UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
Commission File Number 0-18044
PROCYTE CORPORATION
(Exact name of the registrant as specified in its charter)
WASHINGTON 91-1307460
(State of incorporation) (I.R.S. Employer Identification No.)
BUILDING A, 8511 154TH AVENUE N.E., REDMOND, WA 98052
(Address of principal executive offices) (Zip code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (425) 869-1239
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
As of October 26, 1998, there were issued and outstanding 14,489,803 shares of
common stock, par value $.01 per share.
1
PROCYTE CORPORATION
INDEX
PART I - FINANCIAL INFORMATION................................................................... 3
Item 1. Financial Statements...................................................................... 3
Balance Sheets - as of September 30, 1998 (unaudited) and December 31, 1997..................... 3
Statements of Operations - three and nine months ended September 30, 1998 and 1997 (unaudited).. 4
Statements of Cash Flows - nine months ended September 30, 1998 and 1997 (unaudited)............ 5
Statements of Stockholders' Equity - nine months ended September 30, 1998 and 1997 (unaudited).. 6
Notes to Financial Statements (unaudited)....................................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..... 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................ 20
PART II - OTHER INFORMATION........................................................................ 21
Item 1. Legal Proceedings......................................................................... 21
Item 2. Change in Securities...................................................................... 21
Item 3. Defaults Upon Senior Securities........................................................... 21
Item 4. Submission of Matters to a Vote of Security Holders....................................... 21
Item 5. Other Information......................................................................... 21
Item 6. Exhibits and Reports on Form 8-K.......................................................... 21
SIGNATURES......................................................................................... 22
EXHIBIT INDEX...................................................................................... 23
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
BALANCE SHEETS - AS OF SEPTEMBER 30, 1998 (UNAUDITED) AND DECEMBER 31, 1997
------------------ -----------------
September 30, 1998 December 31, 1997
------------------ -----------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents...................................... $ 3,747,794 $ 3,003,524
Securities available for sale.................................. 4,481,122 9,863,093
Accounts receivable............................................ 419,536 208,247
Inventories.................................................... 2,113,278 1,927,325
Other.......................................................... 155,805 154,887
------------ ------------
TOTAL CURRENT ASSETS......................................... 10,917,535 15,157,076
PROPERTY AND EQUIPMENT, AT COST
Equipment...................................................... 2,607,359 2,484,535
Leasehold improvements......................................... 5,513,850 5,513,850
Less accumulated depreciation and amortization................. (2,867,049) (2,394,562)
------------ ------------
PROPERTY AND EQUIPMENT, NET 5,254,160 5,603,823
INTANGIBLE ASSETS, AT COST
Patents................................................... 290,930 290,930
Less accumulated amortization.................................. (137,271) (125,269)
Goodwill.................................................. 3,150,000
Less accumulated amortization.................................. (88,056)
------------ ------------
INTANGIBLE ASSETS, NET 3,215,603 165,661
OTHER 178,385 384,399
------------ ------------
TOTAL ASSETS $ 19,565,683 $ 21,310,959
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable............................................... $ 241,686 $ 203,764
Accrued liabilities............................................ 295,006 470,643
------------ ------------
TOTAL CURRENT LIABILITIES.................................... 536,692 674,407
DEFERRED LEASE PAYMENTS.......................................... 120,877 20,055
STOCKHOLDERS' EQUITY
Preferred stock $.01 par value: 2,000,000 shares authorized;
no shares issued or outstanding...............................
Common stock $.01 par value: 30,000,000 shares authorized;
14,468,678 and 13,364,958 shares issued and outstanding at
September 30, 1998 and December 31, 1997, respectively........ 144,687 133,650
Additional paid-in capital..................................... 84,305,793 82,801,830
Accumulated deficit............................................ (65,542,366) (62,318,983)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY................................... 18,908,114 20,616,497
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................... $ 19,565,683 $ 21,310,959
============ ============
See notes to financial statements
3
STATEMENTS OF OPERATIONS - THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND
1997 (UNAUDITED)
Three months ended September 30, Nine months ended September 30,
1998 1997 1998 1997
--------------------------------- --------------------------------
REVENUES
Product sales........................... $ 640,341 $ 41,391 $ 1,485,927 $ 123,963
Contract manufacturing.................. 123,280 135,723 255,267 705,706
------------ ------------ ------------ ------------
TOTAL REVENUE....................... 763,621 177,114 1,741,194 829,669
OPERATING EXPENSES
Cost of product sales................... 290,990 17,362 634,779 48,583
Research and development................ 492,743 1,025,296 1,605,931 3,677,586
General and administrative.............. 1,241,268 1,036,660 3,182,356 3,542,557
Litigation settlement................... (400,000)
------------ ------------ ------------ ------------
TOTAL COSTS AND EXPENSES............ 2,025,001 2,079,318 5,423,066 6,868,726
------------ ------------ ------------ ------------
OPERATING LOSS...................... (1,261,380) (1,902,204) (3,681,872) (6,039,057)
OTHER INCOME
Interest income......................... 119,544 252,705 438,243 760,235
Other income............................ 7,912 20,246
------------ ------------ ------------ ------------
TOTAL OTHER INCOME.................. 127,456 252,705 458,489 760,235
------------ ------------ ------------ ------------
NET LOSS............................ ($1,133,924) ($1,649,499) ($3,223,383) ($5,278,822)
============ ============ ============ ============
NET LOSS PER COMMON SHARE........... ($0.08) ($0.12) ($0.23) ($0.40)
Weighted average number of common shares
used in computing net loss per common
share................................... 14,468,678 13,340,058 13,992,016 13,315,257
See notes to financial statements
4
STATEMENTS OF CASH FLOWS - NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
Nine months ended September 30,
OPERATING ACTIVITIES 1998 1997
----------- -----------
NET LOSS ($3,223,383) ($5,278,822)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation............................................... 489,300 485,172
Amortization of intangibles................................ 100,058 11,999
Gain (loss) on sale of securities.......................... (2,841) 86
Expenses paid in stock..................................... 15,000 194,250
Changes in assets and liabilities:
Increase in inventories (net of $130,000 acquired from
HumaTech Corporation on April 27, 1998).................... (55,953) (1,190,374)
Increase in accounts receivable (net of $115,000 acquired
from HumaTech Corporation on April 27, 1998)............... (96,289) (230,230)
Decrease in other current assets (net of $30,000 acquired
from HumaTech Corporation on April 27, 1998)............... 29,082 22,537
Increase (decrease) in accounts payable..................... 37,922 (164,544)
Increase (decrease) in accrued liabilities.................. (175,637) 234,778
Increase (decrease) in deferred lease payments.............. 100,822 (119)
---------- ----------
NET CASH USED IN OPERATING ACTIVITIES.................... (2,781,919) (5,915,267)
---------- ----------
INVESTING ACTIVITIES
Purchase of property and equipment........................... (139,637) (539,964)
Purchase of securities....................................... (499,922) (44,160,774)
Proceeds from sale or maturity of securities................. 5,884,734 53,334,935
Purchase of assets of HumaTech Corporation on April 27, 1998. (1,925,000)
Decrease (increase) in security deposits..................... 206,014 (225,000)
---------- ----------
NET CASH PROVIDED BY INVESTING ACTIVITIES................ 3,526,189 8,409,197
---------- ----------
NET INCREASE IN CASH AND CASH EQUIVALENTS................ 744,270 2,493,930
CASH AND CASH EQUIVALENTS:
---------- ----------
AT BEGINNING OF PERIOD............................... 3,003,524 1,804,875
---------- ----------
AT END OF PERIOD..................................... $3,747,794 $4,298,805
========== ==========
See notes to financial statements
5
STATEMENTS OF STOCKHOLDERS' EQUITY - NINE MONTHS ENDED SEPTEMBER 30, 1998 AND
1997 (UNAUDITED)
Common Stock Additional
---------------------------- paid-in Accumulated
Shares Par Value Capital Deficit Total
---------- --------- ----------- ------------ -----------
BALANCE - JANUARY 1, 1997 13,277,558 $132,776 $82,576,340 ($55,870,339) $26,838,777
---------- -------- ----------- ------------ -----------
Restricted stock granted to
Hymedix at $2.59 per share on
March 31, 1997................... 25,000 250 64,500 64,750
Restricted stock granted to
Hymedix at $2.59 per share on
June 30, 1997.................... 25,000 250 64,500 64,750
Restricted stock granted to
Hymedix at $2.59 per share on
September 30, 1997............... 25,000 250 64,500 64,750
Net loss, nine month period....... (5,278,822) (5,278,822)
---------- -------- ----------- ------------ -----------
BALANCE - SEPTEMBER 30, 1997 13,352,558 $133,526 $82,769,840 ($61,149,161) $21,754,205
========== ======== =========== ============ ===========
BALANCE - JANUARY 1, 1998 13,364,958 $133,650 $82,801,830 ($62,318,983) $20,616,497
---------- -------- ----------- ------------ -----------
Shares issued in connection with
the acquisition of the assets of
HumaTech Corporation at $1.38
per share on April 27, 1998...... 1,088,435 10,884 1,489,116 1,500,000
Shares issued under the 1998 Non-
Employee Director stock plan at
$0.98 per share on July 1, 1998.. 15,285 153 14,847 15,000
Net loss, nine month period....... (3,223,383) (3,223,383)
---------- -------- ----------- ------------ -----------
BALANCE - SEPTEMBER 30, 1998 14,468,678 $144,687 $84,305,793 (65,542,366) 18,908,114
========== ======== =========== ============ ===========
See notes to financial statements
6
PROCYTE CORPORATION
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited financial statements of ProCyte Corporation
("ProCyte" or the "Company") for the three- and nine-month periods ended
September 30, 1998 and 1997 have been prepared by the Company in accordance with
generally accepted accounting principles for interim financial information and
the instructions to Form 10-Q and Article 10 of Regulation S-X. Pursuant to such
rules and regulations, the financial statements do not include all of the
information and footnotes required by generally accepted accounting principles
for audited financial statements. Accordingly, this financial information should
be read in conjunction with the complete audited financial statements, including
the notes thereto, which are included in the Company's Annual Report on Form 10-
K for the year ended December 31, 1997. In the opinion of management, all
material adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Interim results are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1998.
2. INVESTMENTS
At September 30, 1998, the Company's investments consisted entirely of US
Treasury bills & notes, US Agency securities, and investment-grade commercial
paper. All investments are classified as "available for sale." At September 30,
1998, the cost and estimated market value for investments maturing in one year
or less was $3,468,622, and for those maturing in one through five years was
$1,012,500. There were no material unrealized gains or losses on investments at
September 30, 1998.
3. INVENTORIES
Inventories consist of raw materials, work in process and finished goods,
and are accounted for at the lower of cost or market. As of September 30, 1998,
finished goods inventory was stated at $778,773, raw materials and work-in-
process inventory was stated at $1,714,505, and a reserve for surplus and
obsolete inventory was maintained at $380,000.
4. STOCKHOLDERS' EQUITY
Information relating to stock options granted, exercised, canceled and
currently exercisable is as follows:
Shares subject Weighted average
to option exercise price
-------------- ----------------
Balance - January 1, 1997............ 1,442,193 $3.53
Granted............................. 207,500 $2.07
Exercised........................... - -
Canceled............................ (447,973) $3.55
-----------------------------------
Balance - September 30, 1997......... 1,201,720 $3.26
===================================
7
Shares subject Weighted average
to option exercise price
-------------- ----------------
Balance - January 1, 1998............ 1,304,374 $2.94
Granted............................. 647,500 $1.30
Exercised - -
Canceled............................ (413,814) $2.86
-----------------------------------
Balance - September 30, 1998......... 1,538,060 $2.28
===================================
Currently exercisable................ 633,069 $3.47
===================================
During the three-month period ended September 30, 1998, the Compensation
Committee of the Board of Directors awarded incentive stock options to employees
under the Company's 1989 Restated Stock Option Plan to purchase 11,000 shares of
common stock. At September 30, 1998 the remaining number of shares reserved for
issuance under the Company's various option plans were as follows:
Number of shares
available for
Option plan option
----------- ----------------
1989 Restated Stock Option Plan................. 181,019
1996 Stock Option Plan.......................... 450,000
1991 Non-Employee Director Stock Option Plan.... 16,000
5. HUMATECH ACQUISITION
On April 27, 1998 the Company purchased substantially all of the assets of
HumaTech Corporation ("HumaTech"), a private distributor of specialty
dermatological products to the professional market. The acquisition was effected
through cash payments of $1.5 million and the distribution of 1,088,435 shares
of ProCyte common stock (valued at $1.5 million at the time of the acquisition)
to the selling HumaTech shareholders. Related acquisition costs amounted to
approximately $425,000. The acquisition has been accounted for using the
purchase method of accounting whereby the value of consideration paid has been
allocated to the assets acquired, principally inventory and accounts receivable.
Goodwill of $3.15 million resulted from the transaction and is being amortized
over 15 years. In connection with the acquisition ProCyte entered into
employment agreements with two of the HumaTech principals which, among other
terms, provided for payments contingent on future sales of HumaTech products.
The following table reflects pro forma consolidated operating results of
the Company and HumaTech assuming the acquisition had been made as of January 1,
1997:
NINE MONTHS ENDED SEPTEMBER 30,
1998 1997
---- ----
Pro forma revenue.................... 2,369,000 2,170,000
Pro forma net loss................... (3,264,000) (5,399,000)
Pro forma loss per common share...... ($0.23) ($0.37)
These pro forma results have been prepared for comparative purposes only
and reflect certain adjustments including amortization of the goodwill. The pro
forma information is not
8
necessarily indicative of either the results of operations that would have
occurred had the acquisition been made on January 1, 1997 or that may occur in
the future.
6. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," was recently issued and is effective for the Company's year ending
December 31, 1998. Management believes that the impact of its adoption will not
be material to the financial statements, taken as a whole.
9
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion contains forward-looking statements that are subject to certain
risks and uncertainties that could cause actual results to differ materially
from those projected. The words "believe", "expect", "intend", "anticipate",
variations of such words and similar expressions identify forward-looking
statements, but their absence does not mean that the statement is not forward-
looking. These statements are not guaranties of future performance and are
subject to certain risks, uncertainties and assumptions that are difficult to
predict. Factors that could affect the Company's actual results include, among
other things, the availability of adequate funding, the availability of contract
manufacturing opportunities, relationships with corporate collaborators, the
progress and costs of pre-clinical studies and clinical trials, the recruitment
of suitable patients, the timing of regulatory approvals, the rate of market
acceptance of the Company's products, the availability of third-party
reimbursement for the Company's products, the ability to obtain and defend
patent and related future products and intellectual property rights and to
market the Company's products and the status of competing products. See
"Important Factors Regarding Forward-Looking Statements." Readers are cautioned
not to place undue reliance on these forward-looking statements, which speak
only as of the date of this report. ProCyte undertakes no obligation to update
publicly any forward-looking statement to reflect new information, events or
circumstances after the date of this report or to reflect the occurrence of
unanticipated events.
Corporate Overview
For the first nine months of 1998 ProCyte continued its marketing and
development efforts for an array of wound care products, expanded its product
line and channels of distribution in cosmetic surgery with the acquisition of
HumaTech Corporation ("HumaTech"), and continued the development of
complementary skin health and hair care products. As the Company's product line
has expanded, it has continued to focus its efforts on the specialty tissue
repair sectors - marketing its products primarily to dermatologists, plastic
surgeons and cosmetic surgeons.
The Company continued to refine its approach to marketing the GraftCyte(TM)
line of copper-peptide containing wound care products for use following hair
restoration in the first three quarters of 1998. Approximately 400,000 hair
restoration procedures are performed annually in the United States. ProCyte is
the only company to provide a line of products that address the importance of
wound repair in the hair transplant process. The Company's GraftCyte(TM)
products are promoted through specialty distributors and its own sales force.
During the first quarter, the Company introduced Complex Cu3(TM) Intensive
Repair Creme, a product used to treat patients following chemical peels,
dermabrasion and laser treatments. The Company also began selling its Pillo(TM)
Pro dressings which provide moisture absorption following liposuction
procedures. Each year in the United States alone, an estimated 400,000 such
surgeries are performed. In December 1997, ProCyte entered into an exclusive
distribution agreement with the Bard Medical Division ("Bard") of C.R. Bard,
Inc. Subject to certain minimum quarterly purchase requirements, ProCyte granted
Bard the exclusive rights to distribute its wound care products in the hospital,
nursing home and extended care markets in the United States and Canada.
ProCyte's Iamin(R) Hydrating Gel, Iamin(R) Wound Cleanser, and OsmoCyte(R)
Pillow Wound Dressings became the first Company products to be added to the Bard
sales effort. The Company shipped its first orders to Bard in January 1998.
During the second quarter ProCyte entered into a distribution
10
agreement with Tanox Pharma for sales of Iamin(R) Hydrating Gel and OsmoCyte(R)
Pillow Wound Dressings in China, Taiwan and Hong Kong. This agreement was
expanded in September 1998 to add five more countries. Approval as a
pharmaceutical in China has been received and the initial orders will be shipped
before the end of 1998.
During the second quarter the Company purchased substantially all the
assets and business of HumaTech, a private company located in Boca Raton,
Florida, which distributes prescription and over-the-counter topical drugs and
skin care products to dermatologists, plastic surgeons and cosmetic surgeons.
HumaTech sales representatives sell therapeutic skin care, dermatologic agents
and anti-aging products as well as an advanced sun protection line, TiSilc(TM).
Most HumaTech products are private-labeled or custom-packaged with the doctor's
name. The Company expects that access to the HumaTech customer base and
integration of its marketing approach will improve the rate of increase of sales
of the Company's Complex Cu3(TM) and Tricomin(R) products. The Company also
expects that as a result of the acquisition there will be opportunities to
enhance the sales of HumaTech products by integrating HumaTech products with the
Company's existing product lines, reformulating certain HumaTech products, and
redesigning the HumaTech packaging and marketing materials.
The Company commenced shipping its Tricomin(R) line of triamino copper
containing hair care products to physicians' offices in the third quarter of
1998. Tricomin(R) shampoos, conditioners, and follicle therapy solution are
positioned to participate in the rapidly growing $1.5 billion United States hair
care market as a program for the maintenance of thinning hair in men and women.
Hair follicles require high concentrations of biological copper and the
Tricomin(R) products deliver copper along with amino acids and botanicals for
nourishing and stimulating the hair and scalp for improved health, strength, and
appearance. Beginning in the fourth quarter the Company will initiate a series
of consumer advertisements focused specifically on the haircare needs and
concerns of an aging babyboomer population.
Operating Losses
The Company is engaged in the development of healthcare products utilizing
copper-peptide containing and polymer-based compounds. Such development has
historically been funded from the Company's equity-derived working capital and
through corporate partnerships. The Company has incurred operating losses since
its inception due to financial and regulatory requirements required to support
research, development and clinical studies of its proprietary technology. At
September 30, 1998, the Company's accumulated deficit was approximately $65.5
million. The Company expects to incur additional operating losses for a number
of years until its product lines have been expanded and have achieved market
acceptance.
Revenue
For the three- and nine-month periods ended September 30, 1998, ProCyte
generated total operating revenue of approximately $763,621 and $1,741,194,
respectively, from product sales and from performing contract manufacturing
services. Comparable revenues were $177,114 and $829,669 for the three- and
nine-month periods ended September 30, 1997. Sales of HumaTech products
amounting to approximately $475,367 are included in ProCyte's operating revenue
for the three months ended September 30, 1998. The nine-month period ended on
that date includes sales of HumaTech products subsequent to the acquisition on
April 27, 1998, amounting to approximately $828,557. The comparable periods in
1997 do not include any sales of HumaTech products.
11
Revenue from product sales was approximately $640,341 and $1,485,927 during
the three- and nine-month periods ended September 30, 1998, respectively, up
from $41,391 and $123,963 during the three and nine months ended September 30,
1997. The increase was primarily a result of revenue from HumaTech products,
revenue from new products (especially the Cu3 line) and revenue from the sale of
various wound care products to Bard. A restructuring of Bard's non-hospital
sales approach reduced sales to Bard during the third quarter.
Contract manufacturing revenue decreased from $705,706 during the nine
months ended September 30, 1997 to $255,267 during the comparable period in
1998. This decline resulted from the completion of a contract manufacturing
project in 1997 that did not carry over into 1998, and from product regulatory
delays faced by one of the Company's largest contract manufacturing customers
that have indefinitely delayed this customer's need for the Company's services.
Interest income was approximately $119,544 and $438,243 for the three- and
nine-month periods ended September 30, 1998, compared to $252,705 and $760,235
for the comparable periods in 1997. The decrease in interest income was
primarily a result of reduced funds available for investment.
Expenses
Research and development expenses were approximately $492,743 and
$1,605,931 for the three- and nine-month periods ended September 30, 1998,
primarily reflecting the continuation of the Company's expenditures for
development of wound care, skin health and hair care product candidates. This
compares to research and development expenses of $1,025,296 and $3,677,586 for
the comparable three- and nine-month periods in 1997. This decrease resulted
from reduced staffing levels and from the completion of various primary research
projects and studies. The Company anticipates that expenditures for product
development will remain at or near current levels.
General and administrative expenses were approximately $1,241,268 and
$3,182,356 for the three- and nine-month periods ended September 30, 1998,
compared to $1,036,660 and $3,542,557 for the same periods in 1997. The increase
in general and administrative expenses during the third quarter of 1998 over the
same period in the prior year reflects certain additional costs of absorbing the
HumaTech operation and expanded sales and marketing efforts related to the
launch of Tricomin(R). The decrease in general and administrative expenses for
the nine months ended September 30, 1998 compared to the same period in the
prior year is primarily related to reduced staffing levels and to the
consolidation of the Company's facilities. The Company anticipates that
expenditures will remain at or near current levels although it is in the process
of eliminating certain duplicative functions. The Company expects to complete
the relocation of the HumaTech operations to Redmond, Washington, during the
fourth quarter of 1998. In May 1997 the Company received a negotiated final
settlement payment of $400,000 from one of its insurance carriers resulting from
the 1996 settlement of the shareholder lawsuit filed against the Company in
October 1994.
Liquidity and Capital Resources
The Company has relied primarily on equity financing, interest income,
product sales, contract manufacturing revenue and corporate partnerships to fund
its operations and capital expenditures. At September 30, 1998, the Company had
approximately $8.2 million in cash, cash equivalents and securities available
for sale, as compared to $12.9 million at December 31, 1997.
12
The principal components of the $4.7 million decrease are approximately $1.9
million used for the HumaTech acquisition and $2.8 million used to fund ongoing
operations. The Company expects that its operating cash needs will continue at
similar levels in future periods.
The increase of $211,289 in trade accounts receivable during the nine-month
period ending September 30, 1998 reflects accounts attributable to the HumaTech
acquisition and the increase in sales of ProCyte products. For the nine-month
period ending September 30, 1998, inventory rose by $185,953, primarily as a
result of inventory purchased in the HumaTech acquisition.
On September 28, 1998 ProCyte received a non-compliance letter from the
NASDAQ Stock market ("NASDAQ") as a result of the price of its common stock
being below $1.00 per share over a period of 30 consecutive trading dates. The
company has until December 26, 1998 to meet this requirement for a minimum of 10
consecutive trading dates. The Board is considering a number of options in this
regard, including the feasibility of a stock repurchase. See "Important Factors
Regarding Forward-Looking Statements Potential Delisting from NASDAQ National
market System."
The Company believes that its existing cash, cash equivalents,
securities available for sale, and interest thereon, will be sufficient to meet
its capital requirements at least through 1999. However, there can be no
assurance that the underlying assumed levels of revenue and expense will prove
accurate. Although the Company believes that its existing and potential products
appear promising, it is unknown whether any of such products will prove
commercially viable. In any event, substantial additional funds will be needed
to commercialize existing products and to continue development of potential
products. The Company will depend upon equity financing, contract manufacturing
fees, interest income, product revenues and funding from corporate partnerships
to meet its future capital needs. There can be no assurance that such funds will
be available as needed or on terms that are acceptable to the Company. In
addition, the Company's ability to raise funds is likely to be adversely
affected if it is unable to meet the listing criteria on NASDAQ. If the Company
is unable to obtain sufficient funds to satisfy its cash requirements, the
Company will be required to delay, reduce or eliminate some or all of its
research and development activities and manufacturing and administrative
programs, or dispose of assets or technology. See "Important Factors Regarding
Forward-Looking Statements."
Year 2000 Software Issue
The Company recognizes that its operations may be negatively affected by
the widely discussed software problems anticipated with the new millennium,
either from its own computer systems or its interactions with outside vendors,
service providers and government agencies. In connection with the relocation of
the operations of HumaTech the Company has substantially upgraded its computer
hardware and implemented new accounting and distribution software which are
certified by the vendors to be year 2000 compliant. The Company plans to
implement any additional vendor upgrades and modifications necessary to avoid
year 2000 software issues and does not expect that the incremental cost of
addressing this issue will be significant. The Company presently believes that
the year 2000 issues can be effectively avoided, but it intends to develop a
contingency plan to allow operations to continue even if significant issues are
experienced. There can be no assurance that the Company has accurately assessed
the need for software and computer upgrades or modifications in this regard and
if such upgrades and modifications are not made, or if they are not made on a
timely basis, or if third parties fail to adequately anticipate and remediate
issues with software, computers and embedded processors, year 2000 problems
could have a material impact on the operations of the Company.
13
IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS
History of Operating Losses; Accumulated Deficit; Fluctuations in Future
Earnings
The Company launched its first product in 1996, launched additional wound
care products in 1997 and the first nine months of 1998 and expects further
product launches in skin health and hair care products in 1998 and 1999. To
date, however, the Company has generated only minimal revenues from product
sales and there can be no assurance that the Company will be able to generate
sufficient product sales to achieve a profitable level of operations. As of
September 30, 1998, the Company's accumulated deficit was approximately $65.5
million. The Company expects to incur additional operating losses at least
through 1999. Historically, the Company's revenues have principally been from
interest income, research fees, license fees and fees for contract manufacturing
services. The Company's ability to achieve a consistent, profitable level of
operations is dependent in large part on successfully manufacturing its
products, entering into agreements with corporate partners for distribution and
commercialization of the Company's products and out-licensing of the Company's
products and technology, of which there can be no assurance. In addition,
payments under corporate partnerships and licensing arrangements, if any, will
be subject to significant fluctuations in both timing and amounts. The time
required to reach sustained profitability is highly uncertain, and there can be
no assurance that the Company will be able to achieve profitability on a
sustained basis, if at all. Moreover, if profitability is achieved, the level of
profitability cannot be predicted and it may vary significantly from quarter to
quarter.
Need for Additional Capital
The Company expects negative cash flow from operations to continue for the
foreseeable future. The Company may require substantial additional funds to
expand or enhance its sales and marketing activities and to continue product
development. The Company's future capital requirements will depend on numerous
factors, including its efforts, and the efforts of its collaborative partners,
to commercialize its products; continued progress in the Company's research and
development programs; the results of research and development activities;
relationships with existing and future corporate collaborators, if any;
competing technological and market developments; the costs involved in filing,
prosecuting and enforcing patent claims; the time and costs of commercialization
activities; and other factors. At September 30, 1998 the Company had cash, cash
equivalents and securities available for sale of $8.2 million. The Company
estimates that at its planned rate of spending, its existing cash, cash
equivalents and securities available for sale and the interest income thereon
will be sufficient to meet its capital requirements at least through 1999. There
can be no assurance that the underlying assumed levels of revenue and expense
will prove accurate. Whether or not these assumptions prove to be accurate, the
Company will need to raise substantial capital to fund operations. The Company
may be required to seek additional funding through public or private financing,
including equity financing, and through collaborative arrangements. Adequate
funds for these purposes, whether obtained through financial markets or from
collaborative or other arrangements with corporate partners or other sources,
may not be available when needed or may not be available on terms favorable to
the Company, if at all. If additional funds are raised by issuing equity
securities, dilution to existing shareholders will result. In addition, in the
event that additional funds are obtained through arrangements with collaborative
partners, such arrangements may require the Company to relinquish rights to
certain of its technologies or potential products that it would otherwise seek
to develop or commercialize itself. If funding is insufficient at any time in
the future, the Company may be required to delay, scale back or
14
eliminate some or all of its marketing and research and development programs or
to license third parties to commercialize products or technologies that the
Company would otherwise seek to develop itself. Furthermore, the terms of any
such license agreements might be less favorable than if the Company were
negotiating from a stronger position. Moreover, if funding is insufficient at
any time in the future, and the Company's existing funds are depleted, the
Company may be required to cease operations.
Potential Delisting from NASDAQ National Market System; Application of Rule 15g-
9 and Penny Stock Rules
The Company's common stock is listed on the NASDAQ National Market System.
In order to remain listed on the NASDAQ, an issuer must comply with the
"continued listing criteria" established by the NASDAQ. These criteria include,
among others, (i) net tangible assets of $4 million, (ii) a public float of
750,000 shares with market value of $5 million, (iii) 400 shareholders, (iv) two
market makers, and (v) a minimum bid price requirement of $1.00 per share. Since
August 14, 1998, the Company has not met the minimum bid price criterion for
continued listing. NASDAQ has informed the Company that if it does not meet this
requirement by December 26, 1998, NASDAQ will delist the Company's securities
from the NASDAQ National Market System.
If delisted from the NASDAQ National Market System, the Company would seek
to list its securities on another securities exchange. If the Company were
unable to meet the eligibility requirements for such an exchange, trading of the
Company's securities could continue only on the OTC Bulletin Board or in the
non-NASDAQ over-the-counter market. Because real-time price information may no
longer be available, an investor is likely to find it more difficult to dispose
of, or obtain accurate quotations on the market value of, the Company's
securities.
In addition, purchases and sales of the Company's securities may be subject
to Rule 15g-9 of the Exchange Act. This Rule imposes various sales practice
requirements on broker-dealers who sell securities governed by the Rule to
persons other than established customers and accredited investors (generally
institutions with assets exceeding $5 million or individuals with a net worth
exceeding $1 million or annual income exceeding $200,000 or $300,000 jointly
with their spouse). For transactions covered by Rule 15g-9, the broker-dealer
must specially determine the purchaser's suitability and obtain the purchaser's
written consent before the sale. Application of his Rule is likely to adversely
affect the ability of broker-dealers to sell the Company's securities, the
salability of the securities in the secondary market and the ability of the
Company to raise funds.
The Company's securities may also become subject to penny stock rules,
which could have a material adverse effect on their market liquidity. The
Securities and Exchange Commission regulates broker-dealer practices in
connection with transactions in "penny stocks," which generally are equity
securities priced at less than $5.00 per share (other than securities registered
on certain national securities exchanges or quoted on the NASDAQ system,
provided that the exchange or system gives current price and volume
information). The penny stock rules require a broker-dealer, before trading in a
penny stock not exempt from the rules, to give the customer a standardized
document providing information about penny stocks and the risks in the penny
stock market, current bid and offer quotations for the penny stock, and a
statement of the compensation of the broker-dealer and its salesperson in the
transaction. The broker dealer must also provide monthly account statements
showing the market value of each penny stock held in the customer's account. If
NASDAQ delists the Company's securities and its common stock continues to trade
below the $5.00
15
per share threshold, the Company's securities may fall within the definition of
penny stocks. If the penny stock rules were to apply, these disclosure
requirements are likely to reduce the level of trading activity in the secondary
market for the Company's securities and make selling the securities more
difficult for an investor.
Uncertainties Related to Contract Manufacturing Operations
Since inception, a substantial portion of the Company's revenues have been
derived from its contract manufacturing operations as the Company has sought to
more fully utilize its existing facility's capacity while its own products were
under development. For the foreseeable future, ProCyte expects to continue to
have excess manufacturing capacity as it works to complete development, and
begin commercialization, of its potential products. Accordingly, the Company
will continue to seek contract manufacturing opportunities. Contract
manufacturing revenues will be adversely affected to the extent the Company's
customers decide to manufacture their products themselves or choose to have them
manufactured elsewhere. In addition, the Company's contract manufacturing
revenues may be adversely affected to the extent its customers experience
regulatory delays, product recalls, or competitive pressures in the marketplace.
The Company expects that it will recognize significantly less revenue from
contract manufacturing in 1998 than it recognized in 1997 as a result of the
loss of two of its most significant contract manufacturing customers, one of
whom faces an indefinite delay in receiving FDA clearance. There can be no
assurance that contract revenues in the future will be significant.
Uncertainties Related to Stage of Development
From the Company's inception in 1986 until it launched its first
commercial product in June 1996, substantially all of its resources were
dedicated to the research and development of wound healing and tissue repair
applications of its topically administered copper-peptide compounds. Although
the Company launched additional wound care product lines in 1997 and the first
nine months of 1998 and expects further product launches in skin health and hair
care in 1998 and 1999, to date the Company has generated relatively minor
revenues from product sales. Historically, the Company's revenues have
principally been from fees for contract manufacturing services, interest income,
research fees and license fees. There can be no assurance that the Company's
current products or its potential products, if successfully developed, will be
successfully commercialized and accepted for use by physicians, healthcare
providers and consumers. The failure of the Company to successfully develop its
potential products or its failure to successfully commercialize its existing or
potential products will have a material adverse effect on the Company's
business, financial condition and results of operations.
Uncertainties Related to Product Development
The Company is dependent upon the successful development of its
potential products. Development of the Company's potential products is highly
uncertain, and unanticipated developments, clinical and regulatory delays,
adverse or unexpected side effects or inadequate therapeutic efficacy could slow
or prevent the successful completion of the Company's product and technology
development. There can be no assurance that the Company will obtain regulatory
approval, that an approved product can be produced in commercial quantities at
reasonable costs or gain acceptance for use by physicians, healthcare providers
and consumers or that any potential products will be successfully marketed at
prices that would permit the Company to operate
16
profitably, the failure of any of which would have a material adverse effect on
the Company's business, financial condition and results of operations.
Dependence on and Management of Existing and Future Corporate Alliances
The successful commercialization of the Company's existing and future
products will depend upon ProCyte's ability to enter into and effectively manage
corporate partnerships. ProCyte currently promotes certain of its products
through specialty distributors. Other products and technology are licensed for
incorporation into products sold by others. In November 1997, the Company
entered into an exclusive worldwide supply and marketing agreement with Osmotics
Corporation ("Osmotics"), pursuant to which the Company granted Osmotics the
right to introduce the Company's copper-peptide-containing products to the
prestige skin care market. In December 1997, the Company entered into an
exclusive distribution agreement with the Bard Medical Division ("Bard") of C.R.
Bard, Inc. Pursuant to this agreement, Bard will be the exclusive supplier of
the Company's wound care products to the hospital, nursing home and extended
care markets in the United States and Canada. Subsequent to the Bard agreement,
ProCyte entered into exclusive distribution agreements for the registration and
distribution of certain of its wound care products in certain foreign countries.
ProCyte plans to seek similar distribution partnerships in additional countries.
There can be no assurance that any of the Company's collaborators will perform
their obligations under their agreements with the Company or that the Company's
products or the products of others that incorporate the Company's products or
technology, will be successfully commercialized, any of which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
There can be no assurance that the Company will be successful in
establishing corporate alliances in the future, or that it will be successful in
maintaining existing or any future corporate alliances. Moreover, there can be
no assurance that the interests and motivations of any corporate partner,
distributor or licensee would be or remain consistent with those of the Company,
or that such partners, distributors or licensees would successfully perform the
necessary technology transfer, clinical development, regulatory compliance,
manufacturing, marketing or other obligations. Failure of any of the foregoing
could have a material adverse effect on the Company's business, financial
condition and results of operations.
Uncertainty of Patent Position and Proprietary Rights
The patent positions of biotechnology, medical device and healthcare
products companies are often uncertain and involve complex legal and factual
questions, and the breadth of claims allowed in such patents cannot be
predicted. In addition, there is a substantial backlog of patents at the US
Patent and Trademark Office that may delay the review and the potential issuance
of patents. The Company's success will depend to a significant degree on its
ability to obtain patents and licenses to patent rights, to maintain trade
secrets and to operate without infringing on the proprietary rights of others,
both in the United States and in other countries. The failure of the Company or
its licensors to obtain and maintain patent protection for the Company's
technology could have a material adverse effect on the Company.
ProCyte's success depends in part upon its ability to protect its products
and technology under intellectual property laws in the United States and abroad.
As of September 30, 1998, the Company had 18 issued United States patents
expiring between 2005 and 2014, and 132 issued foreign patents and patent
registrations. The patents relate to use of the Company's copper-based
17
technology for a variety of healthcare applications, and to the composition of
certain biologically active, synthesized compounds. The Company's strategy has
been to apply for patent protection for certain compounds and their discovered
uses that are believed to have potential commercial value in countries which
offer significant market potential. There can be no assurance that patent
applications relating to the technology used by the Company will result in
patents being issued. There can be no assurance that any patent issued to the
Company will not be subjected to further proceedings limiting the scope of the
rights under the patent or that such patent will provide a competitive advantage
or will afford protection against competitors with similar technology, or will
not be successfully challenged, invalidated or circumvented by competitors.
The Company's processes and potential products may conflict with patents
that have been or may be granted to competitors and others. As the
biotechnology, medical device and healthcare industries expand and more patents
are issued, the risk increases that the Company's processes and potential
products may give rise to claims that they infringe the patents of others. Such
other persons could bring legal actions against the Company claiming damages and
seeking to enjoin clinical testing, manufacturing and marketing of the affected
product or use of the affected process. Litigation may be necessary to enforce
patents issued to the Company, to protect trade secrets or know-how owned by the
Company or to determine the enforceability, scope and validity of proprietary
rights of others. If the Company becomes involved in such litigation, it could
result in substantial expense to the Company and significant diversion of effort
by the Company's technical and management personnel. In addition to any
potential liability for significant damages, the Company could be required to
obtain a license to continue to manufacture or market the affected product or
use the affected process. Costs associated with any licensing arrangement may be
substantial and could include ongoing royalties. There can be no assurance that
any license required under any such patent would be made available to the
Company on acceptable terms, if at all. If such licenses could not be obtained
on acceptable terms, the Company could be prevented from manufacturing and
marketing existing or potential products. Accordingly, an adverse determination
in such litigation could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company also relies upon unpatented proprietary technology. There can
be no assurance that the Company can meaningfully protect its rights in such
unpatented technology, that any obligation to maintain the confidentiality of
such proprietary technology will not be breached by employees, consultants,
collaborators or others, or that others will not independently develop or
acquire substantially equivalent technology. To the extent that corporate
partners or consultants apply Company technological information independently
developed by them or by others to Company projects or apply Company technology
or know-how to other projects, disputes may arise as to the ownership of
proprietary rights to such information. Any failure to protect unpatented
proprietary technology or any breach of obligations designed to protect such
technology or development of equivalent technology may have a material adverse
effect on the Company's business, financial condition and results of operations.
Uncertainty of Government Regulatory Requirements
The manufacture and marketing of ProCyte's products and its research and
development activities in general are subject to extensive regulation in the
United States by the federal government, principally by the FDA, and in other
countries by similar health and regulatory authorities. The Federal Food, Drug
and Cosmetic Act and the regulations promulgated thereunder, and other federal
and state statutes govern, among other things, the testing, manufacture, safety,
18
labeling, storage, record-keeping, advertising and promotion of cosmetic
products and medical devices. Product development and approval or clearance
within the regulatory framework requires a number of years and involves the
expenditure of substantial resources.
In order to obtain FDA clearance to market a new device in the United
States for use in humans, it is necessary to proceed through several stages of
product testing, including research and development, clinical trials, and the
filing of a product 510(k) medical device application with the FDA to obtain
authorization to market a product. The Company's products and product candidates
may be regulated by any of a number of divisions of the FDA. The process of
obtaining and maintaining regulatory approvals for the manufacturing or
marketing of the Company's existing and potential products is costly and time-
consuming and is subject to unanticipated delays. Accordingly, delays,
rejections or unexpected costs may be encountered based on changes in the policy
or regulations of the FDA or foreign governmental authorities during the period
of product development and regulatory review, which changes may result in
limitations or restrictions on the Company's ability to utilize its technology
or develop product candidates. Regulatory requirements ultimately imposed could
also adversely affect the ability of the Company to clinically test, manufacture
or market products. Even if regulatory approval of a potential product is
obtained, such approval may entail limitations on the indicated uses for which
such product may be marketed, which may restrict the patient population for
which any product may be prescribed. In addition, a marketed product is subject
to continual FDA review. Later discovery of previously unknown problems or
failure to comply with the applicable regulatory requirements may result in
restrictions on marketing a product or withdrawal of the product from the
market, as well as possible criminal or civil sanctions.
In the United States, products that do not seek to make effectiveness
claims based on human clinical evaluation may be subject to review and
regulation under the FDA's cosmetic or 510(k) medical device guidelines. Similar
guidelines exist for such products in other countries. Such products, which
include wound care dressings, ointments and gels, must show safety and
substantial equivalency with predicate products already cleared to be marketed
by the FDA. There can be no assurance that such product applications submitted
to the FDA or similar agencies in other countries will receive clearance to be
marketed, or that the labeling claims sought will be approved, or that, if
cleared, such products will be commercially successful.
In addition to obtaining approval or clearance from the FDA or foreign
regulatory bodies to market a product, the prospective manufacturer's quality
control and manufacturing procedures must conform to current good manufacturing
practices ("cGMPs") guidelines, or ISO 9000 standards, when appropriate. In
complying with these regulations, which are subject to change at any time
without notice to the Company, ProCyte must continue to expend time, effort and
financial resources in production and quality control. In addition, ProCyte's
manufacturing plant is subject to the regulations of and inspections by other
foreign, federal, state or local agencies, such as local and regional water and
waste treatment agencies, and state and federal safety and health agencies.
There can be no assurance that the Company's manufacturing facility or its
manufacturing operations will meet or continue to meet all appropriate
guidelines or to pass inspections by any government agency.
The Company also is or may become subject to various other federal, state,
local and foreign laws, regulations and policies relating to, among other
things, safe working conditions, good laboratory practices, animal welfare, and
the use and disposal of hazardous or potentially hazardous substances used in
connection with research, development and/or manufacturing.
19
Failure to obtain regulatory approvals for its product candidates or to
either attain or maintain compliance with cGMP or other manufacturing
requirements would have a material adverse effect on the Company's business,
financial condition and results of operations.
Intense Competition
Competition in the wound care, skin health and hair care markets is
intense. The Company's competitors include well-established pharmaceutical,
cosmetic and healthcare companies such as Bristol Myers Squibb's ConvaTec
division, Kendall Healthcare Company, Johnson and Johnson, and Allergan. These
competitors have substantially more financial and other resources, larger
research and development staffs, and more experience and capabilities in
researching, developing and testing products in clinical trials, in obtaining
FDA and other regulatory approvals, and in manufacturing, marketing and
distribution than the Company. In addition, a number of smaller companies are
developing or marketing competitive products, some of which may have an entirely
different approach than products being marketed or developed by the Company. The
Company's competitors may succeed in developing and commercializing products or
obtaining patent protection or other regulatory approvals for products more
rapidly than the Company. If the Company is successful in commercializing its
products, it will be required to be competitive with respect to manufacturing
efficiency and marketing capabilities, areas in which it has very limited
experience. The Company's competitors may develop new technologies and products
that are available for sale prior to the Company's potential products or that
are more effective than the Company's existing or potential products. In
addition, competitive products may be manufactured and marketed more
successfully than the Company's potential products. Such developments could
render the Company's existing or potential products less competitive or
obsolete, and could have a material adverse effect on the Company's business,
financial condition and results of operations.
The contract manufacturing service business is also highly competitive.
Competitors include major chemical and pharmaceutical companies, as well as
specialized biotechnology firms, smaller contract chemical manufacturers and
some universities. Many of these companies or institutions have greater
financial, technical and marketing resources than the Company.
Potential Volatility of Stock Price
The market prices for securities of healthcare, medical dressings,
pharmaceutical and biotechnology companies are subject to volatility, and the
market has from time to time experienced significant fluctuations that are
unrelated to the operations of the Company. ProCyte's market price has
fluctuated over a wide range since the Company's initial public offering in
1989. Announcements concerning the Company or its competitors, including
fluctuations in operating results, research and development program direction,
results of clinical trials, addition or termination of corporate alliances,
technology licenses, clearance or approval to market products, announcements of
technological innovations or new products by the Company or its competitors,
changes in government regulations, healthcare reform, developments in patent or
other proprietary rights of the Company or its competitors, litigation
concerning business operations or intellectual property, or public concern as to
safety of products, as well as changes in general market conditions and mergers
and acquisitions, may have a significant effect on the market price of ProCyte's
common stock.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None
20
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K
None.
21
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PROCYTE CORPORATION
(REGISTRANT)
Date: October 28, 1998 By: /s/ John F. Clifford
--------------------------------------
John F. Clifford, President and CEO
Date: October 28, 1998 By: /s/ Jerry Scott
--------------------------------------
Jerry P. Scott, Vice President and CFO
22
EXHIBIT INDEX
Exhibit Number Title
-------------- -----
27 Financial Data Schedule
23