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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, 1998
or
[x] 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 0-26862
DEPOTECH CORPORATION
(Exact name of Registrant as specified in its charter)
CALIFORNIA 33-0387911
---------- ----------
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Identification No.)
Organization)
10450 SCIENCE CENTER DRIVE
SAN DIEGO, CALIFORNIA 92121
---------------------------
(Address of principal executive offices, zip code)
(619) 625-2424
--------------
(Registrant's telephone number)
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.
Common Stock: No par value, 17,464,324 shares as of October 31, 1998
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DEPOTECH CORPORATION
TABLE OF CONTENTS
PAGE
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PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Condensed Balance Sheets as of
September 30, 1998 (Unaudited) and December 31, 1997...... 1
Condensed Statements of Operations
for the Three and Nine Months ended
September 30, 1998 and 1997 (Unaudited)................... 2
Condensed Statements of Cash Flows
for the Nine Months ended
September 30, 1998 and 1997 (Unaudited)................... 3
Notes to Condensed Financial Statements................... 4
Item 2 Management's Discussion and Analysis
of Financial Condition and Results of Operations.......... 8
Item 3 Quantitative and Qualitative Disclosures About Market
Risk...................................................... 25
PART II OTHER INFORMATION
Item 1 Legal Proceedings......................................... 26
Item 2 Changes in Securities and Use of Proceeds................. 26
Item 3 Defaults Upon Senior Securities........................... 26
Item 4 Submission of Matters to a Vote of Security Holders....... 26
Item 5 Other Information......................................... 26
Item 6 Exhibits and Reports on Form 8-K.......................... 26
Signatures....................................................... 28
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PART 1 -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DEPOTECH CORPORATION
CONDENSED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- -------------
ASSETS (Unaudited) (Note)
Current assets:
Cash and cash equivalents $ 494,273 $ 6,194,153
Short-term investments 9,472,549 21,166,402
Accounts receivable from collaborations 378,604 1,361,837
Other current assets 1,090,337 1,141,210
------------- -------------
Total current assets 11,435,763 29,863,602
Property and equipment, net 12,724,037 26,948,328
Deposits and other assets 1,007,249 857,756
============= =============
Total assets $ 25,167,049 $ 57,669,686
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and other accrued liabilities $ 1,843,943 $ 3,250,460
Current portion of obligations under capital leases 2,594,315 2,037,416
Current portion of note payable 8,345,820 2,509,467
------------- -------------
Total current liabilities 12,784,078 7,797,343
Obligations under capital leases, less current portion 18,911 2,089,931
Note payable, less current portion 6,901,982
Deferred rent 2,951,937 2,313,133
Other long-term liabilities 174,626 494,506
Shareholders' equity:
Common stock, no par value; 30,000,000 shares authorized,
14,607,181 and 14,237,216 shares issued and outstanding at
September 30, 1998 (unaudited) and December 31, 1997, respectively 102,569,317 101,970,346
Deferred compensation related to stock options and warrants, net (316,702) (109,472)
Unrealized gain on short-term investments 28,034 15,784
Accumulated deficit (93,043,152) (63,803,867)
------------- -------------
Total shareholders' equity 9,237,497 38,072,791
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Total liabilities and shareholders' equity $ 25,167,049 $ 57,669,686
============= =============
See accompanying notes to condensed financial statements.
Note: The balance sheet at December 31, 1997 has been derived from the
audited financial statements at that date, but does not include all of
the disclosures required by generally accepted accounting principles.
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PART 1 -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DEPOTECH CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
-------------------------------- --------------------------------
(UNAUDITED) (UNAUDITED)
Revenues:
Contract revenue $ 527,396 $ 1,045,539 $ 2,592,598 $ 2,977,498
Licensing/milestone payments -- 2,000,000 -- 3,000,000
------------ ------------ ------------ ------------
Total revenues 527,396 3,045,539 2,592,598 5,977,498
Costs and expenses:
Research and development 4,386,276 3,947,542 15,074,502 14,028,748
General and administrative 1,432,545 2,712,347 3,743,728 4,667,951
Repurchase of marketing rights -- -- -- 2,000,000
Impairment of assets 12,858,636 -- 12,858,636 --
------------ ------------ ------------ ------------
Total costs and expenses 18,677,457 6,659,889 31,676,866 20,696,699
------------ ------------ ------------ ------------
Loss from operations (18,150,061) (3,614,350) (29,084,268) (14,719,201)
Interest income 197,473 383,919 791,438 1,228,430
Interest expense (318,348) (356,269) (946,455) (822,534)
------------ ------------ ------------ ------------
Net loss $(18,270,936) $ (3,586,700) $(29,239,285) $(14,313,305)
============ ============ ============ ============
Basic and diluted net loss per share $ (1.25) $ (0.27) $ (2.02) $ (1.09)
============ ============ ============ ============
Shares used in computing
basic and diluted net loss per share 14,595,853 13,382,717 14,498,777 13,178,318
============ ============ ============ ============
See accompanying notes to condensed financial statements.
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PART 1 -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DEPOTECH CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
1998 1997
------------ ------------
(Unaudited)
OPERATING ACTIVITIES
Net cash used by operating activities $(13,809,706) $(12,757,725)
INVESTING ACTIVITIES
Purchases of short-term investments (15,982,561) (29,845,642)
Proceeds from sale of short-term investments 27,688,664 20,102,446
Purchases of property and equipment (1,404,711) (9,403,598)
Proceeds from sale of equipment 248,000 --
Restricted cash 50,823 (37,119)
------------ ------------
Net cash provided (used) by investing activities 10,600,215 (19,183,913)
FINANCING ACTIVITIES
Repayments on capital lease obligations (1,632,291) (1,517,967)
Repayments on note payable (2,170,530) (413,118)
Proceeds from note payable 1,104,901 6,628,702
Proceeds from issuance of common stock, net 207,531 34,007,991
------------ ------------
Net cash (used) provided by financing activities (2,490,389) 38,705,608
------------ ------------
Net increase (decrease) in cash and cash equivalents (5,699,880) 6,763,970
Cash and cash equivalents at beginning of period 6,194,153 1,966,626
------------ ------------
Cash and cash equivalents at end of period 494,273 8,730,596
Short-term investments at end of period 9,472,549 26,022,818
------------ ------------
Cash, cash equivalents and short-term investments at end of period $ 9,966,822 $ 34,753,414
============ ============
SUPPLEMENTAL INFORMATION
Property and equipment acquired through capital lease $ 118,167 $ --
============ ============
Interest paid $ 915,408 $ 822,534
============ ============
See accompanying notes to condensed financial statements.
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DEPOTECH CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. Basis of Presentation and Significant Accounting Policies
The interim unaudited condensed financial statements contained herein
have been prepared in accordance with generally accepted accounting principles
for interim financial information. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. These interim unaudited condensed financial
statements should be read in conjunction with DepoTech's December 31, 1997
audited financial statements. In management's opinion, the unaudited information
includes all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of the financial position, results of
operations and cash flows for the periods presented. Interim results are not
necessarily indicative of results to be expected for the full year. Certain
prior year amounts have been reclassified to conform with the current year
presentation.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
disclosures made in the accompanying notes to the financial statements. Actual
results could differ from those estimates.
2. Net Loss Per Share
Effective December 31, 1997, DepoTech adopted Statement of Financial
Accounting Standards No. 128, "Earnings Per Share" ("FAS 128"), which replaced
the calculation of primary and fully diluted net loss per share with basic and
diluted net loss per share. Basic and diluted net loss per share is calculated
using the weighted-average number of common shares outstanding.
3. New Accounting Standards
Effective January 1, 1998, DepoTech adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS 130") and
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("FAS 131"). Comprehensive loss is not
materially different from the net loss disclosed on the statements of operations
and DepoTech operates in one business segment.
4. Chiron Collaboration
In March 1994, DepoTech entered into a collaboration agreement with
Chiron Corporation ("Chiron") to develop and commercialize sustained-release
formulations of
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DepoCyt(TM) and certain Chiron proprietary products using DepoTech's drug
delivery technology. Under the agreement, Chiron purchased 400,000 shares of
DepoTech's Series C preferred stock for $6.25 per share, or 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 $1.0
million. The warrant was terminated and converted into a marketing rights fee to
DepoTech upon the achievement of a development milestone in January 1995.
In June 1997, DepoTech reacquired rights to DepoCyt in Canada and Europe
from Chiron for aggregate cash payments of up to $13.7 million. Chiron retains
exclusive marketing rights to DepoCyt in the United States. An initial $2.0
million cash payment was paid by DepoTech to Chiron and expensed in 1997. If,
prior to December 31, 1998, the U.S. Food and Drug Administration ("FDA") issues
a letter or other notification to DepoTech indicating that DepoCyt is approvable
or approved, the remaining balance of $11.7 million shall be payable no later
than December 31, 1998. If no FDA notification is received prior to December 31,
1998, the remaining amount shall be payable no later than six months from the
earlier of U.S. or European Union regulatory notification that the application
to market or sell DepoCyt is approvable or approved. If all applications for
regulatory approval to sell DepoCyt in the U.S. and European Union are
permanently withdrawn, DepoTech shall be relieved of any obligation to pay the
remaining $11.7 million. Therefore, such amount will be recorded upon the
receipt of the required notification.
Under the agreement, cumulative reimbursable clinical and manufacturing
scale-up costs for DepoCyt incurred by DepoTech totaled $11.5 million through
September 30, 1998 and $10.2 million through September 30, 1997.
The agreement also provides for the joint development of DepoFoam(TM)
formulations of certain compounds proprietary to Chiron ("Chiron Products"). The
agreement provides that Chiron will pay DepoTech for its feasibility efforts.
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 April 1997, DepoTech had completed feasibility studies on
four Chiron proprietary compounds. No further feasibility studies on Chiron
Products will be performed under the agreement.
Both DepoTech and Chiron have the ability to terminate a portion or all
of the collaboration at certain intervals and with advance notice.
5. Pharmacia & Upjohn Agreement
In July 1997, DepoTech entered into a Marketing and Distribution
Agreement with Pharmacia & Upjohn S.p.A ("P&U"), an affiliate of Pharmacia &
Upjohn Inc., for rights to market and sell DepoCyt in countries outside the
United States. P&U will generally be responsible for submitting regulatory
filings, labeling, packaging, distribution, marketing and sales of DepoCyt in
this territory. Under the agreement, DepoTech will manufacture DepoCyt and
receive a share of the net sales of DepoCyt sold
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by P&U, if any. DepoTech received a cash payment of $2.0 million upon execution
of the agreement and may receive additional payments upon achievement of certain
regulatory milestones. The agreement also provides for reimbursement by P&U of
certain clinical trial expenses and regulatory fees incurred by DepoTech.
Cumulative reimbursable costs incurred by DepoTech under the agreement totaled
$1.7 million as of September 30, 1998. Future milestone payments, if any,
totaling up to the obligation to Chiron of $11.7 million will be set aside in a
restricted cash account for payment to Chiron for the repurchase of DepoCyt
rights.
Both DepoTech and P&U have the ability to terminate the collaboration at
certain intervals and with advance notice.
6. Contingencies
In April 1998, a class action suit was filed against DepoTech and two of
its former officers in the United States District Court for the Southern
District of California. The lawsuit alleges violations of the federal securities
laws and purports to seek unspecified monetary damages on behalf of a class of
shareholders who purchased DepoTech common stock during the period April 1, 1996
through December 18, 1997. DepoTech believes that the lawsuit is without merit
and intends to defend it vigorously.
7. Debt Covenants
DepoTech has financed certain capital expenditures through capital
leases and bank debt. All borrowings are secured by the capital equipment
financed. The terms of DepoTech's bank loan and equipment lease agreements
require DepoTech to maintain certain cash balances. At September 30, 1998,
DepoTech was not in compliance with these covenants. The agreements require
DepoTech to post cash collateral if the covenants are violated. In October 1998,
DepoTech entered into an agreement in which its lenders agreed to not exercise
their rights against DepoTech related to its past non-compliance until January
31, 1999 provided that DepoTech satisfies certain conditions. DepoTech believes
it has satisfied such conditions and is discussing future financing terms with
its lenders. In connection with this agreement, DepoTech pledged $4.7 million as
cash collateral and prepaid a total of $1.3 million in principal and interest
through January 1999 for its equipment leases and bank loan. In addition, long
term capital lease obligations and a bank note payable totaling $6.3 million
have been reclassified as current debt.
8. Asset Impairment
During the third quarter of 1998, DepoTech identified an impairment of
certain capital assets. In accordance with Statement of Financial Accounting
Standards No. 121, "Accounting For The Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of"("FAS 121"), an impairment loss totaling
approximately $12.9 million was recognized based on the amount by which the
carrying amount of the assets exceeded the fair value of the assets. (The
impairment of assets resulted from a change in the extent and manner in which
the assets were used.) During 1998, DepoTech received a "non-approvable" letter
from the FDA for its New Drug Application for DepoCyt for the treatment of
neoplastic meningitis ("NM") from
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solid tumors. As a result of the receipt of the "non-approvable" letter and its
limited existing financial resources, DepoTech has taken certain steps to modify
its business strategy. During 1998, DepoTech has reduced its work force by
approximately 63% to 64 employees through November 1, 1998. In addition,
DepoTech delayed nonessential development and capital expenditure programs.
Also, during the third quarter of 1998, DepoTech began implementing a plan to
sell certain excess capital equipment and intends to sublease a portion of its
headquarters in 1999.
9. Subsequent Events
In November 1998, DepoTech signed a definitive agreement with SkyePharma
PLC, a United Kingdom-based drug delivery company, under which SkyePharma will
acquire all of DepoTech's outstanding shares in a stock-for-stock exchange.
SkyePharma proposes to issue DepoTech shareholders up to $3.50 per share,
equivalent to approximately 5.4 million of its American Depository Shares
(ADS's). DepoTech's shareholders will initially receive $1.75 per share,
equivalent to 2.7 million SkyePharma ADS's. For every ten shares of DepoTech
common stock, DepoTech's shareholders will receive approximately 1.86 SkyePharma
ADS's. Further, DepoTech shareholders will receive up to an additional $1.75 per
share, or approximately 2.7 million SkyePharma ADS's, if certain performance
milestones are met. The share exchange rate is based on the average of the last
sales price for SkyePharma ADS's reported on Nasdaq for the five days ended
October 16, 1998, or $9.43, two days before the date the companies signed a
letter of intent regarding the merger. If the contingent payments are made, the
aggregate value of the acquisition will be approximately $51.1 million based on
a price of $9.43 per SkyePharma ADS. The proposed acquisition is subject to
certain regulatory approvals and the approval of DepoTech's shareholders.
The terms of the contingent payment provide that DepoTech shareholders
will receive approximately 1.5 million additional SkyePharma ADS's if DepoTech's
lead product, DepoCyt, an anticancer drug, is launched in the U.S. no later than
March 31, 2000. Further, DepoTech shareholders will receive approximately 1.2
million additional SkyePharma ADS's if a development agreement is signed with a
corporate partner for either DepoMorphine(TM) or a macromolecule program.
In addition, in October 1998, the two companies formed a strategic
collaboration to develop drug delivery systems. In connection with this
collaboration, SkyePharma purchased approximately 2.9 million shares of
DepoTech's common stock for $5.0 million at a per share price of $1.75.
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Item 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
This discussion may contain forward-looking statements that involve
risks and uncertainties. DepoTech's actual results may differ materially from
the results discussed in such forward-looking statements. Factors that might
cause such a difference include, but are not limited to, those discussed in
"Risks and Uncertainties." DepoTech undertakes no obligation to release publicly
the results of any revisions to these forward-looking statements to reflect
events or circumstances arising after the date hereof.
The following should be read in conjunction with DepoTech's financial
statements and the notes thereto included elsewhere in this Quarterly Report.
Since its inception in October 1989, DepoTech has devoted substantially
all of its resources to the development of its potential products. To date,
DepoTech has not received any revenues from the sale of products. DepoTech has
funded its development programs primarily from equity-derived working capital
and through strategic alliances with other companies. DepoTech has been
unprofitable since its inception and expects to incur additional operating
losses over at least the next two years. As of September 30, 1998, DepoTech's
accumulated deficit was approximately $93.0 million.
DepoTech has financed certain capital expenditures through capital
leases and bank debt. All borrowings are secured by the capital equipment
financed. The terms of DepoTech's bank loan and equipment lease agreements
require DepoTech to maintain certain cash balances. At September 30, 1998,
DepoTech was not in compliance with these covenants. The agreements require
DepoTech to post cash collateral if the covenants are violated. In October 1998,
DepoTech entered into an agreement in which its lenders agreed to not exercise
their rights against DepoTech related to its past non-compliance until January
31, 1999 provided that DepoTech satisfies certain conditions. DepoTech believes
it has satisfied such conditions and is discussing future financing terms with
its lenders. In connection with this agreement, DepoTech pledged $4.7 million as
cash collateral and prepaid a total of $1.3 million in principal and interest
through January 1999 for its equipment leases and bank loan. In addition, long
term capital lease obligations and a bank note payable totaling $6.3 million
have been reclassified as current debt.
During the third quarter of 1998, DepoTech identified an impairment of
certain capital assets. In accordance with Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of" ("FAS 121"), an impairment loss totaling
approximately $12.9 million was recognized based on the amount by which the
carrying amount of the assets exceeded the fair value of assets. (The impairment
of assets resulted from a change in the extent and manner in which the assets
were used.) During 1998, DepoTech received a "non-approvable" letter from the
FDA for its New Drug Application for DepoCyt for the treatment of neoplastic
meningitis ("NM") from solid tumors. As a result of the receipt of the
"non-approvable" letter and its limited existing financial resources, DepoTech
has taken certain steps to modify its business strategy. during 1998, DepoTech
has reduced its workforce by approximately 63% to 64 employees through November,
1998. In addition, DepoTech delayed nonessential development and capital
expenditure programs. Also, during the third quarter of 1998, DepoTech began
implementing a plan to sell certain excess capital equipment and intends to
sublease a portion of its headquarters in 1999.
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In November 1998, DepoTech signed a definitive agreement with SkyePharma
PLC, a United Kingdom-based drug delivery company, under which SkyePharma will
acquire all of DepoTech's outstanding shares in a stock-for-stock exchange.
SkyePharma proposes to issue DepoTech shareholders up to $3.50 per share,
equivalent to approximately 5.4 million of its American Depository Shares
(ADS's). DepoTech's shareholders will initially receive $1.75 per share,
equivalent to 2.7 million SkyePharma ADS's. For every ten shares of DepoTech
common stock, DepoTech's shareholders will receive approximately 1.86 SkyePharma
ADS's. Further, DepoTech shareholders will receive up to an additional $1.75 per
share, or approximately 2.7 million SkyePharma ADS's if certain performance
milestones are met. The share exchange rate is based on the average of the last
sales price for SkyePharma ADS's reported on Nasdaq for the five days ended
October 16, 1998, or $9.43, the date the companies signed a letter of intent
regarding the merger. If the contingent payments are made, the aggregate value
of the acquisition will be approximately $51.1 million based on a price of $9.43
per SkyePharma ADS. The proposed acquisition is subject to certain regulatory
approvals and the approval of DepoTech's shareholders.
The terms of the contingent payment provide that DepoTech shareholders
will receive approximately 1.5 million additional SkyePharma ADS's if DepoTech's
lead product, DepoCyt, an anticancer drug, is launched in the U.S. no later than
March 31, 2000. Further, DepoTech shareholders will receive approximately 1.2
million additional SkyePharma ADS's if a development agreement is signed with a
corporate partner for either DepoMorphine(TM) or a macromolecule program.
In addition, in October 1998, the two companies formed a strategic
collaboration to develop drug delivery systems. In connection with this
collaboration, SkyePharma purchased approximately 2.9 million shares of
DepoTech's common stock for $5.0 million at a per share price of $1.75.
Results of Operations
DepoTech had total revenues of $0.5 million for the three months ended
September 30, 1998 as compared to $3.0 million for the same period in 1997.
Total revenues for the nine months ended September 30, 1998 were $2.6 million
compared to $6.0 million for the same period in 1997. Total revenues for the
three months ended September 30, 1998 were principally generated by DepoTech's
collaborative agreement with Chiron Corporation
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("Chiron") and feasibility studies conducted for various pharmaceutical
companies, and total revenues for the nine months ended September 30, 1998 were
principally generated by DepoTech's collaborative agreements with Chiron and
Pharmacia & Upjohn S.p.A., an affiliate of Pharmacia & Upjohn, Inc. ("P&U").
Total revenues for the three months ended September 30, 1997 were principally
generated by DepoTech's collaborative agreements with Chiron and P&U, and total
revenues for the nine months ended September 30, 1997 were principally generated
by DepoTech's collaborative agreement with Chiron. Total revenues were primarily
derived from reimbursement of certain clinical trial expenses for DepoTech's
lead product, DepoCyt, an anti-cancer drug, under the two collaborative
agreements. In addition, Chiron fully reimbursed DepoTech for certain
pre-clinical and feasibility studies performed on their behalf during 1997 and
the first quarter of 1998.
In July 1997, DepoTech entered into a Marketing and Distribution
Agreement with P&U for rights to market and sell DepoCyt in countries outside
the U.S. Included in total revenue for the three and nine months ended September
1997 is an upfront payment of $2.0 million from P&U paid to DepoTech upon the
signing of the agreement with P&U. Additionally, included in total revenues for
the nine months ended September 30, 1997 is a milestone payment from Chiron of
$1.0 million earned by DepoTech upon the filing of an NDA for DepoCyt. Revenues
may fluctuate from period to period depending on the level of clinical and
process development activity for projects under collaborative agreements and the
achievement of future milestones.
Research and development expenses for the third quarter of 1998 were
$4.4 million compared to $3.9 million for the same period in 1997. Research and
development expenses for the nine months ended September 30, 1998 increased to
$15.1 million from $14.0 million in 1997. Factors contributing to this increase
include expanded efforts in clinical trials, manufacturing scale-up and
preclinical development of potential DepoFoam(TM) products. A non-randomized
Phase IV clinical trial of DepoCyt in solid tumor patients is continuing, as are
randomized Phase III trials of DepoCyt in leukemia and lymphoma patients.
DepoTech is also conducting a dose-finding study of DepoCyt in pediatric
patients. In addition, Phase II clinical trials of DepoMorphine
sustained-release encapsulated morphine sulfate to treat acute post-surgical
pain are underway. Depreciation expense associated with manufacturing equipment
for DepoMorphine also contributed to higher research and development expenses.
General and administrative expenses for the third quarter ended
September 30, 1998 were $1.4 million compared to $2.7 million for the same
period in 1997. General and administrative expenses for the nine months ended
September 30, 1998 were $3.7 million compared to $4.7 million for the comparable
period in the prior year. The reduction in general and administrative expenses
was primarily attributable to a decrease in marketing expenses for DepoCyt
incurred prior to the onset of product revenue. Under the collaborative
agreement with Chiron, DepoTech is obligated to share equally in the funding of
these expenses.
During the third quarter of 1998, DepoTech identified an impairment of
certain capital assets. In accordance with Statement of Financial Accounting
Standards No. 121, "Accounting For The Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of"("FAS 121"), an impairment loss totaling
approximately $12.9 million was recognized based on the amount by which the
carrying amount of the assets exceeded the fair value of the assets. (The
impairment of assets resulted from a change in the extent and manner in which
the assets were used.) During 1998, DepoTech received a "non-approvable" letter
from the FDA for its New Drug Application for DepoCyt for the treatment of
neoplastic meningitis ("NM") from
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solid tumors. As a result of the receipt of the "non-approvable" letter and its
limited existing financial resources, DepoTech has taken certain steps to modify
its business strategy. During 1998, DepoTech has reduced its work force by
approximately 63% to 64 employees through November 1, 1998. In addition,
DepoTech delayed nonessential development and capital expenditure programs.
Also, during the third quarter of 1998, DepoTech began implementing a plan to
sell certain excess capital equipment and intends to sublease a portion of its
headquarters in 1999.
Chiron and DepoTech had been jointly developing DepoCyt in the U.S.,
Canada and Europe since March 1994. In June 1997, DepoTech reacquired rights to
DepoCyt in Canada and Europe from Chiron. Chiron retains exclusive marketing
rights to DepoCyt in the U.S. Included in operating expenses for the nine months
ended September 30, 1997 were expenses of $2.0 million associated with the
repurchase of DepoCyt which was paid to Chiron in December 1997 under the terms
of the agreement with Chiron.
Interest income was $0.2 million and $0.8 million for the three and nine
months ended September 30, 1998 compared to $0.4 million and $1.2 million for
the same periods in 1997. The decrease in interest income was due to a decline
in short-term investments. Interest expense decreased to $0.3 million in the
third quarter of 1998 from $0.4 million for the comparable period in the prior
year. Interest expense increased to $0.9 million for the nine months ended
September 30, 1998 compared to $0.8 million for the comparable period in 1997.
The decrease of $0.1 in interest expense for the three months ended September
30, 1998 as compared to the same period in 1997 was primarily due to the lower
outstanding balance for obligations under capital leases. The increase in
interest expense for the nine month period ended September 30, 1998 as compared
to the same period in 1997 was primarily due to the higher balance outstanding
for the bank note payable.
LIQUIDITY AND CAPITAL RESOURCES
From its inception through September 30, 1998, DepoTech has financed its
operations primarily through public and private placements of equity securities,
which provided aggregate net proceeds of approximately $101.9 million, and
through capital equipment leases and bank credit lines. In October 1998,
DepoTech and SkyePharma PLC, a United Kingdom-based drug delivery company,
formed a strategic collaboration to develop drug delivery systems. In connection
with this collaboration, SkyePharma purchased approximately 2.9 million shares
of DepoTech's common stock for $5.0 million at a per share price of $1.75.
In November 1998, DepoTech signed a definitive agreement with SkyePharma
PLC, a United Kingdom-based drug delivery company, under which SkyePharma will
acquire all of DepoTech's outstanding shares in a stock-for-stock exchange.
SkyePharma proposes to issue DepoTech shareholders up to $3.50 per share,
equivalent to approximately 5.4 million of its American Depository Shares
(ADS's). DepoTech's shareholders will initially receive $1.75 per share,
equivalent to 2.7 million SkyePharma
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ADS's. For every ten shares of DepoTech common stock, DepoTech's shareholders
will receive approximately 1.86 SkyePharma ADS's. Further, DepoTech shareholders
will receive up to an additional $1.75 per share, or approximately 2.7 million
SkyePharma ADS's if certain performance milestones are met. The share exchange
rate is based on the average of the last sales price for SkyePharma ADS's
reported on Nasdaq for the five days ended October 16, 1998, or $9.43, two days
before the date the companies signed a letter of intent regarding the merger. If
the contingent payments are made, the aggregate value of the acquisition will be
approximately $51.1 million based on a price of $9.43 per SkyePharma ADS. The
proposed acquisition is subject to certain regulatory approvals and the approval
of DepoTech's shareholders.
The terms of the contingent payment provide that DepoTech shareholders
will receive approximately 1.5 million additional SkyePharma ADS's if DepoTech's
lead product, DepoCyt, an anticancer drug, is launched in the U.S. no later than
March 31, 2000. Further, DepoTech shareholders will receive approximately 1.2
million additional SkyePharma ADS's if a development agreement is signed with a
corporate partner for either DepoMorphine or a macromolecule program.
Chiron and DepoTech had been jointly developing DepoCyt in the U.S.,
Canada and Europe since March 1994. In June 1997, DepoTech reacquired rights to
DepoCyt in Canada and Europe from Chiron for aggregate cash payments of up to
$13.7 million, of which $2.0 million was paid to Chiron in December 1997. Chiron
retains exclusive marketing rights to DepoCyt in the U.S. If, prior to December
31, 1998, the FDA issues a letter or other notification to DepoTech indicating
that DepoCyt is approvable or approved, the remaining balance of $11.7 million
shall be payable no later than December 31, 1998. If no FDA notification is
received prior to December 31, 1998, the remaining amount shall be payable no
later than six months from the earlier of U.S. or European Union regulatory
notification that the application to market or sell DepoCyt is approvable or
approved. If all applications for regulatory approval to sell DepoCyt in the
U.S. and European Union are permanently withdrawn, DepoTech shall be relieved of
any obligation to pay the remaining $11.7 million.
In July 1997, DepoTech entered into a Marketing and Distribution
Agreement with P&U for rights to market and sell DepoCyt in countries outside
the U.S. P&U will be responsible for submitting regulatory filings, labeling,
packaging, distribution, marketing and sales of DepoCyt in this territory.
DepoTech will manufacture DepoCyt and receive a share of the net sales of
DepoCyt sold by P&U, if any. DepoTech received a cash payment of $2.0 million
upon execution of the agreement and may receive additional payments upon
achievement of certain regulatory milestones. The agreement also provides for
P&U to reimburse DepoTech for certain clinical trial expenses and regulatory
fees incurred by DepoTech. Future milestone payments, if any, totaling up to the
obligation to Chiron of $11.7 million will be set aside in a restricted cash
account for payment to Chiron for the repurchase of DepoCyt rights.
As of September 30, 1998, DepoTech had cash, cash equivalents and
short-term investments of $10.0 million as compared to $27.4 million at December
31, 1997. The decrease of $17.4 million in cash, cash equivalents and short-term
investments was due
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primarily to net cash used to fund operations of $13.8 million and repayment of
capital lease obligations and a note payable totaling $3.8 million. Working
capital decreased to $(1.3) million as of September 30, 1998 compared to $22.1
million as of December 31, 1997. In October 1998, DepoTech and SkyePharma formed
a strategic collaboration to develop drug delivery systems. In connection with
this collaboration, SkyePharma purchased approximately 2.9 million shares of
DepoTech's common stock for $5.0 million at a per share price of $1.75.
DepoTech has financed certain capital expenditures through capital
leases and bank debt. All borrowings are secured by the capital equipment
financed. The terms of DepoTech's bank loan and equipment lease agreements
require DepoTech to maintain certain cash balances. At September 30, 1998,
DepoTech was not in compliance with these covenants. The agreements require
DepoTech to post cash collateral if the covenants are violated. In October 1998,
DepoTech entered into an agreement in which its lenders agreed to not exercise
their rights against DepoTech related to its past non-compliance until January
31, 1999 provided that DepoTech satisfies certain conditions. DepoTech believes
it has satisfied such conditions and is discussing future financing terms with
its lenders. In connection with this agreement, DepoTech pledged $4.7 million as
cash collateral and prepaid a total of $1.3 million in principal and interest
through January 1999 for its equipment leases and bank loan. In addition, long
term capital lease obligations and a bank note payable totaling $6.3 million
have been reclassified as current debt.
DepoTech leases a building housing most of its administrative, research
and clinical and manufacturing activities. The minimum rental commitment for
this building ranges from approximately $2.5 million to $4.3 per year, over 17
years based upon pre-established annual rent increases. DepoTech intends to
sublease a portion of this building in 1999.
In April 1998, a class action suit was filed against DepoTech and two of
its former officers in the United States District Court for the Southern
District of California. The lawsuit alleges violations of the federal securities
laws and purports to seek unspecified monetary damages on behalf of a class of
shareholders who purchased DepoTech common stock during the period April 1, 1996
through December 18, 1997. DepoTech believes that the lawsuit is without merit
and intends to defend it vigorously.
DepoTech'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 DepoTech to achieve profitability are highly
uncertain. There can be no assurance that DepoTech will be able to achieve
profitability at all or on a sustained basis. The development and
commercialization of DepoTech's potential products will require substantial
funds to conduct research and development and preclinical and clinical testing
of products and to manufacture and commercialize any products that are approved
for commercial sale. DepoTech's future capital requirements will depend on many
factors, including, without limitation, additional regulatory requirements
associated with approvals for any of DepoTech's products, the time and costs
involved in obtaining regulatory approvals, continued scientific progress in its
product and process development programs and changes in existing collaborative
programs. DepoTech anticipates that it will be required to raise additional
capital in the near-term in order to
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continue its operations. Such capital may be raised through public or private
financings, as well as collaborative arrangements, borrowings and other
available sources. There can be no assurance that additional funding, if
necessary, will be available on favorable terms if at all. If adequate funds are
not available, DepoTech will be required to curtail operations significantly or
to obtain funds through entering into arrangements with collaborative partners
or others that may require DepoTech to relinquish rights to certain of its
technologies, potential products or potential markets that DepoTech would not
otherwise relinquish. DepoTech may also be required to cease operations. The
failure to receive additional funding would have a material adverse effect on
DepoTech.
YEAR 2000 COMPLIANCE
For the purposes of this section, the terms "we," "our" and "us" refer
to DepoTech.
DESCRIPTION OF THE ISSUE. The Year 2000 ("Y2K") issue refers to the
inability of certain date-sensitive computer chips, software, and systems to
recognize a two-digit date field as belonging to the 21st century. Mistaking
"00" for 1900 or any other incorrect year could result in a system failure or
miscalculations causing disruptions to operations, including manufacturing, or a
temporary inability to process transactions or engage in other normal business
activities. This is a significant issue for most, if not all companies, with far
reaching implications, some of which cannot be anticipated or predicted with any
degree of certainty. The Y2K issue may create unforeseen risks to us from our
internal computer systems as well as from computer systems of others with whom
we deal. Failures of our and/or others' business systems could adversely impact
our ability to conduct our business.
INTERNAL REVIEW OF YEAR 2000 IMPACT. During 1997, we began a review of
our internal business systems, including embedded technology in manufacturing or
other equipment, as well as the business systems of our suppliers, with the goal
of achieving Y2K readiness by late 1999 and minimizing the effect that Y2K
issues will have on our operations. In February 1998, a report to the Audit
Committee of DepoTech's Board of Directors was prepared concerning the status of
our current and proposed Y2K activities. In addition, we currently are reviewing
all of our internal business systems to ensure that such systems either will be
Y2K ready, or will be modified or replaced by Y2K ready systems by no later than
the end of 1998. We plan to simulate and test, in a Y2K environment, our
business systems to verify our Y2K readiness by no later than mid-1999. The
expected completion dates are based on management's best estimates and we cannot
be certain that we will achieve these completion dates.
VENDORS. We are compiling a list of our key services vendors and
products vendors to ensure Y2K readiness of as many vendors as possible. We have
initiated communication with our key vendors to determine to what extent we may
be vulnerable due to their failure to be Y2K ready. This communication,
including site visits by our personnel, will be ongoing throughout calendar
1999. We cannot be certain that the systems of other companies on which we rely
will be Y2K ready on a timely basis and will not have an adverse effect on our
operations. In the instances where we are unable to determine that our vendors
have taken appropriate steps to minimize disruption due to
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non-Y2K readiness, we will consider contingency plans, including moving to
currently identified alternate sources, or developing new alternate sources, to
the extent possible.
COSTS. We do not expect the cost of Y2K assessment, including both
incremental spending and redeployed resources, will be material. The cost
projections are based on management's best estimates we cannot be certain that
we will achieve these estimates. Actual results could differ materially from
those anticipated.
RISK FACTORS RELATING TO DEPOTECH
The following are among the factors that should be considered in
evaluating DepoTech. For the purposes of this section, the terms "we," "our" and
"us" refer to DepoTech.
EARLY STAGE COMPANY. Our products are at an early stage of development.
To date, we have subjected only three of our DepoFoam formulations, DepoCyt,
DepoMorphine and DepoAmikacin(TM), to human clinical testing. Our potential
products will require extensive research, formulation, development, preclinical
and clinical testing, and may involve a lengthy regulatory approval process
prior to commercialization. We cannot be certain that our products or potential
products will prove safe and effective in clinical trials, meet applicable
regulatory standards, or be capable of being made at acceptable cost or
successfully commercialized. In addition, preclinical or clinical testing may
not accurately predict safety or efficacy in broader human use. Unexpected
delays in the regulatory approval process may also arise. Even if all of our
product candidates prove to be safe and effective and the FDA and other
regulatory authorities approve them for marketing, health care providers, payors
and patients still may not accept our products. If we cannot achieve technical
feasibility, demonstrate safety, achieve clinical efficacy, obtain regulatory
approval or, together with our partners, successfully market products, our
business will be adversely affected.
GOVERNMENT REGULATION; UNCERTAINTY OF OBTAINING REGULATORY APPROVAL. Our
research and development activities are, and our future business will be,
subject to significant regulation by governmental authorities in the United
States, primarily by the FDA. Our pharmaceutical products are generally for use
in humans. The Federal Food, Drug, and Cosmetic Act principally governs the
development and commercialization of these products. In addition, FDA
regulations in the United States and comparable laws and regulations in foreign
countries govern such products. We also are subject to regulation under
California's food and drug statutes and regulations.
In April 1997, we completed an NDA for DepoCyt for the treatment of NM
from solid tumors. In May 1998, the FDA informed us that the NDA did not contain
adequate information to support approval for the treatment of NM from solid
tumors. In August 1998, the FDA issued a letter to us inviting us to submit an
NDA for DepoCyt for the treatment of NM from lymphomas. We filed this new NDA in
October 1998. The FDA notified us that it is currently scheduling the NDA for
the lymphoma indication for review by the Oncologic Drugs Advisory Committee
("ODAC") in November 1998. Any final decision regarding our NDA will be made by
the FDA following a recommendation of ODAC. We cannot be certain that the data
from the still ongoing
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arms of the pivotal Phase III trial for NM for lymphomas and leukemia will be
positive and/or confirm earlier results. We also cannot be certain that other
clinical trials of DepoCyt will generate positive results. In addition, these
results and data may not meet the requirements for regulatory approvals
necessary to commercialize DepoCyt in the United States, the European Union, or
other territories where we or our corporate partners wish to market DepoCyt. If
we fail to meet regulatory requirements, Chiron and P&U could terminate our
collaborative agreements. Any of these occurrences could adversely affect our
business.
The clinical testing and FDA review process for new drugs or biologics
requires substantial time, effort and expense. We cannot be certain that the FDA
will grant any approvals for our products on a timely basis, if at all. The FDA
may refuse to approve a product for commercial sale or shipment if we do not
satisfy applicable statutory and/or regulatory criteria or may require
additional testing or information. If we are required to perform additional
testing or provide additional information, our business may be adversely
affected. Also, Congress or the FDA may modify the regulatory process in a
manner that could adversely affect our business.
In 1988, the FDA issued regulations intended to speed up the
development, evaluation and marketing of new drugs to treat life-threatening and
severely debilitating illnesses for which no satisfactory alternatives exist.
These regulations provide for early consultation between the sponsor and the FDA
in the design of both preclinical studies and clinical trials. Currently,
DepoCyt is being developed under this accelerated program. We cannot be certain,
however, that any future products we may develop will be eligible for evaluation
by the FDA under the 1988 regulations. In addition, we cannot be certain that
the FDA will approve DepoCyt or any future products (if eligible) for marketing
sooner than we would traditionally expect or at all. The FDA may restrict the
regulatory approval granted under these regulations as necessary to ensure the
safe use of the drug. In addition, the FDA regulations require post-marketing
clinical studies, sometimes called Phase IV studies, for products approved under
these regulations.
Under the Orphan Drug Act, the FDA may grant orphan drug designation to
drugs intended to treat a "rare disease or condition." This generally is defined
to mean a disease or condition that affects populations of fewer than 200,000
individuals in the United States. Under current law, orphan drug designation
confers United States marketing exclusivity to the first company to receive FDA
approval to market the designated drug for the designated indication. The
marketing exclusivity is for a period of seven years following approval of the
NDA, subject to certain limitations. Orphan drug designation does not shorten
the duration of the regulatory approval process or convey any other regulatory
advantage.
In June 1993, we obtained an orphan drug designation for DepoCyt from
the FDA to treat NM. We cannot be certain that we will receive the first FDA
approval to market DepoCyt to treat NM, and thus, receive market exclusivity for
DepoCyt to treat NM. In addition, we cannot be certain that the marketing
exclusivity that is currently afforded by orphan drug designation and marketing
approval will remain in effect in the future.
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For marketing outside the United States, we are subject to foreign
regulatory requirements governing human clinical trials, manufacturing and
marketing approval for drugs and biologics. Our marketing partner outside the
U.S., P&U, is responsible for regulatory filings for DepoCyt outside the U.S.
under the terms of our collaboration agreement. In January 1998, P&U submitted a
Marketing Authorization Application for Savedar(TM) (known as DepoCyt in the
U.S.) to the European Medicines Evaluation Agency. This filing was based on
safety and efficacy data from the Phase III clinical trial of NM for solid
tumors submitted to the U.S. FDA in April 1997. P&U subsequently withdrew its
application in October 1998, based on an assessment that the FDA would require
additional clinical data to supplement the filing. The requirements relating to
the conduct of clinical trials, manufacturing, product licensing, pricing and
reimbursement vary widely from country to country. We cannot be certain that our
operations or our partners' operations will meet any such requirements.
LIMITED MANUFACTURING EXPERIENCE, RISK OF SCALE-UP. We have no
experience manufacturing products for commercial purposes. Our manufacturing
operations will need to meet ongoing commercial requirements for all markets in
which our products have been approved. The FDA's District Office has notified us
that they are recommending approval for commercial manufacturing of DepoCyt.
This does not imply FDA product approval of DepoCyt. In addition, our
manufacturing operations for DepoCyt will need to pass pre-approval inspections
by regulatory agencies for countries in which there are regulatory filings to
market DepoCyt. For all other products, we will need to significantly scale-up
our current manufacturing operations and comply with cGMPs and other regulations
in the United States and foreign countries relating to achieving the prescribed
quality and required levels of production of such products and obtaining
marketing approval. If we fail to successfully scale-up our manufacturing
operations or to comply with cGMPs and other regulations, our business will be
adversely affected. In particular, we could lose our manufacturing rights under
our collaboration agreements with Chiron and P&U.
FUTURE CAPITAL NEEDS. We will require substantial funds to conduct
research and development and preclinical and clinical testing of our product
candidates and to manufacture and commercialize any of our products that are
approved for commercial sale. In our collaboration agreement with Chiron, we
agreed to fund 50% of the sales and marketing expenses incurred for DepoCyt in
the United States. In addition, in June 1997, we reacquired rights to DepoCyt in
Canada and Europe from Chiron for aggregate cash payments of up to $13.7
million. In December 1997, $2.0 million of this amount was paid to Chiron. If
the FDA notifies us before December 31, 1998 that DepoCyt is approvable or
approved, we must pay the remaining balance of $11.7 million to Chiron no later
than December 31, 1998. If no FDA notification is received before December 31,
1998, we must pay the remaining amount no later than six months from the earlier
of U.S. or European Union regulatory notification that the application to market
or sell DepoCyt is approvable or approved. If all applications for regulatory
approval to sell DepoCyt in the U.S. and European Union are permanently
withdrawn, we will not have any obligation to pay the remaining $11.7 million.
At September 30, 1998, DepoTech had capital lease obligations and a bank
note payable associated with capital expenditures totaling $11.0 million which
is payable over
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the next twelve months. All borrowings are secured by the capital equipment
financed. The terms of our bank loan and equipment lease agreements require us
to maintain certain cash balances. At September 30, 1998, we were not in
compliance with these covenants. The agreements require us to post cash
collateral if the covenants are violated. In October 1998, we entered into an
agreement in which our lenders agreed to not exercise their rights against us
related to our past non-compliance until January 31, 1999 provided that we
satisfy certain conditions. We believe that we have satisfied such conditions
and are discussing future financing terms with our lenders. In connection with
this agreement, we pledged $4.7 million as cash collateral and prepaid a total
of $1.3 million in principal and interest through January 1999 for our equipment
leases and bank loan. Any additional amounts required as cash collateral would
reduce the amount of cash available to fund operations.
We lease a building housing most of our administrative, research and
clinical and manufacturing activities. The minimum rental commitment for this
building ranges from approximately $2.5 million to $4.3 per year, over 17 years
based upon pre-established annual rent increases. We intend to sublease a
portion of this building in 1999.
Our additional future capital requirements will depend on many factors,
including:
o continued scientific progress in our product and process
development programs,
o the time and costs involved in obtaining regulatory approvals,
o the costs involved in filing patents,
o competing technological and market developments,
o changes in existing collaborative relationships,
o our ability to establish development arrangements, and
o the cost of establishing effective sales and marketing
arrangements.
To date, we have not received any revenues from product sales. We
anticipate that our existing available cash, cash equivalents and short-term
investments, committed future contract revenue, projected funding from equipment
and other financing and interest income will be adequate to satisfy our capital
requirements and fund operations into the first quarter of 1999.
UNCERTAINTY OF ADDITIONAL FUNDING. If the proposed merger with
SkyePharma is not approved, we anticipate that we will need to raise additional
capital in the near-term in order to continue our operations. We may raise
capital through public or private financings, as well as collaborative
arrangements, borrowings and other available sources. We believe that additional
funding will be extremely difficult to obtain. If available at all, it likely
will not be available on favorable terms. If adequate funds are not available,
we will be required to curtail operations significantly or to obtain funds
through entering into arrangements with collaborative partners or others. Doing
so may require us to relinquish
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rights to certain of our technologies, potential products or potential markets
that we would not otherwise relinquish. The failure to receive additional
funding would adversely affect our business.
HISTORY OF OPERATING LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY. We
have incurred an accumulated deficit of $93.0 million through September 30,
1998. We expect to continue to incur substantial losses over at least the next
two years as our research and development efforts, clinical testing activities
and manufacturing scale-up and sales and marketing arrangement efforts continue.
All of our revenues to date have consisted of contract revenues, milestone
payments and interest income. No revenues have been generated from product
sales. We cannot be certain that we will be able to generate sufficient product
or contract revenue to become profitable or sustain profitability.
DEPENDENCE UPON PARTNERS FOR DEVELOPMENT AND COMMERCIALIZATION. We do
not currently possess all the resources necessary to develop, complete the FDA
approval process for and commercialize any of our potential products. We intend
to enter into collaborative arrangements with other companies to fund research,
development and clinical trials, to assist in obtaining regulatory approvals in
the United States and internationally and to commercialize our products. Our
ability to apply our drug delivery technology to a broad range of
pharmaceuticals will depend upon our ability to establish and maintain
collaborative arrangements because the rights to many of the drugs most suited
to our drug delivery technology are currently owned by third parties. While we
have entered into preliminary arrangements to test feasibility of our delivery
technology with certain compounds and have entered into collaborations with
Chiron and P&U, we cannot be certain that we will be able to enter into
additional collaborations to develop commercial applications of our drug
delivery technology. In addition, we cannot be certain that we will be able to
enter into or maintain existing or future collaborations or that such
collaborations will be successful. If we fail to enter into a collaboration with
the owner of rights to a particular formulation or drug we will not be able to
develop our drug delivery technology with respect to such formulation or drug.
Our failure to enter into or maintain existing or future collaborations could
adversely affect our business.
Our partners may pursue parallel development of other drug delivery
technologies that may compete with our drug delivery technology. In addition,
agreements negotiated with our partners may allow these partners to terminate
the collaboration at any time without significant penalty. Both we and Chiron
under our agreement with Chiron and P&U under our agreement with P&U may
terminate a portion or all of the collaboration at certain intervals and with
advance notice. Termination of a portion or all of these agreements with Chiron
and P&U would adversely affect our business.
To date we have retained the rights to formulate and manufacture our
products and intend in the future generally to formulate and manufacture
pharmaceuticals for partners. Certain partners, however, may choose to formulate
or manufacture their own formulations, thereby limiting one or more potential
sources of revenue for us. In addition, we believe that the agreements with our
partners may prevent us from entering into arrangements with companies whose
products compete with products our partners sell. We also will have limited or
no control over the resources that any partner may devote to our products, over
partners' development efforts, including the design and
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conduct of clinical trials, or over the pricing of products. We cannot be
certain that any of our present or future collaborative partners will perform
their obligations as expected or will devote sufficient resources to the
development, clinical testing or marketing of our potential products. Any of
these events or failure by a partner to devote sufficient resources to the
development and commercialization of our products would adversely affect our
business.
RELIANCE ON TECHNOLOGY RIGHTS FROM RESEARCH DEVELOPMENT FOUNDATION. In
February 1994, we entered into an Assignment Agreement with the Research
Development Foundation ("RDF"). Under the agreement, RDF assigned to us
exclusive rights to technology. We agreed to pay RDF an earned royalty on gross
revenues from the sale by us or our collaborators of products incorporating this
technology. Our products, including DepoCyt, may incorporate this technology. In
certain other circumstances, we have agreed to pay RDF a percentage of the
royalties or other consideration received by us from licensees (or, if greater,
the amount of royalty we would have owed had we engaged in the same conduct as
the licensees). In addition, RDF retains the right to terminate the agreement or
to convert the exclusive nature of the rights granted under the agreement into a
nonexclusive license if we do not satisfy our contractual obligations, including
making certain minimum annual payments. RDF may also terminate the agreement if
we become bankrupt, if we breach the agreement or if we contest the patents
included in this technology. The termination of the Assignment Agreement or its
conversion to a nonexclusive agreement would adversely affect our business.
PATENTS AND PROPRIETARY TECHNOLOGY. We rely on a combination of
technical leadership, patent, trade secret, copyright and trademark protection
and nondisclosure agreements to protect our proprietary rights. As of November
1,1998, we owned or had exclusive rights to 11 issued or allowed United States
patents, 12 pending United States patent applications, 48 issued foreign patents
and 49 pending foreign applications on file covering various aspects of our drug
delivery technology. We intend to file additional patent applications in the
future. We cannot be certain that any additional patents will be issued to us.
In addition, we cannot be certain that, if any patents are issued, they will
provide us with significant protection or will not be challenged. Even if such
patents are enforceable, we anticipate that any attempt to enforce our patents
would be time consuming and costly. Moreover, the laws of some foreign countries
do not protect our proprietary rights in the products to the same extent as do
the laws of the United States.
The patent positions of pharmaceutical, biotechnology and drug delivery
companies, including us, are uncertain and involve complex legal and factual
issues. Additionally, the coverage claimed in a patent application can be
significantly reduced before the patent is issued. As a consequence, we cannot
be certain that any of our patent applications will result in the issuance of
patents. We also cannot be certain that, if any patents issue, they will provide
significant proprietary protection or will not be circumvented or invalidated.
Because patent applications in the United States are maintained in secrecy until
patents issue and publication of discoveries in the scientific or patent
literature often lag behind actual discoveries, we cannot be certain that we
were the first inventor of inventions covered by our pending patent
applications. We also cannot be certain that we were the first to file patent
applications for such inventions. Moreover,
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we may have to participate in interference proceedings declared by the United
States Patent and Trademark Office to determine priority of invention that could
result in substantial cost to us, even if the eventual outcome is favorable to
us. We cannot be certain that a court would hold our patents, if issued, valid.
An adverse outcome of any patent litigation could subject us to significant
liabilities to third parties. It might also require us to license disputed
rights from or to third parties or require us to cease using the technology in
dispute.
We cannot be certain that others will not assert infringement claims
against us in the future. Infringement claims may result in costly litigation or
require us to obtain a license to intellectual property rights of others. We
cannot be certain that any licenses would be available on terms acceptable to
us, if at all. Furthermore, parties making such claims may be able to obtain
injunctive or other equitable relief that could effectively block our ability to
further develop or commercialize our products in the United States and abroad
and could result in the award of substantial damages. Defense of any lawsuit or
failure to obtain any such license could adversely affect our business. Finally,
litigation, regardless of outcome, could result in substantial cost to and a
diversion of efforts by us.
POSSIBLE VOLATILITY OF STOCK PRICE. Companies like ours have, in recent
years, experienced dramatic stock price volatility. The following factors may
cause the market price of our common stock to fluctuate significantly:
o announcements of technological innovations or new products by
our competitors and others,
o the status of submissions to the FDA or its international
equivalent,
o variations in our results of operations, market conditions,
analysts' estimates and the stock market generally, and
o stock market perceptions of the pharmaceutical, biotechnology
and/or drug delivery industries specifically.
Also, future sales of shares by existing shareholders could adversely
affect the price of our common stock.
DEPENDENCE ON SUPPLIERS. We currently rely on a limited number of
suppliers to provide the materials used to manufacture our DepoFoam
formulations. Certain of these materials are purchased only from one supplier.
If we cannot obtain adequate quantities of necessary materials from our existing
suppliers, we cannot be certain that we will be able to access alternative
sources of supply within a reasonable period of time or at commercially
reasonable rates. Regulatory requirements applicable to drugs tend to make the
substitution of suppliers costly and time-consuming. The unavailability of
adequate commercial quantities, the inability to develop alternative sources, a
reduction or interruption in supply or a significant increase in the price of
materials could adversely affect our ability to manufacture and market our
products.
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RELIANCE ON MANUFACTURING PROCESS. To date, we have relied on a
particular proprietary method of manufacture. We cannot be certain that this
method will be applicable to all pharmaceuticals or biologics we desire to
commercialize. Further, the yield of product incorporated into the delivery
system may be highly variable for different therapeutic agents. Finally, we will
need to successfully meet any manufacturing challenges associated with the
characteristics of the drug to be encapsulated. The physical and chemical
stability of the DepoFoam formulation may vary with each therapeutic agent over
time and under various storage conditions. We cannot be certain that the
manufacturing process will result in economically viable yields of product. The
manufacturing process also may not produce formulations of therapeutic products
sufficiently stable under suitable storage conditions to be commercially useful.
If we decide to pursue alternative manufacturing methods for some or all of our
drugs, we cannot be certain that these methods will prove to be commercially
practical or that we will have or be able to acquire rights to use such
alternative methods.
LIMITED SALES AND MARKETING CAPABILITY. Commercialization of our
products is expected to be expensive and time-consuming. If we elect to
participate directly in sales and marketing efforts for our products, we will
need to build a sales and marketing staff. We cannot be certain that we will be
able to establish an adequate sales and marketing capability in any or all
targeted markets or that we will be successful in gaining market acceptance for
our products. To the extent we enter into co-promotion or other licensing
arrangements, our revenues, if any, will depend on the efforts of third parties.
We cannot be certain that such efforts will be successful. To the extent we rely
on our collaborators, we cannot be certain that any of these collaborators or
their sublicensees will successfully market or distribute our products. We also
cannot be certain that we will be able to establish a successful direct sales
organization or acceptable co-promotion or distribution arrangements.
LEGAL PROCEEDINGS. In April 1998, a class action was filed against us
and two of our former officers. The lawsuit alleges violations of federal
securities laws and seeks unspecified money damages on behalf of a class of
shareholders who purchased our stock during the period April 1, 1996 through
December 18, 1997. We believe the lawsuit is without merit and intend to defend
it vigorously. This litigation and any future litigation brought against us or
our employees, regardless of the outcome, may result in substantial cost and
expense and significant diversions of time and effort by our personnel.
Depending on the amount and timing, an unfavorable resolution of litigation
could adversely affect our business.
ACCESS TO DRUGS. Our ability to develop and commercialize our technology
will be affected by our access and our partners' access to the drugs that are to
be formulated. We intend in certain circumstances to rely on the ability of our
partners to provide access to the drugs that are to be formulated for use with
DepoFoam. We cannot be certain, however, that our partners will have appropriate
drug candidates for formulation in DepoFoam. In addition, we cannot be certain
that we or our partners will not be alleged or determined to be infringing on
third parties' rights and will not be prohibited from using the drug or be found
liable for damages. Any restriction on access or liability for damages would
adversely affect our business.
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DEPENDENCE ON KEY PERSONNEL. Our success is highly dependent, in part,
on our ability to retain highly qualified personnel, including senior management
and scientific personnel. Competition for such personnel is intense and the
inability to retain additional key employees or the loss of one or more current
key employees could adversely affect our business. We cannot be certain that we
will be successful in retaining required personnel in the future. Since February
1998, our workforce has been reduced by approximately 63% to 64 employees
through November 1, 1998 in order to minimize expenditures. We cannot be certain
that we will not be required to reduce our workforce in the future. Any such
further reductions could adversely affect our business.
HIGHLY COMPETITIVE INDUSTRY. The drug delivery, pharmaceutical and
biotechnology industries are highly competitive and rapidly evolving, with
significant developments expected to continue at a rapid pace. Our success will
depend on maintaining a competitive position and developing products and
technologies for efficient and cost-effective drug delivery. Our products will
compete with other formulations of drugs and with other drug delivery systems.
We cannot be certain that any of our products will have advantages that will be
significant enough to cause medical professionals to use them. We believe that
our products will compete on the basis of quality, efficacy, cost, convenience,
safety and patient compliance. New drugs or further development in alternative
drug delivery methods may provide greater therapeutic benefits for a specific
drug or indication or may offer comparable performance at lower cost than our
DepoFoam drug delivery system may offer. We are aware of many other competitors
in the field of drug delivery, including competitors developing injectable or
implantable drug delivery systems, oral drug delivery technologies, passive
transdermal systems, electrotransport systems, oral transmucosal systems and
inhalation systems. We cannot be certain that developments by others will not
render our products or technologies uncompetitive or obsolete. Many of our
existing or potential competitors have substantially greater research and
development capabilities, experience, manufacturing, marketing, financial and
managerial resources than us. Furthermore, acquisitions of competing drug
delivery companies by large pharmaceutical companies could enhance competitors'
financial, marketing and other resources. Accordingly, our competitors may
succeed in developing competing technologies, obtaining FDA approval or gaining
market share for products more rapidly than us.
PRODUCT LIABILITY; AVAILABILITY OF INSURANCE. The design, development
and manufacture of our products involve an inherent risk of product liability
claims and associated adverse publicity. We have obtained clinical trial product
liability insurance for our human clinical trials. We intend to obtain insurance
for future clinical trials of other products under development and for potential
product liability associated with the commercial sale of our products. We cannot
be certain, however, that we will be able to obtain or maintain insurance for
any of our clinical trials or commercial products. Although we currently
maintain general liability insurance, we cannot be certain that the coverage
limits of our insurance policies will be adequate. Product liability insurance
is expensive, difficult to obtain and may not be available in the future on
acceptable terms or at all. A successful claim brought against us in excess of
our insurance coverage would adversely affect our business.
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HAZARDOUS MATERIALS. Our research and development involves the
controlled use of hazardous materials, chemicals and various radioactive
compounds. We cannot completely eliminate the risk of accidental contamination
or injury from these materials. If such an accident occurs, we could be held
liable for any damages that result and any such liability could exceed our
resources. We may incur substantial cost to comply with environmental
regulations.
NO DIVIDENDS. We currently intend to retain any future earnings for use
in our business and do not anticipate paying any cash dividends in the future.
Pursuant to a bank credit facility, we may not, without the bank's prior written
consent, pay or declare dividends except for dividends payable solely in our
stock.
UNCERTAINTY OF HEALTH CARE REFORM MEASURES AND THIRD-PARTY
REIMBURSEMENT. A series of legislative and regulatory health care reform
proposals announced in recent years have created uncertainty that could
adversely affect our ability to raise capital and to identify and reach
agreements with potential partners. If such proposals are eventually adopted,
our business could be adversely affected. Furthermore, our ability to
commercialize our potential product portfolio may be adversely affected to the
extent that such proposals have an adverse effect on the business, financial
condition and profitability of other companies that are current or prospective
collaborators for certain of our proposed products.
Sales of our potential products in foreign and domestic markets, if any,
will depend in part on the availability of reimbursement from third-party payers
such as government health administration authorities, private health insurers
and other organizations. Third-party payers are increasingly challenging the
price and cost-effectiveness of medical products and services. Significant
uncertainty exists as to the reimbursement status of newly approved health care
products. Our proposed products may not be considered cost effective or adequate
third-party reimbursement may not be available to enable us to maintain price
levels sufficient to realize an appropriate return on our investment in product
development. Legislation and regulations affecting the pricing of
pharmaceuticals may change before our proposed products are approved for
marketing and any such changes could further limit reimbursement for medical
products and services.
POSSIBLE ANTI-TAKEOVER EFFECT OF CERTAIN CHARTER PROVISIONS. Certain
provisions of our Articles of Incorporation could make it more difficult for a
third party to acquire us, even if a change in control would be beneficial to
our shareholders. The provisions could preclude transactions in which our
shareholders might receive a premium for their shares over the current market
prices and otherwise limit the ability of our shareholders to approve
transactions that they may deem to be in their best interests. Our Board of
Directors also may issue up to 5,000,000 shares of Preferred Stock in one or
more series and fix the rights and preferences of such Preferred Stock without
any further vote or action by our shareholders. The issuance of Preferred Stock
could decrease the amount of earnings and assets available for distribution to
holders of Common Stock or otherwise adversely affect the rights and powers,
including voting rights, of the holders of the Common Stock. In addition, the
issuance of Preferred Stock could have the effect of delaying or preventing a
change in control.
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YEAR 2000 COMPLIANCE.
DESCRIPTION OF THE ISSUE. The Year 2000 ("Y2K") issue refers to the
inability of certain date-sensitive computer chips, software, and systems to
recognize a two-digit date field as belonging to the 21st century. Mistaking
"00" for 1900 or any other incorrect year could result in a system failure or
miscalculations causing disruptions to operations, including manufacturing, or a
temporary inability to process transactions or engage in other normal business
activities. This is a significant issue for most, if not all companies, with far
reaching implications, some of which cannot be anticipated or predicted with any
degree of certainty. The Y2K issue may create unforeseen risks to us from our
internal computer systems as well as from computer systems of others with whom
we deal. Failures of our and/or others' business systems could adversely impact
our ability to conduct our business.
INTERNAL REVIEW OF YEAR 2000 IMPACT. During 1997, we began a review of
our internal business systems, including embedded technology in manufacturing or
other equipment, as well as the business systems of our suppliers, with the goal
of achieving Y2K readiness by late 1999 and minimizing the effect that Y2K
issues will have on our operations. In February 1998, a report to the Audit
Committee of DepoTech's Board of Directors was prepared concerning the status of
our current and proposed Y2K activities. In addition, we currently are reviewing
all of our internal business systems to ensure that such systems either will be
Y2K ready, or will be modified or replaced by Y2K ready systems by no later than
the end of 1998. We plan to simulate and test, in a Y2K environment, its
business systems to verify our Y2K readiness by no later than mid-1999. The
expected completion dates are based on management's best estimates and we cannot
be certain that we will achieve these completion dates.
VENDORS. We are compiling a list of our key services vendors and
products vendors to ensure Y2K readiness of as many vendors as possible. We have
initiated communication with our key vendors to determine to what extent we may
be vulnerable due to their failure to be Y2K ready. This communication,
including site visits by our personnel, will be ongoing throughout calendar
1999. We cannot be certain that the systems of other companies on which we rely
will be Y2K ready on a timely basis and will not have an adverse effect on our
operations. In the instances where we are unable to determine that our vendors
have taken appropriate steps to minimize disruption due to non-Y2K readiness, we
will consider contingency plans, including moving to currently identified
alternate sources, or developing new alternate sources, to the extent possible.
COSTS. We do not expect the cost of Y2K assessment, including both
incremental spending and redeployed resources, will be material. The cost
projections are based on management's best estimates we cannot be certain that
we will achieve these estimates. Actual results could differ materially from
those anticipated.
Item 3 Quantitative and Qualitative Disclosures About Market Risk.
None.
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PART II - OTHER INFORMATION
Item 1 Legal Proceedings.
None
Item 2 Changes in Securities and Use of Proceeds.
None
Item 3 Defaults Upon Senior Securities
DepoTech has financed certain capital expenditures through
capital leases and bank debt. All borrowings are secured by the capital
equipment financed. The terms of DepoTech's bank loan and equipment lease
agreements require DepoTech to maintain certain cash balances. At September 30,
1998, DepoTech was not in compliance with these covenants. The agreements
require DepoTech to post cash collateral if the covenants are violated. In
October 1998, DepoTech entered into an agreement in which its lenders agreed to
not exercise their rights against DepoTech related to its past non-compliance
until January 31, 1999 provided that DepoTech satisfies certain conditions.
DepoTech believes it has satisfied such conditions and is discussing future
financing terms with its lenders. In connection with this agreement, DepoTech
pledged $4.7 million as cash collateral and prepaid a total of $1.3 million in
principal and interest through January 1999 for its equipment leases and bank
loan. In addition, long term capital lease obligations and a bank note payable
totaling $6.3 million have been reclassified as current debt.
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
Exhibit
Number
-------
3.1 Fourth Restated Articles of Incorporation of DepoTech (filed
as Exhibit 3.2) (1).
3.2 Amended and Restated Bylaws of DepoTech (filed as Exhibit 3.4)
(1).
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Exhibit
Number
-------
10.1 Employment Agreement, dated June 11, 1998, between DepoTech
Corporation and Terrence Chew.
10.2 First Amendment to Marketing and Distribution Agreement dated
September 11, 1998 between the DepoTech Corporation and
Pharmacia & Upjohn S.p.A.
27.1 Financial Data Schedule.
(1) Incorporated by reference to the above noted exhibit to DepoTech's
Registration Statement on Form S-1 (No. 33-95890), as amended.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended September 30,
1998.
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DEPOTECH CORPORATION
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.
DEPOTECH CORPORATION
/s/ Fred A. Middleton
---------------------------------
Date: November 16, 1998 Fred A. Middleton
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
/s/ Dana S. McGowan
----------------------------------
Date: November 16, 1998 Dana S. McGowan
Vice President, Finance and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
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