As filed with the Securities and Exchange Commission on December 19, 1997
Registration No. 333-41195
===========================================================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
POST-EFFECTIVE
AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------
CONNETICS CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 2834 94-3173928
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification Number)
3400 West Bayshore Road
Palo Alto, CA 94303
(650) 843-2800
(Address, including zip code, and telephone number, including area code, of Registrant's principal executive offices)
Thomas G. Wiggans
President and Chief Executive Officer
CONNETICS CORPORATION
3400 West Bayshore Road
Palo Alto, CA 94303
(650) 843-2800
(Name and address, including zip code, and telephone number, including area code, of agent for service)
---------------
COPY TO:
Joshua L. Green
VENTURE LAW GROUP
2800 Sand Hill Road
Menlo Park, California 94025
(650) 854-4488
---------------
Approximate date of commencement of proposed sale to the public:
As soon as practicable after the effective date of this Registration Statement.
---------------
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration number of the earlier effective
registration statement for the same offering. [ ] _____________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the same
offering. [ ] _______________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until this Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
================================================================================
PROSPECTUS
1,750,000 Shares
Connetics Corporation
Common Stock
---------------
All of the shares of Common Stock offered hereby are being issued and sold
directly by Connetics Corporation ("Connetics" or the "Company"). Such shares of
Common Stock will be offered exclusively to institutional investors, and
affiliates of such institutional investors and possibly to other accredited
investors. The Company's Common Stock is quoted on the Nasdaq National Market
under the symbol "CNCT." On December 19, 1997, the last sale price of the
Company's Common Stock as reported on the Nasdaq National Market was $2.94 per
share. See "Price Range of Common Stock."
The Common Stock offered hereby involves a high degree of risk. See "Risk
Factors" beginning on page 7.
---------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
Price to Proceeds to
Public Company(1)
Per Share $ 3.00 $ 3.00
Total $5,250,000 $5,250,000
-- --
(1) Before deducting estimated expenses of $300,000 payable by the Company
and any discounts or commissions payable to broker/dealers or agents.
See "Plan of Distribution." No underwriting discounts or commissions
will be paid by the Company in connection with the sale of the Common
Stock offered hereby.
---------------
The shares of Common Stock offered hereby are offered directly by the
Company. The Company has not fixed a minimum number of shares of Common Stock to
be sold in this offering and funds received by the Company on the sale of less
than all of the shares of Common Stock will not be placed in an escrow, trust or
similar arrangement. It is expected that delivery of certificates for the shares
of Common Stock offered hereby will be made against payment for the Common Stock
at the offices of the Company, 3400 West Bayshore Road, Palo Alto, California,
and the offering of any unsold shares hereunder will terminate, not later than
30 days after the date of this Prospectus.
---------------
December 19, 1997
================================================================================
No person, dealer, sales representative or any other person has been
authorized to give any information or to make any representations in connection
with this offering other than those contained in this Prospectus, and, if given
or made, such information or representations must not be relied upon as having
been authorized by the Company or by any Underwriter. This Prospectus does not
constitute an offer to sell, or a solicitation of an offer to buy any securities
other than the registered securities to which it relates or an offer to, or
solicitation of, any person in any jurisdiction where such an offer or
solicitation would be unlawful. Neither the delivery of this Prospectus nor any
sale made hereunder shall, under any circumstances create any implication that
there has been no change in the affairs of the Company since the date hereof or
that the information contained herein is correct as of any date subsequent to
the date hereof.
--------------------
TABLE OF CONTENTS
Page
----
Prospectus Summary..................................................................................... 3
Risk Factors........................................................................................... 7
The Company............................................................................................ 17
Use of Proceeds........................................................................................ 17
Price Range of Common Stock............................................................................ 17
Dividend Policy........................................................................................ 18
Capitalization......................................................................................... 19
Dilution............................................................................................... 20
Selected Financial Data................................................................................ 21
Management's Discussion and Analysis of Financial Condition and Results of Operations.................. 22
Business............................................................................................... 26
Management............................................................................................. 40
Certain Relationships and Related Transactions......................................................... 49
Principal Stockholders................................................................................. 52
Description of Capital Stock........................................................................... 55
Plan of Distribution................................................................................... 58
Legal Matters.......................................................................................... 58
Experts................................................................................................ 58
Additional Information................................................................................. 59
Index to Financial Statements.......................................................................... F-1
===================================================================================================================
The "C with interlocking hemisphere" logo used alone and with the
Company's name, "Connetics," "ConXn(TM)" and "Ridaura(R)" are trademarks of the
Company. All other tradenames and trademarks appearing in this Prospectus are
the property of their respective holders.
-2-
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and the Financial Statements and Notes thereto contained elsewhere
in this Prospectus. This Prospectus contains forward-looking statements which
involve risks and uncertainties. The Company's actual results may differ
significantly from the results discussed in these forward-looking statements.
Factors that might cause such a difference include, but are not limited to,
those discussed in "Risk Factors" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations," as well as those discussed
elsewhere in this Prospectus.
The Company
Connetics Corporation ("Connetics" or the "Company") is focused on the
development of therapeutics to address serious diseases involving the connective
tissues of the body. Connective tissues are components of the body that form
structural or binding elements such as skin, joints, ligaments and lining of
organs, and form the three-dimensional structure that allows cells to function
normally. The diseases or conditions initially addressed by the Company include
scleroderma, multiple sclerosis, rheumatoid arthritis, psoriasis, and keloids.
Patients suffering from these conditions experience a variety of chronic
problems depending on the particular condition, including excessive
uncontrollable itching, extensive rashes and lesions, hardening of the skin and
internal organs, severe scarring and lack of mobility. The most severe of these
diseases cause painful disfigurement, disability and, in certain cases, death.
The Company estimates that over five million Americans suffer from its targeted
diseases in their various forms, with over five billion dollars spent annually
on treatments that are mostly palliative in nature. Although individually these
diseases have been the subject of various independent research programs, no
concentrated effort has been aimed at developing this market segment as a whole.
The Company has several products in clinical trials addressing these disease
indications: betamethasone valerate quick break foam ("Betamethasone mousse"),
ConXn(TM) (recombinant human relaxin H2) ("relaxin"), T cell receptor V beta
peptide therapeutic vaccines ("TCR Vaccines"), and gamma interferon (1b) ("gamma
interferon"). In December 1996, the Company acquired the exclusive U.S. and
Canadian rights to Ridaura(R) (auranofin), a disease modifying antirheumatic
drug approved for sale, from SmithKline Beecham Corporation and affiliated
entities ("SmithKline"), which is currently distributing the product on the
Company's behalf.
Relaxin. Relaxin is a naturally occurring protein that is known to
promote remodeling of connective tissues. The Company is developing relaxin for
the treatment of scleroderma, as well as other connective tissue diseases.
Scleroderma, a disorder characterized by thickening and hardening of the skin
and internal organs, generally afflicts women in their child-bearing years.
Scleroderma can cause extensive disfigurement and quality of life impairment,
making it impossible for afflicted patients to carry out the most routine daily
functions. This disease affects over 300,000 individuals in the United States
and, in its severe form (known as systemic sclerosis, which affects 60,000 -
80,000 individuals in the U.S.), has a five-year mortality rate of 50%-70%.
Research by two of the Company's founders and their colleagues has shown that
relaxin can inhibit excessive connective tissue formation and promote connective
tissue remodeling. Results from several clinical trials in individuals with
systemic sclerosis, including a 30-patient Company sponsored Phase I clinical
trial, indicate that continuous administration of relaxin was well tolerated,
without any serious drug-related adverse effects. In June 1997, the Company
announced the results of its Phase II clinical trial for use of relaxin in
patients with scleroderma, which showed that administration of relaxin caused a
significant reduction in skin score (a measure of disease progression) and a
trend toward improvement in all twelve other disease parameters. Thus, relaxin
may have a beneficial effect on connective tissue turnover and thus may provide
a treatment for scleroderma. The Company has met with the U.S. Food and Drug
Administration (FDA), and based on that meeting, plans to begin a pivotal trial
of relaxin in 1998. The Company has also conducted a preclinical animal study
that demonstrated relaxin's potential ability to inhibit pulmonary (lung)
fibrosis and is conducting preclinical studies with relaxin in liver and cardiac
fibrosis and infertility.
TCR Vaccines. The Company is developing TCR Vaccines for the treatment
of autoimmune diseases. Connetics has two TCR Vaccines product programs in
development for rheumatoid arthritis and multiple sclerosis. These diseases
collectively disable over two million people nationwide, with combined annual
treatment costs
-3-
exceeding two billion dollars. Results from a physician sponsored Phase I trial
involving 11 patients and a Phase I/II clinical trial involving 23 patients with
chronic progressive multiple sclerosis suggest that a number of patients
achieved the desired immune response to the vaccine, that the vaccine was well
tolerated and that patients who had the desired immune response experienced a
stabilization of disease without side effects during one year of therapy. In
January 1997, the Company initiated a Phase I/II clinical trial designed to
assess the immunogenicity of TCR Vaccines in multiple sclerosis. Patient
enrollment is complete, and results from the trial are expected in early 1998.
The Company has also initiated a pilot clinical study in the use of TCR Vaccines
for the treatment of rheumatoid arthritis and expects to have the results from
this trial by mid-1998.
Betamethasone mousse. The Company has an exclusive license to develop
and market Betamethasone mousse (a quick break foam formulation of the
dermatologic drug, betamethasone valerate) in North America. The product has
been approved for sale in the United Kingdom and is being marketed in the U.K.
by Evans Medical Ltd. The Company is developing Betamethasone mousse for the
treatment of scalp psoriasis, a condition that affects approximately three
million persons in the United States. In August 1997, the Company announced that
results from its Phase III clinical trial with Betamethasone mousse demonstrated
statistically significant improvement over both placebo and betamethasone lotion
for the treatment of scalp psoriasis. The Company intends to file a New Drug
Application (NDA) with the U.S. Food and Drug Administration (FDA) to market the
product for use in all steroid-responsive dermatoses, including psoriasis, in
1998. The Company also has rights to develop additional products in the foam
formulation. The Company has formulated a high potency steroid and plans to
begin Phase III clinical trials of this product early in 1998.
Gamma Interferon. Gamma interferon is one of a family of proteins
involved in the regulation of the immune system and has been shown to inhibit
the production of collagen, the primary component of connective tissue. Gamma
interferon is approved by the FDA and marketed by Genentech, Inc. ("Genentech")
for a rare, serious immune disease. The Company is developing gamma interferon
for the treatment of keloids, which are unsightly, painful, elevated scars
resulting from collagen overproduction. Earlier trials using gamma interferon in
the treatment of keloids have shown clinically significant responses in reducing
the size and/or incidence of recurrence of treated keloids. Based on these
studies, the Company has commenced a Phase II clinical trial for the treatment
of keloids. Patient enrollment has been completed for this trial. In August 1997
the Company also announced results from a Phase III trial of gamma interferon
for the treatment of atopic dermatitis that indicated that the product did not
show an acceptable therapeutic response with respect to the primary clinical
endpoint. As a result, the Company suspended plans to submit a biological
license application for gamma interferon for the treatment of atopic dermatitis
pending complete analysis of the data from the trial. Although the Company's
preliminary conclusion is to not pursue gamma interferon for this indication any
further, the complete results from this trial are expected by the end of 1997.
Ridaura(R). In December 1996, the Company acquired the exclusive U.S.
and Canadian rights to Ridaura (auranofin), a disease modifying antirheumatic
drug, from SmithKline Beecham Corporation and related entities ("SmithKline").
Ridaura is an established therapy for rheumatoid arthritis, an autoimmune
disease that afflicts one to two percent of adult Americans (approximately three
million people), mostly women. Under its agreement with SmithKline, the Company
acquired all rights, title and interest to SmithKline's U.S. and Canadian
intellectual property rights for Ridaura, along with related assets such as
customer lists, contracts, product files and unfilled customer orders. Although
the primary patents for Ridaura expired in 1989 and 1992, the Company intends to
use the other valuable intellectual property rights and assets acquired in
connection with its marketing of the product in the United States. Connetics
began marketing Ridaura through in its own sales force in mid-1997. Through
agreements with SmithKline, customer orders and distribution for the product
will continue to be managed by SmithKline through 1997 (after which time the
Company intends to transition such functions to a third party distributor) and
SmithKline will manufacture and supply Ridaura in final finished package form to
the Company for an initial term of five years. In December 1997, the Company
sold the Canadian rights to Ridaura to Pharmascience Inc., a Canadian company,
for $1,000.
Corporate Strategy. The Company's strategy is to: (i) focus on the
treatment of serious and chronic diseases involving connective tissues caused by
inflammation, abnormal remodeling and autoimmune disorders,
-4-
(ii) target its initial commercial activities at rheumatologists and
dermatologists, which can be effectively served by focused and specialized sales
and marketing activities, (iii) expand its existing product portfolio and pursue
early commercialization opportunities by in-licensing other therapeutically
related products that are already marketed or in late stage clinical
development, (iv) pursue earlier stage opportunities in the field of connective
tissue disorders with high potential, (v) leverage its product development and
commercialization expertise by pursuing additional specialized diseases and
markets, (vi) utilize corporate partnerships to pursue new business
opportunities and overseas licensing of the Company's products in development
and (vii) minimize drug discovery costs, manufacturing costs and capital
requirements.
The Company's principal executive offices are located at 3400 West
Bayshore Road, Palo Alto, CA 94303, and its telephone number at that location is
(650) 843-2800.
-5-
The Offering
Common Stock being offered.............................. 1,750,000 shares
Common Stock to be outstanding after the offering....... 13,100,602 shares(1)
Use of Proceeds......................................... To fund clinical development and a potential product
launch, the repayment of certain indebtedness and
working capital and general corporate purposes. See
"Use of Proceeds."
Nasdaq National Market Symbol........................... CNCT
Summary Financial Data
(In thousands, except per share data)
Nine
Months
Year Ended December 31, Ended
1994 1995 1996 September 30, 1997
---- ---- ---- ------------------
(Unaudited)
Statement of Operations Data:
Product revenues ........................................... $ -- $ -- $ 428 $ 5,053
Cost of product sales....................................... -- -- -- 815
License amortization........................................ -- -- 594 5,344
Research and development expense............................ 6,436 8,271 13,161 14,731
Selling, general and administrative expense................. 1,317 2,113 5,434 6,599
Interest income (expense), net.............................. (97) 12 247 (604)
Net loss.................................................... (7,850) (10,372) (18,514) (23,040)
Net loss per share.......................................... (1.84) (2.34) (2.71) (2.31)
Shares used in computing net loss per share................. 4,276 4,435 6,825 10,034
September 30, 1997
(Unaudited)
------------------------------------
Actual As Adjusted(2)
------ --------------
Balance Sheet Data:
Cash, cash equivalents and short-term investments..................... $ 14,140 $19,090
Working capital....................................................... 1,854 6,804
Total assets.......................................................... 33,839 38,789
Notes payable, current portion........................................ 5,923 5,923
Noncurrent capital lease obligations, capital loans and long-term debt 1,302 1,302
Other long-term liabilities........................................... 6,187 6,187
Redeemable convertible preferred stock, Series A...................... 1,650 1,650
Accumulated deficit................................................... (60,963) (60,963)
Total stockholders' equity............................................ 10,384 15,334
<FN>
- ----------
(1) Based upon the number of shares outstanding as of November 14, 1997.
Excludes 3,033,261 shares of Common Stock issuable upon exercise of options
and warrants outstanding as of November 14, 1997. See "Capitalization,"
"Management -- Stock Plans," and Notes 11 and 12 of Notes to Financial
Statements.
(2) Adjusted to reflect the sale of 1,750,000 shares of Common Stock offered by
the Company hereby at a public offering price of $3.00 per share and the
receipt of the net proceeds therefrom. See "Use of Proceeds."
---------------
</FN>
-6-
RISK FACTORS
In evaluating the Company and its business, prospective investors
should carefully consider the following risk factors in addition to the other
information included in this Prospectus. Because an investment in the Company's
Common Stock involves a high degree of risk, only investors who can accommodate
such risk, including a complete loss of their investment, should purchase the
Common Stock offered hereby.
This Prospectus contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 (the "Securities Act") and Section
21E of the Exchange Act, including, without limitation, statements regarding the
Company's expectations, beliefs, intentions or future strategies. All forward
looking statements included in this document are based on information available
to the Company on the date hereof, and the Company assumes no obligation to
update any such forward looking statements. Actual results could differ
materially from those projected in the forward-looking statements as a result of
the risk factors set forth below. In evaluating the Company's business,
prospective investors should carefully consider the following risk factors in
addition to the other information set forth herein or incorporated herein by
reference.
DEVELOPMENT STAGE COMPANY; UNCERTAINTY OF PRODUCT DEVELOPMENT AND MARKET
ACCEPTANCE
From its inception until its acquisition of Ridaura in December 1996,
Connetics was a development stage company. Except for Ridaura, all of the
Company's products are in clinical or preclinical development, and no revenues
had been generated from products until December 1996, when the Company
recognized $428,000 in December product revenues from Ridaura. To date, the
Company's resources have been primarily dedicated to the research and
development of products that the Company has in-licensed from Genentech and
others. Although the Company believes it has the expertise to develop and
commercialize such products, any or all of the Company's products may fail to be
effective or prove to have undesirable and unintended side effects or other
characteristics that may prevent their development or regulatory approval, or
limit their commercial use. For instance, in August 1997 the Company announced
results from a Phase III trial of gamma interferon for the treatment of atopic
dermatitis. The results indicated that the product did not show an acceptable
therapeutic response with respect to the primary clinical endpoint, and as a
result, the Company suspended plans to submit a biological license application
for gamma interferon for the treatment of atopic dermatitis, pending complete
analysis of the data from the trial (which is expected to be completed by the
end of 1997).
There can be no assurance that the Company, or its collaborative
partners, will be permitted to undertake human clinical trials for any of their
development products not currently in clinical trials or, if permitted, that
such products will be demonstrated to be safe and effective. In addition, there
can be no assurance that any of the Company's products under development will
obtain approval from the FDA or equivalent foreign authorities for any
indication or that an approved compound will be capable of being produced in
commercial quantities at reasonable costs and successfully marketed. Products,
if any, resulting from the Company's research and development programs are not
expected to be commercially available for several years. Even if such products
become commercially available, there can be no assurance that the Company will
be able to gain satisfactory market acceptance for such products.
LIMITED OPERATING HISTORY; HISTORY OF LOSSES; UNCERTAINTY OF FUTURE
PROFITABILITY
Due to its limited operating history, the Company is subject to the
uncertainties and risks associated with any new business. Having no
commercialized products until the December 1996 Ridaura acquisition, the Company
has experienced operating losses every year since its incorporation. Net losses
for the fiscal years ended December 31, 1996 and 1995 were $18.5 million and
$10.4 million, respectively, and the Company had an accumulated deficit of $61.0
million at September 30, 1997. Notwithstanding the Ridaura acquisition, the
Company expects to incur increasing operating losses for at least the next
several years. The amount of net losses and the time required by the Company to
reach profitability are uncertain. There can be no assurance that the Company
will ever be able to generate revenue from its products now under development or
achieve profitability on a sustained basis.
-7-
UNPREDICTABILITY OF CONDUCTING PRECLINICAL AND CLINICAL TRIALS
The Company is conducting a Phase I/II clinical trial of TCR Vaccines
for the treatment of multiple sclerosis, a Phase I clinical trial of TCR
Vaccines for the treatment of rheumatoid arthritis and a Phase II trial for
keloids. There can be no assurance that the Company will be able to successfully
complete its ongoing clinical trials or commence any future trials. In addition,
there can be no assurance that the Company will meet its development schedule
for any of its products in development. If the Company were unable to commence
clinical trials as planned, complete the clinical trials or demonstrate the
safety and efficacy of its products, the Company's business, financial condition
and results of operations would be materially and adversely affected. For
instance, in August 1997 the Company announced results from a Phase III trial of
gamma interferon for the treatment of atopic dermatitis. The results indicated
that the product did not show an acceptable therapeutic response with respect to
the primary clinical endpoint, and as a result, the Company suspended plans to
submit a biological license application for gamma interferon for the treatment
of atopic dermatitis. Even if a product from the Company's research and
development programs or any other therapeutic product is successfully developed
according to plans, there can be no assurance it will be approved by the FDA on
a timely basis or at all.
In addition, because the Company will, in a number of cases, rely on
its contractual rights to access data collected by others in phases of its
clinical trials, the Company is dependent on the continued satisfaction by such
parties' of their contractual obligations to provide such access and cooperate
with the Company in the execution of successful filings with the FDA. There can
be no assurance that the FDA will permit such reliance. If the Company were
unable to rely on clinical data collected by others, the Company may be required
to repeat clinical trials, which could significantly delay commercialization,
and require significantly greater capital.
Before obtaining regulatory approvals for the commercial sale of any of
its products under development, the Company must demonstrate through preclinical
studies and clinical trials that the product is safe and efficacious for use in
the target indication for which approval is sought. The results from preclinical
studies and early clinical trials may not be predictive of results that will be
obtained in later-stage testing and there can be no assurance that the Company's
future clinical trials will demonstrate the safety and efficacy of any products
or will result in approval to market products. A number of companies in the
biotechnology industry have suffered significant setbacks in advanced clinical
trials, even after promising results from earlier trials.
The rate of completion of the Company's clinical trials is dependent
upon, among other factors, the rate of patient enrollment. Patient enrollment is
a function of many factors, including the size of the patient population, the
nature of the protocol, the proximity of patients to clinical sites and the
eligibility criteria for the study. Delays in planned patient enrollment may
result in increased costs and delays, which could have a material adverse effect
on the Company.
FUTURE CAPITAL REQUIREMENTS AND UNCERTAINTY OF FUTURE FUNDING; DILUTIVE AND
OTHER EFFECTS OF EQUITY LINE AGREEMENT
The Company expects that its current cash and cash equivalents and
short-term investments, will be sufficient to fund the Company's operations
through the second quarter of 1998. If the Company is unable to complete this
offering or obtain other financing by mid-1998, the Company's business and
financial condition may be materially and adversely affected.
In addition, the development of the Company's products will require the
commitment of substantial resources to conduct the time-consuming research and
development, clinical studies and regulatory activities necessary to bring any
potential medical product to market and to establish production, marketing and
sales capabilities. The Company will need to raise substantial additional funds
for these purposes. The Company may seek such additional funding through
collaborative arrangements and through public or private financings, including
equity financings. The issuance of the Shares covered by this Registration
Statement, as well as any additional equity financing, if available, will be
dilutive to stockholders and any debt financing, if available, may restrict the
Company's ability to pay dividends on its capital stock or the manner in which
the Company conducts its business. Under the terms of an equity line agreement,
the Company has secured an equity line that potentially allows the
-8-
Company to raise up to $25 million from a certain institutional investor over a
three-year period beginning on December 1, 1997; however, this equity line is
currently unavailable to the Company since the Company does not currently meet a
requirement that the trading price for its Common Stock be at least $7.00 per
share. Other than this equity line, the Company currently has no commitments for
any additional financings and there can be no assurance that any such financings
will be available to the Company or that adequate funds for the Company's
operations, whether from financial markets, collaborative or other arrangements
with corporate partners or from other sources, will be available when needed or
on terms attractive to the Company. The inability to obtain sufficient funds may
require the Company to delay, scale back or eliminate some or all of its
research and product development programs, to limit the marketing of its
products or to license third parties the rights to commercialize products or
technologies that the Company would otherwise seek to develop and market itself.
While the equity line arrangement discussed above may help provide the
Company with additional future financing, the sale of shares thereunder will
have a dilutive impact on other stockholders of the Company. As a result, the
market price of the Company's Common Stock could be materially and adversely
affected, and if the Company is profitable, the Company's net income per share
could be materially decreased in future periods. In addition, the shares to be
issued under the Equity Line Agreement will be issued at a discount (of up to
15%) to the then-prevailing market price of the Company's Common Stock. These
discounted sales could have an immediate adverse effect on the market price of
the Company's Common Stock. The Company also has an obligation to register the
shares to be issued under the equity line before the start of the commitment
period; therefore, the shares sold under the Equity Line Agreement will
generally be eligible for immediate resale, which could further adversely affect
the Company's stock price. Finally, the equity line arrangement will not be
available to the Company if its trading price remains below $7.00 per share and
certain other pricing conditions are not met, which could require the Company to
seek funds from other sources (with the attendant risk factors set forth in the
preceding paragraph).
As a commitment fee to the equity line investor, the Company has issued
a five-year warrant exercisable for 250,000 shares of Common Stock at an
exercise price of $8.25 per share. On each of the first, second, and third
anniversaries of the beginning of the equity line commitment period, the Company
will issue the equity line investor an additional five-year warrant exercisable
for a number of shares based on the amount of the equity line unused by the
Company in the preceding year (up to a maximum of $25,000 in value of warrant
shares if the Company has not drawn any amount under the equity line during the
year and decreasing to zero to the extent the Company has drawn down up to $8.33
million during the year). The Company is obligated to file a registration
statement covering the resale of the shares issuable upon the exercise of such
additional warrants. The issuance and exercise of any such additional warrants
would have a dilutive effect on the Company's stockholders and could have an
adverse effect on the Company's stock price, as could the resale of the shares
acquired thereunder.
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS
The Company had no revenues from products from its inception until
December 1996, when it recognized $428,000 in December product revenues from
Ridaura. As Ridaura revenues continue, there can be no assurance that growth in
Ridaura revenues will be achieved, that current revenue levels will be
maintained, or that the Company will ever be profitable on a quarterly or annual
basis in the future. As noted above, the Company expects to incur quarterly and
annual operating losses for at least the next several years. The Company's
quarterly and annual operating results may fluctuate significantly in the future
depending on such factors as the timing and shipment of significant Ridaura
orders, if any, changes in pricing policies by the Company and its competitors,
the timing and market acceptance of any new products introduced by the Company,
the mix of distribution channels through which Ridaura and other products (if
any) are sold, and the Company's inability to obtain sufficient supplies for its
products. In response to competitive pressures or new product introductions, the
Company may take certain pricing or other actions that could materially and
adversely affect the Company's operating results.
-9-
MANAGEMENT OF RIDAURA PRODUCT; UNCERTAINTY OF FUTURE RIDAURA REVENUES;
OFF-PATENT STATUS OF RIDAURA
The Company's success will depend in part on its ability to manage the
marketing and sales of Ridaura. SmithKline is continuing to manage certain
distribution operations through 1997. Prior to the end of 1997, the Company will
be required to take over distribution. The Company is currently establishing a
relationship with a distribution company; however, there can be no assurance
that such relationship will be finalized or that the prospective distributor
will be prepared to take over distribution functions in a timely manner. If the
Company is unable to maintain sufficient personnel with the appropriate levels
of experience to manage this function, or if the Company is unable to
effectively manage the integration of its rights to Ridaura into the Company's
product line, the Company's business, financial condition and results of
operations could be materially and adversely affected. In addition, there can be
no assurance that the Company's Ridaura revenues will equal or exceed those
achieved by SmithKline over the last several years. The Company's Ridaura
revenues through the first nine months of 1997 have been somewhat below the
Company's preliminary projections at the time of acquisition. If the Company is
not able to market and sell Ridaura successfully, the Company's business,
financial condition and results of operations could be materially and adversely
affected. Furthermore, the primary patents for Ridaura expired in 1989 and 1992;
therefore, the Company will be unable to assert patent infringement claims
against a third party marketing the same product under a different trade name,
which could have a material adverse effect on the Company's business, financial
condition, and results of operations.
POTENTIAL EFFECTS OF GUARANTEE OF VALUE OF SHARES ISSUED TO SMITHKLINE
In connection with its acquisition of U.S. and Canadian rights to
Ridaura in December 1996, the Company issued 637,733 shares of Common Stock to
SmithKline Beecham Properties, Inc. ("SBP"). Pursuant to a December 1997
amendment to the Company's original agreement with SBP, the total value of the
shares issued to SBP is required to be $8.0 million on April 1, 1998; to achieve
such value, the Company may be obligated to issue additional shares to SBP on
such date, or may repurchase a portion of the originally-issued shares to reduce
the market value of the remaining shares to $8.0 million. In the event the
Company is required to issue a substantial number of additional shares to SBP,
such issuance will have a dilutive impact on the other stockholders of the
Company. As a result, the market price of the Company's Common Stock could be
materially and adversely affected, and if the Company is profitable, the Company
net income per share could be materially decreased in future periods. In
addition, SBP currently owns approximately 7.0% of the Company's outstanding
shares of Common Stock. An additional issuance of a substantial number of shares
to SBP would increase SBP's ownership percentage and give SBP increased
influence in matters requiring a stockholder vote, such as electing directors or
approving a merger or sale of the Company. Given the Company's current stock
price, it is likely that the Company will need to issue additional shares to SBP
on April 1, 1998 to achieve the $8.0 million value.
Under the rules of the Nasdaq Stock Market, a second issuance to SBP
cannot result in SBP receiving more than 19.9% or more of the Company's
outstanding Common Stock as of December 30, 1996. Due to the Company's current
stock price and the Nasdaq rules, there is a material likelihood that the
Company will be unable to issue the full amount of shares otherwise issuable to
SBP, and as a result, under the Company's amended agreement with SBP, the
Company would be obligated to increase the amount of deferred royalty-based
payments owed to SBP for Ridaura product sales (currently capped at $6 million)
by the cash value of the unissuable shares. In addition, the Company's royalty
rate for Ridaura sales would increase. Such changes could divert the Company's
available liquid resources away from the Company's operations and development
programs, which could have a material adverse effect on the Company's business
and its results of operations.
POSSIBLE FUTURE PRODUCT ACQUISITIONS
A significant part of the Company's overall strategy is to in-license
or acquire additional marketed or late stage development products in its
targeted therapeutic areas. The 1996 acquisitions of rights to Betamethasone
-10-
mousse and Ridaura reflect this strategy. Future product acquisitions, if any,
may require substantial additional funds (i) for the initial acquisition of
rights to these products and (ii) for the steps necessary to obtain FDA approval
for the product and to market, sell and distribute the products successfully. A
portion of the funds needed to acquire, develop and market any new products may
come from the Company's existing cash and short-term investments; in such case,
fewer resources will be available to the Company's current products and clinical
programs, which could have a material adverse effect on the Company's business,
financial conditions and results of operations. Alternatively, the Company may
seek to raise substantial additional funds for new product acquisitions.
As discussed above under "Future Capital Requirements and Uncertainty
of Future Funding," the Company may seek such additional funding through
collaborative arrangements and through public or private financings, including
equity financings. Any additional equity financing, if available, may be
dilutive to stockholders and any debt financing, if available, may restrict the
Company's ability to pay dividends on its capital stock or the manner in which
the Company conducts business. In addition, any acquisition of rights to
additional products that are not presently approved by the FDA will require the
commitment of substantial resources to conduct the research development,
clinical studies and regulatory activities necessary to bring such potential
product to market. If the newly-acquired product is already approved for sale,
the Company will likely assume the marketing, sale and distribution of such
product, which may require the Company to recruit a substantial number of
qualified employees to perform these functions. If the Company is unable to hire
a sufficient number of employees with the appropriate levels of experience, or
if the Company is unable to effectively manage the integration of any
newly-acquired products into the Company's product line, the Company's business,
financial condition and results of operations could be materially and adversely
affected. Finally, any newly-acquired products may not achieve the marketing or
therapeutic success expected of it by the Company, industry analysts or others
at the time of acquisition. See "-- Management of Ridaura Acquisition;
Uncertainty of Future Ridaura Revenues; Off-Patent Status of Ridaura."
UNCERTAINTIES OF REGULATORY APPROVAL; GOVERNMENT REGULATION
The production and marketing of the Company's products and its ongoing
research and development activities are subject to regulation by numerous
governmental authorities in the United States and other countries. Prior to
marketing, any drug developed by the Company must undergo rigorous preclinical
and clinical testing and an extensive regulatory approval process mandated by
the FDA and equivalent foreign authorities. These processes can take a number of
years and require the expenditure of substantial resources. The Company is also
subject to regulations under the food and drug statutes and regulations of the
State of California.
Obtaining such approvals and completing such testing is a costly and
time-consuming process and approval may not be ultimately obtained. The length
of the FDA review period varies considerably as does the amount of preclinical
and clinical data required to demonstrate the safety and efficacy of a specific
product. The Company may also decide to replace the compounds in testing with
modified or optimized compounds, thus extending the testing process. In
addition, delays or rejections may be encountered based upon changes in FDA
policy during the period of product development and FDA regulatory review of
each submitted new drug application or product license application. Similar
delays may also be encountered in other countries. There can be no assurance
that even after such time and expenditures, regulatory approval will be obtained
for any products developed by the Company. If regulatory approval of a product
is granted, such approval may entail limitations on the indicated uses for which
the product may be marketed. Further, even if such regulatory approval is
obtained, the FDA will require post-marketing reporting and may require
surveillance programs to monitor the usage or side effects of each drug product.
A marketed product, its manufacturer and its manufacturing facilities are
subject to continual review and periodic inspections, and later discovery of
previously unknown problems with a product, manufacturer or facility may result
in restrictions on such product or manufacturer, potentially including
withdrawal of the product from the market. In addition, a failure to comply with
FDA requirements for manufacturing, labeling, advertising, recordkeeping or
reporting of adverse events and other information may result in enforcement
actions including, but not limited to, recalls, seizures, injunctions and
criminal prosecution.
Government regulation in the United States or in foreign countries may
delay marketing of the Company's potential products for years, may impose costly
procedures upon the Company and may furnish a competitive advantage to larger
companies that may compete with the Company. There can be no assurance that FDA
or other regulatory approval for any products developed by the Company will be
granted on a timely basis or at all. A delay in obtaining or a failure to obtain
such approvals would adversely affect the marketing of any potential products
-11-
developed by the Company and the Company's liquidity and capital resources. The
FDA regulatory process is currently under substantial revision as a result of
recently-enacted legislation, and as a result, government regulation may become
more or less restrictive in the future.
PATENTS AND PROPRIETARY RIGHTS
The Company's success will depend in part on the ability of Connetics
and its licensors to obtain patent protection for the Company's products and
processes, to preserve its trade secrets, and to operate without infringing the
proprietary rights of third parties. The Company owns, controls or has
exclusively licensed pending applications and/or issued patents worldwide
relating to the technology of all three of its major programs as well as
technology in the earlier stages of research.
There has been increasing litigation in the biomedical, biotechnology
and pharmaceutical industries with respect to the manufacture, use and sale of
new therapeutic products that are the subject of conflicting patent rights. The
validity and breadth of claims in biomedical/pharmaceutical/biotechnology
patents involve complex factual and legal issues for which no consistent policy
has emerged, and therefore, are highly uncertain. Moreover, the patent laws of
foreign countries differ from those of the U.S. and the degree of protection, if
any, afforded by foreign patents may, therefore, be different. In Europe, a
third party appeal is pending from an opposition to a patent application
concerning relaxin DNA; the original opposition was successfully defended by the
Company's licensor. No assurance can be given that any of the Company's or its
licensors' patent applications will issue as patents or that any such issued
patents will provide a competitive advantage to the Company or will not be
successfully challenged or circumvented by its competitors. In addition, others
may hold or receive patents or file patent applications that contain claims
having a scope that covers products or processes made, used or sold by the
Company. In the event that any claims of third-party patents are upheld as valid
and enforceable with respect to a product or process made, used or sold by the
Company, the Company could be prevented from practicing the subject matter
claimed in such patents or could be required to obtain licenses or redesign its
products or processes to avoid infringement and could be liable to pay damages.
There can be no assurance that such licenses would be available or, if
available, would be on commercially reasonable terms, or that the Company would
be successful in any attempt to redesign its products or processes to avoid
infringement.
Connetics has been awarded U.S. Patent No. 5,614,192 covering its
proprietary TCR Vaccines technology. The Company has become aware that third
parties have also obtained patents relating to TCR Vaccines technology,
including a U.S. patent issued to Immune Response Corporation on March 18, 1997.
With regard to such patents as are known to the Company and its patent counsel,
the Company believes such patents' claims would be found either invalid or not
infringed if asserted against the proposed TCR Vaccines. The Company has filed
an opposition to a European patent claiming compositions for use in treating
multiple sclerosis, covering certain TCR V beta peptides disclosed for treating
multiple sclerosis in the Company's own, earlier-filed application; another
opposition has been filed against this patent by an independent party. The
Company is also aware of other pending third party patent applications which, if
issued, might be asserted against the Company's TCR Vaccines and products or
processes as planned to be made, used or sold by the Company. If such patents
were successfully asserted, the Company could be required to obtain licenses or
redesign its TCR Vaccines products or processes to avoid infringement and could
be liable to pay damages, or could be prevented from commercializing TCR
Vaccines. There can be no assurance that such licenses would be available or, if
available, would be on commercially reasonable terms, or that the Company would
be successful in any attempt to redesign its products or processes to avoid
infringement. Even if the Company's patent counsel render advice that the
Company's products and processes do not infringe any valid claim under third
party patents relating to the TCR Vaccines technology, neither they nor the
Company can assure that no third party will commence litigation to enforce such
patents, or that the Company will not incur substantial expenses or that it will
prevail in any patent litigation. Moreover, patent applications in the U.S. are
maintained in secrecy until issue, and publication of discoveries in the
scientific or patent literature often lag behind actual discoveries, so the
Company cannot be certain that it is aware of all potentially relevant pending
applications and it is not possible to predict with any certainty the scope of
claims that could issue from such a third party's pending application. The
Company anticipates that an interference will be declared between one or more of
its TCR Peptide technology patent applications and those of one or more of its
competitors including the above-referenced patent to
-12-
Immune Response Corporation to determine priority of invention, which could
result in substantial cost to the Company even if the eventual outcome is
favorable. It is not possible to know in advance the invention dates that such
other parties may be able to prove, so the Company cannot know whether its or
its licensors' inventors are the first for inventions covered by their pending
patent applications or that it or its licensors were the first to file patent
applications for such inventions. A judgment adverse to the Company in any such
patent interference, litigation or other proceeding could materially adversely
affect the Company's business, financial condition and results of operation, and
its expense may be substantial whether or not the Company is successful.
Connetics also relies on trade secrets and proprietary know-how. The
Company requires each of its employees, consultants and advisors to execute a
confidentiality agreement providing that all proprietary information developed
or made known to the individual during the course of the relationship will be
kept confidential and not used or disclosed to third parties except in specified
circumstances. The agreements also provide that all inventions conceived by an
employee (or consultant or advisor to the extent appropriate for the services
provided) during the course of the relationship shall be the exclusive property
of the Company, other than inventions unrelated to the Company and developed
entirely on the individual's own time. There can be no assurance, however, that
these agreements will provide meaningful protection or adequate remedies for
misappropriation of the Company's trade secrets in the event of unauthorized use
or disclosure of such information.
DEPENDENCE ON CONTRACT MANUFACTURERS AND SUPPLIERS
The Company currently has no manufacturing facilities for clinical or
commercial production of any of its products, nor does the Company intend to
develop such capabilities in the near future. The Company's products for
research and preclinical testing have been supplied by collaborators and
contract manufacturing companies. Relaxin has been manufactured for Connetics
under contract with four outside vendors: BASF Bioresearch Corp. for
fermentation, Scios, Inc. for purification, Chesapeake Biological Laboratory for
filling and Tektagen, Inc. for testing. TCR vaccines are manufactured for the
Company by American Peptide Company and Multiple Peptide Systems. The Company is
in discussions with additional manufacturers who can supply Relaxin and TCR
Vaccines for clinical and commercial uses. Ridaura is manufactured by SmithKline
(in final finished package form) under an agreement with an initial term through
December 2001. Betamethasone mousse is manufactured for Connetics by CCL
Pharmaceuticals. Gamma interferon is manufactured by Genentech and Parke-Davis.
If the Company is unable to contract for manufacturing capabilities on
acceptable terms, the Company's ability to conduct preclinical and human
clinical testing will be adversely affected, resulting in the delay of
submission of products for regulatory approval and initiation of new development
programs, which in turn could impair materially the Company's competitive
position and the possibility of the Company achieving profitability. In
addition, some materials used in the Company's products may be available only
from sole suppliers. Although neither the Company nor its contract manufacturers
has experienced difficulty acquiring materials for the manufacture of its
products for clinical trials, no assurance can be given that interruptions in
supplies will not occur in the future, which could have a material adverse
effect on the Company's ability to manufacture its products. There can also be
no assurance that the Company will be able to manufacture any of its products on
a commercial scale or at a competitive cost or in sufficient quantities. The
Company currently is seeking additional clinical and commercial suppliers. There
is no assurance that additional suppliers will be engaged by the Company or that
the current manufacturers of relaxin can supply sufficient clinical quantities.
Failure to obtain sufficient clinical or commercial quantities of relaxin or
other products at acceptable terms would have a material adverse impact on the
Company's attempts to complete its clinical trials, and obtain approval for and
commercialize its products.
COMPETITION AND TECHNOLOGICAL CHANGE
Other products and therapies currently exist on the market or are under
development that could compete directly with some of the products that the
Company is marketing, or seeking to develop and market. There can be no
assurance that the Company's products, even if successfully tested and
developed, will be adopted by physicians over such other products, or that the
Company's products will offer an economically feasible alternative to existing
modes of therapy where they exist. In addition, a number of companies are
currently seeking to develop new products and therapies to address diseases
involving connective tissue, particularly in the field of rheumatoid arthritis,
and the number of the Company's competitors in these markets could increase. The
Company intends to
-13-
compete on the basis of the effectiveness, quality and exclusivity of its
products, combined with the effectiveness of its marketing and sales efforts.
There can be no assurance that other products and therapies will not be
developed that will either render the Company's proposed products obsolete or
will have advantages outweighing those of the products and therapies that the
Company is seeking to develop.
With regard to Ridaura, there are numerous products on the market, and
under development, for the treatment of rheumatoid arthritis. There can be no
assurance that Ridaura will continue to be utilized by physicians over other
rheumatoid arthritis products, or that Ridaura will continue to offer a
cost-effective alternative to competing therapies. In addition, although the
Company believes that there will be a continued role for products such as
Ridaura, the market for rheumatoid arthritis will likely change based upon new
product introductions, which could have a material adverse effect on the
Company's sales of Ridaura.
Many of the Company's existing or potential competitors, particularly
large pharmaceutical companies, have substantially greater financial, technical
and human resources than the Company. In addition, many of these competitors
have more collective experience than the Company in undertaking preclinical
testing and human clinical trials of new pharmaceutical products and obtaining
regulatory approvals for therapeutic products. Accordingly, the Company's
competitors may succeed in obtaining FDA approval for products more rapidly than
the Company.
PRODUCT LIABILITY AND AVAILABILITY OF INSURANCE
The Company faces an inherent business risk of exposure to product
liability claims in the event that the use of its technology or potential
products is alleged to have resulted in adverse effects. Such claims, even if
successfully defended by the Company, could injure the Company's reputation.
While the Company has taken, and intends to continue to take, what it believes
are appropriate precautions to minimize exposure to product liability claims,
there can be no assurance that it will avoid liability. The Company believes
that it possesses product liability and general liability and certain other
types of insurance customarily obtained by business organizations of its type.
The Company intends to maintain insurance against product liability risks
associated with the testing, manufacturing and marketing of its products.
However, there can be no assurance that it will be able to obtain such insurance
in the future, or that if obtained, such insurance will be sufficient.
Consequently, a product liability claim or other claims with respect to
uninsured liabilities or in excess of insured liabilities could have a material
adverse effect on the business or financial condition of the Company.
POTENTIAL EFFECTS OF OFFERING ON THE COMPANY'S STOCK PRICE
The Common Stock offered hereby represents approximately 15.8% of the
Company's total outstanding Common Stock as of November 14, 1997. The Company
has no ability to control the timing or volume of resales of the Shares. If all
or a substantial portion of the Shares offered hereby are resold within a short
period of time, the market price for the Company's Common Stock could be
materially and adversely affected.
DEPENDENCE ON KEY PERSONNEL
The Company is dependent on the principal members of its scientific and
management staffs (including Thomas G. Wiggans, its President and Chief
Executive Officer), the loss of whose services might impede the achievement of
development objectives. The Company does not maintain "key person" insurance on
any of these individuals. In addition, the Company's potentially rapid growth
and expansion into areas and activities requiring additional expertise, such as
clinical trials, governmental approvals, manufacturing, sales and marketing,
will increase burdens on the Company's management, operational and financial
resources. Recruiting and retaining management, operational personnel and
qualified scientific personnel to perform research and development work in the
future will be critical to the Company's success. Although the Company believes
it will continue to be successful in attracting and retaining skilled and
experienced management and operational and scientific personnel, there can be no
assurance that the Company will be able to attract and retain such personnel on
acceptable terms given the competition for such personnel among numerous
pharmaceutical and biotechnology companies, universities and other institutions.
-14-
UNCERTAINTY OF PHARMACEUTICAL PRICING AND REIMBURSEMENT; HEALTH CARE REFORM AND
RELATED MATTERS
The levels of revenues and profitability of pharmaceutical companies
may be affected by the continuing efforts of governmental and third party payors
to contain or reduce the costs of health care through various means. In both the
United States and elsewhere, sales of prescription pharmaceuticals are dependent
in part on the availability of reimbursement to the consumer from third party
payors, such as government, employers and private insurance plans. Third party
payors are increasingly seeking to reduce the costs of medical products and
services and looking for improved cost/benefit relationships from the products
and services they buy. If the Company or one of its potential marketing or
strategic alliance partners succeeds in bringing one or more products based upon
the Company's technology to the market, there can be no assurance of market
acceptance of the Company's products or that these products will be considered
cost-effective and that reimbursement to the consumer will be available or will
be sufficient to allow the Company or its partner to sell such products on a
competitive basis. Any inability of the Company or its potential partners to
sell products developed using the Company's technology or in-licensed by the
Company on a competitive basis would have a material adverse effect on the
Company's business.
ENVIRONMENT AND CONTROLLED USE OF HAZARDOUS MATERIALS
The Company is subject to federal, state and local laws and regulations
governing the use, generation, manufacture, storage, discharge, handling and
disposal of certain materials and wastes used in its operations, some of which
are classified as "hazardous." There can be no assurance that the Company will
not be required to incur significant costs to comply with environmental laws and
regulations as its research activities are increased or that the operations,
business and future profitability of the Company will not be adversely affected
by current or future environmental laws and regulations. Although the Company
believes that its safety procedures for handling and disposing materials comply
with such laws and regulations, the risk of accidental contamination or injury
from these materials cannot be eliminated. In the event of such an accident, the
Company could be held liable for any damages that result and any such liability
could exceed the resources of the Company.
EFFECT OF CERTAIN ANTI-TAKEOVER PROVISIONS
The Company's Board of Directors has the authority to issue up to
5,000,000 shares of undesignated Preferred Stock and to determine the rights,
preferences, privileges and restrictions of such shares without further vote or
action by the Company's stockholders. The rights of the holders of Common Stock
will be subject to, and may be adversely effected by, the rights of the holders
of any Preferred Stock that may be issued in the future. The issuance of
Preferred Stock could have the effect of making it more difficult for third
parties to acquire a majority of the outstanding voting stock of the Company. In
April 1997, the Company's Board of Directors adopted a stockholder rights plan,
which entitles existing stockholders of the Company to certain rights (including
the right to purchase shares of Preferred Stock) in the event of an acquisition
of 15% or more of the Company's outstanding common stock, or an unsolicited
tender offer for such shares. The existence of the rights plan could delay,
prevent, or make more difficult a merger or tender offer or proxy contest
involving the Company.
In addition, certain provisions of the Company's charter documents,
including a provision eliminating the ability of stockholders to take actions by
written consent, and of Delaware law could delay or make difficult a merger,
tender offer or proxy contest involving the Company. Further, the Company's
stock option and purchase plans generally provide for the assumption of such
plans or substitution of an equivalent option of a successor corporation or,
alternatively, at the discretion of the Board of Directors, exercise of some or
all of the option stock, including non-vested shares, or acceleration of vesting
of shares issued pursuant to stock grants, upon a change of control or similar
event.
-15-
POSSIBLE VOLATILITY OF STOCK PRICE; LACK OF DIVIDENDS
Prior to February 1996 there was no public market for the Common Stock
of the Company. There can be no assurance that an active trading market will
continue to be sustained or that the market price of the Common Stock will not
decline below the its present market price. The market prices for securities of
biotechnology companies have been highly volatile. Announcements regarding the
results of regulatory approval filings, clinical studies or other testing,
technological innovations or new commercial products by the Company or its
competitors, government regulations, developments concerning proprietary rights
or public concern as to safety of technology have historically had, and are
expected to continue to have, a significant impact on the market prices of the
stocks of biotechnology companies. For instance, in August 1997, the Company's
trading price dropped approximately 46.7% the day the Company announced negative
results from its Phase III clinical trial of gamma interferon for the treatment
of atopic dermatitis. The trading price of the Common Stock could also be
subject to significant fluctuations in response to variations in operating
results. In addition, the Company has never paid cash dividends on its capital
stock and does not anticipate paying cash dividends in the foreseeable future,
but instead intends to retain future earnings for reinvestment in its business.
The Company's credit agreement requires the approval of the Company's bank to
declare or pay cash dividends.
-16-
THE COMPANY
The Company was incorporated in Delaware in February 1993 as Connective
Therapeutics, Inc. and changed its name to Connetics Corporation in May 1997.
The Company's principal executive offices are located at 3400 West Bayshore
Road, Palo Alto, California 94303, and its telephone number is (650) 843-2800.
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 1,750,000 shares
of Common Stock offered hereby (at an offering price of $3.00 per share) are
estimated to be $4,950,000 after deducting estimated offering expenses of
$300,000 and assuming that all shares offered hereby are sold.
The Company expects to use the net proceeds, including the interest
thereon, primarily to fund clinical development programs for relaxin and a high
potency mousse product, to prepare for a potential product launch of
betamethasone mousse and to continue research, development and testing of other
products. After such uses, if proceeds remain available, up to $1,000,000 of the
net proceeds may be used to make a $1,000,000 payment to SmithKline due in April
1998 under a Promissory Note issued in connection with the Ridaura acquisition.
If further proceeds are available, the Company may also use a portion of the net
proceeds to acquire or invest in businesses, products and technologies that are
complementary to those of the Company, although no portion of the net proceeds
has been allocated for any specific acquisition. Remaining proceeds, if any,
will be used for working capital, capital expenditures and general corporate
purposes. Pending such uses, the Company intends to invest such funds in
short-term, interest-bearing obligations of investment grade.
The Company anticipates that its existing capital resources, together
with the net proceeds of this offering, will enable it to maintain its current
and planned operations through the fourth quarter of 1998. The Company's capital
requirements may vary, however, depending upon numerous factors, including those
described above. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
PRICE RANGE OF COMMON STOCK
The Company's Common Stock commenced trading on the Nasdaq National
Market under the symbol CNCT on February 1, 1996. The following table sets
forth, for the periods indicated, the high and low sales prices per share of the
Common Stock as reported on the Nasdaq National Market:
1997 High Low
Fourth Quarter (through December 17, 1997).................... $ 4.25 $ 2.56
Third Quarter................................................. 9.50 3.50
Second Quarter................................................ 7.88 6.00
First Quarter................................................. 8.00 6.63
1996
Fourth Quarter................................................ $ 8.75 $ 6.50
Third Quarter................................................. 10.25 5.75
Second Quarter................................................ 11.00 7.75
First Quarter (from February 1, 1996)......................... 11.25 8.00
The last reported sale price of the Common Stock on the Nasdaq National
Market on December 17, 1997 was $2.75. As of October 31, 1997, there were
approximately 191 stockholders of record of the Company's Common Stock.
-17-
DIVIDEND POLICY
The Company has never paid cash dividends on its capital stock and does
not anticipate paying cash dividends in the foreseeable future, but intends
instead to retain future earnings for reinvestment in its business. Any future
determination to pay cash dividends will be at the discretion of the Board of
Directors and will be dependent upon the Company's financial condition, results
of operations, capital requirements and such other factors as the Board of
Directors deems relevant. The Company's credit agreement requires the approval
of the Company's bank to declare or pay cash dividends.
-18-
CAPITALIZATION
The following table sets forth the capitalization of the Company at
September 30, 1997, as adjusted to reflect the sale of 1,750,000 shares of
Common Stock offered hereby and the application of the net proceeds therefrom as
described under "Use of Proceeds."
September 30, 1997
------------------
Actual As Adjusted
------ -----------
(In thousands)
Noncurrent portion of capital lease obligations, capital loans and long-term debt.. $ 1,302 $ 1,302
Other long-term liabilities........................................................ 6,187 6,187
Redeemable convertible preferred stock, Series A................................... 1,650 1,650
Stockholders' equity:
Preferred Stock, $0.001 par value; 5,000,000 shares authorized; redeemable
convertible Preferred Stock, Series A, 165 shares issued and outstanding,
actual; 5,000,000 shares Series B Participating Preferred Stock, 90,000
shares designated, no shares issued and outstanding, as adjusted................ -- --
Common Stock, $0.001 par value; 50,000,000 shares authorized, 11,075,654 shares
issued and outstanding, actual; and 12,825,654 shares issued and outstanding, as 11 13
adjusted (1)....................................................................
Additional paid in capital......................................................... 72,348 77,296
Notes receivable from stockholders................................................. (75) (75)
Deferred compensation.............................................................. (891) (891)
Deficit accumulated during the development stage................................... (60,963) (60,963)
Treasury stock, at cost (46) (46)
------- -------
Total stockholders' equity...................................................... 10,384 15,334
------- -------
Total capitalization......................................................... $19,523 $24,473
======= =======
<FN>
- ----------
(1) Excludes 1,508,156 shares subject to outstanding options at a weighted
average exercise price of $4.16 per share, 215,429 shares available for
future issuance under the Company's 1994 Stock Plan as of September 30,
1997, and 1,289,194 shares of Common Stock reserved for issuance upon
exercise of warrants at a weighted average exercise price of $8.79 per
share. Also excludes 75,524 shares of Common Stock reserved for issuance
under the Company's 1995 Employee Stock Purchase Plan and 150,000 shares
reserved for issuance under the Company's 1995 Directors' Stock Option
Plan.
</FN>
-19-
DILUTION
The net tangible book value (deficit) of the Company at September 30,
1997 was $(3,403,000), or $(0.31) per share. Net tangible book value (deficit)
per share is determined by dividing the net tangible book value of the Company
(total tangible assets less total liabilities) by the number of shares of Common
Stock outstanding. Without taking into account any changes in net tangible book
value after September 30, 1997, other than to give effect to the sale of the
1,750,000 shares of Common Stock offered hereby (at a public offering price of
$3.00 per share) and the application of the net proceeds therefrom, the pro
forma net tangible book value of the Company at September 30, 1997 would have
been $1,547,000, or $0.12 per share. This represents an immediate increase in
net tangible book value of $0.43 per share to existing stockholders and an
immediate dilution in net tangible book value of $2.88 per share to new
investors. The following table illustrates this dilution per share:
Assumed Public offering price per share................................................. $3.00
Net tangible book value (deficit) per share as of September 30, 1997.................. $(0.31)
Increase in net tangible book value per share attributable to new investors........... 0.43
----
Pro forma net tangible book value after offering........................................ 0.12
-----
Dilution per share to new investors..................................................... $2.88
=====
The following table sets forth on a pro forma basis as of September 30,
1997 the differences between the number and percentage of shares of Common Stock
purchased from the Company, the total consideration (at a public offering price
of $3.00 per share) and percentage of total consideration paid to the Company
and the average price per share paid by existing stockholders and by new
investors:
Shares Purchased Total Consideration Average Price
Number Percent Amount Percent Per Share
------ ------- ------ ------- ---------
Existing stockholders.................. 11,075,654 86% $75,314,447 93% $6.80
New investors.......................... 1,750,000 14% 5,250,000 7% 3.00
---------- ---- -----------
Total........................ 12,825,654 100% $80,564,447 100%
========== ==== =========== ====
The foregoing tables do not assume the exercise of outstanding options
or warrants. At September 30, 1997, there were outstanding options to purchase
1,508,156 shares of Common Stock under the Company's 1994 Stock Plan, at a
weighted average exercise price of $4.16 per share and outstanding warrants to
purchase 1,289,194 shares of Common Stock at a weighted average exercise price
of $8.79 per share. In addition, as of September 30, 1997, an aggregate of
335,953 shares of Common Stock were available for future issuance under the 1994
Stock Plan, the 1995 Employee Stock Purchase Plan and the 1995 Directors' Stock
Option Plan. To the extent that any of these options or warrants or additional
options or warrants are exercised, there will be further dilution to new
investors. See "Management -- Stock Plans" and Notes 9 and 10 of Notes to
Financial Statements.
-20-
SELECTED FINANCIAL DATA
(In thousands, except share and per share amounts)
The following selected financial data for the three years ended
December 31, 1996 and for the period from inception (February 8, 1993) to
December 31, 1993 are derived from the audited financial statements of Connetics
Corporation, which have been audited by Ernst & Young LLP, independent auditors.
The financial data for the nine month periods ended September 30, 1997 and 1996
is derived from unaudited financial statements. The unaudited financial
statements include all adjustments, consisting of normal recurring accruals,
which Connetics Corporation considers necessary for a fair presentation of the
financial position and the results of operations for these periods.
Operating results for the nine months ended September 30, 1997 are not
necessarily indicative of the results that may be expected for the entire year
ending December 31, 1997. The data should be read in conjunction with the
consolidated financial statements, related notes, and other financial
information included herein.
Period
from
inception Nine Nine
(February Months Months
8, 1993) Years Ended December 31, Ended Ended
to December -------------------------------------------- September September
31, 1993 1994 1995 1996 30, 1996 30, 1997
------------ ------------ ------------ ------------ ------------ -------------
Statement of Operations Data:
Product revenues $ -- $ -- $ -- $ 428 $ -- $ 5,053
Operating costs and expenses:
Cost of product sales -- -- -- -- -- 815
License amortization -- -- -- 594 -- 5,344
Research and development 836 6,436 8,271 13,161 9,221 14,731
General and administrative 240 1,317 2,113 5,434 3,419 6,599
Total operating cost and expenses 1,076 7,753 10,384 19,189 12,640 27,489
Loss from operations (1,076) (7,753) (10,384) (18,761) (12,640) (22,436)
Interest income (expense), net (2) (97) 12 247 165 (604)
Net loss $ (1,078) $ (7,850) $ (10,372) $ (18,514) $ (12,475) $ (23,040)
Net loss per share $ (2.71) $ (1.91) $ (2.31)
Shares used to calculate net loss
per share 6,824,668 6,524,574 10,034,185
Pro forma net loss per share $(1.79)
Shares used to calculate pro forma net 5,778,372
loss per share
Balance Sheet Data:
Cash, cash equivalents and short-term $ 729 $ 1,287 $ 9,023 $ 24,554 $ 20,340 $ 14,140
investments
Working capital (147) (979) 5,844 14,904 15,263 1,854
Total assets 930 2,901 11,796 47,922 22,632 33,839
Notes payable -- 1,350 2,205 -- -- --
Non-current portion of capital lease
obligations, capital loans and 13 829 4,933 3,062 3,508 1,302
long-term debt
Other long-term liabilities (1) -- 1,293 1,262 10,858 1,184 6,187
Redeemable convertible preferred stock -- -- -- 2,000 -- 1,650
Total stockholders' equity (net (60) (2,919) 63 21,800 12,707 10,384
capital deficiency)
<FN>
(1) See Note 5 of Notes to Financial statements for a description of the Company's other long-term liabilities.
</FN>
-21-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Connetics Corporation acquires, develops and markets products in the
areas of rheumatology and dermatology. The Company acquired the U.S. and
Canadian rights to Ridaura(R) (auranofin), a treatment for rheumatoid arthritis,
from SmithKline Beecham Corporation and related entities ("SmithKline") in
December 1996. Under a related Transitional Services Agreement, customer orders
and distribution for Ridaura will continue to be managed by SmithKline through
1997. The Company's products under development include betamethasone mousse for
the treatment of scalp psoriasis and other dermatoses; ConXn(TM) (relaxin) for
the treatment of scleroderma and other fibrotic disorders; T-cell Receptor (TCR)
peptide vaccines for the treatment of multiple sclerosis and rheumatoid
arthritis; and gamma interferon for the treatment of keloids. The Company's
stockholders approved a change of the Company's name from "Connective
Therapeutics, Inc." to "Connetics Corporation" at its annual meeting in May
1997.
There can be no assurance that any of the Company's potential products
will be successfully developed, receive the necessary regulatory approvals or be
successfully commercialized.
The Company has financed its operations primarily through the private
sale and issuance of equity securities. Additional cash has been received in
connection with certain credit financing arrangements. To date, substantially
all of the Company's expenditures have been for research and development
activities. The Company has incurred operating losses since its inception and
had an accumulated deficit of $61.0 million at September 30, 1997. The Company
will require additional funds to complete the development of its products and to
fund operating losses which are expected in the next several years. Other than
Ridaura, the Company does not expect its products to be commercialized for the
next several years.
Results of Operations
Nine Months Ended September 30, 1997 and 1996
The Company's revenues, derived from the sales of Ridaura, were $5.1
million for the nine months ended September 30, 1997. The Company had no revenue
for the same periods in 1996, as all of its products were in development stage.
The Company's revenues from Ridaura sales to date have been somewhat below the
Company's preliminary projections at the time of its acquisition of Ridaura.
Under Transitional Services and Supply agreements between SmithKline
and the Company, entered into in conjunction with the acquisition of Ridaura,
SmithKline will manufacture and supply Ridaura in final package form through
December 2001 and manage distribution of the product, with no additional
consideration for performing such services, through December 1997. The Company
is currently in the process of finalizing a distribution arrangement with CORD
Logistics, Inc. ("CORD") under which CORD will manage customer orders and
distribution of Ridaura and any other future products of the Company effective
January 1998. As a result, the Company will begin to incur distribution costs
starting January 1998 currently estimated to be approximately three percent of
net revenue.
The Company's cost of product sales includes the cost of Ridaura
purchased from SmithKline and a percentage royalty cost based on product sales.
For the nine months ended September 30, 1997, the Company recorded $0.8 million
in cost of product sales and recorded amortization expense of $5.3 million
associated with the acquisition of product rights to Ridaura. No product cost
was recorded for the nine months ended September 30, 1996 as the Company was
still in development stage without any revenue generating product.
Research and development expenses were $14.7 million for the nine
months ended September 30, 1997, compared to $9.2 million for the same period in
1996. The $5.5 million increase in research and development expenses was
primarily due to the 555 patient Phase III clinical trial of gamma interferon
for the treatment of atopic
-22-
dermatitis, the 64-patient Phase II clinical trial of ConXn(TM) for the
treatment of scleroderma, the 100-patient Phase I/II clinical trial of TCR
peptide vaccines for the treatment of multiple sclerosis, the 40-patient Phase
II clinical trial of gamma interferon for the treatment of keloids and the
190-patient Phase III clinical trial of betamethasone mousse for the treatment
of scalp psoriasis, all of which commenced subsequent to June 1996. Research and
development expenses are expected to continue to decrease over the next quarter
due to the completion of current clinical trial activities including the
suspension of any further activities associated with gamma interferon for the
treatment of atopic dermatitis. However the decrease could be offset by
unanticipated additional expenses of on-going trials or by possible acquisition
of new technologies and products and initiation of new clinical trials.
Selling, general and administrative expenses increased to $6.6 million
for the nine months ended September 30, 1997, from $3.4 million for the same
period in 1996. The increase was primarily due to the establishment of a new
sales and marketing organization, costs associated with the re-launching of
Ridaura, increases in personnel in the general and administrative functions, and
legal expenses associated with operating as a public company. Selling, general
and administrative expenses are expected to increase primarily due to increased
staffing of the sales organization and costs associated with marketing Ridaura.
Interest income decreased to $714,000 in the nine months ended
September 30, 1997, from $914,000 for the same period in 1996, due to lower
average cash and investment balances held by the Company. Interest earned in the
future will depend on Company funding cycles and prevailing interest rates.
Interest expense increased to $1,318,000 for the nine months ended September 30,
1997, from $749,000 for the same period in 1996. The increase in interest
expense during 1997 was due to imputed interest expense of $830,000 attributable
to the non-interest bearing $11.0 million promissory note payable to SmithKline
as partial consideration for the acquisition of U.S. and Canadian rights to
Ridaura. This was offset in part by lower interest expense associated with lower
balances outstanding for obligations under capital leases and loans, and notes
payable.
The Company incurred a net loss of $23.0 million in the nine months
ended September 30, 1997, compared with $12.5 million for the same period in
1996. The increase of $10.5 million in net loss was primarily due to a higher
level of product development activities and Ridaura-related sales and marketing
expenses, amortization costs and imputed interest expenses. The increase in net
loss was offset in part by revenue generated from the sale of Ridaura less cost
of product sold. The Company expects to incur additional losses over the next
few years and losses are expected to fluctuate from period to period based on
timing of product revenues, clinical material purchases, possible acquisitions
of new products and technologies, scale-up activities and clinical activities.
Years Ended December 31, 1996, 1995 and 1994
The Company recorded its first revenues in December 1996, for a total
of $428,000, due to the initial product sales of Ridaura. In addition, the
Company also recorded amortization cost of $594,000 in December 1996 associated
with the acquisition of product rights to Ridaura from SmithKline. The Company
has determined the useful life of the asset to be three years based on
information regarding products currently in the Company's development pipeline,
competitive products, the off-patent position of Ridaura and expected future
revenues from Ridaura sales.
Research and development expenses were $13.2 million, $8.3 million and
$6.4 million for the years ended December 31, 1996, 1995 and 1994, respectively.
The increase in research and development expenses in 1996 over 1995 was
primarily attributable to significant increases in personnel staffing
particularly related to clinical development, commencement of a Phase III
clinical trial of gamma interferon for the treatment of atopic dermatitis, a
Phase II clinical trial of gamma interferon for the treatment of keloids, a
Phase II clinical trial of ConXn(TM) for the treatment of scleroderma and a
Phase I/II clinical trial of TCR Peptides for the treatment of multiple
sclerosis, and increased outside services required to support operations. The
research and development spending increase in 1995 over 1994 was primarily due
to devoting additional resources to commence the initiation of a Phase I/II
clinical trial of ConXn(TM) for scleroderma, the production of clinical supplies
and increased outside services required to support operations. The factors
contributing to increases in spending were partially offset by decreases in
technology acquisition costs from $1.9 million in fiscal 1994, to $0.9 million
and $35,000 for 1995 and 1996, respectively. Research and development expenses
are expected to continue to increase due to continued expansion of development
-23-
activities, including progression in advanced-stage clinical trials, and
possible acquisition of new technologies and products.
General and administrative expenses were $5.4 million. $2.1 million and
$1.3 million for the year-ended December 31, 1996, 1995 and 1994, respectively.
The increase in general and administrative expenses from 1995 to 1996 was
primarily due to increased support costs associated with operating as a public
company (including costs related to strengthening the senior management team),
professional fees and expenses associated with the acquisition of Ridaura, and
other business development expenses. The increase from 1994 to 1995 was
primarily due to increases in staffing and business development expenses.
General and administrative expenses are expected to continue to increase
primarily due to expanded business development efforts and the creation of a
marketing and sales organization.
Interest income was $1.2 million, $0.4 million and $38,000 for the
years ended December 31, 1996, 1995 and 1994, respectively. The increase in
interest income in 1996 over 1995 was due to higher invested cash balances from
proceeds of the Company's initial public offering and two private placements of
equity securities. The increase in 1995 from 1994 was due to higher balances in
cash and cash equivalents. Interest earned in the future will depend on Company
funding cycles and prevailing interest rates. Interest expense increased to $0.9
million for the year ended December 31, 1996, from $0.4 million and $0.1 million
in 1995 and 1994, respectively, due to increased balances outstanding for
obligations under capital leases and loans, and notes payable.
The Company incurred net losses of $18.5 million, $10.4 million and
$7.9 million for the years ended December 31, 1996, 1995 and 1994, respectively,
primarily due to its development stage activities. The Company expects to incur
substantial additional losses over the next few years and losses are expected to
fluctuate from period to period based on timing of product revenues, clinical
material purchases, possible acquisitions of new products and technologies,
scale-up activities and clinical activities.
For income tax purposes, the Company had a federal net operating loss
carryforward as of December 31, 1996, of approximately $32.4 million available
to offset future taxable income, if any. The net operating loss carryforward
will expire at various dates beginning from 2008 through 2011, if not utilized.
Utilization of the net operating losses and credits may be subject to
substantial annual limitation due to the "change in ownership" provisions of the
Internal Revenue Code of 1986 and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilizations. (See Note 14 of Notes to Financial Statements)
Liquidity and Capital Resources
The Company has financed its operations to date primarily through
private sales of equity securities, proceeds from its initial public offering in
February 1996 and three self-managed financings, two in December 1996 and one in
May 1997.
Working capital decreased by $13.0 million to $1.9 million at September
30, 1997 from $14.9 million at December 31, 1996; cash, cash equivalents and
short-term investments decreased by $10.5 million to $14.1 million at September
30, 1997 from $24.6 million at December 31, 1996. The decrease in cash, cash
equivalents and short-term investments resulted primarily from a $3.0 million
payment to SmithKline for rights to Ridaura made in January 1997, $0.5 million
in consulting and legal fees associated with the acquisition of Ridaura, and
$18.7 million in operating expenses of which approximately $9.7 million relates
to clinical trial activities and $1.8 million relates to sales and marketing
activities. Partially offsetting the decrease during the nine-month period ended
September 30, 1997 was $3.2 million cash generated from Ridaura product sales
(net of product costs) and $10.9 million cash generated from the sale of the
Company's common stock to certain accredited investors in May 1997. The decrease
in working capital was the result of lower cash, cash equivalents and short-term
investments, the now current portion of capital loans, long-term debt and a note
payable due to SmithKline in 1998 for rights to Ridaura, offset in part by lower
accounts payable, accrued process development expenses and higher receivable
balance. The decrease in accounts payable and accrued process development
expenses of $2.5 million during the nine-month period ended September 30, 1997
was due to payments of $3.0 million to SmithKline and $0.7 million for gamma
interferon material associated with the Phase III clinical trial, offset in part
by higher clinical trial activities.
-24-
Receivables at September 30, 1997 increased by $1.5 million to $1.9
million, compared with $0.4 million at December 31, 1996 as a result of
increased sales of Ridaura. Total receivables for the nine months ending
September 30, 1997 was $4.8 million of which $2.8 million has been collected
since September 30, 1997.
For the nine months ended September 30, 1997, expenditures for
equipment and leasehold improvement totaled $0.8 million of which approximately
$0.3 million was financed through a capital loan arrangement. Total additions
for property and equipment for the period from inception to December 31, 1996
totaled $2.5 million of which $2.3 million have been financed through capital
lease and loan arrangements. At September 30, 1997, the Company had invested
$3.3 million in property and equipment, and had approximately $0.6 million
available for borrowing under its capital loan arrangement.
At September 30, 1997, the Company had an aggregate of $16.3 million in
future obligations of principal payments under capital leases, loans, long-term
debt and other obligations, of which $8.8 million is to be paid within the next
year. On November 13, 1997, the Company amended a non-interest bearing $11.0
million promissory note with SmithKline. The amendment allows the Company to
defer the first $6.0 million installment payment, originally due in January
1998, to April 1998, October 1998, and January 1999 with payments of $1.0
million, $1.5 million and $3.5 million, respectively. The Company is required to
pay interest on the principal amount outstanding of the $6.0 million from
January 1, 1998 through January 4, 1999 at prime rate plus 2%. The second
installment payment of $5.0 million under the note, also due January 1999,
remains unchanged.
The Company has a Structured Equity Line Flexible Financing Agreement
(the "Equity Line Agreement") with Kepler Capital LLC ("Kepler") that allows the
Company to access up to $25 million through sales of its Common Stock. The
equity line will be available for a three-year period beginning on or before
December 1, 1997. The Equity Line Agreement provides that the Company can, at
its option, obtain from $500,000 to $2,000,000 at any one time through a sale of
its Common Stock to Kepler, subject to the satisfaction of certain conditions,
including registration of shares for resale, minimum volume requirements, and a
minimum trading price of $7.00 per share over a specified period. In addition,
the Company must sell $500,000 of its Common Stock from time to time if the
price per share exceeds $10.00 and minimum volume requirements are met. Since
the Company's trading price is currently below the $7.00 minimum price
requirement, the Company is presently unable to draw under the equity line.
The Company believes that its existing cash and cash equivalents,
short-term investments, cash generated from the sale of Ridaura, cash expected
to be raised through this offering and funds available under the capital loan,
will be sufficient to fund the Company's operating expenses, debt obligations
and capital requirements through the fourth quarter of 1998. If this offering is
not successful, the Company's currently available financial resources will be
sufficient to fund the Company's operating expenses, debt obligations and
capital requirements through the second quarter of 1998. The Company's future
capital uses and requirements depend on numerous factors, including the progress
of its research and development programs, the progress of clinical and
advanced-stage clinical testing, the time and costs involved in obtaining
regulatory approvals, the cost of filing, prosecuting, and enforcing patent
claims and other intellectual property rights, competing technological and
market developments, the ability of the Company to establish collaborative
arrangements, the level of product revenues, the possible acquisition of new
products and technologies, and the development of commercialization activities,
and therefore such capital uses and requirements may increase in future periods.
As a result, the Company will require substantial additional funds prior to
reaching profitability and may attempt to raise additional funds through equity
or debt financings, collaborative arrangements with corporate partners or from
other sources. Other than the Equity Line Agreement (which is presently
unavailable), the Company currently has no commitments for any additional
financings, and there can be no assurance that additional funding will be
available for the Company to finance its ongoing operations on acceptable terms
if at all. The inability to obtain sufficient funds may require the Company to
delay, scale back or eliminate some or all of its research and product
development programs, to limit the marketing of its products or to license third
parties the rights to commercialize products or technologies that the Company
would otherwise seek to develop and market itself.
-25-
BUSINESS
BACKGROUND
Connective tissue is composed of cells (such as fibroblasts) and the
extracellular matrix (such as collagen-containing fibers) produced by these
cells. Organs of the body such as lungs, kidneys and skin function normally in
part because of the precise three-dimensional arrangement of specialized cells
within a connective tissue framework. Alterations in this framework affect organ
function.
DISEASES INVOLVING CONNECTIVE TISSUE
Inflammation
Inflammation is a natural response to tissue injury and is necessary
for normal healing. During normal wound healing, tissue repair follows an
orderly progression of immune cell infiltration, new blood vessel formation and
connective tissue deposition and remodeling. Under abnormal conditions,
inappropriate regulation of the immune cells results in either local or
widespread tissue injury. Many disorders associated with inflammation occur in
response to an unknown stimulus that misdirects the inflammation process against
normal tissue. This lack of appropriate regulation generally results in chronic,
progressive disease conditions that may ultimately lead to dysfunction or
destruction of the affected organ system.
Abnormal Remodeling
Connective tissue undergoes constant turnover through a normal
remodeling process that links the breakdown of the collagen-based extracellular
matrix with the synthesis of new collagen. The body's ability to regulate this
process normally keeps the amount of connective tissue, which is 95% collagen,
in balance. When this balance is broken, as in the case of certain chronic
diseases, the result can lead to the increase in or breakdown of collagen. Both
excessive formation or destruction of connective tissue can result in serious
disease. There is currently no approved therapy that has been documented to have
significant beneficial effect on the clinical course of abnormal remodeling.
As an example, the overproduction of collagen can result in keloid
formation, hypertrophic scarring and severe systemic disorders, such as
scleroderma and pulmonary fibrosis. Keloids and hypertrophic scars are abnormal
healing responses that occur in the skin, resulting in large, painful, elevated
scars that are unattractive in appearance. There are approximately 300,000
patients treated by dermatologists and plastic surgeons for keloids every year.
Scleroderma is one of the most serious diseases involving the uncontrolled
formation of connective tissue. Approximately 300,000 individuals, primarily
women, suffer from various forms of this disease, with approximately 60,000
having severe or systemic sclerosis with diffuse scleroderma. In its most severe
form, the disease has a five year mortality rate in 50-70% of cases. In the
United States, scleroderma is primarily treated by rheumatologists in the United
States. Currently there is no cure for this often fatal disease and few
therapies ease the pain and suffering of scleroderma patients. Pulmonary
fibrosis represents a group of diseases associated with chronic inflammation and
increase in fibrotic tissue in the walls of the alveolar spaces in the lung.
Ultimately, these diseases result in scarring of lung tissue, impairment of lung
function, and in many cases, death. Approximately 144,000 individuals suffer
from pulmonary fibrosis. Pulmonary fibrosis is primarily treated by
pulmonologists, oncologists and rheumatologists.
Autoimmune Disorders
Connective tissue can also be destroyed by various T cell-mediated
autoimmune diseases. Autoimmune diseases are generally believed to result from
an inappropriate response of the immune system. The immune system is the body's
major biological defense mechanism, first distinguishing antigens (foreign
substances) from the body's tissue and then eliminating a wide variety of
disease-causing pathogens, such as bacteria and viruses. A major component of
this system is T cells. In many autoimmune diseases, these T cells go awry and
attack the body's healthy tissues. There is mounting evidence that these
disease-causing T cells are concentrated at the disease site,
-26-
where they initiate signals leading to tissue destruction. The mechanism
responsible for causing these T cells to attack healthy tissue has, for the most
part, not been identified. Autoimmune diseases can attack virtually any tissue
or organ of the body, are often debilitating and can be fatal.
For example, rheumatoid arthritis is an autoimune disease that attacks
the connective tissue in the joints. Rheumatoid arthritis is a chronic disease
in which the body's immune system leads to an attack on synovial tissue,
resulting in progressive, painful inflammation and destruction of the joints. In
advanced stages of the disease, symptoms include severe pain, body disfigurement
and loss of mobility. It is estimated that between one and two percent of the
adult U.S. population, or more than two million individuals, have rheumatoid
arthritis. Women are three times more susceptible than men. No current therapy
cures the disease and often its progression cannot be stopped. The efficacy of
currently used drugs tends to be directly correlated with systemic toxicity.
Rheumatoid arthritis is primarily treated by rheumatologists. Another example of
an autoimmune disease is multiple sclerosis, a chronic inflammatory disease of
the central nervous system in which the body's immune system attacks myelin, a
substance that encircles and insulates nerve fibers. Multiple sclerosis can
result in impaired mobility, visual impairment, slurred speech, poor bladder
control, sexual dysfunction and, ultimately, confinement to a wheelchair.
Approximately 250,000 persons suffer from multiple sclerosis in the United
States. Multiple sclerosis is primarily treated by neurologists. However, none
of the currently available treatments address the underlying cause of the
disease.
CONNETICS STRATEGY
The key elements of the Company's strategy include:
- Focus on the Treatment of Serious and Chronic Diseases Involving
Connective Tissue. The Company's products and technologies are initially focused
on the treatment of diseases involving connective tissues caused by
inflammation, abnormal remodeling and autoimmune disorders. These diseases
include serious skin and skin structure diseases such as keloids, scleroderma,
organ fibroses, rheumatoid arthritis and multiple sclerosis. Although
individually these diseases have been the subject of many research programs, no
concentrated effort has been aimed at the market segment as a whole,
representing significant and currently underserved opportunities. The Company
believes that its focus on diseases involving connective tissue, combined with
its technological and marketing expertise, maximizes the likelihood of success
in rapidly developing and effectively commercializing products.
- Develop a Marketing Organization Targeting Rheumatologists and
Dermatologists. The Company is targeting its initial commercial activities at
rheumatologists and dermatologists, which can be served by a focused,
specialized marketing organization. Scalp psoriasis and skin dermatoses,
betamethasone mousse's target indications, and keloids, gamma interferon's lead
indication, are treated primarily by dermatologists. Scleroderma, ConXn(TM)'s
lead indication, and rheumatoid arthritis, treated by Ridaura, and for which TCR
Vaccines are being developed, are primarily treated by rheumatologists. With the
acquisition of rights to Ridaura, an established treatment for rheumatoid
arthritis, the Company was able to enter the U.S. and Canadian rheumatology
market in December 1996. As such, the Company's strategy is to target its
marketing activities to the approximately 3,000 rheumatologists and 7,000
dermatologists practicing in the United States. In addition, because these
rheumatologists and dermatologists are primarily concentrated in major
metropolitan areas, they can be effectively served by a relatively small sales
force.
- In-License Development Stage and currently Marketed Products. The
Company expects to continue to in-license and acquire rights to development
products and currently marketed products for the treatment of diseases involving
skin and connective tissue. To date, the Company has in-licensed both gamma
interferon and relaxin from Genentech, and has acquired rights to TCR vaccines
technology primarily from Genentech and XOMA corporation, exclusive license
rights to betamethasone mousse and the mousse delivery technology from Soltec
Research PTY Ltd., and exclusive U.S. and Canadian rights to Ridaura from
SmithKline. Increasing consolidation in the pharmaceutical and biotechnology
industries and continuing changes in the health care system are changing the way
therapeutic products are developed and marketed. As a result, the Company
believes there are significant opportunities to in-license or acquire additional
products from pharmaceutical companies that are not being
-27-
developed or optimally promoted by these companies or do not fit in the present
business strategy of such companies, or from research and academic institutions.
The Company believes it is well-positioned to expand its product portfolio by
licensing such products because of its market focus, complementary products in
development and relevant management experience in product development and
marketing. The Company believes that this strategy can result in accelerated
development and commercialization of novel products to treat serious diseases
involving connective tissue at significantly lower capital requirements than
most biotechnology companies while minimizing the company's exposure to the
risks inherent in drug discovery and basic research.
- Leverage Product Development and Commercialization Expertise. The
Company is leveraging its product pipeline by developing its products for
multiple indications targeted at its strategic markets. In addition, the Company
believes certain of its products can be developed for significant markets and
high-value opportunities outside its strategic markets. Such uses include burn
scarring and infertility for ConXn(TM), and inflammatory bowel disease and type
I diabetes for TCR vaccines. To target such uses, the Company plans to either
retain such products in-house or license them to third parties.
- Utilize Corporate Partnerships to Pursue Additional Markets. In its
strategic markets, the Company plans to retain commercial rights to its products
in North America and to enter into corporate partnerships with respect to
additional market segments in North America and international markets. This
strategy will allow the Company to pursue additional therapeutic markets, offset
near term development costs and enter international markets. The Company intends
to pursue collaborative relationships to provide funding and consulting support
for the Company's research and development programs and to assist in the
clinical and regulatory development and commercialization of specific products
outside of North America.
- Minimize Drug Discovery and Manufacturing Costs. The Company has
sought to minimize the costs of drug discovery and manufacturing by in-licensing
later-stage development and currently marketed products, outsourcing
manufacturing and utilizing research collaborators and consultants. To date, the
Company's clinical supplies have been manufactured by third parties on a
contract basis. The Company also initially intends to use third parties for the
manufacture of its commercial products, including Ridaura, which is being
manufactured for the Company by SmithKline through December 2001. The Company
believes it will be able to minimize costly infrastructure by continuing to use
external resources where appropriate.
PRODUCT DEVELOPMENT
The Company has products in various stages of development as
illustrated in the table below:
PRODUCT INDICATION DEVELOPMENT STATUS
ConXn(TM) Scleroderma Pivotal Trial (to begin in 1998)
Organ Fibrosis Pre-clinical
Infertility Pre-clinical
TCR Peptide Vaccine Multiple Sclerosis Phase I/II
Rheumatoid Arthritis Phase I
Betamethasone Mousse Psoriasis NDA to be filed in 1998
High-potency Steroid Mousse Severe Psoriasis / Skin Dermatoses Phase III (to begin in 1998)
Gamma Interferon Keloids Phase II
Atopic Dermatitis Phase III completed; data analysis on-going
ConXn(TM) Development Program
ConXn(TM) is a naturally occurring peptide hormone that promotes
remodeling of connective tissues. Research by two of the Company's founders and
their colleagues has shown that ConXn(TM) can inhibit excessive connective
tissue formation and promote connective tissue remodeling through at least three
mechanisms: inhibiting the production of collagen by fibroblasts, increasing the
production of collagenase (the enzyme that breaks down collagen) and decreasing
the production of TIMP (a protein that blocks collagenase action). These results
have been confirmed by in vitro studies and in vivo animal models of human
disease. ConXn(TM) can now be
-28-
produced in significant quantities by outside contractors using the Company's
recombinant manufacturing techniques. Connetics is currently developing the
recombinant form of ConXn(TM) for use in the treatment of scleroderma and other
fibrotic conditions, including various organ fibroses and in vitro
fertilization.
Scleroderma. Scleroderma, also called systemic sclerosis in its
advanced stages, is a generalized disorder of connective tissue characterized
clinically by thickening and fibrosis of the skin and internal organs, including
the heart, lungs, kidneys and gastrointestinal tract. Although the underlying
cause of this disease is unknown, the overproduction and accumulation of
collagen and other extracellular matrix proteins in skin and other organs often
leads to severe and painful disfigurement, quality of life impairment,
dysfunction of vital organs and death. There are in excess of 300,000
individuals suffering from scleroderma, of which approximately 60,000 to 80,000
have the most severe form. In the most severe form, the disease has a five-year
mortality rate of 50-70%. There are no effective treatments for this disease;
current therapies are directed to alleviating the symptoms of the disease, not
the underlying cause.
In 1995, the Company completed a Phase I/II clinical trial for
recombinant human ConXn(TM) in patients with scleroderma. This study examined
the safety and pharmacokinetics of continuous subcutaneous infusion of ConXn(TM)
for 28 days at five different dose levels compared to placebo. Thirty patients
with a history of at least two years with systemic sclerosis were enrolled in a
randomized, double-blind, placebo-controlled trial. Administration of ConXn(TM)
was well tolerated through 28 days at all dose levels. In addition, during
global assessments performed at the end of the study, ten of 20 patients
receiving ConXn(TM) reported improvement versus two of ten patients receiving
placebo. No serious adverse events were observed and no patients dropped out of
the study. These safety and pharmacokinetic observations support continued
clinical evaluation of ConXn(TM) for the treatment of scleroderma.
In June 1997, the Company released clinical data from its Phase II
clinical trial. The double-blind, placebo-controlled study involved 64 patients
randomized into one of two treatment groups (25 or 100 ug/kg/day), or placebo.
In the group receiving a dose of 25 ug/kg/day, statistical significance was
found in skin score improvement, the primary clinical endpoint, and positive
trends were seen in all twelve other parameters. As suggested by previous
studies, the higher dose had no effect on the treatment group compared to
placebo. Based upon these results, and a meeting with the Food and Drug
Administration, the Company plans to begin a pivotal trial of ConXn(TM) for the
treatment of scleroderma in 1998.
The Company has been granted Orphan Drug Status for ConXn(TM) for
treatment of progressive systemic sclerosis, a severe form of scleroderma. In
the United States, the Orphan Drug Act of 1983 provides incentives to drug
manufacturers to develop and manufacture products for the treatment of rare
diseases, currently defined as diseases that affect fewer than 200,000
individuals in the United States, or for a disease that affects more than
200,000 individuals in the United States where the sponsor does not
realistically anticipate its product becoming profitable. Under the Orphan Drug
Act, a manufacturer of a designated orphan product can seek certain tax
benefits, and the holder of the first FDA approval of a designated orphan
product will be granted a seven-year period of marketing exclusivity for that
product for the orphan indication. While the marketing exclusivity of an orphan
drug would prevent other sponsors from obtaining approval of the same product
for the same indication, it would not prevent other types of products from being
approved for the same use. The U.S. Congress has considered and may consider in
the future, legislation that would restrict the duration of the market
exclusivity of an orphan drug and, thus, there can be no assurance that the
benefits of the existing statute will remain in effect.
In addition to scleroderma, the Company believes ConXn(TM) may have
potential in organ fibroses, such as pulmonary fibrosis. Pulmonary fibrosis,
also known as interstitial lung disease, represents a group of diseases
associated with chronic inflammation and excessive production of collagen in the
walls of the alveolar spaces in the lung. Approximately 144,000 individuals in
the United States suffer from this disease. In the case of idiopathic pulmonary
fibrosis the underlying cause of the fibrosis is unknown, while other cases may
be associated with another disease process, such as scleroderma, or due to
exposure to toxic drugs or environmental agents. Current therapy for pulmonary
fibrosis consists of corticosteroids and cytotoxic drugs such as
cyclophosphamide, which, when utilized, are largely ineffective.
-29-
Also, based upon work done by Company scientists and external
collaborators, relaxin appears to have an effect on endometrial blood flow
during pregnancy. Higher levels of relaxin have been highly correlated with
successful pregnancy and term delivery. The Company plans to continue its
assessment of these data, and if promising, begin a development program for
relaxin use in in vitro fertilization.
T-Cell Receptor ("TCR") Peptide Development Program
The Company is also developing TCR Peptide vaccines to arrest the
autoimmune disease process by boosting the naturally occurring control arm of
the immune system that functions inefficiently in immune-mediated diseases.
Connetics has two TCR vaccine programs in development, one for multiple
sclerosis and one for rheumatoid arthritis.
Multiple Sclerosis. Multiple sclerosis is an autoimmune disease of the
central nervous system that results from damage to myelin, a substance that
encircles and insulates nerve fibers. Multiple sclerosis can result in impaired
mobility, visual impairment, slurred speech, poor bladder control, sexual
dysfunction and, ultimately, confinement to a wheelchair. Approximately 270,000
persons suffer from multiple sclerosis in the United States. The cost of
treatment in the United States alone was estimated to be $270 million in 1995
and is expected to grow to $1.7 billion worldwide by 1999. However, none of the
currently available treatments address the underlying cause of the disease.
A placebo-controlled, double-blind, randomized, physician sponsored TCR
Vaccine Phase I trial involving 11 patients and a Phase I/II trial involving 23
patients with chronic progressive multiple sclerosis were conducted by an
independent clinical investigator in association with chronic the Company.
Results from these trials suggest that a number of patients achieved the desired
immune response to the vaccine, that the vaccine was well tolerated and that
patients who had the desired immune response experienced a stabilization of
disease without side effects during one year of therapy. Successful peptide
vaccination boosted protective T-cells and lowered pathogenic T-cells thought to
cause the disease. In December 1996, the Company initiated a 100 patient Phase
I/II clinical trial of TCR Vaccines for the treatment of multiple sclerosis and
completed patient enrollment in May 1997. Results from this study are expected
to be available in early 1998.
Rheumatoid Arthritis. Rheumatoid arthritis is a chronic disease in
which the body's immune system attacks synovial tissue in joints, resulting in
progressive, systemic and painful inflammation and erosion of joints. In
advanced phases of the disease, symptoms include severe pain, body disfigurement
and loss of mobility. The cause of rheumatoid arthritis is unknown, though
environmental toxins, certain pathogens and genetic factors have been
implicated. It is estimated that between one and two percent of the worldwide
adult population, including approximately three million individuals in the
United States, suffer from rheumatoid arthritis and about one-half of these will
progress to severe disease. Women are three times more susceptible than men.
Current treatment for rheumatoid arthritis uses a combination of drugs and
physical and occupational therapy in an attempt to prevent further joint damage.
None of these therapies stops progression completely or reverses the damage.
At the tissue level, there is mounting evidence to suggest that T-cells
present at the sites of inflammation cause fibroblast dysfunction that leads to
destruction of the joint capsule. Company investigators have analyzed the
frequency of T-cells with certain types of receptors in patients with rheumatoid
arthritis. Through such studies the Company has identified peptides which mimic
these receptors and which may be useful as therapeutic vaccines. Company
investigators and their collaborators have performed parallel studies in animal
models of arthritis in which disease relevant T cells with specific receptor
configurations have been defined. Therapeutic vaccines based upon the relevant
protein sequences were produced and demonstrated to control the disease process.
Based on these studies, in 1997 the Company initiated a pilot clinical trial of
TCR Vaccines for rheumatoid arthritis.
As part of its TCR Vaccines research program, Connetics has established
a methodology for identifying and isolating disease-causing T cells, which the
Company may use to develop additional products based on its TCR vaccine
technology to treat diseases such as inflammatory bowel disease, psoriasis and
type I diabetes. The TCRs from relevant T cells are analyzed and the resulting
amino acid sequence information is used to chemically synthesize therapeutic
vaccine peptides. The Company believes that these TCR peptides can be
administered to the
-30-
patient as a disease-specific immune booster to halt the progress of the
autoimmune disease. The Company further believes that, because TCR peptides
selectively inhibit only certain T cells, side effects resulting from general,
non-specific immunosuppression can be avoided.
Betamethasone mousse program
In June 1996, the Company signed an agreement with Soltec Research PTY
Ltd. which granted Connetics an exclusive license to develop and market
betamethasone mousse in North America. The product is being marketed in the
United Kingdom by Evans Medical Ltd., a division of Medera PLC. Betamethasone
mousse is a mousse formulation of betamethasone 17-alpha-valerate, a
corticosteroid currently marketed in the U.S. The foam formulation has been
shown to liquify when applied to the body, enabling rapid penetration of active
dermatologic agent. This formulation is designed to be easier to apply and less
messy than currently marketed scalp lotions and gels. In addition, the ease of
use and patient acceptability may enhance patient compliance.
Psoriasis. Psoriasis, a chronic, recurrent dermatologic disease
characterized by inflammation and thickening of the skin, is estimated to affect
over five million people in the United States. Scalp psoriasis, a distinct
manifestation of psoriasis, is a serious problem for more than sixty percent of
psoriatics. Over 1.2 million patients are in treatment at any time in the United
States. Patients with scalp psoriasis suffer from various degrees of erythema,
scaling and itching associated with the disease, and the disease course
typically involves periods of remission followed by acute exacerbations. In a
comparative clinical trial of betamethasone mousse against placebo in scalp
psoriasis patients in the U.K., patients treated with betamethasone mousse
showed statistically significant improvement in erythema (redness), scaling and
plaque. The product was well tolerated and no adverse systemic effects were
noted.
On August 5, 1997, the Company announced results from its Phase III
clinical trial of betamethasone mousse. The results demonstrated statistically
significant improvement over both placebo and a currently marketed betamethasone
lotion for the treatment of scalp psoriasis. The Company intends to file a New
Drug Application (NDA) with the Food and Drug Administration (FDA) to market the
product for use in all steroid-responsive dermatoses, including psoriasis, in
the first quarter of 1998. The 190-patient, placebo-controlled, randomized,
double-blind, multi-center Phase III study demonstrated that patients treated
with betamethasone mousse, administered twice-daily for 28 days, experienced a
statistically significant improvement over patients in the groups treated with
betamethasone lotion, or placebo, in all endpoints, including erythema (redness
of the skin), plaque thickness and scaling. In addition, study investigators
completed a physicians global assessment which showed that overall,
approximately 67% of patients treated with the mousse formulation had complete
or almost complete clearance of symptoms compared with 46% for lotion and 19%
for placebo in an intent to treat analysis. Both betamethasone mousse and lotion
were generally well tolerated.
Gamma Interferon Development Program
Gamma interferon is a member of a family of proteins involved in the
regulation of the immune system, and has been shown to be effective in the
treatment of certain immune-mediated diseases. Gamma interferon is an FDA
licensed product, manufactured and marketed by Genentech for an orphan disease,
chronic granulomatous disease (CGD). Gamma interferon also has been shown to
inhibit the production of IgE (a type of antibody) and collagen. Because of
these biological properties, the Company is developing gamma interferon for use
in the treatment of keloids.
Keloids are abnormal healing responses caused by excess collagen
production, and typically occur in the skin of susceptible individuals resulting
in large, painful, elevated scars which are usually unattractive in appearance.
There are approximately 300,000 patients treated by dermatologists and plastic
surgeons for keloids every year. Although existing therapies are potentially
efficacious, recurrence after therapy is frequent.
In vitro studies have shown that gamma interferon can inhibit collagen
synthesis and production. Phase I/II trials conducted by independent
investigators in collaboration with Genentech have shown preliminary results
indicating that gamma interferon may be efficacious in the treatment of keloids
and hypertrophic scars. One study
-31-
involved ten patients who received intralesional therapy (injection directly
into the keloid) for keloids or hypertrophic scars. At 18 weeks, five of ten
keloids or scars decreased by 50% or more. Therapy was well tolerated and all
patients completed the ten week course of treatment. Another placebo-controlled
study of intralesional therapy was conducted in ten patients with keloids. Six
of eight patients completing the study showed clinically significant responses
in reduction of the size of gamma interferon-treated keloids, as compared to the
placebo-treated keloids. Therapy was well tolerated with no dosage reductions or
patient terminations due to adverse effects of treatment. Based on this in vitro
and clinical information, the Company initiated a Phase II clinical trial in
1996 to demonstrate the efficacy of gamma interferon therapy in patients with
keloids. In May 1997, the Company completed patient enrollment in this trial,
with 40 patients enrolled.
In August 1997, the Company announced the results from its Phase III
clinical trial of gamma interferon for the treatment of atopic dermatitis.
Analysis of the trial did not show an acceptable therapeutic response with
respect to the primary clinical endpoint - a composite clinical severity index
based upon erythema, papulation (swelling) and excoriation (scratch marks). As a
result, the Company announced that it has suspended plans to submit a Biological
License Application (BLA) for gamma interferon for the treatment of atopic
dermatitis. The Company is continuing to evaluate data from the trial and
expects the results to be available by the end of 1997.
MARKETED PRODUCT
On December 31, 1996, the company acquired the exclusive U.S. and
Canadian rights to Ridaura from SmithKline Corporation and related entities
("SmithKline"). Ridaura is an oral formulation of a gold salt (auranofin). Also
classified as a disease-modifying antirheumatic drug, Ridaura has been shown to
slow joint destruction and the progression of rheumatoid arthritis. The drug is
currently indicated for adults with active rheumatoid arthritis who are not
responsive to, or are intolerant of, treatment with non-steroidal
anti-inflammatory drugs.
Rheumatoid arthritis. Rheumatoid arthritis is an autoimmune disease
that afflicts one to two percent of adult Americans (approximately 3 million
patients), with women three times more susceptible than men. It is characterized
by inflammation of synovial tissues with joint pain, swelling and stiffness.
Although autoimmune arthritis can afflict children and adolescents, the
incidences of clinical illness is greatest among those aged 40 to 60 years.
Rheumatoid arthritis is an extremely disabling disease that carries a high
degree of morbidity.
Connetics began marketing Ridaura through its own sales force in
mid-1997. Through agreements with SmithKline, customer orders and distribution
for the product will continue to be managed by SmithKline through 1997 and
SmithKline will manufacture and supply Ridaura (in final finished package form)
to the Company for an initial term through December 2001. The Company is
currently finalizing arrangements with a third party vendor to assume customer
orders and distribution for the product commencing in December 1997, although
there can be no assurance that such arrangements will be consummated.
In December 1997, the Company sold the Canadian rights to Ridaura to
Pharmascience, Inc., a Canadian corporation, for $1,000.
COLLABORATIVE RELATIONSHIPS
The Company's initial products were licensed from Genentech and XOMA.
As part of its business strategy, the Company has entered into and continues to
explore strategic collaborative relationships and consulting agreements with
leading researchers and institutions working in its fields of interest, to
complement its internal research efforts and provide access to technologies that
complement and expand its existing portfolio. The Company is seeking
collaborative agreements with pharmaceutical companies as sources of additional
products and as partners for the development and marketing of existing products.
See "-- Connetics Strategy," "-- Marketing and Sales."
-32-
Genentech. In September 1993, Genentech and Connetics entered into a
license agreement (the "September 1993 Agreement") pursuant to which Connetics
obtained exclusive worldwide rights to relaxin (excluding reproductive
indications and the territories of Japan, Korea and the Republic of China),
including rights licensed to Genentech from the Howard Florey Institute of
Experimental Physiology and Medicine in Melbourne, Australia (the "Florey
Institute"). Connetics also has rights to future developments regarding relaxin.
The Company is obligated to pay royalties on licensed product sales. In
addition, Genentech received an equity position in the Company. The September
1993 Agreement also includes certain technology transfer, supply, and
intellectual property provisions. The Company is responsible for meeting certain
milestones and making payments for supplies provided under the September 1993
Agreement. Failure to timely achieve designated milestones may result in
termination of the agreement by Genentech and a license on a non-exclusive basis
to Genentech of relaxin technology developed by the Company. In July 1994,
Genentech and Connetics amended the September 1993 Agreement to clarify the
Company's right to sub-license the relaxin technology, subject to a right of
first offer held by Genentech. The Company's rights to relaxin were expanded to
include reproductive indications on a co-exclusive basis with Genentech. In
April 1996, the Company acquired rights to Japan, Korea and the Republic of
China from Genentech, thereby giving the Company worldwide rights to the
technology.
The Company is currently negotiating an agreement with the Florey
Institute that will provide for the Company to pay royalties directly to the
Florey Institute (rather than through Genentech) and for such royalty payments
to be restructured. Under the proposed agreement, the Company would provide
approximately $125,000 of annual research funding to the Florey Institute for a
five-year period (which could terminate earlier upon the date of the first sale
of a relaxin product by Connetics or its partner), and the Florey Institute
would receive a royalty on Connetics' sales of relaxin products and a portion of
revenues received from corporate partners. In addition, the Company is engaged
in discussions with a number of pharmaceutical companies regarding marketing and
sales alliances for ConXn for the European and Asian markets. There can be no
assurance that any of the agreements described in this paragraph will be
consummated on a timely basis, or at all.
In December 1995, Genentech and Connetics entered into an agreement
with respect to gamma interferon pursuant to which the Company has acquired
exclusive development and marketing rights in the United States for dermatologic
indications. This Agreement includes supply provisions on the part of Genentech
and obligates the Company to pay for such supply, providing for a profit margin
and an allowance for the Company's expenses in developing and marketing the
product.
XOMA. In June 1994, Connetics entered into an agreement with XOMA
pursuant to which the Company acquired additional TCR Vaccine technology and
patent rights. This Agreement obligates the Company to make certain milestone
payments and to pay certain royalties on sales of TCR vaccine products. The
Company's failure to meet certain milestones may result in the acquisition by
XOMA of a co-exclusive royalty-free license to the TCR vaccine technology with
the right to sublicense.
Arthur A. Vandenbark, Ph.D. (Veterans Administration Medical Center,
Portland, Oregon). In July 1994, the Company entered into a Research
Collaboration and Assignment Agreement with Dr. Vandenbark, the inventor of the
patent rights acquired from XOMA, to establish a framework for a three-year
scientific collaboration relating to the development of the TCR Peptide
vaccines. The agreement provides that the Company pays the Portland Veterans
Affairs Research Foundation in order to fund the collaborative research, gives
the Company access to future inventions and know-how, and obligates the Company
to make certain royalty payments on sales of products not already covered by the
XOMA Agreement. In addition, the Company granted to Dr. Vandenbark options to
purchase the Company's Common Stock, which vest upon the achievement of certain
milestones.
Medical University of South Carolina (Christian Schwabe, Ph.D.). In
April 1995, the Company entered into a Collaborative Research Agreement with the
Medical University of South Carolina to establish a collaborative research
program expanding upon an existing consulting relationship with Dr. Christian
Schwabe in the area of relaxin research, including the biology, receptors,
synthesis and activities of relaxin, the genes encoding relaxin, relaxin
peptides, analogs and related compounds. The agreement provides funding for
collaborative research, gives the Company access to future inventions and
know-how, and obligates the Company to make certain royalty payments on sales of
products covered by licensed patents.
-33-
Soltec. In June 1996, the Company entered into an exclusive License
Agreement with Soltec Research PTY Ltd. to develop and market betamethasone
mousse (a foam mousse formulation of the dermatologic drug, betamethasone
valerate) in North America. Under the terms of the agreement, the Company will
pay a licensing fee to Soltec, plus royalties on future sales of products, if
any, arising from the licensed technology. The Company also has an exclusive
option on Soltec's foam mousse system for the delivery of other compounds and
has exercised such option for clobetasol propionate, a high potency topical
steroid.
SmithKline. In December 1996, the Company entered into an agreement
with SmithKline under which the Company acquired exclusive United States rights
to Ridaura. Ridaura is currently being distributed by SmithKline on behalf of
the Company. Through agreements with SmithKline, customer orders and
distribution for the product will continue to be managed by SmithKline through
1997 and SmithKline will manufacture and supply Ridaura (in final finished
package form) to the Company for an initial term through December 2001.
PATENTS AND PROPRIETARY RIGHTS
The Company's success will depend in part on the ability of Connetics
and its licensors to obtain patent protection for the Company's products and
processes, to preserve its trade secrets, and to operate without infringing the
proprietary rights of third parties. The Company owns, controls or has
exclusively licensed pending applications and/or issued patents worldwide
relating to the technology of all three of its major programs as well as
technology in the earlier stages of research.
The Company's gamma interferon patent portfolio includes issued U.S.
patents and other pending applications relating to the composition of matter,
formulations and methods of treatment, which do not begin to expire until 2009.
The Company's relaxin patent portfolio relates to the composition of matter
(proteins and DNA), analogs and closely related compositions, formulations,
methods of manufacture and methods of treatment, including issued patents in the
U.S. with various international equivalents in addition to other applications
that remain pending. The issued relaxin patents will expire at various times
between 2003 and 2012. The Company's TCR Peptide patent portfolio includes
pending applications in the U.S., and a corresponding international patent and
applications, relating to compositions of matter (peptides, peptide analogs,
peptide fragments, and antibodies), formulations, methods of treatment,
diagnostic methods, and methods of preparing/isolating protective T cells. Two
issued international patents (Australia and Israel) expire in 2010, an issued
U.S. patent expires in 2014 and patents issuing on the pending U.S. and
international applications would expire at various times beginning in 2010.
Extensions may be available for certain key patents in the U.S. and Europe
(subject to statutory changes before product approval). See "Collaborative
Relationships."
There has been increasing litigation in the biomedical, biotechnology
and pharmaceutical industries with respect to the manufacture, use and sale of
new therapeutic products that are the subject of conflicting patent rights. The
validity and breadth of claims in biomedical/pharmaceutical/biotechnology
patents involve complex factual and legal issues for which no consistent policy
has emerged, and therefore, are highly uncertain. Moreover, the patent laws of
foreign countries differ from those of the U.S. and the degree of protection, if
any, afforded by foreign patents may, therefore, be different. In Europe, a
third party appeal is pending from an opposition to a patent application
concerning relaxin DNA; the original opposition was successfully defended by the
Company's licensor. No assurance can be given that any of the Company's or its
licensors' patent applications will issue as patents or that any such issued
patents will provide competitive advantage to the Company or will not be
successfully challenged or circumvented by its competitors. In addition, others
may hold or receive patents or file patent applications that contain claims
having a scope that covers products or processes made, used or sold by the
Company. In the event that any claims of third-party patents are upheld as valid
and enforceable with respect to a product or process made, used or sold by the
Company, the Company could be prevented from practicing the subject matter
claimed in such patents or could be required to obtain licenses or redesign its
products or processes to avoid infringement and could be liable to pay damages.
There can be no assurance that such licenses would be available or, if
available, would be on commercially reasonable terms, or that the Company would
be successful in any attempt to redesign its products or processes to avoid
infringement.
-34-
In March 1997, the Company announced that the United States Patent and
Trademark Office has awarded the Company a patent (U.S. Patent Number 5,614,192)
covering TCR peptides and functional derivatives encompassing the second
complementarity determining region (CDR2) as compositions of matter,
formulations (including peptide cocktails) and methods of treatment of T-cell
mediated diseases.
The Company has become aware that third parties have obtained patents
generally relating to TCR Vaccines technology, including a U.S. patent issued to
Immune Response Corporation on March 18, 1997. With regard to such patents as
are known to the Company and its patent counsel, the Company believes such
patents' claims would be found either invalid or not infringed if asserted
against the proposed TCR Vaccines. The Company has filed an opposition to a
European patent claiming compositions for use in treating multiple sclerosis,
covering certain TCR V beta peptides disclosed for treating multiple sclerosis
in the Company's own, earlier-filed application; another opposition has been
filed against this patent by an independent party. The Company is also aware of
other pending third party patent applications which, if issued, might be
asserted against the Company's TCR Vaccines and products or processes as planned
to be made, used or sold by the Company. If such patents were successfully
asserted, the Company could be required to obtain licenses or redesign its TCR
Vaccines products or processes to avoid infringement and could be liable to pay
damages, or could be prevented from commercializing TCR Vaccines. There can be
no assurance that such licenses would be available or, if available, would be on
commercially reasonable terms, or that the Company would be successful in any
attempt to redesign its products or processes to avoid infringement. Even if the
Company's patent counsel render advice that the Company's products and processes
do not infringe any valid claim under third party patents relating to the TCR
Vaccines technology, neither they nor the Company can assure that no third party
will commence litigation to enforce such patents, or that the Company will not
incur substantial expenses or that it will prevail in any patent litigation.
Moreover, patent applications in the U.S. are maintained in secrecy until issue,
and publication of discoveries in the scientific or patent literature often lag
behind actual discoveries, so the Company cannot be certain that it is aware of
all potentially relevant pending applications and it is not possible to predict
with any certainty the scope of claims that could issue from such a third
party's pending application. The Company anticipates that an interference will
be declared between one or more of its TCR Peptide technology patent
applications and those of one or more of its competitors including the
above-references patent of Immune Response Corporation to determine priority of
invention, which could result in substantial cost to the Company even if the
eventual outcome is favorable. It is not possible to know in advance the
invention dates that such other parties may be able to prove, so the Company
cannot know whether its or its licensors' inventors are the first for inventions
covered by their pending patent applications or that it or its licensors were
the first to file patent applications for such inventions. A judgment adverse to
the Company in any such patent interference, litigation or other proceeding
could materially adversely affect the Company's business, financial condition
and results of operation, and its expense may be substantial whether or not the
Company is successful.
Connetics also relies on trade secrets and proprietary know-how. The
Company requires its employees, consultants and advisors to execute a
confidentiality agreement providing that all proprietary information developed
or made known to the individual during the course of the relationship will be
kept confidential and not used or disclosed to third parties except in specified
circumstances. The agreements also provide that all inventions conceived by an
employee (or consultant or advisor to the extent appropriate for the services
provided) during the course of the relationship shall be the exclusive property
of the Company, other than inventions unrelated to the Company and developed
entirely on the individual's own time. There can be no assurance, however, that
these agreements will provide meaningful protection or adequate remedies for
misappropriation of the Company's trade secrets in the event of unauthorized use
or disclosure of such information.
MARKETING AND SALES
The Company's business strategy is that Connetics should retain
marketing rights for products in the areas of rheumatology and dermatology in
the United States. The Company believes that a large, general sales and
marketing infrastructure is not required to effectively and successfully
maximize the commercial potential of products in the changing health care
market, and in particular products directed toward focused, specialty markets
such as the treatment of connective tissue disorders. The Company is targeting
its initial commercial activities at rheumatologists and dermatologists, which
can be served by a focused and specialized marketing organization. The
-35-
Company has begun to develop such a commercial organization with the deployment
of its initial 14 sales representatives. This sales organization will market the
Company's in-licensed and internally developed products. With regard to Ridaura,
the Company has a transitional services agreement with SmithKline ending
December 31, 1997 whereby SmithKline is performing order entry, packaging,
shipping, invoicing and credit and collection services for Ridaura on behalf of
the Company. The Company currently intends to transition these functions by
January 1998 to a third party vendor. The Company believes these initial sales
representatives will form the core of its sales force, and it expects to expand
the sales force as it prepares to introduce additional products.
Outside the United States, the Company's strategy is to establish
development, marketing and distribution agreements with pharmaceutical
companies. The Company is engaged in discussions with a number of pharmaceutical
companies regarding marketing and sales alliances for both ConXn and its TCR
Peptide products for the European and Asian markets.
As of October 31, 1997, the Company had 18 employees devoted to
marketing and sales.
MANUFACTURING
The Company contracts with independent sources to manufacture its
products, which enables the Company to focus on its product and clinical
development strengths, minimize fixed costs and capital expenditures, and gain
access to advanced manufacturing process capabilities. Gamma interferon is
manufactured by Genentech and Parke-Davis. ConXn(TM) has been manufactured for
Connetics under contract with four outside vendors: BASF Bioresearch Corp. for
fermentation, Scios Nova, Inc. for purification, Chesapeake Biological
Laboratory for filling and Tektagen, Inc. for testing. TCR peptide vaccines are
manufactured by American Peptide Company and Multiple Peptide Systems. The
Company is in discussions with additional manufacturers who can supply ConXn(TM)
and TCR Peptides for clinical and commercial uses. Ridaura is manufactured by
SmithKline (in final finished package form) under an agreement with an initial
term through December 2001. Betamathasone mousse is manufactured for Connetics
by CCL Pharmaceuticals.
The Company's strategy is to continue to use manufacturing agreements
for the production of its current and future products.
COMPETITION
The biopharmaceutical industry is highly competitive. The Company
believes that there are numerous pharmaceutical and biotechnology companies and
academic research groups throughout the world engaged in research and
development efforts with respect to therapeutic products targeted at diseases or
conditions addressed by the Company. There can be no assurance that such other
companies and research institutions will not complete the development and
regulatory approval process sooner and, therefore, market their products earlier
than the Company. Many of these institutions have substantially greater
financial, marketing and human resources and development capabilities than
Connetics. Technological developments by competitors, earlier regulatory
approval for marketing competitive products or superior marketing capabilities
possessed by competitors could adversely affect the commercial potential of the
Company's products. In particular, with respect to the TCR Peptides, the Company
is aware that other companies and research institutions are engaged in research
and development efforts and are in various stages of clinical trials with
respect to rheumatoid arthritis and other autoimmune diseases.
With regard to Ridaura, there are numerous products on the market, and
under development, for the treatment of rheumatoid arthritis. There can be no
assurance that Ridaura will continue to be utilized by physicians over other
rheumatoid arthritis products, or that Ridaura will continue to offer
cost-effective alternative to competing therapies. In addition, although the
Company believes that there will be a continued role for products such as
Ridaura, the market for rheumatoid arthritis will likely change based upon new
product introductions, which could have a material adverse effect on the
Company's sales of Ridaura.
Connetics believes that competitive factors in its industry include
scientific and technological expertise, managerial competence in identifying and
pursuing product in-licensing and acquisition opportunities, operational
-36-
competence in developing, protecting, manufacturing and marketing products and
obtaining timely regulatory agency approvals, and financial resources. The
Company intends to compete on the basis of the quality and exclusivity of its
products, combined with the effectiveness of its marketing and sales efforts.
Competing successfully will depend on the Company's continued ability to attract
and retain skilled and experienced personnel, to develop and secure the rights
to pharmaceutical products and compounds and to exploit these products and
compounds commercially prior to the development of competitive products by
others. The Company expects that there will be continued competition for highly
qualified scientific, technical and managerial personnel.
GOVERNMENT REGULATION
FDA Regulation and Product Approval. Regulation by governmental
entities in the United States and other countries will be a significant factor
in the production and marketing of any pharmaceutical products which are or may
be developed by the Company. It is expected that all of the Company's
pharmaceutical products will require regulatory approval by governmental
agencies prior to commercialization. In particular, human pharmaceutical
therapeutic products are subject to rigorous preclinical and clinical testing
and other approval procedures by the FDA in the United States and similar health
authorities in foreign countries. Various federal and, in some cases, state
statutes and regulations also govern or influence the manufacturing, safety,
labeling, storage, record keeping and marketing of such pharmaceutical products.
The process of obtaining these approvals and the subsequent compliance with
appropriate federal and foreign statutes and regulations are time-consuming and
require the expenditure of substantial resources.
Generally, in order to obtain FDA approval for a new therapeutic agent,
a company first must conduct preclinical studies in the laboratory and in animal
model systems to gain preliminary information on the agent's efficacy and to
identify any safety problems. "Preclinical" studies include toxicity,
pharmacokinetic and efficacy testing in vitro and in animals and chemical or
biological formulation work in preparation for submission of the necessary data
to comply with applicable regulations prior to the commencement of human
testing. The results of these studies are submitted as a part of an
investigational new drug application ("IND"), which the FDA must review before
human clinical trials of an investigational drug can start. The Company has
filed and will continue to be required to sponsor and file INDs and will be
responsible for initiating and overseeing the clinical studies to demonstrate
the safety and efficacy that are necessary to obtain FDA approval of its
products. Clinical trials are normally done in three phases and generally take
two to five years, but may take longer, to complete. "Phase I trials" generally
involve administration of a product to a small number of persons to determine
safety, tolerance and pharmacokinetic characteristics. "Phase I/II trials"
generally involve administration of a product to a small number of persons who
have the targeted disease to determine safety, tolerance and pharmacokinetic
characteristics and/or to obtain preliminary evidence of efficacy. "Phase II
trials" generally involve administration of a product to a limited number of
patients with a particular disease to determine dosage, efficacy and safety.
"Phase III trials" generally examine the clinical efficacy and safety in an
expanded patient population at multiple clinical sites. At least one such trial
is required (but usually two are required) for FDA approval to market a drug.
After completion of clinical trials of a product, the Company will be
required to file a new drug application ("NDA"), if the product is classified as
a new drug, or a biologic license application ("BLA"), if the product is
classified as a biologic, and receive FDA approval before commercial marketing
of the product. The testing and approval processes require substantial time and
effort and there can be no assurance that any approval will be granted on a
timely basis, if at all. While the Company will endeavor to secure expedited
review and approval when possible, NDAs and BLAs can take between one and two
years to be reviewed by the FDA, and can take longer if significant questions
arise during the review process. While recent legislative and regulatory
initiatives have focused on the need to reduce FDA review and approval times,
the ultimate impact of such initiatives on the Company's products cannot be
certain. If questions arise during the FDA review process, approval can take
more than five years. Even if FDA regulatory clearances are obtained, a marketed
product is subject to continual review, and later discovery of previously
unknown problems or failure to comply with the applicable regulatory
requirements may result in restrictions on the marketing of a product or
withdrawal of the product from the market, recalls, seizures, injunctions or
criminal sanctions. For marketing outside the United States, the Company will
also be subject to foreign regulatory requirements governing human clinical
trials, manufacturing and marketing approval for pharmaceutical products. The
requirements governing the conduct of clinical trials, product licensing,
pricing and reimbursement vary widely from country to country.
-37-
Third Party Reimbursement and Health Care Reform. The commercial
success of the Company's products under development will be substantially
dependent upon the availability of government or private third-party
reimbursement for the use of such products. There can be no assurance that
Medicare, Medicaid, health maintenance organizations and other third-party
payers will authorize or otherwise budget such reimbursement. Such governmental
and third party payers are increasingly challenging the prices charged for
medical products and services. If the Company succeeds in bringing one or more
of its development products to market, there can be no assurance that such
products will be viewed as cost-effective or that reimbursement will be
available to consumers or will be sufficient to allow the Company's products to
be marketed on a competitive basis. Furthermore, federal and state regulations
govern or influence the reimbursement to health care providers of fees and
capital equipment costs in connection with medical treatment of certain
patients. In response to concerns about the rising costs of advanced medical
technologies, the current administration of the federal government has in the
past publicly stated its desire to reform health care, including the possibility
of price controls and revised reimbursement policies; while the administration
is no longer pursuing major initiatives, there can be no assurance that any
future actions taken by the administration with regard to health care reform
will not have a material adverse effect on the Company. If any actions are taken
by the administration, such actions could adversely affect the prospects for
future sales of the Company's products. Further, to the extent that these or
other proposals or reforms have a material adverse effect on the Company's
ability to secure funding for its development or on the business, financial
condition and profitability of other companies that are prospective
collaborators for certain of the Company's product candidates, the Company's
ability to develop or commercialize its product candidates may be adversely
affected.
Given recent government initiatives directed at lowering the total cost
of health care throughout the United States, it is likely that the United States
Congress and state legislatures will continue to focus on health care reform and
the cost of prescription pharmaceuticals, as well as on the reform of the
Medicare and Medicaid systems. The Company cannot predict the likelihood of
passage of federal and state legislation related to health care reform or
lowering pharmaceutical costs. In certain foreign markets pricing of
prescription pharmaceuticals is already subject to government control. Continued
significant changes in the U.S. or foreign health care systems could have a
material adverse effect on the Company's business.
Environmental Regulation. The Company's research and development
activities involve the controlled use of hazardous materials, chemicals and
various radioactive materials. The Company is subject to federal, state and
local laws and regulations governing the use, storage, handling and disposal of
such materials and certain waste products. Although the Company believes that
its safety procedures for handling and disposing of such materials comply with
the standards prescribed by state, federal, and local laws and regulations, the
risk of accidental contamination or injury from these materials cannot be
completely eliminated. In the event of such an accident, the Company could be
held liable for any damages that result and any liability could exceed the
resources of the Company. There can be no assurance that the Company will not be
required to incur significant costs to comply with environmental laws and
regulations as its research activities are increased or that the operations,
business and future profitability of the Company will not be adversely affected
by current or future environmental laws and regulations.
SCIENTIFIC ADVISORY BOARD AND OTHER ADVISORS
Connetics utilizes various advisors to provide expertise and critical
review of its programs. For advice on and review of its current and long-term
scientific planning, research and development, the Company has established a
Scientific Advisory Board ("SAB") consisting of distinguished scientists and
clinicians with expertise in biologic processes and diseases that involve the
connective tissues of the body. All of the individuals on the SAB are recognized
as leading authorities in their fields.
SAB members consult with and meet informally with management and key
scientific employees of the Company on a frequent basis. The members of the SAB
are as follows:
NAME POSITION
Edward P. Amento, M.D........................... Consultant, Molecular Medicine Research, Inc.
-38-
Eugene A. Bauer, M.D............................ Dean, Stanford University School of Medicine
Yueh-Hsiu Chien, Ph.D........................... Assistant Professor, Stanford University School of Medicine
Arthur Z. Eisen, M.D............................ Professor, Washington University School of Medicine, Barnes Hospital
Philip C. Hanawalt, M.D......................... Professor of Biological Sciences and Dermatology, Stanford
University and Stanford University School of Medicine
Gerald T. Nepom, M.D., Ph.D..................... Director, Virginia Mason Research Center Professor, University of
Washington School of Medicine, Seattle
Brian Seed, Ph.D................................ Professor, Harvard Medical School (Massachusetts General Hospital)
Each member of the SAB has entered into an agreement with the Company
covering the terms of his position as a member of the SAB. Each member provides
services on an as-needed basis. Four members of the SAB have entered into
separate agreements with the Company covering additional consultation above and
beyond their activities as SAB members. Certain SAB members hold options to
purchase or have purchased Common Stock of the Company. In addition, members of
the SAB receive a fee of $1,000 for attending any SAB meeting and are reimbursed
for out-of-pocket expenses incurred in attending each meeting. All members of
the SAB are employed by institutions other than the Company and may have
commitments to, or consulting or advisory agreements with, other entities that
may limit their availability to the Company.
For its preclinical and clinical development programs the Company has
established relationships with several contract research organizations and
practicing physicians.
Employees
The Company had 72 full-time employees at October 31, 1997, of which 35
are engaged in, or directly support, the Company's research and development
activities. The Company also uses outside consultants. The Company considers
relations with its employees to be good. None of the Company's employees is
covered by a collective bargaining agreement.
Properties
Connetics currently leases approximately 23,500 square feet of
laboratory and office space at 3400 West Bayshore Road in Palo Alto, California.
The Company leases this space under a master lease agreement that commenced in
August 1996 and will expire in July 1999 with a renewal option that, if
exercised, would extend the term of the lease to the year 2001. The Company
currently pays base monthly rent of $45,825 for this space and has the right to
use this space for laboratory research and development, storage and
distribution, offices, marketing and other related uses. The Company also leases
approximately 3,100 square feet of office space at 2483 East Bayshore Road, in
Palo Alto, California. The Company leases this space under an agreement that
expires March 31, 1999. The Company currently pays base monthly rent of $9,300
for this space. The Company believes that its existing facilities are adequate
to meet its requirements for the near term and that additional space will be
available on commercially reasonable terms if needed.
-39-
MANAGEMENT
Executive Officers and Directors
The following table sets forth certain information with respect to the
executive officers and directors of the Company as of November 15, 1997:
Name Age Position(s) with the Company
- ---- --- ----------------------------
G. Kirk Raab(1)............................. 62 Chairman of the Board
Thomas G. Wiggans........................... 45 President, Chief Executive Officer and Director
W. Scott Harkonen, M.D...................... 45 Sr. Vice President, Product Development and Operations
Richard J. Hammel, Ph.D..................... 54 Vice President, Commercial Development
John L. Higgins............................. 27 Vice President, Finance and Administration and Chief
Financial Officer
David A. Lowin, Esq......................... 43 Vice President, Intellectual Property, Chief Patent
Counsel and Assistant Secretary
Ernst H. Rinderknecht, Ph.D................. 50 Vice President, Process Sciences and Manufacturing
Alexander E. Barkas, Ph.D.(1)............... 50 Director
Eugene A. Bauer, M.D........................ 55 Director
Brian H. Dovey(2)........................... 56 Director
John C. Kane(2) ............................ 57 Director
Thomas D. Kiley, Esq.(1).................... 54 Director
Kenneth B. Plumlee(1)....................... 37 Director
Joseph J. Ruvane, Jr.(2).................... 72 Director
<FN>
- ----------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
</FN>
G. Kirk Raab has served as the Chairman of the Board of Directors of
the Company since October 1995. From February 1985 to January 1990, Mr. Raab
served as President and Chief Operating Officer of Genentech, Inc., a
biotechnology company, and from January 1990 to July 1995, he served as
Genentech's President and Chief Executive Officer. Prior to joining Genentech in
1985, Mr. Raab was President, Chief Operating Officer, and a Director of Abbott
Laboratories, and before that held executive positions with Beecham Group, A.H.
Robins and Pfizer, Inc. He is also Chairman of Shaman Pharmaceuticals, Inc. and
a director of Applied Imaging Inc., as well as five private biotechnology
companies. He is a trustee of KQED, the San Francisco Public Broadcasting
station. He received a B.A. from Colgate University.
Thomas G. Wiggans has served as President, Chief Executive Officer and
as a director of the Company since July 1994. From February 1992 to April 1994,
Mr. Wiggans served as President and Chief Operating Officer of CytoTherapeutics,
a biotechnology company. From 1980 to February 1992, Mr. Wiggans served at
various positions at Ares-Serono Group, a pharmaceutical company, including
President of its U.S. pharmaceutical operations and Managing Director of its
U.K. pharmaceutical operations. From 1976 to 1980 he held various sales and
marketing positions with Eli Lilly & Co., a pharmaceutical company. He is
currently a director of the Biotechnology Industry Organization, and a member of
the governing body of its emerging company section. He was also President of the
Board of Directors of the Association of Biotechnology Companies. Mr. Wiggans
received his B.S. degree in Pharmacy from the University of Kansas and his
M.B.A. from Southern Methodist University.
W. Scott Harkonen has served as Senior Vice President, Product
Development and Operations of the Company since September 1995. From March 1991
to August 1995, Dr. Harkonen served as Vice President of medical and regulatory
affairs at Univax Biologics, Inc., a biotechnology company. From May 1989 to
February 1991, he served as Vice President, medical and regulatory affairs at
Scios Nova, Inc., a biotechnology company. He is
-40-
currently a director of Planet Biotechnology, a privately-owned
biopharmaceutical company. He received his B.A. and M.D. from the University of
Minnesota and M.B.A. from the University of California, Berkeley.
Richard J. Hammel has served as Vice President, Commercial Development
of the Company since September 1995. From September 1993 to September 1995, he
served at Matrix Pharmaceutical, Inc., a biotechnology company, as Vice
President of Business Development, Sales and Marketing. From March 1992 to
September 1995, Dr. Hammel served as a Senior Consultant to Marketing
Corporation of America, a marketing company. From 1986 to March 1992, he served
at Glaxo, Inc., a pharmaceutical company, most recently as Director of Business
Development. He received a B.S., M.S. and Ph.D. from the University of
Minnesota.
John L. Higgins has served as Vice President, Finance and
Administration and Chief Financial Officer since September 1997. From August
1994 to September 1997, he was a member of the management team at BioCryst
Pharmaceuticals, Inc., serving most recently as Executive Vice President of
Corporate Development. From July 1992 to July 1994, Mr. Higgins was a member of
the health care banking team of Dillon, Read & Co. Inc., an investment banking
firm. While at Dillon, Read, he focused on financing and advisory assignments
for biotechnology and managed care companies. He received a B.A. in Economics
from Colgate University, where he serves on the Board of Trustees.
David A. Lowin has served as Vice President, Intellectual Property and
Chief Patent Counsel of the Company since January 1995 and Assistant Secretary
of the Company since July 1995. From 1982 to January 1995, Mr. Lowin served at
Syntex Corporation, a pharmaceutical company, as Assistant Director of the
Patent Law Department. From 1979 to 1982, he served as an associate at Owen,
Wickersham & Erickson. He received a B.A. from Hobart College and a J.D. from
the Franklin Pierce Law Center.
Ernst H. Rinderknecht has served as Vice President, Process Sciences
and Manufacturing of the Company since September 1994. From 1980 to September
1994, Dr. Rinderknecht worked at Genentech in various positions, since 1987 as
Staff Scientist. He received his M.S. from the Swiss Federal Institute of
Technology (ETH) and Ph.D.in Biochemistry from the University of Zurich,
Switzerland.
Alexander E. Barkas has served as a director of the Company since
November 1993. He also served as Acting CEO of the Company from November 1993 to
July 1994 and as Chairman of the Board of Directors from August 1994 to October
1995. Dr. Barkas has been a Managing Partner of Prospect Venture Partners, a
venture capital investment firm, since June 1997. He was previously a partner
with Kleiner Perkins Caufield & Byers (KPCB), a venture capital investment firm,
from September 1991 to June 1997. Dr. Barkas also serves as Chairman of the
Board of Directors of Geron Corporation and as a director of several
privately-held medical technology companies.
Eugene A. Bauer has served as a director since January 1996 and also
served as a director from the Company's inception in February 1993 to September
1995. Dr. Bauer has been Dean of the Stanford University School of Medicine
since 1995, Professor, Department of Dermatology, Stanford University School of
Medicine since 1988, and Chief of the Dermatology Service at Stanford University
Hospital from 1988 to 1995. Previously he was a professor at Washington
University School of Medicine from 1982 to 1988. He has served as chairman of
two National Institutes of Health study sections of the National Institute of
Arthritis and Musculoskeletal and Skin Diseases and has served on boards of
scientific counselors for the National Cancer Institute and for the National
Institute of Arthritis and Musculo-Skeletal and Skin Diseases.
Brian H. Dovey has served as a director of the Company since February
1995. Mr. Dovey has been a general partner of Domain Associates, a venture
capital investment firm, since 1988. From 1986 to 1988, Mr. Dovey was President
of Rorer Group, Inc., a pharmaceutical company. Mr. Dovey also serves on the
board of directors of Creative BioMolecules, Inc., Geron Corporation, NABI,
Inc., and Vivus, Inc., all publicly-held companies and as a director of several
privately-held companies.
John C. Kane has served as a director of the Company since March 1997.
Mr. Kane joined Cardinal Health, Inc., a healthcare services provider, as
President and Chief Operating Officer in March 1993. Prior to joining Cardinal,
Mr. Kane served in various operational and management positions at Abbott
Laboratories for 19
-41-
years, most recently as President of Ross Laboratories Division. Mr. Kane is a
director of Cardinal Health, Inc. and serves on several medical advisory
councils and educational foundations.
Thomas D. Kiley has served as a director of the Company since November
1993. He has been self-employed since 1988 as an attorney, consultant and
investor. From 1980 to 1988, he was an officer of Genentech, serving variously
as Vice President and General Counsel, Vice President for Legal Affairs and Vice
President for Corporate Development. From 1969 to 1980, he was with the Los
Angeles law firm of Lyon & Lyon and was a partner in such firm from 1975 to
1980. Mr. Kiley is also a director of Cardiogenesis, Inc., Geron Corporation,
Pharmacyclics, Inc. and certain private biotechnology and other companies.
Kenneth B. Plumlee has served as a director since January 1997. Mr.
Plumlee is currently a principal of Waterpath Investments, a investment company
focusing on health care information technology and consumer health information
services, which he founded in 1996. Mr. Plumlee also founded Access Health Inc.,
a healthcare information company, in October 1988 and served as its President
from the Company's founding until June 1996. Mr. Plumlee also served as Chief
Executive Officer of Access Health Inc. through September 1996 and as Chairman
until April 1997 and continues to serve as a director. From 1986 to 1988, Mr.
Plumlee was responsible for the development of Ask-A-Nurse at Adventist Health
System, a healthcare company, which was later acquired by Access Health Inc.
Joseph J. Ruvane, Jr. has served as a director since November 1995.
From 1981 to 1988, Mr. Ruvane was President, Chief Executive Officer, and
Chairman of Glaxo, Inc., a pharmaceutical company. He has also served as the
executive director of Glaxo Holdings PLC. Mr. Ruvane currently serves on the
board of Intercardia, a public company and serves on the board of Pozen Inc., a
private company. He serves on the Thelonious Monk Institute of Jazz National
Advisory Board and on the University of Virginia Art and Sciences Alumni
Council.
Board of Directors Committees, Compensation of Directors and Other Information
The Company currently has authorized nine directors. Each director is
elected for a period of one year at the Company's annual meeting of stockholders
and serves until the next annual meeting or until his successor is duly elected
and qualified. The executive officers serve at the discretion of the Board of
Directors. There are no family relationships among any of the directors or
executive officers of the Company.
The Board of Directors has an Audit Committee (consisting of Mr.
Barkas, Mr. Raab, Mr. Kiley and Mr. Plumlee), which reviews the results and
scope of the audit and other services provided by the Company's independent
accountants. The Board of Directors also has a Compensation Committee, which was
formed in June 1994 to review and approve the compensation and benefits for the
Company's executive officers, administer the Company's stock purchase and stock
option plans and make recommendations to the Board of Directors regarding such
matters. The committee is currently composed of Mr. Kane, Mr. Dovey and Mr.
Ruvane. In addition, although no longer a member, Mr. Raab served on the
Compensation Committee through October 1996. Petri T. Vainio, a former director
of the Company, also served on the Compensation Committee during 1996.
In October 1995, the Company entered into a Consulting Agreement with
G. Kirk Raab under which Mr. Raab serves as a director, consultant and the
Chairman of the Company's Board of Directors. Pursuant to such agreement, the
Company pays Mr. Raab an annual fee of $150,000. Mr. Raab was also granted an
option to purchase 67,450 shares of the Company's Common Stock at an exercise
price of $0.45 per share. Such shares vest at the rate of 8,431 shares on April
1, 1996 and 1,405 shares each month thereafter. In January 1996, Mr. Raab was
granted an additional option to purchase 50,000 shares of the Company's Common
Stock at an exercise price of $11.00 per share. Such shares vest at the rate of
6,250 shares on July 29, 1996 and 1,041 shares each month thereafter, provided
Mr. Raab continues his service as a director or consultant to the Company. In
January 1997, Mr. Raab was granted an additional option to purchase 25,000
shares of the Company's Common Stock at an exercise price of $7.125 per share.
In July 1997, Mr. Raab was granted an additional option to purchase 5,000 shares
of the Company's Common Stock at an exercise price of $7.75 per share. Mr. Raab
is reimbursed for out-of-pocket expenses incurred in connection with his
attendance at meetings of the Board of Directors and in connection with his
consulting activities on behalf of the Company.
-42-
Non-employee directors currently receive $1,000 per quarter and $1,000
per meeting for services provided in that capacity and are reimbursed for
out-of-pocket expenses incurred in connection with attendance at meetings of the
Board of Directors.
Non-employee directors of the Company are automatically granted options
to purchase shares of the Company's Common Stock pursuant to the terms of the
Company's 1995 Directors' Stock Option Plan. The Directors' Plan provides that
each person who becomes a non-employee director of the Company after the
Company's initial public offering shall be granted a non-statutory stock option
to purchase 30,000 shares of Common Stock (the "First Option") on the date on
which the optionee first becomes a non-employee director of the Company.
Thereafter, on the date of each annual meeting of the Company's stockholders,
each non-employee director (including directors who were not granted a First
Option prior to the date of such annual meeting) shall be granted an option to
purchase 7,500 shares of Common Stock (a "Subsequent Option") if, on such date,
he or she has served on the Company's Board of Directors for at least six
months. The Directors' Plan provides that the First Option shall become
exercisable in installments as to 25% of the total number of shares subject to
the First Option on each of the first, second, third and fourth anniversaries of
the date of grant of the First Option; each Subsequent Option shall become
exercisable in full on the first anniversary of the date of grant of that
Subsequent Option. The exercise price of all stock options granted under the
Directors' Plan shall be equal to the fair market value of a share of the
Company's Common Stock on the date of grant of the option. Directors are also
eligible to receive stock option grants under the Company's 1994 Stock Plan. See
"Stock Plans."
Limitation of Liability and Indemnification Matters
The Company's Certificate of Incorporation limits the liability of
directors to the maximum extent permitted by Delaware law. Delaware law provides
that a director of a corporation will not be personally liable for monetary
damages for breach of such individual's fiduciary duties as a director except
for liability (i) for any breach of such director's duty of loyalty to the
corporation, (ii) for acts or omissions not in good faith or that involve
intentional misconduct or a knowing violation of law, (iii) for unlawful
payments of dividends or unlawful stock repurchases or redemptions as provided
in Section 174 of the Delaware General Corporation Law or (iv) for any
transaction from which a director derives an improper personal benefit.
The Company's Bylaws provide that the Company will indemnify its
directors and may indemnify its officers, employees and other agents to the full
extent permitted by law. The Company believes that indemnification under its
Bylaws covers at least negligence and gross negligence on the part of an
indemnified party and permits the Company to advance expenses incurred by an
indemnified party in connection with the defense of any action or proceeding
arising out of such party's status or service as a director, officer, employee
or other agent of the Company upon an undertaking by such party to repay such
advances if it is ultimately determined that such party is not entitled to
indemnification.
The Company has entered or intends to enter into separate
indemnification agreements with each of its directors and officers. These
agreements require the Company, among other things, to indemnify such director
or officer against expenses (including attorney's fees), judgments, fines and
settlements (collectively, "Liabilities") paid by such individual in connection
with any action, suit or proceeding arising out of such individual's status or
service as a director or officer of the Company (other than Liabilities arising
from willful misconduct or conduct that is knowingly fraudulent or deliberately
dishonest) and to advance expenses incurred by such individual in connection
with any proceeding against such individual with respect to which such
individual may be entitled to indemnification by the Company. The Company
believes that its Certificate of Incorporation and Bylaw provisions and
indemnification agreements are necessary to attract and retain qualified persons
as directors and officers.
At present the Company is not aware of any pending litigation or
proceeding involving any director, officer, employee or agent of the Company
where indemnification will be required or permitted. The Company is not aware of
any threatened litigation or proceeding that might result in a claim for such
indemnification.
-43-
Executive Compensation
The following table sets forth certain compensation paid by the Company
during the fiscal years ended December 31, 1996 and December 31, 1995 to the
Company's Chief Executive Officer and the Company's four other most highly
compensated executive officers during fiscal 1996 (collectively, the "Named
Executive Officers"):
SUMMARY COMPENSATION TABLE
Annual Compensation
Fiscal Year -------------------------------------------------
Name and Principal Position Ended Other Annual All Other
--------------------------- December 31, Salary($) Bonus($) Compensation($) (1) Compensation($)
------------ --------- --------- -------------------- ----------------
Thomas G. Wiggans..................... 1996 $270,833 $120,000 $3,163 $76,809 (2)
President and Chief Executive 1995 $225,000 $20,000 $1,240 $25,959 (3)
Officer
Edward P. Amento, M.D. (4)............. 1996 $187,500 $95,000 $1,926 $144,472 (5)
Formerly, Executive Vice President 1995 $226,155 $20,000 $0 $3,340 (6)
of Scientific and Medical Affairs
W. Scott Harkonen...................... 1996 $210,000 $26,000 $1,288 $0
Senior Vice President, Product 1995 $70,000 $40,782 $0 $20,262 (7)
Development and Operations
Cynthia M. Butitta (8)................. 1996 $175,000 $20,000 $612 $0
Formerly, Vice President, Finance 1995 $14,133 $0 $0 $25,000 (9)
and Administration and Chief
Financial Officer
David A. Lowin, Esq.................... 1996 $172,500 $30,000 $598 $0
Vice President, Intellectual 1995 $148,542 $25,000 $0 $0
Property and
Chief Patent Counsel
Richard J. Hammel...................... 1996 $165,000 $17,500 $1,613 $0
Vice President, Commercial 1995 $55,000 $10,000 $0 $0
Development
<FN>
- ---------------
(1) Represents term life insurance premiums paid by the Company for the
benefit of the Named Executive Officer.
(2) Represents amount of principal and interest forgiven on a loan from the
Company. See "Certain Relationships and Related Transactions."
(3) Represents $253 for taxes paid in conjunction with a bonus and $25,706 for
relocation expenses.
(4) Resigned from the Company in October 1996, but has been retained as a
consultant. See "Certain Relationships and Related Transactions."
(5) Represents $106,972 for taxes and interest paid in conjunction with a
bonus and $37,500 in consulting fees.
(6) Represents reimbursement for disability insurance paid by the executive.
(7) Represents relocation and moving expenses.
(8) Resigned from the Company in August 1997.
(9) Represents bonus upon hire.
</FN>
-44-
OPTION GRANTS IN LAST FISCAL YEAR
There were no stock options granted to the Named Executive Officers
during the fiscal year ended December 31, 1996. In addition, no stock
appreciation rights were granted to these individuals during the fiscal year
ended December 31, 1996.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
The following table sets forth information for the Named Executive
Officers with respect to exercises of options to purchase common stock in the
fiscal year ended December 31, 1996.
Number of Shares Value of Unexercised
Underlying Unexercised in-the-Money Options
Options at Fiscal Year End at Fiscal Year End(1)
--------------------------------- ---------------------------------
Name Shares
---- ------
Acquired on Value
----------- -----
Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
-------- -------- ----------- ------------- ----------- -------------
Thomas G. Wiggans............. 0 $0 42,624 103,518 $332,689 $807,979
Edward P. Amento .............. 6,000 $39,331 1,729 20,375 $13,495 $159,031
W. Scott Harkonen.............. 0 $0 25,762 58,550 $201,078 $456,994
Cynthia M. Butitta............. 0 $0 20,398 54,921 $122,920 $330,959
David A. Lowin, Esq........... 0 $0 9,180 22,296 $71,652 $174,025
Richard J. Hammel.............. 0 $0 19,203 43,750 $149,883 $341,478
<FN>
- ----------
(1) Based on the closing price of the Company's Common Stock on December 31,
1996 as reported on the NASDAQ National Market ($8.25 per share), minus
the per share exercise price, multiplied by the number of shares
underlying the option.
</FN>
Stock Plans
1994 Stock Plan
The Company's 1994 Stock Plan (the "Stock Plan") was adopted by the
Board of Directors and approved by the stockholders in August 1994. The Board of
Directors initially reserved 337,253 shares of Common Stock for issuance under
the 1994 Plan. An additional 1,011,759 shares were approved for issuance under
the 1994 Plan in September 1995 and in December 1995, the Stock Plan was amended
by the Board of Directors to comply with certain requirements of Rule 16b-3 of
the Securities Exchange Act of 1934, as amended, and the Internal Revenue Code
of 1986, as amended (the "Code"). An additional 150,988 shares were approved for
issuance in January 1996. In May 1997, the Company's stockholders approved
amendments to the Stock Plan to increase the number of shares issuable
thereunder to an aggregate of 2,000,000 and to allow for option grants to
non-employee directors. As of November 14, 1997, options to purchase 277,460
shares of Common Stock had been exercised, options to purchase a total of
1,600,204 shares were outstanding and 122,336 shares remained available for
future grants. As of November 14, 1997, the aggregate fair market value of
shares subject to outstanding options under the 1994 Plan was $5,200,633 based
upon the closing price of the Common Stock as reported on The Nasdaq Stock
Market on such date.
The Stock Plan provides for the grant to employees of the Company
(including officers and directors) of "incentive stock options" within the
meaning of Section 422 of the Code, for the grant of nonstatutory stock options
-45-
to employees, consultants and non-employee directors of the Company, and for the
issuance of shares of Common Stock directly pursuant to Restricted Stock
Purchase Agreements. To the extent an optionee would have the right in any
calendar year to exercise for the first time one or more incentive stock options
for shares having an aggregate fair market value (under all plans of the Company
and determined for each share as of the date the option to purchase the share
was granted) in excess of $100,000, any such excess options shall be treated as
nonstatutory stock options. The 1994 Plan is not a qualified deferred
compensation plan under Section 401(a) of the Code, and is not subject to the
provisions of the Employee Retirement Income Security Act of 1974, as amended.
The Administrator selects the optionees and determines the number of
shares to be subject to each option. In making such determination, certain
factors are taken into account, including the duties and responsibilities of the
optionee, the value of the optionee's services, the optionee's present and
potential contribution to the success of the Company, and other relevant
factors.
The 1994 Plan may be administered by the Board of Directors or by a
committee (or committees) of the Board of Directors (the "Administrator"). The
1994 Plan is currently administered by the Compensation Committee. The
Administrator determines the terms of options granted under the Stock Plan,
including the number of shares subject to the option, exercise price, term and
exercisability; provided, however, that the maximum number of shares which may
be subject to options granted to any one employee for any fiscal year of the
Company shall be 150,000, subject to adjustment as provided in the 1994 Plan.
The exercise price of all incentive stock options granted under the Stock Plan
must be at least equal to the fair market value of the Common Stock of the
Company on the date of grant. The exercise price of any incentive stock option
granted to an optionee who owns stock representing more than 10% of the voting
power of all classes of stock of the Company or any Parent or Subsidiary (a "10%
Stockholder") must equal at least 110% of the fair market value of the Common
Stock on the date of grant. The exercise price of all nonstatutory stock options
must equal at least 85% of the fair market value of the Common Stock on the date
of grant; provided, however, that the exercise price of any nonstatutory stock
option granted to any Named Executive Officer must be equal to at least one
hundred percent (100%) of the fair market value of the Common Stock on the date
of grant. Payment of the exercise price may be made in cash, promissory notes or
other consideration determined by the Administrator.
The term of a stock option granted under the Stock Plan may not exceed
10 years; provided, however, that the term may not exceed five years for 10%
Stockholders. No option may be transferred by the optionee other than by will or
the laws of descent or distribution. Each option may be exercised during the
lifetime of the optionee only by such optionee. Options granted to each employee
under the Stock Plan generally become exercisable at the rate of 12.5% of the
total number of shares subject to the options after the six month period from
the date of grant, and approximately 2% each month thereafter.
In the event of certain changes in control of the Company, the Stock
Plan requires that each outstanding option be assumed or an equivalent option
substituted by the successor corporation, unless the Administrator determines in
the exercise of its sole discretion, that the optionee will have the right to
exercise the option as to some or all of the shares covered by the option,
including shares as to which the option would not otherwise be exercisable, in
which case each option will be exercisable for thirty (30) days from the date of
such determination. The Administrator has the authority to amend or terminate
the Stock Plan as long as such action does not adversely affect any outstanding
option and provided that stockholder approval shall be required for an amendment
to increase the number of shares subject to the Stock Plan, or any change in the
designation of the class of persons eligible to be granted options, or an
increase in the annual limitation on grants to employees, or a material increase
in benefits accruing to participants under the Stock Plan if the Company is
registered under Section 12 of the Exchange Act. If not terminated earlier, the
Stock Plan will terminate in 2004.
1995 Employee Stock Purchase Plan
The Company's 1995 Employee Stock Purchase Plan (the "Purchase Plan")
was adopted by the Board of Directors in December 1995 and approved by the
stockholders in January 1996. A total of 100,000 shares of Common Stock has been
reserved for issuance under the Purchase Plan. As of November 14, 1997, 24,476
shares
-46-
had been purchased under the Purchase Plan by the Company's employees, including
its executive officers. Directors who are not executive officers are not
eligible to participate in the Purchase Plan.
The Purchase Plan, which is intended to qualify under Section 423 of
the Code, is implemented through a series of successive offering periods, each
with a maximum duration of 24 months. Each offering period is comprised of four
purchase periods, each with a maximum duration of six months. The current
offering period began June 1, 1997 and will end on May 31, 1999. The Purchase
Plan may be administered by the Board of Directors or by a committee appointed
by the Board of Directors. Employees (including officers and employee directors)
of the Company, or of any majority owned subsidiary designated by the Board of
Directors, are eligible to participate if they are employed by the Company or
any such subsidiary for at least 20 hours per week and more than 5 months per
year. The Purchase Plan permits eligible employees to purchase Common Stock
through payroll deductions, which may not exceed 15% of an employee's
compensation, at a price equal to the lower of 85% of the fair market value of
the Company's Common Stock at the beginning of the offering period or the end of
a purchase period. Employees may end their participation in the offering at any
time during the offering period, and participation ends automatically on
termination of employment with the Company. In addition, participants may
decrease their level of payroll deductions once during an offering period.
The Purchase Plan provides that in the event of a merger of the Company
with or into another corporation or a sale of substantially all of the Company's
assets, each right to purchase stock under the plan will be assumed or an
equivalent right substituted by the successor corporation unless the Board of
Directors shortens the offering period so that employees' rights to purchase
stock under the plan are exercised prior to the merger or sale of assets. The
Board of Directors has the power to amend or terminate the Purchase Plan as long
as such action does not adversely affect any outstanding rights to purchase
stock thereunder. If not terminated earlier, the Purchase Plan will have a term
of twenty years.
1995 Director Stock Option Plan
The 1995 Director Stock Option Plan (the "Directors' Plan") was adopted
by the Board of Directors in December 1995 and by the Company's stockholders in
January 1996. A total of 150,000 shares of Common Stock has been reserved for
issuance under the Directors' Plan. The Directors' Plan is designed to work
automatically without administration; however, to the extent administration is
necessary, it will be performed by the Board of Directors.
The Directors' Plan provides that each person who first becomes a
non-employee director of the Company after the effective date of the Directors'
Plan will be granted a nonstatutory stock option to purchase 30,000 shares of
Common Stock (the "First Option") on the date on which the optionee first
becomes a non-employee director of the Company. Thereafter, on the date of each
Annual Meeting of the Company's shareholders at which non-employee directors are
elected to the Board, each person so elected (including directors who were not
eligible for a First Option) shall be granted an additional option to purchase
7,500 shares of Common Stock (a "Subsequent Option") if he or she shall have
served on the Company's Board of Directors for at least six months prior to the
date of such Annual Meeting. The Directors' Plan provides that the maximum
number of shares for which options may be granted under the Directors' Plan is
150,000 (the "Pool"). However, the Directors' Plan does not specify a maximum or
minimum number of shares for which options may be granted to any one
non-employee director so long as the total number of shares so granted does not
exceed the Pool. No option granted under the Directors' Plan is transferable by
the optionee other than by will or the laws of descent or distribution or
pursuant to a qualified domestic relations order, and each option is
exercisable, during the lifetime of the optionee, only by such optionee or
permitted transferee.
The Directors' Plan provides that the First Option shall become
exercisable in installments as to 25% of the total number of shares subject to
the First Option on each of the first, second, third and fourth anniversaries of
the date of grant of the First Option; each Subsequent Option shall become
exercisable in full on the first anniversary of the date of grant of that
Subsequent Option. The exercise price of all stock options granted under the
Directors' Plan shall be equal to the fair market value of a share of the
Company's Common Stock on the date of grant of the option. Options granted under
the Directors' Plan have a term of ten years.
-47-
In the event of the dissolution or liquidation of the Company, a sale
of all or substantially all of the assets of the Company, the merger of the
Company with or into another corporation in which the Company is not the
surviving corporation or any other capital reorganization in which more than 50%
of the shares of the Company entitled to vote are exchanged, the Company shall
give to each nonemployee director either (i) a reasonable time within which to
exercise the option, including any part of the option that would not otherwise
be exercisable, prior to the effectiveness of any such transaction at the end of
which time the Option shall terminate, or (ii) the right to exercise the option,
including any part of the option that would not otherwise be exercisable (or
receive a substitute option with comparable terms) as to an equivalent number of
shares of stock of the corporation succeeding the Company or acquiring its
business by reason of any such transaction. The Board of Directors may amend or
terminate the Directors' Plan; provided, however, that no such action may
adversely affect any outstanding option, and the provisions regarding the grant
of options under the plan may be amended only once in any six-month period,
other than to comport with changes in the Code or the Employee Retirement Income
Security Act of 1974, as amended. If not terminated earlier, the Directors' Plan
will have a term of ten years.
401(k) Plan
Effective August 1, 1994, the Company's Board of Directors adopted the
Connetics Corporation 401(k) Profit Sharing Plan, which is intended to qualify
under Sections 401(a) and 501 of the Code (the "401(k) Plan"). All employees who
are employed by the Company and who have attained age 21 are eligible to
participate in the 401(k) Plan. The 401(k) Plan provides that each participant
may contribute a percentage of his or her compensation, up to the maximum amount
provided by statute. The Company may also make discretionary contributions based
on a certain percentage of a participant's contributions under the 401(k) Plan,
as determined by the Company, or such additional amounts as the Company may deem
appropriate. To date, the Company has not made any such contributions. The
401(k) Plan is intended to qualify under Section 401 of the Code so that
contributions to the Plan, and income earned on plan contributions, are not
taxable to participants until withdrawn from the 401(k) Plan, and so that
contributions by the Company, if any, will be deductible by the Company when
made. Employer contributions and the investment earnings thereon are fully
vested at all times. Contributions are allocated to each participant's
individual account, which is invested in selected mutual funds according to the
directions of the participant.
-48-
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In June 1994, the Company entered into an employment agreement with
Thomas G. Wiggans, the President and Chief Executive Officer of the Company.
Pursuant to such agreement, Mr. Wiggans receives an annual base salary of
$225,000, which was raised in March 1996 to $280,000 and is subject to annual
review. In consideration of Mr. Wiggans' attainment of corporate goals and
achievement of key milestones, the Compensation Committee awarded him a cash
bonus of $80,000 in February 1996, upon the successful completion of the
Company's initial public offering and a cash bonus of $40,000 in January 1997
for the achievement of the Company's corporate goals for 1996. In addition, Mr.
Wiggans acquired 146,142 shares of Common Stock pursuant to a restricted stock
purchase agreement in June 1994. The shares were released from the Company's
repurchase option at 1/10th in December 1994 and are released at 1/60th each
month thereafter. The employment agreement also entitles Mr. Wiggans to receive
continuation of salary and benefits and continuation of vesting with respect to
all of the Common Stock held by Mr. Wiggans for nine months following the
termination of his employment from the Company other than for cause, and to the
payment of premiums on a life insurance policy in the amount of $1,000,000. The
employment agreement also provided for reimbursement by the Company of up to
$110,000 for combined actual relocation and housing expenses.
Additionally, the Company and Mr. Wiggans have entered into two
interest-bearing loan agreements for up to $108,000 and for $225,000,
respectively, both of which are secured by shares of Common Stock held by Mr.
Wiggans. Amounts drawn on the $108,000 loan are due on the third anniversary of
the date of each draw. The principal balance owed to the Company under the
$108,000 loan was $72,000, which was also the largest aggregate amount that was
outstanding, payable under two $36,000 promissory notes with interest at 5.63%
and 5.73% per annum, respectively. These two loans were forgiven in 1996 for a
total of $76,809, which includes principal plus interest. The remaining $36,000
related to the original loan of $108,000, payable under a promissory note with
interest at 6.15% per annum, was loaned in July 1996 and forgiven in July 1997
for a total forgiveness of principal and accrued interest of $38,244. The
$225,000 loan was amended and restated in July 1996; the new principal amount of
the loan is $256,401.10, and the loan bears interest at a rate of 6.74% per
annum. Under the restated terms, a $50,000 principal payment plus interest
accrued to date was and is due and payable on each of July 31, 1997, July 31,
1998, July 31, 1999, July 31, 2000 and July 31, 2001. The current balance owed
to the Company under this loan at September 30, 1997 was $207,731. The balance
of the principal amount outstanding plus all accrued interest is due and payable
on July 31, 2001.
In October 1995, the Company entered into a consulting agreement with
G. Kirk Raab, the Chairman of the Company's Board of Directors. See "Management
- -- Board of Directors Committees; Compensation of Directors and Other
Information."
In December 1995, the Company entered into a Master Bridge Loan
Agreement with certain stockholders of the Company (the "Bridge Investors"),
pursuant to which such Bridge Investors severally and unconditionally agreed to
lend up to a maximum aggregate total of $5 million to the Company. No loans were
made under this Agreement, and the Company's ability to call for any loans
expired upon the completion of the Company's initial public offering in February
1996. In consideration for this commitment, in February 1996, the Company
delivered to each such Bridge Investor a five-year warrant to purchase a total
of 22,727 shares of Common Stock at an exercise price equal to $11.00, the price
per share of securities issued in the Company's initial public offering. The
following current five percent stockholders of the Company were Bridge
Investors: Sierra Ventures IV, L.P., Sprout Capital VII, L.P., and Domain
Partners III, L.P. See "Principal Stockholders."
In March 1996, the Board authorized the Company to enter into
individual agreements with each of the Company's directors and executive
officers to provide in the event of a merger or acquisition of the Company and
another entity, all stock options held by such person will automatically vest in
full (i) unless the Company is the surviving entity after such transaction and
the Company's stockholders immediately prior to such transaction own a majority
of the outstanding securities of the surviving entity or (ii) if, as the result
of such transaction, the officer or director's position with the Company is
terminated or his or her responsibilities are adversely changed or reduced
without his or her written consent.
-49-
In October 1996, the Company and The Molecular Medicine Research
Institute (MMRI), acting through Dr. Amento, entered into a Laboratory Services
Agreement. Under the terms of the agreement, MMRI is conducting research,
including research on behalf of the Company. Pursuant to this agreement, the
Company has provided $250,000 to assist in establishing MMRI and an additional
grant of $100,000 per year for two years pursuant to a Sponsored Research
Agreement relating to connective tissue research. The Company has also provided
clinical space and three full-time researchers, along with costs to support
three full-time employees at the laboratory through November 1997. The Company
received all intellectual property rights arising from directed research
projects fully funded by the Company and has a right of first negotiation for
certain other intellectual property developed by the laboratory.
In conjunction with the Laboratory Services Agreement, the Company also
entered into an Agreement with Dr. Amento. Pursuant to this agreement, Dr.
Amento resigned his employment relationship with the Company effective October
31, 1996, and became a consultant to the Company. For the first nine months' of
consulting work, Dr. Amento received a fee of $18,750 per month; after July 31,
1997 (and for consulting services exceeding one day per week during the initial
nine months), Dr. Amento is being compensated at a rate of $2,000 per day. The
Company will also pay Dr. Amento $25,000 for any successfully completed
transaction in which his consultation was requested by the Company and given by
Dr. Amento. Dr. Amento was also provided $24,000 over six months for office
expenses. Dr. Amento's stock options were converted to non-qualified options and
continue to vest under the terms of his consultancy. Also under the Agreement,
Dr. Amento resigned his position as a director on May 14, 1997.
In December 1996, the Company acquired the exclusive U.S. and Canadian
rights to Ridaura(R) (auranofin), a disease modifying antirheumatic drug, from
SmithKline Beecham Corporation and related entities ("SmithKline"). As
consideration to SmithKline, the Company provided a $3 million upfront cash
payment, which was paid in January 1997, a non-interest bearing $11.0 million
promissory note, payable in two installments in January 1998 and January 1999
(of $6.0 million and $5.0 million, respectively) and secured by the intellectual
property acquired from SmithKline, 637,733 shares of the Company's common stock
with a guaranteed value of $9.0 million on December 31, 1997, and an obligation
to pay up to $6.0 million in sales-based royalty payments, for an aggregate
purchase price of up to $29.0 million. The $11.0 million promissory note was
discounted at inception using an imputed interest rate of 11% and future imputed
interest expense attributable to these payments is $1.6 million. In November
1997, this note was amended to defer the initial $6.0 million payment,
originally due in January 1998, to April 1998 ($1.0 million), October 1998 ($1.5
million) and January 1999 ($3.5 million). The amendment also provides that
Connetics will pay interest on the unpaid principal from January 1998 to January
1999 at a rate of prime plus two percent (2%). Under a related Transitional
Services Agreement, customer orders and distribution for the product will
continue to be managed by SmithKline through 1997 with no additional
consideration for performing such services. The parties also entered into a
Supply Agreement, under which SmithKline will manufacture and supply Ridaura (in
final finished package form) to the Company for an initial term of five years.
As a result of the share issuance, SmithKline became the beneficial owner of
more than five percent (5%) of the Company's Common Stock. See "Principal
Stockholders" and "Risk Factors -- Potential Effects of Guarantee of Value of
Shares Issued to SmithKline."
In December 1997, the Company entered into an Omnibus Amendment with
SmithKline, pursuant to which several changes were made to the Company's payment
obligations to SmithKline. First, the amendment revised the original requirement
that the 637,733 shares of Common Stock issued to SmithKline in December 1996
would be guaranteed to have a minimum value of $9.0 million on December 31,
1997; the shares are now guaranteed to have a minimum value of $8.0 million on
April 1, 1998. Second, if the Company is unable to issue the full number of
shares otherwise issuable to SmithKline on April 1, 1998, the cash value of the
unissuable shares will be added to the Company's current $6.0 million cap on
sales-based royalty payments owed to SmithKline, and the royalty rate for
Ridaura sales will increase. Third, the promissory note issued to SmithKline was
amended to reduce the October 1998 principal payment to $1,000,000 and to
increase the January 1999 principal payment to $4,000,000. Fourth, in
consideration of the foregoing changes, the Company agreed to pay SmithKline
$1,000,000 on or before December 31, 1997. See "Principal Stockholders" and
"Risk Factors--Potential Effects of Guarantee of Value of Shares Issued to
SmithKline."
In May 1997, the Company and a selling stockholder sold an aggregate of
1,936,357 shares of the Company's Common Stock at a price of $6.05 per share to
certain accredited investors in a private placement. The investors also received
warrants to purchase shares of the Company's common stock at an exercise price
of $9.08 per share. As part of this financing, certain directors and five
percent stockholders of the Company purchased shares of Common Stock from the
Company and received warrants as follows: Sprout Capital VII, L.P. and
affiliated entities (1,239,670 shares for an aggregate price of $7,500,004 and
warrants for an additional 619,835 shares), Domain Partners III, L.P. and
affiliated entities (124,651 shares for an aggregate price of $754,138 and
warrants for an additional 62,325 shares), and Alexander E. Barkas (with his
wife Linda Wijcik) (23,710 shares for an aggregate price of $143,446 and
warrants for an additional 11,855 shares). Brian H. Dovey, a general partner of
the general partner of Domain Partners III, L.P., is a director of the Company.
In October 1997, the Company and Dr. Harkonen entered into a Secured
Loan Agreement and Security Agreement providing for a loan to Dr. Harkonen of
$100,000, which is secured by 25,000 shares of Common Stock issuable upon the
exercise of vested options held by Dr. Harkonen. The current balance owed to the
Company under this loan is $100,000, payable under a promissory note with
interest at 8.5% per annum, compounded annually. All principal and accrued
interest is due and payable on the earliest of (a) October 30, 2000 or (b) the
termination of Dr. Harkonen's employment or consulting relationship with the
Company for any reason.
In September 1997, the Company and Cynthia Butitta, former Vice
President of Finance and Administration and Chief Financial Officer, entered
into a separation agreement, pursuant to which the Company accepted Ms.
Butitta's resignation as an employee and officer of the Company and agreed to
pay Ms. Butitta all accrued salary, accrued and unused vacation earned, and six
(6) months of base salary as a severance benefit. Under the agreement, Ms.
Butitta will serve as a consultant to the Company from the date of the agreement
through March 1998 and will receive $15,000 per month as consulting fees.
-50-
The Company and CORD Logistics, Inc. ("CORD") are currently finalizing
a Distribution Services Agreement, pursuant to which CORD will be appointed the
primary distribution agent in and for the United States, the District of
Columbia, Puerto Rico and Canada for the distribution of Ridaura to the
Company's direct customers. Under the agreement, which is expected to have an
initial term of three years, the Company would pay CORD an initial start-up fee
of $51,000 for implementation and will pay monthly fees of $10,700 for system
access, customer service and financial services, in addition to other per order
and fixed fees for distribution and financial services. CORD is a subsidiary of
Cardinal Health, Inc., of which Mr. Kane (a director of the company) is
President, Chief Operating Officer and a director. There can be no assurance
that this agreement with CORD will be consummated in a timely manner, or at all.
See "Risk Factors -- Management of Ridaura Product; Uncertainty of Future
Ridaura Revenues; Off-Patent Status of Ridaura."
The Company believes that all of the transactions set forth above were
made on terms no less favorable to the Company than could have been obtained
from unaffiliated third parties. All future transactions, including loans,
between the Company and its officers, directors, principal stockholders and
their affiliates will be approved by a majority of the Board of Directors,
including a majority of the independent and disinterested directors, and will
continue to be on terms no less favorable to the Company than could be obtained
from unaffiliated third parties.
In this offering, the Company currently intends to offer shares of
Common Stock to certain directors and five percent stockholders of the Company.
Specifically, the Company intends to offer 434,952 shares to Domain Partners
III, L.P., 15,048 shares to DP III Associates, L.P., (an affiliate of Domain
Partners III, L.P.), 70,000 shares to Alexander E. Barkas (a director of the
Company), and 30,000 shares to Thomas D. Kiley (a director of the Company).
Brian H. Dovey, a general partner of the general partner of Domain Partners III,
L.P. and DP III Associates, L.P., is a director of the Company. Although such
investors have expressed an interest in purchasing such shares, there can be no
assurance that such purchases will occur. See "Principal Stockholders."
-51-
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information known to the Company
with respect to the beneficial ownership of the Company's Common Stock as of
November 14, 1997, and as adjusted to reflect the sale of the Common Stock
offered hereby (assuming all of such shares are sold), by (i) all persons who
are beneficial owners of five percent or more of the Company's Common Stock,
(ii) each director of the Company, (iii) each executive officer of the Company
(including the Named Executive Officers), and (iv) all current directors and all
executive officers as a group. Except as otherwise indicated, the Company
believes that the beneficial owners of the Common Stock listed below, and the
information furnished by such owners, have sole investment and voting power with
respect to such shares, subject to community property laws where applicable.
Percent Beneficially Owned
----------------------------
Number of Before After
Name Shares(1) Offering Offering(21)
---- --------- -------- --------
Sprout Capital VII, L.P. (2)......................................... 2,768,671 23.6% 20.5%
650 Town Centre Drive, Suite 810
Costa Mesa, CA 92626
Sierra Ventures IV, L.P.(3).......................................... 830,564 7.3% 6.3%
3000 Sand Hill Road
Building Four, Suite 210
Menlo Park, CA 94025
Domain Partners III, L.P. (4)(21).................................... 816,859 7.1% 9.7%
One Palmer Square, Suite 515
Princeton, NJ 08542
New York Life Insurance Company (5) ................................. 715,432 6.2% 5.4%
51 Madison Ave
New York, NY 10010
State of Wisconsin Investment Board (6).............................. 695,000 6.1% 5.3%
P.O. Box 7842
Madison, WI 53707
SmithKline Beecham Properties, Ltd. (7).............................. 637,733 5.6% 4.9%
1403 Foulk Road #102
Wilmington, DE 19803-2775
Edward P. Amento, M.D. (8)........................................... 208,266 1.8% 1.6%
Thomas G. Wiggans (9)................................................ 215,718 1.9% 1.6%
Eugene A. Bauer, M.D................................................. 145,467 1.3% 1.1%
Brian H. Dovey (4)(10)(21)........................................... 826,344 7.2% 9.7%
One Palmer Square, Suite 515
Princeton, NJ 08542
Alexander E. Barkas, Ph.D. (11)(21) ................................. 96,924 * 1.3%
G. Kirk Raab (12).................................................... 92,519 * *
Ernst H. Rinderknecht, Ph.D. (13).................................... 50,295 * *
Thomas D. Kiley (14)(21)............................................. 56,857 * *
W. Scott Harkonen (15)............................................... 50,377 * *
David A. Lowin, Esq. (16)............................................ 39,064 * *
Joseph J. Ruvane, Jr. (17)........................................... 29,308 * *
Cynthia M. Butitta (18).............................................. 40,012 * *
Richard J. Hammel (19)............................................... 36,946 * *
Kenneth B. Plumlee .................................................. 23,000 * *
John L. Higgins (20) ................................................ 3,000 * *
John C. Kane......................................................... 5,000 * *
All directors and executive officers as a group (16 persons) 1,919,097 16.4% 18.3%
(8)-(21)...........................................................
<FN>
* Less than one percent (1%).
-52-
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. The number of shares beneficially
owned by a person includes shares of Common Stock subject to options held
by that person that are currently exercisable or exercisable within 60
days of November 14, 1997. Such exercisable options are shown in the
footnotes to this table for each such person. Such shares, however, are
not deemed outstanding for the purposes of computing the percentage
ownership of each other person.
(2) Includes 1,146,200 shares held by Sprout Capital VII, L.P., 267,119 shares
held by Sprout Capital VI, L.P., 68,823 shares held by DLJ Capital
Corporation, 7,412 shares held by The Sprout CEO Fund L.P., 521,618 shares
held by Sprout Growth II, L.P., 132,621 shares held by DLJ First ESC LLC,
301,335 shares issuable upon exercise of warrants held by Sprout Capital
VII, L.P., exercisable within 60 days of November 14, 1997, 1,648 shares
issuable upon exercise of warrants held by Sprout Capital VI, L.P.,
exercisable within 60 days of November 14, 1997, 12,657 shares issuable
upon exercise of warrants held by DLJ Capital Corporation, exercisable
within 60 days of November 14, 1997, 3,464 shares issuable upon exercise
of warrants held by The Sprout CEO Fund L.P., exercisable within 60 days
of November 14, 1997 and 61,984 shares issuable upon exercise of warrants
held by DLJ First ESC LLC, exercisable within 60 days of November 14,
1997.
(3) Includes 793,941 shares held by Sierra Ventures IV, L.P., 31,790 shares
held by Sierra Ventures IV International, L.P., 4,647 shares issuable upon
exercise of warrants held by Sierra Ventures IV, L.P., exercisable within
60 days of November 14, 1997 and 186 shares issuable upon exercise of
warrants held by Sierra Ventures IV International, L.P., exercisable
within 60 days of November 14, 1997.
(4) Includes 721,349 shares held by Domain Partners III, L.P., 25,188 shares
held by DP III Associates, L.P., 4,215 shares held by Domain Associates,
63,898 shares issuable upon exercise of warrants held by Domain Partners
III, L.P., exercisable within 60 days of November 14, 1997 and 2,209
shares issuable upon exercise of warrants held by DP III Associates L.P.,
exercisable within 60 days of November 14, 1997. Brian H. Dovey, a general
partner of the general partner of Domain Partners III, L.P. and DP III
Associates, L.P., is a director of the Company. Mr. Dovey is also a
general partner of Domain Associates. Mr. Dovey disclaims beneficial
ownership of such shares except to the extent of his pecuniary interest in
such shares.
(5) Includes 124,651 shares issuable upon exercise of outstanding warrants
exercisable within 60 days of November 14, 1997.
(6) Such information has been obtained from a filing on Form 13-G by such
person.
(7) The Company may be obligated to issue additional shares to SmithKline
Beecham Properties, Ltd. on April 1, 1998 to bring the total value of the
shares owned by such stockholder to $8.0 million. See "Certain
Relationships and Related Transactions."
(8) Includes shares held indirectly by Dr. Amento as trustee of the Amento
Family Trust. Includes 3,513 shares issuable upon the exercise of
outstanding options exercisable within 60 days of November 14, 1997.
(9) Includes 15,224 shares issuable upon the exercise of outstanding options
exercisable within 60 days of November 14, 1997. Also includes 13,490
shares of Common Stock owned by Kathryn H. Wiggans, spouse of Mr. Wiggans,
8,993 shares of Common Stock held in a Custodial Account for Elizabeth M.
Wiggans and 8,993 shares of Common Stock held in a Custodial Account for
Amanda G. Wiggans.
(10) Includes 9,485 shares issuable upon exercise of outstanding options
exercisable within 60 days of November 14, 1997.
(11) Includes 13,700 shares issuable upon exercise of outstanding options
exercisable within 60 days of November 14, 1997 and 11,855 shares issuable
upon exercise of outstanding warrants exercisable within 60 days of
November 14, 1997. Also includes 25,985 shares of Common Stock owned by
Linda Wijcik, spouse of Dr. Barkas.
(12) Includes 86,899 shares issuable upon exercise of outstanding options
exercisable within 60 days of November 14, 1997.
(13) Includes 15,809 shares issuable upon exercise of outstanding options
exercisable within 60 days of November 14, 1997.
-53-
(14) Includes 8,993 shares held in the Thomas D. and Nancy L.M. Kiley Revocable
Trust under Agreement dated August 7, 1981. Also includes 24,375 shares
issuable upon exercise of outstanding options exercisable within 60 days
of November 14, 1997.
(15) Includes 48,597 shares issuable upon the exercise of outstanding options
exercisable within 60 days of November 14, 1997.
(16) Includes 17,705 shares issuable upon the exercise of outstanding options
exercisable within 60 days of November 14, 1997.
(17) Includes 29,308 shares issuable upon the exercise of outstanding options
exercisable within 60 days of November 14, 1997.
(18) Includes 39,228 shares issuable upon the exercise of outstanding options
exercisable within 60 days of November 14, 1997.
(19) Includes 36,254 shares issuable upon the exercise of outstanding options
exercisable within 60 days of November 14, 1997.
(20) Includes 250 shares of Common Stock owned by Amy K. Higgins, spouse of Mr.
Higgins.
(21) The percent listed in this column includes shares of Common Stock that the
Company currently intends to offer to certain persons listed in the table.
Specifically, the Company intends to offer 450,000 shares to Domain
Partners III, L.P. and its affiliate DP III Associates, L.P., 70,000
shares to Alexander E. Barkas, and 30,000 shares to Thomas D. Kiley. Such
shares are not included in such persons' shareholdings listed under the
column "Number of Shares." Although such persons have expressed an
interest in purchasing such shares, there can be no assurance that such
purchases will occur.
</FN>
-54-
DESCRIPTION OF CAPITAL STOCK
Following the closing of the sale of the shares offered hereby, the
authorized capital stock of the Company will consist of 50,000,000 shares of
Common Stock, $0.001 par value, and 5,000,000 shares of Preferred Stock, $0.001
par value.
Common Stock
As of October 31, 1997, there were 11,349,557 shares of Common Stock
outstanding that were held of record by approximately 191 stockholders. There
will be 13,099,557 shares of Common Stock outstanding after giving effect to the
sale of the shares of Common Stock offered hereby (assuming all of such shares
are sold). See "Management -- Stock Option Plans."
The holders of Common Stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. Subject to preferences that may be
applicable to any outstanding Preferred Stock, the holders of Common Stock are
entitled to receive ratably such dividends, if any, as may be declared from time
to time by the Board of Directors out of funds legally available therefor. See
"Dividend Policy." In the event of a liquidation, dissolution or winding up of
the Company, the holders of Common Stock are entitled to share ratably in all
assets remaining after payment of liabilities, subject to prior rights of
Preferred Stock, if any, then outstanding. The Common Stock has no preemptive or
conversion rights or other subscription rights. There are no redemption or
sinking fund provisions available to the Common Stock. All outstanding shares of
Common Stock are fully paid and non-assessable.
Preferred Stock
The Company is authorized to issue 5,000,000 shares of undesignated
Preferred Stock. The Board of Directors will have the authority to issue the
undesignated Preferred Stock in one or more Series and to determine the powers,
preferences and rights and the qualifications, limitations or restrictions
granted to or imposed upon any wholly unissued series of undesignated Preferred
Stock and to fix the number of shares constituting any Series and the
designation of such series, without any further vote or action by the
stockholders. The issuance of Preferred Stock may have the effect of delaying,
deferring or preventing a change in control of the Company without further
action by the stockholders and may adversely affect the voting and other rights
of the holders of Common Stock. At present, the Company has no plans to issue
any further shares of Preferred Stock except those listed herein.
In December 1996, the Company issued 200 shares of 7% Series A
Redeemable Convertible Preferred Stock ("Series A Redeemable Preferred Stock"),
par value $.001 per share, in a Regulation S offering at a per share price of
$10,000 with a mandatory redemption date of December 4, 1999. Dividends and
principal on the Series A Redeemable Preferred Stock are convertible into common
stock at a conversion price equal to 85% of the average of the daily low trading
price for the ten trading days immediately preceding the conversion date. Each
holder is entitled to convert all or a portion of its Series A Redeemable
Preferred Stock into common stock at any time. Any Series A Redeemable Preferred
Stock that upon conversion would result in the cumulative issuance of common
stock in excess of 20% of the outstanding common stock, will be automatically
redeemed by the Company for cash at a redemption price equal to 120% of the
$10,000 original purchase price plus accrued dividends at the rate of 7%. As of
November 14, 1997, one hundred forty (140) shares of Series A Redeemable
Preferred Stock had been converted into common stock and sixty (60) shares of
Series A Redeemable Preferred Stock remained outstanding.
-55-
In May 1997, the Company adopted a Preferred Shares Rights Agreement
(the "Rights Agreement"), which entitles existing stockholders to certain rights
(including the right to purchase shares of Series B Preferred Stock) in the
event of an acquisition of fifteen percent (15%) or more of the Company's
outstanding common stock or a tender offer for such shares resulting in the
beneficial ownership by a person or group of fifteen percent (15%) or more of
the outstanding common stock. Such rights expire in April 2000 if not redeemed
earlier by the Company or expired pursuant to the consummation of certain
mergers, consolidations or sales of assets, or unless the final expiration date
is extended.
Registration Rights of Certain Holders
The holders of approximately 2,251,752 shares of Common Stock (the
"Registrable Securities") or their transferees are entitled to certain rights
with respect to the registration of such shares under the Securities Act. These
rights are provided under the terms of an agreement between the Company and the
holders of Registrable Securities. Subject to certain limitations in the
agreement, the holders of a majority of the Registrable Securities then
outstanding may require, on two occasions at any time, that the Company use its
best efforts to register the Registrable Securities for public resale. If the
Company registers any of its Common Stock either for its own account or for the
account of other security holders, the holders of Registrable Securities are
entitled to include their shares of Common Stock in the registration. A holder's
right to include shares in an underwritten registration is subject to the
ability of the underwriters to limit the number of shares included in the
offering. Holders of Registrable Securities holding at least 20% of the
Company's outstanding shares of capital stock may also require the Company, on
no more than two occasions over any twelve-month period, to register all or a
portion of their Registrable Securities on Form S-3, provided, among other
limitations, that the proposed aggregate selling price, net of underwriting
discounts and commissions, is at least $250,000. All fees, costs and expenses of
such registrations, excluding those incurred with respect to registrations on
Form S-3, must be borne by the Company and all selling expenses (including
underwriting discounts, selling commissions and stock transfer taxes) relating
to Registrable Securities must be borne by the holders of the securities being
registered. All fees, costs and expenses of registrations on Form S-3, including
all such selling expenses must be born by the holders of the securities being
registered.
Anti-Takeover Provisions of Delaware Law
The Company is subject to the provisions of Section 203 of the Delaware
Law. In general, the statute prohibits a publicly held Delaware corporation from
engaging in a "business combination" with an "interested stockholder" for a
period of three years after the date that the person became an interested
stockholder unless (with certain exceptions) the business combination or the
transaction in which the person became an interested stockholder is approved in
a prescribed manner. Generally, a "business combination" includes a merger,
asset or stock sale or other transaction resulting in a financial benefit to the
stockholder, and an "interested stockholder" is a person who, together with
affiliates and associates, owns (or within three years prior, did own) 15% or
more of the corporation's outstanding voting stock. This provision may have the
effect of delaying, deferring or preventing a change in control of the Company
without further action by the stockholders. In addition, upon completion of this
offering, certain provisions of the Company's charter documents, including a
provision eliminating the ability of stockholders to take actions by written
consent, may have the effect of delaying or preventing changes in control or
management of the Company, which could have an adverse effect on the market
price of the Company's Common Stock. The Company's stock option and purchase
plans generally provide for assumption of such plans or substitution of an
equivalent option of a successor corporation or, alternatively, at the
discretion of the Board of Directors, exercise of some or all of the options
stock, including non-vested shares, or acceleration of vesting of shares issued
pursuant to stock grants, upon a change of control or similar event. The Board
of Directors has authority to issue up to 5,000,000 shares of Preferred Stock
and to fix the rights, preferences, privileges and restrictions, including
voting rights, of these shares without any further vote or action by the
stockholders. The rights of the holders of the Common Stock will be subject to,
and may be adversely affected by, the rights of the holders of any Preferred
Stock that may be issued in the future. The issuance of Preferred Stock, while
providing desirable flexibility in connection with possible acquisitions and
other corporate purposes, could have the effect of making it more difficult for
a third party to acquire a majority of the outstanding voting stock of the
Company, thereby delaying, deferring or preventing a change in control of the
Company. Furthermore, such Preferred Stock
-56-
may have other rights, including economic rights senior to the Common Stock,
and, as a result, the issuance of such Preferred Stock could have a material
adverse effect on the market value of the Common Stock. The Company has no
present plan to issue shares of Preferred Stock.
Warrants
The Company also has outstanding warrants exercisable for 1,289,194
shares of Common Stock at an average weighted exercise price of $8.79 per share.
Transfer Agent and Registrar
The Transfer Agent and Registrar for the Company's Common Stock is U.S.
Stock Transfer Corporation, Glendale, California. Its telephone number is (818)
502-1404.
Listing
The Company's Common Stock is quoted on the Nasdaq National Market
under the trading symbol "CNCT."
-57-
PLAN OF DISTRIBUTION
The Common Stock offered hereby is being offered for sale directly by
the Company to a limited number of institutional buyers, affiliates of such
buyers and other accredited investors. The Company does not anticipate offering
the Common Stock through underwriters, but may engage a registered broker/dealer
to effect sales of the shares. If the Company does offer the Common Stock
through underwriters or broker/dealers or agents, the net proceeds to the
Company would be reduced by any discounts or commissions that would be required
to be paid by the Company to any such underwriter, broker/dealer or agent.
Specifically, one group of prospective institutional purchasers of an aggregate
of 1,200,000 shares has requested that the transaction be effected on an agency
basis through Punk, Ziegel & Company L.P., who would receive a commission of
$0.03125 per share.
There can be no assurance that the Company will be successful in
selling any or all of the Common Stock offered hereby. The Company has not fixed
a minimum number of shares of Common Stock to be sold pursuant to this
Prospectus. Therefore, the Company may sell less than all of the Common Stock
offered hereby, which may significantly reduce the amount of proceeds to be
received by the Company. Funds received by the Company on the sale of less than
all of the Common Stock offered hereby will not be placed in an escrow, trust or
similar account. It is expected that delivery of certificates representing the
shares of Common Stock will be made against payment for the Common Stock in Palo
Alto, California, and the offering of any unsold shares hereunder will terminate
not later than thirty (30) days after the date of this Prospectus.
The Chief Executive Officer, the President and the Chief Financial
Officer of the Company, with assistance of other officers as needed, will
participate in the sale of the Common Stock to the purchasers. The Company
expects that these participants, who will not receive any compensation for these
sales, will not be deemed to be brokers under the Exchange Act.
The Company has engaged Gerard Klauer Mattison & Co., Inc. ("GKM") to
render financial advisory services to the Company for a period of one year
through November 1998, including in connection with this offering. GKM's role in
this offering is limited to providing financial advice, and GKM will not be
serving as an underwriter, broker/dealer, finder or placement agent. In
consideration of GKM's services, the Company will pay GKM a fee of $70,000 and
will issue to GKM a warrant to purchase up to 6,000 shares of the Company's
common stock at an exercise price of $6.00 per share. The warrant will expire
five years from the effective date of this offering, and the Company will be
obligated to register the shares underlying the warrant for resale within one
year of the closing of this offering. The Company will also reimburse GKM for
its reasonable out-of-pocket expenses incurred in connection with its services
to the Company.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for
the Company by its counsel, Venture Law Group, A Professional Corporation, 2800
Sand Hill Road, Menlo Park, California, 94025. Joshua L. Green, a director of
Venture Law Group, is Secretary of the Company.
EXPERTS
The consolidated financial statements of Connetics Corporation at
December 31, 1995 and 1996 and for each of the three years in the period ended
December 31, 1996, appearing in this Prospectus and Registration Statement have
been audited by Ernst & Young LLP, independent auditors, as set forth in their
report thereon appearing elsewhere herein, and are included in reliance upon
such report given upon the authority of such firm as experts in accounting and
auditing.
-58-
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form S-1, of which this Prospectus
constitutes a part, under the Securities Act with respect to the shares of
Common Stock offered hereby. This Prospectus omits certain information contained
in the Registration Statement, and reference is made to the Registration
Statement and the exhibits and schedules thereto for further information with
respect to the Company and the Common Stock offered hereby. Statements contained
herein concerning the provisions of any documents are not necessarily complete,
and in each instance reference is made to the copy of such document filed as an
exhibit to the Registration Statement. Each such statement is qualified in its
entirety by such reference.
The Company also is subject to the informational requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in
accordance therewith files reports, proxy statements and other information with
the Commission. Such reports, proxy statements and other information can be
inspected and copied at the public reference facilities maintained by the
Commission at 450 Fifth Street, N.W., Judiciary Plaza, Room 1024, Washington,
D.C. 20549, and at the Commission's following Regional Offices: Northwest Atrium
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661; and Seven
World Trade Center, 13th Floor, New York, New York 10048. Copies of such
material can be obtained at prescribed rates from the Public Reference Section
of the Commission at 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C.
20549. The Commission maintains a Web site that contains reports, proxy and
information statements and other information regarding Companies, such as the
Company, that file electronically with the Commission at http://www.sec.gov. The
Company's Common Stock is traded on the Nasdaq National Market under the symbol
"CNCT."
-59-
CONNETICS CORPORATION
INDEX TO FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors.......................... F-2
Balance Sheets............................................................. F-3
Statements of Operations................................................... F-4
Statements of Stockholders' Equity (Net Capital Deficiency)................ F-5
Statements of Cash Flows................................................... F-7
Notes to Financial Statements.............................................. F-8
F-1
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
To The Board of Directors and Stockholders of Connective Therapeutics, Inc.
(also known as Connetics Corporation)
We have audited the accompanying balance sheets of Connective
Therapeutics, Inc. (also known as Connetics Corporation) as of December 31, 1996
and 1995, and the related statements of operations, stockholders' 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 aspects, the financial position of Connective
Therapeutics, Inc. 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.
ERNST & YOUNG LLP
Palo Alto, California
January 13, 1997
F-2
CONNETICS CORPORATION
BALANCE SHEETS
(In thousands, except share amounts)
Nine Months
Ended
September 30, Years Ended December 31,
--------------- ----------------------------
1997 1996 1995
---- ---- ----
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 5,767 $14,555 $ 9,023
Short-term investments 8,373 9,999 --
Accounts receivable 1,863 428 --
Prepaid expenses and other current assets 167 124 154
------- ------- -------
Total current assets 16,170 25,106 9,177
Property and equipment, net 1,801 1,484 1,367
Notes receivable from related parties 246 301 414
Deposits and other assets 185 250 838
Licensed assets and product rights 15,437 20,781 --
------- ------- -------
$33,839 $47,922 $11,796
======= ======= =======
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,446 $4,179 $ 441
Accrued liabilities 1,922 2,023 808
Accrued process development expenses 439 1,198 668
Accrued payroll and related expenses 741 394 157
Current notes payable 5,923 -- --
Current portion of capital lease obligations, capital loans and long-term debt 2,845 2,408 1,259
-------- ------- -----
Total current liabilities 14,316 10,202 3,333
Notes payable -- -- 2,205
Non-current portion of capital lease obligations, capital loans and long-term debt 1,302 3,062 4,933
Other long-term liabilities 6,187 10,858 1,262
Redeemable convertible preferred stock, Series A 1,650 2,000 --
Commitments
Stockholders' equity:
Preferred stock, $0.001 par value: 5,000,000 shares authorized; redeemable
convertible preferred stock, Series A, 165 shares issued and outstanding at
September 30, 1997, 200 shares issued and outstanding at December 31, 1996
and no shares issued and outstanding at December 31, 1995; and preferred
stock, no shares
issued and outstanding at December 31, 1996 and 3,965,137 shares issued and
outstanding at December 31, 1995 -- -- 4
Common stock, $0.001 par value: 50,000,000 shares authorized; 11,075,654 share
issued and outstanding at September 30, 1997, 9,057,393 shares issued and
outstanding at
December 31, 1996 and 908, 511 issued and outstanding at December 31, 1995 11 9 1
Additional paid in capital 72,348 60,998 21,425
Notes receivable from stockholders (75) (75) (134)
Deferred compensation, net (891) (1,315) (1,933)
Other 1 (3) --
Accumulated deficit (60,964) (37,814) (19,300)
Treasury stock, at cost (46) -- --
------- ------- -------
Total stockholders' equity 10,384 21,800 63
------- ------- -------
$33,839 $47,922 $11,796
======= ======= =======
<FN>
See accompanying notes to financial statements
</FN>
F-3
CONNETICS CORPORATION
STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
Nine Months Ended September 30, Years Ended December 31,
------------------------------- ----------------------------------------
1997 1996 1996 1995 1994
---- ---- ---- ---- ----
(Unaudited)
Product revenues $ 5,053 $ -- $ 428 $ -- $ --
Operating costs and expenses:
Cost of product sales 815 -- -- -- --
License amortization 5,344 -- 594 -- --
Research and development 14,731 9,221 13,161 8,271 6,436
General and administrative 6,599 3,419 5,434 2,113 1,317
-------- -------- -------- -------- --------
Total operating expenses 27,489 12,640 19,189 10,384 7,753
Interest income 714 914 1,190 405 38
Interest expense (1,318) (749) (943) (393) (135)
-------- -------- -------- -------- --------
Net loss $(23,040) $(12,475) $(18,514) $(10,372) $ (7,850)
======== ======== ======== ======== ========
Net loss per share $ (2.31) $ (1.91) $ (2.71)
=========== ========== ==========
Shares used to calculate net loss per share 10,034,185 6,524,574 6,824,668
=========== ========== ==========
Pro forma net loss per share $ (1.79)
==========
Shares used to calculate pro forma net loss per share 5,778,372
==========
<FN>
See accompanying notes to financial statements
</FN>
F-4
CONNETICS CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
(In thousands, except share and per share amounts)
Convertible Additional
Preferred Stock Common Stock Paid in Notes Deferred
Shares Amount Shares Amount Capital Receivable Compensation
------ ------ ------ ------ ------- ---------- ------------
Balances at December 31, 1993 227,081 $ -- 604,802 $ 1 $ 1,037 $ (20) $ --
Issuance of series A preferred stock 1,116,180 1 -- -- 4,950 -- --
Issuance of common stock under stock
option plans -- -- 261,138 -- 117 (77) --
Net loss -- -- -- -- -- -- --
--------- ---- --------- ----- -------- ------ -------
Balances at December 31, 1994 1,343,261 1 865,940 1 6,104 (97)
--------- ---- --------- ----- -------- ------ -------
Issuance of series B preferred stock,
net of issuance costs 2,621,876 3 -- -- 12,787 (28) --
Issuance of common stock under stock
option plans -- -- 42,571 -- 19 (9) --
Deferred compensation related to certain
options and stock purchase rights
granted to employees and consultants -- -- -- -- 2,265 -- (2,265)
Amortization of deferred compensation -- -- -- -- -- -- 332
Issuance of warrants -- -- -- -- 250 -- --
Net loss -- -- -- -- -- -- --
--------- ---- --------- ----- -------- ------ -------
Balances at December 31, 1995 3,965,137 4 908,511 1 21,425 (134) (1,933)
--------- ---- --------- ----- -------- ------ -------
Issuance of common stock in initial public
offering ("IPO"), net of issuance costs
of $2,981 -- -- 2,500,000 2 24,519 -- --
Conversion of preferred stock into
common stock in conjunction with IPO
in February (3,965,137) (4) 3,965,137 4 -- -- --
Issuance of common stock under stock
option plans, net of repurchases -- -- 51,586 -- 22 -- --
Issuance of common stock warrants -- -- 10,328 -- -- -- --
Issuance of common stock under employee
stock purchase plan -- -- 11,874 -- 96 -- --
Issuance of common stock pursuant to
private placement, net of issuance costs -- -- 972,224 1 5,929 -- --
Issuance of common stock upon asset
purchase from SmithKline Beecham -- -- 637,733 1 8,999 -- --
Payment of notes receivable -- -- -- -- -- 59 --
Deferred compensation related to certain
options and stock purchase rights granted
to consultants -- -- -- -- 145 -- (145)
Amortization and reversal of deferred
compensation -- -- -- -- (137) -- 763
Unrealized loss on investments -- -- -- -- -- -- --
Net loss -- -- -- -- -- -- --
--------- ---- --------- ----- -------- ------ -------
Balances at December 31, 1996 -- -- 9,057,393 9 60,998 (75) (1,315)
--------- ---- --------- ----- -------- ------ -------
Unrealized
Treasury Stock Gains/Loss on Accumulated
Shares Amount Investments Deficit Total
------ ------ ----------- ------- -----
Balances at December 31, 1993 -- $ -- $ -- $ (1,078) $ (60)
Issuance of series A preferred stock -- -- -- -- 4,951
Issuance of common stock under stock
option plans -- -- -- -- 40
Net loss -- -- -- (7,850) (7,850)
------- ------- ------- -------- ---------
Balances at December 31, 1994 -- -- -- (8,928) (2,919)
------- ------- ------- -------- ---------
Issuance of series B preferred stock,
net of issuance costs -- -- -- -- 12,762
Issuance of common stock under stock
option plans -- -- -- -- 10
Deferred compensation related to certain
options and stock purchase rights
granted to employees and consultants -- -- -- -- --
Amortization of deferred compensation -- -- -- -- 332
Issuance of warrants -- -- -- -- 250
Net loss -- -- -- (10,372) (10,372)
------- ------- ------- -------- ---------
Balances at December 31, 1995 -- -- -- (19,300) 63
------- ------- ------- -------- ---------
Issuance of common stock in initial public
offering ("IPO"), net of issuance costs
of $2,981 -- -- -- -- 24,521
Conversion of preferred stock into
common stock in conjunction with IPO
in February -- -- -- -- --
Issuance of common stock under stock
option plans, net of repurchases -- -- -- -- 22
Issuance of common stock warrants -- -- -- -- --
Issuance of common stock under employee
stock purchase plan -- -- -- -- 96
Issuance of common stock pursuant to
private placement, net of issuance costs -- -- -- -- 5,930
Issuance of common stock upon asset
purchase from SmithKline Beecham -- -- -- -- 9,000
Payment of notes receivable -- -- -- -- 59
Deferred compensation related to certain
options and stock purchase rights granted
to consultants -- -- -- -- --
Amortization and reversal of deferred
compensation -- -- -- -- 626
Unrealized loss on investments -- -- (3) -- (3)
Net loss -- -- -- (18,514) (18,514)
------- ------- ------- -------- ---------
Balances at December 31, 1996 -- -- (3) (37,814) 21,800
------- ------- ------- -------- ---------
F-5
Issuance of common stock under stock
option plans, net of repurchases
(unaudited) -- -- 129,762 -- 61 -- --
Issuance of common stock under employee
stock purchase plan (unaudited) -- -- 12,602 -- 64 -- --
Issuance of common stock pursuant to
private placement, net of issuance
costs (unaudited) -- -- 1,810,000 2 10,884 -- --
Conversion of redeemable preferred stock,
Series A (unaudited) -- -- 71,143 -- 422 -- --
Convertible preferred stock, Series A
preferred dividends (unaudited) -- -- -- -- -- -- --
Repurchase of officer's common stock
(unaudited) -- -- -- -- -- -- --
Deferred compensation related to certain
options and stock purchase rights
granted to consultants (unaudited) -- -- -- -- (33) -- --
Amortization and reversal of deferred
compensation (unaudited) -- -- -- -- (48) -- 424
Unrealized gain on investments (unaudited) -- -- -- -- -- -- --
Net loss (unaudited) -- -- -- -- -- -- --
--------- ---- ---------- ----- -------- ------ -------
Balances at September 30, 1997 (Unaudited) -- $ -- 11,080,900 $ 11 $72,348 $ (75) $ (891)
========= ==== ========== ===== ======= ====== =======
Issuance of common stock under stock
option plans, net of repurchases
(unaudited) -- -- -- -- 61
Issuance of common stock under employee
stock purchase plan (unaudited) -- -- -- -- 64
Issuance of common stock pursuant to
private placement, net of issuance
costs (unaudited) -- -- -- -- 10,886
Conversion of redeemable preferred stock,
Series A (unaudited) -- -- -- -- 422
Convertible preferred stock, Series A
preferred dividends (unaudited) -- -- -- (110) (110)
Repurchase of officer's common stock
(unaudited) (5,246) (46) -- -- (46)
Deferred compensation related to certain
options and stock purchase rights
granted to consultants (unaudited) -- -- -- -- (33)
Amortization and reversal of deferred
compensation (unaudited) -- -- -- -- 376
Unrealized gain on investments (unaudited) -- -- 4 -- 4
Net loss (unaudited) -- -- -- (23,040) (23,040)
------- ------- ------- -------- ---------
Balances at September 30, 1997 (Unaudited) (5,246) $ (46) $ 1 $(60,964) $ 10,384
======= ======= ======= ======== =========
<FN>
See accompanying notes to financial statements
</FN>
F-6
CONNETICS CORPORATION
STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended
September 30, Years Ended December 31,
------------------------ ---------------------------------
1997 1996 1996 1995 1994
---- ---- ---- ---- ----
(Unaudited)
Cash flows from operating activities:
Net loss $(23,040) $(12,475) $(18,514) $(10,372) $(7,850)
Adjustments to reconcile net loss to net cash used by operating
activities:
Depreciation and amortization 5,909 491 1,237 393 120
Technology acquired in exchange for note payable and other
long-term liability -- -- -- 855 1,850
Amortization of deferred compensation 378 434 626 332 --
Accrued interest on notes payable 830 -- -- -- --
Changes in assets and liabilities:
Accounts receivable (1,435) -- (428) -- --
Prepaid expenses and other current assets (43) (2) 30 (72) 18
Notes receivable from related parties 9 147 173 (116) (298)
Deposits and other assets (9) 491 487 (543) 8
Accounts payable (1,733) (17) 3,738 (117) 409
Accrued liabilities (932) 348 1,215 587 65
Accrued process development (759) 269 530 209 459
Accrued payroll and related expenses 347 206 237 78 26
Other long-term liabilities 1,252 (78) 221 (31) 793
-------- -------- -------- -------- -------
Net cash used by operating activities (19,226) (10,186) (10,448) (8,797) (4,400)
-------- -------- -------- -------- -------
Cash flows from investing activities:
Purchases of short-term investments (12,169) (25,575) (21,650) (7,560) --
Sales and maturities of short-term investments 13,798 13,617 11,648 7,560 --
Capital expenditures (808) (588) (461) (400) (650)
Licensed assets and product rights -- -- (3,000) -- --
-------- -------- -------- -------- -------
Net cash provided by (used in) investing activities 821 (12,546) (13,463) (400) (650)
-------- -------- -------- -------- -------
Cash flows from financing activities:
Proceeds (payments) from bank loans -- -- -- (750) 750
Payment of notes payable -- (2,205) (2,205) -- --
Proceeds from capital loans and long-term debt 333 415 323 5,230 540
Payments on obligations under capital leases and capital loans (1,693) (745) (1,244) (319) (111)
Proceeds from issuance of redeemable preferred stock -- -- 2,000 -- --
Proceeds from issuance of preferred and common stock,
net of issuance costs 10,977 24,636 30,569 12,772 4,429
-------- -------- -------- -------- -------
Net cash provided by financing activities 9,617 22,101 29,443 16,933 5,608
-------- -------- -------- -------- -------
Net change in cash and cash equivalents (8,788) (631) 5,532 7,736 558
Cash and cash equivalents at beginning of period 14,555 9,023 9,023 1,287 729
-------- -------- -------- -------- -------
Cash and cash equivalents at end of period $ 5,767 $8,392 $14,555 $9,023 $1,287
======== ======== ======== ======== =======
Supplementary information:
Interest paid $ 488 $ 749 $ 1,062 $ 274 $ 71
Investing and financing activities:
Assets acquired under capital leases $ -- $ 199 $ 199 $ 171 $ 611
Issuance of preferred stock in exchange for cancellation of accrued
liability related to technology license $ -- $ -- $ -- $ -- $ 563
Issuance of warrants $ -- $ -- $ -- $ 250 $ --
Issuance of preferred and common stock in exchange for notes receivable $ -- $ -- $ -- $ 37 $ 77
Deferred compensation related to stock options and purchase rights $ -- $ 145 $ 145 $ 2,265 $ --
Issuance of common stock for licensed assets and product rights
purchased from SmithKline Beecham $ -- $ -- $ 9,000 $ -- $ --
Issuance of note payable for licensed assets and product rights
purchased from SmithKline Beecham $ -- $ -- $ 9,375 $ -- $ --
<FN>
See accompanying notes to financial statements
</FN>
F-7
CONNETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
December 31, 1996
(Information as of September 30, 1997 and for the nine
month periods ended September 30, 1997 and 1996 is unaudited)
1. Organization and Summary of Significant Accounting Policies:
Organization
Connetics Corporation (the "Company") was incorporated in the State of
Delaware on February 8, 1993. In March 1997, the Company's Board of Directors
approved a change in the Company's name from "Connective Therapeutics, Inc." to
"Connetics Corporation" which was approved by the Company's stockholders at its
annual meeting on May 14, 1997. References in this section to historical results
include the Company's results when it was known as "Connective Therapeutics,
Inc." From its inception until December 1996, the Company was in the development
stage, principally involved in research and development of therapeutics for
diseases that involve connective tissues of the body, obtaining financing,
recruiting personnel, securing operating facilities, and pursuing business
development opportunities. On December 31, 1996, the Company acquired exclusive
U.S. and Canadian rights to Ridaura(R), a disease modifying antirheumatic drug,
from SmithKline Beecham Corporation and related entities. Ridaura is the first
product the Company markets and it signifies the beginning of the Company's
transition from purely product development to a revenue based sales and
marketing company. The Company has no products from its current development
programs available for sale and does not expect to have any for the next few
years. Accordingly, the Company's ability to continue its research and
development activities is dependent upon the ability of management to obtain
substantial additional financing.
Liquidity and financial viability
In the course of its development activities, the Company has sustained
continuing operating losses and expects such losses to increase over at least
the next few years. The Company's future capital uses and requirements depend on
numerous factors, including the progress of its research and development
programs, the progress of clinical and advanced-stage clinical testing, the time
and costs involved in obtaining regulatory approvals, the cost of filing,
prosecuting, and enforcing patent claims and other intellectual property rights,
competing technological and market developments, the ability of the Company to
establish collaborative arrangements, the level of product revenues, the
possible acquisition of new products and technologies, and the development of
commercialization activities, and therefore such capital uses and requirements
may increase in future periods. As a result, the Company will require
substantial additional funds prior to reaching profitability and may attempt to
raise additional funds through equity or debt financings, collaborative
arrangements with corporate partners or from other sources. Other than the
Equity Line Agreement (which is presently unavailable) (see Note 6), the Company
currently has no commitments for any additional financings, and there can be no
assurance that additional funding will be available
F-8
for the Company to finance its ongoing operations on acceptable terms if at all.
The inability to obtain sufficient funds may require the Company to delay, scale
back or eliminate some or all of its research and product development programs,
to limit the marketing of its products or to license third parties the rights to
commercialize products or technologies that the Company would otherwise seek to
develop and market itself.
Interim financial information
The financial statements as of September 30, 1997 and for the nine
month periods ended September 30, 1997 and 1996 are unaudited, but include all
adjustments (consisting of normal recurring adjustments) which the Company
considers necessary for a fair statement of financial position as of such date
and the operating results and cash flows for such periods. Results for the
interim period are not necessary indicative of the results for the entire year.
Cash, cash equivalents and short-term investments
Cash and cash equivalents consist of cash on deposit with banks and
money market instruments with original maturity of 90 days or less. Investments
with maturities beyond three months at the date of acquisition and that mature
within one year from the balance sheet date are considered to be short-term
investments. Cash equivalents and short-term investments are carried at fair
value, with unrealized gains and losses, net of tax, reported as a separate
component of stockholders' equity. The cost of securities sold is based on the
specific identification method.
Management of the Company believes it has established guidelines for
investment of its excess cash relative to diversification and maturities that
maintain safety and liquidity.
Property and equipment
Property and equipment is stated at cost and depreciated using the
straight-line method over the useful lives of the assets, generally three to
five years. Assets acquired under capital lease arrangements are amortized over
the shorter of the estimated useful lives or the lease term.
Fair value of financial instruments
Statement of Financial Accounting Standards No. 107, "Disclosures About
Fair Value of Financial Instruments," requires that fair values be disclosed for
most of the Company's financial instruments. The carrying amount of cash, cash
equivalents and short-term investments, accounts receivable, current
liabilities, notes payable, and long-term lease obligations, loans and debt are
considered to be representative of their respective fair values.
Research and development
Research and development costs are charged to expense as incurred.
Revenue recognition
Revenues from product sales are recognized upon shipment.
Income taxes
Income taxes are accounted for under the asset and liability method
where deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled.
F-9
Net loss per share
Net loss per share is computed using the weighted average number of
shares of common stock outstanding. Common equivalent shares from stock options
and convertible preferred stock are excluded from the computation as their
effect is antidilutive, except that, pursuant to Securities and Exchange
Commission Staff Accounting Bulletins, common equivalent shares issued during
the twelve-month period prior to the initial public offering in February 1996
have been included in the calculation as if they were outstanding for all
periods through December 31, 1995 (using the treasury stock method for stock
options and the anticipated offering price). Historical net loss per share
calculated on this basis for 1995 was $(2.34). Pro forma net loss per share for
1995 has been computed as described above and also gives effect to the
conversion of convertible preferred shares not included above that automatically
converted into common shares upon completion of the Company's initial public
offering (using the if-converted method) from the original date of issuance.
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
(SFAS 128), which requires the Company to simplify the calculation of earnings
per share ("EPS") and achieve comparability with the recently issued
International Accounting Standard No. 33, "Earnings Per Share." Statement No.
128 is effective for both interim and annual financial statements for periods
ending after December 15, 1997. As a result, the Company will continue to
compute EPS in accordance with Accounting Principles Board ("APB") Opinion No.
15, "Earnings Per Share," and will adopt and report of SFAS 128 new EPS basis in
the fourth quarter ended December 31, 1997. The impact of SFAS 128 is not
expected to be material to the Company's financial statements.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
New accounting standards
In October 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation," which requires the Company to adopt disclosure
provisions for stock-based compensation effective January 1, 1996. The standard
defines a fair value method of accounting for stock options and other equity
instruments. Under the fair value method, compensation is measured at the grant
date based on the fair value of the award and is recognized over the service
period, which is usually the vesting period. This standard encourages rather
than requires companies to adopt the fair value method of accounting for
employee stock-based transactions. Companies are permitted to continue to
account for such transactions under Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees," but will be required to make
pro forma disclosures as if the fair value method had been applied. The Company
has elected to continue to apply APB
F-10
Opinion No. 25 in its financial statements and has provided pro forma
disclosures in the accompanying notes to financial statements.
Effective January 1, 1996, the Company adopted Financial Accounting
Standards Board Statement No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of" ("Statement No. 121").
Statement No. 121 requires losses from impairment to be recorded on long-lived
assets used in operations when indicators of impairment are present and the
undiscounted cash flows estimated to be generated by those assets are less than
the assets' carrying amount. The adoption of Statement No. 121 did not have a
material effect on the Company's financial statements for the twelve months
ended December 31, 1996.
2. Cash Equivalents and Short-term Investments:
The following is a summary of available-for-sale investments ( in thousands):
September 30, 1997
--------------------------------------------
Gross Gross
----------------------
Amortized Unrealized Unrealized Estimated
Costs Gains Loss Fair Value
Corporate bonds ............................ $ 3,332 $ 1 $ (1) $ 3,332
Commercial paper ........................... 5,678 -- -- 5,678
Certificate of deposits .................... 4,043 1 -- 4,044
Money market funds ......................... 28 -- -- 28
-------- -------- -------- --------
Total ................................ 13,081 2 (1) 13,082
Less amount classified as cash equivalents . (4,709) -- -- (4,709)
-------- -------- -------- --------
Total short-term investments ............... $ 8,372 $ 2 $ (1) $ 8,373
======== ======== ======== ========
December 31, 1996
--------------------------------------------
Gross Gross
----------------------
Amortized Unrealized Unrealized Estimated
Costs Gains Loss Fair Value
----- ----- ---- ----------
Corporate bonds ............................ $ 9,802 $ 2 $ (5) $ 9,799
Commercial paper ........................... 8,269 -- -- 8,269
Certificate of deposits .................... 5,021 -- -- 5,021
Money market funds ......................... 14 -- -- 14
-------- -------- -------- --------
Total ................................ 23,106 2 (5) 23,103
Less amount classified as cash equivalents . (13,104) -- -- (13,104)
-------- -------- -------- --------
Total short-term investments ............... $ 10,002 $ 2 $ (5) $ 9,999
======== ======== ======== ========
December 31, 1995
--------------------------------------------
Gross Gross
----------------------
Amortized Unrealized Unrealized Estimated
Costs Gains Loss Fair Value
----- ----- ---- ----------
Money market funds.......................... $ 1,686 $ -- $ -- $ 1,686
Less amounts classified as cash equivalents. (1,686) -- -- (1,686)
-------- -------- -------- --------
Total short-term investments................ $ -- $ -- $ -- $ --
======== ======== ======== ========
F-11
The net unrealized holding gain (loss) on available-for-sale
investments included as a separate component of stockholders' equity at
September 30, 1997 and December 31, 1996 totaled $1,000 and $(3,000),
respectively. The gross realized gains on sales of available-for-sale
investments for the year ended December 31, 1996 totaled $543,000, and the gross
realized losses for the years ended December 31, 1996 and 1995 totaled $289,000
and $21,000, respectively.
Realized gains and losses were calculated based on the specific identification
method.
3. Property and Equipment:
Property and equipment consists of the following (in thousands):
September 30, December 31,
------------- ------------
1997 1996 1995
---- ---- ----
Laboratory equipment............................................. $1,885 $1,357 $ 928
Computer equipment............................................... 395 288 217
Furniture and fixtures........................................... 356 224 169
Leasehold improvements........................................... 713 672 567
------ ------ ------
3,349 2,541 1,881
Less accumulated depreciation and amortization................... (1,548) (1,057) (514)
------ ------ ------
Property and equipment, net...................................... $1,801 $1,484 $1,367
====== ====== ======
Property and equipment includes assets under capitalized leases at
December 31, 1996 and 1995 of approximately $1,005,000 and $805,000,
respectively. Accumulated amortization related to leased assets was
approximately $559,000 and $280,000 at December 31, 1996 and 1995, respectively.
There were no new capitalized leases for the nine months ended September 30,
1997.
4. Notes Receivable from Related Parties
At September 30, 1997 and December 31, 1996 and 1995, the Company held
notes receivable from officers of the Company totaling $246,000, $301,000 and
$414,000, respectively. These notes, which bear interest at rates ranging from
6% to 8% annually, are collateralized by certain personal assets of the officers
and are generally due and payable within three to five years.
5. Research and License Agreements:
Licensed Assets and Product Rights
In December 1996, the Company entered into an agreement with SmithKline
Beecham Corporation and affiliated entities ("SmithKline") under which the
Company acquired exclusive United States and Canadian rights to Ridaura(R), a
disease modifying antirheumatic drug. Under the Asset Purchase Agreement, the
Company provided a $3.0 million upfront cash payment, which was paid in January
1997, a non-interest bearing $11.0 million promissory note payable in two
installments, in January 1998 and January 1999 of $6.0 million and $5.0 million,
respectively, 637,733 shares of common stock with a guaranteed value of $9.0
million at December 31, 1997, and up to $6.0 million in royalty payments based
on future product sales, for a potential aggregate consideration of up to $29.0
million. The $11.0 million promissory note was discounted at inception using an
imputed interest rate of 11% and future imputed interest expense attributable to
F-12
these payments is $1.6 million. The amount of the discounted note, $9.4 million,
has been included in other long-term liabilities, and the total purchase price
of $21.4 million has been capitalized. The Company has determined the useful
life of this asset to be three years based on information regarding products
currently in the Company's development pipeline, competitive products, the
off-patent position of Ridaura and expected future revenues from Ridaura, and
has recorded amortization of $5.3 million and $0.6 million at September 30, 1997
and December 31, 1996, respectively.
On November 13, 1997, the Company amended the terms of its non-interest
bearing $11.0 million promissory note with SmithKline. The amendment allows the
Company to defer the first $6.0 million installment payment, originally due in
January 1998, to April 1998, October 1998 and January 1999 by payments of $1.0
million, $1.5 million and $3.5 million, respectively. The Company is required to
pay interest on the principal amount outstanding of the $6.0 million from
January 1, 1998 through January 4, 1999 at prime rate plus 2%. The second
installment payment of $5.0 million under the note, also due January 1999,
remains unchanged.
Under a related Transitional Services Agreement, customer orders and
distribution for the product will continue to be managed by SmithKline through
1997 with no additional consideration for performing such services. The parties
also entered into a Supply Agreement, under which SmithKline will manufacture
and supply Riduara in final package form to the Company for an initial term
through December 2001.
License agreements
In September 1993, the Company entered into a Letter Agreement and a
License Agreement with a corporation (the "Licensor"), which was subsequently
amended in July 1994, for an exclusive right to make, use and sell certain
products arising from licensed technology in a defined field and territory in
exchange for Series A preferred stock which was issued in September 1994. The
Company charged the value of the preferred stock to research and development
expense in 1993. In addition, the Company charged $684,000 to expense in 1994
for the purchase of research materials and payment of technology transfer costs
under the agreement. This amount is due in September 1998 and has been included
in other long-term liabilities. The Company will also pay to the Licensor
royalties on sales of products arising from the licensed technology, if any. In
April 1996, the Company acquired worldwide rights to such technology from the
Licensor.
In June 1996, the Company entered into an exclusive License Agreement
with Soltec Research PTY Ltd. (the "Licensor"), to develop and market
betamethasone mousse (a foam mousse formulation of the dermatologic drug,
betamethasone valerate) in North America. Under the terms of the Agreement, the
Company will pay $75,000, of which $35,000 was paid in 1996, in licensing fees
to the Licensor (based on certain milestones) plus royalties on future sales of
products, if any, arising from the licensed technology. The Company also has an
exclusive option on the Licensor's foam mousse system for the delivery of other
compounds.
F-13
Technology acquisition agreement
In June 1994, the Company entered into a Technology Acquisition
Agreement (the "Agreement") with a corporation to purchase all rights to certain
technology and for the exclusive right to make, use and sell certain products
pursuant to a sublicense agreement in exchange for the issuance of a $1,350,000
subordinated promissory note. The note, including interest, was paid in full in
February 1996 after the closing of the Company's initial public offering of
common stock. In addition to this note, the Company has accrued additional
consideration of $500,000, which is payable by the Company upon the earlier of
the achievement of commencement of phase III clinical trials for a product
involving the licensed technology, or six years from the date of the agreement.
This amount has been included in other long-term liabilities.
The Agreement also provided for certain contingent payments based on
future financings. As a result of the Series B financing which was completed in
1995, the Company issued an additional note in the amount of $855,000 under this
Agreement. The note, including interest, was paid in full in February 1996 after
the closing of the Company's initial public offering of common stock. An
additional $1,000,000 will be payable by the Company upon FDA approval of a
product involving the licensed technology.
Under the terms of the Agreement, the Company is also committed to pay
royalties on applicable sales.
Technology license agreement
In December 1995, the Company entered into a Technology License
Agreement (the "License") to acquire exclusive rights to develop and market
products arising from certain licensed technology, other than for its currently
marketed indications, for dermatological diseases in the United States as part
of a collaborative marketing and profit sharing agreement. Such agreement is
contingent upon the Company using its best efforts to achieve commencement of a
Phase III clinical trial within 30 months of the agreement effective date. In
September 1996, the Company achieved this milestone with the initiation of a
Phase III clinical trial.
The Company will fund all costs to develop a product using the licensed
technology and has the option to defer payments for the purchase of commercial
materials from the licensor, if any, in exchange for certain debt instruments.
If the Company is successful in commercialization of a product using the
licensed technology, and if certain defined annual sales levels are met, the
licensor has the right to co-promote the product upon terms mutually agreeable
to the parties.
Expenses
Expenses under all of the Company's research and license agreements
totaled $35,000, $855,000 and $3,089,000 for the years ended December 31, 1996,
1995 and 1994, respectively.
F-13
6. Financing Arrangements
Long-Term Debt
On December 21, 1995, the Company entered into a term Loan and Security
Agreement (the "Term Loan") with a bank consortium (the "Lenders") under which
the Company borrowed $5,000,000. The Term Loan bears interest at 13%, with
interest only payments for the first six months, and interest and principal
payments for the following 30 months. In connection with the Term Loan, the
Company issued a warrant to purchase 73,071 shares of Common Stock at a price of
$5.78 per share. The warrant is exercisable at any time through December 2002.
In conjunction with the Term Loan, the Company granted the lender a first
security interest in its corporate assets. Under the terms of the loan, the
Company is required to maintain a minimum cash balance of the greater of
$6,000,000 or six times the Company's average monthly cash usage. If the Company
violates the covenants during the loan period, the Company would be required to
pledge restricted cash of 65% of the outstanding loan, or $2,681,000 as of
December 31, 1996, to cure the violation. On November 14, 1997, the Company
pledged restricted cash of $1,647,000 on the outstanding loan balance of
$2,534,000.
Future minimum principal payments under the Term Loan include
$1,929,000 and $2,196,000 for the years ending December 31, 1997 and 1998,
respectively.
Convertible Subordinated Note Financing
On December 7, 1995, the Company entered into a Master Bridge Loan
Agreement (the "Bridge Loan") with certain shareholders to provide for
borrowings up to $5 million. The Company did not draw down any portion of this
Bridge Loan and the right to draw down funds expired upon the successful
completion of the Company's initial public offering in February 1996. In
connection with the Bridge Loan, the Company issued five-year warrants to
purchase a total of 22,727 shares of common stock at the exercise price equal to
$11.00, the price per share of securities issued in the Company's initial public
offering.
Structured Equity Line Flexible Financing
On December 2, 1996, the Company entered into a Structured Equity Line
Flexible Financing Agreement (the "Agreement") with Kepler Capital LLC
("Kepler") that allows the Company to access up to $25 million through sales of
its Common Stock. The equity line will be available for a three-year period
beginning on or before December 1, 1997. The Agreement provides that the Company
can obtain from $500,000 to $2,000,000 at any one time through a sale of its
Common Stock to Kepler, subject to the satisfaction of certain conditions,
including registration of the shares for resale, minimum volume requirements,
and a minimum trading price of $7.00 per share over a specified period. In
addition, the Company must sell $500,000 of its Common Stock from time to time
if the price per share exceeds $10.00 and certain volume conditions are met.
Such sales will occur no more frequently than every 60 trading days. Any shares
sold under the equity line will be priced at 93% of the lesser of (i) the
average of the daily low trading price of the Common Stock for the 5 days
preceding the sale and (ii) the weighted average of daily low trading price of
the Common Stock during a valuation period. The purchase
F-14
price will be subject to further adjustment, up to a maximum discount of 15%
depending on the length of the valuation period - the period following the
purchase date and ending on the day, not to exceed 80 trading days, on which the
aggregate value of open market trading during the period equals or exceeds the
aggregate value of open market trading during the 20 days preceding the purchase
date. As a commitment fee to Kepler for keeping the equity line available, the
Company has issued a warrant to purchase 250,000 shares of Common Stock (see
Note 11). On September 30, 1997, the Company's trading price was below the $7.00
minimum price requirement and the Company is currently unable to draw under the
equity line.
7. Capital Lease Obligations and Capital Loans
The Company has capital lease and capital loan credit lines available
totaling $3,245,000 at December 31, 1996, of which $975,000 was unused and
available at December 31, 1996. Under the terms of the master lease agreement,
ownership of the leased equipment reverts to the Company at the end of the lease
term.
As of December 31, 1996, future minimum lease payments under capital
leases and principal payments on capital loans are as follows:
Capital Leases Capital Loans
-------------- -------------
(in thousands)
Year ending December 31:
1997........................................................... $ 428 $ 96
1998........................................................... 411 110
1999........................................................... 79 131
2000........................................................... 54 67
Thereafter..................................................... 43 --
-------- -----
Total minimum lease and principal payments, respectively......... 1,015 $ 404
=====
Less amount representing interest................................ 167
--------
Present value of future payments................................. 848
Less current portion of capital lease obligations................ 329
--------
Non-current portion of capital lease obligations................. $ 519
========
The obligations under the capital leases and loans are secured by the
leasehold improvements and equipment financed, bear interest at fixed rates of
approximately 8% to 14% and are payable in monthly installments through January
2002.
8. Operating Leases
The Company subleases its facility under a noncancelable operating
lease which expires in July 1999, with an option to extend the term of the lease
for one additional period of two years. The future minimum rental payments under
the leases are as follows (in thousands):
Years ending December 31:
1997................................................................. $ 561
1998................................................................. 589
1999................................................................. 352
------
$1,502
======
F-15
The Company recognizes rent expenses on a straight-line basis over the
term of each lease. Rent expense under operating leases was approximately
$425,000, $416,000 and $325,000 for the years ended December 31, 1996, 1995 and
1994, respectively.
9. Notes Receivable from Stockholders
At September 30, 1997 and December 31, 1996, the Company held $75,000
in notes receivable from certain stockholders for the purchase of the Company's
common stock. These notes bear interest at rates ranging from 6% to 7% annually
and are secured by the shares of common stock held by the borrowers. The notes
are due and payable, together with any unpaid interest, no later than either the
fourth or fifth anniversary of the note, or, for certain of these notes, within
30 days of termination of employment with the Company.
10. Redeemable Convertible Preferred Stock
In December 1996, the Company issued 200 shares of 7% Series A
Redeemable Convertible Preferred Stock ("Series A Redeemable Preferred Stock"),
par value $.001 per share, in a Regulation S offering at a per share price of
$10,000 with a mandatory redemption date of December 4, 1999. Dividends and
principal on the Series A Redeemable Preferred Stock are convertible into common
stock at a conversion price equal to 85% of the average daily low price for the
ten trading days immediately preceding the conversion date. Each holder is
entitled to convert all or a portion of its Series A Redeemable Preferred Stock
into common stock at any time. Any Series A Redeemable Preferred Stock that upon
conversion would result in the cumulative issuance of common stock in excess of
20% of the outstanding common stock, will be automatically redeemed by the
Company for cash at a redemption price equal to 120% of the $10,000 original
purchase price plus accrued dividends at the rate of 7%. As of September 30,
1997, 35 shares of Series A Redeemable Preferred Stock had been converted to
71,143 shares of common stock at a value of $422,000.
11. Stockholders' Equity
The Company is authorized to issue two classes of shares, common stock
(Common Stock) and preferred stock (Preferred Stock), each with par value of
$.001 per share. Prior to the Company's initial public offering, two series of
Preferred Stock, Series A and B were issued. In connection with the initial
public offering of the Company's common stock in February 1996, each previously
outstanding share of preferred stock (an aggregate of 3,965,137 shares) was
converted into one share of common stock and all previously authorized preferred
stock was eliminated. The Company's Articles of Incorporation was restated to
delete all references to Series A and B of Preferred Stock, and to authorize a
new class of 5,000,000 shares of Preferred Stock.
Warrants
In July 1995, the Company issued warrants to purchase 18,395 shares of
Series B Preferred Stock at an exercise price of $4.89 per share pursuant to a
capital lease and capital loan agreement. Each warrant for the purchase of
preferred stock was converted into a warrant for the purchase of one share of
common stock and such warrants are exercisable any time through the later of
seven
F-16
years from grant date or five years from the Company's initial public offering
of common stock in February 1996.
In connection with a Master Bridge Loan Agreement with certain
stockholders of the company in December 1995, the Company issued warrants which
expire in December 2000 to purchase a total of 22,727 shares of Common Stock at
a price of $11.00 per share.
Also in December 1995, in connection with a loan and security agreement
with a bank consortium, the Company issued warrants which expire in December
2002 to purchase 73,071 shares of Common Stock at a price of $5.78 per share.
In conjunction with the Company's issuance of 200 shares of Series A
Redeemable Preferred Stock in December 1996 (see Note 10), warrants were issued
that allow the holders to purchase up to 20,000 shares of the Company's common
stock at an exercise price equal to 110% of the closing bid price on December 4,
1996, or $7.425 per share, with an expiration date of December 4, 2001.
In conjunction with the Structured Equity Line Flexible Financing
Agreement in December 1996 (See Note 6), the Company issued a warrant on January
2, 1997 to purchase 250,000 shares of common stock at an exercise price of $8.25
per share. The warrant is exercisable over a period of 5 years from date of
issuance. On each of the first, second and third anniversaries of the beginning
of the commitment period, the Company will issue the Investor an additional
five-year warrant exercisable for a number of shares based on the amount of
equity line still available to the Company.
In conjunction with the Company's issuance of 1,810,000 shares in May
1997 to certain private investors, warrants were issued to purchase 905,000
shares of the Company's common stock at a price of $9.08 per share. These
warrants will expire May 15, 2001.
Common stock
The Company has the right to repurchase, at the original issue price
per share, certain shares of common stock issued to employees, consultants,
investors and founders. This right generally expires ratably over a period of
time not greater than five years, in accordance with terms determined by the
Board of Directors.
At September 30, 1997 and December 31, 1996 and 1995, outstanding
shares of 55,132, 154,786 and 392,102, respectively, were subject to repurchase
at original issue prices ranging from $0.04 to $0.45 per share, including shares
issued pursuant to stock purchase rights under the 1994 Stock Plan (see Note
12).
Dividend restrictions
The Company's loan agreement with a bank lender prohibits the Company
from declaring or paying a dividend without the banks' prior written consent.
F-17
Common shares reserved for future issuance
The Company has reserved shares of common stock as follows:
September 30, December 31,
1997 1996
---- ----
1994 Stock Plan............................................................... 1,723,585 1,353,347
1995 Employee Stock Purchase Plan............................................. 75,524 88,126
1995 Directors Stock Option Plan.............................................. 150,000 150,000
Common stock warrants......................................................... 1,289,194 384,193
--------- ---------
3,238,303 1,975,666
========= =========
In addition, the Company is required to reserve shares of common stock
for issuance upon the conversion of the Series A Redeemable Convertible
Preferred Stock based on the conversion formula. The amount was approximately
504,000 shares and 344,000 shares at September 30, 1997 and December 31, 1996,
respectively.
12. Stock Plans
1994 Stock Plan
In August 1994, the Company's Board of Directors (the "Board") adopted
the 1994 Stock Plan (the "Plan") which authorizes the Board to grant incentive
stock options, nonstatutory stock options, and stock purchase rights for up to
1,349,011 shares of common stock. The Plan was amended in January 1996 to
increase the number of shares by 150,989, bringing the total up to 1,500,000
shares of common stock.
The options under this Plan expire no later than ten years from the
date of grant. The exercise price of the incentive stock options, nonstatutory
stock options and options granted to 10% shareholders shall be at least 100%,
85%, and 110%, respectively, of the fair value of the stock subject to the
option on the grant date. The price for shares purchased pursuant to stock
purchase rights by 10% shareholders shall be at least 100% of the fair market
value of the stock on the date of grant.
The options generally become exercisable at such times as determined by
the Company's Board of Directors, but in no event at a rate of less than 20% per
year for a period of five (5) years from date of grant. Shares granted under the
Plan pursuant to stock purchase rights are generally subject to repurchase by
the Company at the original issue price per share. The Company's right to
repurchase these shares generally expires ratably over a period of time not
greater than five years.
The Company has elected to adopt Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," issued in
October 1995. In accordance with the provisions of SFAS No. 123, the Company
applies APB Opinion No. 25 and related interpretations in accounting for its
stock option plans and, accordingly, does not recognize compensation cost. If
the Company had elected to recognize compensation cost based on the fair value
of the options granted at grant date and including stock purchases under the
1995 Employee
F-18
Stock Purchase Plan as prescribed by SFAS No. 123, net loss and net loss per
share would have been increased to the pro forma amounts indicated in the table
below:
(In thousands except per share amounts) 1996 1995
---- ----
Net loss - as reported............................... $(18,514) $(10,372)
Net loss - pro forma................................. $(19,339) $(10,586)
Net loss per share - as reported..................... $ (2.71) $ (2.34)
Net loss per share - pro forma....................... $ (2.83) $ (2.39)
Because SFAS No. 123 is applicable only to options granted subsequent
to December 31, 1994, its pro forma effect will not be fully reflected until
1997.
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions:
Expected stock price volatility .......................... 60.0%
Risk-free interest rate range ........................... 4.24% - 6.32%
Expected life of options ................................. 1.125 to 2.0 years
Option approach .......................................... multiple
The weighted average fair value of options granted during 1996 and 1995
was $4.846 and $2.550 per share, respectively.
In July 1994, in conjunction with a research collaboration agreement,
the Company issued an option to purchase 22,483 shares of common stock at $0.45
per share to a consultant under the Plan. The option becomes exercisable based
on the achievement of certain technical milestones, except as to 6,745 shares
which become exercisable on the earlier of the achievement of milestones or over
a period of five years from the date of grant. Compensation expense will be
recorded for the options to purchase 15,738 common shares, for which vesting is
not fixed, based on the difference between the fair value on the date the
milestones are met and the exercise price of the options. The Company may
terminate the agreement and cancel all unvested shares at 30 days' written
notice. At September 30, 1997, 225 shares were exercisable and no shares were
exercisable at December 31, 1996. No compensation expense has been incurred as
of December 31, 1996 as none of the milestones have been met.
Activity under the plan is summarized as follows:
Outstanding Options
--------------------------------------------
Shares Range Weighted
available for Number of of Exercise avg. price
grant shares Prices per share
------------- --------- ----------- -----------
Balance, December 31, 1993........................ 337,253
Stock purchase rights grants................... (55,678) -- $0.45 $0.45
Options granted................................ (57,772) 57,772 $0.45 $0.45
---------- ---------
Balance, December 31, 1994........................ 223,803 57,772 $0.45 $0.45
Additional shares authorized................... 1,011,758 -- -- --
F-19
Stock purchase rights granted................... (37,320) -- $0.45 $0.45
Options granted................................. (910,178) 910,178 $0.45-2.22 $0.71
Options exercised............................... -- (3,193) $0.45 $0.45
Options and stock purchase rights canceled..... 9,778 (8,655) $0.45 $0.45
---------- ---------
Balance, December 31, 1995........................ 297,841 956,102 $0.45-2.22 $0.71
Additional shares authorized.................... 150,989 -- -- --
Options granted................................. (196,540) 196,540 $6.75-11.00 $8.76
Options exercised............................... -- (62,302) $0.45 $0.45
Shares repurchased.............................. 10,717 -- $0.45 $0.45
Options canceled................................ 57,154 (57,154) $0.45 $0.45
---------- ---------
Balance, December 31, 1996........................ 320,161 1,033,186 $0.45-11.00 $2.04
Additional shares authorized.................... 500,000 -- -- --
Options granted................................. (646,200) 646,200 $4.31-7.75 $6.44
Options exercised............................... -- (129,762) $0.45-2.22 $0.48
Shares repurchased.............................. -- -- -- --
Options canceled................................ 41,468 (41,468) $0.45-9.50 $4.31
---------- ---------
Balance, September 30, 1997....................... 215,429 1,508,156 $0.45-11.00 $4.16
The weighted average contractual lives of the options outstanding at
December 31, 1996 and 1995 were $8.84 and $9.65, respectively. At December 31,
1996 and 1995, options to purchase 284,764 and 99,943 shares were exercisable at
weighted average exercise price of $2.329 and $0.7063, respectively. For the
year ended December 31, 1995, 39,378 shares were issued under the Plan pursuant
to stock purchase rights (none at December 31, 1996).
For the years ended December 31, 1995 and 1996, the Company recorded
deferred compensation expense for the difference between the exercise price and
the deemed fair value of the Company's common stock, related to shares issued
pursuant to stock purchase rights and options granted in 1995 and 1996. These
options were granted to provide additional incentives to retain management and
key employees. This deferred compensation expense is being amortized over the
related vesting period, generally a 48-month period.
1995 Employee Stock Purchase Plan
The Company's 1995 Employee Stock Purchase Plan (the "Purchase Plan")
was adopted by the Board of Directors in December 1995. A total of 100,000
shares of Common Stock has been reserved for issuance under the Purchase Plan.
The Purchase Plan is administered by the Compensation Committee of the Board of
Directors. Employees (including officers and employee directors) of the Company,
or of any majority owned subsidiary designated by the Board of Directors, are
eligible to participate if they are employed by the Company or any such
subsidiary for at least 20 hours per week and more than 5 months per year. The
Purchase Plan permits eligible employees to purchase Common Stock through
payroll deductions, which may not exceed 15% of an employee's compensation, at a
price equal to the lower of 85% of the fair market value of the Company's Common
Stock at the beginning or end of the offering period. As of December 31, 1996,
11,874 shares had been issued under the plan and 88,126 shares were reserved for
future issuance. As of September 30, 1997, a total of 24,476 shares had been
issued under the plan and 75,524 shares were reserved for future issuance.
F-20
1995 Director Stock Option Plan
The 1995 Director Stock Option Plan (the "Directors' Plan") was adopted
by the Board of Directors in December 1995. A total of 150,000 shares of Common
Stock has been reserved for issuance under the Directors' Plan. The Directors'
Plan provides for the grant of nonstatutory stock options to nonemployee
directors of the Company.
The Directors' Plan provides that each person who first becomes a
nonemployee director of the Company after the date of the Company's initial
public offering shall be granted a nonstatutory stock option to purchase 30,000
shares of Common Stock (the "First Option") on the date on which the optionee
first becomes a nonemployee director of the Company. The First Option was not
granted to any nonemployee director who was a director as of the date of the
offering. Thereafter, on the date of each annual meeting of the Company's
stockholders, each nonemployee director (including directors who were not
eligible for a First Option) shall be granted an additional option to purchase
7,500 shares of Common Stock (a "Subsequent Option") if, on such date, he or she
shall have served on the Company's Board of Directors for at least six months.
The Directors' Plan provides that the First Option shall become
exercisable in installments as to 25% of the total number of shares subject to
the First Option on each of the first, second, third and fourth anniversaries of
the date of grant of the First Option; each Subsequent Option shall become
exercisable in full on the first anniversary of the date of grant of that
Subsequent Option. The exercise price of all stock options granted under the
Directors' Plan shall be equal to the fair market value of a share of the
Company's Common Stock on the date of grant of the option. Options granted under
the Directors' Plan have a term of ten years. No options were granted or
outstanding under the Directors' Plan at December 31, 1996. As of September 30,
1997, 105,000 shares had been granted and outstanding, with 45,000 available for
future grants.
1997 Stockholder Rights Plan
In May 1997, the Company adopted a stockholder rights plan (the "Rights
Plan") which provides existing stockholders with the right to purchase one
one-thousandth of a share of the Company's Series B Participating Preferred
Stock, $0.001 par value, at an exercise price of $49 per one one-thousandth of a
preferred share in the event of certain changes in the Company's ownership. The
Company will be entitled to redeem the rights at $0.01 per right at any time on
or before the tenth day following acquisition by a person or group of 15% or
more of the Company's common stock. The Rights Plan may serve as a deterrent to
certain abusive takeover tactics which are not in the best interest of
stockholders. At September 30, 1997, 90,000 shares were designated and no shares
were issued and outstanding.
13. Income Taxes
As of December 31, 1996, the Company had a federal net operating loss
carryforward of approximately $32,400,000. The net operating loss carryforward
will expire at various dates beginning from 2008 through 2011, if not utilized.
Significant components of the Company's deferred tax assets are as
follows:
F-21
December 31,
-------------------------
1996 1995
-------- -------
(in thousands)
Net operating loss carryforward................................... $ 11,300 $ 5,500
Capitalized research and development.............................. 1,200 1,400
Research credits (expires 2008-2011).............................. 800 400
Other............................................................. 1,200 --
-------- -------
Net deferred tax assets........................................... 14,500 7,300
Valuation allowance............................................... (14,500) (7,300)
-------- -------
Total................................................... $ -- $ --
======== =======
Because of the Company's lack of earnings history, the net deferred tax
asset has been fully offset by a valuation allowance.
Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the "ownership change" provisions of the
Internal Revenue Code of 1986.
F-22
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the Company in connection
with the sale of Common Stock being registered. All amounts are estimates except
the registration fee, the NASD filing fee and the Nasdaq National Market listing
fee.
Amount
To be Paid
----------
Registration Fee................................................. $ 1,724
NASD Filing Fee.................................................. 1,069
Nasdaq National Market Listing Fee............................... 17,500
Printing......................................................... 2,000
Legal Fees and Expenses.......................................... 125,000
Accounting Fees and Expenses..................................... 14,000
Blue Sky Fees and Expenses....................................... 5,000
Financial Adviser's Fee.......................................... 70,000
Transfer Agent and Registrar Fees................................ 5,000
Miscellaneous.................................................... 58,707
----------
Total.................................................. $300,000
==========
Item 14. Indemnification of Directors and Officers
Section 145 of the Delaware General Corporation Law authorizes a court
to award, or a corporation's Board of Directors to grant, indemnity to directors
and officers in terms sufficiently broad to permit such indemnification under
certain circumstances for liabilities (including reimbursement for expenses
incurred) arising under the Securities Act of 1933, as amended (the "Act").
Article XI of the Registrant's Amended and Restated Certificate of Incorporation
(Exhibit 3.1 hereto) provides for indemnification of its directors and officers
to the maximum extent permitted by the Delaware General Corporation Law and
Section 6 of Article VII of the Registrant's Bylaws (Exhibit 3.2 hereto)
provides for indemnification of its directors, officers, employees and other
agents to the maximum extent permitted by the Delaware General Corporation Law.
In addition, the Registrant has entered into Indemnification Agreements (Exhibit
10.1 hereto) with its directors and officers containing provisions which are in
some respects broader than the specific indemnification provisions contained in
the Delaware General Corporation Law. The indemnification agreements may require
the Company, among other things, to indemnify its directors against certain
liabilities that may arise by reason of their status or service as directors
(other than liabilities arising from willful misconduct of culpable nature), to
advance their expenses incurred as a result of any proceeding against them as to
which they could be indemnified, and to obtain directors' insurance if available
on reasonable terms.
Item 15. Recent Sales of Unregistered Securities
(a) During the last three years (or such longer period as indicated),
the Registrant has issued and sold (without payment of any selling commission to
any person, unless otherwise noted) the following unregistered securities:
(1) From its inception in February 1993 through December 31,
1995, the Registrant granted options and stock purchase rights under the 1994
Stock Plan to purchase 1,060,948 shares of Common Stock at a weighted average
price of $0.68 per share to 76 service providers.
II-1
(2) From inception through December 31, 1995, the Registrant
issued and sold, pursuant to the exercise of options and stock purchase rights
granted under the 1994 Stock Plan, 95,067 shares of Common Stock to 38 service
providers for an aggregate purchase price of $42,285.
(3) From inception through December 31, 1995, the Registrant
issued and sold an additional 813,444 shares of its Common Stock at a weighted
average price of $0.21 per share for an aggregate purchase price of $169,207.
(4) From February 1995 to December 1995, the Registrant issued
and sold an aggregate of 2,621,876 shares of its Series B Preferred Stock to
certain investors at a purchase price of $4.89 per share for an aggregate
purchase price of $12,827,503. Such Preferred Stock converted into Common Stock
on a one-share-for-one-share basis upon the closing of the Company's initial
public offering in February 1996.
(5) On December 7, 1995, the Company entered into a Master
Bridge Loan Agreement with certain stockholders of the Company (the "Bridge
Investors"), pursuant to which such Bridge Investors severally and
unconditionally agreed to lend up to a maximum aggregate total of $5,000,000 to
the Company. Under such agreement, the Company had the right to require the
Bridge Investors to make loans to the Company, allocated pursuant to each such
Bridge Investor's percentage ownership in the Company. No loans were made under
this Agreement, and the Company's ability to call for any loans expired upon the
closing of the Company's initial public offering in February 1996. In
consideration for this commitment, in February 1996, the Company delivered to
each such Bridge Investor a warrant to purchase a number of shares of Common
Stock equal to (a) the original face principal amount of such Bridge Investor's
commitment times (b) 5%, divided by (c) $11.00, the price per share of the
initial public offering. The exercise price of the warrants is $11.00 per share.
(6) In connection with a loan and security agreement entered
into between the Registrant and a bank consortium on December 21, 1995, the
Registrant issued warrants to such lenders to purchase 73,071 shares of Common
Stock at a price of $5.78 per share. The warrants expire in December 2002.
(7) In January 1996, the Company effected a one-for-4.4477
reverse stock split of the Company's Common Stock.
(8) In January 1996, prior to the Company's initial public
offering, the Company issued options to two consultants, Christian Schwabe and
Bogart Delafiel, to purchase 1,124 and 5,000 shares of common stock at $0.45 and
$4.50, respectively.
(9) In March 1996, the Company issued options to purchase
13,488 shares of Common Stock at $0.45 per share to three members of the
Company's Scientific Advisory Board. These options were granted outside of the
1994 Stock Plan but are subject to the same terms as those options granted under
the Plan
(10) On December 4, 1996, the Company sold 972,224 shares of
Common Stock to four institutional accredited investors at a price of $6.1714
per share for an aggregate purchase price of $5,999,983.20.
(11) On December 4, 1996, the Company issued 200 shares of 7%
Convertible Preferred Stock, Series A (the "Convertible Preferred Stock"), at a
price of $10,000 per share, for an aggregate purchase price of $2,000,000. The
shares were sold to an offshore investor pursuant to the exemption from
registration under Regulation S promulgated under the Securities Act of 1933.
The Convertible Preferred Stock is convertible into Common Stock of the Company
at a conversion price equal to 85% of the average low trading price on the
NASDAQ National Market System of the Company's Common Stock for the ten trading
days immediately preceding the conversion date, subject to certain adjustments.
The Convertible Preferred Stock will accrue dividends at the rate of 7% until
converted, and is redeemable by the Company if not converted within three years.
The Company also issued a warrant to the investor to purchase 20,000 shares of
Common Stock at an exercise price equal to 110% of the closing price of the
Company's Common Stock on December 4, 1996.
II-2
(12) On December 31, 1996, as partial consideration for the
Company's acquisition of the U.S. and Canadian rights to Ridaura(R) from
SmithKline, the Company issued 637,733 shares of its Common Stock to SmithKline
Beecham Properties, Inc.
(13) On May 14, 1997, the Company sold 1,810,000 shares of its
Common Stock to several accredited investors at a price of $6.05 per share and
also issued warrants to purchase an aggregate of 905,000 shares of Common Stock
at an exercise price of $9.08 per share to such investors.
(b) There were no underwritten offerings employed in connection with
any of the transactions set forth in Item 15(a).
The issuances of the above securities were deemed to be exempt from
registration under the Securities Act in reliance on Section 4(2) of such Act as
transactions by an issuer not involving any public offering. The recipients of
securities in each such transaction represented their intentions to acquire the
securities for investment only and not with a view to or for sale in connection
with any distribution thereof and appropriate legends where affixed to the
securities issued in such transactions. All recipients had adequate access,
through their relationships with the Company and in some cases through the
Company's periodic reports filed with the Commission, to information about the
Registrant. In addition, certain issuances described in Item 15(a)(1), (2), and
(8) were deemed to be exempt from registration under the Securities Act in
reliance upon Rule 701 promulgated under such Act.
Item 16. Exhibits and Financial Statement Schedules
(a) Exhibits
Exhibits
3.1(1) Form of Amended and Restated Certificate of Incorporation.
3.2(1) Form of Bylaws.
3.3(5) Certificate of Designation of 7% Redeemable Convertible
Preferred Stock, Series A of Connective Therapeutics, Inc., as
filed with the Delaware Secretary of State on December 4,
1996.
4.1(1) Form of Common Stock Certificate.
5.1** Opinion of Venture Law Group, A Professional Corporation.
10.1(1) Form of Indemnification Agreement with the Company's directors and officers.
10.2(7)* 1994 Stock Plan, as amended, and form of Option Agreement.
10.3(7)* 1995 Employee Stock Purchase Plan, as amended, and form of Subscription Agreement.
10.4(1)* 1995 Directors' Stock Option Plan and form of Option Agreement.
10.5(1) Third Amended and Restated Registration Rights Agreement dated February 14, 1995 among the
Registrant and certain security holders of the Registrant and Amendments Nos. 1 and 2 thereto
dated May 31, 1995 and September 28, 1995.
10.6(1)(2) License Agreement dated September 27, 1993, between Genentech,
Inc. and the Company, Amendment dated July 14, 1994, and side
letter agreement dated November 17, 1994.
10.8(1) Assignment and Assumption Agreement, dated June 3, 1994, by and between the Company and XOMA
Corporation.
10.9(1)(2) Technical Collaboration and Manufacturing Agreement, dated May
24, 1994, by and between the Company and Scios Nova Inc.
10.10(1)(2) Technology Acquisition Agreement dated June 3, 1994 by and between the Company and XOMA
Corporation, and License Agreement dated February 27, 1990 by and between Arthur A. Vandenbark,
Ph.D. and XOMA Corporation.
10.11(1)(2) Agreement on Interferon Gamma-1B dated December 8, 1995 by and between the Company and
Genentech, Inc.
10.12(1) Equipment Lease Line, dated May 31, 1994 with Lease Management Services, Inc.
10.13(1) Business Loan Agreement, dated July 18, 1995, between the Company, Silicon Valley Bank and
MMC/GATX Partnership No. 1.
II-3
10.14(1)(2) Research Collaboration and Assignment Agreement, dated July 1, 1994, between the Company and
Dr. Arthur A. Vandenbark.
10.15(1) Employment and Bonus Agreement between the Company and Edward Amento, dated November 17, 1993.
10.16(1) Secured Loan Agreements between the Company and Edward Amento dated November 1, 1993 and
July 11, 1994, respectively.
10.17(1) Consulting Agreement dated November 17, 1993 between the Company and Brian Seed.
10.18(1) Consulting Agreement dated November 17, 1993 between the Company and Eugene Bauer.
10.19(1) Employment Agreement dated June 9, 1994 between the Company and Thomas Wiggans.
10.20(1) Loan Agreements between the Company and Thomas Wiggans dated July 15, 1994 and August 1, 1994.
10.21(1) Letter Agreement with G. Kirk Raab dated October 1, 1995.
10.23(1) Facility Master Lease between the Company and Renault & Handley dated February 9, 1994.
10.26(1) Loan and Security Agreement dated December 21, 1995 by and among the Company, Silicon Valley
Bank and MMC/GATX Partnership No. 1.
10.27(3)(2) Agreement on Relaxin Rights in Asia dated April 1, 1996
between the Company and Mitsubishi Chemical Corporation
(Exhibits A and B to Exhibit 10.27 have been previously filed
as Exhibit 10.6 above. Confidential treatment has been granted
as to certain portions of Exhibit 10.6 by the SEC).
10.28(3)(2) Soltec License Agreement dated June 14, 1996.
10.29(4) Laboratory Services Agreement dated October 24, 1996.
10.30(4) Agreement with Dr. Edward Amento dated October 24, 1996.
10.31(4) Form of Directors and Officers Change in Control Agreement
10.32(5) Common Stock Purchase Agreement, dated December 4, 1996 by and among the Company and certain
investors.
10.33(5) Registration Rights Agreement, dated December 4, 1996 by and among the Company and certain
investors.
10.34(5) Securities Purchase Agreement, dated December 4, 1996 by and among the Company and a certain
purchaser.
10.35(5) Warrant, dated December 4, 1996 between the Company and a certain purchaser.
10.36(6)(2) Asset Purchase Agreement dated December 2, 1996 between the Company, SmithKline Beecham
Corporation, SmithKline Beecham Pharma Inc., SmithKline Beecham Properties, Inc. and SmithKline
Beecham Inter-American Corporation.
10.37(6) Stock Issuance Agreement dated December 31, 1996 between the Company and SmithKline Beecham
Properties, Inc.
10.38(6) Secured Promissory Note dated December 31, 1996 issued to SmithKline Beecham Corporation.
10.39(6) Security Agreement dated December 31, 1996 between the Company and SmithKline Beecham
Corporation.
10.40(6)(2) Supply Agreement dated December 31, 1996 between the Company and SmithKline Beecham Corporation.
10.41(6) Transitional Services Agreement dated December 31, 1996 between the Company and SmithKline
Beecham Corporation.
10.42(8) Structured Equity Line Flexible Financing Agreement dated January 2, 1997 between the Company
and Kepler Capital LLC.
10.43(8) Registration Rights Agreement dated January 2, 1997 between the Company and Kepler Capital LLC.
10.44(9) Common Stock and Warrant Purchase Agreement dated May 15, 1997 by and among the Company,
Genentech, Inc. and certain investors.
10.45(9) Registration Rights agreement dated May 15, 1997 by and among the Company and certain investors.
10.46(9) Form of Common Stock Purchase Warrant issued to certain investors on May 15, 1997.
10.47(7) Form of Notice of Stock Option Grant to G. Kirk Raab for stock option issued in January 1997.
10.48** Secured Loan Agreement dated October 30, 1997 between the Company and W. Scott Harkonen.
II-4
10.49** Letter Agreement with Cynthia M. Butitta dated September 22, 1997.
10.50** Amendment dated November 13, 1997 to Secured Promissory Note dated December 31, 1996 issued to
SmithKline Beecham Corporation.
10.51** Letter Agreement dated November 26, 1997 between the Company and Gerard Klauer Mattison & Co.,
Inc.
10.52** Letter Agreement with John L. Higgins dated August 25, 1997.
10.53 Omnibus Agreement with SmithKline Beecham Corporation and related entities dated December 18, 1997.
10.54 Canadian Asset Purchase Agreement with Pharmascience, Inc. dated December 19, 1997.
10.55 Supply Agreement with Pharmascience, Inc. dated December 19, 1997.
11.1** Statement of Computation of Net Loss Per Share.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney (see page II-8 of originally filed Registration Statement).
<FN>
- ------------------------------------------------------------------------------------------------------------------------------------
* This item is a compensatory plan required to be listed as an exhibit to this form pursuant to Item 601(a)(10)(iii) of
Regulation S-K.
** Previously filed.
1. Incorporated by reference from an exhibit filed with the Company's
Registration Statement on Form S-1 (File No. 33-80261) declared
effective by the Securities and Exchange Commission (the "SEC") on
January 31, 1996.
2. Certain portions of this Exhibit were granted confidential treatment pursuant to an order from the SEC.
3. Incorporated by reference from an exhibit to the Company's Quarterly Report on Form 10-Q
(File No. 0-27406) filed with the SEC for the fiscal quarter ended June 30, 1996.
4. Incorporated by reference from an exhibit to the Company's Quarterly Report on Form 10-Q
(File No. 0-27406) filed with the SEC for the fiscal quarter ended September 30, 1996.
5. Incorporated by reference from an exhibit to the Company's Report on Form 8-K (File No. 0-27406) dated December 4, 1996.
6. Incorporated by reference from an exhibit to the Company's Report on Form 8-K (File No. 0-27406) dated January 15, 1997.
7. Incorporated by reference from an exhibit filed with Post-Effective Amendment No. 1 to the Company's
Registration Statement on Form S-8 (File No. 333-04985) filed with the SEC on June 30, 1997.
8. Incorporated by reference from an exhibit filed with the Company's Annual Report on Form 10-K
(File No. 0-27406) for the fiscal year ended December 31, 1996.
9. Incorporated by reference from an exhibit filed with the Company's Registration Statement on Form S-3
(File No. 333-21941) filed with the SEC on July 3, 1997.
</FN>
(b) Financial Statement Schedules
Financial statement schedules are omitted because the information
required to be set forth therein is not applicable or is shown in the financial
statements or notes thereto.
Item 17. Undertakings
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 (the "Act") may be permitted to directors, officers and controlling
persons of the Registrant pursuant to the provisions referenced in Item 14 of
this Registration Statement or otherwise, the Registrant has been advised that
in the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act, and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities (other
than the payment by the Registrant of expenses incurred or paid by a director,
officer, or controlling person of the Registrant in the successful defense of
any action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered hereunder,
the Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
II-5
II-6
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
Registrant has duly caused this Amendment to Registration Statement on Form S-1
to be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of Palo Alto, State of California, on December 19, 1997.
CONNETICS CORPORATION
By: /s/ JOHN L. HIGGINS
-------------------------------------
John L. Higgins
Vice President of Finance and
Administration and
Chief Financial Officer
II-7
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
Signature Title Date
- --------- ----- ----
/s/ THOMAS G. WIGGANS* President, Chief Executive Officer and Director December 19, 1997
- ----------------------------------------
Thomas G. Wiggans
/s/ JOHN L. HIGGINS* Vice President of Finance and December 19, 1997
- ----------------------------------------
John L. Higgins Administration and Chief
Financial Officer (Principal
Financial and Accounting
Officer)
/s/ G. KIRK RAAB* Chairman of the Board of Directors December 19, 1997
- ----------------------------------------
G. Kirk Raab
/s/ ALEXANDER E. BARKAS* Director December 19, 1997
- ----------------------------------------
Alexander E. Barkas
/s/ EUGENE A. BAUER* Director December 19, 1997
- ----------------------------------------
Eugene A. Bauer
/s/ BRIAN H. DOVEY* Director December 19, 1997
- ----------------------------------------
Brian H. Dovey
/s/ JOHN C. KANE* Director December 19, 1997
- ----------------------------------------
John C. Kane
/s/ THOMAS D. KILEY* Director December 19, 1997
- ----------------------------------------
Thomas D. Kiley
Director December 19, 1997
- ----------------------------------------
Kenneth B. Plumlee
/s/ JOSEPH J. RUVANE, JR.* Director December 19, 1997
- ----------------------------------------
Joseph J. Ruvane, Jr.
*By: /s/ John L. Higgins December 19, 1997
--------------------------
John L. Higgins
Attorney-in-Fact
II-8
INDEX TO EXHIBITS
Exhibit
3.1(1) Form of Amended and Restated Certificate of Incorporation.
3.2(1) Form of Bylaws.
3.3(5) Certificate of Designation of 7% Redeemable Convertible
Preferred Stock, Series A of Connective Therapeutics, Inc., as
filed with the Delaware Secretary of State on December 4,
1996.
4.1(1) Form of Common Stock Certificate.
5.1** Opinion of Venture Law Group, A Professional Corporation.
10.1(1) Form of Indemnification Agreement with the Company's directors and officers.
10.2(7)* 1994 Stock Plan, as amended, and form of Option Agreement.
10.3(7)* 1995 Employee Stock Purchase Plan, as amended, and form of Subscription Agreement.
10.4(1)* 1995 Directors' Stock Option Plan and form of Option Agreement.
10.5(1) Third Amended and Restated Registration Rights Agreement dated February 14, 1995 among the
Registrant and certain security holders of the Registrant and Amendments Nos. 1 and 2 thereto
dated May 31, 1995 and September 28, 1995.
10.6(1)(2) License Agreement dated September 27, 1993, between Genentech,
Inc. and the Company, Amendment dated July 14, 1994, and side
letter agreement dated November 17, 1994.
10.8(1) Assignment and Assumption Agreement, dated June 3, 1994, by and between the Company and XOMA
Corporation.
10.9(1)(2) Technical Collaboration and Manufacturing Agreement, dated May
24, 1994, by and between the Company and Scios Nova Inc.
10.10(1)(2) Technology Acquisition Agreement dated June 3, 1994 by and between the Company and XOMA
Corporation, and License Agreement dated February 27, 1990 by and between Arthur A. Vandenbark,
Ph.D. and XOMA Corporation.
10.11(1)(2) Agreement on Interferon Gamma-1B dated December 8, 1995 by and between the Company and
Genentech, Inc.
10.12(1) Equipment Lease Line, dated May 31, 1994 with Lease Management Services, Inc.
10.13(1) Business Loan Agreement, dated July 18, 1995, between the Company, Silicon Valley Bank and
MMC/GATX Partnership No. 1.
10.14(1)(2) Research Collaboration and Assignment Agreement, dated July 1, 1994, between the Company and
Dr. Arthur A. Vandenbark.
10.15(1) Employment and Bonus Agreement between the Company and Edward Amento, dated November 17, 1993.
10.16(1) Secured Loan Agreements between the Company and Edward Amento dated November 1, 1993 and
July 11, 1994, respectively.
10.17(1) Consulting Agreement dated November 17, 1993 between the Company and Brian Seed.
10.18(1) Consulting Agreement dated November 17, 1993 between the Company and Eugene Bauer.
10.19(1) Employment Agreement dated June 9, 1994 between the Company and Thomas Wiggans.
10.20(1) Loan Agreements between the Company and Thomas Wiggans dated July 15, 1994 and August 1, 1994.
10.21(1) Letter Agreement with G. Kirk Raab dated October 1, 1995.
10.23(1) Facility Master Lease between the Company and Renault & Handley dated February 9, 1994.
10.26(1) Loan and Security Agreement dated December 21, 1995 by and among the Company, Silicon Valley
Bank and MMC/GATX Partnership No. 1.
10.27(3)(2) Agreement on Relaxin Rights in Asia dated April 1, 1996
between the Company and Mitsubishi Chemical Corporation
(Exhibits A and B to Exhibit 10.27 have been previously filed
as Exhibit 10.6 above. Confidential treatment has been granted
as to certain portions of Exhibit 10.6 by the SEC).
10.28(3)(2) Soltec License Agreement dated June 14, 1996.
10.29(4) Laboratory Services Agreement dated October 24, 1996.
10.30(4) Agreement with Dr. Edward Amento dated October 24, 1996.
10.31(4) Form of Directors and Officers Change in Control Agreement
II-9
10.32(5) Common Stock Purchase Agreement, dated December 4, 1996 by and among the Company and certain
investors.
10.33(5) Registration Rights Agreement, dated December 4, 1996 by and among the Company and certain
investors.
10.34(5) Securities Purchase Agreement, dated December 4, 1996 by and among the Company and a certain
purchaser.
10.35(5) Warrant, dated December 4, 1996 between the Company and a certain purchaser.
10.36(6)(2) Asset Purchase Agreement dated December 2, 1996 between the Company, SmithKline Beecham
Corporation, SmithKline Beecham Pharma Inc., SmithKline Beecham Properties, Inc. and SmithKline
Beecham Inter-American Corporation.
10.37(6) Stock Issuance Agreement dated December 31, 1996 between the Company and SmithKline Beecham
Properties, Inc.
10.38(6) Secured Promissory Note dated December 31, 1996 issued to SmithKline Beecham Corporation.
10.39(6) Security Agreement dated December 31, 1996 between the Company and SmithKline Beecham
Corporation.
10.40(6)(2) Supply Agreement dated December 31, 1996 between the Company and SmithKline Beecham Corporation.
10.41(6) Transitional Services Agreement dated December 31, 1996 between the Company and SmithKline
Beecham Corporation.
10.42(8) Structured Equity Line Flexible Financing Agreement dated January 2, 1997 between the Company
and Kepler Capital LLC.
10.43(8) Registration Rights Agreement dated January 2, 1997 between the Company and Kepler Capital LLC.
10.44(9) Common Stock and Warrant Purchase Agreement dated May 15, 1997 by and among the Company,
Genentech, Inc. and certain investors.
10.45(9) Registration Rights agreement dated May 15, 1997 by and among the Company and certain investors.
10.46(9) Form of Common Stock Purchase Warrant issued to certain investors on May 15, 1997.
10.47(7) Form of Notice of Stock Option Grant to G. Kirk Raab for stock option issued in January 1997.
10.48** Secured Loan Agreement dated October 30, 1997 between the Company and W. Scott Harkonen.
10.49** Letter Agreement with Cynthia M. Butitta dated September 22, 1997.
10.50** Amendment dated November 13, 1997 to Secured Promissory Note dated December 31, 1996 issued to
SmithKline Beecham Corporation.
10.51** Letter Agreement dated November 26, 1997 between the Company and Gerard Klauer Mattison & Co.,
Inc.
10.52** Letter Agreement with John L. Higgins dated August 25, 1997.
10.53 Omnibus Agreement with SmithKline Beecham Corporation and related entities dated December 18, 1997.
10.54 Canadian Asset Purchase Agreement with Pharmascience, Inc. dated December 19, 1997.
10.55 Supply Agreement with Pharmascience, Inc. dated December 19, 1997.
11.1** Statement of Computation of Net Loss Per Share.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney (see page II-8 of originally filed Registration Statement).
<FN>
- ------------------------------------------------------------------------------------------------------------------------------------
* This item is a compensatory plan required to be listed as an exhibit to this form pursuant to Item 601(a)(10)(iii) of
Regulation S-K.
** Previously filed.
1. Incorporated by reference from an exhibit filed with the Company's
Registration Statement on Form S-1 (File No. 33-80261) declared
effective by the Securities and Exchange Commission (the "SEC") on
January 31, 1996.
2. Certain portions of this Exhibit were granted confidential treatment pursuant to an order from the SEC.
3. Incorporated by reference from an exhibit to the Company's Quarterly Report on Form 10-Q
(File No. 0-27406) filed with the SEC for the fiscal quarter ended June 30, 1996.
4. Incorporated by reference from an exhibit to the Company's Quarterly Report on Form 10-Q
(File No. 0-27406) filed with the SEC for the fiscal quarter ended September 30, 1996.
II-10
5. Incorporated by reference from an exhibit to the Company's Report on Form 8-K (File No. 0-27406) dated December 4, 1996.
6. Incorporated by reference from an exhibit to the Company's Report on Form 8-K (File No. 0-27406) dated January 15, 1997.
7. Incorporated by reference from an exhibit filed with Post-Effective Amendment No. 1 to the Company's
Registration Statement on Form S-8 (File No. 333-04985) filed with the SEC on June 30, 1997.
8. Incorporated by reference from an exhibit filed with the Company's Annual Report on Form 10-K
(File No. 0-27406) for the fiscal year ended December 31, 1996.
9. Incorporated by reference from an exhibit filed with the Company's Registration Statement on Form S-3
(File No. 333-21941) filed with the SEC on July 3, 1997.
</FN>
II-11