** **

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

**ý****        QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the Quarter Ended June 30, 2003**

 

**CommissionFile Number 0-21481**

 

**TRANSKARYOTIC THERAPIES, INC.**

(Exactname of registrant as specified in its charter)

 

| **Delaware**                                                     |   | **04-3027191**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **700 Main Street  Cambridge, Massachusetts**                    |   | **02139**                             |
| (Address of principal  executive offices)                        |   | (Zip Code)                            |

 

Registrant’stelephone number, including area code:  **(617)349-0200**

 

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Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

 
| Yes    **ý** |   | No    **o** |
|---------------------------------------|--------|---------------------------------|

 

Indicate by check mark whether the registrant is anaccelerated filer as defined in Rule 12b-2 of the Securities Exchange Act of1934, as amended.

 
| Yes    **ý** |   | No    **o** |
|---------------------------------------|--------|---------------------------------|

 

At July 31, 2003, there were 35,102,849 shares ofCommon Stock, $.01 par value, outstanding.

 

 

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TranskaryoticTherapies, Inc.

 

 

INDEX

 
| PART I.    | FINANCIAL INFORMATION                                                                                                            |
|------------|----------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                             |
| Item  1.   | Condensed  Consolidated Financial Statements (unaudited)                                                                         |
|       |                                                                                                                             |
|       | Condensed  Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002                                                 |
|       |                                                                                                                             |
|       | Condensed  Consolidated Statements of Operations for the Three Months and Six Months  Ended June 30, 2003 and June 30, 2002 |
|       |                                                                                                                             |
|       | Condensed  Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2003  and June 30, 2002                       |
|       |                                                                                                                             |
|       | Notes  to Condensed Consolidated Financial Statements                                                                            |
|       |                                                                                                                             |
| Item 2.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                      |
|       |                                                                                                                             |
| Item  3.   | Quantitative  and Qualitative Disclosures About Market Risk                                                                      |
|       |                                                                                                                             |
| Item 4.    | Controls and Procedures                                                                                                          |
|       |                                                                                                                             |
| PART II.   | OTHER  INFORMATION                                                                                                               |
|       |                                                                                                                             |
| Item 1.    | Legal Proceedings                                                                                                                |
|       |                                                                                                                             |
| Item  4.   | Submission  of Matters to a Vote of Security Holders                                                                             |
|       |                                                                                                                             |
| Item 6.    | Exhibits and  Reports on Form 8-K                                                                                                |
|       |                                                                                                                             |
| SIGNATURES |

 

2

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PART I           FINANCIALINFORMATION

 

Part I - Item 1 - Condensed Consolidated FinancialStatements

 

TranskaryoticTherapies, Inc.

Condensed Consolidated Balance Sheets

(unaudited)

 
| **(in thousands, except par values)**                                                                                                                                                                                              |   | **June 30,  2003** |    | **December 31,  2002** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|---------|------------------------|--------|
|                                                                                                                                                                                                                               |   |               |    |                   |   |
| **Assets**                                                                                                                                                                                                                         |   |               |    |                   |   |
| Current assets:                                                                                                                                                                                                                    |   |               |    |                   |   |
| Cash and cash equivalents                                                                                                                                                                                                          |   | $                  | 169,832 |                   | $      | 154,604 |   |
| Marketable securities                                                                                                                                                                                                              |   | 28,033             |    | 102,104                |   |
| Accounts receivable                                                                                                                                                                                                                |   | 18,713             |    | 15,684                 |   |
| Inventories                                                                                                                                                                                                                        |   | 19,671             |    | 21,650                 |   |
| Prepaid expenses and other current assets                                                                                                                                                                                          |   | 6,861              |    | 4,450                  |   |
| Total current assets                                                                                                                                                                                                               |   | 243,110            |    | 298,492                |   |
| Property and equipment, net                                                                                                                                                                                                        |   | 59,110             |    | 59,372                 |   |
| Other assets                                                                                                                                                                                                                       |   | 1,863              |    | 1,942                  |   |
| Total assets                                                                                                                                                                                                                       |   | $                  | 304,083 |                   | $      | 359,806 |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                                      |   |               |    |                   |   |
| Current liabilities:                                                                                                                                                                                                               |   |               |    |                   |   |
| Accounts payable                                                                                                                                                                                                                   |   | $                  | 6,850   |                   | $      | 11,804 |   |
| Accrued expenses                                                                                                                                                                                                                   |   | 12,158             |    | 12,767                 |   |
| Accrued restructuring expenses                                                                                                                                                                                                     |   | 6,317              |    | —                 |   |
| Accrued intellectual property license expense                                                                                                                                                                                      |   | —             |    | 11,368                 |   |
| Total current liabilities                                                                                                                                                                                                          |   | 25,325             |    | 35,939                 |   |
|                                                                                                                                                                                                                               |   |               |    |                   |   |
| Minority interest                                                                                                                                                                                                                  |   | 336                |    | —                 |   |
|                                                                                                                                                                                                                               |   |               |    |                   |   |
| Stockholders’ equity:                                                                                                                                                                                                         |   |               |    |                   |   |
| Series A convertible preferred stock, $.01 par value, 0 shares  authorized at June 30, 2003 and 10 shares authorized at December 31, 2003; no  shares issued and outstanding at June 30, 2003 and December 31, 2002,  respectively |   | —             |    | —                 |   |
| Series B preferred stock, $.01 par value, 1,000 shares authorized; no  shares issued and outstanding at June 30, 2003 and December 31, 2002,  respectively                                                                         |   | —             |    | —                 |   |
| Common stock, $.01 par value;   100,000 shares authorized; 34,934 and 34,845 shares issued and  outstanding at June 30, 2003 and December 31, 2002, respectively                                                              |   | 349                |    | 348                    |   |
| Additional paid-in capital                                                                                                                                                                                                         |   | 686,189            |    | 685,566                |   |
| Accumulated deficit                                                                                                                                                                                                                |   | (412,399           | )       | (365,434               | )      |
| Accumulated other comprehensive income                                                                                                                                                                                             |   | 6,565              |    | 3,387                  |   |
|                                                                                                                                                                                                                               |   | 280,704            |    | 323,867                |   |
| Less treasury stock, at cost; 367 shares at June 30, 2003                                                                                                                                                                          |   | (2,282             | )       | —                 |   |
| Total stockholders’ equity                                                                                                                                                                                                    |   | 278,422            |    | 323,867                |   |
| Total liabilities and stockholders’ equity                                                                                                                                                                                    |   | $                  | 304,083 |                   | $      | 359,806 |   |

 

See accompanying Notes toCondensed Consolidated Financial Statements.

 

3

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Transkaryotic Therapies,Inc.

CondensedConsolidated Statements of Operations

(unaudited)

 
|                                                        |   | **Three Months Ended June 30,** |    | **Six Months Ended June 30,** |   |
|-------------------------------------------------------------|--------|---------------------------------|---------|-------------------------------|--------|
| **(in thousands, except per share  amounts)**               |   | **2003**                        |    | **2002**                      |   | **2003** |   | **2002** |   |
| Revenues:                                                   |   |                            |    |                          |   |   |   |   |   |
| Product sales                                               |   | $                               | 14,400  |                          | $      | 8,782 |   | $ | 26,583 |   | $ | 14,840 |   |
| License and research revenues                               |   | 14                              |    | 83                            |   | 14 |   | 635 |   |
|                                                        |   | 14,414                          |    | 8,865                         |   | 26,597 |   | 15,475 |   |
| Operating expenses:                                         |   |                            |    |                          |   |   |   |   |   |
| Cost of goods sold                                          |   | 4,775                           |    | 1,650                         |   | 8,276 |   | 2,198 |   |
| Research and development                                    |   | 16,853                          |    | 18,868                        |   | 37,835 |   | 39,277 |   |
| Intellectual property license expense                       |   | —                          |    | 26,000                        |   | 1,350 |   | 26,000 |   |
| Selling, general and administrative                         |   | 9,412                           |    | 7,476                         |   | 18,578 |   | 13,899 |   |
| Restructuring charges                                       |   | 4,957                           |    | —                        |   | 8,559 |   | — |   |
|                                                        |   | 35,997                          |    | 53,994                        |   | 74,598 |   | 81,374 |   |
| Loss from operations                                        |   | (21,583                         | )       | (45,129                       | )      | (48,001 | ) | (65,899 | ) |
| Other income:                                               |   |                            |    |                          |   |   |   |   |   |
| Interest income                                             |   | 596                             |    | 2,248                         |   | 1,372 |   | 4,551 |   |
| Minority interest                                           |   | (33                             | )       | —                        |   | (336 | ) | — |   |
|                                                        |   | 563                             |    | 2,248                         |   | 1,036 |   | 4,551 |   |
| Net loss                                                    |   | $                               | (21,020 | )                             | $      | (42,881 | ) | $ | (46,965 | ) | $ | (61,348 | ) |
| Basic and diluted net loss per share                        |   | $                               | (0.61   | )                             | $      | (1.24 | ) | $ | (1.36 | ) | $ | (1.78 | ) |
| Shares used to compute basic and diluted net loss per share |   | 34,535                          |    | 34,462                        |   | 34,543 |   | 34,397 |   |

 

See accompanying Notes toCondensed Consolidated Financial Statements.

 

4

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TranskaryoticTherapies, Inc.

CondensedConsolidated Statements of Cash Flows

(unaudited)

 
|                                                                                                                                  |   | **Six Months  Ended June 30,** |       |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------|------------|
| **(in thousands)**                                                                                                                    |   | **2003**                       |       | **2002** |   |
|                                                                                                                                  |   |                           |       |   |   |
| **Operating activities:**                                                                                                             |   |                           |       |   |   |
| Net loss                                                                                                                              |   | $                              | (46,965    | ) | $ | (61,348 | ) |
| Adjustments to reconcile net loss to net cash provided by operating  activities:                                                      |   |                           |       |   |   |
| Issuance of common stock, intellectual property license expense                                                                       |   | —                         |       | 15,000 |   |
| Depreciation and amortization                                                                                                         |   | 5,830                          |       | 3,456 |   |
| Loss on fixed asset disposals                                                                                                         |   | 621                            |       | — |   |
| Compensation expense related to equity issuances                                                                                      |   | 624                            |       | 109 |   |
| Change in accrued intellectual property license expense                                                                               |   | (11,368                        | )          | — |   |
| Change in accrued restructuring charges                                                                                               |   | 6,317                          |       | — |   |
| Changes in operating assets and liabilities                                                                                           |   | (7,673                         | )          | (11,106 | ) |
| Net cash used for operating activities                                                                                                |   | (52,614                        | )          | (53,889 | ) |
|                                                                                                                                  |   |                           |       |   |   |
| **Investing activities:**                                                                                                             |   |                           |       |   |   |
| Proceeds from sales and maturities of marketable securities                                                                           |   | 81,807                         |       | 116,773 |   |
| Purchases of marketable securities                                                                                                    |   | (7,956                         | )          | (222,598 | ) |
| Purchases of property and equipment                                                                                                   |   | (6,226                         | )          | (21,109 | ) |
| Proceeds from fixed asset disposal                                                                                                    |   | 36                             |       | — |   |
| Changes in other assets                                                                                                               |   | 416                            |       | 384 |   |
| Net cash provided by (used for) investing activities                                                                                  |   | 68,077                         |       | (126,550 | ) |
|                                                                                                                                  |   |                           |       |   |   |
| **Financing Activities:**                                                                                                             |   |                           | ** ** |   | ** ** |
| Issuance of common stock, net                                                                                                         |   | 1                              |       | 1,507 |   |
| Repurchase of treasury stock                                                                                                          |   | (2,282                         | )          | — |   |
|                                                                                                                                  |   |                           |       |   |   |
| Net cash provided by (used for) financing activities                                                                                  |   | (2,281                         | )          | 1,507 |   |
|                                                                                                                                  |   |                           |       |   |   |
| Effect of exchange rate changes on cash and cash equivalents                                                                          |   | 2,046                          |       | 145 |   |
|                                                                                                                                  |   |                           |       |   |   |
| Net increase (decrease) in cash and cash equivalents                                                                                  |   | 15,228                         |       | (178,787 | ) |
|                                                                                                                                  |   |                           |       |   |   |
| Cash and cash equivalents at January 1                                                                                                |   | 154,604                        |       | 323,877 |   |
|                                                                                                                                  |   |                           |       |   |   |
| Cash and cash equivalents at June 30                                                                                                  |   | $                              | 169,832    |   | $ | 145,090 |   |
|                                                                                                                                  |   |                           |       |   |   |
| Supplemental disclosure of non-cash financing activity:   Issuance of common stock as consideration for intellectual property license |   | $                              | —     |   | $ | 15,000 |   |

 

See accompanying Notes to CondensedConsolidated Financial Statements.

 

5

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Transkaryotic Therapies,Inc.

Notes to CondensedConsolidated Financial Statements (unaudited)

June 30, 2003 and 2002

 

1.               BASIS OFPRESENTATION

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by generally accepted accounting principlesin the United States for complete financial statements.  In the opinion of management, theaccompanying financial statements include all adjustments, consisting only ofnormal recurring adjustments, necessary for a fair presentation of thefinancial position, results of operations and cash flows for the periodspresented.  The results of operationsfor the interim period ended June 30, 2003 are not necessarily indicative ofthe results to be expected for the year ending December 31, 2003.

 

These financial statements should be read in conjunction with theaudited consolidated financial statements and notes thereto for the year endedDecember 31, 2002 included in the Company’s Annual Report on Form 10-K as filedwith the Securities and Exchange Commission.

 

Niche Protein®, Gene-Activated®, and TKT® are registered trademarks andReplagalTM and Transkaryotic TherapyTM are trademarks of the Company.  DynepoTM is a trademark of AventisPharmaceuticals, Inc. (“Aventis”).  Allother trademarks, service marks or trade names referenced in this quarterlyreport are the property of their respective owners.

 

2.               NET LOSS PER SHARE

 

The Company calculates net loss per share in accordance with Statementof Financial Accounting Standard (“SFAS”) No. 128, “Earnings Per Share,” andrelated interpretations.  Basic earningsper share is computed using the weighted average shares outstanding.

 

Basic net loss per share was equivalent to diluted net loss per sharefor the three and six months ended June 30, 2003 and 2002 because commonequivalent shares from convertible preferred stock and stock options have beenexcluded, as their effect is antidilutive.

 

3.               COMPREHENSIVE LOSS

 

Comprehensive loss comprises net loss, unrealized gains and losses onmarketable securities designated as available-for-sale, and foreign currencytranslation adjustments.  The Companyhad a total comprehensive loss of $18,451,000 and $40,895,000 for the threemonths ended June 30, 2003 and 2002, respectively.  For the six months ended June 30, 2003 and 2002, the Company hada total comprehensive loss of $43,787,000 and $60,598,000, respectively.

 

6

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4.               INVENTORIES

 

Inventories consist of the following:

 

| **(in thousands)** |   | **June 30,  2003** |   | **December 31,  2002** |   |
|--------------------|--------|--------------------|--------|------------------------|--------|
|               |   |               |   |                   |   |
| Raw materials      |   | $                  | 188    |                   | $      | 947 |   |
| Work in process    |   | 16,077             |   | 14,689                 |   |
| Finished goods     |   | 3,406              |   | 6,014                  |   |
|               |   | $                  | 19,671 |                   | $      | 21,650 |   |

 

Inventories are stated at the lower of cost or market, with costdetermined under a first-in, first-out method. Inventories are reviewed periodically for slow-moving or obsolete statusbased on sales activity, both projected and historical.

 

5.               INTELLECTUALPROPERTY LICENSE FEE EXPENSE

 

In June 2002, the Company obtained an exclusive license to certainpatents and patent applications from Cell Genesys, Inc. (“Cell Genesys”)related to Cell Genesys’ approach to gene activation. In consideration for thelicense, the Company initially paid Cell Genesys $11,000,000 in cash and issuedto Cell Genesys shares of the Company’s common stock worth $15,000,000 as ofthe date of the license agreement.

 

Under the agreement, the Company agreed that the number of shares ofcommon stock initially issued to Cell Genesys would be adjusted at the time theCompany registered such shares for resale under the Securities Act of 1933, asamended, if the market value of such shares at that time was greater or lessthan $15,000,000, as calculated in accordance with a predetermined formula.Pursuant to the agreed upon formula, at December 31, 2002 with the closingprice of the Company’s common stock at $9.90 per share, the Company would havebeen required to issue to Cell Genesys an additional 1,148,000 shares of commonstock. As a result, the Company recorded an additional non-cash license feeexpense of $8,660,000 in the fourth quarter of 2002.

 

In January 2003, the Company and Cell Genesys renegotiated theconsideration paid for the license, and the Company repurchased the shares ofstock issued to Cell Genesys for $15,000,000 in cash. The Company incurred anadditional license expense in the first quarter of 2003 of $1,350,000, whichrepresents the further decline in the market value of the Company’s commonstock from December 31, 2002 to January 15, 2003. The repurchased shares havebeen recorded as treasury stock.

 

Under the agreement, Cell Genesys also has the potential to receivecertain milestone payments from the Company contingent upon the outcome ofrelated patent matters under the license agreement. If all of the milestonesare achieved, the Company will be obligated to pay Cell Genesys an aggregate of$17,000,000 payable in part in cash and in part in stock. The Company is notrequired to make royalty payments to Cell Genesys.

 

6.               RESTRUCTURINGCHARGE

 

In February 2003, TKT announced a major reorganization in an effort toreduce costs and narrow

 

7

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the scope of the Company’s research initiatives. Under this reorganization,TKT plans to focus its research, development, and commercialization effortsprimarily on therapeutics for the treatment of rare genetic diseases caused byprotein deficiencies. The Company is seeking collaborative partners for itsGene-Activated protein products, which are versions of proteins that wouldcompete with proteins currently being marketed by third parties, and for itsgene therapy programs.

 

As part of this restructuring, during the first quarter of 2003, TKTreduced its U.S. headcount by approximately 100 positions. TKT has reduced itsheadcount through attrition, with the goal of having approximately 310 to 325full-time U.S. employees by the end of 2003. As of June 30, 2003, TKT had 319 full-time U.S. employees. TKT is alsoconsolidating its facilities as part of the restructuring.

 

As a result of the restructuring, the Company recorded a charge of$8,559,000 during the first six months of 2003 in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 146, Accounting for CostsAssociated with Exit or Disposal Activities. Included in the charge is $1,339,000 of employee severance andoutplacement services costs for 74 employees, primarily in research anddevelopment, $6,646,000, representing the remaining lease obligations for threeof four facilities that the Company no longer occupies, and a write-down of$574,000 for leasehold improvements for facilities which were vacated.  The Company expects that itsemployee-related and facility consolidation restructuring actions will besubstantially completed in 2003.  TheCompany will continue to record restructuring charges primarily related tovacated facility expenses during the remainder of 2003 and beyond.

 

The following table outlines the components of the Company’srestructuring charge and accrual as of June 30, 2003:

 
| **(in thousands)**                   |   | **Charges** |   | **Payments** |   | **Other** |   | **Ending  balance** |   |
|--------------------------------------|--------|-------------|--------|--------------|--------|-----------|--------|---------------------|--------|
|                                 |   |        |   |         |   |      |   |                |   |
| Employee  severance and outplacement |   | $           | 1,339  |         | $      | (1,031    | )      | $                   | — |   | $ | 308 |   |
| Lease  obligations                   |   | 6,646       |   | (600         | )      | (37       | )      | 6,009               |   |
| Write-off of  fixed assets           |   | 574         |   | —       |   | (574      | )      | —              |   |
| Total                                |   | $           | 8,559  |         | $      | (1,631    | )      | $                   | (611   | ) | $ | 6,317 |   |

 

7.               STOCK BASEDCOMPENSATION

 

The Company accounts for qualified stock option grants in accordancewith Accounting Principles Board Opinion No. 25, Accounting for Stock Issued toEmployees (“APB 25”) and Financial Accounting Standards Board (“FASB”)Interpretation No. 44, Accounting for Certain Transactions Involving StockCompensation, an Interpretation of APB No. 25, and related interpretation, and,accordingly, recognizes no compensation expense for the issue thereof.  In connection with certain executiveseverance agreements, the Company modified terms of some outstanding optionswhich resulted in a charge of $624,000. The compensation is amortized over the vesting period of each option orthe recipient’s term of employment, if shorter.  The Company has adopted the

 

8

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disclosure-only provisions of Statement of Financial AccountingStandard (“SFAS”) No. 123, Accounting for Stock-Based Compensation as amendedby SFAS No. 148 Accounting for Stock-Based Compensation-Transition andDisclosure.

 

The table below presents the combined net loss and basic and dilutednet loss per common share if compensation cost for the Company’s stock optionplans had been determined based on the estimated fair value of awards underthose plans on the grant or purchase date: 

 
|                                                                                                                  |   | **For the  three months   ended June 30,** |    | **For the  six months  ended June 30,** |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|---------|-----------------------------------------|--------|
|                                                                                                                  |   | **2003**                                   |    | **2002**                                |   | **2003** |   | **2002** |   |
| **(In thousands, except per share prices)**                                                                           |   |                                       |    |                                    |   |   |   |   |   |
| Net loss                                                                                                              |   | $                                          | (21,020 | )                                       | $      | (42,881 | ) | $ | (46,965 | ) | $ | (61,348 | ) |
| Add:  Stock based compensation included in net  loss as reported                                                 |   |                                       | 624     |                                    |   | 44 |   |   | 624 |   |   | 109 |   |
| Deduct: Total  stock-based employee compensation expense determined under the fair value  based method for all awards |   |                                       | (6,490  | )                                       |   | (6,763 | ) |   | (13,556 | ) |   | (12,133 | ) |
| Proforma net  loss                                                                                                    |   | $                                          | (26,886 | )                                       | $      | (49,600 | ) | $ | (59,897 | ) | $ | (73,372 | ) |
|                                                                                                                  |   |                                       |    |                                    |   |   |   |   |   |
| Basic and  diluted net loss per share - as reported                                                                   |   | $                                          | (0.61   | )                                       | $      | (1.24 | ) | $ | (1.36 | ) | $ | (1.78 | ) |
| Basic and  diluted net loss per share - proforma                                                                      |   | $                                          | (0.78   | )                                       | $      | (1.44 | ) | $ | (1.73 | ) | $ | (2.13 | ) |

 

Fair values of awards granted under the stock option plans wereestimated at grant or purchase dates using a Black-Scholes option pricingmodel. The Company uses the multiple option approach and the followingassumptions:

 

|                   |   | **For the  three months**

**ended June  30,** |   | **For the  six months**

**ended June  30,** |   |
|------------------------|--------|------------------------------------------------|--------|----------------------------------------------|--------|
|                   |   | **2003**                                       |   | **2002**                                     |   | **2003** |   | **2002** |   |
| Expected life  (years) |   | 1.5-7.5                                        |   | 1.5-7.5                                      |   | 1.5-7.5 |   | 1.5-7.5 |   |
| Interest rate          |   | 1.1%-4.2%                                      |   | 1.5%-4.0%                                    |   | 1.1%-4.2% |   | 1.5%-4.0% |   |
| Expected  volatility   |   | 0.83                                           |   | 1.00                                         |   | 0.83-0.95 |   | 1.00 |   |

 

The Company has never declared or paid dividends on any of its capitalstock and does not expect to do so in the foreseeable future.

 

The pro forma effects of expensing the estimated fair value of issuedstock options on net loss and net loss per share for the three months endedJune 30, 2003 and 2002, respectively, are not necessarily representative of theeffects on reporting the results of operations for future years as options vestover several years and the Company expects to grant options in future years.

 

### 8.             LEGALPROCEEDINGS

 

The Company is a party toa number of legal proceedings.  TheCompany can provide no assurance

 

9

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as to the outcome of anyof these proceedings. A decision by a court in the United States or in anyother jurisdiction in a manner adverse to the Company could have a materialadverse effect on the Company’s business, financial condition, and results ofoperations.

 

*Replagal Patent Litigation*

 

In July 2000,Genzyme Corporation (“Genzyme”), a competitor, and Mount Sinai School ofMedicine of New York University (“Mount Sinai”) filed a patent infringementaction against the Company in the U.S. District Court of Delaware. Thecomplaint alleges that activities relating to Replagal infringe a patentlicensed by Genzyme from Mount Sinai. In January 2002, the U.S. DistrictCourt of Delaware dismissed this patent litigation granting TKT’s motion forsummary judgment of non-infringement and denying Genzyme’s motion for summaryjudgment of infringement. Genzyme sought monetary damages and injunctiverelief.

 

In March 2002,Genzyme appealed the U.S. District Court of Delaware’s ruling to the U.S. Courtof Appeals for the Federal Circuit, and in January 2003 the U.S. Court ofAppeals for the Federal Circuit heard oral arguments on the appeal. If Genzymeis successful in its appeal, the case may be remanded to the U.S. DistrictCourt of Delaware for further proceedings on non-infringement and invalidityissues. As of June 30, 2003, the Company had incurred $4,662,000 in litigationexpenses associated with the Replagal litigation.

 

*Dynepo Patent Litigation*

 

In April 1997, AmgenInc. (“Amgen”) commenced a patent infringement action against the Company andAventis in the U.S. District Court of Massachusetts. In January 2001, theU.S. District Court of Massachusetts concluded that Dynepo infringed eight ofthe 18 claims of five patents that Amgen had asserted. Amgen did not seek andwas not awarded monetary damages.

 

On January 6, 2003,the U.S. Court of Appeals for the Federal Circuit issued a decision affirmingin part and reversing in part the decision of the U.S. District Court ofMassachusetts and remanded the action to the U.S. District Court ofMassachusetts for further proceedings. In particular, the U.S. Court of Appealsfor the Federal Circuit:

 

•                                          upheldthe U.S. District Court of Massachusetts’ determination of invalidity of one ofAmgen’s patents;

 

•                                          upheldthe U.S. District Court of Massachusetts’ determination that some claims of twoother Amgen patents were infringed, but vacated the U.S. District Court ofMassachusetts’ determination that those patents were not invalid; and

 

•                                          vacatedthe U.S. District Court of Massachusetts’ determination that Replagal infringedsome claims of the two remaining Amgen patents, and vacated the U.S. DistrictCourt of Massachusetts’ determination that one of these patents was notinvalid.

 

As part of the U.S. Courtof Appeal for the Federal Circuit’s ruling, it instructed the U.S. District

 

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Court of Massachusetts to reconsider the validity of Amgen’s patents inlight of potentially invalidating prior art. The U.S. District Court of Massachusetts heard oral argument on some ofthese issues in July 2003.  The Companyexpects that the U.S. District Court of Massachusetts will rule on some of theoutstanding issues and set a schedule for the taking of additional evidence, ifrequired, commencing in October 2003.

 

In addition, in July 1999,Aventis and the Company commenced legal proceedings in the United Kingdomagainst Kirin-Amgen, Inc. (“Kirin-Amgen”), seeking a declaration that aEuropean patent held by Kirin-Amgen will not be infringed by the Company’sactivities relating to Dynepo and that certain claims of Kirin-Amgen’s U.K.patent are invalid.  In April 2001,the High Court of Justice in the United Kingdom ruled that Dynepo infringed oneof four claims of the patent asserted by Kirin-Amgen.  In July 2002, the Court of Appeals in the United Kingdomreversed the High Court of Justice and ruled that Dynepo did not infringeKirin-Amgen’s patent. Kirin-Amgen petitioned the House of Lords to hear anappeal from the decision of the Court of Appeals. In February 2003, theHouse of Lords agreed to hear this appeal.

 

The Company is required toreimburse Aventis, which is paying the expenses of the Amgen and Kirin-Amgenlitigations relating to Dynepo, for 50% of the expenses. Aventis is alsoentitled to deduct up to 50% of any royalties due to the Company from the saleof Dynepo until Aventis has recouped the full amount of TKT’s share oflitigation expenses. The Company currently estimates that its share of theexpenses associated with the litigation will total between approximately$15,000,000 and $20,000,000 by the time the matter is finally adjudicated.

 

* Serono Patent Litigation*

 

In January 2003, AppliedResearch Systems ARS Holdings, N.V., a wholly owned subsidiary of Serono InternationalS.A. (“Serono”), commenced an action against TKT in the District Court at TheHague in the Netherlands claiming that Replagal infringes one of Serono’sEuropean patents relating to Serono’s approach to gene activation. InJanuary 2002, the European Patent Office revoked the Serono patent ongrounds of invalidity due to non-enablement. Serono has appealed the revocationto the Technical Board of Appeal at the European Patent Office and a hearinghas been set for October 2003.  Thelitigation at The Hague has been stayed pending the outcome of the Octoberproceedings before the European Patent Office. The Company expects that the expenses related to this litigation will besignificant.

 

* Shareholder Lawsuits*

 

In the first quarter of2003, at least nine purported class action suits were brought in the U.S.District Court of Massachusetts against **the Company**,**its** former Chief ExecutiveOfficer, Richard F Selden, and in some cases, **its**Chairman of the Board of Directors, Rodman W. Moorhead, III. The complaintsgenerally allege that, during the period from January 2001 throughJanuary 2003, **TKT** made false and misleadingstatements and failed to disclose material information concerning the statusand progress for obtaining U.S. marketing approval of Replagal and seekequitable and monetary relief, an unspecified amount of damages, with interest,and attorney’s fees and costs. **On April 9, 2003,the Court consolidated the various actions under one matter entitled In reTranskaryotic Therapies, Inc. Securities Litigation, C.A. No. 03-10165 RW2.**

 

On July 7, 2003, a Consolidated and Amended Class Action Complaint (the“Amended 

 

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Complaint”) was filed with the U.S. District Court of Massachusettsamending the complaint to include as defendants in the action the Company’sformer Chief Financial Officer, each of the individual members of the Company’sBoard of Directors (other than Mr. Astrue), SG Cowen Securities Corporation,Deutsche Bank Alex. Brown, Pacific Growth Equities, Inc., and Leerink Swann& Company.  The Amended Complaintasserts claims against each of the defendants under Section 11 of theSecurities Act and against Dr. Selden under Section 15 of the Securities Act;against SG Cowen Securities Corporation, Deutsche Bank Alex. Brown, PacificGrowth Equities, Inc., and Leerink Swann & Company under Section 12(a)(2)of the Securities Act; against the Company and Dr. Selden under Section 10(b)of the Exchange Act and Rule 10b-5 promulgated thereunder; and against Dr.Selden under Section 20(a) of the Exchange Act.  The Amended Complaint alleges that the defendants made false andmisleading statements and failed to disclose material information concerningthe status and progress for obtaining U.S. marketing approval of its ReplagalTMproduct to treat Fabry disease.  A classhas not been certified, and the Company has not yet responded to the AmendedComplaint.

** **

**On April 14, 2003, ashareholder derivative suit was filed against the individual members of the Company’sBoard of Directors, the Company’s former Chief Executive Officer, and theCompany in Middlesex Superior Court in the Commonwealth of Massachusettsentitled South Shore Gastrointerology UA 6/6/1980 FBO Harold Jacobs, Nancy R.Jacob Ttee v. Richard F Selden, Jonathan S. Leff, Walter Gilbert, Wayne P.Yetter, Rodman W. Moorhead, III, James E. Thomas, William R. Miller andTranskaryotic Therapies, Inc., Civil Action No. 03-1669. **On May 29, 2003,the parties moved to transfer venue to the Business Litigation Session inSuffolk Superior Court in the Commonwealth of Massachusetts.  The parties’ motion was allowed, and on June4, 2003 the matter was accepted into the Business Litigation Session as CivilAction No. 03-02630-BLS.  **The complaint generally alleges that theindividual defendants breached fiduciary duties owed to the Company and itsstockholders by disseminating false and misleading statements to the marketconcerning the status and progress for obtaining U.S. marketing approval ofReplagal and causing or allowing the Company to conduct its businessimproperly.**

** **

**On August 7, 2003, theplaintiff filed its Verified Amended Derivative Complaint.  The amended complaint alleges that theindividual defendants breached fiduciary duties owed to the Company and itsshareholders by causing the Company to issue materially false and misleadingstatements to the public and signing the Company's Annual Reports on Forms 10-Kfor the years 2000 and 2001 as well as a registration statement.  The amended complaint also alleges that theCompany's former chief executive officer sold shares of Company common stockwhile in possession of material non-public information.  The complaint and the amended complaint eachseek declaratory, equitable and monetary relief, an unspecified amount ofdamages, with interest, and attorney's fees and costs.**

 

**The Company expectsthat expenses related to these litigations will be significant.**

 

*SEC Investigation*

 

**On May 14, 2003, theCompany received a copy of a formal order of investigation by the Securitiesand Exchange Commission.  The order ofinvestigation relates to TKT’s disclosures and public filings with regard toReplagal and the status of the FDA’s approval process for Replagal, as well astransactions in the Company’s securities.  The Company is cooperating with the SEC in the investigation.**

 

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## **ITEM2.          MANAGEMENT’S** DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

###### **Overview**

 

TKT is a biopharmaceutical company developing therapeutics for thetreatment of rare genetic diseases caused by protein deficiencies. TKT hasreceived approval to market and sell Replagal (agalsidase alfa), an enzymereplacement therapy for the long-term treatment of patients with Fabry disease,in 26 countries, principally in Europe. TKT has not received approval to marketand sell Replagal in the United States. TKT recorded $34,682,000 in Replagalproduct sales in 2002 and $26,583,000 in Replagal product sales in the firsthalf of 2003.

 

With the exception of 1995, the Company has incurred substantial annualoperating losses since inception. The Company expects to incur significantoperating losses until substantial product sales are generated. Until suchtime, the Company is dependent upon product sales, existing cash resources,interest income, external financing from equity offerings, debt financings, andcollaborative research and development alliances to finance its operations. AtJune 30, 2003, the Company’s accumulated deficit was $412,399,000.

 

The Company’s results of operations may vary significantly from periodto period depending on, among other factors:

 

•                  thetiming, and amount of Replagal product sales, as well as the collection ofreceivables;

•                  continuedprogress in its research and development programs, particularlyiduronate-2-sulfatase (“I2S”);

•                  thescope and results of its clinical trials;

•                  thetiming of, and the costs involved in, obtaining regulatory approvals;

•                  thecost of manufacturing activities;

•                  thequality and timeliness of the performance of third party suppliers;

•                  thecost of commercialization activities, including product marketing, sales anddistribution;

•                  thecosts involved in preparing, filing, prosecuting, maintaining, and enforcingpatent claims and other patent-related costs, including litigation costs andthe results of such litigation;

•                  theoutcome of pending purported class action and other related, or potentiallyrelated, actions and the litigation costs with respect to such actions;

•                  theoutcome of the SEC investigation; and

•                  TKT’sability to establish and maintain collaborative arrangements.

 

* Corporate Reorganization*

 

In February 2003, TKT’s Board of Directors appointed Michael J. Astrueas President and Chief Executive Officer of the Company and a member of theBoard of Directors. Mr. Astrue replaced Richard F Selden, M.D., Ph.D., whoresigned from TKT and TKT’s Board of Directors. The Board also named David D.Pendergast to the newly-created position of Executive Vice 

 

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President, Operations.  Dr.Pendergast was previously Senior Vice President, Technical Operations at TKT.

 

Upon the appointment of Mr. Astrue, TKT announced a majorreorganization in an effort to reduce costs and narrow the scope of theCompany’s research initiatives. Under this reorganization, TKT is focusing itsresearch, development, and commercialization efforts primarily on therapeuticsfor the treatment of rare genetic diseases caused by protein deficiencies. TheCompany is seeking collaborative partners for its Gene-Activated proteinproducts, which are versions of proteins that would compete with proteinscurrently being marketed by third parties, and for its gene therapy programs.

 

As part of the restructuring, during the first quarter of 2003, TKTreduced its U.S. headcount by approximately 100 positions. TKT has reducedheadcount through attrition, with the goal of having approximately 310 to 325full-time U.S. employees by the end of 2003. As of June 30, 2003, TKT had 319 full-time U.S. employees. TKT is alsoconsolidating its facilities as part of the restructuring.

 

As a result of the restructuring, the Company recorded a charge of$8,559,000 during the first six months of 2003 in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 146, Accounting for CostsAssociated with Exit or Disposal Activities. Included in the charge is $1,339,000 of employee severance andoutplacement services costs for 74 employees, primarily in research anddevelopment, $6,646,000, representing the remaining lease obligation for threeof four facilities that the Company no longer occupies, and a write-down of$574,000 for leasehold improvements for facilities which were vacated.  The Company expects that its employee-relatedand facility consolidation restructuring actions will be substantiallycompleted in 2003.  The Company willcontinue to record restructuring charges primarily related to vacated facilityexpenses during the remainder of 2003 and beyond.

###### *** ***

###### ***Regulatory Status of Replagal in the United States***

 

On April 24, 2003, Genzyme received marketing authorization in theUnited States for Fabrazyme (agalsidase beta), its enzyme replacement therapyproduct for the treatment of Fabry disease. Because Fabrazyme had received orphan drug designation in the UnitedStates, upon its marketing approval, Fabrazyme received orphan drugexclusivity. Once a product receives orphan drug exclusivity, the United StatesFood and Drug Administration (the “FDA”) may not approve another application tomarket the same drug for the same indication for a period of seven years,except in limited circumstances set forth under the United States Food, Drugand Cosmetic Act (the “FDA Statute”) and implementing regulations. BecauseFabrazyme received marketing approval in the United States before Replagal andreceived orphan drug exclusivity, the FDA may not approve Replagal and Replagalwill be excluded from the U.S. market for seven years, until April 2010, unlessTKT can demonstrate that Replagal satisfies the limited criteria for exceptionsset forth in the FDA Statute and implementing regulations.

 

Since the Company submitted a Biologics License Application (“BLA”) forReplagal to the FDA in June 2000, the Company has received two Complete ResponseLetters from the FDA. In the second Complete Response Letter, which the Companyreceived in November 2002, the FDA

 

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indicated that the data relating to Replagal which TKT had previouslysubmitted were not adequate for approval, primarily because of questionsconcerning efficacy, but that the data would be discussed at a meeting of theFDA’s Endocrinologic & Metabolic Drugs Advisory Committee (the“Endocrinologic & Metabolic Drugs Advisory Committee”).

 

On January 14, 2003, the Endocrinologic & Metabolic Drugs AdvisoryCommittee convened to discuss TKT’s BLA for Replagal and concluded by aunanimous vote that TKT’s clinical data did not provide substantial evidence ofefficacy. The Endocrinologic & Metabolic Drugs Advisory Committee alsoconcluded by a vote of 8 to 7 that the renal pathology data presented by TKTwere not adequate to serve as the basis for accelerated approval. As part ofits consideration of an application for marketing authorization, the FDA oftenrequests a review of all or parts of an application for marketing authorizationby an advisory committee of outside experts. The FDA is free to accept orreject the advisory committee’s recommendations.

 

The Company is in the process of examining possible options to breakFabrazyme’s orphan drug exclusivity and secure marketing authorization forReplagal in the United States, and is preparing to talk with the FDA in moredetail about the Company’s options.  Forinstance, the Company may need to conduct additional clinical trials andanalyses in an attempt to break Fabrazyme’s orphan drug exclusivity.

###### *** ***

###### *** Application ofCritical Accounting Policies and Estimates***

 

The discussion and analysis of TKT’s financial condition and results ofoperations is based on our consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States. The preparation of these financial statements requires TKT tomake estimates and judgments that affect its reported assets and liabilities,revenues and expenses, and other financial information. Actual results maydiffer significantly from these estimates under different assumptions andconditions. In addition, TKT’s reported financial condition and results ofoperations could vary due to a change in the application of a particularaccounting standard.

 

The Company regards an accounting estimate underlying its financialstatements as a “critical accounting estimate” if the accounting estimaterequires the Company to make assumptions about matters that are highlyuncertain at the time of estimation and if different estimates that reasonablycould have been used in the current period, or changes in the estimate that arereasonably likely to occur from period to period, would have had a materialeffect on the presentation of financial condition, changes in financialcondition, or results of operations.

 

The Company’s significant accounting policies are described in theNotes to the Consolidated Financial Statements in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2002. The Company regards itspolicies with respect to revenue recognition, inventories and asset impairmentas “critical accounting estimates.” There have been no changes to such policiesor significant changes in assumptions or estimates that would affect suchpolicies in the second quarter of 2003. These policies are described under the caption “Item 7 

 

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Management’s Discussion and Analysis of Financial Condition and Resultsof Operations” in the Company’s Annual Report on Form 10-K.

## ** **

## **Results of Operations**

 

*Revenues*

 

Product sales for the quarter ended June 30, 2003 totaled $14,400,000,an increase of $5,618,000, or 64%, from $8,782,000 for the corresponding periodin 2002.  For the six months ended June30, 2003, product sales totaled $26,583,000, an increase of $11,743,000, or79%, from $14,840,000 for the corresponding period in 2002.  Substantially all Replagal product saleswere in Europe.  The increases in salesin the 2003 periods over the comparative periods in 2002 are due to additionalpatients beginning Replagal therapy, pricing and reimbursement arrangementsbeing established and formalized in additional countries in Europe, and thereceipt of marketing authorizations in additional countries.  In addition, foreign currency fluctuationspositively contributed $2,745,000 and $4,918,000 to the increases over thethree month and six month comparative periods of 2002, respectively.

 

License and research revenues for the second quarter and for the firstsix months of 2003 totaled $14,000. License and research revenues totaled $83,000 and $635,000 for the threeand six months ended June 30, 2002, respectively.  License and research revenues for the three and six months endedJune 30, 2003 were earned under a collaborative agreement with SumitomoPharmaceutical Co. Ltd. (“Sumitomo”). For the corresponding periods in 2002, license and research revenueswere earned from collaborative agreements with Sumitomo and Wyeth, whichsucceeded Genetics Institute, Inc. (“Wyeth”). The decrease in license and research revenues from the 2002 periods wasdue to the timing of completion of obligations related to each collaborativeagreement.

 

In August 2003, the Company reacquired its Factor VIII gene therapyrights in Europe from Wyeth. The Company also received $500,000 as a result ofthe termination of its collaboration with Wyeth, which will be recognized aslicense and research revenue in the third quarter of 2003.

 

*Cost of Goods Sold*

 

For the three months ended June 30, 2003, cost of goods sold totaled$4,775,000, or 33% of product sales, an increase of $3,125,000 from $1,650,000,or 19% of product sales, in the corresponding period in 2002.  For the six months ended June 30, 2003 costof goods sold totaled $8,276,000, or 31% of product sales, an increase of$6,078,000 from $2,198,000, or 15% of product sales, in the correspondingperiod in 2002.  Cost of goods soldconsists of expenses in connection with the manufacture of Replagal.

 

Prior to receiving marketing approval of Replagal in Europe in August2001, the Company expensed all of the cost of manufacturing Replagal asresearch and development costs. Following marketing approval, the Company began recording the costs ofmanufacturing Replagal as inventory rather than as a research and developmentexpense.  The Company sold Replagal thathad been manufactured prior to marketing approval in 2001 and in the first halfof 2002.  As of June 30, 2002, thisinventory had been fully utilized.  As aresult, unlike the three and six months ended June 30, 2002, the Company’s costof goods sold for the three and six 

 

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months ended June 30, 2003 reflects the Company’s current fullproduction costs.  In addition, theCompany incurred charges of $1,757,000 and $2,590,000, or 12% and 10% of 2003product sales, respectively, related to excess capacity at the terminatedcontract manufacturer of the bulk drug substance of Replagal for the three andsix months ended June 30, 2003, respectively.

 

The Company has historically relied on contract manufacturingarrangements with third parties for the production of Replagal for commercialsale, including contract fill and finish services. These third parties haveboth manufactured Replagal bulk drug substance for the Company and performedfill and finish services.  In January2003, the Company terminated its agreement with a third party manufacturer ofthe bulk drug substance of Replagal, effective in July 2003.  The Company has manufactured bulk drugsubstance for Replagal at its Cambridge, Massachusetts facility.  In July 2003, the Company’s manufacturingfacility in Cambridge, Massachusetts was approved by the European Commission tomanufacture the bulk drug substance for Replagal.  At the present time, the Company anticipates that existinginventory and additional inventory manufactured both under the third partycontract manufacturing arrangement and at the Company’s manufacturing facilitywill be sufficient to fill customer orders for Replagal into 2004.  The Company will continue to rely on thirdparty manufacturers for fill and finish services.

 

The Company expects that cost of goods sold will reflect more closelyfull production costs for the remainder of 2003 with respect to inventoryproduced at the contract manufacturer. However, the costs to manufacture Replagal at the Company's Cambridge,Massachusetts facility prior to approval were expensed as research anddevelopment costs.  The Company expectsto sell Replagal that was produced at the Cambridge facility prior to approvalduring the second half of 2003 and into 2004. As a result, cost of goods soldwill not reflect full production costs of manufacturing Replagal at theCompany’s manufacturing facility until some time in 2004.

 

###### ***Research and Development Expenses***

 

Research and development expenses decreased by $2,015,000, or 11%, to$16,853,000 in the second quarter of 2003, from $18,868,000 during the sameperiod in 2002.  The decrease wasprimarily due to decreases in research and development staffing and in outsidetesting and supplies costs in conformance with the Company’s restructuringplan.  In the first six months of 2003,research and development expenses decreased by $1,442,000 or 4%, to $37,835,000from $39,277,000 for the same period in 2002. This decrease reflected the incurrence by the Company in the first sixmonths of 2002 of expenditures of $5,500,000 million related to set-up andtechnology transfer fees paid to the contract manufacturer of the bulksubstance Replagal.  This decrease inresearch and development expenses was partially offset by increases in thefirst six months of 2003 in research and development staffing costs andresearch and development occupancy costs.

 

The Company does not intend to engage in any further productdevelopment activities related to its Gene-Activated protein products which areversions of proteins that would compete with proteins currently being marketedby third parties, except with respect to its potential product for thetreatment of Gaucher disease.  TheCompany does not intend to engage in further product 

 

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development activities related to its gene therapy programs unlessthose activities are funded under a collaboration agreement with a third party.As a result of these decisions, and the Company’s restructuring efforts, theCompany expects its research and development expenses to continue to decreaseduring the remainder of 2003.

 

The Company’s two largest research and development programs, Replagal,enzyme replacement therapy for the treatment of Fabry disease, and I2S, enzymereplacement therapy for the treatment of Hunter syndrome, represent themajority of the Company’s research and development spending. The expensesassociated with these programs totaled approximately 77% and 73% of totalresearch and development expenses for the three and six months ended June 30,2003, respectively, as compared to 72% and 76% of total research anddevelopment expenses for the corresponding periods in 2002. Expenses associatedwith the Company’s preclinical and clinical programs related to the Company’sproducts for the treatment of other rare genetic diseases, and Gene-Activatedprotein products, accounted for the balance of the Company’s research anddevelopment expenses for the three and six months ended June 30, 2003.

 

For the three months ended June 30, 2003, research and developmentexpenses for the Replagal program totaled $5,944,000, a decrease of $3,330,000,or 36%, from $9,274,000 in the corresponding period of 2002.  For the six months ended June 30, 2003,research and development expenses for the Replagal program totaled $12,667,000,a decrease of $8,457,000, or 40%, from $21,124,000 in the corresponding periodof 2002.  The decreases in the 2003periods primarily are the result of the conclusion of certain Replagal clinicaltrials prior to the beginning of the 2003 periods as well as decreased expensesincurred in connection with producing clinical materials and drugdevelopment.  Moreover, in the firstquarter of 2002, the Company incurred a one-time set up fee and technologytransfer fees totaling $5,500,000 paid to the contract manufacturer referred toabove.  Costs for the Replagal programinclude basic research, the costs of clinical trials, manufacturing costs ofclinical supplies and regulatory costs associated with preparation of worldwideproduct marketing applications.

 

The amount of future research and development expenses associated withthe Replagal program is not reasonably certain because these costs aredependent principally upon the regulatory process and information required byregulatory agencies, additional clinical trial expenditures required byregulatory agencies, and the timing of obtaining marketing authorization inother countries, if granted, particularly with respect to the United Stateswhere Fabrazyme, Genzyme’s drug for the treatment of Fabry disease, hasreceived orphan drug exclusivity and the Company is reviewing its strategicoptions.

 

For the three months ended June 30, 2003, research and developmentexpenses for the I2S program totaled $7,075,000, an increase of $2,671,000, or61%, from $4,404,000 in the corresponding period of 2002.  For the six months ended June 30, 2003,research and development expenses for the I2S program totaled $14,954,000, anincrease of $6,371,000, or 74%, from $8,583,000 in the corresponding period of2002.  The increase in the 2003 periodswas due to increases in allocated employee costs associated with I2S researchand development efforts as preparations continue for the Phase II/III trialplanned to be initiated in the second half 

 

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of 2003.  In addition,expenditures for the manufacture of I2S for use in the planned Phase II/IIIclinical study and costs for ongoing maintenance of clinical trials forpatients who were enrolled in the completed Phase I study contributed to theincrease in expenses period over period.

 

Future research and development costs for the I2S program are notreasonably certain because such costs are dependent on a number of variables,including the cost and design of the planned Phase II/III clinical trial and anyadditional clinical trials, uncertainties in the timing of the regulatoryprocess, and the costs associated with large-scale manufacture of I2S. TheCompany expects that these costs will be significant in 2004 to supportapplications for marketing approval of I2S in 2005.

 

###### ***Intellectual Property License Fee Expense***

 

In June 2002, the Company obtained an exclusive license to certainpatents and patent applications from Cell Genesys related to Cell Genesys’approach to gene activation. In consideration for the license, the Companyinitially paid Cell Genesys $11,000,000 in cash and issued to Cell Genesysshares of the Company’s common stock worth $15,000,000 as of the date of thelicense agreement.

 

Under the agreement, the Company agreed that the number of shares ofcommon stock initially issued to Cell Genesys would be adjusted at the time theCompany registered such shares for resale under the Securities Act of 1933, ifthe market value of such shares at that time was greater or less than$15,000,000, as calculated in accordance with a predetermined formula. Pursuantto the agreed upon formula, at December 31, 2002 with the closing price of theCompany’s common stock at $9.90 per share, the Company would have been requiredto issue to Cell Genesys an additional 1,148,000 shares of common stock. As aresult, the Company recorded an additional non-cash license fee expense of$8,660,000 in the fourth quarter of 2002.

 

In January 2003, the Company and Cell Genesys renegotiated theconsideration paid for the license, and the Company repurchased the shares ofstock issued to Cell Genesys for $15,000,000 in cash. The Company incurred anadditional license expense in the first quarter of 2003 of $1,350,000, whichrepresents the further decline in the market value of the Company’s commonstock from December 31, 2002 to January 15, 2003. The repurchased shares havebeen recorded as treasury stock.

 

Under the agreement, Cell Genesys also has the potential to receivecertain milestone payments from the Company contingent upon the outcome ofrelated patent matters under the license agreement. If all of the milestonesare achieved, the Company will be obligated to pay Cell Genesys an aggregate of$17,000,000 payable in part in cash and in part in stock. The Company is not requiredto make royalty payments to Cell Genesys.

 

###### ***Selling, General and Administrative Expenses***

 

For the three monthsended June 30, 2003, selling, general and administrative expenses were$9,412,000, an increase of $1,936,000, or 26%, from $7,476,000 for thecorresponding period in 2002.  For thesix months ended June 30, 2003, selling, general and administrative expenses 

 

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were $18,578,000, anincrease of $4,679,000, or 34%, from $13,899,000 for the corresponding periodin 2002.  Contributing to theseincreases were costs incurred for ongoing Replagal sales and marketinginitiatives in Europe and other countries, executive severance charges andoccupancy costs related to the Company’s new corporate headquarters.

 

Specifically, selling, general and administrative expenses related tosales and marketing activities for Replagal for the three months ended June 30,2003 increased by $509,000 to $4,496,000 from $3,987,000 for the three monthsended June 30, 2002.  Selling, generaland administrative expenses related to sales and marketing activities forReplagal for the six months ended June 30, 2003 increased by $1,633,000 to$8,599,000 from $6,966,000 for the six months ended June 30, 2002.  These increases were offset by a reductionin expenses related to the expansion of U.S. commercial operations.  The Company anticipates that selling,general and administrative expenses related to TKT’s new corporate headquarterswill increase in 2003, because the Company will occupy the facility for a fullyear in 2003 and it only occupied the facility for two months in 2002.

 

###### ***Restructuring Charge***

 

In February 2003, TKT announced a major reorganization in an effort toreduce costs and narrow the scope of the Company’s research initiatives. Underthis reorganization, TKT plans to focus its research, development, andcommercialization efforts primarily on therapeutics for the treatment of raregenetic diseases caused by protein deficiencies. The Company is seekingcollaborative partners for its Gene-Activated protein products, which areversions of proteins that would compete with proteins currently being marketedby third parties, and for its gene therapy programs.

 

As part of the restructuring, during the first quarter of 2003, TKTreduced its U.S. headcount by approximately 100 positions. TKT has reduced itsheadcount through attrition, with the goal of having approximately 310 to 325full-time U.S. employees by the end of 2003. As of June 30, 2003, TKT had 319 full-time U.S. employees. TKT is alsoconsolidating its facilities as part of the restructuring.

 

As a result of the restructuring, the Company recorded charges of$4,957,000 and $8,559,000 for the three and six months ended June 30, 2003,respectively, in accordance with SFAS No. 146, *Accounting for Costs Associated withExit or Disposal Activities*. Included in the charge is $1,339,000 of employee severance andoutplacement services costs for 74 employees, primarily in research anddevelopment, $6,646,000, representing the remaining lease obligation for threeof four facilities that the Company no longer occupies, and a write-down of$574,000 for leasehold improvements for facilities which were vacated.  The Company expects that itsemployee-related and facility consolidation restructuring actions will besubstantially completed in 2003.  TheCompany expects to continue to record restructuring charges primarily relatedto vacated facility expenses during the remainder of 2003 and beyond.

 

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###### ***Interest Income***

 

Interest income was$596,000 for the three months ended June 30, 2003, a decrease of $1,652,000,from $2,248,000 for the three months ended June 30, 2002.  For the six months ended June 30, 2003,interest income was $1,372,000, a decrease of $3,179,000, from $4,551,000 forthe six months ended June 30, 2002. Interest income decreased in the three and six months ended June 30,2003 as a result of significantly lower cash and marketable securities balancesand as well as lower rates of return in 2003. Specifically, during the second quarter of 2003, average cash andmarketable securities balances were $205,083,000 compared to $351,517,000 forthe same period of 2002.  For the sixmonths ended June 30, 2003 and 2002, the average cash and marketable securitiesbalances were $219,122,000 and $368,183,000, respectively.

 

*MinorityInterest*

 

The Company recorded a minority interest charge in the net income ofTKT Europe — 5S AB, the Company’s majority owned, consolidated subsidiary (“TKTEurope”) of $33,000 during the three months ended June 30, 2003 and $336,000during the six months ended June 30, 2003.

 

###### ***Net Loss***

 

The Company had a net loss of $21,020,000 and$42,881,000 for the second quarter ended June 30, 2003 and 2002, respectively.Basic and diluted net loss per share was $0.61 and $1.24 for the three monthsended June 30, 2003 and 2002, respectively. Included in the loss for the threemonths ended June 30, 2002 is an intellectual property license fee expense of$26,000,000, which contributed $0.75 to basic and diluted net loss per share.

 

The Company had a net loss of $46,965,000 and$61,348,000 for the six months ended June 30, 2003 and 2002, respectively.Basic and diluted net loss per share was $1.36 for the six months ended June30, 2003, as compared to a basic and diluted net loss per share of $1.78 forthe corresponding period in 2002. Included in the loss for the six months ended June 30, 2002 is anintellectual property license fee expense of $26,000,000, which contributed$0.76 to basic and diluted net loss per share.

 

###### ***Liquidity and Sources of Capital***

 

Since its inception, TKT has financed its operations through:

 

•                  thesale of common and preferred stock;

•                  borrowingsunder debt agreements;

•                  revenuesfrom collaborative agreements;

•                  interestincome; and

•                  morerecently, with proceeds from product sales.

 

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In the near term, TKT expects to finance its operations principallyfrom existing cash, cash equivalents, marketable securities, and continuedsales of Replagal.

 

###### ***Cash Flows***

 

The Company had cash, cash equivalents and marketable securitiestotaling $197,865,000 at June 30, 2003, including restricted marketablesecurities collateralizing letters of credit totaling $7,992,000. Cashequivalents and marketable securities are invested in United States governmentand agency obligations and money market funds.

 

The Company’s cash requirements for operating activities, financingactivities and investment activities have significantly exceeded its internallygenerated funds. The Company expects that its cash requirements for suchactivities will continue to significantly exceed its internally generated fundsuntil it is able to generate substantial product sales.

 

The Company used net cash of $52,614,000 in operating activities in thefirst six months of 2003. This consisted of a net loss of $46,965,000, combinedwith uses of $11,368,000 related primarily to the payment made to Cell Genesysin January 2003 and $7,673,000 primarily related to changes in other assets andliabilities.  These uses were offsetpartially by depreciation and amortiziation, loss on fixed asset disposals andcompensation expense related to equity issuances totaling $7,075,000 of cashinflow.  In addition, the increase inaccrued restructuring costs contributed $6,317,000 to net cash used foroperating activities for the six months ended June 30, 2003.

 

The Company used net cash of $6,226,000 during the first half of 2003for property and equipment purchases, primarily related to leaseholdimprovements and equipment for the Company’s manufacturing and research anddevelopment facilities. The Company expects to spend an additionalapproximately $20,000,000 to $25,000,000 for purchases of property and equipmentduring the second half of 2003, principally for expanding its internalmanufacturing capabilities.

 

The Company will require substantial additional funds to support itsresearch and development programs, acquisition of technologies, preclinical andclinical testing of its products, pursuit of regulatory approvals, acquisitionof capital equipment, expansion of internal manufacturing capabilities,selling, general and administrative expenses, and the buyout of the minorityinterests in TKT Europe, if applicable, as discussed below. The Company expectsthat its existing capital resources, together with anticipated proceeds fromproduct sales and interest income, will be sufficient to fund its operationsinto 2005.

 

The Company may pursue opportunities to obtain additional externalfinancing in the future through equity financings, debt financings, leasearrangements related to facilities and capital equipment, and collaborativeresearch and development agreements. The source, timing and availability of anyfuture financing will depend principally upon equity and debt marketconditions, interest rates and, more specifically, on the Company’s continuedprogress in its preclinical and clinical development programs, and the extentof its commercial success. There can be no assurance that external funds willbe available on favorable terms, if at all.

 

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###### ***Contractual Obligations***

 

The following table summarizes the Company's significant contractualobligations at June 30, 2003:

 
|                                |   | **Payments  Due by Period** |   |
|-------------------------------------|--------|-----------------------------|--------|
| **(in  thousands)**                 |   | **Less than**

**1 year**   |   | **1-3 years** |   | **4-5 years** |   | **After 5  years** |   | **Total** |   |
| Non-cancelable  operating leases    |   | $                           | 11,292 |   | $ | 30,235 |   | $ | 22,821 |   | $ | 23,513 |   | $ | 87,861 |   |
| Other long term  obligations        |   | 610                         |   | — |   | — |   | — |   | 610 |   |
| Total  contractual cash obligations |   | $                           | 11,902 |   | $ | 30,235 |   | $ | 22,821 |   | $ | 23,513 |   | $ | 88,471 |   |

 

The Company also is subject to the potential commitments discussed inthe following two paragraphs that are not included in the above table:

 

In April 2000, the Company established TKT Europe for the purpose ofmarketing, selling and distributing Replagal in Europe. Under the stockholders’agreement for TKT Europe, the Company is entitled to purchase the Europeanstockholders’ 20% ownership interest in TKT Europe in August 2004, for a pricedetermined in accordance with a formula. Should the Company not exercise thatright, the European stockholders of TKT Europe can require the Company topurchase the European stockholders’ ownership interest sixty days thereafter.The buyout price is equal to (a) 20% of the operating profits, as defined inthe stockholders’ agreement, for the period from September 1, 2003 to August31, 2004, multiplied by a buyout factor of four, subject to adjustment, plus(b) 20% of the accumulated positive earnings of TKT Europe. As a result, theamount of the buyout price is dependent on the profits of TKT Europe and thecommercial success of Replagal in Europe. While these profits cannot beestimated at this time, the Company expects the buyout price could be between$50,000,000 and $70,000,000 based on the Company’s current estimates for salesand expenses.

 

In June 2002, the Company obtained an exclusive license to certainpatent and patent applications from Cell Genesys related to Cell Genesys’approach to gene activation. In consideration for the license, the Company paid$11,000,000 cash in June 2002 and an additional $15,000,000 in January 2003. IfCell Genesys achieves all the milestones related to patent matters under thelicense agreement, the Company will be obligated to pay Cell Genesys anaggregate of $17,000,000 payable in part in cash and in part in stock. TheCompany is not required to make royalty payments to Cell Genesys.

 

###### ***Net Operating Loss Carryforwards***

 

At December 31, 2002, the Company had net operating loss carryforwardsof approximately $266,075,000, which expire at various times through 2022. Dueto the degree of uncertainty related to the ultimate use of loss carryforwardsand tax credits, the Company has fully reserved against any potential taxbenefit. The future utilization of net operating loss carryforwards and taxcredits may be subject to limitation under the changes in stock ownership rulesof the Internal Revenue Code. Because of this limitation, it is possible thattaxable income in future years, which would otherwise be offset by netoperating losses, will not be offset and, therefore, will be subject to tax.

 

###### ***Litigation***

 

In the first quarter of 2003, at least nine purported class actionsuits were brought in the U.S. District Court of Massachusetts against theCompany, its former Chief Executive Officer, and in some cases, its Chairman ofthe Board of Directors. The complaints generally allege that, during the periodfrom January 2001 through January 2003, TKT made false and misleadingstatements and failed to disclose material information concerning the statusand progress for obtaining U.S. marketing approval of Replagal. On April 9,2003, the Court consolidated the various actions under one matter.  On July 7, 2003, the plaintiffs amended theconsolidated complaint to include 

 

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as defendants in the action the Company’s former Chief FinancialOfficer, each of the individual members of the Company’s Board of Directors(other than Mr. Astrue), SG Cowen Securities Corporation, Deutsche Bank Alex.Brown, Pacific Growth Equities, Inc., and Leerink Swann & Company and tofurther allege that the new defendants made false and misleading statements andfailed to disclose material information concerning the status and progress forobtaining U.S. marketing approval of its Replagal product to treat Fabrydisease.  A class has not beencertified, and the Company has not yet responded to the Amended Complaint.  The Company expects that expenses related tothis litigation will be significant.

 

On April 14, 2003, a shareholder derivative suit was filed againstindividual members of the Company’s Board of Directors, the Company’s formerChief Executive Officer, and the Company in Middlesex Superior Court in theCommonwealth of Massachusetts.  On May29, 2003, the parties moved to transfer venue to the Business LitigationSession in Suffolk Superior Court in the Commonwealth of Massachusetts.  The parties’ motion was allowed, and thematter was accepted into the Business Litigation Session as Civil Action No.03-02630-BLS.  The complaint generallyalleges that the individual defendants breached fiduciary duties owed to theCompany and its stockholders by disseminating false and misleading statementsto the market concerning the status and progress for obtaining U.S. marketingapproval of Replagal and causing or allowing the Company to conduct itsbusiness improperly.  

 

On August 7, 2003, the plaintiff filed its amended complaint allegingthat the individual defendants breached fiduciary duties owed to the Companyand its shareholders by causing the Company to issue materially false andmisleading statements to the public and signing the Company's Annual Reports onForms 10-K for the years 2000 and 2001 as well as a registrationstatement.  The amended complaint alsoalleges that the Company's former chief executive officer sold shares ofCompany common stock while in possession of material non-publicinformation.  The Company expects thatexpenses related to this litigation will be significant. As of June 30, 2003,the Company had incurred approximately $86,000 in expenses related to thislitigation.

 

On May 14, 2003, the Company received a copy of a formal order ofinvestigation by the Securities and Exchange Commission. The order ofinvestigation relates to TKT’s disclosures and public filings with regard toReplagal and the status of the FDA’s approval process for Replagal, as well astransactions in the Company’s securities. The Company is cooperating with theSEC in the investigation.

 

The Company has been engaged in patent litigation with Genzyme andMount Sinai with respect to Replagal. As of July 31, 2003, the Company hadincurred approximately $4,662,000 in litigation expenses associated with theReplagal litigation.

 

The Company and Aventis have been involved in patent infringementactions with Amgen and Kirin-Amgen with respect to Dynepo (epoietin delta), afully human erythropoietin for the treatment of anemia related to chronic renalfailure. The litigation is costly and the Company is required to reimburseAventis, which is paying the litigation expenses, for 50% of the expenses.Aventis is entitled to deduct up to 50% of any royalties due to the Companyfrom the sale of Dynepo until Aventis has recouped the full amount of TKT’sshare of litigation expenses. The Company currently estimates that its share ofthe expenses associated with the litigation will total between approximately$15,000,000 and $20,000,000 by the time the matter is finally adjudicated.

 

The Company has been engaged in patent litigation with Serono withrespect to Replagal. The Company expects that expenses relating to thislitigation will be significant.

 

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The Company can provideno assurance as to the outcome of these proceedings. A decision by a court inany jurisdiction in a manner adverse to the Company could have a materialadverse effect on the Company’s liquidity and capital resources.

 

FORWARD-LOOKING STATEMENTS

 

This quarterlyreport contains forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933, as amended, and Section 21E of the Securities andExchange Act of 1934, as amended, that involve risks and uncertainties.  TheCompany may, in some cases, use words such as “project,” “believe,”“anticipate,” “plan,” “expect,” “estimate,” “intend,” “should,” “would,”“could,” “will,” or “may,” or other words that convey uncertainty of futureevents or outcomes to identify these forward–looking statements. There are anumber of important factors that could cause actual results to differmaterially from the results anticipated by these forward–looking statements.These important factors include those set forth below under “Certain FactorsThat May Affect Future Results.”  Thesefactors and the other cautionary statements made in this quarterly reportshould be read as being applicable to all related forward–looking statements whereverthey appear in this quarterly report. If one or more of these factorsmaterialize, or if any underlying assumptions prove incorrect, the Company’sactual results, performance or achievements may vary materially from any futureresults, performance or achievements expressed or implied by theseforward–looking statements. In addition, any forward-looking statementsrepresent the Company’s estimates only as of the date this quarterly report wasfiled with the Securities and Exchange Commission and should not be relied uponas representing the Company’s estimates as of any subsequent date.  Whilethe Company may elect to update forward-looking statements at some point in thefuture, the Company specifically disclaims any obligation to do so, even if itsestimates change.

 

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

 

The following important factors could causeactual results to differ from those indicated by forward-looking statementsmade by the Company from time to time.

 

*Clinical and Regulatory Risks*

 

**Unless we are able to breakFabrazyme’s orphan drug exclusivity, we will not be able to obtain marketingapproval for Replagal in the United States until April 2010.**

 

On April 24, 2003,Genzyme received marketing authorization in the United States for Fabrazyme,its enzyme replacement therapy product for the treatment of Fabry disease.  Because Fabrazyme had received orphan drugdesignation in the United States, upon its marketing approval, Fabrazymereceived orphan drug exclusivity. Once a product receives orphan drugexclusivity, the FDA may not approve another application to market the samedrug for the same indication for a period of seven years, except in limitedcircumstances set forth under the FDA Statute and implementing regulations.Because Fabrazyme received marketing approval in the United States beforeReplagal and received orphan drug exclusivity, the FDA may not approve Replagaland Replagal will be excluded from the U.S. market until April 2010 unless wecan demonstrate that Replagal satisfies the limited criteria for exceptions setforth in the FDA Statute 

 

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and implementing regulations.

 

We are in the process of examining possible options tobreak Fabrazyme’s orphan drug exclusivity, and are preparing to talk with theFDA in more detail about our options. We may need to conduct additional clinical trials and analyses in anattempt to break Fabrazyme’s orphan drug exclusivity and secure marketingauthorization for Replagal in the United States.  We expect to make some strategic decisions on these issues beforethe end of 2003, although we do not intend to make the details of our strategypublic for competitive reasons.

 

**We maynot be able to obtain marketing approvals for our products, whether or not wereceive orphan drug exclusivity for our products.**

 

We are not able tomarket any of our products in Europe, the United States or in any otherjurisdiction without marketing approval from the European Commission, the FDA,or any equivalent foreign regulatory agency. The regulatory process to obtainmarket approval for a new drug or biologic takes many years and requires theexpenditure of substantial resources. We have had only limited experience inpreparing applications and obtaining regulatory approvals.

 

InAugust 2001, the European Commission granted marketing authorization ofReplagal in the European Union, approximately one year after we submitted ourMarketing Authorization Application, or MAA, to the European Agency for theEvaluation of Medicinal Products, or EMEA, and approximately five years afterwe filed our Investigational New Drug Application, or IND, with the FDA. Wehave also received approval to market Replagal in a number of other countries.

 

We have notreceived approval to market and sell Replagal in the United States. As notedabove, because Fabrazyme has received orphan drug exclusivity, we cannotreceive approval in the United States until April 2010 unless we are able tobreak Fabrazyme’s orphan drug exclusivity.

 

Since we submitteda BLA for Replagal to the FDA in June 2000, we have received two CompleteResponse Letters from the FDA. In the second Complete Response Letter, which wereceived in November 2002, the FDA indicated that the data relating toReplagal which we had previously submitted were not adequate for approval,primarily because of questions concerning efficacy, but that the data would bediscussed at a meeting of the Endocrinologic & Metabolic DrugsAdvisory Committee.

 

OnJanuary 14, 2003, the Endocrinologic & Metabolic Drugs AdvisoryCommittee convened to discuss our BLA for Replagal and concluded by a unanimousvote that our clinical data did not provide substantial evidence of efficacy.The Endocrinologic & Metabolic Drugs Advisory Committee also concludedby an 8 to 7 vote that the renal pathology data presented by us were notadequate to serve as the basis for accelerated approval. As part of itsconsideration of an application for marketing authorization, the FDA oftenrequests a review of an application for marketing authorization or parts of anapplication for marketing authorization by an advisory committee of outsideexperts. The FDA is free to accept or reject the advisory committee’srecommendations.

 

Some members ofthe Endocrinologic & Metabolic Drugs Advisory Committee indicated thatwe could re-examine the pathology slides showing the effect of Replagal on thekidney using a different analytical method, and if successful, the data fromthat re-examination might be sufficient to serve as the basis for acceleratedapproval.

 

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We are in the process of examining possible options to breakFabrazyme's orphan drug exclusivity and secure marketing authorization forReplagal in the United States, and we are preparing to talk with the FDA in moredetail about our options.

 

Although the European Commission has granted marketingapproval of Dynepo in the European Union, Dynepo has not been approved in theUnited States. In 2000, Aventis submitted a BLA to the FDA seeking marketingauthorization for Dynepo in the United States. The FDA did not accept the BLAfor filing, and requested that Aventis provide additional manufacturing data.Aventis has not yet submitted the requested additional data to the FDA, and wecannot predict whether or when Aventis will do so.  In addition, Aventis has not launched Dynepo in Europe.

 

There can be no assurance as to whether or when any ofthese applications for marketing authorization relating to Replagal and Dynepo,or additional applications for marketing authorization that we may make in thefuture as to these or other products, will be approved by the relevantregulatory authorities.  If approval isgranted, it may be subject to limitations on the indicated uses for which theproduct may be marketed or contain requirements for costly post-marketingtesting and surveillance to monitor safety or efficacy of the product.  If approval is not granted on a timely basisor at all, our business would be materially harmed.

 

**Wemay not be able to obtain orphan drug exclusivity for our products for thetreatment of rare genetic diseases.**

 

Somejurisdictions, including Europe and the United States, may designate drugs forrelatively small patient populations as “orphan drugs.” Orphan drug designationmust be requested before submitting an application for marketing authorization.Orphan drug designation does not convey any advantage in, or shorten theduration of, the regulatory review and approval process but does make theproduct eligible for orphan drug exclusivity and certain tax credits in theUnited States. Generally, if a product which has an orphan drug designationsubsequently receives the first marketing approval for the indication for whichit has such designation, the product is entitled to orphan drug exclusivity. Orphandrug exclusivity means that another application to market the same drug for thesame indication may not be approved, except in limited circumstances set forthin the FDA Statute and implementing regulations, for a period of up to tenyears in Europe and for a period of seven years in the United States. Obtainingorphan drug designations and orphan drug exclusivity for our products for thetreatment of rare genetic diseases may be critical to the success of theseproducts. Our competitors may obtain orphan drug exclusivity for productscompetitive with our products before we do as Genzyme did with Fabrazyme in theUnited States. Even if we obtain orphan drug exclusivity for any of ourpotential products, we may not be able to maintain it. For example, if acompetitive product is shown to be clinically superior to our product, anyorphan drug exclusivity we have obtained will not block the approval of suchcompetitive product.

 

InAugust 2001, the EMEA granted marketing authorization of Replagal in theEuropean Union. Genzyme’s Fabrazyme was also granted marketing authorization inthe European Union in August 2001. Replagal and Fabrazyme were grantedco-exclusive orphan drug status in the European Union for up to 10 years.

 

**If we fail to comply with the extensiveregulatory requirements to which our products are subject, we could be subjectto adverse consequences and penalties.**

 

The testing,manufacturing, labeling, advertising, promotion, export, and marketing, 

 

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among other things, of our products are subject toextensive regulation by governmental authorities in Europe, the United States,and elsewhere throughout the world.

 

If one of ourproducts is approved by the European Commission, the FDA or another regulatoryagency, we and any third party manufacturers we use will be required to complywith a number of post-approval requirements. In each case, the product, thefacilities at which the product is manufactured, any post-approval clinicaldata and our promotional activities will be subject to continual review andperiodic inspections by the EMEA, the FDA and other regulatoryauthorities.  For example, in the UnitedStates we will be required to report certain adverse events to the FDA and tocomply with certain requirements concerning advertising and promotionallabeling of the products. Also, quality control and manufacturing proceduresmust continue to conform to GMP regulations after approval, and the FDAperiodically inspects manufacturing facilities to assess compliance with GMP.Accordingly, manufacturers must continue to expend time, monies, and effort inthe area of production and quality control to maintain GMP compliance. Inaddition, discovery of problems may result in financial penalties, suspensionor withdrawal or an approved product from the market, operating restrictions,and the imposition of criminal penalties.

 

In addition to regulations adopted by the EMEA, theFDA, and other foreign regulatory authorities, we are also subject to regulationunder the Occupational Safety and Health Act, the Toxic Substances Control Act,the Resource Conservation and Recovery Act, and other federal, state, and localregulations.

 

**If our clinical trials are notsuccessful, we may not be able to develop and commercialize our products.**

 

In order to obtainregulatory approvals for the commercial sale of our potential products, we andour collaborators will be required to complete extensive clinical trials inhumans to demonstrate the safety and efficacy of our products. We may not beable to commence or complete these clinical trials, either because the FDA orother regulatory agencies object, or for other reasons.

 

The results frompreclinical testing of a product that is under development may not be predictiveof results that will be obtained in human clinical trials. In addition, theresults of early human clinical trials may not be predictive of results thatwill be obtained in larger scale, advanced stage clinical trials. Furthermore,we, one of our collaborators, or a regulatory agency with jurisdiction over thetrials may suspend clinical trials at any time if the subjects or patientsparticipating in such trials are being exposed to unacceptable health risks, orfor other reasons.

 

The rate ofcompletion of clinical trials is dependent in part upon the rate of enrollmentof patients. Patient accrual is a function of many factors, including the sizeof the patient population, the proximity of patients to clinical sites, theeligibility criteria for the study, the existence of competitive clinicaltrials, and the availability of alternative treatments. In particular, thepatient populations for some of our products for rare genetic diseases aresmall. For instance, we believe there are up to 5,000 patients worldwideafflicted with Fabry disease, and up to 2,000 patients worldwide afflicted withHunter syndrome in jurisdictions where reimbursement may be possible. We arecurrently conducting clinical trials of I2S for the treatment of Huntersyndrome and additional trials of Replagal. Delays in planned patientenrollment may result in increased costs and prolonged clinical development.

 

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We and ourcollaborators may not be able to successfully complete any clinical trial of apotential product within any specified time period. In some cases, we may notbe able to complete the trial at all. Moreover, clinical trials may not showour potential product to be both safe and efficacious. Thus, the EMEA, the FDAand other regulatory authorities may not approve any of our potential productsfor any indication.

 

**Ourresearch and development efforts may not result in products appropriate fortesting in human clinical trials.**

 

We expendsignificant resources on research and development and preclinical studies ofproduct candidates. However, these efforts may not result in the development ofproducts appropriate for testing in human clinical trials. For example, ourresearch may result in product candidates that are not expected to beefficacious in treating disease or that reveal safety concerns. We may postponeor terminate research and development of a product candidate or a program atany time for any reason such as the safety or efficacy of the potentialproduct, allocation of resources or unavailability of qualified research anddevelopment personnel.

 

**Recent adverse events in the field ofgene therapy may impair our ability to obtain collaborative partners for ourgene therapy programs.**

 

We have terminatedinternal development of our gene therapy programs and are seeking collaborativepartners with which to continue to develop these programs. Recent adverseevents in the field of gene therapy, although not occurring in our clinicaltrials, may impair our ability to enter into collaborations for our programs.In particular, in November 1999, a patient with a rare metabolic disorderdied in a gene therapy trial conducted at the University of Pennsylvania. Inaddition, in October 2002, a French boy developed a leukemia-like diseasenearly three years after participating in a gene therapy study as a baby. As aresult of these and other events, a number of gene therapy clinical trials havebeen terminated or suspended in the United States and in other countries, andregulatory authorities have grown increasingly concerned about the safety ofgene therapy.

 

*Litigationand Intellectual Property Risks*

 

**We are a party to litigation withGenzyme and Mount Sinai involving Replagal which could preclude us frommanufacturing or selling Replagal.**

 

In July 2000,Genzyme and Mount Sinai filed a patent infringement action against us in theU.S. District Court of Delaware. The complaint alleges that activities relatingto Replagal infringe a patent licensed by Genzyme from Mount Sinai. In January 2002,the U.S. District Court of Delaware dismissed this patent litigation. InMarch 2002, Genzyme appealed the U.S. District Court of Delaware’s rulingto the U.S. Court of Appeals for the Federal Circuit, and in January 2003the U.S. Court of Appeals for the Federal Circuit heard oral arguments on theappeal. If Genzyme is successful in its appeal, the case may be remanded to theU.S. District Court of Delaware for further proceedings on non-infringement andinvalidity issues. If we were to ultimately lose this case after trial andappeal, we would be precluded from making, using and selling Replagal. We canprovide no assurance as to the outcome of this litigation. As of June 30, 2003,we have incurred approximately $4.7 million in litigation expensesassociated with the Replagal litigation.

 

 

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**We are a party to litigation withAmgen and Kirin-Amgen involving Dynepo which could preclude us frommanufacturing or selling Dynepo.**

 

InApril 1997, Amgen commenced a patent infringement action against us andAventis in the District Court of Massachusetts. In January 2001, theDistrict Court of Massachusetts concluded that Dynepo infringed 8 of the 18claims of patents asserted by Amgen. Subsequent to the decision, we andAventis, as well as Amgen, filed an appeal of the decision with the Court ofAppeals for the Federal Circuit. On January 6, 2003, the Court of Appealsfor the Federal Circuit issued a decision affirming in part and reversing inpart the decision of the District Court of Massachusetts and remanded theaction to the District Court of Massachusetts for further proceedings.  The U.S.District Court of Massachusetts heard oral argument on some of these issues inJuly 2003.  We expect that the U.S. DistrictCourt of Massachusetts will rule on some of the outstanding issues and set aschedule for the taking of additional evidence, if required, commencing inOctober 2003.

 

In addition, inJuly 1999, we and Aventis commenced legal proceedings in the UnitedKingdom against Kirin-Amgen, seeking a declaration that a European patent heldby Kirin-Amgen will not be infringed by our activities related to Dynepo. InApril 2001, the High Court of Justice in the United Kingdom ruled thatDynepo infringed one of four claims of a patent asserted by Kirin-Amgen. InJuly 2002, the Court of Appeals in the United Kingdom reversed the HighCourt of Justice and ruled that Dynepo did not infringe Kirin-Amgen’s patent.In February 2003, the House of Lords agreed to hear an appeal of thedecision of the Court of Appeals.

 

We can provide noassurance as to the outcome of either litigation. If we and our collaborator,Aventis, are not successful in the Dynepo litigation, we and Aventis would beprecluded from making, using and selling Dynepo in the United States and/or inthe United Kingdom. We are required to reimburse Aventis, which is paying thelitigation expenses, for 50% of the expenses. Aventis is entitled to deduct upto 50% of any royalties due to us from it with respect to the sale of Dynepountil Aventis has recouped the full amount of our share of litigation expenses.We currently estimate that our share of the expenses associated with thelitigation will total between approximately $15.0 million and $20.0 millionby the time the matter is finally adjudicated.

 

**We are a party to litigation withSerono and would be prohibited from selling products using gene activationtechnology in some jurisdictions in Europe if we are not successful in thelitigation.**

 

InJanuary 2003, Applied Research Systems ARS Holdings, N.V., a wholly ownedsubsidiary of Serono, commenced an action against us in the District Court atThe Hague in the Netherlands claiming that Replagal infringes one of Serono’sEuropean patents. The Serono patent relates to Serono’s approach to geneactivation. In January 2002, the European Patent Office revoked the Seronopatent on grounds of invalidity due to non-enablement. Serono has appealed therevocation to the Technical Board of Appeal at the European Patent Office and ahearing has been set for October 2003. The litigation at The Hague has been stayed pending the outcome of theOctober proceedings before the European Patent Office.  The Company expects that the expensesrelated to this litigation will be significant.  We can provide no assurance as to the outcome of this litigation.If we lose this litigation, we may prohibited from selling products using geneactivation technology, including Replagal, in some jurisdictions in Europe.

 

 

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**We are a party to several shareholderlawsuits and a derivative action regarding the adequacy of our publicdisclosure which could have a material adverse affect on our financialcondition.**

 

In the first quarter of 2003, at least nine purported classaction suits were brought in the U.S. District Court of Massachusetts against **us**,**our** former Chief ExecutiveOfficer, and in some cases, **our** Chairman of the Board ofDirectors. The complaints generally allege that, during the period fromJanuary 2001 through January 2003, **we**made false and misleading statements and failed to disclose materialinformation concerning the status and progress for obtaining U.S. marketingapproval of Replagal and seek equitable and monetary relief, an unspecifiedamount of damages, with interest, and attorney’s fees and costs. **OnApril 9, 2003, the Court consolidated the various actions under onematter. **OnJuly 7, 2003, the plaintiffs amended the consolidated complaint to include asdefendants in the action our former Chief Financial Officer, each of theindividual members of our Board of Directors (other than Mr. Astrue), SG CowenSecurities Corporation, Deutsche Bank Alex. Brown, Pacific Growth Equities,Inc., and Leerink Swann & Company and to further allege that the newdefendants made false and misleading statements and failed to disclose materialinformation concerning the status and progress for obtaining U.S. marketingapproval of Replagal.  A class has notbeen certified, and we have not yet responded to the Amended Complaint.

** **

**On April 14, 2003, a shareholder derivative suit was filed againstindividual members of our Board of Directors, our former Chief ExecutiveOfficer, and us in Middlesex Superior Court in the Commonwealth ofMassachusetts.  **OnMay 29, 2003, the parties moved to transfer venue to the Business LitigationSession in Suffolk Superior Court in the Commonwealth of Massachusetts.  The parties’ motion was allowed, and on June4, 2003 the matter was accepted into the Business Litigation Session as CivilAction No. 03-02630-BLS.  **The complaint generally alleges that theindividual defendants breached fiduciary duties owed to us and our stockholdersby disseminating false and misleading statements to the market concerning thestatus and progress for obtaining U.S. marketing approval of Replagal andcausing or allowing us to conduct its business improperly.  On August 7, 2003, the plaintiff filed anamended complaint alleging that the individual defendants breached fiduciaryduties owed to us and our shareholders by causing us to issue materially falseand misleading statements to the public and signing our Annual Reports on Forms10-K for the years 2000 and 2001 as well as a registration statement.  The amended complaint also alleges that theour former chief executive officer sold shares of our common stock while inpossessions of material non-public information.  The complaint and the amended complaint each seek declaratory,equitable and monetary relief, an unspecified amount of damages, with interest,and attorney's fees and costs.**

 

We expect that the costs related to these suits will besignificant.  We can provide noassurance as to the outcome of any of these suits. If we are not successful indefending these actions, our business, results of operations and financialcondition could be adversely affected, possibly materially.

 

**The SEC in investigating us regarding ourpublic disclosures and filings, as well as transactions in our securities,which could have a material adverse effect on our financial condition.**

** **

**On May 14, 2003, we received a copy of a formal order of investigationby the Securities and Exchange Commission. The order of investigation relates to our disclosures and public filingswith regard to Replagal and the status of the FDA’s approval process forReplagal, as well as transactions in our securities.  We are cooperating with the SEC in the investigation.**

 

If thisinvestigation results in a determination that we have failed to properlydisclose information relating to Replagal and the status of the FDA’s approvalprocess for Replagal or that there were improper transactions in the Company’ssecurities, we could be subject to substantial fines or penalties and othersanctions. An adverse determination could have a material effect on ourbusiness, results of operations and financial condition.  However, at this time, we cannot 

 

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accurately predict the outcome of thisproceeding.  In addition, even if we aresuccessful, **this investigation maydivert the attention of our management and other resources that would otherwisebe engaged in running our business.**

 

**We may become involved in additionaland expensive patent litigation or other proceedings.**

 

The biotechnologyindustry has been characterized by significant litigation, and interference andother proceedings regarding patents, patent applications, and otherintellectual property rights. We may become a party to additional patentlitigation and other proceedings with respect to our proteins or othertechnologies. Such litigation could result in liability for damages, preventour development and commercialization efforts, and divert management’sattention and resources.

 

An adverse outcomein any patent litigation or other proceeding involving patents could subject usto significant liabilities to third parties and require us to cease using thetechnology or product that is at issue or to license the technology or productfrom third parties. We may not be able to obtain any required licenses oncommercially acceptable terms, or at all.

 

The cost to us ofany patent litigation or other proceeding, even if resolved in our favor, couldbe substantial. Some of our competitors may be able to sustain these costs moreeffectively than we can because of their substantially greater financialresources. Uncertainties resulting from the initiation and continuation ofpatent litigation or other proceedings could have a material adverse effect onour ability to develop, manufacture, and market products, form strategicalliances, and compete in the marketplace.

 

**If we are unable to obtain patentprotection for our discoveries, the value of our technology and products may beadversely affected.**

 

Our success willdepend in large part on our ability to obtain patent protection for ourprocesses and products in the United States and other countries. The patentsituation in the field of biotechnology generally is highly uncertain andinvolves complex legal, scientific and factual questions. We may not be issuedpatents relating to our technology. Even if issued, patents may be challenged,invalidated, or circumvented. Our patents also may not afford us protectionagainst competitors with similar technology. Because patent applications in theUnited States are maintained in secrecy until patents issue, third parties mayhave filed or maintained patent applications for technology used by us orcovered by our pending patent applications without our being aware of theseapplications.

 

We may not hold proprietaryrights to certain product patents, process patents, and use patents related toour products or their methods of manufacture. In some cases, these patents maybe owned or controlled by third parties. As a result, we may be required toobtain licenses under third party patents to market certain of our potentialproducts. If licenses are not available to us on acceptable terms, we may notbe able to market these products.

 

**If we are unable to protect theconfidentiality of our proprietary information and know-how, the value of ourtechnology and products will be adversely affected.**

 

We rely uponunpatented proprietary technology, processes, and know-how. We seek to protectthis information in part by confidentiality agreements with our employees, consultants,and other third party contractors. These agreements may be breached, and we maynot have adequate remedies for any such breach. In addition, our trade secretsmay otherwise become 

 

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known or be independently developed by competitors.

 

**If we fail to comply with ourobligations under the agreements under which we license commercializationrights to products or technology from third parties, we could lose licenserights.**

 

We are a party toover 20 patent licenses under which we have acquired rights to proprietarytechnology of third parties, including a license to patents related to I2S, andexpect to enter into additional patent licenses in the future. These licensesimpose various commercialization, sublicensing, royalty, insurance, and otherobligations on us. If we fail to comply with these obligations, the licensormay have the right to terminate the license and we could lose our license touse the acquired rights. If these rights are lost, we may not be able to marketproducts that were covered by the license.

 

*BusinessRisks*

 

**Our revenue from product sales isdependent on the commercial success of Replagal.**

 

Replagal is ouronly commercial product. We expect that Replagal will account for all of ourproduct sales into at least 2005. The commercial success of Replagal willdepend on its acceptance by physicians, patients and other key decision-makersfor the treatment of Fabry disease. The commercial success of Replagal willdepend in part upon Replagal receiving marketing approval in the United States,Japan and other countries.  As notedabove, because Fabrazyme received orphan drug exclusivity in the United States,approval for Replagal in the United States will be difficult to obtain.

 

**We face significant competition,which may result in others discovering, developing or commercializing productsbefore, or more successfully, than we do.**

 

The biotechnologyindustry is highly competitive and characterized by rapid and significanttechnological change. Our competitors include pharmaceutical companies,biotechnology firms, universities, and other research institutions. Many ofthese competitors have substantially greater financial and other resources thanwe do and are conducting extensive research and development activities ontechnologies and products similar to, or competitive, with ours.

 

We may be unableto develop technologies and products that are more clinically efficacious orcost-effective than products developed by our competitors. Even if we obtainmarketing approval for our product candidates, many of our competitors havemore extensive and established sales, marketing, and distribution capabilitiesthan we do. Litigation with third parties, including litigation with Amgen,Genzyme and Serono, could delay our time to market or preclude us from reachingthe market for certain products and enable our competitors to more quickly andeffectively penetrate certain markets.

 

*Therapeuticsfor the Treatment of Rare Genetic Diseases*

 

We believe thatthe primary competition with respect to our products for the treatment of raregenetic diseases is from biotechnology and smaller pharmaceutical companies.Competitors include BioMarin Pharmaceutical Inc., Celltech Group plc,Genzyme, and Osiris Therapeutics, Inc. The markets for some of thepotential therapeutics for rare genetic diseases caused by protein deficienciesare quite small. As a result, if competitive products exist, we may 

 

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not be able to successfully commercialize ourproducts.

 

We believe that our primary competition with respectto Replagal is Genzyme. Replagal and Fabrazyme were each granted marketingauthorization in the European Union and were also granted co-exclusive orphandrug status in the European Union for up to 10 years.  Fabrazyme has received marketingauthorization in the United States and orphan drug exclusivity.

 

We believeGenzyme’s product Cerezyme is our primary competition with respect to ourenzyme replacement therapy for the treatment of Gaucher disease.

 

*Gene-ActivatedVersions of Proteins That Would Compete With Currently-Marketed Proteins*

 

In ourGene-Activated protein program, we are developing Gene-Activated proteinproducts that would compete with proteins that are currently being marketed bythird parties. For instance, in the case of Dynepo, competing products aremarketed by Amgen, Johnson & Johnson, F. Hoffmann-La Roche Ltd.(Boehringer Mannheim GmbH), Sankyo Company Ltd., Chugai PharmaceuticalCo., Ltd., and the pharmaceutical division of Kirin Brewery Co., Ltd.in Japan.

 

Many of theproducts against which our Gene-Activated proteins would compete havewell-known brand names, have been promoted extensively and have achieved marketacceptance by third-party payors, hospitals, physicians, and patients. Inaddition, many of the companies that produce these protein products havepatents covering techniques used to produce these products, which have oftenserved as effective barriers to entry in the therapeutic proteins market. Aswith Amgen and its erythropoietin product, these companies may seek to blockour entry into the market by asserting that our Gene-Activated proteinsinfringe their patents. Many of these companies are also seeking to develop andcommercialize new or potentially improved versions of their proteins.

 

*GeneTherapy*

 

Our gene therapysystem will have to compete with other gene therapy systems, as well as withconventional methods of treating the disease and conditions targeted. Althoughno gene therapy product is currently marketed, a number of companies, includingmajor biotechnology and pharmaceutical companies, such as Amgen and Serono, areactively involved in this field.

 

**The market may not be receptive toour products upon introduction.**

 

The commercialsuccess of any of our products for which we obtain marketing approval from theEuropean Commission, the FDA, and other regulatory authorities will depend upontheir acceptance by patients, the medical community and third party payors asclinically effective, safe and cost-effective. It may be difficult for us toachieve market acceptance of our products.

 

Other factors thatwe believe will materially affect market acceptance of our products include:

 

•  the timing of the receipt of marketing approvals;

•  the countries in which such approvals areobtained; and

•  the safety, efficacy, convenience, andcost-effectiveness of the product as compared to competitive products.

 

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**We havelimited experience and resources in manufacturing and are incurring significantcosts to develop this experience and to build our manufacturinginfrastructure.  In addition, we arecontinuing to rely on third parties to manufacture our products on our behalf.**

 

We have limitedmanufacturing experience and in order to continue to develop products, applyfor regulatory approvals, and commercialize our products, we will need todevelop, contract for, or otherwise arrange for the necessary manufacturingcapabilities. We currently use, and expect to continue to use in the future,both internal manufacturing and contract manufacturing by third parties to meetour production requirements for preclinical testing, clinical trials, andcommercial supply.

 

                We have investedsubstantial funds to build our manufacturing facility in Cambridge,Massachusetts at which we manufacture Replagal bulk drug substance and plan tomanufacture I2S.  We have also devotedsubstantial resources to recruiting qualified personnel and developing the expertiseneeded to operate this manufacturing facility. However, we expect that we will need to invest substantial additionalfunds to continue to build out the facility and recruit additional personneland develop additional expertise in order to operate the Cambridge facility inthe manner needed to meet our supply requirements.  There can be no assurance that we will be able to successfullyoperate this facility, that we will be able to successfully build out thisfacility, that the facility will comply with applicable regulations or that thefacility will enable us to manufacture our products at a commerciallyreasonable cost.

 

                In January 2003,we terminated our agreement with the third party manufacturer of the bulk drugsubstance of Replagal, effective in July 2003. As a result, if we are unable to produce Replagal bulk substance at ourCambridge, Massachusetts facility, we would be unable to supply Replagal bulkdrug substance and sales of Replagal, and our business and our business andfinancial condition, would be materially harmed.  We plan to manufacture I2S for clinical trials in our Cambridge,Massachusetts facility.  If we areunable to successfully manufacture I2S in this facility, we may not be able tocomplete our planned clinical trials of I2S.

 

                We are parties toseveral arrangements with third party contract manufacturers with respect tovarious aspects of the manufacture of Replagal and I2S.  As a result, we are dependent upon thesethird parties to perform their obligations in a timely manner and in accordancewith applicable government regulations. In the event that any one of these manufacturers fails to or is unableto comply with its obligations under its manufacturing agreement with us and ifthe manufacturer's failure materially delays the ultimate production ofReplagal or I2S, our sales of Replagal or the timing of our I2S clinical trialscould be adversely affected, and our business and financial condition could bematerially harmed.

 

                In addition, undermost of these third party contract manufacturing arrangements, the liability ofthe third party contract manufacturer is limited by contract.  In the event that any one of ourmanufacturers fails to comply with its obligations under the manufacturingagreement and such failure results in liability to us or non-salable product,we may be limited in our ability to recover from the contract manufacturer.

 

Under ourcollaborative agreement with Aventis, Aventis is responsible for themanufacture of Dynepo for clinical trials and commercial sales and is alsoresponsible for conducting future clinical trials and commercial sales. We arenot a party to any other arrangements relating to the manufacture of Dynepo andas a result, we are dependent on Aventis and its third party manufacturer forthe manufacture of Dynepo.

 

There are alimited number of third-party manufacturers capable of manufacturing our 

 

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protein products with a limited amount of productioncapacity. As a result, we may experience difficulty in obtaining adequatemanufacturing capacity for our needs. If we are unable to obtain or maintaincontract manufacturing of these products, or to do so on commerciallyreasonable terms, we may not be able to complete development of these productsor market them.

 

Any manufacturing of our products must comply with GMPas required by the countries in which we intend to sell our products. Beforeapproving an application for marketing authorization for a product, the FDA,the European Commission, or other equivalent foreign regulatory agency willinspect the facilities at which the product is manufactured. If we or our thirdparty manufacturers do not comply with applicable GMP, such regulatory agencymay refuse to approve our application for marketing authorization. Once theregulatory agency approves a product, we or our third party manufacturers mustcontinue to comply with GMP. If we or our third party manufacturers fail tomaintain compliance with GMP, adverse consequences can result, includingsuspension or withdrawal of an approved product from the market, operatingrestrictions, and the imposition of civil and criminal penalties.

 

**If wefail to manage our inventory correctly, we could experience supply shortages ora significant build-up of high-cost product.**

 

The manufacture of proteins, including our productsand potential products, is expensive. We build inventory in order to ensure the adequate supply of ourproducts and potential products, including Replagal and I2S.  Accordingly, we have significant capitalinvested in inventory because of the high cost of manufacturing proteinproducts, including Replagal and I2S. However, we have limited experience in managing our supply for Replagaland our other potential products.  If wefail to keep an adequate inventory of our products, it is possible thatpatients could miss treatments, which could have an adverse effect on ourability to sell our products. Conversely, if we are unable to sell our high-cost inventory in a timelymanner, or if our high-cost inventory were to be destroyed or expire, we couldexperience cash flow difficulties as well as losses.

 

**If we fail to obtain reimbursement,or an adequate level of reimbursement, by third party payors in a timely mannerfor our products, we may not have commercially viable markets for our products.**

 

In certaincountries, particularly the countries of the European Union, the pricing ofprescription pharmaceuticals and the level of reimbursement are subject togovernmental control. In some countries, it can take an extended period of timeto establish and obtain reimbursement, and reimbursement approval may berequired at the individual patient level, which can lead to further delays. Inaddition, we have experienced in some countries such as Italy, Spain andBelgium, where reimbursement has been established, that even with establishedreimbursement, it can take an extended period of time to collect payment.  In the United States, the availability ofreimbursement by governmental and other third party payors affects the marketfor any pharmaceutical product. These third party payors continually attempt tocontain or reduce the costs of health care by challenging the prices chargedfor medical products and services. If we are not able to obtain pricing andreimbursement for our products that receive marketing approval at satisfactorylevels, our revenues and results of operations will be adversely affected,possibly materially.

 

We expect that theprices for many of our products, when commercialized, including in 

 

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particular, our products for the treatment of raregenetic diseases, may be high compared to other pharmaceutical products. Forexample, have established pricing and reimbursement for substantially allpatients receiving Replagal in Europe. Pricing was initially established as thelocal currency equivalent of an average of approximately $165,000 per patientper year. The price remains fixed in the local currencies and varies in U.S.dollars with exchange rate fluctuations. We may encounter particular difficultyin obtaining satisfactory pricing and reimbursement for products for which weseek a high price.

 

The Centers forMedicare and Medicaid Services of the United States Department of Health andHuman Services has considered proposals from time to time to reduce thereimbursement rate with respect to erythropoietin. If Dynepo is approved andcommercialized, adoption by the Centers for Medicare and Medicaid Services ofany such proposal might have an adverse effect on the pricing of Dynepo.

 

We also mayexperience pricing pressure with respect to Replagal and other products forwhich we may obtain marketing approval due to the trend toward managed healthcare, the increasing influence of health maintenance organizations andlegislative proposals. We may not be able to sell our products profitably ifreimbursement is unavailable or limited in scope or amount.

 

**We havelimited sales and marketing experience and capabilities and will need todevelop this expertise or depend on third parties to successfully sell andmarket our products on our behalf.**

 

We have limitedsales and marketing experience and capabilities. In order to market ourproducts, including Replagal, we will need to develop this experience and thesecapabilities or rely upon third parties, such as our collaborators, to performthese functions. If we rely on third parties to sell, market, or distribute ourproducts, our success will be dependent upon the efforts of these third partiesin performing these functions. In many instances, we may have little or nocontrol over the activities of these third parties in selling, marketing, anddistributing our products. If we choose to conduct these activities directly,as we plan to do with respect to some of our potential products, we may not beable to recruit and maintain an effective sales force.

 

Currently, TKTEurope, our 80% owned subsidiary, markets Replagal in Europe. As a result, ourability to successfully market and sell Replagal in Europe is dependent on themarketing personnel of TKT Europe. We have an 80% equity interest in TKTEurope; the European stockholders own the remaining 20% equity interest in TKTEurope. Although our consent is required for various significant mattersrelating to the operation of TKT Europe, most day-to-day operations of TKTEurope are directed by the European stockholders. If we should determine to buyout TKT Europe or if the European stockholders exercise their contractual rightto require us to buy them out, our ability to successfully market and sellReplagal in Europe would be dependent on our ability to attract and retainexperienced marketing and sales personnel.

** **

**Wedepend on our collaborators to develop, conduct clinical trials, obtain regulatoryapprovals for, and manufacture, market and sell certain products on our behalfand their efforts may not be scientifically or commercially successful.**

 

We are parties tocollaborative agreements with third parties relating to certain of our 

 

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principal products. We are relying on Aventis todevelop, conduct clinical trials, obtain regulatory approvals for, andmanufacture, market, and sell Dynepo in the United States and Europe; andSumitomo to develop and commercialize Replagal for Fabry disease in Japan,Korea, and China. Our collaborators may not devote the resources necessary ormay otherwise be unable or unwilling to complete development andcommercialization of these potential products. Our existing collaborations aresubject to termination without cause on short notice under specifiedcircumstances.

 

Our existingcollaborations and any future collaborative arrangements with third parties maynot be scientifically or commercially successful. Factors that may affect thesuccess of our collaborations include the following:

 

•  our collaborators may be pursuingalternative technologies or developing alternative products, either on theirown or in collaboration with others, that may be competitive with the productas to which they are collaborating with us or which could affect ourcollaborative partners’ commitment to the collaboration with us;

 

•  reductions in marketing or sales efforts ora discontinuation of marketing or sales of our products by our collaboratorswould reduce our revenues, which will be based on a percentage of net sales bythe collaborator;

 

•  our collaborators may terminate theircollaborations with us, as Aventis has done with respect to GA-GCSF, whichcould make it difficult for us to attract new collaborators or adversely affectthe perception of us in the business and financial communities; and

 

•  our collaborators may pursue higher priorityprograms or change the focus of their development programs, which could affectthe collaborator’s commitment to us.

 

**We maybe exposed to product liability claims and may not be able to obtain adequateproduct liability insurance.**

 

Our businessexposes us to the risk of product liability claims that is inherent in themanufacturing, testing, and marketing of human therapeutic products. Wemaintain clinical trial liability insurance and product liability insurance inamounts that we believe to be reasonable. This insurance is subject todeductibles and coverage limitations. We may not be able to obtain additionalinsurance or maintain insurance on acceptable terms or at all. Moreover, anyinsurance that we do obtain may not provide adequate protection againstpotential liabilities. If we are unable to obtain insurance at acceptable costor otherwise protect against potential product liability claims, we will beexposed to significant liabilities, which may materially and adversely affectour business and financial position. These liabilities could prevent orinterfere with our product commercialization efforts.

 

*FinancingRisks*

 

**We havenot been profitable and expect to continue to incur substantial losses.**

 

We haveexperienced significant operating losses since our inception in 1988. As ofJune 30, 2003, our accumulated deficit was $412.4 million. We had net losses of$129.8 million, 

 

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$70.2 million and $51.0 million in 2002,2001 and 2000, respectively.

 

We expect that wewill continue to incur substantial losses and that, until we have substantialproduct sales, our cumulative losses will continue to increase. We recorded$34.7 million in product sales in 2002 and $26.6 million in product salesin the first half of 2003. We expect that the losses that we incur willfluctuate from quarter to quarter and that these fluctuations may besubstantial.

 

**We mayneed additional financing, which may be difficult to obtain. If we do notobtain additional financing our financial condition will be adversely affected.**

 

We expect that ourexisting capital resources, together with anticipated proceeds from productsales, anticipated cash payments under collaborative agreements, and interestincome, will be sufficient to fund our operations into 2005. Our cashrequirements for operating activities, financing activities and investmentactivities have exceeded our internally generated funds. We expect that ourcash requirements for such activities will continue to exceed our internallygenerated funds until we are able to generate substantial product sales. Ourfuture capital requirements will depend on many factors, including thefollowing:

 

•  the timing, and amount of Replagal productsales, as well as the collection of receivables;

 

•  continued progress in our research anddevelopment programs, particularly I2S, as well as the magnitude of theseprograms;

 

•  the scope and results of our clinicaltrials;

 

•  the timing of, and the costs involved in,obtaining regulatory approvals;

 

•  the cost of manufacturing activities;

 

•  the cost of commercialization activities,including product marketing, sales and distribution;

 

•  the costs involved in preparing, filing,prosecuting, maintaining, and enforcing patent claims and other patent-relatedcosts, including litigation costs and the results of such litigation;

 

•  our ability to establish and maintaincollaborative arrangements; and

 

•  the cost of buying out the minority interestin TKT Europe, if applicable.

 

If we determine toseek additional funding, we may do so through collaborative arrangements and publicor private financings. Additional financing may not be available to us onacceptable terms, if at all. If we do not obtain additional financing, ourfinancial condition will be adversely affected.

 

If we raiseadditional funds by issuing equity securities, further dilution to our thenexisting stockholders will result. In addition, the terms of the financing mayadversely affect the 

 

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holdings or the rights of such stockholders. If we areunable to obtain funding on a timely basis, we may be required to significantlycurtail one or more of our research or development programs. We also could berequired to seek funds through arrangements with collaborators or others thatmay require us to relinquish rights to certain of our technologies, productcandidates, or products which we would otherwise pursue on our own.

 

## **ITEM3           QUANTITATIVE AND** QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Companymaintains its investment portfolio consistent with its Investment Policy, whichhas been approved by the Board of Directors. The Company’s investment portfolioconsists of investments only in U.S. government and agency obligations. TheCompany’s investments are also subject to interest rate risk and will decrease invalue if market interest rates increase. However, due to the relatively shortduration of the Company’s investments, interest rate risk is mitigated. TheCompany does not own derivative financial instruments in its investmentportfolio.

 

Accordingly, the Companydoes not believe that there is any material market risk exposure with respectto derivative or other financial instruments which would require disclosureunder this item.

 

As of June 30,2003, the Company did not have any off-balance sheet arrangements.

 

The Company hasexposure to currency risk for Replagal sales in Europe. Pricing was initiallyestablished as the local currency equivalent of an average annual per patientprice of approximately $165,000. The price remains fixed in the local currenciesand varies in U.S. dollars with exchange rate fluctuations.  Foreign currency fluctuations within thequarter and six months period favorably contributed $430,000 and $610,000,respectively, to sales for the three and six months ended June 30, 2003.

 

## **ITEM 4           CONTROLSAND PROCEDURES.**

 

The Company’s management, with the participation ofthe Company’s President and Chief Executive Officer and the Company’s ChiefFinancial Officer, evaluated the effectiveness of the Company’s disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under theExchange Act) as of June 30, 2003. Based on this evaluation, the Company’s President and Chief ExecutiveOfficer and the Company’s Chief Financial Officer concluded that, as of June30, 2003, the Company’s disclosure controls and procedures were (1) designed toensure that material information relating to the Company, including theCompany’s consolidated subsidiaries, is made known to the Company’s Presidentand Chief Executive Officer and the Company’s Chief Financial Officer by otherswithin these entities, particularly during the period in which this report wasbeing prepared and (2) effective, in that they provide reasonable assurancethat information required to be disclosed by the Company in the reports that itfiles or submits under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and forms.

 

**In 2002, sales of theCompany’s Replagal product became material to the Company’s**

** **

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** **

**consolidated financial statements. Sales totaled approximately $35 million for 2002 and approximately $26.6million for the first half of 2003.  Thesales are transacted through and recorded by the Company’s 80% ownedsubsidiary, TKT Europe.  During 2002,with respect to TKT Europe, the Company did not have a timely flow of criticalaccounting and related financial information and experienced difficulties anddelays in verifying that product sales were being properly recognized asrevenue in accordance with United States generally accepted accountingprinciples.  The Company’s independentauditors, in connection with their audit of the Company’s consolidated financialstatements for the year ended December 31, 2002, informed management and theCompany’s audit committee that, in their judgment, a material weakness in theCompany’s internal control system existed as a result of these issues.  Members of the Company’s United Statesaccounting and finance group have been discussing implementing procedures toaddress these issues with the accounting personnel of TKT Europe.**

 

**Notwithstanding theseissues, in light of the processes involved in the preparation by the Company ofits consolidated financial statements for the year ended December 31, 2002,management of the Company believes that those financial statements fairlypresented the Company’s consolidated financial position as of, and theconsolidated results of its operations for, the year ended on that date.  Moreover, as part of these processes,management concluded that no adjustments were needed to such financialstatements or with respect to amounts reported for interim periods in the yearended December 31, 2002.  The Company’sindependent auditors rendered an unqualified opinion with respect to theCompany’s consolidated financial statements for the year ended December 31,2002.**

 

**In connection with the preparation by the Company of its consolidatedfinancial statements for the three months and six months ended June 30, 2003,the Company did not experience any difficulties or delays in obtaining criticalaccounting and related financial information or conducting its internal reviewprocesses with respect to TKT Europe. Management of the Company believes that the consolidated financialstatements for the three months and six months ended June 30, 2003 fairlypresent the Company’s consolidated financial position as of, and theconsolidated results of its operations for, the three months and six monthsended June 30, 2003.**

 

No change to the Company’s internal control overfinancial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under theExchange Act) occurred during the fiscal quarter ended June 30, 2003 that hasmaterially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

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PART II           OTHER INFORMATION

**ITEM 1.****                                                LEGALPROCEEDINGS**

 

The description of thelegal proceedings set forth under note 8 of the Company’s consolidatedfinancial statements in this Quarterly Report on Form 10-Q are incorporatedherein by reference.

 

## **ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

The following matter was submitted to a vote of stockholdersat the Company’s Annual Meeting of Stockholders held on June 10, 2003:

 

Proposal 1.  The election ofMichael J. Astrue, Walter Gilbert, Jonathan S. Leff, William R. Miller, RodmanW. Moorhead, III, James E. Thomas and Wayne P. Yetter to serve as directorsuntil the 2004 Annual Meeting of Stockholders.

 
| **Nominee**             |   | **Votes For** |   | **Votes Withheld** |   |
|-------------------------|--------|---------------|--------|--------------------|--------|
| Michael J. Astrue       |   | 25,190,190    |   | 221,832            |   |
| Walter Gilbert          |   | 21,697,790    |   | 3,714,232          |   |
| Jonathan S. Leff        |   | 25,189,423    |   | 222,599            |   |
| William R. Miller       |   | 24,409,710    |   | 1,002,312          |   |
| Rodman W. Moorhead, III |   | 24,489,433    |   | 922,589            |   |
| James E. Thomas         |   | 25,112,129    |   | 299,893            |   |
| Wayne P. Yetter         |   | 25,112,279    |   | 299,743            |   |

 

**ITEM 6.**                                                **EXHIBITS AND REPORTS ON FORM8-K**

 

(a)                                  TheExhibits listed in the Exhibit index immediately preceding such Exhibits arefiled as part of this Quarterly Report on Form 10-Q, and such Exhibit Index isincorporated herein by reference.

 

(b)                                 Reportson Form 8-K

 

Current Report on Form 8-K, furnished on May 5, 2003, under Item 9,containing a copy of a press release announcing its financial results for thequarter ended March 31, 2003 (including financial statements) pursuant to Item12 (Results of Operations and Financial Condition).

 

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SIGNATURES

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                         |   |   | TRANSKARYOTIC THERAPIES, INC. |
|------------------------------|--------|--------|-------------------------------|
|                         |   |   |                          |
| Date:  August  12, 2003 |   |   | By:                           | /s/ Michael J.  Astrue |   |
|                         |   |   |                          | Michael J. Astrue |   |
|                         |   |   |                          | President and Chief Executive  Officer |

 

 
| Date:  August  12, 2003 |   |   | By:    | s/ Gregory D.  Perry                                                                                |   |
|------------------------------|--------|--------|--------|-----------------------------------------------------------------------------------------------------|--------|
|                         |   |   |   | Gregory D. Perry                                                                                    |   |
|                         |   |   |   | Vice President, Finance, and Chief  Financial Officer (Principal  Financial and Accounting Officer) |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** |   | **Description**                                                                                                                                                                          |
|-----------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.40*          |   | Severance Agreement dated April 28, 2003 between  Douglas Treco and the Registrant.                                                                                                      |
|            |   |                                                                                                                                                                                     |
| 31.1*           |   | Certification by the Registrant’s President and  Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|            |   |                                                                                                                                                                                     |
| 31.2*           |   | Certification by the Registrant’s Chief Financial  Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section  302 of the Sarbanes-Oxley Act of 2002.               |
|            |   |                                                                                                                                                                                     |
| 32.1*           |   | Certification by the Registrant’s President and  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 by the Registrant’s Chief Financial  Officer 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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*       Filed herewith.

 

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