SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 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 September 30, 1997 / / 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 0-20081 PRUTECH RESEARCH AND DEVELOPMENT PARTNERSHIP III - -------------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) California 77-0129484 - -------------------------------------------------------------------------------- (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 440 Mission Court, Suite 250, Fremont, California 94539 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (510) 656-1855 N/A - -------------------------------------------------------------------------------- Former name, former address and former fiscal year, if changed since last report 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 _CK_ No __ Part I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS PRUTECH RESEARCH AND DEVELOPMENT PARTNERSHIP III (a limited partnership) STATEMENTS OF FINANCIAL CONDITION (Unaudited) September 30, December 31, 1997 1996 - ---------------------------------------------------------------------------------------------------- ASSETS Cash and cash equivalents $ 2,478,450 $ 2,342,441 Investments in equity securities 1,999,476 13,321,925 ------------- ------------ Total assets $ 4,477,926 $15,664,366 ------------- ------------ ------------- ------------ LIABILITIES AND PARTNERS' CAPITAL Liabilities Accrued management fee $ 62,500 $ 204,670 Accrued expenses and other liabilities 79,910 80,438 ------------- ------------ Total liabilities 142,410 285,108 ------------- ------------ Contingencies Partners' capital Unitholders (40,934 units issued and outstanding) 2,742,770 8,312,200 General partner 312,491 931,316 Unrealized gain on investments in equity securities 1,280,255 6,135,742 ------------- ------------ Total partners' capital 4,335,516 15,379,258 ------------- ------------ Total liabilities and partners' capital $ 4,477,926 $15,664,366 ------------- ------------ ------------- ------------ - ---------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of these statements 2 PRUTECH RESEARCH AND DEVELOPMENT PARTNERSHIP III (a limited partnership) STATEMENTS OF OPERATIONS (Unaudited) Nine months ended Three months ended September 30, September 30, ------------------------- ------------------------- 1997 1996 1997 1996 - ----------------------------------------------------------------------------------------------------- REVENUES Gain on sale of investments in equity securities $7,090,925 $3,621,513 $1,404,674 $ -- Interest and other income 89,720 33,994 33,921 7,013 Royalty income -- 216,665 -- -- ---------- ---------- ---------- ---------- 7,180,645 3,872,172 1,438,595 7,013 ---------- ---------- ---------- ---------- EXPENSES Management fee 471,840 614,010 62,500 204,670 Write-down of investments in equity securities 295,000 -- -- -- General and administrative 94,449 77,381 41,799 26,430 ---------- ---------- ---------- ---------- 861,289 691,391 104,299 231,100 ---------- ---------- ---------- ---------- Net income (loss) $6,319,356 $3,180,781 $1,334,296 $ (224,087) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ALLOCATION OF NET INCOME (LOSS) Unitholders $5,687,420 $2,862,703 $1,200,866 $ (201,678) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- General partner $ 631,936 $ 318,078 $ 133,430 $ (22,409) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Net income (loss) per unit $ 138.94 $ 69.93 $ 29.34 $ (4.93) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- - ----------------------------------------------------------------------------------------------------- STATEMENT OF CHANGES IN PARTNERS' CAPITAL (Unaudited) UNREALIZED GENERAL GAIN ON UNITHOLDERS PARTNER INVESTMENTS TOTAL - ----------------------------------------------------------------------------------------------------- Partners' capital--December 31, 1996 $8,312,200 $ 931,316 $6,135,742 $15,379,258 Net income 5,687,420 631,936 -- 6,319,356 Distributions (11,256,850) (1,250,761) -- (12,507,611) Change in unrealized gain on investments in equity securities -- -- (4,855,487 ) (4,855,487) ----------- ----------- ----------- ----------- Partners' capital--September 30, 1997 $2,742,770 $ 312,491 $1,280,255 $ 4,335,516 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- - ----------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of these statements 3 PRUTECH RESEARCH AND DEVELOPMENT PARTNERSHIP III (a limited partnership) STATEMENTS OF CASH FLOWS (Unaudited) Nine months ended September 30, ---------------------------- 1997 1996 - ---------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Interest and other income received $ 89,720 $ 33,994 Management fee paid (614,010) (614,010) General and administrative expenses paid (94,977) (79,870) Royalty income received -- 216,665 Cash received for other asset -- 216,669 ------------ ----------- Net cash used in operating activities (619,267) (226,552) ------------ ----------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from the sale of investments in equity securities 13,321,537 3,660,056 Purchase of investments in equity securities (58,650) -- ------------ ----------- Net cash provided by investing activities 13,262,887 3,660,056 ------------ ----------- CASH FLOWS FROM FINANCING ACTIVITIES Distributions (12,507,611) (3,638,578) ------------ ----------- Net increase (decrease) in cash and cash equivalents 136,009 (205,074) Cash and cash equivalents at beginning of period 2,342,441 480,692 ------------ ----------- Cash and cash equivalents at end of period $ 2,478,450 $ 275,618 ------------ ----------- ------------ ----------- RECONCILIATION OF NET INCOME TO NET CASH USED IN OPERATING ACTIVITIES Net income $ 6,319,356 $ 3,180,781 ------------ ----------- Adjustments to reconcile net income to net cash used in operating activities: Gain on sale of investments in equity securities (7,090,925) (3,621,513) Write-down of investments in equity securities 295,000 -- Changes in: Accrued management fee (142,170) -- Accrued expenses and other liabilities (528) (2,489) Other asset -- 216,669 ------------ ----------- Total adjustments (6,938,623) (3,407,333) ------------ ----------- Net cash used in operating activities $ (619,267) $ (226,552) ------------ ----------- ------------ ----------- - ---------------------------------------------------------------------------------------------------- SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES 1997 On June 2, 1997, Cell Genesys Corporation acquired Somatix Therapy Corporation. As a result, the Partnership received 111,265 shares of Cell Genesys Corporation common stock or 0.385 shares for each of its 289,000 shares of Somatix Therapy Corporation common stock. - ---------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of these statements 4 PRUTECH RESEARCH AND DEVELOPMENT PARTNERSHIP III (a limited partnership) NOTES TO FINANCIAL STATEMENTS SEPTEMBER 30, 1997 (Unaudited) A. General These financial statements have been prepared without audit. In the opinion of management, the financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of PruTech Research and Development Partnership III (the 'Partnership') as of September 30, 1997, the results of its operations for the nine and three months ended September 30, 1997 and 1996 and its cash flows for the nine months ended September 30, 1997 and 1996. However, the operating results for the interim periods may not be indicative of the results expected for the full year. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been omitted. It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto included in the Partnership's Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 1996. Certain balances for prior periods have been reclassified to conform with the current financial statement presentation. B. Investments Investments in marketable equity securities available-for-sale include the following: September 30, 1997 December 31, 1996 ------------------------------------------------------ ------------------------------------------------------ Gross unrealized Carrying Gross unrealized Carrying Shares Cost basis gains value Shares Cost basis gains value - ----------------------------------------------------------------------- ------------------------------------------------------ Creative BioMolecules, Inc.-Common Stock 54,484 $178,296 $ 407,407 $ 585,703 509,382 $1,666,928 $ 3,617,910 $ 5,284,838 Kopin Corporation- Common Stock 45,116 337,470 767,879 1,105,349 537,333 4,019,255 2,361,582 6,380,837 Cell Genesys Corporation- Common Stock 39,165 203,455 104,969 308,424 -- -- -- -- Somatix Therapy Corporation- Common Stock -- -- -- -- 500,000 1,500,000 156,250 1,656,250 ---------- ---------------- ------------- ---------- ---------------- ------------ $719,221 $1,280,255 $ 1,999,476 $7,186,183 $ 6,135,742 $ 13,321,925 ---------- ---------------- ------------- ---------- ---------------- ------------ ---------- ---------------- ------------- ---------- ---------------- ------------ The gross unrealized gains would be allocated 90% to the Unitholders and 10% to R&D Funding Corp (the 'General Partner') if realized at September 30, 1997; however, there is no assurance that the Partnership would receive these amounts in the event of the sale of its position in these securities. Creative BioMolecules, Inc. During the first quarter of 1997, the Partnership sold 441,898 shares of Creative BioMolecules, Inc. common stock with a cost basis of $1,446,000 resulting in a gain of $3,573,000, and the Partnership exercised its option to purchase 6,900 shares of Creative BioMolecules, Inc. common stock at an exercise price of $8.50 per share for a total cost of $59,000. During the third quarter of 1997, the Partnership sold 19,900 shares of Creative BioMolecules, Inc. common stock with a cost basis of $101,000 resulting in a gain of $89,000. Between October 1, 1997 and November 7, 1997, the Partnership sold 30,000 shares of Creative BioMolecules, Inc. common stock as discussed in Note E. Kopin Corporation During the first quarter of 1997, the Partnership sold 173,189 shares of Kopin Corporation common stock with a cost basis of $1,295,000 resulting in a gain of $1,002,000. During the second quarter of 1997, the 5 Partnership sold 219,274 shares of Kopin Corporation common stock with a cost basis of $1,640,000 resulting in a gain of $1,208,000. During the third quarter of 1997, the Partnership sold 99,754 shares of Kopin Corporation common stock with a cost basis of $746,000 resulting in a gain of $1,230,000. Between October 1, 1997 and November 7, 1997, the Partnership sold 27,473 shares of Kopin Corporation common stock as discussed in Note E. Somatix Therapy Corporation/Cell Genesys Corporation During the first quarter of 1997, the Partnership sold 205,000 shares of Somatix Therapy Corporation common stock with a cost basis of $615,000 resulting in a loss of $98,000. At March 31, 1997, the General Partner concluded that an impairment in value that was not temporary had occurred for the Partnership's equity investment in Somatix Therapy Corporation. As a result, the value of the Partnership's common stock was written down by $295,000. During the second quarter of 1997, the Partnership sold 6,000 shares of Somatix Therapy Corporation common stock with a cost basis of $12,000 resulting in no gain or loss to the Partnership. On June 2, 1997, Cell Genesys Corporation acquired Somatix Therapy Corporation. As a result, the Partnership received 111,265 shares of Cell Genesys Corporation common stock or 0.385 shares for each of its 289,000 shares of Somatix Therapy Corporation common stock. During the third quarter of 1997, the Partnership sold 72,100 shares of Cell Genesys Corporation common stock with a cost basis of $375,000 resulting in a gain of $86,000. Between October 1, 1997 and November 7, 1997, the Partnership sold 20,400 shares of Cell Genesys Corporation common stock as discussed in Note E. C. Related Parties The General Partner and its affiliates perform certain services for the Partnership (for which they are reimbursed through the management fee) which include, but are not limited to: accounting and financial management; registrar, transfer and assignment functions; asset management; investor communications and other administrative services. The Partnership also reimburses an affiliate of the General Partner for printing services. The management fee and printing costs were: Nine months ended Three months ended September 30, September 30, --------------------- -------------------- 1997 1996 1997 1996 - ------------------------------------------------------------------------- Management fee $471,840 $614,010 $62,500 $204,670 Printing 9,735 8,957 3,150 3,032 -------- -------- ------- -------- $481,575 $622,967 $65,650 $207,702 -------- -------- ------- -------- -------- -------- ------- -------- Effective July 1, 1997, the General Partner reduced its management fee to the greater of (a) $250,000 annually or (b) ten percent of the aggregate amount received from the Partnership's royalty position in a treatment for Alzheimer's disease with Forest Laboratories, Inc. after July 1, 1997 until the dissolution and liquidation of the Partnership, not to exceed the aggregate management fee payable under the terms of the Agreement of Limited Partnership ($818,680 per annum). Printing costs payable to an affiliate of the General Partner (which are included in accrued expenses and other liabilities) as of September 30, 1997 and December 31, 1996 were $6,851 and $4,943, respectively. Prudential Securities Incorporated, an affiliate of the General Partner, owned 724 units in the Partnership at September 30, 1997. The Partnership maintains an account with the Prudential Institutional Liquidity Portfolio Fund, an affiliate of the General Partner, for investment of its available cash in short-term instruments pursuant to the guidelines established by the Partnership Agreement. The Partnership has engaged in research and development co-investment projects with PruTech Research and Development Partnership, PruTech Research and Development Partnership II and PruTech Project Development Partnership (collectively, the 'PruTech R&D Partnerships'), for which R&D Funding Corp serves as the general partner. The allocation of the co-investment projects' profits or losses among the 6 PruTech R&D Partnerships is consistent with the costs incurred to fund the research and development projects. D. Contingencies On April 15, 1994, a multiparty petition captioned Mack et al. v. Prudential Securities Incorporated et al. (Cause No. 94-17695) was filed in the 80th Judicial District Court of Harris County, Texas, purportedly on behalf of investors in the Partnership against the Partnership, the General Partner, Prudential Securities Incorporated, The Prudential Insurance Company of America and a number of other defendants. The petition alleges common law fraud and fraud in the inducement and negligent misrepresentation in connection with the offering of the Partnership; negligence and breach of fiduciary duty in connection with the operation of the Partnership; civil conspiracy; and violations of the federal Securities Act of 1933 (sections 11 and 12), and of the Texas Securities and Deceptive Trade Practices statutes. The suit seeks, among other things, compensatory and punitive damages, costs and attorneys' fees. The General Partner, Prudential Securities Incorporated and the Partnership believe they have meritorious defenses to the complaint and are vigorously defending themselves in this action. The claims of most plaintiffs have been settled or dismissed. It is currently expected that the remaining claims will be resolved shortly. The Partnership has not contributed to any settlement or paid any costs of the litigation, nor is it anticipated that it will. E. Subsequent Events Between October 1, 1997 and November 7, 1997, the Partnership sold 30,000, 27,473 and 20,400 shares of Creative BioMolecules, Inc. common stock, Kopin Corporation common stock, and Cell Genesys Corporation common stock for approximately $316,000, $646,000 and $189,000, respectively. These sales resulted in gains of approximately $217,000, $441,000 and $83,000, respectively. 7 PRUTECH RESEARCH AND DEVELOPMENT PARTNERSHIP III (a limited partnership) ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity and Capital Resources As of September 30, 1997, the Partnership had approximately $2,478,000 of cash and cash equivalents which is an increase of approximately $136,000 as compared to December 31, 1996. The increase in cash and cash equivalents was primarily due to proceeds from the sales of certain investments in equity securities as further discussed below reduced by the payment of distributions and management fees. As of September 30, 1997, the Partnership had approximately $719,000 invested in equity securities with an aggregate market value which exceeded its cost. Certain of these investments are in development stage companies which are more speculative and higher in risk than other equity investments. Additionally, the realization of this market value is further impacted by market volume capacity. The amount to be distributed by the Partnership in future quarters will be based on the extent to which the market value of its investments can be realized and from the revenue stream from royalties and interest income. It is not expected that the Partnership's eventual total distributions will equal the Unitholders initial investments. The Partnership's royalty positions with Forest Laboratories, Inc. and Creative BioMolecules, Inc. did not generate royalty income for the Partnership during the nine months ended September 30, 1997 and 1996. During the first quarter of 1997, the Partnership sold 441,898 shares of Creative BioMolecules, Inc. common stock for $5,019,000, and the Partnership exercised its option to purchase 6,900 shares of Creative BioMolecules, Inc. common stock at an exercise price of $8.50 per share for a total cost of $59,000. Also, during the first quarter of 1997, the Partnership sold 173,189 shares of Kopin Corporation common stock for $2,297,000, and 205,000 shares of Somatix Therapy Corporation common stock for $517,000. In February and March of 1997, the Partnership made distributions of $4,548,222 and $3,411,167, respectively. Unitholders received a total of $4,093,400 ($100 per unit) and $3,070,050 ($75 per unit) on these distributions, respectively, and the General Partner received the remainder. During the second quarter of 1997, the Partnership sold 219,274 shares of Kopin Corporation common stock for $2,848,000, and 6,000 shares of Somatix Therapy Corporation common stock for $12,000. On June 2, 1997, Cell Genesys Corporation acquired Somatix Therapy Corporation. As a result, the Partnership received 111,265 shares of Cell Genesys Corporation common stock or 0.385 shares for each of its 289,000 shares of Somatix Therapy Corporation common stock. During the third quarter of 1997, the Partnership sold 19,900 shares of Creative BioMolecules, Inc. common stock for $190,000, 99,754 shares of Kopin Corporation common stock for $1,976,000, and 72,100 shares of Cell Genesys Corporation common stock for $460,000. During August 1997, the Partnership made a $4,548,222 distribution, of which $4,093,400 ($100 per unit) was paid to the Unitholders, and the remainder to the General Partner. Between October 1, 1997 and November 7, 1997, the Partnership sold 30,000, 27,473, and 20,400 shares of Creative BioMolecules, Inc. common stock, Kopin Corporation common stock, and Cell Genesys Corporation common stock for approximately $316,000, $646,000, and $189,000, respectively. Results of Operations The Partnership's net income increased by approximately $3,139,000 and $1,558,000 for the nine and three months ended September 30, 1997 as compared to the same periods in 1996. These increases were primarily due to larger gains on the sale of investments in equity securities and to a reduction in management fees in 1997 versus 1996, offset, in part, by a 1997 write-down of the Partnership's equity investment in Somatix Therapy Corporation and 1996 royalty income from Kopin Corporation as discussed below. During the nine months ended September 30, 1997, the Partnership recorded gains on the sale of common stock totalling approximately $7,091,000, including gains of $3,662,000 and $3,440,000 on the sale of common stock of Creative BioMolecules, Inc. and Kopin Corporation, respectively. These gains 8 compared to a gain of approximately $3,622,000 on the sale of 75,000 shares of Forest Laboratories, Inc. common stock and 4,334 shares of Kopin Corporation common stock during the first quarter of 1996. Interest and other income increased by $56,000 and $27,000 for the nine and three month periods ended September 30, 1997, respectively, as compared to the same periods in 1996 due to higher amounts invested in short-term instruments funded from 1997 sales of securities. During the second quarter of 1996, the Partnership recorded $217,000 of royalty income as part of an agreement in which the Partnership agreed to transfer to Kopin Corporation its rights to certain technologies and royalties. As a result of the above, the Partnership holds no technology or royalty positions with Kopin Corporation and therefore, no further royalties will be received by the Partnership from Kopin Corporation. Management fees decreased by $142,000 for both the nine and three month periods ended September 30, 1997 as compared to the same periods in 1996. Effective July 1, 1997, the General Partner reduced its management fee to the greater of (a) $250,000 annually or (b) ten percent of the aggregate amount received from the Partnership's royalty position in a treatment for Alzheimer's disease with Forest Laboratories, Inc. after July 1, 1997 until the disolution and liquidation of the Partnership, not to exceed the aggregate management fee payable under the terms of the Agreement of Limited Partnership ($818,680 per annum). At March 31, 1997, the General Partner concluded that an impairment in value that was not temporary had occurred for the Partnership's equity investment in Somatix Therapy Corporation. As a result, the value of the Partnership's common stock was written down by $295,000. General and administrative expenses increased by $17,000 and $15,000 for the nine and three month periods ended September 30, 1997, respectively, as compared to the same periods in 1996. These increases were due primarily to professional and other costs incurred in 1997 in evaluating the orderly liquidation of the Partnership. 9 PART II. OTHER INFORMATION Item 1. Legal Proceedings--This information is incorporated by reference to Note D to the financial statements filed herewith in Item 1 of Part I of the Registrant's Quarterly Report. Item 2. Changes in Securities--None Item 3. Defaults Upon Senior Securities--None Item 4. Submission of Matters to a Vote of Security Holders--None Item 5. Other Information--None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits-- PruTech Research and Development Partnership III Agreement of Limited Partnership (incorporated by reference to Exhibit 3.1 included with Registrant's Form S-1 Registration Statement, File No. 33-6091, filed on June 3, 1986) First Amendment to the Agreement of Limited Partnership of PruTech Research and Development Partnership III (incorporated by reference to Exhibit 3 included with Registrant's Annual Report on Form 10-K filed March 28, 1992) Financial Data Schedule (filed herewith) (b) Reports on Form 8-K--Registrant's Current Report on Form 8-K dated September 17, 1997, as filed with the Securities and Exchange Commission on September 30, 1997, relating to Item 2 regarding the sale of 55,900 shares of Kopin Corporation common stock. 10 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. PruTech Research and Development Partnership III By: R&D Funding Corp A Delaware corporation, General Partner By: /s/ Michael S. Hasley Date: November 13, 1997 ---------------------------------------- Michael S. Hasley President for the Registrant By: R&D Funding Corp A Delaware corporation, General Partner By: /s/ Steven Carlino Date: November 13, 1997 ---------------------------------------- Steven Carlino Vice President and Chief Accounting Officer for the Registrant 11