October 14, 2002 Volume 80, Number 41 CENEAR 80 41 pp. 25-36 ISSN 0009-2347

GENOMICS MOVES ON Companies that focused on gene sequencing and function amassed financial and intellectual wealth but now strive to be sustainable businesses

ANN THAYER, C&EN HOUSTON

Genomics may be a cinderella story. companies based on workhorse gene sequencing and identification tools blossomed overnight to become the belles of the stock market, only to quickly disappear into near investment obscurity. Today, as the search to discover and develop genomics-based therapeutics grows, each of these companies is gussying up and putting its best foot forward in hopes of being rediscovered as a winning drug company.

In "Biotech 2002," his most recent industry report, investment banker G. Steven Burrill notes that while the technology platform business model first appeared to make sense with its focus on delivering products to speed drug discovery, it soon became clear that most new technologies address only a portion of the drug discovery continuum.

"As essential as genomics and its ancillary technologies are to the life sciences, few of these firms were able to convince investors of their ability to generate and sustain profits using their existing business models," Burrill writes. So instead of offering tools and services, genomics firms believe they can create long-term business value by transitioning into drug R&D, a business model proven by existing biopharmaceutical producers.

Most genomics firms have begun the difficult transformation through a variety of changes. These can include new managers with drug-industry experience; in-licensing of product candidates; acquisitions to gain technology and infrastructure, including drug R&D, clinical capabilities, and manufacturing; partnerships and alliances; and a decreased emphasis on sequencing services and database sales.

Genomics companies have recognized "they can't thrive solely by licensing their particular technology and expertise for drug development by others," says consulting firm Ernst & Young in its 2002 biotech industry report. "To maximize the value of their technologies, many of them are venturing into the more risky and more expensive business of developing, and in some cases marketing, their own drugs." Companies fitting this bill include such notable names in gene sequencing and gene function as Celera Genomics, Sciences, Incyte Genomics, Hyseq, Lexicon Genetics, and Millennium Pharmaceuticals. Others--such as Deltagen, Curagen, Exelixis, Sequenom, deCode Genetics, and Myriad Genetics--are using genomics-related technologies to identify drug targets and then move into drug discovery alone and with partners.

Not only do these companies have similar trajectories, but they also share comparable histories. Most were created in the early to mid-1990s when efforts to sequence the human genome were taking off. As the first draft of the genome was nearing completion in January 2000, they saw their stock prices increase manyfold. Buoyed by this bubble, the biotech industry overall raised a record $32 billion through stock offerings that year.

However, the surge in share prices only lasted for a few months, and multi- billion-dollar market capitalizations for small, unprofitable genomics companies vanished as quickly as they appeared. By early 2001, when the genome was published, share prices were down 70%, and they fell another 50% the following year.

Today, stock prices for many genomics firms are near or even below 1999 levels as the companies have yet to convince investors that they'll succeed in developing products. In contrast, stocks of successful biopharmaceutical producers or those simply with promising drugs in their pipelines have been trading at higher prices, despite a market downturn.

Like small biotech start-ups, genomics companies have no track record and no experience in bringing drugs through clinical trials. Yet unlike start-ups, many have substantial intellectual property portfolios created from gene sequencing and expertise in understanding gene function. They also can afford the technology, development, production, and human resources they'll need.

This is because most took advantage of their briefly soaring stock prices to cash in and now have several hundred million, if not a billion or more, dollars in the bank. These cash reserves give them unusual independence, flexibility, and the luxury of being able to support internal efforts for some time. They can often choose between developing products with major pharmaceutical companies or going it alone and creating their own integrated operations.

In fact, according to Ernst & Young, the biggest driver of biotech consolidation has been the aggressive merger and acquisition behavior of these companies. One of the best examples is nine-year-old Millennium Pharmaceuticals.

GENE MACHINES Millennium Pharmaceuticals has built integrated drug discovery and development operations in Cambridge, Mass., to leverage its understanding of gene function. MILLENNIUM PHARMACEUTICALS PHOTO

ON THE STRENGTH of its early ability to produce gene targets, Millennium set up some of the biotech industry's most lucrative alliances with big pharma partners. More than 20 deals between 1995 and 2001 gave it more than $2 billion in funding, while it raised another $830 million in stock sales.

Millennium notes that over time it's been able to shift the deals from straight licensing to more collaborative ventures. Recent relationships with Aventis and --in which the companies share costs, risks, and potential profits--let Millennium maintain significant ownership and decision-making rights from discovery through commercialization.

Although most small biotech companies aren't in the position to share either costs or risks, Millennium has been doing both while at the same time building its business by acquiring key capabilities. By April of this year, with its $2 billion purchase of Cor Therapeutics, the company had become a fully integrated biopharmaceutical producer with two acquired products on the market and another 10 in clinical trials.

The company expects to reach $300 million in revenues this year, although it is still a few years away from being profitable. Spending on R&D and clinical development has increased substantially. And it has been facing the same challenges and potential setbacks of any drug developer, with two of its drug candidates recently disappointing in clinical trials.

Millennium's stock trades at only about $9 per share--it still has to prove it can develop and market its own products. It has moved only one genomically derived drug candidate from its own labs into clinical trials, with help from its partner Abbott. The drug, in Phase I trials, is an enzyme- inhibiting compound involved in regulating metabolism and targeting obesity.

Genomics drugs should represent a new class of therapeutics directed toward genetic causes of disease, and, as such, expectations surrounding them have been extremely high. For example, a widely publicized belief is that genomics can lead to personalized drugs based on an individual's genetics. Company executives have mixed views on this potential, with one calling the idea "deeply flawed," another suggesting it's overpromoted, and a third seeing real possibility.

They do agree, however, that genomics should help design appropriate treatments, using existing or new drugs, for specific patient populations or disease states. A frequently cited example is 's drug Herceptin. While it is not considered a genomics drug per se, since it didn't arise directly from gene sequencing, the monoclonal antibody targets only specific breast cancers in which the HER2 gene is overexpressed.

"I always did my best to cast cold water on those unrealistic expectations. But I don't think that in a raging fire one bucket does much good."

GENOMICS DRUGS are expected to show increased efficacy and lower toxicity because they will be directed at better understood disease targets. But it's uncertain whether they will have any greater success rate in the clinic, company executives say. It's too soon for answers anyway, since most genomics companies are less than a decade old and not enough time has passed for products to have gone through clinical development and regulatory approval.

Nevertheless, Human Genome Sciences (HGS) believes it is likely to be among the first to succeed, having directly put into clinical trials six genomics-based drugs and two via partner GlaxoSmithKline. Its most advanced candidates are in Phase II trials.

"There has been a mismatch between expectation and reality," says William A. Haseltine, HGS chairman and chief executive officer. "I'm actually very pleased with the reality of genomics, but the expectations have been unreasonably high--the notion that sequencing the entire human genome and understanding the correlation between phenotype and genotype would lead to a rapid revolution in drug development. "I always did my best to cast cold water on those unrealistic expectations," he continues. "But I don't think that in a raging fire one bucket does much good."

The problem, Haseltine explains, is that generally no direct or immediate link can be made between understanding the genetic cause of a disease and a route to treatment or prevention. He points to several inherited genetic diseases--Huntington's, Alzheimer's, and Parkinson's--where a genetic link has been found, but "we don't have much idea what to do about it."

On the plus side, understanding genes and finding validated disease targets have helped accelerate early drug discovery work, Haseltine says. However, while genomics has facilitated finding drug candidates, he notes, "it hasn't shortened in any substantial way drug development times and the length of clinical trials."

HGS was founded in 1991 and began its move toward drug R&D much sooner than most of its genomics rivals. It was the first to isolate a virtually complete set of functional human genes in a form in which the genes can be used to make drugs and proteins, Haseltine says, and it has established a strong intellectual property position. Glaxo or its predecessor firms have been partners with HGS since 1993 and have invested $125 million.

The company has an integrated set of technologies that aid discovery through manufacturing and clinical trials, he notes, including monoclonal antibody technology through an alliance with Cambridge Antibody Technology. HGS opened its first manufacturing operation in 1999 and acquired protein-engineering capabilities in 2000. In 2001, it announced plans to complete a commercial-scale plant by 2005. The company employs more than 1,000 people.

Although HGS has collaborative R&D revenues of only a few million dollars per year and no product sales, it has a market capitalization of more than $1.5 billion and about $1.6 billion in cash and short-term investments. At its current spending rate, the company has enough money to operate for more than a decade. If a product moves forward with Glaxo, HGS could get a 20% share of North American and European sales and 10% royalties on certain sales.

HGS took an important step in June 2001 when it didn't renew a consortium agreement with five drug producers; the agreement had given them exclusive access to HGS targets for at least five years and brought in about $20 million in annual revenues. Although it maintains alliances with Glaxo and others on selected targets, HGS became free to use its technology for internal or new partnership programs and has since signed a handful of licensing agreements.

"When bubbles burst, it can be painful, but, in fact, there usually is some substance there. And there is substance to the genome."

INTERNALLY, HGS has focused exclusively on the creation of human proteins and monoclonal antibodies as drugs. "For us, it takes two to two- and-a-half years to move from wanting to treat a disease to clinical trials," Haseltine says. "I attribute that almost exclusively to our genomics foundation and that we selected to work on only proteins and antibodies.

"That time frame is very important when you are building a company," Haseltine says. "If we were to attempt to develop chemical drugs, I think you could add an average of six years to the process. Plus, it takes far more resources than developing proteins as drugs."

David S. Block, Celera Genomics executive vice president, agrees that whether it's small molecules, proteins, or antibodies, there are still "many hundreds of steps between the gene sequence and the drug." Block is also chief operating officer of the company's therapeutics division, which is less than one year old. A former executive vice president for international operations at DuPont Pharmaceuticals, he joined Celera in January as part of a new management team.

"Celera was not originally intending to be in the therapeutics business," Block explains. "It was going to be a services and information business." Yet the four-year-old company has "gone from being a supplier of information to being both a supplier and user of that information. And we're moving as hard and fast as we can down the path of being a therapeutics company."

Celera has sold plant and animal genomics businesses and exited contract gene-sequencing work. In April, it signed an exclusive marketing agreement with its sister company, Inc (ABI). Both companies, and their Celera Diagnostics joint venture, are owned by Applera.

ABI will market Celera's genomic database along with its own reagents, assays, data mining tools, and services. The combination is expected to create long-term financial value for the products, Block says.

"As a stand-alone product, it was in competition with free databases," Block explains of Celera's database. "And, if you are selling a high-quality product and are in competition with something the government is giving away for free, that makes for a difficult business model."

Celera and the government's called it a tie after racing to complete the sequence. Whereas Celera's plan was to sell online access to its sequence data, the government data became publicly available faster and was of a higher quality than had been expected, Block says.

In the deal with ABI, Celera will get revenues from its existing database customers and royalties on ABI's sales. Online subscriptions brought in $73 million, or about 60% of Celera's revenues in the fiscal year that ended June 30. Total revenues for fiscal 2003 are to reach about $90 million. Despite these figures, the company has reported sizable losses.

Celera expects lower operating expenses to decrease its cash burn rate to about $80 million in fiscal 2003. It has eliminated about 16% of its workforce, or 132 jobs, with the recent changes. R&D spending--of which 65% will go to drug discovery and development--is to be about $135 million.

Celera's strengths have been in genomics, proteomics, informatics, and computing. To build its therapeutics effort, the company bought small- molecule drug developer Axys Pharmaceuticals last November for $170 million in stock. The acquisition brought medicinal chemistry, structural biology, screening capabilities, proprietary products, and partnerships with major drug firms, including Merck, Aventis, and Bayer.

Unlike Celera, which has about $890 million in the bank, Axys had been cash-strapped for several years and had trimmed its operations. Celera quickly began rebuilding the business and now has about 330 employees in its therapeutics unit. The company's cash position should allow for additional acquisitions and self-support for several years.

Axys did not have the resources to take forward its own compounds and looked to license them, Block says. "So it's been a substantial shift in thinking to realize those compounds could in fact be retained and developed here." Celera is deciding exactly which compounds it will keep and which it may advance to a point where they have greater licensing value, usually through about Phase II clinical trials.

In 2003, Celera plans to generate and identify differentially expressed proteins in lung cancer, and to validate a number of these as therapeutic targets to move into small-molecule screening and/or antibody development. It also intends to initiate a second disease-specific proteomics program.

Although it, too, is building a therapeutics business, Incyte Genomics emphasizes that it has not stepped away from its database business. "We are building upon it and leveraging it for drug discovery," says CEO Paul A. Friedman, the former president of DuPont Pharmaceuticals Research Laboratories who joined Incyte in November 2001.

"Incyte has a far richer genomic and proteomic database than what's available in the public domain," Friedman boasts, "and an extremely large intellectual-property portfolio built up over the last five or six years." The company was formed as Incyte Pharmaceuticals in 1991.

"The potential value from using our genomics information and intellectual property to discover drugs is far more than could be created by remaining a pure database play," Friedman says. "If it remained a tool company, I don't think the stock price would ever again begin to approach the numbers seen previously."

The rapid upward movement in genomic company stock prices was unsustainable, Friedman says. "To keep the stock price up and keep yourself growing, you need products and revenues. And a couple of products on the therapeutics side for a company of Incyte's size would catapult it to a markedly different market capitalization," he adds.

Information products--including database subscriptions and licensing to more than 50 companies and academic institutions--accounted for 79% of Incyte's 2001 revenues of $219 million. The company has discontinued or sold what Friedman calls "low-margin, noncentral" businesses in custom sequencing, microarray production, and protein-expression databases.

Without these revenue sources, and by using its gene data differently in collaborations and on its own, Incyte expects 2002 revenues to be about $100 million to $130 million. This estimate from September is 15% lower than an earlier one following a slowdown in spending by potential information database subscribers and licensers.

Like other genomics firms, Incyte has cash--about $475 million. "The money gives us a lot of flexibility and, if we spend it prudently, it gives us a reasonable time period to create value," Friedman says. "That's something most small therapeutic discovery companies would envy."

Regarding expectations, he believes observers were somewhat naive about the time frames required for developing genomics-based drugs. "There certainly will be more targets based on all the gene sequences, but once you get into drug screening and optimization, those activities aren't dependent on the sequences and still will take time."

Although the expense involved in generating and maintaining its gene data is significant, Friedman says, Incyte intends to keep its cash flow positive and use that cash to defray some drug discovery costs. It is also discussing in- licensing compounds or a possible acquisition to help jump-start its drug development pipeline.

Creative deal-making is important at Hyseq Pharmaceuticals. Although the 10-year-old company once had a market value of $1.6 billion, it did not cash in on the stock bubble and has limited cash today. It recently raised about $36 million through two private placements and got a $20 million line of credit. The company is pursuing other financing strategies as well.

In the past three years, Hyseq has brought in George B. Rathmann, a founder of biotech industry leader , to serve as chairman, and hired Ted W. Love as president and CEO. Hyseq's goal of creating biopharmaceuticals is "eminently doable," Love says, based on his experience as senior vice president of development at Advanced Medicine (now Theravance) and in senior management positions in medical affairs and product development at Genentech.

Block Friedman Haseltine CELERA INCYTE HGS PHOTO GENOMICS GENOMICS PHOTO PHOTO

TO PLAY TO the new management's strengths, Love wanted Hyseq to move a drug into clinical development quickly. Since none of the company's internal candidates was ready, he sought a licensing deal but was limited financially. Still, he managed to strike a 50-50 partnership deal with Amgen in January for a novel thrombolytic agent, alfimeprase, now in Phase I trials.

Whereas the advantages of partnership was clear for Hyseq, Love says that "the challenge became justifying their giving us half the drug and us not spending a dime." Amgen received warrants in Hyseq while Hyseq is paying future development costs to catch up with Amgen's investment to date.

Hyseq restructured in May to reduce costs and shift focus. The company and BASF Plant Science agreed to accelerate the completion of a collaboration, set up in 1999, to discover and develop agriculturally based genes. Hyseq is cutting about 38% of its workforce, or 79 jobs, mostly related to the BASF collaboration, by the end of this year.

Love also has been working to get a return on noncore assets. Last October, Hyseq moved its DNA chip and sequencing operations into a subsidiary called Callida Genomics. "There really was no synergy between the biopharmaceutical business and Callida's business," Love explains. And if the subsidiary succeeds with products on its own, Hyseq will have the opportunity in the future to sell its interest and raise money to support drug development.

Just recently, it sold Celera Diagnostics a license to a DNA sample and a clinical database related to cardiovascular disease. Built in collaboration with the University of California, San Francisco, the database was another noncore asset "basically sitting in our freezers," Love says. Since the deal is nonexclusive, Hyseq can replicate it with other licensees.

Hyseq anticipates having a dominant intellectual-property position based on a large number of filed patent applications on gene sequences. The company is working with Deltagen and Kirin Brewery's pharmaceutical division to conduct studies of gene function using transgenic mice. Deltagen produces "knock-out" mice, in which the function of the gene of interest is deleted, while Kirin produces "knock-in" mice with increased gene activity.

"We're going right into animal-based, not cell-based, studies to understand what secreted proteins are encoded by certain genes," Love says. Although the expected number of hits is low, the information on those that work is extraordinarily strong, he explains. The company intends to explore dozens of targets and identify at least two clinical candidates this year and have many more for internal development or partnering in the future.

Deltagen has had its own drug development program that was part of an initial plan to move from a technology-based to a drug discovery-based model. "We believed the way to actually translate the genome was by understanding the functions of the genes in vivo and thus understand therapeutic value," says William Matthews, Deltagen chairman and CEO. He and cofounder and chief scientific officer Mark W. Moore worked at Genentech before creating Deltagen in 1997.

Internally, Deltagen has focused on secreted proteins as drugs and has an alliance with Eli Lilly. The company also has the capability, gained largely through acquisitions, to generate small-molecule candidates for sale or licensing, and it offers tools and services for drug discovery. Glaxo, , Merck, Schering-Plough, and subscribe to its Deltabase gene function database, while smaller companies can access single targets through its pilot-phase DeltaOne program.

Just two weeks ago, Deltagen announced a cost savings and realignment plan. "I don't think anybody is willing to predict when the capital markets may again reappear. So cash management is very important to us," Matthews says. "We believe that our secreted protein work will provide long-term upside potential, and we seek to balance that with our small-molecule work, intending that to be a revenue generator for us."

Staff will be reduced by nearly 30%, or 130 employees, in the hope of lowering its cash burn rate by one-third from a current level of $85 million to $90 million. The company had just $49 million in cash as of Sept. 30, down from about $77 million at the end of June, owing to operating costs and outlays for new laboratories. It anticipates having $17 million in revenues and receiving $25 million in cash from customers this year.

Competitor Lexicon Genetics, a leading developer of gene knock-out technology, is on a more stable base with $135 million in the bank and $17 million in revenues for the first half of 2002. The company has drug discovery and functional-genomics collaborations with 12 major biotech and drug firms; custom-targeted gene knock-out deals with about 30 companies and universities; and about 50 corporate and academic subscribers to its gene-analysis and knock-out mice clones database, OmniBank. Lexicon always believed its mammalian functional-genomics technology platform would feed directly into a drug discovery pipeline, and the seven- year-old company has gone through several steps to get there.

It spent its first few years scaling up its technology, explains Arthur T. Sands, president and CEO, which involved "knocking out the entire mammalian genome and then filtering through it to select the very best targets." The next phase has been the physiologic or phenotypic analysis of targets.

Sands Love Matthews LEXICON HYSEQ PHOTO DELTAGEN PHOTO PHOTO

"WE CAN COVER 1,000 genes per year through our complete physiologic profile, which is essentially putting a gene through a hospital-like workup to determine the medical utility of the target," Sands explains. The goal of Lexicon's Genome 5000 program is to look at the in vivo function of 5,000 potential drug targets and therapeutic proteins over five years.

This second phase has already led to the discovery of 14 validated targets in the past 12 months. "These targets have significant market potential and applications in major areas of medicine," Sands says. The company will advance the targets--in oncology, cardiovascular disease, metabolism, neurology, and immunology--into drug discovery and development programs both internally and with collaborators.

To expand its capabilities, a year ago Lexicon acquired Coelacanth, a company founded in 1996 by Nobel Prize winner K. Barry Sharpless. The acquisition, which cost Lexicon only $32 million in stock, added experienced pharmaceutical industry managers and medicinal chemistry.

"We've incorporated that platform into our own drug discovery pipeline to develop small-molecule compounds addressing these 14 targets," Sands says. Although Coelacanth had been licensing its compound libraries to about 18 major drug and biotech firms, Lexicon is reviewing that business strategy. Sands believes in vivo validation of targets and potential therapeutic proteins offers substantial advantages over competing approaches. Those beginning with gene sequences or bioinformatics information may "simply be too far away to provide a bridge all the way to drug discovery," he says.

"Drugs act by altering mammalian physiology, and they must act in the context of all of mammalian physiology running at the same time," Sands explains. "When we knock out a gene, we can see what the antagonism of that target does in the context of all of mammalian physiology, and that link- -merging a gene sequence with its physiologic and medical applications--is critical for making decisions."

The sequencing of the human genome has put the same wealth of information into everyone's hands, and the race is on to find valuable targets and create drugs.

BY MOST ESTIMATES, the genome ended up containing only 30 to 40% of the number of genes anticipated. However, these 30,000 to 40,000 genes are expected to yield between 5,000 and 10,000 "druggable" genes, company executives say, and may encode for 10 times as many proteins. This still leaves a great deal of information to decipher and turn into drugs.

"As a person who was on the outside at the time, the excitement over the human genome looked a lot like hype and frenzy," Celera's Block says. "When bubbles burst, it can be painful, but, in fact, there is usually some substance there.

"And there is substance to the genome, but it needs to be mined, molded into knowledge, and from knowledge into drugs," he continues. "That will occur, but it's not a short process."

Beyond all other expectations, genomics' key contribution to drug discovery may be in providing validated targets for new drugs (see page 47). In the past few years alone, genomics firms have announced a few dozen disease targets. Eventually, most expect to have more targets than they can pursue, and they envision using licensing and partnership opportunities to tap into the resources of larger companies and bring in revenues as they try to build their own businesses.

Only 2 to 3% of druggable genes will offer extremely high value targets for drug discovery, Sands says. Still, that would provide at least another 100 to 150 novel targets, which will more than double the number against which the pharmaceutical industry currently has commercialized drugs. All commercially marketed drugs address only some 122 targets, Sands points out, while the top 100 selling products address only about 45.

"The human genome contains all the potential drug targets for all time," Sands says. "The whole key is finding which genes within the genome actually hold medical value for drug discovery. And if one can answer that question effectively, in a systematic, unbiased way, then the breakthroughs from the genome will be tremendous."

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INTELLECTUAL PROPERTY

Genomics Firms See Patents As Key Asset

Executives say that intellectual property portfolios are crucial to their companies' competitive advantage, especially when trying to create drugs against genome-derived targets. Incyte Genomics, for example, believes it has the largest number of issued U.S. patents--at more than 600--covering full-length human genes, the proteins they encode, and antibodies directed against them. Meanwhile, Hyseq claims to have the largest number of gene-sequence patent applications filed among similar companies.

The unraveling of the human genome created an abundance of genetic information and the desire to obtain rights to it. Although patents on gene sequences were and continue to be an area of heated debate, the U.S. Patent & Trademark Office (PTO) has allowed them and finalized its requirements almost two years ago. In January 2001, PTO issued guidelines, affirming an interim policy proposed two years earlier. Gene sequences are patentable only if they are shown to have specific, credible, and substantial utility. Although gene patents were already allowed, this utility requirement imposed a higher standard than had existed. Companies simply can't try to patent strings of base pairs, unless they also understand and show the medical or diagnostic utility.

Despite PTO's affirmative stand, and a similar one at the European Patent Office, biotech firms are still wary that these positions could change anytime. And with the vast numbers of filed applications, drug developers expect interferences to arise at PTO during review and within the courts after patents are issued. The courts have yet to set many precedents on how they will interpret the validity and scope of gene-sequence patent claims.

The public disclosure and availability of gene sequences have also complicated the situation, possibly adversely affecting companies' ability to obtain patent protection. Genomics companies may also find as they bring products forward that they infringe patents held by others. There have already been a few squabbles among some of them over technology rights.

While patent conflicts are common in the drug industry, emerging drug producers may find them problematic and may require litigation or licensing to have the freedom to operate. "The inherent value of intellectual property will always be mitigated by the time and investment that's needed to transform it into something useful, namely, drugs or diagnostics," comments David S. Block, executive vice president of Celera Genomics.

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