1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 -------------- FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission File Number 000-28782 NEOTHERAPEUTICS, INC. (Exact Name of Registrant as Specified in its Charter) DELAWARE 93-0979187 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 157 TECHNOLOGY DRIVE IRVINE, CALIFORNIA 92618 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code: (949) 788-6700 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of Common Stock as of the latest practicable date: Class Outstanding at August 2, 1999 - --------------------------------- ------------------------------- Common Stock, $.001 par value 7,952,748 2 NEOTHERAPEUTICS, INC. (A Development-Stage Enterprise) TABLE OF CONTENTS PART I. FINANCIAL INFORMATION Page No. -------- ITEM 1. FINANCIAL STATEMENTS Statement regarding financial information.............................................. 3 Condensed Consolidated Balance Sheets as of June 30, 1999 and December 31, 1998.................................................................. 4 Condensed Consolidated Statements of Operations for the three months ended June 30, 1999 and 1998....................................................... 5 Condensed Consolidated Statements of Operations for the six months ended June 30, 1999 and 1998 and for the period from inception (June 15, 1987) to June 30, 1999............................................................................... 6 Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 1999 and 1998 and for the period from inception (June 15, 1987) to June 30, 1999............................................................................... 7 Notes to Condensed Consolidated Financial Statements................................... 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL POSITION... 12 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............................. 18 PART II. OTHER INFORMATION...................................................................... 20 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.............................................. 20 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.................................. 20 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K....................................................... 23 2 3 NEOTHERAPEUTICS, INC. (A Development Stage Enterprise) FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 1999 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS STATEMENT REGARDING FINANCIAL INFORMATION The financial statements included herein have been prepared by NeoTherapeutics, Inc. (the "Company"), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information normally included in the financial statements prepared in accordance with generally accepted accounting principles has been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. It is suggested that the financial statements be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998 as filed with the Securities and Exchange Commission. 3 4 NEOTHERAPEUTICS, INC. AND SUBSIDIARIES (A Development-Stage Enterprise) CONDENSED CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 1999 AND DECEMBER 31, 1998 June 30, December 31, 1999 1998 ------------ ------------ (Unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 1,452,130 $ 1,097,341 Marketable securities and short-term investments 2,020,392 1,769,348 Other receivables, principally investment interest 122,637 112,552 Advance deposit to clinical trial vendor -- 265,727 Prepaid expenses and refundable deposits 522,026 157,495 ------------ ------------ Total current assets 4,117,185 3,402,463 ------------ ------------ PROPERTY AND EQUIPMENT, at cost: Equipment 2,503,609 2,197,253 Leasehold improvements 1,802,264 1,794,794 Accumulated depreciation and amortization (992,468) (740,413) ------------ ------------ Property and equipment, net 3,313,405 3,251,634 ------------ ------------ PREPAID EXPENSES AND DEPOSITS 53,841 172,066 ------------ ------------ $ 7,484,431 $ 6,826,163 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable and accrued expenses $ 1,715,820 $ 1,278,954 Accrued payroll and related taxes 95,783 81,370 Note payable to related party 558,304 558,304 Current portion of long-term debt 498,096 445,297 ------------ ------------ Total current liabilities 2,868,003 2,363,925 LONG-TERM DEBT, net of current portion 848,922 1,126,174 DEFERRED RENT 60,714 46,308 ------------ ------------ Total liabilities 3,777,639 3,536,407 ------------ ------------ COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, par value $0.001 per share, 5,000,000 shares authorized: Issued and outstanding, 320 shares 5% Series A Preferred with Conversion Features at June 30, 1999, none at December 31, 1998, liquidation preference $3.2 million 2,546,994 -- Common stock, par value $0.001 per share, 25,000,000 shares authorized: Issued and outstanding, 6,748,207 and 6,146,854 shares at June 30, 1999 and December 31, 1998, respectively 33,960,256 27,535,329 Unrealized gains on available-for-sale securities 26,704 24,207 Deficit accumulated during the development stage (32,827,162) (24,269,780) ------------ ------------ Total stockholders' equity 3,706,792 3,289,756 ------------ ------------ $ 7,484,431 $ 6,826,163 ============ ============ The accompanying notes are an integral part of these condensed consolidated balance sheets. 4 5 NEOTHERAPEUTICS, INC. AND SUBSIDIARIES (A Development-Stage Enterprise) CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 1999 AND 1998 Three Months Three Months Ended Ended June 30, June 30, 1999 1998 ----------- ----------- (Unaudited) (Unaudited) REVENUES, from grants $ -- $ -- ----------- ----------- OPERATING EXPENSES: Research and development 3,257,756 1,886,253 General and administrative 748,208 757,222 ----------- ----------- 4,005,964 2,643,475 ----------- ----------- LOSS FROM OPERATIONS (4,005,964) (2,643,475) ----------- ----------- OTHER INCOME (EXPENSE): Interest income (expense), net (50,509) 66,591 Other income (expense) -- (4,603) ----------- ----------- Total other income (expense) (50,509) 61,988 ----------- ----------- NET LOSS $(4,056,473) $(2,581,487) =========== =========== BASIC AND DILUTED LOSS PER SHARE $ (0.63) $ (0.47) =========== =========== BASIC AND DILUTED WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 6,444,026 5,493,280 =========== =========== The accompanying notes are an integral part of these condensed consolidated statements. 5 6 NEOTHERAPEUTICS, INC. AND SUBSIDIARIES (A Development-Stage Enterprise) CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 AND FOR THE PERIOD FROM INCEPTION (JUNE 15, 1987) TO JUNE 30, 1999 Six Months Six Months Inception Ended Ended Through June 30, June 30, June 30, 1999 1998 1999 ----------- ------------ ------------ (Unaudited) (Unaudited) (Unaudited) REVENUES, from grants $ -- $ -- $ 497,128 ----------- ------------ ------------ OPERATING EXPENSES: Research and development 6,565,188 3,674,215 22,582,289 General and administrative 1,844,643 1,497,511 10,737,531 ----------- ------------ ------------ 8,409,831 5,171,726 33,319,820 ----------- ------------ ------------ LOSS FROM OPERATIONS (8,409,831) (5,171,726) (32,822,692) ----------- ------------ ------------ OTHER INCOME (EXPENSE): Interest income (expense), net (65,240) 95,362 499,406 Other income (expense) -- (13,414) 27,435 ----------- ------------ ------------ Total other income (expense) (65,240) 81,948 526,841 ----------- ------------ ------------ NET LOSS $(8,475,071) $ (5,089,778) $(32,295,851) =========== ============ ============ BASIC AND DILUTED LOSS PER SHARE $ (1.40) $ (0.93) =========== ============ BASIC AND DILUTED WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 6,036,187 5,482,487 =========== ============ The accompanying notes are an integral part of these condensed consolidated statements. 6 7 NEOTHERAPEUTICS, INC. AND SUBSIDIARIES (A Development-Stage Enterprise) CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998 AND FOR THE PERIOD FROM INCEPTION (JUNE 15, 1987) TO JUNE 30, 1999 Six Months Six Months Inception Ended Ended Through June 30, June 30, June 30, 1999 1998 1999 ----------- ----------- ------------ (Unaudited) (Unaudited) (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) $(8,475,071) $(5,089,778) $(32,295,851) Adjustments to reconcile net loss to net cash used in operating activities Depreciation and amortization 252,055 224,630 1,117,957 Issuance of common stock, options and warrants for services 332,143 184,382 1,023,357 Amortization of deferred compensation -- -- 93,749 Increase in deferred rent 14,406 23,154 60,714 Compensation expense for extension of Debt Conversion Agreements, net -- -- 503,147 Gain on sale of assets -- -- (5,299) (Increase) decrease in other receivables (10,085) 174,864 (122,391) Decrease (increase) in prepaid expenses, deferred charges and refundable deposits 19,421 (11,175) (480,864) Increase in accounts payable and accrued expenses 436,866 72,871 1,875,920 Increase in accrued payroll and related taxes 14,413 77,796 734,477 Increase in employee expense reimbursement and accrued interest to related parties -- -- 300,404 ----------- ----------- ------------ Net cash used in operating activities (7,415,852) (4,343,256) (27,194,680) ----------- ----------- ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (313,825) (135,562) (4,386,175) Purchases of marketable securities and short-term investments, net (251,044) (132,146) (2,020,392) Unrealized gain (loss) on available-for-sale securities 2,497 (4,009) 26,704 Payment of organization costs -- -- (66,093) Proceeds from sale of equipment -- -- 29,665 Issuance of notes receivable -- -- 100,000 ----------- ----------- ------------ Net cash used in investing activities (562,372) (271,717) (6,316,291) ----------- ----------- ------------ 7 8 NEOTHERAPEUTICS, INC. AND SUBSIDIARIES (A Development-Stage Enterprise) CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Six Months Six Months Inception Ended Ended Through June 30, June 30, June 30, 1999 1998 1999 ----------- -------------- ------------ (Unaudited) (Unaudited) (Unaudited) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from common stock issuance including Revenue Participation Units converted to common stock 4,933,369 426,420 28,602,954 Proceeds from preferred stock issuance, net of offering costs 3,614,504 -- 3,614,504 Dividends on preferred stock (82,312) -- (82,312) Repayment of bank line of credit -- (850,000) -- Decrease in restricted cash -- 935,000 -- Proceeds from long-term debt 33,786 -- 1,860,411 Repayment of long-term debt (258,239) (46,468) (513,393) Proceeds from exercise of stock options 91,905 -- 808,985 Receipt of notes from officers and directors for exercise of stock options -- -- (286,560) Proceeds from notes payable to related parties, net -- -- 757,900 Cash at acquisition -- -- 200,612 ----------- -------------- ------------ Net cash provided by financing activities 8,333,013 464,952 34,963,101 ----------- -------------- ------------ Net increase (decrease) in cash and cash equivalents 354,789 (4,150,021) 1,452,130 Cash and cash equivalents, beginning of period 1,097,341 6,063,347 -- ----------- -------------- ------------ Cash and cash equivalents, end of period $ 1,452,130 $ 1,913,326 $ 1,452,130 =========== ============== ============ SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Conversion of accrued payroll into shares of common stock $ -- $ -- $ 1,141,838 =========== ============== ============ Conversion of notes payable to related parties into shares of common stock $ -- $ -- $ 500,000 =========== ============== ============ Conversion of accrued interest into notes payable to related parties $ -- $ -- $ 300,404 =========== ============== ============ Conversion of Revenue Participation Units into shares of common stock $ -- $ -- $ 676,000 =========== ============== ============ Conversion of preferred stock into shares of common stock $ 722,900 $ -- $ 722,900 =========== ============== ============ Issuance of stock options and warrants for services $ 332,143 $ 134,442 $ 1,023,357 =========== ============== ============ Issuance of warrants in connection with equity and debt financings $ 344,610 $ -- $ 389,610 =========== ============== ============ Conversion of other accrued liabilities to shares of common stock $ -- $ -- $ 52,104 =========== ============== ============ Dividends on preferred stock payable in shares of common stock $ 82,312 $ -- $ 82,312 =========== ============== ============ The accompanying notes are an integral part of these condensed consolidated statements. 8 9 NEOTHERAPEUTICS, INC. AND SUBSIDIARIES (A Development-Stage Enterprise) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999 (Unaudited) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND NATURE OF BUSINESS In the opinion of the Company's management, the accompanying unaudited condensed consolidated financial statements include all adjustments (which consist only of normal recurring adjustments) necessary for a fair presentation of its consolidated financial position at June 30, 1999, and consolidated results of operations and cash flows for the periods presented. Although the Company believes that the disclosures in these financial statements are adequate to make the information presented not misleading, certain information and disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted and should be read in conjunction with the Company's audited financial statements included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998 as filed with the Securities and Exchange Commission. Results of operations for interim periods are not necessarily indicative of results to be expected for the full year. NeoTherapeutics, Inc. (the "Company") was incorporated in Colorado as Americus Funding Corporation ("AFC") in December 1987. In August 1996, AFC changed its name to "NeoTherapeutics, Inc." and in June 1997, the Company was reincorporated in the state of Delaware. The Company has two wholly-owned subsidiaries, Advanced ImmunoTherapeutics, Inc., incorporated in California in June 1987, and NeoTherapeutics, GmbH, incorporated in Switzerland in April 1997. All references to the "Company" hereinafter refer to NeoTherapeutics, Inc. and its subsidiaries as a consolidated entity. The Company is a development-stage biopharmaceutical enterprise engaged in the discovery and development of novel therapeutic drugs intended to treat neurodegenerative diseases and conditions such as memory deficits associated with Alzheimer's disease and dementia, stroke, spinal cord injuries, Parkinson's disease, migraine, depression and obesity. The accompanying condensed consolidated financial statements include the results of the Company and its wholly-owned subsidiaries. The Company believes that its existing capital resources, including the $9.5 million proceeds (before payment of offering expenses) realized from the sale of 1,150,000 shares of common stock on July 30, 1999, will be adequate to fund its capital needs for at least 12 months. The Company also believes that it will require substantial additional funds in order to complete the research and development activities currently contemplated and to commercialize its proposed products. In order for the Company to continue to operate through the end of the year 2000, it will need to raise additional funds. While the Company intends to pursue the raising of such funds, there can be no assurance that the Company will be successful in these efforts. 9 10 NEOTHERAPEUTICS, INC. AND SUBSIDIARIES (A Development-Stage Enterprise) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. COMMITMENTS AND CONTINGENCIES Research and Fellowship Grants The Company periodically makes non-binding commitments to various universities and not-for-profit research organizations to fund scientific research and fellowship grants that may further the Company's research programs. As of June 30, 1999, the Company has committed to pay, through December 2000, approximately $570,000 for such grants and fellowships. Grant expense for the six-month periods ended June 30, 1999 and 1998, amounted to $308,500 and $248,000, respectively. 3. STOCKHOLDERS' EQUITY Common Stock On May 11, 1999, the Company completed a private placement of 400,000 shares of common stock, and warrants to purchase 80,000 shares of common stock to a group of private investors for a total purchase price of $4.0 million. Each warrant entitles the investor to purchase one share of common stock at an exercise price of $15.00 per share. The shares of common stock sold to the investors, and the shares issuable upon exercise of the warrants, may be resold in compliance with the provisions of Rule 144 under the Securities Act of 1933, including the one year holding period requirement of said Rule. During May 1999, the Company issued 12,500 shares of common stock to its legal counsel, in consideration for legal services rendered in the amount of $70,000, and a warrant to purchase 25,000 shares of common stock at an exercise price of $11.40 per share in consideration for a discount of 15% on fees for legal services rendered during the months of March through December 1999. The warrant expires May 17, 2004, and may be called by the Company if the closing price of the common stock remains at $22.80 per share or above for any 10 consecutive trading days. The fair value of the warrant is equal to the aforementioned discount, which is recorded as invoices are presented from the legal counsel. For the six months ended June 30, 1999, the total value of the aforementioned legal services rendered in exchange for these shares and the warrant was $121,704. The shares of common stock issued for the aforementioned services and the shares issuable upon exercise of the warrants, may be resold in compliance with the provisions of Rule 144 under the Securities Act of 1933, including the one year holding period requirement of said Rule. Preferred Stock On June 18, 1999, the holders of the Company's preferred stock exercised their conversion privilege and exchanged 80 shares of preferred stock for 68,434 shares of common stock at the conversion price of $11.69 per share. 10 11 4. STOCK OPTIONS Stock option activity during the six month period ended June 30, 1999 are as follows: Option Shares Price --------- ------------- Outstanding at January 1, 1999 853,873 $0.025-$12.875 Granted 320,000 10.25-13.00 Exercised (1,600) 4.50-8.875 Forfeited -- -- --------- -------------- Outstanding at June 30, 1999 1,172,273 $0.025-$13.00 ========= ============== During the six month periods ended June 30, 1999 and 1998, the Company recognized compensation expense for vested consultants options pursuant to SFAS 123 aggregating $332,143 and $184,382, respectively. Options granted to consultants consist of options that vest both immediately and upon the occurrence of certain events as specified in the related agreements. 5. EQUITY TRANSACTION SUBSEQUENT TO JUNE 30, 1999 On July 13, 1999, the holders of the Company's preferred stock exercised their conversion privilege and exchanged 70 shares of preferred stock for 54,390 shares of common stock at the conversion price of $12.875 per share. On July 30, 1999, pursuant to a registration statement filed with the Securities and Exchange Commission on June 3, 1999, as amended, the Company sold 1,150,000 shares of common stock to the public, including the underwriters'15% overallotment, at a price of $9.375 per share, before deducting underwriters' discounts and commissions. The Company realized proceeds of approximately $9,545,000 from this offering, before deducting certain expenses of the offering estimated to aggregate approximately $700,000 of which approximately $307,100 had been incurred through June 30, 1999, and is shown in the accompanying financial statements as a prepaid expense. 11 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL POSITION PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company's actual results may differ materially from the results projected in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed below under "Factors Affecting Future Operating Results," as well as in the Company's Annual Report on Form 10-K for the year ended December 31, 1998 under Item 1, "Description of Business - Risk Factors," and in the Company's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on June 3, 1999, as amended, under "Risk Factors." RESULTS OF OPERATIONS Overview: From the inception of the Company in 1987 through June 30, 1999, the Company incurred a cumulative net loss of approximately $32.3 million. The Company expects its operating expenses to increase over the next several years as it continues to expand its research and development and commercialization activities and operations. The Company expects to incur significant additional operating losses for at least the next several years unless such operating losses are offset, if at all, by licensing revenues under strategic alliances with larger pharmaceutical companies which the Company is seeking currently. Three Months Ended June 30, 1999 Compared to Three Months Ended June 30, 1998: There were no revenues during the three months ended June 30, 1999 or the three months ended June 30, 1998. Research and development expenses for the three months ended June 30, 1999 increased approximately $1,372,000 or 41% over the same period in 1998. Current period increases were due primarily to costs and expenses associated with the conduct of clinical and preclinical trials as the Company continued the acceleration of its program to commercialize its lead compound, NEOTROFIN(TM). These costs and expenses were attributable primarily to increases in the number and duration of outside clinical and preclinical trials, as well as the costs of manufacturing and formulation by the Company's contract manufacturer of NEOTROFIN(TM) and other compounds used in the Company's research and testing programs. In the same period in 1998, the Company had not yet commenced its Phase 2 clinical trials or any of its major long-term preclinical trials. The Company expects its research and development expenses to continue to increase as it expands its laboratories and increases its internal product development and external preclinical and clinical trial activities. General and administrative expenses decreased approximately $9,000 or 1% from the same period in 1998. The Company expects general and administrative expenses to increase in future periods in support of the expected increases in research and development activities as well as sales and marketing activities should the Company successfully bring one or more of its products to market. Net interest expense increased by approximately $112,000 due to the use of invested funds in operations and increased interest expense on higher levels of borrowings. The 12 13 Company expects its net interest expense to decrease in the next quarter due to the reduction of its debt and increase in invested funds from its July 1999 equity financing. Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998: There were no revenues during the six months ended June 30, 1999 or the six months ended June 30, 1998. Research and development expenses for the six months ended June 30, 1999 increased approximately $2,891,000 or 79% over the same period in 1998. Current period increases were due primarily to costs and expenses associated with the conduct of clinical and preclinical trials as the Company continued the acceleration of its program to commercialize its lead compound, NEOTROFIN(TM). These costs and expenses were attributable primarily to increases in the number and duration of outside clinical and preclinical trials, as well as the costs of manufacturing and formulation by the Company's contract manufacturer of NEOTROFIN(TM) and other compounds used in the Company's research and testing programs. In the same period in 1998, the Company had not yet commenced its Phase 2 clinical trials or any of its major long-term preclinical trials. The Company expects its research and development expenses to continue to increase as it expands its laboratories and increases its internal product development and external preclinical and clinical trial activities. General and administrative expenses increased approximately $347,000 or 23% from the same period in 1998 due primarily to professional fees, investor and public relations fees, travel and printing costs. The Company expects general and administrative expenses to increase in future periods in support of the expected increases in research and development activities as well as sales and marketing activities should the Company successfully bring one or more of its products to market. Net interest expense increased by approximately $160,000 due to the use of invested funds in operations and increased interest expense on higher levels of borrowings. The Company expects its net interest expense to decline over the next quarter due to the equity financing obtained in July 1999 and the reduction of debt levels due to principal repayments on its outstanding loans. LIQUIDITY AND CAPITAL RESOURCES From inception through June 30, 1999, the Company financed its operations primarily through government grants, sales of equity securities, borrowings and deferred payment of salaries and other expenses due to related parties. During September and October 1996, the Company effected the public sale of a total of 2,700,000 units of its common stock and attached warrants to the public. Each unit consisted of one share of common stock and one warrant to purchase one share of common stock. The aggregate net proceeds of this offering amounted to approximately $18.2 million. In March 1998, the Company entered into an Equity Line Agreement with a private investor which allows the Company, in its sole discretion and subject to certain restrictions, to sell ("put") to the investor, through February 2001, up to $15 million of the Company's common stock. Through June 30, 1999, the Company has put to the investor 615,868 shares of its common stock and realized gross proceeds of $4.5 million. As of June 30, 1999, $10.5 million remains available under the Equity Line Agreement. In April 1999, the Company's registration statement permitting the investor resale rights expired and the Company is in the process of renewing the registration statement for an additional 900,000 shares. 13 14 On January 29, 1999, the Company sold to two private investors $4.0 million of 5% Series A preferred stock with Conversion Features. A second tranche of $2.0 million remains available, subject to the satisfaction by the Company of certain conditions, to sell to the investors during the period of July 28, 1999 through September 16, 1999. The initial tranche of $4.0 million is convertible into common stock at the lesser of the fixed price or at a variable rate of 101% of the average market price for the ten lowest of the thirty trading days immediately preceding the conversion date. On June 18, 1999, the holders of the preferred shares exercised their conversion right and exchanged 80 preferred shares for 68,434 shares of common stock. On July 13, 1999, 70 preferred shares were converted into 54,390 shares of common stock. Dividends on the preferred stock are payable in cash or in common stock, at the option of the Company, at the annual rate of 5%, except that dividends accrued on shares converted into common stock are payable in cash at the time of conversion. At June 30, 1999, accrued dividends amounted to $66,868. Additional features of the preferred stock issue include, among other things, a redemption feature at the Company's option if the common stock trades below or above a specified price per share. On May 11, 1999, the Company completed a private placement of units consisting of 400,000 shares of common stock, and five-year warrants to purchase 80,000 shares of common stock at an exercise price of $15.00 per share, to a group of private investors for a total purchase price of $4.0 million. The shares of common stock sold to the investors, and the shares issuable upon exercise of the warrants, may be resold in compliance with the provisions of Rule 144 under the Securities Act of 1933, including the one year holding period requirement of said Rule. At June 30, 1999, working capital amounted to approximately $1.2 million. This amount included cash and cash equivalents of approximately $1.5 million and marketable securities and short-term investments of approximately $2.0 million. In comparison, at December 31, 1998, the Company had working capital of approximately $1.0 million, which included cash and cash equivalents of approximately $1.1 million and short-term investments of approximately $1.8 million. The $0.2 million increase in working capital during the six months is attributable primarily to the sale of $4.0 million of preferred stock, the sale of $4.0 million of common stock in a private placement and the sale of $950,000 of common stock to a private investor under the Company's Line of Equity Agreement. These increases were offset by (i) the operating loss for the period, (ii) laboratory equipment purchases and (iii) long-term debt repayment. On July 30, 1999, pursuant to a registration statement filed with the Securities and Exchange Commission on June 3, 1999, as amended, the Company sold 1,150,000 shares of common stock to the public, including the underwriters'15% overallotment, at a price of $9.375 per share, before deducting underwriters' discounts and commissions. The Company realized proceeds of approximately $9,545,000 from this offering, before deducting certain expenses of the offering estimated to aggregate approximately $700,000 of which approximately $307,100 had been incurred through June 30, 1999, and is shown in the accompanying financial statements as a prepaid expense. 14 15 The Company is funding a major clinical trial involving approximately 400 patients which is being conducted by an independent contract research organization in three foreign countries. The agreement with the contract research organization, which is cancelable by either party on thirty days notice, is expected to be completed by December 1999. The Company expects to spend between $4.0 and $5.0 million on this clinical trial, of which approximately $2.5 had been expended through June 30, 1999. During June 1999, the Company committed, on a non-binding basis, to fund an additional clinical trial to take place in the United States using the same independent research organization. Preliminary work on this additional trial commenced in June 1999. This additional clinical trial, which also involves the testing of approximately 400 patients, is expected to cost the Company between $7.0 and $8.0 million, of which approximately $0.2 million has been expended through June 30, 1999. As of June 30, 1999, the Company committed, on a non-binding basis, to provide approximately $570,000 through December 2000 for scientific research grants and fellowships to various universities and not-for-profit research organizations. The Company is in the development stage, devoting substantially all of its efforts to research and development. The Company has incurred cumulative losses of approximately $32.3 million through June 30, 1999, and expects to incur substantial losses over the next several years. In addition to the funds derived from its initial public offering and subsequent private and public equity offerings, the Company will require substantial additional funds in order to complete the research and development activities currently contemplated and to commercialize its proposed products. The Company's future capital requirements and availability of capital will depend upon many factors, including continued scientific progress in research and development programs, the scope and results of preclinical studies and clinical trials, the time and costs involved in obtaining regulatory approvals, the cost involved in filing, prosecuting and enforcing patent claims, the effect of competing technological developments, the cost of manufacturing scale-up, the cost of commercialization activities, and other factors which may not be within the Company's control. While the Company believes that its existing capital resources, including the $9.5 million proceeds (before payment of offering expenses) realized from the sale of 1,150,000 shares of common stock on July 30, 1999, will be adequate to fund its capital needs for at least 12 months, the Company also believes that it will require substantial additional funds in order to complete the research and development activities currently contemplated and to commercialize its proposed products. In order for the Company to continue to operate through the end of the year 2000, it will need to raise additional funds. While the Company intends to pursue the raising of such funds, there can be no assurance that the Company will be successful in these efforts. Without additional funding, the Company may be required to delay, reduce the scope of, eliminate one or more of its research and development projects, or obtain funds through arrangements with collaborative partners or others which may require the Company to relinquish rights to certain technologies, product candidates or products that the Company would otherwise seek to develop or commercialize on its own, and which could be on terms unfavorable to the Company. 15 16 YEAR 2000 READINESS DISCLOSURE All statements contained in the following section are "Year 2000 Readiness Disclosures" within the meaning of the Year 2000 Information and Disclosure Act. The Year 2000 issue (the "Year 2000 Issue") in computers arises from the common industry practice of using two digits to represent a date in computer software code and databases to enhance both processing time and save storage space. Therefore, when dates in the year 2000 and beyond are indicated and computer programs read the date "00", the computer may default to the year "1900" rather than the correct "2000". This could result in incorrect calculations, faulty data and computer shutdowns, which would cause disruptions of operations. In addition, the Year 2000 is a leap year and systems need to recognize it as such. The Company has developed a multi-phase program for Year 2000 Issues that consists of the following: (i) assessment of the corporate systems and operations of the Company that could be affected by the Year 2000 Issue, (ii) remediation of non-compliant systems and components, if any, and (iii) testing of systems and components following remediation. The Company has focused its Year 2000 compliance assessment program on four principal areas: (a) the Company's internal information technology system applications, including voice and data systems ("IT Systems"), (b) the Company's internal non-IT facilities systems, including embedded software in environmental controls, security systems, fire protection systems, elevators and public utility connections for gas, electric and telephone systems ("Facilities Systems"), (c) embedded and external software contained in laboratory and other equipment ("Equipment"), and (d) Year 2000 compliance by third parties with which the Company has a material relationship, such as significant vendors, financial institutions and insurers. The Company has completed an inventory and risk assessment of its own internal IT Systems, Facilities Systems, and Equipment that it believes could be adversely affected by the Year 2000 Issue, and believes that its own internal systems are, at the present time, substantially compliant based upon internal systems tests, currently available information and reasonable assurance by its equipment and software vendors. The cost to remediate the Year 2000 Issues with regard to the Company's IT and Facility Systems and Equipment is not material. In June of 1998, the Company began sending questionnaires to and/or contacting its outside vendors regarding their state of readiness with respect to identifying and remediating their Year 2000 Issues. The Company has completed its risk assessment of its outside vendors and is currently reviewing their compliance. It is not possible for the Company to determine or be assured that adequate remediation of the Year 2000 Issue will be accomplished by such vendors. Furthermore, it is not possible for the Company to determine or be assured that third parties upon which the Company's vendors are dependent, will accomplish adequate remediation of their Year 2000 Issues. Except for the Company's public utility service vendors, who have indicated that they are now in compliance, the Company believes that, with respect to the computer systems of its major outside vendors, should a Year 2000 Issue exist whereby a vendor was unable to address the Company's needs, alternative vendors have been identified and are readily available that could furnish the Company with the same or similar supplies or services that it presently receives from these vendors without undue cost or expense. Based on currently available information, the Company believes that the impact of the Year 2000 Issue, as it relates to its IT Systems, Facilities Systems, Equipment and third parties, 16 17 will not be material. In the event the Company were to fail to implement successfully the Year 2000 Issues with respect to its internal systems in a timely manner, the Company believes that while such events would be disruptive to the Company's operations in the short term, such circumstances would not have a material adverse effect on the business, financial condition and results of operations of the Company over the long term. However, failure of the major third parties, in particular the financial institutions with which the Company has significant banking and investment management relationships and the Company's third party manufacturers, to be Year 2000 compliant could have a material adverse effect on the Company's business, financial condition and results of operations or business prospects. Readers are cautioned that most of the statements contained in the "Year 2000 Readiness Disclosure" paragraphs are forward-looking and should be read in conjunction with the Company's disclosures under the heading "PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS" set forth above. FACTORS AFFECTING FUTURE OPERATING RESULTS The future operating results of the Company are highly uncertain, and the following factors should be carefully reviewed in addition to the other information contained in this quarterly report on Form 10-Q: The Company has incurred losses in every year of its existence and expects to continue to incur significant operating losses for the next several years. The Company has never generated revenues from product sales and there is no assurance that revenue from product sales will ever be achieved. In addition, there is no assurance that any of the Company's proprietary products will ever be developed successfully, receive and maintain required governmental regulatory approvals, become commercially viable or achieve market acceptance. The Company has no experience in manufacturing, procuring products in commercial quantities or marketing, and only limited experience in negotiating, setting up or maintaining strategic relationships and conducting clinical trials or other late stage phases of the regulatory approval process, and there is no assurance that the Company will engage in any of these activities successfully. The Company's need for additional funding is expected to be substantial and will be determined by the progress and cost of the development and commercialization of its products and other activities. The Company believes that its existing capital resources will be sufficient to satisfy its current and projected funding requirements for at least the next twelve months. However, if the Company experiences unanticipated cash requirements during the interim period or fails to obtain sufficient funding under its Equity Line Agreement, the Company could require additional funds sooner. The source, availability, and terms of such funds have not been determined. Although funds may be received from the sale of equity securities or the exercise of outstanding warrants and options to acquire common stock of the Company, there is no assurance any such funding will occur. Factors impacting the future success of the Company include, among other things, the ability to develop products which will be safe and effective in treating neurological diseases and the ability to obtain government approval. 17 18 The Company faces numerous other risks in the operation of its business, including, but not limited to, protecting its proprietary technology and trade secrets and not infringing those of others; attaining a competitive advantage; entering into agreements with others to source, manufacture, market and sell its products; attracting and retaining key personnel in research and development, manufacturing, marketing, sales and other operational areas; managing growth, if any; and avoiding potential claims by others in such areas as product liability and environmental matters. The above factors are not intended to be inclusive. A more comprehensive list of factors which could affect the Company's future operating results can be found in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998, in Item 1, "Description of Business - Risk Factors," and in the Company's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on June 3, 1999, as amended, under "Risk Factors." Failure to satisfactorily achieve any of the Company's objectives or avoid any of the above or other risks would likely have a material adverse effect on the Company's business and results of operations. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK QUANTITATIVE DISCLOSURES The Company is exposed to certain market risks associated with interest rate fluctuations on its marketable securities and borrowing arrangements. All investments in marketable securities and borrowing arrangements are entered into for purposes other than trading. The Company is not subject to risks from currency rate fluctuations. In addition, the Company does not utilize hedging contracts or similar instruments. The Company's exposure to interest rate risk arises from financial instruments entered into in the normal course of business. Certain of the Company's financial instruments are fixed rate, short-term investments in government and corporate notes and bonds, which are available for sale (and have been marked to market in the accompanying financial statements). Changes in interest rates generally affect the fair value of these investments, however, because these financial instruments are considered "available for sale," all such changes are reflected in the financial statements in the period affected. The Company's borrowings bear interest at fixed annual rates. Changes in interest rates generally affect the fair value of such debt, but do not have an impact on earnings or cash flows. Because of the relatively short-term nature of the Company's borrowings, fluctuations in fair value are not deemed to be material. 18 19 QUALITATIVE DISCLOSURES The Company's primary exposures relate to (1) interest rate risk on its borrowings, (2) the Company's ability to pay or refinance its borrowings at maturity at market rates, (3) interest rate risk on the value of the Company's investment portfolio and rate of return, (4) the impact of interest rate movements on the Company's ability to obtain adequate financing to fund future cash requirements. The Company manages interest rate risk on its investment portfolio by matching scheduled investment maturities with its cash requirements. The Company manages interest rate risk on its outstanding borrowings by using fixed rate debt. While the Company cannot predict or manage its ability to refinance existing borrowings and investment portfolio, management evaluates the Company's financial position on an ongoing basis. 19 20 PART II OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS RECENT SALES OF UNREGISTERED SECURITIES On May 11, 1999, the Company completed a private placement of 400,000 shares of common stock, and warrants to purchase 80,000 shares of common stock at an exercise price of $15.00 per share, to a group of private investors for a total purchase price of $4.0 million. The warrants expire May 10, 2004, and may be called by the Company if the closing price of the common stock remains at $30.00 per share or above for any 20 out of any 30 consecutive trading days. The shares of common stock sold to the investors, and the shares issuable upon exercise of the warrants, may be resold in compliance with the provisions of Rule 144 under the Securities Act of 1933, including the one year holding period requirement of said Rule. During May 1999, the Company issued 12,500 shares of common stock to its legal counsel, in consideration for legal services rendered in the amount of $70,000, and a warrant to purchase 25,000 shares of common stock at an exercise price of $11.40 per share in consideration for a discount of 15% on fees for legal services rendered during the months of March through December, 1999. The warrant expires May 17, 2004, and may be called by the Company if the closing price of the common stock remains at $22.80 per share or above for any 10 consecutive trading days. The shares of common stock issued for the aforementioned services and the shares issuable upon exercise of the warrants, may be resold in compliance with the provisions of Rule 144 under the Securities Act of 1933, including the one year holding period requirement of said Rule. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The following matters were voted upon at the Annual Meeting of Stockholders of the Company held on June 14, 1999: 1. The following persons were elected as Class II directors to serve for a two-year term expiring at the Annual Meeting of Stockholders to be held in 2001 or until their successors are elected and qualified: Name Number of Votes Cast ---- ----------------------------------- For Authority Withheld --------- ------------------ Alvin J. Glasky, Ph.D. 5,588,967 291,640 Mark J. Glasky 5,588,967 291,640 Carol O'Cleireacain, Ph.D. 5,588,967 291,640 Joseph Rubinfeld, Ph.D. 5,588,967 291,640 20 21 2. A proposal to approve the issuance of common stock pursuant to conversion rights under a preferred stock financing transaction was approved by the following vote: Votes Cast Number of Shares ---------- ---------------- For 3,064,889 Against 229,723 Abstain 121,238 Broker Non-Votes 2,464,757 3. A proposal to approve the issuance of common stock pursuant to a private equity line of credit agreement was approved by the following vote: Votes Cast Number of Shares ---------- ---------------- For 3,122,445 Against 319,011 Abstain 33,137 Broker Non-Votes 2,406,014 4. A proposal to approve an increase in the number of shares of common stock issuable under the Company's 1997 Stock Incentive Plan by 750,000 was approved by the following vote: Votes Cast Number of Shares ---------- ---------------- For 3,021,284 Against 277,718 Abstain 116,848 Broker Non-Votes 2,464,757 21 22 5. A proposal to consider and act upon the ratification of the selection of Arthur Anderson LLP as independent public accountants of the Company for the current fiscal year was approved by the following vote: Votes Cast Number of Shares ---------- ---------------- For 5,680,415 Against 193,292 Abstain 6,900 22 23 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27. Financial Data Schedule (b) Reports on Form 8-K None 23 24 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NEOTHERAPEUTICS, INC. Date: August 6, 1999 By: /s/ ALVIN J. GLASKY -------------------------------------- Alvin J. Glasky, Ph.D., President Date: August 6, 1999 By: /s/ SAMUEL GULKO -------------------------------------- Samuel Gulko, Chief Financial Officer (Principal Accounting and Financial Officer) 24 25 EXHIBIT INDEX Exhibit Number Description - ------ ----------- 27 Financial Data Schedule