1 Filed Pursuant to Rule 424(a) Registration No. 333-58819 INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION, OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. SUBJECT TO COMPLETION, DATED JANUARY 25, 1999 PROSPECTUS , 1999 4,000,000 SHARES LOGO COMMON STOCK All of the shares of common stock offered hereby are being sold by Intracel Corporation ("Intracel" or the "Company"). Prior to this offering, there has been no public market for the common stock of the Company. It is currently estimated that the initial public offering price will be between $12.00 and $14.00 per share. See "Underwriting" for information relating to the factors considered in determining the initial public offering price. The common stock has been approved for quotation on the Nasdaq National Market under the symbol "ICEL," subject to official notice of issuance. ------------------------ THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" BEGINNING ON PAGE 8 FOR INFORMATION THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS. ------------------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. - ------------------------------------------------------------------------------------------------------- PRICE UNDERWRITING PROCEEDS TO THE DISCOUNTS AND TO THE PUBLIC COMMISSIONS(1) COMPANY(2) - ------------------------------------------------------------------------------------------------------- Per Share...................... $ $ $ Total(3)....................... $ $ $ - ------------------------------------------------------------------------------------------------------- (1) See "Underwriting" for indemnification arrangements with the Underwriters. (2) Before deducting expenses estimated at $ , which will be paid by the Company. (3) The Company and Michael G. Hanna, Ph.D., the Chairman of the Board and Chief Scientific Officer of the Company (the "Selling Stockholder"), have granted to the Underwriters a 30-day option to purchase up to 300,000 and 300,000 additional shares, respectively, at the Price to the Public less Underwriting Discounts and Commissions, solely to cover over-allotments, if any. If such option is exercised in full, the total Price to the Public, Underwriting Discounts and Commissions, Proceeds to the Company, and proceeds to the Selling Stockholder will be $ , $ , $ , and $ , respectively. See "Underwriting." The shares of common stock are being offered by the several Underwriters, subject to prior sale, when, as and if delivered to and accepted by the Underwriters, and subject to various prior conditions, including their right to reject orders in whole or in part. It is expected that delivery of share certificates will be made in New York, New York on or about , 1999. DONALDSON, LUFKIN & JENRETTE PIPER JAFFRAY INC. 2 CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK, INCLUDING STABILIZING, THE PURCHASE OF COMMON STOCK TO COVER SYNDICATE SHORT POSITIONS AND THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING." ------------------------ ZYMMUNE(R) is a registered United States trademark of the Company. ASI(BCL), HumaRAD(16.88), HumaRAD(88BV59), Apo-Tek Lp(a) and Accu-D(x) are trademarks of the Company. Other trademarks used herein belong to various other parties. As used herein, "OncoVAX(CL)" means OncoVAX(CL)(R), "HumaSPECT" means HumaSPECT(R) and "ZYMMUNE" means ZYMMUNE(R). ------------------------ All references to Stage I, Stage II, Stage III and Stage IV colon cancer set forth herein refer to different stages of the disease based upon the status of a patient's tumor nodes and metastases. 2 3 PROSPECTUS SUMMARY The following summary is qualified in its entirety by the more detailed information appearing elsewhere in this Prospectus, including "Risk Factors" and the consolidated financial statements and notes thereto. Unless otherwise indicated, all information in this Prospectus assumes (i) no exercise of the Underwriters' over-allotment option, or currently outstanding stock options, granted by the Company, (ii) the conversion of all shares of the Company's Series A, A-1, A-3, B-1 and B-2 preferred stock into shares of common stock effective upon the closing of this offering (the "Preferred Stock Conversion") and (iii) a 2-for-3 reverse split of the common stock that will be effected prior to the closing of this offering. All references to the "Company" or "Intracel" herein include Intracel Corporation, its predecessor Massachusetts corporation and their respective subsidiaries. Unless otherwise indicated, all references to years refer to the fiscal years of the Company ending December 31. THE COMPANY Intracel is an integrated biopharmaceutical company focused on the development and commercialization of cancer vaccines and immunotherapeutic and diagnostic products for cancers and infectious diseases. Based upon the results of Phase III clinical trials, the Company is preparing a Biologics License Application ("BLA") for its OncoVAX(CL) cancer vaccine for the post-surgical treatment of Stage II colon cancer, the most common form of colon cancer. The Company is also planning to initiate Phase III clinical trials for OncoVAX(CL) in combination with chemotherapy for Stage III colon cancer, has initiated Phase III clinical trials for its proprietary formulation of keyhole limpet hemocyanin ("KLH") for the treatment of refractory bladder cancer, and is planning to initiate a Phase II/III clinical trial for its ASI(BCL) vaccine for the treatment of low-grade B-cell lymphoma. In addition, the Company markets a portfolio of in vitro diagnostic products and is introducing a number of new diagnostic products for detecting and monitoring various cancers, AIDS and heart disease. The Company believes that OncoVAX(CL) is the first vaccine to demonstrate efficacy for the post-surgical treatment of Stage II colon cancer, and has recently announced the results of a ten-year Phase III clinical trial for OncoVAX(CL) conducted at University Hospital, Vrije Universiteit, Amsterdam (the "Amsterdam" trial). This randomized, multi-centered 254-patient clinical trial was the third in a series of clinical trials of OncoVAX(CL) conducted in the United States and Europe. The series included a Phase III clinical trial conducted by the Eastern Cooperative Oncology Group (the "ECOG" trial) and a Phase II/III clinical trial conducted by Dr. Herbert C. Hoover, Jr. (the "Hoover" trial). In the Amsterdam trial, which added a fourth booster vaccination to the regimen, the Company believes that OncoVAX(CL) demonstrated a 61% reduction in the rate of recurrences and a 50% improvement in the survival rate for patients with Stage II colon cancer when compared to surgery alone. The Company believes that the results of the Amsterdam trial are supported by positive trends shown in the ECOG and Hoover trials. Stage II colon cancer accounts for approximately 120,000 of the more than 200,000 new cases of colon cancer diagnosed in the United States and Europe each year. There is currently no product approved by the United States Food and Drug Administration (the "FDA") for patients with Stage II colon cancer, and surgery is the principal means of treatment. The Company plans to file a BLA for OncoVAX(CL) with the FDA in 1999 and is presently seeking the necessary regulatory and reimbursement approvals in certain countries in Europe. If the FDA does not consider the trials discussed above as relevant or supporting to the efficacy of OncoVAX(CL), the FDA may require additional clinical trials of OncoVAX(CL) prior to or after the FDA's approval of the product. There can be no assurance that the Company will obtain FDA approval for OncoVAX(CL) on a timely basis, if at all. OncoVAX(CL) is a multivalent vaccine produced from a patient's own surgically removed tumor. The tumor is collected immediately after surgery and delivered to one of the Company's OncoVAX treatment centers ("OncoVAX Centers") for manufacture and subsequent administration of the vaccine. Each OncoVAX Center has been designed to treat up to 2,000 patients per year. The Company plans to establish OncoVAX Centers at or near hospitals with established surgery practices, serving areas characterized by high population density and high incidence of colon cancer. The Company expects that each OncoVAX Center will require less than 3,000 square feet and will employ a staff of production technicians and a supervising 3 4 physician. Facilities for the first OncoVAX Center in the United States have been established at Lehigh Valley Hospital in Allentown, Pennsylvania, and the terms of the Company's ownership in, and operation of, the center are being developed pursuant to a joint venture with Lehigh Valley Hospital. A second OncoVAX Center in the United States is being established at the Company's therapeutic manufacturing facility in Rockville, Maryland. Future OncoVAX Centers may also be structured as joint ventures with established healthcare providers. The OncoVAX Centers located in the United States will be considered to be manufacturing facilities by the FDA and will be regulated accordingly. The first OncoVAX Center in Europe is being established at University Hospital, Vrije Universiteit, Amsterdam. The Company plans to establish more than 25 OncoVAX Centers in the United States and more than 15 OncoVAX Centers in Europe. The Company estimates that each OncoVAX Center will cost approximately $1.0 to $3.0 million dollars to build. The Company expects revenues from operating OncoVAX Centers to offset the cost of new centers. The Company plans to leverage its OncoVAX Centers to perform expedited clinical trials and to launch other products, such as its in vivo imaging agent, HumaSPECT, and its B-cell lymphoma vaccine ASI(BCL). The Company has filed an amendment to the Investigational New Drug application ("IND") for OncoVAX(CL) with the FDA to commence a Phase III clinical trial for the use of OncoVAX(CL) in combination with chemotherapy for the treatment of Stage III colon cancer. The Company believes that this combination therapy will be more effective in the treatment of Stage III colon cancer than either OncoVAX(CL) or chemotherapy administered alone. The Company is currently in discussions with the FDA regarding the commencement of the Phase III clinical trial for this combination therapy. No assurance can be given that the Company will be given clearance to commence this Phase III clinical trial in a timely manner, if at all. The Company has initiated a Phase III clinical trial for KLH for the treatment of refractory bladder cancer. In Phase II clinical trials, the Company believes that KLH demonstrated significantly less toxicity than the leading FDA-approved product for the treatment of bladder cancer. The Company has entered into a strategic partnership with Mentor Corporation ("Mentor"), a leading urology company, under which Mentor has been funding research and development, is required to make milestone payments to the Company and will market KLH worldwide. Mentor also markets Accu-D(x), the Company's rapid bladder cancer test. The Company plans to file an amendment to the IND for its ASI(BCL) vaccine with the FDA to commence a Phase II/III clinical trial for such vaccine in the first half of 1999. ASI(BCL) is designed to prevent recurrence of low-grade non-Hodgkin's B-cell lymphoma, the most common type of B-cell lymphoma, in patients who have achieved remission through chemotherapy and/or immunotherapy. ASI(BCL), like OncoVAX(CL), is an autologous vaccine and is produced using a unique antigen derived from a patient's own cancerous cells. The Company believes that a Phase I clinical trial has demonstrated that ASI(BCL) can stimulate a specific immune response and is associated with improved clinical outcomes. The Company has substantial expertise in the development and manufacturing of totally human antibodies. In April 1998, the Company commenced enrollment in its Phase I clinical trial for its totally human antibody HumaRAD(16.88) for the treatment of head and neck cancer and plans to submit an IND with the FDA to commence a Phase I clinical trial of a related product, HumaRAD(88BV59) for the treatment of ovarian cancer, in the first half of 1999. In addition, the Company is developing several antibody products to treat life-threatening infectious diseases. Through its wholly owned subsidiary, Bartels, Inc. ("Bartels"), the Company also markets a portfolio of innovative in vitro diagnostic products for the confirmation of viral and bacterial diseases. The Company markets these diagnostic products domestically to approximately 1,500 hospitals and clinical laboratories through its internal sales force. Internationally, the Company relies upon third-party distributors to market its diagnostic products. In 16 foreign countries, the Company is marketing a one-minute test for HIV/AIDS based on its proprietary INSTI technology. In addition, the Company is introducing a number of new diagnostic products, including its Apo-Tek Lp(a) test kit to monitor an important indicator of heart disease, its Accu-D(x) test to monitor the recurrence of bladder cancer and its ZYMMUNE test to monitor CD4/CD8 levels in patients with HIV/AIDS. As a complementary product for OncoVAX(CL), the Company has developed an in vivo diagnostic product, HumaSPECT, to monitor recurrence and metastic spread of colon cancer. For a Phase III clinical trial, the Company believes that HumaSPECT demonstrated significant 4 5 advantages over CT scans, the current standard for detecting recurrence and metastic spread of colon cancer. The Company has filed a BLA in the United States and in December 1998 received marketing authorization for HumaSPECT in Europe. A third party currently holds world-wide distribution rights for the Company's HumaSPECT product. While the Company is currently in negotiations to terminate the agreement providing for such rights, there can be no assurances that the agreement will be terminated on a timely basis, if at all. The Company's technology foundation in cancer vaccines and human antibodies is supported by a clinical trial group with expertise in designing and implementing complex clinical trials and by state-of-the-art manufacturing facilities capable of producing commercial quantities of its therapeutic, diagnostic and prognostic products. To conduct research, development, manufacturing and marketing of its products, the Company employs over 220 people in multiple facilities, including its corporate headquarters in Issaquah, Washington, a therapeutic product facility located in Rockville, Maryland and diagnostic product facilities in Issaquah, Washington and Richmond, British Columbia, Canada. 5 6 THE OFFERING Common Stock Offered by the Company.......... 4,000,000 shares Common Stock to be Outstanding After the Offering................................... 15,440,285 shares(1) Use of Proceeds.............................. To support the establishment and early operation of OncoVAX Centers, to repay existing indebtedness, and the balance for the Company's other research and development programs, to conduct clinical trials for the Company's cancer and infectious disease products and for working capital and other general corporate purposes. The Company may also use a portion of the net proceeds to acquire technologies or products com- plementary to its business. See "Use of Proceeds." Proposed Nasdaq National Market Symbol....... ICEL - --------------- (1) The foregoing computations exclude: (i) 1,341,594 shares of common stock issuable upon exercise of stock options outstanding as of November 30, 1998, at a weighted-average exercise price of $3.55 per share; and (ii) 1,727,002 shares of common stock issuable upon exercise of warrants expected to remain outstanding after this offering, of which 643,664 are at a weighted-average exercise price of $7.96 per share, and 1,083,338 shares which are exercisable at $15.00 per share. RISK FACTORS This offering involves a high degree of risk. See "Risk Factors." 6 7 SUMMARY FINANCIAL DATA The following Summary Consolidated Financial and Operating Data of the Company is qualified by reference to and should be read in connection with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and notes thereto which are included elsewhere in this Prospectus. SIX MONTHS YEAR ENDED PRO FORMA YEAR ENDED JUNE 30, ENDED DECEMBER 31, YEAR ENDED ------------------------- DECEMBER 31, ----------------- DECEMBER 31, 1993 1994 1995 1995 1996 1997 1997(1) ------ ------ ------- ------------ ------- ------- ------------ (UNAUDITED) (DOLLARS IN THOUSANDS) STATEMENT OF OPERATIONS DATA: Revenue...................... $1,776 $1,618 $ 1,566 $ 2,426 $14,718 $13,452 $ 21,341 Cost of revenue.............. 533 449 824 1,779 8,265 8,661 15,277 Selling, general and administrative............. 962 801 1,580 2,593 5,740 8,478 12,922 Research and development..... 785 1,078 1,174 1,118 1,043 556 8,633 Acquired research and development................ 2,100 Amortization of cost in excess of net assets acquired................... 151 908 908 993 Reorganization expense....... 917 ------ ------ ------- ------- ------- ------- -------- Total operating expense.... 2,280 2,328 3,578 7,741 16,873 18,603 37,825 ------ ------ ------- ------- ------- ------- -------- Loss from operations......... (504) (710) (2,012) (5,315) (2,155) (5,151) (16,484) Interest income (expense), net........................ 47 22 68 (135) (2,235) (2,913) (3,750) Gain on pension curtailment................ Other income................. Loss on sale-leaseback transaction................ (335) ------ ------ ------- ------- ------- ------- -------- Loss before extraordinary item....................... (457) (688) (1,944) (5,450) (4,390) (8,064) (20,569) Extraordinary gain on early extinguishment of debt..... 1,367 ------ ------ ------- ------- ------- ------- -------- Net loss................... $ (457) $ (688) $(1,944) $(4,083) $(4,390) $(8,064) $(20,569) ====== ====== ======= ======= ======= ======= ======== NINE MONTHS ENDED SEPTEMBER 30, ------------------------- 1997 1998(2) ----------- ----------- (UNAUDITED) STATEMENT OF OPERATIONS DATA: Revenue...................... $10,231 $ 14,244 Cost of revenue.............. 5,909 9,588 Selling, general and administrative............. 5,912 11,101 Research and development..... 523 8,420 Acquired research and development................ 37,718 Amortization of cost in excess of net assets acquired................... 681 744 Reorganization expense....... ------- -------- Total operating expense.... 13,025 67,571 ------- -------- Loss from operations......... (2,794) (53,327) Interest income (expense), net........................ (2,100) (3,293) Gain on pension curtailment................ 800 Other income................. 1,273 Loss on sale-leaseback transaction................ ------- -------- Loss before extraordinary item....................... (4,894) (54,547) Extraordinary gain on early extinguishment of debt..... 785 ------- -------- Net loss................... $(4,894) $(53,762) ======= ======== SEPTEMBER 30, 1998 -------------------------------------------- PRO FORMA ACTUAL PRO FORMA(4) AS ADJUSTED(5) ----------- ------------- -------------- BALANCE SHEET DATA: Cash, cash equivalents, pledged securities and restricted cash(3)................................................. $ 11,392 $ 17,400 $ 58,760 Working capital........................................... 4,817 9,392 52,752 Total assets.............................................. 51,960 57,968 99,328 Long-term debt, non-convertible, including current portion................................................. 35,038 37,038 30,038 Long-term debt, convertible, including current portion.... 11,035 10,802 10,802 Redeemable, convertible preferred stock................... 21,159 Accumulated deficit....................................... (74,942) (74,942) (74,942) Total stockholders' equity (deficit)...................... (27,097) (868) 47,492 - --------------- (1) Gives effect to the acquisition of PerImmune Holdings, Inc. and Subsidiary ("PerImmune Holdings") as if it had occurred on January 1, 1997. See "Pro Forma Consolidated Financial Information." (2) Represents the Company as consolidated with PerImmune Holdings. (3) $6.0 million of the cash, cash equivalents, pledged securities and restricted cash are maintained in segregated accounts from which the Company is permitted to obtain funds upon request to the lender. Of the $6.0 million, $4.0 million is invested in pledged securities. $4.92 million of the cash, cash equivalents, pledged securities and restricted cash is maintained in a segregated "interest escrow account" which is restricted for the payment of interest under certain outstanding debt obligations. See Note 14 to the Company's consolidated financial statements contained elsewhere in this Prospectus. (4) Gives effect to the automatic mandatory conversion of 1,488,771 shares of outstanding preferred stock into 3,426,953 shares of common stock, and the conversion of $232,500 of short-term notes payable which will automatically convert into 36,433 shares of common stock at the conclusion of this offering, and the issuance of 493,786 shares of common stock for the exercise of warrants at a weighted-average price of $8.12 per share which will automatically expire ten days after the date of this offering. Also reflects $2.0 million of non-convertible debt securities which the Company has agreed to issue pursuant to a letter of intent. See "Business -- Recent Debt Refinancings." (5) Adjusted to reflect the sale of 4,000,000 shares of common stock offered hereby assuming a public offering price of $13.00 per share less estimated underwriting discounts and commissions and other expenses of this offering, resulting in net proceeds of $48,360,000, and the $7,000,000 repayment of various indebtedness that must be redeemed upon completion of this offering. 7 8 RISK FACTORS This Prospectus contains forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those discussed in the forward-looking statements as a result of certain factors, including those set forth below and elsewhere in this Prospectus. The following risk factors should be considered carefully in addition to the other information in this Prospectus before purchasing the shares of common stock offered hereby. DEPENDENCE ON ONCOVAX(CL) The Company's future growth and profitability will depend on its ability to introduce and market OncoVAX(CL) and establish OncoVAX Centers. There can be no assurance that the Company will be able to obtain necessary regulatory approvals for OncoVAX(CL) in a timely manner, if at all. The failure of the Company to introduce and market OncoVAX(CL) and establish OncoVAX Centers in a timely manner would have a material adverse effect on the Company's business, financial condition and results of operations. The Company believes that the results of the Amsterdam, ECOG and Hoover trials of OncoVAX(CL) will provide sufficient evidence to support the approval by the FDA of the Company's BLA for OncoVAX(CL) being prepared for submission. However, based upon a summary data package submitted to the FDA by the Company, the FDA recently raised the question of whether these trials met the criteria for Phase III clinical trials or should rather be considered as an ongoing series of Phase II clinical trials. The Company believes that, if this issue remains current, the BLA will clearly demonstrate that both the ECOG and Amsterdam Trials meet all the criteria for Phase III clinical trials. If the FDA does not consider the ECOG and Hoover trials as relevant or supporting to the efficacy of OncoVAX(CL), there can be no assurance that the FDA will consider the Amsterdam trial alone as a sufficient basis for approval. Given the May 1998 FDA Guidance Document entitled "Providing Clinical Evidence of Effectiveness of Human Drug and Biological Products," which discusses the use and limitations of a single clinical trial to form the basis for approval of a BLA, and the views the FDA has expressed on this subject with respect to OncoVAX(CL) combined with chemotherapy for the treatment of Stage III colon cancer discussed below, there can be no assurance that the FDA will not require additional clinical trials of OncoVAX(CL) prior to FDA acceptance of the Company's BLA for filing or, ultimately, for approval. Any such requirement to conduct additional clinical trials could result in a substantial delay or failure to achieve regulatory approval for OncoVAX(CL). The FDA has raised questions regarding the manufacture of OncoVAX(CL) in accordance with the FDA's requirements for, among other things, sterility that are relevant for both the Phase III clinical trial on OncoVAX(CL) combined with chemotherapy and the BLA for OncoVAX(CL) for Stage II colon cancer. However, there can be no assurance that the Company's submissions on these issues will be sufficient to convince the FDA to accept the BLA for filing and approval. There can be no assurance that the Company will obtain FDA approval for OncoVAX(CL) on a timely basis. The Company may elect to seek approval of OncoVAX(CL) under the accelerated approval provisions of the Food and Drug Administration Modernization Act of 1997 (the "FDA Modernization Act"). The accelerated approval regulations apply to products used in the treatment of serious or life-threatening illnesses that appear to provide meaningful therapeutic benefits over existing treatments. These requirements permit approval of such products based on the product's effect on a clinical endpoint or surrogate endpoint that is likely to predict clinical benefit. When a product is approved under the accelerated approval regulations, the sponsor may be required to conduct additional adequate and well-controlled studies to verify that the effect on the surrogate endpoint correlates with improved clinical outcome or to otherwise verify the clinical benefit. In the event such postmarketing studies do not verify the drug's anticipated clinical benefit, or if there is other evidence that the drug product is not shown to be safe and effective, expedited withdrawal procedures permit the FDA, after a hearing, to remove a product from the market. Significant uncertainty exists as to the extent to which these accelerated approval regulations will result in accelerated review and approval. Furthermore, the FDA has considerable discretion to determine eligibility for accelerated review and approval. Accordingly, the FDA could employ such discretion to deny eligibility of OncoVAX(CL) as a candidate for accelerated review or to require additional clinical trials or other information before approving OncoVAX(CL). A determination that OncoVAX(CL) is not eligible for accelerated review and delays and additional expenses associated with generating a response to any such request for additional trials could have a material adverse effect on the 8 9 Company's business, financial condition and results of operations. See "-- Government Regulation: No Assurance of Regulatory Approvals" and "Business -- Government Regulation." Even if OncoVAX(CL) is approved for marketing by the FDA and other regulatory authorities, there can be no assurance that it will be commercially successful or that the Company will be successful in establishing and operating OncoVAX Centers and manufacturing OncoVAX(CL) on a commercial scale at a cost that will enable the Company to realize a profit. If OncoVAX(CL) is approved, its commercialization through the Company's OncoVAX Centers would be substantially different from the manner in which most anti-cancer treatments, including chemotherapeutics, are now manufactured and distributed. Furthermore, the OncoVAX centers located in the United States will be considered to be manufacturing facilities by the FDA and must comply with all applicable requirements. See "-- Government Regulation: No Assurance of Regulatory Approvals." Despite the results of the clinical trials of OncoVAX(CL) and the absence of any therapeutic products currently approved by the FDA for post-surgical treatment of Stage II colon cancer, there can be no assurance that oncologists and other physicians will refer patients for treatment with OncoVAX(CL). Market acceptance also could be affected by the availability of third-party reimbursement. Failure of OncoVAX(CL) to achieve significant market acceptance could have a material adverse effect on the Company's business, financial condition and results of operations. See "-- Uncertainty Related to Health Care Reform and Third-Party Reimbursement" and "Business -- Competition." On May 26, July 24, September 16, and November 27, 1998, the FDA's Center for Biologics Evaluation and Research ("CBER") advised the Company in writing that its proposed Phase III clinical trial relating to the use of OncoVAX(CL) in combination with chemotherapy for the treatment of Stage III colon cancer had been placed on clinical hold and, therefore, may not begin until certain manufacturing information is provided to CBER. The Company believes it has fully responded to CBER's May 26, July 24 and September 16, 1998 letters. As a result of these letters, a number of concerns have been resolved and the Company is continuing to negotiate the outstanding issues. The Company believes that upon evaluation of the information the Company has provided and will provide to the FDA, CBER will remove the clinical hold and allow the clinical trial to begin. CBER also asked questions regarding the study to determine whether it would constitute a "pivotal" Phase III trial sufficient to support approval. In addition, the FDA questioned whether a single pivotal study would be sufficient to approve a product for this indication and requested further information on this issue. The Company intends to provide all requested information. There can be no assurance at this time that the FDA will allow the study to commence or will consider this clinical trial to be sufficient to support approval. The Company met with FDA officials on September 22, 1998, to discuss these issues. The FDA reiterated that information regarding manufacturing of the product must be submitted to and found acceptable by the FDA before this Phase III clinical trial may begin. These issues must also be resolved with respect to the Stage II product before the FDA will accept the BLA for filing. On October 17, 1998, the Company responded to FDA concerns regarding the manufacturing issues. There was an FDA public meeting on December 10, 1998 to review a variety of issues regarding cancer vaccines, including the development of potency assays, which the Company's Chairman attended as a panelist in the Autologous and Allogeneic Tumor Cells as Tumor Vaccines Session. The Company plans to file additional information to respond to the FDA's concerns. The Company believes that its submissions on manufacturing and potency assays will be sufficient to allow the FDA to permit the clinical trial in 1999. However, there can be no assurance that the Company's submissions on these issues will be sufficient to convince the FDA to allow the Company's Phase III study of OncoVAX(CL) to treat Stage III colon cancer to commence or to accept for filing the Company's BLA for OncoVAX(CL) for treatment of Stage II colon cancer. HISTORY OF OPERATING LOSSES; ANTICIPATED FUTURE LOSSES The Company has experienced significant losses since inception. The Company's net losses were $20.6 million for the year ended December 31, 1997 (on a pro-forma basis after giving effect to the acquisition of PerImmune Holdings as if it had occurred on January 1, 1997) and $4.4 million, $8.1 million and $53.8 million for the years ended December 31, 1996, 1997 and the nine months ended September 30, 1998, 9 10 respectively. The loss for the nine months ended September 30, 1998 includes a one-time expense of $37.7 million related to the acquired in-process research and development in connection with the Company's acquisition of PerImmune Holdings on January 2, 1998. As of September 30, 1998, the Company's accumulated deficit was approximately $74.9 million. The Company expects to incur significant additional operating losses primarily in connection with the establishment and operation of its OncoVAX Centers, ongoing and expanded research and development and expanded and later stage clinical trials. The Company expects that losses will fluctuate from quarter to quarter and that such fluctuations may be substantial. Most of the Company's product candidates are in development in preclinical studies and clinical trials and have not generated product revenues. To achieve and sustain profitable operations, the Company, alone or with others, must develop successfully, obtain regulatory approval for, manufacture, introduce, market and sell its products. The time frame necessary to achieve market success is long and uncertain. There can be no assurance that the Company will ever generate sufficient product revenues to become profitable or to sustain profitability. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Pro Forma Consolidated Financial Information." SUBSTANTIAL LEVERAGE Following the consummation of the offering of common stock pursuant to this Prospectus, the Company will have indebtedness that is substantial in relation to its stockholders' equity, as well as interest and debt service requirements that are significant compared to its income and cash flow from operations. Such indebtedness is secured by substantially all of the Company's assets. At September 30, 1998, the Company's total indebtedness was approximately $46.1 million. The degree to which the Company is leveraged could have important consequences to holders of the common stock, including the following: (i) the Company's ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions or general corporate purposes may be impaired, (ii) a substantial portion of the Company's cash flow from operations must be dedicated to the payment of interest on its debt and its other indebtedness, thereby reducing funds available to the Company for other purposes, (iii) the agreements governing the Company's long-term indebtedness contain certain restrictive financial and operating covenants, (iv) certain of the Company's long-term indebtedness is secured by substantially all the assets of the Company and (v) the Company's substantial degree of leverage may limit its flexibility to adjust to changing market conditions, reduce its ability to withstand competitive pressures and make it more vulnerable to a downturn in general economic conditions or its business. See "Business -- Recent Debt Refinancings." The Company's ability to pay interest on its long-term indebtedness and satisfy its other obligations will depend on its future operating performance, which will be affected by prevailing economic conditions and financial, business and other factors, many of which are beyond its control. Although the Company believes it will be able to pay its obligations as they come due, there can be no assurance that the Company will generate earnings in any future period sufficient to cover its fixed charges. In the absence of adequate operating results and cash flows, the Company may be required to adopt alternative strategies that include reducing or delaying capital expenditures, disposing of material assets or operations, refinancing its indebtedness or seeking additional equity capital to meet its debt service obligations. Certain of the Company's long-term debt instruments contain covenants that restrict the Company's ability to take certain of the foregoing actions, including selling assets and using proceeds therefrom. There can be no assurance as to the timing of such actions, the ability of the Company to consummate such actions under its existing financial agreements or the proceeds that the Company could realize therefrom, and there can be no assurance that any such refinancing would be feasible at the time or that such proceeds would be adequate to meet the obligations then due. DEVELOPMENT, INTRODUCTION AND MARKETING OF NEW PRODUCTS The Company's future growth and profitability will depend, in part, on its ability to develop, introduce and market new products based on its proprietary technologies. Many of the Company's products are currently under development, either in preclinical testing or clinical trials. Other products are planned for future development. The time period required for such development is extensive and highly uncertain and such 10 11 development requires substantial expense. The new products developed by the Company may prove to be ineffective or unreliable. They may be difficult to manufacture in a cost-effective manner, may fail to receive necessary regulatory clearances, may not achieve market acceptance or may encounter other unanticipated difficulties. The failure of the Company to develop, introduce and market new products in a timely manner, if at all, could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business." UNCERTAINTIES ASSOCIATED WITH CLINICAL TRIALS The Company has conducted and plans to continue to undertake extensive and costly clinical trials to assess the safety and efficacy of its product candidates. Such trials are often subject to setbacks and delays. The rate of completion of the Company's clinical trials is dependent upon, among other factors, the rate of patient enrollment. Patient enrollment is a function of many factors, including the nature of the Company's clinical trial protocols, existence of competing protocols, size of the patient population, proximity of patients to clinical sites and eligibility criteria for the study. Delays in patient enrollment will result in increased expenses and delays, which could have a material adverse effect on the Company's business, results of operations and financial condition. The Company cannot assure that patients enrolled in the Company's clinical trials will respond to the Company's product candidates. Failure to comply with FDA regulations applicable to clinical trials could result in delay, suspension or cancellation of such trials (e.g., clinical hold) and/or refusal by the FDA to accept the results of such trials. In addition, the FDA may suspend clinical trials at any time if it concludes that the participants in such trials are being exposed to unacceptable risks. Thus, there can be no assurance that any clinical trials will be completed successfully within any specific time period, if at all, with respect to any of the Company's product candidates. Furthermore, there can be no assurance that human clinical trials will show any current or future product candidate to be safe and effective or that data derived therefrom will be suitable for submission to the FDA or will support the Company's submission of a BLA, Product License Application ("PLA") or New Drug Application ("NDA"). See "-- Dependence on OncoVAX(CL)" for a description of certain issues relating to the clinical trials of OncoVAX(CL), "Business -- Diagnostic Products -- In Vivo Diagnostics" for a description of certain issues relating to the Company's BLA for HumaSPECT and "Business -- Government Regulation." GOVERNMENT REGULATION: NO ASSURANCE OF REGULATORY APPROVALS All new drugs, biologics and diagnostic products, including the Company's products under development, are subject to extensive and rigorous government regulation in the United States and elsewhere. The requirements imposed by regulators of pharmaceuticals and medical devices vary from country to country. In the United States, regulation is administered by the federal government, principally the FDA under the Federal Food, Drug and Cosmetic Act (the "FDC Act") and other laws including, in the case of biologics, the Public Health Service Act (the "PHS Act"), and by state and local governments. Such regulations govern, among other things, the development, testing, manufacture, labeling, storage, premarket approval, advertising, promotion, sales and distribution of such products and post-approval monitoring of safety and efficacy. In the European Union, the European Medicines Evaluation Agency ("EMEA") is responsible for administering a centralized assessment procedure for European Union-wide authorizations valid in Britain, France, Germany, Italy, Spain and Greece ("Member States") for medicinal products of significant therapeutic interest or comprising a significant innovation. In addition, regulatory approval of prices is required in most countries other than the United States. For example, regulators in certain European countries condition their approval of a pharmaceutical product on the agreement of the seller not to sell the product for more than a certain price in their respective countries. In some cases, the price established in any of these countries may serve as a benchmark in the other countries. As such, the price approved in connection with the first approval obtained in any of these European countries may serve as the maximum price that may be approved in the other European countries. Also, a price approved in one of these European countries that is lower than the price previously approved in the other European countries may require a reduction in the prices in those other European countries. In such an event, there can 11 12 be no assurance that the resulting prices would be sufficient to generate an acceptable return on the Company's investment in its products. The regulatory process, which includes preclinical studies and clinical trials of each potential product, is lengthy, expensive and uncertain. Prior to commercial sale in the United States, most new drugs, biologics and diagnostic products, including the Company's products under development, must be approved by the FDA. Securing FDA marketing approvals often requires the submission of extensive preclinical and clinical data and supporting information to the FDA. Product approvals, if granted, can be withdrawn for failure to comply with regulatory requirements or upon the occurrence of unforeseen problems following initial marketing. Moreover, regulatory approvals for products such as new drugs, biologics and diagnostic products, even if granted, may require that the labeling for such products include significant limitations on the uses for which such products may be marketed. There can be no assurance that the Company will be able to obtain necessary regulatory approvals in a timely manner, if at all, for any of its product candidates, and delays in receipt or failures to receive such approvals or failures to comply with existing or future regulatory requirements could have a material adverse effect on the Company's business, financial condition and results of operations. Failure to comply with applicable FDA and other regulatory requirements can result in sanctions being imposed on the Company or the manufacturers of its products, including warning letters, fines, product recalls or seizures, injunctions, refusals to permit products to be imported into or exported out of the United States, refusals of the FDA to grant premarket approval of drugs, biologics or devices, refusals of the FDA to allow the Company to enter into government supply contracts, withdrawals of previously approved marketing applications and criminal prosecutions. The pharmaceutical legislation of the European Union requires any person seeking to market a medicinal product for human use to obtain approval of a Marketing Authorization Application ("MAA"). While procedures for approval of MAAs have been harmonized within the European Union through directives for implementation into the domestic law of each Member State and by regulations having direct effect, the specific approvals and the time required for approval varies from country to country and may, in some instances, involve additional testing. Drugs which fall within the definition of "high technology medicines" under the Annex to Council Regulation 2309/93 undergo the centralized approval system under which the Committee for Proprietary Medicinal Products ("CPMP") is obliged to give an opinion as to whether a marketing authorization has been granted within 210 days (although the "clock" may be stopped if further information is required). Manufacturers of drugs, biologics and devices also are required to comply with the FDA current Good Manufacturing Practice ("cGMP") regulations or similar foreign regulations, which include requirements relating to quality control and quality assurance as well as the corresponding maintenance of records and documentation. The OncoVAX centers located in the United States will be considered to be manufacturing facilities by the FDA and will be regulated accordingly. Manufacturing facilities are subject to inspection by the FDA and other government regulators, including unannounced inspection in their own and other jurisdictions. Certain material manufacturing changes to approved drugs, biologics and diagnostic products also are subject to FDA and foreign regulatory review and approval. There can be no assurance that the Company or its suppliers will be able to comply with the applicable cGMP regulations and other FDA or other post-approval regulatory requirements such as adverse event reporting. Failure to comply with the post-approval regulatory requirements can lead to product withdrawal and/or other regulatory action by the FDA. Such failure could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Governmental Regulation." In addition to regulation by the FDA, the Nuclear Regulatory Commission (the "NRC") and some individual states (referred to as "Agreement States") also regulate companies that possess radioactive material and those that manufacture, prepare or transfer radioactive drugs for commercial distribution. Agreement States typically regulate in a manner similar to the NRC. The Company's incorporation of radioactive materials in its labeled products, HumaSPECT, HumaRAD(16.88) and HumaRAD(88BV59), will subject it to these NRC requirements. To comply, the Company must apply for and maintain appropriate licenses and comply with reporting, recordkeeping and other regulatory requirements. The Company's failure to comply 12 13 with the regulatory requirements could subject it to enforcement actions including civil penalties and orders to modify, suspend, or revoke its licenses. With a suspended or revoked license, the Company would need to cease and desist from possessing the radioactive material necessary for producing its products and from distributing its products. GOVERNMENT REGULATION; FRAUD AND ABUSE, FACILITY LICENSURE AND CORPORATE PRACTICE The Company has established, or may establish in the future, various financial relationships with potential purchasers of the Company's products and with sources of referral, including hospitals, clinical laboratories and physicians. In addition, the Company provides coding advice to customers and, operating through its OncoVAX Centers, expects to seek reimbursement for its products and services from patients and/or third-party payers (including Medicare, Medicaid and private health insurers). Consequently, the Company is subject to various federal and state laws pertaining to health care fraud and abuse, including anti-kickback laws, physician self-referral laws and false claims laws. Anti-kickback laws make it illegal to solicit, offer, receive, or pay any remuneration in exchange for, or to induce, the referral of business. Physician self-referral laws restrict the ability of a physician to refer patients to entities with which the physician has a financial relationship. False claims laws prohibit anyone from knowingly and willfully presenting, or causing to be presented, claims for payment that contain false or fraudulent information. Violations of these laws are punishable by criminal and/or civil sanctions and may render the Company ineligible for reimbursement for its products and services. Although the Company intends to operate in compliance with these laws, because of the broad scope of some of these laws, there can be no assurance that one or more of the Company's practices will not be challenged by governmental authorities under certain of these laws, that the Company will not be required to alter its practices as a result or that the occurrence of one or more of these events will not have a material adverse effect on the Company's business. See "Business -- Government Regulation." The Company's OncoVAX Centers will be subject to state laws regulating the licensure and operation of healthcare facilities and clinics where patients receive treatment. The structure and operation of the OncoVAX Centers and each OncoVAX Center's relationship to supervising physicians and other healthcare professionals also must comply with laws existing in some states that prohibit the corporate practice of medicine and other healthcare professions. These laws vary from state to state and are enforced by the courts and regulatory authorities with broad discretion. The Company intends to structure and operate its OncoVAX Centers in compliance with these laws, but a failure to meet these requirements could have a material adverse effect on the Company's ability to market OncoVAX(CL) and this, in turn, could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Government Regulation." FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING The Company's operations to date have consumed substantial and increasing amounts of cash. The Company's negative cash flow from operations is expected to continue and to accelerate in the foreseeable future. The development of the Company's technology and potential products, including the establishment of OncoVAX Centers in the United States and Europe, will continue to require a commitment of substantial funds. The Company expects that its existing capital resources, including the net proceeds of the Offering and interest thereon, will be adequate to satisfy the requirements of its current and planned operations until the end of 1999. However, the rate at which the Company expends its resources is variable, may be accelerated and will depend on many factors, including the scope and results of preclinical studies and clinical trials, continued progress of the Company's research and development of product candidates, the cost, timing and outcome of regulatory approvals, the expenses of establishing a sales and marketing force, the cost of establishing and operating OncoVAX Centers, the cost of manufacturing, the cost involved in preparing, filing, prosecuting, maintaining, defending and enforcing patent claims, the acquisition of technology licenses, the status of competitive products and the availability of other financing. The Company may need to raise substantial additional capital to fund its operations and may seek such additional funding through public or private equity or debt financings, as well as through collaborative arrangements. There can be no assurance that such additional funding will be available on acceptable terms, if 13 14 at all. If additional funds are raised by issuing equity securities, substantial equity dilution to stockholders may result. If adequate funds are not available, the Company may be required to delay, reduce the scope of, or eliminate one or more of its research and development programs, curtail its operations or obtain funds through arrangements with collaborative partners or others that may require the Company to relinquish rights to certain of its technologies, product candidates or products that the Company would otherwise seek to develop or commercialize on its own. See "Pro Forma Consolidated Financial Information" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." DEPENDENCE UPON PROPRIETARY TECHNOLOGY; UNCERTAINTY OF INTELLECTUAL PROPERTY RIGHTS Extensive research has been conducted in the cancer vaccine and monoclonal antibody fields by pharmaceutical and biotechnology companies and other organizations and a substantial number of patents in these fields have been issued to other pharmaceutical and biotechnology companies. In addition, competitors may have applications for additional patents pending and may obtain additional patents and proprietary rights related to products or processes competitive with or similar to those of the Company. Patent applications are maintained in secrecy for a period after filing and, in the United States, patent applications are confidential until the patent is issued. Publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries and the filing of related patent applications. The Company may not be aware of all of the patents potentially adverse to the Company's interests that may have been issued to other companies, research or academic institutions, or others. No assurance can be given that such patents do not exist, have not been filed, or could not be filed or issued, which contain claims relating to the Company's technology, products or processes. To date, no consistent policy has emerged regarding the breadth of claims allowable in pharmaceutical and biotechnology patents. The Company is aware of various patents that have been issued to others that pertain to a portion of the Company's prospective business. The Company is aware, in particular, of the existence of at least one United States patent owned by another party that may interfere with the manufacture and marketing of HumaSPECT in the United States. There can be no assurance that other patents do not exist in the United States or in other countries or that patents will not be issued to third parties that contain preclusive or conflicting claims with respect to OncoVAX(CL) or any of the Company's other product candidates or programs. Commercialization of cancer vaccines and monoclonal antibody-based products may require licensing and/or cross-licensing of one or more patents with other organizations in the field. There can be no assurance that the licenses that might be required for the Company's processes or products would be available on commercially acceptable terms, if at all. The Company's breach of an existing license or failure to obtain a license to technology required to commercialize its product candidates may have a material adverse effect on the Company's business, financial condition and results of operations. Litigation, which could result in substantial costs to the Company, may also be necessary to enforce any patents issued to the Company or to determine the scope and validity of third-party proprietary rights. If competitors of the Company prepare and file patent applications in the United States that claim technology also claimed by the Company, the Company may have to participate in interference proceedings declared by the United States Patent and Trademark Office to determine priority of invention, which could result in substantial cost to the Company, even if the eventual outcome is favorable to the Company. An adverse outcome could subject the Company to significant liabilities to third parties and require the Company to license disputed rights from third parties or to cease using such technology. Patents issued and patent applications filed internationally relating to biologics are numerous and there can be no assurance that current and potential competitors and other third parties have not filed or in the future will not file applications for, or have not received or in the future will not receive, patents or obtain additional proprietary rights relating to products or processes used or proposed to be used by the Company. Many non-United States jurisdictions allow oppositions by third parties to granted patents and/or issued patents. The Company may have to participate in opposition proceedings in non-United States jurisdictions to prevent a third party from obtaining a patent that may be adverse to the Company's interests. Also, the Company may have to defend against a third party's opposition to a patent granted and/or issued to the Company. There can be no assurance that the Company will be successful in an opposition proceeding, and 14 15 participation in such a proceeding could result in substantial cost to the Company whether or not the eventual outcome is favorable to the Company. Moreover, there is certain subject matter which is patentable in the United States and not generally patentable outside of the United States and this may limit the protection the Company can obtain on some of its inventions outside of the United States. For example, methods of treating humans are not patentable in many countries outside of the United States. These and/or other issues may prevent the Company from obtaining patent protection outside of the United States, which could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Patents and Other Intellectual Property." The Company also relies on trade secrets and trademarks to protect its technology, especially where patent protection is not believed to be appropriate or obtainable. The Company protects its proprietary technology and processes, in part, by confidentiality agreements with its key employees, consultants, medical advisory board members, collaborators and contractors. There can be no assurance that these agreements will not be breached, that the Company would have adequate remedies for any breach, or that the Company's trade secrets and trademarks or those of its collaborators or contractors will not otherwise become known or be discovered independently by competitors. All of the Company's material patents, including those which relate to the Company's OncoVAX(CL), HumaSPECT and the Company's HumaRAD products, have been pledged to secure certain of the Company's existing debt obligations. See "Business -- Recent Debt Refinancings." HIGHLY COMPETITIVE INDUSTRY; RISK OF TECHNOLOGICAL OBSOLESCENCE The pharmaceutical and biotechnology industries are intensely competitive. Many of the product candidates being developed by the Company, if approved, would compete with existing drugs, therapies and diagnostic products and with new drugs, therapies and diagnostic products under development, including, in the case of cancer treatments, angiogenesis inhibitors, gene therapy, advanced hormonal replacement therapy and new chemotherapeutics. There are many pharmaceutical companies, diagnostic companies, biotechnology companies, public and private universities and research organizations actively engaged in research and development of products for the treatment of people with cancer. Many of these organizations have financial, technical, manufacturing and marketing resources greater than those of the Company. Several of them may have developed or are developing therapies or diagnostic products that could be used for treatment or diagnosis of the same diseases targeted by the Company. If a competing company were to develop or acquire rights to a safer or more efficacious treatment of or diagnostic products for the same diseases targeted by the Company, or one which offers significantly lower costs of treatment or diagnosis, the Company's business, financial condition and results of operations could be materially adversely affected. The Company believes that its product development programs will be subject to significant competition from companies utilizing alternative technologies as well as to increasing competition from companies that develop and apply technologies similar to the Company's technologies. Other companies may succeed in developing products earlier than the Company, obtaining approvals for such products from the FDA more rapidly than the Company or developing products that are safer or more effective than those under development or proposed to be developed by the Company. There can be no assurance that research and development by others will not render the Company's technology or product candidates obsolete or non-competitive or result in treatments superior to any therapy developed by the Company, or that any therapy developed by the Company will be preferred to any existing or newly developed technologies. See "Business -- Competition." DEPENDENCE ON MANAGEMENT AND OTHER KEY PERSONNEL The Company is dependent upon a limited number of key management and technical personnel, including Michael G. Hanna, Ph.D., the Chairman of the Board and Chief Scientific Officer of the Company, and Simon R. McKenzie, the President and Chief Executive Officer of the Company. The loss of the services of one or more of such key employees could have a material adverse effect on the Company's business, financial condition and results of operations. If Mr. McKenzie should cease to be the principal executive officer of the Company in charge of the Company's management and policies for a period of 30 days or more and the holders of August 1998 Notes constituting 70% of the total amount due under all such notes have not 15 16 approved a successor to Mr. McKenzie within 180 days after the cessation of his full time service to the Company, the Company will be required, at the request of the noteholders, to prepay certain of the Company's material debt obligations at a price equal to 101% of the principal amount so prepaid, plus accrued interest to the date of prepayment. See "Business -- Recent Debt Refinancings." In addition, the Company's success will be dependent upon its ability to attract and retain additional highly qualified personnel. The Company faces intense competition in its recruiting activities, and there can be no assurance that the Company will be able to attract and/or retain qualified personnel. See "Management." EXPOSURE TO PRODUCT LIABILITY The manufacture and sale of human therapeutic and diagnostic products involve an inherent risk of product liability claims and associated adverse publicity. The Company has only limited commercial product liability insurance. There can be no assurance that the Company will be able to maintain existing insurance or obtain additional product liability insurance on acceptable terms or with adequate coverage against potential liabilities. Such insurance is expensive, difficult to obtain and may not be available in the future on acceptable terms, if at all. An inability to obtain sufficient insurance coverage on reasonable terms or to otherwise protect against potential product liability claims brought against the Company in excess of its insurance coverage, if any, or a product recall could have a material adverse effect upon the Company's business, financial condition and results of operations. UNCERTAINTY RELATED TO HEALTH CARE REFORM AND THIRD-PARTY REIMBURSEMENT Political, economic and regulatory influences are subjecting the health care industry in the United States to fundamental change. Initiatives to reform health care financing continue to be dominated by cost-containment efforts. The Company anticipates that Congress, state legislatures and the private sector will continue to review and assess controls on health care spending through limitations on the growth of private health insurance premiums and Medicare and Medicaid spending, the increased use of capitated managed care contractors by government payers, price controls on pharmaceuticals and other fundamental changes to the health care delivery system. Any such proposed or actual changes could affect the Company's ultimate profitability or could cause the Company to limit or eliminate spending on development projects. In anticipation of the impending demographic shifts brought about by the "baby boom" generation, legislative debate concerning potential reform to Medicare, the government's health financing program for persons over age 65, is expected to continue, and market forces are expected to drive reductions in health care costs. The Company cannot predict what impact the adoption of any federal or state health care reform measures or future private sector reforms may have on its business. In the United States and foreign markets, sales of the Company's proposed products will depend in part upon the availability of reimbursement from third-party payors, such as government health administration authorities, managed care providers, private health insurers and other organizations. The Company has very limited experience obtaining coverage and reimbursement for its products in the United States. Third-party payors are increasingly challenging the price and cost effectiveness of medical products and services. Significant uncertainty exists as to the reimbursement status of newly approved health care products. OncoVAX(CL), as potentially the first vaccine to treat colon cancer approved for marketing by government regulators, faces particular uncertainties due to the absence of a comparable, approved therapy to serve as a model for pricing and reimbursement decisions. As an autologous product that will not generally be sold through traditional commercial channels, OncoVAX(CL) may present unique coverage and payment issues for Medicare. Because the Company's plans concerning the production, distribution and administration of OncoVAX(CL) do not precisely fit the models established for drug coverage and payment by Medicare, the Company cannot predict whether Medicare will cover and pay for the biologic under its established rules for drugs and biologics. Failure to obtain coverage and adequate reimbursement could have a material adverse effect on the Company's ability to market OncoVAX(CL). With respect to private payors, there can be no assurance that the Company's product candidates will be considered cost effective or that adequate third-party reimbursement will be available to enable the Company to maintain price levels sufficient to realize an appropriate return on its investment in 16 17 product development. If adequate coverage and reimbursement rates are not provided by the government and third-party payors for the Company's products, the market acceptance of these products could be adversely affected, which could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Reimbursement." RADIOACTIVE AND OTHER HAZARDOUS MATERIALS The manufacturing and administration of the Company's HumaRAD products and HumaSPECT require the handling, use and disposal of (90)Yttrium and Technetium Tc 99m, respectively, each a radioactive isotope. These activities must comply with various state and federal regulations. Violations of these regulations could delay significantly completion of clinical trials and commercialization of these products. The Company expects to continue using hazardous chemicals and radioactive compounds in its ongoing research activities. Although the Company believes that safety procedures for handling and disposing of such materials will comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. The Company could be held liable for any damages that result from such an accident, contamination or injury from the handling and disposal of these materials, as well as for unexpected remedial costs and penalties that may result from any violation of applicable regulations, which could result in a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company may incur substantial costs to comply with environmental regulations. See "Business -- Radioactive and Other Hazardous Materials." RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS AND FOREIGN CURRENCY FLUCTUATIONS The Company's international operations are anticipated to comprise a substantial percentage of the Company's net revenue in the future and, accordingly, the Company will be subject to risks associated with international operations. Such risks include managing a multinational organization, fluctuations in currency exchange rates, the burden of complying with international laws and other regulatory and product certification requirements and changes in such laws and requirements, tariffs and other trade barriers, import and export controls, restrictions on the repatriation of funds, inflationary conditions, staffing, employment and severance issues, political and economic instability and longer payment cycles in certain countries. The inability to effectively manage these and other risks could adversely affect the Company's business, financial condition and results of operations. TAX LOSS CARRYFORWARDS The Company's net operating loss carryforwards ("NOLs") expire through the year 2012. Under Section 382 of the Internal Revenue Code of 1986, as amended, utilization of prior NOLs is limited after an ownership change, as defined in Section 382, to an annual amount equal to the value of the corporation's outstanding stock immediately before the date of the ownership change multiplied by the federal long-term exempt tax rate. Each of the Company and PerImmune Holdings has experienced an ownership change, and is limited in its use of its prior NOLs. In the event the Company or PerImmune Holdings achieves profitable operations, these limitations would have the effect of increasing the Company's consolidated tax liability and reducing net income and available cash reserves. See Note 8 to the consolidated financial statements of the Company and Note 13 to the consolidated financial statements of PerImmune Holdings. CONTROL BY OFFICERS, DIRECTORS AND PRINCIPAL STOCKHOLDERS Following consummation of this offering, directors, executive officers and principal stockholders of the Company will beneficially own approximately 26.25% of the outstanding shares of the Company's common stock. Accordingly, these stockholders, individually and as a group, may be able to control the Company and direct its affairs and business, including any determination with respect to a change in control of the Company, future issuances of common stock or other securities by the Company, declaration of dividends on the common stock and the election of directors. See "Principal and Selling Stockholders." 17 18 FUTURE MERGERS AND ACQUISITIONS The Company may acquire complementary businesses, products or technologies in the future although the Company has no pending agreements or commitments. No assurance can be given that the Company will not incur problems in integrating any future acquisition and there can be no assurance that any future acquisition will result in the Company's becoming profitable or, if the Company achieves profitability, that such profitability will be sustainable. Furthermore, there can be no assurance that the Company will realize value from any such acquisition which equals or exceeds the consideration paid. Any such problem could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, future acquisitions by the Company may result in dilutive issuances of equity securities, the incurrence of additional debt, large one-time write-offs and the creation of goodwill or other intangible assets that could result in amortization expense. These factors could have a material adverse effect on the Company's business, financial condition and results of operations. ABSENCE OF PRIOR TRADING MARKET; POTENTIAL VOLATILITY OF STOCK PRICE Prior to this offering, there has been no public market for the common stock and there is no assurance that an active market will develop or be sustained after this offering. The initial public offering price will be determined through negotiations among the Company and the Underwriters and may bear no relationship to the price at which the common stock will trade upon consummation of this offering. The securities markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. The market prices of the common stock of many publicly held biotechnology and pharmaceutical companies have in the past been, and can in the future be expected to be, especially volatile. Announcements of technological innovations or new products by the Company or its competitors, release of reports by securities analysts, developments or disputes concerning patents or proprietary rights, regulatory developments, changes in regulatory or medical reimbursement policies, economic and other external factors, as well as period-to-period fluctuations in the Company's financial results, may have a significant and adverse impact on the market price of the common stock. See "Underwriting." POTENTIAL ADVERSE IMPACT OF SHARES ELIGIBLE FOR FUTURE SALE All of the shares of common stock to be sold in this offering will be freely tradable, except for shares purchased by or issued to any "affiliate" of the Company (within the meaning of the Securities Act). The remaining shares of common stock, representing approximately 74.09% of the outstanding common stock upon consummation of this offering, will be deemed "restricted securities" under the Securities Act, and, as such, will be subject to restrictions on the timing, manner and volume of sales of such shares. Certain holders of those shares will have the right to request the registration of their shares under the Securities Act following the completion of a period of one year, in the case of directors and executive officers, and a period of 180 days, in the case of certain other stockholders, after the date of this Prospectus, which, upon the effectiveness of such registration, would permit the free transferability of such shares. In addition, the Company intends to file a registration statement on Form S-8 for the shares held pursuant to its stock option plans, which may make these shares freely tradeable. See "Shares Eligible for Future Sale." The Company, its executive officers and directors and certain of its current stockholders have agreed that, subject to certain limited exceptions, for a period of one year, in the case of directors and executive officers, and a period of 180 days, in the case of such other stockholders, after the date of this Prospectus, without the prior written consent of the Underwriters, they will not, directly or indirectly, offer to sell, sell or otherwise dispose of any shares of common stock. See "Underwriting." No predictions can be made as to the effect, if any, that future sales of shares or the availability of shares for future sale, will have on the market price for common stock prevailing from time to time. The sale of a substantial number of shares held by existing stockholders, whether pursuant to a subsequent public offering or otherwise, or the perception that such sales could occur, could adversely affect the market price of the 18 19 common stock and could materially impair the Company's future ability to raise capital through an offering of equity securities. DILUTION Purchasers of the shares of common stock offered hereby will experience immediate dilution of $11.78 per share in net tangible book value (deficit) per share after deducting the underwriting discounts and estimated offering expenses. Such investors will experience additional dilution upon the exercise of outstanding options. See "Dilution." ADVERSE IMPACT OF POSSIBLE ISSUANCES OF PREFERRED STOCK; ANTI-TAKEOVER EFFECT OF CERTAIN CHARTER AND BYLAW PROVISIONS The Board of Directors has authority to issue up to 5,000,000 shares of preferred stock and to fix the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock could affect adversely the voting power of the holders of common stock and the likelihood that such holders will receive dividend payments and payments upon liquidation. Additionally, the issuance of preferred stock and certain provisions in the Company's Amended and Restated Certificate of Incorporation, as amended (the "Certificate of Incorporation"), and Bylaws may have the effect of delaying, deferring or preventing a change in control of the Company, may discourage bids for the common stock at a premium over the market price of the common stock and may affect adversely the market price of and the voting and other rights of the holders of the common stock. YEAR 2000 COMPLIANCE Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. Beginning in the year 2000, these date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, in less than one year, computer systems and software used by many companies may need to be upgraded to comply with such "Year 2000" requirements. Management has initiated a program to prepare the Company's computer systems and other electronic applications for the year 2000 (the "Year 2000 Program"). Through the Year 2000 Program, management is currently reviewing the Company's computer systems and other electronic applications in order to identify potential Year 2000 problems. Based upon preliminary results of the Year 2000 Program, management anticipates that the Company's Year 2000 compliance expenses will not be material and that the Company's Year 2000 Program will be completed before January 1, 2000. The Company's failure to successfully complete its Year 2000 Program could have a material adverse effect on the Company's business, financial condition and results of operations. FORWARD-LOOKING STATEMENTS This Prospectus contains forward-looking statements, which may be deemed to include the Company's plans to commercialize OncoVAX(CL) and other product candidates, conduct clinical trials with respect to OncoVAX(CL) and other product candidates, seek regulatory approvals, open OncoVAX Centers, expand its sales and marketing capability, use OncoVAX Centers to conduct clinical trials, evaluate additional product candidates for subsequent clinical and commercial development and apply the proceeds of this offering. In addition, this Prospectus states the Company's belief that the net proceeds of this offering and interest thereon will be adequate to satisfy the requirements of its current and planned operations through the end of 1999. Actual results could differ materially from those projected in any forward-looking statements for a variety of reasons, including those detailed above in this "Risk Factors" section or elsewhere in this Prospectus. 19 20 THE COMPANY The Company is an integrated biopharmaceutical company focused on the development and commercialization of cancer vaccines and of immunotherapeutic and diagnostic products for cancers and infectious diseases. Since its formation in 1987, the Company has grown in part as a result of various strategic mergers and acquisitions. On January 2, 1998, the Company acquired in a tax-free merger (the "Merger") all of the capital stock of PerImmune Holdings, which conducts operations through PerImmune, Inc., its wholly owned subsidiary ("PerImmune"). PerImmune's core research and development expertise in cancer and infectious diseases complements those previously developed by the Company. The Company's expanded resources and greater management depth resulting from the Merger have increased the Company's ability to offer a broader spectrum of diagnostic, prognostic and immunotherapeutic products targeted at cancer and infectious diseases. In particular, the addition of PerImmune's large clinical development group has augmented development of the Company's therapeutic products and the Company's sales and marketing organization has enabled the direct launch of many of PerImmune's diagnostic products. PerImmune Holdings was incorporated in 1996 by the management of PerImmune to acquire all of the common stock of PerImmune from Organon Teknika Corporation, an indirect wholly owned subsidiary of Akzo Nobel, NV ("Organon Teknika"). In November 1995, the Company entered into a Stock Purchase Agreement with Dade International, Inc. ("Dade") by which the Company acquired all of the common stock of Bartels held by Dade. This acquisition provided the Company with entry into the diagnostic products retail market. The Company has historically used significant amounts of debt to finance its operations. In 1998, the Company completed a comprehensive refinancing of its outstanding debt securities. See "Business -- Recent Debt Refinancings." The Company was incorporated under the laws of Massachusetts in 1987 and reincorporated under the laws of Delaware in 1997. The Company's principal executive offices are located at 2005 NW Sammamish Road, Suite 107, Issaquah, Washington 98027 and its telephone number is (425) 392-2992. 20 21 USE OF PROCEEDS The net proceeds to the Company from the sale of the 4,000,000 shares of common stock offered hereby, after deducting underwriting discounts and commissions and estimated offering expenses, are estimated to be approximately $48,360,000 million ($51,987,000 million if the over-allotment option granted by the Company to the Underwriters is exercised in full) based upon an assumed initial public offering price of $13.00 per share. The Company anticipates that such net proceeds, together with its other available cash and cash equivalents, will be used as follows: (i) approximately $25.0 million to support the establishment and early operation of OncoVAX Centers; (ii) $5.0 million to repay existing indebtedness bearing interest at a rate of 12% per annum due when the Company receives the proceeds of this offering; (iii) approximately $5.0 million for the Company's other research and development programs and to conduct clinical trials for the Company's cancer and infectious disease products; (iv) approximately $2.0 million to repay indebtedness bearing interest at a rate of 15% per annum due when the Company receives the proceeds from this offering and (v) the balance for working capital and other general corporate purposes. The Company may also use a portion of the net proceeds to acquire technologies or products complementary to its business, although no material expenditures in connection with any such acquisitions are anticipated as of the date of this Prospectus. Pending application as described above, the Company intends to invest the net proceeds from this offering in short-term investment-grade, interest-bearing instruments. The amounts and timing of the Company's actual expenditures for the purposes described above will depend upon a number of factors, including: the scope and results of preclinical studies and clinical trials; continued progress of the Company's research and development of product candidates; the cost, timing and outcome of regulatory approvals; the adequacy of manufacturing and other facilities; the expenses of expanding the Company's sales and marketing force; the cost involved in preparing, filing, prosecuting, maintaining, defending and enforcing patent claims; the acquisition of technology licenses; the status of competitive products and the availability of other financing. The Company will require substantial additional funds to conduct its operations in the future, and there can be no assurance that such funding will be available on acceptable terms, if at all. The Company expects that its existing capital resources, including the net proceeds of this offering and interest thereon, will be adequate to satisfy the requirements of its current and planned operations until the end of 1999. The occurrence of certain unforeseen events or changed business conditions, however, could result in the application of the proceeds of this offering in a manner other than as described in this Prospectus. DIVIDEND POLICY The Company has never paid a cash dividend on its common stock and does not anticipate paying any cash dividends in the foreseeable future. 21 22 CAPITALIZATION The following table sets forth at September 30, 1998: (a) the actual capitalization of the Company; (b) the pro forma capitalization of the Company giving effect to the mandatory conversion of all outstanding preferred stock, automatic conversion of certain convertible notes payable into common stock effective on the closing of this offering, and the exercise of certain warrants and (c) the pro forma as adjusted to give effect to the receipt of the estimated net proceeds from the sale of the 4,000,000 shares of common stock offered hereby at an assumed initial public offering price of $13.00, and after deducting the underwriting discounts and commissions and offering expenses payable by the Company. This table should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements of the Company and notes thereto appearing elsewhere in this Prospectus. SEPTEMBER 30, 1998 ------------------------------------- PRO PRO FORMA AS ACTUAL FORMA(1) ADJUSTED(2) -------- ---------- ------------ (DOLLAR IN THOUSANDS) Cash, cash equivalents, pledged securities and restricted cash(3)................................................... $ 11,392 $ 17,400 $ 58,760 ======== ========== ============ Long-term debt, non-convertible, including current portion................................................... $ 35,038 $ 37,038 $ 30,038 Long-term debt, convertible, including current portion(4)... 11,035 10,802 10,802 Redeemable and convertible preferred stock, $0.0001 par value; 5,000,000 shares authorized; of which 1,780,220 shares have been authorized for issue in five series subject to mandatory redemption, of which 1,488,771 shares are issued and outstanding, actual; none pro forma and pro forma as adjusted(5)...................................... 21,159 Stockholder's equity (deficit): Common stock, $0.0001 par value; 25,000,000 shares authorized; 7,440,365 shares issued and outstanding, actual; 11,397,533 shares issued and outstanding, pro forma; and 15,397,533 shares issued and outstanding, pro forma as adjusted(6)............................... 1 1 2 Additional paid-in capital................................ 48,145 74,373 122,732 Accumulated deficit....................................... (74,942) (74,942) (74,942) Note receivable due from stockholder...................... (300) (300) (300) -------- ---------- ------------ Total stockholders' equity (deficit).............. (27,097) (868) 47,492 -------- ---------- ------------ Total capitalization.............................. $ 40,136 $ 46,972 $ 88,332 ======== ========== ============ - --------------- (1) Gives effect to the automatic mandatory conversion of 1,488,771 shares of outstanding preferred stock into 3,426,953 shares of common stock, and the conversion of $232,500 of short-term notes payable which will automatically convert into 36,433 shares of common stock at the conclusion of this offering, and the issuance of 493,786 shares of common stock for the exercise of warrants at a weighted average price of $8.12 per share which will automatically expire ten days after the date of this offering. Reflects $2.0 million of non-convertible debt securities which the Company has agreed to issue pursuant to a letter of intent. See "Business -- Recent Debt Refinancings." (2) Adjusted to reflect the sale of 4,000,000 shares of common stock offered hereby assuming a public offering price of $13.00 per share less estimated underwriting discounts and commissions and other expenses of this offering, resulting in net proceeds of $48,360,000, and the repayment of $7,000,000 of various indebtedness that must be redeemed upon completion of this offering. (3) $6.0 million of the cash, cash equivalents, pledged securities and restricted cash is maintained in segregated accounts from which the Company is permitted to obtain funds upon request to the lender. Of the $6.0 million, $4.0 million is invested in pledged securities. $4.92 million of the cash, cash equivalents, pledged securities and restricted cash is maintained in a segregated "interest escrow account" which is restricted for the payment of interest under certain outstanding debt obligations. See Note 14 to the Company's consolidated financial statements contained elsewhere in this Prospectus. (4) Actual includes $232,500 in short-term notes payable which will automatically be converted into 36,433 shares of common stock upon consummation of this offering, and pro forma includes approximately $10,802,000 in notes payable which may be converted at anytime prior to the maturity date of January 15, 2000, at the payee's option into common stock calculated by the sum of the then outstanding principal amount and all accrued interest divided by the price to the public per share set forth on the cover page of this Prospectus. (5) On an actual basis, includes Series A, 730,000 shares authorized, 640,639 shares issued and outstanding; Series A-1, 850,000 shares authorized, 690,951 shares issued and outstanding; Series A-3, 200,000 shares authorized, 156,961 shares issued and outstanding; Series B-1, 100 shares authorized, issued and outstanding; and Series B-2, 120 shares authorized, issued and outstanding. None of such shares will be outstanding on a pro forma and pro forma as adjusted basis. (6) The foregoing computations exclude (i) 1,351,594 shares of common stock issuable upon exercise of stock options outstanding as of September 30, 1998, at a weighted-average exercise price of $3.66 per share; (ii) 1,727,004 shares of common stock issuable upon exercise of warrants expected to remain outstanding after this offering, of which 643,665 are at a weighted-average price of $7.96 per share and 1,083,339 shares which are exercisable at $15.00 per share. 22 23 DILUTION The pro forma net tangible book value (deficit) of the Company as of September 30, 1998, was $(29,566,387), or $(2.59) per share of common stock. Pro forma net tangible book value (deficit) per share represents the Company's total tangible assets less total liabilities divided by 11,397,533 shares of common stock outstanding (after reflecting the automatic mandatory conversion of preferred stock into 3,426,953 shares of common stock, the automatic conversion of notes into 36,433 shares of common stock, which notes automatically convert upon consummation of this offering, and the exercise of warrants to purchase 493,786 shares of common stock, which warrants automatically expire ten days after consummation of this offering). Without taking into account any other changes in the net tangible book value after September 30, 1998, other than to give effect to the sale of 4,000,000 shares of common stock by the Company in this offering (assuming a public offering price of $13.00 per share and after deducting the underwriting discounts and commissions and estimated offering expenses) and the application of the estimated proceeds thereof, the pro forma net tangible book value of the Company as of September 30, 1998, would have been $18,793,613, or $1.22 per share. This amount represents an immediate improvement in pro forma net tangible book value of $3.81 per share to existing stockholders and immediate dilution of $11.78 per share to new investors purchasing common stock in this offering. Dilution per share to new investors represents the difference between the pro forma net tangible book value per share of common stock immediately upon consummation of this offering and the amount per share paid by purchasers of common stock of the Company in this offering. The following table illustrates this per share dilution as of September 30, 1998: Assumed initial public offering price per share............. $13.00 Pro forma net tangible book value per share at September 30, 1998............................................... $(2.59) Improvement per share attributable to new investors....... 3.81 ------ Pro forma net tangible book value per share after this offering.................................................. 1.22 ------ Dilution per share to new investors......................... $11.78 ====== 23 24 PRO FORMA CONSOLIDATED FINANCIAL INFORMATION The following unaudited consolidated pro forma statement of operations (the "Pro Forma Consolidated Financial Information") gives pro forma effect to the completion of the Merger of PerImmune Holdings on January 2, 1998, after giving effect to the pro forma adjustments described in the accompanying notes as if the Merger had occurred on January 1, 1997. The Pro Forma Consolidated Financial Information has been prepared from, and should be read in conjunction with, the historical consolidated financial statements and notes thereto of each of the Company and PerImmune Holdings. The Pro Forma Consolidated Financial Information is provided for illustrative purposes only and does not purport to represent what the actual results of operations of the Company would have been had the Merger occurred on the date assumed, nor is it necessarily indicative of the Company's future operating results. The following table enumerates the unaudited pro forma consolidated statement of operations. YEAR ENDED DECEMBER 31, 1997 ------------------------------------------------------- ACQUIRED PRO FORMA PRO FORMA COMPANY BUSINESS ADJUSTMENTS CONSOLIDATED ---------- -------- ----------- ------------ (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Revenue Product..................................... $ 13,452 $ 2,111 $ 15,563 Contract.................................... 5,778 5,778 ---------- -------- ------- ---------- Total revenue............................. 13,452 7,889 21,341 Cost of revenue Product..................................... 8,661 1,600 10,261 Contract.................................... 5,016 5,016 ---------- -------- ------- ---------- Total cost of revenue..................... 8,661 6,616 15,277 Selling, general and administrative........... 8,478 2,849 $ 1,595(1) 12,922 Research and development...................... 556 8,077 8,633 Amortization of cost in excess of net assets acquired.................................... 908 85(1) 993 ---------- -------- ------- ---------- Total operating expense.................. 18,603 17,542 1,680 37,825 ---------- -------- ------- ---------- Loss from operations..................... (5,151) (9,653) (1,680) (16,484) Interest income (expense), net................ (2,913) (837) (3,750) Loss on sale-leaseback transaction............ (335) (335) ---------- -------- ------- ---------- Net loss................................. (8,064) (10,825) (1,680) (20,569) Preferred stock dividends/accretion........... (1,261) (32) 32(2) (1,261) ---------- -------- ------- ---------- Net loss used in calculating loss per share.................................. $ (9,325) $(10,857) $(1,648) $ (21,830) ========== ======== ======= ========== Basic and diluted net loss per share.......... $ (3.43) ========== Pro forma net loss per share.................. $ (3.43) ========== Shares used in calculating per share data..... 2,715,599 6,368,035 ========== ========== - --------------- (1) Represents the pro forma effects of amortization expenses recognized on intangible assets on which a portion of the purchase price was allocated in conjunction with the Merger. The allocation of the purchase price, the amortization periods of the intangible assets and the annual amortization expense to be recognized on those assets are as follows (dollars in thousands): PURCHASE AMORTIZATION ANNUAL PRICE PERIOD AMORTIZATION ALLOCATION (YEARS) EXPENSE ---------- ------------ ------------ Working capital (deficit) acquired.......................... $ (145) Other long-term assets...................................... 5,436 Workforce in progress....................................... 144 3 $ 48 Product technology.......................................... 6,861 10 686 Patents..................................................... 8,608 10 861 Cost in excess of net assets acquired....................... 849 10 85 Acquired in-process research and development................ 37,718 ------- ------ $59,471 $1,680 ======= ====== (2) Represents the pro forma effect of the Merger. The acquired business' Series A and Series B redeemable and convertible preferred stock was exchanged for Intracel Series B-1 and Series B-2 preferred stock. Accordingly, the acquired business' preferred stock dividends/accretion is eliminated. 24 25 SELECTED FINANCIAL DATA SELECTED FINANCIAL DATA FOR INTRACEL CORPORATION The selected financial data below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operation," the consolidated financial statements of the Company and the notes thereto included elsewhere in this Prospectus. The statement of operations data for the years ended June 30, 1993 and June 30, 1994 and the balance sheet data at June 30, 1993, June 30, 1994, June 30, 1995 and December 31, 1995 are derived from the financial statements of the Company not included in this Prospectus. The statement of operations data for the year ended June 30, 1995, the six months ended December 31, 1995 and the year ended December 31, 1996 and the balance sheet data as of December 31, 1996 are derived from the consolidated financial statements of the Company included elsewhere in this Prospectus and have been audited by Ernst & Young LLP, independent auditors. The financial statement data as of and for the year ended December 31, 1997 is derived from the financial statements of the Company included elsewhere in this Prospectus and has been audited by PricewaterhouseCoopers LLP, independent accountants. The pro forma financial data for the year ended December 31, 1997 and the financial data as of and for the periods ended September 30, 1997 and 1998 are unaudited but have been prepared on a basis consistent with the audited consolidated financial statements of the Company and the notes thereto and included all adjustments (constituting only normal recurring adjustments), which the Company considered necessary for a fair presentation of the information. The results of operation for the nine months ended September 30, 1998 are not necessarily indicative of results to be expected for the year or for any future periods. SIX MONTHS YEAR ENDED YEAR ENDED JUNE 30, ENDED DECEMBER 31, -------------------------- DECEMBER 31, ------------------- 1993 1994 1995 1995(2) 1996 1997 ------ ------- ------- ------------ -------- -------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Revenue Product....................................... $1,776 $ 1,618 $ 1,566 $ 2,426 $ 14,718 $ 13,452 Contract...................................... ------ ------- ------- ------- -------- -------- Total revenue............................... 1,776 1,618 1,566 2,426 14,718 13,452 ------ ------- ------- ------- -------- -------- Cost of revenue Product....................................... 533 449 824 1,779 8,265 8,661 Contract...................................... ------ ------- ------- ------- -------- -------- Total cost of revenue....................... 533 449 824 1,779 8,265 8,661 Selling, general and administrative............. 962 801 1,580 2,593 5,740 8,478 Research and development........................ 785 1,078 1,174 1,118 1,043 556 Acquired research and development............... 2,100 Amortization of costs in excess of net assets acquired...................................... 151 908 908 Reorganization expense.......................... 917 ------ ------- ------- ------- -------- -------- Total operating expense..................... 2,280 2,328 3,578 7,741 16,873 18,603 ------ ------- ------- ------- -------- -------- Loss from operations.......................... (504) (710) (2,012) (5,315) (2,155) (5,151) Interest income (expense), net.................. 47 22 68 (135) (2,235) (2,913) Gain on pension curtailment..................... Other income.................................... Loss on sale-leaseback transaction.............. ------ ------- ------- ------- -------- -------- Loss before extraordinary item................ (457) (688) (1,944) (5,450) (4,390) (8,064) Extraordinary gain on early extinguishment of debt.......................................... 1,367 ------ ------- ------- ------- -------- -------- Net loss...................................... (457) (688) (1,944) (4,083) (4,390) (8,064) Preferred stock dividends/accretion............. (211) (266) (790) (1,261) ------ ------- ------- ------- -------- -------- Net loss used in calculating loss per share... $ (457) $ (688) $(2,155) $(4,349) $ (5,180) $ (9,325) ====== ======= ======= ======= ======== ======== Net loss basic and diluted per share(3)....... $(0.18) $ (0.26) $ (0.82) $ (1.68) $ (1.99) $ (3.43) ====== ======= ======= ======= ======== ======== Shares used in computing net loss per share..... 2,610 2,631 2,642 2,591 2,597 2,716 ====== ======= ======= ======= ======== ======== BALANCE SHEET DATA: Cash, cash equivalents, pledged securities and restricted cash(4)............................ $ 648 $ 421 $ 2,370 $ 4,072 $ 3,145 $ 1,975 Working capital (deficit)....................... 1,072 569 2,273 1,986 1,525 (270) Total assets.................................... 1,912 1,632 3,728 25,646 26,523 28,042 Long-term debt, including current portion....... 102 281 193 18,047 22,744 20,275 Redeemable, convertible preferred stock......... 3,961 9,578 10,367 11,222 Accumulated deficit............................. (537) (1,226) (3,381) (7,730) (12,909) (21,180) Total stockholders' equity (deficit)............ 1,422 834 (1,314) (5,624) (10,605) (9,778) PRO FORMA NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, DECEMBER 31, ------------------------- 1997(1) 1997 1998(2) ------------ ----------- ----------- (UNAUDITED) (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Revenue Product....................................... $ 15,563 $ 10,231 $ 10,862 Contract...................................... 5,778 3,382 -------- -------- -------- Total revenue............................... 21,341 10,231 14,244 -------- -------- -------- Cost of revenue Product....................................... 10,261 5,909 7,678 Contract...................................... 5,016 1,910 -------- -------- -------- Total cost of revenue....................... 15,277 5,909 9,588 Selling, general and administrative............. 12,922 5,912 11,101 Research and development........................ 8,633 523 8,420 Acquired research and development............... 37,718 Amortization of costs in excess of net assets acquired...................................... 993 681 744 Reorganization expense.......................... -------- -------- -------- Total operating expense..................... 37,825 13,025 67,571 -------- -------- -------- Loss from operations.......................... (16,484) (2,794) (53,327) Interest income (expense), net.................. (3,750) (2,100) (3,293) Gain on pension curtailment..................... 800 Other income.................................... 1,273 Loss on sale-leaseback transaction.............. (335) -------- -------- -------- Loss before extraordinary item................ (20,569) (4,894) (54,547) Extraordinary gain on early extinguishment of debt.......................................... 785 -------- -------- -------- Net loss...................................... (20,569) (4,894) (53,762) Preferred stock dividends/accretion............. (1,261) (897) (1,958) -------- -------- -------- Net loss used in calculating loss per share... $(21,830) $ (5,791) $(55,720) ======== ======== ======== Net loss basic and diluted per share(3)....... $ (3.43) $ (2.23) $ (7.64) ======== ======== ======== Shares used in computing net loss per share..... 6,368 2,596 7,291 ======== ======== ======== BALANCE SHEET DATA: Cash, cash equivalents, pledged securities and restricted cash(4)............................ $ -- $ 11,392 Working capital (deficit)....................... 858 4,817 Total assets.................................... 22,427 51,960 Long-term debt, including current portion....... 20,281 46,073 Redeemable, convertible preferred stock......... 11,002 21,159 Accumulated deficit............................. (18,011) (74,942) Total stockholders' equity (deficit)............ (12,175) (27,097) - --------------- (1) Gives effect to the acquisition of PerImmune Holdings as if it had occurred on January 1, 1997. See "Pro Forma Consolidated Financial Information." (2) The six months ended December 31, 1995 and the subsequent periods include the operations of Bartels, which was acquired by the Company in November 1995. The 1998 results include the operations of PerImmune Holdings, which the Company acquired in January 1998. See Note 11 to the Company's consolidated financial statements. (3) See Note 2 to the Company's consolidated financial statements contained elsewhere in this Prospectus for an explanation of earnings per share calculations. (4) The 1998 amount includes $6.0 million maintained in segregated accounts from which the Company is permitted to obtain funds upon requests to the lender, and $4.92 million maintained in a segregated "interest escrow account" which is restricted for the payment of interest under certain outstanding debt obligations. Of the $6.0 million in the segregated accounts, $4.0 million is invested in pledged securities. See Note 14 to the Company's consolidated financial statements contained elsewhere in this Prospectus. 25 26 SELECTED FINANCIAL DATA FOR PERIMMUNE HOLDINGS AND PREDECESSOR COMPANIES The selected financial data below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," the consolidated financial statements of PerImmune Holdings and the notes thereto included elsewhere in this Prospectus. The balance sheet data as of December 31, 1993 and the statement of operations data for the year then ended and for the year ended December 31, 1994 are derived from the financial statements of OT Biotechnology Research Institute ("BRI"), a predecessor company to PerImmune which operated as a division of Organon Teknika, an indirect wholly owned subsidiary of Akzo Nobel, NV. Such financial statements are not included in this Prospectus but have been audited by KPMG LLP, independent certified public accountants. The balance sheet data as of December 31, 1994 and 1995 are derived from the financial statements of PerImmune, which was incorporated as a wholly owned subsidiary of Organon Teknika in December 1994 (BRI and PerImmune, collectively, are referred to as the "Predecessor Companies"). Such financial statements are not included in this Prospectus but have been audited by KPMG LLP, independent certified public accountants. The statement of operations data for the year ended December 31, 1995 is derived from the statement of operations of PerImmune, which is included elsewhere in this Prospectus and which was audited by KPMG LLP, independent certified public accountants. The balance sheet data as of August 2, 1996 have been derived from the unaudited financial statements of PerImmune and have been prepared on a basis consistent with the audited financial statements of PerImmune and the notes thereto and include all adjustments (constituting only normal recurring adjustments) necessary for a fair presentation of the information. The statement of operations data for the period ended August 2, 1996 is derived from the financial statements of PerImmune included elsewhere in this Prospectus and has been audited by KPMG LLP, independent certified public accountants. The balance sheet data as of December 31, 1996 and the statement of operations data for the period then ended were derived from the consolidated financial statements of PerImmune Holdings included elsewhere in this Prospectus and have been audited by KPMG LLP, independent certified public accountants. The balance sheet data as of December 31, 1997 and the statement of operations data for the year then ended are derived from the consolidated financial statements of PerImmune Holdings included elsewhere in this Prospectus, and have been audited by PricewaterhouseCoopers LLP, independent accountants. PREDECESSOR COMPANIES (1) PERIMMUNE HOLDINGS ------------------------------------------ --------------------------- JANUARY 1 AUGUST 3 YEAR ENDED DECEMBER 31, THROUGH THROUGH YEAR ENDED ----------------------------- AUGUST 2, DECEMBER 31, DECEMBER 31, 1993 1994 1995 1996 1996 1997 -------- ------- -------- ---------- ------------ ------------ (DOLLARS IN THOUSANDS) STATEMENT OF OPERATIONS DATA: Revenue: Government contracts............................... $ 3,947 $ 6,005 $ 6,578 $ 3,420 $ 2,751 $ 1,869 Commercial and affiliate contracts................. 485 776 2,152 1,106 3,909 Product sales...................................... 821 1,247 1,407 1,632 594 2,111 -------- ------- -------- ------- ------- -------- Total revenue.................................. 4,768 7,737 8,761 7,204 4,451 7,889 -------- ------- -------- ------- ------- -------- Operating expenses: Cost of contracts and sales: Government contracts............................... 3,469 5,173 5,779 3,375 1,968 1,585 Commercial and affiliate contracts................. 9,996 9,796 10,189 6,299 886 3,431 Product sales...................................... 609 822 1,124 1,102 325 1,600 -------- ------- -------- ------- ------- -------- Total cost of contracts and sales.............. 14,074 15,791 17,092 10,776 3,179 6,616 Selling, general and administrative.................. 1,034 1,264 1,283 740 708 2,241 Research and development............................. 467 239 360 189 4,683 8,077 Other................................................ 50 29 14 10 608 -------- ------- -------- ------- ------- -------- Total operating expenses....................... 15,575 17,344 18,764 11,719 8,580 17,542 -------- ------- -------- ------- ------- -------- Loss from operations........................... (10,807) (9,607) (10,003) (4,515) (4,129) (9,653) Interest (expense), net................................ (446) (837) Loss on sale-leaseback transaction..................... (335) -------- ------- -------- ------- ------- -------- Loss before income taxes....................... (10,807) (9,607) (10,003) (4,515) (4,575) (10,825) Provision for income taxes............................. -- -- -- -- -------- ------- -------- ------- ------- -------- Net loss....................................... $(10,807) $(9,607) $(10,003) $(4,515) $(4,575) $(10,825) ======== ======= ======== ======= ======= ======== BALANCE SHEET DATA: (UNAUDITED) Cash and cash equivalents.............................. $ 2 $ 2 $ 2 $ 193 $ 2,424 $ 2,504 Working capital (deficit).............................. 3,123 3,244 3,014 (18) (3,835) (8,871) Total assets........................................... 7,506 12,694 12,829 12,650 13,624 8,030 Long-term debt, including current portion.............. 14,835 10,393 Redeemable, convertible preferred stock................ 9,786 Accumulated deficit.................................... (10,003) (14,518) (5,485) (16,310) Total stockholders' equity (deficit)................... 5,844 10,242 10,521 9,161 (5,485) (16,027) - --------------- (1) Effective August 3, 1996, 100% of PerImmune's common stock was acquired by PerImmune Holdings from Organon Teknika in exchange for a $9,234,935 note payable. Prior to the acquisition, the Predecessor Companies performed certain research and development activities for, and were reimbursed by, Organon Teknika and other affiliates under contractual agreements. The cost related to those activities prior to the acquisition were presented as part of "Cost of contacts and sales -- Commercial and affiliate contracts" in the above selected financial data. Subsequent to the acquisition by PerImmune Holdings, costs incurred in research and development activities were presented as "Research and development" expenses as those activities were primarily performed for PerImmune's own benefit and were not reimbursed. 26 27 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Management's Discussion and Analysis of Financial Condition and Results of Operations may contain forward-looking statements which involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under "Risk Factors" and elsewhere in this Prospectus. This discussion and analysis should be read in conjunction with the financial statements and the notes thereto included elsewhere in this Prospectus. OVERVIEW The Company is an integrated biopharmaceutical company, focused on the development and commercialization of cancer vaccines and of immunotherapeutic and diagnostic products for cancers and infectious diseases. The Company is applying its extensive expertise in immunology and its clinical, regulatory, manufacturing and marketing experience to develop a portfolio of innovative therapeutic, prognostic and diagnostic products. On January 2, 1998, the Company acquired all of the capital stock of PerImmune Holdings. With the consummation of the Merger, PerImmune Holdings became a subsidiary of Intracel. Management's Discussion and Analysis of Financial Condition and Results of Operations for each of Intracel and PerImmune Holdings for 1997, 1996 and 1995 will be presented, as appropriate, on a separate basis. The results of operations for the nine-month period ended September 30, 1998 and forward-looking liquidity and capital resources will be discussed on a consolidated basis. INTRACEL -- RESULTS OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 1997 Revenues increased $4.0 million or 39.2% to $14.2 million as compared to $10.2 million for the nine months ended September 30, 1998 and 1997, respectively. Product revenues generated by the Company's portfolio of diagnostic products, which are used for the confirmation of viral and bacterial diseases, increased by $0.7 million, or 6.9%, to $10.9 million as compared to $10.2 million for the nine months ended September 30, 1997. This increase is primarily the result of $1.5 million of product revenues arising from the acquisition of PerImmune Holdings offset by a decline of $0.9 million of product revenues as compared to the nine months ended September 30, 1997. This decline is due to eroding sales prices of certain of the Company's product lines due to increased competition, the loss of a distributing right to a high sales volume product and the Company's decision at the end of 1997 to move its manufacturing for the INSTI product to Canada, which came on line in March 1998. Contract revenues for the nine months ended September 30, 1998 were $3.4 million, all associated with the acquisition of PerImmune Holdings. Approximately $1.0 million is attributable to non-recurring revenue from a commercial contract for the treatment of refractory bladder cancer, and the remaining $2.4 million is associated with recurring government and commercial projects. Cost of revenues increased $3.7 million, or 62.7%, to $9.6 million as compared to $5.9 million for the nine months ended September 30, 1998 and 1997, respectively. This increase was primarily comprised of $1.9 million for cost of contract revenue and $1.1 million of cost of product revenues wholly attributable to the acquisition of PerImmune Holdings for the nine months ended September 30, 1998 as compared to the nine months ended September 30, 1997. Selling, general and administrative expenses increased $5.2 million, or 88.1%, to $11.1 million as compared to $5.9 million for the nine months ended September 30, 1998 and 1997, respectively. This increase is primarily comprised of $2.0 million of expenses associated with the hiring of additional personnel, primarily resulting from the Company's continued expansion of its internal marketing and sales organization, $1.9 million of related expenses attributable to the acquisition of PerImmune Holdings and $1.3 million of amortization expense pertaining to the assets acquired from PerImmune Holdings. 27 28 Research and development expense increased $7.9 million, or 1,580.0%, to $8.4 million as compared to $0.5 million for the nine months ended September 30, 1998 and 1997, respectively. $8.2 million of this increase is attributable to the acquisition of PerImmune Holdings. Interest expense increased by $1.2 million, or 57.1%, to $3.3 million as compared to $2.1 million for the nine months ended September 30, 1998 and 1997, respectively. This increase is primarily attributable to the overall increase in the Company's debt obligations as a result of the debt refinancings that took place in 1998. See "Business -- Recent Debt Refinancings." A gain of $0.8 million was recognized in conjunction with the curtailment of the PerImmune Holdings pension plan. Other income in the amount of $1.3 million was recognized of which $1.1 million was attributable to the settlement of a contingency for which the Company had previously recorded a liability, and $0.2 million was attributable to the recovery of an investment previously written off. Extraordinary gain on the extinguishment of debt in the amount of $0.8 million was recognized of which $0.4 million was attributable to the settlement of a note payable previously in dispute for the purchase of certain assets, and $0.9 million was in connection with the Company's August 1998 refinancing whereby a noteholder as a condition of early extinguishment agreed to waive a "make-whole" guarantee provision of its note, resulting in a reversal by the Company of all accumulated accrued interest recorded through the date of the refinancing. Offsetting the gain in connection with the refinancing was approximately $0.5 million of loss on the extinguishment of debt attributable to the write-off of the then unamortized balance of debt issue costs associated with the obligations that were refinanced. 1997 COMPARED TO 1996 Diagnostics revenue decreased $1.2 million, or 8.2%, to $13.5 million in 1997 as compared to $14.7 million for the twelve months ended December 31, 1996. The Company believed the decline was in part related to the ineffectiveness of a third-party distributor agreement. In response, the Company decided to establish its own internal marketing and sales organization and terminated such agreement during 1997. During 1997, the Company's INSTI product for HIV/AIDS testing was introduced to international markets at a price designed to facilitate market penetration. This pricing strategy resulted in an increase of revenues from $0.1 million to $0.5 million. Cost of product sales increased $0.4 million, or 4.8%, to $8.7 million in 1997. The increase is a combination of several items. During 1996 and 1997 the Company evaluated its research-related inventory, ("RUO Inventory") to determine obsolete inventory quantities. As a result the Company recorded adjustments in 1996 and 1997 to Cost of Sales in the amounts of $1.1 million and $0.3 million, respectively. After adjusting for obsolescence the Company's cost of products sales increased approximately $1.2 million primarily due to the Company's cost of products sales for INSTI products exceeding product revenues by $0.8 million. Selling, general and administrative expenses increased by $2.8 million, or 49.1%, to $8.5 million. The increase was due to several factors. The Company established its own internal marketing and sales organization in 1997. In addition, the Company formed a regulatory department to provide quality control in compliance with regulatory requirements to support Bartel's lines of production and newly emerging products such as INSTI and ZYMMUNE. The Company also incurred costs in connection with the Company's merger and acquisition program, which included the Merger on January 2, 1998. A lease for a fully developed diagnostic manufacturing facility was acquired in September 1996 with associated costs included for all in 1997. Research and development expenses decreased $0.4 million, or 40.0%, to $0.6 million in 1997 as a result of reduced payments under a specific contract. Reorganization expense of $0.9 million was incurred in 1996, in connection with the Company's relocation from Cambridge, Massachusetts to Issaquah, Washington. Interest expense increased $0.7 million, or 31.8%, to $2.9 million in 1997 primarily related to interest rate increases associated with certain debt instruments and $0.4 million for the Company's make whole provision associated with a certain debt instrument. 28 29 SIX MONTHS ENDED DECEMBER 31, 1995 Due to a change in the Company's fiscal year end from June 30 to December 31 during 1995, all information in the following paragraphs under this section applies to the six months ended December 31, 1995. Product sales for the six months ended December 31, 1995 were $2.4 million, primarily comprised of $1.8 million from diagnostic product sales generated by Bartels from the date of its acquisition. For the six-month period ended December 31, 1995, cost of product sales was $1.8 million, primarily comprised of $1.2 million pertaining to Bartels' cost of product sales. Selling, general and administrative expenses for the six months ended December 31, 1995 totaled $2.6 million. Research and development expenses of $1.1 million for the six-month period ended December 31, 1995 were associated with a specific contract. An additional $2.1 million was expensed in the six months ended December 31, 1995 for acquired in-process research and development associated with the acquisition of Bartels. The Company recognized an extraordinary gain for the six months ended December 31, 1995 of $1.4 million, pertaining to the Company's early retirement of debt. TWELVE MONTHS ENDED JUNE 30, 1995 Net revenues of $1.6 million for the year ended June 30, 1995 were comprised of sales of proteins and antibodies for use in diagnostic and research applications. Cost of sales of $0.8 million consisted of the cost to manufacture the various proteins and antibodies for the year ended June 30, 1995. Selling, general and administrative expenses were $1.6 million for the year ended June 30, 1995. Research and development expenses of $1.2 million for the year ended June 30, 1995 were associated with a specific contract. INTRACEL -- LIQUIDITY The Company's operating activities used $2.5 million in 1997 resulting from the net loss of $2.9 million (adjusted for non-cash items) offset by a $0.4 million reduction in investment in working capital. Investing activities used $4.2 million of which $2.0 million represented the deposit in escrow of restricted cash associated with a debt issue. Additionally, $1.4 million was invested in the purchase of property and equipment and $0.8 million was invested or advanced to Bartels Prognostics, Inc., an unconsolidated subsidiary in which the Company has a minority interest ("Bartels Prognostics"). Net cash from financing activities of $5.5 million was primarily comprised of $1.7 million from the sale of preferred stock and $6.0 million net from the sale of common stock and the exercise of warrants and options, offset by $2.3 million of payments on long-term debt net of proceeds of new issuances and associated costs. PERIMMUNE HOLDINGS -- RESULTS OF OPERATIONS PerImmune Holdings' operations are conducted in one business segment which applies biotechnology and other life sciences technologies to develop and provide products and services. PerImmune Holdings groups these activities into three operating activities: Government Contracts, Commercial Contracts and Product Sales. PerImmune Holdings' operations began on August 3, 1996 with its acquisition of PerImmune from Organon Teknika, an indirect wholly owned subsidiary of Akzo Nobel, NV, in a leveraged buyout. Therefore, all comparisons are for the full year of 1997 as compared to approximately five months of 1996. TWELVE MONTHS ENDED DECEMBER 31, 1997 COMPARED WITH THE FIVE MONTHS ENDED DECEMBER 31, 1996 Revenues increased $3.4 million, or 75.6%, to $7.9 million in the 1997 period. Government contracts revenues decreased $0.9 million, or 32.1%, to $1.9 million. This decrease was the result of several contracts which ended during the United States government fiscal year, October 1996 to September 1997, with only one 29 30 of those contracts being renewed, at a much lower dollar value than in prior years. Management decided to de-emphasize the government contract business and instead focus on future products and services. Commercial contract revenues increased by $2.8 million, or 254.5%, to $3.9 million in the 1997 period. This increase was due to the start of a research and development contract with Baxter Healthcare Corporation ("Baxter") and the difference in the length of the two reporting periods. Product sales increased by $1.5 million, or 250.0%, to $2.1 million in the 1997 period due entirely to the difference in the length of the two reporting periods. There was also a decrease of $0.3 million in 1997 sales due to the completion of research and development for PerImmune's previous parent in 1996. Gross profit was approximately the same for both years. Government contract gross profits declined from 28.5% of sales to 15.2% of sales due to the start-up of new contracts and additional costs not expected on contracts completed. Commercial contract gross profits declined from 19.9% of sales in the 1996 period to 12.2% in the 1997 period of sales due to non-billable overruns on various fixed price research and development contracts. Product sales gross profits decreased from 45.3% in the 1996 period to 24.2% in 1997 of sales due to start-up and validation expenses related to products that received marketing clearance from the FDA in late 1997. Selling, general administrative expense increased by $1.5 million in the 1997 period, or 214.3%, due to the change in reporting periods and the initial payment of over $0.3 million in connection with marketing studies prior to the launch of the HumaSPECT product line. Previously, PerImmune's former parent had paid marketing costs for this product line. Research and development costs increased $3.4 million, or 72.3%, in 1997 due to the change in reporting periods, introduction of several clinical trials and filing of applications for approval with the FDA, offset by lower research and development activity as PerImmune Holdings placed more emphasis on its largest projects while eliminating others. Other expense increased by $0.6 million due in part to facility costs that in the past had been allocated to government contracts that were completed in 1996. Interest expense increased by $0.6 million, or 150.0%, to $1.0 million in 1997, due to the change in reporting periods. Interest income of $0.2 million in 1997 was due to the earnings on excess cash received from the sale-leaseback of PerImmune's corporate headquarters building in January 1997, which also resulted in a $0.3 million loss. PERIMMUNE HOLDINGS -- LIQUIDITY PerImmune Holdings' operating activities used $8.5 million in 1997 resulting from the net loss of $9.9 million (adjusted for non-cash items) offset by a $1.4 million in reduction in investment in working capital. Investing activities generated $3.6 million of which $5.1 million related to the purchase and sale-leaseback transaction referred to above and leaseback improvements offset by capital expenditures of $0.3 million and $1.2 million paid to an investment bank. Net cash from financing activities of $5.0 million included $9.8 million from issuance of convertible preferred stock, $0.3 million from issuance of common stock and $0.9 million from issuance of notes payable offset by $5.6 million in payment of notes payable and $0.4 million of increase in restricted cash. CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES As stated earlier, the future liquidity and capital resources of the Company will be discussed on a post-Merger consolidated basis. The Company's operating activities used $8.9 million for the nine months ended September 30, 1998, resulting from the net loss of $12.4 million (adjusted for non-cash and non-operating items) offset by a $3.6 million reduction in investment in working capital. Investing activities for the nine months ended September 30, 1998 used $8.1 million, as a result of $4.0 million invested in pledged securities, $7.0 million deposited as restricted cash, $1.3 million paid in conjunction with the merger of PerImmune Holdings and $0.5 million used for the acquisition of property and equipment, offset by $2.5 million cash acquired in conjunction with the merger, $2.0 million from the release of restricted cash in escrow and a $0.2 million recovery of an investment in GAIFAR. Financing activities for the nine months ended September 30, 1998 30 31 provided $15.4 million primarily from the issuance of new debt and warrants of $50.1 million, net of issuance costs, offset by payments of long-term debt obligations, a line of credit and pension liability, and redemption of Series A-2 preferred stock in the aggregate amount of $34.3 million and $0.8 million paid in conjunction with the initial public offering of the Company's common stock. During the first quarter of 1998, the Company announced the results of a ten-year Phase III clinical trial for OncoVAX(CL), which the Company believes is the first vaccine to demonstrate efficacy for the post-surgical treatment of Stage II colon cancer. The Company plans to begin treatment of patients using the OncoVAX(CL) vaccine by establishing OncoVAX Centers in Europe and the United States. Over 40 OncoVax Centers are expected to be established in the next several years. The Company expects capital expenditures to increase over the next several years as the OncoVAX Centers are established. Currently, the Company is investigating various options for funding the OncoVAX Center capital expenditures which are estimated to require an investment between $1.0 and $3.0 million per site. This may include, but is not limited to, capital equipment vendor financing, lease lines, and strategic alliances with the hospitals associated with the OncoVAX Centers. Currently the Company has no material commitments for such capital expenditures. In addition to the capital expenditures required for each OncoVAX Center, working capital requirements of the Company will increase in association with the build-up of patient receivables as each OncoVAX Center becomes operational. As of September 30, 1998, the Company's accumulated deficit was approximately $74.9 million. Included in the accumulated deficit is a one-time expense of $37.7 million which was incurred in the first quarter of 1998 related to acquired in-process research and development consisting of six projects which were undergoing continuing development and/or clinical trials as they approached approval by the FDA. As each of these projects was in development at the date of the Merger with PerImmune, technological feasibility for the projects was not established. The research projects acquired were all specifically designed to address specific indications with focused therapies, which may or may not lead to the development of "platform technologies," having alternative future uses outside of the contemplated indications. If the Company continues to pursue such "platform technologies," the aggregate expenditures to facilitate the completion of these projects for the remainder of 1998, 1999, 2000, 2001 and 2002 are estimated to be $1.5 million, $3.5 million, $3.6 million, $3.7 million and $2.7 million, respectively. At September 30, 1998, the Company had working capital of approximately $4.8 million with approximately $11.4 million in cash, cash equivalents and pledged securities as its principal source of liquidity. As all of PerImmune's contracts and commitments survived the Merger, the Company is now responsible for honoring the terms and conditions of these agreements. The Company considers all such contracts and agreements to be of a normal, recurring nature and consistent with the operational functions of the Company. The material contracts are discussed in further detail in the notes to the financial statements of PerImmune Holdings, Inc. and Subsidiary and elsewhere in this Prospectus. During 1997, the Company received certain amendments and waivers to a debt agreement and its covenants. These amendments and waivers were retroactive to January 1, 1997 and remained in effect until June 30, 1998. The amendments and waivers became effective upon the consummation of the Merger. On April 1, 1998, the Company repaid all amounts outstanding under the debt agreement associated with the amendments and waivers. On August 25, 1998, the Company obtained additional financing of approximately $42.0 million through the issuance of equity securities and additional debt instruments. Of this amount, approximately $27.3 million was used for the retirement of existing debt or to redeem outstanding shares of preferred stock, approximately $4.9 million was deposited into an escrow account which is equivalent to four scheduled interest payments on the new debt agreement and $6.0 million was deposited into a segregated bank account from which the Company is permitted to obtain funds upon request to the lender, with the balance applied to meeting the working capital needs of the Company. The Company's current material indebtedness consists of a 12% Guaranteed Senior Secured Primary Note due August 25, 2003 in the aggregate original principal amount of $35.0 million and a 12% Guaranteed Senior Secured Escrow Note due August 25, 2003 in the aggregate original principal amount of $6.0 million. See further discussion of the outstanding indebtedness of the Company as set forth under "Business -- Recent Debt Refinancings" and elsewhere in this Prospectus. 31 32 The Company believes that its sources of liquidity, together with net proceeds from its private placements and borrowings, as well as the proceeds from this offering will be sufficient to satisfy its funding needs for operations through the end of 1999. Since June 30, 1995, the Company has incurred negative cash flow from operations and does not expect to generate positive cash flow to fund its operations for the next few years. This estimate of the period for which the Company expects its available sources of liquidity to be sufficient to meet its capital requirements is a forward-looking statement that involves risks and uncertainties. There can be no assurance that the Company will be able to meet its capital requirements for this period as a result of certain factors set forth under "Risk Factors -- Future Capital Requirements: Uncertainty of Additional Funding" and elsewhere in this Prospectus. In the event the Company's capital requirements are greater than estimated, the Company may need to raise additional capital to fund its research and development and to expand its sales and marketing efforts to support the commercialization of its products under development. The Company's future liquidity and capital funding requirements will depend on numerous factors, including the extent to which the Company's products under development are successfully developed and gain market acceptance, the timing of regulatory actions regarding the Company's products under development, the costs and timing of expansion of sales, marketing and manufacturing activities, procurement and enforcement of patents important to the Company's business and results of clinical trials, regulatory approvals and competition. There can be no assurance that additional capital will be available on terms acceptable to the Company, if at all. Furthermore, any additional equity financing may be dilutive to stockholders, and debt financing, if available, may include restrictive covenants. If adequate funds are not available, the Company may be required to curtail certain Company operations or to obtain funds through entering into collaborative agreements or other arrangements on unfavorable terms. The failure by the Company to raise capital on acceptable terms when needed could have a material adverse effect on the Company's business, financial condition or results of operations. The Company may incur additional operating losses over the next few years in connection with the establishment and operation of its OncoVAX Centers. Historically, such losses have been principally the result of the various costs associated with the Company's research and development programs and pre-clinical and clinical activities. The Company expects that losses will fluctuate from quarter to quarter and that such fluctuations may be substantial. To date the Company's revenues have primarily resulted from product sales of diagnostic test kits. The Company's ability to achieve a consistent, profitable level of operations is dependent in large part upon continued product research and development, obtaining regulatory approvals for its existing identified products and successfully manufacturing and marketing such products. YEAR 2000 COMPLIANCE Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. Beginning in the year 2000, these date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, in less than one year, computer systems and software used by many companies may need to be upgraded to comply with such "Year 2000" requirements. Management has initiated a program to prepare the Company's computer systems and other electronic applications for the year 2000 (the "Year 2000 Program"). Through the Year 2000 Program, management is currently reviewing the Company's computer systems and other electronic applications in order to identify potential Year 2000 problems. Based upon preliminary results of the Year 2000 Program, management anticipates that the Company's Year 2000 compliance expenses will not be material and that the Company's Year 2000 Program will be completed before January 1, 2000. The Company's failure to successfully complete its Year 2000 Program could have a material adverse effect on the Company's business, financial condition and results of operations. 32 33 BUSINESS GENERAL Intracel is an integrated biopharmaceutical company focused on the development and commercialization of cancer vaccines and immunotherapeutic and diagnostic products for cancers and infectious diseases. Based upon the results of Phase III clinical trials, the Company is preparing a BLA for its OncoVAX(CL) cancer vaccine for the post-surgical treatment of Stage II colon cancer, the most common form of colon cancer. The Company is also planning to initiate Phase III clinical trials for OncoVAX(CL) in combination with chemotherapy for Stage III colon cancer, has initiated Phase III clinical trials for KLH for the treatment of refractory bladder cancer, and is planning to initiate a Phase II/III clinical trial for its ASI(BCL) vaccine for the treatment of low-grade B-cell lymphoma. In addition, the Company markets a portfolio of in vitro diagnostic products and is introducing a number of new diagnostic products for detecting and monitoring various cancers, AIDS and heart disease. The Company believes that OncoVAX(CL) is the first vaccine to demonstrate efficacy for the post-surgical treatment of Stage II colon cancer, and has recently announced the results of the ten-year Phase III Amsterdam trial. This randomized, multi-centered 254-patient clinical trial was the third in a series of clinical trials of OncoVAX(CL) conducted in the United States and Europe. The series included the Phase III ECOG trial and the Phase II/III Hoover trial. In the Amsterdam trial, which added a fourth booster vaccination to the regimen, the Company believes that OncoVAX(CL) demonstrated a 61% reduction in the rate of recurrences and a 50% improvement in the survival rate for patients with Stage II colon cancer when compared to surgery alone. The Company believes that the results of the Amsterdam trial are supported by positive trends shown in the ECOG and Hoover trials. Stage II colon cancer accounts for approximately 120,000 of the more than 200,000 new cases of colon cancer diagnosed in the United States and Europe each year. There is currently no product approved by the FDA for patients with Stage II colon cancer, and surgery is the principal means of treatment. The Company plans to file a BLA for OncoVAX(CL) with the FDA in 1999 and is presently seeking the necessary regulatory and reimbursement approvals in certain countries in Europe. If the FDA does not consider the trials discussed above as relevant or supporting to the efficacy of OncoVAX(CL), the FDA may require additional clinical trials of OncoVAX(CL) prior to or after the FDA's approval of the product. There can be no assurance that the Company will obtain FDA approval for OncoVAX(CL) on a timely basis. See "Risk Factors -- Dependence on OncoVAX(CL)" for a description of certain issues relating to the proposed BLA filing. OncoVAX(CL) is a multivalent vaccine produced from a patient's own surgically removed tumor. The tumor is collected immediately after surgery and delivered to one of the Company's OncoVAX Centers for manufacture and subsequent administration of the vaccine. Each OncoVAX Center has been designed to treat up to 2,000 patients per year. The Company plans to establish OncoVAX Centers at or near hospitals with established surgery practices, serving areas characterized by high population density and high incidence of colon cancer. The Company expects that each OncoVAX Center will require less than 3,000 square feet and will employ a staff of production technicians and a supervising physician. Facilities for the first OncoVAX Center in the United States have been established at Lehigh Valley Hospital in Allentown, Pennsylvania, and the terms of the Company's ownership in, and operation of, the center are being developed pursuant to a joint venture with Lehigh Valley Hospital. A second OncoVAX Center in the United States is being established at the Company's therapeutic manufacturing facility in Rockville, Maryland. Future OncoVAX Centers may also be structured as joint ventures with established healthcare providers. The OncoVAX Centers located in the United States will be considered to be manufacturing facilities by the FDA and will be regulated accordingly. The first OncoVAX Center in Europe is being established at University Hospital, Vrije Universiteit, Amsterdam. The Company plans to establish more than 25 OncoVAX Centers in the United States and more than 15 OncoVAX Centers in Europe. The Company estimates that each OncoVAX Center will cost approximately $1.0 to $3.0 million dollars to build. The Company expects revenues from operating OncoVAX Centers to offset the cost of new centers. The Company plans to leverage its OncoVAX Centers to perform expedited clinical trials and to launch other products, such as its in vivo imaging agent, HumaSPECT, and its B-cell lymphoma vaccine ASI(BCL). 33 34 The Company has filed an amendment to the IND for OncoVAX(CL) with the FDA to commence a Phase III clinical trial for the use of OncoVAX(CL) in combination with chemotherapy for the treatment of Stage III colon cancer. The Company believes that this combination therapy will be more effective in the treatment of Stage III colon cancer than either OncoVAX(CL) or chemotherapy administered alone. The Company is currently in discussions with the FDA regarding the commencement of the Phase III clinical trial for this combination therapy. No assurance can be given that the Company will be given clearance to commence this Phase III clinical trial in a timely manner, if at all. The Company has initiated a Phase III clinical trial for KLH for the treatment of refractory bladder cancer. In Phase II clinical trials, the Company believes that KLH demonstrated significantly less toxicity than the leading FDA-approved product for the treatment of bladder cancer. The Company has entered into a strategic partnership with Mentor, a leading urology company, under which Mentor has been funding research and development, is required to make milestone payments to the Company and will market KLH worldwide. Mentor also markets Accu-D(x), the Company's rapid bladder cancer test. The Company plans to file an amendment to the IND for its ASI(BCL)vaccine with the FDA to commence a Phase II/III clinical trial for such vaccine in the first half of 1999. ASI(BCL) is designed to prevent recurrence of low-grade non-Hodgkin's B-cell lymphoma, the most common type of B-cell lymphoma, in patients who have achieved remission through chemotherapy and/or immunotherapy. ASI(BCL), like OncoVAX(CL), is an autologous vaccine and is produced using a unique antigen derived from a patient's own cancerous cells. The Company believes that a Phase I clinical trial has demonstrated that ASI(BCL) can stimulate a specific immune response and is associated with improved clinical outcomes. The Company has substantial expertise in the development and manufacturing of totally human antibodies. In April 1998, the Company commenced enrollment in its Phase I clinical trial for its totally human antibody HumaRAD(16.88) for the treatment of head and neck cancer and plans to submit an IND with the FDA to commence a Phase I clinical trial of a related product, HumaRAD(88BV59) for the treatment of ovarian cancer, in the first half of 1999. In addition, the Company is developing several antibody products to treat life-threatening infectious diseases. Through Bartels, the Company also markets a portfolio of innovative in vitro diagnostic products for the confirmation of viral and bacterial diseases. The Company markets these diagnostic products domestically to approximately 1,500 hospitals and clinical laboratories through its internal sales force. Internationally, the Company relies upon third-party distributors to market its diagnostic products. In 16 foreign countries, the Company is marketing a one-minute test for HIV/AIDS based on its proprietary INSTI technology. In addition, the Company is introducing a number of new diagnostic products, including its Apo-Tek Lp(a) test kit to monitor an important indicator of heart disease, its Accu-D(x) test to monitor the recurrence of bladder cancer and its ZYMMUNE test to monitor CD4/CD8 levels in patients with HIV/AIDS. As a complementary product for OncoVAX(CL), the Company has developed an in vivo diagnostic product, HumaSPECT, to monitor recurrence and metastatic spread of colon cancer. For a Phase III clinical trial, the Company believes that HumaSPECT demonstrated significant advantages over CT scans, the current standard for detecting recurrence and metastatic spread of colon cancer. The Company has filed a BLA in the United States and in December 1998 received marketing authorization for HumaSPECT in Europe. A third party currently holds world-wide distribution rights for the Company's HumaSPECT product. While the Company is currently in negotiations to terminate the agreement providing for such rights, there can be no assurances that the agreement will be terminated on a timely basis, if at all. The Company's technology foundation in cancer vaccines and human antibodies is supported by a clinical trial group with expertise in designing and implementing complex clinical trials and by state-of-the-art manufacturing facilities capable of producing commercial quantities of its therapeutic, diagnostic and prognostic products. To conduct research, development, manufacturing and marketing of its products, the Company employs over 220 people in multiple facilities, including its corporate headquarters in Issaquah, Washington, a therapeutic product facility located in Rockville, Maryland and diagnostic product facilities in Issaquah, Washington and Richmond, British Columbia, Canada. 34 35 BACKGROUND INFORMATION Overview Cancer is a family of more than one hundred different diseases which can be categorized into two broad groups: (i) solid tumors, like colon, breast, prostate and lung cancer and (ii) hematologic, or blood-borne, cancers like B-cell lymphoma and leukemia. Both groups are generally characterized by a breakdown of the cellular mechanisms that ordinarily regulate cell growth and cell death in healthy tissues. Cancers develop from normal cells in the body. When a cell ceases to act according to its pre-programmed function, it may become malignant and grow uncontrollably. In solid tumors, malignant cells disrupt the normal function of the tissues in which they are growing and can also spread to other tissues in the body or "metastasize." This disruption in vital organs, such as the lungs or the liver, frequently leads to death. Blood-borne cancers primarily affect blood cells and the immune system. Death from blood-borne cancers is usually caused by infection and/or vital organ failure. Despite a substantial investment in cancer research and development during the past several decades, the overall incidence of cancer is now higher than it was 30 years ago. According to the World Health Organization, cancer kills six million people per annum worldwide. The American Cancer Society estimates that, in the United States, the incidence of new cancer cases in 1998 will be approximately 1.2 million and that over 560,000 people will die from cancer. In addition, according to the American Cancer Society, over 35% of all Americans, or 85 million people, now living will eventually contract some form of cancer. According to statistics published by the American Cancer Society which are based on estimates from the National Cancer Institute, approximately 35% of all new cancer cases and approximately 24% of cancer deaths in the United States in 1998 will be attributable to colorectal, breast, ovarian, bladder and head and neck cancer. The diagnosis and treatment of these cancers and B-cell lymphoma are the subject of current development efforts by the Company. The following table details the new cases, deaths and direct treatment expenditures for selected cancers in the United States: NEW CASES, DEATHS AND ANNUAL EXPENDITURES FOR SELECTED CANCERS IN THE UNITED STATES - --------------------------------------------------------------------------------- ANNUAL EXPENDITURES(2) TYPE NEW CASES(1) DEATHS(1) (IN MILLIONS) - --------------------------------------------------------------------------------- Lung 171,500 160,100 $5,060 - --------------------------------------------------------------------------------- Colorectal 131,600 56,500 6,465 - --------------------------------------------------------------------------------- Breast 180,300 43,900 6,599 - --------------------------------------------------------------------------------- Prostate 184,500 39,200 4,610 - --------------------------------------------------------------------------------- Ovarian 25,400 14,500 906 - --------------------------------------------------------------------------------- Bladder 54,400 12,500 2,172 - --------------------------------------------------------------------------------- Head and neck 30,300 8,000 N/A - --------------------------------------------------------------------------------- Non-Hodgkin's lymphoma(3) 55,400 24,900 N/A - --------------- (1) Source: American Cancer Society's Cancer Facts and Figures, 1998. (2) Includes all direct treatment expenses but excludes all indirect and actual morbidity costs. Source: Brown M.L., Fintor L.; "The Economic Burden of Cancer," Cancer Prevention and Control, New York, Marcel Dekker, 1995. (3) Includes B-cell lymphoma, which accounts for a vast majority of new cases and deaths. 35 36 Current Cancer Treatments The three most common methods of treating patients with cancer are surgery, chemotherapy and radiation. Surgery is primarily performed to remove solid tumors that are accessible to the surgeon and can be effective if the cancer has not yet metastasized. Frequently, however, the surgeon cannot remove all of the cancerous cells associated with the solid tumor. This results in the need for post-surgical "adjuvant" treatment methods, such as chemotherapy or radiation, to kill or limit growth of remaining cancerous cells and to prevent recurrence of the cancer. Chemotherapy, which typically involves the intravenous administration of cytotoxic drugs designed to destroy cancerous cells, is used for the treatment of both solid tumors and blood-borne malignancies. Chemotherapeutic drugs generally interfere with cell division and are therefore more toxic to rapidly dividing cancer cells. Since cancer cells can often survive the effect of a single drug, several different drugs are usually given in a combination therapy designed to target overlapping mechanisms of cellular metabolism and to overwhelm the ability of cancer cells to develop drug resistance. Nevertheless, partial and even complete remissions achieved by chemotherapy are often not permanent, because the treatment does not kill all the cancer cells, and the cancer resumes its progression within a few months or years of treatment. Chemotherapy is often re-administered to relapsed patients whose response typically becomes shorter with each successive treatment as resistance increases. Eventually, most patients become "refractory" to chemotherapy, meaning that the length of their response, if any, to treatment is so brief as to conclude that further chemotherapy regimes would be of little or no benefit. Chemotherapeutic drugs are not sufficiently specific to cancer cells to avoid affecting normal cells, especially those that are growing rapidly. As a result, patients often experience debilitating side effects such as nausea, vomiting, hair loss, anemia and fatigue, as well as life-threatening side effects such as immune system suppression. These side effects can limit the effectiveness of therapy because the clinician must avoid exceeding the maximum dose of drug that the patient can tolerate. Since dosages must be limited to avoid unacceptable side effects, it may not be possible to administer sufficiently high doses of chemotherapeutic drugs to overcome the natural ability of cancer cells to become resistant. Radiation is employed to irradiate a solid tumor and surrounding tissues and is a first-line therapy for inoperable tumors, but side effects are a limiting factor in treatment. Radiation accomplishes its purpose by killing cancer cells through a process called ionization. Some cells die immediately after radiation because of the direct effect, though most die because the radiation damages the chromosomes and DNA thereby limiting cell division. Radiation is used frequently in conjunction with surgery either to reduce the tumor mass prior to surgery or to destroy any tumor cells that may remain at the tumor site after surgery. However, radiation therapy cannot assure that all tumor cells will be destroyed and has very limited utility for treating widespread metastatic disease. Mechanisms of Immunity The immune system is composed of specialized cells that recognize, destroy and eliminate disease-causing foreign substances or cancer cells. There are two generally recognized components of immunity, cellular immunity and humoral immunity. Cellular immunity is effected by T lymphocytes ("T-cells"), natural killer cells, macrophages, and polymorphonuclear leukocytes. T-cells recognize and can be directly toxic to viruses, bacteria, parasites and cancer cells. T-cells also secrete cytokines which recruit and activate other immune cells, such as macrophages, natural killer cells and polymorphonuclear leukocytes, to the site of infection or tumor, where these cells engulf, or secrete cytotoxic substances that kill, the foreign substances, infectious agents or cancer cells. T-cells also direct the development of humoral immunity. Humoral immunity is effected by antibodies produced by B lymphocytes ("B-cells"). Antibodies are proteins produced in response to foreign substances called "antigens." Antibodies have a region that binds specifically to the antigen and a region that binds other immune cells such as macrophages and natural killer cells. The region that binds other immune cells is only recognized by these cells when the antibody is bound to the antigen. Thus, the antibody specifically directs the elimination of the antigen from the body. In persons with healthy immune systems, cancerous cells are recognized as antigens and eliminated through a process called immune 36 37 surveillance. In patients with cancer, the immune surveillance process often fails, thus allowing cancerous cells to evade elimination by the immune system and develop into tumors and lymphomas. It is believed, however, that the immune system's ability to fight cancer can be enhanced through various immunotherapeutic approaches. Emerging Immunotherapeutic Cancer Treatments Scientific progress in defining key aspects of the molecular biology and immunology of cancer in recent years has yielded a number of promising new treatment approaches, which potentially overcome some of the major drawbacks of current treatment modalities. The Company believes that one of the most promising approaches for the development of cancer treatments is immunotherapy. The four principal immunotherapeutic or cancer vaccine approaches are described in the following table and include: (i) Active Specific Immunotherapy, (ii) Active Non-Specific Immunotherapy, (iii) Antibody-Based Immunotherapy and (iv) Adoptive Immunotherapy. The Company is developing products which utilize one or more of the first three of these approaches. IMMUNOTHERAPEUTIC APPROACHES - ------------------------------------------------------------------------------------- TYPE OF IMMUNOTHERAPY DESCRIPTION - ------------------------------------------------------------------------------------- Active Specific Activation of anti-tumor immunity using antigenic tumor cells, cell lysates, or extracted/synthetic tumor antigens. - ------------------------------------------------------------------------------------- Active Non-Specific Activation of anti-tumor immunity and other nonspecific effector cells using microbial or chemical immunomodulators. - ------------------------------------------------------------------------------------- Antibody-Based Transfer of antibodies or antisera, providing indirect enhancement to immunity. - ------------------------------------------------------------------------------------- Adoptive Transfer of immunological cells from one patient to another. Active Specific Immunotherapy involves the stimulation of a patient's immune system by using a patient's own cancer cells or extracted or synthetic tumor associated antigens. Cancer vaccines based upon active specific immunotherapy are typically mixed with a non-specific adjuvant whose role is to stimulate the immune system's response to the vaccine. By isolating cells or antigenic components from the tumor, mixing them with an adjuvant, and reintroducing this mixture back into the individual, the immune system may be induced to develop a response capable of destroying tumor cells. Active specific immunotherapy treatments are generally being developed as an adjuvant to surgery. Adjuvant therapy is necessary because surgery often fails to remove all primary or metastatic cancer cells. Active specific immunotherapy may offer the means by which an individual's immune system can be activated throughout the body to search out and destroy these residual cancer cells. The Company's active specific immunotherapeutic products include OncoVAX(CL) for the treatment of colon cancer and ASI(BCL) for the treatment of B-cell lymphoma. Active Non-Specific Immunotherapy involves the stimulation of a patient's immune system by using non-specific microbial or chemical immunomodulators, such as Bacillus Calmette-Guerin ("BCG"), the only FDA-approved immunomodulator for the treatment of bladder cancer. The mechanisms by which these non-specific immunomodulators enhance the immune response to antigens are poorly understood but are thought to involve the inducement of a local inflammatory reaction. This reaction results in the recruitment and activation of antigen presenting cells, the production of cytokines and the recruitment of effector T-cells and B-cells to the site of the antigen. Some of these non-specific agents have also been shown to be effective as immunogenic carriers and adjuvants. The Company's active non-specific immunotherapeutic products include KLH for the treatment of refractory bladder cancer. Antibody-Based Immunotherapy involves the use of anti-cancer monoclonal antibodies as stand-alone therapeutics to augment a patient's immune system or as targeting mechanisms for the administration of radiation or chemotherapy. While monoclonal antibodies have been shown to be effective in binding to cancer cells, problems associated with their specificity, immunogenicity and variable binding properties have to date resulted in a limited number of useful applications for even the most effective monoclonal antibodies when 37 38 used alone. Research has increasingly moved towards using monoclonal antibodies as vehicles for targeting the administration of radiation or chemotherapy to the immediate vicinity of malignant cells. The Company's antibody-based immunotherapeutic products include HumaRAD(16.88) and HumaRAD(88BV59), totally human antibodies labeled with (90)Yttrium for the intratumoral treatment of head and neck cancer and of ovarian cancer, respectively. Adoptive Immunotherapy involves the transfer of immunological cells with anti-cancer properties from one patient into another in the hope that these cells either directly or indirectly produce anti-cancer effects on growing tumors. Although significant advances have been made, the available data remains inconclusive. At present, the Company is not active in this field. THERAPEUTIC PRODUCTS The Company has accumulated and developed proprietary technology and expertise in several different approaches to the development of cancer vaccines and immunotherapeutics. The diversity of the Company's product and technology portfolio reflects the Company's belief that different approaches are required for different cancers. The following table sets forth the Company's leading therapeutic and in vivo monitoring products, classifies each according to its immunotherapeutic approach, specifies the cancer indication treated or monitored by each and summarizes the regulatory status of each: - --------------------------------------------------------------------------------------------------------- THERAPEUTIC PRODUCTS - --------------------------------------------------------------------------------------------------------- IMMUNOTHERAPEUTIC/ CLINICAL TRIAL STATUS/ PRODUCT DIAGNOSTIC APPROACH INDICATION EXPECTED MILESTONES(1) - --------------------------------------------------------------------------------------------------------- OncoVAX(CL) Active Specific Stage II colon cancer Phase III complete, BLA Immunotherapy filing expected in 1999. Launch in Europe expected in first half of 1999 subject to opinions on national regulatory status.(2) - --------------------------------------------------------------------------------------------------------- OncoVAX(CL) plus Active Specific Stage III colon cancer Amendment to IND filed for chemotherapy Immunotherapy plus Phase III.(3) chemotherapy - --------------------------------------------------------------------------------------------------------- KLH Active Non-Specific Refractory bladder cancer Phase III initiated. Immunotherapy - --------------------------------------------------------------------------------------------------------- ASI(BCL) Active Specific B-cell lymphoma Phase II/III amendment to Immunotherapy IND planned for submission in 1999. - --------------------------------------------------------------------------------------------------------- HumaRAD(16.88) Antibody-Based Diagnosis Head and neck cancer Phase I enrollment commenced. - --------------------------------------------------------------------------------------------------------- HumaRAD(88BV59) Antibody-Based Diagnosis Ovarian cancer Phase I IND planned for submission in 1999. - --------------------------------------------------------------------------------------------------------- MONOGENE(INT) Antibody-Based Gene HIV Phase I IND planned for Therapy submission in 1999. - --------------------------------------------------------------------------------------------------------- - --------------- (1) See "Risk Factors -- Government Regulation: No Assurance of Regulatory Approvals" and "-- Government Regulation." (2) See "Risk Factors -- Dependence on OncoVAX(CL)" for a description of certain issues relating to the proposed BLA filing. (3) See "Risk Factors -- Dependence on OncoVAX(CL)" for a description of certain issues relating to the status of this IND amendment. OncoVAX(CL) for the treatment of colon cancer The American Cancer Society estimates that approximately 95,600 Americans will be diagnosed with colon cancer in 1998 and approximately 47,700 will die from colon cancer in 1998, ranking second only to lung cancer as a cause of death from cancer. According to Facts and Figures in the European Community (1993), colon cancer afflicts over 120,000 people annually in Europe, with deaths from colon cancer estimated at over 79,000 per year. Colon cancer is generally classified into four categories or stages according to the status of the 38 39 tumor nodes and metastasis. In Stage I colon cancer, the tumor has not penetrated the bowel wall and surgery is curative in more than 90% of the cases. In Stage II colon cancer, penetration of the bowel wall has occurred but regional lymph nodes are negative and surgery is curative for approximately 70% of these patients. Approximately two-thirds of patients with colon cancer present with Stage II disease. In Stage III colon cancer, the tumor has spread to the lymph nodes and the cure rate is moderate to poor depending on the extent of lymph node involvement. In Stage IV colon cancer, the cancer has spread to other vital organs in the body and is fatal in the vast majority of cases. Generally, patients that recur present with advanced colon cancer and the prognosis for these patients is very poor. Except for surgery, there is no medically accepted treatment for either Stage I or Stage II colon cancer and trials using adjuvant chemotherapy have not clearly demonstrated any patient benefit. For Stage III colon cancer, a combination of the chemotherapeutic drugs 5-fluorouracil ("5-FU") and levamisole or leucovorin is the treatment of choice in the United States and in Europe. The Company estimates that between 20% and 30% of patients fail to complete their course of chemotherapy because of adverse reactions. OncoVAX(CL) is an active specific immunotherapeutic for the post-surgical treatment of patients diagnosed with Stage II colon cancer. OncoVAX(CL) is prepared for each patient using the patient's own surgically removed tumor. After receipt at an OncoVAX Center, the tumor is enzymatically treated to separate the tumor cells and these cells are frozen awaiting preparation of the vaccine. The vaccine consists of a regimen of four inoculations administered over a period of six months. When a patient presents approximately four to five weeks after surgery for the first inoculation and one week later for the second inoculation, a portion of the tumor cells is thawed, irradiated to neutralize tumorigenic potential and combined with a proprietary formulation of BCG that serves as an immunogenic enhancer. The third inoculation (given one week after the second inoculation) and the final booster inoculation (given six months after the initial inoculation) are prepared the same way but without the addition of BCG. In the Amsterdam trial, OncoVAX(CL) was tested in the prospectively randomized, multi-center Phase III clinical trial. A total of 254 patients were randomized postoperatively to receive either OncoVAX(CL) or no further treatment after eligibility was established. Eligible patients included patients with confirmed Stage II or Stage III disease whose primary tumors had an adequate number of cells to allow for the production of OncoVAX(CL). Twelve hospitals within a four-hour radius of University Hospital screened potential candidates for the protocol. The potential candidate's colon resection was performed at one of the twelve sites, and the tumor specimen was transported to University Hospital's vaccine production laboratory for processing. The Company believes that the Amsterdam trial demonstrated that, at a median follow-up period of 5.4 years after treatment, OncoVAX(CL) significantly reduces the rate of tumor recurrences by 44% in patients with Stage II and III colon cancer. In Stage II patients, OncoVAX(CL) had the greatest impact with a statistically significant 61% reduction in the rate of recurrences along with proportional increases in overall survival. The Company believes that, in addition to its efficacy, OncoVAX(CL) has demonstrated an extremely favorable safety profile. Over a 15-year period, more than 700 people have received either a three- or four-shot regimen of OncoVAX(CL) with no significant side effects reported. The Company believes that the results of the Amsterdam trial confirmed positive trends seen in the ECOG and Hoover trials that tested OncoVAX(CL) administered in regimens of three inoculations without a six-month booster inoculation. The Company is now preparing a BLA for OncoVAX(CL) for submission to the FDA in 1999. The Company is also seeking the necessary registrations and reimbursement approvals in certain countries in Europe. To commercialize OncoVAX(CL), the Company is planning to establish OncoVAX Centers at or near hospitals with established surgery practices. OncoVAX Centers have been designed to treat up to 2,000 patients per year. The Company expects that each OncoVAX Center will require less than 3,000 square feet and contain all the equipment, facilities and personnel necessary to manufacture, store and administer OncoVAX(CL). The first centers in the United States are planned for areas characterized by high population density and high incidence of colon cancer. In each OncoVAX Center, the Company will employ or otherwise 39 40 retain a staff of production technicians and a supervising physician. Each OncoVAX Center will be responsible for collecting tumors from regional colorectal surgeons. The Company estimates that most OncoVAX Centers can be established and put into operation for an investment between $1.0 and $3.0 million per site. Facilities for the first OncoVAX Center in the United States have been established at Lehigh Valley Hospital in Allentown, Pennsylvania, and the terms of the Company's ownership in, and operation of, the facilities are being developed pursuant to a joint venture with Lehigh Valley Hospital. A second OncoVAX Center in the United States is being established at the Company's therapeutic manufacturing facility in Rockville, Maryland. A Research and Center Agreement has been entered into between the Company and Duke University for the establishment of an OncoVAX Center at Duke University Medical Center whereby the required facilities and personnel will be provided to the Company. In addition, the Company has signed letters of intent with each of Vanderbilt University Medical Center, the Robert H. Lurie Comprehensive Cancer Center of Northwestern University, the University of Rochester Medical Center and Hoag Memorial Hospital Presbyterian to form joint ventures for the formation of additional OncoVAX Centers. The OncoVAX centers located in the United States will be considered to be manufacturing facilities by the FDA and will be regulated accordingly. The first OncoVAX Center in Europe is being established at University Hospital, Vrije Universiteit, Amsterdam. The Company plans to establish more than 25 OncoVAX Centers in the United States and more than 15 OncoVAX Centers in Europe. The Company and Lehigh Valley Hospital have entered into a joint venture agreement to own and operate an OncoVAX Center for the manufacture of OncoVAX(CL) and other oncological products and to provide, or arrange for the provision of, such products to cancer patients in the mid-Atlantic region of the United States. Prior to FDA approval for OncoVAX(CL), the Company will lease facilities and equipment (the "Equipment") from Lehigh Valley Hospital for the purpose of manufacturing and producing OncoVAX(CL) for use in the conduct of clinical trials and arranging and/or sponsoring such clinical trials. Upon receipt of FDA approval for OncoVAX(CL), the parties will form and capitalize a new entity in which Intracel and Lehigh Valley Hospital will be the sole shareholders. In connection with the formation of such new entity, the Company will then purchase the Equipment in exchange for cash in the amount of $36,842 and a promissory note made by the Company and payable to Lehigh Valley Hospital in the maximum principal amount of approximately $663,518 together with interest, convertible into shares of the Company's common stock at a minimum conversion price that is generally based upon the then current public trading price of the Company's common stock (which shall in no event be less than 75% of the per share price to the public of common stock in this offering) and which shall be secured by a pledge of the Equipment. Concurrently with such purchase, the Company will contribute the Equipment in exchange for ninety-five percent of the joint venture entity's issued capital stock and Lehigh Valley Hospital will purchase the remaining five percent for cash. Under the terms of the agreement it is contemplated that the Company shall be primarily responsible for case management, reimbursement, quality assurance, sales and marketing and supply of materials necessary for the manufacture and production of OncoVAX(CL) while Lehigh Valley Hospital shall be primarily responsible for the provision of bioengineering and housekeeping support services, specialized laboratory testing and the development of relationships with managed care entities and physician groups. In addition, Lehigh Valley Hospital shall provide, on a limited basis, an employee physician to serve as "medical director" to the Lehigh Valley Hospital OncoVAX Center in exchange for payment to Lehigh Valley Hospital of an amount reflecting the fair market value of such services, which the parties agree will equal $75,000 for the first year of the agreement. Herbert C. Hoover, Jr., M.D., the Chairman of the Department of Surgery at Lehigh Valley Hospital, has agreed to spend 25% of his professional time to continue to assist the Company in setting up OncoVAX Centers. See "-- Medical Advisory Board." The Company has agreed to pay to Lehigh Valley Hospital the sum of $125,000 per annum, which amount will be offset by Lehigh Valley Hospital against the salary that the hospital pays to Dr. Hoover. It is anticipated that Dr. Hoover's time commitment to the Company will increase with the progressive implementation of the Company's OncoVAX(CL) program and that the salary offset will be renegotiated to appropriately reflect his growing time commitment. Intracel has agreed to grant to Dr. Hoover options to purchase up to 133,333 shares of the Company's common stock with an exercise price equal to the lesser of $13.00 per share and the price per share being offered to the public in this offering, with vesting terms of 25% fully vested upon grant and 25% of such options will vest on each of the first, second 40 41 and third anniversaries of such grant. In addition, the Company has agreed to grant to Dr. Hoover an additional 66,666 options at such time as the OncoVAX Center at Lehigh Valley Hospital is open and treating the first patients. It is anticipated that further stock options will be granted to Dr. Hoover in connection with the achievement of additional milestones to be determined in the future. Dr. Hoover currently is the holder of 200,000 shares of the Company's common stock. The Company plans to leverage its OncoVAX Centers to perform expedited clinical trials and to launch other products, such as its in vivo imaging agent HumaSPECT for monitoring recurrence of colon cancer and ASI(BCL) for prevention of recurrence of disease in B-cell lymphoma. In the immediate term, the Company plans to use the OncoVAX Centers to conduct a Phase III clinical trial for OncoVAX(CL) in combination with chemotherapy to treat Stage III colon cancer patients. See "Risk Factors -- Dependence on OncoVAX(CL)" for the status of the Company's clinical trial for such product. KLH for the treatment of bladder cancer The American Cancer Society estimates that there will be 54,400 new cases of bladder cancer in the United States in 1998. Bladder cancer is the fourth most prevalent malignant disease among male patients and the eighth among female patients. The Company estimates that approximately 350,000 people in the United States currently have had or are living with bladder cancer. Patients diagnosed with bladder cancer present with superficial tumors of which approximately 80% are papillary and the remaining 20% are carcinoma in situ ("CIS"). Superficial papillary tumors respond well to endoscopic surgery and post-surgical adjuvant therapy, but recurrence at the same or another site in the bladder is relatively common. CIS has particularly invasive and lethal potential and is not amenable to surgical resection. Intravesicular therapy, using chemotherapy and/or BCG, is used to treat endoscopically unresectable bladder cancer lesions. It is also used after surgery as adjuvant therapy designed to prevent recurrences. The Company is developing an active, non-specific immunotherapeutic approach for the treatment of bladder cancer using a proprietary formulation of keyhole limpet hemocyanin. Keyhole limpet hemocyanin is a potent immune stimulator that induces a non-specific inflammatory response in the bladder. However, a tumor-specific phenomenon may be involved as it has been recognized that keyhole limpet hemocyanin shares an antigen in common with bladder cancer cells. The Company believes that keyhole limpet hemocyanin has a significantly more favorable toxicity profile than BCG therapy and chemotherapy. Keyhole limpet hemocyanin is also being used by the Company and others as an immunogenic enhancer for products based upon active specific immunotherapy. The Company has completed a Phase I/II dose escalation study on KLH for superficial bladder cancer and CIS of the bladder. KLH was administered as a treatment for those bladder cancer patients that did not respond to treatment with BCG or chemotherapy. Data from the Phase I/II study indicates that, of the 25% of all bladder cancer patients who fail to respond to BCG or other forms of treatment, KLH has a greater than 50% complete response rate. Based upon these results, the Company has commenced a Phase III clinical trial to evaluate the efficacy of KLH for the treatment of refractory bladder cancer. Agreements with Mentor On June 16, 1997, the Company entered into an exclusive distribution agreement with Mentor for the Accu-D(X) bladder cancer diagnostic product, which the Company refers to as Accu-D(X), with an initial term of five years and is automatically renewable for a one year term thereafter until either party terminates the agreement with 180 days written notice. Under this agreement, Mentor accepts title of the product shipments upon receipt and pays the Company a specific purchase price defined by the agreement. Additionally, Mentor will pay the Company a royalty of 50% of its net sales of the Company's product, less the specific purchase price as defined in the agreement. The Company is obligated to provide up to 12,000 units of the product per year to be used by Mentor for promotional purposes, at no cost to Mentor. On December 22, 1997, the Company entered into a research, collaboration and distribution agreement with Mentor whereby the Company agreed to provide certain research, development and pilot programs for Mentor in exchange for research and development fees in an aggregate amount of $3,000,000 based on a 41 42 milestone payment schedule. As of December 31, 1997, the Company had not earned any milestone payments. The Company will receive $1,000,000 within five days of submission of written notice of the completion of each milestone to Mentor. The Company is required to pay the cost in excess of $3,000,000 for expenditures within the scope of the project development schedule. The Company is the owner of all rights to proprietary technical information and the United States Patent to which Mentor was granted exclusive world-wide rights to market, sell and distribute the program product. This agreement is effective for a ten year period following the first approval of commercialized use of products under development. Mentor has the right to terminate this agreement at the expiration of five years from the date of the first approval of commercialized use of the product based upon 180 days written notice to the Company. As of September 30, 1998, the Company has received to date milestone payments from Mentor in the amount of $1,000,000. ASI(BCL) for the treatment of B-cell Lymphoma The American Cancer Society estimates that approximately 55,400 cases of non-Hodgkin's lymphoma will be diagnosed in the United States in 1998. As with other cell types in the body, the B-cells and T-cells of the immune system may become malignant and grow as systemic tumors such as lymphomas. B-cell non- Hodgkin's lymphomas are one such group of cancers of the immune system and currently afflict approximately 250,000 people in the United States alone. B-cell non-Hodgkin's lymphomas are diverse with respect to both diagnosis and treatment and are generally classified as low-grade, intermediate or high grade. The Company estimates that approximately half of the 250,000 patients afflicted with non-Hodgkin's lymphoma in the United States have low-grade or follicular lymphoma and approximately 18,000 of these have been diagnosed within the previous 12 months. Treatment alternatives for lymphoma patients include chemotherapy, radiation and Rituxan(R) and Intron A, which is currently indicated for use in refractory, low-grade, CD20 positive B-cell non-Hodgkin's lymphoma. In conjunction with researchers at Stanford University, the Company has been developing ASI(BCL), an active specific immunotherapeutic product for the treatment of B-cell lymphoma, as an adjuvant therapy to chemotherapy and antibody-based immunotherapy. The approach is based upon the observation that each clone of B-cells expresses on the cell surface an antibody unique to that clone. Each patient's B-cell lymphoma may be characterized by the unique portion of the antibody molecule, the idiotype, expressed on the surface of that patient's tumor cells and this idiotype constitutes a patient-specific, tumor-specific antigen. By stimulating an immune response against this idiotype, the Company believes that ASI(BCL) may be able to prevent the continuous pattern of tumor relapse in B-cell lymphoma patients completing remission therapy. Results from a Phase I study indicated that when B-cell lymphoma patients were immunized during remission, 71% (15 out of 21) developed an immune response to ASI(BCL). Of these responding patients, 87% (13 out of 15) remained in a state of remission for a median duration of 7.9 years. An additional Phase I activity study has been ongoing since 1995 for which the Company has prepared 31 vaccines, of which 27 have now been administered. Based upon results obtained to date, the Company is preparing to file an amendment to its existing IND to commence a Phase II/III clinical trial of ASI(BCL) in the United States in the first half of 1999. HumaRAD The Company is developing HumaRAD(16.88) and HumaRAD(88BV59), radiolabeled human monoclonal antibodies for the treatment of head and neck cancer and of ovarian cancer, respectively. Focal head and neck cancer grows locally and usually metastasizes to the regional lymph nodes rather than to distant sites. This compartmentalization provides an opportunity for intratumoral injection of a radiolabeled monoclonal antibody. The American Cancer Society estimates that 30,300 people in the United States will develop head and neck cancer in 1998 and that approximately 8,000 people will die in 1998 from the disease. Surgery and radiation are the only currently available treatments for head and neck cancer and are often disfiguring. Like head and neck cancer, ovarian cancer is a relatively localized disease. The American Cancer Society estimates that, in 1998, there will be 25,400 cases of newly diagnosed ovarian cancer in the United States and that approximately 14,500 people will die in 1998 from the disease. Approximately 70% of patients with ovarian cancer are diagnosed with advanced disease. The introduction of platinum combination chemotherapy and 42 43 taxol has greatly improved medium-term survival, but long-term survival rates remain low. The prognosis is particularly poor for patients with recurrent or progressive disease. The Company's HumaRAD products utilize radioimmunotherapy ("RIT"), a form of targeted radiation therapy, by having a human monoclonal antibody carry a therapeutic dose of radiation, in this case (90)Yttrium, to tumor cells. By targeting "compartmentalized" tumors with intratumoral injections of a human monoclonal antibody, the Company believes its HumaRAD products may overcome systemic toxicity and the antigenicity of non-human antibodies, two of the major problems previously encountered with RIT in the treatment of solid tumors. The Company has developed extensive expertise in the RIT field. The Company's HumaRAD human monoclonal antibodies bind with a variety of tumor types in vivo and have been shown to be specific for tumor localization in patients with colorectal, breast, ovarian and head and neck cancer. One of the most important advantages seen with these HumaRAD products is their lack of immunogenicity in patients. This is in contrast to a single administration of a mouse monoclonal antibody from which the majority of patients develop a human anti-mouse response precluding further or frequent treatment with the mouse antibody. The administration of HumaRAD, even following multiple infusions, does not elicit a human anti-human response. This is important because multiple infusions are necessary to deliver a therapeutic dose of radiation. The Company, by using intratumoral injections of HumaRAD(16.88) in patients with head and neck cancer, has been able to demonstrate that it can deliver therapeutic doses of radiation to the primary tumor and metastatic lymph nodes. In ovarian cancer, where the whole peritoneal cavity is at risk and the majority of patients present with advanced disease, the Company is evaluating the intraperitioneal administration of HumaRAD(88BV59) in patients who have minimal residual disease following surgery and chemotherapy. The Company has commenced enrollment of its Phase I clinical trial of HumaRAD(16.88) for the treatment of head and neck cancer and plans to submit an IND with the FDA to commence a Phase I clinical trial of HumaRAD(88BV59) for the treatment of ovarian cancer in the first half of 1999. Other products The successful development of HumaSPECT and the Company's HumaRAD products has enabled the Company to extend its human antibody program to the development of products to treat several serious infectious diseases in North America and Europe. The principal targets of this program are life-threatening infectious diseases, including nosocomial, or hospital-borne, infections and HIV/AIDS. The Company is developing human monoclonal antibodies for three different types of bacteria: staphylococcus epidermidis, enterococcus faecalis and enterococcus faecium. Some of this work was initiated pursuant to an agreement with Baxter which terminated in March 1998. Baxter may have some residual licensing rights to products developed during the course of this contract. Staphylococcus epidermis is a major cause of infections of premature infants in hospitals. Enterococcus faecalis and enterococcus faecium are major causes of serious infections in immunocompromised patients. The seriousness of enterococcus infection, particularly faecium, is exacerbated by the increasing prevalence of resistance to antibiotics, including vancomycin. The Company plans to file an IND to commence Phase I clinical trials of one or more of these antibodies in the first half of 1999. The Company has also been developing its MONOGENE(INT) antibody-based gene therapy product for the treatment of patients with HIV/AIDS. MONOGENE(INT) involves the introduction of an antibody gene into key immune cells of the body. The antibody gene allows the immune cells to produce an antibody fragment which binds to the critical integrase protein and which, in extensive preclinical testing, has been shown to strongly inhibit HIV infection. The Company believes that this gene therapy approach is less toxic and less likely to result in viral resistance than certain other therapies. The Company is currently focused on manufacturing clinical grade quantities of MONOGENE(INT) necessary for use in conducting a Phase I clinical trial. 43 44 DIAGNOSTIC PRODUCTS In addition to its therapeutic products portfolio, the Company also develops, manufactures and markets a portfolio of in vitro diagnostic products. The Company's diagnostic business unit has been expanded through acquisition and internal development to include the following products: - ------------------------------------------------------------------------------------------------------ DIAGNOSTIC PRODUCTS - ------------------------------------------------------------------------------------------------------ PRODUCT DIAGNOSTIC USES STATUS(1) - ------------------------------------------------------------------------------------------------------ Confirmatory diagnostic Viruses and bacteria Being marketed. products - ------------------------------------------------------------------------------------------------------ INSTI HIV-1/2 HIV Registered or approved in 16 countries. - ------------------------------------------------------------------------------------------------------ Chemotrax(BR) Breast cancer Pre-market approval ("PMA") application approved. - ------------------------------------------------------------------------------------------------------ ZYMMUNE CD4/CD8 HIV 501(k) cleared. Being marketed. - ------------------------------------------------------------------------------------------------------ Accu-D(x) Bladder cancer 501(k) cleared. Being marketed by Mentor. - ------------------------------------------------------------------------------------------------------ Apo-Tek Lp(a) Cardiovascular disease 501(k) cleared. Being marketed by Sigma Diagnostics, Inc. ("Sigma"). - ------------------------------------------------------------------------------------------------------ HumaSPECT Monitoring of colon BLA submitted in the United States.(2) Marketing cancer authorization granted in Europe. - ------------------------------------------------------------------------------------------------------ HumaSPECT Ovarian cancer Phase II completed. - ------------------------------------------------------------------------------------------------------ (1) See "-- Government Regulation -- Device Regulation." (2) See "Business -- Diagnostic Products -- In Vivo Diagnostics" for a description of certain issues relating to the Company's BLA for HumaSPECT. IN VITRO DIAGNOSTICS Confirmatory diagnostic products With the exception of pathogens which have a major effect on the blood supply, such as HIV and hepatitis, a significant volume of virology and bacteriology testing in the United States and elsewhere continues to employ standard cell culture techniques. Depending on the pathogen suspected and the organs involved, a fecal, sputum or blood sample is taken from the patient and sent to a hospital or clinical laboratory in a plastic transport containing a liquid preservative. The laboratory incubates the patient sample with a cell- line selected for its ability to produce the suspected pathogen. After a standard incubation period, the cells are then exposed to antibodies that recognize the virus or bacterium for which the test has been designed. These antibodies are coupled with dyes or enzymes so laboratory technicians can observe whether the virus or bacterium is present. Through Bartels, the Company manufactures and/or markets a comprehensive family of products required for every step of this process and is widely regarded as one of the leading suppliers in the field. The product portfolio includes 31 transports, 50 cell-lines, more than 60 antibodies and 66 enzyme-linked immuno-assay ("ELISA") tests. The Company also supplies instrumentation required to read the results of its ELISA tests. In accordance with standard industry practice, these instruments are generally furnished to customers at a charge that is based, in part, upon customer purchase volume. INSTI HIV-1/2 After several international clinical trials, the Company is currently launching a rapid test for detection of HIV-1 and HIV-2. The INSTI HIV-1/2 test takes approximately one minute to run, is easy to perform and interpret and is as sensitive and specific as most instrument-based tests which take more than an hour or more and many steps to perform. The product has been registered/approved in India, Thailand, Chile, Russia, 44 45 Pakistan, South Africa, Venezuela, Costa Rica, Panama, Colombia, Jordan, Belize, Haiti, the Dominican Republic, Surinam and Turkey. The Company has not sought and does not anticipate seeking approval of this product for marketing in the United States. INSTI HIV-1/2 is the first product utilizing the Company's INSTI platform technology that provides a fast and accurate antibody detection system for serum, plasma and whole blood samples. In addition to speed and accuracy, the INSTI format has been designed for high-volume, low-cost production. The product is being manufactured at the Company's facility in Richmond, British Columbia, Canada. Chemotrax(BR) Until recently, there has been no FDA-approved test to determine the sensitivity of solid tumors to the range of chemotherapeutic agents available to treat these tumors. In 1996, after a four-year PMA application process, Bartels Prognostics (a company, unrelated to Bartels, in which Intracel has a minority financial interest) received FDA approval to market Chemotrax(BR), a chemotherapeutic sensitivity test to be used in conjunction with the treatment of breast cancer. Clinical trials demonstrated that Chemotrax(BR) accurately measured breast tumor cell sensitivity to 5-FU, a type of chemotherapy widely used to treat breast and other cancers, and that assay results correlated closely to patient clinical responses to 5-FU. Bartels Prognostics has received FDA approval of an investigational device exemption ("IDE") for the testing of four other chemotherapeutic agents and intends to supplement the IDE to obtain FDA approval to those two other chemotherapeutic agents so that a panel of standard chemotherapies can be evaluated for each breast cancer patient. The clinical trials have not yet commenced. The Company has exclusive rights to market Chemotrax(BR). ZYMMUNE CD4/CD8 The Company is launching ZYMMUNE CD4/CD8, a product to determine the number of CD4 and CD8 immune cells in the body. CD4/CD8 counts are an important marker for staging and treating HIV-infected individuals and implementing therapeutic intervention. The demand for CD4/CD8 testing is expected to grow as patients on the new triple therapy regimes live longer and require extended monitoring. The standard methodology used to determine the level of these immune cells has been a combination of flow cytometry and hematology. ZYMMUNE CD4/CD8 is a simpler, less costly alternative to the flow cytometer and provides results in less than 35 minutes. The ZYMMUNE CD4/CD8 testing system received final FDA clearance in November 1995 and is now in expanded field trials. Accu-D(x) The Company has developed Accu-D(x), a point-of-care in vitro diagnostic test for the detection of recurrent bladder cancer. Accu-D(x) is a urine-based test which can be performed in a physician's office in about seven minutes. The Company estimates that the market potential for Accu-D(x) in the United States includes approximately 350,000 persons previously diagnosed with bladder cancer. Accu-D(x) was cleared for marketing by the FDA in April 1997. The Company has also entered into an agreement with Mentor for the marketing and distribution of Accu-D(x), pursuant to which product sales began in early 1998. Under the terms of the agreement, the Company receives 50% of the net sales of the product. Apo-Tek Lp(a) In November 1997, the Company received FDA clearance to market its Apo-Tek Lp(a) test kit which detects Lipoprotein(a) ("Lp(a)"), a single independent risk factor for astherosclerotic cardiovascular disease. The Company estimates that over 57 million Americans have one or more types of cardiovascular disease. The Company's Apo-Tek Lp(a) test can be used with human serum or plasma to detect and accurately quantify Lp(a) levels and shows no cross reactivity with plasminogen or other plasma components. The Company currently has a distribution agreement with Sigma in connection with Apo-Tek Lp(a), pursuant to which product sales began in early 1998. 45 46 IN VIVO DIAGNOSTICS The Company plans to market OncoVAX(CL) in conjunction with HumaSPECT, which has been designed to detect recurrence of colorectal cancer. HumaSPECT is a totally human antibody that is labeled with a radioisotope and then injected into a patient to detect recurrent or metastatic spread of colon cancer. Because HumaSPECT utilizes a human antibody (rather than a non-human antibody that can elicit an adverse reaction by the patient's own immune system), it can be repeatedly infused. A multi-center Phase III clinical trial was completed for HumaSPECT in 1996. In this trial, the Company believes that HumaSPECT demonstrated to be as accurate as CT scans in detecting recurrence of colorectal cancer and significantly superior to CT scans in determining whether a recurrence is inoperable. The Company has since submitted a BLA to the FDA and recently received marketing authorization for HumaSPECT in Europe. The Company believes, with the European Commission's approval, that HumaSPECT is the first totally human antibody approved for use in humans. HumaSPECT is also being evaluated in clinical trials for its efficacy in detecting recurrent lung, ovarian and prostate cancer. The Company plans to recommend HumaSPECT to patients vaccinated with OncoVAX(CL) to monitor recurrence and metastatic spread during the three-year period following vaccination. HumaSPECT can be administered and the results interpreted at an OncoVAX Center, with the results sent to a patient's oncologist or physician for further action, if required. On November 5, 1997, the FDA advised the Company in writing that its BLA for HumaSPECT was not approvable at that time. The letter raised questions regarding clinical and manufacturing process issues and questions related to the FDA's inspection of the manufacturing facility itself. The Company submitted responses to the issues raised in the FDA letter via letters dated April 10, May 19 and 29, and July 15 and 24, 1998. The Company believes it has responded to the issues raised by the FDA. However, discussions with the FDA on these matters are ongoing. Once a company fully responds to the FDA, the agency has six months to either approve the BLA or issue a "complete action" letter setting forth specific deficiencies, if any, and the actions necessary to receive approval. There can be no assurance, however, that upon review of these submissions that the FDA ultimately will approve the BLA for HumaSPECT. A third party currently holds world-wide distribution rights for the Company's HumaSPECT product. While the Company is currently in negotiations to terminate the agreement providing for such rights, there can be no assurances that the agreement will be terminated on a timely basis, if at all. MANUFACTURING The Company manufactures its therapeutic products in Rockville, Maryland in a facility of approximately 120,000 square feet. The Rockville, Maryland facility contains facilities for production of human monoclonal antibodies, gene therapy and production of vaccines from antisera as well as extensive research and development facilities. The Company manufactures all of its FDA-cleared diagnostic products in two registered facilities totaling approximately 54,000 square feet in Issaquah, Washington. The Company's INSTI HIV-1/2 product is manufactured in a facility of approximately 7,000 square feet in Richmond, British Columbia, Canada. Facilities for the first OncoVAX Center in the United States have been established at Lehigh Valley Hospital in Allentown, Pennsylvania, and the terms of the Company's ownership in, and operation of, the center are being developed pursuant to a letter of intent with Lehigh Valley Hospital. A second OncoVAX Center in the United States is being established at the Company's therapeutic manufacturing facility in Rockville, Maryland. The first OncoVAX Center in Europe is being established at University Hospital, Vrije Universiteit, Amsterdam, The Netherlands. The Company is planning to establish more than 40 OncoVAX Centers in the United States and Europe to manufacture and administer OncoVAX(CL). All of the Company's facilities are leased. Upon establishment of the OncoVAX Centers, the Company believes that its facilities will be adequate for the foreseeable future. MARKETING AND SALES The Company markets and sells its diagnostic products in the United States through its own direct sales force, which consists of 17 employees. Outside the United States, the Company utilizes local distributors for the sale of its diagnostic products. The Company has appointed Sigma and Mentor as exclusive world-wide distributors for Apo-Tek Lp(a) and of Accu-D(x), respectively. 46 47 The Company plans to market and sell OncoVAX(CL) and HumaSPECT through OncoVAX Centers to be established in the United States and Europe. The Company anticipates that OncoVAX Centers will be supported by account representatives with both sales and service responsibilities with centralized marketing support located in Rockville, Maryland. The Company has appointed Mentor as exclusive world-wide distributor for KLH, but has not appointed distributors for any of its other therapeutic products. RESEARCH AND DEVELOPMENT The Company employs approximately 25 people in research and development, 16 of whom hold advanced degrees in chemistry and molecular biology. Their research and development efforts range from generic cancer vaccines to gene therapy for HIV/AIDS. For the six months ended December 31, 1995, the year ended December 31, 1996 and the year ended December 31, 1997, the Company (on a pro-forma basis after giving effect to the Merger as if it had occurred on January 1, 1997) spent $1.1 million, $1.0 million and $8.6 million, respectively, on research and development. REIMBURSEMENT The ability of the Company to successfully commercialize its products depends, in part, on coverage and reimbursement of such products by third-party payers, such as government health care programs (including Medicare and Medicaid), indemnity insurers, and managed care organizations. In the past several years there have been numerous initiatives on the federal and state government levels for comprehensive or incremental reforms affecting the payment for health care services and products, including a number of proposals that would significantly limit reimbursement under the Medicare and Medicaid programs. The Company anticipates that federal and state governments will continue to review and assess health care delivery systems and payment methodologies. There can be no assurance that adequate third-party coverage and reimbursement will be available for the Company's products. If adequate coverage and reimbursement are not provided by government and other third-party payers for uses of the Company's products, the market acceptance of these products could be adversely affected. In the United States, almost all people over age 65 have primary health care coverage through the federal Medicare program administered by the Health Care Financing Administration ("HCFA"). The strong correlation between the incidence of cancer and age means that HCFA's decisions concerning coverage and payment for OncoVAX(CL) by Medicare will be financially significant to the Company. As an autologous product that will not generally be sold through traditional commercial channels, OncoVAX(CL) may present unique coverage and payment issues for Medicare. Currently, once approved by the FDA, Medicare covers medically necessary biologics administered as part of or incident to a physician's service when furnished to beneficiaries in settings such as physicians' offices or clinics. Under federal law, HCFA pays physicians the lesser of their actual charge for the drug or 95% of the commercially published price of the drug. The Company plans to work to ensure that HCFA addresses and resolves any unique OncoVAX(CL) issues under its existing policies that generally provide Medicare coverage and payment for FDA-approved drugs. Medicare's decision concerning coverage and reimbursement of OncoVAX(CL) also may be useful in assuring private coverage and payment. Adults under age 65 who have insurance coverage are likely to have employer sponsored or work-related health plans, which are increasingly likely to involve some element of managed care with policies similar to those of Medicare. Because coverage and payment issues for private insurance coverage are heavily dependent on the provisions in the insurance contract, the Company is planning to work closely with payors and patients to obtain coverage and payment for OncoVAX(CL). GOVERNMENT REGULATION The testing, manufacturing, labeling, advertising, promotion, export and marketing, among other things, of the Company's therapeutic and diagnostic products are subject to extensive regulation by governmental authorities in the United States and other countries. Therapeutic and diagnostic products that are administered to patients are regulated as drugs or biologic drugs, while diagnostic products that are used on blood and tissue samples taken from patients are regulated as devices. In Europe, in vitro diagnostic devices will be subject to a Directive, to be adopted in 1999, which will create a harmonized regime for such products. For the 47 48 purposes of European Community law, OncoVAX(CL) is neither a medical device or medicinal product and therefore is unharmonized. Regulatory requirements are accordingly to be determined on a national basis. In certain Member States, OncoVAX(CL) would be unregulated. Drug Regulation Non-biological drugs and biological drugs are generally subject to some of the same laws and regulations. Ultimately, however, they are approved under different regulatory frameworks, with non-biological drugs being approved under the FDC Act through an NDA and biological drugs being approved under the PHS Act by a BLA. Among other things, the FDA Modernization Act clarifies that biological products are subject to the same requirements as non-biological products under the FDC Act, except that a biological product licensed under the PHS Act is not required to have an NDA. Thus, as a biologic, OncoVAX(CL) is subject to IND regulations prior to approval and will be regulated as both a biologic and a drug once it has an approved BLA. Traditionally, a company seeking FDA approval to market a biological drug (in contrast to a non- biological drug) was required to file and obtain approval of a PLA and an Establishment License Application ("ELA") with the FDA pursuant to the PHS Act before commercial marketing of the product could begin. The FDA Modernization Act repealed the statutory requirement for an ELA for a biological product. Instead, a single BLA covering both the product and the facility in which the product is manufactured is now required. As of February 19, 1998, the effective date of the FDA Modernization Act, approval of applications filed under the old system will result in the issuance of a BLA for the product. No refiling or other action on the part of the applicant will be required to implement this conversion to a single license. At the present time, the Company believes that OncoVAX(CL) and other immunotherapeutics that it may develop will be regulated by the FDA as biologics. The steps required before a drug or biologic may be approved for marketing in the United States generally include (i) preclinical laboratory tests and animal tests, (ii) the submission to the FDA of an IND application for human clinical testing, which must become effective before human clinical trials may commence, (iii) adequate and well-controlled human clinical trials to establish the safety and efficacy of the product, (iv) in the case of a biologic, the submission to the FDA of a BLA, or in the case of a drug, an NDA, (v) FDA review of the BLA or NDA and (vi) satisfactory completion of an FDA inspection of the manufacturing facilities at which the product is made to assess compliance with cGMPs. The testing and approval process requires substantial time, effort and financial resources, and there can be no assurance that any approval will be granted on a timely basis, if at all. Preclinical studies include laboratory evaluation of the product, as well as animal studies to assess the safety and potential efficacy of the product. The results of the preclinical studies, together with manufacturing information and analytical data, are submitted to the FDA as part of the IND. The IND automatically will become effective thirty days after receipt by the FDA unless the FDA, before that time, raises concerns or questions about the conduct of the trials as outlined in the IND and places the trial on clinical hold. In such case, the IND sponsor and the FDA must resolve any outstanding concerns before clinical trials can proceed. There can be no assurance that submission of an IND will result in FDA authorization to commence clinical trials. Moreover, once trials have commenced, the FDA may stop the trials, or particular types of trials, by placing a "clinical hold" on such trials because of concerns about, for example, the safety of the product being tested or the adequacy of the trial design. Such holds can cause substantial delay and in some cases may require abandonment of a product or a particular trial. Clinical trials involve the administration of the investigational products to healthy volunteers or patients under the supervision of a qualified principal investigator consistent with an informed consent. Further, each clinical trial must be reviewed and approved by an independent Institutional Review Board ("IRB") at each institution at which the study will be conducted. The IRB will consider, among other things, ethical factors, the safety of human subjects and the possible liability of the institution. Clinical trials typically are conducted in three sequential phases, but the phases may overlap. In Phase I, the initial introduction of the drug into human subjects, the drug is usually tested for safety (adverse effects), dosage tolerance, absorption, metabolism, distribution, excretion and pharmacodynamics. Phase II clinical trials usually involve studies in a limited patient population to (i) evaluate the efficacy of the drug for specific, 48 49 targeted indications, (ii) determine dosage tolerance and optimal dosage and (iii) identify possible adverse effects and safety risks. Phase III clinical trials generally further evaluate clinical efficacy and test further for safety within an expanded patient population and at multiple clinical sites. Phase IV clinical trials are conducted after approval to gain additional experience from the treatment of patients in the intended therapeutic indication and to document a clinical benefit in the case of drugs approved under accelerated approval regulations. If the FDA approves a product while a company has ongoing clinical trials that were not necessary for approval, a company may be able to use the data from these clinical trials to meet all or part of any Phase IV clinical trial requirement. These clinical trials are often referred to as "Phase III/IV post-approval clinical trials." Failure to promptly conduct Phase IV clinical trials could result in withdrawal of approval for products approved under accelerated approval regulations. In the case of products for severe or life-threatening diseases, the initial clinical trials are sometimes done in patients rather than in healthy volunteers. Since these patients are afflicted already with the target disease, it is possible that such clinical trials may provide evidence of efficacy traditionally obtained in Phase II clinical trials. These trials are referred to frequently as Phase I/II trials. There can be no assurance that Phase I, Phase II or Phase III testing will be completed successfully within any specific time period, if at all, with respect to any of the Company's product candidates. Furthermore, the FDA may suspend clinical trials at any time on various grounds, including a finding that the subjects or patients are being exposed to an unacceptable health risk. The results of the preclinical studies and clinical trials, together with detailed information on the manufacture and composition of the product, are submitted to the FDA in the form of a BLA or NDA requesting approval to market the product. Before approving a BLA or NDA, the FDA will inspect the facilities at which the product is manufactured and will not approve the product unless the manufacturing facility is in cGMP compliance. The FDA may delay approval of a BLA or NDA if applicable regulatory criteria are not satisfied, require additional testing or information, and/or require postmarketing testing and surveillance to monitor safety or efficacy of a product. There can be no assurance that FDA approval of any BLA or NDA submitted by the Company will be granted on a timely basis, if at all. Also, if regulatory approval of a product is granted, such approval may entail limitations on the indicated uses for which such product may be marketed. Any FDA approvals that may be granted will be subject to continual review, and newly discovered or developed safety or efficacy data may result in withdrawal of products from marketing. Moreover, if and when such approval is obtained, the marketing and manufacture of the Company's products would remain subject to extensive regulatory requirements administered by the FDA and other regulatory bodies, including compliance with cGMPs and adverse event reporting requirements. Failure to comply with these regulatory requirements could, among other things, result in product seizures, recalls, fines, injunctions, suspensions, or withdrawals of regulatory approvals, operating restrictions and criminal prosecutions. The FDA Modernization Act establishes a new statutory program for the approval of fast track drugs, including biological products. The fast track program is designed to facilitate the development and expedite the approval of therapies that are intended to treat serious or life-threatening conditions, such as cancer and AIDS, and that demonstrate the potential to address unmet medical needs for such conditions. Under the new fast track program, a request for designation may be submitted concurrently with, or any time after, the submission of an application for an IND. If a product meets the statutory criteria, the Secretary is required to designate it as a fast track drug within 60 days of the request for designation. An application for a fast track drug may be approved upon determination that the drug has an effect on a clinical endpoint or a surrogate endpoint that is reasonably likely to predict clinical benefit. While precise time frames for approval of fast track products have not been established, the Prescription Drug User Fee Act established performance goals in correspondence between the FDA Commissioner and Congress committing the agency to a six-month review period for priority drugs. The Company may elect to seek approval of OncoVAX(CL) under this fast track process. If a product is approved under the fast track program, the sponsor may be required to conduct additional adequate and well-controlled studies to verify that the effect on the surrogate marker represents improved clinical outcome or otherwise confirm the effect on a clinical endpoint. In the event such postmarketing studies do not verify the drug's anticipated clinical benefit, or if there is other evidence that the drug product is not shown to be safe 49 50 and effective, expedited withdrawal procedures permit the FDA, after a hearing, to remove a product from the market. For products approved under the fast track provisions, promotional materials must be submitted to the FDA for review 30 days prior to dissemination. Significant uncertainty exists as to the extent to which such initiative will result in accelerated review and approval. Further, the FDA has considerable discretion in determining eligibility for accelerated review and approval and is not bound by discussions that an applicant may have with FDA staff. Accordingly, the FDA could employ such discretion to deny eligibility of OncoVAX(CL) as a candidate for accelerated review or require additional clinical trials or other information before approving OncoVAX(CL). The Company cannot predict the ultimate impact, if any, of the new approval process on the timing or likelihood of FDA approval of OncoVAX(CL) or any of its other potential products. Treatment of patients with an experimental therapy may be allowed under a treatment IND before general marketing begins and pending FDA approval. Charging for an investigation product also may be allowed under a treatment IND to recover certain costs of development, if various requirements are met. The Company may elect to file a treatment IND pending approval of its BLA for OncoVAX(CL). The FDA has full discretion with regard to whether to allow a treatment IND to go into effect and there can be no assurance that the FDA will allow a treatment IND in this instance. The Company also will be subject to a variety of regulations governing clinical trials and sales of its products outside the United States. Whether or not FDA approval has been obtained, approval of a product by the comparable non-U.S. regulatory authorities must be obtained prior to the commencement of marketing of the product in their respective countries. The approval process varies from country to country and the time needed to secure approval may be longer or shorter than that required for FDA approval. The pharmaceutical legislation of the European Union requires any person seeking to market a medicinal product for human use to obtain approval of an MAA. Procedures for granting such authorizations have been harmonized within the European Union through the issue of directives for implementation into the domestic law of each Member State and by Regulations having direct effect. There are two authorization procedures by which approvals can be sought to market pharmaceutical products in more than one Member State. The first is a centralized assessment procedure administered by the EMEA. The second is a decentralized, or "mutual recognition," procedure available only to non-biologics. Pursuant to this procedure, an applicant may apply for a national authorization in one Member State. Upon obtaining that authorization, an applicant may make further national applications in such other Member States as are relevant to the applicant, requesting the relevant national authorities in those Member States to recognize, by reference to the assessment report of the relevant national authority in the first Member State, the marketing authorization already granted. In the event of objection, European Union authorities require that binding arbitration determine whether authorizations should be granted and, if so, on what terms. The Company's policy is to design its clinical trials in order to meet the eligibility requirements for centralized EMEA approval. Drugs which fall within the definition of "high technology medicines" under the Annex to Council Regulation 2309/93 undergo the centralized approval system under which the CPMP is obliged to give an opinion as to whether a marketing authorization has been granted within 210 days (although the "clock" may be stopped if further information is required). In addition, prices are regulated in most countries other than the United States. For example, regulators in certain European countries condition their approval of a pharmaceutical product on the agreement of the seller not to sell the product for more than a certain price in their respective countries. In some cases, the price established in any of these countries may serve as a benchmark in the other countries. As such, the price approved in connection with the first approval obtained in any of these European countries may serve as the maximum price that may be approved in the other European countries. Also, a price approved in one of these European countries that is lower than the price previously approved in the other European countries may require a reduction in the prices in such other European countries. In such event, there can be no assurance that the resulting prices would be sufficient to generate an acceptable return on the Company's investment in its products. 50 51 Device Regulation Pursuant to the FDC Act and the regulations promulgated thereunder, the FDA regulates the preclinical and clinical testing, manufacturing, labeling, distribution and promotion of medical devices. In the United States, medical devices are classified into one of three classes (i.e., Class I, II, or III) on the basis of the controls deemed necessary by the FDA to reasonably ensure their safety and effectiveness. Class I devices are subject to general controls (e.g., labeling, premarket notification and adherence to cGMPs) and Class II devices are subject to general and special controls (such as performance standards, postmarket surveillance, patient registries, and FDA guidelines). Generally, Class III devices are those which must receive premarket approval by the FDA to ensure their safety and effectiveness (life-sustaining, life-supporting and implantable devices, or new devices which have been found not to be substantially equivalent to legally marketed devices). Before a new device can be introduced in the market, the manufacturer must generally obtain FDA clearance or approval through either clearance of a 510(k) notification or approval of a PMA application. However, most Class I devices are now exempt from the FDA's market clearance requirements. A PMA application must be filed if a proposed device is not substantially equivalent to a legally marketed Class I or Class II device, or if it is a preamendment Class III device for which the FDA has called for PMA applications. A PMA application must be supported by valid scientific evidence to demonstrate the safety and effectiveness of the device, typically including the results of clinical trials, bench tests and laboratory and animal studies. The PMA application must also contain a complete description of the device and its components, and a detailed description of the methods, facilities and controls used to manufacture the device. In addition, the submission must include the proposed labeling, advertising literature and any training materials. Once the FDA determines that the PMA application is sufficiently complete to permit a substantive review, the FDA will accept the application for filing and begin its review. Although the FDA has 180 days to review a PMA application, such reviews generally take one to three years, and may take significantly longer, from the date the PMA application is accepted for filing. During the review of a PMA application, an advisory committee likely will be convened to review and evaluate the application and provide recommendations to the FDA as to whether the device should be approved. The FDA is not bound by the recommendation of the advisory panel. In addition, prior to approval, the FDA generally will inspect the manufacturing facility to ensure compliance with applicable cGMP requirements. If granted approval, the PMA application may include significant limitations on the indicated uses for which the product may be marketed, and the agency may require post-marketing studies of the device. If the FDA's evaluation of the PMA application or manufacturing facilities is not favorable, the FDA will deny approval of the PMA application or issue a "non-approval" letter. The FDA may determine that additional clinical trials are necessary, in which case approval may be delayed for one or more years while additional clinical trials are conducted and submitted. The PMA application process can be expensive, uncertain and lengthy, and a number of devices for which FDA clearance has been sought by other companies have never been approved for marketing. Modifications to a device that is the subject of an approved PMA application, its labeling or its manufacturing process may require approval by the FDA of PMA application supplements or new PMA applications. Supplements to a PMA application often require the submission of the same type of information required for an initial PMA application, except they are generally limited to that information needed to support the proposed change. A 510(k) clearance will be granted if the submitted information establishes that the proposed device is "substantially equivalent" to a legally marketed Class I or Class II medical device or a preamendment Class III medical device for which the FDA has not called for PMA applications. In some cases, 510(k) submissions require clinical data. It generally takes from four to 12 months from submission to obtain 510(k) premarket clearance, but it may take longer. The FDA may determine that a proposed device is not substantially equivalent to a legally marketed device, or that additional information is needed before a substantial equivalence determination can be made. A "not substantially equivalent" determination, or a request for additional information could prevent or delay the market introduction of new products that fall into this category. For any devices that are cleared through the 510(k) process, modifications or enhancements 51 52 that could significantly affect safety or effectiveness, or constitute a major change in the intended use of the device, will require new 510(k) submissions. If human clinical trials of a device are required, whether for a 510(k) or a PMA application, and the device presents a "significant risk," the sponsor of the trial (usually the manufacturer or the distributor of the device) will have to file an IDE application prior to commencing human clinical trials. The IDE application must be supported by data, typically including the results of animal and laboratory testing. If the IDE application is approved by the FDA and one or more appropriate IRBs, human clinical trials may begin at a specific number of investigational sites with a specific number of patients, as approved by the FDA. If the device presents a "nonsignificant risk" to the patient, a sponsor may begin the clinical trial after obtaining approval for the study by one or more appropriate IRBs without the need for FDA approval. Submission of an IDE does not give assurance that the FDA will approve the IDE and, if it is approved, there can be no assurance that the FDA will determine that the data derived from these studies supports the safety and efficacy of the device or warrants the continuation of clinical studies. Sponsors of clinical trials are permitted to sell investigational devices distributed in the course of the study provided such compensation does not exceed recovery of the costs of manufacture, research, development and handling. An IDE supplement must be submitted to and approved by the FDA before a sponsor or investigator may make a change to the investigational plan that may affect its scientific soundness or the rights, safety or welfare of human subjects. Although clinical investigations of most devices are subject to the IDE requirements, clinical investigations of in vitro diagnostic ("IVDs") tests are exempt from the IDE requirements, including FDA approval of investigations, provided the testing meets certain exemption criteria. IVD manufacturers must also establish distribution controls to assure that IVDs distributed for the purpose of conducting clinical investigations are used only for that purpose. Pursuant to current FDA policy, manufacturers of IVDs labeled for investigational use only ("IUO") or research use only ("RUO") are encouraged by the FDA to establish a certification program under which investigational IVDs are distributed to or utilized only by individuals, laboratories or health care facilities that have provided the manufacturer with a written certification of compliance indicating that the IUO or RUO product will be restricted in use and will, among other things, meet institutional review board and informed consent requirements. Any devices manufactured or distributed by the Company pursuant to FDA clearance or approvals are subject to pervasive and continuing regulation, including routine inspections of facilities by the FDA and certain state agencies. Manufacturers of medical devices for marketing in the United States are required to adhere to applicable regulations setting forth detailed cGMP requirements, which include testing, control and documentation requirements. Manufacturers must also comply with Medical Device Reporting ("MDR") requirements that a firm report to the FDA any incident in which its product may have caused or contributed to a death or serious injury, or in which its product malfunctioned and, if the malfunction were to recur, it would be likely to cause or contribute to a death or serious injury. Labeling and promotional activities are subject to scrutiny by the FDA and, in certain circumstances, by the Federal Trade Commission. Current FDA enforcement policy prohibits the marketing of approved medical devices for unapproved uses. The Company is subject to routine inspection by the FDA and certain state agencies for compliance with cGMP requirements, MDR requirements, and other applicable regulations. With respect to devices, the FDA Modernization Act will affect the IDE, 510(k) and PMA application processes, and also will affect device standards and data requirements, procedures relating to humanitarian and breakthrough devices, tracking and postmarket surveillance, accredited third-party review, and the dissemination of off-label information. The Company cannot predict how or when these changes will be implemented or what effect the changes will have on the regulation of the Company's products. Changes in existing requirements or adoption of new requirements could have a material adverse effect on the Company's business, financial condition, and results of operations. There can be no assurance that the Company will not incur significant costs to comply with laws and regulations in the future or that laws and regulations will not have a material adverse effect on the Company's business, financial condition or results of operations. Within the European Community, there exists a harmonized European regulatory regime for medical devices (Directive 93/42/EEC) and, from 1999, a separate Directive for in vitro diagnostics will be adopted. 52 53 These Directives require that relevant products satisfy certain Essential Requirements and bear a marking to demonstrate compliance. The Company is also subject to numerous federal, state and local laws relating to such matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control and disposal of hazardous or potentially hazardous substances. There can be no assurance that the Company will not be required to incur significant costs to comply with such laws and regulations in the future or that such laws or regulations will not have a material adverse effect upon the Company's ability to do business. Noncompliance with applicable requirements can result in, among other things, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the government to grant premarket clearance or premarket approval for devices, withdrawal of marketing clearances or approvals, and criminal prosecution. The FDA also has authority to request recall, repair, replacement or refund of the cost of any device manufactured or distributed by the Company. Health Care Fraud and Abuse The Company is subject to various federal and state laws pertaining to health care fraud and abuse, including anti-kickback laws, physician self-referral laws, and false claim laws. Violations of these laws are punishable by criminal and/or civil sanctions. The Company has never been challenged by a government authority under these laws, and intends to seek legal counsel and structure its operations in order to comply with such laws. However, because of the breadth of some of these laws, the Company cannot provide assurances that one or more of its current or future practices would not be challenged by governmental authorities under these laws or that such challenge could not be successful. Anti-Kickback Laws. The Company's operations are subject to federal and state anti-kickback laws. The Federal Health Care Programs Anti-Kickback Statute (section 1128B(b) of the Social Security Act) prohibits persons or entities from, among other things, knowingly and willfully offering, paying, soliciting or receiving any remuneration, directly or indirectly, overtly or covertly, in cash or in kind, in return for or to induce (i) the referral of an individual for the furnishing of any item or service for which payment may be made in whole or in part under a Federal Health Care Program, including Medicare and Medicaid, or (ii) the purchasing, ordering, or recommending of any product or service for which payment may be made in whole or in part under a Federal Health Care Program. The statute is broad in scope and has been interpreted by federal courts and administrative tribunals to apply if even "one purpose" (as opposed to the primary or sole purpose) of an arrangement is to induce the referral of business. The statute contains certain exceptions, and regulations have created certain "safe harbors," which identify specific practices that might otherwise fall within the broad language of the statutory prohibition, but that are not considered unlawful under the statute. Safe harbors exist for, among other things, certain investment interests held in an entity by a referral source, as well as employment and personal service arrangements. Each safe harbor contains a number of requirements that must be met. Practices that do not satisfy all of the requirements of an applicable safe harbor do not necessarily violate the statute, although such practices may be subject to scrutiny by federal enforcement officials. Several states also have anti-kickback laws that vary in scope and may apply regardless of whether a Federal Health Care Program is involved. The Company has established, or may establish in the future, various financial relationships with potential purchasers of the Company's products or sources of referral, including hospitals, clinical laboratories and physicians. For example, the Company may lease space from hospitals and may contract with clinical laboratories for testing to be performed in connection with patient treatment. In addition, the Company may acquire, equipment, products, services and/or capital improvements from hospitals where OncoVAX Centers may be located, through payments of cash, notes and/or stock, and/or may enter into joint ventures for the operation of such centers, as the Company has done with Lehigh Valley Hospital. As long as such relationships involve the lease or purchase by the Company of space, products, services or capital improvements needed for the Company's operations, and the amounts paid represent fair market value, the Company believes that such relationships should not be found to violate the anti-kickback laws. In addition, certain supervising physicians at the Company's OncoVAX Centers, as well as physician-members of the Company's 53 54 Medical Advisory Board, may recommend, order or purchase the Company's products, or refer patients to the Company's OncoVAX Centers. Arrangements with these physicians or their employers will be structured to either meet the requirements of the applicable safe harbors for employment and personal service arrangements or, as with the other relationships described above, compensate the individuals or their employers a fair market value amount for the physician's services. Potential purchasers of the Company's products or sources of referral may acquire investment interests in the Company or in the OncoVAX Centers. The Company believes that such interests could qualify for the investment interests safe harbor or, absent safe harbor compliance, should not be found to violate the anti-kickback laws as long as such interests are offered and purchased for a fair market value amount and any return on investment is proportional to the amount of the investment. The Company may provide certain customers with volume-based discounts on the sale of laboratory reagents and instrumentation necessary to read ELISA tests. The Company believes that its policies for providing discounts and instrumentation are consistent with standard industry practices and should not be found to violate the anti-kickback laws. Moreover, the Company's CEO has made a donation to Lehigh Valley Hospital in the amount of 5,000 shares of Company common stock. Because the contributed shares were owned by the CEO, and provided that if subjected to regulatory scrutiny, the donation was found to be motivated solely by the CEO's charitable purpose, the Company believes that the CEO's donation should not be found to violate the anti-kickback laws. Physician Self-Referral Laws. To the extent it has financial relationships with physicians, the Company is subject to federal and state physician self-referral laws. The federal Medicare/Medicaid physician self-referral law (the "Stark law," section 1877 of the Social Security Act) prohibits a physician from referring Medicare and Medicaid beneficiaries to an entity for specified "designated health services," including outpatient prescription drugs, if the physician has either an investment interest in the entity or a compensation arrangement with the entity. There are several exceptions to the Stark law prohibition, including exceptions for employment and personal service arrangements, as well as investment interests in publicly traded companies with stockholder equity exceeding $75 million. Several states also have physician self-referral laws that vary in scope and may apply regardless of whether a Federal Health Care Program is involved. As described above, the Company has established, or may establish in the future, various financial relationships with physicians who may refer patients to the Company's OncoVAX Centers. Since the centers will furnish designated health services, such as the OncoVAX vaccine, which likely would be deemed an outpatient prescription drug, the Company intends to structure arrangements with referring physicians to be in compliance with the Stark law. For example, arrangements with supervising physicians at the Company's OncoVAX Centers, as well as physician-members of the Company's Medical Advisory Board, will be structured to meet the requirements of applicable Stark law exceptions, including exceptions for employment and personal service arrangements. Certain physician-members of the Company's Medical Advisory Board may hold investment interests in the Company. Since such investment interests would not currently qualify for a Stark law exception, the Company intends to enter into agreements with these physicians that prohibit the physicians from referring patients to the Company's OncoVAX Centers until the Company has sufficient stockholder equity to qualify for the Stark law exception for ownership in a publicly traded company. Moreover, once the Company's stock becomes publicly traded, it will not be in a position to know or control whether some physicians who refer patients to OncoVAX Centers may be investors in the Company. Absent the Company having sufficient stockholder equity to qualify for the Stark law exception for ownership in a publicly traded company, any such referrals that do occur could be found to be in violation of the Stark law. False Claims Laws. The Company is subject to federal and state laws prohibiting individuals or entities from knowingly and willfully presenting, or causing to be presented, false reimbursement claims to third-party payers, including the Medicare and Medicaid programs. Although the Company does not currently submit reimbursement claims to third-party payers for any of its products, the Company may provide customers with CPT coding recommendations for its products. Moreover, once operational, the Company's OncoVAX Centers may submit claims to third-party payers. The Company intends that claims submitted to third-party payers by OncoVAX Centers will comply with requirements imposed by such payers, including Medicare program requirements for the coverage of biologics administered incident to a physician's service. 54 55 Facility Licensure, Corporate Practice of Medicine and other Health Care Professions States generally require that certain types of health care facilities have regulatory licenses in order to operate and treat patients. Facilities must satisfy specified regulatory requirements, and undergo periodic surveys or inspections by state licensing bodies, in order to obtain and maintain such licenses. Some states may require licensure of the Company's OncoVAX Centers. The Company intends to obtain and maintain all required regulatory licenses for the OncoVAX Centers. Many states also have laws restricting the corporate practice of medicine. These laws generally prohibit non-physician entities from practicing medicine or otherwise exercising control over a physician's practice of medicine. In some states, these laws prohibit business corporations from employing physicians to render medical services on behalf of the corporation, although the retention of physicians on an independent contractor basis is generally permissible. Some states also have laws restricting the corporate practice of other health care professions such as nurse practitioners. The Company intends to retain supervising physicians and other health care professionals for its OncoVAX Centers in compliance with these laws. Other Regulation The Company is subject to laws of more general applicability dealing with issues such as occupational safety, employment, medical leave, and civil rights and discrimination. Federal, state and local governments in many instances are expanding the regulatory requirements on businesses, and the imposition of these requirements may have the effect of increasing operating costs and reducing the profitability of the Company's operations. RADIOACTIVE AND OTHER HAZARDOUS MATERIALS The NRC and the Agreement States regulate companies that possess radioactive material and those that manufacture, prepare, or transfer radioactive drugs for commercial distribution to assure the public's safety through proper use of radioactive materials. Agreement States typically regulate in a manner similar to the NRC. The Company's incorporation of radioactive materials into its HumaRAD products and HumaSPECT subjects it to these NRC requirements. To comply, the Company must apply for and maintain appropriate licenses and comply with reporting, recordkeeping, and other regulatory requirements. Obtaining and maintaining a license includes demonstrating that: the Company's equipment and facilities are adequate to protect health and minimize danger to life and property; the personnel are adequately qualified to operate the equipment; and environmental concerns are adequately addressed. Other regulatory requirements include specific packaging and labeling compliance, measuring radiation emitted from products before distribution, conducting daily inspections and maintaining instruments used to measure the product's radiation. The regulatory authorities periodically conduct routine inspections, the frequency of which varies depending on the Company's history and changes in volume or character of manufacturing operations. The NRC takes enforcement actions against those companies failing to achieve compliance with NRC regulations. The Company's failure to comply with the regulatory requirements could subject it to enforcement actions including civil penalties up to $5,500 per violation per day and orders to modify, suspend or revoke its licenses. With a suspended or revoked license, the Company would be required to cease possessing the radioactive material necessary for producing its products and distributing its products. The nature of a particular penalty will depend on who discovered the violation and upon its severity, its repetitiveness and the willfulness involved. The manufacturing and administration of the Company's HumaRAD products and HumaSPECT require the handling, use and disposal of (90)Yttrium and Technetium Tc 99m, respectively, each a radioactive isotope. These activities must comply with various state and NRC regulations regarding the handling and use of radioactive materials. Violations of these regulations could significantly delay completion of clinical trials and commercialization of the Company's HumaRAD products and HumaSPECT. The administration of the Company's HumaRAD products and HumaSPECT entails the introduction of radioactive materials into patients. These patients emit radioactivity at levels that pose a safety concern to others around them, especially healthcare workers for whom the cumulative effect of repeated exposure to radioactivity is of particular concern. These concerns are addressed in regulations promulgated by the NRC, 55 56 as well as by various state and local governments and individual hospitals. Generally, patients who emit radioactivity above specified levels are required to be hospitalized, where they can be isolated from others until radiation falls to acceptable levels. The NRC recently enacted regulations that have made it easier for hospitals to treat patients with radioactive materials on an outpatient basis. Under these regulations, the Company's HumaRAD products and HumaSPECT may be administered on an outpatient basis in most cases. Although state and local governments often follow the lead of the NRC, many currently do not, and there can be no assurance that they will do so or that patients receiving the Company's HumaRAD products and HumaSPECT will not have to remain hospitalized for one to three days following administration, adding to the overall cost. The Company expects to continue using hazardous chemicals and radioactive compounds in its ongoing research activities. Although the Company believes that safety procedures for handling and disposing of such materials will comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. The Company could be held liable for any damages that result from such an accident, contamination or injury from the handling and disposal of these materials as well as for unexpected remedial costs and penalties that may result from any violation of applicable regulations, which could result in a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company may incur substantial costs to comply with environmental regulations. PATENTS AND OTHER INTELLECTUAL PROPERTY The Company believes that patent and trade secret protection is important to its business and that its future will depend in part on its ability to maintain its technology licenses, protect its trade secrets, secure additional patents and operate without infringing the proprietary rights of others. Currently, the Company has an extensive portfolio of patents and additional pending patent applications in connection with most of the Company's therapeutic products. This includes United States Patent No. 5,484,596, which covers the OncoVAX(CL) method of treatment and will expire in January 2013. Extensive research has been conducted in the cancer vaccine and monoclonal antibody fields by pharmaceutical and biotechnology companies and other organizations and a substantial number of patents in these fields have been issued to other pharmaceutical and biotechnology companies. In addition, competitors may have applications for additional patents pending and may obtain additional patents and proprietary rights related to products or processes competitive with or similar to those of the Company. Patent applications are maintained in secrecy for a period after filing and, in the United States, patent applications are confidential until the patent is issued. Publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries and the filing of related patent applications. The Company may not be aware of all of the patents potentially adverse to the Company's interests that may have been issued to other companies, research or academic institutions, or others. No assurance can be given that such patents do not exist, have not been filed, or could not be filed or issued, which contain claims relating to the Company's technology, products or processes. To date, no consistent policy has emerged regarding the breadth of claims allowable in pharmaceutical and biotechnology patents. The Company is aware of various patents that have been issued to others that pertain to a portion of the Company's prospective business. There can be no assurance that other patents do not exist in the United States or in other countries or that patents will not be issued to third parties that contain preclusive or conflicting claims with respect to OncoVAX(CL) or any of the Company's other product candidates or programs. Commercialization of cancer vaccines and monoclonal antibody-based products may require licensing and/or cross-licensing of one or more patents with other organizations in the field. There can be no assurance that the licenses that might be required for the Company's processes or products would be available on commercially acceptable terms, if at all. The Company's breach of an existing license or failure to obtain a license to technology required to commercialize its product candidates may have a material adverse effect on the Company's business, financial condition and results of operations. Litigation, which could result in substantial costs to the Company, may 56 57 also be necessary to enforce any patents issued to the Company or to determine the scope and validity of third-party proprietary rights. If competitors of the Company prepare and file patent applications in the United States that claim technology also claimed by the Company, the Company may have to participate in interference proceedings declared by the United States Patent and Trademark Office to determine priority of invention, which could result in substantial cost to the Company, even if the eventual outcome is favorable to the Company. An adverse outcome could subject the Company to significant liabilities to third parties and require the Company to license disputed rights from third parties or to cease using such technology. Patents issued and patent applications filed internationally relating to biologics are numerous and there can be no assurance that current and potential competitors and other third parties have not filed or in the future will not file applications for, or have not received or in the future will not receive, patents or obtain additional proprietary rights relating to products or processes used or proposed to be used by the Company. Many non-United States jurisdictions allow oppositions by third parties to granted patents and/or issued patents. The Company may have to participate in opposition proceedings in non-United States jurisdictions to prevent a third party from obtaining a patent that may be adverse to the Company's interests. Also, the Company may have to defend against a third party's opposition to a patent granted and/or issued to the Company. There can be no assurance that the Company will be successful in an opposition proceeding, and participation in such a proceeding could result in substantial cost to the Company whether or not the eventual outcome is favorable to the Company. Moreover, there is certain subject matter which is patentable in the United States and not generally patentable outside of the United States and may limit the protection the Company can obtain on some of its inventions outside of the United States. For example, methods of treating humans are not patentable in many countries outside of the United States. These and/or other issues may prevent the Company from obtaining patent protection outside of the United States, which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company also relies on trade secrets and trademarks to protect its technology, especially where patent protection is not believed to be appropriate or obtainable. The Company protects its proprietary technology and processes, in part, by confidentiality agreements with its key employees, consultants, medical advisory board members, collaborators and contractors. There can be no assurance that these agreements will not be breached, that the Company would have adequate remedies for any breach, or that the Company's trade secrets and trademarks or those of its collaborators or contractors will not otherwise become known or be discovered independently by competitors. All of the Company's material patents, including those which relate to the Company's OncoVAX(CL), HumaSPECT and the Company's HumaRAD products, have been pledged to secure certain of the Company's existing debt obligations. See "-- Recent Debt Refinancings." RECENT DEBT REFINANCINGS On April 1, 1998, the Company issued to each of Northstar High Yield Fund and Northstar High Total Return Fund II a 12.5% promissory note (each such note, an "April 1998 Note") in the principal amount of $4.0 million and a warrant to purchase 32,711 shares of common stock (collectively, the "April 1998 Securities"). The Company applied approximately $6.7 million of the $8.0 million proceeds from the sale of the April 1998 Securities to retire the Company's existing credit facility with Creditanstalt AB. The maturity of the April 1998 Notes was subsequently extended from April 17, 1998 to August 21, 1998 and the principal amount of the April 1998 Note issued to Northstar High Total Return Fund II was increased to $6.0 million, bringing the total principal amount outstanding under the April 1998 Notes to $10.0 million. On July 31, 1998, the Company's subsidiary, PerImmune Holdings, entered into an agreement with Organon Teknika (the "Organon Amendment") whereby Organon Teknika agreed to extend the maturity of a promissory note issued by PerImmune Holdings in the original principal amount of approximately $9.2 million, plus all unpaid accrued interest as calculated on the date of this offering (the "Organon Note"), from August 1, 1998 to January 15, 2000. The Organon Amendment provides that, from and after the date of the consummation of this offering until paid in full, interest will accrue on the Organon Note at the rate of 10% per annum, and shall be due and payable on a quarterly basis, commencing on each November 1 thereafter. The Organon Amendment also provides that the Organon Note shall mature on January 15, 2000 and shall be payable in quarterly installments over the nine or twelve month period thereafter, depending on the 57 58 Company's cash and cash equivalent balances as of December 31, 1999. The Organon Note is convertible, at the option of Organon Teknika, into common stock any time from and after the date of the consummation of this offering at a conversion price equal to the price to the public set forth on the cover page of this Prospectus, subject to certain anti-dilution adjustments. The Organon Note is secured by a first priority perfected security interest in all of the patents owned by PerImmune Holdings including those related to OncoVAXCL, HumaSPECT and the Company's HumaRAD products (the "PerImmune Patents"). The Organon Amendment also extended the date of certain milestone payments due under the Intellectual Property Agreement, dated August 2, 1996, by and among PerImmune Holdings and Akzo Nobel Pharma International, B.V. ("Akzo") (the "Intellectual Property Agreement"). Under the Organon Amendment, the Company agreed to guarantee payment of the Organon Note and payment of milestone payments due under the Intellectual Property Agreement. On August 25, 1998, the Company completed a comprehensive refinancing of its outstanding indebtedness (the "August 1998 Refinancing"). In the August 1998 Refinancing, the Company issued to Northstar High Yield Fund, Northstar High Total Return Fund, Northstar High Total Return Fund II and Northstar Strategic Income Fund (collectively, the "Northstar Funds") (i) the Company's 12% guaranteed senior secured primary notes due August 25, 2003 in the aggregate original principal amount of $35.0 million (the "August 1998 Primary Notes"), (ii) the Company's 12% guaranteed senior secured escrow notes due August 25, 2003 in the aggregate original principal amount of $6.0 million (the "August 1998 Escrow Notes" and, together with the August 1998 Primary Notes, the "August 1998 Notes") and (iii) common stock warrants to purchase up to 1,083,338 shares of common stock (the "August 1998 Warrants" and, together with the August 1998 Notes, the "August 1998 Securities"). In addition, the Company amended and restated (i) certain provisions of warrants previously granted to certain of the Northstar Funds and (ii) certain provisions of that portion of a warrant previously granted to CoreStates Enterprise Fund ("CoreStates"), which was assigned and transferred to the Northstar Funds (the "CoreStates Warrant"). The description of the agreements that effected the August 1998 Refinancing contained herein does not purport to be complete and is qualified in its entirety by reference to such agreements, which have been filed as Exhibits to the Registration Statement of which this Prospectus is a part. As consideration for their purchase of the August 1998 Securities, the Northstar Funds (i) contributed to the Company (A) each of the 12.5% April 1998 Notes, (B) a senior secured promissory note in the original principal amount of $4.7 million issued by the Company to Northstar High Total Return Fund on December 27, 1995, due and payable on December 21, 2000 (the "1995 Note") and (C) an aggregate of 47,030 shares of the Company's Series A-2 preferred stock ("Series A-2 Preferred Stock") and (ii) paid the remaining proceeds from the purchase of the August 1998 Securities to the Company. The net cash proceeds from the sale of the August 1998 Securities were applied (i) to discharge the Company's indebtedness to (A) CoreStates in the aggregate amount of $5,097,568.91 for repayment of a Secured Promissory Note, in the original principal amount of $4.0 million, bearing an interest rate of 13% per annum, (B) Northstar High Total Return Fund in the amount of $7,171,131 including interest for repayment of the 1995 Note, (C) Northstar High Yield Fund and Northstar High Total Return Fund II in the amount of $10,113,014 for repayment of the April 1998 Notes and (D) Northstar High Total Return Fund in the amount of $4,876,423 for redemption of certain shares of the Series A-2 Preferred Stock, (ii) to make a $500,000 milestone payment owed by PerImmune Holdings to Akzo pursuant to the Intellectual Property Agreement, (iii) to advance to subsidiaries of the Company capital required by such subsidiaries in the amount of $2,165,365.09, (iv) to fund a (A) $6.0 million escrow account ("Segregated Account") (which sum represents all of the cash proceeds from the sale of the August 1998 Escrow Notes) and (B) a $4.92 million escrow (the "Escrow Account"), which amount was sufficient to pay, together with the proceeds from the investment thereof, the first four quarterly interest payments on the August 1998 Notes. In addition, in conjunction with the sale of the August 1998 Securities, CoreStates transferred the CoreStates Warrant, representing the right to purchase up to 159,073 shares of the Company's Common Stock, to the Northstar Funds. The August 1998 Notes are secured by (i) a first priority security interest in all the existing and future assets of the Company, other than the PerImmune Patents and certain equipment financed pursuant to the 58 59 Loan and Security Agreement, dated September 30, 1997, between the Company and the Washington Economic Development Finance Authority, and a second security interest in certain of the PerImmune Patents and (ii) a pledge of all the issued and outstanding capital stock of the existing and future subsidiaries of the Company. Pursuant to the Interest Escrow Security Agreement, the Company is permitted to obtain funds upon request from such Segregated Account, provided that no event of default (as defined) occurs. The Company may draw out of the Escrow Account to make scheduled interest payments on the August 1998 Notes, provided that, after giving effect to any such withdrawal, the Company, subject to certain conditions, is required to maintain the balance in the Escrow Account at an amount sufficient to pay the next four scheduled interest payments, and, after the first two successive full payments of interest hereafter, at a level sufficient to pay the next two successive full payments of interest on the outstanding August 1998 Notes. The Northstar Funds will have a first priority security interest in the Escrow Account. The Escrow Account will be terminated after payment in full of all interest accrued through and including the twelfth successive interest payment due on the August 1998 Notes, with any balance remaining in the Escrow Account to be retained by the Company. The August 1998 Notes are guaranteed by all the existing subsidiaries of the Company and will be guaranteed by all future subsidiaries of the Company. The August 1998 Notes, among other things, require that the Company comply with certain financial covenants beginning in the year 2000 including, without limitation, maintaining an adjusted debt to EBITDA (as defined) ratio, minimum levels of tangible net worth and interest coverage, and maximum levels of leverage for certain periods. In addition, the August 1998 Notes impose certain limitations on the ability of the Company to, among other things, (i) incur additional indebtedness, (ii) pay dividends or make certain other restricted payments, (iii) consummate certain asset sales, (iv) enter into certain transactions with affiliates, (v) incur liens, (vi) merge or consolidate with any other person or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of its assets, (vii) enter into certain restrictive arrangements relating to the Company's subsidiaries, (viii) extend credit and (ix) make investments. Pursuant to the terms of the August 1998 Primary Notes, up to $5.0 million aggregate principal amount of the August 1998 Primary Notes must be redeemed (at a price equal to 100% of their principal amount plus accrued and unpaid interest, if any, to the date of redemption), when and as the Company receives the net proceeds from the sale of common stock offered hereby. See "Use of Proceeds." Pursuant to the terms of the August 1998 Escrow Notes, the Company must notify the noteholders if the Company or any of its subsidiaries receives cash proceeds from the sale of debt or equity securities or from certain asset sales, and, if requested, up to $6.0 million aggregate principal amount of the August 1998 Escrow Notes must be redeemed, in whole or in part (at a price equal to 100% of their principal amount plus accrued and unpaid interest, if any, to the date of redemption). In January 1999, the August 1998 Escrow Notes were amended to eliminate the Company's obligation to redeem the August 1998 Escrow Notes with proceeds received from this offering or any other debt or equity offering prior to the consummation of this offering. The Northstar Funds may require the Company to repurchase an aggregate of up to $7.5 million aggregate principal of the August 1998 Notes at a price equal to 100% of their principal amount plus accrued and unpaid interest, upon the failure of Intracel to satisfy certain ratios of EBITDA to interest expense as measured at the end of each of three successive fiscal quarters of the Company commencing March 31, 2000. The Northstar Funds may require the Company to prepay the August 1998 Notes, in whole or in part, at a price equal to 101% of the principal amount so prepaid, plus accrued interest to the date of prepayment, if there is a Change of Control (as defined) of the Company, or if Simon R. McKenzie shall cease to be the principal executive officer of the Company in charge of the Company's management and policies for a period of 30 days or more. The August 1998 Primary Notes may be prepaid, in whole or in part, at the option of the Company initially at a redemption price of 112% of the principal amount thereof, and declining to 100% of the principal amount thereof after July 31, 2002, plus accrued and unpaid interest, if any, to the date of redemption. The August 1998 Escrow Notes may be prepaid, in whole or in part, at the option of the Company, provided that certain notice requirements are met. 59 60 Events of default under the August 1998 Notes include, among other things, (i) failure to pay principal or interest on the August 1998 Notes when due, (ii) breaches of representations, warranties and covenants, (iii) defaults under other indebtedness of the Company or its subsidiaries, (iv) failure to consummate an equity offering on or prior to December 31, 1999, with an aggregate offering price of not less than $40.0 million and aggregate proceeds to the Company (net of selling expenses and underwriters' discounts or selling agent's commission) of not less than $35.0 million, (v) the occurrence of certain events of bankruptcy, (vi) certain adverse judgments against the Company or its subsidiaries, (vii) certain ERISA events and (viii) other customary defaults, in certain cases after the expiration of a grace period. The August 1998 Warrants are exercisable until August 25, 2003 at an exercise price of $15.00 per share. As part of the August 1998 Refinancing, the Company agreed to grant certain demand and "piggyback" registration rights to the Northstar Funds and their affiliates with respect to the shares of common stock held by them, including those issuable upon exercise of warrants, and has agreed to file a registration statement covering such shares 181 days after the date of this Prospectus. See "Shares Eligible for Future Sale." In January 1999, the Company and the Northstar Funds entered into a First Amendment and Waiver Agreement which, among other things, (i) amended the terms of the August 1998 Escrow Notes to eliminate the Company's obligation to redeem the August 1998 Escrow Notes with proceeds received from this offering or any other debt or equity offering prior to the consummation of this offering, (ii) amended the Interest Escrow Security Agreement to eliminate the balance required to be maintained in the escrow account created thereunder and to permit the next three scheduled interest payments to be paid out of amounts currently held in such escrow account, and (iii) waived certain non-payment events of default and compliance by the Company with certain covenants set forth in the documentation non-payment executed in connection with the August 1998 Refinancing. The Company has entered into a letter of intent with two accredited investors who currently hold various securities issued by the Company, pursuant to which the Company has agreed to sell to such investors $2 million aggregate principal amount of the Company's non-convertible debt securities bearing interest at the rate of 15% per annum. The proceeds from the issuance and sale of these non-convertible debt securities will be used for working capital and other general corporate purposes. In addition, Messrs. Hanna, McKenzie, Bloom and Schuyler, all being current stockholders, officers and/or directors of the Company, have committed to invest, at the Company's request, up to $5 million in the Company within the next six to twelve months. COMPETITION The pharmaceutical and biotechnology industries are intensely competitive. Many of the product candidates being developed by the Company, if approved, would compete with existing drugs, therapies and diagnostic products. There are many pharmaceutical companies, biotechnology companies, public and private universities and research organizations actively engaged in research and development of products for the treatment of people with cancer. Many of these organizations have financial, technical, manufacturing and marketing resources greater than those of the Company. Several of them may have developed or are developing therapies or diagnostic products that could be used for treatment or diagnosis of the same diseases targeted by the Company. If a competing company were to develop or acquire rights to a more efficacious therapeutic or diagnostic product for the same diseases targeted by the Company, or one which offers significantly lower costs of treatment or diagnosis, the Company's business, financial condition and results of operations could be materially adversely affected. The Company believes that competition in the development and marketing of new cancer therapies will be based primarily on product efficacy and safety, time to market and price. To the extent the Company's product programs are successful, it also intends to rely to some degree on patents and other intellectual property and orphan drug designations to protect its products from competition. The Company believes that its product development programs will be subject to significant competition from companies utilizing alternative technologies as well as to increasing competition from companies that develop and apply technologies similar to the Company's technologies. Other companies may succeed in developing products earlier than the Company, obtaining approvals for such products from the FDA more 60 61 rapidly than the Company or developing products that are more effective than those under development or proposed to be developed by the Company. There can be no assurance that research and development by others will not render the Company's technology or product candidates obsolete or non-competitive or result in treatments superior to any therapy developed by the Company, or that any therapy developed by the Company will be preferred to any existing or newly developed technologies. PRODUCT LIABILITY AND INSURANCE The manufacture and sale of human therapeutic and diagnostic products involve an inherent risk of product liability claims and associated adverse publicity. The Company has only limited commercial product liability insurance. There can be no assurance that the Company will be able to maintain existing insurance or obtain additional product liability insurance on acceptable terms or with adequate coverage against potential liabilities. Such insurance is expensive, difficult to obtain and may not be available in the future on acceptable terms, if at all. An inability to obtain sufficient insurance coverage on reasonable terms or to otherwise protect against potential product liability claims brought against the Company in excess of its insurance coverage, if any, or a product recall could have a material adverse effect upon the Company's business, financial condition and results of operations. HUMAN RESOURCES As of September 30, 1998, the Company had over 220 employees. The Company's employees are not represented by a collective bargaining agreement. The Company believes its relations with its employees are good. MEDICAL ADVISORY BOARD The Company's Medical Advisory Board is comprised of internationally recognized clinical researchers in the fields of oncology and cancer surgery. The Medical Advisory Board advises the Company's management on strategic issues related to the Company's clinical development programs and consists of the following individuals: Herbert C. Hoover, Jr., M.D., co-chairman of the Medical Advisory Board and Medical Director of the Company, is the Chairman of the Department of Surgery at Lehigh Valley Hospital in Allentown, Pennsylvania and the Vice Chairman of the Department of Surgery and Professor of Surgery at Pennsylvania State University/Milton S. Hershey Medical Center, Hershey, Pennsylvania. Dr. Hoover is the holder of the Anne C. and Carl R. Anderson Chair of Surgery at Lehigh Valley Hospital. Dr. Hoover obtained a B.A. from the Kansas State College of Pittsburgh in 1966 and his M.D. in 1970 from the University of Kansas School of Medicine. Dr. Hoover is a member of numerous professional societies and national, regional, medical school and hospital committees and boards, as well as being on the editorial board of various medical and scientific journals. Herbert Michael Pinedo, M.D., Ph.D., co-chairman of the Medical Advisory Board, is Professor of Medical Oncology and Chief of the Department of Medical Oncology at the Vrije Universiteit in Amsterdam, the Netherlands. Dr. Pinedo obtained his M.S. and his M.D. degree in 1967 and his Ph.D. in Medical Science in 1972, from the Medical School of the University of Leiden in Amsterdam, the Netherlands. Dr. Pinedo belongs to numerous professional societies, university and hospital committees and boards, and is on the editorial board of numerous medical journals. Michael Andrew Choti, M.D. is Director, Johns Hopkins Colon Cancer Center, and Medical Director, Outpatient Center at The Johns Hopkins Hospital and has been Assistant Professor in the Department of Surgery at The Johns Hopkins School of Medicine since 1992, Assistant Professor in the Department of Oncology at The Johns Hopkins School of Medicine since 1995, and a full-time staff member in the Department of Surgery at The Johns Hopkins Hospital. Dr. Choti obtained his B.S. in 1979 from the University of California at Irvine and his M.D. in 1983 from Yale University School of Medicine. Dr. Choti is a member of various professional societies as well as being involved in various professional activities. 61 62 Ronald Levy, M.D. has been Chief of the Division of Oncology at Stanford University School of Medicine since 1993. From 1987, Dr. Levy has been Professor of Medicine, Division of Oncology, at Stanford University School of Medicine, holder of the Summy Chair at Stanford University School of Medicine, and an American Cancer Society Clinical Research Professor. Dr. Levy obtained his A.B. from Harvard University in 1963 and obtained his M.D. from Stanford University in 1968. Dr. Levy is a member of numerous medical societies and an active member of various professional review organizations, including the Margaret Early Trust Research Grant Committee and the Scientific Advisory Board of CellPro, Bothell, Washington. H. Kim Lyerly, M.D., Ph.D. is Professor of Surgery, Immunology, and Pathology and Clinical Director of the Duke Center for Genetic and Cellular Therapies at Duke University Medical Center. Dr. Lyerly obtained his B.S. in 1980 from the University of California at Riverside and his M.D. from the University of California at Los Angeles in 1983. Dr. Lyerly is on the Editorial Board of Annals of Surgery and International Journal of Surgical Science. Dr. Lyerly has been awarded numerous honors and belongs to numerous professional societies. Since 1990, Dr. Lyerly has been a research sponsor working with various M.D.s and Ph.D.s, as well as an investigator since 1988 working on protocols for the treatment of diseases such as AIDS and leukemia, and on molecular therapeutics programs. Bruce G. Wolff, M.D. is Professor of Surgery at the Mayo Medical School and a consultant in colon, rectal, and general surgery, at the Mayo Clinic. Dr. Wolff obtained a B.S. from Davidson College and his M.D. from Duke University School of Medicine. Dr. Wolff belongs to numerous in-house Mayo Clinic organizations as well as national and regional organizations including being vice-chairman of the American Cancer Society Executive Committee on Allied Health Personnel. LEGAL PROCEEDINGS On November 30, 1998, a complaint was filed against the Company in the Circuit Court of Cook County, Illinois, Law Division, by Vector Securities International Inc. ("Vector"). In the complaint, Vector alleges a breach of contract by the Company in connection with the Company's retention of Vector as a financial advisor, and seeks damages of approximately $1.6 million plus attorneys' fees. The Company believes it has defenses to the claims alleged in the complaint as well as counterclaims against Vector, and is currently in the process of preparing its answer to the complaint and its counterclaims. In addition, the Company is aware that there has been a trademark opposition proceeding filed with the Trademark Trial and Appeal Board, Jenner Technologies, Inc. v. Theriak S.A. (Case No. 106,938), in which Jenner Technologies, Inc. is challenging Theriak S.A.'s registration of the OncoVAX(CL) trademark. The Company's rights to use the OncoVAX(CL) mark in countries other than the United States derive from Theriak's rights in that mark. The outcome of the above-mentioned proceeding may effect whether or not the Company is or will be entitled to use the OncoVAX(CL) mark. The Company also recently received a request for payment of approximately $990,000 due under a license agreement assumed by the Company in connection with its purchase of certain assets from Zynaxis Inc. The Company is currently in the process of reviewing the underlying contracts and correspondence regarding this claim to determine its validity. In addition, the Company is party to claims and litigation that arise in the normal course of business. Management believes that the ultimate outcome of these claims and litigation will not have a material impact on the financial position or results of operations of the Company. 62 63 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth certain information concerning the Company's current directors and executive officers. NAME AGE POSITION - -------------------------- --- ---------------------------------------------------------- Michael G. Hanna, 62 Chairman of the Board and Chief Scientific Officer Ph.D. .................. Simon R. McKenzie......... 41 President, Chief Executive Officer and Director Lawrence A. Bloom......... 42 Senior Vice President and Chief Financial Officer Daniel S. Reale........... 44 Senior Vice President and President, OncoVAX(CL) Division Persis M. Strong.......... 44 Senior Vice President and President, Bartels Diagnostics Division Diana Goroff, Ph.D........ 46 Senior Vice President, Operations Carl T. Foster............ 33 Senior Vice President European Operations, Business Development Patricia A. Barnett....... 48 Vice President, Reimbursement Raymond J. Schuyler....... 62 Director Joseph Caligiuri.......... 70 Director Steven Gerber, M.D. ...... 44 Director Alexander Klibanov, 49 Director Ph.D. .................. - --------------- Michael G. Hanna, Ph.D. is currently Chairman of the Board and Chief Scientific Officer of the Company. Dr. Hanna had been Chairman of the Board, Chief Executive Officer and President of PerImmune since 1994. Dr. Hanna founded the Litton Institute of Applied Biotechnology ("LIAB") in 1982. In 1985, Organon Teknika assumed operations of LIAB and Dr. Hanna served as Senior Vice President of Organon Teknika. Prior to his position at LIAB in 1982, Dr. Hanna served as the Director of the National Cancer Institute, Frederick Cancer Research Center. Simon R. McKenzie founded Intracel in 1987 and serves as President, Chief Executive Officer and a director of the Company. From 1987 to the present, Mr. McKenzie has served as President of Intracel and, from 1995 to 1997, Mr. McKenzie was also Chairman of the Board. Prior to forming Intracel, Mr. McKenzie co-founded and managed Baltech, Inc., an early stage pharmaceutical company developing a new class of antiviral drugs including candidates for treating Herpes Simplex. Since 1997, Mr. McKenzie has served on the Board of Directors of New Century Pharmaceuticals, an early stage company working in x-ray crystallography. Lawrence A. Bloom is currently Senior Vice President and Chief Financial Officer for the Company. Mr. Bloom joined the Company in January 1998 as Senior Vice President, Corporate Development and was promoted to his current position in August 1998. From 1996 to 1997, Mr. Bloom was a consultant to emerging biotechnology companies. From 1991 to 1995, Mr. Bloom served as Senior Vice President for Dillon Read Inc., an investment banking firm. From 1985 to 1990, Mr. Bloom served as Vice President and Associate Portfolio Manager for Lehman Management Co., a $15 billion money management division of Shearson/ Lehman American Express. Daniel S. Reale is currently Senior Vice President of the Company and President of the Company's OncoVAX(CL) Division. From 1994 to 1997, Mr. Reale served as President and Chief Operating Officer of Coral Therapeutics, a provider of in-hospital apheresis-based technologies, where he was responsible for the establishment of 10 hospital-based state-of-the-art blood service units in cGMP environments. From 1989 to 1994, Mr. Reale served as Senior Vice President, Operations for Chartwell Home Therapies, L.P., where Mr. Reale oversaw 14 infusion pharmacies with hospital based supporting clinics. Persis M. Strong presently serves as Senior Vice President of the Company and President of the Company's Bartels Diagnostics Division. She joined the Company in 1995 as Vice President of Marketing. Ms. Strong has over 17 years of management and business development experience in the medical diagnostics industry. Prior to joining the Company, Ms. Strong spent seven years with Binax, Inc., a point-of-care diagnostics company, where she served as Vice President of Marketing. From 1981 to 1988, Ms. Strong was 63 64 employed by Ventrex Laboratories, Inc., a biotechnology company, in various marketing and management positions. Ms. Strong has extensive international business experience and has successfully organized and negotiated manufacturing and distribution arrangements in over 35 international markets. Diana Goroff, Ph.D. is Senior Vice President of Operations. From 1991 to 1998, Dr. Goroff served as Director of Parenteral Drug Manufacturing for PerImmune. Dr. Goroff has extensive experience with production of monoclonal antibodies and has recently managed the clinical production of the Company's first totally human antibody. Carl T. Foster is Senior Vice President European Operations, Business Development. He joined the Company as Vice President of Business Development in June 1998. From 1997 to June 1998, Mr. Foster served as Managing Director of Ferghana Partners, Inc., an investment banking firm. From 1989 to 1997, Mr. Foster was employed by Merck and Co., Inc. and Astra Merck, Inc., which are affiliated pharmaceutical companies, most recently as Director of Licensing and Business Development of Astra Merck, Inc.. Patricia A. Barnett joined the Company in August 1998 as Vice President of Reimbursement in August 1998. From 1997 to August 1998, Ms. Barnett was employed by Bristol-Myers Squibb Company, a pharmaceutical company, most recently as Associate Director of Reimbursement. In addition, from 1993 to 1997, Ms. Barnett was also employed by Genentech, Inc., a biotechnology company, as a Senior Manager of Health Economics and Policy and Health Care Affairs. Raymond J. Schuyler has been a director of Intracel since August 1995. From February 1974 through 1998, Mr. Schuyler was employed by Orion Capital and Security Insurance Co. of Hartford, one of Intracel's principal institutional stockholders, most recently as a Senior Vice President and Chief Investment Officer. Mr. Schuyler has been involved in investment banking and portfolio management for more than 38 years. Joseph Caligiuri became a director of Intracel immediately following the Merger. Mr. Caligiuri retired as a Corporate Executive Vice President of Litton Industries, Inc. in April 1993, where he had worked since 1969. Mr. Caligiuri also serves as a member of the Board of Directors of Titan Corporation, a commercial and military electronic and information systems company and Avnet, Inc., an electronics components and distribution company. Steven Gerber, M.D. became a director of Intracel immediately following the Merger. Dr. Gerber is a senior pharmaceutical industry analyst and Head of Healthcare Research for CIBC Oppenheimer, an investment banking firm. Dr. Gerber holds a medical staff appointment at Cedars-Sinai Medical Center in Los Angeles. He is also a member of the Board of Overseers of Tufts University School of Medicine, and a member of the Board of Directors of Syncor International Corporation. Alexander Klibanov, Ph.D. has been a director of Intracel since July 1992. For more than five years, Dr. Klibanov has been a Professor of Chemistry in the Department of Chemistry at the Massachusetts Institute of Technology. He serves on the editorial and review board of numerous scientific publications in the fields of chemistry and biochemistry. He is a leader in the fields of enzymology, having published numerous related articles in leading publications. There are no family relationships among any of the persons who are directors or executive officers of Intracel. Directors of the Company are elected by holders of common stock for a three-year term, and are divided into three classes with staggered terms that currently have expiration dates as follows: (a) Class I Directors -- 1999, (b) Class II Directors -- 2000 and (c) Class III Directors -- 2001. As of the date hereof, Messrs. Gerber and Caligiuri serve as Class I Directors, Messrs. Klibanov and Schuyler serve as Class II Directors and Dr. Hanna and Mr. McKenzie serve as Class III Directors. 64 65 SUMMARY OF EXECUTIVE COMPENSATION The table below sets forth certain information concerning the compensation earned by the Company's Chief Executive Officer and each of the other most highly compensated executive officers of the Company (collectively, the "Named Executive Officers") whose aggregate cash compensation exceeded $100,000 for services rendered in all capacities to the Company during the year ended December 31, 1997. SUMMARY COMPENSATION TABLE LONG-TERM ANNUAL COMPENSATION COMPENSATION AWARDS --------------------- ---------------------------- SHARES OF COMMON STOCK UNDERLYING ALL OTHER NAME AND PRINCIPAL POSITION SALARY BONUSES OPTIONS COMPENSATION - ------------------------------------------ -------- ------- ------------ ------------ Simon R. McKenzie President and Chief Executive Officer... $186,434 Persis M. Strong Senior Vice President, Marketing........ 118,550 13,333 Matthew L. Root Chief Financial Officer(1).............. 94,003 $20,000 Cheryl Cataldo Corporate Secretary(1).................. 111,374 - --------------- (1) Mr. Root served as chief financial officer for a portion of 1997, and Ms. Cataldo served as an executive officer for a portion of 1997. They were not officers of the Company as of the last day of fiscal year 1997. The following table sets forth information regarding stock options granted pursuant to the Company Stock Option Plan (as defined) during the fiscal year ended December 31, 1997 to each of the Named Executive Officers. The Company has never granted any stock appreciation rights. OPTION GRANTS IN FISCAL YEAR ENDED DECEMBER 31, 1997 POTENTIAL REALIZABLE PERCENT OF VALUE AT ASSUMED TOTAL OPTIONS ANNUAL RATES OF GRANTED TO STOCK PRICE NUMBER OF EMPLOYEES APPRECIATION FOR SECURITIES IN FISCAL YEAR OPTION TERM UNDERLYING OPTIONS ENDED EXERCISE PRICE EXPIRATION --------------------- NAME GRANTED DECEMBER 31, 1997 PER SHARE(1) DATE 5% 10% - ---------------------- ------------------ ----------------- -------------- ---------- --------- --------- Simon R. McKenzie(2)......... Persis M. Strong(3)... 13,333 15.4% $6.75 12/31/02 $24,865 $54,946 Matthew L. Root....... Cheryl Cataldo........ - --------------- (1) All share numbers and prices adjusted to reflect a two-for-one stock split on December 31, 1997 and a two-for-three reverse stock split on December 28, 1998. The Company granted options totaling 86,666 shares (as adjusted) during the year ended December 31, 1997. (2) Under the terms of a January 2, 1998 employment agreement, the Company had granted Mr. McKenzie warrants to purchase 452,896 shares of common stock at an exercise price of $6.75. (3) On December 31, 1997, the Company issued a five-year option for 13,333 shares at an exercise price of $6.75 per share of which 33% was immediately vested and exercisable. An additional 33% of the options vest and are exercisable on or after the first anniversary date, and the remainder vest and are exercisable on the second anniversary date. 65 66 No options were exercised by the Named Executive Officers in 1997. The following table sets forth the specified information concerning unexercised options held by the Named Executive Officers as of December 31, 1997. FISCAL YEAR-END OPTION VALUES NUMBER OF SHARES SUBJECT VALUE OF UNEXERCISED TO UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS AT FISCAL YEAR END AT FISCAL YEAR END(1) -------------------------------- ---------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - --------------------------------------- ----------- ------------- ----------- ------------- Simon R. McKenzie...................... 133,332(2) $475,480 Persis M. Strong....................... 34,444(2) 18,889 90,000 $ 30,000 Matthew L. Root........................ Cheryl Cataldo......................... 4,978 8,889 4,933 6,667 - --------------- (1) Calculated based upon the difference between the exercise price and the $6.75 estimated fair market value of the underlying securities as of December 31, 1997. (2) As of August 31, 1998, the Company had granted Mr. McKenzie warrants to purchase 452,896 shares of common stock at an exercise price of $6.75 per share and options to Ms. Strong to purchase 10,000 shares of common stock at an exercise price of $11.25 per share. On July 5, 1998, Mr. McKenzie exercised options to acquire 80,000 shares of the Company's common stock at an exercise price of $3.75 per share. Mr. McKenzie received a loan from the Company in the amount of $300,000 to facilitate his exercising such options. The full recourse note, which matures on July 5, 2001, bears interest at a rate of 10% per annum (payable at maturity). EMPLOYMENT AGREEMENTS The Company has entered into employment agreements with certain of its key employees. The following is a summary of the material terms and conditions of such agreements and is subject to the detailed provisions of the respective agreements attached as exhibits to the Registration Statement. Dr. Hanna entered into an employment agreement with the Company as of January 2, 1998, providing for his employment as Chairman of the Board and Chief Scientific Officer of the Company with a base salary of $200,000, which may be increased by discretionary bonus payments. In addition, the agreement provides for a $50,000 bonus if the Company's initial OncoVAX Center commences treatment of its first cancer patient prior to December 31, 1998 and a bonus of $50,000 if HumaSPECT receives FDA or MAA final approval prior to September 30, 1998. The Company may terminate employment for cause (as defined) or either party may terminate upon 30 days prior notice. Pursuant to the employment agreement, the Company has provided to Dr. Hanna a $2,000,000 life insurance policy which will be fully funded within five years. Dr. Hanna's compensation also includes customary perquisites and other personal benefits. If Dr. Hanna's employment is terminated without cause, or Dr. Hanna terminates the agreement by reason of constructive discharge (as defined), the Company is obligated to pay him a lump sum amount equal to the monthly portion of his base salary multiplied by 36, certain benefits for a three-year period following termination and, to the extent he is not fully vested with the Company retirement plans, the difference between any amounts payable to him under such plans and amounts which would have been payable had he been vested. If employment is terminated on account of medical disability (as defined), the Company is obligated to pay Dr. Hanna an amount equal to two-thirds of his base salary (less any amounts paid as workers compensation, social security disability or other federal, state or local disability benefits) for the period ending the earlier of (i) the date that Dr. Hanna becomes employed in a full-time manner or substantially full-time basis, in which case he shall receive his base salary without adjustment or (ii) the date that Dr. Hanna attains normal retirement age. The agreement has an initial three-year term and shall be negotiated on an annual basis upon expiration of the initial term. The agreement also provides that Dr. Hanna may not engage in certain competitive activities with the Company for a period of one year following termination of the agreement. 66 67 Mr. McKenzie entered into an employment agreement with the Company as of January 2, 1998, providing for his employment as President and Chief Executive Officer of the Company with a base salary of $200,000, which may be increased by discretionary bonus payments. In addition, pursuant to the agreement the Company granted to Mr. McKenzie warrants, exercisable at $6.75 per share, to acquire 452,896 shares of common stock. Mr. McKenzie's compensation also includes customary perquisites and other personal benefits. The Company may terminate employment for cause (as defined) or either party may terminate the agreement upon 30 days prior notice. If such agreement is terminated without cause, or Mr. McKenzie terminates the agreement by reason of constructive discharge (as defined), the Company is obligated to pay him a lump sum amount equal to the monthly portion of his base salary multiplied by 36, certain benefits for a three-year period following termination and, to the extent he is not fully vested with the Company retirement plans, the difference between any amounts payable to him under such plans and amounts which would have been payable had he been vested. If employment is terminated on account of medical disability (as defined), the Company is obligated to pay Mr. McKenzie an amount equal to two-thirds of his base salary (less any amounts paid as workers compensation, social security disability or other federal, state or local disability benefits) for the period ending the earlier of (i) the date that Mr. McKenzie becomes employed in a full-time manner or substantially full-time basis, in which case he shall receive his base salary without adjustment or (ii) the date that Mr. McKenzie attains normal retirement age. The agreement has an initial four-year term and shall be negotiated on an annual basis upon expiration of the initial term. Mr. McKenzie has agreed not to compete with the Company for a period of one year following termination of the agreement. Mr. Reale entered into an employment agreement with the Company effective March 8, 1998, providing for his employment as President of the OncoVAX(CL) Division with a base salary of $200,000, which may be increased by discretionary bonus payments. Pursuant to the agreement, the Company has granted Mr. Reale options to purchase 66,667 shares of its common stock at an exercise price of $11.25 per share vesting at a rate of 25% on the commencement of his employment and 25% on each of the first, second and third anniversaries thereof. If Mr. Reale achieves the first and second year performance objectives set forth therein, his options will vest at an accelerated rate. Additionally, Mr. Reale may receive additional performance bonuses totaling up to 100% of his salary. Mr. Reale's compensation includes customary perquisites and other personal benefits. Ms. Strong entered into an employment agreement with the Company effective June 1, 1998, providing for her employment as Senior Vice President and President of the Bartels Diagnostic Division with a base salary of $160,000, which may be increased by discretionary bonus payments. During her employment with the Company, Ms. Strong has purchased 6,666 shares of common stock and been granted options to purchase 63,333 shares of common stock with exercise prices ranging from $3.75 per share to $11.25 per share. Ms. Strong's compensation includes customary perquisites and customary benefits. Mr. Bloom entered into an employment agreement with the Company effective February 1, 1998, providing for his employment as Senior Vice President of Corporate Development with a base salary of $180,000, which may be increased by discretionary bonus payments and option grants. Prior to his entering this employment agreement, Mr. Bloom had a consulting agreement with the Company from August 1997 to February 1998, pursuant to which he was paid $51,000. Mr. Bloom has purchased 13,333 shares of common stock in the Company and has been granted options to purchase 23,333 shares of common stock with the exercise prices ranging from $6.75 per share to $11.25 per share. Mr. Bloom's compensation includes customary perquisites and customary benefits. Subsequent to entering into the employment agreement, Mr. Bloom was promoted to Chief Financial Officer. Mr. Foster entered into an employment agreement with the Company effective May 19, 1998, providing for his employment as Vice President of Business Development with a base salary of $200,000, which may be increased by discretionary bonus payments and is guaranteed to be at least $300,000 during his first year of employment. Pursuant to the agreement, the Company has granted Mr. Foster options to purchase 66,667 shares of its common stock at an exercise price of $15.00 per share vesting at a rate of 25% on the commencement of his employment and 25% on each of the first, second and third anniversaries thereof. If Mr. Foster achieves the first and second year performance objectives set forth therein, his options will vest at an accelerated rate. Additionally, Mr. Foster may receive additional performance bonuses totaling up to 100% of his salary. Mr. Foster's compensation includes customary perquisites and customary benefits. 67 68 STOCK OPTION PLANS Intracel Stock Option Plans The Company has reserved 1,110,172 shares of common stock for issuance under its 1989 Stock Option Plan and 1990-91 Stock Option Plan (the "Company Stock Option Plan") which provides for the granting of options to key employees and consultants of the Company and its subsidiaries. The option price per share, the amount of shares underlying each option, the vesting period and the expiration date are determined by the Board of Directors at the date of the grant, except that the option price may not be less than the fair market value (as defined) of stock on the date of the grant and the option period may not exceed ten years. For stockholders possessing more than a 10% ownership interest, the option price shall not be less than 110% of the fair market value at the date of grant. The vesting period for options issued in 1997 ranged from 24 months to 48 months and all had expiration dates five years from the date of issue. At September 30, 1998, options to purchase 588,014 shares of common stock at $1.50 to $15.00 per share were outstanding, of which 329,745 were vested and exercisable. See Note 10 to the Company's consolidated financial statements contained elsewhere in this Prospectus. The Company's 1999 Stock Incentive Plan (the "1999 Plan") was adopted and approved by the Board of Directors and by the Company's stockholders in January 1999. Options under this plan will not be issued until after the closing of the Company's anticipated public offering in 1999. The 1999 Plan allows granting of options intended to qualify as "incentive stock options" under Section 422 of the Internal Revenue Code of 1986, nonqualified stock options and stock appreciation rights. The 1999 Plan also allows the transfer or sale of common stock to selected individuals in connection with the performances of services to the Company or its affiliates. A total of 3,000,000 shares of common stock have been reserved for issuance under the 1999 Plan, plus an annual increase to be added on the first day of the Company's fiscal year beginning in 2000 equal to two percent (2%) of the number of shares outstanding as of such date not to exceed 500,000 in any plan year. The Board of Directors or a committee designated by the Board is authorized to administer the 1999 Plan, including the selection of individuals eligible for grants of options, issuances of common stock, the terms of such grants or issuances, possible amendments to the terms of such grants or issuances and the interpretation of the terms of, and adoption of rules for, the 1999 Plan. The maximum term of any stock option to be granted under the 1999 Plan is ten years, except that with respect to incentive stock options granted to a person possessing more than 10% of the combined voting power of the Company (a "10% Stockholder"), the term of such stock options shall be for no more than five years. The exercise price of nonqualified stock options and incentive stock options granted under the 1999 Plan must be at least 85% and 100%, respectively, of the fair market value of the common stock on the grant date except that the exercise price of incentive stock options granted to a 10% Stockholder must be at least 110% of such fair market value on the grant date. The aggregate fair market value on the date of grant of the common stock for which incentive stock options are exercisable for the first time by an employee during any calendar year may not exceed $100,000. The purchase price of shares of common stock granted under the 1999 Plan must be at least 85% of the fair market value of the common stock on the grant date except that the purchase price of shares of common stock granted to a 10% Stockholder must be at least 100% of such fair market value on the grant date. The individual agreements under the 1999 Plan may provide for repurchase rights for the Company under the terms and conditions set forth in the 1999 Plan. The 1999 Plan will terminate in 2009, unless earlier terminated by the Board. PerImmune Holdings, Inc. Stock Option Plan Pursuant to the Amended and Restated 1996 Stock Option Plan of PerImmune Holdings (the "PerImmune Stock Option Plan") for independent directors, executive officers and key employees and consultants (all as defined) of PerImmune Holdings, PerImmune and the Company, PerImmune Holdings reserved 500 shares of its common stock, par value $.01 per share, for issuance. At the time of the Merger, options to purchase 257 shares of PerImmune Holdings were outstanding, of which options to purchase 86 shares of PerImmune Holdings were vested and exercisable. In connection with the Merger, the Company assumed PerImmune Holdings' obligations under the PerImmune Stock Option Plan. Consequently, each option outstanding under the PerImmune Stock Option Plan converted into an option to purchase 68 69 6,072.21 shares of common stock upon exercise. Of the options to purchase 257 shares of PerImmune Holdings, options to purchase 255 shares of PerImmune Holdings were granted to employees of PerImmune Holdings at an exercise price of $2,725 per share and options to purchase two shares of PerImmune Holdings were granted to directors of PerImmune Holdings at an exercise price of $45,000 per share. In conjunction with the execution of one year employment agreements with the Company effective August 3, 1998, seven employees holding PerImmune Holdings, Inc. stock options agreed to surrender a total of 79 unvested options. RETIREMENT SAVINGS PLANS The Company has a 401(k) savings plan covering substantially all of its employees. Eligible employees may contribute amounts through payroll deductions. The Company matches employees' contributions at the discretion of the Company's Board of Directors. The Company did not match employee contributions to the 401(k) savings plan in the 1997, 1996 and 1995 periods. The Company does not provide other post-retirement benefits. In connection with the Merger, the Company assumed PerImmune Holdings' employee pension plan, a noncontributory defined benefit pension plan (the "PerImmune Holdings Plan") retroactive to August 2, 1996. The Company froze the benefits under the PerImmune Holdings Plan in February 1998, and determined that the remaining PerImmune Holdings Plan assets and recorded pension liability exceeded the obligation relating to the participants. As a result of the curtailment of the plan benefits, the Company recorded income of $800,000 and reduced the related pension liability in accordance with Statement of Financial Accounting Standards No. 88, "Employers Accounting for Settlements and Curtailments of Defined Benefit Pension Plans." In addition, PerImmune Holdings maintains a defined-contribution savings plan under Section 401(k) of the Internal Revenue Code. This plan covers substantially all full-time employees. Participating employees may defer a portion of their pretax earnings up to the Internal Revenue Service annual contribution limit. PerImmune Holdings matches employee contributions according to a specified formula. PerImmune Holdings' matching contributions totalled $176,098 and $72,779 for the year ended December 31, 1997, and period from August 3, 1996 through December 31, 1996, respectively. COMMITTEES OF THE BOARD OF DIRECTORS In March 1998, the Board of Directors designated a Compensation Committee, which consists of Joseph Caligiuri, Steven Gerber and Alexander Klibanov. The Compensation Committee reviews executive salaries and administers any bonuses, incentive compensation and stock options of the Company issuable to management employees and directors of the Company. In addition, the Compensation Committee consults with management of the Company regarding compensation policies and practices of the Company. Also in March 1998, the Board of Directors established an Audit Committee consisting of Joseph Caligiuri, Simon R. McKenzie and Raymond J. Schuyler, an Executive Committee consisting of Michael J. Hanna, Simon R. McKenzie and Raymond J. Schuyler and a Finance Committee consisting of Steven Gerber, Simon R. McKenzie and Raymond J. Schuyler. The Audit Committee will review the professional services provided by the Company's independent auditors, the annual financial statements of the Company and the Company's internal financial controls. DIRECTOR COMPENSATION Fees. None of the Company's directors who are also employees of the Company receive cash compensation for attendance at meetings of the Board of Directors or at meetings of committees of the Board of Directors of which they are members. Independent, non-employee directors shall be entitled to cash compensation of $1,500 for attendance at meetings of the Board of Directors or at meetings of committees of the Board of Directors of which they are members. All directors receive reimbursement for reasonable travel expenses incurred in connection with attendance at each Board of Directors and committee meeting. Stock Options. To attract and retain independent, non-employee directors for the Company, the Company has issued, and intends to continue to issue, to its independent directors, a one-time grant of 10,000 options to purchase the Company's common stock pursuant to the Company Stock Option Plan, in amounts determined at the discretion of the Board of Directors or the Compensation Committee and exercisable at a 69 70 price equal to the fair market value of the common stock on the date of grant. These options vest over a three-year period. Independent directors will generally be granted stock options upon their initial appointment, and independent directors and stockholder representative directors may be granted stock options during their term of service as an incentive for continued service. Employee directors are not granted stock options for their services as directors. CONFIDENTIALITY AND NON-COMPETE AGREEMENTS The Company has entered into employment agreements containing confidentiality and non-compete provisions with each of its key employees. The agreements provide that, among other things, all inventions, discoveries and ideas which are, directly or indirectly, related to or suggested by the employee's employment or is pertinent to any field of business or research in which the Company is engaged or is considering engaging during the employee's employment shall be the sole and exclusive property of the Company. The agreements also provide that, for a specified period from the date of termination of employment with the Company for any reason, the employee will not, directly or indirectly, engage, participate or invest in any business activity anywhere in the world that is competitive with or similar to the products and services of the Company or make use of any of the Company's confidential information. 70 71 PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth certain information regarding beneficial ownership of the Company's common stock as of November 30, 1998, and as adjusted to reflect the sale of the shares of common stock offered hereby (assuming no exercise of the Underwriters' over-allotment option), by: (i) each person (or group of affiliated persons) known by the Company to own beneficially more than five percent of the Company's outstanding common stock; (ii) each of the Company's directors; (iii) each Named Executive Officer of the Company; and (iv) all directors and executive officers of the Company as a group. Dr. Michael G. Hanna, Jr. (the "Selling Stockholder") has granted the Underwriters a 30-day option to purchase up to an aggregate of 300,000 shares of common stock on the same terms and conditions as the offering to cover over-allotments, if any, in connection with this offering. See "Underwriting." PERCENTAGE OF SHARES OUTSTANDING(3) NAME, TITLE AND -------------------- ADDRESS OF OFFICERS, NUMBER OF SHARES PRIOR TO AFTER DIRECTORS AND BENEFICIAL OWNERS(1) BENEFICIALLY OWNED(2) OFFERING OFFERING ---------------------------------- --------------------- -------- -------- Michael G. Hanna, Ph.D.(4) 3,640,308 31.82% 19.66% Chairman of the Board and Chief Scientific Officer Northstar Funds, TD Partners and 1,069,020 9.34 6.92 Thomas O. Dial(5) 2 Pickwick Plaza Greenwich, CT 06830 Security Insurance Co. of Hartford(6) 884,452 7.73 5.73 600 Fifth Avenue New York, NY 10020 Simon R. McKenzie(7) 798,962 6.69 5.01 President, Chief Executive Officer and Director Mentor Corporation(8) 781,227 6.83 5.06 5425 Hollister Avenue Santa Barbara, CA 93111 Syncor International Corporation(9) 677,217 5.92 4.39 6464 Canoga Avenue Woodland Hills, CA 91367 Dianne Goroff, Ph.D.(10) 182,167 1.58 1.17 Vice President of Operations Raymond Schuyler(11) 119,042 1.04 * Director Persis M. Strong(12) 58,055 * * Senior Vice President and President Bartels Diagnostics Division Alexander Klibanov, Ph.D.(13) 53,333 * * Director Lawrence Bloom(14) 19,166 * * Chief Financial Officer Joseph Caligiuri(15) 18,216 * * Director Daniel S. Reale(16) 16,667 * * Senior Vice President and President, OncoVAX(CL) Division Carl Foster(16) 16,667 * * Vice President, Business Development Steven Gerber, M.D.(17) 6,072 * * Director Patricia Barnett(18) 5,833 * * Vice President, Reimbursement All directors and executive officers as a group (12 persons) 4,861,622 39.80% 26.25% - --------------- * Less than 1% of the outstanding shares of common stock. (1) Unless otherwise indicated, the address for each person is c/o Intracel Corporation, 2005 NW Sammamish Road, Suite 107, Issaquah, Washington 98027. (2) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission (the "Commission"). In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of common stock and preferred stock subject to options and warrants held by that person that are exercisable within 60 days are deemed outstanding. Such shares, however, are not deemed outstanding for purposes of computing percentage ownership of any other person. Options vest over a period of three to five years from the date of grant. Options granted under the PerImmune Holdings, 71 72 Inc. 1996 Stock Option Plan have been adjusted and reflected in the equivalent number of shares of the Company under the merger and consolidation terms of the options agreement. Unless otherwise indicated in the footnotes to this table, the persons and entities named in the table have sole voting and sole investment power with respect to all shares beneficially owned, subject to community property laws where applicable. (3) Based on 11,440,285 shares outstanding prior to this offering (including 7,440,365 shares of common stock, 3,469,705 shares of common stock which will be issued pursuant to the Preferred Stock Conversion, 36,433 shares of common stock which will be issued under automatic conversion features of certain outstanding debt, and 493,786 shares of common stock issuable under warrants immediately exercisable after this offering), and 15,440,285 shares of common stock outstanding after this offering. (4) Includes 3,036,121 shares of common stock held for Dr. Hanna's personal account and 604,187 shares of common stock (over which Dr. Hanna has sole voting power under the terms of a voting trust entered into among certain other founding employees of PerImmune Holdings). Dr. Michael G. Hanna, Jr. (the "Selling Stockholder") has granted the Underwriters a 30-day option to purchase up to an aggregate of 300,000 shares of common stock on the same terms and conditions as the offering to cover over-allotments, if any, in connection with this offering. (5) Includes 15,884 shares of Series A-1 preferred stock (which will be automatically converted to 21,461 shares of common stock at the conclusion of this offering) and warrants to purchase 31,814 shares of common stock at a price of $10.50 per share, held by Northstar High Yield Fund; 254,147 shares of Series A-1 preferred stock (which will be automatically converted to 343,394 shares of common stock at the conclusion of this offering), and 106,049 shares of common stock, and warrants to purchase 127,259 shares of common stock at a price of $10.50 per share held by Northstar Advantage High Total Return Fund; and 148,148 shares of common stock held by Northstar Balance Sheet Opportunities; but does not include warrants to purchase 812,343 shares of common stock held by Northstar Advantage High Total Return Fund, warrants to purchase 270,517 shares of common stock held by Northstar High Total Return Fund II, warrants to purchase 39,634 shares of common stock held by Northstar Strategic Income Fund, and warrants to purchase 151,614 shares of common held by Northstar High Yield Fund, all of which are expected to remain outstanding after this offering. Also includes 68,335 shares of Series A preferred stock and 79,421 shares of Series A-1 preferred stock (which will be automatically converted to 92,332 and 107,311 shares of common stock upon consummation of this offering), and warrants to purchase 3,697 shares of common stock at a price of $6.00 per share) held by TD Partners; and 87,555 shares of common stock beneficially owned by Mr. Thomas O. Dial. Northstar High Yield Fund, High Total Return Fund, High Total Return Fund II, Strategic Income Fund and Balance Sheet Opportunities Fund are registered mutual funds of Northstar Financial Management Services, Inc., a registered financial management firm. Mr. Dial is an employee of Northstar Financial Management Services, Inc. and Portfolio Manager of the Northstar High Total Return Fund, High Total Return Fund II, and Balance Sheet Opportunities Fund, and Managing Partner of TD Partners. Mr. Dial disclaims beneficial ownership of any of Northstar's holdings of the Company's stock. As Managing Partner of TD Partners, Mr. Dial has voting and investment power with respect to that partnership. (6) Includes 384,388 shares of Series A preferred stock and 158,842 shares of Series A-1 preferred stock which will be automatically converted to 519,371 and 214,622 shares of common stock, respectively, upon consummation of this offering, and 150,459 shares of common stock. Security Insurance Co. of Hartford is a subsidiary of Orion Capital Corporation, a New York Stock Exchange-listed insurance holding company. (7) Includes 292,732 shares of common stock beneficially owned, 53,334 shares issuable upon exercise of options that are currently fully vested and exercisable and 452,896 shares issuable upon exercise of warrants to be granted in accordance with an employment agreement dated January 2, 1998. (8) Includes 120 shares of Series B-2 preferred stock which will be automatically converted to 781,227 shares of common stock upon consummation of this offering. Mentor Corporation is a medical technology developer, manufacturer, and distributor. Mentor and the Company are parties in a joint development agreement. Voting control of Mentor's holdings of the Company's securities rests with a Mentor executive committee. (9) Includes 100 shares of Series B-1 preferred stock which will be automatically converted to 677,217 shares of common stock upon consummation of this offering. Syncor International Corp. is a pharmacy services company engaged in compounding and distributing radiopharmaceutical products and services. Syncor and the Company are parties to a joint development agreement. Voting control of Syncor's holdings of the Company's securities rests with a Syncor executive committee. (10) Includes 121,445 shares issuable upon exercise of options that are currently fully vested and exercisable and 60,722 shares which will be distributed from the voting trust upon consummation of this offering. (11) Includes 15,884 shares of Series A-1 preferred stock which will be automatically converted to 21,461 shares of common stock upon consummation of this offering, 84,248 shares of common stock, and 13,333 shares of common stock issuable upon exercise of options which are fully vested and exercisable. (12) Includes 6,666 shares of common stock and 51,389 shares of common stock issuable upon exercise of options which are fully vested and exercisable. (13) Includes 26,667 shares of common stock issuable upon exercise of options which are fully vested and exercisable and 26,666 shares of common stock. (14) Includes 13,333 shares of common stock and 5,833 shares of common stock issuable upon exercise of options which are fully vested and exercisable. (15) Includes 6,072 shares of common stock issuable upon exercise of options which are fully vested and exercisable and 12,144 shares which will be distributed from the voting trust upon consummation of this offering. (16) Includes 16,667 shares of common stock issuable upon exercise of options which are fully vested and exercisable. (17) Includes 6,072 shares of common stock issuable upon exercise of options which are fully vested and exercisable. (18) Includes 5,833 shares of common stock issuable upon exercise of options which are fully vested and exercisable. 72 73 DESCRIPTION OF CAPITAL STOCK The following description of the Company's capital stock does not purport to be complete and is subject in all respects to applicable Delaware law and to the provisions of the Company's Certificate of Incorporation, and Bylaws, copies of which have been filed as exhibits to the Registration Statement of which this Prospectus is a part. As of November 30, 1998, the authorized capital stock of the Company currently consists of (i) 25,000,000 shares of common stock, and (ii) 5,000,000 shares of preferred stock. Immediately prior to the date hereof, there were 11,440,285 shares of common stock outstanding (including 3,469,705 shares of common stock issuable upon the automatic conversion of the 1,488,771 shares of preferred stock issued and outstanding, or accrued, on the date hereof; 493,786 shares of common stock issuable in connection with "in-the-money" warrants issued and outstanding on the date hereof, which warrants automatically expire upon the closing of this offering; and 36,433 shares of common stock issuable in connection with three convertible Promissory Notes issued and outstanding on the date hereof, which Notes automatically convert into common stock upon the consummation of this offering) held by approximately 148 holders of record. COMMON STOCK Holders of common stock are entitled to one vote for each share held of record on all matters on which stockholders are entitled to vote. Holders of common stock do not have cumulative voting rights and, therefore, holders of a majority of the shares of common stock voting for the election of directors can elect all of the directors. In such event, the holders of the remaining shares of common stock will not be able to elect any directors. Holders of common stock are entitled to receive such dividends as may be declared from time to time by the Board of Directors out of funds legally available therefor. The Company has not paid any cash dividends since inception and does not anticipate paying cash dividends in the foreseeable future. In the event of liquidation, dissolution or winding up of the Company, the holders of common stock are entitled to share ratably in any corporate assets remaining after payment of all debts, subject to any preferential rights of any outstanding preferred stock. See "Dividend Policy." Holders of common stock have no preemptive, conversion or redemption rights and are not subject to further calls or assessments by the Company. All of the outstanding shares of common stock are, and the shares offered by the Company hereby will be, if issued, validly issued, fully paid and nonassessable. PREFERRED STOCK The Board of Directors have authority to issue up to 5,000,000 shares of preferred stock and to fix the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. Upon consummation of this offering, all 1,488,771 shares of convertible preferred stock issued and outstanding, or accrued, will automatically convert into 3,469,705 shares of the Company's common stock. WARRANTS In connection with several transactions, the Company issued warrants ("Warrants") to buy a total of 2,351,338 shares of common stock, of which Warrants to purchase 2,220,785 shares of common stock are still outstanding. The Warrants may be exercised in whole or in part at any time after the date of issue until the expiration date by delivering the warrant agreement with the duly executed form of subscription to the Company. Warrants generally expire five years from the date of issue and are subject to antidilution protection. Outstanding Warrants to purchase 493,783 shares of common stock are subject to accelerated expiration upon the earlier of: (i) this offering; or (ii) the date immediately prior to the effective date of any 73 74 consolidation of the Company with or merger of the Company into any other corporation or entity or the sale or transfer of all or substantially all of the assets of the Company to another person or entity. On July 22, 1994, the Company issued Warrants to purchase 51,999 shares of common stock to several Series A stockholders in connection with the Preferred Stock Purchase Agreement between the Company and the Series A preferred stockholders. After giving effect to a two-for-one split of the common stock effective as of December 31, 1997 and the 2-for-3 reverse stock split of the common stock authorized by the Company's Board of Directors on December 28, 1998 (the "Stock Splits"), the remaining outstanding Warrants are currently exercisable for a total of 44,834 shares of the common stock at an exercise price of $6.00 per share, and which will expire upon conclusion of this offering unless exercised. In connection with an additional Preferred Stock Purchase Agreement entered into by the Company and several Series A-1 preferred stockholders on September 22, 1995, the Company issued Warrants to purchase 86,462 shares of common stock. After giving effect to the Stock Splits, such Warrants are currently exercisable into 115,283 shares of common stock at an exercise price of $6.00 per share, and which will expire upon conclusion of this offering unless exercised. On November 21, 1995, the Company issued Warrants to purchase 91,177 shares of common stock in connection with a second closing under the Preferred Stock Purchase Agreement dated September 27, 1995. After giving effect to the Stock Splits, such Warrants are currently exercisable into 121,569 shares of common stock at an exercise price of $6.75 per share, and which will expire upon conclusion of this offering unless exercised. On December 28, 1995, the Company issued Warrants to purchase 94,010 shares of common stock in connection with a Warrant and Note Agreement with Northstar Advantage High Total Return Fund. After giving effect to the Stock Splits, such Warrants are currently exercisable into 125,347 shares of common stock at an exercise price of $10.50 per share. On June 11, 1996, the Company issued Warrants to purchase 159,073 shares of common stock in connection with a Note and Warrant Purchase Agreement with CoreStates Enterprise Fund. After giving effect to the Stock Splits, such Warrants are currently exercisable into 212,097 shares of common stock at an exercise price of $10.50 per share and which will expire upon conclusion of this offering unless exercised. On June 21, 1996, the Company issued Warrants to purchase 79,537 shares of common stock in connection with a Note and Warrant Purchase Agreement with Northstar Advantage High Total Return Fund. These warrants were exercised on November 18, 1997 at a price of $7.00 per share. On January 2, 1998, the Company issued Warrants to purchase 452,896 shares of common stock in connection with an employment agreement between Simon R. McKenzie, the Company's Chief Executive Officer, and the Company. The Warrants currently carry an exercise price of $6.75 per share, and expire five years from the date of issue. On April 1, 1998, the Company issued Warrants to purchase 65,421 shares of common stock in connection with a Note and Warrant Purchase Agreement at a current exercise price of $11.46 per share. On August 25, 1998, the Company issued Warrants to purchase up to 1,083,338 shares of common stock in connection with the August 1998 Refinancing as discussed elsewhere in this Prospectus. See "Business -- Recent Debt Refinancings." CONVERTIBLE NOTES In January 1997, the Company's subsidiary, PerImmune Holdings, issued three promissory notes each in the amount of $77,500 that will each be automatically converted into 12,144 shares of the Company's common stock at the conclusion of this offering. Upon conversion, the rights of each investor under the promissory notes cease and each investor will be entitled to rights as holders of common stock. REGISTRATION RIGHTS Upon consummation of the offering, certain stockholders who will hold an aggregate of 7,813,154 shares of common stock (the "Holders"), including 3,849,666 outstanding shares of common stock, 3,469,705 shares 74 75 of common stock issuable upon the Preferred Stock Conversion at the consummation of this offering, and 493,783 shares of common stock issuable upon exercise of "in-the-money" Warrants (with exercise prices ranging from $6.00 to $10.50 per share) that will otherwise expire upon conclusion of this offering, are entitled to certain registration rights with respect to the common stock under the Securities Act. Pursuant to the terms of these registration rights, the Company is required to notify each Holder of each decision of the Company to file a registration statement. Upon receipt of such notice, a Holder may request to include certain of the Holder's shares of common stock in the Company's registration, subject to the determination of the managing underwriters that inclusion will not interfere with the offering. These rights have been waived by the Holders, other than the Selling Stockholder, to the extent that such Holders had rights to register common stock in this offering. In addition, certain Holders can require the Company to use its best efforts to prepare and file a registration statement on Form S-3 (or any successor form) with respect to such Holders' shares of common stock. The right of the Holders to request the Company to file a registration statement on Form S-3 is available to the Holders no more than twice during any twelve-month period. The Company generally is required to bear the expenses relating to the sale of shares under registrations contemplated by the registration rights, except for underwriting fees and discounts. The Company also is obligated to indemnify the stockholders whose shares are included in any of the Company's registrations against certain losses and limitations, including certain liabilities under the Securities Act and state securities laws generally. Following this offering, the rights of any Holder to cause the Company to register shares terminates when all of such Holder's securities subject to the registration rights can be transferred or sold under the provisions of Rule 144. CERTAIN PROVISIONS OF THE COMPANY'S CERTIFICATE OF INCORPORATION, BYLAWS AND DELAWARE LAW Classified Board of Directors. The Certificate of Incorporation of the Company provides for the Board of Directors to be divided into three classes of directors, as nearly equal in number as is reasonably possible, serving staggered terms so that the directors' initial terms will expire either at the 1999, 2000 or 2001 annual meeting of the stockholders. Starting with the 1999 annual meeting of the stockholders, one class of directors will be elected each year for a three-year term. The Company believes that a classified Board of Directors will help to assure the continuity and stability of the Board of Directors and the Company's business strategies and policies as determined by the Board of Directors, since a majority of the directors at any given time will have had prior experience as directors of the Company. The Company believes that this, in turn, will permit the Board of Directors to more effectively represent the interest of stockholders. With a classified Board of Directors, at least two annual meetings of stockholders, instead of one, will generally be required to effect a change in the majority of the Board of Directors. As a result, a provision relating to a classified Board of Directors may discourage proxy contests for the election of directors or purchases of a substantial block of the common stock because its provisions could operate to prevent obtaining control of the Board of Directors in a relatively short period of time. The classification provision could also have the effect of discouraging a third party from making a tender offer or otherwise attempting to obtain control of the Company. Under the Delaware General Corporation Law (the "DGCL"), a director on a classified board may be removed by the stockholders of the corporation only for cause. Advance Notice Provisions for Stockholder Nominations of Directors and Stockholder Proposals. The Bylaws of the Company establish an advance notice procedure with regard to the nomination, other than by or at the direction of the Board of Directors or a committee thereof, of candidates for election as directors (the "Nomination Procedure") and with regard to other matters to be brought by stockholders before an annual meeting of stockholders of the Company (the "Business Procedure"). The Nomination Procedure requires that a stockholder give prior written notice, in proper form, of a planned nomination for the Board of Directors to the Secretary of the Company. The requirements as to the 75 76 form and timing of that notice are specified in the Bylaws of the Company. If the Chairman of the Board of Directors determines that the other business was not properly brought before such meeting in accordance with the Business Procedure, such business will not be conducted at such meeting. Although the Bylaws of the Company do not give the Board of Directors any power to approve or disapprove stockholder nominations for the election of directors or of any business desired by stockholders to be conducted at an annual meeting, the Bylaws of the Company (i) may have the effect of precluding a nomination for the election of directors or precluding the conduct of business at a particular annual meeting if the proper procedures are not followed or (ii) may discourage or deter a third party from conducting a solicitation of proxies to elect its own slate of directors or otherwise attempting to obtain control of the Company, even if the conduct of such solicitation or such attempt might be beneficial to the Company and its stockholders. Business Combinations. The Company is subject to the provisions of Section 203 of the DGCL, an anti-takeover law. In general, the statute prohibits a publicly held Delaware corporation from engaging in certain transactions and "business combinations" with an "Interested Stockholder" (as defined in Section 203) for a period of three years after the date of the transaction in which the person became an interested stockholder, unless either (i) prior to the date such person becomes an interested stockholder, the Board approves either the business combination or the transaction which resulted in the stockholder becoming an interested stockholder, (ii) upon the consummation of the transaction which resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time of the consummation of such transaction, excluding for purposes of determining the number of shares outstanding those shares owned (a) by persons who are directors and also officers and (b) by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer or (iii) on or subsequent to the date such person becomes an interested stockholder, the business combination is approved by the Board and authorized at an annual or special meeting of stockholders, not by written consent, by the affirmative vote of at least two-thirds of the outstanding voting stock which is not owned by the interested stockholder. A "business combination" includes a merger, asset sale, or other transaction resulting in a financial benefit to the stockholder. For purposes of section 203, an "interested stockholder" is a person who, together with affiliates and associates, owns (or within three years prior, did own) 15% or more of the corporation's voting stock. LIMITATION OF LIABILITY AND INDEMNIFICATION The Company's Certificate of Incorporation contains certain provisions permitted under DGCL relating to the liability of directors. These provisions eliminate a director's personal liability for monetary damages resulting from a breach of fiduciary duty. This provision in the Certificate of Incorporation does not eliminate the duty of care, and in appropriate circumstances equitable remedies such as an injunction or other forms of non-monetary relief would remain available under the DGCL. Each director will continue to be subject to liability for breach of the director's duty of loyalty to the Company, for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of the law, or for any transaction from which the director derived an improper personal benefit. These provisions will not alter a director's liability under federal securities laws. The Bylaws of the Company provide for full indemnification of officers and directors to the full extent permitted under the DGCL, as it now exists or may in the future by amendment (but, in the case of such amendment, only to the extent that such amendment permits the Company to provide broader indemnification rights than permitted prior thereto), or by other applicable law as then in effect, against all expenses, liabilities and losses actually and reasonably incurred or suffered in connection with service for or on behalf of the Company, including payment of expenses in defending an action or proceeding upon receipt of any undertaking by the person indemnified to repay such payment if it is ultimately determined that such person is not entitled to indemnification. Such indemnification will continue to an indemnified person who has ceased to be a director, officer, employee or agent and will inure to the benefit of the indemnified person's heirs, executors and administrators. The Company's Bylaws provide that the Company may maintain insurance, at its expense, to protect itself and any indemnified party against any expense, liability or loss, whether or not the Company would have 76 77 the power to indemnify such person against such expense, liability or loss under the DGCL. The Company, without further stockholder approval, may enter into contracts with any indemnified person in furtherance of the indemnification provisions contained in the Bylaws and may create a trust fund, grant a security interest or use other means (including without limitation, a letter of credit) to ensure the payment of such amounts as may be necessary to effect indemnification as provided in the Bylaws. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the common stock of the Company is American Stock Transfer & Trust Company. 77 78 SHARES ELIGIBLE FOR FUTURE SALE Prior to this offering, there has been no public market for the common stock of the Company. Future sales of substantial amounts of shares of common stock in the public market following this offering could adversely affect the market price of the common stock. Such sales also might make it more difficult for the Company to sell equity securities or equity-related securities in the future at a time and price that the Company deems appropriate or at all. Upon consummation of this offering, the Company will have 15,440,285 shares of common stock outstanding, assuming no exercise of the Underwriters' over-allotment option granted by the Company and no exercise of outstanding options. Of these shares, all of the 4,000,000 shares sold in this offering will be freely tradable without restriction or further registration under the Securities Act, unless such shares are purchased by affiliates of the Company. The remaining 11,440,285 shares of common stock will be restricted securities ("Restricted Shares") within the meaning of the Securities Act. Restricted Shares may be sold in the public market only if registered or if they qualify for an exemption from registration under Rules 144, 144(k) or 701 promulgated under the Securities Act, which rules are summarized below. Holders of substantially all of those shares will have the right to request the registration of their shares under the Securities Act following completion of a period of one year, in the case of directors and executive officers, and 180 days, in the case of such other stockholders, after the date of this Prospectus, which, upon the effectiveness of such registration, would permit the free transferability of such shares. In general, under Rule 144, beginning 90 days after the date of this Prospectus, an affiliate of the Company, or person (or persons whose shares are aggregated) who has beneficially owned Restricted Shares for at least one year, will be entitled to sell in any three-month period a number of shares that does not exceed the greater of (i) one percent of the then outstanding shares of the Company's common stock or (ii) the average weekly trading volume of the Company's common stock on the Nasdaq Stock Market during the four calendar weeks immediately preceding the date on which notice of the sale is filed with the Commission. Sales pursuant to Rule 144 are subject to certain requirements relating to manner of sale, notice and availability of current public information about the Company. A person (or person whose shares are aggregated) who is not deemed to have been an affiliate of the Company at any time during the 90 days immediately preceding the sale and who has beneficially owned Restricted Shares for at least two years is entitled to sell such shares pursuant to Rule 144(k) without regard to the limitations described above. The Company's directors, executive officers and certain stockholders, who in the aggregate hold 4,861,622 shares of common stock of the Company outstanding immediately prior to the consummation of this offering have entered into or are subject to lock-up agreements under which they have agreed not to sell, directly or indirectly, any shares owned by them for a period of one year, in the case of directors and executive officers, and 180 days, in the case of such other stockholders, after the date of this Prospectus without the prior written consent of the Underwriters. See "Underwriting." Upon expiration of the lock-up agreements, approximately 4,861,622 shares of common stock (including approximately 323,312 shares subject to outstanding vested options and, 452,896 shares issuable upon exercise of warrants which do not expire at the conclusion of this offering) will become eligible for immediate public resale, subject in some cases to vesting provisions and volume limitations pursuant to Rule 144. The remaining approximately 7,354,871 shares held by existing stockholders will become eligible for public resale at various times over a period of less than two years following the consummation of this offering, subject in some cases to vesting provisions and volume limitations. 7,813,154 of the shares outstanding immediately following the consummation of this offering will be entitled to registration rights with respect to such shares upon termination of lock-up agreements. The number of shares sold in the public market could increase if registration rights are exercised. Dr. Hanna has agreed with the Company not to sell, other than pursuant to the over-allot option granted to the Underwriters in this offering, more than 10% of the shares of common stock held by him during each of the twelve-month periods commencing on the date of this Prospectus and the first anniversary thereof. In addition, the Company intends to file a registration statement on Form S-8 for the shares held pursuant to its stock option plans, which may make these shares freely tradeable. Such registration statement will become effective immediately upon filing and shares covered by that registration statement will thereupon be eligible for sale in the public markets, subject to the applicable lock-up agreements and Rule 144 limitations applicable to affiliates. See "Description of Capital Stock -- Registration Rights." 78 79 UNDERWRITING Subject to certain terms and conditions contained in an underwriting agreement (the "Underwriting Agreement"), the Underwriters named below (collectively, the "Underwriters"), for whom Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ") and Piper Jaffray Inc. are acting as representatives (the "Representatives"), have severally agreed to purchase the number of shares of common stock from the Company set forth opposite their names below: NUMBER UNDERWRITERS OF SHARES ------------ --------- Donaldson, Lufkin & Jenrette Securities Corporation......... Piper Jaffray Inc........................................... --------- Total............................................. 4,000,000 ========= The Underwriting Agreement provides that the obligations of the several Underwriters to purchase shares of common stock are subject to the approval of certain legal matters by counsel and to certain other conditions. If any of the shares of common stock are purchased by the Underwriters pursuant to the Underwriting Agreement, all such shares of common stock (other than the shares of common stock covered by the over-allotment option described below) must be so purchased. The Company has been advised by the Representatives that the Underwriters propose to offer the shares of common stock to the public initially at the price to the public set forth on the cover page of this Prospectus and to certain dealers (who may include the Underwriters) at such price less a concession not to exceed $ per share. The Underwriters may allow, and such dealers may reallow, discounts not in excess of $ per share to any other Underwriter and certain other dealers. The Company and the Selling Stockholder have granted to the Underwriters an option to purchase up to 600,000 additional shares of common stock at the initial public offering price less underwriting discounts and commissions solely to cover over-allotments. Such option may be exercised in whole or in part from time to time during the 30-day period after the date of this Prospectus. To the extent that the Underwriters exercise such option, each of the Underwriters will be committed, subject to certain conditions, to purchase a number of option shares proportionate to such Underwriter's initial commitment as indicated in the preceding table. The Company, certain stockholders of the Company and the executive officers and directors of the Company have agreed not to directly or indirectly offer, pledge, sell, contract to sell, sell any option or contract to purchase or grant any option, right or warrant to purchase or otherwise transfer or dispose of any shares of common stock or any securities convertible into or exercisable or exchangeable for common stock, or enter into any swap or other arrangement that transfers all or a portion of the economic consequences associated with the ownership of such common stock, or to cause a registration statement covering any shares of common stock to be filed, for a period of one year, in the case of directors and executive officers, and for a period of 180 days, in the case of such other stockholders, after the closing of this offering without the prior written consent of the Underwriters, subject to certain limited exceptions, and provided that the Company may issue shares of common stock upon vesting of rights under the Company Stock Option Plan and the PerImmune Stock Option Plan. See "Shares Eligible for Future Sale." Prior to this offering, there has been no established trading market for the common stock. The initial price to the public for the common stock offered hereby has been determined by negotiation among the Company and the Representatives. The factors considered in determining the initial price to the public include the history of and the prospects for the industry in which the Company competes, the ability of the Company's management, the past and present operations of the Company, the prospects for future earnings of the Company, the general condition of the securities markets at the time of this offering and the recent market prices of securities of generally comparable companies. The Company has been approved for listing of the common stock on the Nasdaq National Market. 79 80 The Underwriters do not intend to make sales to accounts over which they exercise discretionary authority in excess of 5% of the number of shares of common stock offered hereby. In connection with this offering, the Underwriters may engage in transactions that stabilize, maintain or otherwise affect the price of the common stock. Specifically, the Underwriters may over-allot this offering, creating a syndicate short position. Underwriters may bid for and purchase shares of common stock in the open market to cover syndicate short positions. In addition, the Underwriters may bid for and purchase shares of common stock in the open market to stabilize the price of the common stock. These activities may stabilize or maintain the market price of the common stock above independent market levels. The Underwriters are not required to engage in these activities and may end these activities at any time. The Company has agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act. LEGAL MATTERS The validity of the shares offered hereby is being passed upon for the Company by Morrison & Foerster LLP, New York, New York. Certain legal matters will be passed upon for the Underwriters by Brown & Wood LLP, New York, New York. Joseph W. Bartlett, a partner of Morrison & Foerster LLP, holds options to purchase 16,666 shares of the Company's common stock. EXPERTS The consolidated financial statements of the Company at September 30, 1998 and December 31, 1997, and for the nine-month period and the year then ended, included in this Prospectus have been included herein in reliance on the report, after the restatement described in Note 15, of PricewaterhouseCoopers LLP, independent accountants, given on the authority of that firm as experts in accounting and auditing. The consolidated financial statements of the Company at December 31, 1996 and for the year ended December 31, 1996, the six months ended December 31, 1995, and for the year ended June 30, 1995, appearing in this Prospectus have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given upon the authority of such firm as experts in accounting and auditing. The consolidated financial statements of PerImmune Holdings, Inc. and Subsidiary at December 31, 1997 and for the year then ended, included in this Prospectus have been included herein in reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of that firm as experts in accounting and auditing. The consolidated financial statements of PerImmune Holdings, Inc. and Subsidiary as of December 31, 1996 and the related consolidated statements of operations, stockholders' deficit and cash flows for the period from August 3, 1996 through December 31, 1996 and the statements of operations, stockholders' equity and cash flows of the Predecessor Company for the period from January 1, 1996 through August 2, 1996 and for the year ended December 31, 1995 appearing in this Prospectus have been audited by KPMG LLP, independent certified public accountants, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given upon the authority of such firm as experts in accounting and auditing. In February 1998, the Company's Board of Directors dismissed Ernst & Young LLP and appointed PricewaterhouseCoopers LLP as the Company's independent accountants to report on the Company's consolidated balance sheet as of December 31, 1997, and the related consolidated statements of operations, stockholders' deficit, and cash flows for the year then ended. The report of Ernst & Young LLP for the year ended December 31, 1996 and June 30, 1995 and for the six months ended December 31, 1995 did not contain any adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principles. In February 1998, in conjunction with the acquisition of PerImmune Holdings, the Company's Board of Directors dismissed KPMG LLP and appointed PricewaterhouseCoopers LLP as PerImmune Holdings independent accountants to report on its consolidated balance sheet as of December 31, 1997, and the related 80 81 consolidated statements of operations, stockholders' equity (deficit), and cash flows for the year then ended. The report of KPMG Peat Marwick at December 31, 1996 and the period from August 3, 1996 through December 31, 1996 did not contain any adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principles. In connection with the audits for the periods presented within this Prospectus and Registration Statement, there were no disagreements with Ernst & Young LLP or KPMG LLP on any matter of accounting principles or practices, financial disclosure or auditor scope of procedure, which disagreements if not resolved to the satisfaction of Ernst & Young LLP or KPMG LLP would have caused them to make reference thereto in their report on the financial statements for such years. Prior to retaining PricewaterhouseCoopers LLP, the Company had not consulted with PricewaterhouseCoopers LLP regarding the application of accounting principles or the type of audit opinion that might be rendered on the Company's financial statements. During the course of Ernst & Young LLP's audit of the consolidated financial statements of the Company for the year ended December 31, 1996, Ernst & Young LLP notified the Company that it had identified two material weaknesses considered reportable conditions as defined under standards of the American Institute of Certified Public Accountants. The first of these was failure to maintain accurate information to monitor financial position, results of operations and liquidity. The second of these related to the method of accounting, monitoring and valuation of the Company's "Research Use Only" inventory. Ernst & Young LLP attributed the cause for these two material weaknesses to inadequate accounting resources, lack of technical accounting expertise at the Company and the lack of adequate systems to maintain and account for "Research Use Only" inventory. In order to remedy these weaknesses, the Company hired several accounting personnel with technical experience and expertise in financial management and reporting and has performed an extensive analysis of the "Research Use Only" inventory as of December 31, 1997 to assure a consistent and accurate valuation. In connection with the audit of the consolidated financial statements of the Company for the year ended December 31, 1997, the Company's current auditors did not identify any material weaknesses considered reportable conditions. AVAILABLE INFORMATION The Company has filed with the Commission a Registration Statement on Form S-1 (the "Registration Statement") under the Securities Act of 1933, as amended (the "Securities Act"), with respect to the common stock offered hereby. This Prospectus, which constitutes a part of the Registration Statement, does not contain all of the information set forth in the Registration Statement, certain items of which are contained in the schedules and exhibits to the Registration Statement as permitted by the rules and regulations of the Commission. Statements contained in this Prospectus as to the contents of any contract, agreement or other document referred to are not necessarily complete. With respect to each such contract, agreement or other document filed as an exhibit to the Registration Statement, reference is made to the exhibit for a more complete description of the matter involved, and each such statement shall be deemed qualified in its entirety by such reference. As a result of this offering, the Company will become subject to the informational requirements of the Securities Exchange Act of 1934, as amended, and, in accordance therewith, will file reports, proxy statements and other information with the Commission. Such reports, proxy statements and other information can be inspected and copied at the public reference facilities maintained by the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and its regional offices located at Seven World Trade Center, 13th Floor, New York, New York 10048 and Northwestern Atrium Center, 500 West Madison Avenue, Suite 1400, Chicago, Illinois 60661-2511. Copies of such material may be obtained by mail from the Public Reference Section of the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. The Commission also maintains a World Wide Web site on the Internet at http://www.sec.gov that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. Upon approval of the common stock for quotation on the Nasdaq National Market, such reports, proxy and information statements and other information can be inspected at the office of Nasdaq Operations, 1735 K Street, N.W., Washington, D.C. 20006. 81 82 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE INTRACEL CORPORATION Report of PricewaterhouseCoopers LLP, independent accountants............................................ F-2 Report of Ernst & Young LLP, independent auditors......... F-3 Consolidated Balance Sheets as of December 31, 1996 and 1997 and September 30, 1998 ........................... F-4 Consolidated Statements of Operations for the year ended June 30, 1995, the six months ended December 31, 1995, the years ended December 31, 1996 and 1997 and the nine months ended September 30, 1997 (unaudited) and 1998 ....................................................... F-5 Consolidated Statements of Stockholders' Deficit for the year ended June 30, 1995, the six months ended December 31, 1995, the years ended December 31, 1996 and 1997 and the nine months ended September 1998 .............. F-6 Consolidated Statements of Cash Flows for the year ended June 30, 1995, the six months ended December 31, 1995, the years ended December 31, 1996 and 1997 and the nine months ended September 30, 1997 (unaudited) and 1998 ....................................................... F-7 Notes to Consolidated Financial Statements................ F-8 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY Report of PricewaterhouseCoopers LLP, independent accountants............................................ F-38 Consolidated Balance Sheets as of December 31, 1997 and 1996................................................... F-39 Consolidated Statements of Operations for the year ended December 31, 1997 and the period from August 3, 1996 through December 31, 1996.............................. F-40 Consolidated Statements of Stockholders' Equity (Deficit) for the year ended December 31, 1997 and the period from August 3, 1996 through December 31, 1996.......... F-41 Consolidated Statements of Cash Flows for the year ended December 31, 1997 and the period from August 3, 1996 through December 31, 1996.............................. F-42 Notes to Consolidated Financial Statements................ F-43 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY; AND PREDECESSOR COMPANY Report of KPMG LLP, independent certified public accountants............................................ F-56 Consolidated Balance Sheet as of December 31, 1996........ F-57 Statements of Operations for the period from August 3, 1996 through December 31, 1996, the period from January 1, 1996 through August 2, 1996 and the year ended December 31, 1995...................................... F-58 Statements of Stockholders' Equity (Deficit) for the period from August 3, 1996 through December 31, 1996, the period from January 1, 1996 through August 2, 1996 and the year ended December 31, 1995................... F-59 Statements of Cash Flows for the period from August 3, 1996 through December 31, 1996, the period from January 1, 1996 through August 2, 1996 and the year ended December 31, 1995...................................... F-60 Notes to Financial Statements............................. F-61 F-1 83 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Intracel Corporation In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders' deficit and of cash flows, after the restatement described in Note 15, present fairly, in all material respects, the consolidated financial position of Intracel Corporation (the "Company") at September 30, 1998 and December 31, 1997, and the consolidated results of its operations and its cash flows for the nine month period and year then ended, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. Seattle, Washington January 19, 1999 - -------------------------------------------------------------------------------- The foregoing report is in the form that will be signed upon completion of the reverse stock split described in paragraph 13 of Note 10 to the financial statements. PricewaterhouseCoopers LLP F-2 84 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors Intracel Corporation and Subsidiary We have audited the accompanying consolidated balance sheet of Intracel Corporation and subsidiary as of December 31, 1996, and the related consolidated statements of operations, stockholders' deficit, and cash flows for the year ended June 30, 1995, the six months ended December 31, 1995, and the year ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Intracel Corporation and subsidiary at December 31, 1996, and the consolidated results of their operations and their cash flows for the year ended June 30, 1995, the six months ended December 31, 1995, and the year ended December 31, 1996, in conformity with generally accepted accounting principles. Seattle, Washington December 3, 1997, except for paragraph 3 of Note 6 and paragraph 10 of Note 10, as to which the date is January 2, 1998, Note 15, as to which the date is December 10, 1998, and paragraph 13 of Note 10 as to which the date is , 1999. - -------------------------------------------------------------------------------- The foregoing report is in the form that will be signed upon completion of the reverse stock split described in paragraph 13 of Note 10 to the financial statements. ERNST & YOUNG LLP Seattle, Washington January 21, 1999 F-3 85 INTRACEL CORPORATION CONSOLIDATED BALANCE SHEETS DECEMBER 31, ---------------------------- SEPTEMBER 30, 1996 1997 1998 ASSETS ------------ ------------ ------------- Cash and cash equivalents................................... $ 3,145,231 $ 1,974,629 $ 412,526 Pledged securities.......................................... 3,951,400 Restricted cash............................................. 2,000,000 7,027,993 Accounts receivable, net.................................... 2,383,828 2,003,249 2,512,933 Inventories, net............................................ 3,113,187 1,821,013 2,068,451 Other assets................................................ 404,679 398,494 769,876 ------------ ------------ ------------ Total current assets............................... 9,046,925 8,197,385 16,743,179 Property and equipment, net................................. 3,247,333 3,178,959 4,538,909 Restricted cash............................................. 133,236 Cost in excess of net assets acquired, net.................. 12,563,052 11,654,880 12,997,821 Deferred acquisition costs.................................. 2,862,513 Other assets................................................ 1,665,417 2,147,858 17,546,749 ------------ ------------ ------------ Total assets....................................... $ 26,522,727 $ 28,041,595 $ 51,959,894 ============ ============ ============ LIABILITIES AND STOCKHOLDERS' DEFICIT Current portion of long-term debt........................... $ 3,505,122 $ 2,144,729 $ 176,411 Accounts payable............................................ 2,075,033 1,965,995 8,138,480 Accrued liabilities......................................... 1,941,669 4,356,999 3,611,786 ------------ ------------ ------------ Total current liabilities.......................... 7,521,824 8,467,723 11,926,677 Line of credit.............................................. 500,000 500,000 Long-term debt, less current portion........................ 18,738,945 17,630,494 45,896,436 Pension liability........................................... 74,152 ------------ ------------ ------------ Total liabilities.................................. 26,760,769 26,598,217 57,897,265 ------------ ------------ ------------ Commitments and contingencies Redeemable and convertible preferred stock, $0.0001 par value; 5,000,000 shares authorized: Series A preferred stock, 730,000 shares authorized, 557,656, 603,622, and 640,639 shares issued and outstanding at December 31, 1996 and 1997, and September 30, 1998, respectively.................................. 4,461,248 4,828,976 5,121,896 Series A-1 preferred stock, 850,000 shares authorized, 738,235, 651,168 and 690,951 shares issued and outstanding at December 31, 1996 and 1997, and September 30, 1998, respectively.................................. 5,905,880 5,209,340 5,527,580 Series A-3 preferred stock, 200,000 shares authorized, 147,923 and 156,961 shares issued and outstanding at December 31, 1997, and September 30, 1998, respectively............................................ 1,183,384 1,255,696 Series B-1 preferred stock, 100 shares authorized, shares issued and outstanding at September 30, 1998............ 4,166,858 Series B-2 preferred stock, 120 shares authorized, shares issued and outstanding at September 30, 1998............ 5,087,331 ------------ ------------ ------------ 10,367,128 11,221,700 21,159,361 ------------ ------------ ------------ Stockholders' deficit: Series A-2 preferred stock; $0.0001 par value; 155,000 shares authorized; 44,063 and no shares issued and outstanding, $4,406,300 and $0 aggregate preference in liquidation at December 31, 1997 and September 30, 1998, respectively............................................ 4 Common stock, $0.0001 par value; 25,000,000 shares authorized; 2,645,191, 3,579,052 and 7,440,365 shares issued and outstanding at December 31, 1996 and 1997 and September 30, 1998, respectively........................ 265 358 744 Additional paid-in capital................................ 2,404,038 11,401,762 48,145,012 Accumulated deficit....................................... (12,909,473) (21,180,446) (74,942,488) Note receivable due from stockholder...................... (100,000) (300,000) ------------ ------------ ------------ Total stockholders' deficit........................ (10,605,170) (9,778,322) (27,096,732) ------------ ------------ ------------ Total liabilities and stockholders' deficit........ $ 26,522,727 $ 28,041,595 $ 51,959,894 ============ ============ ============ The accompanying notes are an integral part of these consolidated financial statements. F-4 86 INTRACEL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS NINE MONTHS ENDED SIX MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, YEAR ENDED DECEMBER 31, ------------------------- ------------------------- JUNE 30, 1995 1995 1996 1997 1997 1998 ------------- ---------------- ----------- ----------- ----------- ----------- (UNAUDITED) REVENUE Product.......................... $1,565,795 $ 2,426,158 $14,718,421 $13,452,204 $10,231,319 $10,862,482 Contract......................... 3,381,836 ---------- ----------- ----------- ----------- ----------- ----------- Total revenue............. 1,565,795 2,426,158 14,718,421 13,452,204 10,231,319 14,244,318 COST OF REVENUE Product.......................... 823,988 1,779,172 8,264,679 8,661,058 5,908,592 7,678,160 Contract......................... 1,909,755 ---------- ----------- ----------- ----------- ----------- ----------- Total cost of revenue..... 823,988 1,779,172 8,264,679 8,661,058 5,908,592 9,587,915 Selling, general and administrative................... 1,580,336 2,592,940 5,739,937 8,478,175 5,912,557 11,100,805 Research and development........... 1,173,754 1,118,020 1,042,668 555,840 522,775 8,419,774 Acquired research and development...................... 2,100,000 37,718,000 Amortization of cost in excess of net assets acquired.............. 151,362 908,172 908,172 681,129 744,804 Reorganization expense............. 917,442 ---------- ----------- ----------- ----------- ----------- ----------- Total operating expense........ 3,578,078 7,741,494 16,872,898 18,603,245 13,025,053 67,571,298 ---------- ----------- ----------- ----------- ----------- ----------- Loss from operations........... 2,012,283 5,315,336 2,154,477 5,151,041 2,793,734 53,326,980 Interest expense (income), net..... (68,329) 134,400 2,235,496 2,912,592 2,100,560 3,293,131 Gain on pension curtailment........ (800,000) Other income....................... (1,272,720) ---------- ----------- ----------- ----------- ----------- ----------- Loss before extraordinary item......................... 1,943,954 5,449,736 4,389,973 8,063,633 4,894,294 54,547,391 Extraordinary gain on early extinguishment of debt........... (1,367,000) (785,349) ---------- ----------- ----------- ----------- ----------- ----------- Net loss.................. $1,943,954 $ 4,082,736 $ 4,389,973 $ 8,063,633 $ 4,894,294 $53,762,042 Preferred stock dividends/accretion.............. 211,448 266,136 789,552 1,260,928 896,980 1,957,739 ---------- ----------- ----------- ----------- ----------- ----------- Net loss applicable to common stockholders..................... $2,155,402 $ 4,348,872 $ 5,179,525 $ 9,324,561 $ 5,791,274 $55,719,781 ========== =========== =========== =========== =========== =========== Basic and diluted net loss per share before extraordinary item............................. $ 0.82 $ 2.21 $ 1.99 $ 3.43 $ 2.23 $ 7.75 Extraordinary item................. (0.53) (0.11) ---------- ----------- ----------- ----------- ----------- ----------- Basic and diluted net loss per share............................ $ 0.82 $ 1.68 $ 1.99 $ 3.43 $ 2.23 $ 7.64 ========== =========== =========== =========== =========== =========== The accompanying notes are an integral part of these consolidated financial statements. F-5 87 INTRACEL CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT SERIES A-2 PREFERRED STOCK COMMON STOCK NOTE ---------------- ------------------- ADDITIONAL RECEIVABLE PAR PAR PAID-IN ACCUMULATED DUE FROM SHARES VALUE SHARES VALUE CAPITAL DEFICIT STOCKHOLDERS TOTAL -------- ------ ---------- ------ ----------- ------------ ------------ ------------ BALANCE AT JULY 1, 1994....... 2,641,118 $ 264 $ 2,198,030 $ (1,225,674) $(100,000) $ 872,620 Sale of common stock, net..... 1,333 8,000 8,000 Preferred stock dividends..... (211,448) (211,448) Net loss...................... (1,943,954) (1,943,954) ------- --- ---------- ------ ----------- ------------ --------- ------------ BALANCE AT JUNE 30, 1995...... 2,642,451 264 2,206,030 (3,381,076) (100,000) (1,274,782) Preferred stock dividends..... (266,136) (266,136) Net loss...................... (4,082,736) (4,082,736) ------- --- ---------- ------ ----------- ------------ --------- ------------ BALANCE AT DECEMBER 31, 1995........................ 2,642,451 264 2,206,030 (7,729,948) (100,000) (5,623,654) Repurchase of common stock.... (116,742) (11) (326,801) (326,812) Sale of common stock, net..... 117,333 12 339,718 339,730 Exercise of common stock options..................... 2,149 8,061 8,061 Other......................... 177,030 177,030 Preferred stock dividends..... (789,552) (789,552) Net loss...................... (4,389,973) (4,389,973) ------- --- ---------- ------ ----------- ------------ --------- ------------ BALANCE AT DECEMBER 31, 1996........................ 2,645,191 265 2,404,038 (12,909,473) (100,000) (10,605,170) Sale of Series A-2 preferred stock....................... 40,000 $ 4 3,999,996 4,000,000 Preferred stock dividends..... 4,063 (647,288) (207,340) (854,628) Repurchase of common stock.... (68,731) (7) (208,743) (208,750) Sale of common stock, net..... 978,095 98 5,760,826 5,760,924 Exercise of common stock warrants.................... 24,497 2 146,982 146,984 Other......................... (54,049) (54,049) Repayment of stockholder note receivable.................. 100,000 100,000 Net loss...................... (8,063,633) (8,063,633) ------- --- ---------- ------ ----------- ------------ --------- ------------ BALANCE AT DECEMBER 31, 1997........................ 44,063 4 3,579,052 358 11,401,762 (21,180,446) (9,778,322) Common stock issued and stock options granted in conjunction with the acquisition of PerImmune Holdings Inc................ 3,652,436 365 35,421,649 35,422,014 Common stock issued in exchange for 1997 placement costs....................... 46,669 5 315,104 315,109 Preferred stock dividends/accretions........ 2,967 1 (920,425) (920,424) Cash dividends accrued for Series B-1 and B-2 preferred stock....................... (567,192) (567,192) Stock options exercised....... 162,208 16 457,977 (300,000) 157,993 Redemption of Series A-2 preferred stock............. (47,030) (5) (4,876,418) (4,876,423) Warrants issued in conjunction with the issuance of August 1998 Note................... 6,751,050 6,751,050 Re-evaluation of existing stock warrants.............. 190,000 190,000 Other......................... (28,495) (28,495) Net loss...................... (53,762,042) (53,762,042) ------- --- ---------- ------ ----------- ------------ --------- ------------ BALANCE AT SEPTEMBER 30, 1998........................ $ 7,440,365 $ 744 $48,145,012 $(74,942,488) $(300,000) $(27,096,732) ======= === ========== ====== =========== ============ ========= ============ The accompanying notes are an integral part of these consolidated financial statements. F-6 88 INTRACEL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, YEAR ENDED SIX MONTHS ENDED ------------------------- -------------------------- JUNE 30, 1995 DECEMBER 31, 1995 1996 1997 1997 1998 ------------- ----------------- ----------- ----------- ----------- ------------ (UNAUDITED) Operating activities: Net loss........................... $(1,943,954) $ (4,082,736) $(4,389,973) $(8,063,633) $(4,894,294) $(53,762,042) Adjustments to reconcile net loss to net cash used in operating activities: Extraordinary gain on early extinguishment of debt......... (1,367,000) (785,349) Amortization and depreciation.... 124,363 414,933 2,190,808 2,262,103 1,710,529 3,574,597 Gain on pension curtailment...... (800,000) Gain on settlement of a contingent liability........... (1,050,000) Gain on recovery of investment in GAIFAR......................... (222,720) Acquired research and development charge......................... 2,100,000 37,718,000 Noncash investment charge........ 339,408 Noncash interest expense......... 1,198,392 1,993,515 1,462,701 2,798,247 Noncash inventory charge......... 1,119,000 315,831 Noncash charge on fixed assets... 600,618 532,921 Other............................ 58,030 (23,658) 83,009 Changes in operating assets and liabilities: Accounts receivable, net....... 19,027 29,390 (1,156,412) 380,579 299,676 296,401 Inventories, net............... (21,640) 18,357 (2,113,698) 821,568 6,213 115,402 Other assets................... 4,954 (301,901) (323,181) 67,080 17,879 Accounts payable............... 103,232 886,963 339,522 (109,038) (316,033) 3,683,051 Accrued liabilities............ 267,278 666,231 (342,932) (387,292) (575,659) (532,140) ----------- ------------ ----------- ----------- ----------- ------------ Net cash used in operating activities......................... (1,451,694) (1,328,908) (3,059,756) (2,508,930) (1,730,524) (8,865,665) ----------- ------------ ----------- ----------- ----------- ------------ Investing activities: Purchase of pledged securities..... (3,951,400) Deposits of restricted cash........ (2,000,000) (7,027,993) Release of restricted cash......... 2,000,000 Investment in other assets......... (82,129) (330,225) (3,486) Purchase of Bartels, Inc........... (13,000,000) Purchase of assets from Zynaxis, Inc.............................. (519,000) Purchase of property and equipment........................ (106,560) (288,391) (1,587,193) (1,360,209) (912,044) (462,369) Capitalized patent costs........... (183,995) (25,000) (118,754) Investment in GAIFAR............... (283,220) Recovery of investment in GAIFAR... 222,720 Investment in and advances to Bartels Prognostics.............. (348,198) (795,299) (475,000) Cash acquired in conjunction with purchase of PerImmune Holdings, Inc. (Holdings).................. 2,504,064 Cash paid in conjunction with the purchase of Holdings............. (1,307,632) ----------- ------------ ----------- ----------- ----------- ------------ Net cash provided by (used in) investing activities............... (188,689) (13,807,391) (2,402,606) (4,180,508) (1,717,269) (8,144,850) ----------- ------------ ----------- ----------- ----------- ------------ Financing activities: Proceeds from sale of preferred stock............................ 3,750,000 5,350,000 1,732,740 1,773,733 Repurchase of common stock......... (326,812) (208,750) Proceeds from sale of common stock and exercise of common stock options.......................... 8,000 347,791 6,248,201 44,000 157,993 Deferred stock issue costs......... (245,968) (140,933) (848,721) Issuance of common stock warrants......................... 6,751,050 Exercise of common stock warrants......................... 146,984 Repayment of stockholder note receivable....................... 100,000 100,000 Proceeds from the issuance of long-term obligations............ 54,226 14,845,744 5,960,000 713,339 44,054,506 Debt issue costs................... (668,351) (78,967) (658,087) Redemption of Series A-2 preferred stock............................ (4,876,423) Payments of long-term obligations...................... (223,413) (3,356,853) (896,345) (2,908,494) (1,625,006) (28,623,343) Payment of line of credit.......... (500,000) Payment of pension liability....... (300,000) Use of restricted cash............. 326,431 Book overdraft..................... 194,807 Other.............................. 119,000 19,751 (44,039) (34,994) ----------- ------------ ----------- ----------- ----------- ------------ Net cash provided by financing activities......................... 3,588,813 16,838,891 4,535,283 5,518,836 302,562 15,448,412 ----------- ------------ ----------- ----------- ----------- ------------ Net increase (decrease) in cash and cash equivalents................... 1,948,430 1,702,592 (927,079) (1,170,602) (3,145,231) (1,562,103) Cash and cash equivalents at beginning of period................ 421,288 2,369,718 4,072,310 3,145,231 3,145,231 1,974,629 ----------- ------------ ----------- ----------- ----------- ------------ Cash and cash equivalents at end of period............................. $ 2,369,718 $ 4,072,310 $ 3,145,231 $ 1,974,629 $ -- $ 412,526 =========== ============ =========== =========== =========== ============ The accompanying notes are an integral part of these consolidated financial statements. F-7 89 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. THE COMPANY: Intracel Corporation (the "Company") develops and manufactures therapeutic prognostic and diagnostic products for the treatment of cancers and serious viral diseases. The Company's current and future products are based on several proprietary platform technologies, including the development of totally human antibodies, INSTI (a rapid diagnostic format), and ZYMMUNE (a cell counting technology). These technologies allow the Company to leverage its core competencies into large, global clinical markets. In 1995, the Company changed its fiscal year end from June 30 to December 31. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Principles of consolidation The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of all significant intercompany accounts and transactions. Corporate joint ventures are accounted for under the equity method. Cash and cash equivalents Cash and cash equivalents consist of cash on hand, deposits in banks and money market funds carried at cost, which approximates market. Restricted Cash Restricted cash consist of the proceeds of the Company's Guaranteed Senior Secured Escrow Note deposited in a segregated bank account from which the Company is permitted to obtain funds upon request to the lender. Pledged Securities Pledged securities consist of United States-backed treasury bills with terms up to 6 months. Securities held in escrow will be used to fund one full year of interest payments relating to the Company's Guaranteed Senior Secured Primary Note. Trade accounts receivable Accounts receivable are presented net of allowances for doubtful accounts of $60,000, $50,000 and $121,194 at December 31, 1997, 1996 and September 30, 1998, respectively. The Company recorded provisions for doubtful accounts of approximately $99,000, $11,000 and $80,649 for the periods ended December 31, 1997, 1996 and September 30, 1998, respectively. Inventories Inventories consist of raw materials used in the production process and diagnostic products, research reagents and antibodies held for sale. Inventories are valued at the lower of first-in, first-out cost or market. Property and equipment and depreciation Property and equipment are stated at cost less accumulated depreciation. Maintenance and repairs are charged to expense as incurred. Significant betterments are capitalized. Upon retirement or sale the cost of assets disposed of and the related accumulated depreciation and amortization are removed from the accounts and any resulting gain or loss is reflected in the consolidated statements of operations. Depreciation of property and equipment is provided using primarily the straight-line method over the estimated useful lives of three to F-8 90 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) seven years. Leasehold improvements are amortized on a straight-line method over the shorter of the useful life or the lease term. Construction in progress includes the costs of constructed machinery. Construction in progress costs are transferred to other property and equipment categories when the construction/installation is completed and the asset is ready for its intended use. Cost in excess of net assets acquired Cost in excess of net assets acquired represents the excess of the cost of purchased subsidiaries over the estimated fair value of the net assets acquired as of the date of acquisition and is being amortized by the straight-line method. The weighted average amortization period for cost in excess of net assets acquired is 14 years. Other assets Other assets consist primarily of patent and technology costs and an investment (see Note 11). Patent and technology costs are amortized on a straight-line basis over the estimated useful lives. The weighted average amortization period for patent and technology cost is 10 years. The investment is accounted for using the equity method. Valuation of long lived assets The Company periodically evaluates the carrying value of long-lived assets to be held and used, including, but not limited to, property and equipment, cost in excess of net assets acquired, and other assets, when events and circumstances warrant such a review. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flow from such asset is separately identifiable and is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair market values are reduced for the cost to dispose. Income taxes The Company follows the liability method of accounting for income taxes pursuant to Statement of Financial Accounting Standards No. 109 (SFAS No. 109), "Accounting for Income Taxes." Under SFAS No. 109, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company provides a valuation allowance, if necessary, to reduce deferred tax assets to their estimated realizable value. Stock issuance costs Proceeds from issuances of capital stock are presented net of specific incremental costs directly attributable to the related offering. Revenue recognition Revenue from sales of products is recognized on the date of delivery to customers or upon shipment, based on the contractual terms of applicable agreements. The Company has entered into various research and development and licensing agreements. Research and development revenue from cost reimbursement agreements is recorded as the related expenses are incurred, up to contractual limits and when the Company meets its performance obligations under the F-9 91 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) respective agreements. Contract revenue is recognized under other agreements when milestones are met and the Company's performance obligations have been satisfied in accordance with the terms of the respective agreements. Cash received that is related to future performance under such contracts is deferred and recognized as revenue when earned. After performance obligations have been satisfied, the related amounts received are not reimbursable in the event the research is unsuccessful. The Company also engages in contracts with commercial entities and agencies of the U.S. government (Department of Defense and the National Institute of Health) on either a cost-plus-fixed-fee, fixed price or a cost-plus-percentage-fee basis. Revenue on cost-plus-fixed-fee, fixed price and cost-plus-percentage-fee contract is recognized based on the ratio of total direct and indirect costs incurred during the period to total estimated costs using the percentage-of-completion method. Estimates to complete are reviewed periodically and revised as required in the period the revision is determined. Provisions are made for the full amount of anticipated losses, if any, on all contracts in the period in which they are first known and estimable. Contracts with the U.S. government are subject to government audit upon contract completion and therefore, all contract costs are potentially subject to adjustment, even after reimbursement. Management believes adequate provisions for such adjustments, if any, have been made in the consolidated financial statements. Expense recovery rates have been audited through 1996. Research and development The Company makes significant investments in research for the development of new products. Research and development costs are charged to expense as incurred. Reorganization expense The Company recognized reorganization expense of $917,442 in 1996 in connection with the Company's relocation from Cambridge, Massachusetts to Issaquah, Washington. Net loss per share Effective December 31, 1997, the Company adopted Statement of Financial Accounting Standards No. 128 (SFAS No. 128), "Earnings Per Share." SFAS No. 128 requires the presentation of basic and diluted earnings (loss) per share for all periods presented. In accordance with SFAS No. 128, basic net loss per share has been computed using the weighted-average number of shares of common stock outstanding during the period, except that pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 98, if applicable, common shares issued in each of the periods presented for nominal consideration have been included in the calculation as if they were outstanding for all periods presented. Pro forma basic and diluted net loss per share has been computed as described above and also gives effect to the conversion of the convertible instruments that will occur upon completion of the Company's initial public offering. The Company has included the equivalent number of common shares from the conversion of certain convertible notes, preferred stock and the exercise of certain warrants in the calculation of pro forma EPS. The notes and preferred stock are assumed converted because their terms require conversion upon an initial public offering. The warrants are assumed to have been converted as certain warrants have terms that accelerate the warrants expiration date to the date of an IPO or within 10 days of the IPO, at which time the holder must either exercise the warrants or forfeit such warrants. The warrants have exercise prices of between $6.00 and $10.50 per share and, for purposes of determining the Company's fully diluted share values, assume its IPO price to be in excess of the warrants' exercise price. Consequently, the Company anticipates 3,957,172 shares of common stock will be issued upon conversion or exercise of such preferred stock, convertible notes and warrants. F-10 92 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) A reconciliation of shares used in the calculation of basic and diluted and pro forma basic and diluted net loss per share follows: SIX MONTHS NINE MONTHS ENDED ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, YEAR ENDED DECEMBER 31, ------------------------ ------------------------------- JUNE 30, 1995 1995 1996 1997 1997 1998 ------------- ------------ ---------- ----------- -------------- -------------- (UNAUDITED) Net loss......................... $1,943,954 $4,082,736 $4,389,973 $ 8,063,633 4,894,294 $53,762,042 Preferred stock dividends/accretion............ 211,448 266,136 789,552 1,260,928 896,980 1,957,739 ---------- ---------- ---------- ----------- ---------- ----------- Net loss for common stock........ $2,155,402 $4,348,872 $5,179,525 $ 9,324,561 $5,791,274 $55,719,781 ========== ========== ========== =========== ========== =========== Weighted average shares of common stock outstanding (shares used in computing basic and diluted net loss per share)............ 2,641,784 2,590,828 2,596,883 2,715,599 2,595,535 7,291,018 ========== ========== ========== =========== ========== =========== Basic and diluted net loss per share before extraordinary item........................... $ 0.82 $ 2.21 $ 1.99 $ 3.43 $ 2.23 $ 7.75 Extraordinary item............... (0.53) (0.11) ---------- ---------- ---------- ----------- ---------- ----------- Basic and diluted net loss per share.......................... $ 0.82 $ 1.68 $ 1.99 $ 3.43 $ 2.23 $ 7.64 ========== ========== ========== =========== ========== =========== Shares used in computing basic and diluted net loss per share.......................... 2,715,599 7,291,018 ----------- ----------- Adjustment to reflect the effect of the assumed conversion of convertible instruments: Preferred stock - series A 804,829 854,185 Preferred stock - series A-1 868,224 921,267 Preferred stock - series A-3 197,231 209,282 Preferred stock - series B-1 669,615 Preferred stock - series B-2 772,604 Convertible notes 36,433 Common stock warrants 619,131 493,786 ----------- ----------- 2,489,415 3,957,172 ----------- ----------- Shares used in computing pro forma basic and diluted net loss per share................. 5,205,014 11,248,190 =========== =========== Pro forma basic and diluted net loss per share................. $ 1.55 $ 4.78 =========== =========== Had the Company been in a net income position, diluted earnings per share would have included the shares used in the computation of basic net loss per share as well as additional potential common shares related to outstanding options and warrants which were excluded because they are anti-dilutive. F-11 93 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) Supplemental disclosure of cash flow information Noncash investing and financing activities consisted of: SIX MONTHS NINE MONTHS YEAR ENDED ENDED YEAR ENDED DECEMBER 31, ENDED JUNE 30, DECEMBER 31, ----------------------- SEPTEMBER 30, 1995 1995 1996 1997 1998 ---------- ----------------- ---------- ---------- ------------- Preferred stock dividends paid with stock................................ $211,448 $ 266,136 $ 789,552 $1,260,928 $ 1,153,595 Acquisition of Zymmune................. 1,500,000 Property and equipment acquired under capital lease........................ 96,705 Accrued stock issuance costs........... 315,109 Deferred acquisition costs............. 2,862,513 Conversion of note payable into Series A-2 preferred stock.................. 2,000,000 Conversion of accrued interest into Series A-2 preferred stock........... 267,260 Conversion of Series A-1 preferred stock into Series A-3 preferred stock................................ 1,115,128 Common stock issued in exchange for 1997 stock issuance costs............ 315,109 Re-evaluation of existing stock warrants............................. 190,000 Dividends accrued on Series B-1 and B-2 preferred stock...................... 567,192 Accretion on Series B-1 and B-2 preferred stock...................... 236,952 Accrued interest added to note principal............................ 814,165 Common stock issued for a note......... 300,000 Acquisition of Perimmune Holdings, Inc. ("Holdings" -- See note 11) Fair value of assets acquired........ 19,249,000 Acquired research and development.... 37,718,000 Issuance of Intracel Corporation common stock....................... 24,654,000 Assumption of long term debt......... 11,532,000 Grant of options to purchase Intracel Corporation common stock........... 10,768,000 Issuance of Series B-1 preferred stock.............................. 4,098,744 Issuance of Series B-2 preferred stock.............................. 4,918,493 Assumption of acquisition costs...... 3,500,000 Other.................................. 73,800 Net cash paid for interest during 1997, 1996, the six months ended December 31, 1995, the year ended June 30, 1995 and the nine months ended September 30, 1998 totalled $1,506,390, $1,094,350, $59,071, $22,154 and $507,928, respectively. Concentrations of credit risk The Company's customers are predominantly comprised of government research organizations and companies in the biomedical research, pharmaceutical and diagnostic industries throughout the world. No single customer accounted for a significant amount of the Company's revenues and there were no significant accounts receivable from a single customer. The Company reviews the credit histories of potential customers F-12 94 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) prior to extending credit and maintains allowances for potential credit losses. The Company maintains cash and cash equivalents in high credit quality financial institutions. The Company believes that its risk from concentration of credit is limited. Use of estimates and assumptions The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Fair value of financial instruments For certain financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, recorded amounts approximate market value. The Company believes it is not practicable to estimate a fair market value different from the preferred stock's carrying value as these securities have numerous unique features (as described in Note 10) and there is no quoted market price at September 30, 1998. The carrying amount of the senior note payable and the line of credit approximate market value because they have interest rates that vary with market interest rates. The Company believes it is not practicable to estimate the fair value for the residual of the long term debt as these securities have numerous unique features such as detachable warrants and contingent interest rates, as described in Note 6, and there is no quoted market price at September 30, 1998. Reclassifications Certain reclassifications have been made to the 1996 and 1995 financial statements to conform with the 1997 presentation. The reclassifications had no effect on previously reported net loss, stockholders' deficit or cash flows. Unaudited interim financial statements In the opinion of the Company's management, the September 30, 1997 unaudited interim financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the financial statements except for those pertaining to the acquisition of Holdings as discussed further in Note 11. All references hereinafter to September 30, 1997 amounts are based on unaudited information. New accounting pronouncements In June 1997, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This statement requires that changes in comprehensive income be shown in a financial statement that is displayed with the same prominence as other financial statements. The statement is effective for fiscal years beginning after December 15, 1997. Reclassification for earlier periods is required for comparative purposes. The Company does not have any material items of comprehensive income, other than net loss, and accordingly, the statement does not have any material impact on reported financial position or results of operations. In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information." This statement supersedes Statement of F-13 95 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) Financial Accounting Standards No. 14, "Financial Reporting for Segments of a Business Enterprise." This statement includes requirements to report selected segment information quarterly and entity-wide disclosures about products and services, major customers, and the material countries in which the entity holds assets and reports revenues. The statement will be effective for fiscal years beginning after December 15, 1997. Reclassification for earlier periods is required, unless impracticable, for comparative purposes. The Company is currently evaluating the impact this statement will have on its financial statements; however, because the statement requires only additional disclosure, the Company does not expect the statement to have a material impact on its reported financial position or results of operations. In February 1998, the FASB Issued Statement of Financial Accounting Standards No. 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits." This Statement revises employers' disclosures about pension and other postretirement benefit plans. It does not change the measurement or recognition of those plans. It standardizes the disclosure requirements for pensions and other postretirement benefits to the extent practicable, requires additional information on changes in the benefit obligations and fair values of plan assets that will facilitate financial analysis, and eliminates certain disclosures that are no longer as useful as they were when FASB Statements No. 87, Employers' Accounting for Pensions, No. 88, Employers' Accounting for Settlements and Curtailments of Defined Benefit Pensions Plans and for Termination Benefits, and No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, were issued. The Statement suggests combined formats for presentation of pension and other postretirement benefit disclosures. The Statement also permits reduced disclosures for nonpublic entities. This Statement is effective for fiscal years beginning after December 15, 1997. Earlier application is encouraged. Restatement of disclosures for earlier periods provided for comparative purposes is required unless the information is not readily available, in which case the notes to the financial statements should include all available information and a description of the information not available. The Company is currently evaluating the impact this statement will have on its financial statements; however, because the statement requires only additional disclosure, the Company does not expect the statement to have a material impact on its reported financial position or results of operations. 3. INVENTORIES: Inventories consisted of: DECEMBER 31, ------------------------ SEPTEMBER 30, 1996 1997 1998 ---------- ---------- ------------- Raw materials......................... $ 909,198 $1,100,325 $ 826,885 Work in process....................... 265,712 160,886 197,957 Finished goods........................ 1,938,277 559,802 1,043,609 ---------- ---------- ---------- $3,113,187 $1,821,013 $2,068,451 ========== ========== ========== F-14 96 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. PROPERTY AND EQUIPMENT Property and equipment consisted of: DECEMBER 31, -------------------------- SEPTEMBER 30, 1996 1997 1998 ----------- ----------- ------------- Laboratory equipment................ $ 4,173,856 $ 4,183,788 $ 8,331,843 Computer equipment.................. 473,483 550,260 1,283,142 Leasehold improvements.............. 392,786 477,177 506,997 Furniture........................... 337,830 365,532 394,109 Construction in progress............ 1,005,519 ----------- ----------- ----------- 5,377,955 5,576,757 11,521,610 Accumulated depreciation............ (2,130,622) (2,397,798) (6,982,701) ----------- ----------- ----------- $ 3,247,333 $ 3,178,959 $ 4,538,909 =========== =========== =========== Depreciation expense for the years ended December 31, 1997, 1996, the six months ended December 31, 1995, the year ended June 30, 1995 and the nine months ended September 30, 1998 was $982,740, $861,546, $414,933, $124,363 and $1,143,117, respectively. 5. ACCRUED LIABILITIES: Accrued liabilities consisted of: DECEMBER 31, ------------------------ SEPTEMBER 30, 1996 1997 1998 ---------- ---------- ------------- Acquisition costs..................... $ 375,000 $2,862,513 $ 284,618 Taxes payable......................... 291,055 828,594 1,120,882 Interest payable...................... 492,752 596,028 Accrued stock issuance costs.......... 315,109 Accrued payroll....................... 420,544 304,690 659,743 Building maintenance.................. 66,569 Accrued dividends..................... 567,192 Other................................. 362,318 46,093 316,754 ---------- ---------- ---------- $1,941,669 $4,356,999 $3,611,786 ========== ========== ========== F-15 97 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. LONG-TERM DEBT: Long-term debt consisted of: DECEMBER 31, SEPTEMBER 30, -------------------------- ------------- 1996 1997 1998 ----------- ----------- ------------- Senior note payable to bank, collateralized by substantially all of the assets of the Company, interest at the higher of prime plus 1.5% or the federal funds rate plus 0.5% (10% and 9.75% at December 31, 1997 and 1996, respectively). If the interest payments are not made on a timely basis, the stated interest rate will be increased by a penalty amount. Quarterly principal payments of $250,000 plus interest payable through December 31, 1996 at which time the payments increase to $500,000 plus interest through November 16, 2000. The senior note payable to bank must be repaid to the extent of any net proceeds from the issuance and sale of equity securities by the Company. The note was issued with 121,570 detachable warrants to purchase common stock at $6.75 per share expiring November 16, 2002. The warrants were estimated to have an immaterial fair value for financial reporting purposes. During April 1998, the Company repaid all of the senior note payable with the proceeds from the issuance of $8,000,000 of notes payable to an existing note holder (the "April 1998 Notes"). The April 1998 Notes were issued with 65,422 detachable warrants at an exercise price of $11.46 per share expiring April 17, 2003. The warrants were estimated to have an immaterial fair value for financial reporting purposes. During August 1998, the Company repaid all of the April 1998 Notes with proceeds from the issuance of $41,000,000 of notes payable to an existing note holder (the "August 1998 Notes")..................................... $ 8,250,000 $ 6,000,000 F-16 98 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. LONG-TERM DEBT: (CONTINUED) DECEMBER 31, SEPTEMBER 30, -------------------------- ------------- 1996 1997 1998 ----------- ----------- ------------- Subordinated note payable, collateralized by substantially all of the assets of the Company, interest at 8% per year through November 30, 1997, increasing to 11% thereafter. Principal is due December 31, 2000. The maturity date may accelerate under certain circumstances, as disclosed and defined in the terms of the agreement, including a "change in control." The note was issued with 125,347 detachable warrants to purchase common stock at $10.50 per share expiring December 28, 2000. The warrants were estimated to have an immaterial fair value for financial reporting purposes. The note was issued at an original discount of $1,565,000 which is being amortized over the term of the note. The unamortized discount equaled $819,000 and $1,252,000 at December 31, 1997 and 1996, respectively. The proceeds were used to retire a note payable, resulting in an extraordinary gain of $1,367,000 during the period ended December 31, 1995. The Company is required to make quarterly interest payments and has the option under certain conditions to add required interest payments to principal in lieu of paying in cash. Interest payments of $507,106 and $395,061 were made "in kind" by issuing additional promissory notes during 1997 and 1996, respectively. During August 1998, the Company repaid all of the subordinated note payable with proceeds from the issuance of the August 1998 notes....... 5,402,060 6,342,166 Subordinated note payable, collateralized by substantially all of the assets of the Company, interest at 12% per year through June 21, 1998, increasing to 13% thereafter. Principal is due June 30, 2001. The note was issued with 106,049 detachable warrants to purchase common stock at $10.50 per share expiring on April 1, 2003. The warrants were estimated to have an immaterial fair value for financial reporting purposes. In November 1997, the note and warrant holder purchased 106,049 shares of the Company's common stock for $6.75 per share, and simultaneously relinquished to the Company the warrants to purchase 106,049 shares of common stock at $10.50 per share. The note was converted to Series A-2 preferred stock during 1997 (see Note 10)................... 2,000,000 F-17 99 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. LONG-TERM DEBT: (CONTINUED) DECEMBER 31, SEPTEMBER 30, -------------------------- ------------- 1996 1997 1998 ----------- ----------- ------------- Subordinated note payable to bank, collateralized by substantially all of the assets of the Company, interest at 12% through June 11, 1998, increasing to 13% thereafter. Principal is due June 30, 2001. The maturity date may accelerate under certain circumstances, as disclosed and defined in the terms of the agreement, including a "change in control." The note was issued with 212,098 detachable warrants to purchase common stock at $10.50 per share expiring on April 1, 2003. Warrants were estimated to have an immaterial fair value for financial reporting purposes. The note includes a provision guaranteeing the issuer a 20% compounded annual return through any combination of warrant appreciation or interest payments. The Company is required to make quarterly interest payments and has the option under certain conditions to add required interest payments to principal in lieu of paying in cash. Interest payments of $366,666 and $269,333 were made "in kind" by issuing additional promissory notes during 1997 and 1996, respectively. During August 1998, the Company repaid all of the subordinated note payable with proceeds from the issuance of the August 1998 notes....... 4,269,333 4,635,999 Subordinated note payable to the Massachusetts Business Development Corporation in conjunction with a loan agreement issued by the United States Small Business Administration, collateralized by equipment purchased with the proceeds, interest at prime plus 2.75% (11% at December 31, 1996). Principal of $8,334 plus interest payable monthly through April 1, 2002. This note was paid in full by the Company during 1997......................... 566,656 Note payable, in the amount of $450,000, issued in conjunction with the purchase of certain assets of Zymmune Diagnostic Systems and collateralized by the related equipment, inventory, and intellectual property purchased with the proceeds. Principal plus accrued interest at 6% due on October 24, 1999. The note requires contingent payments of up to $1,050,000 based on attaining certain FDA clinical trial milestones. Zymmune Diagnostic Systems believes the milestones are probable of achievement and, accordingly, the Company had accrued the additional amount at December 31, 1997. The Company, however, disputed these amounts (see Note 11). During August 1998 the Company settled such dispute................ 1,500,000 1,500,000 F-18 100 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. LONG-TERM DEBT: (CONTINUED) DECEMBER 31, SEPTEMBER 30, -------------------------- ------------- 1996 1997 1998 ----------- ----------- ------------- 12% Guaranteed Senior Secured Primary Note due August 1, 2003 in the amount of $35 million and a 12% Guaranteed Senior Secured Escrow Note due August 1, 2003 in the amount of $6 million and common stock warrants to purchase up to 1,083,339 shares of the Company's common stock. The warrants were estimated to have a fair value of $6,751,050 for financial reporting purposes. The notes are collateralized by (i) a first priority security interest in all the existing and future assets of the Company, other than the Perlmmune Patents and certain equipment financed pursuant to the Loan and Security Agreement, dated September 30, 1997, between the Company and the Washington Economic Development Finance Authority, and a second security interest in certain of the Perlmmune Patents and (ii) a pledge of all the issued and outstanding capital stock of the existing and future subsidiaries of the Company. Pursuant to the terms of the Primary Notes, up to $5.0 million aggregate principal amount of the Primary Notes must be redeemed upon the closing of an initial public offering. Pursuant to the terms of the Escrow Notes, the Company must notify the noteholders of its sale of common stock upon the closing of an initial public offering and, if requested, up to $6.0 million aggregate principal amount of the August 1998 Escrow Notes must be redeemed, in whole or in part......................... $34,322,680 Note payable, in the amount of $9,234,935 assumed in connection with the merger of Perimmune Holdings, Inc. (see Note 11 for additional discussion of the merger) The 8% note, increased to 10% after certain dates. Accrued interest is added to the principal balance on February 1 and August 1 of which the maturity date is January 15, 2000. The terms of scheduled repayment are variable depending on the company's cash position as of December 31, 1999. The note is convertible at the option of the lender into common stock at any time prior to the repayment of the note in full at a conversion price equal to the price to the public if and when the company was to complete an initial public offering. Certain patents, patent applications, trademarks and plant and equipment collateralize the note........................................ 10,802,170 F-19 101 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. LONG-TERM DEBT: (CONTINUED) DECEMBER 31, SEPTEMBER 30, -------------------------- ------------- 1996 1997 1998 ----------- ----------- ------------- Note payable collateralized by the equipment purchased with the proceeds, payments of principal plus interest at 11% totaling $15,208 due monthly through August 1, 2002. Note allows for additional borrowings of up to $1,500,000 for the purchase of manufacturing equipment. Guaranteed by a bond posted by the State of Washington Economic Development Council................ 664,588 569,273 Three notes payable each in the amount of $77,500 uncollateralized, non-interest bearing assumed in connection with the merger of PerImmune Holdings. Inc. Each note is convertible into the Company's common stock if the company consummates an initial public offering............................. 232,500 Other of which includes $603,000 and $187,000 of interest as of December 31, 1997 and 1996, respectively, in connection with a subordinated note payable that included a provision guaranteeing the issuer a 20% compounded annual return through any combination of warrant appreciation or interest payments. The Company has calculated additional interest expense as the difference between the stated rate of 12%, increased to 13% June 1998, and the guaranteed rate of 20% for the periods effective. On August 25, 1998 the note was extinguished and as a condition of extinguishment the noteholder agreed to waive the "make-whole" guarantee provision. The Company has reversed all accumulated accrued interest associated with the "make-whole" guarantee provision and has reported an "Extraordinary Gain on Extinguishment of Debt" in the amount of $925,000 in its September 30, 1998 financial statements.................................. 256,018 632,470 146,224 ----------- ----------- ----------- 22,244,067 19,775,223 46,072,847 Less current portion........................ (3,505,122) (2,144,729) (176,411) ----------- ----------- ----------- $18,738,945 $17,630,494 $45,896,436 =========== =========== =========== The various debt agreements contain restrictive covenants relating to quarterly profitability, minimum levels of net worth and liquidity, limitations on additional debt and dividends, and other nonfinancial covenants including certain subjective clauses. The Company received certain amendments and waivers to its debt agreement and covenants contained therein. F-20 102 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. LONG-TERM DEBT: (CONTINUED) Future minimum debt payments at September 30, 1998 are as follows: 1999............................................ 176,411 2000............................................ 6,267,373 2001............................................ 6,232,903 2002............................................ 144,740 2003............................................ 41,000,000 ----------- $53,821,427 =========== On April 1, 1998, the Company issued 12.5% notes ("April 1998 Notes") in the original principal amount of $8.0 million including warrants to purchase 65,422 shares of the Company's common stock. The Company applied the proceeds from the April 1998 Notes to retire the Company's senior note payable to bank issued November of 1995 in the principal amount of $6.1 million, including accrued interest, and the line of credit in the amount of $0.5 million (See Note 7). The remaining $1.4 million was used primarily for working capital purposes. In June of 1998 the Company amended its April 1998 Notes whereby the lender agreed to advance an additional $2.0 million to the Company for working capital purposes. The first advance of $1.0 million occurred in June 1998 while the second advance of $1.0 million occurred in July 1998. Both April 1998 Notes as amended, were repaid with proceeds from the "August 1998 Notes" discussed below. On August 25, 1998 the Company completed a comprehensive refinancing of its outstanding debt. The August 1998 Notes are (i) a 12% Guaranteed Senior Secured Primary Note due August 1, 2003 in the amount of $35 million and (ii) a 12% Guaranteed Senior Secured Escrow Note due August 1, 2003 in the amount of $6 million and (iii) common stock warrants to purchase up to 1,083,339 shares of the Company's common stock. The net proceeds from the August 1998 Notes were used to (i) discharge the Company's subordinated note payable to bank issued June of 1996 in the amount of $5.1 million, including accrued interest, (ii) discharge the Company's subordinated note payable issued in December of 1995 in the principal amount of $7.2 million including accrued interest, (iii) discharge the Company's Amended April 1998 notes in the principal amount of $10.1 million including accrued interest, and (iv) redeem an aggregate of 47,030 shares of the Company's Series A-2 Preferred Stock, $.0001 par value per share in the amount of $4.9 million. Of the remaining $13.7 million $6.0 million from the Guaranteed Senior Secured Escrow Note was deposited into a segregated bank account from which the Company is permitted to obtain funds upon request to the lender, $4.9 million was deposited into an escrow account, reflected as restricted cash on the balance sheet, which is equivalent to four scheduled interest payments on the August 1998 notes, $0.5 million was used to comply with a Company milestone obligation, and the remaining $2.3 million will be used for working capital purposes. The August 1998 Notes are collateralized by (i) a first priority security interest in all the existing and future assets of the Company, other than the PerImmune Patents and certain equipment financed pursuant to the Loan and Security Agreement, dated September 30, 1997, between the Company and the Washington Economic Development Finance Authority, and a second security interest in certain of the PerImmune Patents and (ii) a pledge of all the issued and outstanding capital stock of the existing and future subsidiaries of the Company. The Company is permitted to obtain funds upon request from such Segregated Account, provided that no event of default (as defined) occurs. The Company may draw out of the escrow account to make scheduled interest payments on the August 1998 Notes, provided that, after giving effect to any such withdrawal, the F-21 103 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. LONG-TERM DEBT: (CONTINUED) Company, subject to certain conditions, is required to maintain the balance in the escrow account at an amount sufficient to pay the next four scheduled interest payments, and after the first two successive full payments of interest hereafter, at a level sufficient to pay the next two successive full payments of interest on the outstanding August 1998 Notes. The noteholders have a collateralized interest in the escrow account. The escrow account will be terminated after payment in full of all interest accrued through and including the twelfth successive interest payment due on the August 1998 Notes, with any balance remaining in the escrow account to be retained by the Company. The August 1998 Notes are guaranteed by all the existing subsidiaries of the Company and will be guaranteed by all future subsidiaries of the Company. The August 1998 Notes, among other things, require that the Company comply with certain financial covenants beginning in the year 2000 including, without limitation, maintaining an adjusted debt to EBITDA (as defined) ratio, minimum levels of tangible net worth and interest coverage, and maximum levels of leverage for certain periods. In addition, the August 1998 Notes impose certain limitations on the ability of the Company to, among other things, (i) incur additional indebtedness, (ii) pay dividends or make certain other restricted payments, (iii) consummate certain asset sales, (iv) enter into certain transactions with affiliates, (v) incur liens, (vi) merge or consolidate with any other person or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of its assets, (vii) enter into certain restrictive arrangements relating to the Company's subsidiaries, (viii) extend credit and (ix) make investments. Pursuant to the terms of the August 1998 Primary Notes, up to $5.0 million aggregate principal amount of the August 1998 Primary Notes must be redeemed upon the closing of an initial public offering. Pursuant to the terms of the August 1998 Escrow Notes, the Company must notify the noteholders of its sale of common stock upon the closing of an initial public offering and, if requested, up to $6.0 million aggregate principal amount of the August 1998 Escrow Notes must be redeemed, in whole or in part. The noteholders may require the Company to repurchase an aggregate of up to $7.5 million aggregate principal of the August 1998 Notes at a price equal to 100% of their principal amount plus accrued and unpaid interest, upon the failure of Intracel to satisfy certain ratios of EBITDA to interest expense as measured at the end of each of three successive fiscal quarters of the Company commencing March 31, 2000. The noteholders may require the Company to prepay the August 1998 Notes, in whole or in part, at a price equal to 101% of the principal amount so prepaid, plus accrued interest to the date of prepayment, if there is a Change of Control (as defined) of the Company, or if Simon R. McKenzie shall cease to be the principal executive officer of the Company in charge of the Company's management and policies for a period of 30 days or more. The August 1998 Primary Notes may be prepaid, in whole or in part, at the option of the Company initially at a redemption price of 112% of the principal amount thereof, and declining to 100% of the principal amount thereof after July 31, 2002, plus accrued and unpaid interest, if any, to the date of redemption. The August 1998 Escrow Notes may be prepaid, in whole or in part, at the option of the Company, provided that certain notice requirements are met. Events of default under the August 1998 Notes include, among other things, (i) failure to pay principal or interest on the August 1998 Notes when due, (ii) breaches of representations, warranties and covenants, (iii) defaults under other indebtedness of the Company or its subsidiaries, (iv) failure to consummate an equity offering on or prior to December 31, 1999, with an aggregate offering price of not less than $40.0 million and aggregate proceeds to the Company (net of selling expenses and underwriters' discounts or selling agent's commission) of not less than $35.0 million, (v) the occurrence of certain events of bankruptcy, (vi) certain adverse judgments against the Company or its subsidiaries, (vii) certain ERISA events and (viii) other customary defaults, in certain cases after the expiration of a grace period. F-22 104 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. LONG-TERM DEBT: (CONTINUED) The 1,083,339 warrants issued in connection with the August 1998 Notes are exercisable until August 25, 2003 at an exercise price per share equal to the price to the public per share upon the consummation of an initial public offering. In the event the Company does not consummate an initial public offering on or prior to December 31, 1998 all 1,083,339 warrants are exercisable at $15.00 per share. The Company has determined the warrants to have a fair value of $4.6 million which will be accounted for as a note issuance discount and amortized using the effective interest method over the life of the note. In January 1999, the Company and the Northstar Funds entered into a First Amendment and Waiver Agreement which, among other things, (i) amended the terms of the August 1998 Escrow Notes to eliminate the Company's obligation to redeem the August 1998 Escrow Notes with proceeds received from this offering or any other debt or equity offering prior to the consummation of this offering, (ii) amended the Interest Escrow Security Agreement to reduce the balance required to be maintained in the escrow account created thereunder to an amount sufficient to pay the next two scheduled interest payments on the Notes, and (iii) waived certain non-payment events of default and compliance by the Company with certain covenants set forth in the documentation executed in connection with the August 1998 Refinancing. During August 1998 the Company entered into a settlement agreement with Vaxcel, Inc., an assignee of an agreement for the purchases of certain assets of Zymmune Diagnostic Systems from Zynaxis, Inc. (See Note 11). Pursuant to the terms of the settlement agreement the Company paid $100,000 for a complete and unconditional release of all obligations owed to Vaxcel, Inc. In return the Company agreed to certain obligations in the event Company sales of Zymunne-related products equal or exceed $3,000,000. As of September 30, 1998 the Company had not obtained such sales nor does it anticipate reaching such sales in the near future. The Company had $1,500,000 recorded for obligations to Vaxcel, Inc. The Company reported the extinguishment of its long-term debt obligation associated with this agreement as a "Extraordinary Gain on Early Extinguishment of Debt" in the amount of $350,000 and "Other Income" in the amount of $1,050,000. 7. LINE OF CREDIT: Under the terms of the senior note payable to bank (Note 6), the Company has a line of credit with an aggregate borrowing capacity of $1.0 million at prime plus 1.5%. The agreement includes various restrictive covenants which, among other things, require the Company to maintain certain minimum working capital and net worth amounts. The line of credit facility has a maturity date of November 16, 2000. At December 31, 1997 and 1996, there were $500,000 of borrowings on the line of credit facility. During April 1998, the Company repaid the line of credit with the proceeds from the issuance of the April 1998 notes. 8. INCOME TAXES: The Company did not provide an income tax benefit for any of the periods presented because it has experienced operating losses since inception. At September 30, 1998 the Company had net operating loss carryforwards for federal income tax purposes of approximately $49 million which expire through 2018. Utilization of net operating loss carryforwards will be subject to certain limitations under Section 382 of the Internal Revenue Code. F-23 105 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. INCOME TAXES: (CONTINUED) The following is a reconciliation of the income tax benefit to the amount based on the statutory Federal rate: SIX MONTHS YEAR ENDED NINE MONTHS YEAR ENDED ENDED DECEMBER 31, ENDED JUNE 30, DECEMBER 31, --------------- SEPTEMBER 30, 1995 1995 1996 1997 1998 ---------- ------------ ----- ----- ------------- Federal income tax benefit at statutory rate............... (34)% (34)% (34)% (34)% (35)% Change in valuation allowance.................... 34 % 34 % 34 % 34 % 35 % ----- ----- ----- ----- ----- ===== ===== ===== ===== ===== Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are approximately as follows: DECEMBER 31, ------------------------ SEPTEMBER 30, 1996 1997 1998 ---------- ---------- ------------- Deferred income tax assets: Tax loss carryforwards............. $3,392,000 $5,930,000 $ 17,132,000 Tax credit carryforwards........... 96,000 96,000 96,000 Property, plant and equipment...... 171,000 Inventories........................ 548,000 140,000 Other.............................. 333,000 438,000 863,000 ---------- ---------- ------------- 3,992,000 7,012,000 18,231,000 Deferred income tax liabilities: Other.............................. (65,000) (61,000) (75,000) ---------- ---------- ------------- 3,927,000 6,951,000 18,156,000 Valuation allowance.................. (3,927,000) (6,951,000) (18,156,000) ---------- ---------- ------------- Net deferred taxes assets............ $ $ $ ========== ========== ============= A full valuation allowance has been recorded at December 31, 1997, 1996, and September 30, 1998 based on management's determination that the recognition criteria for realization has not been met. 9. COMMITMENTS AND CONTINGENCIES: On November 30, 1998, a complaint was filed against the Company in the Circuit Court of Cook County, Illinois, Law Division, by Vector Securities International Inc. ("Vector"). In the complaint, Vector alleges a breach of contract by the Company in connection with the Company's retention of Vector as a financial advisor, and seeks damages of approximately $1.6 million plus attorneys' fees. The Company believes it has defenses to the claims alleged in the complaint as well as counterclaims against Vector, and is currently in the process of preparing its answer to the complaint and its counterclaims. The Company recently received a request for payment of approximately $990,000 due under a license agreement assumed by the Company in connection with its purchase of certain assets from Zynaxis Inc. The Company is currently in the process of reviewing the underlying contracts and correspondence regarding this claim to determine its validity. F-24 106 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. COMMITMENTS AND CONTINGENCIES: (CONTINUED) In addition, the Company is party to claims and litigation that arise in the normal course of business. Management believes that the ultimate outcome of these claims and litigation will not have a material impact on the financial position or results of operations of the Company. In the ordinary course of business, the Company is subject to extensive and changing federal regulations within the United States and by other foreign countries with regard to the manufacturing and marketing of products. To date the Company has not identified any potential liabilities arising from the manufacturing and marketing of its products. The Company has operating leases for its facilities with remaining fixed terms ranging up to six years. Rental expense was approximately $2,024,000, $783,000, $1,466,000, $200,000, and $192,000 for the nine months ended September 30, 1998 and the years ended December 31, 1997 and 1996, the six months ended December 31, 1995 and the twelve months ended June 30, 1995, respectively. Future approximate minimum operating lease payments are as follows: Year ending September 30: 1999................................................... $2,018,395 2000................................................... 1,880,257 2001................................................... 1,840,377 2002................................................... 1,890,459 2003................................................... 1,945,870 ---------- Total minimum lease payments............................. $9,575,358 ========== 10. CAPITAL STOCK AND STOCKHOLDERS' DEFICIT: Preferred stock The Company is authorized to issue 5 million shares of $0.0001 par value serial preferred stock. Each series of the preferred stock is a separate class and, as a class, has a liquidation preference equal to the aggregate purchase price paid for such class. F-25 107 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. CAPITAL STOCK AND STOCKHOLDERS' DEFICIT: (CONTINUED) The historical share information regarding the Company's preferred stock activity follows: SERIES SERIES SERIES SERIES SERIES SERIES A A-1 A-2 A-3 B-1 B-2 ------- -------- ------- ------- ------ ------ BALANCES AT JULY 1, 1994 Issuance of preferred stock...................... 468,755 Dividend payments in kind........................ 26,431 ------- -------- ------- ------- --- --- BALANCES AT JUNE 30, 1995........................ 495,186 Issuance of preferred stock...................... 668,750 Dividend payments in kind........................ 20,000 13,261 ------- -------- ------- ------- --- --- BALANCES AT DECEMBER 31, 1995.................... 515,186 682,011 Dividend payments in kind........................ 42,470 56,224 ------- -------- ------- ------- --- --- BALANCES AT DECEMBER 31, 1996.................... 557,656 738,235 Issuance of preferred stock...................... 40,000 Conversion of Series A-1 into Series A-3......... (139,390) 139,390 Dividend payments in kind........................ 45,966 52,323 4,063 8,533 ------- -------- ------- ------- --- --- BALANCES AT DECEMBER 31, 1997.................... 603,622 651,168 44,063 147,923 Issuance of preferred stock...................... 100 120 Dividend payments in kind........................ 37,017 39,783 2,967 9,038 Redemption of preferred stock.................... (47,030) ------- -------- ------- ------- --- --- BALANCES AT SEPTEMBER 30, 1998................... 640,639 690,951 -- 156,961 100 120 ======= ======== ======= ======= === === Series A, Series A-1, and Series A-3 redeemable and convertible preferred stock The Series A, Series A-1, and Series A-3 redeemable and convertible preferred stocks were issued for net proceeds of $8.00 per share and are convertible into common stock of the Company at a conversion ratio of 1.33 shares of common stock per one share of preferred stock, which is equivalent to a conversion price of $6.00 per share. Holders of these preferred shares are entitled to receive a cumulative 8% annual dividend. Dividends may be paid in cash or in additional shares ("in kind") at the option of the Company until January 1, 1999 after which time dividends are payable only in cash. The Company is required to redeem all outstanding shares at $8.00 per share, plus accrued dividends, on July 1, 2001 (Series A) and September 22, 2002 (Series A-1 and Series A-3). Each preferred share has voting rights equivalent to two shares of common stock except for the Series A-3 which does not have voting rights unless converted to common stock. The stockholders have a liquidation preference of $8.00 per share upon the dissolution of the Company. The Company covenants that it will not amend the articles of incorporation, recapitalize, pay or declare dividends on junior stock, merge or consolidate, liquidate, dissolve or change the principal business of the Company as long as 25% of the authorized shares are outstanding of each series of preferred stock, unless 51% or more of the preferred stockholders approve the change. The Series A, Series A-1 and Series A-3 preferred stock is mandatorily convertible into common stock at a ratio of two shares of common stock per one share of preferred stock upon the closing of an underwritten public offering pursuant to an effective registration statement on Form S-1 for the sale of common stock at a per share price of at least $6.00 per share with aggregate proceeds of at least $10,000,000, so long as the offering occurs no later than September 19, 1998. The Company is currently in the process of amending the Series A, Series A-1, and Series A-3 stockholder agreements to extend the aforementioned date to June 30, 1999. The Company expects the preferred stockholders to approve the change. F-26 108 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. CAPITAL STOCK AND STOCKHOLDERS' DEFICIT: (CONTINUED) Series A-2 preferred stock The Series A-2 preferred stock was non-convertible, non-voting and were issued in conjunction with the exchange of $2,267,260 of subordinated debt and accrued interest in addition to the receipt of $1,732,740 in cash, resulting in net proceeds of $100 per share. Holders of these preferred shares were entitled to receive a cumulative 13.5% dividend in cash or in kind, at the option of the Company, until February 28, 2007 at which time the dividend rate would have increased to 19% and payable only in cash. The Company had the option to redeem these shares at any time prior to February 28, 2000 for $100 per share. The stockholders also had the right to elect directors and exchange their shares for notes if dividend payments were in arrears for a specified period of time. The stockholders had a liquidation preference of $100 per share upon the dissolution of the Company. On August 25, 1998 all outstanding shares of Series A-2 Preferred Stock were redeemed in conjunction with the refinancing of the Company's long-term debt. Series B-1 and B-2 preferred stock The Series B-1 and B-2 redeemable and convertible preferred stock were issued in conjunction with the merger with Holdings to replace that company's outstanding shares of Holdings Series A and Series B preferred stock with rights and preferences identical to the original issues. The stockholders have a liquidation preference of $45,000 and $50,000 per share, respectively, upon dissolution of the Company. Holders of these preferred shares are entitled to receive a cumulative 7% per annum dividend based on the liquidation preference amount per share. Holders of these preferred shares are entitled to receive annual dividends in cash, commencing on April 24, 1998 and June 16, 1998, respectively, and continuing, thereafter, on each subsequent anniversary date. Each preferred share has voting rights equivalent to 6,072.21 shares of common stock. The Company covenants that it will not amend certain portions of it's articles of incorporation, dissolve, merge or consolidate the Company, unless 51% or more of the Series B-1 preferred stockholders and 51% of the Series B-2 preferred stockholders approve the change. On the fifth anniversary of the Series B-1 and B-2 assumed initial issue date, the Company shall redeem all of the then outstanding shares at the Series B-1 and B-2 liquidation preference amount. Each share of Series B-1 and B-2 preferred stock may be converted into common stock, at any time prior to the respective redemption dates, at the option of the stockholder or will automatically convert to common stock immediately prior to the first registered, underwritten public offering of shares of common stock by the Company. Theses preferred shares are convertible into 6,072.21 shares of common stock per one share of Series B-1 preferred stock or Series B-2 preferred stock. Common stock The Company is authorized to issue 25,000,000 shares of $0.0001 par value voting common stock. Upon liquidation or dissolution, holders of common stock will be paid only after preferred stock preferences have been satisfied. On December 31, 1997, all outstanding shares of common stock were split two for one. In November 1997, the Company issued 805,979 shares of common stock for proceeds of $5,687,124, net of issuance costs of approximately $561,077 and other noncash transactions of $73,800. In conjunction with this transaction, 24,497 warrants to purchase common shares for $6.00 per share were exercised for proceeds of $146,980. In January 1998, the Company issued 3,652,436 shares of common stock in connection with the acquisition of Holdings. The Company also assumed the outstanding stock options granted to Holdings employees equivalent to 1,560,554 shares of Intracel common stock (Note 11). F-27 109 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. CAPITAL STOCK AND STOCKHOLDERS' DEFICIT: (CONTINUED) Common Stock On December 28, 1998, the Company's Board of Directors approved a two-for-three reverse stock split of the Company's common stock. The reverse stock split will become effective at the time an Amended and Restated Certificate of Incorporation is filed with the Secretary of State of Delaware. All references in the consolidated financial statements and related notes thereto referring to shares, share prices, per share amounts and other share information have been retroactively adjusted for the reverse stock split. Initial Public Offering In March 1998, the Company's Board of Directors authorized the Company to file a Registration Statement with the Securities and Exchange Commission to permit the Company to proceed with an initial public offering of its common stock. Stock options The Company's 1989 Amended Stock Option Plan (the "Plan") which covers the Intracel/Bartels employees, provides for the issuance of incentive and nonqualified stock options to employees, directors, and consultants. There are 1,110,172 shares of common stock reserved under the Plan. The Company's Board of Directors establishes the option price per share, vesting period, and option term at the date of grant. Generally, options are granted by the Company's Board of Directors at an exercise price of not less than the fair market value of the Company's common stock at the date of grant. For stockholders possessing at least a 10% ownership interest, the option price shall not be less than 110% of the fair market value at the date of grant. The vesting period of options generally ranges from immediately to ratably over four years. Option terms generally are five or ten years. The Company also has a 1996 Stock Option Plan, which covers the PerImmune employees, provides for the issuance of incentive and nonqualified stock options to employees, directors, and consultants. The Company's Board of Directors establishes the option price per share, vesting period, and option term at the date of grant. The vesting period of options generally ranges from one to three years. Option terms generally are 10 years. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25 (APB No. 25), "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the fair value of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. Under APB No. 25, because the exercise price of the Company's stock options generally equals the fair value, as determined by the Board of Directors, of the underlying stock on the date of grant, no compensation expense is recognized in the Company's consolidated financial statements. F-28 110 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. CAPITAL STOCK AND STOCKHOLDERS' DEFICIT: (CONTINUED) Information regarding activities in the option plan is as follows: WEIGHTED AVERAGE EXERCISE SHARES PRICE ---------- -------- Options outstanding, July 1, 1994........................... 335,356 $3.00 ---------- Options outstanding, June 30, 1995.......................... 335,356 3.00 ---------- Options outstanding, December 31, 1995...................... 335,356 3.00 Options granted........................................... 218,667 4.04 Options canceled.......................................... (6,667) 3.75 ---------- Options outstanding, December 31, 1996...................... 547,356 3.41 Options granted........................................... 86,667 6.75 Options expired........................................... (54,667) 3.75 ---------- Options outstanding, December 31, 1997...................... 579,356 3.87 Options assumed in merger with Holdings, Inc.............. 1,560,554 0.50 Options granted........................................... 316,664 12.27 Options canceled.......................................... (926,102) 1.75 Options exercised......................................... (162,205) 2.82 ---------- Options outstanding, September 30, 1998..................... 1,368,267 $3.66 ========== At December 31, 1996, 1997 and September 30, 1998 the Company granted stock options in excess of the authorized Plan amount by 82,838, 114,838 and 240,163 shares, respectively. The Company intends to submit for shareholder approval an amendment to its stock option plan to increase the number of options authorized for issuance. The following table summarizes information about options outstanding at September 30, 1998: OPTIONS OUTSTANDING OPTIONS EXERCISABLE -------------------------------------- ----------------------- WEIGHTED WEIGHTED AVERAGE WEIGHTED AVERAGE REMAINING AVERAGE RANGE OF NUMBER EXERCISE CONTRACTUAL NUMBER EXERCISE EXERCISE PRICES OUTSTANDING PRICE LIFE EXERCISABLE PRICE - ---------------------------- ----------- -------- ----------- ----------- -------- $ .45...................... 751,434 .45 4 years 531,319 .45 $ 1.50 - $ 2.25............. 72,555 1.56 0 72,555 1.56 $ 2.26 - $ 3.39............. 78,933 2.54 0 78,934 2.54 $ 3.40 - $ 5.10............. 96,534 3.75 2.83 years 88,533 3.75 $ 5.11 - $ 7.65............. 115,477 6.65 4.29 years 42,700 6.63 $11.25 - $15................ 253,334 12.75 5.57 years 75,834 12.51 --------- ----- ---------- -------- ----- 1,368,267 3.66 3.79 years 889,875 2.38 Pro forma information regarding net income (loss) is required by SFAS No. 123, and has been determined as if the Company had accounted for its employee stock options granted after January 1, 1996 under the fair value method of that statement. The fair values of options granted in 1998, 1997 and 1996 (no options were granted during the six months ended December 31, 1995 or the year ended June 30, 1995) were F-29 111 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. CAPITAL STOCK AND STOCKHOLDERS' DEFICIT: (CONTINUED) estimated at the date of grant using the minimum value method and the following weighted-average assumptions: 1996 1997 1998 ------- ------- ------------ Risk free interest rate.................... 6.41% 6.28% 6.5% Expected holding period.................... 4 years 6 years 6 years Dividend yield............................. 0.0% 0.0% 0.0% The minimum value method was developed for use in estimating the fair value of options granted by nonpublic entities and, accordingly, excludes consideration of volatility. In addition, option valuation models require the input of highly subjective assumptions. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the minimum value method does not necessarily provide a reliable single measure of the fair value of its stock options. The weighted average fair values per share at the date of grant for options granted were as follows: NINE MONTHS YEAR ENDED ENDED DECEMBER 31, SEPTEMBER -------------- 30, 1996 1997 1998 ----- ----- ------------ Options granted whose exercise price was equal to the fair value of the stock on the date of grant........................................ $1.13 $2.09 $2.46 ===== ===== ===== The following table presents net loss and per share amounts as if the Company accounted for compensation expense related to stock options under the fair value method prescribed by SFAS No. 123: YEAR ENDED DECEMBER 31, ------------------------------------------------ NINE MONTHS ENDED 1996 1997 SEPTEMBER 30, 1998 PRO FORMA PRO FORMA PRO FORMA ----------- ----------- ------------------ Net loss -- as reported......... $(4,389,973) $(8,063,633) $(53,762,042) Net loss -- pro forma........... (4,420,723) (8,105,094) (53,933,264 Loss per share -- as reported... (1.99) (3.43) (7.64) Loss per share -- pro forma..... (2.00) (3.45) (7.67) For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the option's vesting period. At September 30, 1998, the following warrants to purchase common stock were outstanding: PRICE PER SHARE, NUMBER OF SUBJECT TO SHARES ADJUSTMENT EXPIRATION DATE - --------- ---------- ------------------ 44,835 $ 6.00 July 22, 1999 115,283 6.00 September 22, 2000 121,570 6.75 November 16, 2002 125,347 10.50 December 28, 2000 212,098 10.50 April 1, 2003 - --------- 452,896 6.75 January 2, 2003 65,422 11.46 August 25, 2003 1,083,339 15.00 August 25, 2003 - --------- 2,220,790 ========= F-30 112 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. CAPITAL STOCK AND STOCKHOLDERS' DEFICIT: (CONTINUED) The outstanding warrants carry registration rights, certain anti-dilutive rights, and certain adjustments to the number of shares obtainable under the warrants, as provided in the warrant agreements. The expiration dates of the warrants may accelerate under certain circumstances, including the closing of an initial public offering of common stock at a minimum purchase price per share of $8 to $9 and minimum aggregate proceeds of $10,000,000. On January 2, 1998, the Company issued Warrants to purchase 452,896 shares of common stock in connection with an employment agreement between Simon R. McKenzie, the Company's Chief Executive Officer, and the Company. The Warrants carry an exercise price of $6.75 per share and expire 5 years from the date of issue. On April 1, 1998, the Company issued Warrants to purchase 65,422 shares of common stock in connection with a Note and Warrant Purchase Agreement at an exercise price of $11.46 per share. On August 25, 1998, the Company issued Warrants to purchase 1,083,339 shares of Common Stock in connection with a note and Warrant Purchase Agreement at an exercise price per share of $15.00. 11. ACQUISITIONS: In April 1996, the Company entered into an agreement with Bartels Prognostics acquiring certain manufacturing equipment for $360,000. The agreement also granted the Company exclusive manufacturing and marketing rights subject to the full payment of $1,000,000 for 644,696 shares, or 23.443%, of common stock of Bartels Prognostics. The Company accrued $375,000 and paid $250,000 in 1996 and made the residual payments of $750,000 in 1997, comprising the total consideration of $1,000,000. Additionally, the Company made advances to Bartels Prognostics of $45,299 and $98,198 during 1997 and 1996, respectively. At December 31, 1997 and 1996, advances to Bartels Prognostics are included in other current assets and the investment in Bartels Prognostics is included in other assets. The agreement allows for further discussion regarding the potential future merger of the two entities. In November 1995, the Company purchased certain assets and assumed certain liabilities of Bartels, a biotechnology company in the business of developing, manufacturing, selling, and distributing reagents and cell culture media from Dade International for an aggregate purchase price of approximately $17,667,000. The acquisition was financed primarily via a $9,000,000 term loan and a $1,000,000 revolving credit note from a commercial bank, and a $4,667,000 note payable to the seller (the note payable to the seller was paid in December 1995 primarily from the proceeds of the December 1995 Subordinated Secured Promissory Note). The purchase price was allocated to the assets acquired based upon fair market values. The excess of the purchase price over the fair market value of the assets acquired in the amount of $13,622,586, has been allocated to cost in excess of net assets acquired and is being amortized over 15 years. Acquired in-process research and development approximating $1,300,000 was expensed in 1995 as the technological feasibility of the acquired technology had not been established and the technology had no future alternative use as of the date of acquisition. This acquisition was accounted for as a purchase and, accordingly, the results of operations of the acquired business is included in the accompanying consolidated statement of operations from the date of acquisition. In September 1995, the Company purchased certain assets of Zymmune Diagnostic Systems from Zynaxis, Inc., a developer of drug delivery systems, for an aggregate purchase price of approximately $2,019,000. The financing consisted of a note payable to Zynaxis and a series of contingent payments. The contingent payment liability of $1,050,000 was recorded as a long-term liability due to the Company's view that the milestones underlying the payments are probable of being achieved. The note payable and the contingent payments to Zynaxis resulted in a noncash transaction for the purchase of the assets in the amount of approximately $1,500,000. Assets purchased included technology, patents, equipment, and inventory. The purchase price was allocated to the assets acquired based upon their fair market values. Acquired in-process research and development approximating $800,000 was expensed in 1995 as the technological feasibility of the acquired technology had not been established and the technology had no future alternative use as of the date F-31 113 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. ACQUISITIONS: (CONTINUED) of the acquisition. Although the manufacturing milestone was achieved during fiscal year 1996, the Company has alleged a number of breaches of the agreement by Zynaxis and has accordingly withheld all payments pending resolution of the dispute. In August 1998 the Company settled with the assignee of this agreement (Vaxcel, Inc.) for an amount substantially less than the value of the note and contingent payments. On January 2, 1998, the Company acquired in a tax-free merger all the capital stock of PerImmune Holdings ("Holdings") which conducts operations through PerImmune, Inc., its wholly owned subsidiary ("PerImmune"). As a result of this transaction, Holdings and PerImmune have become subsidiaries of the Company. In anticipation of this acquisition, the Company placed $2,000,000 of cash in a restricted escrow account on December 31, 1997 to satisfy requirements of the holder of the senior note payable. At December 31, 1997, the Company has deferred certain acquisition costs related to this transaction, including legal, accounting and other fees. PerImmune is a research oriented healthcare company that applies biotechnology and other life sciences technologies to develop and provide products and services. PerImmune's focus is on the development of human monoclonal antibodies for cancer and infectious disease applications, as well as cancer vaccines, specific and nonspecific immunotherapy and cardiovascular disease test products. The aggregate purchase price was approximately $59,471,000, payable in 3,652,436 shares of Intracel common stock, 1,560,554 options to purchase Intracel common stock, 220 shares of Intracel Series B-1 and B-2 preferred stock, the assumption of obligations of approximately $11,532,000 and the assumption of other certain liabilities. The acquisition has been accounted for using the purchase method of accounting and the September 30, 1998 financial statements reflect valuation of all assets, including identifiable intangibles, at their estimated fair market values. Perimmune's operating results are included in Intracel's consolidated operating results from the date of acquisition. The Company recognized a one time expense of $37,718,000 in the first quarter of 1998 related to acquired in process research and development as the technological feasibility of the acquired technology had not been established and the technology had no future alternative use as of the date of acquisition. The remaining $21,742,000 of the total purchase price was allocated among the acquired assets including patents, current product technology and long term assets including $849,000 recorded as cost in excess of net assets acquired, which is being amortized over 10 years. In connection with the acquisition of Holdings, the Company assumed the ownership rights of certain patents and other technology rights developed under the research and development contracts with OTC. Under the terms of the ownership rights, the Company is required to make certain milestone payments of up to $10 million if specific future conditions are met, and will make payments of between 5.0% and 7.5% of net product sales and 50% of license revenue. The milestone and royalty payments will continue until the expiration or termination of the related patents covering the products defined in the agreement. As of the date of acquisition $500,000 of milestone payments were included in accrued liabilities for amounts payable to OTC. On August 25, 1998 the liability was satisfied in its entirety through cash payment to OTC. No royalty payments have been accrued or are due to OTC. Also in conjunction with the acquisition, the Company assumed the following contractual rights and obligations from Holdings: Agreement with Baxter On January 1, 1996, PerImmune entered into a research collaboration and license agreement with Baxter Healthcare Corporation (Baxter) whereby PerImmune agreed to provide certain research, development and pilot manufacturing services for Baxter in exchange for reimbursement of research and development costs, milestone payments and certain royalty payments. PerImmune received a non-refundable milestone payment of $1,500,000 in January 1996 and is reimbursed for actual costs incurred plus a fee of 16% during the term of the agreement. Baxter is also obligated to make up to $3,000,000 in additional milestone payments, if PerImmune achieves certain stages of U.S. and European regulatory approvals for the serotherapy products F-32 114 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. ACQUISITIONS: (CONTINUED) for infectious and autoimmune diseases under development. In addition, PerImmune earns a royalty ranging between 4% and 8% of gross profit with a minimum royalty ranging between 2% and 4% of net sales, as defined in the agreement on sales of products depending on whether the product is a result of previously existing technology of PerImmune or new technology resulting from this development agreement. As of September 30, 1998, no royalty or additional milestone payments have been earned. The agreement has a term of three years with an option for a fourth year. Either party may terminate this agreement at any time without cause. All patents and technology developed under this agreement are the property of Baxter. Agreement with Arch Development Corporation PerImmune has a license agreement with the Arch Development Corporation (Arch) to make and sell products under the patent rights for Apotek Lp(a) developed at the University of Chicago. The agreement requires PerImmune to pay Arch a royalty of 4% of related product sales. As of September 30, 1998, PerImmune paid $22,400 of royalty expense under this agreement. Distribution Agreement with Syncor International Corporation On April 1, 1997, PerImmune entered into an exclusive distribution agreement with Syncor International Corporation (Syncor) for the HumaSPECT and antibody conjugated radiotherapeutic products. Under this agreement, Sycor accepts title of the product upon receipt and pays PerImmune a specific purchase price defined by the agreement. Additionally, Syncor will pay PerImmune a royalty of 50% of its net sales of PerImmune's products less the specific purchased price, as defined, and right of return exists if the product received by Syncor has less than one year until its expiration. To date, PerImmune has not earned any royalties under this agreement. PerImmune is obligated to spend 15% of annual sales of products covered by this agreement on research and development to improve upon existing products or develop new products. PerImmune is required to reimburse Syncor for all expenses related to marketing these products up to $1,500,000, plus 50% of amounts over $1,500,000, provided the expenditures are in accordance with the annual market plan as prepared and agreed by the two companies. For the nine month period ended September 30, 1998, PerImmune has reimbursed Syncor for marketing expenses of $138,000. This agreement has a term of five years and is renewable for two additional two-year terms. Agreements with Mentor Corporation On June 16, 1997, the PerImmune entered into an exclusive distribution agreement with Mentor Corporation (Mentor) for the AuraTek -- FDP bladder cancer diagnostic product, which PerImmune refers to as Accu-D(X), with an initial term of five years and is automatically renewable for one year terms thereafter until either party terminates the agreement with 180 days written notice. Under this agreement, Mentor accepts title of the product shipments upon receipt and pays PerImmune a specific purchase price defined by the agreement. Additionally, Mentor will pay PerImmune a royalty of 50% of its net sales of PerImmune's product, less the specific purchase price as defined in the agreement. PerImmune is obligated to provide up to 12,000 units of the product per year to be used by Mentor for promotional purposes, at no cost to Mentor. On December 22, 1997, PerImmune entered into a research, collaboration and distribution agreement with Mentor whereby PerImmune agreed to provide certain research, development and pilot programs for Mentor in exchange for research and development fees in an aggregate amount of $3,000,000 based on a milestone payment schedule. As of December 31, 1997, PerImmune had not earned any milestone payments. PerImmune will receive $1,000,000 within five days of submission of written notice of the completion of each milestone to Mentor. PerImmune is required to pay the cost in excess of $3,000,000 for expenditures within the scope of the project development schedule. PerImmune is the owner of all rights to proprietary technical information and the U.S. Patent to which Mentor was granted exclusive world-wide rights to market, sell and F-33 115 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. ACQUISITIONS: (CONTINUED) distribute the program product. This agreement is effective for a ten-year period following the first approval of commercialized use of products under development. Mentor has the right to terminate this agreement at the expiration of five years from the date of the first approval of commercialized use of the product based upon 180 days written notice to PerImmune. As of September 30, 1998, the Company has received to date milestone payments from Mentor in the amount of $1,000,000. Sigma Agreement On June 30, 1997, PerImmune entered into a product development and license agreement with Sigma Diagnostics, Inc. (Sigma) for a diagnostic product, whereby PerImmune agreed to provide product development and licensing services for Sigma in exchange for a product development fee and royalty payment. PerImmune is entitled to receive an aggregate amount of $348,000 based on a milestone payment schedule that requires a payment of $87,000 upon completion of each respective milestone of which $87,000 was earned in 1997. During 1998, the Company received an additional $87,000. In addition, PerImmune will receive an annual royalty payment ranging between 3.5% and 7% of the net selling price of the licensed product depending on whether there are any additional competitors for this product in the marketplace. PerImmune has sole and exclusive ownership of the licensed patents, while Sigma has the exclusive world-wide right to use and sublicense the project program information. This agreement has a term of five years and is automatically renewable for a one-year term thereafter until Sigma terminates the agreement. Manufacturing/Distribution Agreement with OTC On August 1, 1997, PerImmune entered into an exclusive manufacturing/distribution agreement with OTC for the FDP Dipstick product, which PerImmune refers to as Accu-Dx. Under the agreement, PerImmune paid OTC $250,000 in exchange for the exclusive right to purchase, at a defined price, such OTC product for package and resale under trademarks or tradenames designated by PerImmune. PerImmune is obligated to purchase at least 100,000 units of the product annually at $4.00 per unit, starting on August 1, 1998. This agreement has an initial term of three years and is automatically renewed in two-year terms until written notice of termination from either PerImmune or OTC. Other Contracts and Agreements PerImmune has entered into various other licensing and research and development agreements whereby it is committed to participate in research and development projects, either on a best efforts basis or upon attainment of certain performance milestones, as defined, or both, for various periods unless canceled by the respective parties. Such future amounts to be paid to PerImmune will primarily be determined on a cost-plus basis, and are subject to specific performance criteria. The following unaudited pro forma information has been prepared assuming Holdings had been acquired as of the beginning of the periods presented. The pro forma information is presented for information purposes only and is not necessarily indicative of what would have occurred if the acquisition had been made as of those dates. In addition, the pro forma information is not intended to be a projection of future results. NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, PRO FORMA INFORMATION DECEMBER 31, ------------------- (IN THOUSANDS, EXCEPT PER SHARE) 1997 1997 1998 -------------------------------- ------------ ------- -------- (ACTUAL) Revenue.................................... $21,341 $16,521 $14,244 Net loss................................... 58,287 50,480 53,762 Loss per common share basic and diluted.... 9.35 8.22 7.64 F-34 116 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 12. JOINT VENTURE: During 1995, the Company made a 45% investment in the German American Institute for AIDS Research (GAIFAR), a German limited liability Company. The purpose of the entity was to develop and distribute the Company's products within the Eastern European market. The investment is accounted for under the equity method. Also during 1995, GAIFAR obtained a 1,000,000 Deustche mark (DM) unsecured loan through the German government. During 1996, the Company made an additional contribution of capital approximating $283,000 in accordance with the loan agreement with the German government. No further capital contributions were required based on the terms of the financing. As of December 31, 1996, the Company had written off the entire investment in the joint venture because the amount was deemed not to be recoverable, which resulted in a charge to operations of $339,408. In July of 1997, the Company entered into a termination and sale agreement which resulted in the transfer of all joint venture shares back to GAIFAR on May 14, 1998, releasing the Company from its guarantee of the 1,000,000 DM loan. In September and October, 1998 the Company received approximately $225,000 and $90,500, respectively, which the Company considers a recovery of an investment that was previously written off. These amounts are considered as settlement in full for the transfer of all joint venture shares. 13. EMPLOYEE RETIREMENT BENEFIT PLANS: Retirement Savings Plan The Company maintains two separate retirement savings plans. The first is a 401(k) savings plan covering the Intracel and Bartels employees. Eligible employees may contribute amounts through payroll deductions. The Company matches employees' contributions at the discretion of the Company's Board of Directors. The Company did not match employee contributions to the 401(k) savings plan in the 1997, 1996 and 1995 periods. The Company does not provide other post-retirement benefits. The second is a defined-contribution savings plan under Section 401(k) of the Internal Revenue Code covering substantially all former PerImmune full-time employees. Participating employees may defer a portion of their pretax earnings up to the Internal Revenue Service annual contribution limit. The Company matches employee contributions according to a specified formula. The Company's matching contributions totalled $134,455, $176,098 and $72,779 for the periods ended September 30, 1998, December 31, 1997 and period from August 3, 1996 through December 31, 1996, respectively. Pension Plan In connection with the Company's merger with Holdings, the Company assumed Holdings' employee pension plan. The Company froze the benefits under the Plan in February 1998, and determined that the remaining Plan assets and recorded pension liability exceeded the obligation relating to the participants. As a result of the curtailment of the plan benefits, the Company recorded a gain in the quarter ended March 31, 1998 of $800,000 and reduced the related pension liability in accordance with Statement of Financial Accounting Standards No. 88, "Employers Accounting for Settlements and Curtailments of Defined Benefit Pension Plans." F-35 117 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 13. EMPLOYEE RETIREMENT BENEFIT PLANS: (CONTINUED) The following table sets forth the funded status of the plan and the composition of net periodic pension cost and significant assumptions for the periods ended as follows: DECEMBER 31, ---------------------------- SEPTEMBER 30, 1996 1997 1998 ------------ ------------ ------------- Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of approximately $1,133,561 in 1996, $1,251,865 in 1997 and $1,488,170 in 1998.... $ 1,362,971 $ 1,565,486 $ 1,759,951 Effect of anticipated increase in compensation levels....................................... 718,744 770,256 -- ------------ ------------ ------------ Projected benefit obligation...................... 2,081,715 2,335,742 1,759,951 Plan assets at fair value......................... 1,238,260 1,360,127 1,605,615 ------------ ------------ ------------ Excess of projected benefit obligation over plan assets.......................................... (843,455) (975,615) (154,336) Unrecognized net investment (gain) loss........... (92,424) (208,287) 97,601 ------------ ------------ ------------ Total pension liability accrued......... $ (935,879) $ (1,183,902) $ (56,735) ============ ============ ============ Net periodic pension cost includes the following components: Service cost -- benefits earned during the period....................................... $ 93,606 $ 213,981 $ 54,464 Interest cost on projected benefit obligation... 61,916 151,631 118,929 Actual return on assets......................... (135,097) (173,965) (136,472) Net amortization and deferred investment gain... 92,424 56,376 -- ------------ ------------ ------------ Net periodic pension cost............... $ 112,849 $ 248,023 $ 36,921 ============ ============ ============ Significant assumptions used were as follows: Discount rate................................... 7.5% 7.5% 6.75% Rate of increase in compensation levels (graded by age of participant)....................... 4.0 to 10.5% 4.0 to 10.5% 4.0 to 10.5% Expected rate of return of assets............... 9.5% 9.5% 9.5% ============ ============ ============ 14. SUBSEQUENT EVENTS: The Company has entered into a letter of intent with two accredited investors who currently hold various securities issued by the Company, pursuant to which the Company has agreed to sell $2 million aggregate principal amount of the Company's non-convertible debt securities. The proceeds from the issuance and sale of this non-convertible debt will be used for working capital and other general corporate purposes. 15. RESTATEMENT: The Company's financial statements as of and for the years ended December 31, 1996 and 1997, have been restated for the following: Long-term debt Certain of the Company's debt with a bank, with a stated interest rate of 12%, increased to 13% in June 1998, contained a "make-whole" provision which guaranteed the note holder a 20% return through any combination of interest payments or payments-in-kind or stock warrant appreciation (See Note 6). Previously the Company had not recognized any interest in addition to the stated interest for 1997 and excluded an immaterial portion of the interest in 1996. Accordingly, the 1997 and 1996 financial statements have been restated to recognize additional interest expense of $417,000 and $56,000, respectively, which results in a total F-36 118 INTRACEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 15. RESTATEMENT: (CONTINUED) interest rate of 20% for each year. Such restatements increased previously reported loss before extraordinary item and net loss by like amounts, and increased basic and diluted loss before extraordinary item and net loss per share amounts by $.15 and $.02 in 1997 and 1996, respectively. Inventory At December 31, 1997 the Company directly charged $1.1 million to cost of revenue-product for the estimated amount of obsolete inventory. Subsequently, the Company has become aware of a December 31, 1996 inventory adjustment in the amount of $832,000 to reduce inventory that was inadvertently not reflected in the Company's December 31, 1996 audited financial statements. Accordingly, the 1996 financial statements have been restated to reduce inventory in 1996 with a charge to cost of revenue-product. As a result of this restatement, the 1997 financial statements were also restated to reduce by $832,000 the $1.1 million charge to cost of revenue-product. Such restatements increased loss before extraordinary item and net loss in 1996 by $832,000 and decreased the 1997 amounts by a like amount. Basic and diluted loss before extraordinary item and net loss per share amounts for 1996 and 1997 were increased and decreased by $.32 and $.31, respectively. F-37 119 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Perimmune Holdings, Inc. and Subsidiary In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, stockholders' equity (deficit) and of cash flows present fairly, in all material respects, the financial position of Perimmune Holdings, Inc. and Subsidiary (the "Company") at December 31, 1997, and the results of their operations and their cash flows for the year then ended, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of the 1997 financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP McLean, Virginia April 2, 1998, except for the second paragraph of Note 14 as to which the date is June 8, 1998. F-38 120 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1997 AND 1996 1997 1996 ------------ ----------- ASSETS Current assets: Cash and cash equivalents................................. $ 2,504,064 $ 2,423,910 Accounts receivable, net.................................. 646,524 1,260,719 Costs and estimated earnings in excess of billings on uncompleted contracts.................................. 159,561 749,039 Inventories............................................... 362,840 375,488 Prepaid expenses.......................................... 415,928 293,699 ------------ ----------- Total current assets.............................. 4,088,917 5,102,855 Property and equipment, net................................. 2,040,698 7,283,715 Restricted cash............................................. 433,000 Cost in excess of assets acquired, including acquisition costs, net of accumulated amortization of $383,000 in 1997 and $113,000 in 1996...................................... 1,467,500 1,237,500 ------------ ----------- Total assets...................................... $ 8,030,115 $13,624,070 ============ =========== LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current Liabilities: Current portion of notes payable.......................... $ 10,220,505 $ 5,600,000 Current portion of capitalized lease obligations.......... 44,896 Accounts payable.......................................... 616,140 1,950,427 Accrued liabilities....................................... 2,078,283 1,387,334 ------------ ----------- Total current liabilities......................... 12,959,824 8,937,761 Capitalized lease obligations, less current portion......... 127,342 Pension liability........................................... 1,183,902 935,879 Notes payable, less current portion......................... 9,234,935 ------------ ----------- Total liabilities................................. 14,271,068 19,108,575 ------------ ----------- Commitments and contingencies Series A redeemable and convertible preferred stock -- $0.01 par value; 1,000 shares authorized; 100 shares issued and outstanding at December 31, 1997 (aggregate liquidation preference of $4,500,000)................................. 4,280,165 Series B redeemable and convertible preferred stock -- $0.01 par value; 1,000 shares authorized; 120 shares issued and outstanding at December 31, 1997 (aggregate liquidation preference of $6,000,000)................................. 5,505,952 ------------ ----------- 9,786,117 ------------ ----------- Stockholders' equity (deficit): Common stock -- $0.01 par value; 3,000 and 1,000 shares authorized, respectively; 601.5 and 593.5 shares issued and outstanding at December 31, 1997 and 1996, respectively........................................... 6 6 Additional paid-in capital............................. 282,668 Accumulated deficit.................................... (16,309,744) (5,484,511) ------------ ----------- Total stockholders' equity (deficit).............. (16,027,070) (5,484,505) ------------ ----------- Total liabilities and stockholders' equity (deficit)....................................... $ 8,030,115 $13,624,070 ============ =========== The accompanying notes are an integral part of these consolidated financial statements. F-39 121 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM AUGUST 3, 1996 THROUGH DECEMBER 31, 1996 PERIOD FROM AUGUST 3, 1996 YEAR ENDED THROUGH DECEMBER 31, DECEMBER 31, 1997 1996 ------------ ------------------ REVENUE: Contract research and development revenue: Government............................................. $ 1,869,301 $ 2,750,942 Commercial............................................. 3,909,239 1,105,515 Product sales............................................. 2,110,695 594,157 ------------ ----------- Total revenue..................................... 7,889,235 4,450,614 ------------ ----------- COST OF CONTRACTS AND SALES: Contract research and development costs: Government............................................. 1,584,922 1,968,098 Commercial............................................. 3,431,181 885,942 Cost of products sold..................................... 1,600,054 324,886 ------------ ----------- Total costs of contracts and sales................ 6,616,157 3,178,926 ------------ ----------- GROSS PROFIT................................................ 1,273,078 1,271,688 ------------ ----------- OPERATING EXPENSES: Research and development.................................. 8,077,491 4,683,020 General and administrative................................ 1,685,880 708,247 Marketing................................................. 554,720 Other..................................................... 607,521 10,151 ------------ ----------- Total operating expenses.......................... 10,925,612 5,401,418 ------------ ----------- LOSS FROM OPERATIONS........................................ (9,652,534) (4,129,730) Other income (expense): Interest income........................................... 200,958 Interest expense.......................................... (1,038,467) (445,590) Loss on sale-leaseback transaction........................ (335,190) ------------ ----------- LOSS BEFORE INCOME TAXES.................................... (10,825,233) (4,575,320) Income taxes................................................ ------------ ----------- NET LOSS.................................................... (10,825,233) (4,575,320) Preferred stock accretion................................... 32,332 ------------ ----------- Net loss applicable to common stockholders.................. $(10,857,565) $(4,575,320) ============ =========== The accompanying notes are an integral part of these consolidated financial statements. F-40 122 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM AUGUST 3, 1996 THROUGH DECEMBER 31, 1996 COMMON STOCK ADDITIONAL --------------- PAID-IN ACCUMULATED SHARES AMOUNT CAPITAL DEFICIT TOTAL ------ ------ ---------- ------------ ------------ Issuance of common stock................. 585 $6 $ 5,844 $ 5,850 Acquisition costs paid through issuance of common stock........................ 9 100,000 100,000 Consideration paid in excess of net assets acquired........................ (105,844) $ (909,191) (1,015,035) Net loss for the period from August 3, 1996 through December 31, 1996......... (4,575,320) (4,575,320) --- -- --------- ------------ ------------ Balance at December 31, 1996............. 594 6 (5,484,511) (5,484,505) Issuance of common stock on December 12, 1997................................... 7 315,000 315,000 Issuance of additional common stock to investment advisor (note 2)............ 1 Preferred stock accretion................ (32,332) (32,332) Net loss for the year.................... (10,825,233) (10,825,233) --- -- --------- ------------ ------------ Balance at December 31, 1997............. 602 $6 $ 282,668 $(16,309,744) $(16,027,070) === == ========= ============ ============ The accompanying notes are an integral part of these consolidated financial statements. F-41 123 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEAR ENDED DECEMBER 31, 1997 AND PERIOD FROM AUGUST 3, 1996 THROUGH DECEMBER 31, 1996 PERIOD FROM AUGUST 3, YEAR ENDED 1996 THROUGH DECEMBER 31, DECEMBER 31, 1997 1996 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss.................................................. $(10,825,233) $(4,575,320) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation........................................... 268,688 185,834 Amortization........................................... 270,000 113,000 Loss on sale-leaseback and disposal of equipment....... 365,985 1,330 Changes in assets and liabilities: Decrease in accounts receivable...................... 614,195 230,393 Decrease in costs and estimated earnings in excess of billings.......................................... 589,478 237,825 Decrease (increase) in inventories................... 12,648 (4,840) Increase in prepaid expenses......................... (122,229) (162,592) Increase in accounts payable and accrued liabilities....................................... 329,685 2,170,210 ------------ ----------- Net cash used in operating activities............. (8,496,783) (1,804,160) ------------ ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures...................................... (314,601) (129,280) Acquisition costs......................................... (1,250,000) Proceeds from sale-leaseback and disposal of equipment.... 5,135,564 Payment to investment advisor............................. (1,225,000) ------------ ----------- Net cash provided by (used in) investing activities...................................... 3,595,963 (1,379,280) ------------ ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock.................... 315,000 5,850 Proceeds from issuance of convertible preferred stock (net of transaction costs of $746,215)...................... 9,753,785 Repayment of capital lease obligations.................... (40,381) Proceeds from issuance of notes payable................... 985,570 5,600,000 Payments of notes payable................................. (5,600,000) Increase in restricted cash............................... (433,000) ------------ ----------- Net cash provided by financing activities......... 4,980,974 5,605,850 ------------ ----------- Net increase in cash and cash equivalents................... 80,154 2,422,410 Cash and cash equivalents at beginning of period............ 2,423,910 1,500 ------------ ----------- Cash and cash equivalents at end of period.................. $ 2,504,064 $ 2,423,910 ============ =========== Supplemental cash flow information: Cash paid for: Interest............................................... $ 1,013,347 $ 138,600 Supplemental disclosure of non-cash financing activities: Purchase of common stock of PerImmune, Inc. with a note payable................................................ $ 9,234,935 Acquisition costs paid through issuance of common stock... 100,000 Consideration paid in excess of net assets acquired....... 1,015,035 Preferred stock accretion................................. $ 32,332 Cost in excess of assets acquired included in accrued liabilities............................................ 500,000 Equipment acquired under capital lease obligations........ 212,619 The accompanying notes are an integral part of these consolidated financial statements. F-42 124 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 AND 1996 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Company PerImmune Holdings, Inc. (Holdings) was incorporated on June 28, 1996 for the purpose of acquiring PerImmune, Inc. (PerImmune) in a leveraged buyout transaction. Between 1985 and 1996, PerImmune was owned by Organon Teknika Corporation (OTC), a subsidiary of Akzo Nobel, Inc., which is wholly owned by Akzo Nobel, NV (Netherlands). Prior to December 20, 1994, PerImmune operated as a division of OTC, and was known as Biotechnology Research Institute (BRI). On December 20, 1994, PerImmune, Inc., was formed as a wholly owned subsidiary of OTC with the issuance of 1,000 shares of common stock in exchange for all the assets and liabilities related to PerImmune. Effective August 3, 1996, PerImmune was acquired by Holdings through a leveraged buyout (see note 2). Holdings has no substantive operations. The Company is a research oriented healthcare company that applies biotechnology and other life sciences technologies to develop and provide products and services. The Company's focus is on the development of human monoclonal antibodies for cancer and infectious disease applications, as well as, cancer vaccines, specific and nonspecific immunotherapy and cardiovascular disease test products. Most of PerImmune's products are intended for human use and are, therefore, regulated by the United States Food and Drug Administration. Historically, the Company's primary sources of revenue have been research and development contracts with affiliated companies, revenues generated from government contracts and sales of products and services. PerImmune markets its products in the United States, Europe and other geographic regions. Basis of Presentation The consolidated financial statements include the accounts of Holdings and PerImmune. All significant intercompany accounts and transactions have been eliminated in consolidation. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates. Cash Equivalents Cash equivalents consist of highly liquid investments with original maturities of three months or less at the date of investment. Inventories Inventories are stated at the lower of cost (as determined by the first-in, first-out method) or market. Property and Equipment Property and equipment are stated at cost. Depreciation on property and equipment is computed using the straight-line method over the estimated useful lives of the assets of 3 to 7 years. Expenditures for maintenance, repairs and renewals of relatively minor items are generally charged to expense as incurred. F-43 125 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 AND 1996 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Construction in progress includes the costs of constructed machinery. Construction in progress costs are transferred to other property and equipment categories when the construction/installation is completed and the asset is ready for its intended use. Cost in Excess of Assets Acquired Cost in excess of assets acquired represents the excess of cost of an acquired business over the fair value of the identifiable net tangible and intangible assets acquired. Cost in excess of assets acquired is amortized using the straight-line method over 15 years. The Company periodically evaluates the life and the recoverability of cost in excess of assets acquired by comparing the estimated future undiscounted operational cash flows to the carrying value of cost in excess of assets acquired. Acquisition Costs Acquisition costs represent costs incurred related to the leveraged buyout transaction (see note 2). Amortization of acquisition costs is computed using the straight-line method over five years. Income Taxes Income taxes are accounted for using the asset and liability method pursuant to Statement of Financial Accounting Standard No. 109 (SFAS No. 109), Accounting for Income Taxes. Deferred taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred taxes for a change in tax rates is recognized in income in the period that includes the enactment date. The Company establishes valuation allowances in accordance with the provisions of SFAS No. 109. The Company continually reviews the adequacy of the valuation allowances and will recognize deferred tax benefits only when it is more likely than not that the benefits will be realized. Holdings and its subsidiary file a consolidated U.S. federal income tax return. Fair Value of Financial Instruments The Company has notes payable related to the leveraged buy-out and other notes payable obligations for which it is not practicable to estimate the fair value since they are not traded, and no quoted values are readily available for similar financial instruments. Stock-based Compensation The Company accounts for stock option issuances in accordance with the provisions of APB No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, deferred compensation is recorded to the extent that the fair value of the underlying stock exceeds the exercise price on the date of grant. Such deferred compensation is amortized over the respective vesting periods of related option grants. Transactions with non-employees, in which goods or services are the consideration received for the issuance of equity instruments, are accounted for under the fair-value based method defined in Statement of Financial Accounting Standard No. 123 (SFAS No. 123) Accounting for Stock-Based Compensation (see note 11). Revenue Recognition Revenue from sales of products is recognized on the date of delivery to customers or upon shipment, based upon the contractual terms of applicable agreements. The Company has entered into various research and development and licensing agreements (see note 3). Research and development revenue from cost reimbursement agreements is recorded as the related expenses are incurred, up to contractual limits and when the Company meets its performance obligations under the respective agreements. Contract revenue is recognized under other agreements when milestones are met and the Company's performance obligations have been satisfied in accordance with the terms of the respective F-44 126 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 AND 1996 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) agreements. Cash received that is related to future performance under such contracts is deferred and recognized as revenue when earned. The Company also engages in contracts with commercial entities and agencies of the U.S. government (Department of Defense and the National Institute of Health) on either a cost-plus-fixed-fee, fixed price or a cost-plus-percentage-fee basis. Revenue on cost-plus-fixed-fee, fixed price and cost-plus-percentage-fee contracts is recognized based on the ratio of total direct and indirect costs incurred during the period to total estimated costs using the percentage-of-completion method. Estimates to complete are reviewed periodically and revised as required in the period the revision is determined. Provisions are made for the full amount of anticipated losses, if any, on all contracts in the period in which they are first known and estimable. Contracts with the U.S. government are subject to government audit upon contract completion and therefore, all contract costs are potentially subject to adjustment, even after reimbursement. Management believes adequate provisions for such adjustments, if any, have been made in the financial statements. Expense recovery rates have been audited through 1996. Research and Development Costs Research and development costs are expensed as incurred. Concentration of Credit Risk The Company performs research and development services for nonaffiliated entities. The Company generally does not require collateral or other security in extending credit to its customers. Additionally, the U.S. federal government and Baxter Healthcare Corporation contributed 24% and 34% of total revenue for the year ended December 31, 1997, respectively and 62% and 14% for the period from August 3, 1996 through December 31, 1996, respectively. Reclassifications Certain reclassifications have been made to the 1996 financial statements to conform with the 1997 presentation. The reclassifications had no effect on previously reported net loss, stockholders' equity (deficit) or cash flows. (2) LEVERAGED BUYOUT In 1996, Holdings engaged an investment advisor with regards to the purchase of PerImmune from Akzo Nobel, Inc. for which the investment advisor's fee totalled $1,250,000. As of December 31, 1996, $1,225,000 of the advisor's fee was included in accounts payable and the entire amount was paid in full during 1997. During 1996, the investment advisor also received 8.5 shares of the Company's common stock in exchange for funding certain related legal expenses on behalf of the Company totaling $100,000. The shares are protected from dilution through certain third-party financings. During the year ended December 31, 1997, the investment advisor was issued one additional share of the Company's common stock. Effective August 3, 1996, 100% of PerImmune's common stock was acquired by Holdings from OTC in exchange for a $9,234,935 note payable (see note 8). The transaction was accounted for in accordance with Emerging Issues Task Force Abstracts No. 88-16 (EITF No. 88-16), Basis in Leveraged Buyout Transactions. Because the transaction was wholly financed by OTC, all such consideration was determined to be nonmonetary and, under the provisions of EITF 88-16, the assets and liabilities of PerImmune were carried over at historical cost. Concurrent with the leveraged buyout, the ownership rights of certain patents and other technology rights developed under the research and development contracts with affiliates, which pertain to the business of PerImmune, were transferred to Holdings. Under the terms of the transfer, Holdings is required to make F-45 127 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 AND 1996 (2) LEVERAGED BUYOUT (CONTINUED) certain milestone payments of up to $10 million if specific future conditions are met, and will make payments of between 5% and 7.5% of net product sales and 50% of license revenue. The milestone and royalty payments will continue until the expiration or termination of the related patents covering the products defined in the agreement. As of December 31, 1997, $500,000 of milestone payments were included in accrued liabilities for amounts payable to OTC. No royalty payments have been accrued or are due to OTC. (3) CONTRACTS AND AGREEMENTS Agreement with Baxter On January 1, 1996, PerImmune entered into a research collaboration and license agreement with Baxter Healthcare Corporation (Baxter) whereby the Company agreed to provide certain research, development and pilot manufacturing services for Baxter in exchange for reimbursement of research and development costs, milestone payments and certain royalty payments. The Company received a non-refundable milestone payment of $1,500,000 in January 1996 and is reimbursed for actual costs incurred plus a fee of 16% during the term of the agreement. Baxter is also obligated to make up to $3,000,000 in additional milestone payments, if the Company achieves certain stages of U.S. and European regulatory approvals for the serotherapy products for infectious and autoimmune diseases under development. In addition, the Company earns a royalty ranging between 4% and 8% of gross profit with a minimum royalty ranging between 2% and 4% of net sales, as defined in the agreement, on sales of products depending on whether the product is a result of previously existing technology of the Company or new technology resulting from this development agreement. As of December 31, 1997, no royalty or additional milestone payments has been earned. The agreement has a term of three years with an option for a fourth year. Either party may terminate this agreement at any time without cause. All patents and technology developed under this agreement are the property of Baxter. Agreement with Arch Development Corporation PerImmune has a license agreement with the Arch Development Corporation (Arch) to make and sell products under the patent rights for Apotek Lp(a) developed at the University of Chicago. The agreement requires the Company to pay Arch a royalty of 4 percent of related product sales. As of December 31, 1997, the Company has not incurred any royalty expense under this agreement. Distribution Agreement with Syncor International Corporation On April 1, 1997, the Company entered into an exclusive distribution agreement with Syncor International Corporation (Syncor) for the HumaSPECT and antibody conjugated radiotherapeutic products. Under this agreement, Syncor accepts title of the product upon receipt and pays the Company a specific purchase price defined by the agreement. Additionally, Syncor will pay the Company a royalty of 50% of its net sales of the Company's products less the specific purchased price, as defined, and right of return exists if the product received by Syncor has less than one year until its expiration. To date, the Company has not earned any royalties under this agreement. The Company is obligated to spend 15% of annual sales of products covered by this agreement on research and development to improve upon existing products or develop new products. The Company is required to reimburse Syncor for all expenses related to marketing these products up to $1,500,000, plus 50% of amounts over $1,500,000, provided the expenditures are in accordance with the annual market plan as prepared and agreed by the two companies. For the year ended December 31, 1997, the Company has reimbursed Syncor for marketing expenses of $330,000. This agreement has a term of five years and is renewable for two additional two-year terms. F-46 128 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 AND 1996 (3) CONTRACTS AND AGREEMENTS (CONTINUED) Agreements with Mentor Corporation On June 16, 1997, the Company entered into an exclusive distribution agreement with Mentor Corporation (Mentor) for the AuraTek -- FDP bladder cancer diagnostic product, which the Company refers to as Accu-D(x), with an initial term of five years and is automatically renewable for a one year term thereafter until either party terminates the agreement with 180 days written notice. Under this agreement, Mentor accepts title of the product shipments upon receipt and pays the Company a specific purchase price defined by the agreement. Additionally, Mentor will pay the Company a royalty of 50% of its net sales of the Company's product, less the specific purchase price as defined in the agreement. The Company is obligated to provide up to 12,000 units of the product per year to be used by Mentor for promotional purposes, at no cost to Mentor. On December 22, 1997, the Company entered into a research, collaboration and distribution agreement with Mentor whereby the Company agreed to provide certain research, development and pilot programs for Mentor in exchange for research and development fees in an aggregate amount of $3,000,000 based on a milestone payment schedule. As of December 31, 1997, the Company had not earned any milestone payments. The Company will receive $1,000,000 within five days of submission of written notice of the completion of each milestone to Mentor. The Company is required to pay the cost in excess of $3,000,000 for expenditures within the scope of the project development schedule. The Company is the owner of all rights to proprietary technical information and the U.S. Patent to which Mentor was granted exclusive world-wide rights to market, sell and distribute the program product. This agreement is effective for a ten year period following the first approval of commercialized use of products under development. Mentor has the right to terminate this agreement at the expiration of five years from the date of the first approval of commercialized use of the product based upon 180 days written notice to the Company. Sigma Agreement On June 30, 1997, the Company entered into a product development and license agreement with Sigma Diagnostics, Inc. (SIGMA) for a diagnostic product, whereby the Company agreed to provide product development and licensing services for SIGMA in exchange for a product development fee and royalty payment. The Company is entitled to receive an aggregate amount of $348,000 based on a milestone payment schedule that requires a payment of $87,000 upon completion of each respective milestone of which $87,000 was earned in 1997. In addition, the Company will receive an annual royalty payment ranging between 3.5% and 7% of the net selling price of the licensed product depending on whether there are any additional competitors for this product in the marketplace. The Company has sole and exclusive ownership of the licensed patents, while SIGMA has the exclusive world-wide right to use and sublicense the project program information. This agreement has a term of five years and is automatically renewable for a one year term thereafter until SIGMA terminates the agreement. Manufacturing/Distribution Agreement with OTC On August 1, 1997, the Company entered into an exclusive manufacturing/distribution agreement with OTC for the FDP Dipstick product, which the Company refers to as Accu-D(x). Under the agreement, the Company paid OTC $250,000 in exchange for the exclusive right to purchase, at a defined price, such OTC product for package and resale under trademarks or tradenames designated by the Company. The Company is obligated to purchase at least 100,000 units of the product annually at $4.00 per unit, starting on August 1, 1998. This agreement has an initial term of three years and is automatically renewed in two-year terms until written notice of termination from either the Company or OTC. F-47 129 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 AND 1996 (3) CONTRACTS AND AGREEMENTS (CONTINUED) Other Contracts and Agreements The Company has entered into various other licensing and research and development agreements whereby it is committed to participate in research and development projects, either on a best efforts basis or upon attainment of certain performance milestones, as defined, or both, for various periods unless canceled by the respective parties. Such future amounts to be paid to the Company will primarily be determined on a cost-plus basis, and are subject to specific performance criteria. (4) ACCOUNTS RECEIVABLE Accounts receivable at December 31, 1997 and 1996, were as follows: 1997 1996 -------- ---------- Government contracts................................. $123,964 $ 395,952 Product sales and corporate contracts................ 535,560 879,767 -------- ---------- 659,524 1,275,719 Allowance for doubtful accounts...................... 13,000 15,000 -------- ---------- $646,524 $1,260,719 ======== ========== (5) INVENTORIES Inventories at December 31, 1997 and 1996 were as follows: 1997 1996 -------- -------- Finished goods......................................... $ 92,888 $186,837 Work-in-process........................................ 1,337 Raw materials.......................................... 269,952 187,314 -------- -------- $362,840 $375,488 ======== ======== (6) PROPERTY AND EQUIPMENT Property and equipment at December 31, 1997 and 1996 were as follows: 1997 1996 ---------- ----------- Leasehold improvements............................. $ 990,573 Leased property.................................... $ 212,619 Computers.......................................... 667,557 453,946 Machinery and equipment............................ 3,549,485 3,735,691 Construction in progress........................... 1,005,316 5,935,047 ---------- ----------- 5,434,977 11,115,257 Accumulated depreciation and amortization.......... 3,394,279 3,831,542 ---------- ----------- $2,040,698 $ 7,283,715 ========== =========== Sale-Leaseback of Facility On January 15, 1997, PerImmune exercised its option to purchase the land and building it occupies in Rockville, Maryland, for a pre-established price of $7,900,000. Concurrent with the purchase, PerImmune sold the property to a third-party buyer. The sale included the building and improvements, and certain equipment. The sales price, excluding settlement and transfer costs, was $14,150,000, and the loss resulting from this transaction was approximately $335,000, after consideration of estimated costs for repairs described below. The Company received approximately $5,136,000 in cash at the closing of the transaction. This F-48 130 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 AND 1996 (6) PROPERTY AND EQUIPMENT (CONTINUED) transaction has been treated as a sale-leaseback. As such, the plant and equipment previously owned by the Company were removed from the balance sheet and the loss was recognized. In conjunction with the sale, PerImmune agreed to make certain repairs at its own expense and to obtain the release of certain liens against the property. To ensure compliance with these provisions of the agreement, PerImmune deposited $500,000 (maintenance escrow) and $100,000 (lien escrow) into escrow accounts. In addition, PerImmune has agreed to deposit, on a monthly basis from February 1997 through January 2002, $3,333 for costs to be used for elevator repairs and refurbishment (elevator escrow). The Company is entitled to any amounts not spent for the described purpose. As of December 31, 1997, the balances in the maintenance escrow and elevator escrow were $393,000 and $40,000, respectively. Liens against the property have been released and the $100,000 lien escrow was refunded to the Company in full during 1997. In connection with the sale leaseback transaction, PerImmune issued the buyer a warrant for the purchase of 25,000 shares of PerImmune common stock if PerImmune consummates an initial public offering (IPO) or if certain other events occur, such as a capital reorganization, recapitalization, dissolution or liquidation. The warrants are exercisable for three years following the date of one of the previously described events. The warrants expire in July 1999 if one of the above events has not occurred. The warrant purchase price in an IPO would be the offering price and for the other events described above, the price would be determined by a formula described in the warrant agreement. (7) COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS ON UNCOMPLETED CONTRACTS The following is a summary of costs and estimated earnings in excess of billings on uncompleted contracts as of December 31, 1997 and 1996: 1997 1996 ----------- ----------- Costs incurred on uncompleted contracts........... $30,077,868 $28,548,030 Estimated earnings................................ 2,298,118 2,154,438 ----------- ----------- Total costs and estimated earnings................ 32,375,986 30,702,468 Less: Billings to date................................ 32,148,654 29,836,800 Allowance for losses............................ 67,771 116,629 ----------- ----------- $ 159,561 $ 749,039 =========== =========== (8) NOTES PAYABLE Notes payable at December 31, 1997 and 1996, were as follows: 1997 1996 ----------- ----------- 8% promissory notes to OTC........................ $ 9,988,005 $14,834,935 Other notes....................................... 232,500 ----------- ----------- 10,220,505 14,834,935 Less current portion.............................. 10,220,505 5,600,000 ----------- ----------- $ $ 9,234,935 =========== =========== In August 1996, in connection with the leveraged buyout, Holdings issued an 8% promissory note to OTC for $9,234,935 to purchase the outstanding common stock of PerImmune, Inc. Interest accrued on the note is added to the principal balance on February 1 and August 1 each year. The note matures in August 1998 and is collateralized by the patents, patent applications, trademarks and plant and equipment acquired in the F-49 131 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 AND 1996 (8) NOTES PAYABLE (CONTINUED) leveraged buyout. As of December 31, 1997 and 1996, the principal and accrued interest amount outstanding was $9,988,005 and $9,234,935, respectively. Holdings also issued an 8% note for a credit facility permitting draws of $720,000 per month up to $3,600,000 and a $2,871,532 working capital facility to provide capital for operations, both with OTC. The Company borrowed $3,600,000 and $2,000,000, respectively, under the facilities as of December 31, 1996. These notes were collateralized by the patents, patent applications, trademarks and plant and equipment acquired in the leveraged buyout. These notes matured in January and August 1997, respectively, and principal and accrued interest were paid in full. In January 1997, Holdings issued three uncollateralized, non-interest bearing promissory notes, for a total face amount of $232,500, to its advisors on the sale leaseback transaction (see note 6). Each promissory note is convertible into two shares of Holdings $0.01 par value common stock and have no specified maturity date. As of December 31, 1997, no conversion had taken place. (9) ACCRUED LIABILITIES Accrued liabilities at December 31, 1997 and 1996, were as follows: 1997 1996 ---------- ---------- Accrued payroll..................................... $ 157,856 $ 166,853 Accrued bonuses..................................... 327,648 313,004 Accrued interest -- OTC promissory note............. 332,110 306,990 Accrued repair costs (see note 6)................... 393,000 Due to OTC.......................................... 500,000 Other............................................... 367,669 600,487 ---------- ---------- $2,078,283 $1,387,334 ========== ========== (10) EMPLOYEE RETIREMENT BENEFIT PLANS Pension Plan In December 1996, the Company decided to establish a noncontributory defined benefit pension plan (the Plan) retroactive to the date of the leveraged buyout. This plan has terms similar to those of the Akzo Nobel Retirement Plan (ANRP) and covers substantially all of the Company's employees. Under the terms of this plan employees are given credit for prior service. Pursuant to the terms of the purchase agreement, the fair value of plan assets equal to the present value of the accumulated pension benefit obligation (as determined by an actuarial valuation as of the date of the leveraged buyout) were transferred from ANRP to PerImmune's new pension trust in April 1997. In February 1998, the Company froze the benefit accruals under the plan. F-50 132 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 AND 1996 (10) EMPLOYEE RETIREMENT BENEFIT PLANS (CONTINUED) The following table sets forth the funded status of the plan at December 31, 1997 and 1996, and the composition of net periodic pension cost and significant assumptions for the year ended December 31, 1997 and period from August 3, 1996 through December 31, 1996: 1997 1996 ------------ ------------ Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of approximately $1,251,865 in 1997 and $1,133,561 in 1996................................................... $ 1,565,486 $ 1,362,971 Effect of anticipated increase in compensation levels..... 770,256 718,744 ------------ ------------ Projected benefit obligation................................ 2,335,742 2,081,715 Plan assets at fair value................................... 1,360,127 1,238,260 ------------ ------------ Excess of projected benefit obligation over plan assets..... (975,615) (843,455) Unrecognized net investment gain............................ (208,287) (92,424) ------------ ------------ Total pension liability accrued................... $ (1,183,902) $ (935,879) ============ ============ Net periodic pension cost includes the following components: Service cost -- benefits earned during the period......... $ 213,981 $ 93,606 Interest cost on projected benefit obligation............. 151,631 61,916 Actual return on assets................................... (173,965) (135,097) Net amortization and deferred investment gain............. 56,376 92,424 ------------ ------------ Net periodic pension cost......................... $ 248,023 $ 112,849 ============ ============ Significant assumptions used were as follows: Discount rate............................................. 7.5% 7.5% Rate of increase in compensation levels (graded by age of participant)........................................... 4.0 to 10.5% 4.0 to 10.5% Expected rate of return of assets......................... 9.5% 9.5% ============ ============ Retirement Savings Plan The Company maintains a defined-contribution savings plan under Section 401(k) of the Internal Revenue Code. The plan covers substantially all full-time employees. Participating employees may defer a portion of their pretax earnings up to the Internal Revenue Service annual contribution limit. The Company matches employee contributions according to a specified formula. The Company's matching contributions totalled $176,098 and $72,779 for the year ended December 31, 1997 and period from August 3, 1996 through December 31, 1996, respectively. (11) STOCKHOLDERS' EQUITY Syncor Agreement On April 23, 1997, Holdings issued 100 shares of its Series A Mandatorily Redeemable Convertible Preferred Stock (par value .01/share) (Series A) to Syncor International Corporation (Syncor) for $4,500,000 less transaction costs of $246,215. Dividends are payable if and when declared by the Board of Directors at the rate of 7% of the liquidation preference per annum, where the liquidation preference is initially defined as $45,000 per share, subject to certain adjustments. Each share of Series A may be converted into one share of common stock before the redemption date (as defined below) at the option of the holder, or is automatically converted on the date of a qualifying initial public offering, as defined in the agreement. The Company shall redeem the Series A seven years after the issuance date (the redemption date) in the event that all shares have not been converted by this date. If such redemption occurs, the redemption price shall F-51 133 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 AND 1996 (11) STOCKHOLDERS' EQUITY (CONTINUED) equal the amount of the liquidation preference plus any declared but unpaid dividends. No dividends on the Company's common stock may be made while any shares of preferred stock remain outstanding. In the event of liquidation or dissolution, Syncor shall be entitled to be paid from the assets of Holdings, in preference to the common stockholders, but on an equal basis with Preferred Series B stockholders, the liquidation preference plus all declared but unpaid dividends. Holdings shall also have the right of first refusal to repurchase these shares should Syncor wish to sell them. In connection with this issuance, Syncor and the holders of Holding's stock were also granted certain registration rights as contained in the registration agreement. Mentor Agreements On June 16, 1997, the Company issued 20 shares of Series B Mandatorily Redeemable Convertible Preferred Stock (par value .01/share) (Series B) to Mentor Corporation (Mentor) for $1,000,000. On December 22, 1997, the Company issued an additional 100 shares of Series B to Mentor for $5,000,000 less transaction costs of $500,000. Dividends are payable if and when declared by the Board of Directors at the rate of 7% of the liquidation preference per annum, where liquidation preferences is defined as $50,000 per share, subject to certain adjustments. Each share of Series B preferred stock shall have the same rights, preferences and terms as Series A preferred stock. Options On September 27, 1996, Holdings granted 255 stock options to members of management at an exercise price of $2,725 per option. The options vest over three years and expire ten years from the date of grant. On May 16, 1997, Holdings granted an additional 2 stock options to its directors at an exercise price of $45,000 per option. The options vest over one year and expire ten years from the date of grant. Stock option activity is summarized as follows: WEIGHTED AVERAGE OPTIONS EXERCISE PRICE ------- -------------- Outstanding at August 3, 1996............................ Granted.................................................. 255 $ 2,725 Exercised................................................ Canceled................................................. --- ------- Outstanding at December 31, 1996......................... 255 2,725 Granted.................................................. 2 45,000 Exercised................................................ Canceled................................................. --- ------- Outstanding at December 31, 1997......................... 257 $ 3,054 === ======= Options exercisable at December 31, 1997................. 85 $ 2,725 === ======= The weighted-average remaining contractual life of outstanding options, as of December 31, 1997 and 1996, was 8.75 and 9.75 years, respectively. Under APB No. 25, because the exercise price of the Company's stock options generally equals the fair value, as determined by the Company's management, of the underlying stock on the date of grant, no compensation expense is recognized in the Company's consolidated financial statements. F-52 134 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 AND 1996 (11) STOCKHOLDERS' EQUITY (CONTINUED) Pro forma information regarding net loss is required by SFAS No. 123, and has been determined as if the Company had accounted for its stock options under the fair value method of that statement. The fair value of each option is estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants issued during the year ended December 31, 1997, and period from August 3, 1996 through December 31, 1996: 1997 1996 ------- ------- Risk-free interest rate................................... 6.76% 6.28% Dividend yield............................................ 0.00% 0.00% Volatility factor......................................... 70.00% 70.00% Expected term of option................................... 2 years 3 years For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's net loss would have been as indicated in the pro forma table below: PERIOD FROM YEAR ENDED AUGUST 3, 1996 DECEMBER 31, THROUGH 1997 DECEMBER 31, 1996 ------------ ----------------- Net loss -- as reported........................ $10,825,233 $4,575,320 Net loss -- pro forma.......................... 10,963,095 4,604,552 Weighted average fair value of options granted...................................... 16,654 1,377 (12) COMMITMENTS The Company leases certain equipment under agreements which are classified as capital leases. Assets under capital leases at December 31, 1997 are included in the consolidated balance sheet as follows: Telephone system and equipment.............................. $180,619 Computer equipment.......................................... 32,000 -------- 212,619 Less: accumulated depreciation.............................. 23,652 -------- $188,967 ======== The Company also leases laboratory, office and manufacturing facilities and equipment under noncancelable operating leases which expire at various times through January 31, 2007 (including the lease transaction described in note 6 which is also reflected in the amounts below). F-53 135 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 AND 1996 (12) COMMITMENTS (CONTINUED) Future minimum lease payments, by year end and in the aggregate, under the aforementioned capital and operating leases, are as follows: OPERATING CAPITAL LEASES LEASES ----------- -------- 1998................................................ $ 1,912,291 $ 66,813 1999................................................ 1,766,447 73,976 2000................................................ 1,801,118 69,980 2001................................................ 1,847,568 5,166 2002................................................ 1,902,379 Thereafter.......................................... 8,396,465 ----------- -------- $17,626,268 215,935 =========== Less: imputed interest.............................. 43,697 -------- Present value of net minimum obligations............ 172,238 Current portion..................................... 44,896 -------- Long-term obligation................................ $127,342 ======== Rent expense was $1,753,790 and $588,311 for the year ended December 31, 1997, and the period from August 3, 1996 through December 31, 1996, respectively. Rent expense is included in both selling, general and administrative expenses and costs of contracts in the consolidated statements of operations. In July 1997, the Company entered into a licensing agreement with a computer system company for the non-exclusive rights to its system software and maintenance services. The total licensing fee for the eighteen month period ending December 31, 1998 is $210,095 and the total maintenance fee is $48,120. As of December 31, 1997, the Company had paid $132,215 of the licensing and maintenance fees and the remaining commitment is included in the above future minimum lease payments. On January 2, 1998, the Company entered into a three year employment agreement with a key member of management. The agreement establishes a minimum compensation level and certain other terms. (13) INCOME TAXES The amount computed by applying the Federal corporate income tax rate of 34% to loss before income taxes is reconciled to the provision for income taxes as follows: PERIOD FROM YEAR ENDED AUGUST 3, 1996 DECEMBER 31, THROUGH 1997 DECEMBER 31, 1996 ------------ ----------------- Income tax benefit at statutory rates.......... $(3,680,579) $(1,555,609) State income taxes, net of federal tax benefit...................................... (486,573) (205,675) Valuation allowance adjustment................. 4,167,152 1,759,661 Other.......................................... 1,623 ----------- ----------- $ $ =========== =========== F-54 136 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 AND 1996 (13) INCOME TAXES (CONTINUED) Deferred income tax (assets) and liabilities as of December 31, 1997 and 1996 were as follows: 1997 1996 ------------ ----------------- Net operating loss carryforwards............... $(5,997,028) $(1,802,118) Excess of tax over book basis of assets........ (95,820) (193,520) Allowance for doubtful accounts and other reserves..................................... (32,000) (11,539) Accrued expenses............................... (604,924) (520,259) Other.......................................... 23,610 (11,567) ----------- ----------- Deferred tax assets............................ (6,706,162) (2,539,003) Valuation allowance............................ 6,706,162 2,539,003 ----------- ----------- Net deferred tax asset......................... $ -- $ -- =========== =========== At December 31, 1997 the Company has a net operating loss carryforward for both federal and state purposes of approximately $14,992,000 which expire through the year 2012. This net operating loss carryforward relates to the period August 3, 1996 through December 31, 1996 and for the year ended December 31, 1997 (periods subsequent to the leverage buyout) and as such, is not limited under existing tax laws. However, this carryforward will be limited under the Internal Revenue Code as a result of the changes in ownership of the Company as discussed in note 14. A valuation allowance has been established to reflect the uncertainty of future taxable income to utilize available tax loss carryforwards. (14) SUBSEQUENT EVENTS Merger On January 2, 1998, the stockholders of Holdings sold all outstanding shares of Holding's capital stock to Intracel Corporation ("Intracel") through a tax-free merger. With the consummation of the transaction, Holdings and Perimmune became subsidiaries of Intracel. Intracel is a privately owned biotechnology company developing products that improve the treatment options for patients suffering from serious viral diseases and cancers. The aggregate purchase price was approximately $59,471,000, payable in 5,478,654 shares of Intracel common stock, 2,340,838 options to purchase Intracel common stock, 220 shares of Intracel Series B-1 and B-2 preferred stock, Intracel's assumption of Perimmune's debt of approximately $11,532,000 and Intracel's assumption of other liabilities. The acquisition will be accounted for using the purchase method of accounting and accordingly, Intracel's financial statements will reflect valuation of all of Perimmune's assets, including identifiable intangibles, at their estimated fair market values. Perimmune's operating results will be included in Intracel's consolidated operating results from the date of acquisition. Refinancing On June 8, 1998 OTC negotiated with Intracel to delay the maturity of the 8% note payable until January 2000. F-55 137 INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS' REPORT The Board of Directors and Stockholders PerImmune Holdings, Inc.: We have audited the consolidated balance sheet of PerImmune Holdings, Inc. and subsidiary (the Company) as of December 31, 1996, and the related consolidated statements of operations, stockholders' deficit and cash flows for the period from August 3, 1996 through December 31, 1996. We have also audited the statements of operations, stockholders' equity and cash flows of the Predecessor Company for the period from January 1, 1996 through August 2, 1996 and for the year ended December 31, 1995. These financial statements are the responsibility of the Companies' management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of PerImmune Holdings, Inc. and subsidiary as of December 31, 1996, and the consolidated results of their operations and their cash flows for the period from August 3, 1996 through December 31, 1996, and the results of operations and cash flows for the Predecessor Company for the period from January 1, 1996 through August 2, 1996 and for the year ended December 31, 1995, in conformity with generally accepted accounting principles. KPMG LLP Baltimore, Maryland February 28, 1997, except as to note 14 which is as of April 23, 1997 and June 16, 1997 F-56 138 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY CONSOLIDATED BALANCE SHEET DECEMBER 31, 1996 ASSETS Current assets: Cash and cash equivalents................................. $ 2,423,910 Accounts receivable: Affiliates (Note 3).................................... 218,494 Government............................................. 395,952 Other.................................................. 646,273 Inventories (Note 5)...................................... 375,488 Costs and estimated earnings in excess of billings on uncompleted contracts (Note 7)......................... 749,039 Other current assets...................................... 293,699 ----------- Total current assets........................................ 5,102,855 Plant and equipment, net (Note 6 and 14).................... 7,283,715 Acquisition costs, net (Note 2)............................. 1,237,500 ----------- $13,624,070 =========== LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities: Notes payable (Note 8).................................... $ 5,600,000 Accounts payable (Note 2)................................. 1,950,427 Accrued liabilities (Note 9).............................. 1,387,334 ----------- Total current liabilities................................... 8,937,761 Accrued pension liability (Note 10)......................... 935,879 Note payable (Note 8)....................................... 9,234,935 ----------- Total liabilities........................................... 19,108,575 Stockholders' deficit (Notes 2 and 11): Common stock: $.01 par value; 1,000 shares authorized; 593.5 shares issued and outstanding at December 31, 1996................................................... 6 Accumulated deficit....................................... (5,484,511) ----------- Total stockholders' deficit................................. (5,484,505) Commitments and contingencies (Notes 3, 4 and 12) Subsequent events (Note 14) ----------- $13,624,070 =========== See Accompanying Notes to Financial Statements. F-57 139 PERIMMUNE HOLDINGS INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY STATEMENTS OF OPERATIONS PERIOD FROM AUGUST 3, 1996 THROUGH DECEMBER 31, 1996, PERIOD FROM JANUARY 1, 1996 THROUGH AUGUST 2, 1996 AND YEAR ENDED DECEMBER 31, 1995 PERIMMUNE HOLDINGS PREDECESSOR COMPANY CONSOLIDATED ----------------------------------- ----------------- PERIOD FROM PERIOD FROM JANUARY 1, AUGUST 3, 1996 1996 THROUGH THROUGH YEAR ENDED DECEMBER 31, 1996 AUGUST 2, 1996 DECEMBER 31, 1995 ----------------- -------------- ----------------- Revenues: Contract research and development revenue: Affiliates (Note 3)..................... $ 322,652 $ -- $ -- Government.............................. 2,750,942 3,420,549 6,578,019 Commercial.............................. 782,863 2,151,763 775,700 Product sales.............................. 594,157 1,631,918 1,407,274 ----------- ----------- ------------ 4,450,614 7,204,230 8,760,993 ----------- ----------- ------------ Costs of contracts and sales: Contract research and development costs: Affiliates (Note 3)..................... 300,066 4,312,638 9,545,830 Government.............................. 1,968,098 3,375,008 5,778,534 Commercial.............................. 585,876 1,985,682 643,224 Costs of products sold..................... 324,886 1,102,374 1,124,239 ----------- ----------- ------------ 3,178,926 10,775,702 17,091,827 ----------- ----------- ------------ Gross profit (loss).......................... 1,271,688 (3,571,472) (8,330,834) Operating expenses: Research and development (Note 1).......... 4,683,020 189,261 359,998 Selling, general and administrative........ 708,247 740,174 1,283,234 Other...................................... 10,151 14,211 28,862 ----------- ----------- ------------ Total operating expenses..................... 5,401,418 943,646 1,672,094 ----------- ----------- ------------ Loss from operations......................... (4,129,730) (4,515,118) (10,002,928) Interest expense............................. (445,590) -- -- ----------- ----------- ------------ Loss before income taxes..................... (4,575,320) (4,515,118) (10,002,928) Provision for income taxes (Note 13)......... -- -- -- ----------- ----------- ------------ Net loss..................................... $(4,575,320) $(4,515,118) $(10,002,928) =========== =========== ============ See Accompanying Notes to Financial Statements. F-58 140 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) PERIOD FROM AUGUST 3, 1996 THROUGH DECEMBER 31, 1996, PERIOD FROM JANUARY 1, 1996 THROUGH AUGUST 2, 1996 AND YEAR ENDED DECEMBER 31, 1995 RETAINED COMMON STOCK ADDITIONAL EARNINGS ------------ PAID-IN (ACCUMULATED SHARES AMOUNT CAPITAL DEFICIT) TOTAL ------ ------ ----------- ------------ ------------ PREDECESSOR COMPANY: Balance at January 1, 1995............ 1,000 $ 10 $10,242,309 $ -- $ 10,242,319 Net contribution from parent.......... -- -- 10,282,014 -- 10,282,014 Net loss.............................. -- -- -- (10,002,928) (10,002,928) ----- ---- ----------- ------------ ------------ Balance at December 31, 1995.......... 1,000 10 20,524,323 (10,002,928) 10,521,405 Net contribution from parent.......... -- -- 3,154,644 -- 3,154,644 Net loss for the period from January 1, 1996 through August 2, 1996..... -- -- -- (4,515,118) (4,515,118) ----- ---- ----------- ------------ ------------ Balance at August 2, 1996............... 1,000 10 23,678,967 (14,518,046) 9,160,931 ===== ==== =========== ============ ============ - ----------------------------------------------------------------------------------------------------- PERIMMUNE HOLDINGS, INC.: Issuance of common stock of PerImmune Holdings, Inc. on June 28, 1996.... 585 6 5,844 -- 5,850 Acquisition costs paid through issuance of common stock (Note 2)................................. 8.5 -- 100,000 -- 100,000 Consideration paid in excess of net assets acquired (Note 2)........... -- -- (105,844) (909,191) (1,015,035) Net loss for the period from August 3, 1996 through December 31, 1996..... -- -- -- (4,575,320) (4,575,320) ----- ---- ----------- ------------ ------------ Balance at December 31, 1996............ 593.5 $ 6 $ -- $ (5,484,511) $ (5,484,505) ===== ==== =========== ============ ============ See Accompanying Notes to Financial Statements. F-59 141 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY STATEMENTS OF CASH FLOWS PERIOD FROM AUGUST 3, 1996 THROUGH DECEMBER 31, 1996, PERIOD FROM JANUARY 1, 1996 THROUGH AUGUST 2, 1996 AND YEAR ENDED DECEMBER 31, 1995 PERIMMUNE HOLDINGS PREDECESSOR COMPANY CONSOLIDATED ------------------------------------ --------------------- PERIOD FROM PERIOD FROM AUGUST 3, JANUARY 1, 1996 1996 THROUGH THROUGH YEAR ENDED DECEMBER 31, 1996 AUGUST 2, 1996 DECEMBER 31, 1995 --------------------- --------------- ----------------- Cash flows from operating activities: Net loss.......................................... $(4,575,320) $(4,515,118) $(10,002,928) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization.................. 298,834 270,148 476,186 Loss on disposal of equipment.................. 1,330 -- 44,342 Decrease (increase) in accounts receivable: Affiliates................................... (156,721) 2,720,401 991,941 Government................................... 317,372 140,254 (375,722) Other........................................ 69,742 (439,377) (115,311) Decrease (increase) in costs and estimated earnings in excess of billings............... 237,825 (125,687) (158,452) Increase in inventories........................ (4,840) (57,490) (42,852) Decrease (increase) in other current assets.... (162,592) 102,105 74,058 Increase (decrease) in accounts payable and accrued liabilities.......................... 2,062,411 (628,419) (276,783) Increase in accrued pension liability.......... 112,849 -- -- Increase (decrease) in advance contract billings..................................... (5,050) (516,568) 132,402 ----------- ----------- ------------ Net cash used in operating activities............... (1,804,160) (3,049,751) (9,253,119) ----------- ----------- ------------ Cash flows from investing activities: Acquisition costs................................. (1,250,000) -- -- Capital expenditures.............................. (129,280) (104,893) (1,029,395) ----------- ----------- ------------ Net cash used in investing activities............... (1,379,280) (104,893) (1,029,395) ----------- ----------- ------------ Cash flows from financing activities: Net contribution from parent company.............. -- 3,154,644 10,282,014 Proceeds from issuance of common stock............ 5,850 -- -- Proceeds from issuance of notes payable........... 5,600,000 -- -- ----------- ----------- ------------ Net cash provided by financing activities........... 5,605,850 3,154,644 10,282,014 ----------- ----------- ------------ Net increase (decrease) in cash and cash equivalents....................................... 2,422,410 -- (500) Cash and cash equivalents at beginning of year...... 1,500 1,500 2,000 ----------- ----------- ------------ Cash and cash equivalents at end of year............ $ 2,423,910 $ 1,500 $ 1,500 =========== =========== ============ Supplementary disclosure of non-cash financing activities: Purchase of common stock of PerImmune, Inc. with a note payable (Note 2).......................... $ 9,234,935 -- -- Acquisition costs paid through issuance of common stock.......................................... 100,000 -- -- Consideration paid in excess of net assets acquired....................................... 1,015,035 -- -- =========== =========== ============ See Accompanying Notes to Financial Statements. F-60 142 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY NOTES TO FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Company PerImmune Holdings, Inc. and Subsidiary is composed of PerImmune Holdings, Inc. (Holdings) and PerImmune, Inc. (the Company or PerImmune). Holdings was incorporated on June 28, 1996 for the purpose of acquiring the Company in a leveraged buyout transaction. Between 1985 and 1996, the Company was owned by Organon Teknika Corporation (the Parent Company or OTC), a subsidiary of Akzo Nobel, Inc., which is wholly-owned by Akzo Nobel, NV (Netherlands). Prior to December 20, 1994, the Company operated as a division of OTC, and was known as Biotechnology Research Institute (BRI). On December 20, 1994, PerImmune (the Predecessor Company) was formed as a wholly-owned corporation of OTC with the issuance of 1,000 shares of common stock in exchange for all the assets and liabilities related to the PerImmune business. Effective August 3, 1996, the Company was acquired by Holdings through a leveraged buyout (see Note 2). Holdings has no substantive operations. The Company is a research oriented healthcare company that applies biotechnology and other techniques of modern biology and chemistry to develop, produce and sell products intended to improve the quality of life by diagnosing, preventing and treating human disease. The Company's focus is on the development of human monoclonal antibodies for cancer and infectious disease applications, as well as, cancer vaccines, specific and non-specific immunotherapy and cardiovascular disease test products. Historically, the Company's primary sources of revenue have been research and development contracts with affiliated companies, revenues generated from government contracts and sales of products and services. PerImmune markets its products in the United States, Europe and other geographic regions. While the Company was held by OTC, it successfully developed a number of profitable products for the Parent Company including bladder cancer therapeutic, food pathogen and HIV tests. Most of PerImmune's products are intended for human use and are, therefore, regulated by the United States Food and Drug Administration. Basis of Presentation The consolidated financial statements as of December 31, 1996 and for the period from August 3, 1996 through December 31, 1996 include the accounts of Holdings and the Company. All significant intercompany accounts and transactions have been eliminated in consolidation. The financial statements for the year ended December 31, 1995 and for the period from January 1, 1996 through August 2, 1996 represent the stand-alone results of operations of PerImmune, Inc., a wholly-owned subsidiary of OTC. Due to the change in ownership of the Company, the comparability of the financial statements is affected. In particular, equity has changed significantly due to the new ownership and debt related to the acquisition. Cash and cash equivalents is also different as balances are no longer managed by the former Parent Company. In addition, certain liabilities which were paid for by the Parent Company and allocated to the division or the subsidiary through the intercompany accounts have been recognized by the Company subsequent to the LBO transaction (see Note 3). Also, certain research and development activities performed prior to the leveraged buyout for affiliates and were reimbursed under the contractual arrangements described in Note 3, are subsequently performed for the Company's benefit and are not reimbursed. F-61 143 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates. Cash Equivalents Cash equivalents consist of highly liquid investments with original maturities of three months or less at the date of investment by the Company. Inventories Inventories are stated at the lower of cost or market using the FIFO cost method. Plant and Equipment Plant and equipment are stated at cost. Depreciation on plant and equipment is computed by the straight-line method over the estimated useful lives of the assets of 3 to 7 years. Leasehold improvements are amortized on a straight-line basis over the remaining lease term or asset useful life, whichever is shorter. Construction in progress represents buildings, leasehold improvements and other capital expenditures for facilities under construction and machinery pending installation. This includes the costs of construction, plant and machinery and costs related to obtaining appropriate regulatory approvals. Construction in progress costs are transferred to other plant and equipment categories when the construction/installation is completed, appropriate regulatory approvals have been obtained and the asset is ready for use. Acquisition Costs Acquisition costs represent costs incurred related to the leveraged buyout transaction (see Note 2). Amortization of acquisition costs is computed on a straight-line basis over 5 years. Income Taxes The Company was included in the Akzo Nobel, Inc. consolidated Federal income tax return for the year ended December 31, 1995, and for the period January 1, 1996 through August 2, 1996. The Company will file a separate consolidated Federal income tax return for the period August 3, 1996 through December 31, 1996. Prior to August 3, 1996, deferred income taxes were reflected in stockholders' equity (deficit). Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance for any tax benefits which are not expected to be realized. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in the period that such tax rate changes are enacted. Fair Value of Financial Instruments The carrying amount of current financial instruments approximate fair value because of the short-term nature of these instruments. The Company has notes payable related to the leveraged buyout for which it is F-62 144 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) not practicable to estimate the fair value of these notes since they are not traded, and no quoted values are readily available for similar financial instruments. However, management believes that there has been no permanent impairment in the value of these notes. Stock-based Compensation The Company accounts for share option issuances in accordance with the provisions of APB No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, deferred compensation is recorded to the extent that the market value of the underlying stock exceeds the exercise price on the date of grant. Such deferred compensation is amortized over the respective vesting periods of such option grants. On January 1, 1996, the Company adopted the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation, which allows entities to continue to apply the provisions of APB No. 25 for financial statement reporting purposes and provide pro forma net income (loss) footnote disclosures for employee stock option grants made in 1995 and 1996 as if the fair-value based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the financial statement reporting provisions of APB No. 25 and to provide the pro forma disclosure provisions of SFAS No. 123. Transactions with non-employees, in which goods or services are the consideration received for the issuance of equity instruments, are accounted for under the fair-value based method defined in SFAS No. 123 (see Note 11). Revenue Recognition Revenue from sales of products is recognized on the date of delivery to customers or upon shipment, based upon the contractual terms of applicable agreements. The Company has entered into various research and development and licensing agreements (see Notes 3 and 4). Research and development revenue from cost-reimbursement agreements is recorded as the related expenses are incurred, up to contractual limits and when the Company meets its performance obligations under the respective agreements. Contract revenue is recognized under other agreements when milestones are met and the Company's performance obligations have been satisfied in accordance with the terms of the respective agreements. Cash received that is related to future performance under such contracts is deferred and recognized as revenue when earned. The Company engages in research and development contracts with Organon Teknika International (OT BV) and Organon International (OI). Through August 2, 1996, these contracts were funded by OT BV and OI at the Company's costs plus a 7% fee. Amounts due under these funding commitments were recorded as contributions from Parent Company as the related costs were incurred. Subsequent to August 2, 1996, the contract revenue was recorded on a cost-plus-fixed-fee basis. The Company also engages in contracts with commercial entities and agencies of the U.S. government (Department of Defense and the National Institutes of Health) on either a cost-plus-fixed-fee, fixed price or a cost-plus-percentage-fee basis. Revenue on cost-plus-fixed-fee, fixed price and cost-plus-percentage-fee contracts is recognized based on the total direct and indirect costs incurred during the period to total estimated costs using the percentage-of-completion method. Estimates to complete are reviewed periodically and revised as required in the period the revision is determined. Provisions are made for the full amount of anticipated losses, if any, on all contracts in the period in which they are first known and estimable. Contracts with the U.S. government are subject to government audit upon contract completion and therefore, all contract costs are potentially subject to adjustment, even after reimbursement. Management believes adequate provisions for such adjustments, if any, have been made in the financial statements. Expense recovery rates have been audited through 1995. F-63 145 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Research and Development, Patent and Royalty Costs Research and development, patent and royalty costs are expensed as incurred. Concentration of Credit Risk The Company performs research and development services to both affiliated and non-affiliated entities. The Company generally does not require collateral or other security in extending credit to its customers. The Company had three customers which contributed ten percent or more of revenues. OTC contributed 7%, 41% and 55% of total revenues in the period from August 3, 1996 through December 31, 1996, the period from January 1, 1996 through August 2, 1996 and the year ended 1995, respectively. The U.S. Federal Government contributed 62%, 28% and 34% of total revenues in the period from August 3, 1996 through December 31, 1996, the period from January 1, 1996 through August 2, 1996 and the year ended 1995, respectively. In addition, Baxter Healthcare Corporation contributed 14% of the Company's revenue for the period from August 3, 1996 through December 31, 1996. (2) LEVERAGED BUYOUT In May 1996, Holdings engaged an investment advisor to advise Holdings with regards to the purchase of PerImmune from Akzo Nobel, Inc., for which the investment advisor's fee totaled $1,250,000 of which $1,225,000 is included in accounts payable as of December 31, 1996. The investment advisor also received 8.5 shares of the Company's common stock in exchange for funding certain related legal expenses on behalf of the Company totaling $100,000. The shares are protected from dilution through certain future third-party financings. Effective August 3, 1996, 100% of the Company's common stock was acquired by Holdings from OTC in exchange for a $9,234,935 note payable (see Note 8). The transaction was accounted for in accordance with EITF No. 88-16, Basis in Leveraged Buyout Transactions. Because the transaction was wholly financed by OTC, all such consideration was determined to be nonmonetary and, under the provisions of EITF 88-16, the assets and liabilities of PerImmune were carried over at historical cost. Concurrent with the leveraged buyout, the ownership rights of certain patents and other technology rights developed under the research and development contracts with affiliates, which pertain to the business of PerImmune, were transferred to Holdings. Under the terms of the transfer, Holdings is required to make certain milestone payments of up to $10 million if specific future conditions are met, and will make payments of between 5% and 7.5% of net product sales and 50% of license revenue. Any future milestone payments will be recorded as research and development expense when the milestone is achieved. (3) RELATIONSHIPS WITH RELATED PARTIES Akzo Nobel, NV Prior to the leveraged buyout of PerImmune, ownership rights or patents developed under the research and development contracts with OT BV and OI belonged to these affiliates. Expenses incurred by the Company in developing and obtaining these patents plus a fee (Note 1) were charged to Akzo Nobel, NV and were recorded as contributions from Parent Company prior to August 3, 1996 and as contract research and development revenue thereafter. Organon Teknika Corporation Prior to the incorporation of PerImmune, Inc., OTC provided certain accounting, computer and other administrative services to PerImmune for a management fee which was based on PerImmune's proportionate share of total OTC expenses using a formula considering revenues, property and equipment and payroll factors. OTC also paid all payroll taxes, medical claims, pension and other employee benefit expenses which F-64 146 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (3) RELATIONSHIPS WITH RELATED PARTIES (CONTINUED) were allocated to PerImmune and other affiliates based on the total wages of the respective participating entities. In addition, OTC paid PerImmune's payroll, bonuses, general insurance, relocation and personal property tax expenses, which were charged to PerImmune on a specific identification basis. OTC also provided materials at its cost for certain products for resale by PerImmune. Subsequent to PerImmune, Inc.'s incorporation, the Company was responsible for paying its own payroll taxes, personal property taxes and certain other items. Amounts arising from the transactions described above were treated as expenses and contributions from Parent Company by PerImmune. Product sales to OTC were $432,645, $605,703 and $643,434 in the period from August 3, 1996 through December 31, 1996, the period from January 1, 1996 through August 2, 1996 and the year ended 1995, respectively. Effective August 3, 1996, Holdings and OTC entered into a services agreement to provide each party, including PerImmune, with mutually agreed-upon services. OTC will provide Holdings for varying periods of time with such services as employee benefit plan administration, administrative regulatory support, patent and trademark prosecution and computer and other services. Holdings will provide OTC with various product support and research services. Each party is compensated for services as defined in the agreement, generally cost plus a fee. Revenues and costs related to the research activities are recorded as affiliates revenue and costs in the statement of operations. (4) CONTRACTS AND AGREEMENTS PerImmune has a license agreement with the Arch Development Corporation (Arch) to make and sell products under the patent rights for Apotek Lp(a) developed at the University of Chicago. The agreement requires the Company to pay Arch a royalty of 4 percent of product sales. PerImmune is also collaborating with Stanford University to develop an active-specific immunotherapy vaccine for low grade B-cell lymphomas. Agreement with Baxter On January 1, 1996, PerImmune entered into a research collaboration and license agreement with Baxter Healthcare Corporation (Baxter) whereby the Company agreed to provide certain research, development and pilot manufacturing services for Baxter in exchange for reimbursement of research and development costs, milestone payments and certain royalty payments. The Company received a non-refundable milestone payment of $1,500,000 in January 1996 which was recognized upon receipt as commercial contract research and development revenue. Furthermore the Company is reimbursed for actual costs incurred plus a fee of 16% during the term of the agreement. Baxter is also obligated to make up to $3,000,000 in additional milestone payments, if the Company achieves certain stages of U.S. and European regulatory approvals for the serotherapy products for infectious and autoimmune diseases under development. In addition, the Company earns a royalty ranging between 4% and 8% of gross profit with a minimum royalty ranging between 2% and 4% of net sales, as defined in the agreement, on sales of products depending on whether the product is a result of previously existing technology of the Company or new technology resulting from this development agreement. As of December 31, 1996, no royalty or additional milestone payments were earned. The agreement has a term of three years with an option for a fourth year. Either party may terminate this agreement at any time without cause. All patents and technology developed under this agreement are the property of Baxter. Other Contracts and Agreements The Company has entered into various other licensing and research and development agreements whereby they are committed to participate in research and development projects, either on a best efforts basis or upon attainment of certain performance milestones, as defined, or both, for various periods unless canceled F-65 147 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (4) CONTRACTS AND AGREEMENTS (CONTINUED) by the respective parties. Such future amounts to be paid to the Company will primarily be determined on a cost-plus basis, and are subject to specific performance criteria. (5) INVENTORIES Inventories at December 31, 1996, are summarized as follows: Finished goods............................................ $186,837 Work-in-process........................................... 1,337 Raw materials............................................. 187,314 -------- $375,488 ======== (6) PLANT AND EQUIPMENT Plant and equipment at December 31, 1996, are summarized as follows: Leasehold improvements.................................. $ 990,573 Computers............................................... 453,946 Machinery and equipment................................. 3,735,691 Construction in progress................................ 5,935,047 ----------- 11,115,257 Less accumulated depreciation and amortization.......... 3,831,542 ----------- $ 7,283,715 =========== (7) COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS ON UNCOMPLETED CONTRACTS The following is a summary of costs and estimated earnings in excess of billings on uncompleted contracts as of December 31, 1996: Costs incurred on uncompleted contracts..................... $28,548,030 Estimated earnings.......................................... 2,154,438 ----------- Total costs and estimated earnings.......................... 30,702,468 Less: Billings to date.......................................... 29,836,800 Allowance for losses...................................... 116,629 ----------- $ 749,039 =========== (8) DEBT OBLIGATIONS Current notes payable at December 31, 1996 is summarized as follows: Secured promissory note -- OTC, 8% interest, due January 1997...................................................... $3,600,000 Working capital secured note -- OTC, 8% interest, due August 1997...................................................... 2,000,000 ---------- $5,600,000 ========== In August 1996, in connection with the leveraged buyout, Holdings issued an 8% secured promissory note to OTC for $9,234,935 to purchase the outstanding common stock of PerImmune, Inc. The note matures in F-66 148 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (8) DEBT OBLIGATIONS (CONTINUED) August 1998. In addition, Holdings issued an 8% secured note for a credit facility permitting draws of $720,000 per month up to $3,600,000 and a $2,871,532 working capital facility to provide capital for operations, both with OTC. The Company has borrowed $3,600,000 and $2,000,000, respectively, against the facilities as of December 31, 1996. These notes mature on January and August 1997, respectively, when all principal and accrued interest is due. The note which matured in January 1997 was repaid in full at that time. These notes are all secured by the patents, patent applications and trademarks acquired in the leveraged buyout. The secured promissory note is also secured by the plant and equipment acquired in the leveraged buyout. (9) ACCRUED LIABILITIES Accrued liabilities at December 31, 1996, are summarized as follows: Accrued payroll............................................. $ 166,853 Accrued bonuses............................................. 313,004 Accrued interest -- OTC promissory note..................... 306,990 Other....................................................... 600,487 ---------- $1,387,334 ========== (10) EMPLOYEE RETIREMENT BENEFIT PLANS Pension Plan The Company has a noncontributory defined benefit pension plan (the Plan) covering substantially all of its employees. In December 1996, the Company decided to establish a noncontributory defined benefit pension plan retroactive to the date of the leveraged buyout. This plan has terms similar to those of the Akzo Nobel Retirement Plan (ANRP) and covers substantially all of the Company's employees. Under the terms of this plan employees are given credit for prior service. Pursuant to the term of the purchase agreement, the fair value of the plan assets equal to the present value of the accumulated pension benefit accrued as determined by an actuarial valuation as of the date of the leveraged buyout were transferred from the ANRP to PerImmune's new pension trust in April 1997. F-67 149 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (10) EMPLOYEE RETIREMENT BENEFIT PLANS (CONTINUED) The following table sets forth the funded status of the plan at December 31, 1996 and the composition of net periodic pension cost and significant assumptions for the period from August 3, 1996 through December 31, 1996: Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of $1,133,561................................. $1,362,971 Effect of anticipated increase in compensation levels..... 718,744 ---------- Projected benefit obligation................................ 2,081,715 Plan assets at fair value................................... 1,238,260 ---------- Excess of projected benefit obligation over plan assets..... (843,455) Unrecognized prior service cost............................. -- Unrecognized net investment gain............................ (92,424) ---------- Total pension liability..................................... $ (935,879) ========== Net periodic pension cost includes the following components: Service cost -- benefits earned during the period......... $ 93,606 Interest cost on projected benefit obligation............. 61,916 Actual return on assets................................... (135,097) Net amortization and deferred investment gain............. 92,424 ---------- Net periodic pension cost................................... $ 112,849 ========== Significant assumptions used were as follows: Discount rate............................................... 7.5% Rate of increase in compensation levels (graded by age of participant).............................................. 4.0 to 10.5% Expected rate of return of assets........................... 9.5% ============ Retirement Savings Plan The Company maintains a defined-contribution savings plan under Section 401(k) of the Internal Revenue Code. The plan covers substantially all full-time employees. Participating employees may defer a portion of their pretax earnings up to the Internal Revenue Service annual contribution limit. The Company matches employee contributions according to a specified formula. The Company's matching contributions totaled $72,779, $101,890 and $168,040 in the period from August 3, 1996 through December 31, 1996, the period from January 1, 1996 through August 2, 1996, and the year ended 1995, respectively. (11) STOCKHOLDERS' EQUITY Common Stock On December 20, 1994, PerImmune, Inc. was incorporated and authorized 100,000 shares and issued 1,000 shares of common stock. On June 28, 1996, PerImmune Holdings, Inc. was formed. A total of 1,000 shares of common stock were authorized and 585 shares were issued for $105,850. Holding's investment advisor was also issued 8.5 shares of common stock in 1996 in connection with the leveraged buyout (see Note 2). F-68 150 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (11) STOCKHOLDERS' EQUITY (CONTINUED) Options In August 1996, Holdings granted 255 stock options to members of management. The options vest over three years and expire ten years from the date of grant. Stock option activity is summarized as follows: WEIGHTED AVERAGE OPTIONS EXERCISE PRICE ------- ---------------- Outstanding at August 3, 1996....................... -- $ -- Granted............................................. 255 2,725 Exercised........................................... -- -- Canceled............................................ -- -- --- ------ Outstanding at December 31, 1996.................... 255 $2,725 === ====== Options exercisable at December 31, 1996............ -- -- === ====== Options outstanding and exercisable by price range as of December 31, 1996 are as follows: OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------------------------- ----------------------------- WEIGHTED- WEIGHTED- WEIGHTED- RANGE OF OUTSTANDING AVERAGE AVERAGE EXERCISABLE AVERAGE EXERCISE AS OF REMAINING EXERCISE AS OF EXERCISE PRICES DECEMBER 31, 1996 CONTRACTUAL LIFE PRICES DECEMBER 31, 1996 PRICES -------- ----------------- ---------------- --------- ----------------- --------- $2,725 255 9.75 years $2,725 -- -- ====== === ========== ====== === ====== Pro forma Option Information The per share weighted average fair value of all stock options granted during 1996 was $1,377 on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: expected dividend yield 0%, risk-free interest rate of 6.28%, volatility of 70% and an expected life of 3 years. The Company applies APB No. 25 and related interpretations in accounting for its stock options granted to employees. Accordingly, the Company has recognized no compensation expense in connection with its stock option grants for the period from August 3, 1996 through December 31, 1996, the period from January 1, 1996 through August 2, 1996, and the year ended 1995. Had compensation expense been determined based on the fair value at date of grant for its stock option under SFAS No. 123, net income (loss) would have been reported as the pro forma amounts indicated below: PERIOD FROM PERIOD FROM AUGUST 3, 1996 JANUARY 1, 1996 THROUGH THROUGH YEAR ENDED NET LOSS DECEMBER 31, 1996 AUGUST 2, 1996 1995 -------- ----------------- --------------- ------------ As reported.................................... $(4,575,320) $(4,515,118) $(10,002,928) ----------- ----------- ------------ Pro forma...................................... $(4,604,552) $(4,515,118) $(10,002,928) =========== =========== ============ Pro forma net income (loss) reflects only options granted from August 31, 1996 through December 31, 1996. The effects of applying SFAS No. 123 in the pro forma net income (loss) above may not be representative of the effects on such pro forma information for future years. F-69 151 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (12) COMMITMENTS PerImmune leases laboratory, office and manufacturing facilities and equipment under noncancellable operating leases which expire at various times through January 1, 2007 (including the lease transaction described in Note 14 which is also reflected in the amounts below). Future minimum lease payments under these leases are as follows: 1997............................................ $ 1,744,809 1998............................................ 1,797,334 1999............................................ 1,771,120 2000............................................ 1,798,251 2001............................................ 1,849,638 Thereafter...................................... 10,298,844 ----------- $19,259,996 =========== Rent expense was $588,311 for the period from August 3, 1996 through December 31, 1996, $782,088 for the period from January 1, 1996 through August 2, 1996 and $1,238,370 for the year ended December 31, 1995. Rent expense is included in both selling, general and administrative expenses and costs of contracts in the statements of operations. (13) INCOME TAXES The Company was included in the Akzo Nobel, Inc., consolidated Federal income tax return for the year ended December 31, 1995, and for the period January 1, 1996 through August 2, 1996. They are presented below, however, on a separate company basis. The Company will file a separate consolidated Federal income tax return for the period August 3, 1996 through December 31, 1996. The amount computed by applying the Federal corporate income tax rate of 34% to loss before income taxes is reconciled to the provision for income taxes as follows: PERIMMUNE HOLDINGS CONSOLIDATED PREDECESSOR COMPANY ------------ --------------------------- PERIOD FROM PERIOD FROM AUGUST 3, JANUARY 1, 1996 THROUGH 1996 THROUGH DECEMBER 31, AUGUST 2, YEAR ENDED 1996 1996 1995 ------------ ------------ ----------- Income tax benefit computed at statutory rates..................................... $(1,555,609) $(1,535,140) $(3,400,996) State income tax benefit net of Federal tax....................................... (205,675) (206,748) (472,696) Expenses not deductible for tax purposes.... 1,623 3,036 3,818 Valuation allowance adjustment.............. 1,759,661 1,738,852 3,869,874 ----------- ----------- ----------- $ -- $ -- $ -- =========== =========== =========== F-70 152 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (13) INCOME TAXES (CONTINUED) Deferred income tax (assets)and liabilities as of December 31, 1996 are summarized as follows: Excess of book over tax (tax over book) basis of assets..... $ (193,529) Allowance for doubtful accounts and other reserves.......... (11,539) Accrued expenses............................................ (520,257) Non-SRLY net operating loss carryovers...................... (1,802,118) Other....................................................... (11,567) ----------- (2,539,010) Valuation allowance......................................... 2,539,010 ----------- $ -- =========== Prior to the leveraged buyout, the provision for Federal and state income taxes is recorded using the overall effective tax rate of the consolidated group applied to the Company's pre-tax earnings before adjustments for permanent differences. Deferred income tax assets and liabilities are recorded for the Company's temporary differences using the same effective tax rate. Prior to the leveraged buyout, the total provision for income taxes represents income taxes currently payable to the former Parent Company and has been treated as contributions from parent. At December 31, 1996, the Company has a net operating loss carryforward for both Federal and state purposes of $4,681,000 which expires in the year 2011. This net operating loss carryforward relates to the period August 3, 1996 through December 31, 1996 and as such, is not limited under existing tax laws. However, this carryforward may be significantly limited under the Internal Revenue Code as a result of future ownership changes by the Company. It is more likely than not that the net deferred tax assets reflected above will not be realized in future years. Therefore, a valuation allowance of $2,539,010 has been established for the year ended December 31, 1996. The $478,887 difference between the $2,107,355 net increase in the valuation allowance from December 31, 1995 to December 31, 1996, and the $1,628,468 increase that reconciles expected to actual tax expense in 1996, is related to the increase in deferred tax assets which results from the LBO transaction. Future reductions of the valuation allowance will be reported as reductions of income tax expense in the period(s) in which it becomes more likely than not that the tax benefits will be realized. (14) SUBSEQUENT EVENTS Sale Leaseback of Facility On January 15, 1997, PerImmune exercised its option to purchase the land and building it occupies in Rockville, Maryland for a pre-established price of $7.9 million. Concurrent to the purchase, PerImmune sold the property to a third-party (Buyer). The sale included part of the building, improvements, certain equipment and other items previously owned by the Company and shown in Plant and Equipment at December 31, 1996. The sales price excluding settlement and transfer costs was $14,150,000, and the loss resulting from this transaction was approximately $350,000, after consideration of estimated costs for repairs described below. The Company received approximately $5.2 million at the closing of the transaction. This transaction will be treated as a sale-leaseback. As such, the plant and equipment previously owned by the Company will be removed from the balance sheet and the loss will be recognized immediately. In conjunction with the sale, PerImmune has agreed to make certain repairs at its own expense and to obtain the release of certain liens against the property. To ensure compliance with these provisions of the agreement, PerImmune deposited $500,000 and $100,000 into escrow accounts. In addition, PerImmune has F-71 153 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (14) SUBSEQUENT EVENTS (CONTINUED) agreed to deposit, on a monthly basis from February 1997 through January 2002, $3,333 for costs to be used for elevator repairs and refurbishment. The Company is entitled to any amounts not spent for the described purpose. PerImmune also issued to Buyer in connection with the sale leaseback transaction a warrant for the purchase of 25,000 shares of PerImmune common stock if the company consummates an initial public offering (IPO) or if certain other events occur, such as a capital reorganization, recapitalization, dissolution or liquidation. The warrants are exercisable on or for three years following the date of one of the previously described events. The warrants expire in July 1999 if one of the above events has not occurred. The warrant purchase price in an IPO would be the offering price and in one of the other events described above, the price would be determined by a formula described in the warrant agreement. In January 1997, Holdings issued three uncollateralized, non-interest bearing promissory notes, for a total face amount of $232,500, to its advisors on the sale leaseback transaction. Each promissory note is convertible into two shares of Holdings $0.01 par value common stock and have no specified maturity date. Syncor Agreement On April 23, 1997, Holdings issued 100 shares of its Series A Mandatorily Redeemable Convertible Preferred Stock (par value .01/share) (Series A) to Syncor International Corporation (Syncor) for $4.5 million. Dividends are payable if and when declared by the Board of Directors at the rate of 7% of the Liquidation Preference per annum, where the Liquidation Preference is initially defined as $45,000, subject to certain adjustments. Each share of Series A may be converted into common stock before the Redemption Date (as defined below) at the option of the holder, or is automatically converted on the date of a qualifying initial public offering, using a conversion rate as defined in the agreement. The Company shall redeem the Series A five years after the issuance date (the Redemption Date) in the event that all shares have not been converted by this date. If such redemption occurs, the redemption price shall equal the amount of the Liquidation Preference plus any declared but unpaid dividends. In the event of liquidation or dissolution, Syncor shall be entitled to be paid from the assets of Holdings, in preference to the common stockholders, but on an equal basis with Series B stockholders (see below), the Liquidation Preference plus all declared but unpaid dividends. Holdings shall also have the right of first refusal to repurchase these shares should Syncor wish to sell them. In connection with this issuance, Syncor and the holders of Holding's common stock were also granted certain registration rights as contained in the Registration Rights Agreement. On April 1, 1997, the Company also entered into a distribution agreement for certain products with Syncor. Under this agreement, Syncor will pay the Company 50% of net sales, as defined, and right of return exists in certain situations. The Company is obligated annually to spend 15% of sales of products covered by this agreement on research and development to improve upon the existing or develop new products. The Company will also reimburse Syncor for all expenses related to marketing these products up to $1.5 million, plus 50% of amounts over $1.5 million provided the expenditures are in accordance with the annual market plan as prepared by the two companies. This agreement has a term of five years and is renewable for two additional two-year terms. Mentor Agreement On June 16, 1997, the Company issued 20 shares of Series B Mandatorily Redeemable Convertible Preferred Stock (par value .01/share) (Series B) to Mentor Corporation (Mentor) for $1 million. Dividends are payable if and when declared by the Board of Directors at the rate of 7% of the Liquidation Preference per annum, where Liquidation Preference is defined as $50,000, subject to certain adjustments. Each share of F-72 154 PERIMMUNE HOLDINGS, INC. AND SUBSIDIARY, AND PREDECESSOR COMPANY NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) (14) SUBSEQUENT EVENTS (CONTINUED) Series B shall have the same rights, preferences and terms as Series A described above. Series A and B shall have equal preference. On June 16, 1997, the Company also entered into a distribution agreement for certain products with Mentor with an initial term of 5 years. Under this agreement, Mentor will pay the Company 50% of net sales, as defined in the agreement. The Company is obligated to provide up to 12,000 units of products per year to be used by Mentor for promotional purposes, which will not be reimbursed by Mentor. F-73 155 - --------------------------------------------------------- - --------------------------------------------------------- NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, THE SELLING STOCKHOLDER OR ANY OF THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY THE SHARES BY ANYONE IN ANY JURISDICTION WHERE SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE. ------------------ TABLE OF CONTENTS PAGE Prospectus Summary............................ 3 Risk Factors.................................. 8 The Company................................... 20 Use of Proceeds............................... 21 Dividend Policy............................... 21 Capitalization................................ 22 Dilution...................................... 23 Pro Forma Consolidated Financial Information................................. 24 Selected Financial Data....................... 25 Management's Discussion and Analysis of Financial Condition and Results of Operations.................................. 27 Business...................................... 33 Management.................................... 63 Principal and Selling Stockholders............ 71 Description of Capital Stock.................. 73 Shares Eligible for Future Sale............... 78 Underwriting.................................. 79 Legal Matters................................. 80 Experts....................................... 80 Available Information......................... 81 Index to Consolidated Financial Statements.... F-1 UNTIL , 1999 (25 DAYS AFTER THE COMMENCEMENT OF THIS OFFERING), ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. - --------------------------------------------------------- - --------------------------------------------------------- - --------------------------------------------------------- - --------------------------------------------------------- 4,000,000 SHARES LOGO COMMON STOCK ------------------------ PROSPECTUS ------------------------ DONALDSON, LUFKIN & JENRETTE PIPER JAFFRAY INC. , 1999 - --------------------------------------------------------- - ---------------------------------------------------------