-----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, R2CjQzpjRUTA58NBe2/eTBYEJ8meskYrFS7mIathNsiI3nrvRSMVjpOiG1W3SuLz V8SUoH5TaPni3BltoXND9w== 0000898430-00-001688.txt : 20000524 0000898430-00-001688.hdr.sgml : 20000524 ACCESSION NUMBER: 0000898430-00-001688 CONFORMED SUBMISSION TYPE: S-2 PUBLIC DOCUMENT COUNT: 5 FILED AS OF DATE: 20000523 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PROTEIN POLYMER TECHNOLOGIES INC CENTRAL INDEX KEY: 0000858155 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMMERCIAL PHYSICAL & BIOLOGICAL RESEARCH [8731] IRS NUMBER: 330311631 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-2 SEC ACT: SEC FILE NUMBER: 333-37676 FILM NUMBER: 642344 BUSINESS ADDRESS: STREET 1: 10655 SORRENTO VALLEY RD CITY: SAN DIEGO STATE: CA ZIP: 92121 BUSINESS PHONE: 6195586064 MAIL ADDRESS: STREET 1: 10655 SORRENTO VALLEY ROAD CITY: SAN DIEGO STATE: CA ZIP: 92121 S-2 1 FORM S-2 As filed with the Securities and Exchange Commission on May 23, 2000. Registration No. 333____ ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 _____________________ FORM S-2 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 _____________________ Protein Polymer Technologies, Inc. (Exact name of registrant as specified in its charter) Delaware 33-0311631 (State or other jurisdiction (IRS Employer of incorporation or organization) Identification Number) 10655 Sorrento Valley Road, San Diego, California 92121 (858) 558-6064 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) J. Thomas Parmeter Copies to: Chairman & Chief Executive Officer Robert A. Miller, Jr., Esq. Protein Polymer Technologies, Inc. Paul, Hastings, Janofsky & Walker LLP 10655 Sorrento Valley Road 555 South Flower Street San Diego, California 92121 Los Angeles, California 90071-2371 (858) 558-6064 (213) 683-6000 (Name, address, including zip code, and telephone number, including area code, of agent for service) Approximate date of commencement of proposed sale to the public: From time to time after the effective date of this Registration Statement. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [X] If the registrant elects to deliver its latest annual report to security holders, or a complete and legal facsimile thereof, pursuant to Item 11(a)(1) of this Form, check the following box. [X] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_]_______ If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_]_______ If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_]________ If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. [_] CALCULATION OF REGISTRATION FEE
=================================================================================================================================== Title of Each Class of Amount to be Proposed Maximum Offering Proposed Maximum Amount of Securities to be Registered Registered (1))(2) Price Per Unit (3) Aggregate Offering Price (3) Registration Fee (3) - ----------------------------------------------------------------------------------------------------------------------------------- Common Stock, $0.01 par value 12,640,000 $0.875 $11,060,000 $2,919.84 per share ===================================================================================================================================
(1) Represents the following: (A) the maximum of 4,200,000 shares of common stock issuable upon conversion of our Series G Convertible Preferred Stock; (B) the maximum of 4,200,000 shares issued upon exercise of warrants issued in connection with our Series G Convertible Preferred Stock; (C) the maximum of 4,200,000 shares issuable upon exercise of warrants issued in connection with the exercise and exchange of warrants issued with our Series G Convertible Preferred Stock; (D) the maximum of 15,000 shares issuable upon exercise of warrants issued in connection with a $150,000 loan to us and (E) the maximum of 25,000 shares issuable upon exercise of warrants issued as compensation in relation to our private placement of Series G Convertible Preferred Stock. (2) Pursuant to Rule 416 promulgated under the Securities Act, there are also registered hereunder such indeterminate number of additional shares as may be issued to the Selling Securityholders to prevent dilution resulting from stock splits, stock dividends, or similar transactions pursuant to the terms of our Series G Convertible Preferred Stock and warrants. (3) Estimate based on average of the bid and asked prices of our common stock as reported on the NASD Bulletin Board on May 22, 2000 pursuant to Rule 457(c) promulgated under the Securities Act. The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. Subject to Completion, Dated May 23, 2000 PROSPECTUS - ---------- Protein Polymer Technologies, Inc. 12,640,000 Shares of Common Stock ___________________ The Selling Securityholders are offering (i) up to 4,200,000 shares of our common stock issuable upon conversion of 21,000 shares of our Series G Convertible Preferred Stock, issued to a small group of accredited and institutional investors in a private placement on September 15, 1999; (ii) up to 4,200,000 shares of our common stock issued upon exercise of common stock warrants issued in conjunction with the Series G Convertible Preferred Stock; (iii) up to 4,200,000 shares of our common stock issuable upon exercise of common stock warrants issued in connection with the exercise and exchange of the warrants issued with the Series G Convertible Preferred Stock; (iv) up to 15,000 shares of our common stock issuable upon exercise of common stock warrants issued in connection with a $150,000 bridge loan to us; and (v) up to 25,000 shares of our common stock issuable upon exercise of common stock warrants issued in connection with a consulting agreement. We will not receive any proceeds from the sale of our common stock by the Selling Securityholders except for funds received upon the exercise of the warrants. All costs, expenses and fees incurred in connection with the registration of our common stock, estimated to be approximately $32,920.00, are being borne by us, but all selling and other expenses incurred by the Selling Securityholders will be borne by such Selling Securityholders. Our common stock may be offered from time to time by each Selling Securityholder acting as principal for its own account or in brokerage transactions at prevailing market prices or in transactions at negotiated prices. No representation is made that our common stock will or will not be offered for sale. It is not possible at the present time to determine the price to the public in any sale of our common stock by the Selling Securityholders and each Selling Securityholder reserves the right to accept or reject, in whole or in part, any proposed purchase of shares of our common stock. Accordingly, the public offering price and the amount of any applicable underwriting discounts and commissions will be determined at the time of such sale by the Selling Securityholders. The Selling Securityholders, and the brokers through whom sales of the shares of our common stock offered hereby are made, may be deemed to be "underwriters" within the meaning of Section 2(11) of the Securities Act. In addition, any profits realized by the Selling Securityholders or such brokers on the sale of the shares of our common stock offered hereby may be deemed to be underwriting commissions. Our common stock is traded "over the counter" on the NASD Bulletin Board under the symbol "PPTI.OB." _____________________ Copies of our Annual Report on Form 10-KSB for the year ended December 31, 1999 and our Quarterly Report on Form 10-QSB for the quarter ended March 31, 2000 accompany this prospectus. _____________________ Investing in our common stock involves a high degree of risk. Please consider carefully the Risk Factors beginning on page 5. _____________________ Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of the prospectus. Any representation to the contrary is a criminal offense. Prospectus dated May __, 2000 TABLE OF CONTENTS
Page ---- Available Information......................................................... 2 Incorporation By Reference.................................................... 2 Forward Looking Statements.................................................... 3 The Company................................................................... 3 Risk Factors.................................................................. 5 Plan of Distribution.......................................................... 12 Use of Proceeds............................................................... 13 Selling Securityholders....................................................... 13 Description Of Securities To Be Registered.................................... 17 Legal Matters................................................................. 22 Experts....................................................................... 22 Indemnification Of Directors And Officers..................................... 22
We have not authorized any dealer, salesman or other person to give any information or represent anything not contained in this prospectus or incorporated by reference. You should not rely on any unauthorized information. We are offering to sell, and seeking offers to buy, the securities only in jurisdictions where offers and sales are permitted. The information in this prospectus is accurate as of the date on the cover. Delivery of this prospectus or any sale of the securities does not indicate that there has been no change in our affairs since the date of this prospectus. AVAILABLE INFORMATION We are a public company and file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission. Copies of such reports, proxy and other information may be read and copied at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You can request copies of such documents by writing to the SEC and paying a fee for the copying cost. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a web site at (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants that file electronically with the SEC. This prospectus is part of a Registration Statement on Form S-2 that we filed with the SEC. Certain information in the Registration Statement has been omitted from this prospectus in accordance with the rules and regulations of the SEC. We have also filed exhibits and schedules with the Registration Statement that are excluded from this prospectus. For further information you may: . read a copy of the Registration Statement, including the exhibits and schedules, without charge at the SEC's Public Reference Room; or . obtain a copy from the SEC upon payment of the fees prescribed by the SEC. INCORPORATION BY REFERENCE The SEC allows us to "incorporate by reference" certain of our publicly filed documents into this prospectus, which means that information included in these documents is considered part of this prospectus. We incorporate by reference in this prospectus: . Our Annual Report on Form 10-KSB for the year ended December 31, 1999; and . Our Quarterly Report on Form 10-QSB for the quarter ended March 31, 2000. We will provide any person to whom a copy of this prospectus is delivered, on written or oral request, a copy of any or all of the documents incorporated by reference, other than exhibits to such documents unless specifically incorporated by reference therein. You should direct any requests for documents to Janis Neves, 2 Director, Finance, Protein Polymer Technologies, Inc., 10655 Sorrento Valley Road, San Diego, California 92121, telephone (858) 558-6064. FORWARD LOOKING STATEMENTS Certain statements contained or incorporated by reference in this prospectus constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include those set forth in this prospectus, including under the caption "Risk Factors." Given these uncertainties, prospective investors are cautioned not to place undue reliance on such forward-looking statements. We disclaim any obligation to update any such statements or to publicly announce any updates or revisions to any of the forward-looking statements contained in this prospectus to reflect any change in our expectations or any change in events, conditions, circumstances or assumptions underlying such statements. THE COMPANY We are a development-stage biotechnology company engaged in the research, development, production and clinical testing of medical products based on our proprietary protein-based biomaterials technology. We were incorporated in Delaware on July 6, 1988. Since 1992 we have focused primarily on developing materials, technology and products to be used for: . soft tissues augmentation products; . surgical adhesives and sealants; . wound healing matrices; and . drug delivery devices. We have also developed coating technology that can efficiently modify and improve the surface properties of more traditional biomedical devices. Our primary goal is to develop medical products with significantly improved patient outcomes as compared to current products and practices. In December 1999, we initiated human clinical testing of our urethral bulking agent for the treatment of female stress urinary incontinence. The August 1999 approval by the U.S. Food and Drug Administration of our Investigational Device Exemption allows us to test the safety and effectiveness of the incontinence product in women over the age of 40 who have become incontinent due to the shifting of their bladder or the weakening of the muscle at its base that controls the flow of urine, or both problems combined. We estimate that more than 2.5 million women begin to experience stress urinary incontinence in the United States each year. In most untreated cases, the problem becomes progressively more pronounced. Due to limited efficacy or invasiveness of current treatments, only a small proportion of the women experiencing stress urinary incontinence are clinically treated, relying instead on pads and plugs and the like that only address the symptoms. In contrast, our product is injected, typically in an outpatient procedure, into urethral tissue at the base of the bladder forming a solid implant that provides support to the muscles controlling the flow of urine. We believe that our product will prove to be easy for the physician to use, offer enduring effectiveness, and avoid most of the other limitations of urethral bulking products on the market or in development. In January 2000, we established a strategic alliance with Femcare, Ltd. for the commercialization of the incontinence product in Europe and Australia. In the agreement, Femcare is responsible for clinical testing, regulatory approval, and product sales and marketing within these territories, and we are responsible for product manufacturing. Commercialization of the product in Europe is expected to begin more than a year before approval for marketing the product in the United States can be obtained. We are also in discussions with several companies 3 regarding the establishment of strategic alliances for commercializing the incontinence product in the United States and other markets outside the Femcare territories. The tissue augmentation materials and technology underlying the incontinence product have the potential to be effective and desirable in a number of other clinical applications. We intend to submit an additional Investigational Device Exemption to the U.S. Food and Drug Administration in 2000 to obtain approval to begin human clinical testing of our dermal bulking agent for use in cosmetic and reconstructive surgery applications. We began studies to identify our most promising biomaterial formulations for use in these soft tissue augmentation products in 1996, devoted increasing resources through 1997 and 1998, and have primarily focused in 1999 and 2000 on human clinical testing of the incontinence product. Our other advanced product technology is in the area of tissue adhesives and sealants. We have demonstrated both the adhesive performance and the biocompatibility of our product formulations in animal models, including the resorption of the adhesive matrix in conjunction with the progression of wound healing. Currently our research and development in this area is focused on the repair of spinal discs for the treatment of lower back pain. We are committed to the commercial development of our adhesive and sealant technology and continue to determine the specific markets and products providing the most significant opportunities for their use. We are seeking to establish new strategic alliances with leaders in those markets. To the extent sufficient resources are available, we continue to research the use of our protein polymers for other tissue repair and medical device applications, principally for use in tissue engineering matrices and drug delivery devices. Through 1999, we marketed specialty use products for in vitro cell culture applications including SmartPlastic(R), ProNectin(R) F Cell Attachment Factor and ProNectin(R) L Cell Attachment Factor. ProNectin(R) F was launched commercially in 1991. SmartPlastic is ProNectin(R) F Activated Cultureware where ProNectin F is presented in ready to use form on the surfaces of disposable plastic labware for culturing human and animal cells. SmartPlastic was launched commercially in 1995. In 1998, we discontinued direct sales of our cell culture products, and in February 2000, we sold all rights to the use of the technology for in vitro cell culture applications, the product trademarks, and remaining inventory to Sanyo Chemical Industries, Ltd. Our current development efforts are focused primarily on products to augment the body's soft tissues. Key markets include the treatment of female stress urinary incontinence and the correction of facial contour deficiencies due to aging and disease. Other markets of interest to us are being evaluated in relation to our tissue adhesive and sealant technology, scaffold technology for wound healing and tissue engineering, and drug delivery technology. Our address is Protein Polymer Technologies, Inc., 10655 Sorrento Valley Road, San Diego, California 92121, and our telephone number is (858) 558-6064. 4 RISK FACTORS You should read the following risk factors carefully before purchasing any common stock. If any of the risks discussed below actually occur, our business, financial condition, operating results or cash flows, could be materially adversely affected. This impact could cause the trading price of our common stock to decline, and you could lose all or part of your investment. Dependence on Strategic Partners Our strategy is to enter into partnerships or licensing arrangements with major medical or pharmaceutical companies with broad distribution capabilities in appropriate markets in order to reduce the time and costs for developing and commercializing our potential products. In January 2000, we entered into a license and development agreement, conditioned upon obtaining the requisite regulatory approval, with Prospectivepiercing Limited, to be known as Femcare Urology Limited, for marketing and distribution of our urethral bulking agent for stress urinary incontinence in Australia and Europe. There can be no assurance that we will be able to establish additional strategic partnerships or licensing arrangements, or, if available, that they will be on acceptable terms and conditions. Additionally, these arrangements generally may be subject to termination under various circumstances, or solely at the discretion of the strategic partner without prior notice. Termination of such arrangements would have a material adverse effect on our business and financial condition. Furthermore, our strategy may lead to multiple alliances regarding different product opportunities that are active at the same time. There can be no assurance that we will be able to successfully manage such multiple arrangements in various stages of development. We have entered into certain materials evaluation agreements and preliminary negotiations with other entities regarding additional biomedical and specialty use applications of our polymers and technology, including applications in areas other than those identified above as product candidates. These agreements provide, or are intended to provide, for the evaluation of product feasibility. There can be no assurance that we will be able to establish such agreements, or, if available, do so in a timely manner and on reasonable terms, or that such agreements will lead to joint product development and commercialization agreements. Technological and Commercial Uncertainties Our technological strategy of designing and producing unique biocompatible products based on genetically engineered proteins is commercially unproven. The process of developing products and achieving regulatory approvals is time- consuming and prone to delays. Except for limited sales averaging less than $100,000 per year of ProNectin(R) F, ProNectin(R) L and SmartPlastic(R), we have not completed the development of any product or generated any significant revenues from product sales. In February 2000, we sold all rights to the use of the technology for in vitro cell culture applications, the product trademarks and the remaining inventory of ProNectin(R) F, ProNectin(R) L and SmartPlastic(R) to Sanyo Chemical Industries, Ltd. Our success will depend upon: . our ability to identify products with the most commercial potential; . our ability to allocate sufficient resources to develop such products; . our ability to design and produce biocompatible materials with the intended chemical, biological and functional properties needed for the targeted products; . our ability to secure strategic alliances appropriate to a product's development, marketing and distribution requirements; and . our ability to manufacture our products in sufficient quantity at reasonable costs under regulated conditions to meet product demand. The product candidates we are currently pursuing will require substantial further development, testing and regulatory approvals. There can be no assurance that these efforts will result in commercially acceptable products. There can be no assurance that such products: 5 . can be produced in commercial quantities at reasonable costs; . can be effectively marketed in a timely fashion; . will have significant benefits compared to competitive products on the market at the time of product introduction; or . will be accepted for use by the target markets. There can be no assurance that our research and development activities will be successful or that any of our future products will ultimately be commercially successful. History of Operating Losses; Continued Expectation of Losses; Funding Through January of 2001; Future Capital Requirements We have incurred operating losses since our inception in 1988, and will continue to do so for at least several more years. As of March 31, 2000, our accumulated deficit was approximately $37.7 million, and we have continued to incur losses since that date. Such losses have resulted principally from expenses of research and development and to a lesser extent, from general and administrative expenses. Any potential contract revenues derived from collaborative agreements with possible strategic partners will, alone, be insufficient for us to become profitable. The timing of our losses, and possible offsetting contract revenues, is highly uncertain and may produce financial results that fluctuate significantly from period to period. We believe that our current capital resources will be sufficient to fund our operating losses through January of 2001. We are actively pursuing a number of potential approaches to meet the continuing capital requirements of our operations, such as initiating and engaging in preliminary negotiations with a number of potential collaborative partners. There can be no assurance that we will be able to raise sufficient additional capital funds, if at all, or that such financing will be available on acceptable terms. If adequate funds are not available, we will be required to significantly curtail our operations and relinquish rights to major portions of our technology or products, including rights to the manufacture and sale of protein polymers and rights with respect to our soft tissue augmentation and our tissue repair technologies. Substantial additional capital resources will be required to fund our continuing operating expenditures and activities including: . increasing expenditures related to our research and development activities; . establishment and scale-up of appropriate manufacturing capabilities; . preclinical and clinical testing; . regulatory compliance; . business development activities; and . patent prosecution. Intense Competition and Rapid Technological Change The areas of business in which we engage and propose to engage are characterized by rapidly evolving technology and intense competition. The anticipated commercial uses of our biomaterials are primarily end-use products for medical applications. End-use products using or incorporating our biomaterials would compete with other products that rely on the use of alternative materials or components. Technologies which compete with ours are, therefore, diverse, complex and numerous. Competition in the biomedical and surgical repair markets is particularly significant. Our competitors in those markets include major pharmaceutical, surgical product, chemical and specialized biopolymer companies, many of which have financial, technical, research and development and marketing resources significantly greater than ours. Academic institutions and other public and private research organizations are also conducting research 6 and seeking patent protection, and may commercialize products on their own or through joint ventures. Most of our competitors depend on technology other than protein engineering for developing products, for example Focal, Inc. and Closure Medical Corp. We believe that DuPont and several university laboratories are currently conducting research into similar protein engineering technology. The primary competitive factors in the biomedical and surgical repair products market are: . performance; . cost; . safety; . reliability; . ease of use; and . commercial production capabilities. We believe that our ability to compete in this market will be enhanced by our issued patent claims, the breadth of our other pending patent applications and our experience in protein engineering. However, we currently do not have the resources to compete commercially without the use of collaborative agreements with third parties. Our product technology competes for corporate development and marketing partnership opportunities with numerous other biotechnology companies, research institutes, academic institutions and established pharmaceutical companies. There can be no assurance that our competitors will not succeed in developing products based on our technology or other technologies that are more effective than any which are being developed by us, or which would render our technology and products obsolete and non- competitive. Manufacturing Uncertainties To date, we have manufactured only limited amounts of our biomedical products for internal testing, initial human clinical testing and, in certain cases, evaluation and testing by corporate partners and other third parties. The development and commercialization of certain biomedical products will require us, pursuant to applicable governmental regulations, to upgrade our manufacturing facilities and to obtain manufacturing approvals from the United States Food and Drug Administration. Currently, we are conducting our manufacturing operations under the FDA's "Good Laboratory Practices" and portions of the FDA's Quality System Regulation required for use of our products in preclinical and pilot clinical testing. In May 1999, the FDA conditionally approved our Investigational Device Exemption application requesting permission to begin human clinical feasibility testing of our urethral bulking agent for the treatment of female stress urinary incontinence. In August 1999, unconditional approval was obtained and we initiated pilot human clinical testing in December 1999. There can be no assurance that the human clinical trials will be successful. We are currently considering alternative methods for increased production of our product candidates to meet clinical sample requirements under the FDA's applicable Quality System Regulation and cognate international quality system requirements, i.e., ISO 9001. For example, we may upgrade and expand our existing facility; however, there can be no assurance that, if desired, we could adequately develop, fund, implement and manage such a manufacturing facility. Alternatively, we may establish external contract manufacturing arrangements; however, there can be no assurance that such arrangements, if desired, could be entered into or maintained on acceptable terms, if at all, or would comply with applicable governmental regulations. We have not yet developed a process to manufacture our product candidates on a commercial scale. There can be no assurance that a process can be developed by us or any other party at a cost or in quantities necessary to become commercially viable. Alternative methods may be needed for producing commercial quantities of products, if any. The actual method, or combination of methods, that we may ultimately pursue will depend on a number of factors, including availability, facilities, needed quantities, cost and governmental regulations. There is no assurance that we will successfully assess the ability of such production methods or establish contract manufacturing 7 arrangements to meet our commercial objectives, or that such methods and arrangements would not adversely affect our margins or our ability to compete in the marketplace. Uncertainty of Regulatory Compliance and Approvals Regulation by governmental authorities in the United States and other countries is a significant factor affecting the success of products resulting from biotechnological research. Our current operations and products are, and anticipated products and operations will be, subject to substantial regulation by a variety of local, state, federal and foreign agencies, particularly those products and operations related to biomedical applications. Our activities are subject to regulation primarily under the Occupational Safety and Health Act and the Food, Drug & Cosmetic Act, as amended. Pre-clinical and clinical testing and pre-market approval from the FDA is required for new medical devices, drugs or vaccines, a generally costly and time-consuming process. The FDA could require additional preclinical or clinical testing in addition to those we have completed or planned, which would result in increased costs and significant development delays. The failure to demonstrate adequately to the FDA the safety and efficacy of a product under development would prevent regulatory approval. Many companies have experienced these types of setbacks during later stage clinical trials, despite promising results in earlier trials. If we do not directly produce and sell medical devices, drugs or vaccines, we may not be directly affected by FDA regulations. However, our anticipated customers and strategic partners would be required to comply with such regulations. Additionally, we may be required to file and maintain with the FDA a "Master File" containing information regarding our products. There can be no assurance that we or our customers and strategic partners will be able to obtain or maintain the necessary approvals from the FDA or corresponding international regulatory authorities, or that we will be able to maintain a Master File in accordance with FDA regulations. In either case, our anticipated business could be adversely affected. We have manufactured limited amounts of our biomedical materials and products for internal testing, initial human clinical testing, and, in certain cases, evaluation and testing by strategic partners and other third parties. Preclinical and clinical testing of potential medical device products, where the results will be submitted to the FDA, requires compliance with the FDA's Good Laboratory Practices and other quality system regulations. We have implemented polymer production and quality control procedures, have made certain facilities renovations, and believe we are in compliance with applicable requirements. Before pursuing expanded clinical testing and commercial production, we will be required to conform our operations to additional FDA Quality System Regulations. International quality system requirements, i.e., ISO 9001, are similar to the FDA's Quality System Regulation. Quality System Regulations requirements are rigorous, and there can be no assurance that acceptable Quality System Regulations status could be obtained in a timely manner and without the expenditure of substantial resources, if at all. We may also be required to register our facility with the FDA as an establishment involved in the manufacture of medical devices. Our research, development and production activities are, or may be, subject to various federal and state laws and regulations relating to environmental quality and the use, discharge, storage, transportation and disposal of toxic and hazardous substances. Our future activities may be subject to regulation under the Toxic Substances Control Act, which requires us to obtain pre- manufacturing approval for any new "chemical material" we produce for commercial use that does not fall within the FDA's regulatory jurisdiction. We believe we are currently in substantial compliance with such laws and regulations applicable to our current operations. Although we intend to use our best efforts to comply with all laws and regulations in the future, there can be no assurance that we will be able to fully comply with such laws, or that full compliance will not require substantial capital expenditures. There can be no assurance that future approvals will be sought or obtained, and the failure to obtain or maintain these approvals, or any substantial delay in obtaining these approvals, would likely have a material adverse effect on our operations. 8 Dependence on Key Employees As of May 15, 2000, we had nineteen full-time employees and two part-time employees of whom two hold Ph.D. degrees in the chemical or biological sciences. Our success will depend largely upon the efforts of our scientists and certain of our executive officers. The loss of services of any one of these individuals would have a material adverse effect on our business opportunities and prospects. The recruitment and retention of additional qualified management and scientific personnel is also critical to our success. There can be no assurance that we will be able to attract and retain required personnel on acceptable terms, due to the competition for such experienced personnel from other biotechnology, pharmaceutical and chemical companies, universities and non- profit research institutions. We do not maintain "key-man" or similar life insurance policies with respect to such persons to compensate us in the event of their deaths. Product Liability; Absence of Insurance Product liability claims may be asserted with respect to our technology or products either directly or through our strategic partners. We may be exposed to potential product liability risks whenever human clinical testing is performed or upon the use of any commercially marketed medical product. We believe that our prior sales of SmartPlastic(R), ProNectin (R) F and ProNectin(R) L products do not pose any material product liability risk. Prior to initiating human clinical testing of our urethral bulking agent, we procured product liability insurance. To our knowledge no product liability claims have ever been made against us. There can be no assurance that adequate levels of insurance coverage will continue to be obtainable on acceptable terms, or that the assertion of a product liability claim would not materially adversely affect our business or financial condition. Patents and Trade Secrets Our success will depend, in part, on our ability to obtain patent protection or maintain other protection for our technology and product candidates. Other protection includes maintenance of trade secrets and contractual agreements. Our success will also depend in part on not violating the proprietary rights of third parties, including the infringement of patents. To date, we have been issued eighteen United States patents and six additional United States patent applications are pending. The patent position of biotechnology companies is highly uncertain and involves complex legal, scientific and factual questions. There can be no assurance that patents will issue from any of our pending patent applications or that, if patents do issue, the claims allowed will be sufficiently broad to protect our technology and product candidates. In addition, there can be no assurance that any patents previously or subsequently issued to us will not be challenged, invalidated or circumvented, or that the rights granted thereunder will provide us with any proprietary protection or competitive advantage. Competitors may have filed patent applications or may have obtained patents and other proprietary rights relating to products or processes similar to and competitive with ours. The scope and validity of such patents, the extent to which we may be required to obtain licenses under these patents or other proprietary rights, and the cost and availability of such licenses are presently unknown. There can be no assurance that any licenses required under any patents or proprietary rights will be made available to us on acceptable terms, if at all. Further, we may enter into collaborative research and development arrangements with strategic partners that may result in the development of new technologies or products. There can be no assurance that disputes will not arise in the future with respect to the ownership of rights to any technology or products that may be so developed. We have also applied for patent protection with respect to certain of our patents in foreign countries, including Japan and Europe. We have not yet marketed, sold or developed our products outside the United States, except for limited amounts of ProNectin(R) F, ProNectin(R) L and SmartPlastic(R) cell culture products. To date, we have been issued fifteen foreign patents and we have twenty-seven pending foreign patent applications. There can be no assurance that additional patents will issue from any of our pending foreign patent applications or that, if patents do issue, the claims allowed will be sufficiently broad to protect our technology and product candidates. In addition, there can be no assurance that any foreign patents issued to us will not be challenged, invalidated or circumvented, or that the rights granted thereunder will provide us with any proprietary protection or competitive 9 advantage. Furthermore, certain foreign intellectual properties laws may not be as protective as those of the United States. We also seek to protect our intellectual property in part by confidentiality agreements with our employees and consultants. There can be no assurance that these agreements will not be breached, that we will have an adequate remedy for any breach, or that our trade secrets will not otherwise become known or independently discovered by competitors. Dividend Policy; No Payment of Dividends We have never paid dividends on our common stock, and given our continuing loss situation, we do not anticipate paying any cash dividends on the common stock in the foreseeable future. Additionally, the holders of our Series D Convertible Preferred Stock and Series F Convertible Preferred Stock have certain preferences that entitle them to cumulative dividends prior to the payment of any cash dividends on our common stock. Our Series E Convertible Preferred Stock and Series G Convertible Preferred Stock do not have any preference with respect to cash dividends and share ratably, after payment of preferred dividends on our Series D Convertible Preferred Stock and Series F Convertible Preferred Stock, with the holders of our common stock, Series D Convertible Preferred Stock and Series F Convertible Preferred Stock in any cash dividends declared on our common stock. Volatility of Trading Price There has been significant volatility in market prices of securities of biotechnology companies, and the trading price of the securities could be subject to wide fluctuations. Factors that could have a significant adverse impact on the market price of our common stock include: . announcements of technological innovations by our competitors; . announcements of new commercial products by our competitors; . adverse results in product testing; . litigation; . governmental regulation; or . adverse patent or proprietary rights developments. Investment Company Act Considerations We believe that we are primarily engaged in business other than investing, reinvesting, owning, holding or trading in securities. We invest our cash in cash equivalents and short-term investments of high quality, following the investment guidelines approved by our board of directors. However, there can be no assurance that we may not be required to comply with the registration requirements of the Investment Company Act of 1940. Such registration requirements would have a material adverse effect upon us. Nasdaq Delisting; Potential Regulation as a Penny Stock Our common stock was delisted from the Nasdaq SmallCap Market on September 20, 1999. Trading in the common stock after our delisting, if any, will likely be conducted in the over-the-counter markets in the so-called "pink sheets" or the National Association of Securities Dealers' Electronic Bulletin Board and could also be subject to additional restrictions. As a consequence of such delisting, it is expected that our stockholders will find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, the common stock. In addition, such delisting will make the common stock substantially less attractive as collateral for margin and purpose loans, for investment by financial institutions under their internal policies or state legal investment laws, or as consideration in future capital raising transactions. 10 After our securities were delisted from the Nasdaq SmallCap Market, the common stock may have become subject to regulation as a "penny stock." The Securities and Exchange Commission has adopted regulations which generally define "penny stock" to be any equity security that has a market price or exercise price less than $5.00 per share, subject to certain exceptions, including listing on the Nasdaq SmallCap Market. If the common stock is delisted from the Nasdaq SmallCap Market and no other exception applies, our common stock may become subject to the SEC's Penny Stock Rules, Rule 15g-1 through Rule 15g-9 under the Exchange Act. For transactions covered by these rules, the broker-dealer must make a special suitability determination for the purchase of such securities and have received the purchaser's written consent to the transaction prior to the purchase. Additionally, for any transaction involving a penny stock, unless exempt, the rules require the delivery, prior to the transaction, of a risk disclosure document mandated by the SEC relating to the penny stock market. The broker-dealer must also disclose the commission payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Consequently, the penny stock rules may restrict the ability of broker-dealers to sell our securities and may affect the ability of holders to sell our securities in the secondary market and the price at which such holders can sell any such securities. Rule 15g-9 under the Exchange Act imposes additional sales practice requirements on broker-dealers who sell such securities except in transactions exempted from such rule. Such exempt transactions include those meeting the requirements of Rule 505 or 506 of Regulation D promulgated under the Securities Act and transactions in which the purchaser is an institutional accredited investor or an established customer of the broker-dealer. 11 PLAN OF DISTRIBUTION We issued an aggregate of 21,000 shares of Series G Convertible Preferred Stock to several institutional and accredited investors at a price of $100 per share in a private placement on August 17, 1999 and September 15, 1999 under Rule 506 promulgated under the Securities Act. Each share of Series G Convertible Preferred Stock is convertible into shares of our common stock at a conversion ratio equal to the quotient derived by dividing (A) the stated value of $100 by (B) $0.50 (subject to certain antidilution adjustments for future stock distributions, stock splits or similar capital adjustments). Each share of Series G Convertible Preferred Stock also received a common stock warrant, exercisable for 12 months, that allowed the holder to acquire 200 shares of our common stock at a price of $0.50 per share; all of such warrants were exercised in February 2000. Each holder of the warrants issued in connection with our Series G Convertible Preferred Stock received, in connection with the exercise and exchange of such warrants, an additional common stock warrant, exercisable for 12 months, that allows the holder to acquire 200 shares of our common stock at a price of $1.50 per share. In addition under Section 4(2) of the Securities Act we issued (i) common stock warrants, exercisable for 12 months, to purchase up to 15,000 shares of our common stock at a price of $0.50, in connection with a $150,000 bridge loan to us, and (ii) common stock warrants, exercisable for five years, to purchase up to 25,000 shares of our common stock at a price of $0.75, in connection with a consulting agreement. Shares underlying the Series G Convertible Preferred Stock may only be offered by the Selling Securityholders if such Series G Convertible Preferred Stock is converted prior to such offering. Shares underlying the warrants may only be offered by the Selling Securityholders if such warrants are exercised prior to such offering. The selling holders are the institutional and accredited investors, and any of their pledgees, assignees, donees, other transferees and successors-in-interest, pursuant to the aforementioned transactions and the securities being offered under this prospectus are the shares of our common stock issued or issuable upon conversion of the Series G Convertible Preferred Stock and exercise of the warrants. The shares offered hereby may be sold from time to time by the Selling Securityholders. Such sales may be made in the over-the-counter market or otherwise, at prices and at terms then prevailing or at prices related to the then current market price, or in negotiated transactions. As of May 15, 2000, our common stock is trading only on the NASD Bulletin Board. Our common stock may be sold by each of the Selling Securityholders acting as principal for its own account or in ordinary brokerage transactions and transactions in which the broker solicits purchasers. In effecting sales, broker-dealers engaged by the Selling Securityholders may arrange for other broker-dealers to participate in the resales. Broker-dealers or agents may receive compensation in the form of commissions, discounts or concessions from Selling Securityholders in amounts to be negotiated in connection with the sale. Such broker-dealers and any other participating broker-dealers may be deemed to be "underwriters" within the meaning of the Securities Act in connection with such sales, and any such commission, discount or concession may be deemed to be underwriting discounts or commissions under the Securities Act. In addition, any shares covered by this Prospectus which qualify for sale pursuant to Rule 144 may be sold under Rule 144 rather than pursuant to this Prospectus. The Selling Securityholders may agree to indemnify any broker-dealer or agent that participates in transactions involving sales of the shares offered hereby against certain liabilities, including liabilities arising under the Securities Act. We have agreed to indemnify the Selling Securityholder against certain liabilities in connection with the offering of our common stock, including liabilities arising under the Securities Act. It is not possible at the present time to determine the price to the public in any sale of our common stock by the Selling Securityholders. Accordingly, the public offering price and the amount of any applicable underwriting discounts and commissions will be determined at the time of such sale by the Selling Securityholders. The aggregate proceeds to the Selling Securityholders from the sale of the Shares will be the purchase price of the shares of our common stock sold less all applicable commissions and underwriters' discounts, if any. We will pay substantially all the expenses incident to the registration, offering and sale of the shares of our common stock to the public by Selling Securityholder, other than fees, discounts and commissions of underwriters, dealers or agents, if any, and transfer taxes. Our common stock has been removed from listing by the Nasdaq SmallCap market and if no other exception applies, our common stock may become subject to the SEC's Penny Stock Rules and broker-dealers may 12 become subject to the requirements summarized above under the caption "Risk Factors - Possible Nasdaq Delisting; Potential Regulation as a Penny Stock." USE OF PROCEEDS We will not receive any proceeds from the sale of the shares by the Selling Securityholders and will not receive any proceeds upon conversion of the Series G Convertible Preferred Stock into our common stock. We will only receive proceeds if the selling Securityholders exercise the warrants. If all warrants are exercised, we will receive aggregate proceeds of $8,426,250. All of the warrants issued in connection with our Series G Preferred Stock were exercised in February 2000 upon which we received aggregate proceeds of $2.1 million. There can be no assurance that any of the other warrants will be exercised. If any of the warrants are exercised, we intend to use such proceeds for working capital purposes. To the extent that the net proceeds are not immediately required for such purposes, they may be invested principally in either U.S. government securities, short-term certificates of deposit, money market funds or other short-term interest bearing investments. SELLING SECURITYHOLDERS The following table sets forth as of May 22, 2000, and upon completion of the offering described in this Prospectus, information with regard to the beneficial ownership of our common stock by the Selling Securityholders. The Selling Securityholders may not have a present intention of selling the Shares and may offer no Shares for sale or less than the number of Shares indicated, or may sell the Shares by a means other than this offering. All Selling Securityholders have represented to the Company that they are "accredited investors" as that term is defined in Regulation D promulgated under the Securities Act.
Shares Beneficially Shares Beneficially Owned Owned Before Offering 1 After Offering 1,3 --------------------------- Common Stock ------------------------- Name Amount % Offered 2 Amount % - ---- --------- ----- ---------- ---------- ------ Parmeter, J. Thomas 4, 5.................. 781,777 4.2% 90,000 691,777 3.7% Lamon, Steven M. 4, 6..................... 859,989 4.6% 600,000 259,989 1.4% Davis, Philip J. 4, 7..................... 834,345 4.5% 300,000 534,345 2.9% Wang, Daniel I.C. 4, 8.................... 330,000 1.8% 300,000 30,000 * Stern, Russell T. 4, 9.................... 1,083,223 5.8% 450,000 633,223 3.4% Hurckes, Richard W. 4, 10................. 327,500 1.8% 180,000 147,500 * Hurckes Children Trust 4, 11............. 165,000 * 120,000 45,000 * Lyon, Anthony 4........................... 179,200 1.0% 120,000 59,200 * Smith, Allison 4.......................... 90,000 * 90,000 0 0 Smith, Lindsay 4.......................... 90,000 * 90,000 0 0 Smith, Tracy 4............................ 90,000 * 90,000 0 0 Adelson, Trust fbo Claire 4, 12, 13....... 1,600,572 8.3% 1,500,000 100,572 * Adelson, Richard 4, 12, 14................ 499,600 2.7% 300,000 199,600 1.1% Cole, Bernard IRA 4, 12................... 315,000 1.7% 300,000 15,000 * DeSalvo-Cavelius, Patricia 4, 12.......... 222,453 1.2% 180,000 42,453 * Arthur Kaplan Co. PS fbo A. Kaplan 4, 12.. 313,663 1.7% 180,000 133,663 * McSorley, Edward 4, 12, 15................ 246,225 1.3% 150,000 96,225 * Smith, Donald 4, 12....................... 356,235 1.9% 240,000 116,235 * Ardmore Retirement 4, 12.................. 229,572 1.3% 180,000 49,572 * Baigelman, Carly, Irrev. Trust fbo 4, 12.. 60,000 * 60,000 0 0 Baigelman, Robert, Irrev. Trust fbo 4, 12. 60,000 * 60,000 0 0 Becker, Ellen & Stephen 4, 12............. 161,000 * 120,000 41,000 * Bernstein, Stanley IRA 4, 12.............. 90,000 * 90,000 0 0 Branitz, Marlon IRA 4, 12................. 120,000 * 120,000 0 0 Brown, Douglas, Z.S. Fund fbo 4, 12....... 180,000 1.0% 180,000 0 0 Edelstein Investment Partners 4, 12, 16... 371,700 2.0% 210,000 161,700 * Farber, Alisa S. Trust 4, 12, 17.......... 1,104,086 5.8% 840,000 264,086 1.4%
13
Shares Beneficially Shares Beneficially Owned Owned Before Offering 1 After Offering 1, 3 --------------------------- Common Stock ------------------------- Name Amount % Offered 2 Amount % - ---- --------- ----- ---------- ---------- ----- Goodman, Arline IRA 4, 12................ 90,000 * 90,000 0 0 Gordon, Brian J. 4, 12.................... 90,000 * 90,000 0 0 Gordon, Elizabeth L. 4, 12................ 150,000 * 150,000 0 0 Gordon, Ronald & Claire 4, 12............. 240,000 1.3% 240,000 0 0 Greenblatt, William IRA 4, 12, 18......... 170,250 * 90,000 80,250 * Grubard, Marc 4, 12....................... 120,000 * 120,000 0 0 Holder, Andrew 4, 12...................... 185,000 1.0% 150,000 35,000 * Holder, Andrew SEP IRA 4, 12.............. 150,000 * 150,000 0 0 Intertrade Media Pens & PS 4, 12.......... 170,000 * 150,000 20,000 * Kalman, Tobie 4, 12, 19................... 252,500 1.4% 180,000 72,500 * Kamens, Michael IRA 4, 12................. 150,000 * 150,000 0 0 Kamens, Michael & Joan 4, 12.............. 225,000 1.2% 150,000 75,000 * Katz, Non-Marital Trust uwo Katz 4, 12.... 240,000 1.3% 240,000 0 0 Kaye Family Limited Partership 4, 12, 20.. 227,500 1.2% 150,000 77,500 * Kertes, Ronald 4, 12...................... 180,000 1.0% 180,000 0 0 Kiernan, Kenneth J. IRA 4, 12............. 367,000 2.0% 240,000 127,000 * Kipperman, Eric M. 4, 12.................. 90,000 * 90,000 0 0 Kipperman, Eric M. IRA 4, 12.............. 90,000 * 90,000 0 0 Kipperman, Jerry IRA 4, 12................ 165,000 * 120,000 45,000 * LaFauci, Joseph & Rosalie 4, 12........... 120,000 * 120,000 0 0 Levinsohn, Ross 4, 12..................... 90,000 * 90,000 0 0 Levitt, Steven & Wendi 4, 12, 21.......... 261,658 1.4% 180,000 81,658 * Mann, Michael 4, 12....................... 180,000 1.0% 180,000 0 0 Mercadante, Carmin IRA 4, 12.............. 139,786 * 90,000 49,786 * McGloin John J. 4, 12..................... 90,000 * 90,000 0 0 Marvin Mittman Profit-Sharing 4, 12....... 265,000 1.4% 240,000 25,000 * Moss, Barbara S. 4, 12.................... 120,000 * 120,000 0 0 Moss, Nancy S. 4, 12...................... 120,000 * 120,000 0 0 Newman, Rose 4, 12........................ 272,500 1.5% 240,000 32,500 * Omega 4, 12............................... 305,000 1.7% 240,000 65,000 * Pincus, D.A. & Co. Profit-Sharing 4, 12... 60,000 * 60,000 0 0 Robinson, Douglas 4, 12, 22............... 333,000 1.8% 150,000 183,000 1.0% Rosenberg, Alison & Abraham 4, 12, 23..... 252,500 1.4% 180,000 72,500 * Snyder, David Pension 4, 12............... 210,000 1.1% 210,000 0 0 Susser, Phyllis IRA 4, 12................. 60,000 * 60,000 0 0 Sutton, Patrick 4, 12..................... 110,000 * 90,000 20,000 * Szulik, Matthew & Kyle 4, 12, 24.......... 267,500 1.5% 180,000 87,500 * Techvest Partners LLC 25.................. 40,960 * 25,000 15,960 * Taurus Advisory Group, Inc. 26, 27........ 15,000 * 15,000 0 0 TOTALS 17,426,294 62.5% 12,640,000 4,786,294 24.6% ========== ========== =========
______________ * Amount represents less than 1% of the common stock outstanding. As of May 22, 2000, we had 18,311,882 shares of common stock outstanding. (1) Beneficial ownership is determined in accordance with rules of the Securities and Exchange Commission, and includes, generally, voting power and/or investment power with respect to securities. Shares of common stock subject to options or warrants exercisable within 60 days are deemed outstanding for computing the percentage of the person holding such options or warrants but are not deemed outstanding for computing the percentage of any other person. Except as indicated by footnote, and subject to joint ownership with spouses and community property laws where applicable, the persons named in the table above have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them. Information with respect to 14 beneficial ownership is based upon the Company's stock records and data supplied to the Company by the Selling Securityholders. (2) The Selling Securityholders may offer less than the amount of shares indicated. No representation is made that any shares will or will not be offered for sale. (3) This assumes that all shares owned by the Selling Securityholders which are offered hereby are sold. The Selling Securityholders reserve the right to accept or reject, in whole or in part, any proposed purchase of shares. (4) Shares to be offered represents shares of common stock issuable upon conversion of shares of Series G Convertible Preferred Stock, shares of common stock issued upon exercise of warrants issued in connection with the Series G Convertible Preferred Stock and shares of common stock issuable upon exercise of warrants issued upon the exercise or exchange of the warrants issued in connection with the Series G Convertible Preferred Stock. (5) Shares beneficially owned also includes an additional 40,000 shares issuable upon conversion of Series E Convertible Preferred Stock convertible within 60 days and 160,000 shares issuable upon the exercise of options exercisable within 60 days. Mr. Parmeter is our Chairman of the Board, President and Chief Executivie Officer. (6) Shares beneficially owned also includes an additional 40,000 shares issuable upon conversion of Series E Convertible Preferred Stock convertible within 60 days and 30,000 shares issuable upon the exercise of options exercisable within 60 days. (7) Shares beneficially owned also includes an additional 80,000 shares issuable upon conversion of Series E Convertible Preferred Stock convertible within 60 days and 44,000 shares issuable upon the exercise of options exercisable within 60 days. Mr. Davis is one of our directors and is our Secretary. (8) Shares beneficially owned also includes an additional 30,000 shares issuable upon the exercise of options exercisable within 60 days. (9) Shares beneficially owned also includes an additional 80,000 shares issuable upon conversion of Series E Convertible Preferred Stock convertible within 60 days and 20,000 shares issuable upon the exercise of options exercisable within 60 days. (10) Shares beneficially owned also includes an additional 32,000 shares issuable upon conversion of Series E Convertible Preferred Stock convertible within 60 days. (11) Shares beneficially owned also includes an additional 8,000 shares issuable upon conversion of Series E Convertible Preferred Stock convertible within 60 days. (12) This person is an investment advisory client of Taurus Advisory Group. These shares are held by Sigler & Co. as custodian for the investment advisory clients of Taurus. Taurus is a registered investment advisor that has discretionary authority to vote or dispose of the shares held in its client accounts and therefore may be deemed to be the beneficial owner of these shares. Taurus expressly disclaims such beneficial ownership. Patricia J. Cornell, a vice president and director of Taurus, is one of our directors. (13) Shares beneficially owned also includes an additional 20,000 shares issuable upon exercise of warrants issued in connection with our Series E Convertible Preferred Stock exercisable within 60 days. (14) Shares beneficially owned also includes an additional 16,000 shares issuable upon exercise of warrants issued in connection with our Series E Convertible Preferred Stock exercisable within 60 days and 5,000 shares issuable upon the exercise of options exercisable within 60 days. Mr. Adelson is one of our directors. (15) Shares beneficially owned also includes an additional 4,000 shares issuable upon exercise of warrants issued in connection with our Series E Convertible Preferred Stock exercisable within 60 days. (16) Shares beneficially owned also includes an additional 50,000 shares issuable upon conversion of Series E Convertible Preferred Stock convertible within 60 days, and an additional 12,500 shares issuable upon exercise of warrants issued in connection with our Series E Convertible Preferred Stock exercisable within 60 days. 15 (17) Shares beneficially owned also includes an additional 156,000 shares issuable upon conversion of Series E Convertible Preferred Stock convertible within 60 days, and an additional 55,000 shares issuable upon exercise of warrants issued in connection with our Series E Convertible Preferred Stock exercisable within 60 days. (18) Shares beneficially owned also includes an additional 25,000 shares issuable upon conversion of Series E Convertible Preferred Stock convertible within 60 days, and an additional 6,250 shares issuable upon exercise of warrants issued in connection with our Series E Convertible Preferred Stock exercisable within 60 days. (19) Shares beneficially owned also includes an additional 30,000 shares issuable upon conversion of Series E Convertible Preferred Stock convertible within 60 days, and an additional 7,500 shares issuable upon exercise of warrants issued in connection with our Series E Convertible Preferred Stock exercisable within 60 days. (20) Shares beneficially owned also includes an additional 30,000 shares issuable upon conversion of Series E Convertible Preferred Stock convertible within 60 days, and an additional 7,500 shares issuable upon exercise of warrants issued in connection with our Series E Convertible Preferred Stock exercisable within 60 days. (21) Shares beneficially owned also includes an additional 20,000 shares issuable upon conversion of Series E Convertible Preferred Stock convertible within 60 days, and an additional 5,000 shares issuable upon exercise of warrants issued in connection with our Series E Convertible Preferred Stock exercisable within 60 days. (22) Shares beneficially owned also includes an additional 20,000 shares issuable upon conversion of Series E Convertible Preferred Stock convertible within 60 days, and an additional 5,000 shares issuable upon exercise of warrants issued in connection with our Series E Convertible Preferred Stock exercisable within 60 days. (23) Shares beneficially owned also includes an additional 30,000 shares issuable upon conversion of Series E Convertible Preferred Stock convertible within 60 days, and an additional 7,500 shares issuable upon exercise of warrants issued in connection with our Series E Convertible Preferred Stock exercisable within 60 days. (24) Shares beneficially owned also includes an additional 30,000 shares issuable upon conversion of Series E Convertible Preferred Stock convertible within 60 days, and an additional 7,500 shares issuable upon exercise of warrants issued in connection with our Series E Convertible Preferred Stock exercisable within 60 days. (25) Shares to be offered represents shares of common stock issuable upon exercise of warrants issued in connection with a consulting agreement with us. Shares beneficially owned also includes 15,960 shares of common stock issuable upon exercise of warrants issued in connection with our Series E Convertible Preferred Stock exercisable within 60 days. (26) Shares to be offered represents shares of common stock issuable upon exercise of warrants issued in connection with a loan to us. (27) Shares beneficially owned excludes shares beneficially owned by investment advisory clients of Taurus Advisory Group. Taurus is a registered investment advisor that has discretionary authority to vote or dispose of the shares held in its client accounts and therefore may be deemed to be the beneficial owner of these shares. Taurus expressly disclaims such beneficial ownership. Patricia J. Cornell, a vice president and director of Taurus, is one of our directors. 16 DESCRIPTION OF SECURITIES TO BE REGISTERED Common Stock As of May 22, 2000, there were 18,311,882 outstanding shares of common stock held by approximately 162 holders of record, including 4,200,000 shares issued upon exercise of the warrants issued in conjunction with the Series G Convertible Preferred Stock. After giving effect to conversion of the outstanding Series G Convertible Preferred Stock and the other warrants, there will be 26,751,882 shares of common stock outstanding. The holders of our common stock are entitled to one vote per share on all matters submitted to a vote of stockholders and do not have cumulative voting rights. Accordingly, the holders of a majority of the common stock entitled to vote in any election of directors, together with the Series G Convertible Preferred Stock voting with the common stock as a single class, may elect all of the directors standing for election. The holders of our common stock are entitled to receive such dividends, if any, as may be declared by our board of directors from time to time out of legally available funds, subject to any preferential dividend rights of the holders of our preferred stock. Upon our liquidation, dissolution or winding up, the holders of our common stock are entitled to share in all of our assets that are legally available for distribution, after payment of all debts and other liabilities and subject to the prior rights of any holders of our preferred stock then outstanding. The holders of our common stock have no preemptive, subscription, redemption or conversion rights. The outstanding shares of our common stock are, and the shares of our common stock offered hereby by Selling Securityholders will be, when issued, fully paid and nonassessable. The rights, preferences and privileges of holders of our common stock will be subject to the rights of the holders of shares of our Series D Convertible Preferred Stock, Series E Convertible Preferred Stock, Series F Convertible Preferred Stock and Series G Convertible Preferred Stock and any other series of our preferred stock that we may issue in the future. Preferred Stock Our preferred stock may be issued from time to time in one or more series and our board of directors, without further approval of the holders of our common stock (but subject to the rights of the holders of our outstanding preferred stock), is authorized to fix the dividend rights and terms, conversion rights, voting rights, redemption rights and terms, liquidation preferences, sinking funds and any other rights, preferences, privileges and restrictions applicable to each such series of our preferred stock. The purpose of authorizing our board of directors to determine such rights and preferences is to eliminate delays associated with a stockholder vote on specific issuances. The issuance of our preferred stock, while providing flexibility in connection with possible financings, acquisitions and other corporate purposes, could, among other things, adversely affect the voting power of the holders of our common stock and, under certain circumstances, make it more difficult for a third party to gain control of us. Series D Convertible Preferred Stock. We have authorized 71,600 shares of our Series D Convertible Preferred Stock, of which 1,344.01 shares remain issued and outstanding. The holders of our Series D Convertible Preferred Stock are entitled to receive cumulative dividends when and as declared by our board of directors at a rate of $10.00 per share. In the event of our liquidation, dissolution or winding-up, whether voluntary or involuntary, the holders of shares of our Series D Convertible Preferred Stock are entitled to receive, prior and in preference to any distribution of any of our assets to the holders of our common stock, an amount per share of $100.00, plus an amount equal to all accrued and unpaid dividends on our Series D Convertible Preferred Stock, if any. As of May 22, 2000, no dividends had been declared on the Series D Convertible Preferred Stock. Each share of our Series D Convertible Preferred Stock is convertible at any time at the option of the holder thereof into our common stock at conversion ratio equal to the quotient derived by dividing (A) the stated value of $100 by (B) the lesser of (1) $3.75 (subject to certain antidilution adjustments for future stock distributions, stock splits or similar capital adjustments) or (2) the market price of the common stock at the time of conversion. The conversion ratio is subject to further adjustments in the event of specific dilutive financings. Each share of Series D Convertible Preferred Stock is automatically converted into shares of our common stock at the applicable conversion ratio upon the closing of a firmly committed public offering of our common stock at an aggregate price to the public equal to or exceeding $2.50 per share, or upon a vote in favor of such conversion by the holders of a majority of the then outstanding shares of Series D Convertible Preferred Stock, or upon written notice by us at any time after the 17 average common stock value over a twenty-day period equals or exceeds $5.00. The shares of our common stock offered hereby will not result in automatic conversion of the Series D Convertible Preferred Stock. We may redeem the Series D Convertible Preferred Stock, in whole or in part, after September 13, 1999, out of funds legally available therefore. The redemption price is $100.00 per share, plus all accrued and unpaid dividends, if any, to the date of redemption. Generally, each share of Series D Convertible Preferred Stock has no voting rights. However, so long as any Series D Convertible Preferred Stock is outstanding, without the consent of the holders of at least a majority of the outstanding Series D Convertible Preferred Stock, we may not create or issue any security with rights, preferences or privileges equal or senior to the Series D Convertible Preferred Stock; increase the authorized number of shares of Series D Convertible Preferred Stock or adversely alter or change the rights, preferences or privileges of the Series D Convertible Preferred Stock. The need to obtain the consent of a majority of the outstanding Series D Convertible Preferred Stock may adversely affect our ability to effect these transactions in a manner deemed advisable by our management. Series E Convertible Preferred Stock. We have authorized 55,000 shares of our Series E Convertible Preferred Stock, of which 35,312.50 shares remain issued and outstanding. The holders of the Series E Convertible Preferred Stock are entitled to receive noncumulative dividends when and as declared by our board of directors, if at all; provided, however, that no dividend may be paid on the Series E Convertible Preferred Stock until the preferential cumulative dividends on the Series D Convertible Preferred Stock and the Series F Convertible Preferred Stock have been first fully paid or declared and set aside. In the event of our liquidation, dissolution or winding-up, whether voluntary or involuntary, the holders of shares of Series E Convertible Preferred Stock, together with the holders of our Series F Convertible Preferred Stock, are entitled to receive, prior and in preference to any distribution of any of our assets to the holders of our common stock, but only after the preference is paid or set apart for the Series D Convertible Preferred Stock, an amount per share of $100.00, plus an amount equal to declared and unpaid dividends on the Series E Convertible Preferred Stock, if any. As of May 22, 2000, no dividends had been declared on the Series E Convertible Preferred Stock. Each share of Series E Convertible Preferred Stock is convertible at any time at the option of the holder thereof into our common stock at conversion ratio equal to the quotient derived by dividing (A) the stated value of $100 by (B) $1.25 (subject to certain antidilution adjustments for future stock distributions, stock splits or similar capital adjustments). The conversion ratio is subject to further adjustments in the event of specific dilutive financings. Each share of Series E Convertible Preferred Stock is automatically converted into shares of our common stock at the applicable conversion ratio upon the closing of a firmly committed public offering of our common stock at an aggregate price to the public equal to or exceeding $7.50 per share, where the minimum offering is for at least $15 million or upon a vote in favor of such conversion by the holders of 75% of the then outstanding shares of Series E Convertible Preferred Stock electing to unconditionally convert such shares of Series E Preferred. The shares of our common stock offered hereby will not result in automatic conversion of the Series E Convertible Preferred Stock. We may redeem the Series E Convertible Preferred Stock, in whole or in part, at any time, out of funds legally available therefore. The redemption price is $400.00 per share. Generally, each share of Series E Convertible Preferred Stock has no voting rights. However, so long as any Series E Convertible Preferred Stock is outstanding, without the consent of the holders of at least 75% of the Series E Convertible Preferred Stock, we may not create or issue any security with rights, preferences or privileges equal or senior to the Series E Convertible Preferred Stock; increase the authorized number of shares of Series E Convertible Preferred Stock or adversely alter or change the rights, preferences or privileges of the Series E Convertible Preferred Stock. The need to obtain the consent of the 75% of the Series E Convertible Preferred Stock may adversely affect our ability to effect these transactions in a manner deemed advisable by our management. Series F Convertible Preferred Stock. We have authorized 27,317 shares of our Series F Convertible Preferred Stock, all of which shares remain issued and outstanding. The holders of the Series F Convertible Preferred Stock are entitled to receive cumulative dividends when and as declared by our board of directors at a rate of $10.00 per share. In the event of our liquidation, dissolution or winding-up, whether voluntary or involuntary, the holders of shares of Series F Convertible Preferred Stock, together with the holders of our Series E Convertible 18 Preferred Stock, are entitled to receive, prior and in preference to any distribution of any of our assets to the holders of our common stock, but only after the preference is paid or set apart for the Series D Convertible Preferred Stock, an amount per share of $100.00, plus an amount equal to all accrued and unpaid dividends on the Series F Convertible Preferred Stock, if any. As of May 22, 2000, no dividends had been declared on the Series F Convertible Preferred Stock. Each share of Series F Convertible Preferred Stock is convertible at any time at the option of the holder thereof into our common stock at conversion ratio equal to the quotient derived by dividing (A) the stated value of $100 by (B) the lesser of (1) $3.75 (subject to certain antidilution adjustments for future stock distributions, stock splits or similar capital adjustments) or (2) the market price of the common stock at the time of conversion. The conversion ratio is subject to further adjustments in the event of specific dilutive financings. Each share of Series F Convertible Preferred Stock is automatically converted into shares of our common stock at the applicable conversion ratio upon the closing of a firmly committed public offering of our common stock at an aggregate price to the public equal to or exceeding $2.50 per share, or upon a vote in favor of such conversion by the holders of a majority of the then outstanding shares of Series F Convertible Preferred Stock, or upon written notice by us at any time after the average common stock value over a twenty-day period equals or exceeds $5.00. The shares of our common stock offered hereby will not result in automatic conversion of the Series F Convertible Preferred Stock. We may redeem the Series F Convertible Preferred Stock, in whole or in part, after September 13, 1999, out of funds legally available therefore. The redemption price is $100.00 per share, plus all accrued and unpaid dividends, if any, to the date of redemption. Generally, each share of Series F Convertible Preferred Stock has no voting rights. However, so long as any Series F Convertible Preferred Stock is outstanding, without the consent of the holders of at least a majority of the outstanding Series F Convertible Preferred Stock, we may not create or issue any security with rights, preferences or privileges equal or senior to the Series F Convertible Preferred Stock; increase the authorized number of shares of Series F Convertible Preferred Stock or adversely alter or change the rights, preferences or privileges of the Series F Convertible Preferred Stock. The need to obtain the consent of a majority of the outstanding Series F Convertible Preferred Stock may adversely affect our ability to effect these transactions in a manner deemed advisable by our management. Series G Convertible Preferred Stock. We have authorized 35,000 shares of our Series G Convertible Preferred Stock, of which 21,000 shares remain issued and outstanding. The holders of the Series G Convertible Preferred Stock are entitled to receive non-cumulative dividends when and as declared by our board of directors, if at all; provided, however, that no dividend may be paid on the Series E Convertible Preferred Stock until the preferential cumulative dividends on the Series D Convertible Preferred Stock and the Series F Convertible Preferred Stock have been first fully paid or declared and set aside. In the event of our liquidation, dissolution or winding-up, whether voluntary or involuntary, the holders of shares of Series G Convertible Preferred Stock are entitled to receive, prior and in preference to any distribution of any of our assets to the holders of our common stock, but only after the preference is paid or set apart for the Series D Convertible Preferred Stock, Series E Convertible Preferred Stock and Series F Convertible Preferred Stock, an amount per share of $100.00, plus an amount equal to all declared and unpaid dividends on the Series G Convertible Preferred Stock, if any. As of May 22, 2000, no dividends had been declared on the Series G Convertible Preferred Stock. Each share of Series G Convertible Preferred Stock is convertible at any time at the option of the holder thereof into our common stock at conversion ratio equal to the quotient derived by dividing (A) the stated value of $100 by (B) $0.50 (subject to certain antidilution adjustments for future stock distributions, stock splits or similar capital adjustments). The conversion ratio is subject to further adjustments in the event of specific dilutive financings. Each share of Series G Convertible Preferred Stock is automatically converted into shares of our common stock at the applicable conversion ratio upon the closing of a firmly committed public offering of our common stock at an aggregate price to the public equal to or exceeding $2.50 per share, where the minimum offering is for at least $10 million or upon a vote in favor of such conversion by the holders of a majority of the then outstanding shares of Series G Convertible Preferred Stock. The shares of our common stock offered hereby will not result in automatic conversion of the Series G Convertible Preferred Stock. 19 We may redeem the Series G Convertible Preferred Stock, in whole or in part, at any time, out of funds legally available therefore. The redemption price is $100.00 per share, plus all accrued and unpaid dividends, if any, to the date of redemption. Generally, each share of Series G Convertible Preferred Stock has voting rights and votes on an as converted basis together with the common stock voting as a single class. In addition, so long as any Series G Convertible Preferred Stock is outstanding, without the consent of the holders of at least a majority of the outstanding Series G Convertible Preferred Stock, we may not create or issue any security with rights, preferences or privileges equal or senior to the Series G Convertible Preferred Stock; increase the authorized number of shares of Series G Convertible Preferred Stock or adversely alter or change the rights, preferences or privileges of the Series G Convertible Preferred Stock. The need to obtain the consent of a majority of the outstanding Series G Convertible Preferred Stock may adversely affect our ability to effect these transactions in a manner deemed advisable by our management. Rights Agreement On August 22, 1997, our board of directors declared a dividend distribution of one right to purchase a certain number of units (determined by a formula described herein) for each outstanding share of our common stock at an exercise price of $8.00, subject to adjustment. Each unit is equal to one one-hundredth of a share of our Series X Junior Participating Preferred Stock. The distribution was payable to stockholders of record as of the close of business on September 10, 1997. Our board of directors further declared that one right be distributed with each share of common stock issued after the record date but prior to the separation or the earlier expiration, exchange, redemption or termination of the rights. Initially, the rights attached to the common stock then outstanding, and no separate certificates evidencing the rights were issued. The rights will separate from the common stock, rights certificates will be issued and the rights will become exercisable upon the earlier to occur of 10 business days (or such later date as may be determined by action of our board of directors prior to the separation of the rights) following the earlier to occur of (i) a public announcement or resolution of our board of directors recognizing that a person or group of affiliated or associated persons has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of the outstanding shares of common stock (subject to certain exceptions that may be made by board of directors prior to separation of the rights), or (ii) the commencement or announcement of an intention to make a tender or exchange offer for our common stock the consummation of which would result in the beneficial ownership by a person or group of affiliated or associated persons of 15% or more of such outstanding common stock. However, a person or group of affiliated or associated persons who acquires the beneficial ownership of 15% or more of the common stock then outstanding either (i) by reason of share purchases by us reducing the number of common stock outstanding, or (ii) inadvertently, if such person or group notifies our board of directors of such inadvertent purchase within five business days and within two business days after such notice divests itself of enough common stock so as to no longer have beneficial ownership of 15% or more of the outstanding common stock, will not trigger a separation of the rights. Until the separation of the rights, the rights will be evidenced only by the certificates evidencing, and will be transferred only with, the common stock. Until the separation of the rights, new common stock certificates issued after the record date will contain a notation incorporating the right by reference. Until the separation of the rights, the surrender for transfer, conversion or exchange of any certificates for common stock outstanding on or after the record date, even without such notation, will also constitute the transfer of the rights associated with the common stock represented by such certificates. As soon as practicable following the separation of the rights, separate rights certificates will be mailed to holders of record of the common stock as of the close of business on the date of the separation of the rights, and such separate rights certificates alone will evidence the rights. The rights are not exercisable until the date of the separation of the rights. The rights will expire at the close of business on September 9, 2007, unless earlier redeemed, exchanged or terminated. Following the separation of the rights, holders of the rights (other than rights beneficially owned by an acquiring person that triggered the separation of the rights or its affiliates or associates, which will thereafter be 20 void) will be entitled to receive upon exercise and payment of the exercise price that number of units of the Series X Preferred Stock which equals the result obtained by dividing the exercise price by 50% of the market price per share of common stock. The exercise price payable, and the number of shares of Series X Preferred Stock or other securities or property issuable, upon exercise of the rights are subject to adjustment from time to time to prevent dilution. In the event that, after the separation of the rights we consolidate or merge with another entity or sell or otherwise transfer 50% or more of our consolidated assets or earning power, proper provision will be made so that each rights holder (other than rights beneficially owned by an acquiring person that triggered the separation of the rights or affiliates or associates thereof) will thereafter have the right to receive, upon exercise, either that number of shares of our common stock, if we are the surviving corporation of the merger or consolidation, or of common stock in the surviving acquiring company (or, in the event there is more than one acquiring company, the acquiring company receiving the greatest portion of the assets or earning power transferred), which at the time of such transaction would have a market value of two times the exercise price of the right. We may elect not to issue fractional shares of Series X Preferred Stock upon exercise of a right and in lieu thereof may evidence such fractional shares by depositary receipts or may make an adjustment in cash based on the market price of the Series X Preferred Stock on the last trading date prior to the date of exercise of the right. At any time prior to the earlier to occur of: (i) the separation of the rights or (ii) the expiration date, we may redeem the rights in whole, but not in part, at a price of $.01 per right. Immediately upon the action of our board of directors ordering redemption of the rights, the right to exercise the rights will terminate and the only right of rights holders will be to receive the redemption price. Subject to applicable law, our board of directors, at its option, may, at any time after a person or group becomes an acquiring person that triggers the separation of the rights, exchange all or part of the then outstanding rights (other than rights beneficially owned by such person or affiliates or associates thereof) for common stock at an exchange ratio equal to the exercise price divided by the market price of one share of common stock per right, subject to adjustment. The Series X Preferred Stock purchasable upon exercise of the Rights will not be redeemable and will be, in ranking as to dividends, on a parity with, and as to liquidation preferences, senior to, our common stock but junior to any other series of our preferred stock that we may issue or have issued (unless otherwise provided in the terms of such preferred stock). Each Series X Preferred Stock will have a dividend in an amount equal to 100 times any cash dividend declared on each share of common stock. In the event of liquidation, the holders of Series X Preferred Stock will be entitled to a preferred liquidation payment equal to the greater of $100.00 or 100 times the payment made per each share of common stock. Each share of Series X Preferred Stock will have 100 votes, voting together with the common stock. In the event of any merger, consolidation or other transaction in which shares of common stock are exchanged, each share of Series X Preferred Stock will be entitled to receive 100 times the amount and type of consideration received per share of common stock. The rights of the Series X Preferred Stock as to dividends, liquidation and voting are protected by customary antidilution provisions. Until a right is exercised, the holder thereof, as such, will have no rights as a stockholder, including, without limitation, the right to vote or to receive dividends. The terms of the rights may be amended at any time by our board of directors without the consent of rights holders in order to cure any ambiguity or to correct or supplement any defective or inconsistent provision and may, prior to the separation of the rights, be amended to change or supplement any other provision in any manner that our board of directors may deem necessary or desirable. After the separation of the rights, the terms of the rights may be amended (other than to cure ambiguities or to correct or supplement defective or inconsistent provisions) only so long as the amendment does not adversely affect the interests of rights holders (other than the acquiring person that triggers the separation of the rights). The rights have certain anti-takeover effects. The rights will cause substantial dilution to a person or group that attempts to acquire us without conditioning the offer on a substantial number of rights being acquired. The rights should not interfere with any merger or other business combination approved by our board of directors 21 because the board of directors may, at its option, at any time prior to the separation of the rights, redeem all but not less than all the then outstanding rights at a price of $.01 per right. Delaware Takeover Statute We are subject to the provisions of Section 203 of the Delaware General Corporation Law, which prohibits a publicly-held Delaware corporation from engaging in any ''business combination'' with an ''interested stockholder'' for three years following the date that such stockholder became an interested stockholder, unless: . prior to such date, the board of directors of the corporation approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder; . upon consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding, for purposes of determining the number of shares outstanding, those shares owned (a) by persons who are directors and also officers and (b) by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or . on or subsequent to such date, the business combination is approved by the board of directors and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least 66 2/3 % of the outstanding voting stock not owned by the interested stockholder. Generally, a ''business combination'' includes a merger, asset or stock sale, or other transaction resulting in a financial benefit to the stockholders. An ''interested stockholder'' is a person who, together with affiliates and associates, owns (or within three years prior did own) 15% or more of the corporation's voting stock. Transfer Agent and Registrar The transfer agent and registrar for our common stock is Continental Stock Transfer & Trust Company. LEGAL MATTERS The validity of the shares of common stock offered hereby has been passed upon by Paul, Hastings, Janofsky & Walker LLP, Los Angeles, California. EXPERTS Ernst & Young LLP, independent auditors, have audited our financial statements included in our Annual Report on Form 10-KSB for the year ended December 31, 1999, as set forth in their report, which is incorporated by reference in this prospectus. Our financial statements are incorporated by reference in reliance on Ernst & Young LLP's report, given on their authority as experts in accounting and auditing. INDEMNIFICATION OF DIRECTORS AND OFFICERS Our bylaws provide generally for indemnification of our officers, directors, agents and employees to the extent authorized by the Delaware General Corporation Law. Pursuant to Section 145 of the Delaware General Corporation Law, a corporation generally has the power to indemnify its present and former directors, officers, employees and agents against expenses incurred by them in connection with any suit to which they are, or are threatened to be made, a party by reason of their serving in such positions so long as they acted in good faith and in a manner they reasonably believed to be in, or not opposed to, the best interests of the corporation, and with respect to any criminal action, they had no reasonable cause to believe their conduct was unlawful. With respect to suits by 22 or in the right of a corporation, however, indemnification is not available if such person is adjudged to be liable for negligence or misconduct in the performance of his duty to the corporation unless the court determines that indemnification is appropriate. In addition, a corporation has the power to purchase and maintain insurance for such persons. We currently maintain such directors' and officers' insurance. The statute also expressly provides that the power to indemnify authorized thereby is not exclusive of any rights granted under any bylaw, agreement, vote of stockholders or disinterested directors, or otherwise. As permitted by Section 102 of the Delaware General Corporation Law, our stockholders have approved and incorporated provisions into our certificate of incorporation eliminating a director's personal liability for monetary damages to us and our stockholders arising from a breach of a director's fiduciary duty, except for liability under Section 174 of the Delaware General Corporation Law or liability for any breach of the director's duty of loyalty to us or our stockholders, for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law or for any transaction in which the director derived an improper personal benefit. We have entered into indemnification agreements with each of our directors and executive officers. These agreements contractually obligate us to indemnify our directors and executive officers to the fullest extent permitted by applicable law, including mandatory indemnification unless prohibited by statute, mandatory advancement of expenses, accelerated procedures for the authorization of indemnification and litigation "appeal" rights of an indemnitee in the event of an unfavorable determination or where the board fails or refuses to act. The indemnification agreements are not intended to deny or otherwise limit third-party or derivative suits against us or our directors or officers, but to the extent a director or officer were entitled to indemnity or contribution under the indemnification agreement, the financial burden of a third-party suit would be borne by us, and we would not benefit from derivative recoveries against the director or officer. Such recoveries would accrue to our benefit but would be offset by our obligations to the director or officer under the indemnification agreement. The above discussion of our bylaws, certificate of incorporation and indemnification agreements and of Section 145 of the Delaware General Corporation Law is not intended to be exhaustive and is qualified in its entirety by such bylaws, certificate of incorporation, indemnification agreements and statute. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to our directors, officers and controlling persons pursuant to the foregoing provisions, or otherwise, we have been advised that in the opinion of the Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. 23 PART II. INFORMATION NOT REQUIRED IN PROSPECTUS Item 14. Other Expenses of Issuance and Distribution. The fees and expenses payable by the Company in connection with the sale of the shares of common stock being registered are estimated as follows:
Amount ---------------- SEC Filing Fee....................................................................... $ 3,336.96 Legal Fees and Expenses*............................................................. $15,000.00 Accounting Fees*..................................................................... $10,000.00 Printing and Miscellaneous Expenses*................................................. $ 5,000.04 ---------- Total*.......................................................................... $33,337.00 ========== ___________________ *Indicates estimate
Item 15. Indemnification of Directors and Officers. The Bylaws provide generally for indemnification of officers, directors, agents and employees of the Company to the extent authorized by the Delaware General Corporation Law. Pursuant to Section 145 of the Delaware General Corporation Law, a corporation generally has the power to indemnify its present and former directors, officers, employees and agents against expenses incurred by them in connection with any suit to which they are, or are threatened to be made, a party by reason of their serving in such positions so long as they acted in good faith and in a manner they reasonably believed to be in, or not opposed to, the best interests of the corporation, and with respect to any criminal action, they had no reasonable cause to believe their conduct was unlawful. With respect to suits by or in the right of a corporation, however, indemnification is not available if such person is adjudged to be liable for negligence or misconduct in the performance of his duty to the corporation unless the court determines that indemnification is appropriate. In addition, a corporation has the power to purchase and maintain insurance for such persons. The statute also expressly provides that the power to indemnify authorized thereby is not exclusive of any rights granted under any bylaw, agreement, vote of stockholders or disinterested directors, or otherwise. As permitted by Section 102 of the Delaware General Corporation Law, the Company's stockholders have approved and incorporated provisions into the Company's Certificate of Incorporation eliminating a director's personal liability for monetary damages to the Company and its stockholders arising from a breach of a director's fiduciary duty, except for liability under Section 174 of the Delaware General Corporation Law or liability for any breach of the director's duty of loyalty to the Company or its stockholders, for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law or for any transaction in which the director derived an improper personal benefit. The Company has entered into indemnification agreements with each of its directors and executive officers. These agreements contractually obligate the Company to indemnify its directors and executive officers to the fullest extent permitted by applicable law, including mandatory indemnification unless prohibited by statute, mandatory advancement of expenses, accelerated procedures for the authorization of indemnification and litigation "appeal" rights of an indemnitee in the event of an unfavorable determination or where the board fails or refuses to act. The indemnification agreements are not intended to deny or otherwise limit third-party or derivative suits against the Company or its directors or officers, but to the extent a director or officer were entitled to indemnity or contribution under the indemnification agreement, the financial burden of a third-party suit would be borne by the Company, and the Company would not benefit from derivative recoveries against the director or officer. Such recoveries would accrue to the benefit of the Company but would be offset by the Company's obligations to the director or officer under the indemnification agreement. The above discussion of the Company's Bylaws, Certificate of Incorporation and indemnification agreements and of Section 145 of the Delaware General Corporation Law is not intended to be exhaustive and is qualified in its entirety by such Bylaws, Certificate of Incorporation, indemnification agreements and statute. II-1 Item 16. Exhibits.
Exhibit No. Description - ----------- ----------- 5.1 Opinion of Paul, Hastings, Janofsky & Walker LLP as to legality of securities being registered. 13.1 Annual Report on Form 10-KSB for the year ended December 31, 1999. 13.2 Quarterly Report on Form 10-QSB for the quarter ended March 31, 2000. 23.1 Consent of Ernst & Young LLP, independent auditors. 23.2 Consent of counsel (included in Exhibit 5.1). 24.1 Power of Attorney (included in signature page).
Item 17. Undertakings. The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the Prospectus any facts or events arising after the effective date of this registration statement (or the most recent post- effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in this registration statement; (iii) To include any material information with respect to the plan of distribution not previously disclosed in this registration statement or any material change to such information in this registration statement; Provided, however, that paragraphs (1)(i) and (1)(ii) do not apply if the information required to be included in a post-effective amendment by those paragraphs is contained in periodic reports filed by the registrant pursuant to Section 13 or Section 15(d) of the Exchange Act that are incorporated by reference in this Registration Statement. (2) That, for the purpose of determining any liability under the Securities Act, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof; and (3) To remove from registration by means of post-effective amendment any of the securities which remain unsold at the termination of the offering. The undersigned registrant hereby undertakes that, for purposes of determining any liability under the Securities Act, each filing of the registrant's annual report pursuant to Section 13(a) or Section 15(d) of the Exchange Act that is incorporated by reference in this Registration Statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-2 Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. The undersigned Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-3 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-2 and has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Diego, State of California, on May 22, 2000. PROTEIN POLYMER TECHNOLOGIES, INC., a Delaware corporation By: /s/ J. THOMAS PARMETER ---------------------- J. Thomas Parmeter, Chairman of the Board, President & Chief Executive Officer II-4 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature appears below constitutes and appoints J. Thomas Parmeter and Janis Neves, and each of them, his true and lawful attorney-in-fact and agent, each acting alone, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign this Registration Statement and any and all amendments (including post-effective amendments) to this Registration Statement, and to file the same with all exhibits thereto, and all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in- fact and agent or his substitute or substitutes, may lawfully do or cause to be done by virtue thereof. Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ---- s/ J. THOMAS PARMETER Chairman of the Board, President and Chief May 22, 2000 - ------------------------------------ Executive Officer J. Thomas Parmeter (Principal Executive Officer) /s/ JANIS NEVES Director of Finance and Assistant Secretary May 22, 2000 - ------------------------------------ (Principal Financial and Accounting Officer) Janis Neves /s/ RICHARD ADELSON Director May 22, 2000 - ------------------------------------ Richard Adelson /s/ PATRICIA J. CORNELL Director May 22, 2000 - ------------------------------------ Patricia J. Cornell /s/ EDWARD E. DAVID Director May 22, 2000 - ------------------------------------ Edward E. David /s/ PHILIP J. DAVIS Director May 22, 2000 - ------------------------------------ Philip J. Davis /s/ EDWARD J. HARTNETT Director May 22, 2000 - ------------------------------------ Edward J. Hartnett /s/ J. PAUL JONES Director May 22, 2000 - ------------------------------------ J. Paul Jones /s/ KERRY L. KUHN Director May 22, 2000 - ------------------------------------ Kerry L. Kuhn /s/ GEORGE R. WALKER Director May 22, 2000 - ------------------------------------ George R. Walker
II-5 EXHIBIT INDEX
Exhibit No. Description - ----------- ----------- 5.1 Opinion of Paul, Hastings, Janofsky & Walker LLP as to legality of securities being registered. 13.1 Annual Report on Form 10-KSB for the year ended December 31, 1999. 13.2 Quarterly Report on Form 10-QSB for the quarter ended March 31, 2000. 23.1 Consent of Ernst & Young LLP, independent auditors. 23.2 Consent of counsel (included in Exhibit 5.1). 24.1 Power of Attorney (included in signature page).
II-6 EX-5.1 2 OPINION OF PAUL, HASTINGS, JANOFSKY & WALKER LLP EXHIBIT 5.1 [LETTERHEAD OF PAUL, HASTINGS, JANOFSKY & WALKER LLP] May 22, 2000 Protein Polymer Technologies, Inc. 10655 Sorrento Valley Road San Diego, California 92121 Ladies and Gentlemen: We are furnishing this opinion of counsel to Protein Polymer Technologies, Inc., a Delaware corporation (the "Company"), for filing as Exhibit 5.1 to the Registration Statement on Form S-2 (the "Registration Statement") to be filed by the Company with the Securities and Exchange Commission under the Securities Act of 1933, as amended, relating to the resale of 12,640,000 shares of the Company's common stock, $0.01 par value (the "Shares"). We have examined the Certificate of Incorporation and Bylaws, each as amended to date, of the Company, and the originals, or copies certified or otherwise identified, of records of corporate action of the Company as furnished to us by the Company, certificates of public officials and of representatives of the Company, and such other instruments and documents as we deemed necessary, as a basis for the opinions hereinafter expressed. In such examination, we have assumed the genuineness of all signatures, the authenticity of all corporate records and other documents submitted to us and the conformity to original documents submitted to us as certified or photostatic copies. Based upon our examination as aforesaid, and in reliance upon our examination of such questions of law as we deem relevant under the circumstances, we are of the opinion that the Shares, when purchased as described in the Registration Statement, will be validly issued, fully paid and nonassessable. We express no opinion with respect to the applicability or effect of the laws of any jurisdiction other than the Delaware General Corporation Law, as in effect as of the date hereof. We hereby consent to the filing of this opinion of counsel as Exhibit 5.1 to the Registration Statement. Very truly yours, /s/ Paul, Hastings, Janofsky & Walker LLP EX-13.1 3 FORM 10-KSB FOR YEAR ENDED 12/31/1999 EXHIBIT 13.1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB (Mark One) [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999 OR [_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________________ to ___________________ Commission file number 0-19724 PROTEIN POLYMER TECHNOLOGIES, INC. (Exact name of small business issuer as specified in its charter) Delaware 33-0311631 (State or Other Jurisdiction of (IRS Employer Incorporation or Organization) Identification No.) 10655 Sorrento Valley Road, San Diego, CA 92121 (Address of Principal Executive Offices) Issuer's Telephone Number: (619) 558-6064 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, Redeemable Warrants (Title of Class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Check if there is no disclosure of delinquent filers pursuant to Item 405 of Regulation S-B contained herein, and no disclosure will 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-KSB or any amendment to this Form 10-KSB. [_] The issuer's revenues for the most recent fiscal year were $96,000. The aggregate market value of the voting stock held by non-affiliates of the issuer on March 22, 2000 was $15,208,769. State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: As of March 22, 2000, 18,286,510 shares of common stock were outstanding. DOCUMENTS INCORPORATED BY REFERENCE: Definitive Proxy Statement to be filed no later than April 7, 2000 pursuant to Regulation 14A with respect to the Registrant's 2000 Annual Meeting of Stockholders (incorporated by reference in Part III). Transitional Small Business Disclosure Format: Yes [_] No [X] ================================================================================ PROTEIN POLYMER TECHNOLOGIES, INC. FORM 10-KSB FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 TABLE OF CONTENTS Page No. -------- PART I.................................................................... 2 Item 1. Business.................................................. 2 Item 2. Properties................................................ 18 Item 3. Legal Proceedings......................................... 19 Item 4. Submission of Matters to a Vote of Security Holders....... 19 PART II................................................................... 20 Item 5. Market for Registrant's Common Equity and Related Stockholder Matters....................................... 20 Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 24 Item 7. Financial Statements...................................... F-1 Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................... 29 PART III.................................................................. 29 Items 9, 10, 11 and 12 - Incorporated by Reference Item 13. Financial Statements, Exhibits and Reports on Form 8-K.............................................. 29 Signatures ......................................................... 35 1 PART I ITEM 1. BUSINESS COMPANY BACKGROUND Protein Polymer Technologies, Inc., a Delaware corporation ("PPTI" or "the Company"), is a development-stage biotechnology company incorporated on July 6, 1988 and is engaged in the research, development, production and clinical testing of medical products based on its proprietary protein-based biomaterials technology. Since 1992, the Company has focused primarily on developing materials technology and products to be used in the surgical repair of tissue: surgical adhesives and sealants; soft tissue augmentation products; wound healing matrices; drug delivery devices; and surgical adhesion barriers. The Company has also developed coating technology that can efficiently modify and improve the surface properties of more traditional biomedical devices. A common goal is to develop materials that beneficially interact with human cells, enabling cell growth and the regeneration of tissues with improved outcomes as compared to current products and practices. In December 1999, the Company initiated human clinical testing of its urethral bulking agent for the treatment of female stress urinary incontinence. The August 1999 approval by the U.S. Food and Drug Administration ("FDA") of the Company's Investigational Device Exemption ("IDE") allows PPTI to test the safety and effectiveness of the incontinence product in women over the age of 40 who have become incontinent due to the shifting of their bladder or the weakening of the muscle at its base that controls the flow of urine, or both problems combined. The Company estimates that more than 2.5 million women begin to experience stress urinary incontinence in the United States each year. In most untreated cases, the problem becomes progressively more pronounced. Due to limited efficacy or invasiveness of current treatments, only a small proportion of the women experiencing stress urinary incontinence are clinically treated, relying instead on pads and plugs and the like that only address the symptoms. In contrast, PPTI's product is injected, typically in an out patient procedure, into urethral tissue at the base of the bladder forming a solid implant that provides support to the muscles controlling the flow of urine. The Company believes that its product will prove to be easy for the physician to use, offer enduring effectiveness, and avoid most of the other limitations of urethral bulking products on the market or in development. The tissue augmentation materials and technology underlying the incontinence product have the potential to be effective and desirable in a number of other clinical applications. The Company intends to submit an additional IDE to the FDA in 2000 to obtain approval to begin human clinical testing of its dermal bulking agent for use in cosmetic and reconstructive surgery applications. PPTI began studies to identify its most promising biomaterial formulations for use in these soft tissue augmentation products in 1996, devoted increasing resources through 1997 and 1998, and has primarily focused on this program area in 1999 in preparation for human clinical testing. 2 In January 2000, PPTI established a strategic alliance with Femcare, Ltd. ("Femcare") for the commercialization of the incontinence product in Europe and Australia. In the agreement, Femcare is responsible for clinical testing, regulatory approval, and product sales and marketing within these territories, and PPTI is responsible for product manufacturing. Contingent on successful clinical trials commercialization of the product in Europe is expected to begin more than a year before approval for marketing the product in the United States can be obtained. PPTI also is in discussions with several companies regarding the establishment of strategic alliances for commercializing the incontinence product in the United States and other markets outside the Femcare territories. Between 1994 and 1997, the Company's efforts were focused predominantly on the development of its surgical adhesive and sealant technology. As part of this effort, the Company targeted the establishment of a strategic alliance with a market leader in the field of surgical wound closure products which lead to the execution of comprehensive license, supply and development agreements in September 1995, with Ethicon, Inc. ("Ethicon"), a subsidiary of the Johnson & Johnson Company ("J&J"). Ethicon elected to terminate these agreements in December 1997. The Company has demonstrated both the adhesive performance and the biocompatibility of its product formulations in animal models, including the resorption of the adhesive matrix in conjunction with the progression of wound healing. PPTI is committed to the commercial development of its adhesive and sealant technology. Subsequent to the termination of the Ethicon agreement, the Company has worked to determine the most significant market and product opportunities for its use. PPTI is seeking to establish new strategic alliances with leaders in those markets. To the extent sufficient resources are available, the Company continues to research the use of its protein polymers for other tissue repair and medical device applications, principally for use in tissue engineering matrices and drug delivery devices. Through 1999, PPTI marketed specialty use products for in vitro cell -------- culture applications including SmartPlastic(R) and ProNectin(R) F Cell Attachment Factor. ProNectin F was launched commercially in 1991. SmartPlastic is ProNectin F Activated Cultureware where ProNectin F is presented in ready to use form on the surfaces of disposable plastic labware for culturing human and animal cells. SmartPlastic was launched commercially in 1995. In 1998 the Company discontinued direct sales of its cell culture products, and in February 2000, the Company sold all rights to the use of the technology for in vitro cell -------- culture applications, the product trademarks, and remaining inventory to Sanyo Chemical Industries, Ltd. Prior to 1992, the Company's scientists had successfully demonstrated the ability to create and produce novel protein polymer materials having important physical, biological and chemical properties. During this period, most of the Company's efforts were dedicated to supplying E. I. DuPont de Nemours & Co. ("DuPont") with materials under contract for its proprietary research and testing purposes. 3 In 1992, the Company raised approximately $8.9 million through its initial public offering of common stock and redeemable warrants. The Company used a major portion of these proceeds to generate substantive in vitro -------- laboratory evidence and in vivo animal test data demonstrating the ------- biocompatibility and performance of its protein polymers and derived biomaterials, and to establish a materials science group which has developed important materials modification and fabrication technology. In July 1994, the Company raised approximately $2.1 million from the sale of its unregistered Series C Preferred Stock to private investors. In September 1995, the Company raised approximately $2.4 million from the sale of its unregistered Series D Preferred Stock to the same private investors. Also at this time these investors exchanged all of their holdings of Series C Preferred Stock and accumulated dividends into Series D Preferred Stock. In January 1997, the Company raised approximately $4.6 million from a private placement of the Company's common stock with a number of institutional and accredited investors. In April and May 1998, the Company raised approximately $5.4 million from the private sale of the Company's Series E Convertible Preferred Stock and warrants to a small group of institutional and accredited investors. In connection with this transaction, the Company also issued shares of Series F Convertible Preferred Stock in exchange for the same number of shares of outstanding Series D Convertible Preferred Stock. During April 1999, the Company received approximately $508,000 from the exercise of redeemable, publicly traded warrants originally issued as part of PPTI's Initial Public Offering, and during May 1999 the Company received approximately $416,000 for the conversion of warrants issued in conjunction with its private placement of Series E Convertible Preferred Stock. In August and September of 1999, the Company received approximately $2 million, net of costs, from a private placement of its Series G Convertible Preferred Stock priced at $100 per share with warrants to purchase an aggregate of 4,200,000 shares of common stock to a small group of institutional and accredited investors. The Company's cash balance as of December 31, 1999 was $156,000. The Company believes this amount, in combination with approximately $3.4 million in revenues and receivables obtained in January and February 2000 from licensing and R&D agreements, and the exercise of common stock warrants issued in connection with Series G Convertible Preferred Stock, is sufficient to fund its operations through January 2001. Beyond this fiscal year, we believe there are a number of alternatives available to meet our continuing capital requirements. See the Liquidity and Capital Resources section of Management's Discussion and Analysis of Financial Condition and Results of Operations for further discussion. THE COMPANY'S TECHNOLOGY PPTI is focused on developing products to improve medical and surgical outcomes, based on an extensive portfolio of proprietary biomaterials. Biomaterials are materials that are used to direct, supplement, or replace the functions of living systems. The interaction between materials 4 and living systems is dynamic. It involves the response of the living system to the materials (e.g., biocompatibility) and the response of the materials to the living system (e.g., degradation). The requirements for performance within this demanding biological environment have been a critical factor in limiting the myriad of possible metal, polymer, and ceramic compositions to a relatively small number that to date have been proven useful in medical devices. The goal of biomaterials development historically has been to produce inert materials -- materials that elicit little or no response from the living system. However, the Company believes that such conventional biomaterials are constrained by their inability to convey appropriate messages to the cells that surround them -- the same messages that are conveyed by proteins in normal human tissues. The products targeted for development by PPTI are based on a new generation of biomaterials which have been designed to be recognized and accepted by human cells, to aid in the natural process of bodily repair (including the healing of tissue and the restoration or augmentation of its form and function), and, ultimately, to promote the regeneration of tissues. The Company believes that the successful realization of these properties will substantially expand the role that artificial devices can play in the prevention and treatment of human disability and disease, and enable the culture of native tissues for successful reimplantation. Through its proprietary core technology, PPTI produces high molecular weight polymers that can be processed into a variety of material forms such as gels, sponges, films, and fibers, with their physical strength and rate of resorption tailored to each potential product application. These polymers are constructed of the same amino acids as natural proteins found in the body. The Company has demonstrated that its polymers can mimic the biological and chemical functions of natural proteins and peptides, such as the attachment of cells through specific membrane receptors and the ability to participate in enzymatic reactions, thus overcoming a critical limitation of conventional biomaterials. In addition, materials made from PPTI's polymers have demonstrated excellent biocompatibility in a variety of preclinical feasibility studies. PPTI's patented core technology enables messages that direct activities of cells to be precisely formulated and presented in a structured environment similar to what nature has demonstrated to be essential in creating, maintaining and restoring the body's functions. The Company's protein polymers are made by combining the techniques of modern biotechnology and traditional polymer science. The techniques of biotechnology are used to create synthetic genes that direct the biological synthesis of protein polymers in recombinant microorganisms. The methods of traditional polymer science are used to design novel materials for specific product applications by combining the properties of individual "building block" components in polymer form. In contrast to natural proteins, either isolated from natural sources or produced using traditional genetic engineering techniques, PPTI's technology results in the creation of new proteins with unique properties. PPTI has demonstrated its capability to create materials that: . combine properties of different proteins found in nature; 5 . reproduce and amplify selected activities of natural proteins; . eliminate undesired properties of natural proteins; and . incorporate synthetic properties via chemical modifications. This capability is fundamental to PPTI's current primary product research and development focus -- tissue repair and regeneration. Tissues are highly organized structures made up of specific cells arranged in relation to an extracellular matrix ("ECM"), which is principally composed of proteins. The behavior of cells is determined largely by their interactions with the ECM. Thus, the ability to structure the cells' ECM environment allows the protein messages they receive -- and their activity -- to be controlled. Similar to what nature has demonstrated to be essential in creating, maintaining and restoring the body's functions, PPTI's patented core technology enables messages that direct activities of cells to be precisely formulated and presented in a structured environment. FUNDAMENTAL PROTEIN POLYMERS PPTI's primary products under development are based on protein polymers combining selected properties from two of the most extraordinary structural proteins found in nature: silk and elastin. Silk, based upon its crystalline structure, has long been known as an incredibly strong material, and has a long history of medical use in humans as a material for sutures. Elastin fibers are one of the most remarkable rubber-like materials ever studied. Found in human tissues such as lungs and arteries, elastin fibers must expand and contract over a life time, and can be extended nearly three times their resting length without damaging their flexibility. Despite the incredible individual properties of silk and elastin, neither of these natural protein materials is capable of being processed into forms other than what nature has provided without destroying their valuable materials properties. However, PPTI's proprietary technology has enabled the creation of polymers that combine the repeating blocks of amino acids responsible for the strength of silk and the elasticity of elastin. By precisely varying the number and sequence of the different blocks in the assembled protein polymer, new combinations of properties suitable for various medical applications have been created. The Company has also created protein polymers based on repeating blocks of amino acids found in two other classes of structural proteins found in nature: collagen and keratin. Collagen is the principal structural component of the body, found in some shape or form in virtually every tissue, ranging from shock absorbing cartilage to light transmitting corneas. Keratin is a major component in hair, nails and skin. The development of materials based on these polymers is at an early stage of research. PRODUCT CANDIDATES AND ANTICIPATED MARKETS The Company's technology and materials have the potential to create products and product applications in a variety of medical and specialty use markets. The Company's current development efforts are principally focused on preparations for scale-up and validation of manufacturing processes for its hydrogel bulking agents for soft tissue augmentation. However, 6 opportunities for research and development of product candidates for other medical and specialty use continue to be evaluated, particularly those based on its tissue adhesive and sealant technology. All of the Company's product candidates are subject to preclinical and clinical testing requirements for obtaining U.S. Food and Drug Administration's ("FDA's") marketing approval. The actual development of other product candidates, if any, will depend on a number of factors, including the availability of funds required to research, develop, test and obtain necessary regulatory approvals; the anticipated time to market; the potential revenues and margins that may be generated if a product candidate is successfully developed and commercialized; and the Company's assessment of the potential market acceptance of a product candidate. Soft Tissue Augmentation Conditions where there is a need to augment the body's soft tissues include both cosmetic and medical applications. In the former, for example, current procedures include the injection of collagen-based materials to smooth out facial wrinkles, acne scars and to modify lip contours. However, these treatments only last a matter of months, which puts them economically out of reach for a large portion of the population of people who would otherwise desire the procedure. Medical applications include the treatment of stress urinary incontinence, gastroesophageal reflux, and fecal incontinence, the reversible blockage of fallopian tubes for birth control, the augmentation of vocal chords, and the expansion of gingival tissues impacted by periodontal disease. PPTI believes there is a lack of materials with suitable properties for these applications, primarily because materials having the required durability in vivo ------- either lack the requisite biocompatibility or the ability to be easily injected. The Company has developed protein polymers that demonstrate excellent biocompatibility, are soluble in water at room temperature, and are easily injected into body tissues, irreversibly forming soft, durable gels at body temperature. Previously, PPTI has shown gels of similar composition to persist at least 18 months in an animal model. PPTI's bulking agents are unique in that they are applied as an aqueous solution, easily injected through a 30-gauge needle, rapidly spreading throughout the native tissue architecture. With the increase from room to body temperature, the polymer solution irreversibly transforms within minutes to a soft, pliable hydrogel. Importantly, the volume of material remains constant in the liquid to gel transition, such that the tissue expansion observed by the physician upon administration will be subsequently maintained. This is in direct contrast to the majority of competing technologies, which are suspensions or slurries of solid particles in an aqueous carrier such as saline. When injected through a fine gauge needle, with some difficulty due to their thick constitution, the carrier liquid dissipates through the tissues with time, usually within 24 hours, such that roughly half of the effective bulking volume is lost. This requires the physician to either overcompensate for the expected volume reduction upon initial administration, with increased risks to the patient, or to 7 "top off" the bulking effect with repeated administrations of the product over time, with substantially increased costs. Other hydrogel technologies of which the Company is aware are either preformed gels, difficult to administer by injection, or polymer solutions mixed with a chemical cross-linking agent prior to injection. PPTI believes that such technologies are limited in their overall performance including durability, biocompatibility and ease of administration. In August 1999, the Company obtained the FDA's approval of its Investigational Device Exemption (IDE) to begin human clinical testing of its urethral bulking agent for the treatment of female stress urinary incontinence. The Company began pilot clinical testing of the product's safety and efficacy in December 1999. The Company projects expanding into a multi-site pivotal clinical study in the fourth quarter of 2000. To the extent funds are available, the Company intends to submit an additional IDE to the FDA in 2000 to obtain approval to begin human clinical testing of its dermal bulking agent for use in cosmetic and reconstructive surgery applications. Surgical Adhesives and Sealants Surgeons are master craftsmen. However, instead of working with metal, wood or plastic, they work with living tissues. Like carpenters, they use saws, chisels (knives) and drills to take things apart and fit pieces together. But they only have access to string (sutures) and nails (staples, pins, screws) to hold things in place. Furthermore, a surgeon's work is complicated by the biological healing response occurring when tissues are injured. As in everyday life, there are many surgical uses for glue where string and nails just don't work well. They may not be quick or easy enough to use; they may not be capable of staying in place; they may do more damage than desired; they and/or the tools to use them may not fit within the available work space; they may result in fluid or air leaks; or the "fit and finish" or healing response is just not satisfactory. Certain surgical adhesives and sealants that seek to avoid these limitations have been developed and marketed outside the United States by other parties. In 1998, the FDA approved two such products for certain uses in the U.S. DermaBond(TM), a cyanoacrylate adhesive, was approved for topical application to close skin incisions and lacerations. Cyanoacrylate adhesives set fast and have high strength, but are toxic to certain tissues and form brittle plastics that do not resorb. These limitations restrict their use to bonding the outer surfaces of skin together. Tisseel(TM), a fibrin sealant, was approved for use as an adjunct to hemostasis in surgery. Fibrin sealants have excellent hemostatic properties, but are derived from human and/or animal blood products, set slowly, have low strength, and lose their strength rapidly. A third category of tissue adhesives combines natural proteins such as collagen or albumin with aldehyde cross-linking agents. Such products are marketed in Europe for limited life-threatening indications. The aldehyde cross-linking agents employed (i.e. glutaraldehyde, formaldehyde) in such products are known to cause adverse tissue reactions. Additional adhesive 8 and/or sealant products employing other polymer systems and cross-linking agents are also under development. PPTI is seeking to develop surgical adhesives and sealants that combine the biocompatibility of fibrin glues (without the risks associated with use of blood-derived products) with the high strength and fast setting times of cyanoacrylates. Unique features include significant elasticity within the adhesive matrix (to move as tissues move) and the capability of tailoring the resorption rate of the adhesive matrix with the rate at which the wound heals. A non-resorbable adhesive or sealant can only be used where the damaged tissues will not heal. Otherwise, a barrier to wound healing is unavoidably created. In September 1995, the Company entered into a series of agreements with Ethicon regarding this program. Ethicon elected to terminate these agreements in December 1997. However, the Company has demonstrated both the adhesive performance and the biocompatibility of its product formulations in animal models, including the resorption of the adhesive matrix in conjunction with the progression of wound healing. Subsequently, the Company has worked to determine the specific markets and products providing the most significant opportunities for the use of its adhesive and sealant technology. As a result of its evaluations of the medical market needs, the properties achievable with its technology, and the capabilities of competitive technologies, PPTI has focused its product development interests on certain orthopedic applications, particularly those related to the repair of the spinal disc for the treatment of chronic low back pain. Low back pain is the most common musculoskeletal disorder in industrialized societies. PPTI is committed to the commercial development of its adhesive and sealant technology and is seeking to establish new strategic alliances with market leaders. However, there can be no assurance that such alliances can be entered into. Wound Healing/Tissue Engineering Matrices The current market for wound care products is highly segmented, involving a variety of different approaches to wound care. Products currently marketed and being developed by other parties include fabric dressings (such as gauze), synthetic materials (such as polyurethane films) and biological materials (such as growth factors and living tissue skin graft substitutes). While the type of product used varies depending on the type of wound and extent of tissue damage, the Company believes that a principal treatment goal in all instances is to stimulate wound healing while regenerating functional (as opposed to scar) tissue. The Company has developed protein polymers which it believes may be useful in the treatment of dermal wounds, particularly chronic wounds such as decubitous ulcers, where both reconstruction of the ECM and re-establishment of its function are desired. These polymers, based on key ECM protein sequence blocks, are biocompatible, fully resorbable and have been processed into gels, sponges, films and fibrous sheets. The Company believes that such materials, if successfully developed, could improve the wound-healing process by providing physical support in situ for cell migration and tissue regeneration and as ------- delivery systems for 9 growth factors. Additionally, such materials may serve as scaffolds for the ex vivo production of living tissue substitutes. - ------- This program is in the early stages of research, which the Company has principally conducted in collaboration with third parties. Such collaborations have primarily focused on the treatment of dermal wounds. Controlled Release Drug Delivery Oral delivery of drugs is the most preferred route of administration. However, for many drugs this is not possible and alternative drug delivery routes are required. Alternative routes include transdermal, mucosal, and by implantation or injection. For implantation or injection, it is often desirable to extend the availability of the drug in order to minimize the frequency of these invasive procedures. A few materials have been commercialized which act as depots for a drug when implanted or injected, releasing the drug over periods ranging from one month to several years. Other material and drug combinations are being developed by third parties. PPTI believes that the properties of these materials for such applications can be substantially improved upon, making available the use of depot systems for a wider range of drugs and applications. PPTI's soft tissue augmentation products, its wound healing matrices, and its medical device coating technology all provide platforms for drug delivery applications, serving as controlled release drug depots. The protein polymer materials the Company has developed exhibit exceptional biocompatibility, provide for control over rates of resorption, and are fabricated using aqueous solvent systems at ambient temperatures -- attributes which can be critical in maintaining the activity of the drug, particularly protein-based drugs emerging from the biotechnology industry. This program is in the early stages of research. MANUFACTURING, MARKETING AND DISTRIBUTION Preclinical and clinical testing of potential medical device products, where the results will be submitted to the FDA, requires compliance with the FDA's Good Laboratory Practices ("GLP") and other Quality System Regulations ("QSR"). The Company has implemented, and continues to implement, polymer production and quality control procedures, and has made certain facilities renovations to operate in conformance with FDA requirements. The Company believes its current polymer production capacity is sufficient for supplying its development programs with the required quality and quantity of materials needed for feasibility and preclinical testing and initial ("pilot") clinical testing. To expand beyond initial clinical trials, the Company will require additional manufacturing capacity. The Company is considering several methods for increasing production of its biomedical and other product candidates to meet clinical and commercial requirements. For example, the Company may expand its existing facility to produce needed quantities of materials under FDA's GLP and QSR regulations for clinical and commercial use. Alternatively, the Company may establish external contract manufacturing arrangements for needed quantities of materials. 10 However, there can be no assurance that such arrangements, if desired, could be entered into or maintained on acceptable terms, if at all, or that the existence or maintenance of such arrangements would not adversely affect the Company's margins or its ability to comply with applicable governmental regulations. The actual method, or combination of methods, that the Company may ultimately pursue will depend on a number of factors, including availability, cost and the Company's assessment of the ability of such production methods to meet its commercial objectives. PPTI has entered into an agreement with Femcare for marketing and distribution of its urethral bulking agent for stress urinary incontinence in certain countries, if the required regulatory approvals are obtained (see "Collaborative Agreements). The Company currently expects that its other biomedical products, if any were commercialized, would be marketed and distributed by corporate partners. While this arrangement could minimize the Company's marketing costs and facilitate wider distribution of any biomedical products it may develop, these arrangements could possibly reduce the Company's revenues and profits as compared to what would be possible if the Company directly sold such products. RESEARCH AND DEVELOPMENT Information regarding Company-sponsored research and development activities and contract research and development revenue is set forth below under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations". COLLABORATIVE AGREEMENTS Because of the highly technical focus of its business, the Company must conduct extensive research and development prior to any commercial production of its biomedical products or the biomaterials from which they are created. During this development stage, PPTI's ability to generate revenues is limited. Because of this limitation, the Company does not have sufficient resources to devote to extensive testing or marketing of its products. The Company's primary method of expanding its product development, testing and marketing capabilities is to seek to form collaborative arrangements with selected corporate partners with specific resources that the Company believes complement its business strategies and goals. The medical device industry has traditionally licensed from development stage companies product candidates whose safety and efficacy has been demonstrated at least in pilot human clinical trials. In December 1999, the Company began human clinical testing of its urethral bulking agent for the treatment of female stress urinary incontinence. The Company also intends to submit an additional IDE to the FDA in 2000 to obtain approval to begin human clinical testing of its dermal bulking agent for use in cosmetic and reconstructive surgery applications. 11 Femcare, Ltd. In January 2000, PPTI announced the formation of a strategic alliance with Femcare, Ltd. for the commercialization in Europe and Australia of its urethral bulking agent for treatment of stress urinary incontinence. Femcare is a British-based developer and international marketer of surgical products for gynecological and urological applications. In the alliance, PPTI will provide Femcare with technical assistance, and the incontinence product for Femcare's clinical testing and regulatory approvals in the Femcare territories. Femcare will utilize its existing customer base and its extensive distribution network as the basis for introducing the product into Europe and Australia. Currently, Femcare markets its products in 40 countries worldwide. A new Urology division has been created to extend the company's success in gynecology to urological applications, in particular female stress urinary incontinence. PPTI receives a $1 million license fee and a royalty on the revenues generated by Femcare from the sale of the product. PPTI will be responsible for providing the product to Femcare for commercial sale. Other Agreements PPTI is discussing other potential collaboration agreements with prospective marketing partners for both its soft tissue augmentation products and its tissue adhesive and sealant products. There can be no assurance that the Company will continue such discussions or be able to establish such agreements at all, or do so in a timely manner and on reasonable terms, or that such agreements will lead to successful product development and commercialization. From time to time, the Company is a party to certain materials evaluation agreements regarding biomedical and specialty use applications of its products, polymers and technology, including applications in areas other than those identified as product candidates above. These agreements provide, or are intended to provide, for the evaluation of product feasibility. There can be no assurance that the Company will continue to be able to establish such agreements at all, or do so in a timely manner and on reasonable terms, or that such agreements will lead to joint product development and commercialization agreements. INTENSE COMPETITION The principal anticipated commercial uses of PPTI's biomaterials are as components of end-use products for biomedical and other specialty applications. End-use products using or incorporating the Company's biomaterials would compete with other products that rely on the use of alternative materials. For example, bulking agents for soft tissue augmentation are currently marketed based on bovine collagen and, outside the U.S., silicone particles. Similarly, all targeted applications of the Company's potential products will compete with other products having the same or similar applications. The areas of business in which the Company engages and proposes to engage are characterized by intense competition and rapidly evolving technology. Competition in the biomedical and surgical repair markets is particularly significant. The Company's competitors in 12 the biomedical and surgical repair markets include major pharmaceutical, surgical product, chemical and specialized biopolymer companies, many of which have financial, technical, research and development and marketing resources significantly greater than those of the Company. Academic institutions and other public and private research organizations are also conducting research and seeking patent protection, and may commercialize products on their own or through joint ventures. Most of the Company's competitors depend on synthetic polymer technology rather than protein engineering for developing products. However, the Company believes that DuPont and several university laboratories are currently conducting research into similar protein engineering technology. The primary elements of competition in the biomedical and surgical repair products market are performance, cost, safety, reliability, convenience and commercial production capabilities. The Company believes that its ability to compete in this market will be enhanced by its issued patent claims, the breadth of its other pending patent applications, its early entry into its field and its experience in protein engineering. PATENTS AND TRADE SECRETS PPTI is aggressively pursuing domestic and international patent protection for its technology, making claim to an extensive range of recombinantly prepared structural and functional proteins, methods for preparing synthetic repetitive DNA, methods for the production and purification of protein polymers, end-use products incorporating such materials and methods for their use. The United States Patent and Trademark Office ("USPTO") has issued fifteen patents to the Company. U.S. Patent 5,235,041 (1993) relates to the Company's method for purifying structurally ordered recombinant protein polymers. U.S. Patent 5,243,038 (1993) covers the Company's synthetic DNA compositions that encode polymers and copolymers comprising the amino acid "building blocks" of silk and elastin. U.S. Patent 5,496,712 (1996) covers the Company's family of high molecular weight collagen like polymers and the DNA sequences encoding them. U.S. Patent 5,514,581 (1996) covers DNA sequences encoding silk-like structural building blocks with an intervening sequence coding for the key cell attachment ligand from human fibronectin. One of the claimed sequences encodes ProNectin F. U.S. Patent 5,606,019 (1997) covers the protein compositions comprising copolymers of the amino acid "building blocks" of silk and elastin. These are the primary materials used in the Company's current product development efforts. U.S. Patent 5,641,648 (1997) covers methods by which synthetic genes encoding protein polymers are created. U.S. Patent 5,723,588 (1998) covers molded articles incorporating biologically active proteins. U.S. Patent 5,760,004 (1998) covers chemical modification of protein polymers to enhance their water solubility. U.S. Patent 5,770,697 (1998) broadly covers protein polymers incorporating repetitive amino acid sequences found in naturally occurring proteins. U.S. Patent 5,773,249 (1998) expands the coverage of high molecular weight collagen like polymers. U.S. Patent 5,773,577 (1998) covers protein polymers that can be cross-linked by certain enzymes 13 that naturally occur in the body. U.S. Patent 5,808,012 (1998) expands the coverage of molded articles to those incorporating chemically active proteins. U.S. Patent 5,817,303 (1998) covers the use of protein polymers with chemical cross-linking agents as adhesives and sealants. U.S. Patent 5,830,713 (1998) expands the coverage of methods by which synthetic genes encoding protein polymers are created. U.S. Patent 6,018,030 (2000) broadly covers DNA sequences encoding protein polymers incorporating repetitive amino acid sequences found in naturally occurring proteins. Additionally, PPTI has nine U.S. patent applications pending, two of which have been allowed, covering related aspects of its core technology. Although the Company believes its existing issued patent claims may provide a competitive advantage, there can be no assurance that the scope of the Company's patent protection is or will be adequate to protect its technology or that the validity of any patent issued will be upheld in the future. Additionally, with respect to the Company's allowed and pending applications, there can be no assurance that any patents will be issued, or that, if issued, they will provide substantial protection or be of commercial benefit to the Company. The two patents issued to PPTI in 1993 will expire in 2010, as will one of the patents issued in 1996. The other patent issued in 1996 will expire in 2013, and the patents issued in 1997 will expire in 2014. The three patents issued in 1998, which expand the coverage of previously issued patents, will expire in concert with the original patents. The other five patents issued in 1998 will expire in 2015. The patent issued in 2000 will expire in 2017. Generally, for patent applications filed in the U.S. prior to June 8, 1995, the term of the patent will be 17 years from the issue date. Subsequently filed U.S. patent applications will have a term of 20 years from the date of filing, consistent with the patent laws in international jurisdictions. Although the Company does not currently have any operations outside the U.S., it anticipates that its potential products will be marketed on a worldwide basis, with possible manufacturing operations outside the U.S. For example, the Company has recently established a licensing and distribution agreement with Femcare Ltd. for the sale of its urethral bulking agents in Europe and Australia. Accordingly, international patent applications corresponding to the major U.S. patents and patent applications described above have been filed in these and other important market jurisdictions. Due to translation costs and patent office fees, international patents are significantly more expensive to obtain than U.S. patents. Additionally, there are differences in the requirements concerning novelty and the types of claims that can be obtained compared to U.S. patent laws, as well as the nature of the rights conferred by a patent grant. PPTI carefully considers these factors in consultation with its patent counsel, as well as the size of the potential markets represented, in determining the foreign countries in which to file patents. In almost all cases, the Company files for patents in Australia, Canada, Europe and Japan. Currently, PPTI has fourteen issued foreign patents, and thirty-one pending foreign applications. One of the issued foreign patents is in Europe and the scope of its claims broadly covers protein polymers having biological or chemical activity. 14 Because of the uncertainty concerning patent protection and the unavailability of patent protection for certain processes and techniques, PPTI also relies upon trade secret protection and continuing technological innovation to maintain its competitive position. Although all of the Company's employees have signed confidentiality agreements, there can be no assurance that the Company's proprietary technology will not be independently developed by other parties, or that secrecy will not be breached. Additionally, the Company is aware that substantial research efforts in protein engineering technology are taking place at universities, government laboratories and other corporations and that numerous patent applications have been filed. The Company cannot predict whether it may have to obtain licenses to use any technology developed by third parties or whether such licenses can be obtained on commercially reasonable terms, if at all. In the course of its business, PPTI employs various trademarks and trade names in packaging and advertising its products. The Company has assigned the federal registration of its ProNectin(R) trademark and its SmartPlastic(R) trademark for ProNectin F Activated Cultureware to Sanyo Chemical Industries, Ltd. in connection with the sale to Sanyo of its cell culture business. The Company intends to protect and promote all of its trademarks and, where appropriate, will seek federal registration of its trademarks. REGULATORY MATTERS Regulation by governmental authorities in the United States and other countries is a significant factor affecting the success of products resulting from biotechnological research. The Company's current operations and products are, and anticipated products and operations will be, subject to substantial regulation by a variety of agencies, particularly those products and operations related to biomedical applications. Currently, the Company's activities are subject principally to regulation under the Occupational Safety and Health Act and the Food, Drug and Cosmetic Act. Extensive preclinical and clinical testing and pre-market approval from the FDA is required for new medical devices, drugs or vaccines, which is generally a costly and time-consuming process. PPTI is required to be in compliance with many of the FDA's regulations to conduct testing in support of product approvals; in particular, compliance with the FDA's Good Laboratory Practices ("GLP") regulations and portions of the FDA's Quality Systems Regulations ("QSR"). Where PPTI has conducted such testing, the Company may choose to file product approval submissions itself or maintain with the FDA a "Master File" containing, among other items, such test results. A Master File can then be accessed by the FDA in reviewing particular product approval submissions from companies commercializing products based on PPTI's materials. There can be no assurance that the Company or its customers will be able to obtain or maintain the necessary approvals from the FDA or corresponding international regulatory authorities, or that the Company will be able to maintain a Master File in accordance with FDA regulations. In either case, the Company's anticipated business could be adversely affected. To the extent PPTI manufactures medical devices, as opposed to a component material supplied to a medical device manufacturer, it will be required to conform commercial manufacturing operations 15 to the FDA's QSR requirements. The Company would also be required to register its facility with the FDA as an establishment involved in the manufacture of medical devices. QSR requirements are rigorous, and there can be no assurance that compliance could be obtained in a timely manner and without the expenditure of substantial resources, if at all. International quality system requirements, i.e., ISO 9001 issued by the International Organization for Standardization is the quality model used by medical product manufacturers, and is required for the sale of medical devices in Europe. ISO 9001 standards are similar to the FDA's QSR. In August 1999, the Company obtained the FDA's approval of its IDE to begin human clinical testing of its urethral bulking agent for the treatment of female stress urinary incontinence. The Company initiated clinical testing in December 1999. The Company intends to submit an additional IDE to the FDA in 2000 to obtain approval to begin human clinical testing of its dermal bulking agent for use in cosmetic and reconstructive surgery applications. The Company has implemented, and continues to implement, polymer production and quality control procedures, and has made certain facilities renovations, to operate in conformance with FDA requirements. The Company's research, development and production activities are, or may be, subject to various federal and state laws and regulations relating to environmental quality and the use, discharge, storage, transportation and disposal of toxic and hazardous substances. The Company's future activities may be subject to regulation under the Toxic Substances Control Act, which requires the Company to obtain pre-manufacturing approval for any new "chemical material" the Company produces for commercial use that does not fall within the FDA's regulatory jurisdiction. The Company believes it is currently in substantial compliance with all such laws and regulations. Although the Company intends to use its best efforts to comply with all environmental laws and regulations in the future, there can be no assurance that the Company will be able to fully comply with such laws, or that full compliance will not require substantial capital expenditures. PRODUCT LIABILITY AND ABSENCE OF INSURANCE PPTI's business may expose it to potential product liability risks whenever human clinical testing is performed or upon the use of any commercially marketed medical product. Prior to initiating human clinical testing of its urethral bulking agent, the Company procured product liability insurance. There can be no assurance, however, that PPTI will be able to continue to obtain such insurance on acceptable terms or that such insurance will provide adequate coverage against potential liabilities. A successful product liability claim or series of claims could result in a material adverse effect on the Company. 16 EXECUTIVE OFFICERS OF THE REGISTRANT
Name Age Position with the Company - ---- --- ------------------------- J. Thomas Parmeter 60 Chairman of the Board of Directors, President and Chief Executive Officer Joseph Cappello, Ph.D. 43 Vice President, Research and Development, Chief Technical Officer and Director, Polymer Research Philip J. Davis 69 Corporate Secretary Franco A. Ferrari, Ph.D. 48 Vice President, Laboratory Operations and Polymer Production and Director, Molecular Genetics John E. Flowers 43 Vice President, Planning and Operations Janis Y. Neves 48 Director, Finance and Administration, Treasurer, and Assistant Secretary
Mr. Parmeter has been the Company's President, Chief Executive Officer and Chairman of the Board of Directors since its inception in July 1988 (and, from July 1988 to July 1992, its Chief Financial Officer). From 1982 to November 1987, Mr. Parmeter was President, Chief Executive Officer and, from June 1987 to June 1988, Chairman of the Board of Syntro Corporation. Dr. Cappello has been the Company's Vice President, Research and Development since February 1997 and Director, Polymer Research and Chief Technical Officer since February 1993. From September 1988 to February 1993, he was the Company's Senior Research Director, Protein Engineering. Mr. Davis has been the Company's Secretary since January 1989. Mr. Davis has been a director of the Company since April 1995; he previously served as a director of the Company from January 1989 until October 1991. Mr. Davis has been employed by Donaldson, Lufkin & Jenrette since June 1994 and currently is a Managing Director of Investment Banking. He was Director, Institutional Sales at Merrill Lynch, Inc. (formerly Merrill Lynch Capital Markets) from February 1991 to June 1994, and was a Vice President at Merrill Lynch, Inc. from 1986 to 1991. Mr. Flowers has been the Company's Vice President, Planning and Operations, since February 1993. From September 1988 to February 1993, he was the Company's Vice President, Commercial Development. 17 Dr. Ferrari has been the Company's Vice President, Laboratory Operations and Director, Molecular Genetics since February 1993. From September 1988 to February 1993, he was the Company's Senior Research Director, Genetic Engineering. Ms. Neves has been the Company's Director of Finance since November 1998 and Controller and Assistant Secretary since January 1990. From July 1988 until January 1990, Ms. Neves was the Company's Business Office Manager. All executive officers of the Company were elected by the Board of Directors and serve at its discretion. No family relationships exist between any of the officers or directors of the Company. EMPLOYEES On June 30, 1999, the Company laid off eighteen employees, approximately 60% of its work force, as part of a broad cost cutting measure to preserve cash. In late July, several employees were brought back on the payroll in order to prevent delays in beginning the clinical testing of the Company's lead product, scheduled to begin in December, 1999. With the closing of the Series G Preferred stock offering, several more of the laid off employees were rehired. As of February 29, 2000, PPTI had 19 full-time and one part-time employee, of whom four hold employment contracts with the Company and three hold Ph.D. degrees in the chemical or biological sciences. The Company is highly dependent on the services of its executive officers and scientists. The loss of the services of any one of these individuals would have a material adverse effect on the achievement of the Company's development objectives, its business opportunities and prospects. The recruitment and retention of additional qualified management and scientific personnel is also critical to the Company's success. There can be no assurance that the Company will be able to attract and retain required personnel on acceptable terms, due to the competition for such experienced personnel from other biotechnology, pharmaceutical, medical device and chemical companies, universities and non-profit research institutions. ITEM 2. PROPERTIES PPTI does not own any real property. The Company leases approximately 21,000 square feet in San Diego, California from Sycamore/San Diego Investors. The leased property includes the Company's administrative offices, which encompass approximately 4,000 square feet, and its laboratory facilities, which encompass approximately 17,000 square feet. The current annual rent is approximately $417,000. The lease expires in May 2005. The Company believes that its current facilities are adequate to meet its needs until the end of 2000. The Company retains an option to lease an additional 7,000 square feet of office and laboratory space in its present facility and to extend its lease for an additional five years. 18 ITEM 3. LEGAL PROCEEDINGS None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders during the fourth quarter of 1999. 19 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. NASDAQ Delisting Prior to September 1999, the Company's Common Stock traded on The Nasdaq Stock Market under the symbol "PPTI". The Company's Common Stock was delisted from the NASDAQ Small Cap Quotation System, effective September 20, 1999. The reasons for the delisting were failure to maintain the minimum bid requirement of $1.00 per share for PPTI common stock, and failure to meet the minimum net asset requirement of $2 million. The Company's Common Stock is now traded on the "over-the-counter" NASD Bulletin Board. To access the quotations for the Company's Common Stock, use the call letters PPTI.OB. The trade prices set forth below represent inter-dealer prices without retail markups, markdowns or commissions. Trade Prices ------------------------------- 1999 High Low ---- ------- ------- First Quarter $1.531 $1.063 Second Quarter 2.250 0.875 Third Quarter 1.719 0.750 Fourth Quarter 1.250 0.688 1998 ---- First Quarter $1.531 $1.063 Second Quarter 2.250 0.875 Third Quarter 1.719 0.750 Fourth Quarter 1.250 0.688 As of March 22, 2000, the Company had approximately 163 shareholders of record; it estimates it has approximately 1,500 beneficial holders. The Company has never paid cash dividends on its Common Stock. The Company currently intends to retain earnings, if any, for use in the operation and expansion of its business and therefore does not anticipate paying any cash dividends on the Common Stock in the foreseeable future. Unregistered Offerings On August 16, 1999, the Company received $1,775,000 for 17,750 shares of Series G Convertible Preferred Stock ("Series G Stock") from several institutional and accredited individual investors following the 10 day stockholder notification period required by the NASD prior to the sale. On September 15, 1999, the Company received an additional $325,000 for 3,250 shares of Series G Stock, for a total of $2,100,000. Each share of Series G Stock was priced 20 at $100 per share. Each share can be converted at any time by the holder into common stock at a price of $0.50 per share, subject to certain antidilution adjustments. Each share of Series G Preferred Stock also received a common stock warrant, exercisable for 12 months, that allows the holder to acquire 200 shares of PPTI common stock at a price of $0.50 per share. The Series G Stock, warrants and underlying common stock have not been registered under the Securities Act of 1933, as amended (the "Securities Act"), and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. Between April 1 and April 15, 1999, the Company received approximately $508,000 from the exercise of redeemable, publicly traded, warrants originally issued as part of PPTI's Initial Public Offering. Following the close of business on April 15, the remaining unexercised redeemable, publicly traded, warrants expired. On May 12, 1999, the Company received approximately $416,000 from the exercise of warrants issued in conjunction with the private placement of the Company's Series E Convertible Preferred Stock ("Series E Stock"). In April and May of 1998, the Company raised approximately $5.4 million from the sale of 54,437 shares of the Company's Series E Stock priced at $100 per share, with warrants to purchase an aggregate of 3,266,250 shares of common stock to a small group of institutional and accredited investors. Each share of Series E Stock is convertible at any time at the election of the holder into 80 shares of common stock at a conversion price of $1.25 per share, subject to certain antidilution adjustments. No underwriters were engaged by the Company in connection with such issuance and, accordingly, no underwriting discounts were paid. The offering is exempt from registration under Section 4(2) of the Securities Act, and met the requirements of Rule 506 of Regulation D promulgated under the Securities Act. The Company has registered the shares of common stock underlying the Series E Stock and the warrants with the Securities and Exchange Commission. Each share of Series E Stock received two common stock warrants. One warrant (first warrant) is exercisable at any time for 40 shares of common stock at an exercise price of $2.50 per share, and expires approximately 18 months after the close of the offering; the other warrant (second warrant) is exercisable at any time for 20 shares of common stock at an exercise price of $5.00 per share, and expires approximately 36 months after the close of the offering. In addition, an 18 month warrant to acquire 200,000 common shares exercisable at $2.50 per share and a 36 month warrant to acquire 100,000 common shares exercisable at $5.00 per share were issued as a finder and document review fee paid to a lead investor. An 18 month warrant to acquire 32,000 common shares exercisable at $2.50 per share, a 24 month warrant to acquire 16,000 common shares exercisable at $5.00 per share, and 5 year warrants to acquire an aggregate of 25,200 common shares exercisable at $2.50 per share were issued to certain persons for service as finders in relation to the private placement. In connection with the above private placement, the Company issued 26,420 shares of its Series F Convertible Preferred Stock in exchange for the same number of shares of outstanding Series D Convertible Preferred Stock. The Company's Series F Convertible Preferred Stock is equivalent to the Company's Series E Stock with regard to liquidation preferences. All other 21 terms of the Company's Series F Convertible Preferred Stock remained the same as the Company's Series D Convertible Preferred Stock. On January 7, 1997, the Company received $4,760,000, less expenses of approximately $140,000, from a private placement of 1,904,000 shares of the Company's common stock, at $2.50 per share, with a number of accredited investors. No underwriters were engaged by the Company in connection with such issuance and, accordingly, no underwriting discounts or commissions were paid. The issuance was exempt from registration under Section 4(2) of the Securities Act, and met the requirements of Rule 506 of Regulation D promulgated under the Securities Act. The Company agreed to register the shares with the Securities and Exchange Commission promptly after the closing. The registration was declared effective on January 24, 1997. On September 14, 1995, the Company issued 49,187 shares of its Series D Convertible Preferred Stock and warrants to purchase 500,960 shares of common stock at $1.25 per share in a private placement to certain accredited investors. Of this amount, 20,000 shares of Series D Convertible Preferred Stock and warrants to purchase 400,000 shares of common stock were issued for cash at $100.00 per share; 21,600 shares of Series D Convertible Preferred Stock were issued in exchange for all outstanding shares of the Company's Series C Convertible Preferred Stock and 2,539 shares for accrued and unpaid dividends thereon; and an additional 5,048 shares of Series D Convertible Preferred Stock and warrants to purchase 100,960 shares of common stock were issued in exchange for cancellation of a $500,000 bridge loan and accrued interest thereon. No underwriters were engaged by the Company in connection with such issuance and, accordingly, no underwriting discounts or commissions were paid. The issuance was exempt from registration under Section 4(2) of the Securities Act and met the requirements of Rule 506 of Regulation D promulgated under the Securities Act. Each share of Series D and Series F Convertible Preferred Stock earns a cumulative dividend at the annual rate of $10 per share, payable as and when declared by the Company's Board of Directors in the form of cash, common stock or any combination thereof. The Series D and F Convertible Preferred Stock is convertible into common stock after two years from the date of issuance at the holder's option. The conversion price at the time of conversion is the lesser of $3.75 or the market price. The Series D and F Convertible Preferred Stock is redeemable at the Company's option after four years from the date of issuance. Automatic conversion of all of the Series D and F Convertible Preferred Stock will occur if: (a) the Company completes a public offering of common stock at a price of $2.50 or higher; or (b) the holders of a majority thereof elect to convert. The Company has the option to demand conversion of the Series D and F Convertible Preferred Stock if the average market price of its common stock equals or exceeds $5.00 per share over a period of twenty business days. The Series D Convertible Preferred Stock has a liquidation preference of $100 per share plus accumulated dividends. At the time of purchase, the Series D Convertible Preferred stockholders received warrants to purchase, at an exercise price of $1.25 per share, twenty shares of the Company's common stock for each share of Series D Convertible Preferred Stock acquired for cash, or upon conversion of the outstanding bridge loan and accrued interest thereon, described above. Warrants 22 to acquire a total of 500,960 shares of common stock were issued. All of these warrants were exercised during 1996, from which the Company received aggregate gross proceeds of $626,200. The Series D Convertible Preferred stockholders were granted certain registration rights relating to their shares of common stock issuable upon conversion of the Series D Convertible Preferred Stock and upon the exercise of their warrants. In July 1994, the Company received $2,160,000 from a private placement of the Company's Series C Convertible Preferred Stock with certain accredited investors, consisting of 21,600 shares at $100.00 per share. No underwriters were engaged by the Company in connection with such issuance and, accordingly, no underwriter discounts or commissions were paid. The issuance was exempt from registration under Section 4(2) of the Securities Act and met the requirements under Rule 506 of Regulation D promulgated under the Securities Act. As described above, the investors exchanged 21,600 shares of Series C Convertible Preferred Stock, plus accrued and unpaid dividends thereon, for 24,139 shares of Series D Convertible Preferred Stock. There are currently no shares of Series C Convertible Preferred Stock outstanding. In connection with the issuance of the Series C Convertible Preferred Stock, warrants were also issued to acquire a total of 432,000 shares of the Company's common stock at a price of $1.25 per share. All of these warrants were exercised during 1996, from which the Company received aggregate gross proceeds of $540,000. In July 1996, holders of warrants to acquire 322,663 shares of common stock (all of whom were accredited investors) exercised such warrants at $2.50 per share, resulting in approximately $807,000 in gross proceeds to the Company. These warrants were originally issued in 1991 in connection with the issuance of the Company's Series B Convertible Preferred Stock. The issuance upon exercise of these warrants was exempt from registration under Section 4(2) of the Securities Act and met the requirements under Rule 506 of Regulation D promulgated under the Securities Act. The Company agreed to register the resale of the common stock received upon exercise of these warrants, and the applicable registration was declared effective on July 19, 1996. 23 ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS CERTAIN STATEMENTS CONTAINED OR INCORPORATED BY REFERENCE IN THIS ANNUAL REPORT ON FORM 10-KSB CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. SUCH FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS WHICH MAY CAUSE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE COMPANY, OR INDUSTRY RESULTS, TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY FORWARD-LOOKING STATEMENTS. SUCH RISKS AND UNCERTAINTIES INCLUDE, AMONG OTHERS, HISTORY OF OPERATING LOSSES, RAISING ADEQUATE CAPITAL FOR CONTINUING OPERATIONS, EARLY STAGE OF PRODUCT DEVELOPMENT, SCIENTIFIC AND TECHNICAL UNCERTAINTIES, COMPETITIVE PRODUCTS AND APPROACHES, RELIANCE UPON COLLABORATIVE PARTNERSHIP AGREEMENTS AND FUNDING, REGULATORY TESTING AND APPROVALS, PATENT PROTECTION UNCERTAINTIES AND MANUFACTURING SCALE-UP AND REQUIRED QUALIFICATIONS. WHILE THESE STATEMENTS REPRESENT MANAGEMENT'S CURRENT JUDGMENT AND EXPECTATIONS FOR THE COMPANY, SUCH RISKS AND UNCERTAINTIES COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM ANY FUTURE RESULTS SUGGESTED HEREIN. THE COMPANY UNDERTAKES NO OBLIGATION TO RELEASE PUBLICLY THE RESULTS OF ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES ARISING AFTER THE DATE HEREOF. GENERAL OVERVIEW Incorporated in 1988, Protein Polymer Technologies, Inc. has concentrated its research and development efforts on establishing a scientific and technical leadership position in the production and development of unique protein-based materials. The Company has identified biomedical market and product opportunities for further research and development that management believes will exploit the unique properties of the Company's technology to competitive advantage. The Company has been unprofitable to date, and as of December 31, 1999 has an accumulated deficit of $37,245,495. The Company's product candidates for surgical repair, augmentation and regeneration of human tissues are in various stages of research and development. Its more advanced programs are in the areas of bulking agents for soft tissue augmentation, particularly for use in urethral tissue for the treatment of female stress incontinence and in dermal tissue for cosmetic and reconstructive procedures. The Company currently is devoting the majority of its resources to the development and registration of these products, with the greatest emphasis on the incontinence product which began human clinical trials in December 1999. The Company's other advanced product technology is in the area of tissue adhesives and sealants. Currently the Company's research and development in this area is focused on the repair of spinal discs for the treatment of lower back pain. The Company's first commercial products, ProNectin F and SmartPlastic, are used by biologists and cell culture laboratories, principally to grow mammalian cells for biomedical research purposes. In February 2000, the Company licensed the rights for the 24 manufacture and sale of these products for use in in vitro cell culture, ------- including the transfer of all existing inventory, to a third party. In 1995, the Company entered into a collaborative relationship with Ethicon regarding its surgical adhesives and sealants program. Ethicon terminated the relationship in December 1997 which materially adversely affected the Company. The Company's strategy with most of its programs is to enter into collaborative development agreements with major medical product marketing and distribution companies. Although these relationships, to the extent any are consummated, may provide significant near-term revenues through up-front licensing fees, research and development reimbursements and milestone payments, the Company expects to continue incurring operating losses for the next several years. The Company's cash balance as of December 31, 1999 was $156,000. The Company believes this amount, in combination with funds received from licensing and R&D agreements in January and February 2000, and the exercise of the common stock warrants issued in connection with the Series G Stock in February 2000, which in total will generate approximately $3.4 million (net of costs) during the calendar year 2000, is sufficient to fund its operations through January 2001. The Company will continue to attempt to raise additional funds for continuing operations through private or public offerings and collaborative agreements (see "Liquidity and Capital Resources" below, and Note 1 of the Audited Financial Statements for additional information and a description of the associated risks). RESULTS OF OPERATIONS Interest income was $39,000 for the year ended December 31, 1999, as compared to $135,000 for 1998 and $187,000 for 1997. The year-to-year variability resulted from the amount and timing of the receipt of equity capital and the amounts of excess cash available for investment. Product sales for the years ended December 31, 1999 were $54,000, compared to $71,000 and $77,000 in 1998 and 1997 respectively. Product sales consist of ProNectin F related product revenues and licensing fees. Sales during 1996 reflected disappointing market interest in the line of ProNectin products; as a result the Company discontinued related promotional expenditures to conserve cash. Sales in 1998 and 1999 primarily reflect distributor stocking orders. The manufacturing and marketing rights and the inventory for this product line were sold to Sanyo Chemical Industries, Ltd. in February 2000. Because of previously booked inventory reserves, their was no cost of sales booked for any product sales in 1999. Research and development expenses for the year ended December 31, 1999 were $2,812,000, compared to $4,138,000 in 1998, a decrease of 32%. This decrease is due primarily to a downsizing of the Company's staff and operational expenses in June 1999, but also in part to the completion of preclinical testing and regulatory consulting costs associated with the filing of the Company's Investigational Device Exemption (IDE) with the U.S. Food and Drug Administration to begin human trials for the treatment of female stress urinary incontinence. These latter savings are temporary and will be replaced and increased by the cost of conducting 25 human clinical testing which began in December 1999. Other related expenses include expanded manufacturing capacity and manufacturing process validation, quality assurance efforts, and outside testing services. The Company expects its research and development expenses will increase in the future, to the extent additional capital is obtained, due to the expansion of product-directed development efforts including human clinical testing, increased manufacturing requirements, and increased use of outside testing services. Selling, general and administrative expenses for the year ended December 31, 1999 were $1,554,000, as compared to $1,727,000 for 1998, a decrease of 10%. This decrease was due to the Corporate downsizing in June 1999, and generally tighter cost management following that period. To the extent possible, the Company continues to concentrate on controlling costs reflected in reduced travel, office supplies, and non-regulatory consulting costs. The Company expects its selling, general and administrative expenses will increase in the future, to the extent additional capital is obtained, consistent with supporting its research and development efforts and as business development, patent, legal and investor relations activities require. For the year ended December 31, 1999, the Company recorded a net loss applicable to common shareholders of $4,535,000, or $.36 per share, as compared to $9,183,000, or $.88 per share for 1998, and $4,887,000, or $.52 per share for 1997. The difference between 1999 and previous year end results is due primarily to a non-cash "imputed dividend" expense of $3,266,000 that resulted from the sale and issuance of the Company's Series E Convertible Preferred Stock during 1998. The 1999, 1998 and 1997 losses and per share calculations also include $278,000, $278,000, and $433,000, respectively, of undeclared and/or paid dividends from the Company's Preferred Stock. The Company expects to incur increasing operating losses for the next several years, to the extent additional capital is obtained, based upon the successful continuation of the tissue augmentation program and product registration, and the tissue adhesives program, as well as expected increases in the Company's other research and development, manufacturing and business development activities. The Company's results depend in part on its ability to establish strategic alliances and generate contract revenues, increased research, development and manufacturing efforts, preclinical and clinical product testing and commercialization expenditures, expenses incurred for regulatory compliance and patent prosecution, and other factors. The Company's results will also fluctuate from period to period due to timing differences. To date, the Company believes that inflation and changing prices have not had a material impact on its continuing operations. Based upon the Company's earnings history, a valuation allowance of $12,867,000 is required to reduce the Company's net deferred tax assets to the amount realizable. 26 LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1999, the Company had cash, cash equivalents and short-term investments totaling $156,000, as compared to $1,383,000 at December 31, 1998. As of December 31, 1999, the Company had working capital of $(458,000), compared to $600,000 at December 31, 1998. In April and May of 1999, the Company realized approximately $924,000 from the exercise of common stock warrants and in August and September 1999, approximately $2,075,000, net of expenses, from the private placement of the Company's Series G Convertible Preferred Stock and warrants. Subsequently, the Company received in January and February 2000 approximately $1,350,000 (net of costs) in cash and receivables from licensing and R&D agreements with Femcare, Ltd. for the European and Australian marketing rights to the stress urinary incontinence bulking product, with Perkin-Elmer for a research and development project and commercialization option, and with Sanyo Chemical Industries, Ltd. for the rights to the in vitro cell culture business. Also in February 2000, the Company received approximately $2.1 million from the exercise of common stock warrants originally granted as part of the sale of Series G Convertible Preferred Stock and warrants. The Company had long-term capital lease obligations of $25,000 as of December 31, 1999, compared to an obligation of $106,000 as of December 31, 1998. For the year ended December 31, 1999, the Company's cash expenditures for capital equipment and leasehold improvements totaled $26,000, compared with $197,000 for the same period last year. The Company anticipates that these expenditures will be increased in 2000 as laboratory renovations and additional equipment required to meet GLP manufacturing regulations and production capacity as the Company scales up its manufacturing operations to meet product requirements for clinical testing. The Company anticipates a significant increase in manufacturing-related equipment and leasehold improvement expenditures in 2001 due to an increase in need for products for clinical testing, and anticipated need for additional product manufacturing for European product sales. The Company may enter into additional capital equipment lease arrangements in the future if available at appropriate rates and terms. The Company believes its existing available cash, cash equivalents and short-term investments as of February 29, 2000 would be sufficient to meet its anticipated capital requirements through December 2000. Substantial additional capital resources will be required to fund continuing expenditures related to the Company's research, development, manufacturing and business development activities. The Company believes there may be a number of alternatives available to meet the continuing capital requirements of its operations, such as collaborative agreements and public or private financings. During 2000, the Company expects that the possible exercise of other existing warrants could result in additional funds for continuing operations. Further, the Company is currently in preliminary discussions with a number of potential collaborative partners and, based on the results of various materials evaluations, revenues in the form of license fees, milestone payments or research and development reimbursements could be generated. There can be no assurance that any of these fundings will be consummated in the necessary timeframes needed for continuing operations or on terms favorable to the Company. If adequate funds are not available, the Company will be required to significantly curtail its 27 operating plans and may have to sell or license out significant portions of the Company's technology or potential products. YEAR 2000 COMPLIANCE The Company's plan to modify its information technology in recognition of the year 2000 issue has been successfully implemented. The "Year 2000" issue concerned potential exposure related to the interruption of business practice and financial misinformation resulting from the application of computer programs which have been written using two digits, rather than four, to define the applicable year of business transactions. Based on its assessments to date, the Company does not expect to incur any further significant costs, or anticipate any significant problems or uncertainties associated with remaining Year 2000 compliant. 28 ITEM 7. FINANCIAL STATEMENTS Filed herewith are the following Audited Financial Statements for Protein Polymer Technologies, Inc. (a Development Stage Company):
Description Page ----------- ---- Report of Ernst & Young LLP, Independent Auditors............................. F-2 Balance Sheets at December 31, 1999 and 1998.................................. F-3 Statements of Operations for the years ended December 31, 1999, 1998 and 1997 and the period July 6, 1988 (inception) to December 31, 1999...... F-4 Statements of Stockholders Equity for the period July 6, 1988 (inception) to December 31, 1999....................................................... F-5 Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997 and the period July 6, 1988 (inception) to December 31, 1999...... F-7 Notes to Financial Statements................................................. F-9
F-1 Report of Ernst & Young LLP, Independent Auditors The Board of Directors and Stockholders Protein Polymer Technologies, Inc. We have audited the accompanying balance sheets of Protein Polymer Technologies, Inc. (a Development Stage Company) as of December 31, 1999 and 1998, and the related statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1999 and for the period July 6, 1988 (inception) to December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Protein Polymer Technologies, Inc. (a Development Stage Company) at December 31, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999 and for the period July 6, 1988 (inception) to December 31, 1999 in conformity with accounting principles generally accepted in the United States. ERNST & YOUNG LLP San Diego, California February 29, 2000 F-2 Protein Polymer Technologies, Inc. (A Development Stage Company) Balance Sheets
DECEMBER 31, 1999 1998 -------------------------------- ASSETS Current assets: Cash and cash equivalents $ 155,692 $ 1,383,148 Other current assets 49,266 66,459 ------------------------------- Total current assets 204,958 1,449,607 Deposits 36,177 36,177 Notes receivable from officers 140,000 141,000 Equipment and leasehold improvements, net 360,005 598,447 ------------------------------- $ 741,140 $ 2,225,231 =============================== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 385,932 $ 515,413 Accrued employee benefits 84,335 167,849 Other accrued expenses 17,118 21,574 Current portion capital lease obligations 79,593 84,518 Deferred rent 95,973 60,668 ------------------------------- Total current liabilities 662,951 850,022 Long-term portion capital lease obligations 25,088 105,548 Stockholders' equity: Convertible Preferred Stock, $.01 par value, 188,917 shares authorized, 91,065 and 79,202 shares issued and outstanding at December 31, 1999 and 1998, respectively - liquidation preference of $9,106,500 and $7,480,200 at December 31, 1999 and December 31, 1998, respectively 8,761,072 7,600,226 Common stock, $.01 par value, 25,000,000 shares authorized, 13,443,510 and 10,827,240 shares issued and outstanding at December 31, 1999 and 1998, respectively 134,447 108,274 Additional paid-in capital 28,403,077 26,549,125 Deficit accumulated during development stage (37,245,495) (32,987,964) ------------------------------- Total stockholders' equity 53,101 1,269,661 ------------------------------- $ 741,140 $ 2,225,231 ===============================
See accompanying notes. F-3 Protein Polymer Technologies, Inc. (A Development Stage Company) Statements of Operations
FOR THE PERIOD JULY 6, 1988 (INCEPTION) TO YEARS ENDED DECEMBER 31, DECEMBER 31, 1999 1998 1997 1999 --------------------------------------------------------------- Revenues: Contract revenue $ 2,320 $ 50,000 $ 459,510 $ 4,357,285 Interest income, net 39,343 134,978 186,531 1,120,272 Product and other income 54,304 70,846 76,917 684,317 -------------------------------------------------------------- Total revenues 95,967 255,824 722,958 6,161,874 Expenses: Research and development 2,799,147 4,167,144 3,188,398 24,754,081 Selling, general and administrative 1,554,351 1,726,883 1,988,493 14,704,903 -------------------------------------------------------------- Total expenses 4,353,498 5,894,027 5,176,891 39,458,984 -------------------------------------------------------------- Net loss (4,257,531) (5,638,203) (4,453,933) (33,297,110) Undeclared and/or paid dividends on preferred stock 277,639 3,544,323 432,682 5,239,654 -------------------------------------------------------------- Net loss applicable to common shareholders $ (4,535,170) $ (9,182,526) $ (4,886,615) $ (38,536,764) ============================================================== Net loss per common share - basic and diluted $ (.36) $ (.88) $ (.52) ============================================= Shares used in computing net loss per common share - basic and diluted 12,570,987 10,484,277 9,487,165 =============================================
See accompanying notes. F-4 Protein Polymer Technologies, Inc. (A Development Stage Company) Statements of Stockholders' Equity For the period July 6, 1988 (inception) to December 31, 1999
COMMON STOCK PREFERRED STOCK SHARES AMOUNT SHARES AMOUNT ---------------------------------------------------- Issuance of common stock at $.01 per share for cash 400,000 $ 4,000 -- $ -- Issuance of common stock at $.62 per share for cash and receivables 1,116,245 11,162 -- -- Receivables from sale of common stock -- -- -- -- Net loss -- -- -- -- ---------------------------------------------------- Balance at December 31, 1988 1,516,245 15,162 -- -- Repayment of receivables from sale of common stock -- -- -- -- Issuance of common stock at $.62 per share 359,136 3,594 -- -- Net loss -- -- -- -- ---------------------------------------------------- Balance at December 31, 1989 1,875,381 18,756 -- -- Exercise of common stock options at $.01 per share for cash 60,000 600 -- -- Issuance of common stock at $.68 per share for cash and compensation 5,000 50 -- -- Common stock repurchased at $.01 per share for cash (25,000) (250) -- -- Common stock issued at $.68 per share for cash and compensation 25,000 250 -- -- Net loss -- -- -- -- ---------------------------------------------------- Balance at December 31, 1990 1,940,381 19,406 -- -- Exercise of common stock options at $.68 per share for cash 5,000 50 -- -- Exercise of warrants for common stock 483,755 4,837 -- -- Conversion of notes payable to common stock 339,230 3,391 -- -- Conversion of notes payable to preferred stock -- -- 278,326 2,783 Issuance of preferred stock at $2.00 per share for cash, net of issuance costs -- -- 400,000 4,000 Issuance of warrants for cash -- -- -- -- Issuance of warrants in connection with convertible notes payable -- -- -- -- Net loss -- -- -- -- --------------------------------------------------- Balance at December 31, 1991 2,768,366 27,684 678,326 6,783 Initial public offering at $6.50 per unit, net of issuance costs 1,667,500 16,676 -- -- Conversion of Series B preferred stock into common stock in connection with initial public offering 678,326 6,783 (6,783) -- Conversion of Series A preferred stock into common stock at 1.13342 per share 713,733 7,137 -- -- Net loss -- -- -- -- ---------------------------------------------------- Balance at December 31, 1992 5,827,925 58,280 -- -- Exercise of common stock options at $.68 per share 3,000 30 -- -- Net loss -- -- -- -- ---------------------------------------------------- Balance at December 31, 1993 5,830,925 58,310 -- -- Issuance of preferred stock at $100 per share for cash, net of issuance costs -- -- 21,600 2,073,925 Net loss -- -- -- -- ---------------------------------------------------- Balance at December 31, 1994 5,830,925 58,310 21,600 2,073,925 Issuance of preferred stock at $100 per share for cash and cancellation of bridge loan, net of issuance costs -- -- 25,000 2,432,150 Series C dividends paid in Series D preferred stock -- -- 2,539 253,875 Interest paid in Series D preferred stock -- -- 48 4,795 Exercise of common stock options at $.53 per share 2,000 20 -- -- Net loss -- -- -- -- ---------------------------------------------------- Balance at December 31, 1995 5,832,925 58,330 49,187 4,764,745 Exercise of common stock warrants at $1.25 per share 932,960 9,330 -- -- Exercise of common stock warrants at $2.50 per share, net of issuance costs 322,663 3,226 -- -- Exercise of common stock warrants at $1.00 per share 25,000 250 -- -- Exercise of common stock options 136,000 1,360 -- -- Stock repurchases (16,320) (163) -- -- Net loss -- -- -- -- ---------------------------------------------------- Balance at December 31, 1996 7,233,228 72,333 49,187 4,764,745 Issuance of common stock at $2.50 per share, net of issuance costs 1,904,000 19,040 -- -- Exercise of common stock options 28,000 280 -- -- Issuance of common stock under stock purchase plan 15,036 151 -- -- Conversion of Series D preferred stock into common stock 1,032,537 10,325 (20,973) (2,097,342) Series D dividends paid in common stock 207,921 2,079 -- -- Net loss -- -- -- -- ---------------------------------------------------- Balance at December 31, 1997 10,420,722 $ 104,208 28,214 $ 2,667,403 Issuance of common stock under stock purchase plan 36,715 368 -- -- Exercise of common stock options 12,000 120 -- -- Issuance of common stock at $1.60 per share, net of issuance costs 23,439 234 -- -- Issuance of Series E preferred stock, net of issuance costs -- -- 54,438 5,277,813 Grant of stock to finder 64,000 640 -- -- Conversion of Series D and E preferred stock into common stock 270,364 2,704 (3,450) (344,990) Net Loss -- -- -- -- ---------------------------------------------------- Balance at December 31, 1998 10,827,240 $ 108,274 79,202 $ 7,600,226 Issuance of common stock under stock purchase plan 19,429 194 -- -- Issuance of common stock and warrants for services rendered and debt issued 16,941 180 -- -- Issuance of Series G preferred stock, net of issuance costs -- -- 21,000 2,074,596 Conversion of Series E preferred stock into common stock 731,000 7,310 (9,138) (913,750) Exercise of common stock and Series E warrants at $.50 per share 1,848,900 18,489 -- -- Net Loss -- -- -- -- ---------------------------------------------------- Balance at December 31, 1999 13,443,510 $ 134,447 91,064 $ 8,761,072 ====================================================
F-5 Protein Polymer Technologies, Inc. (A Development Stage Company) Statements of Stockholders' Equity For the period July 6, 1988 (inception) to December 31, 1999
DEFICIT ACCUMULATED DURING RECEIVABLES TOTAL ADDITIONAL DEVELOPMENT FROM STOCKHOLDERS PAID-IN CAPITAL STAGE STOCK EQUITY ----------------------------------------------------- Issuance of common stock at $.01 per share for cash $ -- $ -- $ -- $ 4,000 Issuance of common stock at $.62 per share for cash and receivables 681,838 -- -- 693,000 Receivables from sale of common stock -- -- (86,000) (86,000) Net loss -- (322,702) -- (322,702) ---------------------------------------------------- Balance at December 31, 1988 681,838 (322,702) (86,000) 288,298 Repayment of receivables from sale of common stock -- -- 86,000 86,000 Issuance of common stock at $.62 per share 219,358 -- -- 222,952 Net loss -- (925,080) -- (925,080) ---------------------------------------------------- Balance at December 31, 1989 901,196 (1,247,782) -- (327,830) Exercise of common stock options at $.01 per share for cash -- -- -- 600 Issuance of common stock at $.68 per share for cash and compensation 3,350 -- -- 3,400 Common stock repurchased at $.01 per share for cash -- -- -- (250) Common stock issued at $.68 per share for cash and compensation 16,750 -- -- 17,000 Net loss -- (1,501,171) -- (1,501,171) ---------------------------------------------------- Balance at December 31, 1990 921,296 (2,748,953) -- (1,808,251) Exercise of common stock options at $.68 per share for cash 3,350 -- -- 3,400 Exercise of warrants for common stock 295,493 -- -- 300,330 Conversion of notes payable to common stock 508,414 -- -- 511,805 Conversion of notes payable to preferred stock 553,869 -- -- 556,652 Issuance of preferred stock at $2.00 per share for cash, net of issuance costs 703,475 -- -- 707,475 Issuance of warrants for cash 3,000 -- -- 3,000 Issuance of warrants in connection with convertible notes payable 28,000 -- -- 28,000 Net loss -- (1,143,119) -- (1,143,119) ---------------------------------------------------- Balance at December 31, 1991 3,016,897 (3,892,072) -- (840,708) Initial public offering at $6.50 per unit, net of issuance costs 8,911,024 -- -- 8,927,700 Conversion of Series B preferred stock into common stock in connection with initial public offering -- -- -- -- Conversion of Series A preferred stock into common stock at 1.13342 per share 1,717,065 -- -- 1,724,202 Net loss -- (3,481,659) -- (3,481,659) ---------------------------------------------------- Balance at December 31, 1992 13,644,986 (7,373,731) -- 6,329,535 Exercise of common stock options at $.68 per share 2,010 -- -- 2,040 Net loss -- (3,245,436) -- (3,245,436) ---------------------------------------------------- Balance at December 31, 1993 13,646,996 (10,619,167) -- 3,086,139 Issuance of preferred stock at $100 per share for cash, net of issuance costs -- -- -- 2,073,925 Net loss -- (3,245,359) -- (3,245,359) ---------------------------------------------------- Balance at December 31, 1994 13,646,996 (13,864,526) -- 1,914,705 Issuance of preferred stock at $100 per share for cash and cancellation of bridge loan, net of issuance costs -- -- -- 2,432,150 Series C dividends paid in Series D preferred stock -- (253,875) -- -- Interest paid in Series D preferred stock -- -- -- 4,795 Exercise of common stock options at $.53 per share 1,040 -- -- 1,060 Net loss -- (2,224,404) -- (2,224,404) ---------------------------------------------------- Balance at December 31, 1995 13,648,036 (16,342,805) -- 2,128,306 Exercise of common stock warrants at $1.25 per share $ 1,156,870 $ -- $ -- $ 1,166,200 Exercise of common stock warrants at $2.50 per share, net of issuance costs 779,413 -- -- 782,639 Exercise of common stock warrants at $1.00 per share 24,750 -- -- 25,000 Exercise of common stock options 91,650 -- -- 93,010 Stock repurchases (81,437) -- -- (81,600) Net loss -- (2,864,432) -- (2,864,432) ---------------------------------------------------- Balance at December 31, 1996 15,619,282 (19,207,237) -- 1,249,123 Issuance of common stock at $2.50 per share, net of issuance costs 4,601,322 -- -- 4,620,362 Exercise of common stock options 20,200 -- -- 20,480 Issuance of common stock under stock purchase plan 29,950 -- -- 30,101 Conversion of Series D preferred stock into common stock 2,087,017 -- -- -- Series D dividends paid in common stock 420,262 (422,341) -- -- Net loss -- (4,453,933) -- (4,453,933) ---------------------------------------------------- Balance at December 31, 1997 $ 22,778,033 $(24,083,511) $ -- $ 1,466,133 Issuance of common stock under stock purchase plan 38,010 -- -- 38,378 Exercise of common stock options 7,920 -- -- 8,040 Issuance of common stock at $1.60 per share, net of issuance costs 37,266 -- -- 37,500 Issuance of Series E preferred stock, net of issuance costs 3,266,250 (3,266,250) -- 5,277,813 Grant of stock to finder 79,360 -- -- 80,000 Conversion of Series D and E preferred stock into common stock 342,286 -- -- -- Net Loss -- (5,638,203) -- (5,638,203) ---------------------------------------------------- Balance at December 31, 1998 $ 26,549,125 $(32,987,964) $ -- $ 1,269,661 Issuance of common stock under stock purchase plan 15,111 -- -- 15,305 Issuance of common stock and warrants for services rendered and debt issued 26,440 -- -- 26,620 Issuance of Series G preferred stock, net of issuance costs -- -- -- 2,074,596 Conversion of Series E preferred stock into common stock 906,440 -- -- -- Exercise of common stock and Series E warrants at $.50 per share 905,961 -- -- 924,450 Net Loss -- (4,257,531) -- (4,257,531) ---------------------------------------------------- Balance at December 31, 1999 $ 28,403,077 $(37,245,495) $ -- $ 53,101 ====================================================
See accompanying notes F-6 Protein Polymer Technologies, Inc. (A Development Stage Company) Statements of Cash Flows
FOR THE PERIOD JULY 6, 1988 (INCEPTION) TO YEARS ENDED DECEMBER 31, DECEMBER 31, 1999 1998 1997 1999 ----------------------------------------------------------------------------- OPERATING ACTIVITIES Net loss $ (4,257,531) $ (5,638,203) $ (4,453,933) $ (33,303,029) Adjustments to reconcile net loss to net cash used for operating activities: Stock and warrants issued for services - - - - rendered and debt interest 26,620 80,000 - 131,515 Depreciation and amortization 264,541 368,577 184,300 1,892,838 Write-off of purchased technology - - - 503,500 Changes in assets and liabilities: Deposits - 440 (14,360) (36,177) Notes receivable from officers 1,000 12,000 (153,000) (140,000) Other current assets 17,193 22,409 (11,613) (49,266) Accounts payable (129,481) 91,819 172,273 385,932 Accrued employee benefits (83,514) 16,018 34,219 84,335 Other accrued expenses (4,456) (19,577) (12,374) 17,118 Deferred revenue - - (75,000) - Deferred rent 35,305 60,668 - 95,973 ----------------------------------------------------------------------------- Net cash used for operating activities (4,130,323) (5,005,849) (4,329,488) (30,417,261) INVESTING ACTIVITIES Purchase of technology - - - (570,000) Purchase of equipment and improvements (26,099) (197,460) (295,778) (1,810,814) Purchases of short-term investments - - (4,226,729) (16,161,667) Sales of short-term investments - 974,817 4,244,954 16,161,667 ----------------------------------------------------------------------------- Net cash provided by (used for) investing activities (26,099) 777,357 (277,553) (2,380,814) FINANCING ACTIVITIES Net proceeds from issuance of warrants and sale of common stock 939,755 83,918 4,670,943 17,537,666 Net proceeds from issuance of preferred stock 2,074,596 5,277,813 - 14,290,160 Net proceeds from convertible notes and detachable warrants - - - 1,068,457 Payments on capital lease obligations (85,385) (75,112) (23,594) (184,089) Payment on note payable (150,000) - - (242,750) Proceeds from note payable 150,000 - - 484,323 Deferred offering costs - - 17,356 - ----------------------------------------------------------------------------- Net cash provided by financing activities 2,928,966 5,286,619 4,664,705 32,953,767 Net increase (decrease) in cash and cash equivalents (1,227,456) 1,058,127 57,664 155,692 Cash and cash equivalents at beginning of the period 1,383,148 325,021 267,357 - ----------------------------------------------------------------------------- Cash and cash equivalents at end of the period $ 155,692 $ 1,383,148 $ 325,021 $ 155,692 =============================================================================
F-7 Protein Polymer Technologies, Inc. (A Development Stage Company) Statements of Cash Flows
JULY 6, 1988 (INCEPTION) TO YEARS ENDED DECEMBER 31, DECEMBER 31, 1999 1998 1997 1999 ----------------------------------------------------------------------------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Equipment purchased by capital leases $ - $ - $ 288,722 $ 288,772 Interest paid 19,983 26,692 7,763 117,911 Imputed dividend on Series E Stock - 3,266,250 - 3,266,250 Conversion of Series D preferred stock to common stock - 44,990 2,097,342 2,142,332 Conversion of Series E preferred stock to - - - - common stock 913,750 300,000 - 1,213,750 Series D stock issued for Series C Stock - - - 2,073,925 Series C dividends paid with Series D stock - - - 253,875 Series D dividends paid with common stock - - 422,341 422,341
See accompanying notes. F-8 Protein Polymer Technologies, Inc. (A Development Stage Company) Notes to Financial Statements December 31, 1999 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND BUSINESS ACTIVITIES Protein Polymer Technologies, Inc. (the "Company") was established to design, produce and market genetically engineered protein polymers for a variety of biomedical and specialty materials applications. The Company was incorporated in Delaware on July 6, 1988. For the period from its inception to date, the Company has been a development stage enterprise, and accordingly, the Company's operations have been directed primarily toward developing business strategies, raising capital, research and development activities, conducting clinical testing of its product candidates, exploring marketing channels and recruiting personnel. The Company operates in one segment. LIQUIDITY As of December 31, 1999, the Company had cash, cash equivalents and short-term investments totaling $156,000. In January and February 2000 the Company received approximately $1,350,000 in cash and receivables from licensing and R&D agreements with Femcare, Ltd. for the European and Australian marketing rights to the stress urinary incontinence bulking product, with Perkin-Elmer for a research and development project and commercialization option, and with Sanyo Chemical Industries, Ltd. for the marketing rights, manufacturing technology, and inventory for the in vitro cell culture business. Also in February 2000, the Company received approximately $2 million net of costs from the exercise of common stock warrants originally granted as part of the sale of Series G Convertible Preferred Stock. The Company believes its available cash, cash equivalents and short-term investments would be sufficient to meet its anticipated capital requirements through January 2001. Prior to the commercialization of its products, substantial additional capital resources will be required to fund continuing operations related to the Company's research, development, manufacturing, clinical testing, and business development activities. The Company believes there may be a number of alternatives available to meet the continuing capital requirements of its operations, such as collaborative agreements and public or private financings. During 2000, the Company expects that the possible exercise of existing warrants could result in additional funds for continuing operations. Further, the Company is currently in discussions with a number of potential collaborative partners and, based on the results of various materials evaluations, revenues in the form of license fees, milestone payments or research and development F-9 Protein Polymer Technologies, Inc. (A Development Stage Company) Notes to Financial Statements (continued) December 31, 1999 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (continued) reimbursements could be generated. There can be no assurance that any of these fundings will be consummated in the necessary time frames needed for continuing operations or on terms favorable to the Company. If adequate funds in the future are not available, the Company will be required to significantly curtail its operating plans and may have to sell or license out significant portions of the Company's technology or potential products. CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS Cash and cash equivalents consist of cash and highly liquid investments which include debt securities with remaining maturities of three months or less when acquired. Short-term investments consist primarily of commercial paper, notes and short-term U.S. Government securities with original maturities beyond three months and are stated at estimated fair value. Similar items with original maturities of three months or less are considered cash equivalents. The Company has established guidelines relative to diversification and maturities that maintain safety and liquidity. The Company has not experienced any losses on its short-term investments. EQUIPMENT AND LEASEHOLD IMPROVEMENTS Equipment and leasehold improvements are stated at cost, less accumulated depreciation and amortization. Equipment is depreciated over the estimated useful life of the asset, typically one to seven years, using the straight-line method. Leasehold improvements are amortized over the shorter of the lease term or life of the asset. Equipment and leasehold improvements consist of the following: DECEMBER 31, 1999 1998 -------------------------- Laboratory equipment $ 1,626,822 $ 1,600,723 Office equipment 175,128 175,128 Leasehold improvements 297,635 297,635 -------------------------- 2,099,585 2,073,486 Less accumulated depreciation and amortization (1,739,580) (1,475,039 -------------------------- $ 360,005 $ 598,447 ========================== F-10 Protein Polymer Technologies, Inc. (A Development Stage Company) Notes to Financial Statements (continued) December 31, 1999 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (continued) RESEARCH AND DEVELOPMENT REVENUES AND EXPENSES License fees and research and development contract revenues are recorded as earned based on the performance requirements of the contracts. If the research and development activities are not successful, the Company is not obligated to refund payments previously received. Milestone payments are recorded as revenue when received as they have not been refundable and the Company has no future performance obligations. Payments received in advance of amounts earned are recorded as deferred revenue. Research and development costs are expensed as incurred. PRODUCT REVENUE RECOGNITION Sales are recognized upon shipment of products to customers. IMPAIRMENT OF LONG-LIVED ASSETS In accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, if indicators of impairment exist, the Company assesses the recoverability of the affected long-lived assets by determining whether the carrying value of such assets can be recovered through undiscounted future operating cash flows. If impairment is indicated, the Company will value the asset at fair value. While the Company's current and historical operating and cash flow losses are indicators of impairment, the Company believes the future cash flows to be received from the long-lived assets will exceed the assets' carrying value, and accordingly the Company has not recognized any impairment losses through December 31, 1999. STOCK OPTIONS As permitted by SFAS No. 123, Accounting for Stock-Based Compensation, the Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, ("APB 25") and related Interpretations in accounting for its employee stock options. Under APB 25, if the exercise price of the Company's employee stock options equals or exceeds the fair value of the underlying stock on the date of grant, no compensation expense is recognized. Options issued to non-employees are recorded at their fair value and recognized over the related service period. The effects of using the fair value accounting method, as described in SFAS Statement No. 123 are described below in Note 2. F-11 Protein Polymer Technologies, Inc. (A Development Stage Company) Notes to Financial Statements (continued) December 31, 1999 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (continued) NET LOSS PER COMMON SHARE The Company reports its earnings per share in accordance with SFAS No. 128, Earnings per Share, which requires the presentation of both basic and diluted earnings per share on the statements of operations. Basic earnings per share is calculated based upon weighted-average number of outstanding common shares for the period. Diluted earnings per share is calculated based upon weighted-average number of outstanding common shares, plus the effect of dilutive stock options. The net loss per common share for the years ended December 31, 1999, 1998 and 1997 is based on the weighted average number of shares of common stock outstanding during the periods. Potentially dilutive securities including options, warrants and convertible preferred stock have not been included in the calculation of the net loss per common share as their effect is antidilutive. Consequently, there is no difference between the basic and dilutive net loss per common share for any of the periods presented and none of the prior periods were required to be restated. For purposes of this calculation, net loss in 1999, 1998 and 1997 has been adjusted for accumulated and/or paid dividends on the Preferred Stock. COMPREHENSIVE INCOME SFAS No. 130, Reporting Comprehensive Income, requires that the Company disclose, either in the income statement or in a separate financial statement, net income as currently reported and other components of comprehensive income. Comprehensive income is defined as the change in stockholders' equity during a period resulting from transactions and other events and circumstances from non-owner sources. For the years ended December 31, 1999, 1998 and 1997 the Company did not have any components of comprehensive income as defined in SFAS No. 130. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the amount of revenue and expense reported during the period. Actual results could differ from those estimates. F-12 Protein Polymer Technologies, Inc. (A Development Stage Company) Notes to Financial Statements (continued) December 31, 1999 2. STOCKHOLDERS' EQUITY CONVERTIBLE PREFERRED STOCK On August 16, 1999, the Company received $1,775,000 for 17,750 shares of Series G Preferred Stock from several institutional and accredited individual investors following the 10 day stockholder notification period required by the NASD prior to the sale. On September 15, 1999, the Company received an additional $325,000 for 3,250 shares of Series G Preferred Stock, for total proceeds of $2,100,000. Each share of Series G Convertible Preferred Stock was priced at $100 per share. Each share can be converted at any time by the holder into common stock at a price of $0.50 per share, subject to certain antidilution adjustments. Each share of Preferred Stock also receives a common stock warrant, exercisable for 12 months, that allows the holder to acquire 200 shares of PPTI common stock at a price of $0.50 per share. Between April 1 and April 15, 1999, the Company received approximately $508,000 from the exercise of redeemable, publicly traded, warrants to purchase common stock originally issued as part of PPTI's initial public offering. Following the close of business on April 15, the remaining unexercised redeemable, publicly traded, warrants expired. On May 12, 1999, the Company received approximately $416,000 from the exercise of warrants to purchase common stock issued in conjunction with the private placement of the Company's Series E Convertible Preferred Stock. In April and May of 1998, the Company raised approximately $5.4 million from the sale of 54,437 shares of the Company's Series E Convertible Preferred Stock ("Series E Stock") priced at $100 per share, with warrants to purchase an aggregate of 3,266,250 shares of common stock to a small group of institutional and accredited investors. In connection with this transaction, the Company recorded a non-cash "imputed dividend" expense of $3,266,250 in order to account for the difference between the fair market value of the common stock and the conversion price of the preferred stock into common stock. Each share of Series E Stock is convertible at any time at the election of the holder into 80 shares of common stock at a conversion price of $1.25 per share, subject to certain antidilution adjustments. This registration became effective on October 3, 1998. As of December 31, 1999, 11,650 shares of Series E Stock had been converted into 932,000 shares of the Company's common stock. F-13 Protein Polymer Technologies, Inc. (A Development Stage Company) Notes to Financial Statements (continued) December 31, 1999 2. STOCKHOLDERS' EQUITY (continued) Each share of Series E Stock received two common stock warrants. One warrant is exercisable at any time for 40 shares of common stock at an exercise price of $2.50 per share, and expires approximately 18 months after the close of the offering; the other warrant is exercisable at any time for 20 shares of common stock at an exercise price of $5.00 per share, and expires approximately 36 months after the close of the offering. In addition, an 18 month warrant to acquire 200,000 common shares exercisable at $2.50 per share and a 36 month warrant to acquire 100,000 common shares exercisable at $5.00 per share has been issued as a finder and document review fee paid to a lead investor. An 18 month warrant to acquire 32,000 common shares exercisable at $2.50 per share, a 24 month warrant to acquire 16,000 common shares exercisable at $5.00 per share, and 5 year warrants to acquire an aggregate of 25,200 common shares exercisable at $2.50 per share were issued to certain persons for service as finders in relation to the private placement. In connection with the above private placement, the Company issued 26,420 shares of its Series F Convertible Preferred Stock ("Series F Stock") in exchange for the same number of shares of outstanding Series D Convertible Preferred Stock ("Series D Stock"). Each share of Series D and F Stock earns a cumulative dividend at the annual rate of $10 per share, payable if and when declared by the Company's Board of Directors, in the form of cash, common stock or any combination thereof. The Series D and F Stock is convertible into common stock after two years from the date of issuance at the holder's option. The conversion price at the time of conversion is the lesser of $3.75 or the market price. The Series D and F Stock is redeemable at the Company's option after four years from the date of issuance. Automatic conversion of all of the Series D and F Stock will occur if: (a) the Company completes a public offering of common stock at a price of $2.50 or higher; or (b) the holders of a majority thereof elect to convert. The Company has the option to demand conversion of the Series D and F Stock if the average market price of its common stock equals or exceeds $5.00 per share over a period of twenty business days. The Series D and F Stock have preference in liquidation of $100 per share plus accumulated dividends. The Series E Stock is convertible, at the option of the holder, into shares of the Company's common stock, subject to anti-dilution adjustments, and has a preference in liquidation of $100 per share, but only after any preference is paid or declared set apart for the Series D Stock. Holders of the Series E Stock are entitled to receive dividends when and if declared by the Board of Directors; however, no such dividends will be declared or paid on the Series E Stock until the preferential cumulative dividends on the Series D and F Stock have been fully F-14 Protein Polymer Technologies, Inc. (A Development Stage Company) Notes to Financial Statements (continued) December 31, 1999 2. STOCKHOLDERS' EQUITY (continued) paid or declared and set apart. Automatic conversion of all Series E Stock will occur if: (a) the Company completes a public offering of common stock at a price of $7.50 or higher; or (b) the holders of more than 75% of outstanding Series E Stock elect to convert. The Series D, E and F Preferred Stock has been designated as non-voting stock. STOCK OPTION PLANS In September 1996 the Company established the Protein Polymer Technologies, Inc., Employee Stock Purchase Plan ("Plan"). The Plan commenced January 2, 1997, and allows for offering periods of up to two years with quarterly purchase dates occurring the last business day of each quarter. The purchase price per share is generally calculated at 85% of the lower of the fair market value on an eligible employee's entry date or the quarterly purchase date. The maximum number of shares available for issuance under the Plan is 500,000; an eligible employee may purchase up to 5,000 shares per quarter. The Plan Administrator consists of a committee of at least two non-employee directors of the Company. The Board may modify the Plan at any time. During 1999, a total of 19,429 shares were purchased under the Plan at prices ranging from $0.79 to $1.06. The value of shares issued under the Plan as calculated in accordance with Statement 123 is not significant and is not included in the following pro forma information. In June 1996, the Company adopted the 1996 Non-Employee Directors Stock Option Plan ("1996 Plan"), which provides for the granting of nonqualified options to purchase up to 250,000 shares of common stock to directors of the Company. Such grants of options to purchase 5,000 shares of common stock are awarded automatically on the first business day of June during each calendar year to every Participating Director then in office, subject to certain adjustments. No Participating Director is eligible to receive more than one grant per year. The purchase price of each option is set at the fair market value of the common stock on the date of grant. Each option has a duration of ten years, and is vested and exercisable six months after the grant date. The Board (or a designated committee of the Board) administers the 1996 Plan. At December 31, 1999, 130,000 options to purchase have been granted under the 1996 Plan. The Company adopted the 1992 Stock Option Plan which provides for the issuance of incentive and non-statutory stock options for the purchase of up to 1,500,000 shares of common stock to its key employees and certain other individuals. The options will expire F-15 Protein Polymer Technologies, Inc. (A Development Stage Company) Notes to Financial Statements (continued) December 31, 1999 2. STOCKHOLDERS' EQUITY (continued) ten years from their respective dates of grant. Options become exercisable ratably over periods of up to five years from the dates of grant. At December 31, 1999, options to purchase 527,000 shares of common stock were exercisable, and 212,000 shares were available for future grant. The Company adopted the 1989 Stock Option Plan which provided for the issuance of incentive and non-statutory stock options for the purchase of up to 500,000 shares of common stock to key employees and certain other individuals. The 1989 Stock Option Plan expired as of March 17, 1999. Options granted in the plan became exercisable ratably over periods of up to five years from the date of grant. At December 31, 1999, options for 365,000 shares were exercisable. Since inception, the Company has granted non-qualified options outside the option plans to employees, directors and consultants of the Company. At December 31, 1999, options for 130,000 shares were exercisable. The following table summarizes the Company's stock option activity:
Years ended December 31, ---------------------------------------------------------------------------- 1999 1998 1997 ---------------------- -------------------------- --------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price ------- ------- ------- ------- ------- ------- Outstanding - beginning of year 1,765,000 $1.51 1,540,600 $1.52 1,393,600 $1.38 Granted 548,500 $0.44 568,000 $0.99 190,000 $2.34 Exercised - - (12,000) ($0.67) (28,000) ($0.73) Forfeited/Expired (315,500) ($1.40) (331,600) ($0.83) (15,000) ($0.60) --------- ----- --------- ----- ------- ----- Outstanding - end of year 1,998,000 $1.23 1,765,000 $1.51 1,540,600 $1.52 ========= ===== ========= ===== ========= ===== Exercisable - end of year 1,152,000 $1.37 1,093,600 $1.36 916,600 $1.56 ========= ===== ========= ===== ========= =====
F-16 Protein Polymer Technologies, Inc. (A Development Stage Company) Notes to Financial Statements (continued) December 31, 1999 2. STOCKHOLDERS' EQUITY (continued) The exercise prices for options outstanding as of December 31, 1999 range from $0.22 to $0.84. The weighted average remaining contractual life of these options is approximately 7.20 years. STATEMENT 123 PRO FORMA INFORMATION Pro forma information regarding net loss is required by SFAS No. 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method prescribed by SFAS No. 123, using the Black-Scholes option pricing model. The fair value was estimated using the following weighted-average assumptions: a risk free interest rate of 5.50% for 1999, 6.00% for 1998 and 6.43% for 1997; a volatility factor of the expected market price of the Company's common stock of 100% for 1999, 89% for 1998 and 102% for 1997; expected option lives of 5 years for 1999, 5 years for 1998, and 8 years for 1997; and no dividend yields for all years. The Black-Scholes option valuation model was originally 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 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 is amortized to expense over the expected life of the options. The Company's pro forma information is as follows:
1999 1998 1997 ---- ---- ---- Net loss as reported $ (4,535,170) $ (9,182,526) $ (4,886,615) Net loss per share as reported (0.36) (0.88) (0.52) Net loss pro forma (4,772,359) (9,877,344) (5,188,511) Net loss per share pro forma (.38) (.94) (0.55) Weighted average fair value per share of options granted during the year $ 0.34 $ 0.87 $ 1.77
F-17 Protein Polymer Technologies, Inc. (A Development Stage Company) Notes to Financial Statements (continued) December 31, 1999 2. STOCKHOLDERS' EQUITY (continued) The pro forma effect on net loss for 1999, 1998 and 1997 is not representative of the pro forma effect on net loss in future years because it does not take into consideration pro forma compensation expense from option grants made prior to 1995. 3. STOCKHOLDER PROTECTION AGREEMENT In 1997, the Board of Directors of the Company adopted a Stockholder Protection Agreement ("Rights Plan") that distributes Rights to stockholders of record as of September 10, 1997. The Rights Plan contains provisions to protect stockholders in the event of an unsolicited attempt to acquire the Company. The Rights trade together with the common stock, and generally become exercisable ten business days after a person or group acquires or announces the intention to acquire 15% or more of the outstanding shares of the Company's common stock, with certain permitted exceptions. The Rights then generally allow the holder to acquire additional shares of the Company's capital stock at a discounted price. The issuance of the Rights is not a taxable event, does not affect the Company's reported earnings per share, and does not change the manner in which the Company's common stock is traded. 4. COMMITMENTS The Company leases its office and research facilities totaling 21,000 square feet under an operating lease, which expires in May 2005. The facilities lease is subject to an annual escalation provision based upon the Consumer Price Index. The lease provides for deferred rent payments; however, for financial purposes rent expense is recorded on a straight-line basis over the term of the lease. Accordingly, deferred rent in the accompanying balance sheet represents the difference between rent expense accrued and amounts paid under the lease agreement. F-18 Protein Polymer Technologies, Inc. (A Development Stage Company) Notes to Financial Statements (continued) December 31, 1999 4. COMMITMENTS (continued) Annual future minimum operating and capital lease payments are as follows:
Obligations Operating Under Year ending December 31, Leases Capital Leases ------------------------ --------------- --------------- 2000 $ 451,841 $ 87,228 2001 460,933 25,651 2002 461,782 - 2003 473,200 - 2004 487,396 - Thereafter 164,064 - --------------- --------------- Total minimum operating and capital lease payments $ 2,499,216 112,879 =============== Less amount representing interest (8,198) --------------- Present value of remaining minimum capital lease payments 104,681 Less amount due in one year (79,593) --------------- Long-term portion of obligations under capital leases $ 25,088 ===============
Cost and accumulated depreciation of equipment held under capital leases as of December 31, 1999 was $279,497 and $149,483, respectively. The carrying amount of the Company's obligations under its capital lease agreements approximate their fair value and the implicit interest rate approximates the Company's borrowing rate. Rent expense was approximately $417,000, $442,633, $412,000, and $3,637,633 for the years ended December 31, 1999, 1998 and 1997 and for the period July 6, 1988 (inception) through December 31, 1999, respectively. 5. INCOME TAXES At December 31, 1999, the Company had net operating loss carryforwards of approximately $30,589,000 for federal income tax purposes, which may be applied against future income, if any, and will begin expiring in 2004 unless previously utilized. In addition, F-19 Protein Polymer Technologies, Inc. (A Development Stage Company) Notes to Financial Statements (continued) December 31, 1999 5. INCOME TAXES (continued) the Company had California net operating loss carryforwards of approximately $12,249,000. The California tax loss carryforwards continue to expire. The difference between the tax loss carryforwards for federal and California purposes is attributable to the capitalization of research and development expenses for California tax purposes, the required 50% limitation in the utilization of California loss carryforwards, and the expiration of certain California tax loss carryforwards. The Company also has federal and California research and development tax credit carryforwards of approximately $1,043,000 and $478,000, respectively, which will begin expiring in 2004 unless previously utilized. As a result of an ownership change that occurred in January 1992, approximately $2,700,000 of the Company's federal net operating loss carryforwards will be subject to an annual limitation regarding utilization against taxable income in future periods. However, the Company believes that such limitations will not have a material impact upon the utilization of the carryforwards. Significant components of the Company's deferred tax assets as of December 31, 1999 are shown below. A valuation allowance of $12,867,000 has been recognized to offset the deferred tax assets as realization of such assets is uncertain. 1999 1998 ------------------------------- Deferred tax assets: Net operating loss carryforwards $ 11,410,000 $ 9,899,000 Research and development credits 1,354,000 1,122,000 Other, net 103,000 728,000 ------------------------------- Total deferred tax assets 12,867,000 11,749,000 Valuation allowance for deferred tax assets (12,867,000) (11,749,000) ------------------------------- Net deferred tax assets $ - $ - =============================== 6. EMPLOYEE BENEFITS PLAN On January 1, 1993, the Company established a 401(k) Savings Plan for substantially all employees who meet certain service and age requirements. Participants may elect to defer up to 20% of their compensation per year, subject to legislated annual limits. Each year the F-20 Protein Polymer Technologies, Inc. (A Development Stage Company) Notes to Financial Statements (continued) December 31, 1999 6. EMPLOYEE BENEFITS PLAN (continued) Company may provide a discretionary matching contribution. As of December 31, 1999, the Company had not made a contribution to the Savings Plan. 7. SUBSEQUENT EVENTS Between January 1 and February 29, 2000, the Company received approximately $3.5 million in cash and receivables from license and development agreements, the sale of the Company's cell culture business, and the exercise of common stock warrants. FEMCARE AGREEMENTS On January 26, 2000, PPTI and Femcare Ltd. ("Femcare"), headquartered in Nottingham, Great Britain, executed three related agreements involving the grant of a license to Femcare to register and market PPTI's urethral bulking agent for the treatment of female stress urinary incontinence in Europe and Australia. In addition to the License and Development Agreement, PPTI agreed in a separate Supply Agreement to provide final product to Femcare, and if unable to do so, agreed to make the manufacturing methods and materials available to Femcare as specified in a separate Escrow agreement. In addition to agreeing to purchase the final product from PPTI for a defined percentage of the revenues received by Femcare from the sale of the incontinence product, Femcare agreed to pay PPTI an upfront license fee of $1 million in two installments and agreed to pay PPTI a royalty on revenues received from the sale of the incontinence product. The agreements specify the performance benchmarks and timelines for each party, the definition of yearly minimum royalties and minimum product purchases, and the methods and procedures for determining product manufacturing requirements. The license grant from PPTI to Femcare is for the greater of 20 years or the date upon which the last patent included within the license grant for the territories covered expires, subject to meeting various sales requirements, and is exclusive in the territories covered, subject to certain conditions being maintained. The parties agreed to cooperate extensively in the clinical testing and the registration of the product with the appropriate governmental authorities. SALE OF IN VITRO CELL CULTURE BUSINESS TO SANYO CHEMICAL INDUSTRIES, LTD. -------- On February 18, 2000, PPTI and Sanyo Chemical Industries, Ltd. ("Sanyo"), of Kyoto, Japan, executed an agreement involving the grant of a royalty-free license to Sanyo for exclusive worldwide rights to make and sell ProNectin(R) F and ProNectin(R)L and derivative F-21 Protein Polymer Technologies, Inc. (A Development Stage Company) Notes to Financial Statements (continued) December 31, 1999 7. SUBSEQUENT EVENTS (continued) products for in vitro cell culture and related applications. PPTI will receive -------- from Sanyo $355,000 (less associated expenses) for the license, including assignment of the ProNectin(R) and SmartPlastic(R) trademarks and transfer of remaining product inventory. The agreement remains in effect until the last patent included within the license grant expires. EXERCISE AND EXCHANGE OF SERIES G WARRANTS During February 2000, holders of warrants issued in connection with the sale of Series G Preferred Stock exercised their warrants to purchase common stock which were due to expire in September, 2000. The exercise price was $0.50 per share. As an inducement to exercise the warrant early, the Company offered each holder a new one year warrant for a similar number of shares at an exercise price of $1.50 per share. As a result the Company raised $2.1 million (less offering expenses). The newly issued warrants will expire on the last day of February 2001. F-22 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III Items 9, 10, 11 and 12 are incorporated by reference from the Company's definitive Proxy Statement to be filed by the Company with the Commission no later than April 7, 2000. ITEM 13. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K (a)(1) and (2) Financial Statements and Schedules The Financial Statements are incorporated herein as a part of Item 7. (a)(3) Exhibits The following documents are included or incorporated by reference: Exhibit Number Description ------ ----------- 3.1 (6) Certificate of Incorporation of the Company, as amended. 3.1.1 (13) Certificate of Designation of Series E Convertible Preferred Stock. 3.1.2 (13) Certificate of Designation of Series F Convertible Preferred Stock. 3.1.3 (14) Certificate of Designation of Series G Convertible Preferred Stock. 3.2 (6) Bylaws of the Company, as amended. 10.1 (1) 1989 Stock Option Plan, together with forms of Incentive Stock Option Agreement and Nonstatutory Option Agreement. 10.2 (4) 1992 Stock Option Plan of the Company, together with forms of Incentive Stock Option Agreement and Nonstatutory Option Agreement. 29 10.3 (1) Form of Employee's Proprietary Information and Inventions Agreement. 10.4 (1) Form of Consulting Agreement. 10.5 (1) Form of Indemnification Agreement. 10.6 (4) License Agreement, dated as of April 15, 1992, between the Board of Trustees of the Leland Stanford Junior University and the Company. 10.7 (6) Amended and Restated Registration Rights Agreement dated September 14, 1995, among the Company and the holders of its Series D Preferred Stock. 10.8 (6) Securities Purchase Agreement related to the sale of the Company's Series D Preferred Stock. 10.9 (7) Letter Agreement dated as of October 4, 1996 between the Company and MBF I, LLC ("MBF") relating to the provision of consulting and advisory services. 10.10 (7) Form of Warrant with respect to a warrant for 50,000 shares issued to MBF, and to be used with respect to additional warrants which may be issued to MBF. 10.11 (7) Registration Rights Agreement dated as of October 4, 1996 between the Company and MBF. 10.12 (7) Securities Purchase Agreement dated as of January 6, 1997 among the Company and the investors named therein relating to the sale and purchase of 1,904,000 shares of the Company's common stock. 10.13 (8) Lease, with exhibits, dated March 1, 1996 between the Company and Sycamore/San Diego Investors. 10.14 (8) Second Amendment to Lease between the Company and Sycamore/San Diego Investors, dated March 1, 1996. 10.15 (8) 1996 Non-Employee Directors' Stock Option Plan. 30 10.16 (9) Stockholder Protection Agreement, dated August 22, 1997, between the Company and Continental Stock Transfer & Trust Company as rights agent. 10.17 (10) Employee Stock Purchase Plan, together with Form of Stock Purchase Agreement. 10.18 (11) Lease, with rider and exhibits, dated April 13, 1998, between the Company and Sycamore/San Diego Investors 10.19 (12) First Amendment to Stockholder Protection Agreement dated April 24, 1998, between the Company and Continental Stock Transfer & Trust Company as rights agent. 10.20 (13) Securities Purchase Agreement related to the sale of the Company's Series E Convertible Preferred Stock dated as of April 13, 1998 among the Company and Investors named therein related to the purchase of 54,437.50 shares of Series E Preferred Stock. 10.21 (13) Form of First Warrants to purchase Common Stock related to the sale of the Company's Series E Preferred Stock. 10.22 (13) Form of Second Warrants to purchase Common Stock related to the sale of the Company's Series E Preferred Stock. 10.23 (13) Letter of Agreement dated April 13, 1998 between the Company and Johnson & Johnson Development Corporation for the exchange of up to 27,317 shares of Series D Preferred Stock for a like number of shares of Series F Preferred Stock. 10.24 (14) Securities Purchase Agreement related to the sale of the Company's Series G Convertible Preferred Stock 10.25 (14) Form of Warrant to Purchase Common Stock issued in connection with the Series G Preferred Stock 10.26 (14) Second Amendment to Stockholder Protection Agreement, dated July 26, 1999 between the Company and Continental Stock Transfer and Trust Company as rights agent 10.27 License and Development Agreement dated as of January 26, 2000 between the Company and Prospectivepiercing Limited, to be known as Femcare Urology Limited. 31 10.28 Supply Agreement dated as of January 26, 2000 between the Company and Femcare Urology Limited. 10.29 Escrow Agreement dated as of January 26, 2000 between the Company and Femcare Urology Limited. 10.30 Employment Agreement, dated as of February 17, 2000, between the Company and J. Thomas Parmeter. 10.31 Employment Agreement, dated as of February 17, 2000, between the Company and John E. Flowers. 10.32 Employment Agreement, dated as of February 17, 2000, between the Company and Joseph Cappello. 10.33 Employment Agreement, dated as of February 17, 2000, between the Company and Franco A. Ferrari. 10.34 License Agreement dated as of February 18, 2000 between the Company and Sanyo Chemical Industries, Ltd. 23.1 Consent of Ernst & Young LLP, Independent Auditors 27 Financial Data Schedule 32 (1) Incorporated by reference to the Company's Registration Statement on Form S-1 (No. 33-43875) filed with the Commission on November 12, 1991, as amended by Amendments Nos. 1, 2, 3 and 4 thereto filed on November 25, 1991, December 23, 1991, January 17, 1992 and January 21, 1992, respectively. (2) Incorporated by reference to Registrant's Report on Form 10-Q for the quarter ended March 31, 1992, as filed with the Commission on May 14, 1992. (3) Incorporated by reference to Registrant's Report on Form 10-Q for the quarter ended September 30, 1992, as filed with the Commission on November 13, 1992. (4) Incorporated by reference to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992, as filed with the Commission on March 31, 1993. (5) Incorporated by reference to Registrant's Report on Form 10-KSB for the fiscal year ended December 31, 1994, as filed with the Commission on March 30, 1995. (6) Incorporated by reference to Registrant's Report on Form 10-Q for the quarter ended September 30, 1995, as filed with the Commission on October 24, 1995. (7) Incorporated by reference to Registrant's current Report on Form 8-K, as filed with the Commission on January 7, 1997. (8) Incorporated by reference to Registrant's Report on Form 10-KSB for the fiscal year ended December 31, 1996, as filed with the Commission on March 27, 1997. (9) Incorporated by reference to Registrant's Current Report on Form 8-K, as filed with the Commission on August 27, 1997. (10) Incorporated by reference to Registrant's Report on Form 10-KSB for the fiscal year ended December 31, 1997, as filed with the Commission on April 9, 1998. (11) Incorporated by reference to Registrant's Report on Form 10-Q for the quarter ended March 31, 1998, as filed with the Commission on May 14, 1998. (12) Incorporated by reference to Registrant's Report on Form 10-Q for the quarter ended June 30, 1998, as filed with the Commission on August 13, 1998. (13) Incorporated by reference to Registrant's Report on Form 10-KSB for the fiscal year ended December 31, 1998, as filed with the Commission on April 9, 1999. (14) Incorporated by reference to Registrant's Report on Form 10-Q for the quarter ended September 30, 1999, as filed with the Commission on November 1, 1999. 33 (b) Reports on Form 8-K. On August 17, 1999, the Company filed a Current Report on Form 8-K with the Commission. In Item 5 of the report, the Company reported an initial private placement of 17,750 shares of the Company's Series G Convertible Preferred Stock, and warrants to purchase an aggregate of 3,550,000 shares of common stock. On September 20, 1999, the Company filed a Current Report on Form 8-K with the Commission. In Item 5 of the report, the Company reported the delisting of the Company's common stock from the NASDAQ Small Cap Market. The Company also reported a subsequent closing of a private placement of the Company's Series G Convertible Preferred Stock which, including the previous closing, was for a total of 21,000 shares and warrants to purchase an aggregate of 4,200,000 shares of common stock. On January 27, 2000, the Company filed a Current Report on Form 8-K with the Commission. In Item 5 of the Report, the Company reported the establishment of a strategic partnership with Femcare, Ltd., including the execution of a License and Development Agreement, a Supply Agreement, and an Escrow Agreement which in combination granted Femcare Ltd. the exclusive right to commercialize the Company's urethral bulking agents in Europe and Australia. 34 SIGNATURE In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PROTEIN POLYMER TECHNOLOGIES, INC. March 23, 2000 By /S/ J. THOMAS PARMETER ----------------------- J. Thomas Parmeter Chairman of the Board, Chief Executive Officer, President In accordance with the Exchange Act, 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 Capacity Date - --------- -------- ---- /S/ J. THOMAS PARMETER Chairman of the Board, Chief March 23, 2000 - ----------------------- Executive Officer, President J. Thomas Parmeter /S/ JANIS Y. NEVES Director of Finance, Controller, March 23, 2000 - ------------------- and Assistant Secretary Janis Y. Neves /S/ RICHARD ADELSON Director March 23, 2000 - -------------------- Richard Adelson /S/ PATRICIA J. CORNELL Director March 23, 2000 - ------------------------ Patricia J. Cornell /S/ EDWARD E. DAVID Director March 23, 2000 - -------------------- Edward E. David /S/ PHILIP J. DAVIS Director March 23, 2000 - -------------------- Philip J. Davis /S/ PATRICK A. GERSCHEL Director March 23, 2000 - ------------------------ Patrick A. Gerschel
35
Signature Capacity Date - --------- -------- ---- /S/ EDWARD J. HARTNETT Director March 23, 2000 - ----------------------- Edward J. Hartnett /S/ J. PAUL JONES Director March 23, 2000 - ------------------ J. Paul Jones /S/ GEORGE R. WALKER Director March 23, 2000 - --------------------- George R. Walker
36 EX-13.2 4 FORM 10-QSB FOR YEAR ENDED 3/31/2000 EXHIBIT 13.2 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2000 [_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________________ to ____________________ Commission file number 0-19724 PROTEIN POLYMER TECHNOLOGIES, INC. (Exact name of small business issuer as specified in its charter) Delaware 33-0311631 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 10655 Sorrento Valley Road, San Diego, CA 92121 (Address of principal executive offices) (858) 558-6064 (Issuer's telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: As of May 12, 2000, 18,379,010 shares of common stock were outstanding. Transitional Small Business Disclosure Format (check one): Yes [_] No [X] ================================================================================ PROTEIN POLYMER TECHNOLOGIES, INC. FORM 10-QSB INDEX
Page No. -------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements (unaudited) Condensed Balance Sheets - March 31, 2000 and December 31, 1999................................................ 3 Condensed Statements of Operations - For the Three Months ended March 31, 2000 and 1999 and the period July 6, 1988 (inception) to March 31, 2000.......................................... 4 Condensed Statements of Cash Flows - For the Three Months ended March 31, 2000 and 1999 and the period July 6, 1988 (inception) to March 31, 2000.......................................... 5 Notes to Condensed Financial Statements............................................... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................................................ 9 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K...................................................... 14 Signature ............................................................................ 15
2 PROTEIN POLYMER TECHNOLOGIES, INC. (A Development Stage Company) Condensed Balance Sheets
March 31, December 31, 2000 1999 ------------ ------------ (Unaudited) ASSETS Current assets: Cash and cash equivalents ................................................ $ 2,153,893 $ 155,692 Accounts Receivable ...................................................... 574,869 -- Other current assets ..................................................... 19,490 49,266 ------------ ------------ Total current assets ........................................................ 2,748,252 204,958 Deposits ................................................................. 36,177 36,177 Notes receivable from officers ........................................... 140,000 140,000 Equipment and leasehold improvements, net ................................ 339,992 360,005 ------------ ------------ $ 3,264,421 $ 741,140 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ......................................................... $ 290,042 $ 385,932 Accrued employee benefits ................................................ 60,642 84,335 Other accrued expenses ................................................... 61,778 17,118 Current portion capital lease obligations ................................ 80,493 79,593 Current portion deferred revenue ......................................... 250,000 -- Deferred rent ............................................................ 102,753 95,973 ------------ ------------ 845,708 662,951 Long-term portion deferred revenue .......................................... 666,667 -- Long-term portion capital lease obligations ................................. 4,117 25,088 Stockholders' equity: Convertible Preferred Stock, $.01 par value, 5,000,000 shares authorized, 84,077 and 91,065 shares issued and outstanding at March 31, 2000 and December 31, 1999, respectively; liquidation preference - $8,407,700 8,062,272 8,761,072 Common stock, $.01 par value, 40,000,000 shares authorized, 18,286,510 and 13,443,510 shares issued and outstanding at March 31, 2000 and December 31, 1999, respectively ................................................. 182,877 134,447 Additional paid-in capital ............................................... 31,226,747 28,403,077 Deficit accumulated during development stage ............................. (37,723,967) (37,245,495) ------------ ------------ Total stockholders' equity ............................................... 1,747,929 53,101 ------------ ------------ $ 3,264,421 $ 741,140 ============ ============
See accompanying notes. 3 PROTEIN POLYMER TECHNOLOGIES, INC. (A Development Stage Company) Condensed Statements of Operations (unaudited)
For the Period July 6, 1988 Three Months Ended (Inception) March 31, to March 31, 2000 1999 2000 ------------ ------------ ------------ Revenues: Contract and licensing revenue .................. 386,574 $ -- $ 4,743,859 Interest income ................................. 13,809 13,002 1,134,081 Product and other income ........................ 2,866 22,649 687,184 ------------ ------------ ------------ Total revenues ..................................... 403,249 35,651 6,565,124 Expenses: Research and development ........................ 554,187 714,132 25,308,268 Selling, general and administrative ............. 327,532 427,619 15,032,435 ------------ ------------ ------------ Total expenses ..................................... 881,719 1,141,751 40,340,703 ------------ ------------ ------------ Net loss ........................................... (478,470) (1,106,100) (33,775,579) Undeclared dividends on preferred stock ............ 69,220 68,459 5,308,874 ------------ ------------ ------------ Net loss applicable to common shareholders ......... $ (547,690) $ (1,174,559) $(39,084,453) ============ ============ ============ Net loss per common share - basic and diluted ...... $ (0.04) $ (0.11) ============ ============ Shares used in computing net loss per common share - basic and diluted ............................... 15,320,744 10,940,748 ============ ============
See accompanying notes. 4 PROTEIN POLYMER TECHNOLOGIES, INC. (A Development Stage Company) Condensed Statements of Cash Flows (unaudited)
For the Period July 6, 1988 Three Months Ended (Inception) March 31, to March 31, 2000 1999 2000 ------------ ------------ ------------ OPERATING ACTIVITIES Net loss ............................................. $ (478,470) $ (1,106,100) $(33,781,499) Adjustments to reconcile net loss to net cash used for operating activities: Stock issued for compensation and interest ...... -- 18,000 131,515 Depreciation and amortization ................... 43,963 84,592 1,936,800 Write-off of purchased technology ............... -- -- 503,500 Deferred revenue .............................. 916,667 -- 916,667 Deferred rent ................................. 6,780 -- 102,753 Changes in assets and liabilities: Deposits ...................................... -- (800) (36,177) Notes receivable from officers ................ -- 1,000 (140,000) Other current assets .......................... (545,093) (10,519) (594,359) Accounts payable .............................. (95,890) (45,902) 290,042 Accrued employee benefits ..................... (23,693) 11,032 60,642 Other accrued expenses ........................ 44,660 4,378 61,778 ------------ ------------ ------------ Net cash used for operating activities .............. (131,076) (1,044,319) (30,548,338) INVESTING ACTIVITIES Purchase of technology ............................... -- -- (570,000) Purchase of equipment and improvements ............... (23,951) (22,282) (1,834,765) Purchases of short-term investments .................. -- -- (16,161,667) Sales of short-term investments ...................... -- -- 16,161,667 ------------ ------------ ------------ Net cash provided by (used for) investing activities.. $ (23,951) $ (22,282) $ (2,404,765) ------------ ------------ ------------
5 PROTEIN POLYMER TECHNOLOGIES, INC. (A Development Stage Company) Condensed Statements of Cash Flows, continued (unaudited)
For the Period July 6, 1988 Three Months Ended (Inception) March 31, to March 31, 2000 1999 2000 ------------ ------------ ------------ FINANCING ACTIVITIES Net proceeds from exercise of options and warrants, and sale of common stock ........................ $ 2,173,299 $ 8,770 $ 19,710,966 Net proceeds from issuance of preferred stock....... -- -- 14,290,160 Net proceeds from convertible notes and detachable warrants ............................. -- -- 1,068,457 Payments on capital lease obligations .............. (20,071) (20,204) (204,160) Payment on note payable ............................ -- -- (242,750) Proceeds from note payable ......................... -- -- 484,323 ------------ ------------ ------------ Net cash provided by (used for) financing activities 2,153,228 (11,434) 35,106,996 ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents 1,998,201 (1,078,035) 2,153,893 Cash and cash equivalents at beginning of period.... 155,692 1,383,148 -- ------------ ------------ ------------ Cash and cash equivalents at end of period ......... $ 2,153,893 $ 305,113 $ 2,153,893 ============ ============ ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Equipment purchased by capital leases .............. $ -- $ -- $ 288,772 Interest paid ...................................... 2,731 5,270 120,642 Conversion of Series E preferred stock to common stock ................................. 698,800 200,000 1,912,550 Series D stock issued for Series C stock ........... -- -- 2,073,925 Series C dividends paid with Series D stock ........ -- -- 253,875 Series D dividends paid with common stock .......... $ -- $ -- $ 422,341
See accompanying notes. 6 PROTEIN POLYMER TECHNOLOGIES, INC. (A Development Stage Company) Notes to Condensed Financial Statements (unaudited) March 31, 2000 1. BASIS OF PRESENTATION The condensed financial statements of Protein Polymer Technologies, Inc. (the "Company") for the three months ended March 31, 2000 and 1999 are unaudited. These financial statements reflect all adjustments, consisting of only normal recurring adjustments which, in the opinion of management, are necessary to state fairly the financial position at March 31, 2000 and the results of operations for the three months ended March 31, 2000 and 1999. The results of operations for the three months ended March 31, 2000 are not necessarily indicative of the results to be expected for the year ended December 31, 2000. For more complete financial information, these financial statements and the notes thereto should be read in conjunction with the audited financial statements included in the Company's Annual Report on Form 10-KSB for the year ended December 31, 1999, filed with the Securities and Exchange Commission. 2. NET LOSS PER SHARE Net loss per share is computed using the weighted average number of common shares outstanding during the period. The loss figures used for this calculation recognize accumulated dividends on the Company's Series D and Series F Preferred Stock. Such dividends are payable when declared by the Board of Directors in cash or common stock. 3. BASIC AND DILUTED LOSS PER SHARE In accordance with FAS No. 128, the Company is required to present basic and diluted earnings per share if applicable. Basic and diluted earnings per share are determined based on the weighted average number of shares outstanding during the period. Diluted earnings per share also includes potentially dilutive securities such as options and warrants outstanding and securities convertible into common stock. Both the basic and diluted loss per share for the three months ended March 31, 2000 and 1999 are based on the weighted average number of shares of common stock outstanding during the periods. Since potentially dilutive securities have not been included in the calculation of the diluted loss per share for both periods as their affect is antidilutive, there is no difference between the basic and diluted loss per share calculations. 4. REVENUE AND EXPENSE RECOGNITION License fees and research and development contract revenues are recorded as earned based on the performance requirements of the contracts. If the research and development activities are not successful, the Company is not obligated to refund payments previously received. Milestone payments are recorded as revenue when received as they have not been refundable and the Company has no future performance obligations. Payments received in advance of amounts earned are recorded as deferred revenue. Research and development costs are expensed as incurred. 7 PROTEIN POLYMER TECHNOLOGIES, INC. (A Development Stage Company) Notes to Condensed Financial Statements (unaudited) 5. NOTE RECEIVABLE WITH OFFICER A loan for $140,000, secured by a pledge of stock, was made to an officer of the Company on April 16, 1997, solely to meet tax obligations arising from the exercise of a stock option. Interest accrues at the annual rate of 8% on the unpaid principal balance. In July 1999, the loan term was extended until April 2005. 6. EXERCISE AND EXCHANGE OF SERIES G WARRANTS During February 2000, holders of warrants issued in connection with the sale of Series G Preferred Stock exercised their warrants to purchase common stock which were due to expire in September, 2000. The exercise price was $0.50 per share. As an inducement to exercise the warrant early, the Company offered each holder a new one year warrant for a similar number of shares at an exercise price of $1.50 per share. As a result the Company raised $2.1 million (less expenses). The newly issued warrants will expire on the last day of February 2001. 7. FEMCARE AGREEMENTS On January 26, 2000, PPTI and Femcare Ltd. ("Femcare"), headquartered in Nottingham, Great Britain, executed three related agreements involving the grant of a license to Femcare to register and market PPTI's urethral bulking agent for the treatment of female stress urinary incontinence in Europe and Australia. In addition to the License and Development Agreement, PPTI agreed in a separate Supply Agreement to provide final product to Femcare, and if unable to do so, agreed to make the manufacturing methods and materials available to Femcare as specified in a separate Escrow agreement. In addition to agreeing to purchase the final product from PPTI for a defined percentage of the revenues received by Femcare from the sale of the incontinence product, Femcare agreed to pay PPTI an up front license fee of $1 million in two installments and agreed to pay PPTI a royalty on revenues received from the sale of the incontinence product. The agreements specify the performance benchmarks and timelines for each party, the definition of yearly minimum royalties and minimum product purchases, and the methods and procedures for determining product manufacturing requirements. The license grant from PPTI to Femcare is for the greater of 20 years or the date upon which the last patent included within the license grant for the territories covered expires, subject to meeting various sales requirements, and is exclusive in the territories covered, subject to certain conditions being maintained. The parties agreed to cooperate extensively in the clinical testing and the registration of the product with the appropriate governmental authorities. These activities are scheduled to take place over a period of approximately three years. Accordingly, the Company has recorded the $1 million up front payment as deferred revenue, and is recognizing it as license revenue ratably over a period of three years. In the period ended March 31, 2000, the Company recognized $83,334 of revenue related to this agreement. 8. SALE OF IN VITRO CELL CULTURE BUSINESS TO SANYO CHEMICAL INDUSTRIES, LTD. -------- On February 18, 2000, PPTI and Sanyo Chemical Industries, Ltd. ("Sanyo") of Kyoto, Japan, executed an agreement involving the grant of a royalty-free license to Sanyo for exclusive worldwide rights to make and sell ProNectin(R) F and ProNectin(R) L and derivative products for in vitro cell culture and related applications. PPTI received net proceeds of $284,000 from Sanyo for the issuance of the license, including assignment of the ProNectin(R) and SmartPlastic(R) trademarks and transfer of remaining product inventory. The agreement remains in effect until the last patent included within the license grant expires. 9. LIQUIDITY The Company believes its existing available cash and cash equivalents as of March 31, 2000, plus contractual amounts receivable, is sufficient to meet its anticipated capital requirements until January 2001. Substantial additional capital resources will be required to fund continuing expenditures related to the Company's research, development, clinical trials, and product marketing activities. If adequate funds are not available, the Company will be required to significantly curtail its operating plans and may have to sell or license out significant portions of the Company's technology or potential products. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS CERTAIN STATEMENTS CONTAINED OR INCORPORATED BY REFERENCE IN THIS QUARTERLY REPORT ON FORM 10-QSB CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. SUCH FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS WHICH MAY CAUSE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE COMPANY, OR INDUSTRY RESULTS, TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY FORWARD-LOOKING STATEMENTS. SUCH RISKS AND UNCERTAINTIES INCLUDE, AMONG OTHERS, HISTORY OF OPERATING LOSSES, RAISING ADEQUATE CAPITAL FOR CONTINUING OPERATIONS, EARLY STAGE OF PRODUCT DEVELOPMENT, SCIENTIFIC AND TECHNICAL UNCERTAINTIES, COMPETITIVE PRODUCTS AND APPROACHES, RELIANCE UPON COLLABORATIVE PARTNERSHIP AGREEMENTS AND FUNDING, REGULATORY TESTING AND APPROVALS, PATENT PROTECTION UNCERTAINTIES AND MANUFACTURING SCALE-UP AND REQUIRED QUALIFICATIONS. WHILE THESE STATEMENTS REPRESENT MANAGEMENT'S CURRENT JUDGMENT AND EXPECTATIONS FOR THE COMPANY, SUCH RISKS AND UNCERTAINTIES COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM ANY FUTURE RESULTS SUGGESTED HEREIN. THE COMPANY UNDERTAKES NO OBLIGATION TO RELEASE PUBLICLY THE RESULTS OF ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES ARISING AFTER THE DATE HEREOF. GENERAL OVERVIEW Incorporated in 1988, Protein Polymer Technologies, Inc. has concentrated its research and development efforts on establishing a scientific and technical leadership position in the production and development of unique protein-based materials. The Company has identified biomedical market and product opportunities for further research and development that management believes will exploit the unique properties of the Company's technology to competitive advantage. The Company has been unprofitable to date, and as of March 31, 2000 has an accumulated deficit of $37,723,967. The Company's product candidates for surgical repair, augmentation and regeneration of human tissues are in various stages of research and development. Its more advanced programs are in the areas of bulking agents for soft tissue augmentation, particularly for use in urethral tissue for the treatment of female stress incontinence and in dermal tissue for cosmetic and reconstructive procedures. The Company currently is devoting the majority of its resources to the development and registration of these products, with the greatest emphasis on the incontinence product. In December 1999, the Company initiated human clinical testing of its urethral bulking agent for the treatment of female stress urinary incontinence. The August 1999 approval by the U.S. Food and Drug Administration ("FDA") of the Company's Investigational Device Exemption ("IDE") 9 allows PPTI to test the safety and effectiveness of the incontinence product in women over the age of 40 who have become incontinent due to the shifting of their bladder or the weakening of the muscle at its base that controls the flow of urine, or both problems combined. The Company estimates that more than 2.5 million women begin to experience stress urinary incontinence in the United States each year. In most untreated cases, the problem becomes progressively more pronounced. Due to limited efficacy or invasiveness of current treatments, only a small proportion of the women experiencing stress urinary incontinence are clinically treated, relying instead on pads and plugs and the like that only address the symptoms. In contrast, PPTI's product is injected, typically in an outpatient procedure, into urethral tissue at the base of the bladder forming a solid implant that provides support to the muscles controlling the flow of urine. The Company believes that its product will prove to be easy for the physician to use, offer enduring effectiveness, and avoid most of the other limitations of urethral bulking products on the market or in development. In January 2000, PPTI established a strategic alliance with Femcare, Ltd. for the commercialization of the incontinence product in Europe and Australia. In the agreement, Femcare is responsible for clinical testing, regulatory approval, and product sales and marketing within these territories, and PPTI is responsible for product manufacturing. Contingent on successful clinical trials commercialization of the product in Europe is expected to begin more than a year before approval for marketing the product in the United States can be obtained. See also "Femcare Agreements" in the Notes to the Financial Statements. PPTI also is in discussions with several companies regarding the establishment of strategic alliances for commercializing the incontinence product in the United States and other markets outside the Femcare territories. The tissue augmentation materials and technology underlying the incontinence product have the potential to be effective and desirable in a number of other clinical applications. Assuming additional financial resources are available, the Company intends to submit an additional IDE to the FDA in 2000 to obtain approval to begin human clinical testing of its dermal bulking agent for use in cosmetic and reconstructive surgery applications. PPTI began studies to identify its most promising biomaterial formulations for use in these soft tissue augmentation products in 1996, devoted increasing resources through 1997, 1998 and 1999, and at present is focused primarily on completing human clinical testing of the incontinence product. The Company's first commercial products, ProNectin F and SmartPlastic, are used by biologists and cell culture laboratories, principally to grow mammalian cells for biomedical research purposes. In February 2000, the Company licensed the rights for the manufacture and sale of these products for use in in vitro cell culture, including the transfer of all existing inventory, to a third party. See also "Sale of In Vitro Cell Culture Business to Sanyo Chemical Industries, Ltd." in the Notes to the Financial Statements. The Company's other advanced product technology is in the area of tissue adhesives and sealants. Currently the Company's research and development in this area is focused on the repair of spinal discs for the treatment of lower back pain. The Company's strategy with most of its programs is to enter into collaborative development agreements with major medical product marketing and distribution companies. Although these relationships, to the extent any are consummated, may provide significant near-term revenues through up-front licensing fees, research and development reimbursements and milestone payments, the Company expects to continue incurring operating losses for the next several years. As of March 31, 2000 the Company had cash and cash equivalents totaling $2,154,000, and $573,000 in receivables, primarily from licensing and R&D agreements with Femcare, Ltd. for the European and Australian marketing rights to the stress urinary incontinence bulking product, and from Perkin-Elmer for a research and development project and commercialization option. The Company believes its available cash and cash equivalents and future contractual R&D payments would be sufficient to meet its anticipated capital requirements through January 2001. The 10 Company will continue to attempt to raise additional funds for continuing operations through private or public offerings and collaborative agreements. See "Liquidity and Capital Resources" below for additional information and a description of the associated risks. To the extent sufficient resources are available, the Company continues to research the use of its protein polymers for other tissue repair and medical device applications, principally for use in tissue engineering matrices and drug delivery devices. PPTI is aggressively pursuing domestic and international patent protection for its technology, making claim to an extensive range of recombinantly prepared structural and functional proteins, methods for preparing synthetic repetitive DNA, methods for the production and purification of protein polymers, end-use products incorporating such materials and methods for their use. To date, the United States Patent and Trademark Office ("USPTO") has issued 18 patents to the Company, four of which have been issued in 2000. In addition, PPTI has filed corresponding patent applications in other relevant commercial jurisdictions. In April and May of 1998, the Company raised approximately $5.4 million from the sale of 54,437.5 shares of the Company's unregistered Series E Convertible Preferred Stock ("Series E Stock") priced at $100 per share with warrants to purchase an aggregate of 3,266,250 shares of common stock to a small group of institutional and accredited investors. In connection with this transaction, the Company issued 26,240 shares of Series F Convertible Preferred Stock in exchange for the same number of shares of outstanding Series D Convertible Preferred Stock. Between April 1 and April 15, 1999, the Company received approximately $508,000 from the exercise of redeemable, publicly traded, warrants to purchase common stock originally issued as part of PPTI's initial public offering. Following the close of business on April 15, the remaining unexercised redeemable, publicly traded, warrants expired. On May 12, 1999, the Company received approximately $416,000 from the exercise of warrants to purchase common stock issued in conjunction with the private placement of the Company's Series E Convertible Preferred Stock. On August 16, 1999, the Company received $1,775,000 for 17,750 shares of Series G Preferred Stock from several institutional and accredited individual investors following the 10 day stockholder notification period required by the NASD prior to the sale. On September 15, 1999, the Company received an additional $325,000 for 3,250 shares of Series G Preferred Stock, for total proceeds of $2,100,000. Each share of Series G Convertible Preferred Stock was priced at $100 per share. Each share can be converted at any time by the holder into common stock at a price of $0.50 per share, subject to certain antidilution adjustments. Each share of Preferred Stock also received a common stock warrant, exercisable for 12 months, that allows the holder to acquire 200 shares of PPTI common stock at a price of $0.50 per share. During February 2000, holders of warrants issued in connection with the sale of Series G Preferred Stock exercised their warrants to purchase common stock which were due to expire in September, 2000. The exercise price was $0.50 per share. As an inducement to exercise the warrant early, the Company offered each holder a new one year warrant for a similar number of shares at an exercise price of $1.50 per share. As a result the Company raised $2.1 million (less expenses). The newly issued warrants will expire on the last day of February 2001. RESULTS OF OPERATIONS The Company received $386,574 in contract and licensing revenue for the three months ended March 31, 2000 as compared to no contract or licensing revenue for the three months ended March 31, 1999. The increase in contract and licensing revenue primarily represents the amortized portion of an up front license payment of $1 million (being recognized ratably over a period of three years) from Femcare Ltd. for the commercial rights to PPTI's incontinence product in Europe and Australia, payments from Sanyo Chemical Industries Ltd. for the comprehensive license to PPTI's 11 in vitro cell culture business and existing product inventory, and initial R&D payments from Perkin-Elmer for a development project. The lack of revenue in 1999 reflects primarily the termination of research and development reimbursements from various operating entities of the Johnson & Johnson Company, including Ethicon, Inc. Interest income was $14,000 for the three months ended March 31, 2000 versus $13,000 for the same period in 1999. For the three months ended March 31, 2000 and 1999, sales and license fees from the Company's ProNectin(R) and SmartPlastic(R) products were $3,000 and $23,000, respectively. The Company incurred no cost of sales nor royalty payments for the three months ended March 31, 2000, compared to a royalty expense of $6,000 the three month period ended March 31, 1999. The decline in all of these items was due to the sale of this business to Sanyo Chemical Industries, Ltd. in February 2000. Research and development expenses for the three months ended March 31, 2000 were $554,000, compared to $714,000 for the same period in 1999, a 22% decrease. The decrease was primarily attributable to downsizing reductions in personnel and expenditures implemented in June 1999, and completion of external contracts and consulting services related to the Company's soft tissue augmentation program, including preclinical testing and preparation of the Investigational Device Exemption approved by the Food and Drug Administration ("FDA") in August 1999 granting permission to begin human clinical testing. The Company expects, in general, that its research and development, human clinical testing, and manufacturing expenses will increase over time if its incontinence product and other products in development successfully progress and additional capital is obtained. Selling, general and administrative expenses for the three months ended March 31, 2000 were $328,000, as compared to $428,000 for the same period in 1999, a 23% decrease. This decrease was due both to the downsizing in 1999 and to a reduction in legal and other professional services primarily related to Securities and Exchange Commission filings and reduced investor relations expenses. The Company expects its selling, general and administrative expenses remain largely unchanged in the near term, but will increase in the future as support for its research and development and manufacturing efforts may require and to the extent additional capital is obtained. For the three months ended March 31, 2000, the Company recorded a net loss applicable to common shareholders of $547,690, or $0.04 per share compared to a loss of $1,175,000, or $0.11 per share for the same period in 1999. Also included in each of the three month periods of 2000 and 1999 was $69,000 and $68,000, respectively, for undeclared dividends related to the Company's preferred stock. In general, there can be significant fluctuation in revenue from quarter to quarter due to variability in outside contract and licensing payments. In general, the Company expects to incur increasing operating losses in the future (to the extent additional capital is obtained), due primarily to increases in the Company's soft tissue augmentation program's development, manufacturing and business development activities. The Company's results depend on its ability to establish strategic alliances and generate contract revenues, increased research, development and manufacturing efforts, preclinical and clinical product testing and commercialization expenditures, expenses incurred for regulatory compliance and patent prosecution, and other factors. To date the Company believes that inflation and changing prices have not had a material effect on its continuing operations. 12 LIQUIDITY AND CAPITAL RESOURCES As of March 31, 2000, the Company had cash and cash equivalents of $2,154,000 as compared to $156,000 at December 31, 1999. As of March 31, 2000, the Company had working capital of $1,902,544 as compared to ($458,000) at December 31, 1999. The difference is due primarily to the completion in January 2000 of the strategic alliance with Femcare, Ltd., and in February 2000 from the sale of the in vitro cell culture business to Sanyo Chemical Industries, Ltd., and the receipt of $2,100,000 from the exercise of common stock warrants granted in association with the Series G Convertible Preferred Stock. The Company had long-term debt obligations as of March 31, 2000 of $4,000 in the form of capital lease obligations, versus $25,000 as of December 31, 1999. For the three months ending March 31, 2000, the Company's expenditures for capital equipment and leasehold improvements totaled $24,000, compared with $22,000 for the same period last year. The Company is expecting to increase its capital expenditures in the next few quarters (to the extent additional capital is obtained), as the Company improves existing space to expand capacity to meet materials manufacturing requirements for clinical testing. The Company may enter into additional capital lease arrangements if available at appropriate rates and terms. The Company believes its existing available cash and cash equivalents, in combination with anticipated contract research payments and revenues received from the transfer of clinical testing materials, will be sufficient to meet its anticipated capital requirements until January 2001. Substantial additional capital resources will be required to fund continuing expenditures related to the Company's research, development, manufacturing and business development activities. The Company believes there may be a number of alternatives to meeting the continuing capital requirements of its operations, including additional collaborative agreements and public or private financings. The Company is currently in discussions at various stages with several potential collaborative partners that, based on the results of various in vitro and in vivo product performance evaluations, could result in generating revenues in the form of license fees, milestone payments or research and development reimbursements. However, there can be no assurance that any of these fundings will be consummated in the necessary time frames needed for continuing operations or on terms favorable to the Company. If adequate funds are not available, the Company will be required to significantly curtail its operating plans and may have to sell or license out significant portions of the Company's technology or potential products. 13 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits: Exhibit Number Description ------- ----------- 27 Financial Data Schedule. b. Reports on Form 8-K None. 14 SIGNATURE In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PROTEIN POLYMER TECHNOLOGIES, INC. Date May 15, 2000 By /s/ J. Thomas Parmeter ------------ ----------------------- J. Thomas Parmeter Chairman of the Board, Chief Executive Officer, President Date May 15, 2000 By /s/ Janis Y. Neves ------------ ------------------- Janis Y. Neves Director of Finance, Controller and Assistant Secretary 15 EXHIBIT INDEX Exhibit Sequentially Number Description Numbered Page ------- ----------- ------------- 27 Financial Data Schedule. 16 EX-23.1 5 CONSENT OF ERNST & YOUNG LLP EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the reference to our firm under the caption "Experts" in the Registration Statement (Form S-2) and related Prospectus of Protein Polymer Technologies, Inc. for the registration of shares of its common stock and to the incorporation by reference therein of our report dated February 29, 2000, with respect to the financial statements of Protein Polymer Technologies, Inc. included in its Annual Report on Form 10-KSB for the year ended December 31, 1999, filed with the Securities and Exchange Commission. /s/Ernst & Young LLP Ernst & Young LLP San Diego, California May 17, 2000 -----END PRIVACY-ENHANCED MESSAGE-----