----

**UNITED STATES SECURITIES AND EXCHANGE COMMISSION****WASHINGTON, D.C. 20549**

----

**FORM 10-Q**

| **(Mark   One)** |
|------------------|
|             |
| x                | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE   SECURITIES EXCHANGE ACT OF 1934** |
|             |   |
|             | **For   the quarterly period ended September 30, 2004.** |
|             |   |
| **OR**           |
|             |   |
| o                | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE   SECURITIES EXCHANGE ACT OF 1934** |
|             |   |
|             | **For   the transition period from ____________________ to ____________________** |

**Commission file number:  0-27718**

| **NEOSE   TECHNOLOGIES, INC.**                                         |
|------------------------------------------------------------------------|
|                                                                        |
| **(Exact   name of registrant as specified in its charter)**           |
|                                                                   |   |   |
| **Delaware**                                                           |   | **13-3549286** |
|                                                                        |   |  |
| **(State or   other jurisdiction of   incorporation or organization)** |   | **(I.R.S.   Employer   Identification No.)** |
|                                                                   |   |   |
| **102   Witmer Road Horsham, Pennsylvania**                            |   | **19044** |
|                                                                        |   |  |
| **(Address   of principal executive offices)**                         |   | **(Zip Code)** |
|                                                                   |   |   |
| **(215) 315-9000**                                                     |
|                                                                        |
| **(Registrant’s   telephone number, including area code)**        |

          Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

| Yes  x
No  o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). 

Yes  x
No  o
          Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  24,717,171 shares of common stock, $.01 par value, were outstanding as of October 25, 2004.

**NEOSE TECHNOLOGIES, INC. (a development-stage company)**

**INDEX**

 

 

**Page**

 

 

PART I.

FINANCIAL INFORMATION:

 

 

 

 

Item 1.

Financial Statements (unaudited)

 

 

 

 

 

Balance Sheets as of December 31,   2003 and September 30, 2004

3

 

 

 

 

Statements of Operations for the   three and nine months ended September 30, 2003 and 2004, and for the period   from inception through September 30, 2004

4

 

 

 

 

Statements of Cash Flows for the   nine months ended September 30, 2003 and 2004, and for the period from   inception through September 30, 2004

5

 

 

 

 

Notes to Financial Statements

6

 

 

 

Item 2.

Management’s Discussion and   Analysis of Financial Condition and Results of Operations

11

 

 

 

Item 3.

Quantitative and Qualitative   Disclosure About Market Risk

23

 

 

 

Item 4.

Controls and Procedures

24

 

 

 

PART II.

OTHER INFORMATION:

 

 

 

 

Item 6.

Exhibits

25

 

 

 

SIGNATURES

26

2

**PART I.     FINANCIAL INFORMATION**

**Item   1.**

**Financial   Statements**

**Neose Technologies, Inc.**(a development-stage company)

**Balance Sheets**(unaudited) (in thousands, except per share amounts)

 

 

**December   31,   2003**

 

**September   30,   2004**

 

 

 

 

 

**Assets**

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash   and cash equivalents

 

$

48,101

 

$

55,016

 

Marketable   securities

 

 

4,959

 

 

—  

 

Restricted   funds

 

 

901

 

 

—  

 

Prepaid   expenses and other current assets

 

 

917

 

 

1,878

 

 

 

 

 

Total   current assets

 

 

54,878

 

 

56,894

 

Property and equipment, net

 

 

37,192

 

 

42,158

 

Intangible and other   assets, net

 

 

2,775

 

 

2,028

 

 

 

 

 

Total assets

 

$

94,845

 

$

101,080

 

 

 

 

 

**Liabilities   and Stockholders’ Equity**

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Current   portion of long-term debt and capital lease obligations

 

$

2,231

 

$

3,958

 

Accounts   payable

 

 

2,342

 

 

1,791

 

Accrued   compensation

 

 

2,510

 

 

1,940

 

Accrued   expenses

 

 

2,433

 

 

2,533

 

Deferred   revenue

 

 

4,333

 

 

4,720

 

 

 

 

 

Total   current liabilities

 

 

13,849

 

 

14,942

 

Long-term debt and capital   lease obligations

 

 

8,370

 

 

13,767

 

Other liabilities

 

 

413

 

 

542

 

 

 

 

 

Total   liabilities

 

 

22,632

 

 

29,251

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

Preferred   stock, par value $.01 per share, 5,000 shares authorized, none issued

 

 

—  

 

 

—  

 

Common   stock, par value $.01 per share, 30,000 and 50,000 shares authorized; 19,935   and 24,717 shares issued and outstanding

 

 

199

 

 

247

 

Additional   paid-in capital

 

 

217,849

 

 

248,027

 

Deferred   compensation

 

 

(96

)

 

(53

)

Deficit   accumulated during the development stage

 

 

(145,739

)

 

(176,392

)

 

 

 

 

Total   stockholders’ equity

 

 

72,213

 

 

71,829

 

 

 

 

 

Total liabilities and   stockholders’ equity

 

$

94,845

 

$

101,080

 

 

 

 

 

The accompanying notes are an integral part of these financial statements.

3

**Neose Technologies, Inc.**(a development-stage company)

**Statements of Operations**(unaudited) (in thousands, except per share amounts)

 

 

**Three   months ended   September 30,**

 

**Nine   months ended   September 30,**

 

**Period   from inception   (January 17, 1989) to   September 30, 2004**

 

 

 

 

 

 

 

 

**2003**

 

**2004**

 

**2003**

 

**2004**

 

 

 

 

 

 

 

 

 

Revenue from collaborative agreements

 

$

150

 

$

1,451

 

$

871

 

$

3,592

 

$

22,473

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and   development

 

 

6,747

 

 

9,305

 

 

19,031

 

 

24,971

 

 

151,470

 

Marketing, general and   administrative

 

 

2,456

 

 

2,861

 

 

8,657

 

 

9,047

 

 

69,267

 

 

 

 

 

 

 

 

Total operating   expenses

 

 

9,203

 

 

12,166

 

 

27,688

 

 

34,018

 

 

220,737

 

 

 

 

 

 

 

 

Operating loss

 

 

(9,053

)

 

(10,715

)

 

(26,817

)

 

(30,426

)

 

(198,264

)

Other income

 

 

—  

 

 

—  

 

 

—  

 

 

—  

 

 

7,773

 

Impairment of equity securities

 

 

(1,250

)

 

—  

 

 

(1,250

)

 

—  

 

 

(1,250

)

Interest income

 

 

103

 

 

195

 

 

420

 

 

431

 

 

19,773

 

Interest expense

 

 

(138

)

 

(304

)

 

(338

)

 

(658

)

 

(4,424

)

 

 

 

 

 

 

 

Net loss

 

$

(10,338

)

$

(10,824

)

$

(27,985

)

$

(30,653

)

$

(176,392

)

 

 

 

 

 

 

 

Basic and diluted net loss per share

 

$

(0.59

)

$

(0.44

)

$

(1.66

)

$

(1.38

)

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average shares outstanding used in   computing basic and diluted net loss per share

 

 

17,437

 

 

24,712

 

 

16,828

 

 

22,284

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these financial statements.

4

**Neose Technologies, Inc.**(a development-stage company)

**Statements of Cash Flows**(unaudited) (in thousands)

 

 

**Nine months   ended   September 30,**

 

**Period   from inception   (January 17, 1989) to   September 30, 2004**

 

 

 

 

 

 

 

**2003**

 

**2004**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(27,985

)

$

(30,653

)

$

(176,392

)

Adjustments to reconcile   net loss to cash used in operating activities:

 

 

 

 

 

 

 

 

 

 

Depreciation and   amortization

 

 

3,511

 

 

4,433

 

 

22,360

 

Non-cash compensation

 

 

129

 

 

93

 

 

5,010

 

Loss on disposition of   property and equipment

 

 

99

 

 

5

 

 

269

 

Common stock issued for   non-cash and other charges

 

 

—  

 

 

—  

 

 

35

 

Changes in operating   assets and liabilities:

 

 

 

 

 

 

 

 

 

 

Prepaid expenses and   other current and non-current assets

 

 

(370

)

 

(1,008

)

 

(2,239

)

Accounts payable

 

 

(109

)

 

(551

)

 

1,791

 

Accrued compensation

 

 

222

 

 

(570

)

 

1,521

 

Accrued expenses

 

 

(250

)

 

575

 

 

2,153

 

Deferred revenue

 

 

(250

)

 

387

 

 

4,720

 

Other liabilities

 

 

(220

)

 

129

 

 

123

 

 

 

 

 

 

Net cash used in   operating activities

 

 

(25,223

)

 

(27,160

)

 

(140,649

)

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

 

 

Purchases of property   and equipment

 

 

(2,137

)

 

(8,942

)

 

(59,505

)

Proceeds from   sale-leaseback of equipment

 

 

—  

 

 

—  

 

 

1,382

 

Purchases of marketable   securities

 

 

(38,568

)

 

—  

 

 

(423,307

)

Proceeds from sales of   marketable securities

 

 

8,327

 

 

—  

 

 

29,686

 

Proceeds from   maturities of and other changes in marketable securities

 

 

25,500

 

 

5,000

 

 

394,360

 

Purchase of acquired   technology

 

 

—  

 

 

—  

 

 

(4,550

)

Investment in equity   securities

 

 

—  

 

 

—  

 

 

(1,250

)

Impairment of equity   securities

 

 

1,250

 

 

—  

 

 

1,250

 

 

 

 

 

 

Net cash used in investing activities

 

 

(5,628

)

 

(3,942

)

 

(61,934

)

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

 

 

 

Proceeds from issuance   of debt

 

 

3,785

 

 

12,696

 

 

31,970

 

Repayments of debt

 

 

(2,132

)

 

(5,756

)

 

(16,492

)

Restricted cash related   to debt

 

 

377

 

 

901

 

 

—  

 

Proceeds from issuance   of preferred stock, net

 

 

—  

 

 

—  

 

 

29,497

 

Proceeds from issuance   of common stock, net

 

 

38,893

 

 

30,103

 

 

206,220

 

Proceeds from exercise   of stock options and warrants

 

 

172

 

 

73

 

 

6,651

 

Acquisition of treasury   stock

 

 

—  

 

 

—  

 

 

(175

)

Dividends paid

 

 

—  

 

 

—  

 

 

(72

)

 

 

 

 

 

Net cash provided by financing activities

 

 

41,095

 

 

38,017

 

 

257,599

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

 

10,244

 

 

6,915

 

 

55,016

 

Cash and cash equivalents, beginning of period

 

 

31,088

 

 

48,101

 

 

—  

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

41,332

 

$

55,016

 

$

55,016

 

 

 

 

 

 

The accompanying notes are an integral part of these financial statements.

5

**NEOSE TECHNOLOGIES, INC.**(a development-stage company)

**NOTES TO FINANCIAL STATEMENTS****(unaudited)**

**     1.  Basis of Presentation**

          The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States for presentation of interim financial statements. Accordingly, the unaudited financial statements do not include all the information and footnotes necessary for a comprehensive presentation of the financial position, results of operations, and cash flows for the periods presented. In our opinion, however, the unaudited financial statements include all the normal recurring adjustments that are necessary for a fair presentation of the financial position, results of operations, and cash flows for the periods presented. You should not base your estimate of our results of operations for 2004 solely on our results of operations for the nine months ended September 30, 2004. You should read these unaudited financial statements in combination with:

 

•

The other Notes in this section;

 

•

“Management’s Discussion and Analysis of Financial   Condition and Results of Operations” appearing in the following section; and

 

•

The Financial Statements, including the Notes to the   Financial Statements, included in our Annual Report on Form 10-K for the year   ended December 31, 2003.

          Certain prior year amounts have been reclassified to conform to our current year presentation.

**     2.  Stock-based Compensation   **

          We apply the intrinsic value method of accounting for all stock-based employee compensation in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. We record deferred compensation for option grants to employees for the amount, if any, by which the market price per share exceeds the exercise price per share. 

          We have elected to adopt only the disclosure provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123), as amended by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” The following table illustrates the effect on our net loss and basic and diluted net loss per share if we had recorded compensation expense for the estimated fair value of our stock-based employee compensation, consistent with SFAS No. 123 (in thousands, except per share data):

6

 

 

**Three   months ended   September 30,**

 

**Nine   months ended   September 30,**

 

 

 

 

 

 

 

**2003**

 

**2004**

 

**2003**

 

**2004**

 

 

 

 

 

 

 

Net loss – as reported

 

$

(10,338

)

$

(10,824

)

$

(27,985

)

$

(30,653

)

Add:   Stock-based employee compensation expense included in reported net loss

 

 

72

 

 

11

 

 

104

 

 

89

 

Deduct:   Total stock-based employee compensation expense determined under fair   value-based method for all awards

 

 

(3,159

)

 

(2,634

)

 

(9,409

)

 

(7,732

)

 

 

 

 

 

 

Net loss – pro forma

 

$

(13,425

)

$

(13,447

)

$

(37,290

)

$

(38,296

)

 

 

 

 

 

 

Basic and diluted net loss   per share – as reported

 

$

(0.59

)

$

(0.44

)

$

(1.66

)

$

(1.38

)

 

 

 

 

 

 

Basic and diluted net loss   per share – pro forma

 

$

(0.77

)

$

(0.54

)

$

(2.22

)

$

(1.72

)

 

 

 

 

 

 

**     3.  Revenue Recognition**

          Revenue from collaborative agreements consists of upfront fees, research and development funding, and milestone payments. Non-refundable upfront fees are deferred and amortized to revenue over the related estimated performance period. Periodic payments for research and development activities are recognized over the period in which we perform those activities under the terms of each agreement. Revenue resulting from the achievement of milestone events stipulated in the agreements is recognized when the associated substantive milestone is achieved.

          In April2004, we entered into an agreement with BioGeneriX AG, a company of theratiopharm Group, to use our proprietary GlycoPEGylationTM technology todevelop a long-acting version of granulocyte colony stimulating factor(G-CSF).  Under the agreement, we and BioGeneriX will pursue developmentand commercialization of a long-acting G-CSF. The parties will share equallypreclinical expenses by reconciling quarterly the amounts expended by eachparty. Because each party is the primary obligor for its research and bears therisk of reimbursement from the other party, we will recognize the reimbursementof our preclinical obligations as revenue and record the obligation toBioGeneriX as research and development expense.  The level of spending onpreclinical expenses by each party will vary from quarter to quarter; therefore,we will sometimes owe a net reimbursement or be owed a net reimbursement.BioGeneriX will fund the entire clinical development program. If we andBioGeneriX proceed to commercialization, we will have commercial rights in theU.S., Canada, Mexico and Japan. BioGeneriX will have commercial rights in Europeand the rest of the world. Each company will receive royalties on product salesin the other company’s territory. In connection with the agreement, wereceived from BioGeneriX a non-refundable, upfront fee, which is being amortizedto revenue over the expected performance period.

7

**     4.  Significant Customer Concentration**

          Our revenues from collaborative agreements have been derived from a few major collaborators. Our collaborative agreements have had some or all of the following elements: upfront fees, research and development funding, milestone revenues, and royalties on product sales.

          During the three and nine months ended September 30, 2004, one customer accounted for 42% and 76%, respectively, of total revenues. The same customer accounted for 100% and 25% of total revenues during the three and nine months ended September 30, 2003, respectively.

          During the three and nine months ended September 30, 2004, a second customer accounted for 58% and 24%, respectively, of total revenues. The same customer did not account for any revenue during the three and nine months ended September 30, 2003, respectively.

**     5.  Long-term Debt and Capital Lease Obligations**

          In August 2004, we borrowed $1,255,000 to finance the purchase of equipment and facility improvements, which collateralize the amount borrowed. The terms of the financing require us to pay monthly principal and interest payments over 48 months at an interest rate of 9.0%. During the 12 months ending September 30, 2005, 2006, 2007, and 2008, we will be required to make principal repayments totaling $313,000, $343,000, $375,000, and $224,000, respectively, under this agreement.

          In May 2004, we borrowed $1,500,000 from the landlord of our leased facility in Horsham, Pennsylvania. The terms of the financing require us to pay monthly principal and interest payments over 48 months at an interest rate of 13%. During the 12 months ending September 30, 2005, 2006, 2007, and 2008, we will be required to make principal repayments totaling $291,000, $359,000, $409,000, and $343,000, respectively, under this agreement.

          In March 2004, we borrowed $941,000 to finance the purchase of equipment and facility improvements, which collateralize the amount borrowed. The terms of the financing require us to pay monthly principal and interest payments over 48 months at an interest rate of 8.09%. During the 12 months ending September 30, 2005, 2006, 2007, and 2008, we will be required to make principal repayments totaling $231,000, $250,000, $243,000, and $127,000, respectively, under this agreement.

          In February 2004, we entered into a capital lease obligation for equipment with a book value of $184,000, which was calculated using an assumed incremental annual borrowing rate of 8.66%. The terms of the lease require us to make monthly payments through February 2009. Under this agreement, we will be required to make principal repayments totaling $32,000, $35,000, $39,000, $42,000, and $19,000 during the 12 months ending September 30, 2005, 2006, 2007, 2008, and 2009, respectively. 

          During the three months ended March 31, 2004, we and a bank entered into agreements under which the bank acquired and reissued the $1,000,000 of our outstanding tax-exempt Industrial Development Authority bonds. In addition, we borrowed $8,000,000 from the bank, of which $1,800,000 was combined with $1,100,000 of our restricted cash for the purpose of paying in full the $2,900,000 outstanding of our taxable Industrial Development Authority bonds. The

8

remaining $6,200,000 borrowed funded improvements to our leased facility in Horsham, Pennsylvania, which we occupied in April 2004.

          For the $8,000,000 term loan, we will make quarterly, interest-only payments through March 31, 2005. Commencing on March 31, 2005, we will make quarterly principal payments of $222,000 plus interest over the remaining nine years of the ten-year loan period. The bank debt bears interest at a rate equal to the 90-day LIBOR plus 3.0%.  We will have the option each quarter to incur interest on the outstanding principal at the LIBOR-based variable interest rate or a fixed rate offered by the bank.

          For the $1,000,000 tax-exempt Industrial Development Authority Bond, we will make quarterly, interest-only payments for ten yearsfollowed by a single repayment of principal at the end of the ten-year loan period. If the 90-day LIBOR at the beginning of any calendar quarter is less than 4.0%, as it is currently, the bond will bear interest at a rate equal to the 90-day LIBOR plus 1.5%. If the 90-day LIBOR at the beginning of any calendar quarter is between 4.0% and 6.0%, the bond will bear interest at a rate equal to the 90-day LIBOR plus 1.25%. If the 90-day LIBOR at the beginning of any calendar quarter exceeds 6.0%, the bond will bear interest at a rate equal to the 90-day LIBOR plus 1.0%.  We will have the option each quarter to incur interest on the outstanding principal at the LIBOR-based variable interest rate or a fixed rate offered by the bank.

          To provide credit support for these borrowings, we granted a mortgage to the bank on the land and building where our present headquarters are located, as well as on improvements, certain equipment, and other tangible personal property. Under our agreements with the bank, if the bank determines a material adverse change has occurred in our business, financial condition, results of operations, or business prospects, the bank, in its sole discretion, may declare at any time an event of default, of which one potential outcome could be the accelerated repayment of the loan balance, which was $9,000,000 as of September 30, 2004. Under our agreements with the bank, we agreed to limit our total outstanding debt to $22,000,000. As of September 30, 2004, our total outstanding debt was $17,725,000. At any time after the fourth year of the loan period, or if we fail to maintain a minimum required cash andshort-term investments balance of at least $22,000,000, our bank has the option to require additional collateral from us in the form of a security interest in certain cash and short-term investments, or in the form of a letter of credit, which may have the effect of requiring us to repay the outstanding loan balance to the bank. The agreements with our bank also contain covenants that, among other things, require us to obtain consent from the bank prior to paying dividends, making certain investments, changing the nature of our business, assuming or guaranteeing the indebtedness of another entity or individual, selling or otherwise disposing of a substantial portion of our assets, and merging or consolidating with another entity. 

**     6.  Stockholders’ Equity**

          In May 2004, we sold 4,733,476 shares of common stock in a registered direct offering to a number of institutional and individual investors, including 812,408 shares sold to officers and an investment fund affiliated with a director, at a price of $6.77 per share, generating net proceeds of $29,928,000.

          During the nine months ended September 30, 2004, participating employees purchased 23,564 shares of common stock pursuant to our employee stock purchase plan, resulting in net

9

proceeds of $175,000. In addition, during the nine months ended September 30, 2004, we received proceeds of $73,000 upon the exercise of options to purchase 24,766 shares of common stock.

**     7.  Separation and Non-competition Agreements**

          In September 2004, we entered into a separation agreement with our Chief Financial Officer in connection with his retirement in January 2005. Under the agreement, we are required to pay him $10,781 per month (or one-half of his current monthly base salary)and provide medical benefits over a 12-month period commencing on his retirement date. We have also committed to pay any bonus earned by him for 2004, as determined using the same criteria as if he were employed as of the time of payment. We estimate the present value of these benefits as of the anticipated retirement date will be approximately $240,000, which we will accrue through the anticipated retirement date.  In addition, we extended for twelve months the period during which he may exercise his stock options that were vested and outstanding as of his retirement date. Because the stock options had no intrinsic value as of the modificationdate, there was no charge associated with the option modification.

          In March 2003, our former Chief Executive Officer exercised the right under his separation agreement to enter into a non-competition agreement with us. Under the non-competition agreement, we are required to pay him $39,622 per month for 24 months and, should he leave our board of directors during such two-year period, continue his stock option vesting and exercisability. Upon entering into the non-competition agreement, we recorded a liability of $882,000, which represented the present value of the future payments, and a corresponding asset for the value of the non-competition commitment. The asset is being amortized on a straight-line basis to marketing, general and administrative expense on our statements of operations over the two-year term of the agreement. As of September 30, 2004, the present value of remaining minimum payments under the non-competition agreement was $194,000.

**     8.  Impairment of Equity Securities**

          In 2000, we made an investment of $1,250,000 in Series A convertible preferred stock of Neuronyx, Inc., and entered into a research and development collaboration with Neuronyx for the discovery and development of drugs for treating Parkinson’s disease and other neurological diseases. We recorded the equity investment at cost. In October 2003, Neuronyx informed us that they were nearing completion of a Series C equity financing, under which Series C and Series B Neuronyx investors would have an aggregate liquidation preference that was senior to the Series A liquidation preference and exceeded the assumed post-money valuation of Neuronyx. As a result, we reduced the carrying value of our equity investment to zero as of September 30, 2003 by recording a non-cash charge, which was reflected as an impairment of equity securities in our statements of operations.

**     9.  Net Loss Per Share**

          Basic and diluted net loss per share are presented in conformity with Statement of Financial Accounting Standards No. 128, “Earnings Per Share.” Basic net loss per share is computed by dividing net loss by the weighted-average number of common shares outstanding for the period. Diluted net loss per share reflects the potential dilution from the exercise or conversion of securities into common stock. For the three and nine months ended September 30, 2003 and 2004,

10

the effects of the exercise of outstanding stock options and warrants to purchase 4,323,234 and 5,166,254 shares, respectively, were antidilutive; accordingly, they were excluded from the calculation of diluted net loss per share.

**     10.  Supplemental Disclosure of Cash Flow Information**

          The following table contains additional cash flow information for the periods reported (in thousands).

 

 

**Nine   months ended   September 30,**

 

**Period   from   inception   (January 17, 1989)   to September 30,   2004**

 

 

 

 

 

 

 

**2003**

 

**2004**

 

 

 

 

 

 

 

Supplemental disclosure of   cash flow information:

 

 

 

 

 

 

 

 

 

 

Cash   paid for interest

 

$

352

 

$

533

 

$

4,443

 

 

 

 

 

 

Non-compete   agreement

 

$

882

 

$

—  

 

$

882

 

 

 

 

 

 

Non-cash investing   activities:

 

 

 

 

 

 

 

 

 

 

Increase   (decrease) in accrued property and equipment

 

$

(37

)

$

(475

)

$

380

 

 

 

 

 

 

Assets   acquired under capital leases

 

$

—  

 

$

184

 

$

1,525

 

 

 

 

 

 

Non-cash financing   activities:

 

 

 

 

 

 

 

 

 

 

Conversion   of debt into common stock

 

$

—  

 

$

—  

 

$

660

 

 

 

 

 

 

Issuance   of common stock for dividends

 

$

—  

 

$

—  

 

$

90

 

 

 

 

 

 

Issuance   of common stock to employees in lieu of cash compensation

 

$

—  

 

$

—  

 

$

44

 

 

 

 

 

 

**     11.  Comprehensive Loss**

          Our comprehensive loss for the three and nine months ended September 30, 2004 was comprised only of our net loss, and was $10,824,000 and $30,653,000, respectively. Our comprehensive loss for the three and nine months ended September 30, 2003 was comprised only of our net loss, and was $10,338,000 and $27,985,000, respectively. Our cumulative comprehensive loss from inception (January 17, 1989) through September 30, 2004 was comprised only of our net loss, and was $176,392,000.

**Item 2.**

**Management’s Discussion and   Analysis of Financial Condition and Results of Operations**

*CAUTIONARY STATEMENT PURSUANT TO SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION ACT OF 1995:*

*          This report and the documents incorporated by reference herein contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. When used in*

11

*this report and the documents incorporated herein by reference, the words “anticipate,” “believe,” “estimate,” “may,” “expect,” “intend,” and similar expressions are generally intended to identify forward-looking statements. These forward-looking statements include, among others, the statements in Management’s Discussion and Analysis of Financial Condition and Results of Operations about our:*

 

•

*estimate   of the length of time that our existing cash, cash equivalents and marketable   securities, expected revenue, and interest income will be adequate to finance   our operating and capital requirements;*

 

•

*expected   losses;*

 

•

*expectations   for future capital requirements;*

 

•

*expectations   for increases in operating expenses;*

 

•

*expectations   for increases in research and development, and marketing, general and   administrative expenses in order to develop products, manufacture commercial   quantities of reagents and products, and commercialize our technology;*

 

•

*expectations   for the development of an improved EPO, G-CSF, and subsequent proprietary   drug candidates;*

 

•

*expectations   for incurring additional capital expenditures for renovations of our   facilities;*

 

•

*expectations   for generating revenue; and*

 

•

*expectations   regarding the timing and character of new or expanded collaborations and for   the performance of our existing collaboration partners in connection with the   development and commercialization of    products incorporating our technologies.*•

*          Our actual results could differ materially from the results expressed in, or implied by, these forward-looking statements. Potential risks and uncertainties that could affect our actual results include the following:*

 

•

*our   ability to obtain the funds necessary for our operations;*

 

•

*our   ability to meet forecasted project timelines;*

 

•

*our   ability to develop commercial-scale manufacturing processes for our products   and reagents, either independently or in collaboration with others;*

 

•

*our   ability to enter into and maintain collaborative arrangements;*

 

•

*our   ability to obtain adequate sources of proteins and reagents;*

 

•

*our   ability to expand and protect our intellectual property and to operate   without infringing the rights of others;*

 

•

*our   ability to develop and commercialize therapeutic proteins and to   commercialize our technologies;*

 

•

*our   ability to compete successfully in an intensely competitive field;*

 

•

*our   ability to renovate our facilities as required for our operations;*

 

•

*our   ability to attract and retain key personnel; and*

 

•

*general   economic conditions*

*          These and other risks and uncertainties that could affect our actual results are discussed in this report and in our other filings with the Securities and Exchange Commission, particularly the section entitled “Factors Affecting The Company’s Prospects” of our Annual Report on*

12

*Form 10-K filed February 17, 2004.  Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, events, levels of activity, performance, or achievements. We do not assume responsibility for the accuracy and completeness of the forward-looking statements other than as required by applicable law.*

*          We do not undertake any duty to update after the date of this report any of the forward-looking statements in this report to conform them to actual results.*

          You should read this section in combination with the Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2003, included in our Annual Report on Form 10-K and in our 2003 Annual Report to Stockholders.

**Overview**

          We are a biopharmaceutical company focused on improving protein therapeutics using our proprietary technologies. Our core technologies, GlycoAdvanceTM and GlycoPEGylation, enable us to manipulate, enzymatically, the carbohydrate structures of glycoproteins, and thereby pursue the objective of improving the therapeutic profiles of proteins that have already been marketed or substantially developed.  Our business strategy is to use our technologies to improve proteins for which there exists a substantial body of data demonstrating safety and efficacy.  We intend to apply this strategy to next-generation products that we are developing on our own or in collaboration with others.  We also expect to use our technologies, through strategic partners, to improve products of other parties.

          We have incurred operating losses each year since our inception. As of September 30, 2004, we had an accumulated deficit of approximately $176.4 million. We expect additional losses in 2004 and over the next several years as we expand product research and development efforts, increase manufacturing scale-up activities and expand our intellectual property portfolio. We have financed our operations through private and public offerings of equity securities, proceeds from debt financings, and revenues from our collaborative agreements. 

          We believe that our existing cash and cash equivalents, expected revenue from our existing collaborations and license arrangements, and interest income should be sufficient to meet our operating and capital requirements through 2005, although changes in our collaborative relationships or our business, whether or not initiated by us, may affect the rate at which we deplete our cash and cash equivalents. 

          Under agreements we entered into with a bank during the three months ended March 31, 2004, we have agreed to limit our total outstanding debt to $22.0 million. As of September 30, 2004, our total outstanding debt was approximately $17.7 million. At any time after the fourth year of the ten-year loan period, or if we fail to maintain a minimum required cash and short-term investments balance of at least $22.0 million, the bank has the option to require additional collateral from us in the form of a security interest in certain cash and short-term investments, or in the form of a letter of credit, which may have the effect of requiring us to repay the outstanding loan balance to the bank. See “Financing Activities – Debt Financing Activities – Credit Agreement” in the Liquidity and Capital Resources section of this Form 10-Q for a description of the material features of thisborrowing.  

13

**Liquidity and Capital Resources**

*     Overview*

          We had $55,016,000 in cash and cash equivalents as of September 30, 2004, compared to $53,060,000 in cash, cash equivalents, and marketable securities as of December 31, 2003. The increase for 2004 was primarily attributable to net proceeds from our May 2004 equity financing, proceeds from debt financings, and cash inflows from our collaborative agreements. These sources of cash were partially offset by the use of cash to fund our operating activities, capital expenditures, and debt repayments. 

          The development of next-generation proprietary protein therapeutics, which we are pursuing both independently and in collaboration with selected partners, will require substantial expenditures by us and our collaborators. To finance those expenditures, we plan to continue financing our operations through private and public offerings of equity securities, proceeds from debt financings, and revenues from existing and future collaborative agreements. Our future revenues could be substantially affected by entering into new collaborations and on the financial terms of any new collaborations. Because we do not know the timing or terms of any new collaborations we may enter into, we cannot estimate our future revenues. Other than revenues from our existing collaborations, and any future collaborations with others, we do not expect to generate significant revenues until such time as products incorporating ourtechnologies are commercialized. We expect an additional several years to elapse before we will be able to generate sufficient cash flow from operations to fund our operating and investing requirements. Accordingly, we will need to raise substantial additional funds to continue our business activities and fund our operations beyond 2005.

*     Operating Activities*

          Cash used in operating activities was $27,160,000 and $25,223,000 for the nine months ending September 30, 2004 and 2003, respectively. The net cash used in operating activities is substantially the result of our operating loss. The increase in depreciation and amortization expense over the prior year resulted primarily from the commencement of amortization of leasehold improvements that were placed in service in April 2004. 

          During the nine months ended September 30, 2004, we used cash of $1,038,000 to fund changes in operating assets and liabilities, primarily due to decreases in accrued compensation and accounts payable and an increase in prepaid expenses and other current and non-current assets. The reduction in accrued compensation during the nine months ended September 30, 2004 resulted from the payment of bonuses attributable to employee service in 2003. During the nine months ended September 30, 2004, prepaid expenses and other current and non-current assets increased by $1,008,000, primarily due to an increase in our receivables from collaborative partners and the annual payment of insurance premiums and maintenance agreements. Prepaid expenses fluctuate period-to-period depending on the timing of payment of significant annual expenditures, such as insurance premiums and maintenance contracts. In addition, we areoften required to prepay contract research organizations for services prior to the initiation of work performed. 

14

          Our uses of cash during the nine months ended September 30, 2004 were offset in part by an increase of $387,000 in deferred revenue. This increase was primarily due to the receipt from BioGeneriX of an upfront fee under our collaborative agreement. Fluctuations in operating items vary period-to-period due to, among other factors, the timing of research and development activities, such as the preparation and initiation of preclinical trials. 

***     ****Investing Activities *

          During the nine months ended September 30, 2004, we invested $8,942,000 in property, equipment, and building improvements. Of this amount, $5,075,000 was invested in leasehold improvements that are described below. In addition, we entered into capital lease obligations for equipment with an aggregate book value of $184,000, and we had accrued property and equipment of $380,000 as of September 30, 2004. We anticipate additional capital expenditures during the remainder of 2004 of approximately $1.0 million. We may finance some or all of our capital expenditures through the issuance of new debt or equity. We would prefer to finance capital expenditures through the issuance of new debt, to the extent that we are allowed to do so under our existing bank covenants.  The terms of new debt could require us to maintain a minimum cash and investments balance, or to transfer cash into an escrow account tocollateralize some portion of the debt, or both.

          In April 2004, we occupied our leased facility in Horsham, Pennsylvania and began amortizing the costs of constructing 25,000 square feet of laboratory and office space within the facility, which totals 40,000 square feet. As of September 30, 2004, we had expended $10,165,000 and accrued $101,000 of costs related to improving the facility. During the first quarter of 2004, we entered into agreements with a bank for the purpose of funding these improvements. See “Financing Activities – Debt Financing Activities – Credit Agreement” in the Liquidity and Capital Resources section of this Form 10-Q for a description of the material features of this borrowing.

***     ****Financing Activities*

*          Equity Financing Activities*

          In May 2004, we sold 4,733,476 shares of common stock in a registered direct offering to a number of institutional and individual investors, including 812,408 shares sold to officers and an investment fund affiliated with a director, at a price of $6.77 per share, generating net proceeds of $29,928,000.

          During the nine months ended September 30, 2004, participating employees purchased 23,564 shares of common stock pursuant to our employee stock purchase plan, resulting in net proceeds of $175,000. In addition, during the nine months ended September 30, 2004, we received proceeds of $73,000 upon the exercise of options to purchase 24,766 shares of common stock.

          *Debt Financing Activities*

          Our total debt increased by $7,124,000 to $17,725,000 at September 30, 2004, compared to $10,601,000 at December 31, 2003. This increase primarily resulted from $12,696,000 in proceeds from the issuance of debt during the nine months ended September 30, 2004. Partially 

15

offsetting the debt proceeds were $5,756,000 of debt principal repayments during the nine months ended September 30, 2004. In addition, we entered into a capital lease obligation during the nine months ended September 30, 2004 for equipment with an aggregate book value of $184,000.

*               Term Loan*

          In May 2004, we borrowed $1,500,000 from the landlord of our leased facility in Horsham, Pennsylvania. The terms of the financing require us to pay monthly principal and interest payments over 48 months at an interest rate of 13%. During the 12 months ending September 30, 2005, 2006, 2007, and 2008, we will be required to make principal and interest payments totaling $443,000, $483,000, $483,000, and $362,000, respectively, under this agreement.

*               Credit Agreement*

          During the three months ended March 31, 2004, we and a bank entered into agreements under which the bank acquired and reissued the $1,000,000 of our outstanding tax-exempt Industrial Development Authority bonds. In addition, we borrowed $8,000,000 from the bank, of which $1,800,000 was combined with $1,100,000 of our restricted cash for the purpose of paying in full the $2,900,000 outstanding of our taxable Industrial Development Authority bonds. The remaining $6,200,000 borrowed funded improvements to our leased facility, which we occupied in April 2004, in Horsham, Pennsylvania.       

          For the $8,000,000 term loan, we will make quarterly, interest-only payments through March 31, 2005. Commencing on March 31, 2005, we will make quarterly principal payments of $222,000 plus interest over the remaining nine years of the ten-year loan period. The bank debt bears interest at a rate equal to the 90-day LIBOR plus 3.0%.  We will have the option each quarter to incur interest on the outstanding principal at the LIBOR-based variable interest rate or a fixed rate offered by our bank.

          For the $1,000,000 tax-exempt Industrial Development Authority Bond, we will make quarterly, interest-only payments for ten years followed by a single repayment of principal at the end of the ten-year loan period. If the 90-day LIBOR at the beginning of any calendar quarter is less than 4.0%, as it is currently, the bond will bear interest at a rate equal to the 90-day LIBOR plus 1.5%. If the 90-day LIBOR at the beginning of any calendar quarter is between 4.0% and 6.0%, the bond will bear interest at a rate equal to the 90-day LIBOR plus 1.25%. If the 90-day LIBOR at the beginning of any calendar quarter exceeds 6.0%, the bond will bear interest at a rate equal to the 90-day LIBOR plus 1.0%.  We will have the option each quarter to incur interest on the outstanding principal at the LIBOR-based variable interest rate or a fixed rate offered by our bank.

          To provide credit support for these borrowings, we granted a mortgage to the bank on the land and building where our present headquarters are located, as well as on improvements, certain equipment, and other tangible personal property. Under our agreements with the bank, if the bank determines a material adverse change has occurred in our business, financial condition, results of operations, or business prospects, the bank, in its sole discretion, may declare at any time an event of default, of which one potential outcome could be the accelerated repayment of the loan balance, which was $9,000,000 as of September 30, 2004.  Under our agreements with

16

the bank, we agreed to limit our total outstanding debt to $22,000,000. As of September 30, 2004, our total outstanding debt was $17,725,000. At any time after the fourth year of the loan period, or if we fail to maintain a minimum required cash and short-term investments balance of at least $22,000,000, our bank has the option to require additional collateral from us in the form of a security interest in certain cash and short-term investments, or in the form of a letter of credit, which may have the effect of requiring us to repay the outstanding loan balance to the bank. The agreements with our bank also contain covenants that, among other things, require us to obtain consent from the bank prior to paying dividends, making certain investments, changing the nature of our business, assuming or guaranteeing the indebtedness of another entity or individual, selling or otherwise disposing of a substantial portion of our assets, and merging or consolidating withanother entity.

***               ****Equipment Loans*

          In August 2004, we borrowed $1,255,000 to finance the purchase of equipment and facility improvements, which collateralize the amount borrowed. The terms of the financing require us to pay monthly principal and interest payments over 48 months at an interest rate of 9.0%. During the 12 months ending September 30, 2005, 2006, 2007, and 2008 we will be required to make principal and interest payments totaling $417,000, $414,000, $414,000, and $235,000, respectively, under this agreement.

          In March 2004, we borrowed $941,000 to finance the purchase of equipment and facility improvements, which collateralize the amount borrowed. The terms of the financing require us to pay monthly principal and interest payments over 48 months at an interest rate of 8.09%. During the 12 months ending September 30, 2005, 2006, 2007, and 2008, we will be required to make principal and interest payments totaling $291,000, $291,000, $263,000, and $130,000, respectively, under this agreement.

          In December 2003, we borrowed $1,201,000 to finance the purchase of equipment and facility improvements, which collateralize the amount borrowed. The terms of the financing require us to pay monthly principal and interest payments over 48 months at an interest rate of 8.66%. During the 12 months ending September 30, 2005, 2006, 2007, and 2008, we will be required to make principal and interest payments totaling $366,000, $366,000, $337,000, and $108,000, respectively, under this agreement.

          In September 2003, we borrowed $831,000 to finance the purchase of equipment and facility improvements, which collateralize the amount borrowed. The terms of the financing require us to pay monthly principal and interest payments over 48 months at an interest rate of 8.35%. During the 12 months ending September 30, 2005, 2006, 2007, and 2008, we will be required to make principal and interest payments totaling $269,000, $269,000, $169,000, and $13,000, respectively, under this agreement.

          In March 2003, we borrowed $2,954,000 to finance the purchase of equipment, which collateralize the amount borrowed. The terms of the financing require us to pay monthly principal and interest payments over 42 months at an interest rate of 8.35%. During the 12 months ending September 30, 2005, 2006, and 2007, we will be required to make principal and interest payments totaling $976,000, $976,000, and $81,000, respectively, under this agreement.

17

          In December 2002, we borrowed $2,261,000 to finance the purchase of equipment, which collateralize the amount borrowed. The terms of the financing require us to pay monthly principal and interest payments over 36 months at an interest rate of 8.0%. During the 12 months ending September 30, 2005 and 2006, we will be required to make principal and interest payments totaling $850,000 and $283,000, respectively, under this agreement.

***               ****Capital Lease Obligations*

          In February 2004, we entered into a capital lease obligation for equipment with a book value of $184,000, which was calculated using an assumed incremental annual borrowing rate of 8.66%. The terms of the lease require us to make monthly payments through February 2009. Under this agreement, we will be required to make lease payments totaling $46,000, $46,000, $46,000, $46,000, and $19,000 during the 12 months ending September 30, 2005, 2006, 2007, 2008, and 2009, respectively. 

          In September 2003, we entered into a capital lease for $354,000 of equipment. The terms of the lease require us to make an initial payment of $90,000 followed by monthly payments through September 2006. Under this agreement, we will be required to make lease payments totaling $99,000 during each of the 12 months ending September 30, 2005 and 2006, respectively. We also entered into a capital lease obligation during September 2003 for $60,000 of software. The terms of the lease require us to make monthly payments through September 2008. Under this agreement, we will be required to make lease payments totaling $16,000 during each of the 12 months ending September 30, 2005, 2006, 2007, and 2008, respectively.

          In June 2003, we entered into a capital lease for $119,000 of equipment. The terms of the lease require us to make an initial payment of $31,000 followed by monthly payments through June 2006. Under this agreement, we will be required to make lease payments totaling $37,000 and $28,000 during the 12 months ending September 30, 2005 and 2006, respectively.

          In April and May 2003, we entered into capital leases for $254,000 of equipment. The terms of the leases require us to make monthly payments through April 2006. Under these agreements, we will be required to make lease payments totaling $96,000 and $52,000 during the 12 months ending September 30, 2005 and 2006, respectively.

          In November 2002, we entered into a capital lease for $50,000 of equipment. The terms of the lease require us to make monthly payments over 36 months. Under this agreement, we will be required to make lease payments totaling $19,000 and $5,000 during the 12 months ending September 30, 2005 and 2006, respectively.

**Summary of Contractual Obligations**

          A summary of our obligations to make future payments under contracts existing as of December 31, 2003 is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the year ended December 31, 2003. Other than the two agreements described below, the Liquidity and Capital Resources section of this Form 10-Q describes obligations from contracts entered into during the nine months ended September 30, 2004.

18

          In September 2004, we entered into a separation agreement with our Chief Financial Officer in connection with his retirement in January 2005. Under the agreement, we are required to pay him $10,781 per month (or one-half of his current monthly base salary) and provide medical benefits over a 12-month period commencing on his retirement date. We have also committed to pay any bonus earned by him for 2004, as determined using the same criteria as if he were employed as of the time of payment. We estimate the present value of these benefits as of the anticipated retirement date will be approximately $240,000, which we will accrue through the anticipated retirement date.  In addition, we extended through the twelve months, the period during which he may exercise his stock options that were vested and outstanding as of his retirement date. Because the stock options had no intrinsic value as of themodification date, there was no charge associated with the option modification.

          We also entered into an amendment of an operating lease in September 2004 for our existing warehouse and office space located in Horsham, Pennsylvania. The lease amendment extended our scheduled lease termination date from December 31, 2004 to April 30, 2007. Under the amended lease, we will be required to make payments totaling $47,500, $48,750, and $16,250 in the years ended December 31, 2005, 2006, and 2007, respectively.  

**Off-Balance Sheet Arrangements**

          We are not involved in any off-balance sheet arrangements that have or are reasonably likely to have a material future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.

**Critical Accounting Policies and Estimates**

          A discussion of our critical accounting policies and estimates is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the year ended December 31, 2003. There have not been any changes or additions to our critical accounting policies during the nine months ended September 30, 2004.

**Results of Operations    **

          Our net loss for the three and nine months ended September 30, 2004 was $10,824,000 and $30,653,000, respectively, compared to $10,338,000 and $27,985,000 for the corresponding periods in 2003. The following section explains the changes between the reporting periods in each component of net loss.

*     Revenue from Collaborative Agreements*

          Our revenues from collaborative agreements have historically been derived from a few major collaborators. Our collaborative agreements have had some or all of the following elements: upfront fees, research and development funding, milestone revenues, and royalties on product sales. Revenues from collaborative agreements for the three and nine months ended September 30, 2004 were $1,451,000 and $3,592,000, respectively, compared to $150,000 and $871,000 for the corresponding periods in 2003. These increases were primarily due to research and development funding under our collaboration with Novo Nordisk A/S and BioGeneriX AG. 

19

          We are working in collaboration with Novo Nordisk to incorporate our technology in three next-generation versions of marketed proteins, one of which is currently marketed by Novo Nordisk. Under our agreements with Novo Nordisk, we received a $4,300,000 upfront fee in the fourth quarter of 2003, and Novo Nordisk is funding our research and development activities for these three proteins.  

          In April2004, we entered into an agreement with BioGeneriX, a company of the ratiopharmGroup, to use our proprietary GlycoPEGylation technology to develop along-acting version of G-CSF.  Under the agreement, we will pursue withBioGeneriX the development and commercialization of a long-acting G-CSF. Theparties will share equally all preclinical expenses by reconciling quarterly theamounts expended by each party. Because each party is the primary obligor forits research and bears the risk of reimbursement from the other party, we willrecognize the reimbursement of our preclinical obligations as revenue and recordthe obligation to BioGeneriX as research and development expense.  Thelevel of spending on preclinical expenses by each party will vary from quarterto quarter; therefore, we will sometimes owe a net reimbursement or be owed anet reimbursement. BioGeneriX will fund the entire clinical development program.If we and BioGeneriX proceed to commercialization, we will have commercialrights in the U.S., Canada, Mexico and Japan. BioGeneriX will have commercialrights in Europe and the rest of the world. Each company will receive royaltieson product sales in the other company’s territory. In connection with theagreement, we received from BioGeneriX a non-refundable, upfront fee, which isbeing amortized to revenue over the expected performance period.

          Because our future revenues could be substantially affected by entering into new collaborations and on the financial terms of any new collaborations, we cannot estimate our future revenues. Material cash inflows from proprietary drug development projects are highly uncertain, and we cannot reasonably estimate the period in which we will begin to receive material net cash inflows from our major research and development projects. Cash inflows from development-stage products are dependent on several factors, including entering into collaborative agreements, the achievement of certain milestones, and regulatory approvals. We may not receive milestone payments from any existing or future collaborations if a development-stage product fails to meet technical or performance targets or fails to obtain the required regulatory approvals. Further, our revenues from collaborations will be affected by the levels ofeffort committed and made by our collaborative partners. Even if we achieve technical success in developing drug candidates, our collaborative partners may discontinue development, may not devote the resources necessary to complete development and commence marketing of these products, or they may not successfully market potential products.

     *Research and Development Expense*

          In January 2003, we announced the selection of an improved erythropoietin (EPO) as the target for our first proprietary drug development project. EPO is prescribed to stimulate production of red blood cells, and is approved for sale in major markets around the world for the treatment of anemia associated with oncology chemotherapy, end stage renal disease, and chronic renal insufficiency. Based on our current preclinical data, we believe it is feasible to develop a long- acting EPO through GlycoPEGylation. We are planning to continue various preclinical development activities during the remainder of 2004.

          In October 2003, we announced the selection of an improved granulocyte colony stimulating factor (G-CSF) as the target for our second proprietary drug development project. G-CSF is prescribed to stimulate production of neutrophils (a type of white blood cell), and is approved for sale in major markets around the world for treatment of neutropenia associated with

20

oncology chemotherapy. Based on our current preclinical data, we believe it is feasible to develop a long-acting G-CSF through GlycoPEGylation. We are planning to continue various preclinical development activities with our partner, BioGeneriX, during the remainder of 2004.  

          We are also conducting exploratory research, both independently and with collaborators, to identify proteins that are likely candidates for development using our technologies, which may be advanced for development through our own proprietary drug program or through our partnering and licensing program. In addition, we are continuing some work on the development of our other programs, including new applications of our GlycoPEGylation and GlycoConjugationTM technologies. 

          Our current research and development projects are divided between two categories: (i) GlycoAdvance and GlycoPEGylation and (ii) Other Glycotechnology Programs, which includes projects investigating other applications of our intellectual property. The following chart sets forth our projects in each of these categories and the stage to which each has been developed: 

 

 

***Development   Stage***

 

***Status***

 

 

 

**GlycoAdvance   and GlycoPEGylation**

 

 

 

 

Improved erythropoietin

 

Preclinical

 

Active

Improved granulocyte   colony stimulating factor

 

Preclinical

 

Active

Other protein projects

 

Research/   Preclinical

 

Active

**Other   Glycotechnology Programs**

 

 

 

 

Non-protein therapeutic applications

 

Research

 

Active

Nutritional applications

 

N/A

 

Inactive

          The process of bringing drugs from the preclinical research and development stage through Phase I, Phase II, and Phase III clinical trials to FDA approval is time consuming and expensive. Because our announced product candidates are currently in the preclinical stage and there are a variety of intermediate clinical and non-clinical outcomes that can occur in drug development, we cannot reasonably estimate either the timing or costs we will incur to complete these research and development projects. In addition, the timing and costs to complete our proprietary research and development projects will be affected by the timing and nature of any collaboration agreements we may enter into with any third parties, none of which we can currently estimate.

          For each of our research and development projects, we incur both direct and indirect expenses. Direct expenses include salaries and other costs of personnel, raw materials, and supplies for each project. We may also incur third-party costs related to these projects, such as contract research and manufacturing, consulting, preclinical and clinical development costs. Indirect expenses include depreciation expense and the costs of operating and maintaining our facilities, property, and equipment, to the extent used for our research and development projects, as well as the costs of general management of our research and development projects.

          Our research and development expenses were $9,305,000 and $24,971,000 for the three and nine months ended September 30, 2004, respectively, and $6,747,000 and $19,031,000 for the comparable 2003 periods. We expect our research and development expenses to continue to

21

be significantly greater in 2004 than they were in 2003 primarily due to development and preclinical activities we plan to conduct during the year, including process development and pilot plant activities associated with our proprietary drug development programs. The following table illustrates research and development expenses incurred during 2003 and 2004 in each period for our significant groups of research and development projects (in thousands).

 

 

**Three   months ended   September 30,**

 

**Nine   months ended   September 30,**

 

 

 

 

 

 

 

**2003**

 

**2004**

 

**2003**

 

**2004**

 

 

 

 

 

 

 

GlycoAdvance,   GlycoPEGylation and GlycoConjugation

 

$

2,535

 

$

4,386

 

$

6,854

 

$

11,254

 

Other Glycotechnology   Programs

 

 

84

 

 

19

 

 

468

 

 

141

 

Indirect expenses

 

 

4,128

 

 

4,900

 

 

11,709

 

 

13,576

 

 

 

 

 

 

 

 

 

$

6,747

 

$

9,305

 

$

19,031

 

$

24,971

 

 

 

 

 

 

 

          *GlycoAdvance, GlycoPEGylation, and GlycoConjugation*

          Our GlycoAdvance, GlycoPEGylation and GlycoConjugation expenses result primarily from the development and preclinical activities, including process development and pilot plant activities, associated with our proprietary drug development programs. These expenses increased during the 2004 periods, compared to 2003, primarily due to hiring of additional employees and increased purchases of outside services and supplies associated with our proprietary drug development programs. 

*          Other Glycotechnology Programs*

          Research and development expenses related to our Other Glycotechnology Programs decreased during the 2004 periods, compared to 2003, consistent with our decision to focus our resources on our GlycoAdvance, GlycoPEGylation, and GlycoConjugation programs.

          *Indirect expenses*

          Our indirect research and development expenses increased during the 2004 periods, compared to 2003, primarily due to increases related to additional personnel, depreciation of capital expenditures, and operating an additional facility.

*     Marketing, General and Administrative Expense*

          Marketing, general and administrative expenses for the three and nine months ended September 30, 2004 were $2,861,000 and $9,047,000, respectively, compared to $2,456,000 and $8,657,000 for the corresponding periods in 2003. The increase for the three and nine months ended September 30, 2004 was primarily due to higher patent legal expenses. These costs were partially offset by savings in salary and other personnel-related costs as well as lower marketing costs.  During 2004, we expect our marketing, general and administrative expenses to increase by less than 10% over 2003.

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*     Impairment of Equity Securities*

          In 2000, we made an investment of $1,250,000 in Series A convertible preferred stock of Neuronyx, Inc., and entered into a research and development collaboration with Neuronyx for the discovery and development of drugs for treating Parkinson’s disease and other neurological diseases. We recorded the equity investment at cost. In October 2003, Neuronyx informed us that they were nearing completion of a Series C equity financing, under which Series C and Series B Neuronyx investors would have an aggregate liquidation preference that was senior to the Series A liquidation preference and exceeded the assumed post-money valuation of Neuronyx. As a result, we reduced the carrying value of our equity investment to zero as of September 30, 2003 by recording a non-cash charge, which was reflected as an impairment of equity securities in our statements of operations.

*     Interest Income and Interest Expense*

          Interest income for the three and nine months ended September 30, 2004 was $195,000 and $431,000, respectively, compared to $103,000 and $420,000 for the corresponding periods in 2003. The increases during the 2004 periods resulted primarily from slightly higher cash, cash equivalents, and marketable securities balances due to our May 2004 equity offering, partially offset by lower interest rates.

          Interest expense for the three and nine months ended September 30, 2004 was $304,000 and $658,000, respectively, compared to $138,000 and $338,000 for the corresponding periods in 2003. The increases in the 2004 periods were due to higher average debt balances. Partially offsetting the increases during the nine months ended September 30, 2004 was $131,000 of interest that was capitalized during the construction of improvements to our leased facility in Horsham, Pennsylvania. See “Investing Activities” in the Liquidity and Capital Resources section of this Form 10-Q for a description of those improvements. During the nine months ended September 30, 2003, we capitalized interest of $15,000. We expect our interest expense during 2004 to increase compared to 2003 primarily due to the issuance of new debt. See “Financing Activities – Debt Financing Activities” in the Liquidity andCapital Resources section of this Form 10-Q for a description of the material features of our debt financings.

**Item   3.**

**Quantitative   and Qualitative Disclosure About Market Risk**

          As of September 30, 2004, our holdings of financial instruments are comprised solely of money market securities.  To date, our market risk exposure has consisted principally of exposure to changes in interest rates. Our holdings are also exposed to the risks of changes in the credit quality of issuers. We typically invest in the shorter-end of the maturity spectrum. As of September 30, 2004, we were not invested in any marketable securities. The approximate principal amount of our investment portfolio as of September 30, 2004 was $55.0 million. The annualized weighted-average interest rate earned on our portfolio during the nine months ended September 30, 2004 was approximately 1.0%.

          We have exposure to changing interest rates on our tax-exempt bonds and variable rate bank debt, and we are currently not engaged in hedging activities. Interest on approximately $9.0 million of outstanding indebtedness is at an interest rate that varies quarterly, depending on

23

changes in the 90-day LIBOR. During the nine months ended September 30, 2004, the annualized weighted-average, interest rate on this debt was approximately 4.0%. 

**Item   4.**

**Controls   and Procedures**

**          **We carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), for financial reporting as of September 30, 2004. Based on that evaluation, our principal executive officer and principal financial officer concluded that these controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported as specified in Securities and Exchange Commission rules and forms. There were no changes in these controls or procedures identified inconnection with the evaluation of such controls or procedures that occurred during our last fiscal quarter, or in other factors that have materially affected, or are reasonably likely to materially affect, these controls or procedures.

          Our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission. These disclosure controls and procedures include, among other things, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Our internal controls and procedures for financial reporting are designed to provide reasonable assurance, and management believes that they provide such reasonable assurance, that ourtransactions are properly authorized, our assets are safeguarded against unauthorized or improper use, and our transactions are properly recorded and reported, in order to permit the preparation of our financial statements in conformity with generally accepted accounting principles.

          Our management group, including our principal executive officer and principal financial officer, does not expect that our disclosure controls and internal controls and related procedures will prevent all error and all fraud. A control system, no matter how well designed and implemented, can provide only reasonable assurance that the objectives of the control system are met. In addition, the design and implementation of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered in relation to their costs. The design of any system of controls is based, in part, upon certain assumptions about the likelihood of future events, which may prove to be incorrect. Due to the limitations of all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within an organization havebeen detected or prevented. 

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**PART II.     OTHER INFORMATION**

**Item 6.**

**Exhibits**

 

 

 

 

 

10.10

Separation Agreement   between the Company and Robert I. Kriebel dated September 23, 2004.(1)

 

 

 

 

10.11

Promissory Note of the   Company to General Electric Capital Corporation dated August 20, 2004.*

 

 

 

 

10.12

Form of Incentive Stock   Option Award Agreement under the Company’s 2004 Equity Incentive Plan.*

 

 

 

 

10.13

Form of Non-Qualified   Stock Option Award Agreement under the Company’s 2004 Equity Incentive Plan.*

 

 

 

 

10.14

Form of Annual Director   Grant Agreement under the Company’s 2004 Equity Incentive Plan.*

 

 

 

 

10.15

Form of Director Fee   Option Grant Agreement under the Company’s 2004 Equity Incentive Plan.*

 

 

 

 

31.1

Certification by Chief   Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted   pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

 

 

 

 

31.2

Certification by Chief   Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted   pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

 

 

 

 

32.1

Certification Pursuant to   18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the   Sarbanes-Oxley Act of 2002.*

 

 

 

 

32.2

Certification Pursuant to   18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the   Sarbanes-Oxley Act of 2002.* |
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