F-1
Form 10-K Items 14(a) (1) and (2)
Cypros Pharmaceutical Corporation
Years ended July 31, 1998, 1997 and 1996
with Report of Independent Auditors
Cypros Pharmaceutical Corporation
Form 10-K Items 14(a) (1) and (2)
Contents
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Report of Ernst & Young LLP, Independent Auditors ......F-2
Audited Financial Statements (Item 14(a) (1)):
Balance Sheets ......F-3
Statements of Operations ......F-4
Statements of Shareholders' Equity ......F-5
Statements of Cash Flows ......F-6
Notes to Financial Statements ......F-7
Financial Statement Schedules (Item 14(a) (2)):
All financial statement schedules are omitted because the
information described therein is not applicable, not
required or is furnished in the financial statements or
notes thereto.
Report of Ernst & Young LLP, Independent Auditors
The Board of Directors and Shareholders
Cypros Pharmaceutical Corporation
We have audited the accompanying balance sheets of Cypros
Pharmaceutical Corporation as of July 31, 1998 and 1997, and
the related statements of operations, shareholders' equity,
and cash flows for each of the three years in the period
ended July 31, 1998. 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 financial
position of Cypros Pharmaceutical Corporation at July 31,
1998 and 1997, and the results of its operations and its
cash flows for each of the three years in the period ended
July 31, 1998, in conformity with generally accepted
accounting principles.
ERNST & YOUNG LLP
San Diego, California
August 21, 1998
Cypros Pharmaceutical Corporation
Balance Sheets
July 31,
1998 1997
Assets
Current assets:
Cash and cash equivalents (Note 3) $ 3,015,890 $ 5,101,710
Short-term investments, held to
maturity
(Note 3) 10,428,580 9,465,561
Accounts receivable 516,886 355,425
Inventories (Note 3) 83,078 93,177
Prepaid expenses and other current
assets 214,765 75,038
Total current assets 14,259,199 15,090,911
Property, equipment and leasehold
improvements, net (Note 3) 1,063,566 675,686
Purchased technology, net of
accumulated amortization of
$2,118,226 and $1,220,838 at July 31,
1998 and 1997,respectively (Note 2) 4,163,487 5,060,875
Deferred financing costs, net of
accumulated amortization of $520,011
and $260,884 at July 31, 1998 and
1997, respectively - 259,127
Licenses and patents, net of
accumulated amortization of $160,212
and $118,376 at July 31, 1998 and
1997, respectively 176,927 162,592
Other assets 72,461 95,525
Total assets $19,735,640 $21,344,716
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 551,191 365,386
Accrued compensation 125,434 109,778
Other accrued liabilities 15,641 118,658
Purchased asset obligations (Note
2) - 1,272,000
Current portion of long-term debt
(Note 4) 97,477 41,367
Current portion of capital lease
obligations (Note 5) 91,740 106,206
Total current liabilities 881,483 2,013,395
Long-term debt (Note 4) 59,408 -
Capital lease obligations (Note 5) 157,656 148,787
Deferred rent 125,761 129,165
Mandatorily convertible notes
(Note 5) - 4,027,461
Shareholders' equity (Note 6):
Common stock, 30,000,000 shares
authorized, 15,711,877 and
13,650,405 shares issued
and outstanding as of July 31,
1998 and 1997, respectively 41,328,470 32,344,793
Deferred compensation (87,334) (161,950)
Accumulated deficit (22,729,804)(17,156,935)
Total shareholders' equity 18,511,332 15,025,908
Total liabilities and
shareholders'equity $19,735,640 $21,344,716
See accompanying notes.
Cypros Pharmaceutical Corporation
Statements of Operations
Years ended
July 31,
1998 1997 1996
Net sales $ 3,445,955 $ 2,428,348 $ 1,275,240
Cost of sales 770,437 538,725 405,142
Gross profit 2,675,518 1,889,623 870,098
Operating expenses:
Sales and marketing 1,309,963 993,765 343,054
General and administrative 3,246,619 2,396,465 1,642,152
Clinical testing and
regulatory 2,521,386 1,967,334 1,389,128
Pre-clinical research and
development 822,225 1,032,486 1,002,226
Depreciation and
amortization 1,239,217 1,075,431 611,848
Total operating expenses 9,139,410 7,465,481 4,988,408
Loss from operations (6,463,892) (5,575,858) (4,118,310)
Research grant income 169,834 98,785 270,510
Interest and other income,
net 809,254 662,421 757,692
Sublease income, net(Note 5) 171,062 - -
Amortization of discount and
costs on mandatorily
converible notes
(Note 5 ) (259,127) (1,860,051) -
Net loss $(5,572,869)$(6,674,703) $(3,090,108)
Net loss per share, basic
and diluted $(0.37) $(0.54) $(0.27)
Shares used in computing net
loss per share, basic
diluted 15,186,984 12,303,274 11,518,169
See accompanying notes.
Cypros Pharmaceutical Corporation
Statements of Shareholders' Equity
Years ended July 31, 1998, 1997 and 1996
Common Stock
Deferred
Shares Amount Compensation
Balance at July 31, 1995 11,352,017 $20,944,995 $(186,993)
Discount on mandatorily
convertible notes - 1,582,935 -
notes
Issuance of common stock, net
of offering costs 162,500 940,956 -
offering costs
Issuance of common stock in
business acquisitions 169,231 1,032,309 -
Issuance of common stock for
services 200,000 284,375 (284,375)
Common stock repurchased (280,000) (1,540,000) -
Exercise of stock options 10,000 35,163 -
Deferred compensation related
to grant of stock options - 140,695 (140,695)
grant of stock options
Amortization of deferred
compensation - - 307,754
Net loss - - -
Balance at July 31, 1996 11,613,748 23,421,428 (304,309)
Conversion of mandatorily
convertible notes 953,907 3,972,538 -
Issuance of common stock, net
of offering costs 1,075,000 4,714,507 -
Exercise of stock options 7,750 21,963 -
Forfeitures of stock options - (52,568) 52,568
Deferred compensation related
to grant of stock options - 266,925 (266,925)
Amortization of deferred
compensation - - 356,716
Net loss - - -
Balance at July 31, 1997 13,650,405 32,344,793 (161,950)
Conversion of mandatorily
convertible notes 1,205,446 4,025,588 -
Issuance of common stock upon
exercise of B Warrants 856,026 4,707,576 -
Deferred compensation related
to grant of stock options - 250,513 (250,513)
Amortization of deferred
compensation - - 325,129
Net loss - - -
Balance at July 31, 1998 15,711,877$41,328,470 $(87,334)
Cypros Pharmaceutical Corporation
Statements of Shareholders' Equity (Continued)
Accumulated Total
Deficit Equity
Balance at July 31, 1995 $ (7,392,124) $13,365,878
Discount on mandatorily
convertible notes - 1,582,935
Issuance of common stock, net
of offering costs - 940,956
Issuance of common stock in
business acquisitions - 1,032,309
Issuance of common stock for
services - -
Common stock repurchased - (1,540,000)
Exercise of stock options - 35,163
Deferred compensation related
to grant of stock options - -
Amortization of deferred
compensation - 307,754
Net loss (3,090,108) (3,090,108)
Balance at July 31, 1996 (10,482,232) 12,634,887
Conversion of mandatorily
convertible notes - 3,972,538
Issuance of common stock, net
of offering costs - 4,714,507
Exercise of stock options - 21,963
Forfeitures of stock options - -
Deferred compensation related
to grant of stock options - -
Amortization of deferred
compensation - 356,716
Net loss (6,674,703) (6,674,703)
Balance at July 31, 1997 (17,156,935) 15,025,908
Conversion of mandatorily
convertible notes - 4,025,588
Issuance of common stock upon
exercise of B Warrants - 4,707,576
Deferred compensation related -
to grant of stock options - -
Amortization of deferred -
compensation - 325,129
Net loss (5,572,869) (5,572,869)
Balance at July 31, 1998 $(22,729,804)$18,511,332
See accompanying notes.
Cypros Pharmaceutical Corporation
Statements of Cash Flows
Years ended July 31,
1998 1997 1996
Operating activities
Net loss $(5,572,869 $(6,674,703) $(3,090,108)
Adjustments to reconcile
net loss to net cash
used in operating
activities:
Amortization of deferred
compensation 325,129 356,716 307,754
Depreciation and
amortization 1,239,217 1,075,431 611,848
Amortization of discount
and costs on mandatorily
convertible notes 259,127 1,860,051 -
Deferred rent (3,404) (16,215) 39,892
Write-off of patent 41,311 - -
Changes in operating
assets and liabilities, net of
effects from acquisitions:
Accounts receivable (161,461) (205,799) (149,626)
Inventory 10,099 (29,791) 18,829
Prepaid expenses and
other current expenses (139,727) (13,629) 18,536
Accounts payable 185,805 246,294 (19,445)
Accrued compensation
and other accrued
liabilities (87,361) (56,948) 114,305
Net cash flows used in
operating activities (3,904,134) (3,458,593) (2,148,015)
Investing activities
Short-term investments (963,019) (2,537,126) 1,486,815
Investment in purchased
technology - (2,014,048) (1,835,356)
Installment payment for
purchased technology (1,272,000) (200,000) (82,215)
Purchase of property,
equipment and leasehold
improvements (587,265) (239,941) (100,770)
Increase in licenses and
patents (97,482) (82,460) (37,499)
Decrease in other assets 23,064 21,375 6,197
Net cash flows used in
investing activities (2,896,702) (5,052,200) (562,828)
Financing activities
Issuance of common stock,
net 4,707,576 4,736,470 976,119
Cash paid for repurchase of
mandatorily convertible notes (1,873) - -
Issuance of mandatorily
convertible notes - - 7,458,498
Repurchase and retirement
of common stock - - (1,540,000)
Issuance of long-term debt 209,406 - -
Repayment of long-term debt (93,888) (99,282) (99,283)
Repayments of capital lease
obligations (106,205) (93,299) (42,622)
Net cash flows provided by
financing activities 4,715,016 4,543,889 6,752,712
Increase (decrease) in cash
and cash equivalents (2,085,820) (3,966,904) 4,041,869
Cash and cash equivalents
at beginning of year 5,101,710 9,068,614 5,026,745
Cash and cash equivalents
at end of year $3,015,890 $5,101,710 $9,068,614
Supplemental disclosures of
cash flow information:
Cash paid for interest $ 132,269 $ 123,997 $ 47,953
Noncash investing and
financing activities:
Conversion of mandatorily
convertible notes $4,025,588 $ 3,972,538 $ -
Equipment financed under
capital lease obligations $ 100,608 $ 79,992 $ 234,256
Purchased asset obligation
incurred for acquisition $ - $ 1,200,000 $ 200,000
Common stock issued for
acquisitions $ - $ - $ 1,032,309
See accompanying notes.
Cypros Pharmaceutical Corporation
Notes to Financial Statements
July 31, 1998
1. Organization and Summary of Significant Accounting
Policies
Organization and Business Activity
Cypros Pharmaceutical Corporation (the "Company") was
incorporated in San Diego, California on November 2, 1990.
The Company develops and markets acute-care, hospital-based
products. The Company is currently marketing three
products, Ethamolin, Glofil and Inulin, will be launching
two burn/wound care products and is developing two drugs,
Cordox (formerly CPC-111) and Ceresine. The Company's
pre-clinical and clinical development programs focus on
cytoprotective drugs designed to reduce ischemia (low blood
flow) induced tissue damage in acute-care settings and
Cordox and Ceresine are in late-stage clinical trials in two
settings: sickle cell crisis and traumatic brain injury.
Cash, Cash Equivalents and Short-Term Investments
The Company considers highly liquid investments with
remaining maturities of three months or less when acquired
to be cash equivalents. Short-term investments consist of
certificates of deposit, money market funds, U.S. government
obligations and investment grade corporate debt securities.
The Company has established guidelines relative to
diversification and maturities that maintain safety and
liquidity. The Company has not experienced any losses on
its cash equivalents or short-term investments. Management
believes the credit risk associated with these investments
is limited due to the nature of the investments.
Management determines the appropriate classification of debt
securities at the time of purchase and reevaluates such
designations as of each balance sheet date. Debt securities
are classified as held-to-maturity when the Company has the
positive intent and the ability to hold the securities to
maturity. Held-to-maturity securities are carried at cost,
adjusted for amortization of premiums and accretion of
discounts. Interest, dividends and amortization on the
securities classified as held-to-maturity are included in
interest income.
Concentration of Credit Risk
The Company extends credit to its customers, primarily
hospitals and large pharmaceutical companies conducting
clinical research, in connection with its product sales.
The Company has not experienced significant credit losses on
its customer accounts. Two customers individually accounted
for 23% and 12% of current year sales.
Inventories
Inventories are stated at the lower of cost (first-in,
first-out method) or market.
Depreciation and Amortization
Property and equipment are stated at cost and depreciated
over the estimated useful lives of the assets (generally
five years) using the straight-line method. Leasehold
improvements are amortized over the lesser of the estimated
useful lives (seven years) or the remaining term of the
lease.
Purchased Technology
Purchased technology associated with the acquisitions of
Glofil, Inulin and Ethamolin is stated at cost and amortized
over the period estimated to be benefited (seven years).
Deferred Financing Costs
The Company deferred banking, legal and accounting fees
associated with the issuance of $8 million in principal
amount of mandatorily convertible notes in 1996. These costs
were amortized over the term of the notes, which was three
years, using the effective interest method commencing with
the closing of the transactions. In fiscal 1998, upon the
conversion of the remaining balance of the notes, all such
costs were fully amortized.
License and Patent Costs
The Company capitalizes certain costs related to license
rights and patent applications. Accumulated costs are
amortized over the estimated economic lives of the license
rights and patents (generally six years) commencing at the
time the license rights are granted or the patents are
issued.
Accounting Standard on Impairment of Long-Lived Assets
In accordance with Statement of Financial Accounting
Standards No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of ("SFAS 121"), the Company regularly evaluates its long-
lived assets for indicators of possible impairment. To
date, no such indicators have been identified.
Revenue Recognition
Revenues from product sales of Ethamolin and whole vials of
Glofil and Inulin are recognized upon shipment. Revenues
from Glofil unit dose sales are recognized upon receipt by
the Company of monthly sales reports from its third-party
distributor. The Company is not obligated to accept returns
of products sold that have reached their expiration date.
Net Loss Per Share
In the second quarter of the fiscal year ended July 31,
1998, the Company adopted Statement of Financial Accounting
Standards No. 128, Earnings Per Share ("SFAS 128"), which
replaced the calculation of primary and fully diluted net
loss per share with basic and diluted net income or loss per
share. Basic net income or loss per share is calculated
using the weighted average number of common shares
outstanding. Diluted net income or loss per share is
calculated using the weighted average number of common
shares outstanding plus the dilutive effect of options and
warrants, if any, using the treasury stock method. All net
loss per share amounts for all periods have been presented,
and where appropriate restated, to conform to the SFAS 128
requirements and the recently effective Securities and
Exchange Commission Staff Accounting Bulletin No. 98.
Stock Options
The Company has elected to follow Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to
Employees ("APB 25") and related Interpretations in
accounting for its employee stock options because the
alternative fair value accounting provided for under
Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation ("SFAS 123")
requires use of option valuation models that were not
developed for use in valuing employee stock options. Under
APB 25, when the exercise price of the Company's employee
stock options equals or exceeds the market price of the
underlying stock on the date of grant, no compensation
expense is recognized.
Recently Issued Accounting Standards
Effective August 1, 1998, the Company will adopt Statement
of Financial Accounting Standards No. 130, Reporting
Comprehensive Income (Loss) ("SFAS 130"). SFAS 130 requires
that all components of comprehensive income (loss),
including net income (loss), be reported in the financial
statements in the period in which they are recognized.
Comprehensive income (loss) is defined as the change in
equity during the period from transactions and other events
and circumstances from non-owner sources. Net income (loss)
and other comprehensive income (loss), including unrealized
gains and losses on investments, shall be reported, net of
their related tax effect, to arrive at comprehensive income
(loss). The Company does not believe comprehensive loss
will be different than the net loss previously reported.
Effective August 1, 1998, the Company will adopt Statement
of Financial Accounting Standards No. 131, Disclosures about
Segments of an Enterprise and Related Information ("SFAS
131"). SFAS 131 redefines segments and requires companies to
report financial and descriptive information about their
operating segments. The Company has determined that it
operates in one business segment and therefore the adoption
of SFAS 131 will not affect the Company's financial
statements.
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 amounts
reported in the financial statements and disclosures made in
the accompanying notes to the financial statements. Actual
results could differ from those estimates.
Reclassifications
Certain previously reported amounts have been reclassified
to conform with the 1998 presentation.
2. Acquisitions
On August 9, 1995, the Company acquired two businesses,
including (i) the New Drug Application for Glofil and
finished goods inventory of Glofil on hand at the time of
closing from Iso-Tex Diagnostics, Inc., a Texas corporation,
(the "Glofil Acquisition") and (ii) the New Drug Application
for Inulin and the raw material and finished goods inventory
of Inulin on hand at the time of closing from Iso-Tex
Diagnostics "B," Inc. ("ITDB"), a Texas corporation (the
"Inulin Acquisition"). The Glofil Acquisition was
accomplished in an arms' length negotiation through a
purchase of assets and the Inulin Acquisition was
accomplished through a merger of ITDB with and into the
Company (the "Merger"). The total purchase price was
$3,149,880, of which the Company paid $1,582,215 in cash
from
its working capital and issued 169,231 shares of restricted
Common Stock of the Company (the "Restricted Shares") which
were paid at closing.
As part of the Glofil Acquisition, the Company made an
additional cash payment of $200,000 on January 15, 1996 and
a final cash payment of $200,000 on August 9, 1996.
On November 4, 1996, the Company acquired the New Drug
Application, the U.S. trademark for Ethamolin Injection (the
"Ethamolin Assets") and the finished goods inventory on hand
at closing from Schwarz Pharma, Inc., a Delaware
corporation. The total purchase price was $3,286,642, of
which the Company paid $2,086,642 in cash from its working
capital and issued a $1,200,000 8% note (the "Schwarz Note")
which was paid in full during fiscal year 1998.
All of these acquisitions were accounted for using the
purchase method and, accordingly, the financial statements
include the operations of the businesses from the date of
acquisition. The following unaudited pro forma data reflects
the combined results of operations of the Company as if the
Glofil Acquisition and the Inulin Acquisition had occurred
on August 1, 1994 and the Ethamolin acquisition had occurred
on August 1, 1995:
Years end July 31,
1997 1996
Net sales $2,752,691 $2,402,006
Net loss (6,394,987) (2,679,376)
Net loss per share (0.52) (0.23)
3. Financial Statement Details
Short-Term Investments
All short-term investments of the Company are classified as
held-to-maturity. The following is a summary of
held-to-maturity investments at amortized cost at July 31:
1998 1997
Corporate debt securities $ 9,933,424 $10,465,202
Money market funds 2,656,423 2,723,458
U.S. government obligations 495,156 995,770
13,085,003 14,184,430
Less: amounts classified as cash
equivalents (2,656,423) (4,718,869)
Short-term investments $10,428,580 $ 9,465,561
As of July 31, 1998, the difference between cost and
estimated fair value of the held-to-maturity investments was
not significant. Of the above-referenced 1998 investments,
$6,265,682 mature at various dates through July 31, 1999 and
$4,162,898 will mature at various dates after July 31, 1999
through December 14, 2001.
Inventories
Inventories consist of the following at July 31:
1998 1997
Raw materials $ 2,087 $ 4,252
Finished goods 80,991 88,925
$83,078 $93,177
Property, Equipment and Leasehold Improvements
Property, equipment and leasehold improvements consist of
the following at July 31:
1998 1997
Laboratory equipment $756,525 $785,573
Office equipment,
furniture and
fixtures 783,446 284,902
Leasehold improvements 353,149 134,772
1,893,120 1,205,247
Less accumulated
depreciation
and amortization (829,554) (529,561)
$1,063,566 $ 675,686
Depreciation and amortization expense totaled $299,993,
$252,453 and $138,471 for the years ended July 31, 1998,
1997 and 1996, respectively.
4. Long-Term Debt
Long-term debt consists of the following at July 31:
CAPTION>
1998 1997
Note payable to a pharmaceutical
company due November 1999,
collateralized by certain purchased
assets totaling $234,000, bearing
interest at 8% until November 1998 and
4% thereafter, payable in three
semiannual installments starting
November 1998, of $39,300, $46,200 and
$48,500, plus interest $142,025 $ -
Note payable to a leasing company due
November 2001, collateralized by real
property, bearing interest at 10%,
payable in 53 monthly installments of
$438 including interest 14,860 -
Note payable to a financial institution
due December 1997, collateralized by
$84,048 of the Company's short-term
investments at July 31, 1997, bearing
interest at prime plus 1.6% (10.10% at
July 31, 1997) - 41,367
156,885 41,367
Less current portion (97,477) (41,367)
Total
$ 59,408 $ -
Interest expense incurred on these notes totaled $10,748,
$9,524 and $19,897 for the years ended July 31, 1998, 1997
and 1996, respectively.
5. Commitments
Leases
The Company leases its office and research facilities under
operating lease agreements and certain equipment under
capital lease agreements. A security deposit of $64,260
under one of the facilities lease agreements is included in
other assets.
Minimum future obligations under both operating and capital
leases as of July 31, 1998 are as follows:
Operating Capital
Leases Leases
1999 $464,942 $108,903
2000 491,649 87,794
2001 418,356 33,111
2002 127,310 25,061
2003 25,061
Thereafter - 10,443
$1,502,257 290,373
Less amounts representing interest (40,977)
Present value of net minimum lease
payments 249,396
Current portion of capital lease
obligations (91,740)
Long-term capital lease obligations $157,656
Rent expense totaled $445,095, $420,697 and $193,880 for
the years ended July 31, 1998, 1997 and 1996, respectively.
The net book value of the equipment acquired under capital
leases totaled $222,101 and $228,878 (net of accumulated
amortization of $288,732 and $181,347) at July 31, 1998 and
1997, respectively.
Rent expense comprises the cost associated with two
buildings leased by the Company, its current headquarters
located at 2714 Loker Avenue West in Carlsbad, California
and its former headquarters located at 2732 Loker Avenue
West. In April 1996, the Company subleased its former
headquarters for the remainder of the original lease term
plus an additional 36 month option. Net sublease income
totaled $171,062 for the year ended July 31, 1998. Scheduled
aggregate future sublease income at July 31, 1998 is
approximately $1,128,081.
Mandatorily Convertible Notes
During the year ended July 31, 1996, the Company issued $8
million in principal amount of non-interest bearing
mandatorily convertible notes (the "Notes") to institutional
investors in private placements under the provisions of the
Securities and Exchange Commission (the "SEC") Regulation D.
The Notes were convertible at the option of the investors
into shares of the Company's Common Stock at various dates
from January 31, 1997 through July 31, 1999 at a discount to
the market price of the stock immediately preceding
conversion, ranging from 15% to 25%, with the actual
discount depending on the length of time each investor has
held the note being converted. The Notes were all converted
at various dates through July 31, 1998, except for $1,873
which was paid in cash. The Notes were recorded net of the
$1,582,935 discount available upon conversion (assuming full
conversion at the earliest possible dates), and the discount
represents an effective interest rate of 33%. The discount
has been added to Common Stock and was amortized to expense
during fiscal year 1997.
License Agreements
The Company has licenses to various patents for Cordox and
Ceresine, its two clinical development programs, for the
remaining term of the patents. The license agreements
require payments of cash, warrants or the issuance of stock
options to the licensers upon accomplishment of various
milestones and the payment of royalties to the licensers
upon the commercial sale of products incorporating the
licensed compound. The only remaining significant
development milestone under these agreements is the
requirement that the Company pay the licensor of Cordox
$250,000 upon the filing of a New Drug Application with the
Food and Drug Administration (the "FDA") for the approval to
market that compound. In the event milestone or royalty
payments to the licensor of Cordox are not made by the
Company within specified time periods, that licensor may
elect to terminate the license agreement and all rights
thereunder. Such a termination could have a significant
adverse impact upon the Company.
6. Shareholders' Equity
Preferred Stock
The Company has authorized 1,000,000 shares of convertible
preferred stock. As of July 31, 1998 and 1997, no such
shares were issued or outstanding.
Warrants
As of July 31, 1997, 4,673,512 Redeemable Class B Warrants
were outstanding. In November 1997, the Company received
net proceeds of $4,707,576 from the exercise of 856,026
Redeemable Class B Warrants and the concurrent issuance of
856,026 shares of
Common Stock. During fiscal year 1998, all Redeemable Class
B Warrants expired and none are outstanding at July 31,
1998.
Stock Option Plans
Pro forma information regarding net loss and loss per share
is required by SFAS 123, and has been determined as if the
Company has accounted for its employee stock options under
the fair value method set forth in SFAS 123. The fair value
of these options was estimated at the date of grant using
the Black-Scholes option pricing model with the following
weighted average assumptions for 1998, 1997 and 1996:
risk-free interest rates of 6.0%; dividend yields of 0%;
volatility factors of the expected market price of the
Company's Common Stock of 79% for 1998 and 84% for 1997 and
1996; and the weighted-average life of the options of eight
years.
The Black-Scholes option valuation model was developed for
use in estimating the fair value of traded options which
have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of
highly subjective assumptions including the expected stock
price volatility. 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 existing models
do not necessarily provide a single reliable measure of the
fair value of its employee stock options. 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 pro forma net loss for the years ended
July 31, 1998, 1997 and 1996 is as follows:
1998 1997 1996
Pro forma net loss $(6,844,607) $(7,658,837) $(3,943,018)
Pro forma net loss
per share, basic and
diluted $(0.45) $(0.62) $(0.34)
As of July 31, 1998, 2,766,288 shares of Common Stock were
reserved for issuance under the 1992 Stock Option Plan (the
"1992 Plan"). The 1992 Plan provides for the grant of
incentive and nonstatutory stock options with various
vesting periods, generally four years, to employees,
directors and consultants. The exercise price of incentive
stock options must equal at least the fair market value on
the date of grant, and the exercise price of nonstatutory
stock options may be no less than 85% of the fair market
value on the date of grant. The maximum term of options
granted under the 1992 Plan is ten years.
In June 1993, the Company adopted the 1993 Non-Employee
Directors' Stock Option Plan (the "1993 Plan"), under which
250,000 shares of Common Stock were reserved for issuance.
The 1993 Plan provides for the granting of 25,000 options to
purchase Common Stock upon appointment as a non-employee
director and an additional 3,000 options each January
thereafter, beginning January 1, 1994. Options vest over
four years. The exercise price of the options is 85% of the
fair market value on the date of grant. The maximum term of
options granted under the 1993 Plan is ten years.
The following table summarizes stock option activity under
the 1992 and 1993 Plans:
Options Weighted
Outstanding Average
Exercise Price
Balance at July 31, 1995 1,018,000 $3.83
Granted 360,000 $5.30
Exercised (10,000) $3.52
Canceled (12,188) $5.40
Balance at July 31, 1996 1,355,812 $4.21
Granted 309,499 $4.33
Exercised (7,750) $2.83
Canceled (219,125) $4.47
Balance at July 31, 1997 (1,438,436) $4.25
Granted 749,700 $4.85
Exercised - $ -
Canceled (295,647) $5.08
Balance at July 31, 1998 1,892,489 $4.36
At July 31, 1998, options to purchase 1,254,699 shares of
Common Stock were exercisable and there were 623,799 shares
available for future grant under the 1992 and 1993 Plans.
The weighted average grant-date fair value for the options
granted during 1998, 1997 and 1996 were $3.74, $3.40 and
$4.39, respectively.
Exercise prices and weighted average remaining contractual
life for the options outstanding under the 1992 and 1993
Plans as of July 31, 1998 are as follows:
Options Outstanding Options
Exercisable
Weighted Weighted Weighted
Range of Average Average Average
Exercise Number Remaining Exercise Number Exercise
Price Outstanding Contractual Price Exercisable Price
Life
$1.44 97,500 4.05 $1.44 97,500 $1.44
$2.20-$2.46 93,000 4.78 $2.22 93,000 $2.32
$3.06-$4.00 571,833 7.74 $3.70 398,452 $3.70
$4.05-$4.95 293,449 7.89 $4.68 204,524 $4.42
$5.00-$5.75 717,958 6.03 $5.33 362,762 $5.33
$6.00-$6.80 76,249 5.10 $6.31 67,524 $6.31
$7.86-$8.50 42,500 7.03 $8.08 30,937 $8.08
1,892,489 $4.36 1,254,699
The Company has recorded deferred compensation for the
difference between the price of options granted and the fair
value of the Company's Common Stock. Deferred compensation
is amortized to expense during the vesting period of the
related stock or options.
7. Income Taxes
The Company accounts for income taxes using the liability
method under Financial Accounting Standards Board Statement
No. 109, Accounting for Income Taxes. 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 as of July 31, 1998 and 1997 are as follows:
1998 1997
Deferred tax liabilities:
Purchased technology $ 267,000 $ 423,000
Total Deferred tax liabilities 267,000 423,000
Deferred tax assets:
Net operating loss carryforwards 6,439,000 4,554,000
Capitalized research and development
costs 569,000 547,000
Research and development tax credit
carryforwards 836,00 530,000
Other - net 53,000 1,243,000
Total deferred tax assets 7,897,000 6,874,000
Valuation allowance (7,630,000) (6,451,000)
Net deferred tax assets $ - $ -
At July 31, 1998, the Company has federal and California tax
net operating loss carryforwards of approximately
$17,520,000 and $5,335,000, respectively. The federal tax
loss carryforwards will begin to expire in 2007, unless
previously utilized. The California tax loss carryforwards
began expiring in 1997 (approximately $340,000 expired in
1998 and will continue to expire unless previously
utilized). The Company also has federal and California
research and development tax credit carryforwards of
approximately $666,000 and $263,000, respectively, which
will begin expiring in 2007 unless previously utilized. The
above carryforwards were determined as if the Company were
filing a tax return at July 31, 1998; however, for tax
return purposes the Company uses a calendar year end.
In accordance with the Internal Revenue Code, the use of the
Company's net operating loss and credit carryforwards may be
limited upon cumulative changes in ownership of more than
50%.
The valuation allowance increased $1,179,000 from July 31,
1997 to July 31, 1998 due principally to the increase in
deferred tax assets resulting from the increase in tax net
operating loss carryforwards. Realization of deferred tax
assets is dependent on future earnings, the timing and
amount of which will be dependent on scientific success,
results of clinical trials and regulatory approval of the
Company's products currently under development.
Accordingly, the full valuation reserve has been established
to reflect these uncertainties.
8. Legal Proceedings
In July 1998, the Company was served with a complaint in the
United States Bankruptcy Court for the Southern District of
New York by the Trustee for the liquidation of the business
of A. R. Baron & Co., Inc. ("A.R. Baron") and the Trustee of
The Baron Group, Inc. (the "Baron Group"), the parent of
A. R. Baron. The complaint alleges that A. R. Baron and the
Baron Group made certain preferential or fraudulent
transfers of funds to the Company prior to the commencement
of bankruptcy proceedings involving A. R. Baron and the
Baron Group. The Trustee is seeking return of the funds
totaling $3.2 million. The Company believes that the
Trustee's claims are unfounded and intends to contest the
allegations in the complaint vigorously. The Company
contends that the transfers challenged by the Trustee relate
to (i) the exercise by A. R. Baron in 1995 of unit purchase
options issued to it in 1992 as part of its negotiated
compensation for underwriting the Company's initial public
offering and (ii) the repayment by the Baron Group of the
principal and interest (at 12% per annum) payments and
certain loan extension fees related to certain
collateralized loans made to it by the Company in 1995 and
1996. The Company believes that it has insurance coverage
sufficient to cover any costs, expenses, or losses that
might be incurred in connection with this action.
9. Year 2000 Issue (unaudited)
The Company has modified or replaced portions of its
software so that its computer systems will function properly
with respect to dates in the year 2000 and thereafter. The
Company believes that, with these modifications to existing
software and conversions to new software, the Year 2000
Issue will not pose significant operational problems for its
computer systems.