1
Exhibit 13.1
1996 Annual Report to Shareholders (to be
deemed filed only to the extent required by the
instructions to exhibits for reports on Form 10-K).
2
EXHIBIT 13
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
o Overview
Since its inception in October 1989, DepoTech Corporation (the "Company") has
devoted substantially all of its resources to the development of its potential
products. To date, the Company has not received any revenues from the sale of
products. The Company has funded its development programs primarily from
equity-derived working capital and through strategic alliances with other
companies. The Company has been unprofitable since its inception and expects
to incur additional operating losses over at least the next 18 months. As of
December 31, 1996, the Company's accumulated deficit was approximately $42.4
million.
The following discussion is qualified in its entirety by the more detailed
information and the Financial Statements and Notes thereto appearing elsewhere
in this Annual Report, including information under "Risk and Uncertainties."
o Results of Operations
The Company had total revenues of $4.4 million for the year ended December 31,
1996 compared to $6.8 million for 1995 and $0.6 million for 1994. Total
revenues were principally attributed to the Company's collaborative agreement
with Chiron. Total revenues were primarily derived from reimbursement of 50%
of the clinical trial and manufacturing scale-up expenses for the Company's
lead product, DepoCyt, under the Chiron agreement. In addition, Chiron
reimbursed DepoTech for 100% of pre-clinical development costs for DepoIGF-1
and feasibility studies performed on their behalf. Total revenues in 1995
included a one-time marketing rights fee and reimbursement of prior year
clinical trial expenses for DepoCyt totaling $3.5 million, earned by the
Company upon achievement of a development milestone under the Chiron agreement.
Revenues from the reimbursement of clinical trial expenses from prior years and
the marketing rights fee were one time payments which will not re-occur in
future periods. Revenues may fluctuate from year to year depending on the
level of clinical and development activity for projects under collaborative
agreements with Chiron and other companies and the achievement of future
milestones.
Research and development expenses increased to $18.0 million for the year ended
December 31, 1996, from $12.7 million in 1995 and $7.4 million in 1994. Factors
contributing to these increases include substantial expansion in staff,
research and process development supplies, payments to clinical sites, and the
expansion of manufacturing and laboratory facilities and equipment depreciation
expense in support of clinical trials and manufacturing scale-up of products
under development. During 1996, DepoTech completed a Phase III clinical trial
for DepoCyt in the solid tumor indication and a Phase I clinical trial of
DepoAmikacin. The Company has Phase III clinical trials in progress for two
other indications of DepoCyt and has begun a Phase IV clinical trial. Other
pre-clinical development programs included DepoMorphine and DepoIGF-1. In
addition, the Company is evaluating the feasibility of developing several early
stage compounds. Research and development expenses are expected to continue to
increase in 1997 as a result of: (1) on-going or new clinical trials for
DepoCyt, DepoMorphine and DepoAmikacin; (2) manufacturing scale-up for
DepoMorphine and (3) preclinical development and feasibility efforts associated
with other potential DepoFoam products.
General and administrative expenses increased to $4.1 million during 1996 from
$2.8 million in 1995 and $1.9 million in 1994. The increases were primarily
due to expansion in administrative staffing, higher facility expenses and costs
associated with being a public company. Included in general and administrative
expenses for 1996 were 50% of the pre-launch expenses, or $0.6 million,
incurred for DepoCyt prior to the onset of any product revenue. Under the
collaborative agreement with Chiron, the Company is obligated to share in the
funding of these expenses. DepoCyt sales and marketing expenses are expected
to increase significantly in 1997 in anticipation of the possible launch of
DepoCyt. Other general and administrative expenses are expected to increase
modestly during 1997.
Interest income was $1.7 million for the year ended December 31, 1996 compared
to $1.1 million in 1995 and $0.3 million in 1994. The increases were
principally due to higher average cash investment balances and increases in
available market interest rates. Interest expense was $0.8 million for the
year ended December 31, 1996 compared to $0.4 million in 1995 and $0.1 million
in 1994. The increases in interest expense were due to higher balances
outstanding for obligations under capital leases and a note payable.
12
3
o Liquidity and Capital Resources
Since its inception, DepoTech has financed its operations primarily through
public and private placements of equity securities, which provided aggregate
net proceeds of approximately $67.5 million through December 31, 1996, and
through capital equipment lease financing. In October 1995, the Company
completed an initial public offering ("IPO") of common stock which raised net
proceeds of $38.1 million. In January 1997, the Company completed a private
placement of newly issued shares of common stock which raised net proceeds of
$19.1 million.
Working capital decreased to $14.9 million as of December 31, 1996 compared to
$35.4 million as of December 31, 1995. The decrease in working capital in 1996
was primarily due to cash used to fund operations of $15.0 million. As of
December 31, 1996, DepoTech had cash, cash equivalents and short-term
investments totaling $18.2 million. During 1996, the Company entered into an
agreement to expand an existing leaseline from $2.6 million to $5.1 million.
The incremental borrowing amount of $2.5 million was used principally to
finance certain tenant improvement and equipment costs incurred in 1996. In May
1996, the Company signed a bank credit facility for $9.0 million to finance
future capital equipment purchases, of which $2.2 million was utilized through
December 31, 1996. The Company believes the impact of inflation on its
business activities has not been significant to date.
Through December 31, 1996, the Company has invested an aggregate of $19.8
million in leasehold improvements and manufacturing, laboratory and office
equipment, of which $11.4 million has been funded through capital leases or
bank credit facilities. The Company intends to continue to fund capital
expenditures through external financing supplemented by internal cash resources
where appropriate. In September 1995, the Company occupied the initial phase
(50,000 square feet) of an 82,000 square foot build-to-suit facility housing
its administrative, research and clinical activities. DepoTech began paying
rent in mid-March 1996 for the remaining space (32,000 square feet) which is
intended to provide future manufacturing and process development capabilities.
The minimum rental commitment for this facility ranges from approximately $2.1
million to $4.3 million per year, over 20 years, based upon pre-established
annual rent increases. The Company is installing a manufacturing line in this
facility to support clinical and commercial production of DepoFoam products
under development. The cost of equipment and tenant improvement expenses are
estimated to total approximately $8.1 million through 1997. DepoTech intends
to finance such expenditures through new and existing bank credit facilities.
The Company has a right of first refusal and right of first offer to purchase
land located adjacent to its headquarters which must be exercised on or before
October 15, 1997. At present, the Company has not made a decision concerning
the exercise of such option.
The Company's operations to date have consumed substantial amounts of cash,
which is expected to continue over the foreseeable future. The amount of net
losses and the time required for the Company to achieve profitability are
highly uncertain. There can be no assurance that the Company will be able to
achieve profitability at all or on a sustained basis. It is the Company's
intention to fund product research and development, manufacturing, and sales
and marketing costs through additional collaborative relationships with
suitable corporate partners. There can be no assurance that the Company will
enter into collaborative arrangements with corporate partners or that any
agreements resulting from these discussions will successfully reduce the
Company's funding requirements. Additional equity or debt financing will be
required, and there can be no assurance that these funds will be available on
terms favorable to the Company, if at all. If adequate funds are not
available, the Company may be required to delay, scale back or eliminate one or
more of its product development programs or obtain funds through arrangements
with collaborative partners or others that may require the Company to
relinquish rights to certain of its technologies, product candidates or
products that the Company would not otherwise relinquish.
DepoTech anticipates that its existing available cash, cash equivalents and
short-term investments, committed future contract revenue, projected funding
from equipment leases and interest income will be adequate to satisfy its
capital requirements and fund operating losses into 1998. The Company's future
capital requirements will depend on many factors, including continued
scientific progress in its products and process development programs, progress
with preclinical testing and clinical trials, the time and costs involved in
obtaining regulatory approvals, the costs involved in filing and maintaining
patents, competing technological and market developments, changes in existing
collaborative relationships, the ability of the Company to establish
development arrangements, the cost of manufacturing scale-up, and the
establishment of effective sales and marketing arrangements.
13
4
SELECTED FINANCIAL DATA
DepoTech Corporation
Years Ended December 31,
(dollars, except share amounts) 1996 1995 1994 1993 1992
Statement of Operations Data:
Total revenues $4,391,024 $6,825,784 $582,120 $69,500 $15,000
Total expenses 22,039,072 15,525,785 9,307,676 4,058,419 1,175,662
Net loss (16,775,605) (8,020,547) (8,561,487) (3,896,906) (1,209,506)
Net loss per share (1.46) (0.92) (1.26) (0.78) (0.52)
Shares used in computing
net loss per share 11,451,334 8,717,550 6,773,178 4,989,332 2,326,059
Balance Sheet Data:
Cash, cash equivalents and
short-term investments 18,198,097 38,661,534 9,983,046 7,519,096 6,095,987
Total assets 37,608,405 48,977,573 15,346,654 10,107,087 6,333,479
Long-term liabilities 7,272,025 3,218,957 2,618,664 408,538 90,148
Shareholders' equity 25,229,234 41,505,530 10,903,253 8,702,521 6,170,556
15
5
STATEMENTS OF OPERATIONS
DepoTech Corporation
Years Ended December 31,
1996 1995 1994
Revenues:
Contract revenue $ 4,391,024 $ 5,825,784 $ 582,120
Marketing rights fee - 1,000,000 -
------------ ----------- -----------
Total revenues 4,391,024 6,825,784 582,120
Costs and expenses:
Research and development 17,951,636 12,699,247 7,426,815
General and administration 4,087,436 2,826,538 1,880,861
------------ ----------- -----------
Total costs and expenses 22,039,072 15,525,785 9,307,676
------------ ----------- -----------
Loss from operations (17,648,048) (8,700,001) (8,725,556)
Interest income 1,659,852 1,084,244 286,984
Interest expense (787,409) (404,790) (122,915)
------------ ----------- -----------
Net loss $(16,775,605) $(8,020,547) $(8,561,487)
============ =========== ===========
Net loss per share $(1.46) $(0.92) $(1.26)
============ =========== ===========
Shares used in computing net loss per share 11,451,334 8,717,550 6,773,178
============ =========== ===========
See accompanying notes.
16
6
BALANCE SHEETS
DepoTech Corporation
December 31,
1996 1995
ASSETS
Current assets:
Cash and cash equivalents $ 1,966,626 $ 5,883,911
Short-term investments 16,231,471 32,777,623
Accounts receivable from Chiron collaboration 614,580 400,000
Other current assets 1,160,394 566,924
----------- -----------
Total current assets 19,973,071 39,628,458
Property and equipment, net 16,851,574 8,610,978
Restricted cash 289,023 420,860
Deposits and other assets 494,737 317,277
----------- -----------
Total assets $37,608,405 $48,977,573
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,633,756 $ 1,741,724
Current portion of note payable 493,481 -
Other accrued liabilities 939,331 705,868
Current portion of obligations under capital leases and loans 2,040,578 1,805,494
----------- -----------
Total current liabilities 5,107,146 4,253,086
Deferred revenue 54,839 -
Obligations under capital leases, less current portion 4,129,750 2,831,010
Note payable, less current portion 1,709,813 -
Deferred rent 1,377,623 387,947
Commitments
SHAREHOLDERS' EQUITY
Common stock, no par value; 30,000,000 shares authorized; 11,543,816 and
11,285,630 shares issued and outstanding
at December 31, 1996 and 1995,respectively 67,797,617 67,133,738
Deferred compensation related to stock options (161,960) (214,448)
Unrealized (loss) gain on short-term investments (10,886) 206,172
Accumulated deficit (42,395,537) (25,619,932)
----------- -----------
Total shareholders' equity 25,229,234 41,505,530
----------- -----------
Total liabilities and shareholders' equity $37,608,405 $48,977,573
=========== ===========
See accompanying notes.
17
7
STATEMENTS OF CASH FLOWS
DepoTech Corporation
Years Ended December 31,
1996 1995 1994
OPERATING ACTIVITIES
Net loss $(16,775,605) $ (8,020,547) $ (8,561,487)
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization 1,512,151 837,168 582,939
Deferred revenue from Chiron collaboration - (1,000,000) 1,000,000
Amortization of deferred compensation 52,488 47,990 -
Deferred rent 989,676 275,602 7,173
Deferred revenue 54,839 - -
Issuance of note payable in exchange for acquired technology - - 231,938
Forgiveness of employee notes receivable 39,283 56,333 128,508
Changes in operating assets and liabilities:
Accounts receivable from Chiron collaboration (214,580) (156,123) (243,877)
Other current assets (632,753) (494,873) 22,662
Deposits and other assets (196,931) (115,614) (162,064)
Accounts payable and other accrued liabilities 125,495 1,376,791 592,537
------------ ------------ ------------
Net cash used by operating activities (15,045,937) (7,193,273) (6,401,671)
INVESTING ACTIVITIES
Purchases of short-term investments (17,244,027) (38,410,705) (12,228,388)
Proceeds from sale or maturities of short-term investments 33,573,121 11,171,032 6,896,610
Purchases of property and equipment (6,395,815) (1,419,044) (1,362,231)
Restricted cash 131,837 16,740 166,651
------------ ------------ ------------
Net cash provided (used) by investing activities 10,065,116 (28,641,977) (6,527,358)
FINANCING ACTIVITIES
Repayment of capital lease obligations (1,803,637) (831,262) (300,842)
Proceeds from notes payable 2,203,294 - -
Proceeds from issuance of common stock, net 663,879 38,163,652 69,395
Proceeds from issuances of convertible preferred stock, net - - 10,678,720
Repayment of facilities payable - (237,569) (413,000)
Proceeds from bank borrowing - 4,000,000 -
Repayment of bank borrowing - (4,000,000) -
------------ ------------ ------------
Net cash provided by financing activities 1,063,536 37,094,821 10,034,273
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents (3,917,285) 1,259,571 (2,894,756)
Cash and cash equivalents at the beginning of year 5,883,911 4,624,340 7,519,096
------------ ------------ ------------
Cash and cash equivalents at the end of year 1,966,626 5,883,911 4,624,340
Short-term investments at the end of year 16,231,471 32,777,623 5,358,706
------------ ------------ ------------
Cash, cash equivalents and short-term investments at
the end of year $ 18,198,097 $ 38,661,534 $ 9,983,046
============ ============ ============
SUPPLEMENTAL INFORMATION
Property and equipment acquired through capital leases
and loans $ 3,337,461 $ 3,677,018 $ 1,661,036
============ ============ ============
Facilities payable recorded for leasehold improvements $ - $ - $ 237,569
============ ============ ============
Issuance of common stock in exchange for note payable $ - $ 231,938 $ -
============ ============ ============
Interest paid $ 787,409 $ 404,790 $ 122,915
============ ============ ============
See accompanying notes.
18
8
STATEMENTS OF SHAREHOLDERS' EQUITY
DepoTech Corporation
Deferred
Convertible Notes Compensation Unrealized
Preferred Stock Common Stock Receivable Related Gain Total
------------------- ------------------------- from to Stock (Loss) on Accumulated Shareholders'
Shares Amount Shares Amount Shareholders Options Investments Deficit Equity
------------------------------------------------------------------------------------------------------------
Balance at
January 1, 1994 4,379,101 $14,008,505 1,309,111 $13,091 $(9,600) $- $ - $ (5,309,475) $ 8,702,521
Issuance of
common stock - - 222,152 69,395 - - - - 69,395
Issuance of
convertible
preferred stock 1,603,890 10,656,296 - - - - - - 10,656,296
Accretion on
convertible
preferred stock - 1,896,029 - - - - - (1,896,029) -
Forgiveness of
notes receivable
from shareholders - - - - 9,600 - - - 9,600
Unrealized gain
on investments - - - - - - 26,928 - 26,928
Net loss - - - - - - - (8,561,487) (8,561,487)
--------- ----------- --------- ------- ------ -- -------- ------------ -----------
Balance at
December 31, 1994 5,982,991 26,560,830 1,531,263 82,486 - - 26,928 (15,766,991) 10,903,253
Issuance of
common stock - - 78,908 36,306 - - - - 36,306
Exercise of warrants - - 242,468 308,654 - - - - 308,654
Deferred compensation
related to issuance
of stock options - - - 262,438 - (262,438) - - -
Amortization of
deferred compensation - - - - - 47,990 - - 47,990
Accretion on convertible
preferred stock - 1,832,394 - - - - - (1,832,394) -
Unrealized gain
on investments - - - - - - 179,244 - 179,244
Issuance of common
stock upon initial
public offering, net - - 3,450,000 38,050,630 - - - - 38,050,630
Conversion of
convertible preferred
stock upon initial
public offering (5,982,991) (28,393,224) 5,982,991 28,393,224 - - - - -
Net loss - - - - - - - (8,020,547) (8,020,547)
--------- ----------- --------- ------- ------ -- -------- ------------ -----------
Balance at
December 31, 1995 - - 11,285,630 67,133,738 - (214,448) 206,172 (25,619,932) 41,505,530
Issuance of
common stock - - 258,186 663,879 - - - - 663,879
Amortization of
deferred compensation - - - - - 52,488 - - 52,488
Unrealized loss
on investments - - - - - - (217,058) - (217,058)
Net loss - - - - - - - (16,775,605) (16,775,605)
--------- ----------- --------- ------- ------ -- -------- ------------ -----------
Balance at
December 31, 1996 - $ - 11,543,816 $67,797,617 $ - $(161,960) $(10,886) $(42,395,537) $25,229,234
========= =========== ========== =========== ====== ========= ======== ============ ===========
See accompanying notes.
19
9
NOTES TO FINANCIAL STATEMENTS
DepoTech Corporation
December 31, 1996
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
o Organization and Business Activities
DepoTech Corporation (the "Company") was incorporated in California on October
30, 1989. The Company is a drug delivery company engaged in the development and
manufacture of sustained-release therapeutic products based on DepoFoam, an
injectable, depot drug delivery technology.
o Cash, Cash Equivalents and Short-Term Investments
The Company invests its excess cash in deposit accounts, money market accounts,
commercial paper and U.S. Government securities. The Company has established
guidelines relative to diversification and maturities that maintain safety and
an adequate level of liquidity. These guidelines are periodically reviewed and
modified to take advantage of trends in yields and interest rates.
The Company considers all highly liquid investments with a maturity of three
months or less from the date of purchase that are readily convertible into cash
to be cash equivalents. Short-term investments are classified as
available-for-sale, and are carried at market value, in accordance with
Financial Accounting Standards Board Statement No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." The unrealized gain or loss on such
investments is reported as a separate component of shareholders' equity.
o Property and Equipment
Property and equipment consist primarily of manufacturing, laboratory and
office equipment and leasehold improvements and are stated at cost. Property
and equipment under capital leases are recorded at the present value of the
minimum lease payments. Depreciation and amortization are calculated using the
straight-line method over the shorter of the estimated useful life of the
assets (ranging from three to fifteen years) or the lease term.
o Restricted Cash
Restricted cash consists of certificates of deposit maintained as collateral
for letters of credit securing certain lease agreements.
o Patent Costs
Deposits and other assets consist primarily of patent and trademark filing
costs totaling approximately $453,000 and $299,000 at December 31, 1996 and
1995, respectively, which are amortized over the estimated economic life of the
patents or trademarks.
o Deferred Rent
Rent expense is recognized on a straight-line basis over the term of the lease.
Accordingly, rent expense incurred in excess of rent paid is accrued and
recorded as deferred rent in the accompanying balance sheets.
o Contract Revenues and Expenses
Contract revenue is recorded as earned based on the performance requirements of
the contract. Research and development costs are expensed as incurred.
o Accounting Standard on Impairment of Long-Lived Assets
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 121 "Accounting for Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of" ("FAS 121"), regarding the
impairment of long-lived assets, identifiable intangibles and goodwill related
to those assets. The adoption of FAS 121 had no effect on the accompanying
financial statements.
o Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
20
10
o Net Loss Per Share
For periods subsequent to the completion of the Company's initial public
offering ("IPO") in October 1995, net loss per share is computed using the
weighted average number of common shares outstanding. Common share equivalents
have not been included in computing net loss per share since the effect would
be antidilutive.
Prior to the IPO, net loss per share is computed using the weighted average
number of common shares outstanding during the period. Pursuant to the
requirements of the Securities and Exchange Commission ("SEC"), common stock
issued by the Company during the twelve months immediately preceding the IPO,
plus the number of common equivalent shares which were granted or issued during
the same period pursuant to the grant or issuance of stock options and
warrants, have been included in the calculation of the shares used in computing
net loss per share as if these shares were outstanding for all periods
presented using the treasury stock method. In addition, pursuant to SEC
policy, the calculation of the shares used in computing net loss per share also
includes convertible preferred shares which converted into common shares
immediately prior to the closing of the IPO as if they were converted into
common shares as of the original dates of issuance.
o Reclassifications
Certain prior year amounts have been reclassified to conform with the current
year presentation.
NOTE 2 - CHIRON COLLABORATION
In March 1994, the Company entered into a collaboration agreement ("the
Collaboration Agreement") with Chiron Corporation ("Chiron") to develop and
commercialize sustained release formulations of selected generic products and
certain Chiron proprietary products using the Company's drug delivery
technology. Under the agreement, Chiron purchased 400,000 shares of the
Company's Series C preferred stock for $6.25 per share, for an aggregate
consideration of $2.5 million, and a warrant to purchase 365,000 shares of
Series C preferred stock at an exercise price of $6.25 per share for $1
million. The warrant was terminated and converted into a marketing rights fee
to the Company upon the achievement of a development milestone in January 1995.
The Collaboration Agreement grants Chiron rights to market and sell the
Company's initial product, DepoCyt(TM), in the United States, Canada and Europe
(the "Territory"). Phase III clinical trial costs of DepoCyt incurred
subsequent to June 1993 will be shared equally by Chiron and the Company. Any
additional clinical trials required in Europe will be funded entirely by
Chiron. Canadian registration expenses will be funded by Chiron. The Company
will manufacture DepoCyt in the Territory, Chiron will market, sell and
distribute the product in the Territory, and the parties will share all profits
equally. Chiron will make additional payments to the Company upon achievement
of certain milestones in the development of DepoCyt. Chiron also has a right
of first refusal to obtain a license to alternate DepoFoam formulations of
cytarabine under terms and conditions to be negotiated in the future.
Reimbursable clinical and manufacturing scale-up costs for DepoCyt incurred by
the Company totaled $3,194,312, $2,541,847 and $1,790,460 for the years ended
December 31, 1996, 1995 and 1994, respectively. The cumulative amount due
through December 31, 1994 became billable and was recognized as contract
revenue upon the achievement of a development milestone in January 1995.
The Collaboration Agreement also provides for the joint development of DepoFoam
formulations of certain compounds proprietary to Chiron ("Chiron Products").
Chiron must fund one feasibility program for a Chiron Product per year or lose
its option to develop DepoFoam formulations of additional Chiron proprietary
compounds. Through 1996, the Company has completed feasibility studies on two
Chiron proprietary proteins, one of which has been selected for further
preclinical development. A third feasibility study is on-going. The agreement
provides that Chiron will pay the Company for its feasibility efforts, and that
Chiron will be responsible for all development costs thereafter. The agreement
also provides for Chiron to make payments to the Company upon achievement of
certain development milestones for the Chiron Products. Chiron will have
exclusive, worldwide distribution rights to all Chiron Products and will
manufacture the bulk unencapsulated drug. The Company will then encapsulate
the bulk drug in DepoFoam creating the Chiron Products, and Chiron will market,
sell and distribute the Chiron Products. Chiron will compensate the Company
based on its manufacturing costs, including a manufacturing profit, and a
percentage of Chiron's net sales of the Chiron Products.
Both the Company and Chiron have the ability to terminate a portion or all of
the collaboration at certain intervals and with advance notice. In addition,
Chiron has the ability to terminate the development of a Chiron Product with a
limited amount of advance notice.
21
11
NOTE 3 - SHORT-TERM INVESTMENTS
The following is a summary of available-for-sale short-term investments:
Gross Gross
DECEMBER 31, 1996 Cost Unrealized Gains Unrealized Losses Estimated Fair Value
U.S. government securities $12,208,677 $ - $ (13,986) $ 12,194,691
Certificates of deposit 498,940 1,020 - 499,960
Corporate obligations 3,534,740 2,080 - 3,536,820
----------- --------- --------- ------------
$16,242,357 $ 3,100 $ (13,986) $ 16,231,471
----------- --------- --------- ------------
DECEMBER 31, 1995
U.S. government securities $32,072,511 $ 205,047 $ - $ 32,277,558
Certificates of deposit 498,940 1,125 - 500,065
----------- --------- --------- ------------
$32,571,451 $ 206,172 $ - $ 32,777,623
=========== ========= ========== =============
The amortized cost and estimated fair value of short-term investments at
December 31, 1996, by contractual maturity, are shown below:
Cost Estimated Fair Value
Due in one year or less $ 8,879,965 $ 8,882,591
Due after one year through three years 7,362,392 7,348,880
----------- -----------
$16,242,357 $16,231,471
=========== ===========
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
December 31,
1996 1995
Manufacturing, laboratory and office equipment $12,254,274 $ 7,184,905
Leasehold improvements 2,041,001 1,989,257
Leasehold improvements and manufacturing equipment under construction 5,552,015 939,853
----------- ------------
19,847,290 10,114,015
Less accumulated depreciation and amortization (2,995,716) (1,503,037)
----------- ------------
$16,851,574 $ 8,610,978
=========== ============
NOTE 5 - TECHNOLOGY ASSIGNMENT
In 1994, in connection with an assignment agreement under which the Company was
assigned exclusive rights to certain intellectual property, the Company issued
108,029 shares of common stock and a warrant to purchase 154,327 shares of
preferred stock at $2.00 per share. The Company also issued a non-interest
bearing note payable in the amount of $231,938, which was expensed as acquired
in-process research and development. Upon the completion of the IPO, the
warrant was exercised and the note and cash were exchanged for common stock.
Royalties or a percentage of royalties will be paid to the assignor on net
revenues in connection with the sale of products incorporating the acquired
intellectual property or received by the Company from licensees.
22
12
The assignor has the right to terminate the agreement or to convert the
exclusive nature of the rights granted under the agreement into a nonexclusive
license in the event that the Company does not make certain minimum annual
payments or upon certain other events.
NOTE 6 - COMMITMENTS
o Lease Obligations
The Company leases its facilities and certain equipment under operating and
capital leases. Provisions of the facilities leases provide for abatement of
rent during certain periods and escalating rent payments during the lease terms
which extend through August 1, 2015. Included in restricted cash and deposits
and other assets are $300,709 and $449,107 related to these agreements at
December 31, 1996 and 1995, respectively. Annual future minimum lease payments
as of December 31, 1996 are as follows:
Operating Leases Capital Leases
1997 $3,128,085 $ 2,661,423
1998 3,228,701 2,409,226
1999 3,312,314 1,628,090
2000 3,432,296 631,866
2001 3,560,700 -
Thereafter 52,360,160 -
---------- -----------
Total $69,022,256 7,330,605
==========
Less amount representing interest (1,160,277)
-----------
Present value of net minimum payments 6,170,328
Less current portion (2,040,578)
-----------
Amounts due after one year $ 4,129,750
===========
The Company subleased certain of its existing laboratory and administrative
facilities. Rental income from the sublease agreement over the next four years
will range from $223,000 to $290,000 per year.
Assets acquired under capital leases consist of manufacturing, laboratory and
office equipment, and leasehold improvements with an aggregate cost of
approximately $9.1 million and $5.8 million at December 31, 1996 and 1995,
respectively. Accumulated amortization of assets acquired under these
arrangements is included in total depreciation and amortization.
Rent expense was approximately $3,895,000, $1,467,000 and $583,000 during the
years ended December 31, 1996, 1995 and 1994, respectively.
o Note Payable
During June 1996, the Company established a credit line with a bank for
borrowing up to $9 million to finance certain capital equipment expenditures.
Borrowing under the credit line bears interest at a floating rate equal to
prime plus .5% (8.75% at December 31, 1996) on the outstanding balance. The
credit line expires on June 30, 2001 and all borrowings are secured by the
capital equipment financed. At December 31, 1996, approximately $6,797,000
remains available for future equipment acquisitions. Annual future minimum
payments as of December 31, 1996 are as follows:
1997 $ 650,074
1998 650,074
1999 650,075
2000 650,075
----------
Total 2,600,298
Less amount representing interest (397,004)
----------
Present value of net minimum payments 2,203,294
Less current portion (493,481)
----------
Amounts due after one year $1,709,813
==========
23
13
NOTE 7 - SHAREHOLDERS' EQUITY
o Stock Purchase Warrants
In connection with various stock purchase or lease financing transactions, the
Company has issued warrants to purchase 42,354, 22,400 and 503,287 shares of
common stock at prices of $2.75, $6.25 and $7.00 per share, respectively. The
warrants are generally exercisable through 2001, and these warrants remain
outstanding at December 31, 1996.
o Deferred Compensation
Pursuant to certain provisions of the SEC regulations, the Company recorded and
is amortizing over the related vesting periods deferred compensation
representing the difference between the exercise price of stock options granted
and the deemed fair value (for accounting purposes) of the Company's common
stock at the date of grant. Stock options generally vest over four to five
years. Shares included in the computation of deferred compensation include
option grants to employees and officers of the Company from July 1994 through
June 1995.
o Stock Option Plans
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, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"),
requires use of option valuation models that were not developed for use in
valuing employee stock options. Under APB 25, because the exercise price of
the Company's employee stock options equals the market price of the underlying
stock on the date of grant, no compensation expense is recognized.
The Company's 1995 Stock Option/Stock Issuance Plan has authorized the grant of
options to employees, directors and consultants of the Company for up to
2,000,000 shares of the Company's common stock. No options granted under the
Plan have a term in excess of ten years.
Pro forma information regarding net income and earnings per share is required
by FAS 123, and has been determined as if the Company has accounted for its
employee stock options under the fair value method of that Statement. 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 1995 and 1996, respectively: risk-free interest rates of 6.5%
and 6.1%; dividend yields of 0%; volatility factors of the expected market
price of the Company's common stock of 73% and 58%; and a weighted-average life
of the option of 4 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 reliable single
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 December 31, 1996 and 1995 reflect increases
of approximately $307,000 and $55,000, respectively. The pro forma net loss
per share for the years ended December 31, 1996 and 1995 are ($1.49) and
($0.93) per share, respectively.
The results above are not likely to be representative of the effects of
applying FAS 123 on reported net income or loss for future years as these
amounts reflect the expense for only one or two years vesting.
24
14
A summary of the Company's stock option activity, and related information for
the years ended December 31, are as follows:
1996 1995 1994
Weighted Weighted Weighted
Average Average Average
Options Exercise Price Options Exercise Price Options Exercise Price
Outstanding-beginning of year 1,102,439 $ 2.02 917,314 $ .68 758,850 $ .31
Granted 467,744 19.77 258,300 6.54 389,650 1.32
Exercised (209,848) .68 (48,908) .75 (222,152) .31
Forfeited (64,472) 14.46 (24,267) 1.84 (9,034) .71
----------------------- ----------------------- --------------------
Outstanding-end of year 1,295,863 $ 8.03 1,102,439 $2.02 917,314 $ .68
======================= ======================= ====================
Exercisable at end of year 547,407 415,790 230,425
Weighted average fair value of
options granted during the year $ 9.69 $2.50
A summary of the Company's stock options outstanding at December 31, 1996 is
as follows:
Options Outstanding Options Exercisable
Weighted Average
Range of Number Remaining Weighted Average Number Weighted Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
$ 0.10 to $ 4.00 749,017 6.9 years $ 1.13 463,960 $ 0.81
$ 7.00 to $12.00 84,633 8.6 years $ 8.30 27,718 $ 9.01
$15.25 to $19.625 394,963 9.5 years $18.30 47,389 $18.64
$23.50 to $25.125 67,250 9.3 years $24.32 8,340 $23.52
The weighted-average remaining contractual life of those options is 7.9 years.
At December 31, 1996, options for 222,147 shares were available for future
grant.
o Employee Stock Purchase Plan
In October 1995, the Company adopted an Employee Stock Purchase Plan ("the
ESPP") whereby employees, at their option, can purchase shares of Company
common stock through payroll deductions at the lower of 85% of fair market
value on the ESPP offering date or on certain other predetermined exercise
dates. The Company has reserved 250,000 shares of common stock for issuance
under the ESPP, of which 48,338 shares have been issued as of December 31,
1996.
25
15
NOTE 8 - INCOME TAXES
At December 31, 1996, the Company has federal and California tax net operating
loss carryforwards of approximately $39,874,000 and $7,667,000, respectively.
The difference between the federal and California tax loss carryforwards is
primarily attributable to the capitalization of research and development
expenses for California franchise tax purposes and the fifty-percent limitation
on California loss carryforwards.
The federal and California tax loss carryforwards will begin expiring in 2005
and 1997, respectively, unless previously utilized. The Company also has
federal and California research and development tax credit carryforwards
totaling $1,086,000 and $557,000, respectively, which will being expiring in
2005 unless previously utilized.
Pursuant to Internal Revenue Code Sections 382 and 383, annual use of the
Company's net operating loss and credit carryforwards may be limited if a
cumulative change in ownership of more than 50% occurs within any three year
period.
Significant components of the Company's deferred tax assets and liabilities are
shown below. A valuation allowance of $17,622,000, of which $7,722,000 is
related to 1996, has been recognized to offset the deferred tax assets as
realization of such assets is uncertain.
December 31,
1996 1995
Deferred tax assets:
Net operating loss carryforwards $ 14,416,000 $ 8,192,000
Research and development credit carryforwards 1,448,000 912,000
Capitalized research expenses 1,713,000 826,000
Other, net 558,000 272,000
------------ -----------
Net deferred tax assets 18,135,000 10,202,000
Valuation allowance for deferred tax assets (17,622,000) (9,900,000)
------------ -----------
Total deferred tax assets 513,000 302,000
Deferred tax liabilities:
Depreciation (513,000) (302,000)
------------ -----------
Net deferred tax assets $ - $ -
============= ===========
Approximately $974,000 of the valuation allowance for deferred tax assets
relates to stock option deductions which, when recognized, will be allocated
directly to common stock.
NOTE 9 - SUBSEQUENT EVENT
On January 3, 1997, the Company completed the private placement of 1,500,000
newly issued shares of common stock at $13.50 per share raising net proceeds
totaling $19.1 million.
26
16
REPORT OF ERNST & YOUNG LLP,
INDEPENDENT AUDITORS
The Board of Directors and Shareholders
DepoTech Corporation
We have audited the accompanying balance sheets of DepoTech Corporation as of
December 31, 1996 and 1995, and the related statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of DepoTech Corporation at
December 31, 1996 and 1995, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1996, in
conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
San Diego, California
January 29, 1997
27
17
CORPORATE INFORMATION
DepoTech Corporation
BOARD OF DIRECTORS
o Chairman of the Board
Fred A. Middleton
General Partner
Sanderling Ventures
o Directors
Roger C. Davisson
General Partner
Brentwood Associates
Jean Deleage
Managing Partner
Burr, Egan, Deleage & Co.
George W. Dunbar, Jr.
President and Chief Executive Officer
Metra Biosystems, Inc.
Edward L. Erickson
President and Chief Executive Officer
DepoTech Corporation
Stephen B. Howell, M.D.
Professor of Medicine
University of California San Diego
Peter Preuss
President
Preuss Foundation
Pieter J. Strijkert, Ph.D.
Chairman
IntroGene BV
OFFICERS
Edward L. Erickson
President and Chief Executive Officer
John P. Longenecker, Ph.D.
Senior Vice President
Research, Development and Operations
David B. Thomas
Senior Vice President
Quality Assurance and Regulatory Affairs
Williams S. Ettouati, D.Pharm
Vice President, Marketing and Business Development
Sinil Kim, M.D.
Vice President, Advanced Technology
Chief Scientific Officer and Director Emeritus
Linda J. Paradiso, D.V.M.
Vice President, Clinical Development
Sheldon A. Schaffer, Ph.D.
Vice President, Pharmaceutical Development
Dana S. McGowan, C.P.A.
Senior Director, Finance and Administration
Chief Financial Officer, Treasurer and Assistant Secretary
Faye H. Russell, Esq.
Secretary
OTHER MANAGEMENT
Thomas E. Swedberg
Senior Director, Human Resources
CORPORATE INFORMATION
o Corporate Headquarters
10450 Science Center Drive
San Diego, California 92121
(619) 625-2424
o Shareholder Inquiries
General information regarding the Company can be obtained by contacting
Investor Relations at DepoTech. Inquiries relating to lost certificates should
be directed to the Transfer Agent.
o SEC Form 10-K
A copy of the Company's annual report to the Securities and Exchange Commission
on Form 10-K is available without charge by contacting Investor Relations at
DepoTech Corporation.
o Transfer Agent And Registrar
Chase Mellon Shareholder Services
400 South Hope Street, 4th Floor
Los Angeles, California 90071
(800) 522-6645
o Independent Auditors
Ernst & Young LLP
San Diego, California
o Corporate Counsel
Brobeck Phleger & Harrison LLP
San Diego, California
o Annual Meeting Of Shareholders
The annual meeting of shareholders will be held at 9:00 AM on Wednesday, May
14, 1997, at DepoTech Corporation.
o Price Range Of Common Stock
The Company's Common Stock began trading on September 29, 1995 and is listed on
the Nasdaq National Market under the symbol DEPO. High and low sales prices are
set forth below for the periods indicated:
High Low
1995
- -------------------------------------------------------------
3rd Quarter $14.00 $12.75
4th Quarter $21.75 $12.50
1996
- -------------------------------------------------------------
1st Quarter $25.50 $18.00
2nd Quarter $29.50 $22.50
3rd Quarter $25.50 $14.50
4th Quarter $17.00 $12.75
At March 20, 1997, there were approximately 1700 beneficial shareholders of
record. The Company has never declared or paid dividends on its Common Stock.
18
High Low
1995
3rd Quarter $14.00 $12.75
4th Quarter $21.75 $12.50
1996
1st Quarter $25.50 $18.00
2nd Quarter $29.50 $22.50
3rd Quarter $25.50 $14.50
4th Quarter $17.00 $12.25
28