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S. SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q (Mark One) x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 OF THE SECURITIES EXCHANGE
ACT OF 1934
 For the quarterly period ended June 30, 2004. o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM  TO
.
 Commission file number 0-22170 Epoch Biosciences, Inc. (Exact name of Registrant as specified in its charter)
 Delaware(State or other jurisdiction of incorporation or organization)
    
    91-1311592(I.R.S. Employer Identification No.)
 21720 23rd Drive SE, #150, Bothell, WA 98021(Address of principal executive office, including zip code) (425) 482-5555(Issuers telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report) Check whether the issuer (1) filed all reports to be filed by Section 13 or
15(d) of the Exchange Act during the past 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 o     NOx As of June 30, 2004, the aggregate market value of voting stock held by
non-affiliates, computed by reference to the price at which the stock was sold
on such date, was approximately $52,086,272 28,635,671 shares of Common Stock were outstanding at August 5, 2004.




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Epoch Biosciences, Inc.
Index To Form 10-Q Page NumberPart I. Financial InformationItem 1. Financial Statements
    
    
    3Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    9Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    22Item 4. Controls and Procedures
    
    
    22Part II. Other InformationItem 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    22Item 4. Submission of Matters to a Vote of Security Holders
    
    
    23Item 6. Exhibits and Reports on Form 8-K
    
    
    24Note: Items 1, 3, and 5 are omitted, as they are not applicable.Signature
    
    
    25EXHIBIT 10.40EXHIBIT 10.41EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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Part I. Financial Information 
 Item 1. Financial Statements Epoch Biosciences, Inc.
Balance Sheets
(unaudited) December 31,
    
    June 30,2003
    
    2004AssetsCurrent assets:Cash and cash equivalents
    
    $
    4,415,298
    
    
    $
    9,158,738Restricted cash
    
    
    
    
    
    
    92,495Accounts receivable, net of allowance of $63,311 and $70,366
    
    
    1,342,377
    
    
    
    1,408,800Inventory
    
    
    97,540
    
    
    
    92,203Prepaid expenses and other assets
    
    
    216,547
    
    
    
    205,969Total current assets
    
    
    6,071,762
    
    
    
    10,958,205Property and equipment, net
    
    
    2,569,552
    
    
    
    2,510,438Identifiable intangible assets, net
    
    
    867,647
    
    
    
    838,235Restricted cash
    
    
    653,723
    
    
    
    580,666Other assets
    
    
    10,000
    
    
    
    5,001Total assets
    
    $
    10,172,684
    
    
    $
    14,892,545Liabilities and Stockholders EquityCurrent liabilities:Current portion of long-term obligations
    
    $
    524,562
    
    
    $
    479,821Accounts payable and accrued liabilities
    
    
    1,452,733
    
    
    
    1,720,335Deferred revenue  current portion
    
    
    451,338
    
    
    
    371,395Common stock warrants
    
    
    
    
    
    
    913,577Total current liabilities
    
    
    2,428,633
    
    
    
    3,485,128Long-term obligations, less current portion
    
    
    358,764
    
    
    
    369,451Deferred revenue, less current portion
    
    
    2,510,548
    
    
    
    2,615,840Deferred rent
    
    
    332,984
    
    
    
    368,500Stockholders equity:Preferred stock, par value $.01; 10,000,000 shares
authorized; no shares issued and outstanding
    
    
    
    
    
    
    Common stock, par value $.01; 50,000,000 shares
authorized; shares issued and outstanding:26,155,484 at December 31, 2003 and
28,635,671 at June 30, 2004
    
    
    261,555
    
    
    
    286,357Additional paid-in capital
    
    
    83,191,731
    
    
    
    87,074,284Accumulated deficit
    
    
    (78,911,531
    )
    
    
    (79,307,015
    )Total stockholders equity
    
    
    4,541,755
    
    
    
    8,053,626Total liabilities and stockholders equity
    
    $
    10,172,684
    
    
    $
    14,892,545
 See accompanying notes to financial statements. 3




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Epoch Biosciences, Inc.
Statements of Operations
(unaudited) Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2004
    
    2003
    
    2004Revenue:Product sales
    
    $
    688,616
    
    
    $
    488,911
    
    
    $
    1,437,045
    
    
    $
    1,055,447License fees and royalty income
    
    
    1,371,685
    
    
    
    1,447,926
    
    
    
    2,689,754
    
    
    
    2,814,508Contract research revenue
    
    
    392,000
    
    
    
    
    
    
    
    741,000
    
    
    
    Total revenue
    
    
    2,452,301
    
    
    
    1,936,837
    
    
    
    4,867,799
    
    
    
    3,869,955Operating expenses:Cost of product sales
    
    
    642,820
    
    
    
    347,053
    
    
    
    1,382,557
    
    
    
    738,975Research and development
    
    
    1,086,277
    
    
    
    982,272
    
    
    
    2,343,484
    
    
    
    1,910,086Selling, general and administrative
    
    
    981,973
    
    
    
    1,378,671
    
    
    
    2,282,103
    
    
    
    2,590,409Loss on sale of San Diego operations
    
    
    2,804,862
    
    
    
    
    
    
    
    2,804,862
    
    
    
    Total operating expenses
    
    
    5,515,932
    
    
    
    2,707,996
    
    
    
    8,813,006
    
    
    
    5,239,470Operating loss
    
    
    (3,063,631
    )
    
    
    (771,159
    )
    
    
    (3,945,207
    )
    
    
    (1,369,515
    )Interest income, net
    
    
    3,895
    
    
    
    22,578
    
    
    
    11,043
    
    
    
    33,539Warrant valuation adjustment
    
    
    
    
    
    
    178,107
    
    
    
    
    
    
    
    940,492Net loss
    
    
    (3,059,736
    )
    
    
    (570,474
    )
    
    
    (3,934,164
    )
    
    
    (395,484
    )Net loss per
share - basic and diluted
    
    $
    (0.12
    )
    
    $
    (0.02
    )
    
    $
    (0.15
    )
    
    $
    (0.01
    )Weighted average number of common shares
outstanding  basic and diluted
    
    
    25,949,689
    
    
    
    28,635,671
    
    
    
    25,840,243
    
    
    
    27,888,402
 See accompanying notes to financial statements. 4




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Epoch Biosciences, Inc.

Statements of Cash Flows
(unaudited) Six Months EndedJune 30,2003
    
    2004Cash flows from operating activities:Net loss
    
    $
    (3,934,164
    )
    
    $
    (395,484
    )Adjustments to reconcile net loss to net
cash used in operating activities:Depreciation and amortization:Property and equipment
    
    
    461,782
    
    
    
    322,160Intangible assets
    
    
    131,083
    
    
    
    29,412Issuance of common stock warrants for services
    
    
    1,421
    
    
    
    1,043Warrant valuation adjustment
    
    
    
    
    
    
    (940,492
    )Loss on sale of San Diego operations
    
    
    2,804,862
    
    
    
    Interest accrued on restricted cash
    
    
    (19,332
    )
    
    
    (19,438
    )Deferred revenue
    
    
    2,801
    
    
    
    25,349Deferred rent
    
    
    43,975
    
    
    
    35,516Changes in operating assets and liabilities:Accounts receivable
    
    
    714,097
    
    
    
    (66,423
    )Inventory
    
    
    158,833
    
    
    
    5,337Prepaid expenses and other assets
    
    
    (6,278
    )
    
    
    15,577Accounts payable and accrued liabilities
    
    
    (385,983
    )
    
    
    267,602Net cash used in operating activities
    
    
    (26,903
    )
    
    
    (719,841
    )Cash flows from investing activities:Acquisition of property and equipment
    
    
    (384,065
    )
    
    
    (263,046
    )Proceeds from sale of assets, net
    
    
    1,081,561
    
    
    
    Net cash provided by (used in) investing activities
    
    
    697,496
    
    
    
    (263,046
    )Cash flows from financing activities:Proceeds from bank loan
    
    
    408,418
    
    
    
    271,324Repayment of long-term obligations
    
    
    (255,509
    )
    
    
    (305,378
    )Proceeds from exercise of warrants
    
    
    212,250
    
    
    
    Proceeds from exercise of stock options
    
    
    65,060
    
    
    
    12,284Proceeds from the issuance of common stock and warrants
    
    
    
    
    
    
    5,748,097Net cash provided by financing activities
    
    
    430,219
    
    
    
    5,726,327Net increase in cash and cash equivalents
    
    
    1,100,812
    
    
    
    4,743,440Cash and cash equivalents at beginning of period
    
    
    3,507,645
    
    
    
    4,415,298Cash and cash equivalents at end of period
    
    $
    4,608,457
    
    
    $
    9,158,738Supplemental disclosure of cash flow information Interest payments
    
    $
    17,545
    
    
    $
    16,869Non-cash financing activities -Fair value of common stock warrants originally classified as liability
    
    
    
    
    
    $
    1,854,069
 See accompanying notes to financial statements. 5




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Epoch Biosciences, Inc.
Notes to Financial Statements
June 30, 2004
(unaudited) 1. Summary of Significant Accounting Policies (a) Nature of Business Epoch Biosciences, Inc. is a biotechnology company developing technologies
and products to help scientists, clinicians, and physicians around the world
perform genetic research to improve our lives and our environment. Genetic
analysis has become a pervasive activity in academic, biopharmaceutical,
clinical, agricultural, veterinary and forensic laboratories. Our technologies
facilitate rapid, accurate and cost-effective genetic analysis at the scale
necessary to generate the massive amounts of genetic information being studied
today. As the human genome and other animal and plant genomes are sequenced, the
task of understanding the structure and function of genes lies before us.
Researchers want to know when and why a gene switches on and begins producing
its protein (gene expression) and what the genes protein does in the body
(proteomics); they also want to know what the genetic differences among
individuals mean for their health and susceptibility to disease. For example,
single nucleotide polymorphisms, or SNPs, are tiny differences in our DNA that
make humans different from one another. SNPs have been linked to
susceptibility to diseases, and to peoples response to medications. Our technologies are useful in genetic research, drug development,
prenatal testing, molecular diagnostics, including infectious disease,
oncology, genetic disease and population screening to assess our risk of
disease or to predict our response to drugs. Epochs products also have
application in forensics, food testing, and environmental testing, including
bio-warfare and bioterrorism. We market our products directly to end-users and through distributors that
provide worldwide reach, and license our technologies to other companies for
incorporation into their products. (b) Basis of Presentation The unaudited financial statements have been prepared in accordance with
accounting principles generally accepted in the United States for interim
financial information and with the instructions to Form 10-Q. Accordingly,
they do not include all of the information and footnotes required to be
presented for complete financial statements. The accompanying financial
statements include all adjustments (consisting only of normal recurring
accruals), which are, in the opinion of management, necessary for a fair
presentation of the results for the interim periods presented. The financial statements and related disclosures have been prepared with
the presumption that users of the interim financial information have read or
have access to the audited financial statements for the preceding fiscal year.
Accordingly, these financial statements should be read in conjunction with the
audited financial statements and the related notes included in our 2003 Annual
Report on Form 10-K as filed with the Securities and Exchange Commission. 6




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(c) Stock-Based Compensation We apply APB Opinion No. 25, Accounting for Stock Issued to Employees
and related interpretations in measuring compensation costs for its employee
stock option plans. We disclose proforma net loss and net loss per share as if
compensation cost had been determined consistent with Statement of Financial
Accounting Standard (SFAS) No. 123, Accounting for Stock-Based Compensation.
Stock options and warrants issued to non-employees are accounted for using the
fair value method prescribed by SFAS 123 and Emerging Issues Task Force 96-18. Had we determined compensation cost based on the fair value of our stock
options on the grant date under SFAS 123, our net loss and net loss per share
would have been the pro forma amounts indicated below: Three months ended June 30,
    
    Six months ended June 30,2003
    
    2004
    
    2003
    
    2004Net loss:As reported
    
    $
    (3,059,736
    )
    
    $
    (570,474
    )
    
    $
    (3,934,164
    )
    
    $
    (395,484
    )Add: Stock-based employee
compensation expense included in
reported net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Deduct: Stock-based employee
compensation determined under
fair value based method for all
awards
    
    
    262,804
    
    
    
    225,227
    
    
    
    498,270
    
    
    
    487,187Pro forma
    
    $
    (3,322,540
    )
    
    $
    (795,701
    )
    
    $
    (4,432,434
    )
    
    $
    (882,671
    )Net loss per share  basic and diluted:As reported
    
    $
    (0.12
    )
    
    $
    (0.02
    )
    
    $
    (0.15
    )
    
    $
    (0.01
    )Pro forma
    
    $
    (0.13
    )
    
    $
    (0.03
    )
    
    $
    (0.17
    )
    
    $
    (0.03
    )
 Three months ended June 30,
    
    Six months ended June 30,2003
    
    2004
    
    2003
    
    2004Weighted average fair value of option
granted using the Black-Scholes option
pricing model
    
    $
    1.67
    
    
    $
    1.35
    
    
    $
    1.67
    
    
    $
    1.92Options granted during the period
    
    
    172,500
    
    
    
    238,000
    
    
    
    172,500
    
    
    
    602,420Expected dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %Risk-free interest rate
    
    
    2.57
    %
    
    
    3.81
    %
    
    
    2.74
    %
    
    
    3.34
    %Expected volatility
    
    
    126
    %
    
    
    90
    %
    
    
    126
    %
    
    
    96.95
    %Expected life in years
    
    
    5
    
    
    
    5
    
    
    
    5
    
    
    
    5
 In March 2004, the Financial Accounting Standards Board issued an Exposure
Draft of a proposed Statement of Financial Accounting Standards entitled
Share-Based Payment. This proposed Statement addresses accounting for
stock-based compensation and would result in stock-based compensation costs,
including employee options, being recognized as an expense in the financial
statements. The proposed Statement would eliminate the ability to account for
stock-based compensation transactions using the intrinsic value method under
APB Opinion No. 25, and generally would require that such transactions be
accounted for using a fair-value based method. If approved, the proposed
statement would be applied to public entities, prospectively, for fiscal years
beginning after December 15, 2004. 7




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(d) Net Loss Per Share Basic loss per share is computed based on weighted average shares
outstanding during the reporting period and excludes any potential dilution.
Diluted per share amounts reflect potential dilution from the exercise or
conversion of securities into common stock or from other contracts to issue
common stock. Our capital structure includes common stock options and common
stock warrants, of which the following have been excluded from the net loss per
share calculation as they are antidilutive. June 30,2003
    
    2004Outstanding options excluded from net loss per share
    
    
    2,620,963
    
    
    
    2,684,483Outstanding warrants excluded from net loss per
share
    
    
    90,000
    
    
    
    906,000
 (e) Concentration of Credit Risk Credit is extended based on an evaluation of a customers financial
condition and collateral is generally not required. The majority of revenues
are derived from private and public companies and public enterprises in the
research market in the United States. The table below summarizes the revenue and approximate accounts receivable
of our customers where our risk is significantly concentrated. Percent of Revenues
    
    Accounts ReceivableThree months
    
    Six monthsended June 30,
    
    ended June 30,
    
    Dec 31, 2003
    
    Jun 30, 20042003
    
    2004
    
    2003
    
    2004Customer:Applied Biosystems,
Inc.
    
    
    56
    %
    
    
    69
    %
    
    
    48
    %
    
    
    70
    %
    
    $
    1,134,000
    
    
    $
    1,253,000Amersham Biosciences
    
    
    21
    %
    
    
    0
    %
    
    
    21
    %
    
    
    0
    %
    
    $
    18,000
    
    
    $
    
 The amounts due from Applied Biosystems in the above chart primarily
represent quarterly royalties and have historically been paid in accordance
with the terms of the underlying agreement. (f) Private Equity Financing On February 23, 2004, we consummated the issuance of 2,470,000
newly-issued shares of our common stock, and warrants to purchase 741,000
newly-issued shares of our common stock, to a small number of institutional
investors, resulting in our receipt of $6,175,000 in gross proceeds, prior to
placement agent fees and other offering costs totaling $427,000 and the
exercise of the warrants. Investors received a warrant to purchase 0.3 shares
of common stock for each share of common stock purchased. The effective price
in the private placement was $2.50 for each unit, consisting of one share of
common stock and a warrant to purchase 0.3 shares of common stock. The
warrants have an exercise period of five years and an exercise price of $3.89
per share. Our placement agent with respect to the transaction received a cash
fee equal to 5.5% of the gross proceeds, and its affiliates received warrants
to purchase an aggregate of 75,000 shares of our common stock, carrying the
same terms as the warrants received by the investors. The registration
statement covering the resale by the investors of these shares and the shares
of common stock issuable upon exercise of the warrants was declared effective
by the SEC on April 30, 2004. Accordingly, these shares and the shares
issuable upon exercise of the warrants 8




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may be offered or re-sold in the United States, pursuant to the effective
registration statement or an applicable exemption from the registration
requirements of the Securities Act. The warrants issued in the private equity placement provide for cash
redemption by the warrant holders upon the occurrence of a change in control
that may be outside of the control of our Board of Directors, subject to
certain exceptions. As a result, and in accordance with EITF 00-19,
Accounting for Derivative Financial Instruments Indexed To, and Potentially
Settled In a Companys Own Stock, the fair value of the warrants, measured
using the Black-Scholes valuation method, is recorded as a current liability on
our balance sheet. The decrease in the market price of our common stock and
other changes in the valuation assumptions from the closing of the equity
placement on February 23, 2004 to March 31, 2004 resulted in a decrease in the
value of the warrants between these dates of $762,000. The decrease in the
market price of our common stock and other changes in the valuation assumptions
from April 1, 2004 to June 30, 2004 resulted in a further decrease in the value
of the warrants between these dates of $178,000. Therefore, we report $178,000
and $940,000 as a warrant valuation adjustment in our statements of operations
for the three and six month periods, respectively, ending June 30, 2004. The assumptions used in the Black-Scholes pricing model were: February 23, 2004
    
    March 31, 2004
    
    June 30, 3004Expected dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %Risk-free interest rate
    
    
    3.03
    %
    
    
    2.81
    %
    
    
    3.81
    %Expected volatility
    
    
    104
    %
    
    
    99
    %
    
    
    90
    %Remaining contractual life in years
    
    
    5
    
    
    
    4.9
    
    
    
    4.7
 Until the warrants are exercised or expire, the valuation of the warrants
and the corresponding liability will be re-measured quarterly and the financial
statements will reflect a non-cash valuation adjustment based on the change in
the fair value of the warrants at the end of each reporting period. 
 Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations This Quarterly Report on Form 10-Q includes forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
That Act provides a safe harbor for forward-looking statements to encourage
companies to provide prospective information about themselves so long as they
identify these statements as forward-looking and provide meaningful, cautionary
statements identifying important factors that could cause actual results to
differ from the projected results. Other than statements of historical fact, all statements in this Quarterly
Report on Form 10-Q and, in particular, any projections of or statements as to
our expectations or beliefs concerning our future financial performance or
financial position or as to future trends in our business or in our markets,
are forward-looking statements. Forward-looking statements reflect our current
expectations and are inherently uncertain and our actual results in future
periods may differ materially from our expectations concerning our projections
of those results or of future business trends described in this Quarterly
Report on Form 10-Q. The sections below entitled Certain Factors that May
Affect Our Business and Future Results under Item 2, Managements Discussion
and Analysis of Financial Condition and Results of Operations, describe some,
but not all, of the factors, risks and uncertainties that could cause these
differences, including but not limited to the fact that we have realized
operating profitability in only one quarter and anticipate future losses, and
that we may require additional capital; the fact that we will be dependent upon
our agreement with Applied Biosystems for a significant portion of our revenues
for 9




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2004 and future periods; the possibility that potential products utilizing
the Companys technology may be ineffective or, although effective, may be
uneconomical to market; that third parties may hold proprietary rights that
preclude Epoch or its licensees from marketing its products; or that third
parties may market superior products. Readers of this Quarterly Report on Form
10-Q are urged to read those sections in their entirety. In light of the
significant uncertainties inherent in the forward-looking information included
in this document, the inclusion of information should not be regarded as a
representation by us or any other person that our objectives or plans will be
achieved. The forward-looking statements contained in this Quarterly Report on
Form 10-Q are made only as of the date of this Quarterly Report on Form 10-Q
and Epoch undertakes no obligation to update or revise the forward-looking
statements, whether as a result of new information, future events or otherwise. The following discussion of Epochs financial condition and results of
operations should be read in conjunction with the financial statements and the
related notes thereto included elsewhere in this Quarterly Report on Form 10-Q
and other documents Epoch files from time to time with the Securities and
Exchange Commission, including subsequent Current Reports on Form 8-K,
Quarterly Reports on Form 10-Q and Annual Reports on Form 10-K. Results of Operations Overview Epoch develops technology and products that enable and accelerate genomic
analysis. The foundation of our business strategy is the continued funding of
innovative research and development and commercialization of the resultant
products through a number of channels. We earn revenues through a variety of sources. Historically, the majority
of our revenues have been generated in the research field. In July 2004, we
commenced commercial sale of our analyte specific reagents to sophisticated
clinical testing laboratories for diagnostic testing. We license our
technology and sell chemical intermediates to companies, thereby allowing them
to incorporate our technology into their products and we generate product
revenue and earn license fees and royalties from those companies. We also sell
our products to end-users through our direct sales force and through
distributors that provide worldwide reach. We also earn revenues through
contract research activities, whereby third parties pay for specific research
and development activities carried out by our scientists, and through research
grants. We expect to incur operating losses for at least the current fiscal year
as we continue funding research and development to apply our technology to
genomic analysis for the research markets and other fields, and as we incur
costs to commercialize the resultant products through various channels. Critical Accounting Policies Our accounting policies are more fully described in Note 1 to our
financial statements included with Form 10-K. However, certain of our
accounting policies are particularly important to the portrayal of our
financial position and results of operations and require the application of
significant judgment by our management. As a result they are subject to an
inherent degree of uncertainty. In applying those policies, our management
uses its judgment to determine the appropriate assumptions to be used in the
determination of certain estimates. Those estimates are based on our
historical experience, terms of existing contracts, our observance of trends in
the industry, information provided by our customers and information available
from other outside sources, as appropriate. Our critical accounting policy is
revenue recognition. 10




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Revenue recognition. We earn revenues from sales of chemical
intermediates and reagents to manufacturers for incorporation into their
products, from the sale of specialty oligonucleotides and value added reagents
to end users and distributors in the fields of genomics and molecular
diagnostics, from license fees for the use of our proprietary technology and
know-how, and by providing services to third parties for performing research
and development on their behalf. We also have license agreements that result
in royalties to us upon ultimate sales of products by our partners. Many of
our arrangements contain multiple deliverables which require us to determine
the fair value of the various deliverables. To the extent we are unable to
determine the fair value of undelivered elements, we are required to defer all
revenue and recognize it over the appropriate period or until such time that
the fair value of remaining undelivered elements can be determined.  
    
    Revenues from product sales that require no ongoing
obligations are recognized when shipped to the customer and title
has passed. To the extent that sales are made to distributors and
not sold through to end users our future sales could decline
although distributors generally have no right of return.
    
    License fees are recognized over the term of the agreement to
which the license fees correspond, which may extend to the
expiration of the underlying patents, and based on the terms and
future performance obligations in the underlying agreements. These
upfront fees are generally nonrefundable regardless of future
performance. Deferred revenue principally represents these license
fees received in advance and prepayments for product purchases.
    
    Contract research revenues are recognized as the applicable
research and development activities are performed under the terms of
commercial collaboration and supply agreements and government
grants. Direct costs related to these contracts and grants are
reported as research and development expenses.
    
    Royalty revenues are recognized when earned under the terms
of the related agreements, which is generally upon sale of products
by our partner containing our component products. To the extent our
partners no longer use our component products or sales of their
products are less than expected, our royalty revenues could decrease
in the future. Revenues Revenues for the three and six month periods ended June 30, 2004 decreased
21% and 20%, respectively, over the similar periods of 2003, primarily due to
the reduction in product sales caused by the sale of the assets and customer
base for our non-proprietary oligonucleotide business located in San Diego (San
Diego Operations) in May 2003, and a reduction in contract research revenues,
partially offset by increased sales of our MGB Eclipse products. Product Sales. Product sales include sales of specialty oligonucleotides
to end users and to our distribution partners in the research market and sales
of chemical intermediates and our dyes, quencher, and modified bases to
collaborative partners and distributors. Product sales decreased 29% in the
second quarter of 2004 to $489,000 from $689,000 in the comparable quarter of
2003. Product sales also decreased 27% in the six month period ended June 30,
2004 to $1,055,000 from $1,437,000 in the comparable period of 2003. The
decrease in product sales in both periods was primarily due to the absence of
sales from our San Diego Operations that were sold in May 2003 and a reduction
in sales of chemical intermediates to Applied Biosystems. During the three and
six month periods ended June 30, 2003, we recognized $184,000 and $451,000 in
product sales from our San Diego Operations, respectively. Sales of our
products other than from our San Diego Operations, decreased 3% and increased 7% for the three and six month periods ending June 30, 2004,
respectively. 11




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In both periods, we realized increased sales of our MGB Eclipse Probe
System products into the research field. These products are sold directly to
end users, and also through QIAGEN, our worldwide distributor. Revenues from
the sale of these products in the second quarter of 2004 were 23% higher than
in the comparable quarter of 2003, and 31% higher for the six month period
ended June 30, 2004 compared to the comparable period of 2003, due to increased
levels of direct selling activities by Epoch personnel and the introduction in
late 2003 of MGB Eclipse By Designassays that we design, manufacture, and
functionally validate. We expect continued growth in our MGB Eclipse Probe
System sales in the research field and also in the molecular diagnostic market
as a result of our launch of MGB Eclipse Detection Reagents in July 2004. Chemical intermediate revenues represent component chemistries that we
generally supply on cost-plus terms for incorporation in our partners
products, and sales of dyes, quencher, and modified bases through distributors.
These revenues decreased 40% in the quarter ended June 30, 2004 and also
decreased 38% in the six month period ended June 30, 2004 from the comparable
periods of 2003 primarily as a result of a continued decrease in shipments to
Applied Biosystems. In 2002 Applied Biosystems actively built an initial
inventory of finished goods as well as inventory of component materials in
support of their Assays-on-Demand and Assays-by-Design product launches. In
2002, the initial inventory levels were established and the products launched,
and in 2003 operating inventory levels were achieved. As a result, shipments
to Applied Biosystems continued to decline in the first six months of 2004
compared to 2003, and are expected to be lower in the second half of 2004
compared to 2003. License Fees and Royalty Income. License fees reflect the amortization of
initial payments for technology and know-how. These amounts are amortized over
the life of the contract. Royalty income represents amounts due under license
agreements with other companies for their sales of products that include our
technologies and/or for contractual minimum amounts. License fees and royalty
income increased to $1,448,000 in the quarter ended June 30, 2004 from
$1,372,000 in the comparable period of 2003 and also increased to $2,815,000 in
the six month period ended June 30, 2004 from $2,690,000 in the comparable
period of 2003. These increases are the result of higher contractual minimums
from Applied Biosystems and higher sales of products that incorporate our
technologies by our partners, partially offset by a reduction in technology
access fees from our collaboration with Amersham Biosciences. In 2003,
Amersham Biosciences paid us technology access fees for a specified period that
expired in June 2003. In October 2003 we terminated our distribution agreement
with Amersham that gave rise to such technology access fees. Contract Research Revenue. Contract research revenue reflects payments
for contract research and development performed for our corporate partners and
research grants from the National Institute of Health. We do not have any
contract research agreements at this time as a result of completion of work
under grants from the National Institute of Health and the termination of
contract programs with Amersham Biosciences. In 2003, Amersham Biosciences
paid us for specified research activities related to application of our MGB
Eclipse Probe Systems. Those programs terminated in June 2003, and in October
2003 we terminated our distribution agreement with Amersham that gave rise to
such programs. Cost of Product Sales. The cost of product sales represents the cost of
manufacturing products that we sell, including costs of material, labor and
overhead allocations. The cost of product sales decreased to $347,000 in the
second quarter of 2004 compared to $643,000 in the comparable quarter of the
prior year and decreased to $739,000 for the six month period ended June 30,
2004 compared to $1,383,000 in the comparable six month period of 2003. Costs
as a percentage of product sales 12




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decreased from 93% in the second quarter of 2003 to 71% in the second quarter
of 2004, and decreased from 96% in the six month period ended June 30, 2003 to
70% in the comparable six month period of 2004. Generally, changes in costs of product sales are tied to changes in
revenues, while the changes in costs as a percentage of product sales are
impacted by the product mix and economies of scale resulting from changes in
volume. Shipments of the majority of our chemical intermediates and certain
other products, for example, are to larger volume customers and selling prices
are determined by contract and tied to fully burdened manufacturing costs,
which results in lower gross margins. Further, we manufacture MGB Eclipse
Probe System products to various customer specifications - including custom
orders, catalog orders, and functionally validated assays. The gross margin on
these different products can vary significantly. The reduction in the dollar cost of product sales and in the percentage
cost of product sales in 2004 is primarily the result of the sale of our San
Diego Operations on May 30, 2003. Many costs of our non-proprietary
oligonucleotide manufacturing operations in San Diego were fixed within a wide
range of capacity output. As a result, the low level of sales volume we
experienced in our San Diego Operations in 2003 did not result in
proportionally lower costs and we experienced very poor gross margins on those
sales until we sold the assets and customer base in May 2003. Research and Development. Research and development costs of $982,000 in
the second quarter of 2004 decreased 10% compared to the comparable period of
2003. Research and development costs of $1,910,000 in the six month period
ended June 30, 2004 similarly decreased 18% compared to the comparable period
of 2003. Research and development costs are heavily impacted by our use of
research and development personnel in our manufacturing operations to meet
variations in customer demand. As such, the use of research and development
personnel in manufacturing has, and will continue to fluctuate depending on
volumes and mix of product sales and the availability of research and
development personnel to conduct such activities. Significant changes in
research and development costs were due to:  
    
    Transfer of personnel from research and development to
manufacturing reduced research and development expenses by $82,000
in the second quarter of 2004, and by $316,000 in the six month
period ended June 30, 2004, compared to the similar periods of 2003.
    
    Costs of chemicals and supplies used in research activities
in the first half of 2004 being $76,000 lower than in the comparable
period of 2003.
    
    Decreased consulting costs incurred in 2003, primarily
related to our efforts to obtain a Department of Defense contract,
which resulted in lower costs of $44,000 and $83,000 in the three
and six month periods ended June 30, 2004, respectively, compared to
the similar periods of 2003.
    
    Increased patent expenses of $56,000 in the six month period
ended June 30, 2004 compared to the similar period of 2003. Selling, General and Administrative. Selling, general and administrative
expenses of $1,379,000 in the second quarter of 2004 increased $397,000, or
40%, compared to the comparable period of 2003 and similarly increased
$308,000, or 14%, in the six month period ended June 30, 2004 compared to the
comparable period of 2003. Selling, general and administrative expenses are
expected to continue above 2003 levels due to significantly expanded direct
sales and marketing activities. Significant changes in the 2004 periods
compared to the 2003 periods were primarily the result of:  
    
    Increased selling and marketing expenses of $208,000 and
$347,000 for the three and six month periods ending June 30, 2004,
respectively, as compared to the similar periods of 13




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2003, due to overall increased sales and marketing efforts in the
research market and in support of our launch of molecular
diagnostic products in July 2004.  
    
    The sale of our San Diego Operations in May 2003 resulted in
the elimination of our administrative functions which supported
those operations and reduced administrative expenses and associated
goodwill amortization by a total of $169,000 and $424,000 in the
three and six month periods ended June 30, 2004, respectively,
compared to the similar periods of 2003.
    
    Recovery of arbitration expenses incurred in 2002 and the
first quarter of 2003 as a result of the settlement of our dispute
with Third Wave in the second quarter of 2003 resulting in lower
reported expenses of $177,000 and $31,000 for the three and six
month periods ended June 30, 2003, respectively, compared to the
similar periods of the current year.
    
    Increased personnel and other expenses of $79,000 and
$144,000 in the three and six month periods ended June 30, 2004,
respectively, resulting from our implementation of the FDAs quality
systems regulation.
    
    Increased professional fees associated with business
development efforts of $141,000 and $204,000 in the three and six
month periods ended June 30, 2004, respectively, compared to the
similar periods of 2003. Liquidity and Capital Resources Cash and cash equivalents amounted to $9,159,000 at June 30, 2004, a
$4,743,000 increase from December 31, 2003 balances, primarily as a result of
the private equity financing we completed in February 2004. Also impacting
cash flow were changes in working capital accounts, the purchase and financing
of equipment, and the repayment of bank debt. Cash used in operations during the quarter ended June 30, 2004 amounted to
$720,000 primarily as a result of our net loss of $395,000 adjusted for the
change in fair value of common stock warrants of $940,000 and for certain
non-cash reconciling items and fluctuations in working capital accounts. The
most significant changes were depreciation and amortization of $352,000 and
changes in working capital accounts that impacted cash used in operations,
including an increase in accounts payable and accrued liabilities of $268,000
and an increase in accounts receivable of $66,000, all the result of normal
business fluctuations. Cash used in investing activities represents the purchase of $263,000 of
manufacturing equipment. Future capital expenditures may include increased
manufacturing capacity for our Bothell facility and other investments to
support our operational growth. We may also require a larger inventory of raw
materials and products to provide better service to our customers or to meet
our customers demand, particularly in light of our launch of molecular
diagnostic products in July 2004. We may finance these purchases from our cash
and cash equivalents on hand, cash generated from our operations, borrowings,
equity offerings, or a combination thereof. Cash provided by financing activities in the six months ended June 30,
2004 of $5,726,000 was the result of $5,748,000 received in a private equity
transaction in February 2004, $271,000 in proceeds from bank loans, and $12,000
received from the exercise of stock options, offset by repayments on term loans
of $305,000. Private Equity Financing. On February 23, 2004, we consummated the
issuance of 2,470,000 newly-issued shares of our common stock, and warrants to
purchase 741,000 newly-issued shares of our common stock, to a small number of
institutional investors, resulting in our receipt of $6,175,000 in gross
proceeds, prior to placement agent fees and other offering costs totaling
$427,000 and the exercise of the 14




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warrants. Investors received a warrant to purchase 0.3 shares of common
stock for each share of common stock purchased. The effective price in the
private placement was $2.50 for each unit, consisting of one share of common
stock and a warrant to purchase 0.3 shares of common stock. The warrants have
an exercise period of five years and an exercise price of $3.89 per share. Our
placement agent with respect to the transaction received a cash fee equal to
5.5% of the gross proceeds, and its affiliates received warrants to purchase an
aggregate of 75,000 shares of our common stock, carrying the same terms as the
warrants received by the investors. The warrants issued in the private equity placement provide for cash
redemption by the warrant holders upon the occurrence of a change in control
that may be outside of the control of our Board of Directors, subject to
certain exceptions. As a result, and in accordance with EITF 00-19,
Accounting for Derivative Financial Instruments Indexed To, and Potentially
Settled In a Companys Own Stock, the fair value of the warrants, measured
using the Black-Scholes valuation method, is recorded as a current liability on
our balance sheet. The decrease in the market price of our common stock and
other changes in the valuation assumptions from the closing of the equity
placement on February 23, 2004 to June 30, 2004 resulted in a decrease in the
value of the warrants between these dates and the $940,000 warrant valuation
adjustment reported in our statements of operations for the period ending June
30, 2004. Until the warrants are exercised or expire, the valuation of the warrants
and the corresponding liability will be re-measured quarterly and the financial
statements will reflect a non-cash valuation adjustment based on the change in
the fair value of the warrants at the end of each reporting period. Bank Financing. Our term loan facility expired on June 30, 2004 and our
working capital line of credit will expire at the end of August 2004. Advances
under the term loan are secured by a first position security interest in our
assets excluding intellectual property, and are repayable in 36 monthly
payments of principal and interest at the banks prime rate plus 0.5%. We have
not taken any advances against the working capital line of credit. We have had
preliminary discussions with the commercial lender about the renewal of the
term loan facility. There can be no assurance that such discussions will lead
to a renewal of that facility on acceptable terms, or at all. Summary. Based on cash and cash equivalents on hand at June 30, 2004, as
well as on results of operations and cash flows for the quarter ended June 30,
2004, we currently anticipate that existing cash balances, projected cash from
operations and unused borrowing capacity under existing bank loans will be
sufficient to meet our anticipated working capital and capital expenditures
needs through at least 2005. However, our future capital requirements depend
on numerous factors, including but not limited to:  
    
    the magnitude of our future losses;
    
    the timing and terms of new technology licensing agreements
or other strategic relationships that may provide up front license
fees or other payments;
    
    resources that we devote to research and development and
sales and marketing in support of our business strategy;
    
    technology licenses necessary to support our molecular
diagnostic products that may require upfront license fees or other
payments; and
    
    capital expenditures necessary to expand manufacturing
capacity. It is possible that we may need to raise additional capital to fund our
activities and/or to consummate acquisitions of other businesses, products or
technologies. We may be able to raise such 15




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funds by selling more stock to the public or to selected investors, or by
borrowing money. In addition, even though we may not need additional funds, we
may still elect to sell additional equity securities or obtain credit
facilities for other reasons. We may not be able to obtain additional funds on
terms that would be favorable to our shareholders and us, or at all. If we
raise additional funds by issuing additional equity or convertible debt
securities, the ownership percentages of existing shareholders would be
reduced. In addition, the equity or debt securities that we issue may have
rights, preferences or privileges senior to those of the holders of our common
stock. Certain Factors That May Affect Our Business And Future Results Forward Looking Statements Some of the information included herein contains forward-looking
statements. These statements can be identified by the use of forward-looking
terms such as may, will, expect, anticipates, estimate, continue,
or other similar words. These statements discuss future expectations,
projections or results of operations or of financial condition or state other
forward-looking information. When considering these forward-looking
statements, you should keep in mind the risk factors and other cautionary
statements we make. These risk factors could cause our actual results to
differ materially from those contained in any forward-looking statement. If
any of the following risks actually occur, our business could be harmed and the
trading price of our common stock could decline. We have realized operating profits in only one quarter and anticipate future
losses, and we may require additional capital Since our formation in 1985, we have generated limited revenues and
realized operating profit in only one quarter, which was the quarter ended
December 31, 2002. As of June 30, 2004, we had an accumulated deficit of
approximately $79 million. While we are commercializing our products and
technologies, prior to adequate revenues being generated from these activities
we expect to incur additional operating losses as we expand our manufacturing
capacity, continue our research and development activities and fund our product
commercialization efforts. There is no assurance that we will ever become
profitable from operations or that we will sustain operational profitability if
we do become profitable. Should we experience continued or unforeseen
operating losses, our capital requirements would increase and our stock price
would likely decline. Additionally, as of June 30, 2004 we had approximately $9 million in cash
and cash equivalents. We currently anticipate that our current cash balances
and cash from operations will be sufficient to meet our cash needs through
2005. However, we may need to seek additional equity and/or debt capital, and
there can be no assurance that such capital will be available to us on
favorable terms, or at all. If additional funds are not available, we would be
required to delay, reduce, or eliminate expenditures for some or all of our
programs or products. We will be dependent upon our agreement with Applied Biosystems for a
significant portion of our revenues for 2004 and future periods, and a
reduction of sales under or early termination of this agreement would seriously
harm our revenues and operating results and would likely cause our stock price
to decline In January 1999, Epoch and Applied Biosystems entered into a License and
Supply Agreement pursuant to which we licensed some of our technology to
Applied Biosystems for use in its TaqMan® 5-nuclease real-time PCR assays,
(TaqMan® is a registered trademark of Roche Molecular Systems, Inc.). 16




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In July 1999, we licensed our proprietary software, which speeds the design of
oligonucleotide probes used in the study of genes, to Applied Biosystems. In
August 2000, the agreement was amended to, among other things, provide for
Epoch manufacturing product for Applied Biosystems. In July 2002 this
agreement was further amended to remove the manufacturing rights from the
contract effective October 2002, redefine product categories, increase the
minimum royalties and royalty rates, and establish that minimum royalties are
measured and paid quarterly. We will depend upon product sales and royalties
from Applied Biosystems sales of its TaqMan® assays under this agreement for a
significant portion of our revenues in 2004 and future periods. The technology licenses and Applied Biosystems obligation to pay us
royalties on their sale of products that incorporate our technologies continue
until the expiration of the underlying patents. Since the July 2002 amendment
that increased the minimum royalty levels, quarterly royalties earned based on
actual sales by Applied Biosystems have been less than the contractual minimum
royalty levels. As a result, we have received the specified quarterly minimum
amounts. The current agreement calls for quarterly royalty minimums through
September 2005. Thereafter, we will receive royalty payments based on actual
sales. Based on experience to date, those payments may be significantly less
than the minimum payments currently being made. Either party may terminate the agreement upon 180 days written notice. In
the event that this agreement is terminated, our revenues, financial condition
and operating results would be adversely affected and our stock price would
likely decline. There is a risk that our technology may not be as effective as alternatives The science and technology of synthetic DNA-based products is rapidly
evolving. While we believe that our technology is cost-effective and produces
results equal or superior to other competing technologies, we face the risk
that any or all of our products and proposed products could prove to be less
effective or more costly than products currently marketed, or under
development, by others. If we do not have commercially viable products, we
will not be able to sell our products, we will not be able to attract partners,
and we will not be able to generate funds internally to support operations. Our inability to implement effective marketing programs and build a successful
direct sales force and other distribution channels would limit our revenue
growth We have limited direct sales and marketing experience in general, little
infrastructure, and no recent experience selling to the molecular diagnostics
market. We believe that to market our products effectively, in particular our
new analyte specific reagents, we must continue to expand our direct sales
operations. This expansion will require significant management attention and
financial resources to successfully develop direct and indirect U.S. and
international sales and support channels, and theres no assurance that we will
be successful or that our expenditures in this effort will not exceed the
amount of any resulting revenues. Competition for qualified sales personnel is
intense and we may not be able to hire and train as many qualified individuals
as we may require in the future. We will continue to incur the expenses for a
sales and marketing infrastructure before we recognize significant revenue from
sales of the products. If we are not able to successfully build a sales and
marketing infrastructure or if our direct sales force is not successful we may
not meet our revenue goals and our stock price would likely decline. 17




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We introduced our initial menu of molecular diagnostic products in July 2004.
There is a risk that these products may not be commercially viable or
successful, which would limit our revenue growth We are currently developing and commercializing only a limited number of
molecular diagnostic products based on our technologies. We plan to develop
additional molecular diagnostic products. We cannot assure you that we will be
able to complete development of our products that are currently under
development or that we will be able to develop additional new products. In
addition, some of the products we develop may not be useful or cost effective
in molecular diagnostic applications. If our molecular diagnostic products are
not commercially successful, we may not meet our revenue goals and our stock
price would likely decline. We have limited manufacturing experience While we have experience in researching and developing unique, proprietary
technologies to enhance the study of genes, and in manufacturing
oligonucleotides and other chemical intermediates at relatively small scales,
our experience in manufacturing at larger scales is relatively limited. We
currently have sufficient manufacturing capacity to meet current customer
needs. Anticipated increases in customer demand over the next year may require
us to expand our manufacturing capacity in Bothell, acquire additional
manufacturing capacity, or utilize costly third-party manufacturing vendors, as
necessary. Any delay or inability to expand our manufacturing capacity could
materially adversely affect our manufacturing ability. There is a risk that we do not own exclusive rights to our technology, or that
our competition may have access to our technology which may prevent us from
selling our products We attempt to protect our proprietary technology by relying on several
methods, including United States patents. We also have international patent
applications that correspond to many of the U.S. patents and patent
applications. The issued patents and pending patent applications cover
inventions relating to the components of our core technologies. The expiration
dates of these patents range from January 2012 to July 2020. Additionally, as
sales of our MGB Eclipse products to parties other than Applied Biosystems have
become a larger proportion of our revenues, we have become increasingly
dependent upon certain patent rights that we licensed from Applied Biosystems
covering certain technology necessary for the manufacture and use of our MGB
Eclipse products. We make no guarantee that any licensed patents or our issued
patents will provide us with significant proprietary protection, that pending
patents will be issued, or that products incorporating the technology covered
by licensed patents, our issued patents or pending applications will be free
from challenges by competitors. Further, third parties may hold proprietary
rights which precede our claims or claims made under licensed patents and could
therefore prohibit us from marketing our current or proposed products. Some of our technology might infringe on the rights of others, which may
prevent us from selling our products There is a great deal of litigation regarding patents and other
intellectual property rights in the biomedical industry. We were defendants in
one intellectual property litigation case, which we settled prior to 1997.
Although patent and intellectual property disputes in the biomedical area are
sometimes settled through licensing or similar arrangements, this kind of
solution can be expensive, if a license can be obtained at all. An adverse
determination in a judicial or administrative proceeding or our failure to
obtain necessary licenses could prevent us from manufacturing and selling our
products. This would substantially hurt our business. We face numerous competitors and changing technologies which could make our
products obsolete Many companies do research and development and market products designed to
analyze genes 18




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and diagnose conditions based on a number of technologies and are
developing additional products. In the molecular diagnostics market, we also
potentially compete with several companies offering alternative technologies to
our MGB Eclipse Detection Reagents. Many of these companies have substantially
greater capital resources, larger research and development and marketing staffs
and facilities and greater experience in developing and commercializing
products than we have. Furthermore, the fields in which we operate are subject
to significant and rapid technological change. Even if we successfully
introduce our products or proposed products, our technologies could be replaced
by new technologies or our products or proposed products might be obsolete or
non-competitive. We will be dependent on our agreement with QIAGEN N.V. for the distribution of
our MGB Eclipse products and the resultant revenues. Lower than expected
sales, or early termination of this agreement would seriously harm our
projected revenues and operating results and would likely cause our stock price
to decline In October 2002, Epoch and QIAGEN entered into a license and supply
agreement under which QIAGEN became the co-exclusive worldwide sales, marketing
and distribution partner to the research field of our MGB Eclipse Probe Systems
for gene expression. We will depend upon product sales to QIAGEN under this agreement for a
significant portion of our revenues in future periods. In the event that this
agreement is terminated, or if QIAGEN is unsuccessful at commercializing our
technologies, our revenues, financial condition and operating results would be
adversely affected and our stock price would likely decline. Some of our customers may experience financial difficulties, which could
adversely impact our collection of accounts receivable Although historically we have experienced limited credit losses from our
trade receivables, our experience is limited. At June 30, 2004, our allowance
for doubtful accounts was $70,000. We regularly review the collectibility and
credit worthiness of our customers and the receivables to determine an
appropriate allowance for doubtful accounts, however future uncollectible
accounts could exceed our current or future allowances. The loss of key personnel could adversely affect operations by impairing our
research and our efforts to commercialize and license our products Our performance is greatly dependent upon our key management, including
our Chief Executive Officer, Dr. William Gerber, and technical personnel and
consultants. Our future success will depend in part upon our ability to retain
these people and to recruit additional qualified personnel. We must compete
with other companies, universities, research entities and other organizations
in order to attract and retain highly qualified personnel. Although we have
entered into agreements with our key executive officers, we make no guarantee
that we will retain these highly qualified personnel or hire additional
qualified personnel. We currently maintain no key man life insurance on any of
our management or technical personnel. The value of our common stock could change significantly in a very short time The market price of our common stock may fluctuate significantly. For
example, in the 52 weeks ended August 6, 2004 our stock traded as high as
$3.70, and as low as $1.46. The rapid price changes that our stock has
experienced recently, and throughout our history, place your investment in our
common stock at risk of total loss over a short period of time. We are in the
biotechnology industry and 19




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the market price of securities of biotechnology companies have fluctuated
significantly and these fluctuations have often been unrelated to the
companies operating performance. Announcements by us or our competitors
concerning technological innovations, new products, proposed governmental
regulations or actions, developments or disputes relating to patents or
proprietary rights, and other factors that affect the market generally could
significantly impact our business and the market price of our securities. Public opinion regarding ethical issues surrounding the use of genetic
information may adversely affect demand for our products Public opinion regarding ethical issues related to the confidentiality and
appropriate use of genetic testing results may influence governmental
authorities to call for limits on, or regulation of the use of, genetic
testing. In addition, these authorities could prohibit testing for genetic
predisposition to certain conditions, particularly for those that have no known
cure. Furthermore, adverse publicity of public opinion relating to genetic
research and testing, even in the absence of any governmental regulation, could
harm our business. Any of these scenarios could reduce the potential markets
for our products and technologies, which could materially and adversely affect
our revenues. Government regulation of genetic research or testing may adversely affect the
demand for our products and impair our business and operations Federal, state and local governments may adopt regulations relating to the
conduct of genetic research and genetic testing. These regulations could limit
or restrict genetic research activities as well as genetic testing for research
or clinical purposes. In addition, if state and local regulations are adopted,
these regulations may be inconsistent with, or in conflict with, regulations
adopted by other state or local governments. Regulations relating to genetic
research activities could adversely affect our ability to conduct our research
and development activities. Regulations restricting genetic testing could
adversely affect our ability to market and sell our products and our
technologies. Accordingly, any regulations of this nature could harm our
business. Health care cost containment initiatives could limit the adoption of genetic
testing as a clinical tool, which would harm our revenues and prospects In recent years, health care payers as well as federal and state
governments have focused on containing or reducing health care costs. We
cannot predict the effect that any of these initiatives may have on our
business, and it is possible that they will adversely affect it. Health care
cost containment initiatives focused on genetic testing could cause the growth
in the clinical market for genetic testing to be curtailed or slowed. In
addition, health care cost containment initiatives could also cause
pharmaceutical companies to reduce research and development spending. In
either case, our business and our operating results could be harmed. We introduced products for the molecular diagnostics market in July 2004, and
need to comply with FDA quality system regulations and other regulations
relating to the manufacturing, marketing and sale of such products The manufacturing, labeling, distribution and marketing of our analyte
specific reagents are subject to regulation in the United States and in certain
other countries. In the United States, the Food and Drug Administration, or the FDA,
regulates, as medical devices, most diagnostic tests and in vitroreagents that
are marketed as finished test kits. Some clinical 20




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laboratories, however, purchase molecular diagnostic products which are
marketed under FDA regulations as analyte specific reagents, or ASRs, and
develop and prepare their own diagnostic tests generically referred to as home
brews. The FDA regulates ASRs as medical devices that are exempt from
premarket approval requirements. Unless otherwise exempt, medical devices require FDA approval or clearance
prior to marketing in the United States. We believe our currently marketed
products, as well as those ASRs we intend to market in the future, are exempt
from 510(k) premarket notification and premarket approval requirements. To
date, we have not applied for FDA or any other regulatory approvals or
clearances with respect to any of our molecular diagnostic products. However,
products that we may seek to introduce in the future may require FDA approvals
or clearances prior to commercial sale in the United States and that process
can be time-consuming, expensive, and uncertain. We may experience
difficulties that could delay or prevent the successful development,
introduction and marketing of new clinical products. There can be no assurance
that the FDA will not require us to conduct clinical studies as a condition of
approval or clearance. In addition, we cannot assure you that regulatory
approval or clearance of any molecular diagnostic products for which we seek
such approvals will be granted by the FDA or foreign regulatory authorities on
a timely basis, if at all. If approval or clearance is obtained we will be
subject to continuing FDA obligations. When manufacturing medical devices, including ASRs, we are required to
adhere to Quality System Regulations, which require us to manufacture our
products and maintain records in a prescribed manner. Our manufacturing
facility for ASRs is subject to periodic and unannounced inspections by the FDA
and state agencies for compliance with quality system regulations. We have
never undergone an FDA Quality System inspection, and we cannot assure you that
we can pass an FDA audit or maintain compliance in the future. Further, the
FDA may place substantial restrictions on the indications for which our
products may be marketed or to whom they may be marketed. Failure to comply
with applicable FDA requirements can result in, among other things:  
    
    administrative or judicially imposed sanctions;
    
    injunctions, civil penalties, recall or seizure of our products;
    
    total or partial suspension of production;
    
    failure of the government to grant premarket clearance or
premarket approval for our products;
    
    withdrawal of marketing clearance or approvals; and
    
    criminal prosecution. Customers purchasing our products for molecular diagnostics use in the
United States may be regulated under the Clinical Laboratory Improvement
Amendments of 1998, known as CLIA. CLIA is intended to ensure the quality and
reliability of clinical laboratories in the United States by mandating specific
standards in the areas of personnel qualification, administration,
participation in proficiency testing, patient test management, quality control,
quality assurance and inspections. The regulations promulgated under CLIA
establish three levels of clinical tests and the standards applicable to a
clinical laboratory depend on the level of the tests it performs. CLIA
requirements may prevent some clinical laboratories from using our products.
The FDA restricts the sale of our current ASR products to clinical laboratories
certified under CLIA to perform high complexity testing. CLIA regulations and
future administrative interpretations of CLIA could harm our business by
limiting the potential market for our current and future products. 21




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Item 3. Quantitative and Qualitative Disclosures About Market Risk Our financial instruments include cash and short-term investment grade
debt securities. We also have term loans on capital equipment through a
commercial bank. At December 31, 2003 and June 30, 2004 the carrying values of
our financial instruments approximated their fair values based on current
market prices and rates. We do not believe that fluctuations in interest rates
would have a material impact on us. It is our policy not to enter into
derivative financial instruments. We do not currently have material foreign
currency exposure as our international transactions are minimal and the
majority of our international transactions are denominated in U.S. currency.
Accordingly, we do not have significant exposure to foreign currency exchange
rate risk at June 30, 2004. In the future, under the terms of the QIAGEN
agreement, we anticipate conducting increasing volumes of business in Euros for
QIAGEN sales in Europe and in Yen for QIAGEN sales in Japan. We do not
anticipate that these transactions will create significant exposure to foreign
currency exchange rate risk. 
 Item 4. Controls and Procedures The Company carried out an evaluation, under the supervision and with the
participation of the Companys management, including the Companys Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
Companys disclosure controls and procedures as of the end of the period
covered by this report, pursuant to Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended. Based on that evaluation, the
Companys Chief Executive Officer and Chief Financial Officer have concluded
that the Companys disclosure controls and procedures, as of the end of the
period covered by this report, were effective in timely alerting them to
material information relating to the Company required to be included in the
Companys periodic SEC filings. There has been no change in the Companys internal control over financial
reporting during the period covered by this report that has materially
affected, or is reasonably likely to materially affect, the Companys internal
control over financial reporting. 
 Part II. Other Information 
 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities Recent Sales of Unregistered Securities On February 23, 2004, we consummated the issuance of 2,470,000
newly-issued shares of our common stock, and warrants to purchase 741,000
newly-issued shares of our common stock, to a small number of institutional
investors, resulting in our receipt of approximately $6,175,000 in gross
proceeds, prior to placement agent fees and other offering costs totaling
$427,000 and the exercise of the warrants. Investors received a warrant to
purchase 0.3 shares of common stock for each share of common stock purchased.
The effective price in the private placement was $2.50 for each unit,
consisting of one share of common stock and a warrant to purchase 0.3 shares of
common stock. The warrants have an exercise period of five years and an
exercise price of $3.89 per share. Our placement agent with respect to the
transaction received a fee equal to 5.5% of the gross proceeds, and its
affiliates received warrants to purchase an aggregate of 75,000 shares of our
common stock, carrying the same terms as the warrants received by the
investors. The registration statement covering the resale by the investors of
these shares and the shares of common stock issuable upon exercise of the
warrants was declared effective by the SEC on April 30, 2004. Accordingly,
these shares and the shares issuable upon exercise of the warrants 22




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may be offered or re-sold in the United States, pursuant to the effective
registration statement or an applicable exemption from the registration
requirements of the Securities Act. Any opportunity to participate in the
private placement was available to a very limited group of institutional and
other accredited investors. Exemption from the registration requirements of
the Securities Act for the sales of the securities described above was claimed
under Section 4(2) of the Securities Act, among others, on the basis that such
transactions did not involve any public offering and the purchasers were
sophisticated with access to the kind of information registration would
provide. We plan to use proceeds from the private placement principally to
expand our sales and marketing infrastructure to support direct selling
initiatives of products. 
 Item 4. Submission of Matters to a Vote of Security Holders  (a)
    
    An Annual Meeting of Stockholders was held on May 17, 2004.(b)
    
    The following persons were duly elected to serve as directors of the Company. Frederick B. Craves, Ph.D.Richard L. DunningWilliam G. Gerber, M.D.Herbert L. Heyneker, Ph.D.Michael Y. LuceroR. Janet WhitmoreSanford S. Zweifach
  (c)
    
    Purpose of the Annual Stockholders Meeting:  (1)
    
    Election of Directors. To elect the following seven nominees to serve as directors
until the next annual meeting to stockholders or until their successors are elected and
have qualified. The following is a tabulation of votes for each of the proposed seven
nominees for election as directors of the company. For
    
    WithheldFrederick B. Craves, Ph.D.
    
    
    23,031,207
    
    
    
    630,532William G. Gerber, M.D.
    
    
    23,031,207
    
    
    
    630,532Richard L. Dunning
    
    
    23,565,607
    
    
    
    96,132Herbert L. Heyneker, Ph.D.
    
    
    23,565,023
    
    
    
    96,716Michael Lucero
    
    
    23,030,623
    
    
    
    631,116R. Janet Whitmore
    
    
    23,564,857
    
    
    
    96,882Sanford S. Zweifach
    
    
    23,023,707
    
    
    
    638,032
  (2)
    
    To ratify the appointment of KPMG LLP as independent auditors of the company for the
fiscal year ending December 31, 2004. The following is the tabulation of the votes. For
    
    Against
    
    Abstain23,623,645
    
    
    16,853
    
    
    
    21,241
 23




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Item 6. Exhibits and Reports on Form 8-K (a) Exhibits ExhibitNumber
    
    Description10.40
    
    Amendment dated April 5, 2004 to Co-Exclusive License and
Supply Agreement between Epoch Biosciences and QIAGEN NV,
dated November 4, 2002. (Portions of this exhibit are
omitted and were filed separately with the SEC pursuant to
rule 406 of the Securities Act.).10.41
    
    License Agreement by and between Epoch Biosciences, Inc.,
and Applera Corporation (formerly PE Corporation), dated
May 14, 2001 (Portions of this exhibit are omitted and were
filed separately with the SEC pursuant to rule 406 of the
Securities Act.).31.1
    
    Certification of Chief Executive Officer Pursuant to Rule
13a-14(a)/15d-14(a), As Adopted Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer Pursuant to Rule
13a-14(a)/15d-14(a), As Adopted Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
 (b) Reports onForm 8-K: On May 4, 2004, Epoch furnished a report on Form 8-K
regarding a press release issued by the Company to announce the
Companys first quarter 2004 results. (The information in the
foregoing report on Form 8-K, including all exhibits thereto,
was furnished pursuant to Item 12 of Form 8-K and shall not be
deemed filed for the purposes of Section 18 of the Securities
Exchange Act of 1934, as amended, or otherwise subject to the
liability of that section, nor shall it be deemed incorporated
by reference herein). 24




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Signatures In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized. Epoch Biosciences, Inc.Date: August 11, 2004
    
    By:
    
    /s/ Bert W. Hogue
  Bert
W. Hogue  Vice
President and Chief Financial Officer
 25




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EXHIBIT INDEX ExhibitNumber
    
    Description10.40
    
    Amendment dated April 5, 2004 to Co-Exclusive License and
Supply Agreement between Epoch Biosciences and QIAGEN NV,
dated November 4, 2002. (Portions of this exhibit are
omitted and were filed separately with the SEC pursuant to
rule 406 of the Securities Act.).10.41
    
    License Agreement by and between Epoch Biosciences, Inc.,
and Applera Corporation (formerly PE Corporation), dated
May 14, 2001 (Portions of this exhibit are omitted and were
filed separately with the SEC pursuant to rule 406 of the
Securities Act.).31.1
    
    Certification of Chief Executive Officer Pursuant to Rule
13a-14(a)/15d-14(a), As Adopted Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer Pursuant to Rule
13a-14(a)/15d-14(a), As Adopted Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.