forward-looking statements.
We have DeltaBase agreements with
GlaxoSmithKline, Pfizer and Merck ("DeltaBase Agreements"). The milestone payments under the DeltaBase
Agreements are triggered only when all of the following conditions are
satisfied: (i) issuance of patents claiming knockout mice; (ii) such patents
having claims with specified language relating to certain recited phenotypes
and/or diseases; and (iii) the progression of a drug candidate relating to use
of DeltaBase data and/or mouse lines to certain specified drug development and
approval milestones. As of June 30, 2006, the Company had
been issued ten patents claiming knockout mice.
There is significant uncertainty as to how many additional patents, if
any, the Company will be successful in obtaining in the future, what the total
cost associated with such patent prosecution efforts would be, and whether and
to what extent the Company will continue to pursue such patents in the
future. In addition, satisfaction of the
drug development and approval milestones under our DeltaBase Agreements depends
solely upon the efforts and success of our pharmaceutical collaborators, which
are not controlled by Deltagen. We may
never know whether our DeltaBase collaborators have been successful in their
drug development efforts relating to DeltaBase.
Our collaborators may also dispute whether milestone triggers have been
satisfied and may resist or refuse to pay milestone payments. Furthermore, the more significant milestone
payment amounts are associated with drug approval, which is a rare event and
takes many years to achieve. As a result
of these factors, there is significant uncertainty as to whether the Company
will receive any milestone payments and, if so, how many milestone payments the
Company may ultimately receive from its DeltaBase Agreements and what the value
of any such payments may be. There are
no royalty obligations under the DeltaBase Agreements. The Company is a party to a few DeltaOne
agreements that specify royalty payments based on sales of approved drugs by
such customers. However, these agreements generally involve a relatively small
fraction of the targets involved in the DeltaBase Agreements. Therefore, given the relatively few targets
involved in these deals and the low probability of approval and significant
sales for any given drug compound, we currently do not expect that such royalty
payments, if any, would be significant.
For a list
of additional risk factors that may affect our future operating results, refer
to the "Risk Factors" section of "Management's Discussion and Analysis of
Financial Conditions and Results of Operations" for the year ended December 31,
2005, as posted on the Company's website (www.deltagen.com). The risk factors listed there are not the
only ones we face and additional risks and uncertainties not presently known to
us or that we currently deem immaterial also may impair or otherwise affect our