-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PI6ExrVbListNert2gloko/0HblK0wKVMSQTnJ1AQObe8ZVe4g+M7rCZ1nThWLEY xoaVxcQ1oYC2YhR7Y7W+jw== 0000950144-99-003681.txt : 19990402 0000950144-99-003681.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950144-99-003681 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CYTRX CORP CENTRAL INDEX KEY: 0000799698 STANDARD INDUSTRIAL CLASSIFICATION: BIOLOGICAL PRODUCTS (NO DIAGNOSTIC SUBSTANCES) [2836] IRS NUMBER: 581642740 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-15327 FILM NUMBER: 99580601 BUSINESS ADDRESS: STREET 1: 154 TECHNOLOGY PKWY STREET 2: TECHNOLOGY PARK/ATLANTA CITY: NORCROSS STATE: GA ZIP: 30092 BUSINESS PHONE: 4043689500 MAIL ADDRESS: STREET 1: 154 TECHNOLOGY PARKWAY CITY: NORCROSS STATE: GA ZIP: 30092 10-K405 1 CYTRX CORPORTATION 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 ----------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. 0-15327 ------- CYTRX CORPORATION ----------------- (Exact name of Registrant as specified in its charter) Delaware 58-1642740 --------------------------------- ------------------------------------ (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 154 Technology Parkway Norcross, Georgia 30092 30092 ----------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (770) 368-9500 ------------------ ----------------- Securities registered pursuant to Section l2(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001 par value per share 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 and (2) has been subject to such filing requirements for the past 90 days. YES X NO . --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] On March 22, 1999, the aggregate market value of the Registrant's common stock held by non-affiliates was approximately $20,740,000. On March 22, 1999, there were 7,630,249 shares of the Registrant's common stock outstanding, exclusive of treasury shares. DOCUMENTS INCORPORATED BY REFERENCE Portions of the CytRx Corporation 1998 Annual Report to Stockholders are incorporated by reference into Parts II and IV. Portions of the CytRx Corporation Proxy Statement for the 1999 Annual Meeting of Stockholders (the "Proxy Statement") are incorporated by reference into Part III. 2 THIS FORM 10-K AND OTHER STATEMENTS ISSUED OR MADE FROM TIME TO TIME BY CYTRX CORPORATION OR ITS REPRESENTATIVES CONTAIN STATEMENTS WHICH MAY CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE "1933 ACT"), AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THOSE STATEMENTS INCLUDE STATEMENTS REGARDING THE INTENT, BELIEF OR CURRENT EXPECTATIONS OF CYTRX CORPORATION AND MEMBERS OF ITS MANAGEMENT TEAM, AS WELL AS THE ASSUMPTIONS ON WHICH SUCH STATEMENTS ARE BASED. PROSPECTIVE INVESTORS ARE CAUTIONED THAT ANY SUCH FORWARD-LOOKING STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND THAT ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTEMPLATED BY SUCH FORWARD-LOOKING STATEMENTS. IMPORTANT FACTORS CURRENTLY KNOWN TO MANAGEMENT THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN FORWARD-LOOKING STATEMENTS ARE INCLUDED AS EXHIBIT 99.1 TO THIS FORM 10-K, AND ARE HEREBY INCORPORATED BY REFERENCE. THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE OR REVISE FORWARD-LOOKING STATEMENTS TO REFLECT CHANGED ASSUMPTIONS, THE OCCURRENCE OF UNANTICIPATED EVENTS OR CHANGES TO FUTURE OPERATING RESULTS OVER TIME. PART I ITEM 1. BUSINESS GENERAL CytRx Corporation, a Delaware corporation ("CytRx"), was founded in 1985 and is engaged in the development and commercialization of pharmaceutical-related products and services primarily involving human therapeutics focused on high-value critical-care therapies (the "Core Business"). The Company's lead product is FLOCOR, now in pivotal Phase III clinical trials for the treatment of acute sickle cell crisis. CytRx is also developing FLOCOR for acute respiratory disorders and has plans to expand its development for other vascular disorders such as shock and stroke over time. CytRx is also currently engaged in research in the areas of infectious disease, gene and drug delivery, vaccines, and animal feed additives. CytRx has in the past, and may in the future, create operating subsidiaries to develop its technologies for indications outside of its Core Business. CytRx intends to use the proceeds from the sale of the operations of its subsidiaries to fund its Core Business. Vaxcel, Inc. ("Vaxcel") is developing technologies to enhance the effectiveness of vaccines. Prior to the divestiture of substantially all of its assets related to its cattle marketing operations in April 1998, CytRx Animal Health, Inc. ("CytRx Animal Health") (formerly VetLife, Inc.) was engaged in developing technologies to enhance food animal growth and marketing and distributing products to enhance North American beef cattle productivity. Before the divestiture of substantially all of its non-real estate assets in February 1998, Proceutics, Inc. ("Proceutics") provided preclinical development services to the pharmaceutical industry (see "New Business Developments"). Reference herein to "the Company" includes CytRx and its majority-owned subsidiaries. Certain financial information concerning the industry segments in which the Company operates can be found in Note 13 to the Company's Consolidated Financial Statements. NEW BUSINESS DEVELOPMENTS Divestiture of Subsidiaries and Sale of Real Estate During the first half of 1998, CytRx divested itself of its real estate assets and substantially all of the assets of two operating subsidiaries to allow CytRx to focus its activities on its Core Business and, specifically, to raise capital to undertake Phase III testing of FLOCOR. See "Product Development." Proceutics - In February 1998, CytRx's wholly-owned subsidiary, Proceutics consummated a sale of substantially all of its non-real estate assets to Oread Laboratories, Inc. ("Oread") for approximately $2.1 million. The Company recorded a gain of approximately $782,000 related to such sale. Prior to consummation of this transaction, Proceutics provided 2 3 preclinical development services to the pharmaceutical industry. Proceutics retained its real estate assets consisting solely of a laboratory building which it leased to Oread. The laboratory building was subsequently sold in May 1998. CytRx Animal Health - In April 1998, CytRx's wholly-owned subsidiary, CytRx Animal Health, consummated a sale of substantially all of its assets related to its cattle marketing operations to VetLife, LLC ("VL LLC") (an unaffiliated company) for a total purchase price of $7,500,000, subject to certain working capital adjustments, plus certain contingent payments based on certain events and future sales of specified products of VL LLC and its affiliates that, if made in full, could total up to $5,500,000. CytRx Animal Health retained $5.3 million in investments that were pledged to secure a letter-of-credit, as well as the rights to certain technologies licensed from CytRx. The Company recorded a gain of approximately $6,230,000 related to the sale. Prior to consummation of this transaction, CytRx Animal Health was engaged in marketing and distributing products to enhance North American beef cattle productivity. Sale of Real Estate - In May 1998, CytRx and Proceutics consummated the sale of the two buildings owned by them at 150 and 154 Technology Parkway, Norcross, Georgia, to Alexandria Real Estate Equities, Inc. ("Alexandria") for $4.5 million. Proceutics' rights and obligations under the lease to Oread were assigned to Alexandria, and CytRx began leasing the building at 154 Technology Parkway from Alexandria. The CytRx lease is for a period of ten years, with base annual rent of $148,500, escalating 4% annually. CytRx will also be responsible for all operating expenses for the property. The Company recorded a gain of $434,000 for the sale of the Proceutics building which was recognized during the second quarter of 1998. A gain of $279,000 on the sale/leaseback of the CytRx building was deferred and will be amortized over the ten year lease period. Vaxcel - During 1998, Vaxcel's Board of Directors retained an investment banking firm to introduce Vaxcel and its technology licenses to the trade with the purpose of concluding a strategic transaction for the benefit of the Vaxcel shareholders. The Company was considering all available options for the disposition of Vaxcel, including license or sale of specific technologies and possible merger with another organization. Based on the results of the investment banking firm's efforts and management's reevaluation of CytRx's strategic direction, in the fourth quarter of 1998 the Company adopted a plan to dispose of the research and development activities in which Vaxcel is engaged. The Company intends to complete the plan during 1999. As a result of adopting such a plan, the operations of Vaxcel are presented as discontinued operations in the consolidated statements of operations. In January 1999, Vaxcel entered into an agreement with a third party giving the third party the option to purchase the rights to certain of its technologies for an aggregate purchase price of $600,000. The third party paid a nonrefundable option fee of $200,000, with an additional $400,000 due upon the exercise of the option. The initial option period expired on March 22, 1999, but was extended to April 1 upon the payment of additional fees by the third party. PRODUCT DEVELOPMENT FLOCOR General. CytRx's human therapeutics product development efforts are focused on critical-care products providing target opportunities for high-value breakthrough products to address unmet medical needs. CytRx's current product development focus is FLOCOR, a novel, intra-vascular agent with pharmacological properties that can be characterized as rheologic, cytoprotective and anti-adhesive / anti-thrombotic. FLOCOR is an intravenous solution that has the unique property of improving blood flow. Extensive preclincial and clinical studies suggest FLOCOR may be of significant benefit in acute ischemic vascular disorders such as stroke, heart attack, and vaso-occlusive crisis of sickle cell disease. FLOCOR may also provide benefit in acute care situations such as circulatory shock and acute respiratory distress syndromes where it's favorable effects on microvascular blood flow may improve recovery from widespread ischemic / reperfusion injury. The active agent in FLOCOR is a highly purified form of poloxamer 188 which is a synthetic block copolymer composed of polyoxyethylene and polyoxypropylene. A commercial grade of poloxamer 188 was originally synthesized in the 1950's as a surfactant / emulsifying agent, and was extensively used as a food additive and excipient in pharmaceutical products. Commercial grade poloxamer 188 has also been extensively used as an anti-hemolytic agent in the priming fluid of cardiopulmonary bypass pump oxygenators. 3 4 The safety profile of FLOCOR is well established. It has been investigated in 13 clinical studies representing administration to more than 2,400 patients and healthy volunteers. A pivotal phase III study investigating FLOCOR for the treatment of acute vaso-occlusive crisis of sickle cell disease is currently in progress. The use of poloxamer 188 as a intravascular therapeutic for obstructive vascular disorders was discovered and patented by CytRx in the mid 1980's. At that time, CytRx utilized a formulation of commercial grade poloxamer 188 which it referred to as RheothRx(R) Copolymer For Injection ("RheothRx"). CytRx began clinical testing on RheothRx in 1989. Following the completion of phase I studies in 1990, CytRx licensed RheothRx to the former Burroughs Wellcome Company on a exclusive world wide basis. Between 1990 and 1996, Burroughs Wellcome conducted nine clinical studies. In phase II studies in sickle cell crisis and acute myocardial infarction (AMI),RheothRx was well tolerated and achieved statistical significance in the primary efficacy endpoints. However, in larger trials in AMI patients, RheothRx was associated with mild to moderate, but reversible elevations in creatinine in a small percentage of patients. The elevations in creatinine resulted in discontinuation of the dose that was effective in phase II studies and the outcome of the larger AMI studies were equivocal. Following the merger between Glaxo and Burroughs Wellcome, Glaxo-Wellcome terminated the license and all rights to RheothRx were returned to CytRx in 1996. Scientists at CytRx discovered that small amounts of impurities present in commercial grade poloxamer 188 (RheothRx) were contributing to the renal toxicity observed in clinical studies. More importantly, CytRx discovered a process for removing the nephrotoxic impurities without altering the beneficial properties of the compound. CytRx refers to the purified form of poloxamer 188 as FLOCOR. When compared in a standard model of renal failure, FLOCOR is 63% less nephrotoxic compared to RheothRx. Consistent with that observation, no elevation in creatinine was observed following 48 hour continuous infusion of FLOCOR in sickle cell patients (n = 15) at doses up to 33% higher than those that were previously discontinued due to elevated creatinine. CytRx believes that the therapeutic index of FLOCOR is significantly improved compared to RheothRx and for this reason, the development of RheothRx was discontinued by CytRx in favor of FLOCOR. CytRx has met with the U.S. Food and Drug Administration concerning the switch from RheothRx to FLOCOR. Specifically, CytRx inquired whether the existing pharmacology, toxicology, and human safety data for RheothRx could be used to support a New Drug Application ("NDA") submission for FLOCOR. CytRx was informed that data generated with RheothRx would support an NDA for FLOCOR. FLOCOR for Sickle Cell Crisis. The Company believes that FLOCOR has significant potential in treating a variety of vascular-occlusive diseases where blood flow is restricted. CytRx has chosen the painful vaso-occlusive crisis associated with sickle cell anemia as its first development priority. Sickle cell disease is an inherited abnormality of hemoglobin, the oxygen-carrying molecule in red blood cells. Under conditions of low blood oxygen, which is generally caused by dehydration or stress, the sickle cell victim's hemoglobin becomes rigid. This causes red blood cells to lose their normal flexibility. The cells become rough, sticky and irregularly shaped, often looking like sickles, which gives the disease its name. Estimates place the number of persons suffering from sickle cell anemia in the U.S. at about 72,000, or roughly one in 400 African-Americans. It is also estimated that complications from sickle cell disease results in healthcare expenditures of from $1.0 to $1.5 billion annually in the U.S. The most common problem sickle cell patients face is episodic pain (also referred to as vaso-occlusive crisis, or VOC). These episodes can last anywhere from five minutes to days or weeks, and can vary significantly in their severity. The deformed sickle cells cannot easily flow through the smaller blood vessels of the body and tend to clump together, forming occlusions which impede blood flow. The occlusions deprive tissues of vital oxygen that can result in tissue death, inflammation and intense throbbing pain. Patients suffering from sickle cell disease may experience several crisis episodes each year. Hospitalization is required when pain becomes too much to bear. There are about 100,000 hospital admissions annually to treat sickle cell patients undergoing acute vascular-occlusive crisis caused by the disease. On average, these patients require in-patient treatment for 7.2 days. Currently there is no effective treatment to alleviate the pain and suffering sickle cell anemia patients in crisis must endure. As there is currently no effective treatment to alleviate the crisis, patients only receive narcotics, fluids and rest. Aside from causing considerable pain and suffering, these crisis episodes slowly destroy vital organs as they are deprived of oxygen. As a result, the life expectancy of sickle cell victims is about twenty years shorter than those without the disease. 4 5 FLOCOR's unique surface-active properties decrease blood viscosity and enable the rigid sickled cells to become more flexible, thus allowing easier passage of blood cells through narrow blood vessels. In a Phase II human clinical trial, FLOCOR demonstrated positive results, reducing the duration of crisis by 16 to 45%, the need for pain medication by 2.8 to 4.3 fold, pain intensity by 40 to 45%, and the duration of hospital stay by 1 to 2 days. CytRx is currently conducting a Phase III double-blind placebo-controlled multicenter trial to assess the efficacy and safety of FLOCOR in vaso-occlusive crisis of sickle cell disease. The trial will involve 224 patients, ages 10 to 65, and is expected to be completed by the end of 1999. In January 1999, the Company announced a favorable review from an independent Safety and Data Monitoring Board following examination of data from the first 50 patients enrolled in the trial. As of March 22, 1999 a total of 129 patients have been enrolled in the trial. The Company is also currently conducting a Phase I study in patients with Acute Chest Syndrome (ACS), a life-threatening condition associated with sickle cell disease, and is planning follow-on studies on the recurrent use of FLOCOR in sickle cell patients. FLOCOR for Other Indications. CytRx believes that FLOCOR has the potential to be an effective treatment for other vascular-occlusive diseases as well. CytRx plans to explore the opportunities with FLOCOR in significant diseases such as Acute Lung Injury (ALI), shock and stroke. However, CytRx's current strategy is to focus its efforts and resources on gaining approval for the acute crisis of sickle cell anemia. Orphan Drug Status. In June 1989, the FDA informed CytRx of its decision to grant RheothRx "Orphan Drug" designation for the treatment of sickle cell crisis and this designation applies to FLOCOR as well. The Orphan Drug Act of 1983, as amended, provides incentive to drug manufacturers to develop drugs for the treatment of rare diseases (e.g. diseases that affect less than 200,000 individuals in the United States, or diseases that affect more than 200,000 individuals in the United States where the sponsor does not reasonably anticipate that its product will become profitable). As a result of the designation of RheothRx/FLOCOR as an Orphan Drug, if the Company is the first manufacturer to obtain FDA approval to market FLOCOR for treatment of sickle cell crisis, the Company will obtain a seven-year period of marketing exclusivity beginning from the date of FLOCOR's approval. During this period, the FDA may not approve the same drug for the same use from another sponsor. In March 1990, RheothRx also received Orphan Drug designation for the treatment of severe burns. Other Product Development Efforts Vaccine Adjuvants / Delivery Systems -- CytRx has discovered the use of certain non-ionic block copolymers (poloxamers) both alone and in a variety of emulsion systems as vaccine delivery systems - immunoadjuvants. The adjuvant-delivery systems have potential for use in both injectable and oral vaccines. CytRx's subsidiary, Vaxcel, has the rights for the human therapeutic use of these compounds while CytRx holds the rights for veterinary use. Anti-Microbial -- CRL-1072 is a highly purified poloxamer that has demonstrated potent activity against a wide range of infectious agents. In animal models of fatal Mycobacterium tuberculosis, Mycobacterium avium, and Toxoplasmosis infection, CRL-1072 results in significantly improved survival rates. More importantly, the compound is active against drug resistant isolates of M.tuberculosis. CRL-1072 has also been shown to reduce viral load and viral reactivation in models of chronic hepatitis B infection. P-Glycoprotein Inhibitor -- CytRx has identified a series of novel non-toxic inhibitors of the drug efflux pump P-glycoprotein. These compounds have potential therapeutic use as (a) chemosensitizers for drug resistant bacteria, (b) oral bioavailability enhancers for antibiotics or chemotherapeutics, and (c) chemosensitizers for drug resistant cancer. Gene Delivery -- CytRx has discovered the use of certain poloxamers for oligionucleotide delivery. Poloxamers are as effective as cationic liposomes but are significantly less toxic and are not metabolized. CytRx believes there is potential use for this technology in (a) gene-based vaccines, (b) gene replacement therapy, and (c) ribozyme and anti-sense delivery. Animal Growth Promotant -- CytRx's growth promotant has been shown to have a consistent effect to improve the rate of weight gain and feed efficiency in well-controlled studies in poultry and swine. 5 6 Expenditures for research and development activities related to continuing operations were $7.3 million, $3.6 million, and $2.0 million during the years ended December 31, 1998, 1997, and 1996, respectively. Products and Services Currently Marketed Titermax(R) - CytRx manufactures, markets and distributes TiterMax, an adjuvant used to produce cell mediated and humoral responses in research animals. The keys to the potency of TiterMax lie in its immunostimulatory activity and the formation of stable water-in-oil emulsions. TiterMax aids in the antigen's effective presentation to the immune system without the toxic effects of other research adjuvants. Spectrum Recruitment Research - CytRx also has a small group of human resource professionals who, in addition to their services to the Company, provide recruiting services to third parties under the name of Spectrum Recruitment Research. MANUFACTURING The Company requires three suppliers of materials or services to manufacture FLOCOR; (i) a supplier of the raw drug substance, (ii) a supplier of the purified drug which is refined from the raw drug substance and (iii) a manufacturer who can formulate and sterile fill the purified drug substance into the finished drug product. The raw drug substance is currently widely available at commercial scales from numerous manufacturers. The Company has not entered into a formal agreement with any supplier for the raw drug substance because of its wide availability. The Company entered into an agreement with a French company to obtain the purified drug substance for use in clinical studies, and is currently negotiating with another supplier for a longer-term commercial supply contract. There can be no assurance that the Company's relationship with such supplier will continue or that the Company will be able to obtain additional purified drug substance if the Company's current supply is inadequate. Such inability to obtain additional purified drug substance in amounts and at prices acceptable to the Company could have a material adverse effect on the Company's business. To meet the need for manufacture of the Company's finished drug product, the Company has entered into a supply agreement with the Hospital Products Division of Abbott Laboratories. The inability of the Company to maintain such relationship on terms acceptable to the Company could have a material adverse effect on the Company's business. Management believes that the Company has an adequate supply of materials on hand to meet the Company's needs for 2 to 3 years (both drug substance and formulated drug product) which management anticipates to be sufficient to complete the anticipated studies necessary for filing an NDA/Product License Application with the FDA. However, there can be no assurance that delays and complications, among other factors, could make the Company's current supply inadequate. If the Company modifies its manufacturing process or changes the source or location of product supply, regulatory authorities will require the Company to demonstrate that the material produced from the modified or new process or facility is equivalent to the material used in the Company's clinical trials. Further, any manufacturing facility and the quality control and manufacturing procedures used by the Company for the commercial supply of a product must comply with applicable Occupational Safety and Health Administration, Environmental Protection Agency, and FDA standards, including Good Manufacturing Practice regulations. See "Government Regulation". PATENTS AND PROPRIETARY TECHNOLOGY The Company actively seeks patent protection for its technologies, processes, uses, and ongoing improvements and considers its patents and other intellectual property to be critical to its business. The Company continually evaluates the patentability of new inventions and improvements developed by its employees and collaborators. Whenever appropriate, the Company will endeavor to file United States and international patent applications to protect these new inventions and improvements. However, there can be no assurance that any of the current pending patent applications or any new patent applications that may be filed will ever be issued in the United States or any other country. The Company also attempts to protect its proprietary products, processes and other information by relying on trade secrets and non-disclosure agreements with its employees, consultants and certain other persons who have access to such products, processes and information. Under the agreements, all inventions conceived by employees are the exclusive property of the Company. Nevertheless, there can be no assurance that these agreements will afford significant protection against misappropriation or unauthorized disclosure of the Company's trade secrets and confidential information. 6 7 COMPETITION Many companies, including large pharmaceutical, chemical and biotechnology firms with financial resources, research and development staffs, and facilities that are substantially greater than those of the Company, are engaged in the research and development of pharmaceutical products that could compete with FLOCOR or other products under development by the Company. The industry is characterized by rapid technological advances and competitors may develop their products more rapidly and/or such products may be more effective than those under development by the Company or its licensees and corporate partners. The Company competes in this research and development environment by attempting to develop its products and technologies in an innovative and timely fashion that would provide the Company with an advantage in the licensing and/or marketing of its products and technologies. GOVERNMENT REGULATION The marketing of pharmaceutical products requires the approval of the FDA and comparable regulatory authorities in foreign countries. The FDA has established guidelines and safety standards which apply to the pre-clinical evaluation, clinical testing, manufacture and marketing of pharmaceutical products. The process of obtaining FDA approval for a new therapeutic product (drug) generally takes several years and involves the expenditure of substantial resources. The steps required before such a product can be produced and marketed for human use in the United States include preclinical studies in animal models, the filing of an Investigational New Drug ("IND") application, human clinical trials and the submission and approval of an NDA. The NDA involves considerable data collection, verification and analysis, as well as the preparation of summaries of the manufacturing and testing processes, preclinical studies, and clinical trials. The FDA must approve the NDA before the drug may be marketed. There can be no assurance that the Company will be able to obtain the required FDA approvals for any of its products. The manufacturing facilities and processes for the Company's products, whether manufactured directly by the Company or by a third party, will be subject to rigorous regulation, including the need to comply with Federal Good Manufacturing Practice regulations. The Company is also subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the Nuclear Energy and Radiation Control Act, the Toxic Substance Control Act and the Resource Conservation and Recovery Act. ENVIRONMENTAL PROTECTION During 1998 compliance with federal, state and local regulations pertaining to environmental standards did not have a material effect upon the capital expenditures or earnings of the Company. EMPLOYEES As of December 31, 1998, the Company had sixteen full-time and four part-time employees, ten of which were directly involved in the conduct of scientific or research and development activities for the Company. ITEM 2. PROPERTIES The Company currently subleases laboratory and related space from Oread at 150 Technology Parkway, Norcross, Georgia, and leases administrative office space from Alexandria at 154 Technology Parkway, Norcross, Georgia. See "Business - New Business Developments." These facilities are in satisfactory condition and suitable for purposes of the Company's present operations. ITEM 3. LEGAL PROCEEDINGS None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 7 8 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is traded on The Nasdaq Stock Market under the symbol CYTR. The following table sets forth the high and low sale prices for the Common Stock for the periods indicated as reported by Nasdaq. Such prices represent prices between dealers without adjustment for retail mark-ups, mark-downs, or commissions and may not necessarily represent actual transactions.
High Low COMMON STOCK: ---------- --------- 1999 January 1 to March 22 3 3/8 1 1998 Fourth Quarter 1 1/4 3/4 Third Quarter 2 1/8 29/32 Second Quarter 3 7/16 2 1/16 First Quarter 3 5/8 2 9/16 1997 Fourth Quarter 5 5/8 2 7/8 Third Quarter 5 3 5/32 Second Quarter 4 1/4 3 1/4 First Quarter 5 3 1/4
On March 22, 1999, the closing price of the Common Stock as reported on The Nasdaq Stock Market, was $2 3/4 and there were approximately 1,500 holders of record of the Company's Common Stock. The number of record holders does not reflect the number of beneficial owners of the Company's Common Stock for whom shares are held by Cede & Co., certain brokerage firms and other institutions. The Company has not paid any dividends since its inception and does not contemplate payment of dividends in the foreseeable future. ITEM 6. SELECTED FINANCIAL DATA Information with respect to this item is incorporated herein by reference from the Company's 1998 Annual Report to Stockholders. The applicable portion of the 1998 Annual Report to Stockholders is included in Exhibit 13.1 to this report. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information with respect to this item is incorporated herein by reference from the Company's 1998 Annual Report to Stockholders. The applicable portion of the 1998 Annual Report to Stockholders is included in Exhibit 13.1 to this report. ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK Information with respect to this item is incorporated herein by reference from "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in the Company's 1998 Annual Report to Stockholders. The applicable portion of the 1998 Annual Report to Stockholders is included in Exhibit 13.1 to this report. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information with respect to this item is incorporated herein by reference from the Company's 1998 Annual Report to Stockholders. The applicable portion of the 1998 Annual Report to Stockholders is included in Exhibit 13.1 to this report. 8 9 ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information with respect to this item is incorporated herein by reference from the Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION Information with respect to this item is incorporated herein by reference from the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information with respect to this item is incorporated herein by reference from the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Documents filed as part of this 10-K: 1. Financial Statements The financial statements listed below are incorporated by reference from the Company's 1998 Annual Report to Stockholders: Consolidated Balance Sheets as of December 31, 1998 and 1997 Consolidated Statements of Operations for the Years Ended December 31, 1998, 1997 and 1996 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1996, 1997 and 1998 Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements Report of Independent Auditors 2. Financial Statement Schedules: Schedule II - Valuation and Qualifying Accounts for the years ended December 31, 1998, 1997 and 1996 9 10 All other schedules are omitted because they are not required, not applicable, or the information is provided in the financial statements or notes thereto. 3. Exhibits required by Item 601 of Regulation S-K: See Exhibit Index on page 11 of this Form 10-K. (b) Reports on Form 8-K: None 10 11 CYTRX CORPORATION FORM 10-K EXHIBIT INDEX
Exhibit Number ------- 2.1 Agreement and Plan of Merger and Contribution dated as of December 6, 1996, among CytRx Corporation, Vaxcel, Inc., Vaxcel Merger Subsidiary, Inc. and Zynaxis, Inc. (a) 2.2 Preferred Stock and Warrant Agreement dated as of December 6, 1996, among CytRx Corporation, Zynaxis, Inc., Vaxcel, Inc. and each of the holders of Zynaxis, Inc. warrants signatory thereto (a) 3.1 Certificate of Incorporation (c) 3.2 By-Laws (d) 4.1 Shareholder Protection Rights Agreement dated April 16, 1997 between CytRx Corporation and American Stock Transfer & Trust Company as Rights Agent (e) 4.2 CytRx Corporation Stock Purchase Warrants dated as of October 22, 1997 in favor of various investors (b) 10.1 Agreement with Emory University, as amended (f) 10.2 Agreement with BASF Corporation, as amended (f) 10.3 * 1995 Employment Agreement between CytRx Corporation and Jack J. Luchese (l) 10.4 * Amendment No. 1 to 1995 Employment Agreement between CytRx Corporation and Jack J. Luchese (g) 10.5 * Amendment No. 2 to 1995 Employment Agreement between CytRx Corporation and Jack J. Luchese (h) 10.6 * Change of Control Employment Agreement between CytRx Corporation and Jack J. Luchese (h) 10.7 * 1986 Stock Option Plan, as amended and restated (i) 10.8 * 1994 Stock Option Plan, as amended and restated (h) 10.9 * 1995 Stock Option Plan (j) 10.10 * 1998 Long-Term Incentive Plan 10.11 Asset Purchase Agreement dated February 10, 1998 by and between Proceutics, Inc. and Oread Laboratories, Inc. (l) 10.12 Sublease Agreement dated February 16, 1998 by and between CytRx Corporation and Oread, Inc. (l) 10.13 Purchase and Sale Agreement dated February 23, 1998 by and between CytRx Corporation and Alexandria Real Estate Equities, Inc. (l) 10.14 Purchase and Sale Agreement dated February 23, 1998 by and between Proceutics, Inc. and Alexandria Real Estate Equities, Inc. (l) 10.15 Acquisition Agreement dated April 17, 1998 by and among CytRx, VetLife, Inc. and VetLife, L.L.C. (k) 13.1 Selected Portions of the 1998 CytRx Corporation Annual Report to Shareholders 21.1 Subsidiaries of Registrant 23.1 Consent of Ernst & Young LLP 27.1 Financial Data Schedule (for SEC use only). 27.2 Financial Data Schedule - 1996 Restatement (for SEC use only). 27.3 Financial Data Schedule - 1997 Restatement (for SEC use only). 99.1 Safe Harbor Compliance Statement for Forward-looking Statements
*Indicates a management contract or compensatory plan or arrangement. - ------------------- (a) Incorporated by reference to the Registrant's Current Report on Form 8-K filed on December 6, 1996. (b) Incorporated by reference to the Registrant's Current Report on Form 8-K filed on November 6, 1997. (c) Incorporated by reference to the Registrant's Registration Statement on Form S-3 (File No. 333-39607) filed on November 5, 1997. 11 12 (d) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 333-37171) filed on July 21, 1997. (e) Incorporated by reference to the Registrant's Current Report on Form 8-K filed on April 21, 1997. (f) Incorporated by reference to the Registrant's Registration Statement on Form S-l (File No. 33-8390) filed on November 5, 1986. (g) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q filed on August 14, 1997. (h) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q filed on November 13, 1997. (i) Incorporated by reference to the Registrant's Annual Report on Form 10-K filed on March 27, 1996. (j) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 33-93818) filed on June 22, 1995. (k) Incorporated by reference to the Registrant's Current Report on Form 8-K filed on May 1, 1998. (l) Incorporated by reference to the Registrant's Annual Report on Form 10-K filed on March 30, 1998. 12 13 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. CYTRX CORPORATION By: /s/ Jack J. Luchese -------------------------- Jack J. Luchese, President Date: March 30, 1999 and Chief Executive Officer (Principal Executive Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ---- /s/ Jack L. Bowman Director March 30, 1999 - ------------------------------ Jack L. Bowman /s/ Raymond C. Carnahan, Jr. Director March 30, 1999 - ------------------------------ Raymond C. Carnahan, Jr. /s/ Lyle A. Hohnke Director March 30, 1999 - ------------------------------ Lyle A. Hohnke /s/ Max Link Chairman of the March 30, 1999 - ------------------------------ Board of Directors Max Link /s/ Jack J. Luchese Director March 30, 1999 - ------------------------------ President and Chief Executive Officer Jack J. Luchese (Principal Executive Officer) /s/ Herbert H. McDade, Jr. Director March 30, 1999 - ------------------------------ Herbert H. McDade, Jr. /s/ Mark W. Reynolds Chief Financial Officer March 30, 1999 - ------------------------------- (Principal Financial Officer) Mark W. Reynolds
13 14 CYTRX CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Additions --------------------------- Balance at Charged to Charged to Balance at Beginning Costs and Other End Description of Period Expenses Accounts Deductions of Period - -------------------------------------- ------------ ------------ ----------- ------------ ------------- Reserve Deducted in the Balance Sheet from the Asset to Which it Applies: Allowance for Bad Debts Year ended December 31, 1998 $ 22,187 $ -- $ -- $ 22,187 $ -- Year ended December 31, 1997 48,430 44,850 -- 71,093 22,187 Year ended December 31, 1996 -- 2,516 45,914 -- 48,430 Allowance for Deferred Tax Assets Year ended December 31, 1998 $ 17,684,000 $3,085,000 $ $ $ 20,769,000 Year ended December 31, 1997 15,200,000 2,484,000 -- -- 17,684,000 Year ended December 31, 1996 13,600,000 1,600,000 -- -- 15,200,000
14 EX-10.10 2 1998 LONG TERM INCENTIVE PLAN 1 EXHIBIT 10.10 CYTRX CORPORATION 1998 LONG-TERM INCENTIVE PLAN 2 CYTRX CORPORATION 1998 LONG-TERM INCENTIVE PLAN ARTICLE I PURPOSE 1.1 GENERAL. The purpose of the CytRx Corporation 1998 Long-Term Incentive Plan (the "Plan") is to promote the success, and enhance the value, of CytRx Corporation (the "Corporation"), by linking the personal interests of its employees, officers, consultants and directors to those of Corporation shareholders and by providing such persons with an incentive for outstanding performance. The Plan is further intended to provide flexibility to the Corporation in its ability to motivate, attract, and retain the services of employees, officers, consultants and directors upon whose judgment, interest, and special effort the successful conduct of the Corporation's operation is largely dependent. Accordingly, the Plan permits the grant of incentive awards from time to time to selected employees, officers, consultants and directors. ARTICLE 2 EFFECTIVE DATE 2.1 EFFECTIVE DATE. The Plan shall be effective as of the date upon which it shall be approved by the Board. However, the Plan shall be submitted to the shareholders of the Corporation for approval within 12 months of the Board's approval thereof. No Incentive Stock Options granted under the Plan may be exercised prior to approval of the Plan by the shareholders and if the shareholders fail to approve the Plan within 12 months of the Board's approval thereof, any Incentive Stock Options previously granted hereunder shall be automatically converted to Non-Qualified Stock Options without any further act. In the discretion of the Committee, Awards may be made to Covered Employees which are intended to constitute qualified performance-based compensation under Code Section 162(m). Any such Awards shall be contingent upon the shareholders having approved the Plan. ARTICLE 3 DEFINITIONS 3.1 DEFINITIONS. When a word or phrase appears in this Plan with the initial letter capitalized, and the word or phrase does not commence a sentence, the word or phrase shall generally be given the meaning ascribed to it in this Section or in Section 1.1 unless a clearly different meaning is required by the context. The following words and phrases shall have the following meanings: (a) "Award" means any Option, Stock Appreciation Right, Restricted Stock Award, Performance Unit Award, Dividend Equivalent Award, or Other Stock-Based Award, or any other right or interest relating to Stock or cash, granted to a Participant under the Plan. -2- 3 (b) "Award Agreement" means any written agreement, contract, or other instrument or document evidencing an Award. (c) "Board" means the Board of Directors of the Corporation. (d) "Change in Control" means and includes each of the following: (1) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Exchange Act) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 25% or more of the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); provided, however, that for purposes of this subsection (1), the following acquisitions shall not constitute a Change of Control: (i) any acquisition by a Person who is on April 1, 1998 the beneficial owner of 25% or more of the Outstanding Company Voting Securities, (ii) any acquisition directly from the Company, (iii) any acquisition by the Company, (iv) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company, or (v) any acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (3) of this definition; or (2) Individuals who, as of April 1, 1998, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to April 1, 1998 whose election, or nomination for election by the Company's stockholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (3) Consummation of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial owners of the Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 60% of the combined -3- 4 voting power of the then outstanding voting securities entitled to vote generally in the election of directors of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Voting Securities, and (ii) no Person (excluding any corporation resulting from such Business Combination or any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 25% or more of the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination, and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (4) Approval by the stockholders of the Company of a complete liquidation or dissolution of the Company. (e) "Code" means the Internal Revenue Code of 1986, as amended from time to time. (f) "Committee" means the committee of the Board described in Article 4. (g) "Corporation" means CytRx Corporation, a Delaware corporation. (h) "Covered Employee" means a covered employee as defined in Code Section 162(m)(3). (i) "Disability" shall mean any illness or other physical or mental condition of a Participant that renders the Participant incapable of performing his customary and usual duties for the Corporation, or any medically determinable illness or other physical or mental condition resulting from a bodily injury, disease or mental disorder which, in the judgment of the Committee, is permanent and continuous in nature. The Committee may require such medical or other evidence as it deems necessary to judge the nature and permanency of the Participant's condition. (j) "Dividend Equivalent" means a right granted to a Participant under Article 11. -4- 5 (k) "Effective Date" has the meaning assigned such term in Section 2.1. (l) "Fair Market Value", on any date, means (i) if the Stock is listed on a securities exchange or is traded over the Nasdaq National Market, the closing sales price on such exchange or over such system on such date or, in the absence of reported sales on such date, the closing sales price on the immediately preceding date on which sales were reported, or (ii) if the Stock is not listed on a securities exchange or traded over the Nasdaq National Market, the mean between the bid and offered prices as quoted by Nasdaq for such date, provided that if it is determined that the fair market value is not properly reflected by such Nasdaq quotations, Fair Market Value will be determined by such other method as the Committee determines in good faith to be reasonable. (m) "Incentive Stock Option" means an Option that is intended to meet the requirements of Section 422 of the Code or any successor provision thereto. (n) "Non-Qualified Stock Option" means an Option that is not an Incentive Stock Option. (o) "Option" means a right granted to a Participant under Article 7 of the Plan to purchase Stock at a specified price during specified time periods. An Option may be either an Incentive Stock Option or a Non-Qualified Stock Option. (p) "Other Stock-Based Award" means a right, granted to a Participant under Article 12, that relates to or is valued by reference to Stock or other Awards relating to Stock. (q) "Parent" means a corporation which owns or beneficially owns a majority of the outstanding voting stock or voting power of the Corporation. For Incentive Stock Options, the term shall have the same meaning as set forth in Code Section 424(e). (r) "Participant" means a person who, as an employee, officer, consultant or director of the Corporation or any Subsidiary, has been granted an Award under the Plan. (s) "Performance Unit" means a right granted to a Participant under Article 9, to receive cash, Stock, or other Awards, the payment of which is contingent upon achieving certain performance goals established by the Committee. (t) "Plan" means the CytRx Corporation 1998 Long-Term Incentive Plan, as amended from time to time. -5- 6 (u) "Restricted Stock Award" means Stock granted to a Participant under Article 10 that is subject to certain restrictions and to risk of forfeiture. (v) "Retirement" means a Participant's voluntary termination of employment with the Corporation, Parent or Subsidiary after attaining age 55. (w) "Stock" means the $0.001 par value common stock of the Corporation and such other securities of the Corporation as may be substituted for Stock pursuant to Article 14. (x) "Stock Appreciation Right" or "SAR" means a right granted to a Participant under Article 8 to receive a payment equal to the difference between the Fair Market Value of a share of Stock as of the date of exercise of the SAR over the grant price of the SAR, all as determined pursuant to Article 8. (y) "Subsidiary" means any corporation, limited liability company, partnership or other entity of which a majority of the outstanding voting stock or voting power is beneficially owned directly or indirectly by the Corporation. For Incentive Stock Options, the term shall have the meaning set forth in Code Section 424(f). (z) "1933 Act" means the Securities Act of 1933, as amended from time to time. (z) "1934 Act" means the Securities Exchange Act of 1934, as amended from time to time. ARTICLE 4 ADMINISTRATION 4.1 COMMITTEE. The Plan shall be administered by the Compensation Committee of the Board or, at the discretion of the Board from time to time, by the Board. The Committee shall consist of two or more members of the Board. It is intended that the directors appointed to serve on the Committee shall be "non-employee directors" (within the meaning of Rule 16b-3 promulgated under the 1934 Act) and "outside directors" (within the meaning of Code Section 162(m) and the regulations thereunder) to the extent that Rule 16b-3 and, if necessary for relief from the limitation under Code Section 162(m) and such relief is sought by the Company, Code Section 162(m), respectively, are applicable. However, the mere fact that a Committee member shall fail to qualify under either of the foregoing requirements shall not invalidate any Award made by the Committee which Award is otherwise validly made under the Plan. The members of the Committee shall be appointed by, and may be changed at any time and from time to time in the discretion of, the Board. During any time that the Board is acting as administrator of the Plan, it shall have all the powers of the Committee hereunder, and any reference herein to the Committee (other than in this Section 4.1) shall include the Board. -6- 7 4.2 ACTION BY THE COMMITTEE. For purposes of administering the Plan, the following rules of procedure shall govern the Committee. A majority of the Committee shall constitute a quorum. The acts of a majority of the members present at any meeting at which a quorum is present, and acts approved unanimously in writing by the members of the Committee in lieu of a meeting, shall be deemed the acts of the Committee. Each member of the Committee is entitled to, in good faith, rely or act upon any report or other information furnished to that member by any officer or other employee of the Corporation or any Parent or Subsidiary, the Corporation's independent certified public accountants, or any executive compensation consultant or other professional retained by the Corporation to assist in the administration of the Plan. 4.3 AUTHORITY OF COMMITTEE. The Committee has the exclusive power, authority and discretion to: (a) Designate Participants; (b) Determine the type or types of Awards to be granted to each Participant; (c) Determine the number of Awards to be granted and the number of shares of Stock to which an Award will relate; (d) Determine the terms and conditions of any Award granted under the Plan, including but not limited to, the exercise price, grant price, or purchase price, any restrictions or limitations on the Award, any schedule for lapse of forfeiture restrictions or restrictions on the exercisability of an Award, and accelerations or waivers thereof, based in each case on such considerations as the Committee in its sole discretion determines; (e) Accelerate the vesting or lapse of restrictions of any outstanding Award, based in each case on such considerations as the Committee in its sole discretion determines; (f) Determine whether, to what extent, and under what circumstances an Award may be settled in, or the exercise price of an Award may be paid in, cash, Stock, other Awards, or other property, or an Award may be canceled, forfeited, or surrendered; (g) Prescribe the form of each Award Agreement, which need not be identical for each Participant; -7- 8 (h) Decide all other matters that must be determined in connection with an Award; (i) Establish, adopt or revise any rules and regulations as it may deem necessary or advisable to administer the Plan; (j) Make all other decisions and determinations that may be required under the Plan or as the Committee deems necessary or advisable to administer the Plan; and (k) Amend the Plan or any Award Agreement as provided herein. 4.4. DECISIONS BINDING. The Committee's interpretation of the Plan, any Awards granted under the Plan, any Award Agreement and all decisions and determinations by the Committee with respect to the Plan are final, binding, and conclusive on all parties. ARTICLE 5 SHARES SUBJECT TO THE PLAN 5.1. NUMBER OF SHARES. Subject to adjustment as provided in Section 14.1, the aggregate number of shares of Stock reserved and available for Awards or which may be used to provide a basis of measurement for or to determine the value of an Award (such as with a Stock Appreciation Right or Performance Unit Award) shall be 500,000, of which not more than 10% may be granted as Awards of Restricted Stock or unrestricted Stock Awards. 5.2. LAPSED AWARDS. To the extent that an Award is canceled, terminates, expires or lapses for any reason, any shares of Stock subject to the Award will again be available for the grant of an Award under the Plan and shares subject to SARs or other Awards settled in cash will be available for the grant of an Award under the Plan. 5.3. STOCK DISTRIBUTED. Any Stock distributed pursuant to an Award may consist, in whole or in part, of authorized and unissued Stock, treasury Stock or Stock purchased on the open market. 5.4. LIMITATION ON AWARDS. Notwithstanding any provision in the Plan to the contrary, the maximum number of shares of Stock with respect to one or more Options and/or SARs that may be granted during any one calendar year under the Plan to any one Covered Employee shall be 175,000. The maximum fair market value (measured as of the date of grant) of any Awards other than Options and SARs that may be received by a Covered Employee (less any consideration paid by the Participant for such Award) during any one calendar year under the Plan shall be $500,000. -8- 9 ARTICLE 6 ELIGIBILITY 6.1. GENERAL. Awards may be granted only to individuals who are employees, officers, consultants or directors of the Corporation or a Parent or Subsidiary. ARTICLE 7 STOCK OPTIONS 7.1. GENERAL. The Committee is authorized to grant Options to Participants on the following terms and conditions: (a) EXERCISE PRICE. The exercise price per share of Stock under an Option shall be determined by the Committee, provided that the exercise price for any Incentive Stock Option shall not be less than the Fair Market Value as of the date of the grant. (b) TIME AND CONDITIONS OF EXERCISE. The Committee shall determine the time or times at which an Option may be exercised in whole or in part. The Committee also shall determine the performance or other conditions, if any, that must be satisfied before all or part of an Option may be exercised. The Committee may waive any exercise provisions at any time in whole or in part based upon factors as the Committee may determine in its sole discretion so that the Option becomes exerciseable at an earlier date. (c) PAYMENT. The Committee shall determine the methods by which the exercise price of an Option may be paid, the form of payment, including, without limitation, cash, shares of Stock, or other property (including "cashless exercise" arrangements), and the methods by which shares of Stock shall be delivered or deemed to be delivered to Participants; provided that if shares of Stock surrendered in payment of the exercise price were themselves acquired otherwise than on the open market, such shares shall have been held by the Participant for at least six months. (d) EVIDENCE OF GRANT. All Options shall be evidenced by a written Award Agreement between the Corporation and the Participant. The Award Agreement shall include such provisions, not inconsistent with the Plan, as may be specified by the Committee. 7.2. INCENTIVE STOCK OPTIONS. The terms of any Incentive Stock Options granted under the Plan must comply with the following additional rules: (a) EXERCISE PRICE. The exercise price per share of Stock shall be set by the Committee, provided that the exercise price for any Incentive Stock Option shall not be less than the Fair Market Value as of the date of the grant. -9- 10 (b) EXERCISE. In no event may any Incentive Stock Option be exercisable for more than ten years from the date of its grant. (c) LAPSE OF OPTION. An Incentive Stock Option shall lapse under the earliest of the following circumstances; provided, however, that the Committee may, prior to the lapse of the Incentive Stock Option under the circumstances described in paragraphs (3), (4) and (5) below, provide in writing that the Option will extend until a later date, but if Option is exercised after the dates specified in paragraphs (3), (4) and (5) below, it will automatically become a Non-Qualified Stock Option: (1) The Incentive Stock Option shall lapse as of the option expiration date set forth in the Award Agreement. (2) The Incentive Stock Option shall lapse ten years after it is granted, unless an earlier time is set in the Award Agreement. (3) If the Participant terminates employment for any reason other than as provided in paragraph (4) or (5) below, the Incentive Stock Option shall lapse, unless it is previously exercised, three months after the Participant's termination of employment; provided, however, that if the Participant's employment is terminated by the Company for cause or by the Participant without the consent of the Company, the Incentive Stock Option shall (to the extent not previously exercised) lapse immediately. (4) If the Participant terminates employment by reason of his Disability, the Incentive Stock Option shall lapse, unless it is previously exercised, one year after the Participant's termination of employment. (5) If the Participant dies while employed, or during the three-month period described in paragraph (3) or during the one-year period described in paragraph (4) and before the Option otherwise lapses, the Option shall lapse one year after the Participant's death. Upon the Participant's death, any exercisable Incentive Stock Options may be exercised by the Participant's beneficiary, determined in accordance with Section 13.6. If a Participant exercises an Option after termination of employment, the Option may be exercised only with respect to the shares that were otherwise vested on the Participant's termination of employment. (d) INDIVIDUAL DOLLAR LIMITATION. The aggregate Fair Market Value (determined as of the time an Award is made) of all shares of Stock -10- 11 with respect to which Incentive Stock Options are first exercisable by a Participant in any calendar year may not exceed $100,000.00. (e) TEN PERCENT OWNERS. No Incentive Stock Option shall be granted to any individual who, at the date of grant, owns stock possessing more than ten percent of the total combined voting power of all classes of stock of the Corporation or any Parent or Subsidiary unless the exercise price per share of such Option is at least 110% of the Fair Market Value per share of Stock at the date of grant and the Option expires no later than five years after the date of grant. (f) EXPIRATION OF INCENTIVE STOCK OPTIONS. No Award of an Incentive Stock Option may be made pursuant to the Plan after the day immediately prior to the tenth anniversary of the Effective Date. (g) RIGHT TO EXERCISE. During a Participant's lifetime, an Incentive Stock Option may be exercised only by the Participant or, in the case of the Participant's Disability, by the Participant's guardian or legal representative. (h) DIRECTORS. The Committee may not grant an Incentive Stock Option to a non-employee director. The Committee may grant an Incentive Stock Option to a director who is also an employee of the Corporation or Parent or Subsidiary but only in that individual's position as an employee and not as a director. ARTICLE 8 STOCK APPRECIATION RIGHTS 8.1. GRANT OF SARs. The Committee is authorized to grant SARs to Participants on the following terms and conditions: (a) RIGHT TO PAYMENT. Upon the exercise of a Stock Appreciation Right, the Participant to whom it is granted has the right to receive the excess, if any, of: (1) The Fair Market Value of one share of Stock on the date of exercise; over (2) The grant price of the Stock Appreciation Right as determined by the Committee, which shall not be less than the Fair Market Value of one share of Stock on the date of grant. (b) OTHER TERMS. All awards of Stock Appreciation Rights shall be evidenced by an Award Agreement. The terms, methods of exercise, methods of settlement, form of consideration payable in settlement, and any other terms and conditions of any Stock Appreciation Right shall be determined by the Committee at the time of the grant of the Award and shall be reflected in the Award Agreement. -11- 12 ARTICLE 9 PERFORMANCE UNITS 9.1. GRANT OF PERFORMANCE UNITS. The Committee is authorized to grant Performance Units to Participants on such terms and conditions as may be selected by the Committee. The Committee shall have the complete discretion to determine the number of Performance Units granted to each Participant. All Awards of Performance Units shall be evidenced by an Award Agreement. 9.2. RIGHT TO PAYMENT. A grant of Performance Units gives the Participant rights, valued as determined by the Committee, and payable to, or exercisable by, the Participant to whom the Performance Units are granted, in whole or in part, as the Committee shall establish at grant or thereafter. The Committee shall set performance goals and other terms or conditions to payment of the Performance Units in its discretion which, depending on the extent to which they are met, will determine the number and value of Performance Units that will be paid to the Participant. 9.3. OTHER TERMS. Performance Units may be payable in cash, Stock, or other property, and have such other terms and conditions as determined by the Committee and reflected in the Award Agreement. ARTICLE 10 RESTRICTED STOCK AWARDS 10.1. GRANT OF RESTRICTED STOCK. The Committee is authorized to make Awards of Restricted Stock to Participants in such amounts and subject to such terms and conditions as may be selected by the Committee. All Awards of Restricted Stock shall be evidenced by a Restricted Stock Award Agreement. 10.2. ISSUANCE AND RESTRICTIONS. Restricted Stock shall be subject to such restrictions on transferability and other restrictions as the Committee may impose (including, without limitation, limitations on the right to vote Restricted Stock or the right to receive dividends on the Restricted Stock). These restrictions may lapse separately or in combination at such times, under such circumstances, in such installments, upon the satisfaction of performance goals or otherwise, as the Committee determines at the time of the grant of the Award or thereafter. 10.3. FORFEITURE. Except as otherwise determined by the Committee at the time of the grant of the Award or thereafter, upon termination of employment during the applicable restriction period or upon failure to satisfy a performance goal during the applicable restriction period, Restricted Stock that is at that time subject to restrictions shall be forfeited and reacquired by the Corporation; provided, however, that the -12- 13 Committee may provide in any Award Agreement that restrictions or forfeiture conditions relating to Restricted Stock will be waived in whole or in part in the event of terminations resulting from specified causes, and the Committee may in other cases waive in whole or in part restrictions or forfeiture conditions relating to Restricted Stock. 10.4. CERTIFICATES FOR RESTRICTED STOCK. Restricted Stock granted under the Plan may be evidenced in such manner as the Committee shall determine. If certificates representing shares of Restricted Stock are registered in the name of the Participant, certificates must bear an appropriate legend referring to the terms, conditions, and restrictions applicable to such Restricted Stock. ARTICLE 11 DIVIDEND EQUIVALENTS 11.1 GRANT OF DIVIDEND EQUIVALENTS. The Committee is authorized to grant Dividend Equivalents to Participants subject to such terms and conditions as may be selected by the Committee. Dividend Equivalents shall entitle the Participant to receive payments equal to dividends with respect to all or a portion of the number of shares of Stock subject to an Award, as determined by the Committee. The Committee may provide that Dividend Equivalents be paid or distributed when accrued or be deemed to have been reinvested in additional shares of Stock, or otherwise reinvested. ARTICLE 12 OTHER STOCK-BASED AWARDS 12.1. GRANT OF OTHER STOCK-BASED AWARDS. The Committee is authorized, subject to limitations under applicable law, to grant to Participants such other Awards that are payable in, valued in whole or in part by reference to, or otherwise based on or related to shares of Stock, as deemed by the Committee to be consistent with the purposes of the Plan, including without limitation shares of Stock awarded purely as a "bonus" and not subject to any restrictions or conditions, convertible or exchangeable debt securities, other rights convertible or exchangeable into shares of Stock, and Awards valued by reference to book value of shares of Stock or the value of securities of or the performance of specified Parents or Subsidiaries. The Committee shall determine the terms and conditions of such Awards. ARTICLE 13 PROVISIONS APPLICABLE TO AWARDS 13.1. STAND-ALONE, TANDEM, AND SUBSTITUTE AWARDS. Awards granted under the Plan may, in the discretion of the Committee, be granted either alone or in addition to, in tandem with, or in substitution for, any other Award granted under the Plan. If an Award is granted in substitution for another Award, the Committee may require the surrender of such other Award in consideration of the grant of the new Award. Awards granted in addition to or in tandem with other Awards may be granted either at the same time as or at a different time from the grant of such other Awards. -13- 14 13.2. EXCHANGE PROVISIONS. The Committee may at any time offer to exchange or buy out any previously granted Award for a payment in cash, Stock, or another Award (subject to Section 14.1), based on the terms and conditions the Committee determines and communicates to the Participant at the time the offer is made. 13.3. TERM OF AWARD. The term of each Award shall be for the period as determined by the Committee, provided that in no event shall the term of any Incentive Stock Option or a Stock Appreciation Right granted in tandem with the Incentive Stock Option exceed a period of ten years from the date of its grant (or, if Section 7.2(e) applies, five years from the date of its grant). 13.4. FORM OF PAYMENT FOR AWARDS. Subject to the terms of the Plan and any applicable law or Award Agreement, payments or transfers to be made by the Corporation or a Parent or Subsidiary on the grant or exercise of an Award may be made in such form as the Committee determines at or after the time of grant, including without limitation, cash, Stock, other Awards, or other property, or any combination, and may be made in a single payment or transfer, in installments, or on a deferred basis, in each case determined in accordance with rules adopted by, and at the discretion of, the Committee. 13.5. LIMITS ON TRANSFER. No right or interest of a Participant in any unexercised or restricted Award may be pledged, encumbered, or hypothecated to or in favor of any party other than the Corporation or a Parent or Subsidiary, or shall be subject to any lien, obligation, or liability of such Participant to any other party other than the Corporation or a Parent or Subsidiary. No unexercised or restricted Award shall be assignable or transferable by a Participant other than by will or the laws of descent and distribution or, except in the case of an Incentive Stock Option, pursuant to a domestic relations order that would satisfy Section 414(p)(1)(A) of the Code if such Section applied to an Award under the Plan; provided, however, that the Committee may (but need not) permit other transfers where the Committee concludes that such transferability (i) does not result in accelerated taxation, (ii) does not cause any Option intended to be an incentive stock option to fail to be described in Code Section 422(b), and (iii) is otherwise appropriate and desirable, taking into account any factors deemed relevant, including without limitation, any state or federal tax or securities laws or regulations applicable to transferable Awards. 13.6 BENEFICIARIES. Notwithstanding Section 13.5, a Participant may, in the manner determined by the Committee, designate a beneficiary to exercise the rights of the Participant and to receive any distribution with respect to any Award upon the Participant's death. A beneficiary, legal guardian, legal representative, or other person claiming any rights under the Plan is subject to all terms and conditions of the Plan and any Award Agreement applicable to the Participant, except to the extent the Plan and Award Agreement otherwise provide, and to any additional restrictions deemed necessary or appropriate by the Committee. If no beneficiary has been designated or survives the Participant, payment shall be made to the Participant's estate. Subject to the foregoing, a -14- 15 beneficiary designation may be changed or revoked by a Participant at any time provided the change or revocation is filed with the Committee. 13.7. STOCK CERTIFICATES. All Stock certificates delivered under the Plan are subject to any stop-transfer orders and other restrictions as the Committee deems necessary or advisable to comply with federal or state securities laws, rules and regulations and the rules of any national securities exchange or automated quotation system on which the Stock is listed, quoted, or traded. The Committee may place legends on any Stock certificate to reference restrictions applicable to the Stock. 13.8. ACCELERATION UPON A CHANGE IN CONTROL. Except as otherwise provided in the Award Agreement, upon the occurrence of a Change in Control, all outstanding Options, Stock Appreciation Rights, and other Awards in the nature of rights that may be exercised shall become fully exercisable and all restrictions on outstanding Awards shall lapse; provided, however that such acceleration will not occur if, in the opinion of the Company's accountants, such acceleration would preclude the use of "pooling of interest" accounting treatment for a Change in Control transaction that (a) would otherwise qualify for such accounting treatment, and (b) is contingent upon qualifying for such accounting treatment. To the extent that this provision causes Incentive Stock Options to exceed the dollar limitation set forth in Section 7.2(d), the excess Options shall be deemed to be Non-Qualified Stock Options. 13.9. ACCELERATION UPON CERTAIN EVENTS NOT CONSTITUTING A CHANGE IN CONTROL. In the event of the occurrence of any circumstance, transaction or event not constituting a Change in Control (as defined in Section 3.1) but which the Board of Directors deems to be, or to be reasonably likely to lead to, an effective change in control of the Company of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of the 1934 Act, the Committee may in its sole discretion declare all outstanding Options, Stock Appreciation Rights, and other Awards in the nature of rights that may be exercised to be fully exercisable, and/or all restrictions on all outstanding Awards to have lapsed, in each case, as of such date as the Committee may, in its sole discretion, declare, which may be on or before the consummation of such transaction or event. To the extent that this provision causes Incentive Stock Options to exceed the dollar limitation set forth in Section 7.2(d), the excess Options shall be deemed to be Non-Qualified Stock Options. 13.10. ACCELERATION FOR ANY OTHER REASON. Regardless of whether an event has occurred as described in Section 13.8 or 13.9 above, the Committee may in its sole discretion at any time determine that all or a portion of a Participant's Options, Stock Appreciation Rights, and other Awards in the nature of rights that may be exercised shall become fully or partially exercisable, and/or that all or a part of the restrictions on all or a portion of the outstanding Awards shall lapse, in each case, as of such date as the Committee may, in its sole discretion, declare. The Committee may discriminate among Participants and among Awards granted to a Participant in exercising its discretion pursuant to this Section 13.10. -15- 16 13.11 EFFECT OF ACCELERATION. If an Award is accelerated under Section 13.8 or 13.9, the Committee may, in its sole discretion, provide (i) that the Award will expire after a designated period of time after such acceleration to the extent not then exercised, (ii) that the Award will be settled in cash rather than Stock, (iii) that the Award will be assumed by another party to the transaction giving rise to the acceleration or otherwise be equitably converted in connection with such transaction, or (iv) any combination of the foregoing. The Committee's determination need not be uniform and may be different for different Participants whether or not such Participants are similarly situated. 13.12. PERFORMANCE GOALS. The Committee may (but need not) determine that any Award granted pursuant to this Plan to a Participant (including, but not limited to, Participants who are Covered Employees) shall be determined solely on the basis of (a) the achievement by the Corporation or a Parent or Subsidiary of a specified target return, or target growth in return, on equity or assets, (b) the Corporation's, Parent's or Subsidiary's stock price, (c) the achievement by an individual or a business unit of the Corporation, Parent or Subsidiary of a specified target, or target growth in, revenues, net income or earnings per share, (d) the achievement of objectively determinable goals with respect to (i) product development milestones, (ii) corporate financings, (iii) merger and acquisition activities, (iv) licensing transactions, (v) development of strategic partnerships or alliances, or (vi) acquisition or development of new technologies, or (e) any combination of the goals set forth in (a) through (d) above. If an Award is made on such basis, the Committee shall establish goals prior to the beginning of the period for which such performance goal relates (or such later date as may be permitted under Code Section 162(m) or the regulations thereunder) and the Committee may for any reason reduce (but not increase) any Award, notwithstanding the achievement of a specified goal. Any payment of an Award granted with performance goals shall be conditioned on the written certification of the Committee in each case that the performance goals and any other material conditions were satisfied. 13.13. TERMINATION OF EMPLOYMENT. Whether military, government or other service or other leave of absence shall constitute a termination of employment shall be determined in each case by the Committee at its discretion, and any determination by the Committee shall be final and conclusive. A termination of employment shall not occur in a circumstance in which a Participant transfers from the Corporation to one of its Parents or Subsidiaries, transfers from a Parent or Subsidiary to the Corporation, or transfers from one Parent or Subsidiary to another Parent or Subsidiary. ARTICLE 14 CHANGES IN CAPITAL STRUCTURE 14.1. GENERAL. In the event a stock dividend is declared upon the Stock, the shares of Stock then subject to each Award shall be increased proportionately without any change in the aggregate purchase price therefor. In the event the Stock shall be changed -16- 17 into or exchanged for a different number or class of shares of stock or securities of the Corporation or of another corporation, whether through reorganization, recapitalization, reclassification, stock split-up, combination of shares, merger or consolidation, there shall be substituted for each such share of Stock then subject to each Award the number and class of shares into which each outstanding share of Stock shall be so exchanged, all without any change in the aggregate purchase price for the shares then subject to each Award. ARTICLE 15 AMENDMENT, MODIFICATION AND TERMINATION 15.1. AMENDMENT, MODIFICATION AND TERMINATION. The Board or the Committee may, at any time and from time to time, amend, modify or terminate the Plan without shareholder approval; provided, however, that the Board or Committee may condition any amendment or modification on the approval of shareholders of the Company if such approval is necessary or deemed advisable with respect to tax, securities or other applicable laws, policies or regulations. 15.2 AWARDS PREVIOUSLY GRANTED. At any time and from time to time, the Committee may amend, modify or terminate any outstanding Award without approval of the Participant; provided, however, that such amendment, modification or termination shall not, without the Participant's consent, reduce or diminish the value of such Award determined as if the Award had been exercised, vested, cashed in or otherwise settled on the date of such amendment or termination. No termination, amendment, or modification of the Plan shall adversely affect any Award previously granted under the Plan, without the written consent of the Participant. ARTICLE 16 GENERAL PROVISIONS 16.1. NO RIGHTS TO AWARDS. No Participant or employee, officer, consultant or director shall have any claim to be granted any Award under the Plan, and neither the Corporation nor the Committee is obligated to treat Participants and employees, officers, consultants or directors uniformly. 16.2. NO SHAREHOLDER RIGHTS. No Award gives the Participant any of the rights of a shareholder of the Corporation unless and until shares of Stock are in fact issued to such person in connection with such Award. 16.3. WITHHOLDING. The Corporation or any Parent or Subsidiary shall have the authority and the right to deduct or withhold, or require a Participant to remit to the Corporation, an amount sufficient to satisfy federal, state, and local taxes (including the Participant's FICA obligation) required by law to be withheld with respect to any taxable event arising as a result of the Plan. With respect to withholding required upon any taxable event under the Plan, the Committee may, at the time the Award is granted or -17- 18 thereafter, require that any such withholding requirement be satisfied, in whole or in part, by withholding shares of Stock having a Fair Market Value on the date of withholding equal to the amount to be withheld for tax purposes, all in accordance with such procedures as the Committee establishes. 16.4. NO RIGHT TO EMPLOYMENT OR OTHER STATUS. Nothing in the Plan or any Award Agreement shall interfere with or limit in any way the right of the Corporation or any Parent or Subsidiary to terminate any Participant's employment or status as a consultant or director at any time, nor confer upon any Participant any right to continue as an employee, officer, consultant or director of the Corporation or any Parent or Subsidiary. l6.5. UNFUNDED STATUS OF AWARDS. The Plan is intended to be an "unfunded" plan for incentive and deferred compensation. With respect to any payments not yet made to a Participant pursuant to an Award, nothing contained in the Plan or any Award Agreement shall give the Participant any rights that are greater than those of a general creditor of the Corporation or any Parent or Subsidiary. 16.6. RELATIONSHIP TO OTHER BENEFITS. No payment under the Plan shall be taken into account in determining any benefits under any pension, retirement, savings, profit sharing, group insurance, welfare or benefit plan of the Corporation or any Parent or Subsidiary unless provided otherwise in such other plan. 16.7. EXPENSES. The expenses of administering the Plan shall be borne by the Corporation and its Parents or Subsidiaries. 16.8. TITLES AND HEADINGS. The titles and headings of the Sections in the Plan are for convenience of reference only, and in the event of any conflict, the text of the Plan, rather than such titles or headings, shall control. 16.9. GENDER AND NUMBER. Except where otherwise indicated by the context, any masculine term used herein also shall include the feminine; the plural shall include the singular and the singular shall include the plural. 16.10. FRACTIONAL SHARES. No fractional shares of Stock shall be issued and the Committee shall determine, in its discretion, whether cash shall be given in lieu of fractional shares or whether such fractional shares shall be eliminated by rounding up. 16.11. GOVERNMENT AND OTHER REGULATIONS. The obligation of the Corporation to make payment of awards in Stock or otherwise shall be subject to all applicable laws, rules, and regulations, and to such approvals by government agencies as may be required. The Corporation shall be under no obligation to register under the 1933 Act, or any state securities act, any of the shares of Stock paid under the Plan. The shares paid under the Plan may in certain circumstances be exempt from registration under the -18- 19 1933 Act, and the Corporation may restrict the transfer of such shares in such manner as it deems advisable to ensure the availability of any such exemption. 16.12. GOVERNING LAW. To the extent not governed by federal law, the Plan and all Award Agreements shall be construed in accordance with and governed by the laws of the State of Georgia. 16.13 ADDITIONAL PROVISIONS. Each Award Agreement may contain such other terms and conditions as the Committee may determine; provided that such other terms and conditions are not inconsistent with the provisions of this Plan. The foregoing is hereby acknowledged as being the CytRx Corporation 1998 Long-Term Incentive Plan as adopted by the Board of Directors of the Company on April 8, 1998 and approved by the shareholders of the Company on June 10, 1998. CytRx Corporation By: --------------------------- Its: --------------------------- -19- EX-13.1 3 SELECTED PORTIONS OF 1998 ANNUAL REPORT 1 EXHIBIT 13.1 SELECTED PORTIONS OF THE CYTRX CORPORATION 1998 ANNUAL REPORT TO SHAREHOLDERS 2 FIVE YEAR SELECTED FINANCIAL DATA * CytRx Corporation and Subsidiaries
1998 1997 1996 1995 1994 ---------------------------------------------------------------------------- Statement of Operations Data: Revenues: Net product sales $ 481,495 $ 456,029 $ 522,385 $ 512,528 $ 500,814 Net service revenues 350,789 422,039 357,517 -- -- Investment and other income 1,762,747 1,381,306 1,558,914 1,990,506 2,236,751 ---------------------------------------------------------------------------- Total revenues 2,595,031 2,259,374 2,438,816 2,503,034 2,737,565 ============================================================================ Loss from continuing operations (7,506,060) (4,426,292) (2,068,302) (9,273,777) (7,100,343) Income (loss) from discontinued operations 2,712,701 (1,626,700) (3,723,477) (1,378,805) (599,843) Extraordinary item (325,120) -- -- -- -- ---------------------------------------------------------------------------- Net loss $(5,118,479) $(6,052,992) $(5,791,779) $(10,652,582) $(7,700,186) ============================================================================ Basic and diluted loss per common share: Loss from continuing operations $ (0.99) $ (0.60) $ (0.27) $ (1.17) $ (0.90) Income (loss) from discontinued operations 0.36 (0.22) (0.48) (0.18) (0.08) Extraordinary item (0.04) -- -- -- -- ---------------------------------------------------------------------------- Net loss $ (0.67) $ (0.82) $ (0.75) $ (1.35) $ (0.98) ============================================================================ Balance Sheet Data: Total assets $16,641,568 $24,905,995 $24,299,322 $ 30,959,983 $38,660,567 Convertible debentures -- 2,000,000 -- -- -- Total stockholders' equity 14,688,548 19,248,395 22,337,734 29,770,485 38,026,347
* Restated for the reclassification of the results of operations of Vaxcel, Inc. from continuing operations to discontinued operations for the four years ended December 31, 1997 3 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CytRx Corporation and Subsidiaries Liquidity and Capital Resources At December 31, 1998, the Company had cash equivalents and investments of $15.3 million and net assets of $14.7 million, compared to $11.2 million and $19.2 million, respectively, at December 31, 1997. Working capital totaled $13.7 million at December 31, 1998, compared to $7.1 million at December 31, 1997. Management believes that cash and investments on hand, combined with interest income and operating revenues will be sufficient to satisfy the Company's projected liquidity and working capital needs through the first quarter of 2000, but it is likely that additional funding will be required for the commercialization of any products for human use. Definitive statements as to the time required and costs involved in reaching certain objectives for the Company's products are difficult to project due to the uncertainties of the medical research field. Requirements could vary depending upon the results of research, competitive and technological developments, and the time and expense required for governmental approval of products, some of which factors are beyond management's control. CytRx anticipates that it may raise funds through equity offerings. Additional funding for research and development expenditures may be obtained through joint ventures and product licensing arrangements with other companies. During 1996 and 1997, the Company received federal government funding for certain research and development activities via several Small Business Innovative Research (SBIR) grants. Most recently, the Company received a grant from the U.S. Food and Drug Administration's Division of Orphan Drug Development to support CytRx's Phase III clinical trial of FLOCOR. This grant will provide approximately $400,000 over two years, $200,000 of which was received during 1998, to help defray the overall costs of the study. The Company intends to continue to seek government assistance for its product development efforts. In February 1998, CytRx's wholly-owned subsidiary, Proceutics, Inc. ("Proceutics") consummated a sale of substantially all of its non-real estate assets to Oread Laboratories, Inc. ("Oread") for approximately $2.1 million. (See Note 10 to Financial Statements.) Also, in May 1998, CytRx and Proceutics consummated a sale of the two buildings owned by them at 150 and 154 Technology Parkway, Norcross, Georgia to ARE-150/154 Technology Parkway, LLC, an affiliate of Alexandria Real Estate Equities, Inc. ("Alexandria") for approximately $4.5 million. Alexandria assumed the existing lease with Oread. In addition, CytRx entered into a 10 year lease with Alexandria for administrative office space at the 154 Technology Parkway building. (See Notes 11 and 12 to Financial Statements.) In April 1998, the Company and its wholly-owned subsidiary, CytRx Animal Health, Inc. ("CytRx Animal Health") (formerly VetLife, Inc.) entered into an Acquisition Agreement (the "Acquisition Agreement") with VetLife L.L.C., a Delaware limited liability company ("VL LLC"), pursuant to which VL LLC acquired substantially all of CytRx Animal Health's assets related to its business of marketing and distributing products that improve the value of food animal products to the cattle industry (collectively, the "Assets") for a total purchase price consisting of: (i) a cash payment of $3,500,000, subject to certain working capital adjustments, (ii) an unsecured, subordinated promissory note in the principal amount of $4,000,000 bearing interest at an annual rate of 12%, and (iii) certain contingent payments based on future sales of specified products of VL LLC and its affiliates that, if made in full, could total up to $5,500,000. The sale of the Assets closed on the same day. VL LLC repaid the $4 million note to CytRx Animal Health in December 1998. The Company has consulting agreements with various individuals and companies for routine business activities including assistance with regulatory, marketing, investor relations and research and development activities. As of December 31, 1998 there were no significant firm commitments pursuant to any of such agreements, and none of such agreements are with affiliates of the Company. At December 31, 1998 the Company and its subsidiaries had net operating loss carryforwards for income tax purposes of approximately $49.2 million, which will expire in 2000 through 2018 if not utilized. The Company also has research and development credits available to reduce income taxes, if any, of approximately $1.2 million which will expire in 2000 through 2010 if not utilized. Based on an assessment of all available evidence including, but not limited to, the Company's limited operating history and lack of profitability, uncertainties of the commercial viability of the Company's technology, the impact of government regulation and healthcare reform initiatives, and other risks normally associated with biotechnology companies, the Company has concluded that it is more likely than not that these net operating loss 4 carryforwards and credits will not be realized and, as a result, a 100% deferred tax valuation allowance has been recorded against these assets. The above statements regarding the Company's plans and expectations for future financing are forward-looking statements that are subject to a number of risks and uncertainties. The Company's ability to obtain future financings through joint ventures, product licensing arrangements, equity financings or otherwise is subject to market conditions and the Company's ability to identify parties that are willing and able to enter into such arrangements on terms that are satisfactory to the Company. There can be no assurance that the Company will be able to obtain future financing from these sources. Additionally, depending upon the outcome of the Company's fund raising efforts via its subsidiaries discussed above, the accompanying financial information may not necessarily be indicative of future operating results or future financial condition. Results of Operations The Company recorded a net loss of $5,118,000 for the year ended December 31, 1998 as compared to net losses of $6,053,000 for 1997 and $5,792,000 for 1996. Loss from continuing operations before extraordinary items was $7,506,000, $4,426,000 and $2,068,000 in 1998, 1997 and 1996, respectively. Net product sales from continuing operations, which consist primarily of sales of TiterMax research adjuvant, were $481,000 in 1998, $456,000 in 1997 and $522,000 in 1996. Cost of product sales was $36,000 in 1998, $40,000 in 1997 and $63,000 in 1996, or 7%, 9% and 12% of net product sales, respectively. During 1996, the Company began marketing the services of its small group of human resource professionals to third parties under the name of Spectrum Recruitment Research ("Spectrum") as a way of offsetting the Company's cost of maintaining this function. Net service revenues from continuing operations related to Spectrum were $351,000 in 1998, $422,000 in 1997 and $357,000 in 1996. Cost of service revenues was $187,000 in 1998, $242,000 in 1997 and $171,000 in 1996, or 53%, 57% and 48% of net service revenues, respectively. Although the TiterMax and Spectrum operations are profitable, the Company is not dependent on the cash flow which they generate. Interest income from continuing operations was $1,007,000 in 1998 as compared to $752,000 in 1997 and $1,162,000 in 1996. The variances between years is directly attributable to fluctuating cash and investment balances. Collaborative, grant and license fee income was $511,000 in 1998 versus $94,000 in 1997 and $59,000 in 1996. The increase during 1998 is due to a $200,000 grant from the U.S. Food and Drug Administration's Division of Orphan Drug Development to support CytRx's Phase III clinical trial of FLOCOR, as well as certain additional Small Business Innovative Research (SBIR) grants for the Company's additional research programs. Other income was $244,000, $535,000 and $338,000 in 1998, 1997 and 1996, respectively, and primarily relates to administrative and facilities costs allocated by CytRx to its discontinued subsidiaries. The related costs are included in selling, general and administrative expenses. The decrease from 1997 to 1998 is reflective of the discontinuance of the Proceutics and CytRx Animal Health operations in early 1998. Research and development expenditures from continuing operations during 1998 were $7,306,000 versus $3,605,000 in 1997 and $2,032,000 in 1996. Research and development expenditures have increased during the three year period primarily as a result of the Company's development activities for FLOCOR, including the completion of a Phase II clinical trial in 1997 and initiation of a pivotal Phase III trial in March 1998. The Company expects patient enrollment in the Phase III trial to be completed during the second half of 1999, with the final statistical analysis of the study completed by the end of 1999. During 1997 and 1998, the Company also devoted significant resources toward addressing manufacturing issues for FLOCOR. Selling, general and administrative expenses from continuing operations during 1998 were $2,527,000 as compared to $2,505,000 in 1997 and $2,240,000 in 1996. The overall increase during the three year period is due to general corporate activities in support of the Company's FLOCOR development efforts. Interest expense was $46,000, $293,000 and $0 in 1998, 1997 and 1996, respectively. Included in the 1997 amount is $265,000 related to the beneficial conversion feature of $2,000,000 of convertible notes issued in 1997. (See Note 5 to Financial Statements.) The extraordinary loss in 1998 relates to the early extinguishment of 6% convertible notes which resulted in payment of premiums of $150,000 and expensing of capitalized debt issuance costs of $175,000. 5 Discontinued Operations - Net income (loss) from the discontinued operations of Proceutics, CytRx Animal Health and Vaxcel (net of minority interest) was $2,713,000, $(1,627,000) and $(3,723,000) in 1998, 1997 and 1996. As discussed above, the assets of Proceutics and CytRx Animal Health were sold during 1998, thus the results of their operations have been presented as discontinued operations. During 1998, the Company adopted a plan to dispose of the research and development activities of Vaxcel and has also presented its results of operations as discontinued operations. The following table presents the breakdown of net income (loss) from discontinued operations (see Notes 11 and 13 to Financial Statements).
1998 1997 1996 ----------- ----------- ----------- Proceutics: Gain on sale of business $ 782,000 $ -- $ -- Gain on sale of real estate 434,000 -- -- Operations 171,000 (138,000) (1,448,000) ----------- ----------- ----------- 1,387,000 (138,000) (1,448,000) CytRx Animal Health: Gain on sale of business 6,230,000 -- -- Operations (585,000) 868,000 (1,151,000) ----------- ----------- ----------- 5,645,000 868,000 (1,151,000) Vaxcel: Impairment loss (3,213,000) -- -- Operations (1,721,000) (2,599,000) (1,124,000) Minority interest 615,000 242,000 -- ----------- ----------- ----------- (4,319,000) (2,357,000) (1,124,000) ----------- ----------- ----------- Net income (loss) from discontinued operations $ 2,713,000 $(1,627,000) $(3,723,000) =========== =========== ===========
The impairment charge recorded by Vaxcel in 1998 relates to acquired developed technology and goodwill. See Note 11 to Financial Statements. Inflation - Management believes that inflation had no material impact on the Company's operations during the three year period ended December 31, 1998. Market Risk - The Company's financial instruments that are sensitive to changes in interest rates are its investments. The principal amount of investments, which are all classified as held-to-maturity, was $14,874,000 at December 31, 1998. All of the investments are zero coupon notes and mature in early 1999. The weighted average yield-to-maturity of the investments at December 31, 1998 was 5.18%. The fair value of investments at December 31, 1998 was $14,839,000. The Company is not subject to any other material market risks. Year 2000 Issue Introduction The term "Year 2000 issue" is a general term used to describe the various problems that may result from the improper processing of dates and date-sensitive calculations by computers and other machinery as the year 2000 is approached and reached. These problems generally arise from the fact that most of the world's computer hardware and software have historically used only two digits to identify the year in a date, often meaning that the computer will fail to distinguish dates in the "2000's" from dates in the "1900's." These problems may also arise from other sources as well, such as the use of special codes and conventions in software that make use of the date field. State of Readiness The Company has developed and is implementing a comprehensive plan (the "Year 2000 Plan") for the Company to become Year 2000 ready by the middle of the fourth quarter 1999. The Year 2000 Plan covers the following Company systems (collectively, the "Systems"): - the Company's business-critical information technology and operating systems ("Critical IT Systems") which are comprised substantially of commercial off-the-shelf software and other third party software and hardware relating primarily to financial operations and reporting, including accounts payable, - the Company's non-critical information technology and operating systems ("Non-Critical IT Systems") which also are substantially comprised of commercial off-the-shelf software and other third party software and hardware relating to, among others, spreadsheet, word processing, and supporting and related operating systems; 6 - the systems of the Company's major vendors and other material service providers ("Third Party Systems"); and - the Company's non-information technology systems, including embedded technology ("Non-IT Systems") relating to, among others, security systems and HVAC. The Year 2000 Plan consists of four phases: (i) awareness, (ii) assessment, (iii) remediation, and (iv) creation of contingency plans in the event of year 2000 failures. The Company has completed the awareness and assessment phases of its Year 2000 Plan for all of its Systems, and is well under way toward completing the remediation phase. As part of the assessment phase, the Company has polled substantially all of the third parties who provide material services to the Company regarding each third party's Year 2000 compliance plan and state of readiness. The Company has received responses regarding Year 2000 compliance from most of such third parties, all of whom have assured the Company that their hardware and/or software is or will be Year 2000 compliant. The Company is actively seeking responses from the remainder of such third parties. The initial actions in the remediation phase have already commenced in that the Company, during 1998, replaced a significant portion of its desktop computer systems. The Company intends to schedule any additional required upgrades or replacements regarding its Systems beginning in the second quarter of 1999 and ending during the fourth quarter of 1999. Costs To date, the Company has not incurred significant costs in connection with the implementation of its Year 2000 Plan. Future costs may include, among others, the engagement of outside consultants, upgrades or replacements of hardware and software, and implementation of viable contingency plans. The Company estimates such future costs will not exceed $25,000. The Company expenses costs associated with the Year 2000 Plan as they are incurred. Risks and Contingency Plans The failure to remediate a material Year 2000 problem or develop and implement a viable contingency plan could result in an interruption in, or a failure of, certain normal business activities or operations. Such failures could materially and adversely affect the Company's business, financial condition and results of operations. Due to the general uncertainty inherent in the Year 2000 issue, the Company is currently unable to determine the most reasonably likely worst case Year 2000 scenarios or whether the Year 2000 issue will have a material impact on the Company. The Company is creating contingency plans intended to address perceived risks. 7 CONSOLIDATED BALANCE SHEETS CytRx Corporation and Subsidiaries
December 31, ------------------------------ 1998 1997 ----------- ----------- ASSETS Current assets: Cash and cash equivalents $ 8,855,375 $ 5,895,008 Short-term investments 6,417,066 -- Accounts receivable 83,249 1,917,013 Note receivable 300,000 -- Inventories 10,935 2,272,798 Other current assets 10,377 29,157 ----------- ----------- Total current assets 15,677,002 10,113,976 Property and equipment, net 195,030 4,713,586 Other assets: Long-term investments (restricted) -- 5,326,647 Notes receivable -- 400,000 Acquired developed technology, net 600,000 3,454,356 Other assets 169,536 897,430 ----------- ----------- Total other assets 769,536 10,078,433 ----------- ----------- Total assets $16,641,568 $24,905,995 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 540,089 $ 1,273,303 Accrued expenses and other current liabilities 1,409,034 1,765,815 ----------- ----------- Total current liabilities 1,949,123 3,039,118 6% Convertible debentures -- 2,000,000 Minority interest in Vaxcel, Inc. 3,897 618,482 Commitments Stockholders' equity: Preferred Stock, $.01 par value, 1,000 shares authorized, including 1,000 shares of Series A Junior Participating Preferred Stock; no shares issued and outstanding -- -- Common stock, $.001 par value, 18,750,000 shares authorized; 8,236,926 and 7,986,441 shares issued at December 31, 1998 and 1997, respectively 8,237 7,986 Additional paid-in capital 66,423,577 65,793,491 Treasury stock, at cost (625,816 and 555,154 shares held at December 31, 1998 and 1997, respectively) (2,270,238) (2,198,533) Accumulated deficit (49,473,028) (44,354,549) ----------- ----------- Total stockholders' equity 14,688,548 19,248,395 ----------- ----------- Total liabilities and stockholders' equity $16,641,568 $24,905,995 =========== ===========
See accompanying notes. 8 CONSOLIDATED STATEMENTS OF OPERATIONS CytRx Corporation and Subsidiaries
Year Ended December 31, ------------------------------------------------ 1998 1997 1996 ----------- ----------- ----------- (restated) (restated) Revenues: Net product sales $ 481,495 $ 456,029 $ 522,385 Net service revenues 350,789 422,039 357,517 Interest income 1,007,019 751,526 1,161,513 Collaborative, grant and license fee income 511,375 94,477 59,232 Other 244,353 535,303 338,169 ----------- ----------- ----------- 2,595,031 2,259,374 2,438,816 Expenses: Cost of product sales 35,749 39,941 63,171 Cost of service revenues 187,047 242,343 171,462 Research and development 7,305,835 3,605,408 2,032,101 Selling, general and administrative 2,526,572 2,504,926 2,240,384 Interest 45,888 293,048 -- ----------- ----------- ----------- 10,101,091 6,685,666 4,507,118 ----------- ----------- ----------- Loss from continuing operations before extraordinary item (7,506,060) (4,426,292) (2,068,302) Income (loss) from discontinued operations 2,098,116 (1,869,187) (3,723,477) Minority interest in discontinued operations (614,585) (242,487) -- ----------- ----------- ----------- Loss before extraordinary item (4,793,359) (6,052,992) (5,791,779) Extraordinary item: Loss on early extinguishment of debt (325,120) -- -- ----------- ----------- ----------- Net loss $(5,118,479) $(6,052,992) $(5,791,779) =========== =========== =========== Basic and diluted income (loss) per common share: Continuing operations $ (0.99) $ (0.60) $ (0.27) Discontinued operations 0.36 (0.22) (0.48) Extraordinary item (0.04) -- -- ----------- ----------- ----------- Net loss $ (0.67) $ (0.82) $ (0.75) =========== =========== =========== Basic and diluted weighted average shares outstanding 7,625,578 7,424,372 7,737,949
See accompanying notes. 9 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY CytRx Corporation and Subsidiaries
Common Stock --------------------- Additional Shares Paid-in Accumulated Treasury Issued Amount Capital Deficit Stock Total -------------------------------------------------------------------------------- Balance at December 31, 1995 7,915,308 $7,915 $62,514,691 $(32,509,778) $ (242,343) $29,770,485 Issuance of common stock 29,895 30 138,324 138,354 Purchase of treasury stock (1,779,326) (1,779,326) Net loss (5,791,779) (5,791,779) -------------------------------------------------------------------------------- Balance at December 31, 1996 7,945,203 7,945 62,653,015 (38,301,557) (2,021,669) 22,337,734 Issuance of common stock 41,238 41 169,373 169,414 Purchase of treasury stock (176,864) (176,864) Unrealized gain on sale of shares of subsidiary 2,706,397 2,706,397 Beneficial conversion feature of convertible debentures 264,706 264,706 Net loss (6,052,992) (6,052,992) -------------------------------------------------------------------------------- Balance at December 31, 1997 7,986,441 7,986 65,793,491 (44,354,549) (2,198,533) 19,248,395 Issuance of common stock 250,485 251 630,086 630,337 Purchase of treasury stock (71,705) (71,705) Net loss (5,118,479) (5,118,479) -------------------------------------------------------------------------------- Balance at December 31, 1998 8,236,926 $8,237 $66,423,577 $(49,473,028) $(2,270,238) $14,688,548 ================================================================================
See accompanying notes. 10 CONSOLIDATED STATEMENTS OF CASH FLOWS CytRx Corporation and Subsidiaries
Year Ended December 31, -------------------------------------------------- 1998 1997 1996 ----------- ------------ ------------ Cash flows from operating activities: Net loss $(5,118,479) $ (6,052,992) $ (5,791,779) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 216,811 607,349 655,006 Amortization 282,732 145,644 -- Gain on sales of subsidiary operations (7,012,305) -- -- Gain on sale of real estate (433,786) -- -- Charge for acquired incomplete research and development -- 951,017 -- Charge for beneficial conversion feature of convertible debentures -- 264,706 -- Impairment loss (discontinued operations) 3,212,615 -- -- Extraordinary loss on early extinguishment of debt 325,120 Minority interest in net loss of subsidiary (614,585) (242,487) -- Changes in assets and liabilities: Receivables 1,082,390 (979,874) (552,002) Inventories 1,037,197 (2,263,290) (3,190) Notes receivable 100,000 -- (975,000) Other assets 98,545 537,902 (162,443) Accounts payable 208,884 640,383 320,795 Unearned revenue 172,380 (85,005) 251,192 Other liabilities (495,323) 382,053 200,103 ----------- ------------ ------------ Total adjustments (1,819,325) (41,602) (265,539) ----------- ------------ ------------ Net cash used in operating activities (6,937,804) (6,094,594) (6,057,318) Cash flows from investing activities: Purchases of held-to-maturity securities (6,417,066) (22,103,140) (12,024,022) Maturities of held-to-maturity securities -- 32,399,348 5,036,000 Decrease in long-term investments 5,326,647 -- -- Net proceeds from sales of subsidiary operations 8,336,985 -- -- Net proceeds from sale of real estate 4,260,747 -- -- Net cash paid for acquisition -- (1,257,974) -- Capital expenditures, net (13,317) (273,755) (530,051) ----------- ------------ ------------ Net cash provided by (used in) investing activities 11,493,996 8,764,479 (7,518,073) Cash flows from financing activities: Net proceeds from issuance of common stock 125,880 169,414 138,354 Redemption of debt (1,650,000) -- -- Purchase of treasury stock (71,705) (176,864) (1,779,326) Proceeds from issuance of debt, net of issuance costs -- 1,803,366 -- ----------- ------------ ------------ Net cash provided by (used in) financing activities (1,595,825) 1,795,916 (1,640,972) ----------- ------------ ------------ Net increase (decrease) in cash and cash equivalents 2,960,367 4,465,801 (15,216,363) Cash and cash equivalents at beginning of year 5,895,008 1,429,207 16,645,570 ----------- ------------ ------------ Cash and cash equivalents at end of year $ 8,855,375 $ 5,895,008 $ 1,429,207 =========== ============ ============ Supplemental disclosure of cash flow information: Cash paid during the year for interest $ 45,888 $ 23,342 $ -- =========== ============ ============
See accompanying notes 11 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CytRx Corporation and Subsidiaries 1. Nature of Business CytRx Corporation ("CytRx" or "the Company") is a biopharmaceutical company focused on the development and commercialization of high-value human therapeutics. The Company's lead product is FLOCOR, now in pivotal Phase III clinical trials for the treatment of acute sickle cell crisis. CytRx is also developing FLOCOR for acute respiratory disorders and plans to expand its development for other vascular disorders such as shock and stroke. CytRx is also currently engaged in research in the areas of infectious disease, gene and drug delivery, vaccines, and animal feed additives. The Company's product sales from continuing operations include sales of TiterMax research adjuvant. Titermax is currently sold worldwide through both distributor and direct channels. The Company also markets the services of its small group of human resources professionals under the name of Spectrum Recruitment Research ("Spectrum") as a way of offsetting the Company's cost of maintaining this function. Spectrum's services are marketed primarily within metropolitan Atlanta, Georgia. The Company's operational focus is on the development and commercialization of pharmaceutical products; the TiterMax and Spectrum operations were formed as ancillary activities, and, while these operations are profitable, the Company is not dependent on the cash flows which they generate. 2. Summary of Significant Accounting Policies Basis of Presentation - The consolidated financial statements include the accounts of CytRx together with those of its majority-owned subsidiaries. Certain prior year amounts have been reclassified to conform to the 1998 financial statement presentation. As more thoroughly discussed in Note 11, the operations of Proceutics, Inc. ("Proceutics") and CytRx Animal Health, Inc. ("CytRx Animal Health") (formerly VetLife, Inc.), and Vaxcel, Inc. ("Vaxcel") are presented as discontinued operations for all periods presented. Reverse Stock Split - All share and per share information in the accompanying consolidated financial statements and notes thereto has been retroactively adjusted to reflect a one-for-four reverse stock split effected in February 1996. Cash Equivalents - The Company considers all highly liquid debt instruments with an original maturity of 90 days or less to be cash equivalents. Cash equivalents consist primarily of auction-market preferred stock, commercial paper and amounts invested in money market accounts. Restricted Cash - In connection with a marketing and distribution agreement, CytRx Animal Health was required to obtain a letter of credit in the amount of $5 million in favor of the other party. Such unused letter of credit was collateralized by approximately $5.3 million in cash equivalents and investments at December 31, 1997. Such collateral was presented as long-term investments in the accompanying consolidated balance sheet. (See Note 11). Investments - Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. Marketable equity securities and debt securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses reported in a separate component of stockholders' equity. Realized gains and losses are included in investment income and are determined on a first-in, first-out basis (see Note 3). Fair Value of Financial Instruments - The carrying amounts reported in the balance sheet for cash and cash equivalents, investments (see Note 3), accounts receivable, notes receivable, accounts payable and convertible debentures approximate their fair values. The carrying amount reported in the balance sheet for long-term debt approximates its fair value. The fair value of such long-term debt is estimated using discounted cash flow analyses based on the Company's current incremental borrowing rate for similar types of borrowing arrangements. Inventories - Inventories are valued at the lower of cost or market using the first-in, first-out (FIFO) method. 12 Property and Equipment - Property and equipment are stated at cost and depreciated using the straight-line method based on the estimated useful lives (twenty years for buildings and five years for equipment and furniture) of the related assets. Acquired Developed Technology and Other Intangibles - Acquired developed technology and other intangible assets, primarily goodwill, (see Note 11) are amortized over their estimated useful lives (fifteen years) on a straight-line basis. Management continuously monitors and evaluates the realizability of recorded acquired developed technology and other intangible assets to determine whether their carrying values have been impaired. In accordance with Financial Accounting Standards Board ("FASB") Statement No. 121, Accounting for the Impairment of Long-Lived Assets, the Company records impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of those assets. Any impairment loss is measured by comparing the fair value of the asset to its carrying amount. As more fully discussed in Note 11, management evaluated these assets during 1998 and has recorded a provision for impairment of such assets. Patents and Patent Application Costs - Although the Company believes that its patents and underlying technology have continuing value, the amount of future benefits to be derived therefrom is uncertain. Patent costs are therefore expensed rather than capitalized. Accrued Expenses and Other Current Liabilities - Accrued expenses and other current liabilities at December 31 are summarized as follows (in thousands):
1998 1997 ------ ------ Clinical research grants $ 370 $ -- Deferred revenue 261 166 Employee incentives 87 350 Distributor incentives -- 641 Other 691 609 ------ ------ $1,409 $1,766 ====== ======
Basic and Diluted Loss per Common Share - Basic and diluted loss per share are computed based on the weighted average number of common shares outstanding. Common share equivalents (which may consist of options, warrants and convertible debentures) are excluded from the computation of diluted loss per share since the effect would be antidilutive. Shares Reserved for Future Issuance - The Company has reserved approximately 2,453,000 of its authorized but unissued shares of common stock for future issuance pursuant to stock options and warrants and employee benefit plans. Revenue Recognition - Sales are recognized at the time products are shipped or services rendered. The Company does not require collateral or other securities for sales made on credit. Revenues from collaborative research arrangements and grants are generally recorded as the related costs are incurred. The costs incurred under such arrangements approximated the revenues reported in the accompanying statements of operations. License fees reported in the accompanying statements of operations consist of nonrefundable fees received upon the signing of certain technology license and option agreements. These fees were recognized as income when they were received. Such agreements generally contain provisions for additional fees upon the achievement of certain development milestones by the licensee and upon approval of the related products, followed by a royalty based upon net sales. Such fees, if any, will be recognized as income when they become receivable under the terms of the related contracts. Sale of Stock by a Subsidiary - The Company does not recognize gains on the sale of previously unissued stock of subsidiaries when there are significant uncertainties regarding the Company's ability to ultimately realize its investment in the subsidiary. Such gains are reflected as additional paid-in capital in the Company's consolidated financial statements. Stock-based Compensation - The Company grants stock options and warrants for a fixed number of shares to key employees and directors with an exercise price equal to the fair market value of the shares at the date of grant. The Company accounts for stock option grants and warrants in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), and, accordingly, recognizes no compensation expense for the stock option grants and warrants for which the terms are fixed. For stock option grants and warrants which vest based on certain corporate performance criteria, compensation expense is recognized to the extent that the quoted market price per share exceeds the exercise price on the date such criteria are achieved or are probable. The Company has also granted a limited number of stock options to consultants and certain third parties. These stock options generally expire after ten years from the date of grant and have exercise prices equal to the fair market value of the underlying common stock at the date of grant. Stock 13 options granted to consultants and certain third parties are valued at their fair market value on the date the options vest and have been immaterial to date. In October 1995, the FASB issued Statement of Financial Accounting Standards No. 123, Accounting for Stock-based Compensation ("Statement 123"), which provides an alternative to APB 25 in accounting for stock-based compensation issued to employees. However, the Company has continued to account for stock-based compensation in accordance with APB 25. Concentrations of Credit Risk - Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash investments. The Company maintains cash equivalents and investments in large well-capitalized financial institutions and the Company's investment policy disallows investment in any debt securities rated less than "investment-grade" by national ratings services. Use of Estimates - The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Segment Information - Effective January 1, 1998, the Company adopted FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information ("Statement 131"). Statement 131 superceded FASB Statement No. 14, Financial Reporting for Segments of a Business Enterprise. Statement 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. Statement 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. The adoption of Statement 131 did not affect results of operations or financial position, but did affect the disclosure of segment information. See Note 13. 3. Investments At December 31, 1998 $8,457,000 and $6,417,000 of investments were included in cash and cash equivalents and short-term investments, respectively, in the accompanying consolidated balance sheets. At December 31, 1997, $5,214,000 and $5,327,000 of investments were included in cash and cash equivalents and long-term investments, respectively. The contractual maturities of securities held at December 31, 1998 are one year or less. Actual maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations with or without prepayment penalties. At December 31, 1998 and 1997, the Company has classified all of its investments (consisting entirely of corporate debt securities) as held-to-maturity, as summarized below (in thousands):
1998 1997 ------- ------- Cost $14,874 $10,541 Gross Unrealized Gains 3 1 Gross Unrealized Losses (38) -- ------- ------- Fair Market Value $14,839 $10,542 ======= =======
4. Property and Equipment Property and equipment at December 31 consist of the following (in thousands):
1998 1997 ----- ------- Land $ -- $ 220 Buildings and improvements -- 4,184 Equipment and furnishings 799 2,963 ----- ------- 799 7,367 Less accumulated depreciation (604) (2,653) ----- ------- $ 195 $ 4,714 ===== =======
5. 6% Convertible Debentures In October 1997, the Company privately placed with certain investors $2,000,000 of convertible notes (the "Debentures") maturing in October, 2001. The Debentures were convertible on and after December 31, 1997 into shares of CytRx Common Stock at a price of the lesser of (a) 85% of the average closing bid price for the 10 days preceding the conversion, or (b) $5.68 per share. Such beneficial conversion feature was determined to have a fair value of $265,000 at the date of issuance and was amortized to interest expense from the date of issuance through the date the Debentures first became convertible. The Debentures were sold at par and bore interest at a rate of 6% per annum. The provisions for 14 conversion of the Debentures allowed the Company, at its discretion, to disallow conversions below $4.00 per share by redeeming the amount attempted to be converted at a 10% premium. Also in connection with the issuance of the Debentures, the investors were issued two year warrants to purchase 40,000 shares of CytRx common stock at an exercise price of $5.68. The fair value of such warrants was determined to be insignificant. In February and March 1998, $500,000 of the Debentures were converted into 204,104 shares of common stock. In February and May 1998, $1,500,000 of the Debentures were redeemed by the Company and total redemption premiums of $150,000 were paid. In addition, $175,000 of previously capitalized debt issue costs were expensed. The redemption premiums and debt issue costs are reflected as an extraordinary item in the statement of operations as loss on early extinguishment of debt. At December 31, 1998 there were no remaining outstanding Debentures. 6. Commitments and Contingencies Rental expense from continuing operations under operating leases during 1998, 1997 and 1996 approximated $154,000, $13,000 and $14,000, respectively. Minimum annual future obligations for operating leases are $164,000, $163,000, $167,000, $171,000, $178,000 and $863,000 in 1999, 2000, 2001, 2002, 2003, and 2004 and beyond, respectively. Aggregate minimum future subrentals the Company expects to receive under noncancellable subleases total approximately $38,000 at December 31, 1998. 7. Stock Options and Warrants CytRx and Vaxcel have stock option plans pursuant to which certain key employees and directors are eligible to receive incentive and/or nonqualified stock options to purchase shares of CytRx's or Vaxcel's common stock. The options granted under the plans generally become exercisable over a three year period from the dates of grant and have lives of ten years. Certain options granted to the Company's executive officers and others contain alternative or additional vesting provisions based on the achievement of corporate objectives. Additionally, the Company has granted warrants to purchase shares of the Company's common stock to its President and Chief Executive Officer subject to vesting criteria as set forth in his warrant agreements; such warrants have lives of ten years from the dates of grant. Exercise prices of all options and warrants are set at the fair market values of the common stock on the dates of grant. During 1998, the Company repriced all outstanding options and warrants held by current employees to the then current market value. No compensation expense was recorded for the three years ended December 31, 1998; however, as of March 9, 1999, the vesting criteria for 680,238 options and warrants had been achieved, resulting in $735,500 of compensation expense which will be recorded in the first quarter of 1999. A summary of the Company's stock option and warrant activity and related information for the years ended December 31 is shown below.
Options and Warrants Weighted Average Exercise Price ------------------------------------ ------------------------------- 1998 1997 1996 1998 1997 1996 ---------- ---------- ---------- ----- ---- ---- Outstanding - beginning of year 1,439,297 1,237,031 1,018,289 $4.87 $5.00 $ 6.08 Granted 902,488 221,700 275,688 2.65 4.35 3.72 Exercised -- -- -- -- -- -- Forfeited (83,477) (19,434) (56,946) 4.37 6.64 20.44 Expired -- -- -- -- -- -- ---------- ---------- ---------- ----- ----- ------ Outstanding - end of year 2,258,308 1,439,297 1,237,031 $1.17 $4.87 $ 5.00 ========== ========== ========== Exercisable at end of year 1,104,620 940,541 874,946 $1.33 $5.22 $ 5.22 Weighted average fair value of options and warrants granted during the year: $ 2.30 $ 3.97 $ 3.39
The following table summarizes additional information concerning options and warrants outstanding and exercisable at December 31, 1998:
Options Outstanding Options Exercisable -------------------------------------------------------------------- ----------------------------- Weighted Average Remaining Weighted Weighted Range of Contractual Average Number Average Exercise Prices Number of Shares Life (years) Exercise Price Exercisable Exercise Price --------------- ---------------- ------------ -------------- ----------- -------------- $ .75 - 1.00 2,189,206 7.3 $ .99 1,045,518 $ 1.00 2.75 - 5.00 23,750 4.8 3.96 16,750 4.25 6.50 - 7.75 34,414 5.2 7.27 29,414 7.19 9.125 - 31.00 10,938 5.7 12.01 10,938 12.01 --------- --------- 2,258,308 7.3 1.17 1,104,620 1.33 ========= =========
15 A summary of Vaxcel's stock option activity and the related information for the years ended December 31 is shown below.
Options Weighted Average Exercise Price --------------------------------------- --------------------------------- 1998 1997 1996 1998 1997 1996 ---- ---- ---- ---- ---- ---- Outstanding - beginning of year 847,000 794,453 735,000 $1.63 $1.50 $1.50 Granted 510,000 63,000 73,620 .63 3.18 1.50 Exercised -- (5,333) -- -- 1.50 -- Forfeited (281,500) (5,120) (14,167) 1.73 1.50 1.50 --------- ------- -------- Outstanding - end of year 1,075,500 847,000 794,453 $1.12 $1.63 $1.50 ========= ======= ======== Exercisable at end of year 160,661 293,663 184,332 $1.68 $1.57 $1.50 Weighted average fair value of options granted during the year $ .42 $ 1.82 $ 0.83
The exercise prices for Vaxcel's options outstanding as of December 31, 1998 ranged from $.63 to $3.25. The weighted average remaining contractual life of those options is 6.2 years. The Company and Vaxcel have elected to follow APB 25 and related Interpretations in accounting for their employee stock options and warrants because, as discussed below, the alternative fair value accounting provided for under Statement 123 requires use of option valuation models that were not developed for use in valuing employee stock options. Pro forma information regarding net loss and loss per share is required by Statement 123, which also requires that the information be determined as if the Company and Vaxcel had accounted for their employee stock options granted and warrants issued subsequent to December 31, 1994 under the fair value method of that Statement. The fair value for the Company's options and warrants was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions:
1998 1997 1996 ----- ----- ---- Weighted average risk free interest rate 5.64% 6.22% 6.30% Dividend yields 0% 0% 0% Volatility factors of the expected market price of the Company's common stock 1.026 1.055 1.12 Weighted average life of the option 8 8 8 (years)
The fair value for Vaxcel's options was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions:
1998 1997 1996 ---- ---- ---- Weighted average risk free interest rate 5.83% 6.53% 6.34% Dividend yields 0% 0% 0% Volatility factors of the expected market price of the subsidiary's common stock .563 .585 .378 Weighted average life of the option 8 8 8 (years)
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's and its subsidiary's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options and warrants is amortized to expense over the options' vesting periods. The Company's pro forma information is as follows (in thousands, except per share data):
1998 1997 1996 ------- ------- ------- Pro forma net loss $(6,521) $(6,969) $(6,343) Pro forma net loss per share (basic and diluted) $ (.86) $ (.94) $ (.82)
16 8. Shareholder Protection Rights Plan Effective April 16, 1997, the Company's Board of Directors declared a distribution of one Right for each outstanding share of the Company's common stock to stockholders of record at the close of business on May 15, 1997 and for each share of common stock issued by the Company thereafter and prior to a Flip-in Date (as defined below). Each Right entitles the registered holder to purchase from the Company one-ten thousandth (1/10,000th) of a share of Series A Junior Participating Preferred Stock, at an exercise price of $30. The Rights are generally not exercisable until 10 business days after an announcement by the Company that a person or group of affiliated persons (an "Acquiring Person") has acquired beneficial ownership of 15% or more of the Company's then outstanding shares of common stock (a "Flip-in Date"). In the event the Rights become exercisable as a result of the acquisition of shares, each Right will enable the owner, other than the Acquiring Person, to purchase at the Right's then current exercise price a number of shares of common stock with a market value equal to twice the exercise price. In addition, unless the Acquiring Person owns more than 50% of the outstanding shares of common stock, the Board of Directors may elect to exchange all outstanding Rights (other than those owned by such Acquiring Person) at an exchange ratio of one share of common stock per Right. All Rights that are owned by any person on or after the date such person becomes an Acquiring Person will be null and void. The Rights have been distributed to protect the Company's stockholders from coercive or abusive takeover tactics and to give the Board of Directors more negotiating leverage in dealing with prospective acquirors. 9. Retirement Plan The Company maintains a defined contribution retirement plan (the "Plan") covering employees of the Company. Historically, at the Board of Directors' discretion, the Company has matched 50% of the participant's contribution with common stock. The Company's matching contribution vests over 3 years. Total expense for the Plan for the years ended December 31, 1998, 1997 and 1996 was approximately $110,000, $176,000 and $156,000, respectively, of which $44,000, $120,000 and $95,000 related to discontinued operations for the years ended December 31, 1998, 1997 and 1996, respectively. 10. Income Taxes For income tax purposes, CytRx and its subsidiaries have an aggregate of approximately $49.2 million of net operating losses available to offset against future taxable income, subject to certain limitations. Included in this amount is $3,360,000 of net operating losses generated by Zynaxis prior to the merger. See discussion below. Such losses expire in 2000 through 2018. They also have an aggregate of approximately $1.2 million of research and development credits available for offset against future income taxes which expire in 2000 through 2010. Deferred income taxes reflect the net effect of temporary differences between the financial reporting carrying amounts of assets and liabilities and income tax carrying amounts of assets and liabilities. The components of the Company's deferred tax assets and liabilities are as follows:
December 31, ------------------------------- 1998 1997 ------------ ------------ Deferred tax assets: Net operating loss carryforward $ 18,677,000 $ 16,942,000 Tax credit carryforward 1,245,000 1,096,000 Other 1,218,000 1,396,000 ------------ ------------ Total deferred tax assets 21,140,000 19,434,000 Deferred tax liabilities: Acquired developed technology and other (228,000) (1,556,000) intangibles Depreciation and other (143,000) (194,000) ------------ ------------ Total deferred tax liabilities (371,000) (1,750,000) ------------ ------------ Net deferred tax assets 20,769,000 17,684,000 Valuation allowance (20,769,000) (17,684,000) ------------ ------------ $ -- $ -- ============ ============
Based on assessments of all available evidence as of December 31, 1998 and 1997, management has concluded that the respective deferred income tax assets should be reduced by valuation allowances equal to the amounts of the deferred income tax assets. 17 The total amount of net operating loss carryforwards generated by Zynaxis, Inc. prior to its merger with Vaxcel (see Note 11) was $31,000,000. The use of pre-acquisition operating loss carryforwards is subject to limitations imposed by the Internal Revenue Code. The Company anticipates that these limitations will affect utilization of the carryforwards prior to expiration. Therefore, for financial reporting purposes the Company has recorded a deferred tax asset of $1,277,000 related only to $3,360,000 of net operating losses not anticipated to be affected by these limitations. A corresponding valuation allowance of $1,277,000 has been recorded. When realized, the tax benefit of these loss carryforwards will be applied to reduce acquired developed technology and other intangibles related to the acquisition of Zynaxis. 11. Discontinued Operations Vaxcel, Inc. Acquisition of Zynaxis, Inc. - In December 1996 CytRx, Vaxcel, Inc. ("Vaxcel") and Zynaxis, Inc. ("Zynaxis") signed an agreement whereby Zynaxis would be merged with a wholly-owned subsidiary of Vaxcel. At that time Zynaxis was a publicly-held biotechnology company engaged in the development of certain vaccine technologies. The transaction was approved by the Zynaxis stockholders at a meeting held on May 21, 1997 and was consummated as of that date. Under the terms of the agreement all of the outstanding shares of Zynaxis were converted into shares of Vaxcel based upon certain exchange ratios defined in the agreement, resulting in the issuance of an aggregate of 1.4 million (12.5%) of the outstanding (post-merger) shares of Vaxcel common stock (at $2.91 per share) to former Zynaxis stockholders at the date of closing. The merger was treated as a purchase by Vaxcel and constituted a tax-free reorganization for Zynaxis stockholders. The results of operations of Zynaxis are included in the statement of operations since May 21, 1997. Pursuant to the agreement, CytRx was to provide up to $2 million to Zynaxis under a secured credit facility during the period prior to closing of the merger, at which time the outstanding principal and interest was to be contributed to the capital of Vaxcel, together with additional equity in the amount of $4 million less the outstanding principal and interest of the secured note. At the time of closing the outstanding principal and interest of the secured note to Zynaxis was approximately $1.7 million, resulting in a net cash infusion from CytRx to Vaxcel of approximately $2.3 million. In addition, at the date of closing, Vaxcel issued to CytRx a one-year warrant entitling CytRx to purchase a number of shares of Vaxcel common stock equal to the amount of capital which may be necessary for Vaxcel to satisfy requirements for inclusion in the Nasdaq SmallCap Market, divided by one-half of the $2.91 per share transaction price at the date of closing. The warrant expired unexercised. As a result of this transaction, CytRx owns 87.5% of the outstanding Vaxcel common stock and former Zynaxis stockholders own the remaining 12.5%. An unrealized gain of $2,706,000 relating to the sale of 12.5% of Vaxcel common stock is reflected in stockholders' equity. The change to equity reflecting CytRx's proportionate share of the increase in Vaxcel's equity related to the shares issued in connection with the acquisition of Zynaxis was recorded as an equity transaction since realization of the gain was not assured. In accordance with the provisions of APB Nos. 16 and 17, all identifiable assets acquired, including identified intangible assets and liabilities assumed, were assigned a portion of the purchase price based on their respective fair values. The fair values of the acquired developed technology and incomplete research and development were determined based on an independent appraisal. A summary of the allocation of the purchase price is as follows (in thousands): Net tangible assets, less outstanding liabilities $ (830) Acquired developed technology and other intangibles 4,241 Acquired incomplete research and development 951 ------ $4,362 ======
Presentation as Discontinued Operations - During 1998, Vaxcel's Board of Directors retained an investment banking firm to introduce Vaxcel and its technology licenses to the trade with the purpose of concluding a strategic transaction for the benefit of the Vaxcel shareholders. The Company was considering all available options for the disposition of Vaxcel, including license or sale of specific technologies and possible merger with another organization. Based on the results of the investment banking firm's efforts and management's reevaluation of CytRx's strategic direction, in the fourth quarter of 1998 the Company adopted a plan to dispose of the research and development activities in which Vaxcel is engaged. The Company intends to complete the plan during 1999. As a result of adopting such a plan, the operations of Vaxcel are presented as discontinued operations in the accompanying consolidated statements of operations. The results of operations 18 of Vaxcel have been reclassified from income (loss) from continuing operations to discontinued operations for the two years ended December 31, 1997. Net losses (net of minority interest) associated with Vaxcel included in income (loss) from discontinued operations were approximately $(4,319,000), $(2,357,000) and $(1,124,000) for the years ended December 31, 1998, 1997 and 1996, respectively. See discussion below regarding the 1998 impairment loss. A summary of the assets and liabilities of Vaxcel which are included in the consolidated balance sheets at December 31, 1998 and 1997 is as follows (in thousands):
1998 1997 Current assets $314 $ 833 Property and equipment, net 7 74 Other assets 655 4,551 ---- ------ Total assets $976 $5,458 ==== ====== Total liabilities $618 $ 167 ==== ======
Impairment Loss - In its efforts to raise additional capital, Vaxcel has been soliciting bids for the sublicense or purchase of Vaxcel's acquired developed technology, either together with or separately from Vaxcel's other technologies. During the fourth quarter, the results of the investment firms's efforts indicated to management that the acquired developed technology might be impaired. As a result of this indication, Vaxcel performed an evaluation to determine, in accordance with Statement 121, whether future cash flows (undiscounted and without interest charges) expected to result from the use and eventual disposition of the acquired developed technology would be less than its aggregate carrying amount and an allocation of goodwill resulting from the Zynaxis merger. Statement 121 requires that when a group of assets being tested for impairment was acquired as part of a business combination accounted for using the purchase method of accounting, any goodwill that arose as part of the transaction must be included as part of the asset grouping. As a result of the evaluation, management determined that the estimated future cash flows expected to be generated by the acquired developed technology would be less than its carrying amount and allocated goodwill, and therefore the asset is impaired as defined by Statement 121. Consequently, the original cost basis of the acquired developed technology and allocated goodwill were reduced to reflect the fair market value at the date the evaluation was made, resulting in a $3,213,000 impairment loss. In determining the fair market value of the asset, management considered the transaction described below, among other factors. Potential Sale of Technology - In January 1999, Vaxcel entered into an agreement with a third party giving the third party the option to purchase the rights to certain of its technologies for an aggregate purchase price of $600,000. The third party paid a nonrefundable option fee of $200,000, with an additional $400,000 due upon the exercise of the option. The initial option period expires on March 22, 1999, subject to extension upon payment of additional fees by the third party. Proceutics, Inc. In February 1998, CytRx's wholly-owned subsidiary, Proceutics consummated a sale of substantially all of its non-real estate assets to Oread Laboratories, Inc. ("Oread") for approximately $2.1 million. Proceutics retained its real estate assets consisting of a laboratory building which it leased to Oread. The laboratory building was subsequently sold in May 1998 (see Note 12). Prior to consummation of this transaction, Proceutics provided preclinical development services to the pharmaceutical industry. Net income (loss) associated with Proceutics included in income (loss) from discontinued operations was approximately $1,387,000, $(138,000) and $(1,448,000) for the years ended December 31, 1998, 1997 and 1996, respectively (see Note 13). A $782,000 gain related to the sale of non-real estate assets is included in income from discontinued operations for 1998, as well as a $434,000 gain on the sale of Proceutics' real estate assets (see Note 12). A summary of the assets and liabilities of Proceutics which were sold and which are included in the consolidated balance sheet at December 31, 1997 is as follows (in thousands): Current assets $ 721 Property and equipment, net 696 ------ Total assets $1,417 ------ Total liabilities $ 228 ======
CytRx Animal Health, Inc. In April 1998, CytRx's wholly-owned subsidiary, CytRx Animal Health, consummated the sale of substantially all of its assets related to its cattle marketing operations to VetLife, LLC ("VL LLC") (an unaffiliated company) for a total 19 purchase price of $7,500,000, subject to certain working capital adjustments, plus contingent payments based on certain events and future sales of specified products of VL LLC and its affiliates that, if made in full, could total up to $5,500,000. CytRx Animal Health retained $5.3 million in investments that were pledged to secure a letter-of-credit, as well as the rights to certain technologies licensed from CytRx. Prior to consummation of this transaction, CytRx Animal Health was engaged in marketing and distributing products to enhance North American beef cattle productivity. Net income (loss) associated with CytRx Animal Health included in income (loss) from discontinued operations was approximately $5,645,000, $868,000 and $(1,151,000) for the years ended December 31, 1998, 1997 and 1996, respectively (see Note 13). A gain related to the sale of $6,230,000 is included in income from discontinued operations for 1998. A summary of the assets and liabilities of CytRx Animal Health which were sold and which are included in the consolidated balance sheet at December 31, 1997 is as follows (in thousands): Current assets $3,695 Property and equipment, net 100 ------ Total assets $3,795 ====== Total liabilities $2,048 ======
12. Sale of Real Estate In May 1998, CytRx and Proceutics consummated the sale of the two buildings owned by them at 150 and 154 Technology Parkway, Norcross, Georgia, to Alexandria Real Estate Equities, Inc. ("Alexandria") for $4.5 million. Proceutics' rights and obligations under the lease to Oread (See Note 11) were assigned to Alexandria, and CytRx leases the building at 154 Technology Parkway from Alexandria. CytRx will also be responsible for all operating expenses for the property. Proceutics recorded a gain of $434,000 for the sale of the its building. A gain of $279,000 on the sale/leaseback of the CytRx building was deferred and will be amortized over the ten year lease period. 13. Segment Reporting The Company has six reportable segments: Research Products (TiterMax), Recruiting Services (Spectrum), Product Development (core business of development and commercialization of pharmaceutical-related products), Cattle Marketing Operations (CytRx Animal Health), Vaccine Development (Vaxcel) and Pharmaceutical Services (Proceutics). See Notes 1 and 11 for a description of these operations. The Company adopted FASB Statement No. 131, Disclosures About Segments of an Enterprise and Related Information, in 1998 which changes the way the Company reports information about its operating segments. The information for 1997 and 1996 has been restated from the prior year's presentation in order to conform to the 1998 presentation. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies (see Note 1). The Company evaluates performance of its operating segments based primarily on profit or loss from operations before income taxes. Summarized financial information concerning the Company's reportable segments is shown in the following table.
Continuing Operations Discontinued Operations ----------------------------------------------- ------------------------------------------------- Total Cattle Pharma- Total Research Recruiting Product Continuing Marketing ceutical Vaccine Discontinued (in thousands) Products Services Development Operations Operations Services Development Operations - --------------------------- -------- -------- ----------- ---------- ---------- -------- ----------- ---------- 1998: Sales to external customers $481 $351 $ -- $ 832 $ 4,383 $ 419 $ -- $ 4,802 Intersegment sales -- -- -- -- -- 131 -- 131 Collaborative, grant & other -- -- 756 756 -- -- 167 167 revenue Interest income -- -- 1,007 1,007 -- 22 13 35 Interest expense -- -- 46 46 -- 3 7 10 Depreciation and amortization -- -- 120 120 8 78 294 380 Unusual Items: Gain on sale of business -- -- -- -- 6,230 782 -- 7,012 Gain on sale of real estate -- -- -- -- -- 434 -- 434 Provision for asset impairment -- -- -- -- -- -- 3,213 3,213 Loss on early debt extinguishment -- -- 325 325 -- -- -- -- Segment profit (loss) 231 114 (8,176) (7,831) 5,645 1,387 (4,319) 2,713 Total assets -- -- 15,666 15,666 -- -- 976 976 Capital expenditures -- -- 112 112 -- 12 4 16 1997: Sales to external customers 456 422 -- 878 13,469 1,984 -- 15,453 Intersegment sales -- -- -- -- -- 853 -- 853 Collaborative, grant & other revenue -- -- 630 630 -- -- 243 243 Interest income -- -- 752 752 -- 2 46 48 Interest expense -- -- 293 293 -- 36 1 37 Depreciation and amortization -- -- 171 171 16 365 201 582 Segment profit (loss) 193 77 (4,696) (4,426) 868 (138) (2,357) (1,627) Total assets -- -- 11,477 11,477 3,795 4,176 5,458 13,429 Capital expenditures -- -- 98 98 11 165 -- 176 1996: Sales to external customers 522 358 -- 880 711 1,004 -- 1,715 Intersegment sales -- -- -- -- -- 627 -- 627 Collaborative, grant & other revenue -- -- 397 397 -- -- 128 128 Interest income -- -- 1,162 1,162 -- 2 7 9 Interest expense -- -- -- -- -- 25 -- 25 Depreciation and amortization -- -- 151 151 15 437 52 504 Segment profit (loss) 173 28 (2,269) (2,068) (1,151) (1,448) (1,124) (3,723) Total assets -- -- 18,869 18,869 735 4,317 378 5,430 Capital expenditures -- -- 76 76 115 336 3 454
20 Report of Independent Auditors The Board of Directors and Stockholders CytRx Corporation We have audited the accompanying consolidated balance sheets of CytRx Corporation as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of CytRx Corporation at December 31, 1998 and 1997 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP Atlanta, Georgia March 9, 1999 EX-21.1 4 CYTRX CORPORATION SUBSIDIARIES 1 EXHIBIT 21.1 CYTRX CORPORATION SUBSIDIARIES
Percentage Name of Subsidiary State of Incorporation of Ownership ------------------------- ---------------------- ------------ Custom Adjuvants, Inc. Georgia 100% Proceutics, Inc. Delaware 100% CytRx Animal Health, Inc. Delaware 100% Vaxcel, Inc. Delaware 87.5%
EX-23.1 5 CONSENT OF INDEPENDENT AUDITORS 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 10-K) of CytRx Corporation of our report dated March 9, 1999, included in the 1998 Annual Report to Shareholders of CytRx Corporation. Our audits also included the financial statement schedule of CytRx Corporation listed in Item 14(a). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, as of the date of our report referred to in the preceding paragraph, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statements on Form S-8 Nos. 33-48706 and 333-31717 pertaining to the CytRx Corporation 401(k) Profit Sharing Plan, No. 33-93816 pertaining to the CytRx Corporation 1994 Stock Option Plan, and No. 33-93818 pertaining to the CytRx Corporation 1995 Stock Option Plan, and on Form S-3 Nos. 33-93820, 333-39607, 333-44043 and 333-48837 and the related Prospectuses, of our report dated March 9, 1999, with respect to the consolidated financial statements incorporated herein by reference, and our report included in the preceding paragraph with respect to the financial statement schedule included in this Annual Report (Form 10-K) of CytRx Corporation. /s/ ERNST & YOUNG LLP Atlanta, Georgia March 26, 1999 EX-27.1 6 FINANCIAL DATA SCHEDULE
5 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEC FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-K. YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 8,855,375 6,417,066 383,249 0 10,935 15,677,002 799,439 604,409 16,641,568 1,949,123 0 0 0 8,237 14,680,311 16,641,568 481,495 2,595,031 35,749 222,796 9,878,295 0 45,888 (7,506,060) 0 (7,506,060) 2,712,701 (325,120) 0 (5,118,479) (.67) (.67)
EX-27.2 7 FINANCIAL DATA SCHEDULE 1996 RESTATEMENT
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CYTRX CORPORATION'S SEC FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 1,429,207 9,564,827 643,079 0 9,508 12,179,020 7,059,101 2,046,292 24,299,322 1,961,588 0 0 0 7,945 22,329,789 24,299,322 522,385 2,438,816 63,171 234,633 4,272,485 0 0 (2,068,302) 0 (2,068,302) (3,723,477) 0 0 (5,791,779) (.75) (.75)
EX-27.3 8 FINANCIAL DATA SCHEDULE 1997 RESTATEMENT
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CYTRX CORPORATION'S SEC FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-K. YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 5,895,008 0 1,917,013 0 2,272,798 10,113,976 7,367,227 2,653,641 24,905,995 3,039,118 2,000,000 0 0 7,986 19,240,409 24,905,995 456,029 2,259,374 39,941 282,284 6,403,382 0 293,048 (4,426,292) 0 (4,426,292) (1,626,700) 0 0 (6,052,992) (.82) (.82)
EX-99.1 9 SAFE HARBOR COMPLIANCE STATEMENT 1 EXHIBIT 99.1 SAFE HARBOR COMPLIANCE STATEMENT FOR FORWARD-LOOKING STATEMENTS CytRx Corporation ("CytRx") intends to qualify both its written and oral forward-looking statements for protection under Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and any other similar safe harbor provisions. Generally, forward-looking statements include expressed expectations of future events and the assumptions on which the expressed expectations are based. All forward-looking statements include expressed expectations of future events and the assumptions on which the expressed expectations are based. All forward-looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected. Due to those uncertainties and risks, investors are urged not to place undue reliance on written or oral forward-looking statements of CytRx. CytRx undertakes no obligation to update or revise this Safe Harbor Compliance Statement for Forward-Looking Statements to reflect future developments. In addition, CytRx undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time. CytRx provides the following risk factor disclosure in connection with its continuing effort to qualify its written and oral forward-looking statements for the safe harbor protection of the Securities Act of 1933 and the Securities Exchange Act of 1934 and any other similar safe harbor provisions. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements include the disclosures contained in the Annual Report on Form 10-K to which this statement is appended as an exhibit and also include the following: WE MAY NOT HAVE ADEQUATE FUNDS TO CONTINUE PRODUCT TESTING AND RESEARCH AND DEVELOPMENT On December 31, 1998, we had approximately $8,850,000 in cash and cash equivalents and $6,400,000 in short-term investments. We believe that our current funds will satisfy our projected liquidity and working capital needs through the first quarter of 2000. However, we may not have adequate funds to conduct the required testing and data collection for the FDA to approve FLOCOR or any of our other products. If we have insufficient funds, we will have to either: 1. severely reduce or terminate testing and research and development activities with respect to some or all of our products; or 2. obtain additional financing from third parties to fund the required testing. 2 Our reduction in, or termination of, testing and research and development activities could have a material adverse impact on our business and future results of operations. If we elect to attempt to obtain additional financing, we may be unable to obtain funds from any third party or to obtain such financing on terms that we believe are acceptable. Our inability to obtain additional financing could have a material adverse effect on our business and future results of operations. See "We Will Require Additional Financing." WE HAVE NO SIGNIFICANT SOURCE OF REVENUE FROM OUR OPERATIONS We will require substantial funds to complete - research and development activities, - preclinical studies and testing activities, and - required data collection and other activities required for FDA review. We currently have no significant source of operating revenue. Our inability to generate revenues in amounts adequate to satisfy our operating needs may have a material adverse effect on our business and may cause us to depend on raising funds by borrowing from third parties or by entering into collaborative relationships with third parties. See "We Will Require Additional Financing." During the first half of 1998, we sold substantially all of the assets of two of our operating subsidiaries to raise capital, which we plan to use for funding the clinical trials and continued research and development for FLOCOR and our other pharmaceutical products. Those two subsidiaries accounted for substantially all of our operating revenues for 1997. Our total revenues for 1998 were approximately $2.6 million. Approximately 47% of our 1998 revenues or $1.2 million consisted of non-operating revenue such as interest income and grants from government agencies. Approximately 32% of our 1998 revenues or $830,000 was derived from selling our services and products (mainly consisting of TiterMax). If the FDA does not approve the commercialization of FLOCOR or one of our other pharmaceutical products, we may not be able to generate significant revenues for an extended period of time, which would have a material adverse effect on our business, financial condition and future results of operations. WE HAVE OPERATED AT A LOSS FOR OVER FIVE YEARS AND WILL PROBABLY CONTINUE TO OPERATE AT A LOSS FOR SOME TIME - 2 - 3 We have incurred significant net losses for each of the last five years. Our inability to operate at a profit in the future could have a material adverse effect on our business and financial condition. Since our inception, we have primarily conducted research and development of our products. The costs of our research and development and our lack of operating revenues has resulted in our net losses. We will continue to incur substantial additional losses in the near future because we are continuing to conduct research and development of our products while we continue to fail to generate any significant revenues. We will probably incur losses until one or more of our products is approved by the FDA and that product has achieved significant sustained commercial sales. The activities required for the FDA review process of a new pharmaceutical are extremely costly and usually take several years. See "We May Incur Substantial Unanticipated Costs If We Have Significant Delays in the Regulatory Approval of Our Products." Also, we may never obtain FDA approval of any of our products currently under development. WE WILL REQUIRE ADDITIONAL FINANCING We believe that are current funds are adequate to satisfy our projected liquidity and working capital needs until the first quarter of 2000. However, we believe that we do not have enough funds (1) to complete the required testing and data collections necessary to obtain regulatory approval of FLOCOR or any of our other products currently under development or (2) to manufacture, market, and distribute any of our products, if we obtain FDA approval with respect to that product. The initiation of the Phase III clinical trials for FLOCOR and the related activities in preparation for its commercialization has greatly increased our need for capital. We may have to raise additional funds through an equity or debt offering, a third party loan, or a third party collaborative arrangement. We may be unable to obtain any financing when we need it or on terms that we believe to be acceptable. Our inability to raise the required additional financing when we need it could have a material adverse effect on our business and financial condition, and could result in the termination of our operations. In addition, if we are able to obtain financing when we require it, such financing may be on terms which may result in dilution to our then-existing stockholders. WE MAY BE UNABLE TO SUCCESSFULLY DEVELOP OR COMMERCIALIZE OUR PRODUCTS Our overall success substantially depends on our ability to successfully develop and commercialize our products. Our inability to successfully develop and commercialize our products could have a material adverse effect on our business, financial condition and future results of operations. Our products are in various stages of development and significant amounts of time and money will be required to develop and commercialize them. Cost overruns - 3 - 4 caused by unanticipated regulatory delays or unexpected adverse side effects could end or substantially delay our development efforts. We also may be unable to obtain FDA approval of those products, if we are unable to prove to the FDA that those products are safe and effective. Even if we are able to obtain FDA approval of one or more of our products, we may not have adequate financial or other resources, or the expertise to successfully commercialize, market and distribute those products. If we do not have adequate resources or the expertise to successfully commercialize our products, we may rely on third parties to provide financial or other resources to help us commercialize those products or we may have such third parties market and distribute our products for us. In order to enter into any such arrangements with a third party, we may have to give up some or all of our rights to some of our products. Also, we may be unable to find a third party willing to provide us with resources or to market and distribute our products. Even if we find a willing third party, we may not be able to reach an agreement on terms that we believe are acceptable. Our inability to successfully commercialize our products, alone or with the assistance of third parties, may have a material adverse effect on our business, financial condition and future results of operations. WE MAY INCUR SUBSTANTIAL UNANTICIPATED COSTS IF WE HAVE SIGNIFICANT DELAYS IN THE REGULATORY APPROVAL OF OUR PRODUCTS Our products are subject to extensive regulation by federal, state and local governments in the United States, including the FDA, and similar agencies in other countries where we test and intend to market our current and future products. Regulatory approval of a product can take several years and requires the expenditure of substantial resources. If we experience significant delays in the regulatory approval process of our products, we may incur substantial unanticipated additional costs. Because we generate insignificant revenues from operations and we have limited funds, if we incur substantial unanticipated costs, we may have to seek additional financing earlier than we had anticipated. At that time, we may be unable to obtain additional financing or financing on terms that we believe are acceptable. Our inability to obtain additional financing to complete the regulatory approval process could have a material adverse effect on our business, financial condition and our ability to continue to operate. WE MAY BE UNABLE TO SUCCESSFULLY COMPETE AGAINST OTHER PHARMACEUTICAL AND BIOTECHNOLOGY COMPANIES Our competitors mainly consist of pharmaceutical and biotechnology companies. Many of those companies have advantages over us, including the following: - substantially greater financial resources and research and development staffs, - substantially superior facilities, - more extensive experience regarding FDA and other regulatory processes, - 4 - 5 - greater manufacturing and marketing expertise, and - alliances with major pharmaceutical companies that may afford greater resources and other advantages. If our competitors develop better products than us; or if they develop their products and obtain regulatory approval faster than us; or if they more successfully manufacture, market and distribute their products than us, then that could have a material adverse effect on our business and future results of operations. WE MAY BE UNABLE TO ESTABLISH AND MAINTAIN NECESSARY RELATIONSHIPS WITH THIRD PARTIES We may have to rely on third parties to enable us to offer our products to a larger customer base than we could otherwise reach through direct marketing efforts. Consequently, our success will depend in part on our ability to enter into relationships with strategic partners and the performance of those partners. We may be unable to find third parties willing to enter into a relationship with us or to enter a relationship on terms that are acceptable to us. Also, we may be unable to maintain any relationships once we have formed them. Our inability to establish and maintain such third party relationships or the unsuccessful performance of one or more of our strategic partners could have a material adverse effect on our business, financial condition and future results of operations. If we are unable to establish and maintain third party relationships, or if such third parties are unsuccessful, we may have to establish our own marketing and distribution channels for our products. We may not have the available financial or other resources at such time to establish our own marketing or distribution channels. Our inability to develop our own marketing and distribution channels in such case could have a material adverse effect on our business and financial condition, and could result in the termination of our operations. WE DEPEND ON CERTAIN SUPPLIERS FOR AN ADEQUATE SUPPLY OF MATERIALS We require three suppliers of materials or services to manufacture FLOCOR. These consist of a supplier of the raw drug substance, a supplier of the purified drug which is refined from the raw drug and a manufacturer who can formulate and sterile fill the purified drug substance into the finished drug product. Our inability to maintain relationships with those suppliers could result in (1) lengthy delays in the FDA and other regulatory agencies approval processes, causing us to incur substantial unanticipated costs or (2) our inability to produce, market and distribute our product. Such delays or inability could have a material adverse effect on our business, financial condition and future results of operation. We have not entered into an agreement with any supplier for the raw drug substance because we believe that it is widely available. - 5 - 6 We have entered into an agreement with a French company to obtain the purified drug substance for use in clinical trials and we are negotiating with another supplier for a commercial supply contract. If our current supply is inadequate to complete the FDA approval process, we may be unable to obtain the necessary additional purified drug substance or to obtain it on terms acceptable to us. We have also entered into an agreement with the Hospital Products Division of Abbott Laboratories for the manufacture of our finished drug product. Our inability to maintain such relationship on terms acceptable to us or to replace such supplier if it fails to adequately perform could have a material adverse effect on our business, financial condition and future results of operations. WE DEPEND ON CERTAIN MEMBERS OF MANAGEMENT FOR FUTURE SUCCESS We depend to a significant extent on the members of the management staff, particularly Jack J. Luchese, for our future success. We may be unable to retain his services or the services of such members of management, or to replace them with qualified skilled individuals. Our loss of the services of Mr. Luchese or any of the other members of management could have a material adverse effect on our business and future results of operations. We have an employment agreement with Mr. Luchese, however, we would be unable to prevent him from terminating his employment with us. Also, we carry no key man life insurance on the life of Mr. Luchese or any other member of the management team. WE MAY INCUR SUBSTANTIAL COSTS AND LIABILITY FROM PRODUCT LIABILITY CLAIMS We may be exposed to claims for person injury resulting from allegedly defective products. Even if the commercialization of one or more of our products is approved by the FDA, users may claim that such product caused unintended adverse effects. We currently carry product liability insurance covering the use of our products in human clinical trials and may extend that coverage to third parties who collaborate with us on the development of our products. However, if a claim is successfully asserted against us and the amount of such claims exceeds our policy limits or is not covered by our policy, such successful claim may have a material adverse effect on our business. Even if claims asserted against us are unsuccessful, they may divert management's attention from our operations and we may have to incur substantial costs to defend such claims. If a significant number of claims are asserted against us, regardless of whether they are successful, they may have a material adverse effect on our operations and business. WE DEPEND ON OUR PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS FOR OUR FUTURE SUCCESS - 6 - 7 Our future success, if any, will depend in a substantial part, on our ability to protect our products by obtaining patents covering them in the United States and other countries. If we are unable to obtain patents covering our products, other companies may develop, manufacture, market and distribute products similar to or the same as our products. Our inability to obtain patents in each country in which we intend to market our products or our inability to successfully challenge third party infringement of our patent claims could have a material adverse effect on our business and future results of operations. Third parties may challenge the validity of our patents through challenges filed with the United States Patent and Trademark Office and its foreign equivalents or through lawsuits. Third parties may also claim that our products infringe their rights under their patents. If a third party successfully asserts an infringement claim against us, we may be prevented from practicing the subject matter claimed in such third party's patents or we could be required to obtain licenses or redesign our products to avoid infringement. If any of our patents are successfully challenged, or any of our products are determined to infringe on the rights of others, we may incur substantial additional costs which may have a material adverse effect on our business, financial condition and future results of operations. In addition, we depend on our trade secrets, proprietary know-how and continuing technological innovation, which we seek to protect with confidentiality agreements with our employees, consultants and collaborators. However, we may be unable to prevent an employee, consultant or collaborator from disclosing trade secrets, know-how or other information. If we are unable to prevent such disclosure, we may have a cause of action against the disclosing party for only monetary damages, which may not be an adequate remedy compared to the harm we may have suffered from the disclosure. Our inability to adequately protect our proprietary information and trade secrets could have a material adverse effect on our business, financial condition and future results of operations. WE MAY BE UNABLE TO SUCCESSFULLY MARKET OUR PRODUCTS IF THEIR COSTS ARE NOT ADEQUATELY REIMBURSED BY GOVERNMENT AND THIRD PARTY PAYORS The success of each of our products will depend in part upon the extent to which a consumer will be able to obtain reimbursement for the cost of such product from government health administration authorities, private health insurers and other organizations. We are uncertain as to the reimbursement status of any of our products that we are currently developing. Government and other third party payors are increasingly attempting to decrease health care costs by refusing to provide coverage for products that have not been approved by the FDA, and by limiting the coverage and reimbursement levels for new products approved by the FDA. If the government and other third party payors do not adequately cover our products, the market may not accept our products. The lack of market acceptance could have a material adverse effect on our business, financial condition and future results of operations. We have initiated discussions with consultants and other advisors who will help us to develop a strategy for seeking adequate reimbursement from the government and other third party payors for - 7 - 8 However, we will be unable to finalize our strategy until we have obtained all of the required regulatory approvals for Flocor and established its market price. GOVERNMENT PRICING REGULATION MAY REDUCE OUR FUTURE REVENUES AND PROFITABILITY Our future revenues and profitability may be affected by the continuing efforts of governments to decrease or contain the costs of health care through the regulation of the pricing and profitability of pharmaceutical products. We are unable to predict whether any federal, state, local or foreign governments will adopt such regulations. However, if such regulations are adopted, they could have a material adverse effect on our business and future results of operations. WE MAY INCUR SUBSTANTIAL COSTS AND LIABILITY UNDER ENVIRONMENTAL AND HAZARDOUS MATERIALS LAWS Our research and development activities involve the use of hazardous materials, which are subject to federal, state and local laws regarding the use, manufacture, storage, handling and disposal of such materials. Although we believe that we comply with applicable environmental laws and regulations, we are unable to completely eliminate the risk of accidental contamination or injury from our hazardous materials and other waste products. If an accident or injury were to occur, we could be liable for any damages that result and any such liability could exceed our resources, which could have a material adverse effect on our business. In addition, we may have to incur substantial costs to comply with environmental laws and regulations in the future which could also have a material adverse effect on our business and future results of operations. WE MAY EXPERIENCE VOLATILITY IN OUR STOCK PRICE The market price of our common stock may experience significant volatility from time to time. Such volatility may be affected by factors such as: - our quarterly operating results; - announcements of regulatory developments, technological innovations or new therapeutic products; - developments in patent or other proprietary rights; and - public concern regarding the safety of our products. Other factors which may affect our stock price is general changes in the economy, financial markets or the pharmaceutical or biotechnology industries. - 8 - 9 OUR ANTI-TAKEOVER PROVISIONS MAY LIMIT STOCKHOLDER VALUE We have provisions in our bylaws and in our shareholder protection rights agreement that may discourage or prevent a person or group from acquiring us without our board of directors' approval. A stockholder may not receive as much in exchange for their shares of common stock as they could without these provisions. The following is a description of these provisions which may reduce the market value of our shares of common stock. We have a classified board of directors, which requires that at least two stockholder meetings, instead of one, will be required to effect a change in the majority control of our board of directors. This provision applies to every election of directors, not just an election occurring after a change in control. The classification of our board increases the amount of time it takes to change majority control of our board of directors and may cause our potential purchasers to lose interest in the potential purchase of us, regardless of whether our purchase would be beneficial to us and our stockholders. Our bylaws provide that directors may only be removed for cause by the affirmative vote of the holders of at least a majority of the outstanding shares of our capital stock then entitled to vote at an election of directors. This provision prevents stockholders from removing any incumbent director without cause. Our bylaws also provide that a stockholder must give us at least 120 days notice of a proposal or director nomination that such stockholder desires to present at any annual meeting or special meeting of stockholders. Such provision prevents a stockholder from making a proposal or director nomination at a stockholder meeting without us having advance notice of that proposal or director nomination. This could make a change in control more difficult by providing our directors with more time to prepare an opposition to a proposed change in control. Under our shareholder protection rights agreement, on May 15, 1997, we distributed one preferred stock purchase right for each then-outstanding share of our common stock. Each right entitles registered holders to purchase one ten-thousandth of a share of our Series A Junior Participating Preferred Stock at an initial purchase price of $30 per share, subject to adjustment. Our preferred stock purchase rights are exercisable only if a person or group (1) announces that they have acquired beneficial ownership of 15% or more of our common stock, or (2) commences a tender offer for 15% or more of our common stock. If a person or group announces that they had acquired 15% or more of our common stock, or commences a tender offer for 15% or more of our common stock, then, after ten days, each right not owned by the person or group which acquired 15% or more of our common stock or who commenced a tender offer for 15% or more of our stock entitles its holder to purchase at the purchase price the number of shares of common stock having a market value equal to twice the purchase price. We may exchange or terminate the preferred stock purchase rights at any time before they become exercisable. - 9 - 10 The preferred stock purchase rights will cause substantial dilution to a person or group that attempts to acquire us on terms not approved by our board of directors, which encourages persons who seek to acquire us to initiate such an acquisition through negotiations with our board of directors. This could discourage any potential acquiror of us and could result in the lower prices of our common stock than may occur during a hostile acquisition attempt. - 10 - -----END PRIVACY-ENHANCED MESSAGE-----