-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QCYMkXmnVqAQz8/xGwm0hZBNlpotEcp0BMgpEyGwtLohz5AOPTHnUEIdeyOTh5U/ /BmfoZ5pvqeOsBihqVs2Kw== 0000891618-00-001855.txt : 20000331 0000891618-00-001855.hdr.sgml : 20000331 ACCESSION NUMBER: 0000891618-00-001855 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CERUS CORP CENTRAL INDEX KEY: 0001020214 STANDARD INDUSTRIAL CLASSIFICATION: BIOLOGICAL PRODUCTS (NO DIAGNOSTIC SUBSTANCES) [2836] IRS NUMBER: 680262011 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 333-72185 FILM NUMBER: 585703 BUSINESS ADDRESS: STREET 1: 2525 STANWELL DRIVE SUITE 300 CITY: CONCORD STATE: CA ZIP: 94520 BUSINESS PHONE: 5106039071 MAIL ADDRESS: STREET 1: 2525 STANWELL DRIVE STREET 2: STE 300 CITY: CONCORD STATE: CA ZIP: 94520 FORMER COMPANY: FORMER CONFORMED NAME: CERUS TECHNOLOGIES INC DATE OF NAME CHANGE: 19960731 10-K 1 FORM 10-K YEAR ENDED DECEMBER 31, 1999 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 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, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 0-21937 CERUS CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 68-0262011 (STATE OR OTHER JURISDICTION OF (IRS EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 2525 STANWELL DR., SUITE 300 CONCORD, CALIFORNIA 94520 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(925) 603-9071 (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 $.001 PER SHARE (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. [ ] The approximate aggregate market value of the Common Stock held by non-affiliates of the registrant, based upon the closing price of the Common Stock reported on the Nasdaq National Market on March 24, 2000, was $487,427,794. As of March 24, 2000, there were 12,786,551 shares of the registrant's common stock outstanding. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 TABLE OF CONTENTS
PAGE ---- PART I Item 1. Business.................................................... 3 Item 2. Properties.................................................. 32 Item 3. Legal Proceedings........................................... 32 Item 4. Submission of Matters to a Vote of Security Holders......... 32 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters......................................... 33 Item 6. Selected Financial Data..................................... 34 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 35 Item 7A. Quantitative and Qualitative Disclosures About Market Risk........................................................ 38 Item 8. Financial Statements and Supplemental Data.................. 38 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................... 38 PART III Item 10. Directors and Executive Officers of the Registrant.......... 39 Item 11. Executive Compensation...................................... 39 Item 12. Security Ownership of Certain Beneficial Owners and Management.................................................. 39 Item 13. Certain Relationships and Related Transactions.............. 39 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................................................... 40
2 3 PART I This report contains forward-looking statements. These forward-looking statements are based on Cerus Corporation's current expectations about its business and industry, and include, but are not limited to, statements concerning Cerus' plans to continue development of its current product candidates; conduct clinical trials with respect to its product candidates; seek regulatory approvals; address certain markets; engage third-party manufacturers to supply its clinical trial and commercial requirements; continue to rely on a third party for a marketing, sales and distribution capability; and evaluate additional product candidates for subsequent clinical and commercial development. In some cases, these statements may be identified by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential," or "continue' or the negative of such terms and other comparable terminology. In addition, statements that refer to expectations or other characterizations of future events or circumstances are forward-looking statements. These statements involve known and unknown risks and uncertainties that may cause Cerus' or its industry's results, levels of activity, performance or achievements to be materially different from those expressed or implied by the forward-looking statements. Factors that may cause or contribute to such differences include, among others, those discussed under the captions "Business," "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Forward-looking statements not specifically described above also may be found in these and other sections of this report. Cerus undertakes no obligation to update any forward-looking statement to reflect events after the date of this report. ITEM 1. BUSINESS OVERVIEW Cerus Corporation is developing medical products based on a platform technology that prevents nucleic acid (DNA and RNA) replication. Cerus' initial application of this technology is the development of systems to inactivate viruses, bacteria and other pathogens in blood components used for transfusion. These blood components are platelets, fresh frozen plasma (FFP) and red blood cells. Cerus is also focusing research and development efforts on other potential health care applications for this platform technology, including pathogen inactivation of source plasma used for fractionation, improving the outcomes of stem cell transplantation procedures and treatments for proliferative disorders, such as restenosis. Cerus' platelet pathogen inactivation system is in Phase 3 clinical trials in the United States and in Europe. Cerus' FFP pathogen inactivation system is in Phase 3 clinical trials in the United States, and its red blood cell pathogen inactivation system is in Phase 1 clinical trials in the United States. Cerus' allogeneic cellular immune therapy (ACIT) program, designed to enhance the safety and efficacy of bone marrow transplants, is in Phase 1 clinical trials in the United States. Cerus' pathogen inactivation system for source plasma and treatment for restenosis are in pre-clinical development. Cerus is conducting its platelet, FFP and red blood cell pathogen inactivation product development and commercialization programs with Baxter Healthcare Corporation pursuant to agreements providing for development, manufacture and marketing of pathogen inactivation systems for these blood components. These agreements provide for Baxter and Cerus to generally share development expenses, for Baxter's exclusive right and responsibility to market the systems worldwide and for Cerus to receive a share of the gross profits from the sale of the systems. INDUSTRY BACKGROUND Blood Supply Market. Blood transfusions are required to treat a variety of medical conditions, including anemia, low blood volume, surgical bleeding, trauma, acquired and congenital bleeding disorders and chemotherapy-induced blood deficiencies. Worldwide, over 90 million whole blood donations occur each year. Approximately 40 million of those donations occur in North America, Western Europe and Japan, the major geographical markets for Cerus' products. Whole blood is composed of plasma, the liquid portion of blood containing essential clotting proteins, and three cellular blood components: platelets, red blood cells and white blood cells. Platelets are essential to 3 4 coagulation, while red blood cells carry oxygen to tissues and carbon dioxide to the lungs. Leukocytes play a critical role in immune and other defense systems, but can cause harmful transfusion-related immune reactions in, or transmit disease to, transfusion recipients. Blood collection centers periodically experience shortages of critical blood components due to temporary increases in demand, reduced donor availability during holiday periods and the limited shelf life of cellular blood components. To efficiently allocate the limited available blood supply and to optimize transfusion therapy, essentially all donated blood is separated into platelets, plasma and red blood cells. These blood components are obtained either by manually processing donor units of whole blood or by apheresis, a process by which a specific blood component is separated and collected from the donor's blood while the other components are simultaneously returned to the donor. Patients requiring transfusions typically are treated with one or more specific blood components required for their particular deficiency, except in cases of rapid, massive blood loss, in which whole blood may be transfused. Platelets often are used to treat cancer patients following chemotherapy or organ transplantation. Red blood cells frequently are administered to patients with trauma or surgical bleeding, acquired chronic anemia or genetic disorders, such as sickle cell anemia. Plasma used for transfusions is stored in frozen form and is referred to as fresh frozen plasma, or FFP. FFP generally is used to control bleeding. Plasma also can be separated, or "fractionated," into different products that are used to expand blood volume, fight infections or treat diseases such as hemophilia. Blood Supply Contaminants. A primary goal of every blood collection center is to provide blood components for transfusion that are free of viruses, bacteria and protozoans. Despite recent improvements in donor screening and in the testing and processing of blood, patients receiving blood transfusions still face a number of significant risks from blood contaminants, as well as adverse immune and other transfusion-related reactions induced by leukocytes. Viruses such as hepatitis B (HBV), hepatitis C (HCV), human immunodeficiency virus (HIV), cytomegalovirus (CMV) and human T-cell lymphotropic virus (HTLV) can present life-threatening risks. In addition, bacteria, the most common agents of transfusion-transmitted disease, can cause complications such as sepsis, which can result in serious illness or death. Many other agents can transmit disease during transfusion, including the protozoans that cause malaria and Chagas' disease. Infectious pathogens are not the only cause of adverse events arising from the transfusion of blood components. Leukocytes present in a blood unit can multiply after transfusion, mounting an often fatal graft versus host immune response against the recipient. Similarly, alloimmunization, an immune response that can develop from repeated exposure to transfused leukocytes, can significantly reduce the efficacy of subsequent transfusions. Moreover, leukocytes themselves may harbor and transmit bacteria and infectious viruses, such as HIV, CMV and HTLV. Emerging and unidentified pathogens also present a threat to the blood supply, a problem illustrated by the recent history of HIV. It is estimated that HIV was present in the blood supply for at least seven years before it was identified as the causative agent of AIDS and at least eight years before a test was commercially implemented to detect the presence of HIV antibodies in donated blood. During those years, many transfusion recipients were infected with the virus, including approximately 70% of patients with severe hemophilia. Recently, new variants of HIV and other viruses such as hepatitis G have been identified. Transfused blood is not routinely tested for these emerging viruses, despite the potential risk to transfusion recipients. The risk of transmission of pathogens from an infected donor is compounded by a number of factors. If a unit of blood contains an infectious pathogen, dividing the blood into its components may expose three or more patients to the pathogen in that unit. Blood products are commonly pooled from several donors to form a single therapeutic dose, which increases the recipient's risk of infection. Similarly, patient populations that require frequent transfusions, such as patients with cancer, suppressed immune systems, congenital anemias and kidney and liver disorders, experience a heightened risk of infection due to multiple donor exposures. Current Approaches to Address Blood Supply Contamination. Public awareness in recent years of the significant rates of hepatitis, HIV and other viral transmission from blood transfusions has led to expanded efforts to improve the safety of the blood supply. For many years, the only approach available to reduce the 4 5 risk of transmission of diseases was donor screening interviews. In addition to required donor screening, diagnostic tests have been developed to detect the presence of certain infectious pathogens known to be transmitted in blood. However, there remain a number of other blood-borne pathogens for which tests have not been routinely administered or even developed. Although donor screening and diagnostic testing of donated blood have been successful in reducing the incidence of transmission of some of these known pathogens, these current methods have significant limitations. As the preceding table indicates, tests are currently performed for only a limited number of blood-borne pathogens. Moreover, these tests occasionally fail, and human errors, such as mistesting or mislabeling, further expose patients to contaminated blood. All tests currently approved for use in blood centers are intended to detect antibodies directed against a pathogen or surface antigens. These tests can fail if performed during the "infectivity window," that is, early in the course of an infection before antibodies or antigens appear in detectable quantities. Similarly, tests for viral infection may be ineffective in detecting a genetic variant of the virus that the test was not developed to detect. For instance, certain strains of HIV, such as Subtype O, are sometimes not detected in the standard HIV tests. Finally, there are no current tests available to screen effectively for many emerging pathogens, and testing cannot be performed for pathogens that have yet to be identified. As a result of these limitations, a number of infectious pathogens still pass into the blood supply. In light of these continuing concerns, many patients have attempted to mitigate the risks of transfusion through "autologous donation," donation of their own blood for anticipated future use, or, where autologous donation is impracticable, through the designation of donors such as family members. Although autologous donations eliminate many risks, the blood collected is still subject to the risk of bacterial growth during storage and is rarely available in emergency situations or when a patient is chronically ill. In addition, the statistical incidence of positive diagnostic test results from designated donor blood has been found to be as high as in random donor blood. Blood centers and health care providers have initiated additional procedures in an effort to address pathogen transmission issues. For example, platelet apheresis is sometimes used to limit donor exposure from pooled, manually collected platelets. In addition, blood centers may quarantine single donor plasma apheresis units until after the infectivity window has elapsed, followed by confirmatory retesting of the donor, if the donor is available, to verify the safety of the donated plasma. However, quarantined plasma can be unwieldy, and the process is expensive and inventory is difficult to manage. Moreover, a quarantine cannot be used with platelets and red blood cells because these components have shelf lives that are shorter than the infectivity window related to antibody production. No commercial processes are currently available to eliminate pathogens in platelets and red blood cells. Two pathogen inactivation methods are used commercially for FFP; treatment with solvent-detergent and methylene blue, which is used in Europe. Because the solvent-detergent process pools hundreds of units of plasma, the potential risk of transmitting pathogens not inactivated by the process, such as parvovirus B19, is increased. Methylene blue has not been shown to be effective in the inactivation of intracellular viruses and bacteria. The current method used by blood centers to inactivate leukocytes utilizes gamma irradiation. This nonspecific method for inactivating leukocytes has a narrow range of efficacy: insufficient treatment can leave viable leukocytes in the blood, while excessive treatment can impair the therapeutic function of the desirable blood components being transfused. Leukocyte depletion by filtration decreases the concentration of leukocytes in transfusion units, but does not inactivate or completely eliminate leukocytes. Economic Costs of Blood Supply Contamination. In economically developed countries, many of the tests and inactivation measures described above are mandated by regulatory agencies, resulting in a safer and more uniform blood supply, but also significantly increasing costs of processing and delivering blood products. Moreover, the development and widespread use of testing for many unusual or low-incidence pathogens may not be cost-effective to undertake. For example, the development of tests to detect the presence of all forms of harmful bacteria would be extremely expensive. As a result, the only test regularly conducted to detect the presence of bacteria is the test for the bacterium that causes syphilis. With managed health care organizations and other third-party payors increasingly challenging the cost of medical services performed, these cost limitations may become more pronounced in the future. 5 6 The continuing risk of transmission of serious diseases through transfusion of contaminated blood components from both known and unknown pathogens, together with the limitations of current approaches to providing a safe blood supply, have created the need for a new approach to pathogen inactivation that is safe, easy to implement and cost-effective. To address this need, a successful approach should have broad application in the effective inactivation of clinically significant pathogens, whether or not currently identified, while providing therapeutically functional blood components. THE CERUS SOLUTION Cerus is developing pathogen inactivation systems to improve the safety of blood transfusions. These systems employ Cerus' proprietary small molecule compounds. Studies conducted by Cerus have indicated the ability of these compounds to inactivate a broad array of viral and bacterial pathogens that may be transmitted in blood transfusions. Cerus believes that, as a result of the mechanism of action of its proprietary technology, its systems also have the potential to inactivate many new pathogens before they are identified and before tests are developed to detect their presence in the blood supply. Because Cerus' systems are being designed to inactivate rather than merely test for pathogens, Cerus' systems also have the potential to reduce the risk of transmission of pathogens that would otherwise remain undetected by testing. Cerus' inactivation compounds act by preventing the replication of DNA or RNA. Platelets, FFP and red blood cells do not contain nuclear DNA or RNA. When the inactivation compounds are introduced into the blood components for treatment, they cross bacterial cell walls or viral membranes, then move into the interior of the nucleic acid structure. When subsequently activated by an energy source, such as light, the compounds bind to the nucleic acid of the viral or bacterial pathogen, preventing replication of the nucleic acid. This process prevents infection because a virus, bacteria or other pathogenic cell must replicate in order to cause infection. The Cerus compounds react in a similar manner with the nucleic acid in leukocytes. This interaction inhibits the leukocyte activity that is responsible for certain adverse immune and other transfusion-related reactions. These compounds are designed to react with nucleic acid only during the pathogen inactivation process and not after the treated blood component is transfused. The systems are also designed to reduce the amount of unbound, or residual, inactivation compound and breakdown products of the inactivation process prior to transfusion. Cerus' pathogen inactivation systems are being designed to integrate into current blood collection, processing and storage procedures. Furthermore, Cerus believes that the use of its pathogen inactivation products could, over time, lead to a reduction in the use of certain costly procedures that are currently employed in blood component transfusions, such as gamma irradiation, CMV testing and leukocyte filtration. CERUS STRATEGY Cerus' objective is to improve the safety of blood products by becoming the global leader in the development and commercialization of systems to inactivate pathogens in blood components used for transfusion and for fractionation into derivative blood products. Cerus' compounds target and bind with DNA and RNA, thereby preventing pathogens from replicating and causing infection. Using this approach, the Cerus systems have the ability to inactivate a broad array of pathogens, with the potential to inactivate emerging pathogens (such as HIV and hepatitis C were in the 1980s, prior to the development of screening and testing methods). Key elements of Cerus' strategy to achieve this objective are the following: Establish Pathogen Inactivation Systems as the Standard of Care. Domestically, the target customers for Cerus' blood component treatment systems are the approximately 105 community blood center organizations that collect approximately 85% of blood in the United States. There is an even greater concentration among blood centers in foreign countries. Baxter, Cerus' development and marketing partner, has a significant marketing presence in these blood centers in the United States and abroad. In addition, Cerus has developed strong relationships with prominent transfusion medicine experts in a number of these centers as well as in the broader medical communities worldwide. Cerus intends to work with these experts to encourage support for the adoption of its pathogen inactivation systems as the standard of care. 6 7 Leverage Expertise and Core Technology. Cerus is using its broad expertise in nucleic acid chemistry to develop proprietary compounds designed to inactivate infectious pathogens in blood components. Cerus has first sought to gain regulatory approval and commercialize its platelet pathogen inactivation system. Cerus' strategy is to build on its core technology and experience gained in developing its platelet pathogen inactivation system to develop its FFP and red blood cell pathogen inactivation systems. Cerus believes that, if regulatory approval of its first product is obtained, market penetration achieved by such product may facilitate the entry into the market of its other products. Cerus further believes that it can leverage its development activities and expertise to develop a pathogen inactivation system for source plasma. In addition, Cerus believes that its nucleic acid-targeting platform technology has potential application in a number of health and research-related fields, such as bone marrow transplantation and restenosis, which are beyond the initial area of pathogen inactivation targeted by Cerus. Use Strategic Alliances. Cerus has received significant development funding from Baxter, and intends to leverage Baxter's manufacturing, marketing and distribution expertise and resources. Cerus believes that Baxter's established position as a manufacturer and leading supplier of devices, disposables and other products related to the transfusion of human blood products can provide Cerus with access to an established marketing, sales and distribution network. The pathogen inactivation systems are being designed to integrate into Baxter's current product line and into current blood collection, processing and storage processes. Cerus has entered into an agreement for development of its pathogen inactivation system for source plasma with the Consortium for Plasma Science, an industry group funded by several large plasma fractionators with a charter to improve the safety of plasma derivative products. Under this agreement, currently in its initial term which will expire on June 30, 2000, the Consortium is providing development funding and technical assistance in the development of the system and Cerus will pay the Consortium a royalty based on a percentage of product sales, if any. Cerus intends to continue to develop its products together with partners that can provide direct funding and manufacturing, marketing and distribution resources and expertise. Protect and Enhance Proprietary Position. Cerus believes that the protection of its proprietary technologies is important to its business prospects and that its intellectual property position may create competitive barriers to entry into the blood component treatment market. Cerus currently holds issued and allowed patents covering a number of fundamental aspects of Cerus' blood component treatment system technology. Cerus intends to continue to pursue its patent filing strategy and to vigorously defend its intellectual property position against infringement. 7 8 PRODUCT DEVELOPMENT Cerus is developing treatment systems to inactivate infectious pathogens and leukocytes in platelets, FFP, red blood cells and source plasma and to improve the outcomes of bone marrow transplantation procedures. The following table identifies Cerus' product development programs:
CERUS PRODUCT INACTIVATION DEVELOPMENT PROGRAM THERAPEUTIC INDICATION IN DEVELOPMENT COMPOUND STATUS ------- ------------------------------------- ----------------- ------------ ------------------------------ Platelets Surgery, cancer chemotherapy, Platelet Pathogen S-59 Phase 1 and 2 Clinical Trials transplantation, bleeding disorders Inactivation completed; European Phase 3 System (CE Marking) Clinical Trial ongoing, enrollment completed in March 2000; Phase 3 Clinical Trial enrollment commenced in the United States in July 1999 Plasma (FFP) Surgery, transplantation, bleeding FFP Pathogen S-59 Phase 1 and 2 Clinical Trials disorders Inactivation completed; Phase 3 Clinical System Trial enrollment commenced in the United States in July 1999 Red Blood Cells Surgery, transplantation, anemia, Red Blood Cell S-303 Phase 1a and 1b Clinical cancer chemotherapy, trauma Pathogen Trials completed; Phase 1c Inactivation Clinical Trial protocol System currently under discussion with the FDA Allogeneic Allogeneic bone marrow transplant to Leukocyte S-59 Phase 1 Clinical Trial Cellular treat leukemia and lymphoma Treatment Systems enrollment commenced in the Immunotherapies United States in June 1999 (ACIT) Plasma for Coagulation factor and immunoglobulin Source Plasma -- Pre-clinical development Fractionation deficiencies, blood volume expansion Pathogen Inactivation System
Clinical Trial Design. Cerus conducts clinical trials using several designs. In a controlled study, treated and untreated blood components are administered to subjects who are randomly assigned to either a test group or a control group, and the results are compared. In a cross-over study, each subject receives both treated and untreated blood components in random order. To avoid bias in reporting side effects, studies are usually blinded. In a single-blind study, subjects are not told whether they are receiving treated or untreated blood components. In a double-blind study, neither the subject (patient) nor the investigator (physician) knows whether the subject is receiving treated or untreated blood components. PLATELET PROGRAM Platelet Usage and Market. Platelets are cellular components of blood that are an essential part of the clotting mechanism. Platelets facilitate blood clotting and wound healing by adhering to damaged blood vessels and to other platelets. Platelet transfusions are used to prevent or control bleeding in platelet-deficient patients, such as those undergoing chemotherapy or organ transplant. Transfusion units of platelets are obtained either by combining the platelets from four to six whole blood donations (pooled random donor platelets), or in an automated procedure in which a therapeutic dose of platelets is obtained from a single donor (apheresis or single donor platelets). A principal motivation for platelet apheresis is to limit donor exposure from pooled, manually collected platelets. Platelet transfusions may also require one or more additional procedures with additional costs. Cerus believes that its platelet pathogen inactivation system may reduce the need for many of these procedures. Cerus estimates the production of platelets in 1999 to have been 2.0 million transfusion units in North America, 1.3 million transfusion units in Western Europe and 0.7 million transfusion units in Japan. In the United States, based on a study of six blood centers conducted in October 1998 on behalf of Cerus (the "Cost Study"), the estimated base cost for a transfusion unit of apheresis platelets ranges from approximately $400 to $550 and for a transfusion unit of random donor platelets ranges from approximately $170 to $330. These estimates include donor screening and diagnostic tests, such as those for HIV, HTLV, HBV and HCV. Blood centers may also charge up to $210 per unit for additional procedures such as gamma irradiation and CMV screening. The table below indicates, based on the Cost Study, the estimated range of costs for the additional 8 9 procedures for platelet transfusions described above for each of apheresis and random donor platelet transfusion units. The frequency of use and additional charge for each procedure vary widely.
ADDED COST PER ------------------------------- APHERESIS RANDOM DONOR TRANSFUSION TRANSFUSION PROCEDURE UNIT UNIT --------- ------------- -------------- Gamma irradiation........................................ $10 to $50 $60 to $210 CMV screening............................................ $15 to $35 $90 to $210 Leukocyte filtration..................................... $32 to $60 $32 to $ 60
Platelet Pathogen Inactivation System. Cerus is developing a system for pathogen inactivation in platelets using a technology that combines light and Cerus' proprietary inactivation compound, S-59, which is a synthetic small molecule from a class of compounds known as psoralens. The selection of S-59 was based on analyses of over 100 psoralen derivatives assessing safety, ability to inactivate pathogens and leukocytes and post-treatment platelet function. When illuminated, S-59 undergoes a specific and irreversible chemical reaction with nucleic acid. This chemical reaction renders the genetic material of a broad array of pathogens and cells incapable of replication. A virus, bacteria or other pathogenic cell must replicate in order to cause infection. A similar reaction with leukocyte nucleic acid inhibits the leukocyte activity that is responsible for certain adverse immune and other transfusion-related reactions. Most of the S-59 is converted to breakdown products during and after the inactivation reaction. Studies conducted by Cerus with pre-clinical models have indicated that, following transfusion, the unbound S-59 and its unbound breakdown products are rapidly metabolized and excreted. As a further safety measure, the system under development employs a removal process designed to reduce the amount of residual S-59 and unbound breakdown products prior to transfusion (the S-59 reduction device or SRD). Cerus' platelet pathogen inactivation system, developed with Baxter, has been designed for use in the blood center setting. The system consists of a disposable processing set, containing the S-59 compound and the SRD, and an illumination device to deliver light to trigger the inactivation reaction. The current configuration of the platelet photochemical treatment system under development involves the collection of the platelets, as normally performed, but with two-thirds of the plasma replaced by a platelet additive solution (PAS III) followed by transfer of the platelets to a disposable treatment container with the S-59 compound. The mixture of S-59 and platelets is then illuminated for approximately three minutes. The final step employs the SRD, a passive adsorption device, to reduce the amount of residual S-59 and unbound S-59 breakdown products. Following the SRD treatment, which takes approximately six hours, the platelets are transferred to the final storage container. Development Status. Cerus' platelet pathogen inactivation system is in Phase 3 clinical trials in Europe and the United States. In vitro and non-primate animal model studies conducted by Cerus have indicated the efficacy of Cerus' platelet pathogen inactivation system for the inactivation of a broad array of viral and bacterial pathogens transmitted through blood transfusions, including HIV, CMV, model hepatitis viruses and thirteen strains of bacteria. A primate study conducted by Cerus in collaboration with the National Institutes of Health demonstrated that platelet concentrates contaminated with high levels of hepatitis B virus or hepatitis C virus, and treated with Cerus' pathogen inactivation system, did not transmit the viruses to susceptible animals. Cerus has tested these pathogens at and above concentrations that it believes may be present in contaminated platelet concentrates. However, there can be no assurance that contamination levels will never exceed the capacity of Cerus' platelet pathogen inactivation system. Similar in vitro studies have indicated inhibition of leukocyte activity, including the synthesis of certain proteins associated with adverse immune reactions. In addition, three studies conducted by Cerus have indicated that use of the platelet pathogen inactivation system prevented graft-versus-host disease in two pre-clinical mouse models. Because of the mechanism of action of its platelet pathogen inactivation system and based on studies performed with psoralens other than S-59, Cerus believes that its platelet system may also inactivate protozoans in platelets. However, to date Cerus has 9 10 conducted no studies on protozoans with S-59 in platelets, and there can be no assurance that Cerus' platelet pathogen inactivation system would effectively inactivate protozoans. To complete the safety profile for regulatory submission, Cerus will be required to perform additional pre-clinical safety studies of its S-59 psoralen compound. Planned studies include a three month chronic transfusion study; other studies may be performed as required. In March 1996, Cerus completed a Phase 1a single-blind, randomized clinical trial in 23 healthy human subjects divided between two sites. This study used a cross-over design in which all subjects received both treated and untreated platelets. The study compared the proportion of transfused platelets circulating in the first hours after transfusion (post-transfusion recovery) and the length of time the transfused platelets circulate in the recipient's bloodstream (lifespan) of a small volume of five-day-old treated and untreated platelets. Under current FDA regulations, platelets may not be stored for more than five days after collection from the donor. This pilot study was conducted without the use of the SRD, which was evaluated in Phase 2a. In September 1996, Cerus completed a Phase 1b single-blind, randomized, cross-over clinical trial in 10 healthy human subjects. This study compared the tolerability and safety of photochemically treated platelets processed with the SRD with untreated platelets. This second study involved the transfusion of full therapeutic doses of platelets given at the maximum tolerable transfusion rate. No adverse events attributable to transfusion with the treated platelets were reported. Post-transfusion levels of S-59 in plasma and clearance of S-59 were measured. These clinical data, together with Cerus' pre-clinical data, reflected acceptable safety margins. In November 1996, Cerus completed a Phase 2a clinical trial designed to measure the post-transfusion platelet recovery and lifespan of photochemically treated platelets processed with the SRD and stored for five days. This study was conducted in 16 healthy subjects from the Phase 1a study to permit comparisons with prior results. In Cerus' Phase 2a clinical study report, the average post-transfusion recovery of five-day-old platelets treated with Cerus' platelet pathogen inactivation system was lower than that of the untreated five- day-old platelets. Although this difference was statistically significant, the average post-transfusion recovery was within the range of average recoveries reported in most published studies funded by NIH and Baxter, as well as in a number of other studies reported in the scientific literature. These published studies used currently approved processing and storage systems. In addition, in Cerus' clinical study, the average lifespan of treated platelets was shorter than that of untreated platelets. Although this difference was statistically significant and the average lifespan was lower than the range of average untreated platelet lifespans reported in the published studies referred to above, the average lifespan was within the distribution of ranges of untreated platelet lifespans reported in such studies. Post-transfusion recovery and lifespan of five-day-old standard platelets varies widely, even in healthy individuals. As a result, there is no established regulatory or clinical standard for post- transfusion recovery and lifespan of platelets. The clinical investigators reported no adverse events attributable to transfusion with the treated platelets. In 1997, Cerus completed a Phase 2b clinical trial in 15 healthy subjects available from the Phase 2a clinical trial to assess the combined effect of treatment with the platelet pathogen inactivation system and gamma irradiation on post-transfusion platelet recovery and lifespan. The mean platelet recovery and life span data collected in Phase 2b were consistent with those of the 2a study, and fell within the range of published studies of currently approved platelet concentrates. The clinical investigators reported no adverse events attributable to transfusion with the treated platelets. Cerus believes, based on discussions with the FDA, that the post-transfusion recovery and lifespan of platelets following treatment with Cerus' platelet pathogen inactivation system are clinically acceptable. In 1998, Cerus completed a Phase 2c clinical trial in 29 platelet-deficient patients. The Phase 2c trial was initially designed as a double-blind, randomized, cross-over study in which double dose platelet transfusions were given to platelet-deficient patients and post-transfusion platelet count increment and bleeding time correction were measured. Cerus amended the Phase 2c protocol to include patients for whom only platelet count increment would be measured and to add a second site to evaluate its system with platelets collected using alternate automated collection equipment. Based on the results from this study, the FDA cleared Cerus 10 11 to proceed into a Phase 3 clinical trial. The Phase 2c clinical trial, given its small size, was of limited statistical power. In July 1999, Cerus commenced a United States Phase 3 clinical trial of treated apheresis donor platelets in patients requiring platelet transfusions. The trial is a double-blind, randomized, controlled study designed to evaluate the ability of platelets treated with Cerus' pathogen inactivation system to control clinical bleeding. The United States Phase 3 trial will enroll approximately 600 patients, who will receive either treated or untreated platelets for a specified period of time. The primary endpoint to be evaluated is the clinical severity of bleeding. The Phase 3 United States apheresis clinical trial is designed to assess the therapeutic efficacy of platelets treated with the pathogen inactivation system for apheresis platelets. In order to obtain FDA approval of the platelet pathogen inactivation system for use in treating pooled random donor platelets, Cerus will need to complete development of an additional configuration of its platelet system and may be required by the FDA to conduct additional clinical studies. Additionally, because of the risk of bacterial growth, current FDA rules require that pooled platelets be transfused within four hours of pooling and, as a result, most pooling occurs at hospitals. However, Cerus' platelet pathogen inactivation system is intended to be used at blood centers, not at hospitals, and requires a processing time (including processing with the SRD) of approximately six hours. Therefore, in order for Cerus' platelet pathogen inactivation system to be effectively implemented and accepted at blood centers using pooled random donor platelets, the FDA-imposed limit on the time between pooling and transfusion would need to be lengthened or eliminated for pooled random donor platelets treated with Cerus' systems, which are being designed to inactivate bacteria that would otherwise contaminate the platelets. In March 2000, Cerus completed enrollment in a European Phase 3 (CE Marking) clinical trial of treated pooled random donor platelets in 100 patients requiring platelet transfusions. The study is being conducted in four European countries. The random donor platelets are collected using the Buffy Coat process, which is used predominantly in Europe to prepare platelet concentrates. The trial is a double-blind, randomized, controlled study designed to assess the therapeutic efficacy of platelets treated with the pathogen inactivation system for pooled random donor platelets. The primary endpoint in these studies is the increase in post-transfusion platelet count. Cerus will be required to perform additional separate clinical studies to qualify the system for its commercial configuration and for apheresis donor platelets. FFP PROGRAM FFP Usage and Market. Plasma is a noncellular component of blood that contains coagulation factors and is essential for maintenance of intravascular volume. Plasma is either separated from collected units of whole blood or collected directly by apheresis. The collected plasma is then packaged and frozen to preserve the coagulation factors. Some of the frozen plasma is made available for fractionation into plasma derivatives, while some is designated for use as FFP. FFP is a source of all blood clotting factors except platelets and is used to control bleeding in patients who require clotting factors, such as patients undergoing transplants or other extensive surgical procedures, patients with chronic liver disease or certain genetic clotting factor deficiencies. Cerus estimates the production of FFP in 1999 to have been 2.5 million transfusion units in North America, 2.2 million transfusion units in Western Europe and 2.3 million transfusion units in Japan. In the Cost Study, the estimated base price of a 250 ml transfusion unit of FFP in the United States ranges from approximately $26 to $55. In comparison, donor retest procedures have a $56 to $110 added cost per transfusion unit, and solvent detergent pathogen inactivation is priced at approximately $125 per transfusion unit. A typical therapeutic transfusion consists of four transfusion units of FFP. FFP Pathogen Inactivation System. The pathogen inactivation system for FFP uses the same S-59 psoralen compound and illumination device and an SRD similar to that being used by Cerus in its clinical trials for its platelet pathogen inactivation system. The FFP pathogen inactivation system is compatible with plasma collected either manually or by apheresis. In the Cerus system, untreated plasma is transferred to a disposable container with S-59. The mixture of S-59 and plasma is then illuminated for approximately three 11 12 minutes. In the final step, the treated plasma then undergoes an SRD step, which reduces the amount of residual S-59 and unbound S-59 breakdown products, and is transferred into the final storage container and frozen in accordance with standard protocols. Development Status. Cerus' FFP pathogen inactivation system currently is in Phase 3 clinical trials in the United States. In vitro studies conducted by Cerus to date have indicated the efficacy of the FFP pathogen inactivation system for the inactivation in FFP of a broad array of viral pathogens transmitted through blood transfusion. Because of the mechanism of action of its FFP pathogen inactivation system, Cerus believes that its system may also inactivate protozoans and inhibit leukocyte activity. Although bacterial contamination in FFP is typically not as significant a problem as in platelets, Cerus believes that the FFP pathogen inactivation system will inactivate bacteria at the levels typically found in FFP. To date, Cerus has conducted no studies on protozoans or to detect inhibition of leukocyte activity in FFP and only limited studies on bacteria in FFP which were not performed under good laboratory practice standards. There can be no assurance that Cerus' FFP pathogen inactivation system would effectively inactivate protozoans, leukocytes or bacteria. Cerus has assessed the impact of S-59 photochemical treatment on the function of plasma proteins. Plasma derived from whole blood or apheresis must be frozen within eight hours of collection to meet the standard as "fresh frozen plasma." After freezing, FFP may be stored for up to one year, thawed once, and must be transfused within four hours of thawing. Cerus has measured the in vitro coagulation function activity of various clotting factors in FFP after photochemical treatment, SRD treatment, freezing and thawing. Cerus believes that in vitro data from these studies indicate that treated FFP maintained adequate levels of coagulation function for FFP. These results are not necessarily indicative of coagulation function that may be obtained in clinical trials or with the commercial system configuration, and there can be no assurance that the FDA or foreign regulatory authorities would view such levels of coagulation function as adequate. In July 1997, Cerus completed a Phase 1 clinical study in healthy subjects that demonstrated the safety and tolerability of FFP treated with the pathogen inactivation system as well as the comparability of post-transfusion coagulation factors between subjects transfused with treated and untreated FFP. In November 1998, Cerus completed a Phase 2a clinical trial. In this study, 27 healthy subjects donated plasma. The Phase 2a study showed that post-transfusion coagulation factor levels of subjects receiving FFP treated with Cerus' FFP pathogen inactivation system were comparable to those of subjects receiving untreated FFP. There were no safety issues attributable to transfusion of the treated FFP. In 1999, Cerus completed a Phase 2b clinical trial, in patients, of its FFP pathogen inactivation system. The study was a controlled, double-blind trial in 13 patients diagnosed with chronic liver diseases. Each patient, prior to an invasive surgical or diagnostic procedure, received a therapeutic dose of up to two liters of either treated or untreated FFP. Correction of patients' blood clotting time and certain coagulation factor levels after transfusion were recorded and compared, and found to be comparable to those of patents receiving untreated FFP. The Phase 2b clinical trial, given its small size, was of limited statistical power. In July 1999, Cerus initiated three Phase 3 clinical trials of its FFP pathogen inactivation system to address each of the three major clinical indications for FFP use. The Phase 3a trial is an open-label study in 20 to 35 patients with congenital coagulation factor deficiencies treated with FFP. The Phase 3b trial is a double-blind, randomized, controlled, trial of treated versus untreated FFP in 120 patients with chronic liver disease and other acquired coagulation factor deficiencies requiring FFP transfusions. The Phase 3c trial is a prospective, double-blind, randomized, controlled study of treated versus untreated FFP used in therapeutic plasma exchange of 30 patients with a disease called thrombotic thrombocytopenic purpura (TTP). The Phase 3 studies will assess coagulation factor function and effectiveness of plasma exchange therapy with treated FFP. RED BLOOD CELL PROGRAM Red Blood Cell Usage and Market. Red blood cells are essential components of blood that carry oxygen to tissues and carbon dioxide to the lungs. Red blood cells may be transfused as a single treatment in surgical 12 13 and trauma patients with active bleeding or on a repeated basis in patients with acquired anemia or genetic disorders, such as sickle cell anemia, or in connection with chemotherapy. Cerus estimates the production of red blood cells in 1999 to have been 14.0 million transfusion units in North America, 15.5 million transfusion units in Western Europe and 4.8 million transfusion units in Japan. The Cost Study indicated that the estimated base cost of a transfusion unit of red blood cells in the United States ranges from approximately $66 to $93. A typical red blood cell transfusion consists of two or more red blood cell transfusion units. As shown in the Cost Study, a red blood cell transfusion may also require one or more additional procedures with additional costs ranging from $10 to $164 for each procedure. The procedures are used to address problems presented by leukocytes and to conduct pathogen diagnostic testing beyond the standard testing.
ADDED COST PROCEDURE PER UNIT --------- -------------- Gamma irradiation.............................. $10 to $ 50 CMV screening.................................. $15 to $ 35 Leukocyte filtration........................... $22 to $ 57 Designated donor............................... $0 to $114 Autologous donor............................... $30 to $164
Red Blood Cell Pathogen Inactivation System. Cerus is developing a system for pathogen inactivation in red blood cells using a compound that forms covalent bonds with nucleic acids, as does S-59, but does not require light. Cerus' method for inactivating pathogens in red blood cells is based on a proprietary frangible anchor-linker-effector (FRALE) compound, S-303, a small molecule synthesized by Cerus. The selection of S-303 was based on analyses of many compounds assessing safety and ability to inactivate pathogens and leukocytes, and post-treatment red blood cell survival and function. Development Status. Cerus' red blood cell pathogen inactivation system is in Phase 1 clinical trials in the United States. In vitro studies by Cerus have indicated the efficacy of the FRALE process for the inactivation of a broad array of viral and bacterial pathogens with preservation of red blood cell function. Because of the mechanism of action of its red blood cell FRALE treatment system, Cerus believes that its system may also inactivate protozoans and inhibit leukocyte function. However, Cerus has conducted no studies on protozoans or to detect inhibition of leukocyte activity in red blood cells, and there can be no assurance that Cerus' red blood cell system would be effective to inactivate protozoans or leukocytes. Cerus is currently conducting toxicology and pathogen inactivation validation studies consistent with good laboratory practice standards on its red blood cell pathogen inactivation system. In May 1999, Cerus completed a Phase 1a clinical trial of its red blood cell pathogen inactivation system. The study was a randomized, controlled trial in 42 healthy subjects. The study was designed to evaluate the post-transfusion viability of treated red blood cells which were stored for 35 days prior to transfusion. The study showed that the circulation of treated red blood cells exceeded the American Association of Blood Banks standard for red blood cell recovery 24 hours after transfusion. In October 1999, Cerus completed a Phase 1b clinical trial of its red blood cell pathogen inactivation system. The study included 28 healthy subjects, each of whom received four transfusions of treated red blood cells. The study demonstrated there was no detectable immune response directed against treated red blood cells which were stored for 35 days prior to transfusion. The study also showed that circulation of treated red blood cells exceeded the American Association of Blood Banks standard for red blood cell recovery in response to multiple small doses of treated red blood cells 24 hours after transfusion. Cerus anticipates that it will conduct a Phase 1c trial to evaluate the safety and tolerability of full transfusion doses of S-303 treated red blood cells following the completion of additional development work which is currently underway. There can be no assurance as to the timing of these studies or acceptance of the design of the Phase 1c study or any later studies by the FDA. 13 14 ACIT PROGRAM Cerus believes its proprietary technology may have application in treating leukocytes (or white blood cells) which are transfused during stem cell (blood-forming) transplantation procedures used to treat certain cancers such as lymphoma and leukemia. Cerus has conducted pre-clinical studies which have indicated that donor white blood cells treated with its technology may reduce the risk of serious complications and may also improve the availability and success rate of bone marrow transplantation. Stem Cell Transplantation. Stem cells used for transplantation can be harvested from either bone marrow or circulating blood. ACIT uses donor leukocytes which are transfused to improve immune function in patients whose immune systems have been weakened by disease or disease-related therapies such as chemotherapy and radiation therapy. A typical application is following a bone marrow or stem cell transplantation, which are used principally in leukemia and lymphoma patients to reconstitute blood-forming cells after chemotherapy or radiation therapy to kill leukemia and lymphoma cells. The stem cells are collected from the patient (autologous transplantation) or from a closely-matched donor (allogeneic transplantation). Autologous transplantation is typically safer but is not a curative therapy and often results in a relapse of the disease. Allogeneic transplantation can be curative, but carries significant risk of complications such as GVHD and viral and bacterial infections which often lead to the patient's death. GVHD is nearly always fatal and occurs when the donor leukocytes recognize the patient's body as foreign and proliferate and attack the patient's healthy tissue. Allogeneic transplantation also requires very close matching between the donor and the patient. Often, patients die from the progression of disease while awaiting transplantation from a matched donor. Stem Cell Transplantation Market. Bone marrow and stem cell transplantation are emerging as the primary treatments for many patients diagnosed with a variety of advanced malignant diseases. Typical diseases for which this therapy is used include chronic and acute leukemias and non-Hodgkin's lymphoma where first line therapies such as chemotherapy have not been effective. Each year over 200,000 new cases of these diseases are diagnosed. Donor Leukocyte Treatment System. Cerus believes that it can apply its proprietary technology to slightly modify donor leukocytes to improve the engraftment of donor stem cells and the reconstitution of a patient's immune system while greatly reducing the risk of GVHD. Cerus is developing a system designed to treat the leukocytes in a way that will preserve their therapeutic properties while eliminating their ability to proliferate and attack the patient's healthy tissues. Cerus further believes that its technology can increase the number of suitable stem cell donors available for a patient. Development Status. In vitro and animal studies conducted and presented by Cerus have indicated that it can modulate the dosage of its proprietary technology to slightly modify leukocytes in a way that has the potential to prevent the leukocytes from proliferating while preserving their ability to aid engraftment and to improve transplant outcomes. Cerus has also completed animal studies that indicate that its technology can facilitate engraftment of donor stem cells, which indicate the system has the potential to increase the number of patients eligible to receive allogeneic transplants. In June 1999, Cerus commenced enrollment in a Phase 1 clinical study of its ACIT system designed to treat allogeneic donor leukocytes with S-59 for use as supplemental therapy in conjunction with mismatched bone marrow transplantation. The study is designed to measure the tolerability, safety, and efficacy of S-59 treated allogeneic leukocytes in approximately 30 patients receiving mismatched allogeneic bone marrow transplants. Cerus believes that there are potential applications for its ACIT system beyond allogeneic stem cell transplantation procedures for leukemia and lymphoma. SOURCE PLASMA PROGRAM Cerus believes that its technology may have application in the decontamination of pooled source plasma which is separated (fractionated) into commonly used plasma components or fractions. These derivatives include Factor VIII concentrate, Factor IX concentrate, albumin and immunoglobulins. Worldwide, approxi- 14 15 mately 11 million liters of plasma are collected and fractionated annually for treatment of a variety of coagulation factor and immunoglobulin deficiencies. Annual sales of blood products derived from this fractionation process are estimated to be approximately $5.0 billion. The market is highly concentrated, with four manufacturers providing the majority of products derived from human plasma. The plasma is collected from either dedicated collection facilities as source plasma, or obtained from blood banks as recovered plasma, or FFP that is not used for transfusion. Plasma is pooled and then processed into several specialized plasma derivative proteins used to treat diseases such as hemophilia and immune deficiency. The pooling of 5,000 to 10,000 liters, typical for the fractionation process, introduces the risk of contamination of thousands of blood products with the inadvertent use of one contaminated unit. In the early 1980's, such occurrences resulted in the transmission of HIV to approximately 70% of the hemophiliac community. The FDA has since mandated an improvement in the pathogen inactivation methods used during processing to reduce the risk of transmission of infectious pathogens through use of blood products derived from source plasma. Further, regulatory agencies worldwide are moving towards the requirement for two decontamination processing steps for all manufactured components. Today, a variety of inactivation procedures are used for one or more of the fractionated components during the processing; however, there is no up-front treatment of plasma prior to the commencement of the fractionation process. FUTURE PRODUCT DEVELOPMENT Cerus believes that its proprietary technology may have applications beyond inactivating pathogens in blood products and in modifying leukocytes to improve clinical outcomes of cellular therapies. Cerus is currently researching methods to apply its technology to prevent or inhibit restenosis, which can restrict or occlude blood flow through arteries following angioplasty. Cerus is also researching the application of its technology for the development of "universal" red blood cells which will not require donor and recipient type matching. Such immunologically-transparent red blood cells would improve outcomes of patients who require repeated red blood cell transfusion to treat diseases such as sickle-cell anemia. ALLIANCE WITH BAXTER Cerus has established an alliance with Baxter for the development of pathogen inactivation systems for transfusion blood products. Under two primary development, manufacturing and marketing agreements, Cerus and Baxter generally share development activities with the primary development activity for the compounds and the pre-clinical and clinical studies by Cerus and the primary development activity for the system disposable and device at Baxter. Upon commercialization, Cerus will be required to provide the inactivation compounds and Baxter will be responsible for manufacturing and assembling the system disposables and ultraviolet light devices. Baxter will also be responsible for marketing, selling, and distributing the systems. Agreement with Baxter for the development of pathogen inactivation systems for platelets. In December 1993, Cerus entered into a development and commercialization agreement with Baxter to develop a system for inactivation of pathogens in platelets used for transfusions. As amended to date, the agreement provides for Baxter and Cerus to generally share system development costs equally, subject to mutually agreed budgets established from time to time, and for Cerus to receive 33.5% of revenue from sales of inactivation system disposables after each party is reimbursed for its cost of goods above a specific level. The agreement also provides for Baxter to make a $5 million cash milestone payment to Cerus upon approval by the FDA of an application to market products developed under the platelet program, comparable approval in Europe or termination of the program. Agreement with Baxter for the development of pathogen inactivation systems for red blood cells and FFP. In April 1996, Cerus entered into a development and commercialization agreement with Baxter, principally focused on the development of plasma and red blood cell pathogen inactivation systems. The agreement was amended in March 1998 and June 1998. The amended agreement provides for Baxter and Cerus generally to share red blood cell system development costs equally, subject to mutually agreed to budgets established from time to time. The agreement also provides for a sharing of revenue from sales of red blood cell inactivation system disposables after each party is reimbursed for its cost of goods and a specified 15 16 percentage allocation, not to exceed 14% of revenue, is retained by Baxter for marketing and administrative expenses. Also under the agreement, Cerus and Baxter equally funded the FFP program development through December 31, 1997 after which time Baxter's funding commitment for the FFP development program was limited to $1.2 million which offset payments owed Baxter in January 1999 and January 2000. The agreement provides for Cerus to receive 75% and Baxter to receive 25% of revenue from sales of FFP inactivation system disposables after each party is reimbursed for its cost of goods and a specified percentage allocation, not to exceed 14% of revenue, is retained by Baxter for marketing and administrative expenses. Baxter will be responsible for manufacturing and marketing the FFP product, and will retain its exclusive, worldwide distribution license. As of December 31, 1999, Baxter has made approximately $22.2 million of development and milestone payments to Cerus and has made $37.0 million of equity investments. Baxter has certain discretion in decisions concerning the development and marketing of pathogen inactivation systems. There can be no assurance that Baxter will not elect to pursue alternative technologies or product strategies or that its corporate interests and plans will remain consistent with those of Cerus. If the agreements with Cerus were terminated, if Baxter failed to provide the funding committed or if Baxter's product development efforts were unsuccessful, Cerus may need to obtain additional funding from other sources and would be required to devote additional resources to the development of its products, delaying the development of its products. Any such delay would have a material adverse effect on Cerus' business, financial condition and results of operations. There can also be no assurance that disputes will not arise in the future with respect to these agreements. Possible disagreements between Baxter and Cerus could lead to delays in the research, development or commercialization of certain planned products or could require or result in time-consuming and expensive litigation or arbitration and would have a material adverse effect on Cerus' business, financial condition and results of operations. A development program under the agreements may be terminated by either Baxter or Cerus on 90 days' notice in the case of the platelet program, or 270 days' written notice in the case of the FFP or red blood cell program. If either party so terminates a program, the other party gains exclusive development and marketing rights to the program, and the terminating party's sharing in program revenue is significantly reduced. ALLIANCE WITH THE CONSORTIUM FOR PLASMA SCIENCE In December 1998, Cerus and the Consortium entered into an agreement for the development of a pathogen inactivation system for source plasma used for fractionation. The Consortium is co-funded by four plasma fractionation companies: Alpha Therapeutics Corporation, Aventis Behring, Bayer Corporation and Baxter. The Consortium, which is a separate entity from its members, provides research and development funding worldwide for technologies to improve the safety of plasma derivative products. Under the agreement, the Consortium is funding development of Cerus' proprietary technology for use with source plasma, subject to an annual review process. Subject to the Consortium meeting certain funding requirements, Cerus will pay the Consortium a royalty based on a percentage of product sales, if any. The initial term of the agreement expires on June 30, 2000. There is no guarantee that the agreement will be renewed. RESEARCH GRANTS Cerus has an ongoing federal grant which is administered by the National Institutes of Health (NIH) which funds pre-clinical research related to its ACIT program. The grant is a three-year award totaling approximately $800,000. This federal grant must be renewed annually by submitting an Application for Continuing Support to the NIH. Cerus retains all rights to technology funded by these grants, subject to certain rights of the federal government if Cerus fails to commercialize the technology in a timely manner or if action is necessary to alleviate health or safety needs not addressed by Cerus, to meet requirements for public use specified by federal regulations or in the event Cerus were to breach certain agreements. The United States government also has a non-exclusive, non-transferable, irrevocable, paid-up license to practice or have practiced for or on its behalf any subject invention throughout the world. 16 17 MANUFACTURING AND SUPPLY Cerus has used, and intends to continue to use, third parties to manufacture and supply the psoralen and FRALE inactivation compounds for its systems for use in clinical trials and for the potential commercialization of its products in development. Cerus has no experience in manufacturing products for commercial purposes and does not have any manufacturing facilities. Consequently, Cerus is dependent on contract manufacturers for the production of compounds and on Baxter for other system components for development and commercial purposes. Under its agreements with Baxter, Cerus is responsible for developing and delivering its proprietary compounds for effecting pathogen inactivation to Baxter for incorporation into the final system configuration. Baxter is responsible for manufacturing or supplying the disposable units, such as blood storage containers and related tubing, as well as any device associated with the inactivation process. This arrangement applies both to the current supply for clinical trials and, if applicable regulatory approvals are obtained, the future commercial supply. In order to provide the inactivation compounds for its platelet and FFP pathogen inactivation systems, Cerus has contracted with two manufacturing facilities for pilot-scale synthesis of S-59, although one currently performs only the final step of the manufacturing process. Cerus currently has a stock of compound sufficient to support the anticipated remaining clinical trials planned for the platelet and FFP pathogen inactivation systems. There can be no assurance that Cerus will be able to contract for the manufacturing of products and compounds for its pathogen inactivation systems in the future on reasonable terms, if at all. The red blood cell pathogen inactivation system will require the manufacture of S-303, which Cerus has produced in only limited quantities for its research, pre-clinical and early clinical development requirements. Although Cerus has contracted with a manufacturing facility that has produced sufficient quantities of S-303 for pre-clinical and clinical studies, no assurance can be given that this or any new manufacturer will be able to produce S-303 on a commercial scale or that Cerus will be able to enter into arrangements for the commercial-scale manufacture of S-303 on reasonable terms, if at all. Under the terms of its agreements with Cerus, Baxter is responsible for manufacturing or supplying the disposable units, such as blood storage containers and related tubing, as well as any device associated with the inactivation processes. If these agreements were terminated or if Baxter otherwise failed to deliver an adequate supply of components, Cerus would be required to identify other third-party component manufacturers. There can be no assurance that Cerus would be able to identify such manufacturers on a timely basis or enter into contracts with such manufacturers on reasonable terms, if at all. Any delay in the availability of devices or disposables from Baxter could adversely affect the timely submission of products for regulatory approval or the market introduction and subsequent sales of such products and would have a material adverse effect on Cerus' business, financial condition and results of operations. Moreover, the inclusion of components manufactured by others could require Cerus to seek new approvals from government regulatory authorities, which could result in delays in product delivery. There can be no assurance that Cerus would receive any such required regulatory approvals. Any such delay would have a material adverse effect on Cerus' business, financial condition and results of operations. There can be no assurance that Cerus will be able to contract for the manufacturing of products and compounds for its pathogen inactivation systems on reasonable terms, if at all. In the event that Cerus is unable to obtain or retain third-party manufacturing, it will not be able to commercialize its products as planned. Cerus' dependence upon third parties, including Baxter, for the manufacture of critical portions of its pathogen inactivation systems may adversely affect Cerus' operating margins and its ability to develop, deliver and sell products on a timely and competitive basis. Failure of any third-party manufacturer to deliver the required quantities of products on a timely basis and at commercially reasonable prices could materially adversely affect Cerus' business, financial condition and results of operations. In the event Cerus undertakes to establish its own commercial manufacturing capabilities, it will require substantial additional funds, manufacturing facilities, equipment and personnel. Cerus purchases certain key components of its compounds from a limited number of suppliers. While Cerus believes that there are alternative sources of supply for such components, establishing additional or replacement suppliers for any of the components in Cerus' compounds, if required, may not be accomplished 17 18 quickly and could involve significant additional costs. Any failure by Cerus to obtain any of the components used to manufacture Cerus' compounds from alternative suppliers, if required, could limit Cerus' ability to manufacture its compounds and could have a material adverse effect on Cerus' business, financial condition and results of operations. MARKETING, SALES AND DISTRIBUTION The market for blood component treatment systems consists of the blood centers and hospitals that collect, store and distribute blood and blood components. In the United States, the American Red Cross collects and distributes approximately 50% of the nation's supply of blood and blood components. Other major blood centers include the New York Blood Center and United Blood Services, each of which distributes approximately 6% of the nation's supply of blood and blood components. In Western Europe and Japan, various national blood transfusion services or Red Cross organizations collect, store and distribute virtually all of their respective nations' blood and blood components supply. Hospital-affiliated blood banks also store and dispense blood and blood components but generally do not collect significant quantities of blood. Cerus believes that, if its products receive appropriate regulatory approvals, the relatively concentrated nature of the market may facilitate its ability to penetrate the market. However, if Cerus fails to gain market acceptance from any of these participants, its business, results of operations and financial condition will be materially adversely affected. Cerus believes that market acceptance of Cerus' pathogen inactivation systems will depend, in part, on Cerus' ability to provide acceptable evidence of the safety, efficacy and cost-effectiveness of its products, as well as the ability of blood centers to obtain appropriate FDA licenses and adequate reimbursement for such products. Cerus believes that market acceptance of its pathogen inactivation systems will also depend upon the extent to which physicians, patients and health care payors perceive that the benefits of using blood components treated with Cerus' systems justify the additional costs and processing requirements in a blood supply that has become safer in recent years. While Cerus believes that its pathogen inactivation systems are able to inactivate pathogens up to concentrations that Cerus believes are present in contaminated blood components when the blood is donated, there can be no assurance that contamination will never exceed such levels. Cerus does not expect that its planned products will be able to inactivate all known and unknown infectious pathogens, and there can be no assurance that the inability to inactivate certain pathogens will not affect the market acceptance of its products. There can be no assurance that Cerus' pathogen inactivation systems will gain any significant degree of market acceptance among blood centers, physicians, patients and health care payors, even if clinical trials demonstrate safety and efficacy and necessary regulatory approvals and health care reimbursement approvals are obtained. If appropriate regulatory approvals are received, Baxter will be responsible for the marketing, sales and distribution of Cerus' pathogen inactivation systems for blood components worldwide. Cerus does not currently maintain, nor does it intend to develop, its own marketing and sales organization but instead expects to continue to rely on Baxter to market and sell its pathogen inactivation systems. There can be no assurance that Cerus will be able to maintain its relationship with Baxter or that such marketing arrangements will result in payments to Cerus. Revenue to be received by Cerus through any marketing and sales arrangement with Baxter will be dependent on Baxter's efforts, and there can be no assurance that Cerus will benefit from Baxter's present or future market presence or that such efforts will otherwise be successful. If the agreements were terminated or if Baxter's marketing efforts were unsuccessful, Cerus' business, financial condition and results of operations would be materially adversely affected. COMPETITION Cerus expects to encounter significant competition in the sale of products it may develop. If regulatory approvals are received, Cerus' products may compete with other approaches to blood safety currently in use, as well as with future products developed by medical device, biotechnology and pharmaceutical companies, hospital supply companies, national and regional blood centers, and certain governmental organizations and agencies. Many companies and organizations that may be competitors or potential competitors have substantially greater financial and other resources than Cerus and may have greater experience in pre-clinical 18 19 testing, human clinical trials and other regulatory approval procedures. Cerus' ability to compete successfully will depend, in part, on its ability to develop proprietary products, develop and maintain products that reach the market first, are technologically superior to and/or are of lower cost than other products on the market, attract and retain scientific personnel, obtain patent or other proprietary protection for its products and technologies, obtain required regulatory approvals, and manufacture, market and sell any product that it develops. In addition, other technologies or products may be developed that have an entirely different approach or means of accomplishing the intended purposes of Cerus' products, or that might render Cerus' technology and products uncompetitive or obsolete. Cerus believes that the primary competitive factors in the market for pathogen inactivation systems will include the breadth and effectiveness of pathogen inactivation processes, ease of use, the scope and enforceability of patent or other proprietary rights, product price, product supply and marketing and sales capability. In addition, the length of time required for products to be developed and to receive regulatory and, in some cases, reimbursement approval is an important competitive factor. Cerus believes it competes favorably with respect to these factors, although there can be no assurance that it will be able to continue to do so. The biopharmaceutical field is characterized by rapid and significant technological changes. Accordingly, Cerus' success will depend in part on its ability to respond quickly to medical and technological changes through the development and introduction of new products. Product development involves a high degree of risk, and there can be no assurance that Cerus' product development efforts will result in any commercially successful products. In its agreements with Cerus, Baxter agreed to certain limited restrictions on its ability to independently develop and market products that compete with the products under the agreements with the exception of methylene blue for FFP. Baxter is conducting several independent product development efforts in blood collection and processing that may improve blood component quality and safety. The development and commercialization of Cerus' FFP pathogen inactivation system could be materially adversely affected by competition with a methylene blue-based product developed and marketed by Baxter or by Baxter's election to pursue alternative methods for improving blood safety outside the field of pathogen inactivation. PATENTS, LICENSES AND PROPRIETARY RIGHTS Cerus' success depends in part on its ability to obtain patents, to protect trade secrets, to operate without infringing upon the proprietary rights of others and to prevent others from infringing on the proprietary rights of Cerus. Cerus' policy is to seek to protect its proprietary position by, among other methods, filing United States and foreign patent applications related to its proprietary technology, inventions and improvements that are important to the development of its business. As of December 31, 1999, Cerus owned 52 issued or allowed United States patents and 19 issued or allowed foreign patents. Cerus' patents expire at various dates between 2003 and 2018. In addition, Cerus has 23 pending United States patent applications and has filed 19 corresponding patent applications under the Patent Cooperation Treaty, 12 of which are currently pending in Europe, Japan, Australia and Canada. Proprietary rights relating to Cerus' planned and potential products will be protected from unauthorized use by third parties only to the extent that they are covered by valid and enforceable patents or are effectively maintained as trade secrets. There can be no assurance that any patents owned by, or licensed to, Cerus will afford protection against competitors or that any pending patent applications now or hereafter filed by, or licensed to, Cerus will result in patents being issued. In addition, the laws of certain foreign countries do not protect Cerus' intellectual property rights to the same extent as do the laws of the United States. The patent positions of biopharmaceutical companies involve complex legal and factual questions and, therefore, their enforceability cannot be predicted with certainty. There can be no assurance that any of Cerus' patents or patent applications, if issued, will not be challenged, invalidated or circumvented, or that the rights granted thereunder will provide proprietary protection or competitive advantages to Cerus against competitors with similar technology. Furthermore, there can be no assurance that others will not independently develop similar technologies or duplicate any technology developed by Cerus. Because of the extensive time required for development, testing and regulatory review of a potential product, it is possible that, before any of Cerus' products can be commercialized, any related patent may expire or remain in existence for only a short period 19 20 following commercialization, thus reducing any advantage of the patent, which could adversely affect Cerus' ability to protect future product development and, consequently, its operating results and financial position. Because patent applications in the United States are maintained in secrecy until patents issue and since publication of discoveries in the scientific or patent literature often lag behind actual discoveries, Cerus cannot be certain that it was the first to make the inventions covered by each of its issued or pending patent applications or that it was the first to file for protection of inventions set forth in such patent applications. There can be no assurance that Cerus' planned or potential products will not be covered by third-party patents or other intellectual property rights, in which case continued development and marketing of such products would require a license under such patents or other intellectual property rights. There can be no assurance that such required licenses will be available to Cerus on acceptable terms, if at all. If Cerus does not obtain such licenses, it could encounter delays in product introductions while it attempts to design around such patents, or could find that the development, manufacture or sale of products requiring such licenses is foreclosed. Litigation may be necessary to defend against or assert such claims of infringement, to enforce patents issued to Cerus, to protect trade secrets or know-how owned by Cerus or to determine the scope and validity of the proprietary rights of others. In addition, interference proceedings declared by the United States Patent and Trademark Office may be necessary to determine the priority of inventions with respect to patent applications of Cerus. Litigation or interference proceedings could result in substantial costs to and diversion of effort by Cerus, and could have a material adverse effect on Cerus' business, financial condition and results of operations. There can be no assurance that these efforts by Cerus would be successful. Cerus is a licensee under a license agreement with Miles, Inc. and Diamond Scientific Corporation with respect to two United States patents covering inventions pertaining to psoralen-based photochemical decontamination treatment of whole blood or blood components and four United States patents relating to vaccines, as well as related foreign patents. Whether Cerus' psoralen-based pathogen inactivation systems practice either of the photochemical decontamination patents depends on an interpretation of the scope of the patent claims. If such systems practice such patents, the license would provide for Cerus to make certain milestone payments which may be credited against any royalties payable by Cerus. The license requires a royalty payable by Cerus on revenue from such systems and certain annual minimum royalty payments per year until termination of the license. The manner in which any such milestone payments and royalties would be shared by Baxter, if at all, has not been determined. Cerus does not believe that any amounts that might be payable by it under the agreement to date would be material. Cerus may rely, in certain circumstances, on trade secrets to protect its technology. However, trade secrets are difficult to protect. Cerus seeks to protect its proprietary technology and processes, in part, by confidentiality agreements with its employees and certain contractors. There can be no assurance that these agreements will not be breached, that Cerus will have adequate remedies for any breach, or that Cerus' trade secrets will not otherwise become known or be independently discovered by competitors. To the extent that Cerus' employees or its consultants or contractors use intellectual property owned by others in their work for Cerus, disputes may also arise as to the rights in related or resulting know-how and inventions. GOVERNMENT REGULATION Cerus and its products are comprehensively regulated in the United States by the FDA and, in some instances, by state and local governments, and by comparable governmental authorities in other countries. The FDA regulates drugs, medical devices, and biologics under the Federal Food, Drug, and Cosmetic Act and other laws, including, in the case of biologics, the Public Health Service Act. These laws and implementing regulations govern, among other things, the development, testing, manufacturing, record keeping, storage, labeling, advertising, promotion and pre-market clearance or approval of products subject to regulation. Cerus believes its pathogen inactivation systems will be regulated by the FDA as medical devices. It is also possible, however, that the FDA will decide to regulate the pathogen inactivation systems as biologics, as drugs, as combination products including drugs or biologics and one or more medical devices, or as drugs or biologics with one or more medical devices (i.e., the blood bags and light source) requiring separate approval or clearance. Whether the FDA regulates the pathogen inactivation systems as devices or as one or more of 20 21 the other alternatives, it is likely that the FDA's Center for Biologics Evaluation and Research will be principally responsible for regulating the pathogen inactivation systems. Before a medical device may be marketed in the United States, the FDA must clear a pre-market notification (a "510(k)") or approve a pre-market approval application (PMA) for the product. Before a new drug may be marketed in the United States, the FDA must approve an NDA for the product. Before a biologic may be marketed in the United States, the FDA must approve a Biologic License Application (BLA). Before a combination product can be marketed in the United States, it must have an approved NDA, BLA or PMA, depending on which statutory authority the FDA elects to use. Despite the multiplicity of statutory and regulatory possibilities, the steps required before approval are essentially the same whether the product is ultimately regulated as a medical device, biologic, drug, a combination product, or a combination thereof. The steps required before a medical device, drug or biologic may be approved for marketing in the United States pursuant to a PMA, BLA or NDA, respectively, generally include (i) pre-clinical laboratory and animal tests, (ii) submission to the FDA of an investigational device exemption (IDE) (for medical devices) or an investigational new drug application (IND) (for drugs or biologics) for human clinical testing, which must become effective before human clinical trials may begin, (iii) appropriate tests to show the product's safety, (iv) adequate and well-controlled human clinical trials to establish the product's safety and efficacy for its intended indications, (v) submission to the FDA of a PMA, BLA or NDA, as appropriate and (vi) FDA review of the PMA, BLA or NDA in order to determine, among other things, whether the product is safe and effective for its intended uses. In addition, the FDA inspects the facilities at which the product is manufactured and will not approve the product unless compliance with current Good Manufacturing Practices (cGMP) or Quality System Regulation requirements is satisfactory. The steps required before a medical device may be cleared for marketing in the United States pursuant to a 510(k) are likely to be the same, except that instead of conducting tests to demonstrate safety and efficacy, data, including clinical data if necessary, must be obtained to show that the product is substantially equivalent to a legally marketed device, and the FDA must make a determination of substantial equivalence rather than a determination that the product is safe and effective. Cerus believes the FDA will require a PMA for its platelet, FFP and red blood cell pathogen inactivation systems. Cerus is developing a European investigational plan based on the platelet and FFP treatment systems using S-59 being categorized as Class III drug/device combination under the Medical Device Directives (MDD) of the European Union. However, there can be no assurance that this approach will be accepted by European authorities. The European Union requires that medical devices affix the CE Marking, an international symbol of adherence to quality assurance standards and compliance with the MDD. Failure to receive CE Marking certification will prohibit Cerus from selling its products in the European Union. To support Cerus' requests for FDA approval to market its pathogen inactivation products, Cerus conducts various types of studies, including toxicology studies to evaluate product safety, in vitro and animal studies to evaluate product effectiveness and human clinical trials to evaluate the safety, tolerability and effectiveness of treated blood components. Cerus believes that, in deciding whether a pathogen inactivation system is safe and effective, the FDA is likely to take into account whether it adversely affects the therapeutic efficacy of blood components as compared to the therapeutic efficacy of blood components not treated with the system, and that the FDA will weigh the system's safety, including potential toxicities of the inactivation compounds, and other risks against the benefits of using the system in a blood supply that has become safer in recent years. Cerus has conducted many toxicology studies designed to demonstrate its products' safety, and will be required to conduct additional studies, including three month tolerability studies for the S-59 compound and various studies to evaluate the safety of the S-303 compound. There can be no assurance that the FDA will not require further toxicology or other studies of Cerus' products. Based on discussions with the FDA, Cerus believes that it will be required to provide data from human clinical studies to demonstrate the safety of treated platelets and their therapeutic comparability to untreated platelets, but that only data from in vitro and animal studies, not data from human clinical studies, will be required to demonstrate the system's efficacy in inactivating pathogens. In light of these criteria, Cerus' clinical trial programs for platelets and FFP consist of studies that differ from typical Phase 1, Phase 2 and Phase 3 clinical studies. 21 22 There can be no assurance, however, that these means of demonstrating safety and efficacy will ultimately be acceptable to the FDA or that the FDA will continue to believe that this clinical plan is appropriate. Moreover, even if the FDA considers these means of demonstrating safety and efficacy to be acceptable in principle, there can be no assurance that the FDA will find the data submitted sufficient to demonstrate safety and efficacy. In particular, although Cerus anticipates that the FDA will consider in vitro and animal data an appropriate means of demonstrating efficacy in pathogen inactivation, there can be no assurance that the FDA will so conclude, and any requirement to provide other than in vitro and animal data would adversely affect the timing and could affect the success of Cerus' efforts to obtain regulatory approval. The testing and approval/clearance process requires substantial time, effort and financial resources, and is generally lengthy, expensive and uncertain. Even if regulatory approval or clearance is granted, it could include significant limitations on the indicated uses for which a product could be marketed. For example, Cerus does not believe that it will be able to make any labeling or promotional claims that Cerus' pathogen inactivation systems may inactivate any pathogens for which it does not have in vitro, and in certain cases animal, data supporting such claims. After FDA approval for the initial indications, further clinical trials will be necessary to gain approval for the use of the product for additional indications. The FDA may also require post- marketing testing, which can involve significant expense. Later discovery of problems with a product may result in restrictions on the product, including withdrawal of the product from the market. In addition, the policies of the FDA may change, and additional regulations may be promulgated which could prevent or delay regulatory approval of Cerus' planned products. There can be no assurance that any approval or clearance will be granted on a timely basis, if at all. Any failure to obtain or delay in obtaining such approvals or clearances, and any significant limitation on their indicated uses or any restrictions from discovery of product problems, could have a material adverse effect on Cerus' business, financial condition and results of operations. A medical device, biologic or drug, its manufacturer, and the holder of the PMA or 510(k), BLA or NDA for the product are subject to comprehensive regulatory oversight, both before and after approval or clearance is obtained. Violations of regulatory requirements at any stage, including during the pre-clinical and clinical testing process, during the approval/clearance process or after the product is approved/cleared for marketing, could result in various adverse consequences, including the FDA's requiring that a clinical trial be suspended or halted, the FDA's delay in approving/clearing or refusing to approve/clear a product, withdrawal of an approved/cleared product from the market and the imposition of criminal penalties. For example, the holder of a PMA or 510(k), BLA or NDA is required to report certain adverse reactions to the FDA, and must comply with certain requirements concerning advertising and promotional labeling for the product. Also, quality control and manufacturing procedures must continue to conform to cGMP and Quality System regulations after approval or clearance, and the FDA periodically inspects manufacturing facilities to assess compliance with cGMP and Quality System. Accordingly, manufacturers must continue to expend time, monies and efforts on regulatory compliance, including cGMP and Quality System compliance. In addition, new government requirements may be established that could delay or prevent regulatory approval or clearance of Cerus' products under development or otherwise alter the applicable law. There can be no assurance that the FDA will determine that the facilities and manufacturing procedures of Baxter or any other third-party manufacturer of Cerus' planned products will conform to cGMP or Quality System requirements. In addition to the regulatory requirements applicable to Cerus and its products, there are also regulatory requirements applicable to Cerus' prospective customers, which are primarily entities that ship blood and blood products in interstate commerce. Such entities are regulated by the FDA pursuant to the Food, Drug and Cosmetic Act and the Public Health Service Act and implementing regulations. Blood centers and others that ship blood and blood products interstate will likely be required to obtain approved license supplements from the FDA before shipping products processed with Cerus' pathogen inactivation systems. This requirement and/or FDA delays in approving such supplements may deter some blood centers from using Cerus' products, and blood centers that do submit supplements may face disapproval or delays in approval that could provide further disincentives to use of the systems. The regulatory impact on potential customers could have a material adverse effect on Cerus' business, financial condition and results of operations. The Phase 3 European Buffy Coat clinical trial is being conducted to assess the therapeutic efficacy of the platelet pathogen inactivation system for use in treating pooled random donor platelets collected using the 22 23 Buffy Coat process. The Buffy Coat process is the predominant method used in Europe to prepare platelet concentrates. If Cerus decides to seek European regulatory approval for apheresis donor platelets, Cerus will be required to perform additional clinical studies. The Phase 3 United States apheresis clinical trial is being conducted to assess the therapeutic efficacy of the platelet pathogen inactivation system for use in treating apheresis platelets, which represent approximately 60% of the market, not pooled random donor platelets. If Cerus decides to seek FDA approval of the platelet pathogen inactivation system for use in treating pooled random donor platelets, Cerus will be required by the FDA to conduct additional clinical studies. In addition, there currently are three principal manufacturers of automated apheresis collection equipment, including Baxter. The equipment of each manufacturer collect platelets into plastic disposables designed for that equipment; thus, a pathogen inactivation system designed for disposables used by one manufacturer will not necessarily be compatible with other manufacturers' collection equipment. Cerus intends initially to seek FDA approval of a platelet pathogen inactivation system configured for Baxter's apheresis collection equipment. If Cerus determines that compatibility with other equipment is desirable, it will need to develop additional processing procedures. Cerus believes that the FDA may also require supplemental clinical data before approving its system for use with platelets collected using other equipment. Because of the risk of bacterial growth, current FDA rules require that platelets may not be stored for more than five days after collection from the donor. The rules also require that pooled platelets be transfused within four hours of pooling and, as a result, most pooling occurs at hospitals. However, Cerus' platelet pathogen inactivation system is being designed to be used at blood centers, not at hospitals, and requires a processing time of approximately six hours. Therefore, in order for Cerus' platelet pathogen inactivation system to be effectively implemented and accepted at blood centers as planned, the FDA-imposed limit on the time between pooling and transfusion would need to be lengthened or eliminated for blood products treated with Cerus' systems, which are being designed to inactivate bacteria that would otherwise contaminate pooled platelets. If Cerus were to pursue the pooled random donor platelet market, it would need to work with the FDA during the approval/clearance process to obtain the necessary changes in these limitations. There can be no assurance, however, that the FDA would change this requirement and, if such a change were not made, Cerus' business, financial condition and results of operations would be materially adversely affected. Cerus is conducting its clinical trials using prototype system disposables and ultraviolet light sources, and is completing the commercial design for these products contemporaneously. Cerus' current clinical plan includes a study in patients using the commercial version of the system prior to receiving regulatory approval. However, there can be no assurance that regulatory agencies will not require additional studies. Such additional studies, if required, could delay commercialization of the system. Cerus is subject to federal, state and local laws, rules, regulations and policies governing the use, generation, manufacture, storage, air emission, effluent discharge, handling and disposal of certain materials, biological specimens and wastes. There can be no assurance that Cerus will not be required to incur significant costs to comply with environmental and health and safety regulations in the future. Cerus' research and development involves the controlled use of hazardous materials, including certain hazardous chemicals and radioactive materials. Although Cerus believes that its safety procedures for handling and disposing of such materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be eliminated. In the event of such an accident, Cerus could be held liable for any damages that result and any such liability could exceed the resources of Cerus. HEALTH CARE REIMBURSEMENT AND REFORM The future revenue and profitability of biopharmaceutical and related companies as well as the availability of capital to such companies may be affected by the continuing efforts of the United States and foreign governments and third-party payors to contain or reduce costs of health care through various means. In the United States, given recent federal and state government initiatives directed at lowering the total cost of health care, it is likely that the United States Congress and state legislatures will continue to focus on health care reform and the cost of pharmaceuticals and on the reform of the Medicare and Medicaid systems. While Cerus cannot predict whether any such legislative or regulatory proposals will be adopted, the announcement 23 24 or adoption of such proposals could have a material adverse effect on Cerus' business, financial condition and results of operations. Cerus' ability to commercialize its products successfully will depend in part on the extent to which appropriate reimbursement levels for the cost of the products and related treatment are obtained from governmental authorities, private health insurers and other organizations, such as HMOs. Third-party payors are increasingly challenging the prices charged for medical products and services. The trend toward managed health care in the United States and other countries and the concurrent growth of organizations such as HMOs, which could control or significantly influence the purchase of health care services and products, as well as legislative proposals to reform health care or reduce government insurance programs, may all result in lower prices for Cerus' products. The cost containment measures that health care payors and providers are instituting and the effect of any health care reform could materially adversely affect Cerus' ability to operate profitably. EMPLOYEES As of February 29, 2000, Cerus had 115 employees, 80 of whom were engaged in research and development and 35 in general and administrative. No employees of Cerus are covered by collective bargaining agreements, and Cerus believes that its relationship with its employees is good. RISK FACTORS Cerus' business faces significant risks. These risks include those described below and may include additional risks of which Cerus is not currently aware or which Cerus currently does not believe are material. If any of the events or circumstances described in the following risks actually occurs, Cerus' business, financial condition or results of operations could be materially adversely affected. These risks should be read in conjunction with the other information set forth in this report. OUR PRODUCTS ARE IN AN EARLY STAGE OF DEVELOPMENT AND THERE IS A HIGH RISK OF FAILURE. We have no products that have received regulatory approval for commercial sale. All of our product candidates are in early stages of development, and we face the risks of failure inherent in developing medical devices and biotechnology products based on new technologies. Our products must satisfy rigorous standards of safety and efficacy before they can be approved by the United States Food and Drug Administration and international regulatory authorities for commercial use. Our platelet, fresh frozen plasma, red blood cell and stem cell transplantation programs are undergoing clinical testing. Our other programs are still in the early stages of research and development. We will have to conduct significant additional research and pre-clinical (animal) and clinical (human) testing before we can file applications with the FDA for product approval. Clinical trials are expensive and have a high risk of failure. In addition, to compete effectively, our products must be easy to use, cost-effective and economical to manufacture on a commercial scale. We cannot assure you that we can achieve any of these objectives. Any of our products may fail in the testing phase or may not attain market acceptance. Also, third parties may develop superior products or have proprietary rights that preclude us from marketing our products. If research and testing is not successful, our products are not commercially viable or we cannot compete effectively, our business, financial condition and results of operation will be materially adversely affected. THE PROGRESS AND RESULTS OF OUR PRE-CLINICAL AND CLINICAL TESTING ARE UNCERTAIN. We must provide the FDA and foreign regulatory authorities with pre-clinical and clinical data that demonstrate the safety and efficacy of our products before they can be approved for commercial sale. Clinical development, including pre-clinical testing, is a long, expensive and uncertain process. It may take us several years to complete our testing, and failure can occur at any stage of testing. We cannot rely on interim results of trials to necessarily predict their final results, and acceptable results in early trials might not be repeated in later trials. Any trial may fail to produce results satisfactory to the FDA. Pre-clinical and clinical data can be interpreted in different ways, which could delay, limit or prevent regulatory approval. Negative or inconclusive 24 25 results from a pre-clinical study or clinical trial or adverse medical events during a clinical trial could cause a pre-clinical study or clinical trial to be repeated or a program to be terminated, even if other studies or trials relating to a program are successful. We typically rely on third-party clinical investigators to conduct our clinical trials and other third-party organizations to perform data collection and analysis, and as a result, we face certain additional delaying factors outside our control. These factors include: - difficulty in enrolling qualified subjects - inadequately trained or insufficient personnel at the study site - delays in approvals from a study site's review board. We cannot assure you that planned trials will begin on time or that any of our clinical trials will be completed on schedule or at all. Certain of our clinical trials involve patient groups that have rare medical conditions, and we may have difficulty in identifying and enrolling a sufficient number of patients to complete the trials on a timely basis. We cannot assure you that any trials will result in marketable products or that any products will be commercially successful even if approved for marketing. Our product development costs will increase if we have delays in testing or approvals. If the delays are significant, our business, financial condition and results of operations will be materially adversely affected. WE FACE MANUFACTURING UNCERTAINTIES BECAUSE OUR PRODUCTS HAVE NOT BEEN MANUFACTURED ON A COMMERCIAL SCALE. Our products, and many of their components, have never been manufactured on a commercial scale. It may be difficult or impossible to economically manufacture our products on a commercial scale. We intend to use third-party manufacturers to produce commercial quantities of our products, including the inactivation compounds. We have contracted with two manufacturers to provide enough S-59, the inactivation compound we use in our platelet and fresh frozen plasma systems, to meet our anticipated clinical trial requirements. Only one of the manufacturers is performing the complete synthesis of S-59. If this manufacturer cannot produce S-59 in commercial quantities, we may face delays and shortfalls before our alternate manufacturer can produce sufficient quantities. Also, any new manufacturer will have to prove both to us and to the FDA that its manufacturing process complies with government regulations. We may need to identify and qualify additional manufacturers for commercial production. We cannot be certain that our existing manufacturers or any new manufacturer will be able to provide required quantities of S-59. We have produced only limited quantities of S-303, the inactivation compound we use in our red blood cell pathogen inactivation system, sufficient for pre-clinical research and early clinical development. To date, S-303 has been produced by a sole third-party manufacturer. We cannot be certain that this manufacturer will be able to produce S-303 on a commercial scale. We also do not know whether we will be able to enter into arrangements for the commercial-scale manufacture of S-303 on reasonable terms or at all. We purchase certain key components of our compounds from a limited number of suppliers. While we believe there are alternative suppliers for these components, it would be expensive and time-consuming to establish additional or replacement suppliers for our compounds. Baxter is responsible for manufacturing and assembling components of our systems. Baxter has not manufactured these components in commercial quantities and may not be able to provide them to us on an economical basis. Baxter intends to rely on third parties to manufacture some of these components, which are customized and have not been manufactured on a commercial scale. If Baxter or its third-party component suppliers fail to develop commercially acceptable manufacturing processes for these components, our business, results of operations and financial condition will be materially adversely affected. If we were unable to find adequate suppliers for these components, we would be required to redesign the systems, which could lead to additional testing and clinical trials. If we were required to redesign the products, our development costs would increase and our programs could be delayed significantly. 25 26 OUR PRODUCTS MAY NEVER BE ACCEPTED BY THE HEALTH CARE COMMUNITY. We believe that our ability to commercialize our pathogen inactivation systems effectively will depend on the safety, efficacy and cost-effectiveness of our products and the availability of adequate insurance reimbursement for these products. We believe that market acceptance will depend on the extent to which physicians, patients and health care payors perceive that the benefits of using our systems justify their additional cost, given that the blood supply has become safer in recent years. Our ability to successfully commercialize our products depends in part on obtaining adequate reimbursement for product costs and related treatment of blood components from governmental authorities and private health care insurers (including health maintenance organizations). Government and private third-party payors are increasingly attempting to contain health care costs by limiting both the extent of coverage and the reimbursement rate for new tests and treatments. In addition, we do not expect our products to inactivate all known pathogens, and the inability of our systems to inactivate certain pathogens may adversely affect market acceptance of our products. Even if our products receive the necessary regulatory and health care reimbursement approvals, our products may not achieve any significant degree of market acceptance among blood centers, physicians, patients and health care payors. Other technologies have been developed in recent years that have the potential to improve the safety of the blood supply. These technologies include donor retested fresh frozen plasma, solvent-detergent treated fresh frozen plasma and new methods to test for various blood-borne pathogens. For various reasons, such as implementation costs and logistical concerns, the transfusion industry has not always integrated these technologies into their processes. Although we believe our inactivation systems can significantly improve the safety of the blood supply, we cannot assure you that our technologies will be accepted rapidly or at all. If our products fail to achieve market acceptance, our business, results of operations and financial condition would be materially adversely affected. We are currently developing our platelet pathogen inactivation system in the United States to treat apheresis platelets. Apheresis platelets are collected from a single donor using an automated collection machine. Currently, we estimate that approximately 60% of platelets are collected by apheresis in the United States, and the balance are pooled random donor platelets. We cannot predict whether the market for apheresis platelets will be maintained or will develop further. If this market declines, our business, results of operation and financial condition will be materially adversely affected. If we conduct additional clinical trials to obtain FDA approval of the system for use in treating random donor platelets, our development expenses will increase significantly. In addition, FDA regulations limit the time from pooling to transfusion to four hours to minimize the proliferation of bacterial contamination in the pooled product. As a result, most pooling occurs in hospitals. Our platelet system is designed for use in blood centers and requires approximately six hours of processing. Therefore, the FDA's time limit between pooling and transfusion currently precludes the use of our system with pooled random donor platelets. Although our system is designed to reduce the risk of bacterial contamination, we cannot predict whether the FDA would remove this process time constraint to allow our system to be used with pooled random donor platelets. Baxter is one of three primary manufacturers of equipment for the collection of apheresis platelets. The equipment, design and materials used to collect the platelets vary from manufacturer to manufacturer. We are conducting our pre-clinical and clinical studies using only Baxter's equipment and materials, and initially we intend to seek FDA approval for our systems for use only with Baxter's collection systems. As a result, market acceptance of our platelet system will depend on the market acceptance of Baxter's collection equipment. Blood centers may be reluctant to replace their existing equipment, and the FDA may require us to make our systems compatible with other equipment. If we are required to develop our platelet system for use on other manufacturers' equipment, or if we decide to address a broader market, we will need to perform additional studies, which will increase our development costs and which may not be successful. A SMALL NUMBER OF CUSTOMERS WILL DETERMINE MARKET ACCEPTANCE OF OUR PRODUCTS. The market for our pathogen inactivation systems is dominated by a small number of blood collection centers. In the United States, the American Red Cross collects and distributes approximately 50% of the nation's supply of blood and blood components. Other major United States blood centers include the New York Blood Center and United Blood Services, each of which distributes approximately 6% of the nation's 26 27 supply of blood and blood components. In Western Europe and Japan, various national blood transfusion services or Red Cross organizations collect, store and distribute virtually all of their respective nations' blood and blood components supply. If we fail to properly market, price or sell our products to even a small number of these large customers, our business, financial condition and results of operations could be materially adversely affected. WE RELY HEAVILY ON BAXTER FOR DEVELOPMENT FUNDING, MARKETING AND SALES. We have development and marketing agreements with Baxter for our platelet, fresh frozen plasma and red blood cell pathogen inactivation systems, and we rely on Baxter for significant financial and technical contributions to these programs. Our ability to develop, manufacture and market these products successfully depends significantly on Baxter's performance under these agreements. - Baxter can terminate our agreements or fail to perform. Baxter can terminate the agreements without cause under certain circumstances. If Baxter terminates the agreements or fails to provide adequate funding to support the product development efforts, we will need to obtain additional funding from other sources and will be required to devote additional resources to the development of our products. We cannot assure you that we would be able to find a suitable substitute partner in a timely manner, on reasonable terms or at all. If we fail to find a suitable partner, our research, development or commercialization of certain planned products would be delayed significantly which would cause us to incur additional expenditures. - We rely on Baxter for the marketing, sales and distribution of our products. We do not have and currently do not plan to develop our own marketing and sales organization. Instead, we plan to rely on Baxter to market and sell the pathogen inactivation systems. If our joint development agreements with Baxter are terminated or if Baxter is unable to market the products successfully, we will be required to find another marketing, sales and distribution partner or develop these capabilities ourselves. We may not be able to find a suitable partner on favorable terms or on a timely basis, if at all. Developing marketing, sales and distribution capabilities ourselves would delay commercialization of our products and increase our costs. - We lack control over management decisions. Baxter and we share responsibility for managing the development programs for the pathogen inactivation systems. Management decisions are made by a management board that has equal representation from both Baxter and us. Our interests and Baxter's may not always be aligned. If we disagree with Baxter on program direction, a neutral party will make the decision. The neutral party may not decide in our best interest. Under the agreements, Baxter may independently develop a pathogen inactivation system for fresh frozen plasma using their pre-existing methylene blue technology. Such an effort by Baxter could create conflicts in our joint program for the development of a pathogen inactivation system for fresh frozen plasma. OUR PRODUCTS ARE SUBJECT TO EXTENSIVE REGULATION BY DOMESTIC AND FOREIGN GOVERNMENTS. Our products under development and anticipated future products are subject to extensive and rigorous regulation by United States local, state and federal regulatory authorities and by foreign regulatory bodies. These regulations are wide-ranging and govern, among other things: - product development, - product testing, - product manufacturing, - product labeling, - product storage, - product pre-market clearance or approval, - product sales and distribution, and - product advertising and promotion. 27 28 The FDA and other agencies in the United States and in foreign countries impose substantial requirements upon the manufacturing and marketing of products such as those being developed by our company or any partner. The process of obtaining FDA and other required regulatory approvals is long, expensive and uncertain. The time required for regulatory approvals is uncertain and the process typically takes a number of years, depending on the type, complexity and novelty of the product. We may encounter significant delays or excessive costs in our efforts to secure necessary approvals or licenses. We cannot be sure that our products will receive FDA approval in a timely manner, if at all. Even if approvals are obtained, the marketing and manufacturing of drug products are subject to continuing FDA and other regulatory requirements, such as requirements to comply with good manufacturing practices. The failure to comply with such requirements could result in enforcement action, which could adversely affect us and our business. Later discovery of problems with a product, manufacturer or facility may result in additional restrictions on the product or manufacturer, including withdrawal of the product from the market. The government may impose new regulations which could further delay or preclude regulatory approval of our potential products. We cannot predict the impact of adverse governmental regulation which might arise from future legislative or administrative action. We intend to generate product revenue from sales outside of the United States. Distribution of our products outside the United States also may be subject to extensive government regulation. These regulations, including the requirements for approvals or clearance to market, the time required for regulatory review and the sanctions imposed for violations, vary by country. It is uncertain whether we will obtain regulatory approvals in such countries or that we will be required to incur significant costs in obtaining or maintaining our foreign regulatory approvals. Failure to obtain necessary regulatory approvals or any other failure to comply with regulatory requirements could result in reduced revenue and earnings. To support our requests for FDA approval to market our products, we intend to conduct various types of studies including: - toxicology studies to evaluate product safety, - in vitro and animal studies to evaluate product effectiveness, and - human clinical trials to evaluate the safety, tolerability and effectiveness of treated blood components. We have conducted many toxicology studies to demonstrate our products' safety, and we plan to conduct additional toxicology studies throughout the product development process. At any time, the FDA may require further toxicology or other studies to further demonstrate our products' safety, which could delay commercialization. We believe the FDA is likely to weigh the potential risks of using our pathogen inactivation products against the incremental benefits, which may be less compelling in light of improved safety in the blood supply. In addition, our clinical development plan assumes that we will not be required to perform human clinical studies to demonstrate our systems' ability to inactivate pathogens. Although we have discussed this plan with the FDA, they may find it unacceptable at any time and may require human clinical trials to demonstrate efficacy in inactivating pathogens. Such trials may be too large and expensive to be practical. Regulatory agencies may limit the uses, or indications, for which any of our products is approved. For example, we believe that we will be able to claim the inactivation of particular pathogens only to the extent we have in vitro or animal data to support such claims. In addition to the regulatory requirements applicable to us and our products, there are regulatory requirements applicable to our prospective customers, the blood centers that process and distribute blood and blood products. Blood centers and others will likely be required to obtain approved license supplements from the FDA before shipping products processed with our pathogen inactivation systems interstate. This requirement or FDA delays in approving these supplements may deter some blood centers from using our products. Blood centers that do submit supplements may face disapproval or delays in approval that could provide further delay or deter them from using our products. The regulatory impact on potential customers could slow or limit the potential sales of our products. 28 29 WE ARE USING PROTOTYPE COMPONENTS IN OUR CLINICAL TRIALS AND HAVE NOT COMPLETED THEIR COMMERCIAL DESIGN. The system disposables and ultraviolet light sources we use in our clinical trials are prototypes. We are developing the commercial design for these products at the same time. As a result, we plan to perform studies, both pre-clinical and clinical, to demonstrate the equivalence of the prototype and the commercial design. However, regulatory agencies may require us to perform additional studies, both pre-clinical and clinical, using the commercial versions of the systems, which may delay the commercialization of our products. If we fail to develop commercial versions of the systems on schedule, our business, results of operations and financial condition will be materially adversely affected. WE HAVE ONLY A LIMITED OPERATING HISTORY AND WE EXPECT TO CONTINUE TO GENERATE LOSSES. We may never achieve a profitable level of operations. To date, we have engaged primarily in research and development. Our development and general and administrative expenses have resulted in substantial losses. As of December 31, 1999, we had an accumulated deficit of approximately $87.5 million. All of our products are in the research and development stage, and we have not received any revenue from product sales. We have received all of our revenue under our agreements with Baxter and the Consortium, and federal research grants. We will be required to conduct significant research, development, clinical testing and regulatory compliance activities for each of these products. We expect our losses to continue at least through 2002. We also expect our losses to fluctuate significantly from quarter to quarter due to differences in the timing of our expenses and potential revenue from Baxter. Our ability to become profitable will depend on our ability to, among other things: - establish adequate protection of our intellectual property rights, - complete our product development, - obtain product regulatory approvals, and - achieve market acceptance for our products. WE WILL NEED ADDITIONAL FUNDS. Our product development programs are capital-intensive. We expect to continue to spend substantial funds for our operations for the foreseeable future. We believe that our existing capital resources, together with anticipated payments from Baxter under our agreements with Baxter and projected interest income, will support our current and planned operations for at least the next 18 months. Our cash, liquidity and capital requirements will depend on numerous factors, including additional research and development needs, product testing results, regulatory requirements, competitive pressures and technological advances and setbacks. In addition, we may require substantial funds for our long-term product development, marketing programs and operating expenses. We cannot assure you that we will be able to raise additional funds on acceptable terms. If we raise additional funds by issuing equity securities, our existing stockholders may experience substantial dilution. WE OPERATE IN A COMPETITIVE INDUSTRY WITH RAPIDLY CHANGING TECHNOLOGY. We expect our products to encounter significant competition. Our products may compete with other approaches to blood safety and improving the outcome of stem cell transplantation currently in use, as well as with future products developed by biotechnology and pharmaceutical companies, hospital supply companies, national and regional blood centers, and governmental organizations and agencies. Our success will depend in part on our ability to respond quickly to medical and technological changes through the development and introduction of new products. Product development is risky and uncertain, and we cannot assure you that we will develop our products successfully. Competitors' products or technologies may make our products obsolete or non-competitive before we are able to generate any significant revenue. Many of our competitors or potential competitors have substantially greater financial and other resources than we have. They may also 29 30 have greater experience in pre-clinical testing, human clinical trials and other regulatory approval procedures. Our ability to compete successfully will depend, in part, on our ability to: - attract and retain skilled scientific personnel, - develop technologically superior products, - develop lower cost products, - obtain patent or other proprietary protection for our products and technologies, - obtain required regulatory approvals for our products, - be early entrants to the market, and - manufacture, market and sell our products, independently or through collaborations. Several companies are developing technologies which are, or in the future may be, the basis for products that will directly compete with or reduce the market for our pathogen inactivation systems. A number of companies are specifically focusing on alternative strategies for pathogen inactivation in various blood components. In May 1998, the FDA approved solvent-detergent for use in treating fresh frozen plasma in the United States. If the treatment of fresh frozen plasma by solvent-detergent becomes a widespread practice, which has not happened to date, it could adversely affect our ability to market our fresh frozen plasma pathogen inactivation system in the United States. Several other companies are currently marketing solvent-detergent or methylene blue-based pathogen inactivation systems for fresh frozen plasma in Europe. Other groups are developing synthetic blood product substitutes and products to stimulate the growth of platelets. If any of these technologies is successfully developed, it could have a material adverse effect on our business, financial condition and results of operations. Baxter has agreed to certain restrictions on its ability to independently develop and market products that compete with our products, however, these provisions may not prevent Baxter from developing or marketing competing products using methylene blue. FAILURE TO ATTRACT AND RETAIN KEY EMPLOYEES WILL ADVERSELY AFFECT OUR BUSINESS. Because of the scientific nature of our business, we depend on the principal members of our management and scientific staff. Our success will depend largely on our ability to attract and retain highly skilled scientific and managerial personnel. Competition for such personnel is intense. We cannot assure you that we will be successful in attracting and retaining such personnel. The failure to maintain our management and scientific staff and to attract additional key personnel could materially adversely affect our business, financial condition and results of operations. Although we intend to provide incentive compensation to attract and retain our key personnel, we cannot guarantee these efforts will be successful. WE MAY NOT BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY OR OPERATE OUR BUSINESS WITHOUT INFRINGING INTELLECTUAL PROPERTY RIGHTS OF OTHERS. Our technology will be protected from unauthorized use by others only to the extent that it is covered by valid and enforceable patents or effectively maintained as trade secrets. As a result, our success depends in part on our ability to: - obtain patents, - protect trade secrets, - operate without infringing upon the proprietary rights of others, and - prevent others from infringing on our proprietary rights. We cannot be certain that our patents or patents that we license from others will be enforceable and afford protection against competitors. Our patents or patent applications, if issued, may be challenged, invalidated or circumvented. Our patent rights may not provide us with proprietary protection or competitive advantages against competitors with similar technologies. Others may independently develop technologies 30 31 similar to ours or independently duplicate our technologies. Due to the extensive time required for development, testing and regulatory review of our potential products, our patents may expire or remain in existence for only a short period following commercialization. This would reduce or eliminate any advantage of the patents. We cannot be certain that we were the first to make the inventions covered by each of our issued or pending patent applications or that we were the first to file patent applications for such inventions. We may need to license the right to use third-party patents and intellectual property to continue development and marketing of our products. We may not be able to acquire such required licenses on acceptable terms, if at all. If we do not obtain such licenses, we may need to design around other parties' patents or we may not be able to proceed with the development, manufacture or sale of our products. We may face litigation to defend against claims of infringement, assert claims of infringement, enforce our patents, protect our trade secrets or know-how, or determine the scope and validity of others' proprietary rights. Patent litigation is costly. In addition, we may require interference proceedings declared by the United States Patent and Trademark Office to determine the priority of inventions relating to our patent applications. Litigation or interference proceedings could have a material adverse effect on our business, financial condition and results of operations and could be unsuccessful in our efforts to enforce our intellectual property rights. WE MAY BE LIABLE IF OUR PRODUCTS HARM PEOPLE. We are exposed to potential liability risks inherent in the testing and marketing of medical devices and products. We may be liable if any of our products causes injury, illness or death. We intend to obtain product liability insurance before the commercial introduction of any product, but do not know whether we will be able to obtain and maintain such insurance on acceptable terms. Any insurance we obtain may not provide adequate coverage against potential liabilities. A liability claim, regardless of merit or eventual outcome, could materially adversely affect our business, results of operation and financial condition. WE USE HAZARDOUS SUBSTANCES THAT ARE SUBJECT TO ENVIRONMENTAL REGULATION. Our research and development involves the controlled use of hazardous materials, including certain hazardous chemicals, radioactive materials and pathogens. Accordingly, we are subject to federal, state and local laws governing the use, handling and disposal of these materials. We may incur significant costs to comply with additional environmental and health and safety regulations in the future. Although we believe that our safety procedures for handling and disposing of hazardous materials comply with regulatory requirements, we cannot eliminate the risk of accidental contamination or injury. If an accident occurs, we could be held liable for any damages that result. THE MARKET PRICE OF OUR STOCK MAY BE HIGHLY VOLATILE. The market prices for securities of emerging medical device and biotechnology companies like us have been highly volatile. Announcements may have a significant impact on the market price of our common stock. Such announcements may include: - biological or medical discoveries, - technological innovations or new commercial services by us or our competitors, - developments concerning proprietary rights, including patents and litigation matters, - regulatory developments in both the United States and foreign countries, - public concern as to the safety of new technologies, - general market conditions, - comments made by analysts, including changes in analysts' estimates of our financial performance, and - quarterly fluctuations in our revenue and financial results. 31 32 The stock market has from time to time experienced extreme price and volume fluctuations, which have particularly affected the market prices for emerging biotechnology and medical device companies, and which have often been unrelated to the operating performance of such companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, following periods of volatility in the market price of a company's stock, securities class action litigation has occurred against the issuing company. Such litigation could result in substantial costs and a diversion of management's attention and resources, which could have a material adverse effect on our revenue and earnings. Any adverse determination in such litigation could also subject us to significant liabilities. DELAWARE LAW, PROVISIONS IN OUR CHARTER AND OUR RIGHTS PLAN COULD MAKE THE ACQUISITION OF OUR COMPANY BY ANOTHER COMPANY MORE DIFFICULT. Provisions of our certificate of incorporation may have the effect of delaying or preventing changes in control or management or limit the price that investors may be willing to pay for shares of our common stock. We also are subject to the provisions of Section 203 of the Delaware General Corporation Law, an anti-takeover law, which could delay a merger, tender offer to proxy contest or make a similar transaction more difficult. In addition, our board of directors has the authority to issue up to 5,000,000 shares of preferred stock without stockholders' approval, of which 8,327 shares currently are outstanding. The rights of the holders of common stock will be subject to, and may be affected by, the rights of the holders of outstanding preferred stock and any preferred stock that may be issued in the future. The issuance of preferred stock could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. Also, in November 1999, our board of directors adopted a stockholder rights plan, or "poison pill," which has anti-takeover effects. ITEM 2. PROPERTIES Cerus leases approximately 17,400 square feet for its main facility and approximately 9,900 square feet for an additional facility, both of which contain laboratory and office space, in Concord, California. The lease of the main facility extends through June 2004 with one five-year renewal option. The lease of the additional facility extends through January 2005. Cerus also has a lease for approximately 11,300 square feet at a facility located near its main facility in Concord. The lease extends through August 31, 2000, with options to renew for five additional one-year periods. In addition, Cerus has a lease for 21,400 square feet of office space in a office building currently under construction near its main facility in Concord. This lease extends through July 2004, with options to renew for two additional three-year periods. Cerus expects to be able to occupy this space in September 2000. Cerus believes that its facilities will be adequate to meet its needs for the foreseeable future. ITEM 3. LEGAL PROCEEDINGS Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 32 33 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (a) Cerus' common stock is traded on the Nasdaq National Market under the symbol "CERS." Cerus completed the initial public offering of its common stock on January 30, 1997. The following table sets forth, for the periods indicated, the high and low sales prices for the common stock as reported by the Nasdaq National Market:
HIGH LOW ------ --- Year Ended December 31, 1998: First Quarter............................................. $22 1/2 $14 1/2 Second Quarter............................................ 16 7/8 12 Third Quarter............................................. 25 13 1/4 Fourth Quarter............................................ 21 11 1/4 Year Ended December 31, 1999: First Quarter............................................. 33 7/8 19 Second Quarter............................................ 24 3/4 15 1/4 Third Quarter............................................. 29 3/8 20 3/8 Fourth Quarter............................................ 31 1/8 20 13/16
On March 24, 2000, the last reported sale price of Cerus' common stock on the Nasdaq National Market was $49.00 per share. On March 24, 2000, Cerus had approximately 207 holders of record of common stock. Cerus has not paid dividends on its common stock and does not intend to pay cash dividends on its common stock in the foreseeable future. (b) On February 16, 2000, Cerus sold 1,000,000 shares of unregistered common stock to selected institutional and other accredited investors, including Baxter Healthcare Corporation, for an aggregate purchase price of $25 million. Such sale of common stock was exempt from registration under the Securities Act pursuant to Section 4(2) thereof, as a transaction not involving any public offering. 33 34 ITEM 6. SELECTED FINANCIAL DATA The following table summarizes certain selected financial data for the fiscal year ended December 31, 1999. The information presented should be read in conjunction with the financial statements and notes included elsewhere herein. The selected financial data for the periods prior to the financial statements included herein are derived from audited financial statements.
YEARS ENDED DECEMBER 31, ------------------------------ 1999 1998 1997 1996 1995 -------- -------- -------- -------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Revenue.................................... $ 2,408 $ 2,903 $ 6,851 $ 3,609 $ 6,799 Operating expenses: Research and development................... 22,514 29,783 19,569 12,080 8,125 General and administrative................. 4,837 3,841 3,163 2,200 1,517 -------- -------- -------- -------- ------- Total operating expenses........... 27,351 33,624 22,732 14,280 9,642 -------- -------- -------- -------- ------- Loss from operations....................... (24,943) (30,721) (15,881) (10,671) (2,843) Net interest income........................ 2,315 1,163 1,217 464 483 -------- -------- -------- -------- ------- Net loss................................... $(22,628) $(29,558) $(14,664) $(10,207) $(2,360) ======== ======== ======== ======== ======= Net loss per share-basic and diluted(1).... $ (2.04) $ (3.17) $ (1.76) $ (5.98) $ (1.67) Shares used in computing net loss per share-basic and diluted(1).............. 11,102 9,325 8,352 1,706 1,414
AS OF DECEMBER 31, --------------------------------------------------- 1999 1998 1997 1996 1995 -------- -------- -------- -------- ------- (IN THOUSANDS) BALANCE SHEET DATA: Cash, cash equivalents and short-term investments............................. $ 40,419 $ 19,802 $ 21,581 $ 6,002 $ 9,659 Working capital............................ 31,951 537 21,374 2,653 7,263 Total assets............................... 41,780 20,934 27,315 8,812 11,349 Capital lease obligations, less current portion................................. 115 12 43 92 32 Redeemable convertible preferred stock..... 5,000 5,000 -- -- -- Accumulated deficit........................ (87,518) (64,428) (34,870) (20,206) (9,999) Total stockholders' equity (deficit)....... 27,959 (3,656) 22,475 4,839 8,663
- --------------- (1) See Note 1 of Notes to Financial Statements for a description of the method used in computing the net loss per share. 34 35 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of the financial condition and results of operations of Cerus should be read in conjunction with the Financial Statements and Notes thereto included elsewhere in this report. This report contains forward-looking statements that involve risks and uncertainties. Cerus' actual results could differ significantly from those discussed in these forward-looking statements as a result of certain factors, including those set forth under "Risk Factors" and elsewhere in this report. OVERVIEW Since its inception in 1991, Cerus has devoted substantially all of its efforts and resources to the research, development and clinical testing of systems based on its platform technologies, which prevent nucleic acid (DNA and RNA) replication. Cerus has been unprofitable since inception and, as of December 31, 1999, had an accumulated deficit of approximately $87.5 million. All of Cerus' systems are in the research and development stage, and Cerus has not received any revenue from product sales. Cerus will be required to conduct significant research, development, pre-clinical and clinical evaluation and regulatory compliance activities on these systems that, together with anticipated general and administrative expenses, are expected to result in substantial losses at least until after commercialization of its products under development. Cerus' ability to achieve a profitable level of operations in the future will depend on its ability to successfully complete development, obtain regulatory approvals and achieve market acceptance of its pathogen inactivation systems. Cerus may never achieve a profitable level of operations. Further, under the agreements discussed below, a significant portion of Cerus' development funding is provided by Baxter based on an annual budgeting process. There can be no assurance that these agreements will not be modified or terminated. Agreement with Baxter for the development of pathogen inactivation systems for platelets. Cerus has a development and commercialization agreement with Baxter for the joint development of a system for inactivation of viruses, bacteria and other infectious pathogens in platelets used for transfusion (the "Platelet Agreement"). The Platelet Agreement provides for Baxter and Cerus to generally share system development costs equally, subject to mutually determined budgets established from time to time, and for Cerus to receive 33.5% of revenue from sales of inactivation system disposables after each party is reimbursed for its cost of goods above a specified level. The Platelet Agreement also provides for Baxter to make a $5 million cash milestone payment to Cerus upon approval by the FDA of an application to market products developed under the platelet program, comparable approval in Europe or termination of the platelet system development program. Cerus has received a $1.0 million equity investment under the Platelet Agreement from Baxter and has recognized $14.7 million in revenue from Baxter cumulatively through December 31, 1999, including $3.0 million in license fees, $2.5 million in milestone payments and $9.2 million in development funding. License fees and payments for achieved milestones are non-refundable and are not subject to future performance. Development funding is in the form of balancing payments made by Baxter to Cerus, if necessary, to reimburse Cerus for development spending in excess of the levels agreed to by Baxter and Cerus. Development funding revenue is recognized as the related project costs are incurred. Agreement with Baxter for the development of pathogen inactivation systems for red blood cells and FFP. Cerus also has a development and commercialization agreement with Baxter for the joint development of systems for inactivation of viruses, bacteria and other infectious pathogens in red blood cells and fresh frozen plasma (FFP) (the "RBC/FFP Agreement"). The RBC/FFP Agreement provides for Baxter and Cerus generally to share red blood cell system development costs equally, subject to mutually determined budgets established from time to time. The RBC/ FFP Agreement also provides for an equal sharing of revenue from sales of red blood cell inactivation disposables after each party is reimbursed for its cost of goods and a specified percentage allocation, not to exceed 14% of revenue, is retained by Baxter for marketing and administrative expenses. Under the RBC/FFP Agreement, Cerus and Baxter equally funded the FFP program development through December 31, 1997, after which time Baxter's funding commitment for the FFP development 35 36 program was limited to $1.2 million, which offset payments owed to Baxter in January 1999 and January 2000. Baxter has an exclusive, worldwide distribution license and will be responsible for manufacturing and marketing the FFP product. The RBC/FFP Agreement also provides for Cerus to receive 75% and Baxter to receive 25% of revenue from sales of FFP inactivation system disposables after each party is reimbursed for its cost of goods and a specified percentage allocation, not to exceed 14% of revenue, is retained by Baxter for marketing and administrative expenses. Under the RBC/FFP Agreement, Cerus received $16.0 million in equity investments from Baxter and recognized $7.5 million in revenue from Baxter cumulatively through December 31, 1999 to fund the development of the red blood cell and FFP systems. Development funding is in the form of payments made by Baxter to Cerus, if necessary, to reimburse Cerus for development spending in excess of the levels agreed to by Baxter and Cerus. Development funding revenue is recognized as the related project costs are incurred. Agreement with the Consortium for Plasma Science. In December 1998, Cerus and the Consortium entered into an agreement for the development of a pathogen inactivation system for source plasma used for fractionation. The Consortium is co-funded by four plasma fractionation companies: Alpha Therapeutics Corporation, Aventis Behring, Bayer Corporation and Baxter. The Consortium, which is a separate entity from its members, provides research and development funding worldwide for technologies to improve the safety of plasma derivative products. Under the agreement, the Consortium is funding development of Cerus' proprietary technology for use with source plasma, subject to an annual review process. Subject to the Consortium meeting certain funding requirements, Cerus will pay the Consortium a royalty based on a percentage of product sales, if any. The initial term of the agreement expires on June 30, 2000. There is no guarantee that the agreement will be renewed. RESULTS OF OPERATIONS 1999 COMPARED WITH 1998 Revenue. Cerus anticipates that its sources of revenue until product sales occur will be limited to payments under collaboration agreements, including Cerus' development and commercialization agreements with Baxter and development agreement with the Consortium, and payments from the United States government under research grant programs. For the year ended December 31, 1999, development revenue from Baxter and the Consortium decreased 20% to $1.7 million from $2.1 million for 1998. Revenue earned under the agreements with Baxter is dependent on the relative spending by Cerus and Baxter on the programs for which development costs are shared. The decrease in revenue from Baxter was primarily a result of Cerus being solely responsible for funding the FFP program in 1999, whereas Baxter partially funded this program in 1998. Additionally, development revenue from Baxter for the red blood cell pathogen inactivation system for 1999 was significantly less than in 1998, as Baxter's relative share of expenses for this program increased in 1999. Decreased revenue from Baxter was partially offset by $0.8 million of development revenue from the Consortium in 1999. Cerus did not recognize any revenue from the Consortium in 1998. Government grant revenue decreased 8% to $0.7 million for 1999, compared to $0.8 million for 1998. Cerus' current government grant expires in 2002. There can be no assurance that Cerus will receive additional government grants in the future. Research and Development Expenses. Research and development expenses decreased 24% to $22.5 million for 1999 from $29.8 million for 1998. The decrease was primarily due to a one-time expense of $8.3 million in 1998 which related to Cerus' purchase of an increased share of future platelet pathogen inactivation system revenue. In addition, Cerus incurred research and development expenses during 1998 related to an amendment to the Platelet Agreement, under which Cerus funded $5 million of development costs previously to be funded by Baxter. In 1999, Cerus and Baxter shared the development costs of the platelet program equally. Excluding the effects of these items in 1998, research and development expenses increased, due to the addition of scientific personnel, increased costs for toxicology studies and clinical trials and increased expenses incurred for fee-for-service development activities at Baxter relating to the FFP program. Cerus anticipates that its research and development expenses will continue to increase as Phase 3 36 37 clinical trials of its platelet and FFP systems continue, and as research and development activity relating to its other programs increases. General and Administrative Expenses. General and administrative expenses increased 26% to $4.8 million for 1999 from $3.8 million for 1998. The increase was primarily attributable to increased personnel levels associated with the expansion of Cerus' operations. Cerus expects its general and administrative expenses to continue to increase as it expands its development activities. Net Interest Income. Net interest income increased 99% to $2.3 million for 1999 from $1.2 million for 1998. The increase was attributable primarily to increased average cash balances related to proceeds from Cerus' public offering of common stock in April 1999 and private placements of common and preferred stock to Baxter. Cerus typically maintains substantial balances of cash equivalents and short-term investments to fund future research and development activities. Cerus expects to earn interest at market rates in proportion to the securities balances it maintains. 1998 COMPARED WITH 1997 Revenue. For 1998 and 1997, Cerus primary source of revenue was development funding from Baxter. Revenue earned under the agreements with Baxter is dependent on the relative spending by Cerus and Baxter on the programs for which development costs are shared. For the year ended December 31, 1998, development revenue from Baxter decreased 66% to $2.1 million from $6.2 million for 1997. The decrease was primarily due to an increase in Baxter's relative share of development expenses for the platelet and red blood cell programs, and Cerus' agreement to fund a portion of Baxter's development commitment for the platelet system in 1998. Government grant revenue increased 18% to $0.8 million for 1998, compared to $0.7 million for 1997. Research and Development Expenses. Research and development expenses increased 52% to $29.8 million for 1998 from $19.6 million for 1997. The increase was primarily due to increased third-party costs relating to toxicology studies and clinical trials, and costs related to increased personnel. In addition, under amendments to the Platelet Agreement, Cerus recognized research and development expenses in 1998 and 1997 of $8.3 million and $5.5 million, respectively, to increase its share of platelet pathogen inactivation system adjusted product revenue from 26.0% to 33.5%. General and Administrative Expenses. General and administrative expenses increased 21% to $3.8 million for 1998 from $3.2 million for 1997. The increase was primarily attributable to increased personnel levels associated with the expansion of Cerus' operations. Net Interest Income. Net interest income, relatively unchanged between the two years, was $1.2 million in 1998 and 1997. LIQUIDITY AND CAPITAL RESOURCES Cerus' sources of capital to date have consisted of public and private placements of equity securities, development funding by Baxter and the Consortium, United States government grants and interest income. To date, Cerus has not received any revenue from product sales, and it will not derive revenue from product sales unless and until one or more planned products receives regulatory approval and achieves market acceptance. In March 1999, Baxter purchased 3,327 shares of Series B preferred stock for an aggregate purchase price of $9.5 million. From April 1999 until March 2000, a premium equal to 7% per annum on the purchase price is being accrued. The premium is payable in cash to Baxter in March 2000. At any time after one year from issuance, the holder may convert the Series B preferred stock into 332,700 common shares. Cerus has the right to redeem the Series B preferred stock prior to conversion for a payment to Baxter equal to the aggregate purchase price of the shares redeemed. In April 1999, Cerus completed a public offering of 2,200,000 shares of common stock at $21.00 per share and received net proceeds of $42.7 million, after deducting offering expenses. Also in April 1999, Cerus 37 38 sold 62,912 shares of common stock to Baxter pursuant to Cerus' achievement of a milestone under the RBC/ FFP Agreement. The purchase price was $31.79 per share, for an aggregate purchase price of $2.0 million. At December 31, 1999, Cerus had cash, cash equivalents and short-term investments of approximately $40.4 million. In February 2000, Cerus completed a private placement of 1,000,000 shares of common stock at $25.00 per share and received net proceeds of approximately $23.5 million, after deducting estimated offering expenses. The shares were purchased by institutional and other accredited investors, including Baxter, which purchased 390,000 shares. Net cash used in operating activities was approximately $33.3 million in 1999, compared to $9.7 million in 1998. The use of cash primarily resulted from a net loss of $22.6 million and a decrease in accounts payable to Baxter of $12.2 million. Accounts payable to Baxter decreased primarily due to payments to Baxter in 1999. Net cash used in investing activities in 1999 of approximately $23.9 million resulted principally from purchases of $71.9 million of short-term investments offset by the sale and maturities of $48.6 million of short-term investments and the purchase of $0.7 million of furniture and equipment. Working capital increased to $32.0 million at December 31, 1999 from $0.5 million at December 31, 1998, primarily due to increases in short-term investments balances and the decrease in accounts payable to Baxter. Cerus believes that its available cash balances, together with cash flows from existing development and grant arrangements, will be sufficient to meet its capital requirements for at least the next twelve months. These near-term capital requirements are dependent on various factors, including the development progress of Cerus' pathogen inactivation systems and other programs; payments by Baxter and the Consortium; and costs related to creating, maintaining and defending Cerus' intellectual property position. Cerus' long-term capital requirements will be dependent on these factors and on Cerus' ability to raise capital through public or private equity or debt financings or through additional collaborative arrangements or government grants, the achievement of milestones, regulatory approval and successful commercialization of Cerus' pathogen inactivation systems and other products under development, competitive developments and regulatory factors. Future capital funding transactions may result in dilution to investors in Cerus. Capital may not be available on favorable terms, or at all. There can be no assurance that Cerus will be able to meet its capital requirements for this or any other period. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Cerus maintains an investment portfolio of various issuers, types and maturities. These securities are generally classified as available for sale and, consequently, are recorded on the balance sheet at fair value with unrealized gains or losses reported as a separate component of stockholders' equity, if material. Unrealized gains and losses at December 31, 1999 and 1998 were not material. Cerus' investments primarily consist of short-term money market mutual funds, United States and state government obligations and commercial paper. Of Cerus' investments balance of $40.4 million at December 31, 1999, approximately 9% have original maturity dates of less than 90 days, 55% have original maturities of 90 days to one year and the remaining balance have maturities of two years or less. Cerus does not believe its exposure to interest rate risk to be material given the short-term nature of its investment portfolio. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA The Company's financial statements, together with related notes and report of Ernst & Young LLP, independent auditors, are listed in Item 14(a) and included herein beginning on page 42. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 38 39 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding the Company's directors and officers, and the compliance of certain reporting persons with Section 16(a) of the Securities Exchange Act of 1934 will be set forth under the captions "Election of Directors," "Management" and "Compliance with the Reporting Requirements of Section 16(a)" in the Company's proxy statement for use in connection with the Annual Meeting of Stockholders to be held on May 11, 2000 (the "2000 Proxy Statement") and is incorporated herein by reference. The 2000 Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of the Company's fiscal year. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated herein by reference from the information set forth under the caption "Executive Compensation" in the 2000 Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated herein by reference from the information set forth under the caption "Security Ownership of Certain Beneficial Owners and Management" in the 2000 Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated herein by reference from the information set forth under the option "Certain Transactions" in the 2000 Proxy Statement. 39 40 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K The following documents are being filed as part of this report on Form 10-K: (a) Financial Statements.
PAGE ---- Report of Ernst & Young LLP, Independent Auditors........... 42 Balance Sheets as of December 31, 1999 and 1998............. 43 Statements of Operations for the three years ended December 31, 1999.................................................. 44 Statements of Stockholders' Equity (Deficit) for the three years ended December 31, 1999............................. 45 Statements of Cash Flows for the three years ended December 31, 1999.................................................. 46 Notes to Financial Statements............................... 47
Other information is omitted because it is either presented elsewhere, is inapplicable or is immaterial as defined in the instructions. (b) The Company filed a report on Form 8-K, dated November 3, 1999, reporting adoption of a Stockholder Rights Plan. (c) Exhibits
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------- ---------------------- 3.1.1(4) Restated Certificate of Incorporation of Cerus Corporation, as amended to date. 3.2(1) Bylaws of Cerus. 10.1(1) Form of Indemnity Agreement entered into between Cerus and each of its directors and executive officers. 10.2(1) 1996 Equity Incentive Plan. 10.3(1) Form of Incentive Stock Option Agreement under the 1996 Equity Incentive Plan. 10.4(1) Form of Nonstatutory Stock Option Agreement under the 1996 Equity Incentive Plan. 10.5(1) 1996 Employee Stock Purchase Plan Offering. 10.14(1) Series E Preferred Stock Purchase Agreement, dated April 1, 1996, between Cerus and Baxter Healthcare Corporation. 10.15(1) Common Stock Purchase Agreement, dated September 3, 1996 between Cerus and Baxter Healthcare Corporation. 10.16(1) Amended and Restated Investors' Rights Agreement, dated April 1, 1996, among Cerus and certain investors. 10.17+(1) Development, Manufacturing and Marketing Agreement, dated December 10, 1993 between Cerus and Baxter Healthcare Corporation. 10.21(1) Industrial Real Estate Lease, dated October 1, 1992, between Cerus and Shamrock Development Company, as amended on May 16, 1994 and December 21, 1995. 10.22(1) Real Property Lease, dated August 8, 1996, between the Registrant and S.P. Cuff. 10.23(1) Lease, dated February 1, 1996, between Cerus and Holmgren Partners. 10.24(1) First Amendment to Common Stock Purchase Agreement, dated December 9, 1996, between Cerus and Baxter Healthcare Corporation. 10.25+(1) Amendment, dated as of January 3, 1997, to the Agreement filed as Exhibit 10.17. 10.26(1) Memorandum of Agreement, dated as of January 3, 1997, between Cerus and Baxter Healthcare Corporation. 10.27+ License Agreement, dated as of November 30, 1992, by and among the Company, Miles Inc. and Diamond Scientific Corporation. 10.28+(2) Amendment to Development, Manufacturing and Marketing Agreement, dated as of March 6, 1998, by and between Cerus and Baxter Healthcare Corporation.
40 41
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------- ---------------------- 10.29(3) Series A Preferred Stock Purchase Agreement, dated as of June 30, 1998, by and between Cerus and Baxter Healthcare Corporation. 10.30(3) Series B Preferred Stock Purchase Agreement, dated as of June 30, 1998, by and between Cerus and Baxter Healthcare Corporation. 10.31(3) Memorandum of Agreement, dated as of June 30, 1998, by and between Cerus and Baxter Healthcare Corporation. 10.32(3) Second Amendment to Development, Manufacturing and Marketing Agreement, dated as of June 30, 1998, by and between Cerus and Baxter Healthcare Corporation. 10.33+(3) Development, Manufacturing and Marketing Agreement, dated April 1, 1996, by and between Cerus and Baxter Healthcare Corporation, as amended and restated June 30, 1998. 10.34(4) Stockholder Rights Plan, dated November 3, 1999. 23.1 Consent of Ernst & Young LLP, Independent Auditors. 27.1 Financial Data Schedule.
- --------------- + Certain portions of this exhibit are subject to a confidential treatment order. (1) Incorporated by reference to Cerus' Registration Statement on Form S-1 (File No. 333-11341) and amendments thereto. (2) Incorporated by reference to Cerus' Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (3) Incorporated by reference to Cerus' Current Report on Form 8-K, dated June 30, 1998. (4) Incorporated by reference to Cerus' Current Report on Form 8-K, dated November 3, 1999. 41 42 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Stockholders Cerus Corporation We have audited the accompanying balance sheets of Cerus Corporation as of December 31, 1999 and 1998, and the related statements of operations, stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 1999. 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 auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Cerus Corporation at December 31, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States. /s/ ERNST & YOUNG LLP Walnut Creek, California January 27, 2000, except for Note 9, as to which the date is February 16, 2000 42 43 CERUS CORPORATION BALANCE SHEETS ASSETS
DECEMBER 31, ---------------------------- 1999 1998 ------------ ------------ Current assets: Cash and cash equivalents................................. $ 3,537,134 $ 6,161,088 Short-term investments.................................... 36,881,664 13,640,945 Other current assets...................................... 238,436 312,398 ------------ ------------ Total current assets................................... 40,657,234 20,114,431 Furniture and equipment at cost: Laboratory and office equipment........................... 2,229,818 1,458,084 Leasehold improvements.................................... 1,668,351 1,597,520 ------------ ------------ 3,898,169 3,055,604 Less accumulated depreciation and amortization............ 2,899,121 2,330,876 ------------ ------------ Net furniture and equipment................................. 999,048 724,728 Other assets................................................ 123,968 94,536 ------------ ------------ Total assets...................................... $ 41,780,250 $ 20,933,695 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable to a related party....................... $ 531,474 $ 12,718,801 Accounts payable.......................................... 1,479,905 1,335,776 Accrued compensation and related expenses................. 1,130,829 982,458 Accrued contract research expenses........................ 3,157,359 2,571,000 Accrued cash dividend on preferred stock, payable to a related party.......................................... 462,414 -- Other accrued expenses.................................... 1,913,032 1,939,016 Current portion of capital lease obligations.............. 31,138 30,792 ------------ ------------ Total current liabilities.............................. 8,706,151 19,577,843 Capital lease obligations, less current portion............. 115,022 12,211 Commitments and contingencies Redeemable convertible preferred stock, $.001 par value; 5,000,000 shares authorized: issuable in series; 5,000 shares issued and outstanding at December 31, 1999 and 1998; aggregate liquidation preference of $5,000,000 at December 31, 1999 and 1998................................ 5,000,000 5,000,000 Stockholders' equity (deficit): Preferred stock: issuable in series; 3,327 shares issued and outstanding at December 31, 1999 and none at December 31, 1998; aggregate liquidation preference of $9,495,996 at December 31, 1999........................ 9,495,996 -- Common stock, $.001 par value; 50,000,000 shares authorized: 11,744,092 and 9,416,843 shares issued and outstanding at December 31, 1999 and 1998, respectively.......... 11,744 9,417 Additional paid-in capital................................ 105,976,758 60,813,174 Deferred compensation..................................... (7,089) (50,853) Accumulated deficit....................................... (87,518,332) (64,428,097) ------------ ------------ Total stockholders' equity (deficit)................... 27,959,077 (3,656,359) ------------ ------------ Total liabilities and stockholders' equity (deficit)....................................... $ 41,780,250 $ 20,933,695 ============ ============
See accompanying notes. 43 44 CERUS CORPORATION STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, -------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Revenue: Licenses, milestones and development funding from related parties........................ $ 1,692,787 $ 2,127,413 $ 6,190,781 Government grants.............................. 715,546 775,886 660,066 ------------ ------------ ------------ Total revenue.......................... 2,408,333 2,903,299 6,850,847 Operating expenses: Research and development....................... 22,513,960 29,783,285 19,569,469 General and administrative..................... 4,837,490 3,840,816 3,163,012 ------------ ------------ ------------ Total operating expenses............... 27,351,450 33,624,101 22,732,481 ------------ ------------ ------------ Loss from operations............................. (24,943,117) (30,720,802) (15,881,634) Interest income (expense): Interest income................................ 2,336,623 1,171,903 1,232,322 Interest expense............................... (21,327) (9,153) (14,901) ------------ ------------ ------------ Net interest income.............................. 2,315,296 1,162,750 1,217,421 ------------ ------------ ------------ Net loss......................................... $(22,627,821) $(29,558,052) $(14,664,213) ============ ============ ============ Net loss per share -- basic and diluted.......... $ (2.04) $ (3.17) $ (1.76) ============ ============ ============ Shares used in computing net loss per share -- basic and diluted.............................. 11,102,226 9,325,269 8,351,872 ============ ============ ============
See accompanying notes. 44 45 CERUS CORPORATION STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
NOTES PREFERRED STOCK COMMON STOCK ADDITIONAL RECEIVABLE ----------------------- -------------------- PAID-IN DEFERRED FROM SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION STOCKHOLDERS ---------- ---------- ---------- ------- ------------ ------------ ------------ Balances at December 31, 1996...................... 3,001,630 $ 3,002 1,928,807 $ 1,929 $ 25,425,529 $(310,387) $(75,206) Public offering of common stock, net of expenses of $2,945,259................ -- -- 2,000,000 2,000 21,052,741 -- -- Issuance of common stock.... -- -- 714,080 714 10,542,502 -- -- Conversion of preferred stock..................... (3,001,630) (3,002) 4,412,243 4,412 (3,118) -- -- Issuance of common stock under stock option and employee stock purchase plans and warrant exercises................. -- -- 129,664 130 459,754 -- -- Common shares reacquired.... -- -- (1,165) (1) (633) -- -- Payment on notes receivable................ -- -- -- -- -- -- 75,206 Amortization of deferred compensation.............. -- -- -- -- -- 169,450 -- Net loss.................... -- -- -- -- -- -- -- ---------- ---------- ---------- ------- ------------ --------- -------- Balances at December 31, 1997...................... -- -- 9,183,629 9,184 57,476,775 (140,937) -- Issuance of common stock.... -- -- 159,595 159 2,975,470 -- -- Issuance of common stock under stock option and employee stock purchase plans and warrant exercises................. -- -- 77,984 78 364,767 -- -- Common shares reacquired.... -- -- (4,365) (4) (3,838) -- -- Amortization of deferred compensation.............. -- -- -- -- -- 90,084 -- Net loss.................... -- -- -- -- -- -- -- ---------- ---------- ---------- ------- ------------ --------- -------- Balances at December 31, 1998...................... -- -- 9,416,843 9,417 60,813,174 (50,853) -- Issuance of common stock.... -- -- 62,912 62 1,999,911 -- -- Public offering of common stock, net of expenses of $3,523,556................ -- -- 2,200,000 2,200 42,674,244 -- -- Issuance of Series B preferred stock........... 3,327 9,495,996 -- -- -- -- -- Issuance of common stock under stock option and employee stock purchase plans and warrant exercises................. -- -- 78,770 79 499,724 -- -- Common shares reacquired.... -- -- (14,433) (14) (10,295) -- -- Accretion of cash dividend on preferred stock........ -- -- -- -- -- -- -- Amortization of deferred compensation.............. -- -- -- -- -- 43,764 -- Net loss.................... -- -- -- -- -- -- -- ---------- ---------- ---------- ------- ------------ --------- -------- Balances at December 31, 1999...................... 3,327 $9,495,996 11,744,092 $11,744 $105,976,758 $ (7,089) $ -- ========== ========== ========== ======= ============ ========= ======== TOTAL ACCUMULATED STOCKHOLDERS' DEFICIT EQUITY (DEFICIT) ------------ ---------------- Balances at December 31, 1996...................... $(20,205,832) $ 4,839,035 Public offering of common stock, net of expenses of $2,945,259................ -- 21,054,741 Issuance of common stock.... -- 10,543,216 Conversion of preferred stock..................... -- (1,708) Issuance of common stock under stock option and employee stock purchase plans and warrant exercises................. -- 459,884 Common shares reacquired.... -- (634) Payment on notes receivable................ -- 75,206 Amortization of deferred compensation.............. -- 169,450 Net loss.................... (14,664,213) (14,664,213) ------------ ------------ Balances at December 31, 1997...................... (34,870,045) 22,474,977 Issuance of common stock.... -- 2,975,629 Issuance of common stock under stock option and employee stock purchase plans and warrant exercises................. -- 364,845 Common shares reacquired.... -- (3,842) Amortization of deferred compensation.............. -- 90,084 Net loss.................... (29,558,052) (29,558,052) ------------ ------------ Balances at December 31, 1998...................... (64,428,097) (3,656,359) Issuance of common stock.... -- 1,999,973 Public offering of common stock, net of expenses of $3,523,556................ -- 42,676,444 Issuance of Series B preferred stock........... -- 9,495,996 Issuance of common stock under stock option and employee stock purchase plans and warrant exercises................. -- 499,803 Common shares reacquired.... -- (10,309) Accretion of cash dividend on preferred stock........ (462,414) (462,414) Amortization of deferred compensation.............. -- 43,764 Net loss.................... (22,627,821) (22,627,821) ------------ ------------ Balances at December 31, 1999...................... $(87,518,332) $ 27,959,077 ============ ============
See accompanying notes. 45 46 CERUS CORPORATION STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, ------------------------------------------ 1999 1998 1997 ------------ ------------ ------------ OPERATING ACTIVITIES Net loss............................................. $(22,627,821) $(29,558,052) $(14,664,213) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization...................... 568,245 611,892 562,066 Amortization of deferred compensation.............. 43,764 90,084 169,450 Accrued cash dividend on preferred stock, payable to a related party.............................. (462,414) -- -- Changes in operating assets and liabilities: Accounts receivable from a related party...... -- 4,376,141 (4,050,626) Other current assets.......................... 73,962 (97,711) (8,672) Other assets.................................. (29,432) 17,189 12,938 Accounts payable to a related party........... (12,187,327) 12,718,801 -- Accounts payable.............................. 144,129 36,908 907,601 Accrued compensation and related expenses..... 148,371 50,467 300,611 Accrued contract research expenses............ 586,359 1,675,000 41,700 Accrued cash dividend on preferred stock, payable to a related party................. 462,414 -- -- Other accrued expenses........................ (25,984) 338,514 1,085,654 Deferred revenue.............................. -- -- (981,523) ------------ ------------ ------------ Net cash used in operating activities................ (33,305,734) (9,740,767) (16,625,014) INVESTING ACTIVITIES Purchases of furniture and equipment................. (700,806) (304,791) (378,645) Purchases of short-term investments.................. (71,864,541) (29,261,767) (31,977,178) Sale of short-term investments....................... 4,114,471 -- 1,000,000 Maturities of short-term investments................. 44,509,351 25,598,000 21,000,000 ------------ ------------ ------------ Net cash used in investing activities................ (23,941,525) (3,968,558) (10,355,823) FINANCING ACTIVITIES Net proceeds from sale of preferred stock............ 9,495,996 5,000,000 -- Net proceeds from issuance of common stock........... 45,176,220 3,340,474 32,613,983 Payment of fractional shares on preferred stock conversion......................................... -- -- (1,708) Repurchase of common stock........................... (10,309) (3,842) (634) Payments on notes receivable from shareholders....... -- -- 75,206 Payments on capital lease obligations................ (38,602) (69,815) (104,464) ------------ ------------ ------------ Net cash provided by financing activities............ 54,623,305 8,266,817 32,582,383 ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents........................................ (2,623,954) (5,442,508) 5,601,546 Cash and cash equivalents, beginning of period....... 6,161,088 11,603,596 6,002,050 ------------ ------------ ------------ Cash and cash equivalents, end of period............. $ 3,537,134 $ 6,161,088 $ 11,603,596 ------------ ------------ ------------ Supplemental disclosures: Interest paid...................................... $ 21,327 $ 9,153 $ 14,901 ------------ ------------ ------------ Supplemental schedule of noncash investing and financing activities: Capital lease obligations incurred................. $ 141,759 $ -- $ 31,025 ------------ ------------ ------------ Conversion of preferred stock to common stock...... $ -- $ -- $ 24,534,998 ------------ ------------ ------------
See accompanying notes. 46 47 CERUS CORPORATION NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1999 1. THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION Cerus Corporation (the "Company") (formerly Steritech, Inc.), incorporated on September 19, 1991, is developing systems designed to improve the safety of transfusion blood products through inactivation of viruses, bacteria and other pathogens. In addition to systems to treat platelets, fresh frozen plasma ("FFP") and red blood cells intended for transfusion, the Company is developing a system to treat plasma derivative products. The Company's platform technologies, which prevent viral, bacterial and other cellular replication, have potential applications in the health care field beyond pathogen inactivation in blood components. The Company has collaboration agreements with Baxter Healthcare Corporation ("Baxter") and the Consortium for Plasma Science ("the Consortium") (see Note 2). The Company has not received any revenue from product sales, and all revenue recognized by the Company to date has resulted from the Company's agreements with Baxter and the Consortium and federal research grants. The Company will be required to conduct significant research, development, testing and regulatory compliance activities on its pathogen inactivation systems that, together with anticipated general and administrative expenses, are expected to result in substantial additional losses, and the Company may need to adjust its operating plans and programs based on the availability of cash resources. The Company's ability to achieve a profitable level of operations will depend on successfully completing development, obtaining regulatory approvals and achieving market acceptance of its pathogen inactivation systems. There can be no assurance that the Company will ever achieve a profitable level of operations. 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 at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. REVENUE AND RESEARCH AND DEVELOPMENT EXPENSES Development funding is in the form of payments made (i) by Baxter to the Company to reimburse the Company for development spending in excess of the levels determined by Baxter and the Company and (ii) by Baxter and the Consortium to reimburse the Company for certain fee-for-service development activities. Revenue related to the cost reimbursement provisions under development contracts is recognized as the costs on the project are incurred. Revenue related to milestones specified under development contracts is recognized as the milestones are achieved. License fees and payments for achieved milestones are non-refundable and are not subject to future performance. Research and development costs are expensed as incurred. Revenue recognized under agreements with Baxter and the Consortium for the years ended December 31, 1999, 1998 and 1997 consisted of the following:
1999 1998 1997 ---------- ---------- ---------- Licenses................................................... $ -- $ -- $ 981,523 Milestones................................................. -- -- 750,000 Development funding........................................ 1,692,787 2,127,413 4,459,258 ---------- ---------- ---------- Total licenses, milestones and development funding........................................ $1,692,787 $2,127,413 $6,190,781 ========== ========== ==========
The Company receives certain United States government grants which support the Company's research effort in defined research projects. These grants generally provide for reimbursement of approved costs 47 48 CERUS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) incurred as defined in the various grants. Revenue associated with these grants is recognized as costs under each grant are incurred. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS The Company considers all highly liquid investments with original maturities of less than three months to be cash and cash equivalents. Cash equivalents consist principally of short-term money market instruments and commercial paper. In accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company has classified all debt securities as available-for-sale at the time of purchase and reevaluates such designation as of each balance sheet date. The available-for-sale securities recorded at amounts which approximate fair value at December 31, 1999 and 1998 totaled $40,418,398 and $19,801,633, respectively. Unrealized gains and losses at December 31, 1999 and 1998 and realized gains and losses for the years then ended were not material. Accordingly, the Company has not made a provision for such amounts in its balance sheets. The cost of securities sold is based on the specific identification method. Substantially all of the Company's cash, cash equivalents and short-term investments are maintained by three major financial institutions. FURNITURE AND EQUIPMENT Furniture and equipment is stated at cost less accumulated depreciation and amortization. Depreciation on furniture and equipment is calculated on a straight-line basis over the estimated useful lives of the assets (generally three to five years). Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or the estimated useful lives of the improvements. STOCK-BASED COMPENSATION In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"). The Company adopted FAS 123 in 1996. The Company accounts for employee stock options in accordance with Accounting Principles Board Opinion No. 25 and has adopted the "disclosure only" alternative described in FAS 123. INCOME TAXES The Company accounts for income taxes based upon Financial Accounting Standards Board Statement No. 109, "Accounting for Income Taxes." Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. NET LOSS PER SHARE -- BASIC AND DILUTED The Company calculates basic and diluted earnings per share in accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("FAS 128"). Under FAS 128, basic earnings per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the assumed conversion of all dilutive securities, such as options, warrants, convertible debt and convertible preferred stock. Common stock equivalent shares from redeemable convertible preferred stock and from stock options and warrants are not included as the effect is anti-dilutive. 48 49 CERUS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) COMPREHENSIVE INCOME (LOSS) In 1997, the Financial Accounting Standards Board issued Statement No. 130, "Reporting Comprehensive Income" ("FAS 130"), which requires that all items that are required to be recognized under accounting standards as comprehensive income (revenues, expenses, gains and losses) be reported in a financial statement that is displayed with the same prominence as other financial statements. The Company does not have material components of other comprehensive income. Therefore, comprehensive loss is equal to net loss reported for all periods presented. DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE In 1997, the Financial Accounting Standards Board issued Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information," ("FAS 131"), which establishes standards for the way public business enterprises report information about operating segments in annual financial statements. The Company has one reportable operating segment under this statement, which is the development of biomedical systems to treat blood products, and the required disclosures are reflected in the financial statements. 2. LICENSING AGREEMENTS AGREEMENTS WITH BAXTER, A RELATED PARTY OF THE COMPANY The Company has a development and commercialization agreement with Baxter for the joint development of a system for inactivation of viruses, bacteria and other infectious pathogens in platelets used for transfusions (the "Platelet Agreement"). The Platelet Agreement provides for Baxter and Cerus to generally share system development costs equally, subject to mutually determined budgets established from time to time, and for the Company to receive 33.5% of revenue from sales of inactivation system disposables after each party is reimbursed for its cost of goods above a specified level. The Platelet Agreement also provides for Baxter to make a $5 million cash milestone payment to the Company upon approval by the FDA of an application to market products developed under the platelet program, comparable approval in Europe or termination of the platelet system development program. The Company also has a development and commercialization agreement with Baxter for the joint development of systems for inactivation of viruses, bacteria and other infectious pathogens in red blood cells and FFP for transfusion (the "RBC/FFP Agreement"). The RBC/FFP Agreement provides for Baxter and the Company generally to share red blood cell system development costs equally, subject to mutually determined budgets established from time to time. The RBC/FFP Agreement also provides for an equal sharing of revenue from sales of red blood cell inactivation system disposables after each party is reimbursed for its cost of goods and a specified percentage allocation is retained by Baxter for marketing and administrative expenses. Under the RBC/FFP Agreement, the Company and Baxter equally funded the FFP program development through December 31, 1997 after which time Baxter's funding commitment for the FFP development program was limited to $1.2 million. The RBC/FFP Agreement also provides for the Company to receive 75% and Baxter to receive 25% of revenue from sales of FFP inactivation system disposables after each party is reimbursed for its cost of goods and a specified percentage allocation not to exceed 14% of revenue is retained by Baxter for marketing and administrative expenses. Baxter will be responsible for manufacturing and marketing the FFP product, and will retain its exclusive, worldwide distribution license. As of December 31, 1999, the Company has received $37.0 million in equity investments from Baxter and has recognized approximately $22.2 million in revenue, since inception. Development funding is in the form of balancing payments made between Baxter and the Company to adjust the relative spending of the companies to the levels agreed to by Baxter and the Company and to reimburse each party for fee-for-service development activities. 49 50 CERUS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) As of December 31, 1999, Baxter owned 1,680,337 shares of the common stock of the Company, representing approximately 14.3% of the outstanding common stock. Baxter has agreed that it will not at any time, nor will it permit any of its affiliates, to acquire, other than by conversion of preferred stock, any capital stock of the Company if, after such acquisition, Baxter and its affiliates would own 20.1% or more of the outstanding voting power of the Company. Such restrictions on stock purchases will not apply in the event a third party makes a tender offer for a majority of the outstanding voting securities of the Company or if the Board of Directors of the Company determines to liquidate or sell to a third party substantially all of the assets or a majority of the voting securities of the Company or to approve a merger or consolidation in which the Company's stockholders will not own a majority of the voting securities of the surviving entity. AGREEMENT WITH THE CONSORTIUM FOR PLASMA SCIENCE In December 1998, the Company and the Consortium entered into an agreement for the development of a pathogen inactivation system for source plasma used for fractionation. The Consortium is co-funded by four plasma fractionation companies, one of which is Baxter, a related party of the Company. The Consortium, which is a separate entity from its members, provides research and development funding worldwide for technologies to improve the safety of plasma derivative products. Under the agreement, the Consortium is funding development of the Company's proprietary technology for use with source plasma, subject to an annual review process. The Company will pay the Consortium a royalty based on a percentage of product sales, if any, subject to the Consortium meeting certain funding requirements. The initial term of the agreement expires on June 30, 2000. There is no guarantee that the agreement will be renewed. 3. INVESTMENTS Available-for-sale securities are recorded at amounts which approximate fair market value. Realized and unrealized gains and losses at December 31, 1999 and 1998 were not material. Investments classified as available-for-sale were as follows:
DECEMBER 31, -------------------------- 1999 1998 ----------- ----------- Money market mutual funds................................. $ 1,045,320 $ 344,265 United States and state government obligations............ 9,615,817 3,001,128 Commercial paper.......................................... 29,757,261 16,456,240 ----------- ----------- Total investments......................................... 40,418,398 19,801,633 Less: amounts classified as cash equivalents.............. (3,536,734) (6,160,688) ----------- ----------- Short-term investments.................................... $36,881,664 $13,640,945 =========== ===========
4. COMMITMENTS AND CONTINGENCIES The Company leases its office facilities and certain equipment under non-cancelable operating leases with initial terms in excess of one year which require the Company to pay operating costs, property taxes, insurance and maintenance. These facility leases generally contain renewal options and provisions adjusting the lease payments. Capital lease obligations represent the present value of future rental payments under capital lease agreements for laboratory and office equipment. The original cost and accumulated amortization on the equipment under capital leases is $586,753 and $441,698, respectively, at December 31, 1999 and $444,994 and $373,071, respectively, at December 31, 1998. 50 51 CERUS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) Future minimum payments under capital and operating leases are as follows:
CAPITAL OPERATING YEAR ENDING DECEMBER 31, LEASES LEASES ------------------------ -------- ---------- 2000........................................................ $ 47,916 $ 531,927 2001........................................................ 45,120 682,941 2002........................................................ 39,528 682,941 2003........................................................ 39,528 682,941 2004........................................................ 19,763 412,031 Thereafter.................................................. -- 7,115 -------- ---------- Total minimum lease payments................................ 191,855 $2,999,896 ========== Amount representing interest................................ 45,695 -------- Present value of net minimum lease payments................. 146,160 Current portion............................................. 31,138 -------- Long-term portion........................................... $115,022 ========
Rent expense for office facilities and certain equipment was $520,994, $641,564 and $677,501 for the years ended December 31, 1999, 1998 and 1997, respectively. PATENT LICENSES The Company is a licensee under a license agreement with an unaffiliated company with respect to two United States patents covering inventions pertaining to psoralen-based photochemical decontamination treatment of whole blood or blood components and four United States patents relating to vaccines, as well as related foreign patents. Whether the Company's psoralen-based pathogen inactivation systems practice either of the photochemical decontamination patents depends on an interpretation of the scope of the patent claims. If such systems practice such patents, the license would provide for the Company to make certain milestone payments which may be credited against any royalties payable by the Company. The license requires a royalty payable by the Company on revenues from such systems and certain annual minimum royalty payments per year until termination of the license. The manner in which any such milestone payments and royalties would be shared by Baxter, if at all, has not been determined. The Company does not believe that any amounts that might be payable by it under the agreement to date would be material. 5. PREFERRED STOCK SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK In June 1998, the Company and Baxter entered into an agreement for Baxter to purchase 5,000 shares of Series A preferred stock at $1,000.00 per share. These shares were issued in July 1998. The holders of Series A preferred stock have no voting rights, except in certain instances. The Company may redeem all or a portion of these shares at the original issuance price upon achievement of certain milestones. If the shares are not redeemed upon achievement of these milestones, each share will be automatically converted into common shares equal to the original issuance price divided by 120% of the average closing price of the common stock. Upon termination of the Platelet Agreement, either the Company or the holders of the majority of outstanding Series A preferred stock may require the Company to redeem all Series A preferred stock at the original issuance price. If the shares are not redeemed upon termination, each share will be automatically converted into common shares equal to the original issuance price divided by the average closing price of the common stock. 51 52 CERUS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) SERIES B PREFERRED STOCK In March 1999, Baxter purchased 3,327 shares of Series B preferred stock for an aggregate purchase price of $9.5 million. From April 1999 until March 2000, a premium equal to 7.0% per annum on the purchase price is being accrued. The premium is payable in cash to Baxter in March 2000. At December 31, 1999, $462,414 has been accrued under this arrangement. At any time after one year from issuance, the holder may convert each share of Series B preferred stock into 100 common shares. The Company has the right to redeem the Series B preferred stock prior to conversion for a payment equal to the aggregate purchase price of the shares redeemed. 6. STOCKHOLDERS' EQUITY COMMON STOCK In January 1997, the Company completed an initial public offering of 2,000,000 shares of common stock at $12.00 per share. The Company received net proceeds of $21.1 million, after deducting offering expenses. Simultaneously, the Company sold an additional 496,878 shares of its common stock to Baxter for an aggregate purchase price of approximately $5.5 million. Additionally, at the time of the initial public offering, 33,315 warrants to purchase 47,605 shares of common stock were exercised for an aggregate price paid to the Company of $183,000 and Series A, B, C, D and E preferred stock converted into 4,412,243 shares of common stock. In April 1999, the Company completed a public offering of 2,200,000 newly issued shares of its common stock at $21.00 per share. The Company received net proceeds of $42.7 million, after deducting offering expenses. Also in April 1999, the Company sold 62,912 shares of common stock to Baxter pursuant to the achievement of a milestone under the RBC/FFP Agreement. The purchase price was $31.79 per share, for an aggregate purchase price of $2.0 million. In November 1999, the Company's Board of Directors adopted a stockholder rights plan, commonly referred to as a "poison pill," that is intended to deter hostile or coercive attempts to acquire the Company. The stockholder rights plan enables stockholders to acquire shares of the Company's common stock, or the common stock of an acquiror, at a substantial discount to the public market price should any person or group acquire more than 15% of the Company's common stock without the approval of the Board of Directors under certain circumstances. Baxter will be exempt from the rights plan, unless it acquires beneficial ownership of 20.1% or more of the Company's common stock, excluding shares of the Company's common stock issuable upon conversion of Series A or Series B preferred stock currently held by Baxter. The Company has designated 250,000 shares of Series C Junior Participating preferred stock for issuance in connection with the stockholder rights plan. STOCK OPTION PLANS The Company has reserved 1,470,000 shares of common stock for issuance under its 1996 Equity Incentive plan (the "1996 Plan"). The 1996 Plan provides for grants of Incentive Stock Options ("ISOs") to employees and Nonstatutory Stock Options ("NSOs"), restricted stock purchase awards, stock appreciation rights and stock bonuses to employees, directors and consultants of the Company. The ISOs may be granted at a price per share not less than the fair market value at the date of grant. The NSOs may be granted at a price per share not less than 85% of the fair market value at the date of grant. The option term is ten years. Vesting, as determined by the Board of Directors, generally occurs ratably over four years. In the event option holders cease to be employed by the Company, except in the event of death or disability or as otherwise provided in the option grant, all unvested options are forfeited and all vested options must be exercised within a three-month period, otherwise the options are forfeited. 52 53 CERUS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) The Company has reserved 120,000 shares of common stock for issuance under its 1998 Non-Officer Stock Option Plan. Under the terms of this plan, options may be granted to employees or consultants at an exercise price of at least 85% of the fair market value per share at the date of grant. The option term is ten years. In April 1999, the Company adopted the 1999 Equity Incentive plan (the "1999 Plan") (approved by the stockholders in July 1999), and reserved an additional 580,000 shares of common stock for issuance thereunder. The 1999 Plan provides for grants of ISOs to employees and NSOs, stock bonuses and restricted stock purchase awards to employees, directors and consultants of the Company. The option term is ten years. Options granted are immediately exercisable, and unvested (but issued) shares are subject to repurchase by the Company if the holder is no longer employed by the Company. As of December 31, 1999, 1,643 outstanding shares were subject to this repurchase provision. STOCK-BASED COMPENSATION The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock awards because, as discussed below, the alternative fair value accounting provided for under FAS 123 requires the use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee common stock options equals the market price of the underlying common stock on the grant date (for certain Company common stock grants), no compensation expense is recorded. Pro forma information regarding net loss and net loss per share is required by FAS 123, and has been determined as if the Company had accounted for its employee stock options and employee stock purchase plan under the fair value method of that Statement. The fair value for these options and shares was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for the years ended December 31:
EMPLOYEE STOCK STOCK OPTION PLANS PURCHASE PLAN -------------------------- -------------------------- 1999 1998 1997 1999 1998 1997 ------ ------ ------ ------ ------ ------ Expected dividend yield........................ 0% 0% 0% 0% 0% 0% Expected volatility .6500.. .6267 .7424 .6500 .6267 .7424 Risk-free interest rate........................ 6.55% 5.75% 6.13% 5.76% 5.75% 6.13% Expected life of the option (years)............ 5 5 5 0.5 0.5 0.5
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options and purchased shares have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock awards. 53 54 CERUS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the awards' vesting period. The effects of applying FAS 123 on pro forma net loss are not likely to be representative of the effects on reported net loss/income for future years. The Company's reported and pro forma information for the years ended December 31 follows:
1999 1998 1997 ------------ ------------ ------------ Net loss, as reported.................... $(22,627,821) $(29,558,052) $(14,664,213) Net loss, pro forma...................... (25,103,291) (30,271,930) (14,966,213) Net loss per share -- basic and diluted, as reported............................ (2.04) (3.17) (1.76) Net loss per share -- basic and diluted, pro forma.............................. (2.25) (3.25) (1.79)
Activity under the stock option plans is set forth below:
NUMBER OF WEIGHTED AVERAGE OPTIONS EXERCISE PRICE OUTSTANDING PER SHARE ----------- ---------------- Balances at December 31, 1996............................ 407,383 $ 2.523 Granted................................................ 51,300 14.925 Cancelled.............................................. (10,184) 3.240 Exercised.............................................. (61,229) 1.045 --------- ------- Balances at December 31, 1997............................ 387,270 $ 4.380 Granted................................................ 558,742 14.788 Cancelled.............................................. (8,794) 4.310 Exercised.............................................. (18,784) 1.026 --------- ------- Balances at December 31, 1998............................ 918,434 $10.778 Granted................................................ 381,450 22.256 Cancelled.............................................. (190,075) 12.978 Exercised.............................................. (43,033) 4.943 --------- ------- Balances at December 31, 1999............................ 1,066,776 $14.725 ========= =======
The weighted average fair value of options granted during the years ended December 31, 1999, 1998 and 1997 was $11.039, $7.212, and $8.107 per share, respectively. Options to purchase 484,590 shares of common stock were available for future grant.
OPTIONS OUTSTANDING ---------------------------------------- WEIGHTED OPTIONS VESTED AVERAGE -------------------------- REMAINING WEIGHTED WEIGHTED NUMBER CONTRACTUAL AVERAGE NUMBER AVERAGE RANGE OF EXERCISE PRICES OF SHARES LIFE EXERCISE PRICE OF SHARES EXERCISE PRICE ------------------------ --------- ----------- -------------- --------- -------------- $ 0.262 - 2.721........................ 246,236 6.26 $ 2.589 223,278 $ 2.576 $ 4.082 - 15.000........................ 82,145 7.67 $12.096 53,045 $11.514 $15.500 - 22.250........................ 576,665 9.08 $17.033 133,771 $16.453 $22.750 - 29.250........................ 161,730 9.48 $26.305 17,116 $25.441 --------- ---- ------- ------- ------- 1,066,776 8.38 $14.725 427,210 $ 8,947 ========= ==== ======= ======= =======
54 55 CERUS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) EMPLOYEE STOCK PURCHASE PLAN The Company has reserved 220,500 shares of common stock for issuance under its Employee Stock Purchase Plan (the "Purchase Plan"). The Purchase Plan is intended to qualify as an employee stock purchase plan within the meaning of Section 423(b) of the Internal Revenue Code. Under the Purchase Plan, the Board of Directors may authorize participation by eligible employees, including officers, in periodic offerings following the adoption of the Purchase Plan. The offering period for any offering will be no more than 27 months. Employees purchased 18,784, 32,189 and 20,830 shares under the Purchase Plan during the years ended December 31, 1999, 1998 and 1997, respectively. At December 31, 1999, 148,697 shares were available for issuance. The weighted average fair value of the rights granted during the years ended December 31, 1999, 1998 and 1997 using the Black-Scholes model was $4.330, $2.834 and $2.240, respectively. STOCK SPLIT On January 14, 1997, the Company effected a stock split of all outstanding shares of common stock such that each share of common stock was split into 1.47 shares of common stock. All common shares in the accompanying financial statements have been retroactively adjusted to reflect the stock split. In connection with the stock split, the conversion and exercise provisions of the outstanding shares of preferred stock, stock options and warrants have been adjusted accordingly. 7. INCOME TAXES Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets are as follows:
DECEMBER 31, ---------------------------- 1999 1998 ------------ ------------ Net operating loss carryforward......................... $ 26,600,000 $ 17,800,000 Research and development credit carryforward............ 4,800,000 2,600,000 Certain expenses not currently deductible for tax purposes.............................................. 4,500,000 4,500,000 Accrued liabilities..................................... 2,000,000 1,500,000 Capitalized research and development.................... 600,000 800,000 Other................................................... 600,000 700,000 ------------ ------------ Gross deferred tax assets............................... 39,100,000 27,900,000 Valuation allowance..................................... (39,100,000) (27,900,000) ------------ ------------ Net deferred tax assets................................. $ -- $ -- ============ ============
The valuation allowance increased by $11,200,000 and $12,700,000 for the years ended December 31, 1999 and 1998, respectively. The increase is primarily attributable to the increase in the net operating loss and tax credit carryforwards. The Company believes that, based on a number of factors, the available objective evidence creates sufficient uncertainty regarding the realizability of the deferred tax assets such that a full valuation allowance has been recorded. These factors include the Company's history of net losses since its inception, the need for regulatory approval of the Company's products prior to commercialization, expected near-term future losses and the absence of taxable income in prior carryback years. The valuation allowance at December 31, 1999 includes $700,000 related to deferred tax assets arising from tax benefits associated with stock option plans. This benefit, when realized, will be recorded as an increase in stockholders' equity rather than as a reduction in the income tax provision. Although management's operating plans assume, beyond the near-term, taxable and operating income in future periods, management evaluation of all available information in assessing the realizability of the deferred 55 56 CERUS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) tax assets in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," indicates that such plans were subject to considerable uncertainty. Therefore, the valuation allowance was increased to fully reserve the Company's deferred tax assets. The Company will continue to assess the realizability of the deferred tax assets based on actual and forecasted operating results. At December 31, 1999, the Company had net operating loss carryforwards of approximately $67,800,000 for federal and $59,000,000 for state income tax purposes. The Company also had research and development tax credit carryforwards of approximately $3,500,000 for federal income tax purposes and approximately $2,000,000 for state income tax purposes at December 31, 1999. The federal net operating loss and tax credit carryforwards expire between the years 2007 and 2019. The state net operating loss carryforwards expire between the years 2001 and 2004. Utilization of the Company's net operating losses and credits may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code. The annual limitation may result in the expiration of net operating losses and credits before utilization. 8. RETIREMENT PLAN The Company maintains a defined contribution savings plan (the "401(k) Plan") that qualifies under the provisions of Section 401(k) of the Internal Revenue Code and covers all employees of the Company. Under the terms of the 401(k) Plan, employees may contribute varying amounts of their annual compensation. The Company may contribute a discretionary percentage of qualified individual employee's salaries, as defined, to the 401(k) Plan. The Company did not contribute to the 401(k) Plan in the years ended December 31, 1999, 1998 and 1997. 9. SUBSEQUENT EVENT In February 2000, the Company completed a private placement of 1,000,000 shares of common stock to accredited investors, including Baxter, which purchased 390,000 shares. The purchase price was $25.00 per share, and the Company received net proceeds of approximately $23.5 million, after deducting estimated offering expenses. 56 57 SIGNATURES Pursuant to the requirement 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, in the City of Concord, State of California, on the 29th day of March, 2000. CERUS CORPORATION By: /s/ STEPHEN T. ISAACS ------------------------------------ Stephen T. Isaacs President and Chief Executive Officer Pursuant to the requirements of the Securities Act of 1933, this report has been signed below by the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ STEPHEN T. ISAACS President, Chief Executive March 29, 2000 - ----------------------------------------------------- Officer and Director (Principal Stephen T. Isaacs Executive Officer) /s/ GREGORY W. SCHAFER Chief Financial Officer and March 29, 2000 - ----------------------------------------------------- Vice President, Finance Gregory W. Schafer (Principal Financial and Accounting Officer) /s/ B. J. CASSIN Chairman of the Board March 29, 2000 - ----------------------------------------------------- B. J. Cassin /s/ JOHN E. HEARST Director March 29, 2000 - ----------------------------------------------------- John E. Hearst /s/ C. RAYMOND LARKIN, JR. Director March 29, 2000 - ----------------------------------------------------- C. Raymond Larkin, Jr. /s/ PETER H. MCNERNEY Director March 29, 2000 - ----------------------------------------------------- Peter H. McNerney /s/ DALE A. SMITH Director March 29, 2000 - ----------------------------------------------------- Dale A. Smith
57 58 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT - ------- ---------------------- 23.1 Consent of Ernst & Young LLP, Independent Auditors. 27.1 Financial Data Schedule.
EX-23.1 2 EXHIBIT 23.1 1 EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Form S-8) pertaining to the 1996 Equity Incentive Plan, Employee Stock Purchase Plan, 1998 Non-Officer Stock Option Plan and 1999 Equity Incentive Plan of Cerus Corporation of our report dated January 27, 2000, except for Note 9 as to which the date is February 16, 2000, with respect to the financial statements of Cerus Corporation included in its Annual Report (Form 10-K) for the year ended December 31, 1999, filed with the Securities and Exchange Commission. Walnut Creek, California March 29, 2000 EX-27.1 3 FINANCIAL DATA SCHEDULE
5 1 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 3,537,134 36,881,664 0 0 0 40,657,234 3,898,169 2,899,121 41,780,250 8,706,151 0 5,000,000 9,495,996 11,744 18,451,337 41,780,250 0 2,408,333 0 0 27,351,450 0 21,327 (22,627,821) 0 (22,627,821) 0 0 0 (22,627,821) (2.04) (2.04)
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