-----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, OS6sjdgbuUYoYPTkVhXLWWuq/NhSaIoTbL1QGDs1KSgHOKW8Gc4MlVnY3sl23Py4 mcvghPcntnfRvfmda1oR3A== 0001047469-98-012394.txt : 19980331 0001047469-98-012394.hdr.sgml : 19980331 ACCESSION NUMBER: 0001047469-98-012394 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: GALAGEN INC CENTRAL INDEX KEY: 0000889872 STANDARD INDUSTRIAL CLASSIFICATION: BIOLOGICAL PRODUCTS (NO DIAGNOSTIC SUBSTANCES) [2836] IRS NUMBER: 411719104 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-27976 FILM NUMBER: 98578049 BUSINESS ADDRESS: STREET 1: 4001 LEXINGTON AVE N CITY: ARDEN HILLS STATE: MN ZIP: 55440 BUSINESS PHONE: 6124812105 MAIL ADDRESS: STREET 1: 4001 LEXINGTON AVE NORTH CITY: ARDEN HILLS STATE: MN ZIP: 55126 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K (Mark One) /X/ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Fiscal Year Ended December 31, 1997 or / / Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition Period From _______________ to ________________. Commission file number 0-27976 GalaGen Inc. - ------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 41-1719104 - ------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) 4001 Lexington Avenue North Arden Hills, Minnesota 55126 - ------------------------------------------------------------------------------- (Address of principal executive offices) (Zip code) (612) 481-2105 - ------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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 / / Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. / / The aggregate market value of the Common Stock held by non-affiliates of the registrant as of March 19, 1998 was $10,179,947 based on the closing sale price for the Common Stock on that date as reported by The Nasdaq Stock Market. For purposes of determining such aggregate market value, all officers, and directors of the registrant are considered to be affiliates of the registrant, as well as stockholders holding 10% or more of the outstanding Common Stock as reflected on Schedules 13D or 13G filed with the registrant. This number is provided only for the purpose of this report on Form 10-K and does not represent an admission by either the registrant or any such person as to the status of such person. As of March 19, 1998 the registrant had 7,962,198 shares of Common Stock issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive Proxy Statement dated March 30, 1998 for the annual meeting of stockholders to be held on May 13, 1998 and the Annual Report to Stockholders for the year ended December 31, 1997 are incorporated by reference in Parts II, III and IV. PART I ITEM 1. BUSINESS FORWARD-LOOKING STATEMENTS The information presented in this Annual Report on Form 10-K under the headings "Item 1. Business" and "Item 2. Properties" and incorporated by reference under "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" contains forward-looking statements within the meaning of the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are subject to risks and uncertainties, including those discussed under "Risk Factors" below beginning on page 16 of this Annual Report on Form 10-K, that could cause actual results to differ materially from those projected. Because actual results may differ, readers are cautioned not to place undue reliance on these forward-looking statements. Certain forward-looking statements are indicated below by an asterisk. INTRODUCTION GalaGen Inc. ("GalaGen" or the "Company"), which was incorporated in 1992 as a successor to a company incorporated in 1987, has expertise in obtaining and processing polyclonal antibodies, as follows: ACCESS TO COLOSTRUM. The Company has agreements with Land O'Lakes which provide the Company with access to the Land O'Lakes dairy system. This dairy system has approximately 400,000 cows, from which the Company receives its supply of colostrum, which is milk collected in the first few milkings of a dairy cow after its calf is born. From this colostrum, the Company obtains its antibodies, which are food proteins. These cows are located primarily in the upper Midwest and both the East and West coasts. PROPRIETARY TECHNOLOGY. Using its proprietary immunization technologies, including the use of immune system stimulating adjuvants, the Company can produce antibodies in the cow that target specific pathogens infecting the human gastrointestinal ("GI") tract, including bacteria and their toxins, parasites, fungi and viruses. This technology increases by many fold a dairy cow's natural production of pathogen-specific antibodies in its colostrum. PROPRIETARY MANUFACTURING. The Company has patented, proprietary manufacturing processes that are used to concentrate antibodies from the colostrum. Standard dairy processing techniques destroy the activity of most of the antibodies present in milk and colostrum, whereas the Company's processing retains the antibody activity. The Company is utilizing this expertise to develop a portfolio of proprietary nutritional products, including dietary supplements, which will incorporate its Proventra-TM- Brand Natural Immune Components ("Proventra"). These products will target needs of both consumers and healthcare professionals.* GalaGen is also developing oral pharmaceuticals that target life threatening and emerging pathogens. In December 1997, the Company introduced Basics Plus-TM-, a dietary supplement product, in conjunction with its marketing and manufacturing partner, Lifeway Foods, Inc. Basics Plus is the first product to emerge from the collaboration with Lifeway Foods, Inc. It contains active kefir cultures, which are cultures that contain 2 beneficial bacteria strains, and GalaGen's Proventra. Basics Plus is the first dairy-based dietary supplement sold in the United States in the refrigerated section of health food stores and grocery stores, and is currently in test markets in Chicago, New York City and Milwaukee. The product was featured in the February 1998 issue of DAIRY FOODS MAGAZINE. Diffistat-G, the Company's lead pharmaceutical product in development, is being developed for the treatment and prevention of antibiotic-associated diarrhea, a disease that annually affects more than 400,000 patients in the United States. Because the Company's antibodies, including Proventra, are derived from cows' milk, they do not represent new chemical compounds with uncertain toxicity, but rather their components are commonly found in dairy foods that are already widely consumed. Antibodies for incorporation into multiple nutritional and pharmaceutical products can be manufactured using a single, proprietary manufacturing process and facility, and as a result, the Company believes that additional products will not require significant separate investments in manufacturing facilities or process techniques.* BACKGROUND GENERAL Passive immunity consists of using antibodies produced by one individual or animal to treat, prevent or protect against infection in another. Such antibodies can be administered orally for GI infections. Breast feeding is the most common example of passive immunity delivered to the GI tract, with the mother providing natural protective antibodies to her infant through her milk. Similarly, dairy cows provide antibodies to calves through the colostrum, which is the milk produced during the first several days of lactation. The concentration of antibodies in colostrum is many times higher than the normal concentration in milk. Through their natural exposure to the environment, cows have developed antibodies that recognize and bind to many human pathogens. NUTRITIONAL PRODUCTS According to Frost & Sullivan, a competitive-market analysis firm, the market for nutraceutical or functional food beverages now exceeds $20 billion. The Company believes that this significant market size is due to a number of factors, including (i) increased interest in healthier lifestyles, (ii) the publication of research findings supporting the positive health effects of certain nutritional supplements and (iii) the aging of the "Baby Boom" generation combined with the tendency of consumers to purchase more nutritional supplements as they age.* The Company believes that the inclusion of antibodies in nutritional products, along with including other components such as active cultures and dietary soluble fiber, provide important benefits and competitive advantages, including (i) a unique immune-enhancing system, (ii) a fit with consumer needs, and (iii) a safe, proven means to fight pathogens.* PHARMACEUTICALS Antibiotics and vaccines (active immunizations) are currently the most common therapies for the treatment and prevention of infections. Unfortunately, both have significant limitations for the management of infections. Pathogens are increasingly resistant to antibiotics. Overuse of antibiotics may result in selection for additional resistant strains and, occasionally, results in the onset of serious secondary infections. Vaccines are not immediately effective and usually require repeated vaccinations to raise the concentration of antibodies in the body to levels high enough to prevent or counteract disease. This delay may be unacceptable because it may permit progression of the disease to severe or even fatal stages. Active immunization of the GI tract is also difficult. For these reasons, new therapeutic approaches for treating and preventing GI infections are needed. One 3 alternative to antibiotics and vaccines is passive immunity. As a result of these advantages, passive immunity can be used in pharmaceutical applications for both acute treatment and long-term prevention of disease. Advantages of passive immunity for treating or preventing GI tract infections are numerous. Orally-delivered antibodies provide immediate treatment of existing infections and provide for rapid temporary protection against developing infection. They may be delivered in high concentrations directly to the site of infection in the GI tract rather than through the blood-stream. They are polyclonal, meaning that they bind to many different surface features of a pathogen and are thus less likely to permit the development of resistant pathogens. They do not disrupt the GI tract's natural bacterial flora, which is necessary for normal digestion and intestinal function. THE COMPANY'S CORE ANTIBODY TECHNOLOGY AND PRODUCT BENEFITS The Company's products contain polyclonal antibodies derived from bovine colostrum, which is the first milk from a cow after her calf is born. The antibodies are orally administered to humans and provide passive immunity within the GI tract. The Company's goal is to provide passive immunity for individuals either through regular use of nutritional products that have lower concentrations of antibodies over a longer period of time or through periodic use of pharmaceutical products that have higher concentrations of antibodies over a shorter period of time.* The antibodies may block a pathogen's effect by immobilizing it, killing it, promoting its ingestion and destruction by white blood cells, or preventing it from attaching to and colonizing the GI tract. In these ways, the antibodies help to eliminate the pathogen from the infected individual. The Company's proprietary immunization technologies, through the use of immune system stimulating adjuvants, increase by many fold a dairy cow's natural production of pathogen-specific antibodies in its colostrum. Standard dairy processing techniques destroy the activity of most antibodies present in milk and colostrum. The Company's proprietary processes used to concentrate antibodies have been developed through many years of research and development. This work resulted in a process that uses several well-tested and efficient dairy manufacturing techniques that have been modified to preserve the biological activity of the antibodies. The Company will manufacture its nutritional products in accordance with the appropriate license issued by Minnesota Department of Agriculture ("MDA"). The Company will manufacture its pharmaceutical products in accordance with pharmaceutical specifications for oral dosage formulations and will support its proprietary processing system with a quality control system that regulates, monitors and reviews the processing system in compliance with current Good Manufacturing Practices ("GMP") for the manufacture of biologics. PRODUCTS IN DEVELOPMENT NUTRITIONAL PRODUCTS In addition to therapeutic products targeted at GI diseases, the Company believes that its antibody technology lends itself to the creation of food products or dietary supplements with health claims, often called "functional foods" or "nutraceuticals".* These have been defined as foods which provide benefits beyond their nutritional value. While there is not a regulatory definition for the terms "functional food" or "nutraceutical", these terms are widely used in the marketplace. The Company believes that the enactment by Congress of the Nutrition Labeling and Education Act ("NLEA") in 1990 and the Dietary Supplement Health and Education Act ("DSHEA") in 1994 enabled the regulatory process for marketing foods or dietary supplements. DSHEA permits such products to bear "structure-function" claims related to how the product affects the structure or function of the body, and such claims do not require FDA review or approval, but must be supported by scientific evidence. NLEA permits products to carry more specific health claims, but requires FDA approval and general scientific consensus to support the claim in question. The Company believes that the incorporation of Proventra in foods or dietary supplements would add benefits to these products.* 4 As previously described above, the Company currently has one product, Basics Plus, being sold in test markets through its manufacturing and marketing partner Lifeway Foods, Inc. The Company is applying its resources to two other products as described below. The Company does not anticipate spending significant resources to market the final products, but will seek to find partners with the appropriate distribution and marketing credentials*:
Product Target Population Stage of Development ------- ----------------- -------------------- - Clinical Nutrition Patients in Market research Beverage hospitals, nursing completed; homes and elderly clinical evaluation to population begin in the second quarter of 1998 - Consumer Nutritional Health-oriented Product formulation Beverage consumers underway; market research scheduled to begin in the second quarter of 1998
CLINICAL NUTRITION PRODUCT The Company is developing a dairy-based nutritional beverage for patients in hospitals and nursing homes. Based upon market research results, the Company believes that a need exists for a superior tasting refrigerated beverage that will provide Proventra and other active components.* The Company believes that a superior tasting dairy-based beverage, which includes a combination of these ingredients, will increase consumption compliance, in turn leading to better nutrition, improved defense against infection and more regular bowel function.* Clinical evaluation of this product is anticipated to begin in the second quarter of 1998.* CONSUMER NUTRITION PRODUCT GalaGen is developing an enhanced beverage product targeted at health-oriented consumers. Market trends indicate that consumers, particularly baby boomers and mature adults, are taking a more proactive role in managing their health. The Company believes that a superior tasting beverage containing its proprietary immune-enhancing ingredients, including Proventra, will be the first product of its kind.* Product development is underway with market research to begin in the second quarter of 1998.* PHARMACEUTICALS The Company believes that its colostrum-derived antibody products in development may provide many attractive clinical benefits and offer a safe and effective alternative to antibiotics and other therapeutics.* WELL-TOLERATED, DAIRY-DERIVED ANTIBODIES. Orally-delivered, dairy-derived antibodies have been administered in several studies by the Company and others to over 1,000 individuals with no serious adverse effects. Antibodies are among the many milk proteins commonly consumed in everyday dairy products such as milk, yogurt and cheese. Lactose levels in the Company's product candidates have been reduced to approximately one-tenth that of milk. The Company believes that the product should, therefore, be tolerable by all but the most lactose-intolerant individuals.* RAPID ONSET OF ACTION AND A SUPPLEMENT TO ACTIVE IMMUNITY. Antibody products deliver high concentrations of pathogen-specific antibodies to the site of infection and have a rapid onset of action, while active immunizations, such as polio or hepatitis B vaccines, may take weeks or months to provide adequate immune protection. Passive immune protection may be especially important where there is not 5 time for active immunizations to be effective (for example, when there is exposure to infection or when an infection has become established and immediate therapy is needed) or where the underlying immune suppression leaves an individual incapable of responding to the active immunization (for example, in cancer patients). AVOID PROBLEMS ASSOCIATED WITH ANTIBIOTIC USE. Antibodies recognize multiple binding sites on a target pathogen and have multiple potential mechanisms of action, including the neutralization of toxins. With appropriate immunization regimens, antibodies can be produced that recognize different strains of the same pathogen and affect even those strains that may be resistant to antibiotics. In contrast, other classes of antiinfectives work by interrupting a single mechanism or by binding to a single site and are, therefore, more likely to be overcome by bacterial adaptation. Unlike broad-spectrum antibiotics, orally-delivered antibody products are selective for specific pathogens and do not disrupt the GI tract's normal bacterial flora. Broad-spectrum antibiotics may disrupt the natural and beneficial GI bacterial flora and foster the subsequent overgrowth of certain disease-causing pathogens. The selectivity of antibodies should permit their use for prolonged periods to prevent infections, without promoting the development of resistant strains. STABILITY AND EASE OF USE. The Company's product candidates are stable powder concentrates with a shelf life exceeding two years. These products can be formulated into a variety of delivery formats, including tablets, capsules, chewing gum and sterile liquids. The standard dosage form is a dry powder which, when reconstituted, has the consistency and flavor of milk. The Company currently has one product in development under the first tier of products to which it is applying its resources. The Company does not anticipate applying significant resources toward the second tier products but will seek to find partners who will fund the required development and clinical trials*:
Product Disease Target Stage of Development ------- -------------- -------------------- FIRST TIER: DIFFISTAT-G Antibiotic associated diarrhea Phase I bioavailability due to CLOSTRIDIUM DIFFICILE clinical trial completed. ("C. DIFFICILE"). Second Phase I bioavailability study in ileostomy patients completed. Phase II clinical trial underway. SECOND TIER: CANDISTAT-G Oral and esophageal European Phase I/II candidiasis from the fungus clinical trial in bone species CANDIDA ("CANDIDA") in marrow transplant cancer, organ/bone marrow patients completed. transplant and other immunocompromised patients. PYLORIMUNE-G Gastrointestinal ulcers and Preclinical development. gastritis due to HELICOBACTER PYLORI ("H. PYLORI").
DIFFISTAT-G The Company is developing DIFFISTAT-G for the treatment and prevention of antibiotic-associated diarrhea. This complication of antibiotic therapy results when the antibiotics eliminate the GI tract's normal bacterial flora and foster the subsequent overgrowth of certain disease-causing bacteria, most often C. DIFFICILE. 6 Each year, it is estimated that more than 400,000 patients in hospitals and long-term health care institutions in the U.S. contract antibiotic-associated diarrhea due to C. DIFFICILE. The severity of diarrhea resulting from C. DIFFICILE may vary from a mild diarrhea to a life-threatening condition. Even the most mild cases in hospitals and long-term health care institutions warrant treatment due to the contagious nature of the disease. Currently, the first stage of treatment for antibiotic-associated diarrhea involves the discontinuation of the causal antibiotic therapy, if possible, and often the initiation of different antibiotics to treat the C. DIFFICILE infection. Discontinuation of the causal antibiotic may result in inadequate treatment of the underlying infection. Often, the serious nature of the underlying infection makes it impossible to discontinue the causal antibiotic. Therefore, prophylaxis for high risk patients would be desirable if there were a product available that avoided the problems presented by antibiotics. Metronidazole is the antibiotic of choice to treat antibiotic-associated diarrhea, with oral vancomycin as a second choice that is generally reserved for more severe or relapsing diarrhea. The initial response to these antibiotics usually is rapid and satisfactory. However, relapse can be a significant problem occurring in 20 to 40 percent of patients. These relapses can occur multiple times and result in significant disability for the patient. In addition, the use of oral vancomycin for this indication is being discouraged to reduce the likelihood that other serious pathogens will develop resistance to vancomycin. The Company believes that DIFFISTAT-G may prevent and treat C. DIFFICILE-associated diarrhea without the complications associated with antibiotic treatment.* An animal model study of DIFFISTAT-G demonstrating positive prophylactic results was completed in 1991. When the product was administered to animals before the introduction of C. DIFFICILE organisms, the animals receiving DIFFISTAT-G survived longer and had markedly less diarrhea than animals receiving a placebo. Additional laboratory studies conducted at Boston University have shown that the product effectively blocks the binding and action of toxins produced by C. DIFFICILE. Results of these preclinical efficacy studies for Diffistat-G were published in the February 1996 issue of ANTIMICROBIAL AGENTS AND CHEMOTHERAPY. A Phase I study was completed in normal volunteers at Boston University to assess the bioavailability of the product and to guide the choice of appropriate dosage for a Phase I/II therapeutic trial. Results of the first Phase I bioavailability trial were published in ANTIMICROBIAL AGENTS AND CHEMOTHERAPY in February 1997. A second Phase I bioavailability trial in ileostomy patients was completed in February 1997 at Beth Israel-Deaconess Medical Center, Harvard Medical School in Boston and demonstrated higher than anticipated recovery of functional antibodies in the ileum of these patients. Based on these positive results, the Company initiated a multi-center Phase II clinical trial in August 1997 to assess safety, efficacy and formulation. Principal investigators in the study are from Beth Israel-Deaconess Medical Center, Harvard Medical School in Boston. Additionally, an emergency use compassionate release program was initiated at the request of the FDA, and the initial pediatric patient treated under this program had clearing of symptoms and the infection. If positive results are shown from the Phase II clinical trial, the Company anticipates that it will need to secure a partner to continue further clinical development and to market Diffistat-G.* CANDISTAT-G The Company is clinically developing an oral antibody product, CANDISTAT-G, for the prevention/treatment of thrush, or infection of the throat and oral cavity with the fungus species CANDIDA. This infection occurs in most immunocompromised patients (cancer, organ/bone marrow transplant and HIV/AIDS) at some time during their illness. Short-term therapy with traditional antifungal agents improves symptoms of thrush in immunocompromised patients but often fails to clear the pathogen, resulting in a recurrence of symptoms within weeks. Prolonged therapy with these agents may produce clinical benefits but also has been associated with increasing reports of drug-resistant fungal strains. The Company believes that an antibody-based product such as CANDISTAT-G may fulfill such a need, particularly for the prevention of more severe thrush and blood-borne infections originating from the GI tract.* 7 CANDISTAT-G has been prepared by immunizing cows with several different antigens thought to be important in the establishment of oral infections with CANDIDA. These preparations were shown to substantially inhibit the binding of CANDIDA to human cheek cells in culture. A pilot clinical evaluation for CANDISTAT-G treated bone marrow transplant recipients and historically-matched controls in a European Phase I/II dose-ranging clinical trial at a major teaching hospital in Sweden was completed in the third quarter of 1997. The results from this clinical trial showed that CANDISTAT-G provided a reduction in the number of CANDIDA organisms in the oral cavity of eight out of eleven highly immunocompromised transplant patients with pre-existing CANDIDA colonization. No product related adverse events were noted. PYLORIMUNE-G The Company is developing a polyclonal antibody product to treat gastritis and ulcers caused by the bacterium H. PYLORI. Since the discovery of the relationship between H. PYLORI infection and ulcers, a major trend in the treatment has been the increased use of antibacterial "triple therapy" (a combination of several antibiotics, bismuth, and inhibitors of gastric acid production) instead of or in addition to conventional ulcer therapies. While most of these antibiotic-based regimens are partially effective, compliance is difficult and 10 to 20 percent of patients fail therapy in part because of antibiotic resistance. The Company believes that the limited effectiveness of currently available therapies and growing antibiotic resistance offer an opportunity for its antibody product in development, PYLORIMUNE-G.* Initial laboratory studies with PYLORIMUNE-G have successfully demonstrated neutralizing antibody activity against a key feature of H. PYLORI. The Company has access to five key antigens for producing antibodies to inhibit or eradicate H. PYLORI. The Company is developing cell culture systems and animal models for screening the efficacy of these proprietary antibody preparations. In 1995 the Company entered into a strategic alliance with Chiron Corporation ("Chiron") for the development of colostrum-based antibody products to treat H. PYLORI. Chiron's participation in the research and development program included testing of prototype antibody products in its animal models. See "Chiron Relationship" below. MANUFACTURING SYSTEM The Company's manufacturing system can be used for producing antibodies to be used for both nutritional products and pharmaceuticals and utilizes the existing milk production infrastructure. The Company's system has been designed to access very large numbers of cows in commercial milking herds, organize them into discrete product-specific groups, immunize them with specific antigens to heighten the natural production of pathogen-specific antibodies in their colostrum, collect the colostrum and concentrate the antibodies using a proprietary process. This process preserves the essential antibody activity while reducing unnecessary components, including microbial contaminants. Modern dairy cows, having been bred for high volume milk production, produce colostrum in quantities far greater than their calves can consume. This surplus colostrum is not placed into the commercial milk supply and is ordinarily a waste product. The Company's technology turns the surplus colostrum into a valuable raw material. With the Company's manufacturing system, the Company believes that antibodies can be produced from colostrum at a fraction of the cost of either human serum-derived polyclonal antibodies or cell culture-derived monoclonal antibodies.* The high cost of producing monoclonal antibodies, in particular, makes their administration by the oral route prohibitively costly. The Company's processing system is the same for the manufacture of all of the Company's pharmaceutical products. The colostrum for each potential product is processed to a bulk powder using the same procedures, according to the same specifications, and on the same equipment. This bulk powder may undergo final finishing steps, depending on the dosage form that is desired. The primary point of product differentiation is the antigen/adjuvant combination (immunogen) used to produce the specific and desired antibody response in the cow. This antibody specificity is used to define a product targeting a specific disease and indication. 8 Standard dairy processing techniques destroy the activity of most of the antibodies present in milk and colostrum and render them inactive. The proprietary process used by the Company to concentrate antibodies has been developed by the Company through many years of research and development. This work has resulted in a process that uses well-tested and efficient dairy manufacturing techniques that have been modified to preserve the biological activity of the antibodies. The Company has two patents that have been issued for this process. The process reduces the bioburden to levels significantly lower than those present in milk or milk products, and in accordance with pharmaceutical specifications for oral dosage formulations. The Company is supporting its proprietary antibody processing system with a quality control system designed to regulate, monitor and review the processing system in compliance with Good Manufacturing Practices for the manufacture of biologics. The Company has developed additional processes for the manufacture of Proventra Brand Natural Immune Components and final product formulations as part of its nutritional product development efforts. The Company has obtained Kosher certification for these natural immune components. Additionally, the Company has obtained the appropriate license from Minnesota Department of Agriculture. Construction of the Company's pilot plant facility within the existing Land O'Lakes pilot plant complex in Arden Hills, Minnesota was completed in 1996. The Company does not anticipate that it will need to fully validate the facility for pharmaceutical purposes in 1998.* Land O'Lakes has guaranteed the equipment leases associated with the pilot plant facility. The Company believes that the capacity of this facility will be adequate for the production of nutritional and pharmaceutical products, either for sale or clinical requirements, in 1998 and believes that contract manufacturers would be available to increase its production capacity quickly, if required.* LICENSE AGREEMENTS AND RESEARCH COLLABORATIONS The Company's research and development strategy is to pursue its own research programs internally and to complement such programs by establishing relationships with key external medical, academic, governmental and major research organizations. Specifically, the Company intends to continue complementing its extensive current technology base by acquiring access to additional proprietary technology and patents in the areas of antibodies, vaccine, molecular biology, and processing and manufacturing technology.* The Company also may seek collaborative arrangements for commercialization of its antibody products.* The Company's antibody technology may be applied to the development of nutritional and pharmaceutical products in many areas.* To exploit its core technology as broadly as possible in human applications, the Company's strategy is to enter into licensing and collaborative relationships with food and pharmaceutical companies with complementary product lines.* The Company spent $3.9 million, $5.3 million and $3.7 million for research and development in fiscal years 1997, 1996 and 1995, respectively. LAND O'LAKES RELATIONSHIP The Company believes that the Company's existing relationship with Land O'Lakes provides it with certain advantages over existing and potential competitors.* Land O'Lakes made significant advances in the development and commercialization of antibody products for treating and preventing diseases in animals. This technology provides the Company with a solid foundation on which to base its efforts to develop similar products for human use. Under a supply agreement with Land O'Lakes, the Company agreed to purchase all of its commercial requirements for colostrum from Land O'Lakes through May 7, 2002, subject to Land O'Lakes' option to renew the supply agreement for an additional ten-year period. The Company must provide program specifications to Land O'Lakes prior to commencing each of its commercial programs and Land O'Lakes must notify the Company within a specified period whether it will supply according to the agreement. If Land O'Lakes does not 9 confirm during that period that it will supply colostrum according to the specifications, then the Company has the right to obtain the colostrum from alternative sources. Commercial production could be delayed if Land O'Lakes does not elect to supply according to the supply agreement and the Company is required to locate an alternate supplier. When the Company was formed, it signed a letter of intent with Land O'Lakes to develop strategic relationships focused on the development of functional food products. In March 1998, the Company and Land O'Lakes signed an amended and restated license agreement (the "Restated License") in which the Company has significantly broadened its rights to develop and market functional foods. Under the Restated License, the Company can use, improve, exploit, license or share existing Procor technology, Procor technology improvements and new technologies, as defined, in all areas of functional foods except under certain "reserved food product" and "first refusal food product" categories, as defined. If the Company intends to engage in manufacturing or marketing any "first refusal food product", the Company must give Land O'Lakes notice of its intent, in which case Land O'Lakes can negotiate with the Company, in good faith and within a defined period of time, to undertake any part of the manufacturing or marketing areas. If the Company intends to engage in manufacturing or marketing any "reserved food product", the Company must give Land O'Lakes notice of its intent and must only work with Land O'Lakes to undertake the manufacturing or marketing of such products. In the original license agreement with Land O'Lakes, the Company retained rights to pursue the development of infant formula products containing polyclonal antibody technology. In March 1997, Land O'Lakes granted the Company a license (the "Kefir License") to use existing antibody technology and future improvements in the development, formulation, manufacture, marketing, distribution and sale of kefir-based products, as defined in the Kefir License. In consideration of granting the Kefir License, Land O'Lakes will receive a royalty based on food components or ingredients sold by the Company to be included in any kefir-based product and on net receipts from any kefir-based finished product sold by the Company. As mentioned below under "Chiron Relationship", Land O'Lakes consented to the Company's use of antibody technology for food applications of an H. PYLORI product. CHIRON RELATIONSHIP In March 1995, the Company and Chiron entered into a License and Collaboration Agreement involving the licensing of Chiron adjuvant technology to the Company for the development of antibody products processed from bovine colostrum and the cross-licensing of Chiron proprietary H. PYLORI-associated technology and Company proprietary H. PYLORI antigens for a collaboration to research and develop passive immune therapies, using bovine antibodies, against H. PYLORI. Under the agreement, Chiron granted the Company an exclusive worldwide license for the use of a proprietary Chiron adjuvant for the production of PYLORIMUNE-G. See "Products in Development - Pharmaceuticals - PYLORIMUNE-G" above. Use of the adjuvant for providing additional polyclonal antibody products processed from bovine colostrum can be designated under the terms of the agreement. Except as described below with regard to PYLORIMUNE-G, the Company's license to the Chiron adjuvant technology expires on the later of the expiration date of the last to expire of the licensed patents covering the technology or, within a given country, 10 years after the first commercial sale of a product making use of the licensed technology within such country. In addition, under the agreement Chiron and the Company may collaborate on the development of antibody products processed from bovine colostrum targeting infections caused by H. PYLORI, the bacterium associated with ulcers and gastritis. The research program would, if and when commenced, focus on producing specific, high potency antibodies directed against several products of H. PYLORI that the bacterium uses to attach to the stomach surfaces, and neutralize gastric acidity that would otherwise kill the bacterium, and inflame the gastric and duodenal surfaces. Chiron has an option for exclusive worldwide marketing rights for any H. PYLORI product resulting from the collaboration with profits being shared between Chiron and the Company according to 10 a preset formula. In connection with the agreement, Land O'Lakes consented to the Company's use of polyclonal antibody technology for food applications of an H. PYLORI product. The Company's license to the Chiron adjuvant technology for use in PYLORIMUNE-G is subject to early termination by Chiron if (i) no PLA has been filed for PYLORIMUNE-G by March 1, 2001, (ii) certain competitors of Chiron acquire control of the Company or, (iii) by the time of the first demonstration of efficacy of PYLORIMUNE-G, Chiron has not received an opinion of independent counsel selected by Chiron that the manufacture, use or sale of PYLORIMUNE-G does not infringe third party patents. PROPRIETARY RIGHTS AND PATENTS The Company's policy is to protect its proprietary technology as trade secrets and by filing patent applications on technology for which the Company believes patent protection is available and is in the best interest of the Company. The Company also relies upon know-how, continuing technological innovations and licensing opportunities to develop and maintain its competitive position. The Company believes that certain of its process improvements are more valuable as trade secrets than as patented processes, where the process improvements would have to be publicly disclosed. The Company relies on trade secrets and proprietary know-how it developed while manufacturing antibody products for veterinary use. The Company believes that substantial barriers exist for competitors desiring to commercialize antibody products derived from milk or colostrum*; however, there can be no assurance that other companies will not develop production processes or initiate relationships with other large dairy cooperatives to develop a similar procurement system. The Company seeks to protect trade secrets and know-how through confidentiality agreements with employees, consultants and other parties. These agreements provide that all confidential information developed or made known during the course of the relationship with the Company is to be kept confidential and not disclosed to third parties, except in specific circumstances. No assurance can be given that such agreements will provide meaningful protection for the Company's unpatented trade secrets or provide adequate remedies in the event of unauthorized use of such information. Neither can assurance be given that others will not independently develop substantially equivalent proprietary information and technology or otherwise gain access to the Company's trade secrets or disclose such technology. The Company has been issued two patents, #5,670,196 and #5,707,678 from the United States Patent & Trademark Office. The patents cover significant processes in its core manufacturing technology for antibodies for microfiltering milk and colostrum that reduces bioburden while improving yield. The Company also has two United States patent applications pending and has acquired licenses to a number of patents or patent applications of others. The Company's two United States patent applications are in the area of antibody products for humans. The Company believes that useful, new and unobvious antibody formulations may be patentable.* Furthermore, in some cases, patent coverage may be available for the vaccines or antigens used to provoke the immunological response which produces the antibodies. The Company's strategy is to pursue patent protection for each of its products where possible, including their components (e.g., antigens, vaccine compositions), as well as for certain process and formulation improvements, although the Company may not be successful in achieving broad patent protection for its technology. The Company has become aware of several patents that may relate to its antibody technology. In 1991, the Company became aware of one such issued patent. Land O'Lakes engaged outside patent counsel to review the patent and such counsel rendered its written opinion to Land O'Lakes that the patent is not infringed by the Company's technology. The Company engaged its own outside patent counsel to review the patent and such counsel rendered its independent opinion that the patent is not infringed by the Company's technology and that, in any event, the patent would be invalid if it were interpreted broadly enough so as to cover the Company's technology. While the Company does not regard the patent as a threat to its business*, there can be no assurance that the holder of the patent will not pursue litigation which could be costly to the Company. In 1993, the Company became aware of another issued patent relating to the application of colostrum-based passive immunity technology to an H. PYLORI-specific product. The Company engaged outside patent counsel to review the patent, 11 and a related patent which was subsequently issued, and such counsel rendered its independent opinion to the Company that neither patent is valid and, in any event, it is not certain at this time if the Company's technology would infringe either patent even if valid. While the Company does not regard the patents as a threat to its business*, there can be no assurance that the holder of the patents will not pursue litigation which could be costly to the Company. The Company is aware of a published international patent application entitled "Urease-Based Vaccine and Treatment of Helicobacter Infection". To date, no patent on this application has been granted and therefore the Company cannot meaningfully assess the impact, if any, of this patent application on its business. GOVERNMENT REGULATION NUTRITIONAL PRODUCTS GENERAL The formulation, manufacturing, processing, packaging, labeling, advertising, distribution and sale of nutritional supplements such as those being developed by the Company are subject to regulation by one or more federal agencies, principally the FDA and the Federal Trade Commission (the "FTC"), and to a lesser extent the Consumer Product Safety Commission and the United States Department of Agriculture. These activities are also regulated by various governmental agencies for the states and localities in which the Company's products are sold, as well as by governmental agencies in certain foreign countries in which the Company's products are sold. Among other matters, regulation of the Company by the FDA and FTC is concerned with claims made with respect to a product which refer to the value of the product in treating or preventing disease or other adverse health conditions. Federal agencies, primarily the FDA and FTC, have a variety of remedies and processes available to them, including initiating investigations, issuing warning letters and cease and desist orders, requiring corrective labels or advertising, requiring consumer redress (for example, requiring that a company offer to repurchase products previously sold to consumers), seeking injunctive relief or product seizure and imposing civil penalties or commencing criminal prosecution. In addition, certain state agencies have similar authority, as well as the authority to prohibit or restrict the manufacture or sale of products within their jurisdiction. These federal and state agencies have in the past used these remedies in regulating participants in the nutritional products industry, including the imposition by federal agencies of civil penalties in the millions of dollars against a few industry participants. There can be no assurance that the regulatory environment in which the Company operates will not change or that such regulatory environment, or any specific action taken against the Company, will not result in a material adverse effect on the Company's business, financial condition or results of operations.* In addition, increased sales and publicity of nutritional supplements may result in increased regulatory scrutiny of the nutritional supplements industry. DIETARY SUPPLEMENT HEALTH AND EDUCATION ACT DSHEA was enacted in October 1994, amending the Food, Drug and Cosmetic Act. The Company believes this law is generally favorable to the dietary supplement industry.* DSHEA establishes a new statutory class of "dietary supplements," which includes vitamins, minerals, herbs, amino acids and other nutritional supplements for human use to supplement the diet and includes in such class all dietary ingredients on the market as of October 15, 1994. Such class of nutritional supplements will not require the submission by the manufacturer or distributor of evidence of a history of use or other evidence of safety establishing that the supplement will reasonably be expected to be safe, but a nutritional supplement which contains a dietary ingredient which was not on the market as of October 15, 1994 does require such submission of evidence of a history of use or other evidence of safety. Among other things, this law prevents the further regulation of dietary ingredients as "food additives" and allows the use of statements of nutritional support on product labels. 12 PHARMACEUTICAL PRODUCTS GENERAL The Company's pharmaceutical products are classified as human biological drugs and their research, development and marketing are subject to substantial regulation by the FDA as well as state and local entities. The Federal Food, Drug and Cosmetic Act, the Public Health Service Act and other federal statutes govern the testing, manufacture, safety, effectiveness, approval, storage, recordkeeping, labeling, advertising and promotion of the Company's products. Noncompliance with applicable statutory and regulatory requirements may result in fines, recall or seizure of products, refusal to permit the Company to enter into government supply contracts, refusal to approve Product Licensing Applications ("PLA"), suspension or revocation of product licenses and establishment licenses previously granted, criminal prosecution, and debarment. The process required by the FDA before the Company's products may be marketed in the United States generally involves the following: (1) preclinical laboratory and animal testing; (2) the submission to the FDA of an application for Investigational New Drug application ("IND") approval to conduct human clinical trials; (3) adequate and well-controlled human clinical trials to establish the safety and efficacy of the biologic; (4) the submission of a PLA for approval of a biologic; and (5) FDA approval of and issuance of a license pertaining to a PLA prior to any commercial sale or shipment of the drug or biologic. In addition, drug manufacturing establishments must be registered with and approved by the FDA. Manufacturers of biologics must currently also submit and obtain approval of an Establishment License Application ("ELA") prior to commercial distribution of an approved biologic. Manufacturing establishments are subject to regular inspections by the FDA. All manufacturing facilities, production, testing and packaging operations and recordkeeping practices must substantially conform to, among other requirements, FDA GMP regulations. PRECLINICAL STUDIES Preclinical studies are conducted in the laboratory and in animal models to gain preliminary information on biochemical and pharmacological properties of the investigational drug or biologic and to identify any significant safety problems. The results of these studies are submitted to the FDA as part of the IND application. Testing of previously unapproved new drugs and biologics in humans may not commence until the IND becomes effective. IND APPLICATION The IND application notifies the FDA of the sponsor's investigational plan for the drug or biologic and provides brief descriptions of the chemical structure of the compound, the known pharmacological and toxicological effects of the compound, and known information relating to the compound's safety and effectiveness in humans, including possible risks and anticipated side effects. The IND authorizes a sponsor to conduct human clinical studies in order to demonstrate relative safety and efficacy of the product in support of an ELA/PLA. Any time prior to or following the commencement of clinical trials under an IND, the FDA may determine that human subjects are or would be exposed to an unreasonable and significant risk of injury by participating in the trial and may delay initiation of or suspend an ongoing trial. CLINICAL STUDIES Human clinical studies are typically conducted in three phases, which may overlap, and are designed to collect additional data relating to the safety, dosing and side effects of the proposed product and to the product's efficacy in comparison with placebos or any currently accepted therapy. Phase I clinical studies are generally performed in 10 to 30 healthy human subjects or, more rarely, selected patients with a targeted disease or disorder. The goal is to establish an initial data base about tolerance, safety and dosing of the product in humans. Phase II clinical studies are generally performed in small numbers of carefully selected patients, usually 13 50 to 200. Phase II studies are used to obtain definitive statistical evidence of the efficacy and safety of the product and dosing regimen. Phase III consists of expanded large-scale studies of patients (200 to 2,000 patients or more) with the target disease or disorder, to obtain statistical evidence of the efficacy and safety of the proposed product and dosing regimen in a broader patient population. These studies may include investigation of the effects in subpopulations of patients, such as the elderly, women or certain racial groups. When patients are studied, Phase I and II studies may be combined. Phase I/II clinical studies are designed to establish initial data regarding the tolerance, safety and dosing of the investigational drug or biologic, and to obtain preliminary efficacy data in patients with the specific disease. The combination of different phases encourages the use of larger sample sizes and may result in more reliable statistical results in the earlier phases. Subsequent to the Phase I and II studies, pivotal studies are carried out with larger numbers of patients with the target disease or disorder. These pivotal studies may be either Phase II or Phase III. Additional clinical trials beyond the pivotal studies are sometimes required for licensing. PRODUCT LICENSING APPLICATION Upon successful completion of clinical testing, the Company will file a PLA and ELA with the FDA.* The regulatory environment is evolving rapidly and is being closely monitored. The Company will pursue aggressively the possibility of a streamlined, single filing, if the current procedure is modified by the FDA.* These applications include, among other things, details of the manufacturing and testing processes and results of preclinical studies and clinical trials which, taken together, demonstrate that the drug or biologic is safe, pure, potent and effective. FDA approval of the applications is required before the new product may be marketed. There can be no assurance that the FDA will act favorably or quickly in reviewing submitted applications, and significant difficulties or costs may be encountered by the Company in its efforts to obtain FDA approvals for its novel biological products. The FDA may grant marketing approval, require additional testing or information or deny the applications. The clinical studies may take three to five years or more to complete and there are no assurances that the clinical data obtained will demonstrate to the FDA that the product is safe and effective. The FDA may require the Company to perform additional human testing. There can be no assurance that the FDA will ever accept the Company's data as being sufficient to demonstrate the product's safety, purity, potency, or efficacy. FDA policies currently require that the Company's manufacturing facility or the manufacturing facility of a contract manufacturer be operational and in full compliance with GMP standards prior to completing pivotal or Phase III clinical trials. If the Company or its designated contract manufacturer is unable to make its facility operational before completing pivotal or Phase III clinical trials on a product, the Company may have to perform additional clinical testing with the product produced at the new facility. The Company's clinical trials are at an early stage, and the Company has not received approval from the FDA or any other government agency for the manufacturing or marketing of any of its pharmaceutical products. Consequently, the commencement of manufacturing and marketing of its pharmaceutical products is, in all likelihood, at least two to three years away.* Moreover, even after FDA approval of a PLA has been obtained, further studies will likely be required to provide additional data on safety or to gain approval for the use of a product as a treatment in clinical indications other than those for which the product was initially tested. The FDA may also require post-marketing testing and surveillance programs to monitor the product's effects. Significant side effects may prevent or limit the further marketing of the product, or move the FDA to withdraw its approval to market the product, either temporarily, for example, by ordering a product recall, or permanently, 14 by withdrawing the New Drug Application ("NDA") or PLA approval. Continued compliance with all FDA requirements and the conditions in an approved application, including product specification, manufacturing process, labeling and promotional materials and record keeping and reporting requirements, is necessary for all products. OTHER REGULATORY REQUIREMENTS The Company is also subject to regulation by the Occupational Safety and Health Administration, the Environmental Protection Agency and the Minnesota Environmental Quality Board and to regulation under the Toxic Substances Control Act, the Resource Conservation and Recovery Act, among others, and other regulations, and may in the future be subject to other federal, state and local statutes or regulations. The Company is unable to predict whether any agency will adopt any regulation which would have a material adverse effect on the Company. Sales of biologics outside the United States are subject to foreign regulatory requirements that may vary widely from country to country. Whether or not FDA approval has been obtained, approval of a product by comparable regulatory authorities of foreign countries must be obtained prior to the commencement of marketing the products in those countries. The time required to obtain such approval may be longer or shorter than that required for FDA approval. COMPETITION NUTRITIONAL PRODUCTS The nutritional products area is highly competitive with many large nationally known manufacturers and many smaller manufacturers and marketers of nutritional products. The Company knows of no other company that is developing or marketing a product that incorporates antibody technology combined with active cultures and other ingredients. Potential competitors, however, could be larger than the Company, have greater access to capital and may be better able to withstand volatile market conditions. Moreover, because the nutritional products industry generally has low barriers to entry, additional competitors could enter the market at any time. In that regard, although the nutritional products industry to date has been characterized by many relatively small participants, national or international companies (which may include pharmaceutical companies or other suppliers to mass merchandisers) may seek to enter or to increase their presence in this industry, which would have a material adverse effect on the Company's competitive position. The Company has assessed the factors that may make it competitive in this environment and believes that its central strength is that its products will be unique and distinct in the marketplace by offering direct immune enhancing benefits that are currently not offered by a single product.* Other nutritional or dietary supplement products, such as vitamins and herbs, may help the immune system to function better, but they do not provide specific immune protection against common pathogens.* The Company believes that its nutritional beverages will further be distinguished by the fact that they are fresh, refrigerated products that contain active cultures and antibodies while maintaining a superior taste to other nutritional beverages.* PHARMACEUTICAL PRODUCTS The human pharmaceutical and biotechnology industries are subject to intense competition as well as rapid and significant technological change. The Company is aware of companies which are developing products that will compete for the same disease markets. The Company expects that the pharmaceutical and biotechnology industries will continue to experience rapid technological development which may render the Company's processes and products non-competitive or obsolete. 15 The Company is aware of direct competition from companies with products designed to use immune mechanisms to treat infections and also potential competition from companies developing new antibiotics and other anti-infective substances. At least two companies, Biomune Systems, Inc. and ImmuCell Corp., are developing colostrum-derived or milk-derived antibody products for treating certain diseases; others are developing vaccines designed to elicit active immune defenses against H. PYLORI or C. DIFFICILE. Numerous pharmaceutical, biotechnology and chemical companies, academic institutions, governmental agencies and other public and private research organizations are conducting research and development in the area of infectious diseases, including research and development of new antibiotic products which will address the same diseases the Company has targeted. Many of these competitors, either alone or through collaborative arrangements with large pharmaceutical companies or academic institutions, have significantly greater financial, human and other resources and greater expertise in research and development, testing, manufacturing, marketing and distribution than the Company. Consequently, these competitors may succeed in developing, obtaining patent protection for, or commercializing technologies and products that are more effective, easier to use or less expensive than those the Company is developing. In addition, early entry into the market may have important advantages in gaining product acceptance and market share. Many of the Company's competitors, particularly large pharmaceutical companies, have significantly greater experience than the Company in conducting clinical trials and in obtaining FDA and other regulatory approvals of products. As a result, these competitors may succeed in obtaining regulatory approval earlier than the Company for products with similar indications. Moreover, if the Company is successful in forming a strategic alliance to commercialize its products, it may be required to compete with respect to manufacturing efficiency, an area in which it has no experience. The Company has assessed the factors that may make it competitive in this environment and believes that its central strengths are its proprietary dairy procurement and production processes, as well as its relationship with Land O'Lakes to provide the raw materials for manufacturing products on a large commercial scale. While there can be no assurance that other biopharmaceutical companies will not initiate relationships with other large dairy cooperatives to develop a similar procurement and production process, the Company believes that the resources required to duplicate a system of similar scale in time, dollars and expertise are substantial. EMPLOYEES At December 31, 1997, the Company had 17 employees, three of whom have Ph.D. degrees and two of whom have M.D. degrees (one of which also has a Ph.D. degree). Nine employees are currently working in research and development and three employees are working in the clinical regulatory area. The Company believes its employee relationships are good. RISK FACTORS Certain statements made in this Annual Report on Form 10-K, including those indicated by an asterisk above (some of which are summarized below), are forward-looking statements that involve risks and uncertainties, and actual results may differ. Factors that could cause actual results to differ include those identified below. GENERAL The Company's ability to satisfy its anticipated cash requirements through approximately the first quarter of 1999 for its working capital and capital requirements will depend upon numerous factors, including the progress of the Company's research and development programs, clinical trials, the timing and cost of obtaining regulatory approvals, marketing activities and its ability to secure strategic alliances. The Company's capital requirements also will depend on the levels of resources devoted to the development of manufacturing capabilities, technological advances, the status of competitive products and the ability of the Company to establish strategic alliances to provide funding for research, development and marketing. The 16 Company's ability to continue funding its planned operations beyond the first quarter of 1999 is dependent upon its ability to obtain additional funds through product revenues, equity or debt financing, strategic alliances, license agreements or from other financing sources. A lack of adequate funding could eventually result in the insolvency or bankruptcy of the Company. At a minimum, if adequate funds are not available, the Company may be required to delay or to eliminate expenditures for certain of its product development efforts or to license to third parties the rights to commercialize products or technologies that the Company would otherwise seek to develop itself. Because of the Company's significant long-term capital requirements, it may seek to raise funds when conditions are favorable, even if it does not have an immediate need for such additional capital at such time. If the Company has not raised funds prior to such time as the Company's needs for funding become immediate, the Company may be forced to raise funds when conditions are unfavorable which could result in significant dilution of the Company's current stockholders. Although at its inception GalaGen entered into a letter of intent with Land O'Lakes to enter into discussions regarding a strategic alliance for the commercialization of functional food products, no such discussions are currently underway. The Company intends to form additional strategic alliances that will leverage its technology to bring products to market, including alliances for marketing, manufacturing and distribution for all of its products. There are no assurances, however, that the Company will be able to form such strategic alliances. Without such alliances, the Company may not have the financial resources necessary to continue the development of certain, if not all, nutritional and pharmaceutical products. NUTRITIONAL PRODUCTS The Company, like any manufacturer of products that are designed to be ingested, faces an inherent risk of exposure to product liability claims in the event that the use of its products results in injury. In the event that the Company does not have adequate insurance or contractual indemnification, product liability claims could have a material adverse effect on the Company. The Company is not currently a named defendant in any product liability lawsuit. The successful assertion or settlement of any uninsured claim, a significant number of insured claims, or a claim exceeding the Company's insurance coverage could have a material adverse effect on the Company. The Company will be highly dependent upon consumers' perception of the safety and quality of its products as well as similar products distributed by other companies. Thus, the mere publication of reports asserting that such products may be harmful could have a material adverse effect on the Company, regardless of whether such reports are scientifically supported and regardless of whether the harmful effects would be present at the dosages recommended for such products. Although the ingredients in the Company's products have a long history of human consumption, some of the Company's products may contain innovative ingredients or combinations of ingredients. Although the Company believes all of its potential products will be safe when taken as directed by the Company, there is little long-term experience with human consumption of certain of these innovative product ingredients or combinations thereof in concentrated form. Although the Company performs research and/or tests the formulation and production of its products, it will sponsor only limited clinical studies or rely on other outside published data. The nutritional products area is highly competitive with many large nationally known manufacturers and many smaller manufacturers and marketers of nutritional products. The Company currently knows of no other company that is developing or marketing a product that incorporates antibody technology combined with active cultures and other ingredients. Potential competitors, however, could be larger than the Company, have greater access to capital and may be better able to withstand volatile market conditions. Moreover, because the nutritional products industry generally has low barriers to entry, additional competitors could enter the market at any time. In that regard, although the nutritional products industry to date has been characterized by many relatively small participants, there can be no assurance that national or international companies (which may include pharmaceutical companies or other suppliers to mass merchandisers) will not seek to enter or to increase 17 their presence in this industry. Increased competition in the industry could have a material adverse effect on the Company. Market and related data (including, without limitation, information as to the dollar amount of retail sales for the nutritional beverage market) were obtained from Frost & Sullivan, a competitive-market analysis firm. The Company has not independently verified the accuracy of such information, and, in any event, the methodology typically used in compiling market and related data means that such data is subject to inherent uncertainties and estimations. As a result, there can be no assurance as to the accuracy or completeness of the market and other similar information (including information as to sales) appearing in this Annual Report on Form 10-K. The Company believes that its pilot plant will meet the anticipated requirements for the production of nutritional products and believes that contract manufacturers would be available to increase its production capacity quickly, if required. However, given the limited manufacturing experience of the Company in nutritional products, no assurance can be given that the Company will be successful in producing acceptable product on a commercial scale and at acceptable costs in its pilot plant facility. The Company's nutritional products will be regulated by MDA under the appropriate license. PHARMACEUTICAL PRODUCTS Diffistat-G will require additional research and development and further extensive clinical testing and regulatory approval prior to any commercial sales. There can be no assurance that clinical testing of any of the Company's products will be completed successfully within any specified time period, if at all, or that a partner will be found with adequate resources to fund further clinical testing or research and development if needed. Time required for completion of trials may be affected by the rate at which patients meeting trial criteria can be found and enrolled. Moreover, the Company or the FDA may suspend clinical trials at any time if the subjects or patients participating in such trials are thought to be exposed to unacceptable health risks. Although the Company believes that its products are safe, there can be no assurance that the Company will not encounter problems in clinical trials which will cause the Company or the FDA to suspend clinical trials or which will result in delays in the Company's clinical trials. The Company's human clinical trials were preceded by preclinical testing in animals, and the Company is continuing to conduct additional animal studies as part of its development program. Such testing may not be predictive of the results seen in humans. The Company believes that certain of its products in development may face a shorter and less expensive path to regulatory approval than many other biopharmaceutical products. Factors that the Company believes may result in a shorter and less expensive path include the favorable safety profile of the Company's products and that multiple products can be manufactured by the Company using a single, proprietary manufacturing process and facility, and as a result will not require separate investments in manufacturing facilities or process techniques. However, GalaGen is still at an early stage of product development. The Company does not have the approval of the FDA for the sale of any products, nor is the Company aware of any other FDA-approved biologic based on bovine colostrum-derived polyclonal antibody technology for the human health care market. The Company's products will require significant laboratory and clinical testing, additional development and investment prior to commercialization. There can be no assurance that any of the Company's product development efforts will be successful or that any candidate products will prove to be safe and effective in clinical trials and receive necessary regulatory approvals. Even if the Company is able to develop products that receive required regulatory approvals, there can be no assurance that any such products will achieve market acceptance and be commercially successful. The Company believes that its pilot plant will meet the anticipated requirements for the production of pharmaceutical products, either for sale or clinical requirements, in 1998 and believes that contract manufacturers would be available to increase its production capacity quickly, if required. The Company does not 18 anticipate that it will need to fully validate the facility for pharmaceutical purposes in 1998. To successfully establish commercial pharmaceutical manufacturing capacity, the Company will have to scale up its manufacturing processes and demonstrate the ability to consistently manufacture a clinically safe pharmaceutical product. Given the limited manufacturing experience of the Company in pharmaceutical products, no assurance can be given that the Company will be successful in producing acceptable product on a commercial scale and at acceptable costs in its pilot plant facility. The Company's pharmaceutical products will be regulated by FDA as human biologics, respectively, and its manufacturing facility may have to be operational prior to its potential partner completing required pivotal clinical trials. The human pharmaceutical and biotechnology industries are subject to intense competition as well as rapid and significant technological change. The Company expects that the human pharmaceutical and biotechnology industries will continue to experience rapid technological development which may render the Company's processes and products noncompetitive or obsolete. GalaGen is also aware of companies which are developing products that will compete for the same disease markets as several of the Company's products. Many of these competitors, or potential competitors, either alone or through collaborative arrangements with large pharmaceutical companies or academic institutions, have significantly greater financial, human and other resources and greater expertise in research and development, testing, manufacturing, marketing and distribution than the Company. Consequently, these competitors may succeed in developing, obtaining patent protection for, or commercializing technologies and products that are more effective, easier to use or less expensive than those GalaGen is developing. 19 ITEM 2. PROPERTIES The Company leases approximately 4,500 square feet of administrative and laboratory space at the Land O'Lakes corporate office located in Arden Hills, Minnesota. In addition, the Company leases a portion of the existing Land O'Lakes pilot plant facility in Arden Hills for its current manufacturing needs to process antibody products for development, early stage clinical use and potential commercial use. At the end of 1996, the Company completed its pilot plant. Management believes that the Company's facilities are suitable and adequate for current office, research and manufacturing requirements. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material legal proceeding. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM X. EXECUTIVE OFFICERS OF REGISTRANT The executive officers of the Company are:
Name Age Position ---- --- -------- Robert A. Hoerr, M.D., Ph.D. 48 President and Chief Executive Officer John G. Watson 53 Chief Operating Officer Eileen F. Bostwick, Ph.D. 47 Vice President, Research and Development Michael E. Cady 45 Vice President, Manufacturing and Engineering Francois Lebel, M.D., FRCPC 46 Vice President, Scientific and Regulatory Affairs Gregg A. Waldon 37 Vice President, Chief Financial Officer, Secretary and Treasurer
ROBERT A. HOERR, M.D., PH.D., was named President and Chief Operating Officer of the Company in February 1994 and became President and Chief Executive Officer in September 1994. He served as Vice President, Medical and Regulatory Affairs of the Company from January 1993 to December 1993 and Senior Vice President from December 1993 to February 1994. Dr. Hoerr was Director of Medical Affairs for Sandoz Nutrition Corporation, a research-based nutrition company, from March 1990 to January 1993. From 1986 to 1990, Dr. Hoerr was Research Scientist and Assistant Program Director at the Clinical Research Center, Massachusetts Institute of Technology ("MIT"). Dr. Hoerr received his A.B. in Biology from Indiana University, his M.D. from Indiana University School of Medicine and his Ph.D. in Nutritional Biochemistry and Metabolism from MIT. JOHN G. WATSON has served as Chief Operating Officer of the Company since September 1996. From February 1992 to August 1996, Mr. Watson was President of Bioconsult, a consulting company servicing the biotechnology and pharmaceutical industry. Mr. Watson was Chief Operating Officer at Vestar, Inc., a pharmaceutical company (now NeXstar Pharmaceuticals, Inc., a biopharmaceutical company), from October 1988 to January 1992. From January 1982 to September 1988, Mr. Watson held various positions with American Cyanamid Company Corporation, a pharmaceutical, medical device and agricultural products company (now American Home Products, a pharmaceutical and consumer products company), including Director of Pharmaceutical and Medical Device Operation, Far East and Australia, and Chief Executive Officer of Northern Europe Operations. From 1980 to December 1982, Mr. Watson was a Pharmaceutical Product Director at Johnson & Johnson, a manufacturer of pharmaceuticals and health, baby and other products. Prior to that time he held various positions with The Dow Chemical Company, a manufacturer of chemicals, plastics and household pharmaceutical products, in London, England, Zurich, Switzerland and Midland, Michigan. A 20 graduate of Cambridge University, England, Mr. Watson earned his MBA as a Fulbright Scholar at Indiana University, Bloomington in 1973. EILEEN F. BOSTWICK, PH.D., has served as Manager of Research and Development since July 1992, Director of Research and Development since September 1993 and Vice President of Research & Development since March 1997. Dr. Bostwick joined the Company's predecessor, Procor Technologies, Inc. ("Procor") in 1988 as Immunology Group Leader. Prior thereto, Dr. Bostwick was a Senior Immunologist in the Biotechnology Section at Minnesota Mining & Manufacturing. Dr. Bostwick received her B.S. and M.S. degrees from Michigan State University in Dairy Science, and her Ph.D. in immunology and physiology from the University of Minnesota. MICHAEL E. CADY has served as Vice President, Manufacturing and Engineering of the Company since July 1992. From January 1988 to July 1992, Mr. Cady served as Director of Operations for Procor. From 1979 to 1988, Mr. Cady held engineering and planning positions within several operating groups at Land O'Lakes. Mr. Cady was a member of the Land O'Lakes group that evaluated and implemented the polyclonal antibody technology used as a basis for the Company's manufacturing process. Prior to joining Land O'Lakes Mr. Cady was an engineer at Swift & Company, a food processing company. Mr. Cady received his B.S. in Engineering from the University of Iowa and earned his M.B.A. from the University of St. Thomas in 1985. FRANCOIS LEBEL, M.D., FRCPC has served as Vice President, Scientific and Regulatory Affairs of the Company since December 1996. From April 1991 to October 1992, Dr. Lebel was Medical Director of Burroughs Wellcome Inc., a research-based pharmaceutial company. In October 1992, he was promoted to Vice President, Scientific Affairs for its Canadian operations and became a core member of the Research Committee of Burroughs Wellcome Co. (U.S.A.), a post he held until May 1995. From July 1985 to November 1996, Dr. Lebel served as an Assistant Professor of Medicine at McGill University and as an Associate Physician in the Division of Infectious Disease at Montreal General Hospital, in Canada. Dr. Lebel earned his B.Sc. in Biology and his M.D. at the University of Ottawa, Canada. He completed his post-graduate and research training at McGill University and Harvard Medical School. GREGG A. WALDON served as Controller of the Company from July 1992 to September 1992, and was elected Treasurer in September 1992, Secretary in March 1993, Vice President in December 1993 and Chief Financial Officer in November 1994. From April 1989 to April 1992, Mr. Waldon served as an Audit Manager with Price Waterhouse LLP, a public accounting firm, in its Middle Market and Emerging Growth Practice in Minneapolis, Minnesota and from 1986 to 1989 was Senior/Staff accountant with Price Waterhouse. Officers of the Company are chosen by and serve at the discretion of the Board of Directors. There are no family relationships among any of the directors, officers or key employees of the Company. 21 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Incorporated herein by reference is the information appearing under the heading "Market For Registrant's Common Equity and Related Stockholder Matters" in the Company's Annual Report to Stockholders for the year ended December 31, 1997 (the "1997 Annual Report"). ITEM 6. SELECTED FINANCIAL DATA Incorporated herein by reference is the information appearing under the heading "Selected Financial Data" in the 1997 Annual Report. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Incorporated herein by reference is the information appearing under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the 1997 Annual Report. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Incorporated herein by reference is the information appearing under the headings "Balance Sheets", "Statements of Operations", "Statement of Changes in Stockholders' Equity", "Statements of Cash Flows", "Notes to Financial Statements" and "Report of Independent Auditors" in the 1997 Annual Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Incorporated herein by reference is the information appearing under the headings "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's Proxy Statement dated March 30, 1998 (the "Proxy Statement"). See also Part I hereof under the heading "Item X. Executive Officers of Registrant". ITEM 11. EXECUTIVE COMPENSATION Incorporated herein by reference is the information appearing under the headings "Report of the Compensation Committee", "Executive Compensation" and "Comparative Stock Performance" in the Company's Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated herein by reference is the information appearing under the heading "Security Ownership of Principal Stockholders and Management" in the Company's Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated herein by reference is the information appearing under the heading "Certain Relationships and Related Transactions" in the Company's Proxy Statement. 22 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Documents filed as part of this report: 1. Financial Statements: The consolidated financial statements of the Company are incorporated herein by reference from the information appearing under the headings "Balance Sheets", "Statements of Operations", "Statement of Changes in Stockholders' Equity", "Statements of Cash Flows", "Notes to Financial Statements" and "Report of Independent Auditors" in the 1997 Annual Report. 2. Financial Statement Schedules: Financial statement schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. (b) Reports on Form 8-K No reports on Form 8-K were filed by the Company during the fourth quarter of the year ended December 31, 1997. (c) Exhibits: The following exhibits are filed as part of this Annual Report on Form 10-K for the year ended December 31, 1997.
Exhibit No. Description Method of Filing ----------- ----------- ---------------- 3.2 Restated Certificate of Incorporation of the Company.(3) Incorporated By Reference 3.4 Restated Bylaws of the Company.(1) Incorporated By Reference 4.1 Specimen Common Stock Certificate.(1) Incorporated By Reference 4.2 Warrant to purchase 13,541 shares of Common Stock of the Company Incorporated By issued to Piper Jaffray Inc., dated January 26, 1993.(1) Reference 4.3 Warrant to purchase 20,312 shares of Common Stock of the Company Incorporated By issued to Gus A. Chafoulias, dated October 12, 1993.(1) Reference 4.4 Warrant to purchase 20,312 shares of Common Stock of the Company Incorporated By issued to John Pappajohn, dated October 12, 1993.(1) Reference 4.5 Warrant to purchase 9,479 shares of Common Stock of the Company Incorporated By issued to Cato Holding Company, dated June 21, 1994.(1) Reference 4.6 Form of Common Stock Warrant to purchase shares of Common Stock Incorporated By of the Company, issued in connection with the sale of Reference 23 Exhibit No. Description Method of Filing ----------- ----------- ---------------- Convertible Promissory Notes.(1) 4.7 Warrant to purchase 17,144 shares of Series F-1 Convertible Incorporated By Preferred Stock of the Company issued to Chiron Corporation, Reference dated March 29, 1995.(1) 4.8 Warrant to purchase 42,856 shares of Series F-2 Convertible Incorporated By Preferred Stock of the Company issued to Chiron Corporation, Reference dated March 29, 1995.(1) 4.9 Warrant to purchase 60,000 shares of Series F-3 Convertible Incorporated By Preferred Stock of the Company issued to Chiron Corporation, Reference dated March 29, 1995.(1) 4.10 Warrant to purchase 80,000 shares of Series F-3 Convertible Incorporated By Preferred Stock of the Company issued to Chiron Corporation, Reference dated March 29, 1995.(1) 4.11 Warrant to purchase 18,250 shares of Common Stock of the Company Incorporated By issued to IAI Investment Funds VI, Inc. (IAI Emerging Growth Reference Fund), dated January 30, 1996.(1) 4.12 Warrant to purchase 6,250 shares of Common Stock of the Company Incorporated By issued to IAI Investment Funds IV, Inc. (IAI Regional Fund), Reference dated January 30, 1996.(1) 4.13 Warrant to purchase 25,000 shares of Common Stock of the Company Incorporated By issued to John Pappajohn, dated February 2, 1996.(1) Reference 4.14 Warrant to purchase 25,000 shares of Common Stock of the Company Incorporated By issued to Edgewater Private Equity Fund, L.P., dated February 2, Reference 1996.(1) 4.15 Warrant to purchase 10,000 shares of Common Stock of the Company Incorporated By issued to Joseph Giamenco, dated February 2, 1996.(1) Reference 4.16 Warrant to purchase 25,000 shares of Common Stock of the Company Incorporated By issued to Gus A. Chafoulias, dated February 2, 1996.(1) Reference 4.17 Warrant to purchase 25,000 shares of Common Stock of the Company Incorporated By issued to JIBS Equities, dated February 2, 1996.(1) Reference 4.18 Warrant to purchase 25,000 shares of Common Stock of the Company Incorporated By issued to Land O Lakes, Inc., dated February 2, 1996.(1) Reference 4.19 6% Convertible Debenture Purchase Agreement dated November 18, Incorporated By 1997 among the Company and the Purchasers named therein.(8) Reference 4.20 Registration Rights Agreement dated November 18, 1997 among the Incorporated By Company and the Holders named therein.(9) Reference 4.21 6% Convertible Debenture due May 18, 1999 issued to CPR (USA) Incorporated By Inc. dated November 18, 1997.(10) Reference 24 Exhibit No. Description Method of Filing ----------- ----------- ---------------- 4.22 6% Convertible Debenture due May 18, 1999 issued to Libertyview Incorporated By Plus Fund dated November 18, 1997.(11) Reference 4.23 6% Convertible Debenture due May 18, 1999 issued to Libertyview Incorporated By Fund, LLC dated November 18, 1997.(12) Reference 4.24 Stock Purchase Warrant issued to CPR (USA) Inc. dated Incorporated By November 18, 1997.(13) Reference 4.25 Stock Purchase Warrant issued to Libertyview Plus Fund dated Incorporated By November 18, 1997.(14) Reference 4.26 Stock Purchase Warrant issued to Libertyview Fund, LLC dated Incorporated By November 18, 1997.(15) Reference 4.27 Warrant issued to CLARCO Holdings dated as of Incorporated By December 1,1997.(16) Reference 4.28 Warrant issued to CLARCO Holdings dated as of Incorporated By December 1,1997.(17) Reference 4.29 Warrant issued to CLARCO Holdings dated as of Incorporated By December 1,1997.(18) Reference #10.1 License Agreement between the Company and Land O'Lakes dated Incorporated By May 7, 1992.(1) Reference #10.2 Royalty Agreement between the Company and Land O'Lakes dated Incorporated By May 7, 1992.(1) Reference #10.3 Supply Agreement between the Company and Land O'Lakes dated Incorporated By May 7, 1992.(1) Reference 10.4 Master Services Agreement between the Company and Land O'Lakes Incorporated By dated May 7, 1992.(1) Reference *10.5 GalaGen Inc. 1992 Stock Plan, as amended.(5) Incorporated By Reference 10.7 Stock and Warrant Purchase Agreement between the Company and Incorporated By Chiron Corporation dated March 20, 1995.(1) Reference #10.8 License and Collaboration Agreement between the Company and Incorporated By Chiron Corporation dated March 20, 1995.(1) Reference *10.9 GalaGen Inc. Employee Stock Purchase Plan, as amended.(2) Incorporated By Reference 10.10 Credit Agreement between the Company and Norwest Bank Minnesota, Incorporated By N.A., dated as of January 24, 1996.(1) Reference 10.11 Commitment Letter between the Company and Cargill Leasing Incorporated By Corporation, dated June 5, 1996.(2) Reference 10.12 Master Equipment Lease between the Company and Cargill Leasing Incorporated By Corporation, dated June 6, 1996.(2) Reference 25 Exhibit No. Description Method of Filing ----------- ----------- ---------------- 10.13 Agreement for Progress Payments between the Company and Cargill Incorporated By Leasing Corporation, dated June 6, 1996.(2) Reference 10.14 Agreement for Lease between the Company and Land O'Lakes, dated Incorporated By June 3, 1996.(2) Reference *10.15 Letter agreement with John G. Watson dated September 14, 1996.(3) Incorporated By Reference #10.16 Agreement with Colorado Animal Research Enterprises, Inc. dated Incorporated By November 1, 1996.(4) Reference *10.17 Letter agreement with Francois Lebel, M.D., dated December 27, Incorporated By 1996.(4) Reference *10.18 Consulting agreement with Stanley Falkow, Ph.D., dated Incorporated By January 15, 1997.(4) Reference *10.19 GalaGen Inc. Annual Short Term Incentive Cash Compensation Incorporated By Plan.(4) Reference *10.20 GalaGen Inc. Annual Long Term Incentive Stock Option Incorporated By Compensation Plan.(4) Reference *10.21 GalaGen Inc. 1997 Incentive Plan.(6) Incorporated By Reference 10.22 Master Loan and Security Agreement with TransAmerica Business Incorporated By Credit Corporation dated June 8, 1997.(7) Reference 10.23 Amended and Restated License Agreement between the Company and Electronic Land O'Lakes dated March 11, 1998. Transmission 11.1 Statement re: computation of per share earnings (loss). Electronic Transmission 13.1 1997 Annual Report to Stockholders Electronic Transmission 23.1 Consent of Ernst & Young LLP. Electronic Transmission 27.1 Financial Data Schedule for Year Ended December 31, 1997. Electronic Transmission 27.2 Restated Financial Data Schedule for Quarter ended March 31, Electronic 1996. Transmission
----------------------------------------------- (1) Incorporated herein by reference to the same numbered Exhibit to the Company's Registration Statement on Form S-1 (Registration No. 333-1032). (2) Incorporated herein by reference to the same numbered Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1996 (File No. 0-27976). 26 (3) Incorporated herein by reference to the same numbered Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1996 (File No. 0-27976). (4) Incorporated herein by reference to the same numbered Exhibit to the Company's Annual Report on Form 10-K for the period ended December 31, 1996 (File No. 0-27976). (5) Incorporated herein by reference to the same numbered Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1997 (File No. 0-27976). (6) Incorporated herein by reference to Appendix A to the Company's 1997 Definitive Proxy Statement on Schedule 14A (File No. 0-27976). (7) Incorporated herein by reference to the same numbered Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997 (File No. 0-27976). (8) Incorporated herein by reference to Exhibit No. 4.4 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (9) Incorporated herein by reference to Exhibit No. 4.5 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (10) Incorporated herein by reference to Exhibit No. 4.6 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (11) Incorporated herein by reference to Exhibit No. 4.7 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (12) Incorporated herein by reference to Exhibit No. 4.8 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (13) Incorporated herein by reference to Exhibit No. 4.9 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (14) Incorporated herein by reference to Exhibit No. 4.10 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (15) Incorporated herein by reference to Exhibit No. 4.11 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (16) Incorporated herein by reference to Exhibit No. 4.12 to Amendment No. 1 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (17) Incorporated herein by reference to Exhibit No. 4.13 to Amendment No. 1 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (18) Incorporated herein by reference to Exhibit No. 4.14 to Amendment No. 1 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). * Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K. # Contains portions for which confidential treatment has been granted to the Company. 27 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, on March 30, 1998. GALAGEN INC. By /s/ Robert A. Hoerr -------------------------------------- Robert A. Hoerr, M.D., Ph.D. Chief Executive Officer and President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 30, 1998. /s/ Robert A. Hoerr -------------------------------------------- Robert A. Hoerr, Chief Executive Officer and President (Principal Executive Officer) and Director /s/ Gregg A. Waldon -------------------------------------------- Gregg A. Waldon, Vice President, Chief Financial Officer, Treasurer and Secretary (Principal Financial Officer and Principal Accounting Officer) /s/ Arthur D. Collins, Jr. -------------------------------------------- Arthur D. Collins, Jr., Director /s/ Stanley Falkow -------------------------------------------- Stanley Falkow, Director /s/ Ronald O. Ostby -------------------------------------------- Ronald O. Ostby, Director /s/ R. David Spreng -------------------------------------------- R. David Spreng, Director /s/ Winston R. Wallin -------------------------------------------- Winston R. Wallin, Director 28 EXHIBIT INDEX
Exhibit Description Method of Filing - ------- ----------- ---------------- 3.2 Restated Certificate of Incorporation of the Incorporated By Company.(3) Reference 3.4 Restated Bylaws of the Company.(1) Incorporated By Reference 4.1 Specimen common stock Certificate.(1) Incorporated By Reference 4.2 Warrant to purchase 13,541 shares of common stock Incorporated By of the Company issued to Piper Jaffray Inc., dated Reference January 26, 1993.(1) 4.3 Warrant to purchase 20,312 shares of common stock Incorporated By of the Company issued to Gus A. Chafoulias, dated Reference October 12, 1993.(1) 4.4 Warrant to purchase 20,312 shares of common stock Incorporated By of the Company issued to John Pappajohn, dated Reference October 12, 1993.(1) 4.5 Warrant to purchase 9,479 shares of common stock Incorporated By of the Company issued to Cato Holding Company, Reference dated June 21, 1994.(1) 4.6 Form of common stock Warrant to purchase shares of Incorporated By common stock of the Company, issued in connection Reference with the sale of Convertible Promissory Notes.(1) 4.7 Warrant to purchase 17,144 shares of Series F-1 Incorporated By Convertible Preferred Stock of the Company issued Reference to Chiron Corporation, dated March 29, 1995.(1) 4.8 Warrant to purchase 42,856 shares of Series F-2 Incorporated By Convertible Preferred Stock of the Company issued Reference to Chiron Corporation, dated March 29, 1995.(1) 4.9 Warrant to purchase 60,000 shares of Series F-3 Incorporated By Convertible Preferred Stock of the Company issued Reference to Chiron Corporation, dated March 29, 1995.(1) 4.10 Warrant to purchase 80,000 shares of Series F-3 Incorporated By Convertible Preferred Stock of the Company issued Reference to Chiron Corporation, dated March 29, 1995.(1) 4.11 Warrant to purchase 18,250 shares of common stock Incorporated By of the Company issued to IAI Investment Funds VI, Reference Inc. (IAI Emerging Growth Fund), dated January 30, 1996.(1) 4.12 Warrant to purchase 6,250 shares of common stock Incorporated By of the Company issued to IAI Investment Funds IV, Reference Inc. (IAI Regional Fund), dated January 30, 1996.(1) 4.13 Warrant to purchase 25,000 shares of common stock Incorporated By of the Company issued to John Pappajohn, dated Reference February 2, 1996.(1) Exhibit Description Method of Filing - ------- ----------- ---------------- 4.14 Warrant to purchase 25,000 shares of common stock Incorporated By of the Company issued to Edgewater Private Equity Reference Fund, L.P., dated February 2, 1996.(1) 4.15 Warrant to purchase 10,000 shares of common stock Incorporated By of the Company issued to Joseph Giamenco, dated Reference February 2, 1996.(1) 4.16 Warrant to purchase 25,000 shares of common stock Incorporated By of the Company issued to Gus A. Chafoulias, dated Reference February 2, 1996.(1) 4.17 Warrant to purchase 25,000 shares of common stock Incorporated By of the Company issued to JIBS Equities, dated Reference February 2, 1996.(1) 4.18 Warrant to purchase 25,000 shares of common stock Incorporated By of the Company issued to Land O'Lakes, Inc., dated Reference February 2, 1996.(1) 4.19 6% Convertible Debenture Purchase Agreement dated Incorporated By November 18, 1997 among the Company and the Reference Purchasers named therein.(8) 4.20 Registration Rights Agreement dated November 18, Incorporated By 1997 among the Company and the Holders named Reference therein.(9) 4.21 6% Convertible Debenture due May 18, 1999 issued Incorporated By to CPR (USA) Inc. dated November 18, 1997.(10) Reference 4.22 6% Convertible Debenture due May 18, 1999 issued Incorporated By to Libertyview Plus Fund dated November 18, Reference 1997.(11) 4.23 6% Convertible Debenture due May 18, 1999 issued Incorporated By to Libertyview Fund, LLC dated November 18, Reference 1997.(12) 4.24 Stock Purchase Warrant issued to CPR (USA) Inc. Incorporated By dated November 18, 1997.(13) Reference 4.25 Stock Purchase Warrant issued to Libertyview Plus Incorporated By Fund dated November 18, 1997.(14) Reference 4.26 Stock Purchase Warrant issued to Libertyview Fund, Incorporated By LLC dated November 18, 1997.(15) Reference 4.27 Warrant issued to CLARCO Holdings dated as of Incorporated By December 1,1997.(16) Reference 4.28 Warrant issued to CLARCO Holdings dated as of Incorporated By December 1,1997.(17) Reference 4.29 Warrant issued to CLARCO Holdings dated as of Incorporated By December 1,1997.(18) Reference #10.1 License Agreement between the Company and Land Incorporated By O'Lakes dated May 7, 1992.(1) Reference Exhibit Description Method of Filing - ------- ----------- ---------------- #10.2 Royalty Agreement between the Company and Land Incorporated By O'Lakes dated May 7, 1992.(1) Reference #10.3 Supply Agreement between the Company and Land Incorporated By O'Lakes dated May 7, 1992.(1) Reference 10.4 Master Services Agreement between the Company and Incorporated By Land O'Lakes dated May 7, 1992.(1) Reference *10.5 GalaGen Inc. 1992 Stock Plan, as amended.(5) Incorporated By Reference 10.7 Stock and Warrant Purchase Agreement between the Incorporated By Company and Chiron Corporation dated March 20, Reference 1995.(1) #10.8 License and Collaboration Agreement between the Incorporated By Company and Chiron Corporation dated March 20, Reference 1995.(1) *10.9 GalaGen Inc. Employee Stock Purchase Plan, as Incorporated By amended.(2) Reference 10.10 Credit Agreement between the Company and Norwest Incorporated By Bank Minnesota, N.A., dated as of January 24, Reference 1996.(1) 10.11 Commitment Letter between the Company and Cargill Incorporated By Leasing Corporation, dated June 5, 1996.(2) Reference 10.12 Master Equipment Lease between the Company and Incorporated By Cargill Leasing Corporation, dated June 6, 1996.(2) Reference 10.13 Agreement for Progress Payments between the Incorporated By Company and Cargill Leasing Corporation, dated Reference June 6, 1996.(2) 10.14 Agreement for Lease between the Company and Land Incorporated By O'Lakes, dated June 3, 1996.(2) Reference *10.15 Letter agreement with John G. Watson dated Incorporated By September 14, 1996.(3) Reference #10.16 Agreement with Colorado Animal Research Incorporated By Enterprises, Inc. dated November 1, 1996.(4) Reference *10.17 Letter agreement with Francois Lebel, M.D., dated Incorporated By December 27, 1996.(4) Reference *10.18 Consulting agreement with Stanley Falkow, Ph.D., Incorporated By dated January 15, 1997.(4) Reference *10.19 GalaGen Inc. Annual Short Term Incentive Cash Incorporated By Compensation Plan.(4) Reference *10.20 GalaGen Inc. Annual Long Term Incentive Stock Incorporated By Option Compensation Plan.(4) Reference Exhibit Description Method of Filing - ------- ----------- ---------------- *10.21 GalaGen Inc. 1997 Incentive Plan.(6) Incorporated By Reference 10.22 Master Loan and Security Agreement with Incorporated By TransAmerica Business Credit Corporation dated Reference June 8, 1997.(7) 10.23 Amended and Restated License Agreement between the Electronic Company and Land O'Lakes dated March 11, 1998. Transmission 11.1 Statement re: computation of per share earnings Electronic (loss). Transmission 13.1 1997 Annual Report to Stockholders Electronic Transmission 23.1 Consent of Ernst & Young LLP. Electronic Transmission 27.1 Financial Data Schedule for Year ended December Electronic 31, 1997. Transmission 27.2 Restated Financial Data Schedule for Quarter ended Electronic March 31, 1996. Transmission
- ----------------------------- (1) Incorporated herein by reference to the same numbered Exhibit to the Company's Registration Statement on Form S-1 (Registration No. 333-1032). (2) Incorporated herein by reference to the same numbered Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1996 (File No. 0-27976). (3) Incorporated herein by reference to the same numbered Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1996 (File No. 0-27976). (4) Incorporated herein by reference to the same numbered Exhibit to the Company's Annual Report on Form 10-K for the period ended December 31, 1996 (File No. 0-27976). (5) Incorporated herein by reference to the same numbered Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1997 (File No. 0-27976). (6) Incorporated herein by reference to Appendix A to the Company's 1997 Definitive Proxy Statement on Schedule 14A (File No. 0-27976). (7) Incorporated herein by reference to the same numbered Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997 (File No. 0-27976). (8) Incorporated herein by reference to Exhibit No. 4.4 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (9) Incorporated herein by reference to Exhibit No. 4.5 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (10) Incorporated herein by reference to Exhibit No. 4.6 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (11) Incorporated herein by reference to Exhibit No. 4.7 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (12) Incorporated herein by reference to Exhibit No. 4.8 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (13) Incorporated herein by reference to Exhibit No. 4.9 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (14) Incorporated herein by reference to Exhibit No. 4.10 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (15) Incorporated herein by reference to Exhibit No. 4.11 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (16) Incorporated herein by reference to Exhibit No. 4.12 to Amendment No. 1 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (17) Incorporated herein by reference to Exhibit No. 4.13 to Amendment No. 1 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). (18) Incorporated herein by reference to Exhibit No. 4.14 to Amendment No. 1 to the Company's Registration Statement on Form S-3 (Registration No. 333-41151). * Management contact or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K. # Contains portions for which confidential treatment has been granted to the Company. EX-10.23 2 EXHIBIT 10.23 EXHIBIT 10.23 AMENDED AND RESTATED LICENSE AGREEMENT AMENDED AND RESTATED LICENSE AGREEMENT, dated as of May 7, 1992, and amended and restated as of March 11, 1998, by and between GalaGen Inc., a Delaware corporation ("Licensor") and Land O'Lakes, Inc., a Minnesota cooperative corporation ("Land O'Lakes"). Licensor and Land O'Lakes are parties to that certain License Agreement dated as of May 7, 1992 (the "1992 License Agreement") by and between Licensor's predecessor, Procor Technologies, Inc., a Minnesota corporation, and Land O'Lakes. Licensor and Land O'Lakes desire to amend and restate the 1992 License Agreement as provided herein. NOW, THEREFORE, in consideration of the promises and mutual covenants and agreements herein contained, the parties agree that the 1992 License Agreement shall be amended and restated in its entirety as set forth herein and shall be in full force and effect as follows: 1. DEFINITIONS. The following terms shall have the indicated meanings: "Animal Products" means any food or Functional Food, drug or medication for use by any animal. "Approved Collaborators" means the entities and businesses (and, in each case, their successors) listed on Schedule A attached hereto, as well as any others requested by Licensor from time to time and approved by Land O'Lakes. "Existing Procor Technology" means information, technology and skills possessed by Licensor as of the date of this Agreement for obtaining and processing bovine milk-derived, immunoglobulin (IgG) -based passive immunity products. "FDA" means the United States Food and Drug Administration. "Farm Animals" means all animals of the species which are raised on farms in the United States for food or food related purposes, such as cows, pigs, goats, sheep, chickens, turkeys, geese and ducks, and shall also include horses, dogs and cats. "Farm Animals" does not include animals that are primarily for laboratory use, such as primates, rats and mice. "Functional Foods" means foods, food additives, food components, food ingredients, dietary foods, chewing gum, snack foods, beverages, engineered foods, supplements and medical foods, in each case which are marketed for oral consumption and which provide any kind of nutritional, health or medical benefits or functionality, including the prevention or treatment of disease, but excluding (i) Infant Formula, (ii) any prescription drug for human use, or (iii) any over-the-counter drug for human use regulated by the FDA. "Infant Formula" means a liquid (or powder to be mixed with water) for oral consumption by human infants and children as a food or nutritional supplement. "New Technologies" means information, technology and skills now possessed or hereafter developed or acquired by Licensor for products or services that are not bovine milk-derived, immunoglobulin (IgG)-based passive immunity products or services. Transgenics is an example of a New Technology. "Procor Technology Improvements" means information, technology and skills developed or acquired by Licensor after the date of this License Agreement and prior to the fifteenth (15th) anniversary of the date of this License Agreement for obtaining or processing bovine milk-derived, immunoglobulin (IgG)-based passive immunity products. "Reserved Food Product" means any food product that (i) is included within one of the categories listed on Schedule B attached hereto and (ii) contains bovine milk-derived, immunoglobulin (IgG)-based passive immunity ingredients. "First Refusal Food Product" means any food product that (i) is included within one of the categories listed on Schedule C attached hereto and (ii) contains bovine milk-derived, immunoglobulin (IgG)-based passive immunity ingredients. 2. GRANT OF LICENSE; SUBLICENSING. (a) Upon the terms and conditions herein set forth, Licensor hereby grants Land O'Lakes a perpetual paid-up, world-wide license to use the Existing Procor Technology, whether patented or unpatented, for (i) Animal Products, (ii) Functional Foods, and (iii) Infant Formula. (b) Land O'Lakes shall have the right to sublicense to others the right to use the Existing Procor Technology, whether patented or unpatented, for use in (i) Animal Products and (ii) Functional Foods. Land O'Lakes shall provide Licensor with 15 days prior written notice of and a copy of any such sublicense. (c) Any sublicense granted by Land O'Lakes pursuant to this Section 2 shall require each sublicensee to maintain the confidentiality of confidential or proprietary Existing Procor Technology and other confidential or proprietary information of Licensor. 3. RIGHT OF FIRST REFUSAL. In the event Licensor intends to grant any third party any right to distribute or market (i) any Animal Products for use by Farm Animals and -2- which are based on New Technologies, or (ii) any Animal Products for use by animals other than Farm Animals and which are based on Procor Technology Improvements, then Licensor shall give written notice to Land O'Lakes prior to any such grant. Such notice shall state the material terms of the proposed grant, such as a description of the proposed distribution or marketing activities to be undertaken, the costs or obligations proposed to be borne by the third party, any quotas or minimums, pricing, commissions or other compensation, customer or prospect restrictions or requirements, and territories. Upon receipt of Licensor's written notice, Land O'Lakes shall have a right of first refusal for a period of ninety (90) days to enter into an agreement with Licensor to undertake the distribution and marketing activities described in Licensor's notice on the same terms as described in such notice. In the event that within such ninety (90) day period Land O'Lakes does not exercise such right of first refusal, then Licensor shall have the right for a subsequent ninety (90) day period to conclude its proposed grant of distribution or marketing rights to the third party on the terms stated in its notice to Land O'Lakes, free and clear of Land O'Lakes right of first refusal. If such grant is not completed within such subsequent ninety (90) day period, then Land O'Lakes right of first refusal shall again come into effect. 4. ROYALTY. In consideration for the license and rights hereunder granted, Land O'Lakes shall pay to Licensor a fee of $10,000.00, due and payable within fifteen (15) days after the date hereof, which amount constitutes payment for a fully paid license for the rights hereunder granted. No additional consideration shall be due. 5. DELIVERY OF DOCUMENTATION. Within sixth (60) days after execution of this Agreement, Licensor shall deliver to Licensee: (a) such documentation, data and information necessary and appropriate for the use and commercialization of Land O'Lakes; and (b) a complete, documented, up-to-date, and correct manufacturing protocol for all Animal Products which have been manufactured by Licensor to date. 6. OTHER ACTIVITIES BY LICENSOR. Licensor and Land O'Lakes acknowledge and agree that Licensor's ability to use, improve, exploit, license or share Existing Procor Technology, Procor Technology Improvements and New Technologies shall not be limited or restricted except as specifically provided herein. By way of example only (and not by way of limitation), notwithstanding Section 10 below, Licensor has the ability to compete with respect to any "Functional Food" that is not a "Reserved Food Product" or "First Refusal Food Product," on its own or with any Approved Collaborator (as determined from Schedule A hereto as amended from time to time). 7. REPRESENTATIONS, WARRANTIES AND COVENANTS. Licensor hereby covenants, represents and warrants that: -3- (a) it has full right and power to grant the license and immunities herein set forth; and (b) it has no license or other agreements with or obligations, commitments, liens or mortgages and encumbrances of any kind which may diminish, encumber or limit in any manner the right granted to Land O'Lakes hereunder. (c) it will not divest itself of any Existing Procor Technology, Procor Technology Improvements, or New Technology that is subject to Land O'Lakes' Right of First Refusal under Section 3 above, where the effect of its doing so may be to diminish, encumber or impair the rights of Land O'Lakes thereunder. 8. TERM. The term of this Agreement is perpetual. 9. CONFIDENTIALITY. Land O'Lakes and Licensor each agrees that during the term of this Agreement and thereafter it shall not disclose to any third party any confidential or proprietary information concerning the other party or the other party's business which has been or is hereafter obtained by it. Land O'Lakes and Licensor each further agrees to protect and treat with the same care it uses in the protection of its own proprietary information all confidential or proprietary information concerning the other party For purposes of this agreement "confidential or proprietary information" means all information concerning a party and its research, products, services, production techniques, trade secrets, marketing, customers and business plans, except where such information is or becomes generally known to the public by means other than a breach of this Agreement. 10. NON-COMPETITION. (a) Licensor shall not directly or indirectly, without Land O'Lakes prior written consent, prior to the fifteenth anniversary of the date of this Agreement, anywhere in the world use the Existing Procor Technology for manufacturing or marketing Animal Products or Reserved Food Product. (b) Licensor shall not directly or indirectly, without Land O'Lakes prior written consent, prior to the fifteenth anniversary of the date of this Agreement, anywhere in the world use the Procor Technology Improvements for manufacturing or marketing (i) Animal Products for Farm Animals or (ii) Reserved Food Product. (c) Land O'Lakes shall not directly or indirectly, prior to the fifteenth anniversary of the date of this Agreement, anywhere in the world engage in manufacturing or marketing (i) prescription drugs for human use, or (ii) over-the-counter drugs for human use which are regulated by the FDA. (d) Licensor shall not directly or indirectly, without providing Land O'Lakes with those rights of first refusal and participation provided in Section 11 below, prior to the fifteenth anniversary of the date of this Agreement, collaborate with any other person or entity -4- in manufacturing or marketing any First Refusal Food Product. Without intending to limit the scope of any other activities that would be permitted hereunder, Land O'Lakes and Licensor specifically acknowledge and agree that this Section 10(d) shall not limit (i) any research and development activities or discussions, which may include third parties, conducted as part of normal business development activities or (ii) Licensor's ability to purchase ingredients or other supplies from any supplier. (e) Licensor shall not directly or indirectly, without Land O'Lakes prior written consent, prior to the fifteenth anniversary of the date of this Agreement, collaborate with any other person or entity in manufacturing or marketing any Reserved Food Product. Without intending to limit the scope of any other activities that would be permitted hereunder, Land O'Lakes and Licensor specifically acknowledge and agree that this Section 10(e) shall not limit (i) any research and development activities or discussions, which may include third parties, conducted as part of normal business development activities or (ii) Licensor's ability to purchase ingredients or other supplies from any supplier. 11. RIGHTS OF FIRST REFUSAL AND PARTICIPATION. (a) If Licensor intends to collaborate with any other person or entity in manufacturing or marketing any First Refusal Food Product, then Licensor shall give written notice to Land O'Lakes prior to entering into any definitive agreement relating thereto. Such notice shall state the material terms of the proposed activities, such as a description of the proposed manufacturing, distribution or marketing activities to be undertaken, the costs or obligations proposed to be borne by each party, any quotas or minimums, pricing, commissions or other compensation, customer or prospect restrictions or requirements, specifications and quality parameters, and territories. Upon receipt of Licensor's written notice, Land O'Lakes shall have a right of first refusal for a period of thirty (30) days to enter into an agreement with Licensor to undertake the manufacturing, distribution and marketing activities described in Licensor's notice on the same terms as described in such notice. Land O'Lakes shall also have the right during such thirty (30) day period to negotiate in good faith its undertaking any part of the activities described in such notice if and to the extent that (i) Land O'Lakes is qualified to perform such activities as well or better than the other parties specified in the notice, consistent with the specifications and quality parameters required by the other participants and by applicable legal regulations and (ii) Land O'Lakes agrees to perform such activities on terms which are commercially reasonable and which are no less favorable than would be negotiated between unrelated parties in an arm's-length transaction. If within such thirty (30) day period Land O'Lakes does not exercise such rights of first refusal or participation, then Licensor shall have the right for a subsequent ninety (90) day period to conclude its proposed agreement relating to the activities described in its notice to Land O'Lakes on substantially the terms stated in such notice and thereafter to engage in such activities without any time limit, free and clear of Land O'Lakes rights of first refusal and participation. If such grant is not completed within such subsequent ninety (90) day period, then Land O'Lakes rights of first refusal and participation shall again come into effect. -5- (b) If Licensor intends to directly engage in manufacturing or marketing any First Refusal Food Product (as opposed to collaborating with any other person or entity, which is covered by Section 11(a) above), then Licensor shall give written notice to Land O'Lakes prior to commencing such manufacturing or marketing. Such notice shall describe in reasonable detail the proposed activities. Upon receipt of Licensor's written notice, Licensor and Land O'Lakes shall negotiate in good faith for a period of sixty (60) days to have Land O'Lakes undertake any part of the activities described in such notice if and to the extent that (i) Land O'Lakes desires to and is qualified to perform such activities consistent with the specifications and quality parameters required by the proposed activities and by applicable legal regulations and (ii) Land O'Lakes agrees to perform such activities on terms which are no less favorable than would be negotiated between unrelated parties in an arms's-length transaction. If Licensor negotiates with Land O'Lakes in good faith during such sixty (60) day period, then except to the extent Licensor and Land O'Lakes agree on Land O'Lakes' participation in the proposed activities, Licensor shall have the right to proceed with the activities described in its notice to Land O'Lakes on substantially the terms stated in such notice and thereafter to engage, without collaborating with any other person or entity, in such activities without any time limit, free and clear of any obligation to negotiate with Land O'Lakes regarding Land O'Lakes' participation in such activities. 12. NO WAIVER. No delay or failure by either party to enforce any right or claim which it may have hereunder shall constitute a waiver of such right or claim. Any waiver by a party of any term, provision or condition hereof or of any default hereunder shall be deemed to be a further or continuing waiver of such term, provision or condition or of any subsequent default hereunder. 13. NOTICES. Any notices required hereunder shall be given in writing and addressed, if to Land O'Lakes, at 4001 Lexington Avenue North, Arden Hills, Minnesota 55440, attention: President, and if to Purchaser, at 4001 Lexington Avenue North, Arden Hills, Minnesota 55440, Attention: President, or in each case at such other address as the notifying party may specify in a notice delivered hereunder to the other party. 14. HEADINGS. The headings in this Agreement are for convenience of reference only and do not form a part hereof and in no way interpret or construe this Agreement. 15. INTEGRATION; MODIFICATIONS. This Agreement constitutes the entire agreement between the parties hereto with respect to the transactions contemplated hereby, superseding any other understandings or agreements, oral or written, with respect thereof. By amending and restating this Agreement, the parties do not intend to and shall not be deemed to have in any way limited the scope of the waiver and consent provided by that letter agreement between Land O'Lakes and Licensor dated March 6, 1997 regarding Licensor's collaboration with Lifeway Foods, Inc. This Agreement shall be amended or modified only by a written instrument signed by the parties hereto. -6- 16. SEVERABILITY. If any term of this Agreement shall be deemed illegal or unenforceable, the other terms hereof shall not be affected thereby and shall continue in full force and effect. 17. BINDING EFFECT AND GOVERNING LAW. This Agreement shall be binding upon and inure to the benefit of the successors and assigns of the respective parties thereto. This Agreement shall be governed by and construed in accordance with the laws of the State of Minnesota. 18. ARBITRATION. (a) All disputes, controversies or claims arising out of or related to the interpretation or enforcement of this Agreement or any alleged breach, termination or claim of invalidity of this Agreement shall be settled finally and without resort to any legal proceedings (except for the enforcement of the arbitration award) by arbitration conducted in accordance with the provisions of this Section. (b) Notwithstanding the foregoing, the remedy at law for any breach of the provisions of this Section is acknowledged by the parties to be inadequate, and an aggrieved party seeking relief or remedies for such a breach shall have the right and is hereby granted the privilege, in addition to all other remedies at law or in equity, to temporary or permanent injunctive relief from any court of competent jurisdiction without the necessity of proving actual damage. (c) In the event of any dispute of the nature described in paragraph (a) above (including without limitation any dispute regarding an alleged breach or non-compliance, or whether a breach or non-compliance has been cured or cured within the specified period time, or any other aspect of a breach or cure and the dispute arises under or is related to this Agreement) either party may submit the dispute to arbitration by delivering a request for arbitration pursuant to paragraph (d) below. The arbitrator shall be empowered to require appropriate remedies including, but not limited to, termination of the obligation to pay amounts otherwise due or any other rights or obligations hereunder, or any combination thereof. The arbitrator shall not terminate obligations or rights under this Agreement on the basis of non-material breaches or unintentional breaches. Neither party shall have the right to terminate this Agreement or any portion hereof, except insofar as such termination is effected by arbitration according to the above guidelines. All arbitration proceedings shall be held in St. Paul, Minnesota in accordance with paragraph (d) below. Judgment upon the award rendered by the arbitrator may be entered in any court having jurisdiction thereof. Pending final resolution of the dispute, the parties shall continue to observe the limitations imposed by this Agreement and shall continue to make payment for amounts due in accordance with the provisions of this Agreement. (d) If any matter is submitted to arbitration pursuant to this Agreement, the following procedures will be followed: -7- (i) Either party may initiate arbitration proceedings by delivering a written request for arbitration to the other party stating with specificity the nature of the dispute or disputes to be arbitrated. (ii) Arbitration proceedings will be conducted by one arbitrator who will be chosen by mutual agreement of the parties. If the parties are unable to agree upon a single arbitrator within ten business days after receipt of the request for arbitration, then the arbitration proceedings will be conducted by three arbitrators, one chosen by each of the parties and the third chosen by the first two arbitrators. Each party will notify the other party, in writing, of the name and address of its arbitrator within 25 business days after receipt of the request for arbitration. Any party failing to give such written notice will forfeit the right to name an arbitrator, and the second arbitrator will be selected by the American Arbitration Association (AAA) in accordance with the Commercial Arbitration Rules then in effect. The two arbitrators so selected will choose a third. Unless otherwise agreed by the parties, no arbitrator will be an employee, officer, director, counsel, shareholder or consultant for any party to this Agreement. (iii) Each arbitrator will be paid a reasonable fee for his or her services and will be reimbursed for reasonable and necessary expenses upon submission of receipts therefor. The fees and expenses of the arbitrator(s), as well as all other out-of-pocket costs of arbitration required under the terms of this provision, will be shared equally by the parties. Costs resulting from requests not required by this provision will be borne by the party making the request. (iv) Discovery will be conducted in accordance with the Federal Rules of Civil Procedure, except as otherwise agreed by the parties or as ordered by the arbitrator(s). The arbitrator(s) will determine a discovery schedule which the parties will comply. (v) Unless otherwise agreed by the parties and the arbitrator(s), the arbitrator(s) will fix the date and specific location of the arbitration hearing and give the parties at least 30 days' advance notice of the date and location. The hearing will proceed in general in the manner of a non-jury trial under the Federal Rules of Civil Procedure and the arbitrator shall apply the Federal Rules of Evidence. The arbitrator(s) will entertain such presentation of sworn testimony and other evidence, written briefs, and/or oral argument as the parties may wish to present; however, no testimony or exhibits will be admissible unless the adverse party was afforded an opportunity to examine such witnesses and to inspect and copy such exhibits during the pre-hearing discovery phase. Any party may be represented by counsel at the hearing. A qualified court reporter will record and transcribe the proceeding. The arbitrator(s) will apply the substantive law of the State of Minnesota. -8- (vi) Upon request of either party, the arbitrator(s) will provide both parties with written findings of fact and conclusions of law. (vii) The decision of the arbitrator(s) will be in writing and will be signed by a majority of the arbitrators. The decision of the arbitrator(s) shall be binding. If the parties settle their dispute during the course of the arbitration, the arbitrator(s) will set forth the terms of the agreed settlement in an award. Such an award may be referred to as a consent award. (viii) Any matters not controlled by this provision will be controlled by the Commercial Arbitration Rules of the AAA in effect at the time of the arbitration hearing. IN WITNESS WHEREOF, this Amended and Restated License Agreement has been executed by the parties hereto as of March 11, 1998. LAND O'LAKES, INC. By /s/ Christopher Policinski -------------------------------- Its VP of Strategy & Development ---------------------------- GALAGEN INC. By /s/ Robert Hoerr -------------------------------- Its President & CEO ---------------------------- -9- EX-11.1 3 EXHIBIT 11.1 EXHIBIT 11.1 GALAGEN INC. (A DEVELOPMENT STAGE COMPANY) STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS (LOSS)
For the Year Ended December 31 ------------------------------------------- 1997 1996 1995 ----------- ------------ ----------- BASIC LOSS PER SHARE: Weighted average shares outstanding 7,184,722 6,604,902 1,904,059 ----------- ------------ ----------- ----------- ------------ ----------- Net loss applicable to common stockholders $(5,635,134) $(14,783,591) $(5,474,038) ----------- ------------ ----------- ----------- ------------ ----------- Basic net loss per share applicable to common stockholders $ (.78) $ (2.24) $ (2.87) ----------- ------------ ----------- ----------- ------------ ----------- DILUTED LOSS PER SHARE: Weighted average shares outstanding 7,184,722 6,604,902 1,904,059 Dilutive potential common shares - - - ----------- ------------ ----------- Total 7,184,722 6,604,902 1,904,059 ----------- ------------ ----------- ----------- ------------ ----------- Net loss applicable to common stockholders $(5,635,134) $(14,783,591) $(5,474,038) ----------- ------------ ----------- ----------- ------------ ----------- Diluted net loss per share applicable to common stockholders $ (.78) $ (2.24) $ (2.87) ----------- ------------ ----------- ----------- ------------ -----------
EX-13.1 4 EXHIBIT 13.1 EXHIBIT 13.1 GALAGEN INC. INDEX TO FINANCIAL INFORMATION 1997
Page ---- Management's Discussion and Analysis of Financial Condition and Results of Operations............................ 1 Balance Sheets...................................................... 5 Statements of Operations............................................ 6 Statement of Changes in Stockholders' Equity........................ 7 Statements of Cash Flows............................................ 13 Notes to Financial Statements....................................... 14 Report of Independent Auditors...................................... 26 Selected Financial Data............................................. 27 Market for Registrant's Common Equity and Related Stockholder Matters............................................ 29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS The information presented in this Annual Report to Stockholders for the year ended December 31, 1997 (the "Annual Report") contains forward-looking statements within the meaning of the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Such statements are subject to risks and uncertainties, including those discussed below under "Disclosure Regarding Forward-Looking Statements" and in the Company's Annual Report on Form 10-K for the year ended December 31, 1997 ("Form 10-K") under "Risk Factors", that could cause actual results to differ materially from those projected. Because actual results may differ, readers are cautioned not to place undue reliance on these forward-looking statements. GENERAL GalaGen has broadened its focus to include nutritional products and is utilizing its expertise in its platform antibody technology to develop a portfolio of proprietary nutritional products, including dietary supplements, which incorporate its Proventra-TM- Brand Natural Immune Components. These products will target needs of both consumers and healthcare professionals. GalaGen continues to develop oral pharmaceuticals that target life threatening and emerging pathogens. These antibodies used in nutritional and pharmaceutical products are food proteins that are derived from the milk collected in the first few milkings of a dairy cow after its calf is born. Using its proprietary procedures, the Company has produced antibodies that target specific pathogens infecting the human gastrointestinal tract, including bacteria and their toxins, parasites, fungi and viruses. Because the Company's antibodies are derived from cows' milk, they do not represent new chemical compounds with uncertain toxicity, but rather their components are commonly found in dairy foods that are already widely consumed. In August 1997, the Company announced that it was placing its Sporidin-G clinical trial on hold due to continuing decline in the patient population for the product's initial indication, AIDS-related CRYPTOSPORIDIUM PARVUM infection. The decline was brought about by the effectiveness and increased use of new AIDS therapies, including protease inhibitors and earlier administration of combination therapy. In December 1997, the Company introduced Basics Plus, a dietary supplement product, in conjunction with its marketing and manufacturing partner, Lifeway Foods. Basics Plus is the first product to emerge from the collaboration with Lifeway Foods and contains active beneficial kefir cultures and GalaGen's Proventra-TM- Brand Natural Immune Components. Diffistat-G, its pharmaceutical product in Phase II clinical development, is being developed for the treatment and prevention of antibiotic-associated diarrhea, a disease which annually affects more than 400,000 patients in the United States. RESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 GENERAL. The net loss applicable to common stockholders decreased by $9,148,457, or 61.9%, in 1997 to $5,635,134 from $14,783,591 in 1996 and increased by $9,309,553, or 170.1%, in 1996 from $5,474,038 in 1995. The decrease in 1997 and increase in 1996 was due primarily to a one time non-cash charge to earnings in April 1996 of $7,296,844 for a preferred stock dividend, as described below, relating to the value of additional shares issued to holders of certain preferred stock upon conversion into Common Stock at the closing of the Company's initial public offering (the "Offering"), which occurred in April 1996. Historical spending levels 1 may not be indicative of future spending levels. The Company is continuing its nutritional and pharmaceutical product development activity, which is planned to include costs relating to research and development activity, small-scale manufacturing, clinical trial activity and market research. For these reasons, the Company believes its expenses and losses will increase before any material product revenues are generated. RESEARCH AND DEVELOPMENT EXPENSES. Expenses for research and development decreased $1,321,803, or 25.1%, in 1997 to $3,935,817 from $5,257,620 in 1996 and increased $1,526,543, or 40.9%, in 1996 from $3,731,077 in 1995. The decrease in 1997 was due primarily to decreased clinical trial expenses associated with Sporidin-G of approximately $2,000,000 and decreased personnel and administration expenses of approximately $280,000 offset primarily by increased manufacturing expenses of approximately $440,000, increased clinical expenses for Diffistat-G of approximately $320,000 and increased nutritional products expense of approximately $200,000. The increase in 1996 as compared to 1995 was due primarily to increased expenses associated with the Sporidin-G clinical trial as well as increased development, clinical and personnel expenses for the Company's other products, offset by a $300,000 license fee paid to Chiron Corporation in 1995 in the form of Company stock. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased $76,642 or 4.1% in 1997 to $1,966,001 from $1,889,359 in 1996 and decreased $132,840, or 6.6%, in 1996 from $2,022,199 in 1995. The increase in 1997 is due primarily to increased public reporting and shareholder relations expense of approximately $157,000 and increased insurance costs of approximately $68,000 offset by decreased outside consulting expense of approximately $83,000 and decreased deferred compensation expense of approximately $65,000. The decrease in 1996 compared to 1995 was due primarily to a decrease of $136,200 in deferred compensation expense (see Note 9 of Notes to Financial Statements). INTEREST INCOME. Interest income was $448,322 in 1997, $605,548 in 1996 and $30,526 in 1995. The decrease in 1997 is attributable to the decreased level of investable funds. The increase from 1995 to 1996 was due to the investment of funds received by the Company from the Offering. INTEREST EXPENSE. Interest expense was $181,638 in 1997, $945,316 in 1996 and $506,709 in 1995. Interest expense for 1997 consisted primarily of line of credit interest expense of $91,679 (see Note 7 of Notes to Financial Statements) and convertible debt interest expense of $82,459 (see Note 8 of Notes to Financial Statements). Interest expense for 1996 was due primarily to warrants valued at $768,064 which were issued to guarantors of a line of credit for the Company and to purchasers of the Company's promissory notes and to interest over a period of approximately three months on the convertible promissory notes (the "Convertible Promissory Notes") issued by the Company. The Convertible Promissory Notes converted into Common Stock upon the closing of the Offering. Interest expense for 1995 related primarily to interest on the Convertible Promissory Notes. EXTRAORDINARY GAIN ON EXTINGUISHMENT OF DEBT. The extraordinary gain on extinguishment of debt of $605,421 in 1995 related to certain debt reduction settlements negotiated in connection with the termination of the Company's transgenics program (see Note 12 of the Notes to the Financial Statements). PREFERRED STOCK DIVIDEND. The preferred stock dividend of $7,296,844 in 1996 related to the value of additional Common Stock received by the holders of Convertible Promissory Notes, Series E and Series F-1 Preferred Stock upon the conversion of such securities into Common Stock at the closing of the Offering (the Convertible Promissory Notes converting first into Series D Preferred Stock which in turn converted immediately into Common Stock at the closing). The Convertible Promissory Notes and the Series D, Series E and Series F-1 Preferred Stock provided that their conversion prices be automatically adjusted to reflect the lower of their currently effective conversion price or 70% of the Offering price. 2 LIQUIDITY AND CAPITAL RESOURCES The Company was incorporated in March 1992. On July 24, 1992, Procor, the Company's predecessor, was merged with and into the Company (the "Procor-GalaGen Merger"). At the time of the Procor-GalaGen Merger, Procor was a wholly-owned subsidiary of Land O'Lakes. Since the Company's inception through December 31, 1997, investments in the Company have totaled approximately $53.1 million, including approximately $7.1 million of inter-company obligations payable to Land O'Lakes which were forgiven and recorded as contributed capital at the time of the Procor-GalaGen Merger, $17.9 million from the Offering (after deducting underwriting discounts and offering expenses) and approximately $28.1 million from private placements of equity and convertible debt and from conversion of accrued interest on such debt and the exercise of stock options and warrants. The Company has invested funds received in the Offering and these private placements in investment-grade, interest-bearing obligations. Cash used in operating activities decreased by $83,664, or 1.4%, in 1997 to $6,052,148 from $6,135,812 in 1996 and increased by $2,903,924, or 89.9%, in 1996 from $3,231,888 in 1995. Cash used in operations went primarily to fund operating losses and was offset slightly by changes in operating assets and liabilities. The Company invested $13,276 in 1997 and $7,498,343 in 1996 in available-for-sale securities. The Company invested $215,320 in 1997 and $1,264,342 in 1996 in equipment and tenant improvements related to the Company's pilot plant manufacturing facility, the majority of which has been subsequently financed through the line-of-credit (see Note 7 of Notes to the Financial Statements). The Company invested $63,685 in 1997, $193,012 in 1996 and $36,311 in 1995 in lab equipment, computer equipment and software and furniture used primarily to support the Company's operations. The Company's seven-year operating lease for manufacturing equipment is in effect through 2003 and requires future annual minimum payments of approximately $140,000. Additionally the Company's five-year lease agreement with Land O'Lakes for specified manufacturing space is in effect through June 2001 and requires future annual minimum payments of approximately $86,000 (see Note 10 of the Notes to the Financial Statements). The Company anticipates that its existing resources and interest thereon will be sufficient to satisfy its anticipated cash requirements through approximately the first quarter of 1999. The Company's working capital and capital requirements will depend upon numerous factors, including the progress of the Company's market research, product development and marketing and distribution for nutritional products in addition to the clinical trials, research and development programs and the timing of and cost of obtaining regulatory approvals and marketing activities for pharmaceutical products. The Company's capital requirements also will depend on the levels of resources devoted to the development of manufacturing capabilities, technological advances, the status of competitive products and the ability of the Company to establish strategic alliances to provide funding to the Company for research, development and marketing. The Company expects to incur substantial additional research and development and other costs, including costs related to clinical studies and marketing activities for both nutritional and pharmaceutical products. Capital expenditures may be necessary to obtain licensure of the existing pilot plant facility and to establish additional commercial scale manufacturing facilities. The Company will need to raise substantial additional funds for longer-term product development, manufacturing and marketing activities that may be required in the future. The Company's ability to continue funding its planned operations beyond the first quarter of 1999 is dependent upon its ability to generate product revenues or to obtain additional funds through equity or debt financing, strategic alliances, license agreements or from other financing sources. A lack of adequate revenues or funding could eventually result in the insolvency or bankruptcy of the Company. At a minimum, if adequate funds are not available, the Company may be required to delay or to eliminate expenditures for certain 3 of its product development efforts or to license to third parties the rights to commercialize products or technologies that the Company would otherwise seek to develop itself. Because of the Company's significant long-term capital requirements, it may seek to raise funds when conditions are favorable, even if it does not have an immediate need for such additional capital at such time. If the Company has not raised funds prior to such time as the Company's needs for funding become immediate, the Company may be forced to raise funds when conditions are unfavorable which could result in substantial dilution to the Company's current stockholders. YEAR 2000 ISSUES Certain of the Company's business systems may require updating to continue to function properly beyond 1999. The Company believes that it will have adequate resources for this purpose and does not expect to incur significant expenditures to address this issue. DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS This Annual Report to Stockholders contains certain forward looking statements within the meaning of Section 21E of the Exchange Act. Such forward-looking statements are based on the beliefs of the Company's management as well as on assumptions made by and information currently available to the Company at the time such statements were made. When used in this Annual Report, the words "anticipate," "believe," "estimate," "expect," "intend" and similar expressions, as they relate to the Company, are intended to identify such forward-looking statements. Although the Company believes these statements are reasonable, readers of this Annual Report should be aware that actual results could differ materially from those projected by such forward-looking statements as a result of the risk factors listed below and set forth in the Company's Form 10-K under the caption "Risk Factors." Readers of this Annual Report should consider carefully the factors listed below and under the caption "Risk Factors" in the Company's Form 10-K, as well as the other information and data contained in this Annual Report. The Company cautions the reader, however, that such list of factors under the caption "Risk Factors" in the Company's Form 10-K and listed below may not be exhaustive and that those or other factors, many of which are outside of the Company's control, could have a material adverse effect on the Company and its results of operations. Factors that could cause actual results to differ include, without limitation, the Company's ability to generate sufficient working capital and obtain necessary financing, the Company's ability to form strategic alliances with marketing and distribution partners, the Company's exposure to product liability claims, consumers' perception of product safety and quality, the Company's reliance on flawed market research, potential competitors that are larger and financially stronger, the Company's ability to receive regulatory approval for its products and the Company's ability to manufacture an acceptable product on a commercial scale. All forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the cautionary statements set forth hereunder and under the caption "Risk Factors" in the Company's Form 10-K. 4 GALAGEN INC. (A DEVELOPMENT STAGE COMPANY) BALANCE SHEETS
ASSETS December 31 ------------------------------ 1997 1996 ------------------------------ Current assets: Cash and cash equivalents .................. $ 155,908 $ 3,869,549 Available-for-sale securities .............. 7,511,619 7,498,343 Prepaid expenses ........................... 196,672 87,274 ------------- ------------- Total current assets ......................... 7,864,199 11,455,166 Property, plant and equipment ................ 1,869,974 1,687,838 Less accumulated depreciation ............. (363,355) (195,483) ------------- ------------- 1,506,619 1,492,355 Deferred expenses ............................ 158,953 11,944 ------------- ------------- Total assets ................................. $ 9,529,771 $ 12,959,465 ------------- ------------- ------------- ------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ........................... $ 559,498 $ 1,486,928 Note payable ............................... 238,250 - Accrued expenses ........................... 38,129 192,633 ------------- ------------- Total current liabilities .................... 835,877 1,679,561 Commitments Convertible notes, net of discount of $428,182 in 1997 .......................... 1,071,818 - Note payable, long term portion .............. 923,998 - Other long-term liabilities .................. 45,000 45,000 Stockholders' equity: Preferred Stock, $.01 par value: Authorized shares - 15,000,000 Issued and outstanding shares - none in 1997 and 1996 ...................... - - Common stock, $.01 par value: Authorized shares - 40,000,000 Issued and outstanding shares - 7,234,974 in 1997; 7,163,769 in 1996 ............ 72,350 71,638 Additional paid-in capital ................. 59,669,586 58,926,654 Deficit accumulated during the development stage ........................ (52,819,054) (47,183,920) Deferred compensation ...................... (269,804) (579,468) ------------- ------------- Total stockholders' equity ................. 6,653,078 11,234,904 ------------- ------------- Total liabilities and stockholders' equity ... $ 9,529,771 $ 12,959,465 ------------- ------------- ------------- -------------
See accompanying notes. 5 GALAGEN INC. (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF OPERATIONS
Period from November 17, 1987 Year ended December 31 (inception) to ---------------------------------------- December 31, 1997 1996 1995 1997 ----------------------------------------------------------------- Revenues: Product sales........................................ $ - $ - $ - $ 1,449,593 Product royalties.................................... - - - 62,747 Research and development revenues.................... - - 150,000 396,350 ------------ ------------- ------------ ------------- - - 150,000 1,908,690 Operating costs and expenses: Cost of goods sold................................... - - - 3,468,711 Research and development............................. 3,935,817 5,257,620 3,731,077 27,131,353 General and administrative........................... 1,966,001 1,889,359 2,022,199 16,014,596 ------------ ------------- ------------ ------------- 5,901,818 7,146,979 5,753,276 46,614,660 ------------ ------------- ------------ ------------- Operating loss......................................... (5,901,818) (7,146,979) (5,603,276) (44,705,970) Interest income........................................ 448,322 605,548 30,526 1,205,674 Interest expense....................................... (181,638) (945,316) (506,709) (2,627,335) ------------ ------------- ------------ ------------- Net loss before extraordinary gain..................... (5,635,134) (7,486,747) (6,079,459) (46,127,631) Extraordinary gain on extinguishment of debt........... - - 605,421 605,421 ------------ ------------- ------------ ------------- Net loss for the period and deficit accumulated during the development stage................................ (5,635,134) (7,486,747) (5,474,038) (45,522,210) Less preferred stock dividends......................... - (7,296,844) - (7,296,844) ------------ ------------- ------------ ------------- Net loss applicable to common stockholders............. $(5,635,134) $(14,783,591) $(5,474,038) $(52,819,054) ------------ ------------- ------------ ------------- ------------ ------------- ------------ ------------- Net loss per share applicable to common stockholders Basic and Diluted.................................... $ (.78) $ (2.24) $ (2.87) $ (25.93) Weighted average number of common shares outstanding Basic and Diluted.................................... 7,184,722 6,604,902 1,904,059 2,036,959
See accompanying notes. 6 GALAGEN INC. (A DEVELOPMENT STAGE COMPANY) STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Series A Series B Series C Preferred Stock Preferred Stock Preferred Stock ----------------------------------------------------------------------- Shares Amount Shares Amount Shares Amount ----------------------------------------------------------------------- Common stock issued to parent on January 1, 1988 at $1.00 per share..................................... Net loss for the year................................ Balance at December 31, 1988............................. Net loss for the year................................ Balance at December 31, 1989............................. Net loss for the year................................ Balance at December 31, 1990............................. Net loss for the year................................ Balance at December 31, 1991............................. Sale of 941,148 shares of GalaGen common stock in May 1992 at $1.23 per share.................... Merger of GalaGen with Procor Technologies, Inc. Issuance of 812,502 shares of GalaGen common stock to Land O'Lakes.................... Cancellation of Procor Technologies, Inc. common stock held by Land O'Lakes............... Contribution of payable to Land O'Lakes to capital of GalaGen........................... Sale of 2,500,000 shares of GalaGen Series A Preferred Stock in July 1992 at $2.00 per share, net of offering costs of $42,000.................. 2,500,000 $25,000 Exercise of stock option............................. Compensation related to stock options/warrants....... Net loss for the year................................ ----------------------------------------------------------------------- Balance at December 31, 1992............................. 2,500,000 25,000 - - - - Sale of 1,234,748 shares of GalaGen Series B Preferred Stock in March 1993 at $3.25 per share, net of offering costs of $18,460........... 1,234,748 $12,347 Sale of 539,000 shares of GalaGen Series C Preferred Stock in December 1993 at $5.00 per share, net of offering costs of $133,316.......... 539,000 $5,390 Exercise of stock option............................. Compensation related to stock warrants............... Net loss for the year................................ ----------------------------------------------------------------------- Balance at December 31, 1993............................. 2,500,000 25,000 1,234,748 12,347 539,000 5,390 Sale of 12,000 shares of GalaGen Series C Preferred Stock in March 1994 at $5.00 per share, net of offering costs of $5,479............ 12,000 120 Exercise of stock options............................ Common stock issued for services..................... Warrant valuation for convertible promissory notes............................................. Net loss for the year................................ ----------------------------------------------------------------------- Balance at December 31, 1994............................. 2,500,000 $25,000 1,234,748 $12,347 551,000 $5,510
7
Series F-1 Series E Preferred Stock Preferred Stock Common Stock Additional ---------------------------------------------------------- Paid-In Shares Amount Shares Amount Shares Amount Capital ------------------------------------------------------------------------ Common stock issued to parent on January 1, 1988 at $1.00 per share..................................... 13,541 $13,541 $ 36,459 Net loss for the year................................ --------------------------------- Balance at December 31, 1988............................. 13,541 13,541 36,459 Net loss for the year................................ --------------------------------- Balance at December 31, 1989............................. 13,541 13,541 36,459 Net loss for the year................................ --------------------------------- Balance at December 31, 1990............................. 13,541 13,541 36,459 Net loss for the year................................ --------------------------------- Balance at December 31, 1991............................. 13,541 13,541 36,459 Sale of 941,148 shares of GalaGen common stock in May 1992 at $1.23 per share.................... 941,148 9,411 1,148,923 Merger of GalaGen with Procor Technologies, Inc. Issuance of 812,502 shares of GalaGen common stock to Land O'Lakes.................... 812,502 8,125 21,875 Cancellation of Procor Technologies, Inc. common stock held by Land O'Lakes............... (13,541) (13,541) (36,459) Contribution of payable to Land O'Lakes to capital of GalaGen........................... 7,127,720 Sale of 2,500,000 shares of GalaGen Series A Preferred Stock in July 1992 at $2.00 per share, net of offering costs of $42,000.................. 4,933,000 Exercise of stock option............................. 13,541 135 16,532 Compensation related to stock options/warrants....... 27,000 Net loss for the year................................ ------------------------------------------------------------------------ Balance at December 31, 1992............................. - - - - 1,767,191 17,671 13,275,050 Sale of 1,234,748 shares of GalaGen Series B Preferred Stock in March 1993 at $3.25 per share, net of offering costs of $18,460........... 3,982,124 Sale of 539,000 shares of GalaGen Series C Preferred Stock in December 1993 at $5.00 per share, net of offering costs of $133,316.......... 2,556,294 Exercise of stock option............................. 14,895 149 18,184 Compensation related to stock warrants............... 112,000 Net loss for the year................................ ------------------------------------------------------------------------ Balance at December 31, 1993............................. - - - - 1,782,086 17,820 19,943,652 Sale of 12,000 shares of GalaGen Series C Preferred Stock in March 1994 at $5.00 per share, net of offering costs of $5,479............ 54,401 Exercise of stock options............................ 100,886 1,009 142,359 Common stock issued for services..................... 5,025 50 55,616 Warrant valuation for convertible promissory notes............................................. 77,000 Net loss for the year................................ ------------------------------------------------------------------------ Balance at December 31, 1994............................. - $ - - $ - 1,887,997 $18,879 $20,273,028
Deficit Accumulated Deferred During the Receivable Compen- Development From sation Stage Officer Total ---------------------------------------------------- Common stock issued to parent on January 1, 1988 at $1.00 per share..................................... $ 50,000 Net loss for the year................................ $ (1,724,853) (1,724,853) -------------- ------------- Balance at December 31, 1988............................. (1,724,853) (1,674,853) Net loss for the year................................ (2,819,808) (2,819,808) -------------- ------------- Balance at December 31, 1989............................. (4,544,661) (4,494,661) Net loss for the year................................ (2,863,109) (2,863,109) -------------- ------------- Balance at December 31, 1990............................. (7,407,770) (7,357,770) Net loss for the year................................ (3,103,948) (3,103,948) -------------- ------------- Balance at December 31, 1991............................. (10,511,718) (10,461,718) Sale of 941,148 shares of GalaGen common stock in May 1992 at $1.23 per share.................... 1,158,334 Merger of GalaGen with Procor Technologies, Inc. Issuance of 812,502 shares of GalaGen common stock to Land O'Lakes.................... 30,000 Cancellation of Procor Technologies, Inc. common stock held by Land O'Lakes.............. (50,000) Contribution of payable to Land O'Lakes to capital of GalaGen........................... 7,127,720 Sale of 2,500,000 shares of GalaGen Series A Preferred Stock in July 1992 at $2.00 per share, net of offering costs of $42,000.................. 4,958,000 Exercise of stock option............................. 16,667 Compensation related to stock options/warrants....... 27,000 Net loss for the year................................ (3,497,040) (3,497,040) ------------------------------------------------------- Balance at December 31, 1992............................. - (14,008,758) - (691,037) Sale of 1,234,748 shares of GalaGen Series B Preferred Stock in March 1993 at $3.25 per share, net of offering costs of $18,460........... 3,994,471 Sale of 539,000 shares of GalaGen Series C Preferred Stock in December 1993 at $5.00 per share, net of offering costs of $133,316.......... 2,561,684 Exercise of stock option............................. $ (18,333) - Compensation related to stock warrants............... 112,000 Net loss for the year................................ (7,523,499) (7,523,499) ---------------------------------------------------- Balance at December 31, 1993............................. - (21,532,257) (18,333) (1,546,381) Sale of 12,000 shares of GalaGen Series C Preferred Stock in March 1994 at $5.00 per share, net of offering costs of $5,479............ 54,521 Exercise of stock options............................ 18,333 161,701 Common stock issued for services..................... 55,666 Warrant valuation for convertible promissory notes............................................. 77,000 Net loss for the year................................ (5,394,034) (5,394,034) ---------------------------------------------------- Balance at December 31, 1994............................. $ - $(26,926,291) $ - $(6,591,527)
8 GALAGEN INC. (A DEVELOPMENT STAGE COMPANY) STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
Series A Series B Series C Preferred Stock Preferred Stock Preferred Stock ----------------------------------------------------------------------- Shares Amount Shares Amount Shares Amount ----------------------------------------------------------------------- Balance at December 31, 1994............................ 2,500,000 $ 25,000 1,234,748 $ 12,347 551,000 $ 5,510 Sale of 338,461 shares of GalaGen Series E Preferred Stock at $3.25 per share in December 1995, net of offering costs of $23,610............ Issuance of Series F-1 Preferred Stock at $17.50 per share to Chiron Corporation in March 1995..... Warrant valuation for Chiron Corporation agreement, net of offering costs of $24,803....... Exercise of stock options .......................... Common stock issued for services.................... Warrant valuation for convertible promissory notes ............................................ Deferred compensation related to stock options...... Amortization of deferred compensation............... Net loss for the year............................... ----------------------------------------------------------------------- Balance at December 31, 1995............................ 2,500,000 25,000 1,234,748 12,347 551,000 5,510 Sale of Series E Preferred Stock.................... Issuance of Series F-1 Preferred Stock.............. Warrant valuation for line of credit and notes...... Warrant valuation for Convertible Promissory Notes............................................ Conversion of Series A Preferred Stock.............. (2,500,000) (25,000) Conversion of Series B Preferred Stock.............. (1,234,748) (12,347) Conversion of Series C Preferred Stock.............. (551,000) (5,510) Conversion of Series F-1 Preferred Stock............ Conversion of Series E Preferred Stock.............. Conversion of Convertible Promissory Notes, net of financing costs of $131,010............... Initial public offering, net of offering costs of $2,078,225....................................... Preferred stock dividend............................ Stock issued through Employee Stock Purchase Plan............................................. Amortization of deferred compensation............... Deferred compensation adjustment, canceled options.......................................... Exercise of stock options........................... Net loss for the year............................... ----------------------------------------------------------------------- Balance at December 31, 1996............................ - $ - - $ - - $ -
9
Series F-1 Series E Preferred Stock Preferred Stock Common Stock Additional ---------------------------------------------------------- Paid-In Shares Amount Shares Amount Shares Amount Capital ------------------------------------------------------------------------ Balance at December 31, 1994............................ - $ - - $ - 1,887,997 $18,879 $20,273,028 Sale of 338,461 shares of GalaGen Series E Preferred Stock at $3.25 per share in December 1995, net of offering costs of $23,610............ 338,461 3,385 1,073,002 Issuance of Series F-1 Preferred Stock at $17.50 per share to Chiron Corporation in March 1995..... 17,143 171 299,829 Warrant valuation for Chiron Corporation agreement, net of offering costs of $24,803....... 125,197 Exercise of stock options .......................... 36,670 367 45,434 Common stock issued for services.................... 27,585 276 305,282 Warrant valuation for convertible promissory notes............................................. 33,333 Deferred compensation related to stock options...... 1,657,000 Amortization of deferred compensation............... Net loss for the year............................... ------------------------------------------------------------------------ Balance at December 31, 1995............................ 17,143 171 338,461 3,385 1,952,252 19,522 23,812,105 Sale of Series E Preferred Stock.................... 46,154 461 149,539 Issuance of Series F-1 Preferred Stock.............. 17,144 171 299,849 Warrant valuation for line of credit and notes...... 768,064 Warrant valuation for Convertible Promissory Notes............................................ (68,474) Conversion of Series A Preferred Stock.............. 677,063 6,771 18,229 Conversion of Series B Preferred Stock.............. 543,413 5,434 6,913 Conversion of Series C Preferred Stock.............. 248,758 2,488 3,022 Conversion of Series F-1 Preferred Stock............ (34,287) (342) 85,717 857 (515) Conversion of Series E Preferred Stock.............. (384,615) (3,846) 178,568 1,786 2060 Conversion of Convertible Promissory Notes, net of financing costs of $131,010............... 1,434,495 14,345 8,918,954 Initial public offering, net of offering costs of $2,078,225....................................... 2,000,000 20,000 17,901,775 Preferred stock dividend............................ 7,296,844 Stock issued through Employee Stock Purchase Plan............................................. 3,642 36 13,512 Amortization of deferred compensation............... Deferred compensation adjustment, canceled options.......................................... (261,200) Exercise of stock options........................... 39,861 399 65,977 Net loss for the year............................... ------------------------------------------------------------------------ Balance at December 31, 1996............................ - $ - - $ - 7,163,769 $71,638 $58,926,654
Deficit Accumulated Deferred During the Receivable Compen- Development From sation Stage Officer Total ---------------------------------------------------- Balance at December 31, 1994............................ $ - $(26,926,291) $ - $(6,591,527) Sale of 338,461 shares of GalaGen Series E Preferred Stock at $3.25 per share in December 1995, net of offering costs of $23,610............ 1,076,387 Issuance of Series F-1 Preferred Stock at $17.50 per share to Chiron Corporation in March 1995..... 300,000 Warrant valuation for Chiron Corporation agreement, net of offering costs of $24,803....... 125,197 Exercise of stock options .......................... 45,801 Common stock issued for services.................... 305,558 Warrant valuation for convertible promissory notes............................................. 33,333 Deferred compensation related to stock options...... (1,657,000) - Amortization of deferred compensation............... 476,266 476,266 Net loss for the year............................... (5,474,038) (5,474,038) ---------------------------------------------------- Balance at December 31, 1995............................ (1,180,734) (32,400,329) - (9,703,023) Sale of Series E Preferred Stock.................... 150,000 Issuance of Series F-1 Preferred Stock.............. 300,020 Warrant valuation for line of credit and notes...... 768,064 Warrant valuation for Convertible Promissory Notes............................................ (68,474) Conversion of Series A Preferred Stock.............. - Conversion of Series B Preferred Stock.............. - Conversion of Series C Preferred Stock.............. - Conversion of Series F-1 Preferred Stock............ - Conversion of Series E Preferred Stock.............. - Conversion of Convertible Promissory Notes, net of financing costs of $131,010............... 8,933,299 Initial public offering, net of offering costs of $2,078,225....................................... 17,921,775 Preferred stock dividend............................ 7,296,844 Stock issued through Employee Stock Purchase Plan............................................. 13,548 Amortization of deferred compensation............... 340,066 340,066 Deferred compensation adjustment, canceled options.......................................... 261,200 - Exercise of stock options........................... 66,376 Net loss for the year............................... (14,783,591) (14,783,591) ---------------------------------------------------- Balance at December 31, 1996............................ $ (579,468) $(47,183,920) $ - $ 11,234,904
10 GALAGEN INC. (A DEVELOPMENT STAGE COMPANY) STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
Series A Series B Series C Preferred Stock Preferred Stock Preferred Stock -------------------------------------------------------------------------- Shares Amount Shares Amount Shares Amount -------------------------------------------------------------------------- Balance at December 31, 1996......................... - $ - - $ - - $ - Amortization of deferred compensation............ Deferred compensation adjustment, canceled options....................................... Exercise of stock options........................ Common stock issued for services................. Discount valuation for convertible debentures.... Valuation of issued options & warrants........... Warrant valuation for note payable............... Stock issued through Employee Stock Purchase Plan.......................................... Net loss for the year............................ -------------------------------------------------------------------------- Balance at December 31, 1997......................... - $ - - $ - - $ - -------------------------------------------------------------------------- --------------------------------------------------------------------------
See accompanying notes. 11
Series F-1 Series E Preferred Stock Preferred Stock Common Stock Additional ---------------------------------------------------------- Paid-In Shares Amount Shares Amount Shares Amount Capital ------------------------------------------------------------------------ Balance at December 31, 1996......................... - $ - - $ - 7,163,769 $71,638 $58,926,654 Amortization of deferred compensation............ Deferred compensation adjustment, canceled options....................................... (35,800) Exercise of stock options........................ 64,703 647 79,004 Common stock issued for services................. 1,493 15 14,376 Discount valuation for convertible debentures.... 500,182 Valuation of issued options & warrants........... 98,450 Warrant valuation for note payable............... 78,800 Stock issued through Employee Stock Purchase Plan.......................................... 5,009 50 7,920 Net loss for the year............................ ------------------------------------------------------------------------ Balance at December 31, 1997......................... - $ - - $ - 7,234,974 $72,350 $59,669,586 ------------------------------------------------------------------------ ------------------------------------------------------------------------
Deficit Accumulated Deferred During the Receivable Compen- Development From sation Stage Officer Total ----------------------------------------------------- Balance at December 31, 1996......................... $(579,468) $(47,183,920) $ - $ 11,234,904 Amortization of deferred compensation............ 273,864 273,864 Deferred compensation adjustment, canceled options....................................... 35,800 - Exercise of stock options........................ 79,651 Common stock issued for services................. 14,391 Discount valuation for convertible debentures.... 500,182 Valuation of issued options & warrants........... 98,450 Warrant valuation for note payable............... 78,800 Stock issued through Employee Stock Purchase Plan.......................................... 7,970 Net loss for the year............................ (5,635,134) (5,635,134) ----------------------------------------------------- Balance at December 31, 1997......................... $(269,804) $(52,819,054) $ - $ 6,653,078 ----------------------------------------------------- -----------------------------------------------------
12 GALAGEN INC. (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF CASH FLOWS
Period from November 17, 1987 Year ended December 31 (inception) to ------------------------------------------------ December 31, 1997 1996 1995 1997 ------------------------------------------------------------------- OPERATING ACTIVITIES: Net loss................................................ $(5,635,134) $(14,783,591) $(5,474,038) $(52,819,054) Adjustments to reconcile net loss to cash used in operating activities: Depreciation and amortization......................... 408,403 68,797 128,966 1,300,561 Deferred compensation amortization.................... 273,864 340,066 476,266 1,090,196 Preferred stock dividend.............................. - 7,296,844 - 7,296,844 Warrants issued, net.................................. - 768,064 - 907,064 Loss on equipment disposal............................ - - 468 221,524 Extraordinary gain on extinguishment of debt.......... - - (605,421) (605,421) Notes issued for services............................. - - - 1,915,000 Stock issued for services and license agreement....... 14,391 - 1,005,558 1,075,615 Deferred expense...................................... - - - (76,806) Changes in operating assets and liabilities: Inventory........................................ - - - (738,636) Prepaid expenses................................. (31,738) (5,571) (20,961) (108,607) Other assets..................................... - 123,967 (99,670) (110,528) Accounts payable and accrued expenses............ (1,081,934) 55,612 887,617 1,510,767 Other long-term liabilities...................... - - 469,327 653,404 ----------- ------------ ----------- ------------ Net cash used in operating activities................... (6,052,148) (6,135,812) (3,231,888) (38,488,077) ----------- ------------ ----------- ------------ INVESTING ACTIVITIES: Purchase of property, plant and equipment............... (279,005) (1,457,354) (36,311) (2,942,948) Purchase of available-for-sale securities, net.......... (13,276) (7,498,343) - (7,511,619) Purchase of trademark................................... - - - (50,000) Purchase of equipment from Land O'Lakes................. - - - (729,941) ----------- ------------ ----------- ------------ Net cash used in investing activities................... (292,281) (8,955,697) (36,311) (11,234,508) ----------- ------------ ----------- ------------ FINANCING ACTIVITIES: Proceeds from Land O'Lakes borrowings................... - - - 12,733,223 Proceeds from sale of stock to Land O'Lakes............. - - - 50,000 Proceeds from sale of common stock, net of offering costs................................................. - 17,921,775 - 19,096,776 Proceeds from sale of preferred stock................... - 450,020 676,387 12,695,083 Proceeds from common stock options exercised............ 79,651 66,376 45,801 353,529 Proceeds from borrowings from investors................. - 500,000 - 700,000 Proceeds from convertible notes, net of issuance costs.. 1,380,919 - 2,500,000 7,740,919 Net proceeds from note payable.......................... 1,162,248 - - 1,162,248 Payment to Land O'Lakes................................. - - - (4,100,000) Payment to investors on borrowings...................... - (500,000) - (700,000) Proceeds from Chiron warrant purchase................... - - 125,197 125,197 Proceeds from Employee Stock Purchase Plan.............. 7,970 13,548 - 21,518 ----------- ------------ ----------- ------------ Net cash provided by financing activities............... 2,630,788 18,451,719 3,347,385 49,878,493 ----------- ------------ ----------- ------------ Increase (decrease) in cash............................. (3,713,641) 3,360,210 79,186 155,908 Cash and cash equivalents at beginning of period........ 3,869,549 509,339 430,153 - ----------- ------------ ----------- ------------ Cash and cash equivalents at end of period.............. $ 155,908 $ 3,869,549 $ 509,339 $ 155,908 ----------- ------------ ----------- ------------ ----------- ------------ ----------- ------------ SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Discount valuation for convertible debentures........... $ 500,182 $ - $ - $ 500,182 Valuation of issued options & warrants.................. 177,250 - 33,333 287,583 Deferred compensation recognized for employee options... - - 1,657,000 1,657,000 Deferred compensation adjustment, canceled options...... 35,800 261,200 - 297,000 Conversion of convertible promissory notes plus related accrued interest, net of financing costs.............. - 8,864,825 - 8,864,825
13 GALAGEN INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS GalaGen Inc. is utilizing its expertise in its platform antibody technology to develop a portfolio of proprietary nutritional products, including dietary supplements. These products will target needs of both consumers and healthcare professionals. GalaGen is also developing oral pharmaceuticals that target life threatening and emerging pathogens. These antibodies used in nutritional products and pharmaceuticals are derived from the milk collected in the first few milkings of a dairy cow after its calf is born. Using its proprietary procedures, the Company has produced antibodies that target specific pathogens infecting the human gastrointestinal ("GI") tract, including bacteria and their toxins, parasites, fungi and viruses. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CASH EQUIVALENTS Cash equivalents include short-term highly liquid investments purchased at cost, which approximates market, with remaining maturities of three months or less. INVESTMENTS Investments in debt securities with a remaining maturity of more than three months at the date of purchase are classified as marketable securities. Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Debt securities are classified as available-for-sale as of December 31, 1997 and 1996. The book value of the investments approximates their estimated market value. The estimated market value of investments by security type as of December 31, 1997 and 1996 is as follows:
1997 1996 ---------- ---------- Corporate debt securities $1,939,501 $2,686,131 U.S. Government securities 1,397,838 2,012,987 U.S. Treasury securities 4,174,280 2,602,968 Investment grade debt securities - 196,257 ---------- ---------- $7,511,619 $7,498,343 ---------- ---------- ---------- ----------
All investments as of December 31, 1997 and 1996 have a contractual maturity of one year or less. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are recorded at cost and depreciated primarily on a straight-line basis over their estimated useful lives of three to seven years. At December 31, 1996, construction in progress consisted of leasehold improvements and manufacturing equipment in connection with the Company's pilot plant manufacturing facility. The Company transferred the construction in progress to its respective asset account and began depreciation in the third quarter of 1997. At December 31, 1997 and 1996, property, plant and equipment consisted of the following: 14
1997 1996 ----------- ----------- Furniture, fixtures and equipment $1,869,974 $ 423,496 Construction in progress - 1,264,342 1,869,974 1,687,838 Less accumulated depreciation (363,355) (195,483) ----------- ----------- $1,506,619 $1,492,355 ----------- ----------- ----------- -----------
RESEARCH AND DEVELOPMENT COSTS All research and development costs are charged to operations as incurred. INCOME TAXES Income taxes are accounted for using the liability method. Deferred income taxes are provided for temporary differences between financial reporting and tax bases of assets and liabilities. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. NET LOSS PER SHARE In 1997, the Financial Accounting Standards Board issued Statement No. 128, EARNINGS PER SHARE ("Statement 128"). Statement 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. All earnings per share amounts for all periods have been presented, and where appropriate, restated to conform to Statement 128 requirements. STOCK BASED COMPENSATION The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK BASED COMPENSATION ("Statement 123"), but applies Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25"), and related interpretations in accounting for its stock plans. Under APB 25, when the exercise price of stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. 3. MERGER In March 1992, GalaGen was incorporated as a wholly-owned subsidiary of its predecessor, Procor Technologies, Inc.("Procor"), a wholly-owned subsidiary of Land O'Lakes Inc. ("Land O'Lakes"), and issued 270 shares of its $.01 par value common stock to Procor for $1.23 per share. In May 1992, GalaGen sold 941,148 shares of its common stock to certain outside investors and future officers, directors, and advisors of GalaGen for $1.23 per share. Effective July 24, 1992, GalaGen was merged with Procor and GalaGen was the surviving entity. As part of this merger, the 13,541 shares of Procor's common stock held by Land O'Lakes were converted into 812,502 shares of $.01 par value common stock of GalaGen. Additionally, the 270 shares of common stock of GalaGen issued to Procor were canceled and $7,127,720 of inter-company obligations owed to Land O'Lakes were forgiven and recorded as contributed capital. 15 4. RELATED PARTY TRANSACTIONS During 1992, the Company entered into the following agreements with Land O'Lakes: PURCHASE AND SALE OF ASSETS AGREEMENT Land O'Lakes purchased from the Company all equipment, inventory, and certain other assets and assumed all current liabilities at book value, which approximated $1,636,000. The purchase price was paid by crediting against other indebtedness owed by the Company to Land O'Lakes. ROYALTY AGREEMENT The Company will pay to Land O'Lakes a royalty on net receipts from any product, other than infant formula, which is based on existing technology or technology improvements, as defined by the agreement. The Company will pay an additional royalty on net receipts from infant formula based on existing or improved technology and an additional royalty on net receipts from infant formula based on new technology, as defined by the agreement. This agreement will continue until terminated by both parties. Royalty payments range from one to two percent of net receipts. LICENSE AGREEMENT The Company has licensed to Land O'Lakes the rights to use the Company's existing technologies and technology improvements, as defined by the agreement, for Land O'Lakes' use in animal products, functional foods and infant formula. The Company received a lump sum license fee. The Company has agreed not to compete for fifteen years in the area of animal products and functional foods based on milk and colostrum based immunoglobulin technology. Land O'Lakes has agreed not to compete for fifteen years in the areas of prescription drugs and over-the-counter drugs regulated by the Food and Drug Administration. The term of this agreement is perpetual. In March 1997, Land O'Lakes granted a five-year license, an amendment to the license above, in the area of functional foods to use existing technology and future technology improvements in the development, formulation, manufacture, marketing, distribution and sale of kefir-based products, as defined in the granted license. In consideration of granting the Company this license, Land O'Lakes will receive a royalty of five percent from food components or ingredients sold by the Company to be included in a kefir-based product and one percent of net receipts from a kefir-based finished product sold by the Company. In March 1998, the Company and Land O'Lakes signed an amended and restated license agreement in which the Company has significantly broadened its rights to develop and market functional foods. Under the restated license agreement, the Company can use, improve, exploit, license or share existing technology, technology improvements and new technologies, as defined, in all areas except under certain "reserved food" and "first refusal food product" categories. SUPPLY AGREEMENT The Company has entered into an agreement with Land O'Lakes whereby the Company will purchase and Land O'Lakes will supply, at their option, all of the Company's commercial requirements for colostrum and milk. As part of this agreement, Land O'Lakes will provide expertise in dairy herd selection, on-farm management, membership relations and procurement to the Company for the manufacture of antibody material. The agreement will last for ten years and Land O'Lakes, at its sole discretion, has the option to extend the agreement for an additional ten years. 16 MASTER SERVICES AGREEMENT The Company has entered into an agreement with Land O'Lakes whereby the Company may purchase services from Land O'Lakes for certain administrative and research and development activities. This agreement will enable the Company to access expertise, on an as-needed basis, from Land O'Lakes. The agreement terminated on December 31, 1992, but has been renewed annually and is currently extended through December 31, 1998. The Company was charged approximately $442,000, $682,000 and $641,000 in 1997, 1996 and 1995, respectively, in accordance with the Master Services Agreement. STRATEGIC ALLIANCE LETTER OF INTENT The Company and Land O'Lakes have entered into a letter of intent for good faith discussions designed to lead to a definitive agreement regarding a strategic alliance to provide research, development, regulatory and product support, manufacturing, marketing, sales and distribution for certain functional food products. PROMISSORY NOTE The Company issued a promissory note to Land O'Lakes for $4,000,000 as part of the merger. This note had an interest rate of five percent and was due December 31, 1992. Payment of $3,000,000 plus accrued interest of $43,333 was made upon the sale of the Series A preferred stock. Land O'Lakes extended the remaining $1,000,000 note for consideration of $100,000. The $1,000,000, accrued interest of $50,959 and the $100,000 extension fee were paid in 1993. Subsequent to 1992, the Company has entered into other related party agreements as noted below: In December 1995 and January 1996, Land O'Lakes and certain investment funds controlled by IAI purchased 169,230 and 76,923 shares, respectively, of Series E preferred stock at $3.35 per share. In January 1996, the Company entered into a $2.7 million line of credit agreement with a commercial bank, which expired with the closing of the Company's initial public offering (the "Offering"). Loans under this line of credit were guaranteed by six parties and the guarantee was collateralized by letters of credit posted by them in the aggregate amount of $2.7 million. In consideration for the guarantees and letters of credit posted by these parties, the Company issued warrants to purchase an initial aggregate of 162,011 shares of common stock at $7.00 per share. In connection with this transaction Land O'Lakes guaranteed $500,000 of the $2.7 million line of credit, and in exchange received a warrant to purchase 30,002 shares of common stock at $7.00 per share. See Note 9. In January 1996, the Company issued two convertible promissory notes for $375,000 and $125,000 to two investment funds controlled by IAI. The notes became due on completion of the Offering. The notes were convertible into Series E preferred stock at the option of the holder. In connection with these notes, the Company issued warrants to purchase 30,001 shares which are identical to the line of credit warrants described above. The notes have been repaid. In June 1996, the Company entered into a five-year lease agreement with Land O' Lakes for specified space within the Land O' Lakes facility in connection with the Company's pilot plant manufacturing facility. See Note 10. In December 1996, the Company entered into an equipment operating lease which was guaranteed by Land O'Lakes. See Note 10. 17 5. REVERSE STOCK SPLIT On January 19, 1996, the Board approved a reverse stock split of 3.6923-for-1 for the Company's outstanding common stock. The Company's stockholders approved this reverse stock split in March 1996. Certain information in the financial statements with respect to the common stock and to the conversion prices and ratios of the preferred stock have been adjusted to reflect this change. The reverse stock split had no effect upon the numbers of shares of preferred stock issued and outstanding (as opposed to the conversion prices of the preferred stock and the numbers of shares of common stock into which the preferred stock converted). 6. STOCK INITIAL PUBLIC OFFERING GalaGen Inc. consummated the Offering on April 1, 1996, which consisted of 2,000,000 shares of common stock at a $10 per share price to the public. All of the Company's preferred stock mandatorily converted into common stock immediately prior to the closing of the Offering. The 2,500,000 shares of Series A preferred stock, 1,234,748 shares of Series B preferred stock and 551,000 shares of Series C preferred stock that were outstanding prior to the Offering were converted into 677,063, 543,413 and 248,758 shares of common stock, respectively, upon the closing of the Offering. The $8,275,000 of Convertible Promissory Notes to investors, plus accrued interest, that were outstanding prior to the Offering converted into shares of Series D preferred stock and simultaneously into 1,434,495 shares of common stock upon the closing of the Offering. The 338,461 shares of Series E preferred stock and 34,287 shares of Series F stock outstanding prior to the Offering were converted into 178,568 and 85,717 shares, respectively, of common stock upon the closing of the Offering. PREFERRED STOCK DIVIDEND The Series D preferred stock, Series E preferred stock and Series F-1 preferred stock converted into common stock at 70% of the Offering price. These reductions in the conversion prices to 70% of the Offering price were valued at $7,296,844 and recorded as a non-cash preferred stock dividend to arrive at the net loss available to holders of common stock in the calculation of net loss per share. EMPLOYEE STOCK PURCHASE PLAN In March 1996, the Company adopted the Employee Stock Purchase Plan whereby 270,833 shares of common stock have been reserved. All employees who have met the service eligibility requirements are eligible to participate and may direct the Company to make payroll deductions of one to 10 percent of their compensation during a purchase period for the purchase of shares under the plan. Participants may purchase up to 5,000 shares of common stock for a given calendar year provided the fair market value of the stock is not more than $25,000 (determined at the beginning of each purchase period). The plan provides a participating employee the right, subject to certain limitations, to purchase the Company's common stock at a price equal to the lower of 85% of the fair market value of the Company's common stock on the first day, or the last day, of the applicable purchase period. The first purchase period commenced on July 1, 1996 and ended on December 31, 1996, of which 3,642 shares of common stock were issued to employees for $13,548. In May 1997, the Employee Stock Purchase Plan was amended by stockholders to have two six month purchase periods beginning on January 1 and July 1 of each year. In 1997, 8,279 shares of common stock were purchased of which 5,009 shares were issued in 1997. 7. LINE-OF-CREDIT In June 1997, the Company established a $2,000,000 line-of-credit for fixed assets with Transamerica Business Credit Corporation ("Transamerica") which extends through June 1998. Terms of the line-of-credit 18 include monthly payments over four years equal to 2.5837% of each advance with a final balloon payment of 12.5% at the end of the four-year period. The line-of-credit is secured by the Company's fixed assets. Transamerica received a warrant for 40,000 shares of common stock granted at the fair market value on the date of grant. The warrant was valued at approximately $79,000 and will be amortized to interest expense over the expected term of the outstanding line-of-credit. The Company drew approximately $1,319,000 of the line-of-credit in 1997, of which $1,162,248 is outstanding at December 31, 1997. 8. CONVERTIBLE DEBENTURES In November 1997, the Company raised $1,500,000 through the private placement sale of 6% convertible debentures (the "Debentures") to three institutional investors pursuant to Regulation D under the Securities Act of 1933. The principal and interest of the Debentures can be converted into shares of the Company's common stock at 82.5% of the lowest closing bid price of the Company's common stock three days prior to conversion. One-third of the Debentures can convert to common stock upon the effective date of registration, one-third after five months from the closing date and the remaining one third twelve months after the closing date or nine months if the price of the common stock does not average at least $2.00 per share in the eighth month after closing. An aggregate maximum of 1,400,000 discounted shares of common stock (the "Discounted Shares") can be issued upon the conversion of the Debentures, with each investor owning at any given time a maximum of 4.99% of the then issued and outstanding shares of common stock. If there remains any unconverted principal and accrued interest due to all the Discounted Shares being issued, the Company has the obligation to repay the investors, in the aggregate, a maximum principal of $500,000. The Debentures automatically convert into the Discounted Shares eighteen months from the closing date. Five-year warrants were issued to the investors to purchase, in the aggregate, 200,000 shares of common stock at 110% of the market value of the common stock on the closing date. The value of the warrants plus the value of the discount of the Discounted Shares was $500,182, which the Company is amortizing over the term of the Debentures. In 1997, $72,000 was amortized and recorded as interest expense. A deferred expense was recorded for $119,081, which represents costs associated with closing the Debentures. These deferred expenses are being amortized until the Debentures are converted into Discounted Shares. In 1997, $9,378 was amortized and recorded as an expense. In February and March 1998, $499,500 of Debenture principal plus accrued interest was converted into 718,543 shares of common stock. The net carrying value of the Debentures approximates fair market value. In connection with this private placement, the Company has reserved 1,129,062 shares of common stock for issuance. 9. OPTIONS AND WARRANTS STOCK OPTION PLAN The Company has established a 1992 Stock Plan (the "1992 Plan") and a 1997 Incentive Plan (the "1997 Plan"), under which both incentive and non-qualified options may be granted, which have reserved 880,210 and 1,250,000 shares of common stock, respectively, for issuance. The Company uses these plans as an incentive for employees, directors and technical advisors. Stock awards in the aggregate of 100,000 shares of common stock may also be granted under the 1997 Plan. Options are granted at fair market value as determined on the date of grant and normally vest over three to five years. 19 The following plan and non-plan options are outstanding at December 31, 1997:
Outside Weighted 1992 Plan 1997 Plan Plans Average Options Options Options Option Outstanding Outstanding Outstanding Price ----------- ----------- ----------- -------- Balance at December 31, 1994.......... 353,842 27,082 $4.86 Granted.............................. 272,076 140,830 6.66 Exercised............................ (36,684) - 1.25 Canceled............................. (238,101) (13,541) 6.97 ---------- ---------- Balance at December 31, 1995.......... 351,133 154,371 5.67 Granted.............................. 477,476 57,003 4.68 Exercised............................ (39,902) - 1.66 Canceled............................. (118,479) (25,730) 7.36 ---------- ---------- Balance at December 31, 1996.......... 670,228 185,644 4.74 Granted.............................. 379,300 3.96 Exercised............................ (51,162) (13,541) 1.23 Canceled............................. (69,335) (60,000) (4,334) 4.51 ---------- ----------- ---------- Balance at December 31, 1997.......... 549,731 319,300 167,769 $4.96 ---------- ----------- ---------- ---------- ----------- ----------
The following table summarizes information about the stock options outstanding at December 31, 1997:
Options Outstanding Options Exercisable ------------------------------------------------- ------------------------ Weighted Weighted-Average Weighted Average Range of Number Remaining Average Number Exercise Exercise Price Outstanding Contractual Life Exercise Price Exercisable Price -------------- ----------- ---------------- -------------- ----------- --------- $ 1.23 5,416 LESS THAN 1 year $ 1.23 5,416 $ 1.23 2.50 - 3.25 21,000 10 years 3.21 15,000 3.25 3.69 163,439 LESS THAN 1 year 3.69 114,166 3.69 4.00 510,000 9 years 4.00 122,000 4.00 4.88 50,000 4 years 4.88 16,667 4.88 5.25 - 5.38 45,471 3 years 5.37 14,802 5.37 5.75 128,000 4 years 5.75 25,600 5.75 7.39 16,249 3 years 7.39 2,166 7.39 11.08 97,225 3 years 11.08 39,532 11.08 ---------- --------- $1.23 - 11.08 1,036,800 $ 4.96 355,349 $ 4.86 ---------- --------- ---------- ---------
Options expire in five years and three months to ten years from the grant date. Fully vested and exercisable options were 355,349, 189,986 and 161,426 as of December 31, 1997, 1996 and 1995, respectively. The weighted average exercise prices for the fully vested and exercisable options as of December 31, 1997, 1996 and 1995 were $4.86, $3.80 and $2.63, respectively. In May 1997, the Company granted options for 20,000 shares of common stock to two consultants for services provided, of which 15,000 are fully vested. In August 1997, a consultant was granted a stock award, based upon the value of the common stock at the date of grant, from the 1997 Plan of 1,493 shares of common stock in exchange for services provided. WARRANTS In January 1993, the Company granted a warrant to purchase 13,541 shares of the Company's common stock at $12.00 per share to an investment banking firm for financial advisory services. This warrant expires May 1998. 20 In June 1993, the Company granted a warrant to purchase 9,479 shares of the Company's common stock at $.18 per share to a contract research organization for services rendered in 1993. Expense was recorded for the difference between the exercise price and fair market value of the common stock, as determined by the Board of Directors. This warrant expires December 1998. In October 1993, the Company granted a warrant to purchase 20,312 shares of the Company's common stock at $18.46 per share to each of a board member and an investor in return for their guarantee for the Company's line of credit. These warrants expire October 1998. In connection with the June 1994 to October 1995 Convertible Promissory Notes (the "Notes") issuance of $8,275,000, each Note holder received a warrant, exercisable at $11.07 per share, to purchase that number of shares of common stock equal to 20% of the principal amount of such holder's Note divided by $11.07. The Company granted warrants to purchase 149,384 shares of the Company's common stock. These warrants expire five years from the date of grant, which range from June 1999 to October 2000. In March 1995, Chiron was issued warrants to purchase 200,000 shares of the Company's Series F preferred stock for which the Company was paid $150,000. The Company issued the warrants to purchase 200,000 shares of Series F preferred stock to Chiron as follows: (i) warrant to purchase 17,144 shares of Series F-1 preferred stock, exercise price of $17.50 per share (pre-Offering) or $24.00 per share (post-Offering); (ii) warrant to purchase 42,856 shares of Series F-2 preferred stock, exercise price of $18.70 per share (pre-Offering) or $27.00 per share (post-Offering); (iii) warrant to purchase 60,000 shares of Series F-3 preferred stock, exercise price of $25.00 per share (pre-Offering) or $33.00 per share (post-Offering); and (iv) warrant to purchase 80,000 shares of Series F-3 preferred stock, exercise price of $25.00 per share (pre-Offering) or $36.00 per share (post-Offering). If, after the Company's Offering, the market value (as defined in the purchase agreement for the warrants) of a share of common stock is less than the stated post-Offering exercise price of any such warrant, the exercise price is reduced to such per share market value and the number of shares of common stock covered by the warrant are increased proportionately. Based upon the warrant agreements, the ceiling price for the warrants described in clauses (ii), (iii) and (iv) above were set at the closing of the Offering at $10.11, $9.24 and $10.08, respectively, per share of common stock. Chiron exercised the warrant described in clause (i) above in March 1996 which converted into 42,860 shares of common stock at the closing of the Company's Offering. Assuming the remaining three warrants were exercised in full on December 31, 1997, 3,117,672 shares of the Company's common stock would have been issued upon such exercise based upon the twenty day average of the average of the high and low closing market price, as reported by Nasdaq National Market, prior to December 31, 1997 of $1.93 per share. The warrants expire on the earlier of six years from the date of issuance or 120 days after the warrant holder receives notice from the Company of the occurrence of certain defined milestone events. See Note 10. In January 1996, the Company granted warrants to purchase 162,011 shares of common stock at $7.00 per share to six parties, one of which is a company which has a representative on the Company's Board which received a warrant to purchase 30,002 shares of common stock, in return for their guarantee on the Company's $2.7 million line of credit. The Company also granted warrants to purchase 7,500 and 22,501 shares of the Company's common stock at $7.00 per share to certain investment funds associated with a representative on the Company's Board in return for their issuance of two convertible promissory notes totaling $500,000. These warrants expire February 2001. The difference between the Offering price and exercise price of these warrants multiplied by the number of warrants, plus the intrinsic value of the warrants was $768,064 which was recorded as interest expense in 1996. In March 1997, the Company issued warrants to purchase 10,000 shares of common stock, granted at the fair market value on the date of grant, for certain services to be rendered. The warrant expires in March 2002. 21 In connection with the line-of-credit, Transamerica received a five-year warrant for 40,000 shares of common stock granted at the fair market value on the date of grant. The intrinsic value of the warrant is approximately $79,000 and is being amortized to interest expense over the expected term of the outstanding line-of-credit. See Note 7. In conjunction with the issuance of the Debentures, the Company issued warrants to purchase 200,000 shares of the Company's common stock at 110% of the market value of the common stock on the closing date of the Debentures. The intrinsic value of these warrants is $182,000, which is being amortized as interest expense. These warrants expire in December 2002. See Note 8. In December 1997, the Company issued five-year warrants to financial consultants to purchase 25,000, 40,000 and 75,000 shares of common stock at $2.50, $3.00 and $6.50, respectively, which was greater than the market value of the common stock at the date of grant. These warrants have an intrinsic value of $50,450 which is being amortized over the term of the consulting relationship. The warrant for 75,000 shares of common stock will vest upon the Company's common stock trading for ten consecutive days, from the time of grant until June 30, 1998, at or greater than $6.50 per share. STOCK OPTION AND WARRANT AGREEMENT REVISIONS In March 1994, the Company canceled all common stock option and warrant agreements that were issued in 1993 that had exercise prices of $12.00 per share and $18.46 per share and issued new stock option and warrant agreements with the same terms and conditions except that the grant prices were $7.38 per share and $11.07 per share, respectively. In August 1996, the Company canceled all common stock option agreements, totaling 57,715 shares of common stock under the Plan and 18,958 shares of common stock outside of the Plan, with the exception of officer and director options, that were issued with a grant price greater than the fair market value at the date of re-grant and issued new stock option agreements with the same terms and conditions except that the grant prices were $5.375 per share. STOCK-BASED COMPENSATION The Company has elected to follow APB 25 and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under Statement 123, requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, if the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Pro forma information regarding net loss and loss per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of Statement 123. The fair value for these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions for 1997, 1996 and 1995: risk-free interest rates approximating 6.2%; volatility factor of the expected market price of the Company's common stock ranging from .3 to .527 and a weighted-average expected life of the option of 5 years. The weighted average fair value of the options granted in 1997 and 1996 is $2.16 and $2.54 per share, respectively, as computed as described above. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions. 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 22 materially affect the fair value estimate, in management's opinion, the existing models may 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 options' vesting period. The Company's pro forma information is as follows:
1997 1996 1995 ----------- ------------ ----------- Pro forma amortized expense .......... $ 435,589 $ 165,762 $ 1,763 Pro forma net loss applicable to common stockholder. ............. $(6,070,723) $(14,949,353) $(5,475,801) Pro forma net loss per common share, Basic and Diluted................... $ (0.84) $ (2.26) $ (2.88)
The pro forma effect on net loss for 1997, 1996 and 1995 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 related to grants made prior to 1995. DEFERRED COMPENSATION In December 1995, the Company canceled certain stock option agreements within the Plan and certain stock options that were outside of the Plan that had grant prices ranging from $7.38 per share to $11.07 per share and issued new stock option agreements with the same terms and conditions except that the grant prices were $3.69 per share. The Company recorded $1,657,000 as deferred compensation for the difference between the new grant price per share of common stock and the fair market value of the common stock per share on the date of grant, as determined by the board of directors, multiplied by the total number of options affected. In December 1997 and 1996, the Company adjusted the deferred compensation balance by $35,800 and $261,200 to account for terminated employee options that were not vested. The deferred compensation is amortized ratably over the vesting period of the options. In 1997, 1996 and 1995, $273,864, $340,066 and $476,266 was amortized, respectively. The remaining deferred compensation is expected to be amortized as follows: 1998............................ $185,400 1999............................ 82,400 2000............................ 2,004 -------- $269,804 -------- --------
10. COMMITMENTS The Company has commitments under the following agreements: LICENSE AGREEMENTS In March 1993, Nestec, an affiliate of Nestle' Ltd., granted a license to the Company, including the right to grant sublicenses, relating to the production and use of bovine anti-rotavirus and anti-E. Coli antibodies derived from milk and colostrum for therapeutic and prophylactic applications. The license is exclusive in North America and semi-exclusive in the rest of the world and obligates the Company to pay royalties on products incorporating the licensed technology. 23 In September 1993, Institut Pasteur granted the Company an exclusive worldwide license to certain applications relating to human passive immunity. Conversely, the Company granted Institut Pasteur an exclusive worldwide license relating to certain technology regarding active immunity. Both license agreements expire upon the earlier of ten years from the date of the first commercial sale arising out of the use of these certain technologies or upon the expiration of the last to issue licensed patent on a country-by-country basis. In March 1995, the Company entered into a License and Collaboration Agreement with Chiron Corporation involving the licensing of Chiron adjuvant technology and a collaboration to research and develop passive immune therapies using bovine antibodies for certain products. Pursuant to this Agreement, Chiron has granted an exclusive worldwide license for certain of Chiron's proprietary adjuvant technology to the Company for which the Company issued 17,143 shares of its Series F-1 preferred stock to Chiron. Additionally, Chiron has been granted certain rights to exclusively market a certain product for which the Company was paid $100,000. See Note 9. In November 1997, the Company entered into a product development agreement with Taste Technologies, Inc. to collaborate on the creation of nutritional products containing GalaGen antibodies. Based upon their contributions Taste Technologies is entitled to receive royalties on certain net sales. The royalties on the above agreements range from one-half to five percent, depending on the volume, of certain net sales. OTHER AGREEMENTS A three-year service agreement that began in 1996 for specified raw material preparation assistance requires minimum payments of approximately $24,000 in 1998 and $14,000 in 1999. The Company entered into a clinical service agreement with a contract research organization in June 1997. This agreement requires payment over the length of the clinical trial that is anticipated to be completed in 1998. The agreement requires a minimum payment of approximately $36,000 in 1998. LEASE COMMITMENTS The Company leases certain office equipment under an operating lease. During June 1996, the Company entered into a five-year lease agreement with Land O'Lakes for specified space within the Land O'Lakes facility in connection with the Company's pilot plant manufacturing facility. The lease calls for annual payments of approximately $87,000 and can be extended for additional one-year periods at the option of the Company. In December 1996, the Company entered into an operating lease with Cargill Leasing Corporation for $835,393 of manufacturing equipment for the Company's pilot plant facility. Lease payments of $10,990 per month plus tax will continue for a period of seven years with the Company's option to extend for an additional 12 months. The rental percentage was computed on a weighted average of the 30-day LIBOR rate and the rate on five-year U.S. Treasury Notes. The lease is guaranteed by Land O'Lakes. 24 The total lease expense was $199,808, $3,133 and $9,547, respectively, for the years ended December 31, 1997, 1996, and 1995. The future minimum annual lease payments are as follows: 1998..................... $ 228,000 1999..................... 228,000 2000..................... 227,000 2001..................... 184,000 2002..................... 140,000 Thereafter............... 140,000 ---------- $1,147,000 ---------- ----------
11. INCOME TAXES Prior to the effective date of the merger with Procor, GalaGen's losses were utilized by Land O'Lakes in its consolidated tax return. Subsequent to the effective date of the merger and through December 31, 1997, GalaGen has operating loss carryforwards to offset future taxable income of approximately $33,500,000 which begin to expire in 2007. No benefit has been recorded for such loss carryforwards, and utilization in future years may be limited, if significant ownership changes have occurred. Components of deferred tax assets are as follows:
December 31 ------------------------------------------- 1997 1996 1995 ------------ ------------ ----------- Loss carryforwards....................... $ 12,403,000 $ 10,270,000 $ 7,500,000 Research and development tax credit carryforwards.......................... 791,000 566,000 322,000 ------------ ------------ ----------- $ 13,194,000 $ 10,836,000 $ 7,822,000 Less valuation allowance................. (13,194,000) (10,836,000) (7,822,000) ------------ ------------ ----------- Net deferred tax assets.................. $ - $ - $ - ------------ ------------ ----------- ------------ ------------ -----------
12. EXTRAORDINARY ITEM In July 1995, the Company terminated its fund raising efforts for its wholly owned subsidiary, Altra Bio Inc., and sold the Corporation to a former officer for the nominal consideration of $1.00. Altra Bio had no book value at the time of the sale and, accordingly, no gain or loss was recognized in the transaction. As part of the terminated fund raising efforts, the Company negotiated debt reduction settlements with certain research collaborators and a vendor in the aggregate amount of $605,421. The effect on the December 31, 1995 net loss per share was $.32 for basic and diluted net loss per share. 25 REPORT OF INDEPENDENT AUDITORS Board of Directors GalaGen Inc. We have audited the accompanying balance sheets of GalaGen Inc. (a development stage company) as of December 31, 1997, and 1996, and the related statements of operations, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997, and for the period from November 17, 1987, (inception) to December 31, 1997. These financial statements are the responsibility of GalaGen's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of GalaGen Inc. at December 31, 1997 and 1996 and the results of its operations and cash flows for each of the three years in the period ended December 31, 1997 and for the period from November 17, 1987, (inception) to December 31, 1997, in conformity with generally accepted accounting principles. Ernst & Young LLP Minneapolis, Minnesota February 13, 1998 26 SELECTED FINANCIAL DATA The selected financial data set forth below as of December 31, 1997 and 1996 and for each of the three years in the period ended December 31, 1997 are derived from the financial statements of the Company which have been audited by Ernst & Young LLP, independent auditors, and are included herein. The selected financial data as of December 31, 1995, 1994 and 1993 and for each of the two years in the period ended December 31, 1994 are derived from audited financial statements which are not included herein. The data set forth below should be read in conjunction with the financial statements and notes thereto included in the appendix and with "Management's Discussion and Analysis of Financial Condition and Results of Operations", included above.
Year Ended December 31 ------------------------------------------------------------ 1997 1996 1995 1994 1993 --------- --------- --------- --------- --------- (in thousands, except share numbers and per share data) STATEMENTS OF OPERATIONS: Revenues..................................... $ - $ - $ 150 $ - $ - Operating costs and expenses: Cost of goods sold....................... - - - - - Research and development................. 3,936 5,258 3,731 3,442 4,659 General and administrative............... 1,966 1,889 2,022 1,720 2,875 Operating loss............................... (5,902) (7,147) (5,603) (5,162) (7,534) Interest income.............................. 448 605 31 28 49 Interest expense............................. (181) (945) (507) (260) (38) Net loss before extraordinary gain........... (5,635) (7,487) (6,079) (5,394) (7,523) Extraordinary gain on extinguishment of debt(1).................................. - - 605 - - Net loss for the period...................... (5,635) (7,487) (5,474) (5,394) (7,523) Preferred stock dividend(2).................. - (7,297) - - - Net loss applicable to common stockholders... $ (5,635) $ (14,784) $ (5,474) $ (5,394) $ (7,523) Net loss per share applicable to common stockholders Basic and Diluted........................ $ (.78) $ (2.24) $ (2.87) $ (2.89) $ (4.26) Weighted average number of common shares outstanding Basic and Diluted........................ 7,184,722 6,604,902 1,904,059 1,866,561 1,767,272
December 31, ------------------------------------------------------------ 1997 1996 1995 1994 1993 --------- --------- --------- --------- --------- (in thousands) BALANCE SHEET DATA: Cash and cash equivalents.................... $ 156 $ 3,870 $ 509 $ 430 $ 1,926 Available-for-sale securities(3)............. 7,512 7,498 - - - Working capital (deficiency)................. 7,028 9,776 (1,033) (846) (1,501) Total assets................................. 9,530 12,959 818 686 2,196 Note payable(4).............................. 1,162 - - - 1,000 Accrued expenses payable to Land O'Lakes..... - - 225 26 727 Convertible notes(5)......................... 1,072 - 8,199 5,707 - Total liabilities............................ 2,877 1,724 10,521 7,278 3,742 Stockholders' equity (deficiency)............ 6,653 11,235 (9,703) (6,592) (1,546)
- ---------------- Net loss per share applicable to common stockholders has been restated to comply with the Financial Accounting Standards Board issued Statement No. 128, EARNINGS PER SHARE. See Note 2 of the Notes to the Financial Statements for further discussion. 27 (1) See Note 12 of Notes to Financial Statements for an explanation of the extraordinary item. (2) See Note 6 of Notes to Financial Statements for an explanation of the preferred stock dividend. (3) See Note 2 of Notes to Financial Statements for an explanation of the available-for-sale securities. (4) See Note 7 of Notes to Financial Statements for an explanation of the note. (5) See Note 6 and Note 8 of Notes to Financial Statements for an explanation of convertible notes. 28 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock, par value $.01 per share ("Common Stock"), has been publicly traded since the closing of the Company's initial public offering on April 1, 1996 (the "Offering"). The Common Stock trades on the Nasdaq National Market tier of The Nasdaq Stock Market under the symbol GGEN. At March 19, 1998, the number of holders of the Common Stock was approximately 1,385, consisting of 179 record holders and 1,206 stockholders whose stock is being held by a bank, broker or other nominee. On March 19, 1998, the closing sale price of a share of the Common Stock was $1.688. The high and low sale prices per share of the Common Stock for the four quarters during the years ended December 31, 1997 and 1996 were as follows:
1997 1996 ----------------- ------------------ High Low High Low ------ ------ ------- ------ First Quarter $4.625 $1.750 $ - $ - Second Quarter $3.250 $2.000 $10.375 $7.125 Third Quarter $2.750 $2.000 $ 7.500 $3.813 Fourth Quarter $2.375 $1.500 $ 6.125 $4.000
The Company has never paid cash dividends on the Common Stock. The Board of Directors does not anticipate paying cash dividends in the foreseeable future. RECENT SALES OF UNREGISTERED SECURITIES During the year ended December 31, 1997, the Company has sold the following equity securities pursuant to exemptions from registration under the Securities Act of 1933, as amended (the "Securities Act"). All such sales were made in reliance upon the exemptions from registration provided under Sections 3(b) and 4(2) of the Securities Act. 1. In March 1997, the Company issued warrants to purchase 10,000 shares of Common Stock, granted at the fair market value on the date of grant, for certain investor relations services to be rendered by CTC, Inc. The warrant is exercisable one year from the date of grant and expires in March 2002. 2. In June 1997, the Company established a $2,000,000 line of credit with Transamerica Business Credit Corporation ("Transamerica") which extends through June 1998. In connection with this transaction, Transamerica received a warrant for 40,000 shares of Common Stock granted at the fair market value on the date of grant. The warrant was valued at approximately $79,000 and will be amortized to interest expense over the expected term of the outstanding line of credit. The warrant is immediately exerciseable and expires in June 2002. 3. In November 1997, the Company raised $1,500,000 through the private placement sale of 6% convertible debentures (the "Debentures") to CPR (USA) INC., Libertyview Plus Fund and Libertyview Fund, LLC, all institutional investors. The Malachi Group, Inc. acted as an agent in this transaction The principal and interest of the Debentures can be converted into shares of the Company's Common Stock at 82.5% of the lowest closing bid price of the Company's Common Stock three days prior to conversion. One-third of the Debentures can convert to Common Stock upon the effective date of registration, one-third after five months from the closing date and the remaining one third twelve months after the closing date or nine months if the price of the Common Stock does not average at least $2.00 per share in the eighth month after closing. An aggregate maximum of 1,400,000 discounted shares of Common Stock (the "Discounted Shares") can be issued upon the conversion of the Debentures, with each investor owning at any given time a maximum of 4.99% of the then issued and outstanding shares of Common Stock. If there remains any unconverted principal and accrued interest due to all the Discounted Shares being issued, the Company has the obligation to repay the investors, in the aggregate, a maximum principal of $500,000. The Debentures automatically convert into the Discounted Shares eighteen months from the closing date. Five-year warrants were issued to the investors to purchase, in the aggregate, 200,000 shares of Common Stock at 110% of the market value of the Common Stock on the closing date. The value of the warrants plus the value of the discount of the Discounted Shares was $500,182, which the Company is amortizing over the term of the Debentures. In February and March 1998, $499,500 of Debenture principal plus accrued interest was converted into 718,543 shares of Common Stock. In connection with this private placement, the Company has reserved 1,129,062 shares of Common Stock for issuance. These warrants expire in December 2002. 4. In December 1997, the Company issued five-year warrants to CLARCO Holdings, which is associated with the Malachi Group, Inc., for financial services rendered, to purchase 25,000, 40,000 and 75,000 shares of Common Stock at $2.50, $3.00 and $6.50, respectively, each of which was greater than the market value of the Common Stock at the date of grant. A portion of the warrant for 40,000 shares was issued as partial payment for services rendered in connection with the private placement of the Debentures. These warrants have an intrinsic value of $50,450 which is being amortized over the term of the consulting relationship. The warrants for 25,000 and 40,000 shares of Common Stock are immediately exercisable. The warrant for 75,000 shares of Common Stock will vest upon the Company's Common Stock trading for ten consecutive days, from the time of grant until June 30, 1998, at or greater than $6.50 per share. These warrants expire in December 2002. 29 EX-23.1 5 EX 23.1 EXHIBIT 23.1 Consent of Ernst & Young LLP We consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-05415, 333-05417, 333-27031 and 333-33351) pertaining to the GalaGen Inc. 1992 Stock Plan, Employee Stock Purchase Plan, Non-Statutory Stock Option Agreements and 1997 Incentive Plan of our report dated February 13, 1998 with respect to the financial statements of GalaGen Inc. incorporated by reference in this annual report (Form 10-K) for the year ended December 31, 1997. Ernst & Young LLP Minneapolis, Minnesota March 25, 1998 EX-27.1 6 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 155,908 7,511,619 0 0 0 7,864,199 1,869,974 363,355 9,529,771 835,877 0 0 0 72,350 6,580,728 9,529,771 0 0 0 0 5,901,818 0 181,638 (5,635,134) 0 (5,635,134) 0 0 0 (5,635,134) (.78) (.78)
EX-27.2 7 EXHIBIT 27.2
5 3-MOS DEC-31-1996 JAN-01-1996 MAR-31-1996 345,894 0 0 0 0 1,092,869 231,975 161,384 1,294,470 2,720,433 0 0 47,045 19,606 (1,095,718) 1,294,470 0 0 0 0 1,172,109 0 304,204 (1,471,233) 0 (1,471,233) 0 0 0 (1,471,233) (.75) (.75)
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