1
EXHIBIT 20.2
DISCOVERY PARTNERS INTERNATIONAL, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
DISCOVERY PARTNERS INTERNATIONAL, INC.
Report of Ernst & Young LLP, Independent Auditors............. F-2
Consolidated Balance Sheets as of December 31, 1998 and 1999.. F-3
Consolidated Statements of Operations for the years ended
December 31, 1997, 1998 and 1999............................ F-4
Consolidated Statements of Stockholders' Equity (Deficit)
for the years ended December 31, 1997, 1998 and 1999........ F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1998 and 1999............................ F-6
Notes to Consolidated Financial Statements.................... F-7
F-1
2
REPORT OF ERNST & YOUNG, LLP, INDEPENDENT AUDITORS
The Board of Directors
Discovery Partners International, Inc.
We have audited the accompanying consolidated balance sheets of Discovery
Partners International, Inc. as of December 31, 1998 and 1999 and the related
consolidated statements of operations, stockholders' equity (deficit), and cash
flows for each of the three years in the period ended December 31, 1999. 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 auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audits to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects the consolidated financial position of Discovery
Partners International, Inc. at December 31, 1998 and 1999, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1999 in conformity with accounting principles
generally accepted in the United States.
ERNST & YOUNG LLP
San Diego, California
March 10, 2000, except for Note 11,
as to which the date is July 27, 2000
F-2
3
DISCOVERY PARTNERS INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
----------------------------
1998 1999
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents............................ $ 10,714,889 $ 2,884,639
Accounts receivable.................................. 1,642,065 2,785,618
Inventories.......................................... 1,107,041 1,517,297
Prepaid and other current assets..................... 327,537 201,284
------------ ------------
Total current assets............................... 13,791,532 7,388,838
Property and equipment, net............................ 1,398,517 4,655,227
Restricted cash and cash equivalents and other
assets............................................... 193,314 2,264,200
Patent and license rights, net......................... 1,212,497 1,137,625
Goodwill, net.......................................... -- 6,205,830
------------ ------------
Total assets....................................... $ 16,595,860 $ 21,651,720
============ ============
LIABILITIES, REDEEMABLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses................ $ 2,413,714 $ 2,348,226
Deferred business acquisition payment................ -- 1,721,775
Current portion of obligations under capital leases
and equipment notes payable........................ 205,980 226,575
Line of credit....................................... -- 958,346
Deferred revenue..................................... 2,196,200 1,935,249
Notes payable to stockholders........................ -- 3,861,920
------------ ------------
Total current liabilities.......................... 4,815,894 11,052,091
Obligations under capital leases and equipment notes
payable, less current portion........................ 95,685 282,317
Deferred rent.......................................... 75,824 51,906
Long-term debt from stockholder........................ -- 1,627,860
Commitments
Redeemable convertible preferred stock, $.001 par
value, 7,333,333 shares authorized, 6,562,278 issued
and outstanding at December 31, 1998 and 1999;
liquidation preference and redemption value --
$28,048,404 at December 31, 1999..................... 27,906,717 27,906,717
Stockholders' equity (deficit):
Preferred stock, $.001 par value, 1,000,000 shares
authorized, no shares issued and outstanding....... -- --
Common stock, $.001 par value, 10,000,000 shares
authorized, 1,420,973, and 1,611,763, issued and
outstanding at December 31 1998 and 1999,
respectively....................................... 1,421 1,612
Additional paid-in capital........................... 234,384 1,399,376
Deferred compensation................................ -- (642,282)
Note receivable from stockholder..................... (172,000) (240,000)
Accumulated other comprehensive loss................. -- (55,448)
Accumulated deficit.................................. (16,362,065) (19,732,429)
------------ ------------
Total stockholders' equity (deficit)............... (16,298,260) (19,269,171)
------------ ------------
Total liabilities, redeemable preferred stock and
stockholders' equity (deficit)................... $ 16,595,860 $ 21,651,720
============ ============
See accompanying notes.
F-3
4
DISCOVERY PARTNERS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
---------------------------------------
1997 1998 1999
----------- ----------- -----------
Revenues.................................. $ 3,149,479 $ 6,213,736 $13,075,835
Cost of revenues (exclusive of $7,238 in
1999 of stock-based compensation)....... 1,311,681 2,785,514 8,234,858
----------- ----------- -----------
Gross margin......................... 1,837,798 3,428,222 4,840,977
Cost and expenses:
Research and development (exclusive of
$65,828 in 1999 of stock-based
compensation)........................ 4,143,193 5,057,851 3,537,651
Selling, general and administrative
(exclusive of $238,322 in 1999 of
stock-based compensation)............ 2,527,902 4,984,645 4,439,021
Amortization of stock-based
compensation......................... -- -- 311,388
Amortization of goodwill................ -- -- --
----------- ----------- -----------
Total operating expenses............. 6,671,095 10,042,496 8,288,060
----------- ----------- -----------
Loss from operations...................... (4,833,297) (6,614,274) (3,447,083)
Interest income........................... 106,617 386,058 270,645
Interest expense.......................... (92,678) (112,698) (60,003)
Foreign currency gains (losses)........... (2,661) 63,401 (133,923)
----------- ----------- -----------
Net loss.................................. $(4,822,019) $(6,277,513) $(3,370,364)
=========== =========== ===========
Historical net loss per share, basic and
diluted................................. $ (8.85) $ (8.20) $ (3.00)
=========== =========== ===========
Shares used in calculating historical net
loss per share, basic and diluted....... 544,876 765,263 1,125,040
=========== =========== ===========
Pro forma net loss per share, basic and
diluted................................. $ (0.44)
============
Shares used in calculating pro forma net
loss per share, basic and diluted....... 7,728,820
============
See accompanying notes.
F-4
5
DISCOVERY PARTNERS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
NOTES ACCUMULATED
COMMON STOCK ADDITIONAL RECEIVABLE OTHER
------------------ PAID-IN DEFERRED FROM COMPREHENSIVE ACCUMULATED
SHARES AMOUNT CAPITAL COMPENSATION STOCKHOLDER LOSS DEFICIT
--------- ------ ---------- ------------ ----------- ------------- ------------
Balance at December 31, 1996....... 895,800 $ 896 $ 32,994 $ -- $ -- $ -- $ (5,262,533)
Common stock issued for
compensation................... 16,800 17 3,523 -- -- -- --
Exercise of options to purchase
common stock................... 44,131 44 11,850 -- -- -- --
Net loss......................... -- -- -- -- -- -- (4,822,019)
--------- ------ ---------- ----------- --------- --------- ------------
Balance at December 31, 1997....... 956,731 957 48,367 -- -- -- (10,084,552)
Exercise of options to purchase
common stock, net of
repurchases.................... 34,242 34 14,447 -- -- -- --
Issuance of common stock in
exchange for a promissory
note........................... 430,000 430 171,570 -- (172,000) -- --
Net loss......................... -- -- -- -- -- -- (6,277,513)
--------- ------ ---------- ----------- --------- --------- ------------
Balance at December 31, 1998....... 1,420,973 1,421 234,384 -- (172,000) -- (16,362,065)
Exercise of options to purchase
common stock, net of
repurchases.................... 20,790 21 5,412 -- -- -- --
Issuance of common stock in
exchange for a promissory
note........................... 170,000 170 67,830 -- (68,000) -- --
Issuance of warrants to purchase
preferred stock................ -- -- 138,080 -- -- -- --
Deferred compensation related to
stock options and restricted
stock.......................... -- -- 953,670 (953,670) -- -- --
Amortization of deferred
compensation................... -- -- -- 311,388 -- -- --
Comprehensive loss:
Foreign currency translation
adjustment................... -- -- -- -- -- (55,448) --
Net loss....................... -- -- -- -- -- -- (3,370,364)
Comprehensive loss............... -- -- -- -- -- -- --
--------- ------ ---------- ----------- --------- --------- ------------
Balance at December 31, 1999....... 1,611,763 1,612 1,399,376 (642,282) (240,000) (55,448) (19,732,429)
TOTAL
STOCKHOLDERS'
EQUITY (DEFICIT)
----------------
Balance at December 31, 1996....... $ (5,228,643)
Common stock issued for
compensation................... 3,540
Exercise of options to purchase
common stock................... 11,894
Net loss......................... (4,822,019)
------------
Balance at December 31, 1997....... (10,035,228)
Exercise of options to purchase
common stock, net of
repurchases.................... 14,481
Issuance of common stock in
exchange for a promissory
note........................... --
Net loss......................... (6,277,513)
------------
Balance at December 31, 1998....... (16,298,260)
Exercise of options to purchase
common stock, net of
repurchases.................... 5,433
Issuance of common stock in
exchange for a promissory
note........................... --
Issuance of warrants to purchase
preferred stock................ 138,080
Deferred compensation related to
stock options and restricted
stock.......................... --
Amortization of deferred
compensation................... 311,388
Comprehensive loss:
Foreign currency translation
adjustment................... (55,448)
Net loss....................... (3,370,364)
------------
Comprehensive loss............... (3,425,812)
------------
Balance at December 31, 1999....... (19,269,171)
See accompanying notes.
F-5
6
DISCOVERY PARTNERS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
---------------------------------------
1997 1998 1999
----------- ----------- -----------
OPERATING ACTIVITIES
Net loss............................................ $(4,822,019) $(6,277,513) $(3,370,364)
Adjustments to reconcile net loss to net cash used
in operating activities:
Common stock issued for compensation.............. 3,540 -- --
Depreciation and amortization..................... 242,550 561,049 360,322
Amortization of deferred compensation............. -- -- 311,388
Noncash interest expense for warrants issued...... -- -- --
Change in operating assets and liabilities:
Accounts receivable............................. (1,150,870) (334,487) (444,341)
Inventories..................................... (475,735) (423,365) (357,037)
Other current assets............................ (179,359) (65,907) 130,727
Accounts payable and accrued expenses........... 812,870 1,395,725 (567,171)
Deferred revenue................................ 324,800 1,871,400 (774,987)
Deferred rent................................... (7,619) 6,069 (23,918)
Restricted cash................................. -- -- (1,000,000)
----------- ----------- -----------
Net cash used in operating activities............... (5,251,842) (3,267,029) (5,735,381)
INVESTING ACTIVITIES
Purchases of property and equipment................. (525,084) (848,202) (1,112,191)
Deposits and other assets........................... (16,599) (7,331) 181,313
Purchase of patents and license rights.............. -- (1,212,497) --
Acquisition of DTL, net of cash acquired of
$559,946.......................................... -- -- (4,963,444)
Additional cash consideration for acquisition of
DTL............................................... -- -- --
----------- ----------- -----------
Net cash used in investing activities............... (541,683) (2,068,030) (5,894,322)
FINANCING ACTIVITIES
Proceeds from issuance of equipment notes payable... 85,008 -- --
Principal payments on capital leases and equipment
notes payable..................................... (185,800) (262,165) (205,980)
Principal payments on line of credit................ -- -- --
Issuance of redeemable preferred stock, net of
issuance costs.................................... 1,937,139 13,568,346 --
Issuance of common stock............................ 11,894 14,481 5,433
Proceeds from convertible notes payable............. -- 2,448,395 4,000,000
----------- ----------- -----------
Net cash provided by financing activities........... 1,848,241 15,769,057 3,799,453
Effect of exchange rate changes..................... -- -- --
----------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents....................................... (3,945,284) 10,433,998 (7,830,250)
----------- ----------- -----------
Cash and cash equivalents at beginning of period.... 4,226,175 280,891 10,714,889
----------- ----------- -----------
Cash and cash equivalents at end of period.......... $ 280,891 $10,714,889 $ 2,884,639
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid....................................... $ 92,678 $ 112,697 $ 60,004
=========== =========== ===========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Conversion of convertible notes payable to preferred
stock............................................. $ -- $ 2,448,395 $ --
=========== =========== ===========
Issuance of common stock for promissory note........ $ -- $ 172,000 $ 68,000
=========== =========== ===========
Issuance of warrant to purchase preferred stock..... $ -- $ -- $ 138,080
=========== =========== ===========
Deferred acquisition payment for DTL................ $ -- $ -- $ 1,721,775
=========== =========== ===========
See accompanying notes.
F-6
7
DISCOVERY PARTNERS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF PRESENTATION
ORGANIZATION AND BUSINESS
Discovery Partners International, Inc. (the "Company") was incorporated in
California on March 22, 1995, under the name IRORI. The Company develops and
offers libraries of drug-like compounds, proprietary instruments, consumables
and computational tools to generate compound libraries, test, screen and
optimize potential drugs. In 1998, the Company changed its name to Discovery
Partners International, Inc.
CONSOLIDATION
The consolidated financial statements include all the accounts of the
Company and its wholly owned subsidiaries, IRORI Europe, Ltd. and Discovery
Technologies, Ltd. All intercompany accounts and transactions have been
eliminated. The Company has determined that it operates in only one segment.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
RECLASSIFICATION
Certain prior year balances have been reclassified to conform to the 1999
presentation.
CASH EQUIVALENTS
The Company considers all highly liquid investments with a remaining
maturity of less than three months when purchased to be cash equivalents. At
December 31, 1998 and 1999, the cost of cash equivalents was the same as the
market value. Accordingly, there were no unrealized gains and losses. The
Company evaluates the financial strength of institutions at which significant
investments are made and believes the related credit risk is limited to an
acceptable level.
F-7
8
DISCOVERY PARTNERS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LONG-LIVED ASSETS
In accordance with SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of, if indicators of
impairment exist, the Company assesses the recoverability of the affected
long-lived assets by determining whether the carrying value of such assets can
be recovered through undiscounted future operating cash flows. If impairment is
indicated, the Company measures the future cash flows associated with the use of
the asset and records the asset at fair value. While the Company's current and
historical operating and cash flow losses are indicators of impairment, the
Company believes the future cash flows to be received from the long-lived assets
will exceed the assets' carrying value, and accordingly, the Company has not
recognized any impairment losses through December 31, 1999.
INVENTORIES
Inventories are recorded at the lower of weighted average cost
(approximates first-in first-out) or market. Inventories consist of the
following:
DECEMBER 31,
------------------------
1998 1999
---------- ----------
Raw materials.................................. $ 958,811 $ 588,048
Work-in process................................ -- 601,432
Finished goods................................. 148,230 327,817
---------- ----------
$1,107,041 $1,517,297
========== ==========
PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
DECEMBER 31,
-------------------------
1998 1999
---------- -----------
Furniture and equipment...................... $1,974,374 $ 4,821,335
Software..................................... -- 362,108
Leasehold improvements....................... 375,429 633,387
---------- -----------
2,349,803 5,816,830
Less accumulated depreciation and
amortization............................... (951,286) (1,161,603)
---------- -----------
$1,398,517 $ 4,655,227
========== ===========
Property and equipment, including equipment under capital leases and
equipment notes payable, are stated at cost and depreciated over the estimated
useful lives of the assets (three to seven years) or the term of the related
lease, using the straight-line method. Amortization of assets acquired under
capital leases is included in depreciation expense.
F-8
9
DISCOVERY PARTNERS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PATENT AND LICENSE RIGHTS
The Company has purchased patents and license rights for the labeling of
chemical libraries and related to products for sale and in development. The
purchased patents and license rights are amortized ratably over a period of ten
years.
REVENUE RECOGNITION
Product sales, which include the sale of combinatorial chemistry
instruments and proprietary libraries, are recorded as products are shipped.
Development contract revenues and high-throughput screening service revenues are
recognized on a percentage of completion basis. Advances received under these
development contracts and high-throughput screening service agreements are
recorded as deferred revenue and recognized as costs are incurred over the term
of the contract. Revenues from chemistry service agreements is recognized on a
monthly basis and is based upon the number of full time equivalent (FTE)
employees that actually worked on each agreement and the agreed-upon rate per
FTE per month.
The Company does not have a history of significant returns of its products
nor does it allow its customers the right to return its products.
RESEARCH AND DEVELOPMENT COSTS
Costs incurred in connection with research and development is charged to
operations as incurred.
STOCK-BASED COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees and related Interpretations ("APB
25") in accounting for its employee stock options because the alternative fair
value accounting provided for under Financial Accounting Standards Board
("SFAS") No. 123, Accounting for Stock-Based Compensation, requires use of
option valuation models which the Company believes were not developed for use in
valuing employee stock options. Under APB 25, when the exercise price of the
Company's employee stock options equals the fair value of the underlying stock
on the date of grant, no compensation expense is recognized.
Deferred compensation for options granted to non-employees has been
determined in accordance with SFAS No. 123 and EITF 96-18 as the fair value of
the consideration received or the fair value of the equity instruments issued,
whichever is more reliably measured. Deferred charges for options granted to
non-employees are periodically remeasured as the underlying options vest.
COMPREHENSIVE LOSS
SFAS No. 130, Reporting Comprehensive Income, requires the Company to
report in the consolidated financial statements, in addition to net income,
comprehensive income (loss) and its components including foreign currency items
and unrealized gains and losses on certain
F-9
10
DISCOVERY PARTNERS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
investments in debt and equity securities. For the year ended December 31, 1999,
the Company has disclosed comprehensive loss as a component of shareholders'
equity. Comprehensive loss was the same as net loss for the years ended December
31, 1997 and 1998.
NET LOSS PER SHARE
Basic and diluted net loss per common share are presented in conformity
with the SFAS No. 128, Earnings per Share, and SAB 98, for all periods
presented. Under the provisions of SAB 98, common stock and redeemable
convertible preferred stock that has been issued or granted for nominal
consideration prior to the anticipated effective date of the initial public
offering must be included in the calculation of basic and diluted net loss per
common share as if these shares had been outstanding for all periods presented.
To date, the Company has not issued or granted shares for nominal consideration.
In accordance with SFAS No. 128, basic and diluted net loss per share has
been computed using the weighted-average number of shares of common stock
outstanding during the period; less shares subject to repurchase. Pro forma
basic and diluted net loss per common share, as presented in the statements of
operations, has been computed for the year ended December 31, 1999 as described
above, and also gives effect to the assumed conversion of preferred stock which
will automatically convert to common stock immediately prior to the completion
of the Company's initial public offering (using the "as if converted" method)
from the original date of issuance.
The Company has excluded all convertible preferred stock, outstanding stock
options and warrants, and shares subject to repurchase from the calculation of
diluted net loss per common share because all such securities are antidilutive
for all applicable periods presented. The total number of shares excluded from
the calculations of diluted net loss per share, prior to application of the
treasury stock method for options and warrants, were 4,636,150, 7,102,923 and
6,987,176 for the years ended December 31, 1997, 1998 and 1999, respectively.
Such securities, had they been dilutive, would have been included in the
computation of diluted net loss per share.
RECENTLY ISSUED ACCOUNTING STANDARDS
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,
will be effective January 1, 2001. This statement establishes accounting and
reporting standards requiring that every derivative instrument, including
certain derivative instruments imbedded in other contracts, be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
statement also requires that changes in the derivative's fair value be
recognized in earnings unless specific hedge accounting criteria are met. The
Company believes the adoption of SFAS No. 133 will not have an effect on the
financial statements because the Company does not engage in derivative or
hedging activities.
In December 1999, the SEC released Staff Accounting Bulletin No. 101,
Revenue Recognition in Financial Statements, which provides guidance on the
recognition, presentation and disclosure of revenue in financial statements. The
Company's revenue recognition policy complies with SAB 101.
F-10
11
DISCOVERY PARTNERS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FOREIGN CURRENCY TRANSLATION
The financial statements of IRORI Europe, Ltd. are measured using the U.S.
dollar as the functional currency. The financial statements of Discovery
Technologies, Ltd. are measured using the local currency as the functional
currency. Assets and liabilities of the Company are translated at the rates of
exchange at the balance sheet date. Income and expense items are translated at
the average rate of exchange during the reporting period. The resulting foreign
currency gains (losses) for IRORI Europe, Ltd. are included in the consolidated
statement of operations. The resulting translation adjustments for Discovery
Technologies, Ltd. are unrealized and included as a separate component of other
comprehensive income (loss). Transactions denominated in currencies other than
the local currency are recorded based on exchange rates at the time such
transactions arise. Subsequent changes in exchange rates result in transaction
gains and losses which are reflected in income as unrealized (based on
period-end translations) or realized upon settlement of these transactions.
3. ACQUISITION OF DISCOVERY TECHNOLOGIES, LTD.
On December 31, 1999, the Company acquired Discovery Technologies, Ltd.
("DTL"), located near Basel, Switzerland. The acquisition of DTL was accounted
for as a purchase in accordance with the provisions of Accounting Principles
Board Opinion ("APB") No. 16. The Company's consolidated financial statements
include the financial position of DTL as of December 31, 1999.
A summary of the DTL acquisition costs and allocation to the assets
acquired and liabilities assumed is as follows:
Total acquisition costs:
Cash paid at acquisition.................................. $ 3,438,025
Advances to DTL prior to acquisition...................... 1,878,300
Deferred acquisition payment.............................. 1,721,775
Acquisition related expenses.............................. 151,617
-----------
$ 7,189,717
===========
Allocated to assets and liabilities as follows:
Tangible assets acquired.................................. $ 4,999,019
Tangible liabilities assumed.............................. (4,015,132)
Skilled workforce......................................... 400,000
Goodwill.................................................. 5,805,830
-----------
$ 7,189,717
===========
The goodwill is amortized on a straight-line basis over a period of ten
years from the date of acquisition. The skilled workforce is amortized on a
straight-line basis over a period of four years from the date of acquisition. In
addition, the agreement provided for additional cash consideration to be issued
based upon the 1999 and 2000 operating results, of which $1,721,775 was earned
based on the 1999 operating results of DTL. The Company may be required to pay
up to an additional $950,000 as consideration based on DTL's operating results
for 2000. The value of additional cash consideration will be accounted for as an
increase to goodwill.
F-11
12
DISCOVERY PARTNERS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITION OF DISCOVERY TECHNOLOGIES, LTD. (CONTINUED)
Assuming that the acquisition of DTL had occurred on the first day of the
Company's fiscal year ended December 31, 1998, pro forma condensed consolidated
financial information would be as follows:
YEARS ENDED DECEMBER 31,
--------------------------
1998 1999
----------- -----------
(UNAUDITED)
Revenues.......................................... $ 8,622,310 $18,131,870
Net loss.......................................... (8,692,454) (3,713,466)
Net loss per share, basic and diluted............. $ (11.36) $ (3.30)
This pro forma information is not necessarily indicative of the actual
results that would have been achieved had DTL been acquired the first day of the
Company's fiscal year ended December 31, 1998, nor is it necessarily indicative
of future results.
4. DEBT
EQUIPMENT NOTES PAYABLE
At December 31, 1999, obligations under equipment notes totaled $55,698
payable in monthly installments through the year 2000 with a weighted-average
interest rate of 14.58% secured by the assets of the Company. In March 2000, the
Company signed two equipment notes payable totaling $747,150 payable in monthly
installments through the year 2003 with a weighted-average interest rate of
13.82% secured by assets of the Company.
NOTES PAYABLE TO SHAREHOLDERS
On December 10, 1999, the Company borrowed $4.0 million from certain of its
principal investors. The notes accrue interest at 8% per annum and are due and
payable on the earlier of the closing of a preferred stock financing round or
February 10, 2000. Subsequent to December 31, 1999, the noteholders informally
extended the maturity of the notes until the closing of the redeemable
convertible Series E preferred stock sale. Deferred interest expense of $138,080
related to the valuation of warrants is offset against the balance of notes
payable at December 31, 1999 (see Note 7 and 11).
On March 9, 2000, the Company borrowed $2.0 million from one of its
principal investors. The promissory note accrues interest at 8% per annum and is
due and payable upon the earlier of the closing of a preferred stock financing
round or June 9, 2000. In connection with the note, the Company issued warrants
to purchase a variable number of shares of redeemable convertible preferred
stock at a purchase price of $5.00 per share (see Note 7 and 11).
LINE OF CREDIT
The Company's wholly owned subsidiary, DTL, has $1.0 million outstanding
under a line of credit with a financial institution. Under the terms of the line
of credit, the Company has pledged $1.3 million of cash and cash equivalents as
collateral. The amount is included in restricted cash and cash equivalents as of
December 31, 1999. The line of credit accrues interest at 4.75% per
F-12
13
DISCOVERY PARTNERS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. DEBT (CONTINUED)
annum plus 0.25% per quarter based on the average borrowed amount and is
available until December 31, 2000.
LONG-TERM DEBT
The Company's wholly owned subsidiary, DTL, has approximately $1.6 million
in long-term debt as of December 31, 1999. The debt accrues interest at 5% per
annum and is due and payable on June 30, 2001 to an investor.
5. COMMITMENTS
LEASES
The Company leases a facility under an operating lease agreement that
expires on August 31, 2000. The Company has the option to extend the lease to
January 21, 2006. The Company leases a second facility under an operating lease
agreement that expires on August 31, 2006. Rent expense was $396,809, $829,343
and $648,788 for the years ended December 31, 1997, 1998 and 1999, respectively.
Additionally, the Company leases certain equipment under operating leases with
initial terms in excess of one year.
Annual future minimum lease obligations, including property and equipment
under capital leases, as of December 31, 1999 are as follows:
OPERATING CAPITAL
LEASES LEASES
---------- ---------
2000........................................................ $ 669,436 $ 188,422
2001........................................................ 730,994 148,435
2002........................................................ 741,106 148,435
2003........................................................ 742,672 1,773
2004........................................................ 759,284 --
Thereafter.................................................. 1,300,548 --
---------- ---------
Total minimum lease payments................................ $4,944,040 487,065
==========
Less amount representing interest........................... (33,871)
---------
Total present value of minimum payments..................... 453,194
Less current portion........................................ (170,877)
---------
Non-current portion......................................... $ 282,317
=========
At December 31, 1999, cost and accumulated amortization of property and
equipment under capital leases was $624,947 and $170,183, respectively. At
December 31, 1998, cost and accumulated amortization of property and equipment
under capital leases was $211,741 and $126,726, respectively.
F-13
14
DISCOVERY PARTNERS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. COMMITMENTS (CONTINUED)
LETTER OF CREDIT
The Company signed a standby letter of credit for $700,000 required under
the terms of the Company's lease of its facilities. The Company pledged $1.0
million of cash equivalents as collateral for the letter of credit. The amount
is included in restricted cash and cash equivalents as of December 31, 1999.
The letter of credit expires in fiscal 2004.
6. REDEEMABLE CONVERTIBLE PREFERRED STOCK
A summary of redeemable convertible preferred stock issued and outstanding
at December 31, 1999 is as follows:
REDEMPTION
VALUE AND
SHARES ISSUED PREFERENCE IN
AND OUTSTANDING LIQUIDATION
--------------- -------------
Series A........................................ 2,000,000 $ 4,000,000
Series B........................................ 2,000,000 6,000,000
Series C........................................ 333,333 2,000,000
Series D........................................ 2,228,945 16,048,404
--------- -----------
6,562,278 $28,048,404
========= ===========
In 1997, the Company issued 333,333 shares of Series C redeemable preferred
stock for net proceeds of $1.9 million. In 1998, the Company issued 2,228,945
shares of Series D redeemable preferred stock in exchange for net cash proceeds
of $13.6 million and conversion of notes payable of $2.4 million.
The redeemable convertible Series A, B, C, and D preferred stock are
convertible, at the option of the holder, into an equal number of shares of the
Company's common stock subject to certain anti-dilution adjustments. The Company
reserved 6,606,044 shares for issuance upon conversion which includes an
additional 43,766 shares issuable pursuant to the anti-dilution provisions. The
preferred stock will convert automatically upon the closing of an underwritten
public offering of the Company's common stock with proceeds to the Company of at
least $15,000,000 and at a price not less than $10.00 per share or upon the
consent of 67% of the holders of the outstanding shares. The holders of Series
A, B, C, and D preferred stock are entitled to elect five directors to the Board
of Directors, and in all other matters the holder of each share of preferred
stock is entitled to one vote for each share of common stock into which it would
convert.
Anytime after July 17, 2002, upon the request of at least 51% of the
holders of preferred stock, the Company shall redeem all of the shares by paying
in cash an amount per share equal to $2.00, $3.00, $6.00, and $7.20 plus any
declared but unpaid dividends for holders of the redeemable convertible Series
A, B, C, and D preferred stock, respectively.
Annual dividends of $0.14, $0.21, $0.42, and $0.504 per share of redeemable
convertible Series A, B, C and D preferred stock, respectively, are payable
whenever funds are legally available when, and if declared by the Board of
Directors. In the event of a liquidation of the Company, holders of redeemable
convertible Series A, B, C, and D preferred stock are entitled to a
F-14
15
DISCOVERY PARTNERS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED)
liquidation preference of $2.00, $3.00, $6.00, and $7.20, respectively, per
share plus any declared but unpaid dividends on such shares.
7. SHAREHOLDERS' EQUITY
STOCK OPTIONS
In November 1995, the Company adopted the 1995 Stock Option/Stock Issuance
Plan (the "Plan"), under which 1,950,000 shares of common stock are reserved for
issuance of stock and stock options granted by the Company. In January 2000, the
Company increased the authorized shares in the Plan by 500,000 shares of common
stock. The Plan provides for the grant of incentive and nonstatutory options.
The exercise price of incentive stock options must equal at least the fair value
on the date of grant, and the exercise price of nonstatutory stock options may
be no less than 85% of the fair value on the date of grant. The options
generally vest over a four-year period and all expire ten years after the date
of grant.
A summary of the Company's stock option activity and related information is
as follows:
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------
1997 1998 1999
------------------- --------------------- --------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
------- --------- --------- --------- -------- ---------
Outstanding at beginning of
period....................... 137,500 $0.21 483,720 $0.31 980,075 $0.49
Granted...................... 488,885 0.33 1,087,700 0.51 191,500 1.50
Exercised.................... (44,131) 0.27 (464,242) 0.40 (190,790) 0.38
Forfeited.................... (98,534) 0.30 (127,103) 0.34 (46,275) 0.75
------- ----- --------- ----- -------- -----
Outstanding at end of period... 483,720 $0.31 980,075 $0.49 934,510 $0.71
======= ===== ========= ===== ======== =====
Exercisable.................... 94,648 $0.21 204,893 $0.35 418,469 $0.53
======= ===== ========= ===== ======== =====
Exercise prices for options outstanding as of December 31, 1999 ranged from
$0.30 to $1.50. The weighted-average remaining contractual life of those options
is approximately eight years. The weighted-average fair value of the options
granted in 1997, 1998 and 1999 is $0.07, $0.13 and $0.39 per share,
respectively.
At December 31, 1999, options for 133,727 shares were available for
future grant.
Pro forma information regarding net income or loss is required by SFAS No.
123, and has been determined as if the Company had accounted for its employee
stock options under the fair value method of that Statement. The fair value of
these options was estimated at the date of grant using the minimum value
(derived from the Black-Scholes model) option pricing model with the following
weighted average assumptions in 1997, 1998 and 1999: risk-free interest rate of
6.20%, 6.0% and 6.0%, respectively; dividend yield of 0% for all years; and a
weighted-average life of five years.
F-15
16
DISCOVERY PARTNERS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. SHAREHOLDERS' EQUITY (CONTINUED)
For purposes of adjusted pro forma disclosures, the estimated fair value of
the options is amortized to expense over the vesting period. The Company's
adjusted pro forma information is as follows:
YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1998 1999
----------- ----------- -----------
Adjusted pro forma net loss......................... $(4,825,506) $(6,296,500) $(3,435,570)
Adjusted pro forma basic net loss per share......... $ (8.86) $ (8.23) $ (3.05)
The pro forma effect on net loss for 1997, 1998 and 1999 is not likely to
be representative of the pro forma effects on reported net income or loss in
future years because these amounts reflect less than four years of vesting.
DEFERRED STOCK COMPENSATION
In conjunction with the Company's initial public offering contemplated by
this prospectus and other events which occurred in 1999 and 2000, the Company
reviewed its exercise prices and arrived at the estimated fair value for each
option grant in 1999. With respect to the grant of stock options and sale of
restricted stock to employees during the year ended December 31, 1999, the
Company has recorded deferred stock compensation totaling approximately $1.0
million, representing the difference at the date of grant between the exercise
or purchase price and estimated fair value of the Company's common stock as
estimated by the Company's management for financial reporting purposes in
accordance with APB No. 25. Deferred compensation is included as a reduction of
stockholders' equity and is being amortized to expense on an accelerated basis
in accordance with Financial Accounting Standards Board Interpretation No. 28
over the vesting period of the options and restricted stock. During the year
ended December 31, 1999 the Company recorded amortization of stock-based
compensation expense of approximately $0.3 million.
WARRANTS
In prior years, the Company has issued warrants to purchase a total of
468,522 shares of common and preferred stock in connection with convertible
bridge notes issued to investors and obligations under capital leases. The
warrants have exercise prices ranging from $.01 to $2.00 per share. The Company
determined the relative fair value of the warrants at issuance was not material;
accordingly, no value has been assigned to the warrants.
In connection with the issuance of notes payable in December 1999, the
Company issued warrants to investors to purchase a variable number of shares of
redeemable convertible preferred stock at a purchase price of $5.00 per share.
The number of shares to be issued under the warrants is determined by a formula
based on the total number of days the notes payable are outstanding subject to a
maximum allowable of 144,656 shares. As of December 31, 1999, warrants to
purchase 27,616 shares had been earned. The estimated fair value of the warrants
of $138,080 was based on using the Black Scholes valuation model and recorded as
deferred interest expense as of December 31, 1999 to be amortized ratably over
the term of the notes payable. In March 2000, the
F-16
17
DISCOVERY PARTNERS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. SHAREHOLDERS' EQUITY (CONTINUED)
Company issued additional notes payable and warrants to purchase a variable
number of shares of redeemable convertible preferred stock at a purchase price
of $5.00 per share. The number of shares is to be issued under the warrants is
determined by a formula based on the total days the warrants are outstanding
subject to a maximum allowable of 131,507 shares.
As of March 31, 2000, an additional 193,316 shares were earned for a total
of 220,932 shares available for purchase under the warrant agreements. The
estimated fair value of the warrants of $1,243,847 was based on using the Black
Scholes valuation model and was recorded as interest expense during the three
months ended March 31, 2000 as the related notes payable were converted to
equity on April 7, 2000.
COMMON SHARES RESERVED FOR FUTURE ISSUANCE
At December 31, 1999, common shares reserved for future issuance consist of
the following:
Conversion of convertible redeemable preferred stock........ 6,606,044
Warrants.................................................... 496,138
Stock options............................................... 1,068,237
---------
8,170,419
=========
8. INCOME TAXES
At December 31, 1999, the Company had federal and California income tax net
operating loss carryforwards of approximately $14,627,000 and $10,934,000,
respectively. The difference between the federal and California tax operating
loss carryforwards is primarily attributable to the capitalization of research
and development expenses for California income tax purposes.
The federal and California tax loss carryforwards will begin to expire in
2010 and 2003, respectively, unless previously utilized. The Company also has
federal and California research tax credit carryforwards of approximately
$680,000 and $393,000, respectively, which will begin to expire in 2010 unless
previously utilized.
Pursuant to Sections 382 and 383 of the Internal Revenue Code, annual use
of the Company's net operating loss and credit carryforwards may be limited if
cumulative changes in ownership of more than 50% occur during any three year
period.
Significant components of the Company's deferred tax assets are shown
below. A valuation allowance, of which $320,000 related to 1999, has been
recognized to offset the deferred tax assets, as realization of such assets is
uncertain.
F-17
18
DISCOVERY PARTNERS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
DECEMBER 31,
--------------------------
1998 1999
----------- -----------
Deferred tax assets:
Net operating loss carryforwards........................ $ 5,257,000 $ 5,776,000
Research and development credits........................ 829,000 935,000
Deferred revenue........................................ 739,000 583,000
Capitalized research and development expenses........... 199,000 179,000
Other, net.............................................. 178,000 49,000
----------- -----------
Total deferred tax assets................................. 7,202,000 7,522,000
Valuation allowance for deferred tax assets............... (7,202,000) (7,522,000)
----------- -----------
Net deferred tax assets................................... $ -- $ --
=========== ===========
9. RETIREMENT PLAN
In 1996, the Company established a 401(k) plan covering substantially all
employees. The Company pays all administrative fees of the plan. The plan
contains provisions allowing for the Company to declare a match up to 25% of
funds contributed to the plan by employees. There were no matching contributions
declared by the Company for the years ended December 31, 1997, 1998 and 1999.
10. SIGNIFICANT CUSTOMERS, SUPPLIERS AND FOREIGN OPERATIONS
Substantially all of the Company's operations and long-lived assets are
based in the United States. DTL located near Basel, Switzerland had long-lived
assets totalling $2,354,836 at December 31, 1999.
Major customers, responsible for 10% or more of revenues, include
collaborative partners and pharmaceutical and biotechnology companies. The
percentages of sales of each of these third party major customers to total
revenue derived from third parties for the years ended December 31, 1997, 1998
and 1999 were as follows:
1997 1998 1999
---- ---- ----
Customer A................................................. 17% 4% 22%
Customer B................................................. 16 6 --
Customer C................................................. 10 3 20
Customer D................................................. 9 23 7
The Company depends on sole source suppliers for the mesh component of its
reactors, the RF tags used in its commercial products and the two dimensional
bar code tags used in its NanoKan reactors.
11. SUBSEQUENT EVENTS
ISSUANCE OF PREFERRED STOCK
On April 7, 2000, the Company issued 1,392,503 shares of Series E
redeemable convertible preferred stock at $8.00 per share in exchange for the
conversion of $6.0 million in notes payable to
F-18
19
DISCOVERY PARTNERS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. SUBSEQUENT EVENTS (CONTINUED)
shareholders and $5.0 million in cash. The Series E preferred stock has the same
conversion features as the Series A, B, C and D redeemable convertible preferred
stock (Note 6). Anytime after July 17, 2002, upon the request of at least 51% of
the holders of preferred stock, the Company shall redeem all the shares by
paying in cash an amount per share equal to $8.00 plus any declared but unpaid
dividends for holders of the redeemable convertible Series E preferred stock.
Annual dividends of $.56 per share of redeemable convertible Series E preferred
stock are payable whenever funds are legally available when, and if declared by
the Board of Directors. In the event of a liquidation of the Company, holders of
redeemable convertible Series E preferred stock are entitled to a liquidation
preference of $8.00 per share plus any declared but unpaid dividends on such
shares.
ACQUISITION OF AXYS ADVANCED TECHNOLOGIES, INC.
On April 28, 2000, the Company acquired Axys Advanced Technologies, Inc.
("AAT"), a wholly owned subsidiary of Axys Pharmaceuticals, Inc. The acquisition
was accounted for as a purchase in accordance with the provisions of APB No. 16.
The Company and Axys will make certain income tax elections so that the total
cost of the acquisition will be allocated to the income tax basis of the assets
acquired. The Company has obtained a report from Houlihan Valuation Advisors, an
independent valuation firm and performed other procedures necessary to complete
the purchase price allocation.
A summary of the AAT acquisition costs and allocation to the assets
acquired and liabilities assumed is as follows:
Total acquisition costs:
Cash paid at acquisition.................................. $ 50,000
Issuance of promissory note............................... 550,000
Issuance of common stock, warrant and stock options....... 59,769,000
Acquisition related expenses.............................. 250,000
-----------
$60,619,000
===========
Allocated to assets and liabilities as follows:
Tangible assets acquired.................................. $12,143,000
Assumed liabilities....................................... (2,867,000)
In-process research and development....................... 9,000,000
Assembled workforce....................................... 1,300,000
Below market value lease.................................. 1,200,000
Goodwill.................................................. 39,843,000
-----------
$60,619,000
===========
The goodwill will be amortized on a straight-line basis over a period of
ten years from the date of acquisition. The assembled workforce and below market
lease intangible assets will be amortized on a straight-line basis over a period
of three and four years, respectively, from the date of acquisition.
The valuation of the in-process research and development was determined
based on a discounted cash flow analysis of projected future earnings for each
project. The revenue stream
F-19
20
DISCOVERY PARTNERS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. SUBSEQUENT EVENTS (CONTINUED)
from each research and development project was estimated based upon its stage of
completion as of the acquisition date. The discount rates used for the analysis
were adjusted based on the stage of completion to give effect to uncertainties
in meeting the projected cash flows. The discount rates used ranged from 20% to
40%.
Assuming that the acquisition of AAT had occurred on the first day of the
Company's fiscal year ended December 31, 1998, pro forma condensed consolidated
financial information would be as follows:
YEARS ENDED DECEMBER 31,
--------------------------
1998 1999
----------- -----------
(UNAUDITED)
Revenues.......................................... $18,239,000 $27,050,000
Net loss.......................................... (6,976,000) (4,170,000)
Net loss per share, basic and diluted............. $ (0.85) $ (0.49)
This pro forma information is not necessarily indicative of the actual
results that would have been achieved had AAT been acquired the first day of the
Company's fiscal year ended December 31, 1998, nor is it necessarily indicative
of future results. The above pro forma condensed financial information does not
include a $9.0 million charge for the write-off of in-process research and
development.
ACQUISITION OF STRUCTURAL PROTEOMICS, INC.
On May 5, 2000, the Company entered into agreements with Structural
Proteomics, Inc. (SPI) and its shareholders to acquire 75% of the outstanding
shares of SPI in exchange for $1,000,000 in cash and 150,000 shares of DPI
common stock. The acquisition will be accounted for as a purchase in accordance
with the provisions of APB No. 16. The pro forma results of operations as if the
acquisition of SPI had occurred on the first day of the Company's fiscal year
ended December 31, 1998 are not materially different than the reported net loss.
INITIAL PUBLIC OFFERING
In May 2000, the board of directors authorized management of the Company to
file a registration statement with the Securities and Exchange Commission
permitting the Company to sell shares of its common stock to the public. If the
initial public offering is closed under the terms presently anticipated, all of
the preferred stock outstanding at March 31, 2000 will convert into common
stock. Unaudited pro forma stockholders' equity, as adjusted for the assumed
conversion of the preferred stock, is set forth on the balance sheet. The board
of directors also approved (subject to stockholder approval) that prior to the
effective date of the Offering contemplated by this Prospectus, the Company will
reincorporate in Delaware. The financial statements and accompanying notes have
been retroactively restated to reflect the effect of the reincorporation in
Delaware.
F-20