-----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, NDLwiCH5IC7ZgcnqmwulKJmAokBdwEyirh/9FKJXbe9pCNT17yJ+kwZUOjfdWo/K C9eB+DiSG8BNgaUCUWNInw== 0000893838-99-000299.txt : 19991109 0000893838-99-000299.hdr.sgml : 19991109 ACCESSION NUMBER: 0000893838-99-000299 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19991108 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COCENSYS INC CENTRAL INDEX KEY: 0000895034 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 330538836 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 033-55522 FILM NUMBER: 99743378 BUSINESS ADDRESS: STREET 1: 213 TECHNOLOGY DRIVE CITY: IRVINE STATE: CA ZIP: 92618 BUSINESS PHONE: 9497536100 MAIL ADDRESS: STREET 1: 213 TECHNOLOGY DRIVE CITY: IRVINE STATE: CA ZIP: 92618 10-K/A 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A FOURTH AMENDMENT [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 0-20954 COCENSYS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 33-0538836 (STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NO.) 213 TECHNOLOGY DRIVE, IRVINE, CA 92618 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE) (949) 753-6100 (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 $0.001 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 and 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 number of shares of Common Stock outstanding as of September 28, 1999, was 1,000, all of which is held by the sole stockholder of the registrant. See Item 7. "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - RECENT DEVELOPMENTS." - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION CONTAINS, IN ADDITION TO HISTORICAL INFORMATION, CERTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED BELOW AND ELSEWHERE IN THIS REPORT. OVERVIEW Since its inception in February 1989, the Company has devoted substantially all of its resources to the discovery and development of pharmaceutical products for the treatment of disorders affecting the brain. The Company has incurred losses since inception and expects losses to continue for the foreseeable future, primarily due to the expansion of programs for research and development. Operating results are expected to fluctuate as a result of uncertainty in the timing and amount of expenses for product development and in the timing and amount of revenues to be earned from the achievement of research and development milestones and sales of Company products, if any. As of December 31, 1998, the Company's accumulated deficit was approximately $116.2 million. RESULTS OF OPERATIONS 1998 AS COMPARED TO 1997 The Company's revenues consist of co-promotion revenues and co-development revenues. Co-promotion revenues arose from contractual agreements that called for the Company to promote other pharmaceutical companies' products in return for commissions. Co-development revenues arise from contractual agreements with large pharmaceutical companies pursuant to which the Company licenses various commercialization or development rights relating to compounds or performs research activities in exchange for licensing fees, milestone payments or research funding. In October 1997, the Company sold its sales and marketing force to Watson Pharmaceuticals, Inc. ("Watson") and, except for certain residual items recognized in fiscal 1998, is no longer involved in co-promotional activities. CO-PROMOTION REVENUES were $540,000 for the year ended December 31, 1998, compared to $3.3 million in fiscal 1997. Co-promotion revenues in 1998 resulted from a bonus related to fiscal 1997 activity that was received and recognized in the first quarter of 1998. CO-DEVELOPMENT REVENUES were $2.0 million for the year ended December 31, 1998, compared to $8.6 million in 1997. The decrease in co-development revenues of $6.6 million, or 77 percent, compared to the prior year resulted primarily from an agreement with the Wyeth-Ayerst Laboratories Division of American Home Products Corporation in May 1997, which provided for a one-time license fee of $5.0 million plus an additional $2.2 million during 1997 to fund research on a back-up compound in connection with the Company's anxiolytic program. RESEARCH AND DEVELOPMENT expenses were $15.7 million in fiscal 1998 compared to $23.3 million in 1997. This decrease of $7.6 million, or 32 percent, is attributable to a lower level of external clinical trials and certain headcount reductions in the current year in comparison to the prior year. In fiscal 1997, the Company made significant external expenditures for the development of compounds treating epilepsy, migraine, acute stroke and insomnia. In fiscal 1998, external expenditures were focused on clinical trials of the Company's compound to treat acute migraine and on preclinical testing of the Company's compound to treat neuropathic pain. MARKETING, GENERAL AND ADMINISTRATIVE expenses were $3.9 million in fiscal 1998 compared to $10.0 million in 1997. This decrease of $6.1 million, or 61 percent, is due to the disposition of the sales and marketing force in October 1997. As a result of this transaction, the Company incurred nine months of expense associated with the sales function in fiscal 1997 compared to no expense in fiscal 1998. 2 GAIN ON DISPOSITION OF SALES FORCE was $1.0 million in fiscal 1998 compared to a gain of $4.7 million in 1997. The fiscal 1998 gain related to two deferred payments that were based on Watson's ability to retain certain percentages of the sales and marketing force at specified dates subsequent to the sale. No further payments are due to the Company from Watson. ACCRETION OF PREFERRED STOCK FOR BENEFICIAL CONVERSION FEATURE was $890,000 in fiscal 1998 whereas there was none in the prior year. The beneficial conversion feature allows holders of the Company's Series E Convertible Preferred Stock to convert into common stock at a discount of 10% below the market price of the common stock starting 122 days after issuance. At the time the Series E Convertible Preferred Stock was issued in June 1998, $890,000 of the $8.0 million in proceeds was allocated to the beneficial conversion feature. This amount was amortized over the 122 day period ended October 8, 1998. DIVIDENDS ON PREFERRED STOCK were $1.1 million in fiscal 1998 whereas no dividends were recorded in the prior fiscal year. Of the fiscal 1998 total, $562,000 related to dividends on the Company's Series D Convertible Preferred Stock issued in October 1997 and January 1998 to Warner-Lambert Company ("Warner-Lambert") in connection with a research and development program, and $490,000 related to the Company's Series E Convertible Preferred Stock issued in June 1998 to private investors. All dividends result in an increase in the value of outstanding preferred stock and do not involve the payment of any cash. 1997 AS COMPARED TO 1996 CO-PROMOTION REVENUES were $3.3 million for the year ended December 31, 1997, compared to $9.1 million in fiscal 1996. This $5.8 million, or 64 percent, decrease in 1997 compared to 1996 resulted from the termination of the Novartis Pharma, A.G. ("Novartis") co-promotion agreement in December 1996, the loss of co-promotion rights for Cognex(R) in June 1997 and the sale of the sales and marketing force in October 1997. CO-DEVELOPMENT REVENUES were $8.6 million for the year ended December 31, 1997, compared to $6.1 million in 1996. This $2.5 million, or 41 percent, increase in 1997 is primarily attributable to the May 1997 agreement with the Wyeth-Ayerst mentioned above. In fiscal 1996, the Company recognized $3.6 million related to the G.D. Searle & Co. ("Searle") Development and Commercialization Agreement in connection with its insomnia program and $2.5 million related to the Novartis Research and Development Agreement in connection with its compound to treat stroke and traumatic brain injury. The program with Searle was terminated in July 1998 and the program with Novartis was terminated effective October 1997. RESEARCH AND DEVELOPMENT expenses were $23.3 million in fiscal 1997 compared to $20.9 million in 1996. This increase of $2.4 million, or 11 percent, is attributable to a higher level of clinical activity in the fiscal 1997 in comparison to fiscal 1996. During 1997, the Company conducted significant clinical trials for ganaxolone in the treatment of migraine and epilepsy, licostinel in the treatment of stroke and CCD 3693 in the treatment of insomnia. During 1996, clinical activities were focused mainly on licostinel for the treatment of stroke and, to a lesser extent, ganaxolone for the treatment of epilepsy. MARKETING, GENERAL AND ADMINISTRATIVE expenses were $10.0 million in fiscal 1997 compared to $13.9 million in 1996. This decrease of $3.9 million, or 28 percent, is due to the disposition of the sales and marketing force in October 1997. As a result of this transaction, the Company incurred nine months of expense associated with the sales function in fiscal 1997 compared twelve months of expense in fiscal 1996. GAIN ON DISPOSITION OF SALES FORCE was $4.7 million in fiscal 1997. This amount relates entirely to the sale of the sales and marketing force to Watson. LIQUIDITY AND CAPITAL RESOURCES From its inception in February 1989 through December 31, 1998, the 3 Company has financed its operations primarily through private and public offerings of its equity securities, raising net proceeds of approximately $102.1 million through sales of these securities. At December 31, 1998, the Company's balances of cash, cash equivalents and investments totaled $12.2 million, compared to $13.0 million at December 31, 1997. As of December 31, 1998, the Company had invested $7.7 million in leasehold improvements, laboratory and computer equipment and office furnishings and equipment. The Company has financed $3.6 million of these capital additions through capital lease lines. In addition, the Company leases its laboratory and office facilities under operating leases. While additional equipment will be needed as the Company increases its research and development activities, the Company has no material commitments for the acquisition of property and equipment. On June 8, 1998, the Company issued 8,000 shares of Series E Convertible Preferred Stock with a stated value of $1,000 per share for an aggregate of $8.0 million in a private placement pursuant to Regulation D of the Securities Act of 1933, as amended. See Note 2 of the Notes to Financial Statements "Private Placement of Preferred Stock," below. Pursuant to an agreement with Watson, in October 1997, the Company sold its sales and marketing force, related co-promotion agreements and certain other assets to Watson for $8.0 million in cash with an additional $1.0 million due to CoCensys contingent upon the occurrence of specified events. Of this contingent amount, Watson paid the Company $750,000 in April 1998 and $250,000 in October 1998. Pursuant to the 1995 collaboration agreement with Warner-Lambert, as amended and extended in October 1997, Warner-Lambert is obligated to make certain milestone payments for each compound selected for development, as well as pay for its share of development costs. Under the terms of the 1995 agreement, Warner-Lambert purchased $2.0 million of CoCensys Common Stock in October 1995 and an additional $2.0 million of CoCensys Common Stock in March 1997. Under the terms of the 1997 amendment, Warner-Lambert purchased preferred stock with a face value of $7.0 million, of which Warner-Lambert paid the Company $1.0 million in October 1997 and $6.0 million in January 1998. Of this $7.0 million in total proceeds, the Company has allocated $1.6 million to be recognized as co-development revenue during fiscal 1998, $4.4 million as preferred stock and $1.0 million as a liability (payable in cash or common stock at the election of Warner-Lambert) due to Warner Lambert on December 31, 1999. The preferred stock accrues an imputed non-cash dividend at 12 percent per annum until its mandatory conversion date in October 2001. If converted on the mandatory conversion date, the Series D stock would have been converted into such number of shares of common stock equal to the quotient of the aggregate face value of the preferred stock divided by the average of the closing prices of the common stock for a period of thirty (30) trading days ending on the third trading day prior to the automatic conversion date. The preferred stock is convertible at an earlier date at the Company's option into such number of shares of common stock equal to the aggregate original issue price of such shares divided by the greater of (a) the average of the closing prices of the common stock for the 30 trading days during the period ending on the third trading day prior to the date of original issuance of such shares or (b) the average of the closing prices of the common stock for the 30 trading days during the period ending on the third trading day prior to the date upon which the Company notifies the holders of such optional conversion. On August 5, 1999, the Company converted the Series D preferred stock into 227,425 shares of common stock in accordance with the terms governing the Series D preferred stock. Pursuant to the May 1997 Development and Commercialization Agreement with Wyeth-Ayerst, Wyeth-Ayerst paid the Company a $5.0 million license fee and purchased 100,000 shares of the Company's Series C Convertible Preferred stock for $5.0 million. Furthermore, Wyeth-Ayerst is obligated to pay all development costs associated with Co 2-6749, as well as make milestone payments upon the occurrence of certain agreed upon events and pay the Company $3.0 million per year for up to three years to identify back-up compounds. However, if Co 2-6749 fails to meet certain criteria, and the back-up program fails to produce a back-up compound that meets other certain criteria, Wyeth-Ayerst has the right to 4 terminate the back-up program and require CoCensys to reimburse them for a portion of the back-up funding. As of December 31, 1998, the Company had $2.6 million of deferred revenue recorded on its balance sheet related to the Wyeth-Ayerst back-up program. Pursuant to the Company's Development and Commercialization Agreement with Searle, both companies were obligated to pay a portion of the development costs of CCD 3693 and its back-up compounds for the U.S. market. In addition, Searle purchased 100,000 shares of the Company's Series B Convertible Preferred Stock for $7.0 million during 1996. In May 1998, the preferred stock converted, in accordance with its terms, into 200,000 shares of common stock at a conversion price of $35.00 per share. In July 1998, Searle notified CoCensys that it had decided not to participate further in the development of the Company's proprietary compounds for the treatment of insomnia. CoCensys intends to continue research and development of its compounds to treat insomnia and will consider seeking a new partner for the program in the future. CoCensys' operations to date have consumed substantial amounts of cash. While the Company's cash forecasts for the twelve months ending December 31, 1999, project a positive cash balance, certain cash inflows included in these forecasts are estimates and are not guaranteed. Should the Company not receive these anticipated payments, or should the timing or amount of these payments differ substantially from the forecasted amounts, or should the Company incur expenses in excess of those currently forecasted, the ability of the Company to continue funding its operations could be jeopardized. However, the Company is actively considering three courses of action that management believes will increase cash inflows, or decrease cash outflows, sufficiently to ensure adequate funding for its operations through at least fiscal 1999. First, the Company is aggressively seeking partners for several of its compounds. The Company is in negotiations with several pharmaceutical companies regarding Co 102862 for neuropathic pain. Management is actively working to sign a licensing agreement within in the next six months for Co 102862 and is attempting to secure initial payments that, when combined with the current cash balance, will be sufficient to fund operations through at least fiscal 1999. Other compounds may be licensed later in the year. Second, the Company is attempting to generate revenues by selling clinical and preclinical development services either to its collaboration partners or to third parties. CoCensys currently employs over thirty individuals in the development area who have extensive pharmaceutical development expertise in numerous indications. Third, in the absence of a revenue generating licensing or service deal, the Company will take steps to reduce expenses through reductions in headcount and other costs. Cost savings associated with these expense reductions, when combined with our current cash balance, will be adequate to fund the Company's operations through at least fiscal 1999. The Company's future capital requirements will depend on many factors, including the progress of the Company's research and development programs, the scope and results of preclinical testing and clinical trials, the time and costs involved in obtaining regulatory approvals, the rate of technological advances, determinations as to the commercial potential of the Company's products under development, the status of competitive products, the establishment of third-party manufacturing arrangements and the establishment of additional collaborative relationships. There are no assurances that the Company will available to it the substantial capital resources necessary to continue product development and other Company operations. 5 IMPACT OF YEAR 2000 Some of the Company's older computer programs were written using two digits rather than four to define the applicable year. As a result, those computer programs recognize a date using "00" as the year 1900 rather than the year 2000. This could cause a system failure or miscalculations causing disruptions of operations, including a temporary inability to process transactions or engage in normal business activities. The Company has developed a plan to address the Year 2000 issues. The plan is segregated into four phases: 1. Information collection. 2. Risk assessment and testing of mission critical systems. 3. Remediation. 4. Monitoring and contingency planning The Company has completed the first two phases of the project and has tested, upgraded or developed plans to upgrade all individual software and hardware applications that fall within the mission critical category. All of the Company's major software applications and hardware systems are purchased from major vendors and the Company performs little or no customizations to those applications and systems. The Company's major software providers have attested to Year 2000 compliance. The Company has reviewed other equipment for embedded technologies which may be Year 2000 susceptible and has already upgraded or developed plans to upgrade all mission critical systems. The Company has spent less than $50,000 to date on hardware and software upgrades to ensure Year 2000 compliance and it anticipates that further upgrades will cost less than $100,000, most of which will be spent acquiring a Year 2000 compliant telephone system. The funds for these upgrades will come from current cash or new capital lease lines. The Company expects to be fully Year 2000 compliant by June 1999. A contingency plan will also be developed by that date. In addition to risks associated with the Company's own computer systems and equipment, the Company has relationships with, as is to a varying degrees dependent upon, a large number of third parties, that do not share information systems with the Company (external agents), who provide information, services and goods. These external agents include financial institutions, suppliers, vendors, research partners and governmental agencies. The Company has instituted programs, including internal records review and use of external questionnaires, to identify third parties, assess their level of Year 2000 compliance, update contracts and address potential non-compliance issues. To date, the Company is not aware of any external agent with a Year 2000 issue that would materially impact the Company's results of operations, liquidity, or capital resources. However, the Company has no means of ensuring that external agents will be Year 2000 ready. The inability of external agents to complete their Year 2000 resolution process in a timely fashion could materially impact the Company. The effect of non-compliance by external agents is not determinable. Based upon its efforts to date, the Company believes that the vast majority of both its IT and its non-IT systems, including all critical and important systems, will remain up and running after January 1, 2000. Accordingly, the Company does not currently anticipate that internal systems failures will result in any material adverse effect to its operations or financial condition. During 1999, the Company will also continue and expand its efforts to ensure that major third-party businesses and public and private providers of infrastructure services will also be prepared for the year 2000, and to develop contingency plans to address any failures on their part to become Y2K compliant. At this time, the Company believes that the most likely "worst- case" scenario involves potential disruptions in areas in which the Company's operations must rely on such third parties whose systems may not work properly after January 1, 2000. While such failures could affect important operations of the Company, either directly or indirectly, in a significant manner, the Company cannot at present estimate either the likelihood or the potential cost of such failures. RECENT DEVELOPMENTS 6 On August 5, 1999, the Company, Purdue Pharma L.P., a Delaware limited partnership, and Purdue Acquisition Corporation, a Delaware corporation and an indirect wholly owned subsidiary of Purdue Pharma, entered into an Agreement and Plan of Merger. On August 12, 1999, Purdue Acquisition Corporation commenced a cash tender offer for all outstanding shares of common stock, par value $0.001 per share, including the associated rights to purchase Series A Junior Participating Preferred Stock, of the Company at $1.16 per share. Purdue Acquisition Corporation acquired 91.4% of the outstanding shares of common stock pursuant to the tender offer, which expired on September 23, 1999, and on September 28, 1999, merged with and into the Company in a short-form merger pursuant to Section 253 of the General Corporation Law of the State of Delaware. As a result of the merger, Purdue Pharma L.P., which owned indirectly all the outstanding stock of Purdue Acquisition Corporation, became the indirect holder of 100% of the outstanding equity of the Company, and all shares of common stock held by stockholders (other than Purdue, the Company or their respective affiliates) were converted into the right to receive $1.16 per share in cash. As a result of the merger, the public stockholders no longer possess any interest in, or rights as stockholders of, the Company other than their right to receive $1.16 per share in cash, or, if they perfect their dissenter's appraisal rights, the right to receive the value of their shares as determined by the Chancery Court of the State of Delaware. Prior to the consummation of the merger, the shares of common stock were registered under Section 12(g) of the Exchange Act and were traded on the OTC Bulletin Board. On September 29, 1999, the Company informed the OTC Bulletin Board of the merger and requested that the common stock be removed from listing on the OTC Bulletin Board. 7 PART IV ITEM 14. (A) EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K FINANCIAL STATEMENTS The financial statements required by this item are submitted in a separate section beginning on Page 10 of this report. Financial Statements of CoCensys, Inc. -------------------------------------- Report of Independent Auditors 10 Balance Sheets as of December 31, 1998 and 1997 11 Statements of Operations for the years ended December 31, 1998, 1997 and 1996; and the period from inception (February 15, 1989) to December 31, 1998 12 Statements of Stockholders' Equity for the period from inception (February 15, 1989) to December 31, 1998 13 Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996; and the period from inception (February 15, 1989) to December 31, 1998 16 Notes to Financial Statements 17 Schedules are omitted as the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements or notes thereto. 8 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. COCENSYS, INC. Date: November 2, 1999 By: /s/ Stuart D. Baker ------------------------------------- Stuart D. Baker Vice President 9 Report of Independent Auditors Board of Directors and Stockholders CoCensys, Inc. We have audited the accompanying balance sheets of CoCensys, Inc. (a development stage company) as of December 31, 1998 and 1997, and the related statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998, and the period from inception (February 15, 1989) to December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CoCensys, Inc. at December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, and for the period from inception (February 15, 1989) to December 31, 1998, in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP Orange County, California January 29, 1999, except for the last paragraph of Note 2 as to which the date is March 24, 1999, the second paragraph of Note 1, as to which the date is April 15, 1999 10 COCENSYS, INC. (A development stage company) BALANCE SHEETS (In thousands, except share and par value amounts)
DECEMBER 31, DECEMBER 31, 1998 1997 ----------------- ------------- ASSETS Current assets: Cash and cash equivalents $ 2,222 $ 3,410 Short-term investments 9,973 9,050 Other current assets 321 898 ------------ ------------ TOTAL CURRENT ASSETS 12,516 13,358 Property and equipment, net 2,466 2,823 Investments - 500 Notes receivable from officers 56 178 Other noncurrent assets 61 57 ------------ ------------ $ 15,099 $ 16,916 ============ ============ LIABILITIES & STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 534 $ 866 Accrued compensation and benefits 748 1,107 Due to corporate partners 1,322 747 Other accrued liabilities 1,326 1,911 Deferred revenue 2,955 - Capital lease obligations - current portion 316 353 ------------ ------------ TOTAL CURRENT LIABILITIES 7,201 4,984 Capital lease obligations, less current portion 366 567 Other liabilities 26 534 Commitments and contingencies Stockholders' equity: Convertible nonvoting preferred stock, $.001 par value Authorized shares - 5,000,000 Issued and outstanding shares - 206,445 at December 31, 1998 and 214,286 at December 31, 1997 16,386 13,000 Common stock, $.001 par value Authorized shares - 9,375,000 Issued and outstanding shares - 3,422,773 at December 31, 1998 and 2,857,188 at December 31, 1997 107,381 97,230 Deficit accumulated during the development stage (116,151) (98,983) Deferred compensation (138) (430) Accumulated other comprehensive income 28 14 ------------ ------------ TOTAL STOCKHOLDERS' EQUITY 7,506 10,831 ------------ ------------ $ 15,099 $ 16,916 ============ ============ See accompanying notes
11 COCENSYS, INC. (A development stage company) STATEMENTS OF OPERATIONS (In thousands, except per share amounts)
PERIOD FROM INCEPTION (FEBRUARY 15, YEAR ENDED DECEMBER 31, 1989) TO --------------------------------------- DECEMBER 31, 1998 1997 1996 1998 -------- --------- --------- ------------ REVENUES Co-promotion revenues from corporate partners $ 540 $ 3,264 $ 9,085 $ 30,705 Co-development revenues from corporate partners 2,046 8,650 6,073 18,739 -------- --------- --------- ----------- Total revenues 2,586 11,914 15,158 49,444 -------- --------- --------- ----------- OPERATING EXPENSES Research and development 15,745 23,308 20,949 106,674 Marketing, general and administrative 3,894 9,975 13,862 52,050 Acquired research and development - - - 14,879 -------- --------- --------- ----------- Total operating expenses 19,639 33,283 34,811 173,603 -------- --------- --------- ----------- Operating loss (17,053) (21,369) (19,653) (124,159) Gain on disposition of sales force 1,000 4,728 - 5,728 Interest income 908 898 1,304 5,361 Interest expense (81) (78) (139) (1,139) -------- --------- --------- ----------- Net loss (15,226) (15,821) (18,488) (114,209) Accretion of preferred stock for beneficial conversion feature 890 - - 890 Dividends on preferred stock 1,052 - - 1,052 -------- --------- --------- ----------- Net loss applicable to common stockholders $(17,168) $ (15,821) $ (18,488) $ (116,151) ======== ========= ========= =========== Basic and diluted loss per share $ (5.60) $ (5.60) $ (6.79) ======== ========= ========= Shares used in computing basic and diluted loss per share 3,066 2,822 2,723 ======== ========= ========= See accompanying notes
12 COCENSYS, INC. (A development stage company) STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands, except share and per share amounts)
DEFICIT ACCUMULATED CONVERTIBLE ACCUMULATED OTHER PREFERRED STOCK COMMON STOCK DURING THE DEFERRED COMPREHENSIVE TOTAL ------------------ -------------------- DEVELOPMENT COMPEN- INCOME STOCK HOLDERS' SHARES AMOUNT SHARES AMOUNT STAGE SATION (LOSS) EQUITY ---------- ------- --------- -------- ----------- -------- ------------- -------------- Net loss - $ - - $ - $ (147) $ - $ - $ (147) Issuance of common stock for cash at $0.04 per share - - 122,500 5 - - - 5 --------- ------- --------- -------- ----------- -------- ------------- ----------- BALANCE AT DECEMBER 31, 1989 - - 122,500 5 (147) - - (142) Net loss - - - - (910) - - (910) Issuance of Series A convertible preferred stock upon conversion of promissory note, net of offering costs of $5 at $.25 per share 400,000 95 - - - - - 95 Issuance of Series B convertible preferred stock for $3,110 cash and conversion of $515 of convertible promissory notes, net of offering costs of $46 at $1.50 per share 2,416,666 3,579 - - - - - 3,579 Issuance of warrants to purchase 30,100 shares of Series B convertible preferred stock in connection with a note payable - 8 - - - - - 8 Common stock issued in connection with services rendered - - 834 - - - - - --------- ------- --------- -------- ----------- -------- ------------- ----------- BALANCE AT DECEMBER 31, 1990 2,816,666 3,682 123,334 5 (1,057) - - 2,630 Net loss - - - - (2,369) - - (2,369) Common stock issued in connection with services rendered - - 417 - - - - - --------- ------- --------- -------- ----------- -------- ------------- ----------- BALANCE AT DECEMBER 31, 1991 2,816,666 3,682 123,751 5 (3,426) - - 261 Net loss - - - - (6,267) - - (6,267) Issuance of Series C convertible preferred stock for cash, net of offering costs of $60 at $5.00 per share 2,631,218 13,096 - - - - - 13,096 Issuance of Series C convertible preferred stock in exchange for services at $5.00 per share 3,332 17 - - - - - 17 Issuance of Series C convertible preferred stock in exchange for stock purchase option at $5.00 per share 20,000 100 - - - - - 100 Deferred compensation related to the issuance of certain stock options - - - 2,842 - (2,842) - - Amortization of deferred compensation - - - - - 152 - 152 --------- ------- --------- -------- ----------- -------- ------------- ------------ BALANCE AT DECEMBER 31, 1992 5,471,216 16,895 123,751 2,847 (9,693) (2,690) - 7,359 Net loss - - - - (10,273) - - (10,273) Issuance of Series B convertible preferred stock in exchange for noncash exercise of warrants 25,083 226 - - - - - 226 Conversion of convertible preferred stock into common stock at the close of the initial public offering (5,496,299) (17,121) 687,037 17,121 - - - - Issuance of common stock for cash in initial public offering at $72.00 per share, net of offering costs and underwriters' discount of $2,193 - - 312,500 20,307 - - - 20,307 Common stock issued in connection with stock options - - 14,600 18 - - - 18 Issuance and termination of certain stock options - - - 43 - (43) - - Amortization of deferred compensation - - - - - 760 - 760 ---------- ------- --------- -------- ----------- -------- ------------- ------------- BALANCE AT DECEMBER 31, 1993 - - 1,137,888 40,336 (19,966) (1,973) - 18,397 See accompanying notes
13 COCENSYS, INC. (A development stage company) STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED) (In thousands, except share and per share amounts)
DEFICIT ACCUMULATED CONVERTIBLE ACCUMULATED OTHER PREFERRED STOCK COMMON STOCK DURING THE DEFERRED COMPREHENSIVE TOTAL ------------------ -------------------- DEVELOPMENT COMPEN- INCOME STOCK HOLDERS' SHARES AMOUNT SHARES AMOUNT STAGE SATION (LOSS) EQUITY --------- ------- --------- -------- ------------ -------- ------------- -------------- Net loss - - - - (26,586) - - (26,586) Unrealized loss on investments - - - - - - (25) (25) ---------- Comprehensive income - - - - - - - (26,611) Purchase of common stock by Acea shareholders pursuant to merger agreement at $36.48 and $40.88 per share - - 51,921 2,002 - - - 2,002 Acquisition of Acea in exchange for common stock at $24.00 per share - - 473,042 11,353 - - - 11,353 Exchange of Acea options and warrants for equivalent options and warrants - - - 592 - - - 592 Purchase of common stock by corporate partner at $36.08 per share - - 55,402 2,000 - - - 2,000 Common stock issued in connection with: Stock options - - 8,548 32 - - - 32 Other employee programs - - 2,500 75 - - - 75 Issuance and termination of certain stock options - - - 110 - (110) - - Amortization of deferred compensation - - - - - 707 - 707 --------- ------- --------- -------- ----------- --------- ------------- ------------- BALANCE AT DECEMBER 31, 1994 - - 1,729,301 56,500 (46,552) (1,376) (25) 8,547 Net loss - - - - (18,122) - - (18,122) Unrealized gain on investments - - - - - - 3 3 --------- Comprehensive income - - - - - - - (18,119) Purchase of common stock by corporate partner at $27.84 per share - - 179,372 5,000 - - - 5,000 Issuance of common stock and related warrants for cash at $26.00 per share, net of cost of $149 - - 463,462 11,901 - - - 11,901 Purchase of common stock by corporate partner at $56.00 per share, net of costs of $14 - - 35,746 1,986 - - - 1,986 Common stock issued in connection with: Stock options - - 11,072 109 - - - 109 Employee Stock Purchase Plan - - 4,966 152 - - - 152 Other employee programs - - 500 29 - - - 29 Issuance and termination of certain stock options - - - 619 - (619) - - Amortization of deferred compensation - - - - - 1,039 - 1,039 --------- ------- --------- -------- ----------- --------- ------------- ------------- BALANCE AT DECEMBER 31, 1995 - - 2,424,419 76,296 (64,674) (956) (22) 10,644 Net loss - - - - (18,488) - - (18,488) Unrealized gain on investments - - - - - - 50 50 --------- Comprehensive income - - - - - - - (18,438) Issuance of common stock for cash at $52.00 per share, net of costs of $1,162 - - 303,750 14,633 - - - 14,633 Issuance of Series B convertible preferred stock for cash to corporate partner 100,000 7,000 - - - - - 7,000 Common stock issued in connection with: Stock options - - 17,345 194 - - - 194 Employee Stock Purchase Plan - - 14,093 446 - - - 446 Other employee programs - - 813 54 - - - 54 Issuance and termination of certain stock options - - - 2,363 - (629) - 1,734 Amortization of deferred compensation - - - - - 680 - 680 --------- ------- ---------- -------- ----------- --------- ------------- ------------- BALANCE AT DECEMBER 31, 1996 100,000 7,000 2,760,420 93,986 (83,162) (905) 28 16,947 See accompanying notes
14 COCENSYS, INC. (A development stage company) STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED) (In thousands, except share and per share amounts)
DEFICIT ACCUMULATED CONVERTIBLE ACCUMULATED OTHER PREFERRED STOCK COMMON STOCK DURING THE DEFERRED COMPREHENSIVE TOTAL ------------------ -------------------- DEVELOPMENT COMPEN- INCOME STOCK HOLDERS' SHARES AMOUNT SHARES AMOUNT STAGE SATION (LOSS) EQUITY --------- ------- --------- -------- ----------- -------- ------------- -------------- Net loss - - - - (15,821) - - (15,821) Unrealized loss on investments - - - - - - (14) (14) --------- Comprehensive income - - - - - - - (15,835) Issuance of Series C convertible preferred stock for cash to corporate partner 100,000 5,000 - - - - - 5,000 Issuance of Series D convertible preferred stock for cash to corporate partner 14,286 1,000 - - - - - 1,000 Issuance of common stock for cash at $49.28 per share to corporate partner - - 40,558 2,000 - - - 2,000 Common stock issued in connection with: Services rendered - - 2,914 8 - - - 8 Stock options - - 41,934 202 - - - 202 Employee Stock Purchase Plan - - 11,362 251 - - - 251 Issuance and termination of certain stock options - - - 783 - 206 - 989 Amortization of deferred compensation - - - - - 269 - 269 --------- ------- ---------- -------- ----------- --------- ------------- ------------- BALANCE AT DECEMBER 31, 1997 214,286 13,000 2,857,188 97,230 (98,983) (430) 14 10,831 Net loss - - - - (17,168) - - (17,168) Unrealized gain on investments - - - - - - 14 14 -------- Comprehensive income - - - - - - - (17,154) Conversion of Series B convertible preferred into common stock by corporate partner (100,000) (7,000) 200,000 7,000 - - - - Issuance of Series D convertible preferred stock for cash to corporate partner 85,714 3,429 - - - - - 3,429 Issuance of Series E convertible preferred stock, related warrants and beneficial conversion feature for cash, less offering costs 8,000 6,611 - 1,280 - - - 7,891 Conversion of Series E convertible preferred into common stock by investors (1,555) (1,596) 320,383 1,596 - - - - Accretion of preferred stock for beneficial conversion feature - 890 - - - - - 890 Dividends accrued on preferred stock - 1,052 - - - - - 1,052 Common stock issued in connection with: Services rendered - - 3,416 126 - - - 126 Stock options - - 24,419 48 - - - 48 Employee Stock Purchase Plan - - 17,055 135 - - - 135 Other employee programs - - 312 10 - - - 10 Issuance and termination of certain stock options - - - (44) - 148 - 104 Amortization of deferred compensation - - - - - 144 - 144 --------- ------- ---------- -------- ----------- --------- ------------- ------------- BALANCE AT DECEMBER 31, 1998 206,445 $ 16,386 3,422,773 $ 107,381 $ (116,151) $ (138) $ 28 $ 7,506 ========= ======= ========== ======== ========== ========= ============= ============= See accompanying notes
15 COCENSYS, INC. (A development stage company) STATEMENTS OF CASH FLOWS (In thousands)
PERIOD FROM INCEPTION (FEBRUARY 15, YEAR ENDED DECEMBER 31, 1989) TO ------------------------------------ DECEMBER 31, 1998 1997 1996 1998 ---------- ----------- ----------- ------------- OPERATING ACTIVITIES Net loss $ (15,226) $ (15,821) $ (18,488) $(114,209) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 907 936 2,072 7,732 Amortization of deferred compensation 144 269 680 3,751 Issuance of stock, stock options and warrants for services 240 419 1,788 2,576 Loss on sale of fixed assets - 74 - 100 Gain on disposition of sales force (1,000) (4,728) - (5,728) Acquired research and development - - - 12,279 Decrease (increase) in other current assets 191 72 (101) (365) Decrease (increase) in receivables from partners 386 245 (659) (28) Increase (decrease) in amounts due to partners 575 301 (2,698) 1,322 Increase in deferred revenue 2,955 - - 2,955 Increase (decrease) in accounts payable and other accrued liabilities (1,784) (991) 685 982 ---------- ----------- ----------- --------- NET CASH USED IN OPERATING ACTIVITIES (12,612) (19,224) (16,721) (88,633) ---------- ---------- ---------- --------- INVESTING ACTIVITIES Decrease (increase) in investments (409) 7,386 (10,343) (9,945) Purchases of property and equipment (566) (1,475) (812) (7,666) Decrease (increase) in other assets and notes receivable from officers 118 (1,083) 199 (1,273) Cash received on sale of fixed assets 16 1 - 36 Cash received on disposition of sales force 1,000 8,000 - 9,000 Increase in deferred costs - - - (2,475) Acquisition of Acea, net of cash acquired - - - (62) ---------- ----------- ----------- --------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 159 12,829 (10,956) (12,385) ---------- ---------- ------------ --------- FINANCING ACTIVITIES Net cash proceeds from issuance of common stock 183 2,460 15,273 61,428 Net cash proceeds from issuance of preferred stock 11,320 6,000 7,000 40,701 Proceeds from sales/leaseback of fixed assets and notes payable 281 1,002 649 5,516 Payments on capital lease obligations and notes payable (519) (707) (1,090) (4,405) ----------- ---------- ---------- --------- NET CASH PROVIDED BY FINANCING ACTIVITIES 11,265 8,755 21,832 103,240 ------------ ---------- ---------- ---------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,188) 2,360 (5,845) 2,222 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 3,410 1,050 6,895 - ----------- ----------- ----------- ---------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,222 $ 3,410 $ 1,050 $ 2,222 ========== ========== ========== ========= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid for interest $ 81 $ 66 $ 139 $ 901 ========== ========== =========== ========== Non-Cash Financing Activity: Accretion of preferred stock for beneficial conversion feature $ 890 $ 0 $ 0 $ 890 ========== ========== ========== ========== See accompanying notes 16
COCENSYS, INC. (A development stage company) NOTES TO FINANCIAL STATEMENTS December 31, 1998 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BUSINESS CoCensys, Inc. ("CoCensys" or the "Company") was incorporated in 1989 for the purpose of discovering, developing and commercializing novel products to treat disorders of the brain. Since inception, the Company has devoted substantially all of its resources to the discovery and development of such products. The Company has not generated any revenues from the development of its own products and has sustained continuing operating losses from its development activities. Such losses could continue for several years. The Company plans to finance its future development activities through a combination of sales of equity securities, payments from corporate development partners and revenues from performing product development services. There can be no assurance that the Company will be successful in these areas. REVERSE STOCK SPLIT At the Special Meeting of Stockholders held on January 27, 1999, stockholders authorized the Board of Directors to effect a reverse stock split within a range of one new share of common stock for every six, seven or eight outstanding shares of stock. The Board subsequently approved a reverse split of one-for-eight effective April 15, 1999. All share and per share amounts have been restated to reflect this reverse stock split. 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. Significant estimates made in preparing the financial statements include the determination of co-promotion and co-development revenues and the valuation allowance for deferred tax assets. FAIR VALUE OF FINANCIAL INSTRUMENTS Financial investments that subject the Company to concentration of credit risk consist principally of cash, cash equivalents and investments, of which $12,095,000 is not federally insured as of December 31, 1998. CASH EQUIVALENTS AND INVESTMENTS The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Short-term investments consist of debt securities classified as "available for sale" and have maturities greater than three months and less than twelve months from the date of acquisition. Investments classified as "available for sale" are reported at fair value with unrealized gains and losses reported as a separate component of other comprehensive income (loss) in the statement of stockholders' equity. 17 The Company invests primarily in U.S. government securities and corporate obligations. The following table summarized unrealized gains and losses on the Company's investments:
Gross Gross unrealized unrealized Fair Cost loss gain value -------------- -------------- ------------- -------------- As of December 31, 1998 $ 11,342,471 $ (15,045) $ 43,433 $ 11,507,135 As of December 31, 1997 $ 11,694,727 $ (3,401) $ 18,150 $ 11,855,580
Realized gains and losses were not significant for the years ended December 31, 1998, 1997 and 1996. In October 1998, the Company established an escrow account to hold funds that are committed to satisfy an obligation related to the purchase of certain drug marketing rights and new drug approvals (NDAs) in connection with the disposition of its sales and marketing force in October 1998. The escrow account held $552,400 and $1,005,900 at December 31, 1998 and 1997, respectively. Under the terms of the escrow agreement, $500,000 will be paid in October 1999 to satisfy the remaining obligation and all excess funds will be released to the Company. PROPERTY AND EQUIPMENT Property and equipment is stated at cost and consists of the following at December 31, (in thousands): 1998 1997 ---------- --------- Laboratory equipment $ 2,271 $ 2,218 Computer equipment and software 1,483 1,107 Office equipment 924 930 Leasehold improvements 2,206 2,105 ---------- ---------- 6,884 6,360 Less accumulated depreciation (4,418) (3,537) ---------- ---------- Net property and equipment $ 2,466 $ 2,823 ========== ========== The carrying value of leased assets (treated as capital leases) at December 31, 1998 and 1997 were $1,082,000 and $1,007,000 respectively, net of accumulated amortization of $204,000 and $130,000 respectively. Depreciation of property and equipment, including assets under capital lease obligations, has been provided using the straight-line method over the estimated useful lives of the assets which range from three to five years, except for leasehold improvements which are amortized over the lease term. REVENUE AND EXPENSE RECOGNITION See Notes 4, 5, 6, 7, 8 and 9 for revenue recognition policies related to co-promotion and co-development revenues from corporate partners. Co-promotion revenue is a commission earned for marketing products of another company to a specified class of medical doctors. The amount of commission earned is, generally, a base fee with a bonus calculated by reference to an agreed upon measure of activity such as sales volume or prescriptions written. The Company recognizes revenue from co-promotion activities in the period in which the promotional services are provided. Co-development revenue is earned pursuant to agreements with other pharmaceutical companies to develop and commercialize CoCensys' compounds. Revenue is earned in the form of licensing fees, payment for the attainment of developmental milestones or funding for research. The Company recognizes co- 18 development revenue in the period in which the underlying event occurs. COMPREHENSIVE INCOME As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). SFAS 130 establishes new rules for the reporting and display of comprehensive income and its components; however, the adoption of this Statement had no impact on the Company's net income or stockholders' equity. SFAS 130 requires unrealized gains and losses on available-for-sale securities, which prior to adoption were reported separately on stockholders' equity, to be included in other comprehensive income. Prior financial statements have been restated to conform to the requirements of SFAS 130. LOSS PER SHARE In 1998, Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS No. 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 exclude any dilutive effect of options, warrants and convertible securities. All per share amounts for all prior periods have been presented and, where appropriate, restated to conform to the SFAS No. 128 requirements. Both basic and diluted loss per share are computed using the weighted average number of shares of common stock outstanding. Common equivalent shares from stock options and warrants are excluded from the computation of diluted earnings per share as their effect would be antidilutive. STOCK OPTION PLANS Effective January 1, 1996, the Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") and accordingly, is continuing to account for its stock-based compensation plans under previous accounting standards. The adoption of SFAS No. 123 had no impact on the Company's results of operations or financial position. NOTES RECEIVABLE FROM OFFICERS The Company advanced funds to certain officers in exchange for notes secured by mortgages on real property. Interest on these notes accrues at 8.5% per annum. RECLASSIFICATIONS Certain reclassifications have been made to prior year data to conform to the 1998 presentation. 2. PRIVATE PLACEMENT OF PREFERRED STOCK In June 1998, the Company raised $8.0 million through the private placement of Series E Convertible Preferred Stock (the "Series E Preferred"). The Series E Preferred is convertible into common stock on June 8, 2001, or earlier at the holder's option at a price which is discounted from the fair market value of the Company's common stock at the time of conversion, subject to a maximum price of $31.44 per share. The terms of the private placement included the issuance of warrants to purchase 43,750 shares of common stock at $36.00 per share issued in June 1998 and 12,500 shares at $5.00 per share in November 1998. The Series E Preferred carries an annual dividend of 7.5 percent of the face value of the outstanding shares, subject to reductions in the dividend rate if the market price of Company's common stock increases to certain levels. Dividends are payable quarterly in cash or, at the election of the Company, by adding the amount of the dividend to the conversion value of the Series E Preferred. Additionally, $390,000 of the $8.0 million in proceeds was allocated to the warrants and $890,000 was allocated to a beneficial conversion feature that allows investors to convert at 90% of the market price of the common stock starting 122 days after issuance. These two allocated amounts have been credited to additional paid in capital and will be treated as issuance discounts. 19 Accordingly, the $890,000 was amortized over the first 122 days and the $390,000 will be amortized over three years, in the form of additional noncash preferred dividends. During fiscal 1998, the holders of the Series E Preferred converted approximately $1.6 million, including accrued dividends, into approximately 320,000 shares of common stock. Through March 24 of fiscal 1999, the holders of the Series E Preferred converted approximately $1.5 million, including accrued dividends, into approximately 835,000 shares of common stock. The impact of the conversion on loss per share would be anti-dilutive. 3. CYTOVIA LICENSING AGREEMENT In January 1998, the Company licensed certain non-core technology to Cytovia, Inc., a new company that focuses on the commercialization of patented drug screening technology, using living cells, in the area of apoptosis or programmed cell death. In exchange, CoCensys received shares of common stock of Cytovia, will be entitled to receive certain royalties and will retain certain rights relating to the development of future therapeutic agents for central nervous system disorders. As of December 31, 1998, CoCensys' interest in Cytovia was less than twenty percent and is accounted for on a cost basis and is valued at zero. 4. DISPOSITION OF SALES AND MARKETING FORCE On October 8, 1997, the Company entered into an Asset Purchase Agreement (the "Agreement") to sell its sales and marketing force (the "Force") to Watson Laboratories, Inc. ("Watson"), a wholly owned subsidiary of Watson Pharmaceuticals, Inc. Under the terms of the Agreement, Watson assumed the Force's co-promotion agreements, acquired certain of its operating assets and the right to hire approximately 70 employees of the Force. As consideration for these assets, the Company received $8.0 million from Watson in October 1998 with up to $1.0 million more due to the Company if Watson retained, as of specified future dates, certain percentages of the employees from the Force. Pursuant to this contingency arrangement, Watson paid CoCensys $750,000 in April 1998 and $250,000 in October 1998. In order to satisfy certain provisions of the Agreement, the Company entered into, and transferred to Watson, agreements with two pharmaceutical companies for marketing rights and NDAs for two drugs with an aggregate cost of $2.0 million. Of this total, the Company paid $1.0 million in October 1997. Additionally, $1.0 million of the $8.0 million of proceeds from the sale of the Force was placed into an escrow account to satisfy the future obligations related to these acquisitions. In October 1998, the Company made the first $500,000 payment against this obligation and will make the final $500,000 payment in October 1999. 5. DEVELOPMENT AND COMMERCIALIZATION AGREEMENT WITH WYETH-AYERST LABORATORIES In May 1997, the Company entered into a development and commercialization agreement for Co 2-6749, its lead anxiolytic compound, with the Wyeth-Ayerst Laboratories Division ("Wyeth-Ayerst") of American Home Products Corporation ("AHP"). Under the terms of the agreement, Wyeth-Ayerst paid CoCensys a non-refundable $5.0 million licensing fee and AHP paid $5.0 million to purchase 100,000 shares of the Company's Series C Convertible Preferred Stock. Additionally, CoCensys will receive specified milestone payments dependent upon the achievement of key development events and $750,000 per quarter for up to three years to identify back-up compounds. However, if Co 2-6749 fails to meet certain criteria, and the back-up program fails to produce a back-up compound that meets other certain criteria, Wyeth-Ayerst has the right to terminate the back-up program and require CoCensys to reimburse it for a portion of the back-up funding. As of December 31, 1998, the Company had $2.6 million recorded as deferred revenue related to the Wyeth-Ayerst back-up program; this deferred amount will be recognized as revenue when Co 2-6749 or a back-up compound meets applicable criteria for acceptance by Wyeth-Ayerst. Wyeth-Ayerst is responsible for the costs associated with developing Co 2-6749. Wyeth-Ayerst and the Company will co-promote any resulting product in certain market segments in the United States, while Wyeth-Ayerst will have rights to develop, register and market any drugs derived from the collaboration in the 20 rest of the world, subject to royalty obligations to CoCensys. The preferred stock is convertible into common stock after May 12, 1999, at the election of Wyeth-Ayerst, at a conversion price based on the market price of the common stock at that time (subject to certain minimum and maximum limits). 6. MARKETING AND DEVELOPMENT COLLABORATION WITH WARNER-LAMBERT COMPANY In October 1995, the Company entered into a collaboration with Warner-Lambert Company ("Warner-Lambert") and its Parke-Davis division to develop and market therapeutic drugs for the treatment of certain central nervous system disorders. This arrangement consists of the Research, Development and Marketing Collaboration Agreement (the "1995 Warner Collaboration Agreement"), for the worldwide development and commercialization of a new class of neurological and psychiatric drugs, termed subtype selective NMDA receptor antagonists ("SSNRAs"), and the Parke-Davis Promotion Agreement. Pursuant to the Parke-Davis Promotion Agreement, the Company co-promoted Parke-Davis' central nervous system drug, Cognex(R), until June 1997 when Parke-Davis terminated the co-promotion agreement. In October 1997, the 1995 Warner Collaboration Agreement was amended, restated and extended until October 1999 (the "1997 Amended Warner Collaboration Agreement"). Under the 1997 Amended Warner Collaboration Agreement, both companies share technology and resources to develop SSNRA candidates. The parties are obligated to make specified contributions to development costs with respect to any development candidates. Promotion costs of, and profits from any products developed under the agreement will be shared equally in the United States and Japan. Warner-Lambert will have the exclusive right to develop and market any product, at its own cost, for markets outside the United States and Japan, subject to a specified royalty payment to the Company. Warner-Lambert is obligated to pay its specified portion of the development costs and to make certain milestone payments, upon achievement of certain clinical development and regulatory milestones, for each development compound. Payments received under both the 1995 Warner Collaboration Agreement 1997 Amended Warner Collaboration Agreement are recognized as co-development revenues and payments made are recognized as expenses. Pursuant to the 1995 Warner Collaboration Agreement, Warner-Lambert purchased $2.0 million of CoCensys Common Stock in October 1995 and an additional $2.0 million of CoCensys Common Stock in March 1997. Pursuant to the 1997 Amended Warner Collaboration Agreement extension of the Warner Collaboration Agreement, Warner-Lambert purchased 14,286 shares of the Company's Series D Convertible Preferred Stock for $1.0 million in October 1997 and an additional 85,714 shares of the same series of convertible preferred stock for $6.0 million in January 1998. If converted on the mandatory conversion date, the Series D stock would have been converted into such number of shares of common stock equal to the quotient of the aggregate face value of the preferred stock divided by the average of the closing prices of the common stock for a period of thirty (30) trading days ending on the third trading day prior to the automatic conversion date. The preferred stock is convertible at an earlier date at the Company's option into such number of shares of common stock equal to the aggregate original issue price of such shares divided by the greater of (a) the average of the closing prices of the common stock for the 30 trading days during the period ending on the third trading day prior to the date of original issuance of such shares or (b) the average of the closing prices of the common stock for the 30 trading days during the period ending on the third trading day prior to the date upon which the Company notifies the holders of such optional conversion. As part of the extension of the Warner Collaboration Agreement in October 1997, the companies agreed to expand the collaboration to allow the companies to analyze and consider for collaborative development each company's AMPA modulator technologies. In January 1998, the parties agreed to return the focus of their collaboration agreement solely to SSNRAs. Each party retained all rights to its respective AMPA modulator technology. In addition, as part of removal of the AMPA modulator technology from the Warner Collaboration Agreement, the Company is obligated to pay to Warner-Lambert $1 million on December 31, 1999. The due date for this amount, which originally was January 1999, has been extended to December 31, 1999 and is payable in common stock (based on the then current stock price) or cash at the election of Warner-Lambert and is secured by the 21 Company's assets. This $1.0 million amount is included in "Due to corporate partners" on the accompanying balance sheet. 7. DEVELOPMENT AND COMMERCIALIZATION AGREEMENT WITH G.D. SEARLE & CO. In May 1996, the Company entered into an agreement with G.D. Searle & Co. ("Searle") to co-develop and co-promote CCD 3693, the Company's lead compound for the treatment of insomnia along with its back-up compounds. Pursuant to the agreement, Searle paid a $3.0 million license fee and purchased 100,000 shares of the Company's Series B Convertible Preferred Stock for $7.0 million. The license fee was recognized as co-development revenue in 1996. In May 1998, the Series B Convertible Preferred Stock converted, in accordance with its terms, into 200,000 shares of common stock at a conversion price of $35.00 per share. In July 1998, Searle notified CoCensys that it had decided not to participate further in the development of the Company's proprietary compounds for the treatment of insomnia. CoCensys intends to continue research and development of its compounds to treat insomnia and will seek a new partner for the program in the future. 8. PROMOTION AGREEMENT WITH SOMERSET PHARMACEUTICALS, INC. In January 1996, the Company and Somerset Pharmaceuticals, Inc. ("Somerset") entered into the Somerset Promotion Agreement, pursuant to which the Company, through its Sales Force, promoted Somerset's drug Eldepryl(R) to neurologists in the United States for the treatment of Parkinson's disease. Effective January 1, 1997, the initial agreement was superseded by the 1997 Somerset Promotion Agreement. Under the 1997 Somerset Promotion Agreement, CoCensys had the exclusive right to detail Eldepryl to certain neurologists and other physicians in the United States and was compensated based upon the number of details undertaken and gross sales of Eldepryl. In October 1997 the Company sold its sales and marketing force, and all related co-promotion agreements, to Watson. 9. MARKETING AND DEVELOPMENT COLLABORATION WITH NOVARTIS PHARMA, A.G. In May 1994, the Company entered into a marketing and development collaboration with Novartis Pharma, A.G. (formerly Ciba-Geigy Limited) ("Novartis") for the co-promotion by the Company of certain Novartis products and the development and commercialization of ACEA 1021, a compound being developed by the Company. This collaboration consisted of the Novartis Promotion Agreement and the Novartis Research and Development Agreement. Pursuant to the Novartis Promotion Agreement, CoCensys established a sales force to co-promote and market certain Novartis products in the United States initially to psychiatrists. The agreement provided for the advance of funds to the Company to cover a portion of the expenses incurred by the CoCensys sales force in promoting the Novartis products. CoCensys realized co-promotion revenues from its share of sales of Novartis products above certain baseline levels specified in the contract. The Novartis Promotion Agreement terminated at the end of 1996. In connection with the Novartis Research and Development Agreement, Novartis purchased $7.0 million of CoCensys common stock and agreed to make certain nonrefundable milestone payments in connection with specified events in the course of the development of ACEA 1021. In April 1999, Novartis advised the Company that it would not continue the development of ACEA 1021, and the agreement terminated effective October 1999. The Company is seeking a new partner to develop ACEA 1021. There can be no assurance that the Company will be able to secure another partner to continue the development of this compound. 10. COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS The Company leases office and research facilities and certain equipment under operating leases and capital leases with varying terms extending through July 2002. Annual future minimum payments under operating and capital leases as of December 31, 1998, are as follows (in thousands): 22
OPERATING CAPITAL LEASES LEASES ---------- --------- Year ending December 31, 1999 $ 890 $ 372 2000 886 320 2001 879 72 2002 548 - ---------- ---------- Total minimum payments $3,203 764 ========== Less amount representing interest (82) ---------- Present value of future minimum payments 682 Current portion (316) ---------- Long-term portion $ 366 ==========
Rent expense for the years ended December 31, 1998, 1997 and 1996 was $1,006,000, $1,040,000, and $1,082,000, respectively. CONTINGENT BONUSES In December 1998, the Board of Directors approved a broad-based 1999 employee bonus program whereby an aggregate of approximately $390,000 may be paid to employees contingent upon the occurrence of certain events. 11. COMMON STOCK The Company has reserved 1.6 million shares of common stock for issuance upon exercise of options and warrants, for issuance under the 1995 Employee Stock Purchase Plan and for conversion of all preferred stock except the Series E Preferred. The Series E Preferred is convertible at a rate based on the market price of the common stock and is not subject to a minimum conversion price. Based on the December 31, 1998 closing price for the Company's common of $2.50 per share, the Series E Preferred outstanding at year end, including accrued dividends, was convertible into approximately 3.0 million shares of common stock. STOCKHOLDER RIGHTS PLAN In April 1995, the Company adopted a Stockholder Rights Plan (the "Plan") which provides for the distribution of rights ("Rights") to holders of outstanding shares of common stock. Pursuant to the Plan, a portion of Convertible Preferred Stock was designated as Junior Preferred Stock, of which 350,000 shares were reserved for issuance upon exercise of the Rights. The Rights will become exercisable only in the event, with certain exceptions, that an acquiring party accumulates or announces an offer to acquire 20 percent or more of the Company's voting stock. Each Right entitles the holder to buy one-hundredth of a share of Junior Preferred Stock at a price of $25. In addition, upon the occurrence of certain events, holders of Rights will be entitled to purchase either CoCensys' stock or shares in an "acquiring entity" at half of market value. The Company will generally be entitled to redeem the Rights at $.001 per right at any time until the tenth day following acquisition of a 20 percent position in its voting stock. The Rights expire in April 2005. 12. STOCK OPTION PLANS The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided under SFAS No. 123 requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, for certain options the Company recognizes as deferred compensation expense the excess of fair market value of the common stock at the date of grant over the aggregate exercise price of such 23 options. This deferred compensation expense is amortized ratably over the vesting period of each option. During the years ended December 31, 1998, 1997 and 1996, the Company recorded deferred compensation of $223,000, $579,000 and $629,000, respectively, in connection with the issuance and termination of certain stock options. Pro forma information regarding net income and earnings per share is required by SFAS No. 123, and has been determined as if the Company has accounted for its employee stock options under the fair value method of that Statement. Had compensation cost for the Company's grants since 1995 under the stock-based compensation plans been determined based on SFAS No. 123, the Company's pro forma net income, and pro forma diluted earnings per share for the years ending December 31, would be as follows (in thousands except per share data): YEARS ENDED DECEMBER 31, ----------------------------------------- 1998 1997 1996 -------- --------- --------- Net loss $(19,516) $(17,974) $(19,745) ========= ========= ======== Net loss per share $ (6.40) $ (6.40) $ (7.28) ========= ========= ======== The effects of applying SFAS No. 123 in this pro forma disclosure are not indicative of future amounts. SFAS 123 does not apply to awards prior to 1995, and additional awards in future years are anticipated. The fair value for these options was estimated at the date of grant using the Black-Scholes option-pricing model with the following assumptions:
YEARS ENDED DECEMBER 31, ----------------------------------------- 1998 1997 1996 --------- ---------- ---------- Expected dividend yield 0.0% 0.0% 0.0% Expected stock price volatility 85.0% 72.1% 44.2% Risk-free interest rate 4.8% 6.1% 6.2% Expected option term 4.5 years 4.6 years 5.0 years
24 A summary of the Company's stock option activity, including those issued outside of plans, and related information is as follows (in thousands, except per share amounts):
WEIGHTED- AVAILABLE SHARES OPTION AGGREGATE AVERAGE FOR OUT- PRICE EXERCISE EXERCISE GRANT STANDING PER SHARE PRICE PRICE --------- --------- --------- --------- ---------- BALANCE, DECEMBER 31, 1995 87 301 $ 0.40 - $65.04 $ 7,195 $ 23.92 Authorized 475 - - - - Granted (120) 120 $26.00 - $73.04 5,719 47.52 Exercised - (17) $ 1.60 - $41.68 (193) 11.12 Canceled and forfeited 23 (23) $ 4.00 - $67.04 (943) 40.96 ---------- ---------- ---------- BALANCE, DECEMBER 31, 1996 465 381 $ 0.40 - $73.04 11,778 30.88 Granted (213) 213 $24.00 - $57.04 8,698 40.88 Exercised - (39) $ 0.40 - $41.68 (199) 5.04 Canceled and forfeited 26 (26) $20.00 - $67.04 (1,114) 42.96 ---------- ---------- ---------- BALANCE, DECEMBER 31, 1997 278 529 $ 0.40 - $73.04 19,163 36.24 Authorized 250 - - - - Retired (82) - - - - Granted (245) 245 $ 2.00 - $31.04 3,107 12.64 Exercised - (21) $ 1.04 - $26.32 (49) 2.40 Canceled and forfeited 146 (146) $12.24 - $73.04 (5,199) 35.84 ---------- ---------- ---------- BALANCE, DECEMBER 31, 1998 347 607 $ 0.40 - $73.04 $ 17,022 $ 28.00 ========== ========== ==========
The weighted-average fair value of options granted was $12.72, $24.48 and $26.00 during 1998, 1997 and 1996, respectively. The weighted-average remaining contract life was 6.4 years, 7.3 years and 6.8 years for 1998, 1997 and 1996, respectively. The following table summarizes information about stock options outstanding at December 31, 1998:
RANGE WEIGHTED WEIGHTED OF NUMBER REMAINING AVERAGE NUMBER AVERAGE EXERCISE OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE PRICES (IN THOUSANDS) LIFE PRICE (IN THOUSANDS) PRICE -------- ------------- ----------- --------- -------------- -------- $ 0.40 to 12.00 253 7.2 $ 6.96 105 $ 4.56 16.24 to 24.00 20 5.7 20.80 17 20.80 24.56 to 36.00 109 7.5 28.16 56 27.92 37.04 to 73.04 225 5.6 52.24 175 52.48
Options to purchase approximately 353,000, 238,000 and 188,000 million shares of common stock were exercisable as of December 31, 1998, 1997 and 1996, respectively. 1990 STOCK OPTION PLAN Under the Company's 1990 Stock Option Plan, as amended, options granted to purchase common stock of the Company may be either incentive stock options to employees or nonqualified stock options to employees, directors or consultants, at the discretion of the Board of Directors. The plan permits the Company to grant incentive stock options at 100% of the fair value at the date of grant, while statutory stock options may be granted at 50% of the fair value at the grant date. Options granted to date generally vest at the rate of 25% of the total shares upon the first anniversary of the vesting commencement date, and 2.08% of the total shares per month thereafter. Vesting begins on either the grant date or, if different, on the vesting commencement date specified by the Board of Directors. Such vesting is subject to continued employment with the Company. The options expire ten years from the date of grant or 90 days from termination, if sooner. 1992 NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN 25 In December 1992, the Company adopted the 1992 Non-Employee Directors' Stock Option Plan (the "Directors' Plan"), as amended, to provide for the automatic grant of options to purchase shares of common stock to non-employee directors of the Company. Each such director is granted an option to purchase 2,500 shares of common stock (5,000 shares for the Chairman of the Board). At the beginning of each fiscal year, each non-employee director will be granted an option to purchase an additional 1,000 shares of common stock (1,500 for the Chairman). Vesting on the initial grant occurs in five equal annual installments from the date of the grant for each year that the optionee remains a director. Annual grants vest in full one year from the date of grant. Vesting accelerates upon certain changes in ownership of the Company. The exercise price of options under the Directors' Plan must equal or exceed the fair market value of the common stock on the date of the grant. 1995 EMPLOYEE STOCK PURCHASE PLAN In March 1995, the Company adopted the 1995 Employee Stock Purchase Plan and reserved 43,750 shares of common stock for issuance thereunder. In June 1997, the Company reserved an additional 25,000 shares for issuance under the plan, which was approved by shareholders in June 1998. Pursuant to the provision of the plan, employees purchased 17,055, 11,362 and 14,093 shares of common stock in 1998, 1997 and 1996, respectively, at $1.92 to $56.96 per share. 1996 EQUITY INCENTIVE PLAN In December 1996, the Company adopted the 1996 Equity Incentive Plan to provide for the issuance of stock options, restricted stock, stock bonuses and stock appreciation rights to employees, directors or consultants, at the discretion of the Board of Directors. The plan permits the Company to grant incentive stock options at 100% of the fair value at the date of grant, while nonqualified stock options may be granted at 85% of the fair value at the grant date. Options granted will generally vest at the rate of 25% of the total shares upon the first anniversary of the vesting commencement date, and 2.08% of the total shares per month thereafter. Vesting will begin on either the grant date or, if different, on the vesting commencement date specified by the Board of Directors. Such vesting will be subject to continued employment with the Company. The options will expire ten years from the date of grant or 90 days from termination, if sooner. The Company has reserved 350,000 shares of common stock for issuance under this plan. 1998 NON-OFFICER EQUITY INCENTIVE PLAN In September 1998, the Company adopted the 1998 Non-Officer Equity Incentive Plan to provide for the issuance of stock options, restricted stock and stock bonuses to employees or consultants, at the discretion of the Board of Directors. Officers of the Company are not eligible to receive any benefits under this plan. The plan permits the Company to grant nonqualified stock options with an exercise price of not less than 85% of the fair value at the grant date. Options granted will generally vest at the rate of 25% of the total shares upon the first anniversary of the vesting commencement date, and 2.08% of the total shares per month thereafter. Vesting will begin on either the grant date or, if different, on the vesting commencement date specified by the Board of Directors. Such vesting will be subject to continued employment with the Company. The options will expire ten years from the date of grant or 90 days from termination, if sooner. The Company has reserved 250,000 shares of common stock for issuance under this plan. OTHER OPTIONS AND WARRANTS In September 1990, the Company granted to a director of the Company an option to purchase 2,500 shares of common stock at $0.40 per share, outside of any plans. The option is fully vested and expires in September 2001, or three months after termination as a director, if sooner. In November 1995, the Company granted to an officer of the Company an option to purchase 3,125 shares of common stock at $4.00 per share, outside of any plans. The option is fully vested and expires in November 2005. In connection with the June 1994 purchase of Acea Pharmaceuticals, Inc., the Company issued warrants to purchase 3,998 shares of common stock at $0.32 per 26 share. The warrants were exercised on October 2, 1998. In July 1992, the Company issued a warrant to purchase 5,250 shares of common stock at $40.00 per share in connection with a capital lease agreement. The warrant expires in July 2002. As part of a private offering in June 1995 that included the sale of 463,462 shares of common stock, the Company issued 185,385 warrants. Each warrant entitles the holder to purchase one share of common stock at a pre-determined price ranging from $31.20 per share to $35.20 per share during the five-year exercise period. As of December 31, 1998, 173,870 of these warrants were outstanding. As discussed above in Note 2, as part of a private offering in June 1998 that included the sale of $8.0 million of convertible preferred stock, the Company issued warrants to purchase 43,750 shares of common stock at $36.00 per share and in November 1998 issued warrants to purchase 12,500 shares at $5.00 per share. 13. DEFERRED INCOME TAXES Deferred income taxes reflect the net tax effect of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities at December 31, are as follows (in thousands):
1998 1997 ---------- ----------- DEFERRED TAX LIABILITIES Book/tax depreciation difference $ (117) $ (161) ---------- ----------- Total deferred tax liabilities (117) (161) DEFERRED TAX ASSETS Net operating loss carryovers 32,797 27,860 Research and development credit carryovers 5,704 4,822 Capitalized state research and development costs 6,301 5,376 Other 92 152 ---------- ----------- Total deferred tax assets 44,894 38,210 Valuation allowance for deferred tax assets (44,777) (38,049) ---------- ----------- Net deferred tax assets 117 161 ---------- ----------- Net deferred taxes $ - $ - ========== ===========
At December 31, 1998, the Company had operating loss carryovers of approximately $96 million for federal income tax purposes. The federal loss carryovers begin to expire in 2004. For federal and California income tax purposes, the Company also had unused research and development credits of approximately $4.0 million and $1.7 million respectively, which expire beginning in 2004. The difference between the financial reporting and tax loss carryforwards for California purposes is attributable to the capitalization of research and development expenses and the 50% limitation on loss carryforwards for California tax purposes. The Tax Reform Act of 1986 includes provisions which significantly limit potential use of net operating losses and tax credit carryovers in situations where there is a change in ownership, as defined in Internal Revenue Code Section 382, of more than 50% during a three-year period. Accordingly, if a change in ownership occurs, the ultimate benefit realized from these carryovers may be significantly reduced in total, and the amount that may be utilized in any given year may be significantly limited. California has enacted similar legislation. The Company has had stock issuances and an ownership change occurred as a result of the Acea acquisition in June 1994. The annual limitation is approximately $2.4 million on accumulated net operating losses of approximately $24.6 million. 14. EMPLOYEE SAVINGS PLAN 27 The Company has an employee savings plan that permits participants to make contributions by salary reduction pursuant to section 401(k) of the Internal Revenue Service. During 1996, the Company began matching 50% of a participant's contribution up to a maximum participant contribution of 4% of eligible compensation. In connection with this matching contribution, the Company recognized expense of $63,000, $176,000 and $51,000 in 1998, 1997 and 1996, respectively. 15. BUSINESS SEGMENTS Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS 131), which superseded Statement of Financial Accounting Standards No. 14, "Financial Reporting for Segments of a Business Enterprise." SFAS No. 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. The adoption of SFAS 131 did not affect results of operations or financial position, but did affect the following disclosure of segment information. Historically, the Company has operated in two business segments, drug promotion and drug development. Promotion revenues arise from contractual agreements under which the Company promotes other pharmaceutical companies' products in return for commissions. Development revenues arise from contractual agreements with large pharmaceuticals companies pursuant to which the Company licenses various commercialization or development rights relating to compounds or performs research activities in exchange for licensing fees, milestone payments or research funding. In October 1997, the Company sold its sales and marketing force to Watson and ceased all drug promotion activities. The accounting policies of these segments are the same as those described in the summary of significant accounting policies except that interest income and certain expenses are not allocated to the segments. Assets allocated to the segments include only other current and noncurrent assets and net property and equipment. 28 Selected financial information for the Company's business segments as of and for the years ended December 31, 1998, 1997 and 1996 follows (in thousands):
1998 1997 1996 ------------- ------------- ------------- Revenues from external partners Drug promotion segment $ 540 $ 3,264 $ 9,085 Drug development segment 2,046 8,650 6,073 ------------- ------------- ------------- $ 2,586 $ 11,914 $ 15,158 ============= ============= ============= Operating income Drug promotion segment $ 540 $ (4,408) $ (3,140) Drug development segment (17,593) (16,961) (16,513) ------------- ------------- ------------- $ (17,053) $ (21,369) $ (19,653) ============= ============= ============= Assets Drug promotion segment $ - $ - $ 605 Drug development segment 2,819 3,364 2,663 ------------- ------------- ------------- $ 2,819 $ 3,364 $ 3,268 ============= ============= ============= Depreciation and amortization Drug promotion segment $ - $ 29 $ 738 Drug development segment 907 907 1,334 ------------- ------------- ------------- $ 907 $ 936 $ 2,072 ============= ============= ============= Expenditures for long-lived assets Drug promotion segment $ - $ 121 $ 80 Drug development segment 566 1,354 732 ------------- ------------- ------------- $ 566 $ 1,475 $ 812 ============= ============= ============= In fiscal 1998, three partners represented 96 percent of revenues. In fiscal 1997, three partners represented 88 percent of revenues. In fiscal 1996, four partners represented 100 percent of revenue.
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