-----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, EUb0293RhvnxJ3s+SyFUesOriEjwbrm7EwF5v4wsdQO07EPlbsKUR6cYXYovjLjx tZe0oGlKu6ZnkqYvqZlepA== 0000936392-98-000539.txt : 19980401 0000936392-98-000539.hdr.sgml : 19980401 ACCESSION NUMBER: 0000936392-98-000539 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: DEPOTECH CORP CENTRAL INDEX KEY: 0000931686 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 330387911 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 033-85362 FILM NUMBER: 98583512 BUSINESS ADDRESS: STREET 1: 10450 SCIENCE CENTER DRIVE STREET 2: STE 100 CITY: SAN DIEGO STATE: CA ZIP: 92037 BUSINESS PHONE: 6196252424 MAIL ADDRESS: STREET 1: 10450 SCIENCE CENTER DRIVE CITY: SAN DIEGO STATE: CA ZIP: 92121 10-K 1 FORM 10-K 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For fiscal year ended December 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from ________ to _______. Commission File Number: 0-26862 DEPOTECH CORPORATION (Exact name of Registrant as specified in its charter) CALIFORNIA 33-0387911 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 10450 Science Center Drive, San Diego, California 92121 (Address of principal executive offices) (zip code) Registrant's telephone number, including area code: (619) 625-2424 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value 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 voting stock held by nonaffiliates of the registrant as of March 2, 1998 was approximately $41,640,856. For the purposes of this calculation, shares owned by officers, directors and 10% shareholders known to the registrant have been deemed to be owned by affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The number of shares outstanding of the registrant's Common Stock as of March 2, 1998 was 14,342,245. 2 Documents Incorporated by Reference Portions of the Registrant's 1997 Annual Report to Shareholders, a copy of which is attached hereto as Exhibit 13.1, are incorporated as provided in Part II. Portions of Registrant's Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on May 13, 1998, to be filed on or about April 6, 1998, referred to herein as the "Proxy Statement", are incorporated as provided in Part III. 2 3 PART I Item 1. BUSINESS The discussion of the Company's business contained in this Annual Report on Form 10-K may contain certain projections, estimates and other forward-looking statements that involve a number of risks and uncertainties, including those discussed below at "Risks and Uncertainties." While this outlook represents management's current judgment on the future direction of the business, such risks and uncertainties could cause actual results to differ materially from any future performance suggested below. The Company undertakes no obligation to release publicly the results of any revisions to these forward-looking statements to reflect events or circumstances arising after the date hereof. OVERVIEW DepoTech Corporation ("DepoTech" or the "Company") is a drug delivery company engaged in the development and manufacture of sustained-release therapeutic products based on its DepoFoam(TM) injectable drug delivery technology ("DepoFoam"). The Company does not engage in the discovery of new chemical entities. DepoFoam consists of microscopic, spherical particles composed of hundreds to thousands of nonconcentric chambers each separated from adjacent chambers by a bilayer lipid membrane. The Company has developed DepoFoam formulations which release drugs over an extended period of time, such as several weeks, or over a shorter period, such as a few days. The breadth of the Company's technology is illustrated by its ability to encapsulate and control the release of a wide spectrum of water-stable drugs, including small molecules, proteins, peptides and various forms of genetic material. The technology allows for injection of sustained release forms of these pharmaceutical products via several routes including under the skin, within muscle tissue, into cerebrospinal fluid, within joints and within the abdominal cavity. These features allow DepoTech to develop new formulations of products in a variety of therapeutic areas. The Company is currently developing products in cancer, pain management and other medical fields alone or on behalf of funded partners. The Company's lead product, DepoCyt(TM), cytarabine liposome injection, ("DepoCyt"), is a proprietary DepoFoam formulation of a generic, anti-cancer drug also known as Cytarabine. DepoCyt is being developed in collaboration with Chiron Corporation ("Chiron") in the United States, and with Pharmacia & Upjohn S.p.A., an affiliate of Pharmacia & Upjohn, Inc. ("P&U"), outside the United States. DepoCyt is being developed for the treatment of neoplastic meningitis ("NM")-the spread of cancers to the soft tissue membrane of the brain and spinal cord (known as the meninges) due to cancers from either solid tumors, leukemia (a form of cancer involving white blood cells) or lymphomas (a form of cancer involving tissues of the lymphatic system). Since April 1994, the Company has been conducting clinical trials of DepoCyt for the treatment of NM from each of these types of cancer. Data from a multicenter Phase III clinical trial in the solid tumor arm comparing DepoCyt with the current standard therapy (methotrexate) suggested that treatment with DepoCyt leads to higher complete response rates and extended survival. These results were not statistically significant. In addition, DepoCyt-treated patients showed a statistically significant longer time to disease progression. In April 1997 the Company completed the filing of a New Drug Application ("NDA") with the U.S. Food and Drug Administration ("FDA") for the treatment of NM from solid tumors. In December 1997, the Oncologic Drugs Advisory Committee ("ODAC") to the FDA declined to recommend approval for NM arising from solid tumors. In March 1998, DepoTech reached an agreement with the FDA to submit an amendment to the NDA to provide data from a Phase IV clinical trial of NM from solid tumors. In addition, the Company will submit interim data from a Phase III study of NM from lymphomas. Submission of the amendment will approximately double the number of patients treated with DepoCyt under review, and extend the review time for an FDA decision by three months. The final decision regarding the approval of new therapeutics resides with FDA officials subsequent to any recommendation of ODAC. In September 1997, the Company filed, on behalf of P&U, a New Drug Submission with the Canadian Health Protection Branch for DepoCyt for the treatment of NM from solid tumors. In January 1998, DepoTech's marketing partner, P&U, filed a Marketing Authorization Application with the European Medicines Evaluation Authority for the same indication. Pivotal Phase III trials of DepoCyt for the treatment of lymphomas and leukemia are continuing. Also, a Phase IV nonrandomized trial in solid tumor patients is scheduled for completion in 1998. In addition, during 1997, the Company and its U.S. corporate partner, Chiron, began a dose-finding clinical trial in pediatric patients. 3 4 The Company estimates, based on market survey data, that the current treated market for NM is approximately 20,000 patients per year in the United States. Based on data derived from autopsies, the Company estimates that approximately 65,000 patients per year in the United States develop NM. In addition to DepoCyt, the Company's development pipeline includes the following product candidates based on DepoFoam technology: (i) DepoMorphine(TM) sustained-release encapsulated morphine sulfate ("DepoMorphine"), for acute post-surgical pain management; (ii) DepoAmikacin(TM) sustained-release encapsulated amikacin ("DepoAmikacin"), a potent, broad-spectrum antibiotic for the treatment and prevention of bacterial infections; and (iii) DepoBupivacaine(TM), a DepoFoam formulation of the local anesthetic bupivacaine, for the treatment of regional pain. Furthermore, the Company and Chiron are assessing the feasibility of a DepoFoam formulation of a gene therapy product for an undisclosed indication. DepoTech is also evaluating, in conjunction with the Monsanto Company and Synthelabo, the feasibility of DepoFoam formulations of several additional compounds. For DepoMorphine, DepoTech has completed a Phase I safety and pharmacokinetics study and is scaling up the manufacturing process for commercial manufacturing. Patient enrollment in Phase II clinical studies designed to assess the safety and efficacy of the drug is expected to conclude in 1998. The Company completed a Phase I clinical trial for DepoAmikacin in April 1996 in which the drug was found to be well-tolerated for all dosage levels studied. DepoTech has completed formulation studies of DepoBupivacaine for use during or after a surgical procedure or trauma. In order to focus the Company's resources on DepoCyt, DepoMorphine and partner-funded feasibility programs, DepoTech will evaluate financing options before proceeding with further development of DepoAmikacin and DepoBupivacaine. The Company's strategy is focused on the development and commercialization of proprietary DepoFoam formulations of generic drugs or, in collaboration with corporate partners, the development of DepoFoam formulations of compounds proprietary to the corporate partners. The Company is implementing this strategy by: (i) developing high value-added DepoFoam formulations of approved or late-stage drugs; (ii) expanding the product pipeline by identifying new product opportunities according to stringent criteria and by conducting feasibility studies; (iii) establishing collaborative and funding arrangements for development and commercialization of new DepoFoam products; and (iv) retaining certain manufacturing rights to DepoFoam formulations. The Company believes this strategy minimizes certain risks associated with pharmaceutical discovery and development, including risks associated with determining the efficacy and safety of the underlying drug. Since 1995, the Company has manufactured clinical material in a 14,400 square foot manufacturing plant built for this purpose. This manufacturing plant has completed validation to comply with current Good Manufacturing Practices ("cGMPs") regulations for the manufacture of pharmaceuticals and was inspected by the California Department of Health Services Food and Drug Branch and received a license from the State of California to manufacture drugs. This manufacturing plant has undergone pre-approval inspections ("PAI") from the FDA for the manufacture of DepoCyt. The Company has been notified by the FDA's District Office that they are recommending approval for commercial manufacturing of DepoCyt. However, this does not imply FDA product approval of DepoCyt which currently remains subject to FDA review as described above. The Company occupies an 82,000 square foot facility housing its administrative, research and development and future manufacturing activities. Since March 1994, DepoTech and Chiron have collaborated in the development of DepoCyt and performed preclinical and feasibility studies of DepoFoam formulations of certain of Chiron's proprietary products. The contractual arrangement provides for the future development of additional DepoFoam formulations of other Chiron proprietary products, including certain therapeutic proteins, vaccines, and gene therapy products. The original contractual arrangement (the "Chiron Agreement") between DepoTech and Chiron grants Chiron rights to market and sell DepoCyt in the United States, Canada and Europe. DepoTech will manufacture DepoCyt, Chiron will market, sell, and distribute DepoCyt, and the parties will share profits equally. Chiron also has a right of first refusal to obtain a license to alternate DepoFoam formulations of cytarabine under terms and conditions to be negotiated in the future. Following an evaluation of the markets and certain other factors, the Company and Chiron mutually agreed not to further develop any additional generic cancer compounds named in the Chiron Agreement. In June 1997, DepoTech and Chiron amended the Chiron Agreement and DepoTech repurchased Canadian and European rights to DepoCyt from Chiron for up to $13.7 million, of which $2.0 million was expensed and paid to Chiron in December 1997. The remaining $11.7 million is payable upon the earlier of U.S. or European regulatory notification that the application to market or sell DepoCyt is approvable or approved. If all applications for regulatory approval to sell DepoCyt in the U.S. and European Union are permanently withdrawn, DepoTech will be relieved of any obligation to pay the remaining $11.7 million. 4 5 The Chiron Agreement also provides for the joint development of DepoFoam formulations of certain compounds proprietary to Chiron ("Chiron Products"). In 1998 and thereafter, Chiron must fund one feasibility program for a Chiron Product per year or lose its option to develop DepoFoam formulations of additional Chiron Products. The Chiron Agreement provides that Chiron will pay DepoTech for the Company's feasibility efforts, and that Chiron will be responsible for all development costs thereafter. The Chiron Agreement also provides for payments by Chiron to DepoTech upon achievement of certain development milestones with regard to Chiron Products. Chiron will have exclusive, worldwide distribution rights to all Chiron Products and will manufacture the bulk unencapsulated drug. DepoTech will then encapsulate the bulk drug in DepoFoam creating the Chiron Product, and Chiron will market, sell and distribute the Chiron Products. Chiron will compensate DepoTech based on both manufacturing costs, including a manufacturing profit, and a percent of Chiron's sales of the Chiron Products, in any. Both DepoTech and Chiron have the ability to terminate a portion or all of the collaboration at certain intervals and with advance notice. In addition, Chiron has the ability to terminate the development of a Chiron Product with a limited amount of advance notice. In July 1997, the Company signed a Marketing and Distribution Agreement with P&U. Under the contractual arrangement (the "P&U Agreement"), P&U has rights to market and sell DepoCyt in countries outside the United States. P&U will be responsible for submitting regulatory filings, and for labeling, packaging, distributing, marketing and selling DepoCyt outside the U.S. The Company will manufacture DepoCyt and receive a share of the net sales of this product from P&U. DepoTech received an upfront payment of $2.0 million and may receive milestone payments totaling up to $17.0 million. In addition, the Company receives reimbursement for clinical trials expenses up to a certain amount. In February 1998, the Company reduced its workforce aimed at lessening operating expenses and focusing resources on DepoCyt, DepoMorphine and partner-funded feasibility programs. The company reduced its staff by approximately 25% to 124 employees. DEPOFOAM TECHNOLOGY DepoFoam is a proprietary enabling drug delivery technology that permits the formulation of sustained release therapeutic products. DepoFoam consists of microscopic, spherical particles composed of hundreds to thousands of nonconcentric internal aqueous chambers containing the encapsulated drug, with each chamber separated from adjacent chambers by a bilayer lipid membrane. DepoFoam formulations can be administered by a number of routes, including under the skin, within muscle tissue, into cerebrospinal fluid, within joints and within the abdominal cavity. Because the components of DepoFoam are synthetic duplicates of lipids normally present in the body, the material is biodegradable and biocompatible. Typically, a DepoFoam particle consists of less than 10% lipid, with the remaining 90% consisting of drug in aqueous solution. The resulting DepoFoam formulation is stored under refrigeration in ready-to-use form. The Company has tested DepoFoam formulations that release drugs over a period of days to weeks with the period of release defined by the lipid composition, chemistry of the encapsulated drug and manufacturing parameters of the DepoFoam particles. The Company believes drugs may be released from DepoFoam particles as the drugs diffuse through the walls, by gradual erosion of the particles, and by processes involving the rearrangement of lipid bilayers. The nature of drug release may also be determined by the specific chemistry and size of each drug molecule. DepoTech has demonstrated that its proprietary DepoFoam technology can be used to encapsulate a wide spectrum of generic and proprietary water-stable drugs, including small molecules, proteins, peptides, antisense oligonucleotides and DNA, for a range of therapeutic indications. ADVANTAGES OF DEPOFOAM TECHNOLOGY The Company believes the DepoFoam technology addresses many of the limitations associated with traditional drug delivery technologies. Most drugs are administered orally, by injection in intermittent and frequent doses or by continuous infusion. These routes of administration are not optimal for several reasons, including difficulty in achieving therapeutic drug levels over time, problems with toxicity, high costs due to frequent or continuous administration and poor patient compliance. Furthermore, innovations in biotechnology have led to an increase in the number of large-molecule protein and peptide drugs under development. These therapeutics, because of their large molecular size and susceptibility to degradation in the gastrointestinal tract or in the blood, must usually be administered by multiple injections often in a hospital or other clinical setting. The Company believes that DepoFoam technology's key advantage over traditional methods of drug delivery, including injections and oral administration, is that the sustained-release characteristics of DepoFoam particles allow drugs to be administered less frequently and more conveniently. To attain the desired therapeutic effect, conventional drug delivery often results in a dosage that 5 6 delivers an initially high level of the drug followed by a sharp decline over time, whereas DepoFoam formulations can provide a more consistent drug level over an extended period, potentially improve safety and efficacy. For example, DepoCyt clinical trials to date have shown that DepoCyt has a therapeutic life of up to two weeks after a single intrathecal injection compared to one day with unencapsulated cytarabine. The Company believes that key features of the DepoFoam technology, including lower initial drug levels and delivery of therapeutic drug levels over an extended period of time, make it superior not only to traditional drug delivery techniques but also to other sustained-release delivery formulations. DepoFoam may: - Enhance safety and efficacy. The Company believes DepoFoam drug delivery may improve the ratio of therapeutic effect to toxicity by decreasing the initial peak concentrations of drug associated with toxicity, while maintaining levels of drug at therapeutic, sub-toxic concentrations for an extended period of time. Many drugs demonstrate optimal efficacy when concentrations are maintained at therapeutic levels over an extended period of time. When a drug is administered intermittently, the therapeutic concentration is often exceeded for some period of time, and then the concentration rapidly drops below effective levels. Excessively high concentrations are a major cause of side effects, and sub-therapeutic concentrations are ineffective. - Improved convenience and lower overall treatment costs. To be commercially viable in today's health care market, drugs must be convenient to use and show cost effectiveness, as well as therapeutic effectiveness. The Company believes that DepoFoam formulations of drugs may offer cost savings by reducing the need for continuous infusion, the frequency of administration and the number of visits a patient must make to the doctor. These formulations may also enable some patients that are typically treated in a hospital to be treated as out-patients, reduce the need for diagnostic monitoring of some products, reduce complications of therapy caused by poor compliance and eliminate the need for additional procedures or equipment. - Expand types of drugs which can be delivered over an extended period of time. Proteins, peptides and nucleic acids, because of their large molecular size and susceptibility to degradation in the gastrointestinal tract and other sites, must currently be administered frequently by injection or by continuous infusion, typically in a hospital or other clinical setting. The Company believes DepoFoam may be able to deliver these drugs more effectively. - Expand indications of currently-marketed drugs. The Company believes that the therapeutically useful release of drugs from a DepoFoam formulation may allow such drugs to be marketed for indications where they are currently not thought to be useful because of the limitations of current delivery methods. - Improve profit margins through proprietary reformulation. The Company believes DepoFoam offers the potential to produce new proprietary formulations of generic products that may be differentiated from the nonsustained-release versions by virtue of reduced dosing requirements, improved efficacy, additional applications or decreased toxicity. The Company believes the proprietary position of such DepoFoam formulations will be based on the proprietary nature of DepoFoam particles, and, as such, may offer more attractive margins and increased sales relative to the generic competition. DEPOTECH'S STRATEGY DepoTech's strategy is focused on the development and commercialization of proprietary DepoFoam formulations of generic drugs or, in collaboration with corporate partners, the development of DepoFoam formulations of compounds proprietary to its corporate partners. The Company is implementing this strategy by: - Developing high value-added DepoFoam formulations of approved or late-stage drugs. The Company's product development efforts are focused primarily on drugs that either have proven safety and efficacy and are approved for marketing or are in late-stage clinical trials. The Company does not engage in basic research to discover new molecular entities. - Expanding the product pipeline by identifying new product opportunities according to stringent criteria and by conducting feasibility studies. The Company focuses its efforts on selecting new drug candidates based on stringent criteria and developing DepoFoam formulations of drugs where sustained-release formulations offer a clear medical or cost benefit. Once a candidate compound passes these screening criteria, DepoTech performs a limited set of tests to establish technical feasibility for the product before undergoing expensive clinical development. The Company believes that proprietary DepoFoam 6 7 formulations will add additional value to such drugs by potentially increasing their level of efficacy, reducing their toxicity and side effects, lowering overall treatment costs and expanding the indications they address. - Establishing collaborative and funding arrangements for development and commercialization of new DepoFoam products. As part of its commercialization strategy, the Company intends to focus its efforts on establishing collaborative arrangements with corporate partners to obtain access to specific compounds, obtain marketing and distribution capabilities and fund product development. With respect to products that are proprietary to the partner, DepoTech will seek to have the partner fund the feasibility, formulation, development, clinical testing and regulatory costs of the DepoFoam formulations of the product and will generally grant worldwide distribution rights to the DepoFoam formulation to the partner. The Company has entered into collaborations with Chiron and P&U that contained these strategic elements. In addition, in selected instances, DepoTech may retain certain marketing or co-promotion rights. - Retaining certain manufacturing rights to DepoFoam formulations. A key strategy of the Company is to seek to maintain exclusive formulation and manufacturing rights to DepoFoam encapsulated drugs, including proprietary products of corporate partners. The Company believes it has developed significant proprietary expertise in the formulation and manufacture of DepoFoam and expects to receive compensation for its expertise and effort in manufacturing DepoFoam formulations of drugs. DepoTech intends to manufacture DepoCyt for both Chiron and P&U, subject to regulatory approval. PRODUCT RESEARCH AND DEVELOPMENT PROGRAMS The table below summarizes DepoTech's portfolio of products currently under development and formulations undergoing feasibility testing.
PRODUCT CORPORATE (ACTIVE COMPOUND) INTENDED USE STATUS(1) PARTNER(2) - ----------------------------- ------------------------ ------------------------- ------------- DepoCyt (cytarabine) Neoplastic meningitis Solid tumors NDA filed U.S./Phase IV Chiron Solid tumors NDS filed Canada P&U Solid tumors MAA filed Europe P&U Leukemia/lymphoma Phase III Chiron (U.S.) P&U (ex-U.S.) Pediatric use Dose-finding Chiron DepoMorphine (morphine) Acute post-surgical pain Phase II None DepoAmikacin (amikacin) Bacterial infections Phase I completed None DepoBupivacaine (bupivacaine) Regional pain Preclinical None F0104 Undisclosed Feasibility Monsanto F0701 Undisclosed Feasibility Synthelabo F0303 Undisclosed Feasibility Chiron
(1) "Feasibility" means initial laboratory testing to determine the ability to encapsulate the drug efficiently in DepoFoam, establish preliminary stability, engineer appropriate in vitro release rates and conduct limited animal studies. "Preclinical" means formulation optimization, scale-up experiments, additional stability testing following initial feasibility studies and other studies, including additional animal studies focused on toxicology and efficacy, necessary to prepare and file an IND. "Dose-finding" means a study to determine the appropriate dose in a patient population (e.g., pediatric patients). "Phase I" means initial human studies designed to establish the safety, dose tolerance and sometimes pharmacokinetics of a compound. "Phase II" means human studies designed to demonstrate preliminary efficacy of a compound and to select appropriate dose(s) and patient populations for further studies. "Phase III" means human studies designed to lead to accumulation of data sufficient to support an NDA. "Phase IV" means human studies that are generally performed after approval of a new drug. In the case of DepoCyt, the FDA has 7 8 requested that the Company submit a Phase IV protocol prior to submission of an NDA. Completion of a Phase IV study is not a prerequisite for review of an NDA by the FDA. (2) The Company will seek to maintain manufacturing rights to DepoFoam formulations of compounds and will generally grant worldwide distribution rights to the DepoFoam formulation to the partner. For instance, in its collaborations with Chiron and P&U, DepoTech will manufacture DepoCyt. In addition, DepoTech will encapsulate Chiron's proprietary compounds in a DepoFoam formulation. DepoCyt The Company's lead product, DepoCyt(TM), cytarabine liposome injection, is a proprietary DepoFoam formulation of a generic, anti-cancer drug also known as cytarabine. DepoCyt is being developed in collaboration with Chiron in the United States, and with P&U outside the United States. In April 1997, the Company completed the filing of an NDA initially for the treatment of NM from solid tumors. In September 1997, on behalf of P&U, the Company filed a New Drug Submission with the Canadian Health Protection Branch for DepoCyt for the treatment of NM from solid tumors. In January 1998, DepoTech's marketing partner, P&U, filed a Marketing Authorization Application with the European Medicines Evaluation Authority for the same indication. Background. NM is the spread of cancers to the soft tissue membrane of the brain and spinal cord (known as the meninges) due to cancer from either solid tumors, leukemia (a form of cancer involving white blood cells) or lymphomas (a form of cancer involving tissues of the lympohatic system). Because of the blood-brain barrier, drugs in the bloodstream do not penetrate well into the cerebral spinal fluid ("CSF"). Thus, when cancer cells metastasize to the meninges, the most effective therapy is to inject anti-cancer drugs directly into the CSF. Cytarabine is one of the two drugs most commonly used for this therapy. Cytarabine acts by inhibiting a vital enzyme in DNA synthesis, DNA polymerase, causing a halt to the synthesis of DNA and resulting in death of a dividing cell. Therefore, the best results are obtained when the drug is localized in the vicinity of dividing cancer cells for an extended period. Because the therapeutic half-life of cytarabine in the CSF is relatively short, frequent and repeated injections are necessary for effective treatment. For safety reasons, continuous intrathecal infusion of cytarabine is not a viable option. The result is that NM cannot be treated effectively without the use of repeated, intrathecal injections that are inconvenient and uncomfortable for patients, require physician supervision and increase the risk of infection. Because of these and other factors, the disease is often under-diagnosed and frequently left untreated. Without effective treatment, life expectancy for patients diagnosed with this disease is between two and four months. Clinical trials to date have shown that DepoCyt maintained concentrations of cytarabine in the CSF for two weeks after a single intrathecal injection as compared to less than one day with traditional intrathecal injections of cytarabine. As a consequence, the use of DepoCyt results in less frequent injections and may extended therapeutic levels of the drug in the CSF. Markets. The Company estimates that the current treated market for NM is approximately 20,000 patients per year in the United States. However, the Company expects the treatment market to grow and estimates that approximately 65,000 patients per year in the United States develop this disease. In June 1993, the Company obtained orphan drug designation for DepoCyt from the FDA to treat NM. Clinical Development. In the Phase III clinical trial as originally designed and initiated in April 1994, patients with one of the three subtypes of NM selected from multiple centers were randomized to receive either DepoCyt or standard therapy. Standard therapy for metastases of solid tumors is methotrexate and the standard therapy for metastases of leukemia and lymphoma is unencapsulated cytarabine. Within each subtype, at least 20 patients were to receive DepoCyt and at least 20 patients were to receive standard therapy. A total of 40 patients were to be treated for each subtype of the disease and a minimum total of only 120 patients were required to complete all three arms of the study. Enrollment of patients into the Phase III trial for NM from solid tumors was completed in May 1996 and the data from the trial was analyzed subsequently based on a data cutoff date of October 1, 1996. Data from a multicenter Phase III clinical trial in the solid tumor arm comparing DepoCyt with the current standard therapy (methotrexate) suggested that treatment with DepoCyt resulted in a higher complete response rate and extended survival when compared to standard therapy. These results were not statistically significant. In addition, DepoCyt-treated patients showed a statistically significant longer time to disease progression. In April 1997 , the Company completed the filing an NDA with the FDA for the treatment of NM from solid tumors. In December 1997, ODAC declined to recommend approval for NM from solid tumors. In March 1998, DepoTech reached an agreement with the FDA to submit an amendment to the NDA to provide data from the Phase IV clinical trial of NM from solid tumors. In addition, the Company will submit interim data from the Phase III study of NM from lymphomas. Submission of the 8 9 amendment will approximately double the number of patients treated with DepoCyt under review, and extend the review time for an FDA decision by three months. The final decision regarding the approval of new therapeutics resides with FDA officials subsequent to any recommendation of ODAC. In September 1997, the Company filed a New Drug Submission with the Canadian Health Protection Branch for DepoCyt for the treatment of NM from solid tumors. In January 1998, DepoTech's marketing partner, P&U, filed a Marketing Authorization Application with the European Medicines Evaluation Authority for the same indication. Additional Territories and Indications. Pivotal Phase III trials of DepoCyt for the treatment of lymphomas and leukemia are continuing. Also, a Phase IV nonrandomized trial in solid tumor patients is scheduled for completion in 1998. With P&U, DepoTech intends to start a dose confirmation study trial of DepoCyt in Japan. This trial is designed to confirm the applicability of the dosing regimen used in the North American and European trials to the Japanese population. In parallel, the Company intends to submit an orphan drug application for the accelerated marketing approval of DepoCyt in Japan. To establish the appropriate use of DepoCyt in children afflicted with NM, DepoTech, in conjunction with Chiron, began a multi-center pediatric dose finding trial in 1997. This study will evaluate the safety and pharmacokinetics of DepoCyt in children of various ages. In addition, the study is expected to provide information regarding the efficacy of DepoCyt in children and to collect data on the long-term use of the drug. The Company is planning to explore additional indications for DepoCyt, including its use in the treatment of other cancers including ovarian, lung and breast cancer, and AIDS-related non-Hodgkin's lymphoma. DepoMorphine DepoTech is developing DepoMorphine sustained-release encapsulated morphine sulfate for use in moderating acute pain following surgery. This product is intended for epidural administration and provides up to two days of pain relief following surgery. DepoMorphine may replace repeated epidural or intravenous administration of opiates or patient controlled analgesia. The Company believes that DepoMorphine could be used in management of pain associated with many types of surgery, including Cesarean sections (epidural morphine is often used in Cesarean sections in the United States), hysterectomies, deep abdominal surgeries, hip and knee replacements and other surgical procedures. In 1995, the Company identified a total of approximately 5.6 million procedures occurring in the United States that may have been candidates for DepoMorphine. The Company estimates the target market to be approximately 3.8 million procedures. In 1995, morphine worldwide unit sales were approximately 64.0 million units, including 41.6 million units in the United States, 9.8 million units in Japan and 12.6 million units in Europe. The Company believes that DepoFoam offers the opportunity to reformulate morphine sulfate, which has been a generic product for many years, into a proprietary new product with traditional pharmaceutical margins. DepoTech has completed formulation development, initial manufacturing scale-up and preclinical studies of DepoMorphine. Preclinical studies in animals showed that DepoMorphine provided a minimum of two to three days of pain control following a single epidural injection. One characteristic of certain DepoFoam formulations of drugs is that an enhanced local effect may occur with limited systemic toxicity. A number of pharmacokinetic studies in animals have confirmed that there are high levels of morphine at the injection site and in the local cerebral spinal fluid with very low levels in the blood. These data also show a sustained effect of the morphine and reproducibility from multiple batches of DepoMorphine. In December 1996, The Company filed an IND with the FDA to begin clinical studies of DepoMorphine for the management of acute post-operative pain. In December 1997, DepoTech completed a Phase I dose-escalation study that assessed the safety and pharmacokinetics of single doses of DepoMorphine administered epidurally to healthy volunteers. The study was conducted at a single site under the leadership of members of the Department of Anesthesiology at Stanford University Medical Center. This study identified the maximum tolerated dose of DepoMorphine and indicated that the adverse event profile for the drug is similar to that seen with epidurally administered free morphine. Patient enrollment in a Phase II clinical study designed to assess the safety and efficacy of the drug is expected to conclude in 1998. 9 10 DepoAmikacin Another product in the Company's development pipeline is DepoAmikacin sustained-release encapsulated amikacin, a DepoFoam formulation of this potent, broad-spectrum antibiotic. The Company believes that DepoFoam offers the opportunity to reformulate amikacin, which became a generic antibiotic in 1990, into a proprietary new product and to improve its therapeutic profile. The Company has successfully encapsulated amikacin in DepoFoam and has tested various formulations in animals. DepoTech completed a Phase I clinical trial for DepoAmikacin in April 1996 in which the drug was found to be well-tolerated for all dosage levels studied. The Company has conducted formulation optimization and scale-up studies and defined Phase II clinical targets. In order to focus resources on DepoCyt, DepoMorphine, and partner-funded feasibility programs, the Company will evaluate financing options before proceeding with further development of DepoAmikacin. Background. Bacteria cause a wide range of illnesses in people, ranging from clinically unimportant infections to fatal diseases. Injectable forms of antibiotics are important tools of the physician, especially for more acutely ill patients. However, most antibiotics that are administered orally, by injection or by continuous infusion achieve high systemic concentrations but lesser concentrations in infected tissue, and are generally eliminated from the body within several hours of administration. Furthermore, the concentration of certain antibiotics, including amikacin, that can be achieved in the infected tissue using current formulations is limited by the amount of drug that the body can tolerate in the bloodstream without causing damage to the kidneys and auditory nerves. DepoAmikacin can be administered directly into the site of infection and may deliver therapeutic levels of amikacin while potentially reducing certain systemic toxicities associated with this drug. Consequently, DepoAmikacin may be able to expand the indications for amikacin and result in more attractive prices and margins. The Company believes DepoAmikacin may be used in many applications, including treatment and prophylaxis of bacterial infections associated with open fractures, indwelling vascular catheters, orthopedic implants, peritonitis and vascular grafts. Markets. In 1995, there were reported to be a total of over 7.0 million procedures occurring in the United States in which site-specific antibiotic treatment may have been appropriate. DepoTech estimates the target United States market for DepoAmikacin to be approximately 5.6 million procedures. Worldwide 1995 sales of the general class of antibiotics known as aminoglycosides, which includes amikacin, were approximately $447.0 million. In 1995, amikacin worldwide unit sales were approximately 8.4 million units, including 0.6 million units in the United States, 5.7 million units in Japan and 2.0 million units in Europe. Clinical Development. In animal studies performed by the Company, a single injection of DepoAmikacin administered locally at the site of an intentionally infected implanted foreign body significantly reduced the number of bacteria present versus the use of either systemic or local injection of free amikacin. This animal model is analogous to many surgical situations, from complicated hip replacement surgery to insertion of catheters. Additional animal models of infection, including models for peritonitis and infected surgical wounds, have been completed. Information from these studies will be used to support the selection and design of follow-on studies, including a Phase II clinical study of efficacy. DepoTech completed a Phase I clinical trial for DepoAmikacin in April 1996 in which the drug was found to be well-tolerated for all dosage levels studied. DepoBupivacaine DepoTech has completed formulation studies of DepoBupivacaine, a sustained-release formulation of the widely used local anesthetic bupivacaine for use during or after a surgical procedure or trauma. One dose of DepoBupivacaine is expected to provide 24 hours of regional pain relief, compared to two to six hours following conventional bupivacaine administration. The Company has successfully encapsulated bupivacaine into DepoFoam. Pharmacokinetic studies have shown that DepoFoam encapsulated bupivacaine is released slowly from the site of injection, resulting in prolonged duration (more than 24 hours) of analgesia following a single-dose administration. DepoTech believes that a DepoFoam formulation of a local anesthetic may complement its current DepoMorphine program and that the DepoMorphine and local anesthetic formulations may give physicians improved drugs to manage post-operative pain. Background. Pain associated with surgery or injury is often treated with local anesthetics. However, the usefulness of local anesthetics is frequently limited by their short half-lives which results in recurrence of pain and the need for repeated drug administration by a medical professional. A DepoFoam formulation of a local anesthetic may be useful either locally or regionally to provide long-lasting pain relief of approximately 24 hours. The Company believes there are more than 5 million surgical procedures and serious trauma injuries per year that may benefit from longer lasting analgesia. The current pain relief drugs are short-acting and frequently do not provide adequate duration of pain 10 11 relief. The Company believes that a long-lasting, safe DepoFoam formulation of a local anesthetic, such as bupivacaine, could be useful for controlling post-surgical and post-injury pain. In order to focus resources on DepoCyt, DepoMorphine, and partner-funded feasibility programs, the Company will evaluate financing options before proceeding with further development of DepoBupivacaine. Chiron Proprietary Products Under its agreement with Chiron, two Chiron proprietary proteins, IGF-1 and IL-2, were chosen as the first two proprietary compounds to be developed into DepoFoam formulations. Feasibility studies on DepoFoam formulations of IGF-1 and IL-2 have been completed. In addition, Chiron and the Company have completed preclinical development on an additional DepoFoam formulation of IGF-1 for undisclosed indications. No further work is planned for either compounds at this time. In March 1997, Chiron selected a gene therapy product for an undisclosed indication as the 1997 feasibility study candidate. In 1998 and thereafter, Chiron must fund one feasibility program for a Chiron Product per year or lose its option to develop DepoFoam formulations of additional Chiron proprietary compounds. New Product Feasibility Programs DepoTech is also evaluating DepoFoam formulations of several additional compounds including certain proprietary molecules of the Monsanto Company and Synthelabo. The objectives of the feasibility programs are to: (i) determine the ease and efficiency of encapsulation of candidate drugs; (ii) evaluate in vitro and in vivo drug release characteristics; and (iii) conduct initial efficacy and/or safety studies in animal models to demonstrate potential clinical utility and advantages of the DepoFoam formulations. STRATEGIC ALLIANCES As part of its commercialization strategy, the Company intends to focus its efforts on establishing collaborative arrangements with corporate partners to obtain access to specific compounds, obtain access to sales and distribution organizations and fund development work. The Company intends to seek to collaborate with major pharmaceutical or fully-integrated biotechnology companies that have significant clinical development, financial and marketing resources. With respect to products that are proprietary to its partners, DepoTech will seek to have its partners fund the feasibility, formulation, development, clinical testing and regulatory costs associated with the product and will generally grant worldwide distribution rights to the DepoFoam formulation to the partner. A key strategy of the Company is to retain exclusive formulation and manufacturing rights to any DepoFoam encapsulated drugs, including proprietary products of corporate partners. Under these collaborative arrangements, DepoTech expects to receive compensation based on both the partner's sales of the product and manufacturing costs of the product. The Company will have limited or no control over the resources that any partner may devote to the Company's products, over partners' development efforts, including the design and conduct of clinical trials, or over the pricing of products. There can be no assurance that any of the Company's present or future collaborative partners will perform their obligations as expected or will devote sufficient resources to the development, clinical testing or marketing of the Company's potential products. Any parallel development by a partner of alternate drug delivery technologies, preclusion from entering into competitive arrangements, failure to obtain timely regulatory approvals, premature termination of a collaborative agreement or failure by a partner to devote sufficient resources to the development and commercialization of the Company's products would have a material adverse effect on the Company. Chiron In March 1994, the Company entered into a collaboration agreement with Chiron. The objective of the collaboration is to develop and commercialize DepoCyt for use in the treatment of cancer, and to explore the use of the Company's DepoFoam technology for certain Chiron Products. DepoTech believes that Chiron's pharmacological, clinical development and marketing resources in these areas complement DepoTech's resources. See "--Product Research and Development Programs." 11 12 The Chiron Agreement grants Chiron rights to market and sell DepoCyt in the United States, Canada and Europe. Chiron has funded and will continue to fund 50% of the clinical development expenses in the United States. Canadian registration expenses and the cost of clinical trials required in Europe were funded by Chiron until June 1997. DepoTech will manufacture DepoCyt, Chiron will market, sell, and distribute DepoCyt, and the parties will share all profits equally. Chiron will make payments to DepoTech upon completion of filing of an NDA and upon achievement of certain milestones in the European development of DepoCyt. Chiron also has a right of first refusal to obtain a license to alternate DepoFoam formulations of cytarabine under terms and conditions to be negotiated in the future. Following an evaluation of the markets and certain other factors, the Company and Chiron mutually agreed not to further develop certain additional generic cancer compounds named in the Agreement. In June 1997, DepoTech and Chiron amended the Chiron Agreement, and DepoTech repurchased rights to DepoCyt in Canada and Europe from Chiron for aggregate cash payments of up to $13.7 million, of which $2.0 million was expensed and paid to Chiron in December 1997. Chiron will retain exclusive marketing rights to DepoCyt in the U.S. If prior to December 31, 1998, the FDA issues a letter or other notification to DepoTech indicating that DepoCyt is approvable or approved, the remaining balance of $11.7 million shall be payable no later than December 31, 1998. If no FDA notification is received prior to December 31, 1998, the remaining amount shall be payable no later than six month from the earlier of U.S. or European Union regulatory notification that the application to market or sell DepoCyt is approvable or approved. If all applications for regulatory approval to sell DepoCyt in the U.S. and European Union are permanently withdrawn, DepoTech shall be relieved of any obligation to pay the remaining $11.7 million. The Chiron Agreement also provides for the joint development of DepoFoam formulations of certain Chiron Products. Two Chiron proprietary proteins, IGF-1 and IL-2, were chosen as the first two proprietary compounds to be developed into DepoFoam formulations. Feasibility studies on DepoFoam formulations of IGF-1 and IL-2 have been completed. In addition, Chiron and the Company have completed preclinical development on an additional DepoFoam formulation of IGF-1 for undisclosed indications. No further work is planned for either compounds at this time. In March 1997, Chiron selected a gene therapy product for an undisclosed indication as the 1997 feasibility study candidate. In 1998 and thereafter, Chiron must fund one feasibility program for a Chiron Product per year or lose its option to develop DepoFoam formulations of additional Chiron proprietary compounds. The Chiron Agreement provides that Chiron will pay DepoTech for the Company's feasibility efforts, and that Chiron will be responsible for all development costs thereafter. The agreement also provides for payments by Chiron to DepoTech upon achievement of certain development milestones with regard to the Chiron Products. Chiron will have exclusive, worldwide distribution rights to all Chiron Products and will manufacture the bulk unencapsulated drug. DepoTech will then encapsulate the bulk drug in DepoFoam creating the Chiron Product, and Chiron will market, sell and distribute the Chiron Products. Chiron will compensate DepoTech based on both manufacturing costs, including a manufacturing profit, and a percentage of Chiron's sales of the Chiron Products. Both DepoTech and Chiron have the ability to terminate a portion or all of the collaboration at certain intervals and with advance notice. In addition, Chiron has the ability to terminate the development of a Chiron Product with a limited amount of advance notice. In connection with the Chiron Agreement, Chiron made a $2.5 million equity investment in the Company. In addition, Chiron paid $1.0 million in March 1994 for a warrant which was converted in January 1995 to a DepoCyt marketing rights fee. Further, in January 1995, upon achievement of a development milestone, Chiron reimbursed DepoTech approximately $2.5 million for Chiron's share of DepoCyt's clinical trial and development costs from July 1993 through December 1994 and will continue to share equally in DepoCyt's United States clinical trials and development costs. Finally, in 1997, the Company received a $1.0 million milestone payment from Chiron upon completing the filing of the NDA for DepoCyt in the U.S. The Company will fund 50% of the sales and marketing expenses incurred for DepoCyt. DepoTech may receive additional payments upon achievement of certain other developmental milestones. Pharmacia & Upjohn In July 1997, the Company signed a Marketing and Distribution Agreement with P&U. Under the contractual arrangement (the "P&U Agreement"), P&U has rights to market and sell DepoCyt in countries outside the United States. P&U will be responsible for submitting regulatory filings, and for labeling, packaging, distributing, marketing and selling DepoCyt outside the U.S. The Company will manufacture DepoCyt and receive a share of the net sales of this product from P&U. DepoTech received an upfront payment of $2.0 million and may receive milestone payments totaling up to $17.0 million. In addition, the Company receives reimbursement for clinical trials expenses up to a certain amount. Future milestone payments, if any, totaling up to the obligation to Chiron of $11.7 million will be set aside in a restricted cash account for payment to Chiron for the repurchase of DepoCyt rights. Both DepoTech and P&U have the ability to terminate a portion or all of the marketing and distribution agreement upon certain events and with advance notice. 12 13 MANUFACTURING In connection with its collaborative arrangements, DepoTech intends to maintain exclusive formulation and manufacturing rights to any DepoFoam encapsulated drugs, including proprietary products of corporate partners, and expects to receive compensation based on both manufacturing costs of the product and the value added by the Company's technology to the partner's product. To date, the Company has manufactured its drug delivery formulations only for clinical trials and testing formulations of certain potential therapeutic products and has no experience manufacturing products for commercial purposes. Since 1995, the Company has manufactured clinical material in a 14,400 square foot manufacturing plant built for this purpose. This manufacturing plant has completed validation to comply with cGMP regulations for the manufacture of pharmaceuticals and was inspected by the California Department of Health Services Food and Drug Branch and received a license from the State of California to manufacture drugs. This manufacturing plant has undergone pre-approval inspections from the FDA for the manufacture of DepoCyt. The Company has been notified by the FDA's District Office that they are recommending approval for commercial manufacturing of DepoCyt. However, this does not imply FDA product approval of DepoCyt which currently remains subject to FDA review. Further, the Company must undergo and pass a PAI for all countries outside the U.S. in which applications to obtain marketing approval have been filed. Prior to marketing DepoCyt (and any other pharmaceutical products), the Company will need to meet applicable regulatory standards, achieve prescribed product quality and reach necessary levels of production of such products and obtain marketing approvals. In addition, the Company occupies an 82,000 square foot facility housing its administrative, research and development and future manufacturing activities. Prior to commencing commercial manufacturing operations from this facility, the Company will need to comply with additional and necessary validation, regulatory and inspection requirements. The Company currently relies on a limited number of suppliers to provide the materials used to manufacture its DepoFoam formulations. Certain of these materials are purchased only from one supplier. In the event the Company could not obtain adequate quantities of necessary materials from its existing suppliers, there can be no assurance that the Company would be able to access alternative sources of supply within a reasonable period of time or at commercially reasonable rates. Regulatory requirements applicable to pharmaceutical products tend to make the substitution of suppliers costly and time-consuming. The unavailability of adequate commercial quantities, the inability to develop alternative sources, a reduction or interruption in supply or a significant increase in the price of materials could have a material adverse effect on the Company's ability to manufacture and market its products. To date, the Company has relied on a particular proprietary method of manufacture. There can be no assurance that this method will be applicable to all pharmaceuticals the Company desires to commercialize. Further, the yield of product incorporated into the delivery system may be highly variable for different therapeutic agents. Finally, the Company will need to successfully meet any manufacturing challenges associated with the characteristics of the drug to be encapsulated. The physical and chemical stability of the DepoFoam formulation may vary with each therapeutic agent over time and under various storage conditions. There can be no assurance that the manufacturing process will result in economically viable yields of product or that it will produce formulations of therapeutic products sufficiently stable under suitable storage conditions to be commercially useful. In the event that the Company decides to pursue alternative manufacturing methods for some or all of its drugs, there can be no assurance that these methods will prove to be commercially practical or that the Company will have or be able to acquire rights to use such alternative methods. GOVERNMENT REGULATION DepoTech's research and development activities are, and its future business will be, subject to significant regulation by governmental authorities in the United States, primarily the FDA. Pharmaceutical products intended for therapeutic use in humans are governed principally by the Federal Food, Drug, and Cosmetic Act, as amended, and by FDA regulations in the United States and by comparable laws and regulations in foreign countries. The process of completing clinical testing and obtaining FDA approval for new drugs or biological products requires a number of years and the expenditure of substantial resources. DepoTech will also be subject to regulation under the food and drug statutes and regulations of the State of California. Pharmaceutical products developed by DepoTech likely will be classified by the FDA as "new drugs" even though typically the active ingredient in the product was previously approved. This is because the Company's products will be intended for new 13 14 indications or routes of administration, will provide significantly different pharmacokinetics or will claim to provide significantly increased safety or efficacy, requiring approval under an NDA. In some cases, the Company's products may be marketed as "new drugs" under abbreviated provisions for generic drugs (e.g., "paper NDA") where there are substantial similarities with a currently marketed product that is not protected by patents. It is also likely that some of the drugs developed by the Company will be classed as "biologics" under the Public Health Service Act and relevant portions of the Federal Food, Drug, and Cosmetic Act. In this case, the products will be subject to somewhat different regulations. Prior to marketing a new drug product in the United States, other than a generic drug, it is necessary to complete the following: (i) preclinical laboratory and animal tests; (ii) submission to the FDA of an application for an IND, allowing clinical and other studies to assess safety and parameters of use; (iii) adequate and well-controlled clinical trials to establish the safety and effectiveness of the drug; (iv) submission of an NDA to the FDA; and (v) FDA approval of the NDA. For biological products, the process is similar, but not identical to that described above for drugs, with the NDA being replaced with a Product License Application ("PLA"). For marketing of a product under the generic drug provisions, an Abbreviated New Drug Application ("ANDA") must be submitted to the FDA and approved prior to commercial sale or shipment of the drug. Typically, for non-generic new drugs and therapeutic biological products, preclinical studies are conducted in the laboratory and in animal model systems to gain preliminary information about the drug's pharmacology and toxicology and to identify any potential safety problems. The results of these studies are submitted to the FDA as part of the IND application. Testing in humans may commence after clearance of the IND by the FDA. A three-phase clinical trial program is usually required for FDA approval of a pharmaceutical product. Phase I clinical trials are designed to determine the metabolism and pharmacological effects of the drug in humans and the side effects associated with increasing doses. Phase II studies are conducted to evaluate the effectiveness of the drug for a particular indication and provide evidence of the short-term side effects and risks associated with the drug or biologic. Phase III clinical trials often involve a substantial number of patients in multiple study centers and may include chronic administration of the agent in order to assess the overall risk/benefit relationship of the drug or biologic and are generally designed to provide substantial evidence of safety and effectiveness of a drug or biologic required to obtain FDA approval.. A clinical trial may combine the elements of more than one phase and typically two or more Phase III studies are required. Upon completion of clinical testing that the Company believes demonstrates that the product is safe and effective for a specific indication, an NDA or PLA may be submitted to the FDA. The FDA closely monitors the progress of each of the three phases of clinical testing and may, at its discretion, re- evaluate, alter, suspend or terminate the testing based on the data that have been accumulated to that point and its assessment of the risk to the patient. The clinical testing and FDA review process for new drugs or biologics will require substantial time, effort and expense. There can be no assurance that any approval will be granted to the Company on a timely basis, if at all. The FDA may refuse to approve an NDA or PLA and may require additional testing or information. There can be no assurance that such additional testing or the provision of such information, if required, will not have a material adverse effect on the Company. Also, the regulatory process can be modified by Congress or the FDA in a manner that could materially affect the Company. In 1988, the FDA issued regulations intended to expedite the development, evaluation and marketing of new therapeutic products to treat life-threatening and severely debilitating illnesses for which no satisfactory alternative therapies exist. These regulations provide for early consultation between the sponsor and the FDA in the design of both preclinical studies and clinical trials. In some cases, the objectives of the Phase I and Phase II studies are combined as a single Phase I/II study. If the results of Phase I and Phase II trials support the safety and effectiveness of the therapeutic agent, and their design and execution are deemed satisfactory upon review by the FDA, marketing approval may be sought at the end of Phase II trials or only limited Phase III trials may be required. NDA or PLA approval granted under these regulations may be restricted by the FDA as necessary to ensure the safe use of the drug. In addition, post-marketing clinical studies, sometimes called Phase IV studies, may be required. If, after approval, a post-marketing clinical study establishes that the drug does not perform as expected, or if post-marketing restrictions are not adhered to or are not adequate to ensure the safe use of the drug, FDA approval may be withdrawn. The expedited approval may shorten the traditional drug development process by as much as two to three years. At the present time, DepoCyt is being developed under such an accelerated program. There can be no assurance, however, that any future products the Company may develop will be eligible for evaluation by the FDA under the 1988 regulations. In addition, there can be no assurance that DepoCyt or any future products (if eligible) will be approved for marketing at all or, if approved for marketing, will be approved for marketing sooner than would be traditionally expected. 14 15 Once the sale of a product is approved, the FDA regulates production, marketing and other activities under the Federal Food, Drug, and Cosmetic Act and the FDA's implementing regulations. Post-marketing reports are required to monitor the product's usage and effects. Product approvals may be withdrawn, or other actions may be ordered, or sanctions imposed, including criminal prosecution, if compliance with regulatory requirements is not maintained. Other countries in which any products developed by the Company or its licensees may be marketed impose a similar regulatory process. Under the Orphan Drug Act, the FDA may grant orphan drug designation to drugs intended to treat a "rare disease or condition," which generally is a disease or condition that affects populations of fewer than 200,000 individuals in the United States. Orphan drug designation must be requested before submitting an NDA or PLA, and after the FDA grants orphan drug designation, the generic identity of the therapeutic agent and its potential orphan use are publicly disclosed by the FDA. Under current law, approval of the first NDA for a drug with orphan drug designation confers United States marketing exclusivity to market such designated drug for the designated indication for a period of seven years following approval of the NDA, subject to certain limitations. Orphan drug designation does not convey any advantage in, or shorten the duration of, the regulatory approval process. In June 1993, the Company obtained orphan drug designation for DepoCyt from the FDA to treat NM. There can be no assurance that the Company will receive the first FDA approval to market DepoCyt to treat NM and thus take advantage of orphan drug exclusivity for DepoCyt to treat NM from leukemia, lymphoma or solid tumor metastases. Although obtaining FDA approval to market a product with an orphan drug exclusivity can be advantageous, there can be no assurance that the scope of protection or the level of marketing exclusivity that is currently afforded by orphan drug designation will remain in effect in the future. In addition to regulations enforced by the FDA and the State of California, the Company also is subject to regulation under the Occupational Safety and Health Act, the Controlled Substances Act, the Environmental Protection Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act and other similar federal, state and local regulations governing permissible laboratory activities, waste disposal handling of toxic, dangerous or radioactive materials and other matters. The Company believes that it is in compliance with such regulations. These regulations are subject to change, however, and may, in the future, require substantial effort and cost to the Company to comply with each of the regulations, and may possibly restrict the Company's business activities. For marketing outside the United States, the Company will be subject to foreign regulatory requirements governing human clinical trials, manufacturing and marketing approval for drugs and biologics. The requirements relating to the conduct of clinical trials, manufacturing, product licensing, pricing and reimbursement vary widely from country to country. For DepoMorphine, there may be additional regulatory requirements relating to controlled substances for sale in foreign countries. PATENTS AND PROPRIETARY RIGHTS DepoTech relies on a combination of technical leadership, patent, trade secret, copyright and trademark protection and nondisclosure agreements to protect its proprietary rights. As of March 2, 1998, the Company owned or had exclusive rights to 10 issued or allowed United States patents, 10 pending United States patent applications, 45 issued foreign patents and 53 pending foreign applications on file covering various aspects of its drug delivery technology. The Company intends to file additional patent applications in the future. There can be no assurance that the Company will be issued any additional patents or that, if any patents are issued, they will provide the Company with significant protection or will not be challenged. Even if such patents are enforceable, the Company anticipates that any attempt to enforce its patents would be time consuming and costly. Moreover, the laws of some foreign countries do not protect the Company's proprietary rights in the products to the same extent as do the laws of the United States. The United States Patent and Trademark Office ("PTO") has instituted changes to the United States patent law including changing the term to 20 years from the date of filing for applications filed after June 8, 1995. While one of the above applications was filed after June 8, 1995, the Company cannot predict the effect that such changes on the patent laws may have on its business, or on the Company's ability to protect its proprietary information and sustain the commercial viability of its products. In February 1994, the Company entered into an Assignment Agreement with the Research Development Foundation ("RDF"), pursuant to which RDF assigned to DepoTech exclusive rights to certain intellectual property relating to the DepoFoam technology, including corresponding patents and patent applications for such property (the "RDF Technology"). The Company is obligated under the Assignment Agreement to prosecute certain patent applications and maintain issued patents relating to the RDF Technology. The term of the Assignment Agreement extends through the life of the last to expire of the patents or patent applications included in the RDF Technology. RDF retains the right to terminate the agreement or to convert the exclusive nature of the rights granted under the 15 16 agreement into a nonexclusive license in the event that the Company does not satisfy its contractual obligations, including making certain minimum annual payments. Additional termination events include bankruptcy, an uncured material breach of the agreement or a contest by DepoTech of the patents included in the RDF Technology. The termination of the Assignment Agreement or the conversion of its exclusive nature to a nonexclusive agreement would have a material adverse effect on the Company. The patent positions of pharmaceutical, biotechnology and drug delivery companies, including DepoTech, are uncertain and involve complex legal and factual issues. Additionally, the coverage claimed in a patent application can be significantly reduced before the patent is issued. As a consequence, there can be no assurance that any of the Company's patent applications will result in the issuance of patents or, if any patents issue, that they will provide significant proprietary protection or will not be circumvented or invalidated. Because patent applications in the United States are maintained in secrecy until patents issue and publication of discoveries in the scientific or patent literature often lag behind actual discoveries, the Company cannot be certain that it was the first inventor of inventions covered by its pending patent applications or that it was the first to file patent applications for such inventions. Moreover, the Company may have to participate in interference proceedings declared by the PTO to determine priority of invention that could result in substantial cost to the Company, even if the eventual outcome is favorable to the Company. There can be no assurance that the Company's patents, if issued, would be held valid by a court of competent jurisdiction. An adverse outcome of any patent litigation could subject the Company to significant liabilities to third parties, require disputed rights to be licensed from or to third parties or require the Company to cease using the technology in dispute. There can be no assurance that third parties will not assert infringement claims against the Company in the future or that any such assertions will not result in costly litigation or require the Company to obtain a license to intellectual property rights of such parties. There can be no assurance that any such licenses would be available on terms acceptable to the Company, if at all. Furthermore, parties making such claims may be able to obtain injunctive or other equitable relief that could effectively block the Company's ability to further develop or commercialize its products in the United States and abroad and could result in the award of substantial damages. Defense of any lawsuit or failure to obtain any such license could have a material adverse affect on the Company. Finally, litigation, regardless of outcome, could result in substantial cost to and a diversion of efforts by the Company. As part of its confidentiality procedures, the Company generally enters into nondisclosure agreements with its employees and suppliers, and limits access to and distribution of its proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use the Company's technology without authorization. Accordingly, there can be no assurance that the Company will be successful in protecting its proprietary technology or that DepoTech's proprietary rights will preclude competitors from developing products or technology equivalent or superior to that of the Company. The Company may require additional technology in the formulation and manufacture of DepoFoam formulations to which the Company currently does not have rights. If the Company determines that this additional technology is relevant to the development of future products and further determines that a license to this additional technology is needed, there can be no assurance that the Company can obtain a license from the relevant party or parties on commercially reasonable terms, if at all. There can be no assurance that the Company can obtain any license to any technology that the Company determines it needs, on reasonable terms, if at all, or that DepoTech could develop or otherwise obtain alternate technology. The failure of the Company to obtain licenses, if needed, would have a material adverse affect on the Company. The Company's ability to develop and commercialize its technology will be affected by the Company's or its partners' access to the drugs that are to be formulated. The Company intends in certain circumstances to rely on the ability of its partners to provide access to the drugs that are to be formulated for use with DepoFoam. There can be no assurance that the Company's partners will be able to provide access to drug candidates for formulation in DepoFoam, or that, if such access is provided, the Company or its partner will not be alleged or determined to be infringing on third parties' rights and will not be prohibited from using the drug or be found liable for damages that may not be subject to indemnification. Any restriction on access or liability for damages would have a material adverse effect on the Company. COMPETITION The drug delivery, pharmaceutical and biotechnology industries are highly competitive and rapidly evolving, with significant developments expected to continue at a rapid pace. The Company's success will depend upon maintaining a competitive position and developing products and technologies for efficient and cost-effective drug delivery. The Company's products will compete with other formulations of drugs and with other drug delivery systems. There can be no assurance that any of the Company's products will have 16 17 advantages that will be significant enough to cause medical professionals to adopt their use. DepoTech believes that its products will compete on the basis of quality, efficacy, cost, convenience, safety and patient compliance. New drugs or further development in alternative drug delivery methods may provide greater therapeutic benefits for a specific drug or indication, or may offer comparable performance at lower cost than those offered by the Company's DepoFoam drug delivery system. The Company is aware of many other competitors in the field of drug delivery, including competitors developing injectable or implantable drug delivery systems, oral drug delivery technologies, passive transdermal systems, electrotransport systems, oral transmucosal systems and inhalation systems. There can be no assurance that developments by others will not render the Company's products or technologies uncompetitive or obsolete. Many of the Company's existing or potential competitors have substantially greater research and development capabilities, experience, manufacturing, marketing, financial, and managerial resources than the Company. Furthermore, acquisitions of competing drug delivery companies by large pharmaceutical companies could enhance competitors' financial, marketing and other resources. Accordingly, the Company's competitors may succeed in developing competing technologies, obtaining FDA approval or gaining market share for products more rapidly than the Company. SALES AND MARKETING Commercialization of the Company's products is expected to be expensive and time-consuming. In the event that the Company elects to participate directly in sales and marketing efforts for the Company's products, the Company will need to build such capability in the targeted markets. The Company currently has a limited marketing staff. There can be no assurance that the Company will be able to establish an adequate sales and marketing capability in any or all targeted markets or that it will be successful in gaining market acceptance for its products. To the extent the Company enters into co-promotion or other licensing arrangements, any revenues received by the Company will be dependent on the efforts of third parties and there can be no assurance that such efforts will be successful. To the extent the Company relies on its collaborators, there can be no assurance that any of these collaborators or their sublicensees will successfully market or distribute the Company's products or that the Company will be able to establish a successful direct sales organization, co-promotion or distribution arrangements. HUMAN RESOURCES As of March 2, 1998, DepoTech had approximately 122 full-time employees, including 103 in research, development and operations, and 19 in finance and administration. Of these employees, 37 hold advanced degrees, of which 21 are M.D.s, D.Pharm.s, or Ph.Ds. The Company's future success will depend in large part upon its ability to attract and retain highly qualified personnel. The Company's employees are not represented by any collective bargaining agreements, and the Company has never experienced a work stoppage. In February 1998, the Company reduced its workforce aimed at lessening operating expenses and focusing resources on DepoCyt, DepoMorphine and partner-funded feasibility programs. The company reduced its staff by approximately 25% to 124 employees. The Company believes that its employee relations are good. RISKS AND UNCERTAINTIES Early Stage Company. DepoTech's products are at an early stage of development, and, to date, only three of the Company's DepoFoam formulations, DepoCyt, DepoMorphine and DepoAmikacin, have been subject to any human clinical testing. The Company's potential products will require extensive research, formulation, development, preclinical and clinical testing, and may involve a lengthy regulatory approval process prior to commercialization. There can be no assurance that DepoCyt, DepoMorphine, DepoAmikacin or any of the Company's other products or potential products, will prove safe and effective in clinical trials, meet applicable regulatory standards, be capable of being produced in commercial quantities at acceptable cost or be successfully commercialized. In addition, there can be no assurance that preclinical or clinical testing will accurately predict safety or efficacy in broader human use, or that delays in the regulatory approval process will not arise, delaying approval longer than currently expected by the Company. Even if all of the Company's products prove to be safe and effective and are approved for marketing by the FDA and other regulatory authorities, there can be no assurance that health care providers, payors and patients will accept the Company's products. Any failure of the Company to achieve technical feasibility, demonstrate safety, achieve clinical efficacy, obtain regulatory approval or, together with its partners, successfully market products would have a material adverse effect on the Company. Government Regulation; Uncertainty of Obtaining Regulatory Approval. DepoTech's research and development activities are, and its future business will be, subject to significant regulation by governmental authorities in the United States, primarily by the FDA. Pharmaceutical products intended for therapeutic use in humans are governed principally by the Federal Food, Drug, and Cosmetic 17 18 Act, as amended, and by the FDA regulations in the United States and by comparable laws and regulations in foreign countries. DepoTech is also subject to regulation under the food and drug statutes and regulations of the State of California. In April 1997, the Company completed and NDA for DepoCyt for the treatment of NM from solid tumors. As with all drugs subject to accelerated approval, the FDA requested that the Company conduct a Phase IV clinical trial on DepoCyt which is in process. In December 1997, ODAC declined to recommend approval of DepoCyt for use in patients with NM from solid tumors. In March 1998, DepoTech reached an agreement with the FDA to submit an amendment to the NDA to provide data from a Phase IV clinical trial of NM from solid tumors. In addition, the Company will submit interim data from a Phase III study of NM from lymphomas. Submission of the amendment will approximately double the number of patients treated with DepoCyt under review, and extend the review time for an FDA decision by three months. The final decision regarding the approval of new therapeutics resides with FDA officials subsequent to any recommendation of ODAC. The Company has been notified by the FDA's District Office that they are recommending approval for commercial manufacturing of DepoCyt. However, this does not imply FDA product approval of DepoCyt which currently remains subject to FDA review as described above. There can be no assurance that the data from the solid tumor arm of the DepoCyt Phase III clinical trial reported to date regarding DepoCyt will be sufficient to gain FDA approval, that additional results from the still ongoing arms of the pivotal Phase III trial for NM from lymphomas and leukemia will be positive and/or confirm earlier results or that the Phase IV, pediatric, European and other clinical trials of DepoCyt will generate positive results. There can be no assurance that these results and data will meet the requirements for regulatory approvals necessary to commercialize DepoCyt in the United States or otherwise. Any of these occurrences could have a material adverse effect on the Company and its ability to fund the further development and commercialization of DepoCyt and its other products. The clinical testing and FDA review process for new drugs or biologics requires substantial time, effort and expense. There can be no assurance that any approval will be granted to the Company on a timely basis, if at all. The FDA may refuse to approve a product for commercial sale or shipment if applicable statutory and/or regulatory criteria are not satisfied, or may require additional testing or information. There can be no assurance that such additional testing or the provision of such information, if required, will not have a material adverse effect on the Company. Also, the regulatory process can be modified by Congress or the FDA in a manner that could materially affect the Company. In 1988, the FDA issued regulations intended to expedite the development, evaluation and marketing of new therapeutic products to treat life-threatening and severely debilitating illnesses for which no satisfactory alternative therapies exist. These regulations provide for early consultation between the sponsor and the FDA in the design of both preclinical studies and clinical trials. At the present time, DepoCyt is being developed under such an accelerated program. There can be no assurance, however, that any future products the Company may develop will be eligible for evaluation by the FDA under the 1988 regulations. In addition, there can be no assurance that DepoCyt or any future products (if eligible) will be approved for marketing at all or, if approved for marketing, will be approved for marketing sooner than would be traditionally expected. Regulatory approval granted under these regulations may be restricted by the FDA as necessary to ensure the safe use of the drug. In addition, post-marketing clinical studies, sometimes called Phase IV studies, will be required for products approved under this provision. Under the Orphan Drug Act, the FDA may grant orphan drug designation to drugs intended to treat a "rare disease or condition," which generally is a disease or condition that affects populations of fewer than 200,000 individuals in the United States. Under current law, orphan drug designation confers United States marketing exclusivity upon the first company to receive FDA approval to market such designated drug for the designated indication for a period of seven years following approval of the NDA, subject to certain limitations. Orphan drug designation does not convey any advantage in, or shorten the duration of, the regulatory approval process. In June 1993, the Company obtained an orphan drug designation for DepoCyt from the FDA to treat NM. There can be no assurance that the Company will receive the first FDA approval to market DepoCyt to treat NM, and thus, receive market exclusivity for DepoCyt to treat NM arising from leukemia, lymphoma or solid tumor metastases. There can be no assurance that the scope of protection or the level of marketing exclusivity that is currently afforded by orphan drug designation and marketing approval will remain in effect in the future. For marketing outside the United States, the Company will be subject to foreign regulatory requirements governing human clinical trials, manufacturing and marketing approval for drugs and biologics in such foreign jurisdictions. The requirements relating to the conduct of clinical trials, manufacturing, product licensing, pricing and reimbursement vary widely from country to country and there can be no assurance that the Company or any of its partners will meet and sustain any such requirements. 18 19 Limited Manufacturing Experience, Risk of Scale-Up. The Company has no experience manufacturing products for commercial purposes. The Company's manufacturing operations will need to meet ongoing commercial requirements for all markets in which products have been approved. The Company has been notified by the FDA's District Office that they are recommending approval for commercial manufacturing of DepoCyt. However, this does not imply FDA product approval of DepoCyt which currently remains subject to FDA review. The manufacturing operations for DepoCyt will require the completion of a PAI inspectional observations for all countries in which there are regulatory filings to market DepoCyt. For all other products, the Company will need to significantly scale-up its current manufacturing operations and comply with cGMPs and other regulations prescribed by various regulatory agencies in the United States and other countries to achieve the prescribed quality and required levels of production of such products and to obtain marketing approval. Failure by the Company to successfully scale-up its manufacturing operations or to comply with cGMPs and other regulations would have a material adverse impact on the Company, including the loss of manufacturing rights under the Chiron Agreement and the P&U Agreement. Future Capital Needs. The development and commercialization of the Company's products will require substantial funds to conduct research and development and preclinical and clinical testing of products and to manufacture and commercialize any products that are approved for commercial sale. The Company has a contractual commitment arising from the Chiron collaboration to fund 50% of the sales and marketing expenses incurred for DepoCyt in the United States. In June 1997, DepoTech reacquired rights to DepoCyt in Canada and Europe from Chiron for aggregate cash payments of up to $13.7 million, of which $2.0 million was expensed and paid to Chiron in December 1997. If prior to December 31, 1998, the FDA issues a letter or other notification to DepoTech indicating that DepoCyt is approvable or approved, the remaining balance of $11.7 million shall be payable no later than December 31, 1998. If no FDA notification is received prior to December 31, 1998, the remaining amount shall be payable no later than six month from the earlier of U.S. or European Union regulatory notification that the application to market or sell DepoCyt is approvable or approved. If all applications for regulatory approval to sell DepoCyt in the U.S. and European Union are permanently withdrawn, DepoTech shall be relieved of any obligation to pay the remaining $11.7 million. The Company leases its headquarters housing most of its administrative, research and clinical and manufacturing activities. The minimum rental commitment for this facility ranges from approximately $3.3 million to $3.7 million per year, over 18 years, with a future minimum rental commitment, based upon pre-established annual rent increases. The Company's additional future capital requirements will depend on many factors, including continued scientific progress in its products and process development programs, progress with preclinical testing and clinical trials, the time and costs involved in obtaining regulatory approvals, the costs involved in filing patents, competing technological and market developments, changes in existing collaborative relationships, the ability of the Company to establish development arrangements, the cost of establishing effective sales and marketing arrangements. To date, the Company has not received any revenues from product sales. The Company anticipates that its existing available cash, cash equivalents and short-term investments, committed future contract revenue, projected funding from equipment and other financing and interest income will be adequate to satisfy its capital requirements and fund operations through 1998. Uncertainty of Additional Funding. The Company anticipates that it will be required to raise additional capital in the near-term in order to continue to conduct its operations. Such capital may be raised through public or private financings, as well as collaborative arrangements, borrowings and other available sources. There can be no assurance that additional funding, if necessary, will be available on favorable terms if at all. If adequate funds are not available, the Company will be required to curtail operations significantly or to obtain funds through entering into arrangements with collaborative partners or others that may require the Company to relinquish rights to certain of its technologies, potential products or potential markets that the Company would not otherwise relinquish. The failure to receive additional funding would have a material adverse effect on the Company. History of Operating Losses; Uncertainty of Future Profitability. The Company has incurred an accumulated deficit of $63.8 million through December 31, 1997. The Company expects to continue to incur substantial losses over at least the next two years as the Company's research and development efforts, clinical testing activities and manufacturing scale-up and sales and marketing arrangement efforts expand. All of the Company's revenues to date have consisted of contract revenues, milestone payments and interest income. No revenues have been generated from product sales. There can be no assurance that the Company can generate sufficient product or contract revenue to become profitable or sustain profitability. 19 20 Dependence Upon Partners for Development and Commercialization. The Company does not currently possess all the resources necessary to develop, complete the FDA approval process for and commercialize any of its potential therapeutic products. The Company intends to enter into collaborative arrangements with other companies to fund research, development and clinical trials, to assist in obtaining regulatory approvals in the United States and internationally and to commercialize its products. In addition, the Company's ability to apply its drug delivery technology to a broad range of pharmaceuticals will depend upon its ability to establish and maintain collaborative arrangements because the rights to many of the pharmaceuticals most suited to the Company's drug delivery technology are currently owned by third parties. While the Company has entered into preliminary collaborations to test feasibility of its delivery technology with certain compounds and has entered into a collaboration with Chiron and P&U, there can be no assurance that the Company will be able to enter into additional collaborations to develop commercial applications of its drug delivery technology. In addition, there can be no assurance that the Company will be able to enter into or maintain existing or future collaborations or that such collaborations will be successful. The failure of the Company to enter into a collaboration with the owner of rights to a particular formulation or pharmaceutical would preclude the Company from developing its drug delivery technology with respect to such formulation or pharmaceutical. The failure to enter into or maintain existing or future collaborations would have a material adverse effect on the Company. The Company's partners may pursue parallel development of other drug delivery technologies that may compete with the Company's drug delivery technology. In addition, definitive agreements negotiated with such partners may provide that these partners may terminate the collaboration at any time without significant penalty. Both the Company and Chiron under the Chiron Agreement and P&U under the P&U Agreement have the ability to terminate a portion or all of the collaboration at certain intervals and with advance notice. In addition, Chiron has the ability to terminate the development of a Chiron Product with a limited amount of advance notice. Termination of a portion or all of the Chiron Agreement and/or P&U Agreement would have a material adverse effect on the Company. To date the Company has retained the rights to formulate and manufacture its products and intends in the future generally to formulate and manufacture pharmaceuticals for partners, however, certain partners may choose to formulate or manufacture their own formulations, thereby limiting one or more potential sources of revenue for DepoTech. In addition, the Company believes that it may be precluded from entering into arrangements with companies whose products compete with products sold by its partners. The Company also will have limited or no control over the resources that any partner may devote to the Company's products, over partners' development efforts, including the design and conduct of clinical trials, or over the pricing of products. There can be no assurance that any of the Company's present or future collaborative partners will perform their obligations as expected or will devote sufficient resources to the development, clinical testing or marketing of the Company's potential products. Any parallel development by a partner of alternate drug delivery technologies, preclusion from entering into competitive arrangements, failure to obtain timely regulatory approvals, premature termination of a collaborative agreement or failure by a partner to devote sufficient resources to the development and commercialization of the Company's products would have a material adverse effect on the Company. Reliance on Technology Rights From Research Development Foundation. In February 1994, the Company entered into an Assignment Agreement with the RDF, pursuant to which RDF assigned to DepoTech exclusive rights to the RDF Technology. As consideration for the assignment of the RDF Technology, DepoTech will pay RDF an earned royalty on gross revenues from the sale by DepoTech or its collaborators of products incorporating the RDF Technology. The Company's products, including DepoCyt, may incorporate the RDF Technology. In certain other circumstances, DepoTech will pay RDF a percentage of the royalties or other consideration received by DepoTech from licensees (or, if greater, the amount of royalty DepoTech would have owed had it engaged in the same conduct as the licensees). In addition, RDF retains the right to terminate the agreement or to convert the exclusive nature of the rights granted under the agreement into a nonexclusive license in the event that the Company does not satisfy its contractual obligations, including making certain minimum annual payments. Additional termination events include bankruptcy, a material uncured breach of the agreement by DepoTech or a contest by DepoTech of the patents included in the RDF Technology. The termination of the Assignment Agreement or the conversion of its exclusive nature to a nonexclusive agreement would have a material adverse effect on the Company. Patents and Proprietary Technology. DepoTech relies on a combination of technical leadership, patent, trade secret, copyright and trademark protection and nondisclosure agreements to protect its proprietary rights. As of March 2, 1998, the Company owned or had exclusive rights to 10 issued or allowed United States patents, 10 pending United States patent applications, 45 issued foreign patents and 53 pending foreign applications on file covering various aspects of its drug delivery technology. The Company intends to file additional patent applications in the future. There can be no assurance that the Company will be issued any additional patents or that, if any patents are issued, they will provide the Company with significant protection or will not be challenged. Even if such patents are enforceable, the Company anticipates that any attempt to enforce its patents would be time consuming and costly. Moreover, the laws 20 21 of some foreign countries do not protect the Company's proprietary rights in the products to the same extent as do the laws of the United States. The patent positions of pharmaceutical, biotechnology and drug delivery companies, including DepoTech, are uncertain and involve complex legal and factual issues. Additionally, the coverage claimed in a patent application can be significantly reduced before the patent is issued. As a consequence, there can be no assurance that any of the Company's patent applications will result in the issuance of patents or, if any patents issue, that they will provide significant proprietary protection or will not be circumvented or invalidated. Because patent applications in the United States are maintained in secrecy until patents issue and publication of discoveries in the scientific or patent literature often lag behind actual discoveries, the Company cannot be certain that it was the first inventor of inventions covered by its pending patent applications or that it was the first to file patent applications for such inventions. Moreover, the Company may have to participate in interference proceedings declared by the United States Patent and Trademark Office to determine priority of invention that could result in substantial cost to the Company, even if the eventual outcome is favorable to the Company. There can be no assurance that the Company's patents, if issued, would be held valid by a court of competent jurisdiction. An adverse outcome of any patent litigation could subject the Company to significant liabilities to third parties, require disputed rights to be licensed from or to third parties or require the Company to cease using the technology in dispute. There can be no assurance that third parties will not assert infringement claims against the Company in the future or that any such assertions will not result in costly litigation or require the Company to obtain a license to intellectual property rights of such parties. There can be no assurance that any such licenses would be available on terms acceptable to the Company, if at all. Furthermore, parties making such claims may be able to obtain injunctive or other equitable relief that could effectively block the Company's ability to further develop or commercialize its products in the United States and abroad and could result in the award of substantial damages. Defense of any lawsuit or failure to obtain any such license could have a material adverse affect on the Company. Finally, litigation, regardless of outcome, could result in substantial cost to and a diversion of efforts by the Company. Possible Volatility of Stock Price. Factors such as the announcements of technological innovations or new products by the Company, its competitors and other third parties, the status of submissions to the FDA or its international equivalent, as well as variations in the Company's results of operations, market conditions, analysts' estimates and the stock market generally (and stock market perceptions of the pharmaceutical, biotechnology and/or drug delivery industries specifically) may cause the market price of the Company's Common Stock to fluctuate significantly. Companies such as DepoTech have, in recent years, experienced dramatic stock price volatility. Also, future sales of shares by existing shareholders pursuant to Rule 144 of the Securities Act of 1933, as amended, or through the exercise of outstanding registration rights, could have an adverse effect on the price of the Company's Common Stock. Dependence on Suppliers. The Company currently relies on a limited number of suppliers to provide the materials used to manufacture its DepoFoam formulations. Certain of these materials are purchased only from one supplier. In the event the Company could not obtain adequate quantities of necessary materials from its existing suppliers, there can be no assurance that the Company would be able to access alternative sources of supply within a reasonable period of time or at commercially reasonable rates. Regulatory requirements applicable to pharmaceutical products tend to make the substitution of suppliers costly and time-consuming. The unavailability of adequate commercial quantities, the inability to develop alternative sources, a reduction or interruption in supply or a significant increase in the price of materials could have a material adverse effect on the Company's ability to manufacture and market its products. Reliance on Manufacturing Process. To date, the Company has relied on a particular proprietary method of manufacture. There can be no assurance that this method will be applicable to all pharmaceuticals or biologics the Company desires to commercialize. Further, the yield of product incorporated into the delivery system may be highly variable for different therapeutic agents. Finally, the Company will need to successfully meet any manufacturing challenges associated with the characteristics of the drug to be encapsulated. The physical and chemical stability of the DepoFoam formulation may vary with each therapeutic agent over time and under various storage conditions. There can be no assurance that the manufacturing process will result in economically viable yields of product or that it will produce formulations of therapeutic products sufficiently stable under suitable storage conditions to be commercially useful. In the event that the Company decides to pursue alternative manufacturing methods for some or all of its drugs, there can be no assurance that these methods will prove to be commercially practical or that the Company will have or be able to acquire rights to use such alternative methods. 21 22 Limited Sales and Marketing Capability. Commercialization of the Company's products is expected to be expensive and time-consuming. In the event that the Company elects to participate directly in sales and marketing efforts for the Company's products, the Company will need to build such capability in the targeted markets. The Company currently has a limited marketing staff. There can be no assurance that the Company will be able to establish an adequate sales and marketing capability in any or all targeted markets or that it will be successful in gaining market acceptance for its products. To the extent the Company enters into co-promotion or other licensing arrangements, any revenues received by the Company will be dependent on the efforts of third parties and there can be no assurance that such efforts will be successful. To the extent the Company relies on its collaborators, there can be no assurance that any of these collaborators or their sublicensees will successfully market or distribute the Company's products or that the Company will be able to establish a successful direct sales organization, co-promotion or distribution arrangements. Access to Drugs. The Company's ability to develop and commercialize its technology will be affected by the Company's or its partners' access to the drugs that are to be formulated. The Company intends in certain circumstances to rely on the ability of its partners to provide access to the drugs that are to be formulated for use with DepoFoam. There can be no assurance that the Company's partners will be able to provide access to drug candidates for formulation in DepoFoam, or that, if such access is provided, the Company or its partner will not be alleged or determined to be infringing on third parties' rights and will not be prohibited from using the drug or be found liable for damages that may not be subject to indemnification. Any restriction on access or liability for damages would have a material adverse effect on the Company. See "--Dependence Upon Partners for Development and Commercialization." Dependence on Key Personnel. The success of the Company is highly dependent, in part, on its ability to retain highly qualified personnel, including senior management and scientific personnel. Competition for such personnel is intense and the inability to retain additional key employees or the loss of one or more current key employees could adversely affect the Company. There can be no assurance that the Company will be successful in retaining required personnel in the future. Highly Competitive Industry. The drug delivery, pharmaceutical and biotechnology industries are highly competitive and rapidly evolving, with significant developments expected to continue at a rapid pace. The Company's success will depend upon maintaining a competitive position and developing products and technologies for efficient and cost-effective drug delivery. The Company's products will compete with other formulations of drugs and with other drug delivery systems. There can be no assurance that any of the Company's products will have advantages that will be significant enough to cause medical professionals to use them. DepoTech believes that its products will compete on the basis of quality, efficacy, cost, convenience, safety and patient compliance. New drugs or further development in alternative drug delivery methods may provide greater therapeutic benefits for a specific drug or indication, or may offer comparable performance at lower cost than those offered by the Company's DepoFoam drug delivery system. The Company is aware of many other competitors in the field of drug delivery, including competitors developing injectable or implantable drug delivery systems, oral drug delivery technologies, passive transdermal systems, electrotransport systems, oral transmucosal systems and inhalation systems. There can be no assurance that developments by others will not render the Company's products or technologies uncompetitive or obsolete. Many of the Company's existing or potential competitors have substantially greater research and development capabilities, experience, manufacturing, marketing, financial and managerial resources than the Company. Furthermore, acquisitions of competing drug delivery companies by large pharmaceutical companies could enhance competitors' financial, marketing and other resources. Accordingly, the Company's competitors may succeed in developing competing technologies, obtaining FDA approval or gaining market share for products more rapidly than the Company. Product Liability; Availability of Insurance. The design, development and manufacture of the Company's products involve an inherent risk of product liability claims and associated adverse publicity. The Company obtained clinical trial product liability insurance for its human clinical trials and intends to obtain insurance for future clinical trials of other products under development and for potential product liability associated with the commercial sale of the Company's products. There can be no assurance, however, that the Company will be able to obtain or maintain insurance for any of its clinical trials or commercial products. Although the Company currently maintains general liability insurance, there can be no assurance that the coverage limits of the Company's insurance policies will be adequate. Product liability insurance is expensive, difficult to obtain and may not be available in the future on acceptable terms or at all. A successful claim brought against the Company in excess of the Company's insurance coverage would have a material adverse effect upon the Company. Hazardous Materials. The Company's research and development involves the controlled use of hazardous materials, chemicals and various radioactive compounds. The risk of accidental contamination or injury from these materials cannot be completely eliminated. 22 23 In the event of such an accident, the Company could be held liable for any damages that result and any such liability could exceed the resources of the Company. The Company may incur substantial cost to comply with environmental regulations. No Dividends. The Company currently intends to retain any future earnings for use in its business and does not anticipate paying any cash dividends in the future. Pursuant to a bank credit facility, DepoTech may not, without the bank's prior written consent, pay or declare dividends except for dividends payable solely in the Company's Stock. Uncertainty of Health Care Reform Measures and Third-Party Reimbursement. The uncertainty created by a series of legislative and regulatory proposals announced in recent years could have a materially adverse effect on the Company's ability to raise capital and to identify and reach agreements with potential partners. In the event such proposals are eventually adopted, they could have a material adverse effect on the Company. Furthermore, the Company's ability to commercialize its potential product portfolio may be adversely affected to the extent that such proposals have a material adverse effect on the business, financial condition and profitability of other companies that are current or prospective collaborators for certain of the Company's proposed products. In both domestic and foreign markets, sales of the Company's potential products, if any, will depend in part on the availability of reimbursement of third-party payors such as government health administration authorities, private health insurers and other organizations. Third-party payors are increasingly challenging the price and cost-effectiveness of medical products and services. Significant uncertainty exists as to the reimbursement status of newly approved health care products. There can be no assurance that the Company's proposed products will be considered cost effective or that adequate third-party reimbursement will be available to enable the Company to maintain price levels sufficient to realize an appropriate return on its investment in product development. Legislation and regulations affecting the pricing of pharmaceuticals may change before the Company's proposed products are approved for marketing and any such changes could further limit reimbursement for medical products and services. Possible Anti-Takeover Effect of Certain Charter Provisions. The Company's Articles of Incorporation includes certain charter provisions which may discourage certain types of transactions involving an actual or potential change in control of the Company, including transactions in which shareholders might otherwise receive a premium for their shares over the current market prices, and may limit the ability of the shareholders to approve transactions that they may deem to be in their best interests. The Board of Directors also has the authority to issue up to 5,000,000 shares of Preferred Stock in one or more series and to fix the rights, priorities, preferences, qualifications, limitations and restrictions, including the dividend rates, conversion rights, voting rights, terms of redemption, terms of sinking funds, liquidation preferences and the number of shares constituting any series, without any further vote or action by the shareholders, which could decrease the amount of earnings and assets available for distribution to holders of Common Stock or adversely affect the rights and powers, including voting rights, of the holders of the Common Stock. The issuance of Preferred Stock may have the effect of delaying or preventing a change in control of the Company and may adversely affect the rights of the holders of Common Stock. Item 2. PROPERTIES The Company currently maintains its headquarters in leased facilities in San Diego, California, that contain most of its administrative, research and development and manufacturing activities in 82,000 square feet of space. The future minimum rental commitment for this facility will range from approximately $2.5 million to $4.3 million per year over 18 years, based upon pre-established annual rent increases. The Company's right of first refusal and right of first offer to purchase land located adjacent to its headquarters has expired. The Company also maintains a 14,400 square foot manufacturing plant for its production needs. The Company has subleased certain of its existing facilities with annual rental income ranging from $223,000 to $290,000. The Company believes its existing facilities will be adequate to meet its needs through 1998. Item 3. LEGAL PROCEEDINGS From time to time, DepoTech may be involved in litigation relating to claims arising out of its operations in the normal course of business. As of the date of this Annual Report, the Company is not a party to any legal proceedings. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 23 24 PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information required by Item 5 of Form 10-K is incorporated herein by reference from the information contained in the section captioned "Price Range of Common Stock" of the Registrant's 1997 Annual Report to Shareholders, a copy of which is attached hereto as Exhibit 13.1. Item 6. SELECTED FINANCIAL DATA The information required by Item 6 of Form 10-K is incorporated herein by reference from the information contained in the section captioned "Selected Financial Data" of the Registrant's 1997 Annual Report to Shareholders, a copy of which is attached hereto as Exhibit 13.1. Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by Item 7 of Form 10-K is incorporated herein by reference from the information contained in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Registrant's 1997 Annual Report to Shareholders, a copy of which is attached hereto as Exhibit 13.1. Item 7.(a) QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. None. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Company's financial statements at December 31, 1997 and 1996, and for each of the three years in the period ended December 31, 1997, and the Report of Ernst & Young LLP, independent auditors, are included the Registrant's 1997 Annual Report to Shareholders and are incorporated herein by reference. Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) Identification of Directors. The information under the caption "Election of Directors," appearing in the Proxy Statement, is incorporated herein by reference. (b) Identification of Executive Officers. The information under the headings "Executive Officers," appearing in the Proxy Statement, is incorporated herein by reference. (c) Section 16(a) Beneficial Ownership Regarding Compliance. The information under the heading " Section 16(a) Beneficial Ownership Reporting Compliance," appearing in the Proxy Statement, is incorporated herein by reference. Item 11. EXECUTIVE COMPENSATION The information under the headings "Executive Compensation and Other Information," appearing in the Proxy Statement, is incorporated herein by reference. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information under the headings " Ownership of Securities," appearing in the Proxy Statement, is incorporated herein by reference. 24 25 Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information under the heading "Certain Transactions," appearing in the Proxy Statement, is incorporated herein by reference. PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) Financial Statements
PAGE NO. -------- Financial Statements ............................................. * Balance Sheets at December 31, 1997 and 1996 ..................... * Statements of Operations for 1997, 1996 and 1995 ................. * Statements of Cash Flows for 1997, 1996 and 1995 ................. * Statements of Shareholders' Equity for 1997, 1996 and 1995 ....... * Notes to Financial Statements .................................... * Report of Ernst & Young LLP, Independent Auditors ................ *
- ------------ * Incorporated herein by reference to the Registrant's 1997 Annual Report to Shareholders, a copy of which is attached hereto as Exhibit 13.1. (2) Financial Statement Schedules All schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. (b) No reports on Form 8-K have been filed during the last quarter of the period covered by this report. (c)Exhibits
EXHIBIT PAGE NUMBER ------ #3.2 Fourth Restated Articles of Incorporation of the Company -- #3.4 Amended and Restated Bylaws of the Company -- #4.1 Form of Certificate for Common Stock. -- #10.3 Amended and Restated Investors' Rights Agreement among the -- Company and certain shareholders of the Company, dated December 16, 1994, as amended pursuant to the Amendment to the Investors' Rights Agreement dated May 24, 1995. #10.10 Master Equipment Lease Agreement dated November 26, 1993 -- between the Company and Phoenix Leasing Incorporated. #10.11 Warrant Agreement dated January 1, 1994 between the Company -- and Phoenix Leasing Incorporated.
25 26
EXHIBIT PAGE NUMBER ------ #10.12 Master Equipment Lease dated March 20, 1995 between the -- Company and Phoenix Leasing Incorporated. #10.13 Master Lease Agreement Number 10476 dated December 21, 1994, -- between the Company and Lease Management Services, Inc. #10.14 Addendum to Master Lease Agreement 10476 dated December 21, -- 1994, between the Company and Lease Management Services, Inc. #10.15 Negative Covenant Pledge Agreement dated December 21, 1994, -- between the Company and Lease Management Services, Inc. #10.17 Addendum to Equipment Financing Agreement 10776 dated -- January 5, 1995, between the Company and Lease Management Services, Inc. #10.18 Lease for the Company's facilities at 11025 North Torrey -- Pines Road dated April 2, 1992, as amended. #10.19 Industrial Real Estate Triple Net Lease for the Company's -- facilities at 11011 North Torrey Pines Road dated August 17, 1993 #10.20 Torrey Pines Science Center Industrial Real Estate Lease, -- dated December 8, 1994. #10.21 Sublease for the Company's facilities at 11025 North Torrey -- Pines Road dated July 9, 1993. #10.27 Form of Series B Preferred Stock Purchase Warrant dated July 14, -- 1992, July 15, 1992, October 15, 1992 and October 27, 1992 between the Company and certain individuals listed on the attached schedule. #10.30 Form of Series D Preferred Stock Purchase Warrant dated -- December 16, 1994 between the Company and certain individuals listed on the attached schedule. #10.31 Series D Preferred Stock Purchase Warrant dated December 16, -- 1994 between the Company and LASDK, a California Limited Partnership #10.32 Form of Amendment to Series B Warrant and Agreement to -- Exercise. #10.33 Assignment Agreement dated February 9, 1994 by and between -- the Company and Research Development Foundation (with certain confidential portions omitted). #10.36 Collaboration Agreement dated March 31, 1994 between the -- Company and Chiron Corporation (with certain confidential portions omitted).
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EXHIBIT NUMBER PAGE ------ ---- #+10.40 Consulting Agreement dated November 1, 1993 between the -- Company and Stephen B. Howell, M.D., as amended May 24, 1995. #+10.41 The Company's 1991 Stock Option Plan, as amended. -- #+10.42 1991 Stock Option Plan Form of Incentive Stock Option -- Agreement, as amended. #+10.43 1991 Stock Option Plan Form of Nonstatutory Option Agreement. -- #+10.44 1991 Stock Option Plan Form of Notice of Exercise and Stock -- Purchase Agreement. #+10.45 The Company's 1994 Stock Option Plan. -- #+10.46 1994 Stock Option Plan Form of Notice of Grant. -- #+10.47 1994 Stock Option Plan Form of Stock Option Agreement. -- #+10.48 1994 Stock Option Plan Form of Stock Purchase Agreement. -- #+10.49 The Company's 1995 Stock Option Plan. -- #+10.50 1995 Stock Option Plan Form of Notice of Grant. -- #+10.51 1995 Stock Option Plan Form of Stock Option Agreement. -- #+10.52 1995 Stock Option Plan Form of Stock Purchase Agreement. -- #+10.53 The Company's 1995 Stock Option/Stock Issuance Plan. -- #+10.54 1995 Employee Stock Purchase Plan. -- #10.55 Form of Employee Proprietary Information Agreement. -- #10.56 Form of Indemnification Agreements between the Company and -- each of its directors. #10.57 Form of Indemnification Agreement between the Company and -- each of its officers. #10.59 Loan and Security Agreement dated August 16, 1995 between -- the Company and Silicon Valley Bank. #10.60 Series D Preferred Stock Purchase Warrant dated August 16, -- 1995 between the Company and Silicon Valley Bank. #10.61 Registration Rights Agreement dated August 16, 1995 between -- the Company and Silicon Valley Bank. *10.65 Extension to Equipment Financing Agreement 10776 dated --
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EXHIBIT NUMBER PAGE ------ ---- December 8, 1995 between the Company and Lease Management Services, Inc. **10.66 Confidential Early Retirement and Separation Agreement -- between the Company and David B. Thomas dated November 4, 1996. **10.67 Stock Purchase Agreement dated November 18, 1996. -- +!10.68 David B. Thomas Employment Agreement dated June 30, 1997. -- (Exhibit 10.1) +&10.69 The Company's 1995 Stock Option/Stock Issuance Plan as -- amended. (Exhibit 99.1) ++10.70 Amendment #2 to Collaboration Agreement, dated June 5, 1997 -- between DepoTech Corporation and Chiron Corporation. (Exhibit 2.1) !!10.71 Marketing and Distribution Agreement between DepoTech -- Corporation and Pharmacia & Upjohn S.p.A. dated July 2, 1997 (with confidential portions omitted). (Exhibit 10.1) !!10.72 Stock Purchase Agreement between DepoTech Corporation and -- Ross Financial Corporation dated September 10, 1997. (Exhibit 10.2) ##+10.73 The Company's 1997 Supplemental Stock Option Plan -- (Exhibit 99.1) 10.74 Amendment #3 to Collaboration Agreement dated December 13, 1997 between DepoTech Corporation and Chiron Corporation 11.1 Computation of pro forma net loss per share. -- 13.1 Portion of the 1997 Annual Report to Shareholders -- 23.1 Consent of Ernst & Young LLP, Independent Auditors. -- 24.1 Power of Attorney (see page 30). 27.1 Financial Data Schedule. --
- ---------- + Management contract or compensatory plan. # Incorporated by reference to the same-numbered exhibit (except as otherwise indicated) to the Company's Registration Statement on Form S-1 (No. 33-95890), as amended. * Incorporated by reference to the same-numbered exhibit (except as otherwise indicated) to the Company's Annual Report on Form 10-K for the year ended December 31, 1995. 28 29 ** Incorporated by reference to the same numbered exhibit (except as otherwise indicated) to the Company's Annual Report or Form 10-K for the year ended 12/31/96. ! Incorporated by reference to the same numbered exhibit (except as otherwise indicated) to the Company's Report on Form 10Q for the quarter ended June 30, 1997, filed on August 14, 1997. ++ Incorporated by reference to the same numbered exhibit (except as otherwise indicated) to the Company's Current Report on Form 8-K filed June 20, 1997. & Incorporated by reference to the same numbered exhibit (except as otherwise indicated) to the Company's Registration Statement on Form S-8 (No. 333-28531), filed on June 4, 1997. !! Incorporated by reference to the same numbered exhibit (except as otherwise indicated) to the Company's Report on Form 10Q for the quarter ended September 30, 1997, filed on November 14, 1997. ## Incorporated by reference to the same numbered exhibit (excepted as otherwise indicated) to the Company's Registration Statement on Form S-8 (No. 333-42459) filed on December 17, 1997. Supplemental Information Copies of the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held May 13, 1998 and copies of the form of proxy to be used for such Annual Meeting were furnished to the Commission prior to the time they were distributed to the shareholders. 29 30 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. DEPOTECH CORPORATION Date: March 31, 1998 By: /s/ Fred A. Middleton ------------------------------------- Fred A. Middleton Chairman of the Board and Chief Executive Officer POWER OF ATTORNEY Know all men by these presents, that each person whose signature appears below constitutes and appoints Fred A. Middleton or Dana S. McGowan, his or her attorney-in-fact, with power of substitution in any and all capacities, to sign any amendments to this Annual Report on Form 10-K, and to file the same with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that the attorney-in-fact or his or her substitute or substitutes may do or cause to be done by virtue hereof. 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 in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ Fred A. Middleton Chairman of the Board and Chief Executive March 31, 1998 - ---------------------------------- Officer (Fred A. Middleton) /s/ John P. Longenecker President and Chief Operating Officer March 31, 1998 - ---------------------------------- Officer and Director (John P. Longenecker) (Principal Executive Officer) /s/ Dana S. McGowan Vice President, Finance and Chief March 31, 1998 - ---------------------------------- Financial Officer (Dana S. McGowan) (Principal Financial and Accounting Officer) /s/ Pieter J. Strijkert Director March 31, 1998 - ---------------------------------- (Pieter J. Strijkert) /s/ Roger C. Davisson Director March 31, 1998 - ---------------------------------- (Roger C. Davisson) /s/ George W. Dunbar, Jr. Director March 31, 1998 - ---------------------------------- (George W. Dunbar, Jr.) /s/ Stephen B. Howell Director March 31, 1998 - ---------------------------------- (Stephen B. Howell)
30 31 /s/ Peter Preuss Director March 31, 1998 - ---------------------------------- (Peter Preuss)
31 EX-10.74 2 EXHIBIT 10.74 1 EXHIBIT 10.74 AMENDMENT #3 TO COLLABORATION AGREEMENT This Amendment #3 to Collaboration Agreement (this "Amendment") is made and entered into as of December 15, 1997, by and between DepoTech Corporation, a California corporation ("DepoTech") and Chiron Corporation, a Delaware corporation ("Chiron"). The Collaboration Agreement dated as of March 31, 1994, between Chiron and DepoTech (the "Collaboration Agreement") was previously amended by Amendment #1 to Collaboration Agreement, dated as of April 1, 1997 ("Amendment #1") and Amendment #2 to Collaboration Agreement, dated as of June 4, 1997 ("Amendment #2). The parties hereby agree to amend Section 3.B.(i) of Amendment #2 to read in full as follows: The entire $11,700,000 shall be payable upon the date of the earlier of the following events (such earlier date referred to as the "Payment Date"). If neither event occurs, payment shall be governed by subsection (ii) or (iii) below. If, prior to December 31, 1998, the FDA issues a letter of other notification (each an "FDA Notification") indicating that the NDA with respect to DTC 101 in the United States is approvable or approved, the Payment Date shall be the date of the first FDA Notification. Notwithstanding subsection (aa) above, if, prior to December 28, 1997, at least two-thirds of the voting members of the Oncologic Drugs Advisory Committee to the FDA ("ODAC") (i.e. absent or abstaining members are excluded) vote to recommend that the FDA approve such NDA for the indications submitted, and, at the meeting at which such vote occurs, the ODAC does not recommend any material adverse changes to the product labeling from that submitted in connection with the NDA, the Payment Date shall be the date of such ODAC meeting. DepoTech shall, at its option, pay the entire amount in cash within five(5) working days after the Payment Date, or deliver to Chiron within five(5) working days after the Payment Date a promissory note in the form attached hereto as Exhibit A, for the principal amount of the unpaid balance. Such note shall be payable in full not later than December 31, 1998, and shall bear interest from the Payment Date until paid in full at a rate equal to the 12 month Treasury Bill rate on the Payment Date plus 150 basis points, not to exceed the maximum rate permitted by applicable law. Except as set forth herein, the Collaboration Agreement, as previously amended by Amendment #1 and Amendment #2, remains in full force and effect. Executed by the parties as of the date first written above. DEPOTECH CORPORATION CHIRON CORPORATION By /s/ EDWARD L. ERICKSON By /s/ MAGNUS LUNDBERG ------------------------------ ----------------------------- (Edward L. Erickson), President (Magnus Lundberg), President and Chief Executive Officer Chiron Therapeutics EX-11.1 3 EXHIBIT 11.1 1 EXHIBIT 11.1 COMPUTATION OF NET LOSS PER SHARE
Years ended December 31, ------------------------------------------------ 1997 1996 1995 ------------ ------------ ------------ Net loss ($21,408,330) ($16,775,605) ($ 8,020,547) ============ ============ ============ Calculation of shares used in computing net loss per share: Weighted average common shares outstanding used in calculating net loss per share in accordance with generally accepted accounting principles 13,433,915 11,451,334 2,498,295 Adjustments to reflect certain requirements of the SEC: Conversion of preferred stock- weighted average shares 5,994,416 ------------ ------------ ------------ Shares used in computing net loss per share 13,433,915 11,451,334 8,492,711 ============ ============ ============ Net loss per share ($ 1.59) ($ 1.46) ($ 0.94) ============ ============ ============
EX-13.1 4 EXHIBIT 13.1 1 EXHIBIT 13.1 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Since its inception in October 1989, DepoTech Corporation (the "Company") has devoted substantially all of its resources to the development of its potential products. To date, the Company has not received any revenues from the sale of products. The Company has funded its development programs primarily from equity-derived working capital and through strategic alliances with other companies. The Company has been unprofitable since its inception and expects to incur additional operating losses over at least the next two years. As of December 31, 1997, the Company's accumulated deficit was approximately $63.8 million. The following discussion is qualified in its entirety by the more detailed information and the Financial Statements and Notes thereto appearing elsewhere in this Annual Report, including information under "Risks and Uncertainties." This report may contain, in addition to historical information, forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from the results discussed in such forward-looking statements. Factors that could cause or contribute to such differences include those discussed under "Risks and Uncertainties." Results of Operations The Company had total revenues of $6.9 million for the year ended December 31, 1997 compared to $4.4 million for 1996 and $6.8 million for 1995. Total revenues were principally generated by the Company's collaborative agreements with Chiron Corporation ("Chiron") and Pharmacia & Upjohn S.p.A., an affiliate of Pharmacia & Upjohn, Inc. ("P&U"). Total revenues were primarily derived from milestone payments earned and reimbursement of certain clinical trial and manufacturing scale-up expenses for the Company's lead product, DepoCyt, under the two collaboration agreements. In addition, Chiron reimbursed DepoTech for 100% of certain pre-clinical and feasibility studies performed on their behalf. Further, DepoTech is reimbursed for conducting feasibility studies for various pharmaceutical companies. Total revenues in 1995 included a one-time marketing rights fee and reimbursement of prior year clinical trial expenses for DepoCyt totaling $3.5 million, earned by the Company upon achievement of a development milestone under the Chiron agreement. Included in total revenue for 1997 is a milestone payment from Chiron of $1.0 million paid to DepoTech upon the filing of a New Drug Application for DepoCyt. In July 1997, the Company entered into a Marketing and Distribution Agreement with P&U for rights to market and sell DepoCyt in countries outside the U.S. The Company received a cash payment of $2.0 million upon signing of the agreement. Revenues from the reimbursement of clinical trial expenses from prior years and the marketing rights fee were one time payments which will not re-occur in future periods. Revenues may fluctuate from year to year depending on the level of clinical and development activity for projects under collaborative agreements and the achievement of future milestones. Research and development expenses increased to $20.1 million for the year ended December 31, 1997, from $18.0 million in 1996 and $12.7 million in 1995. Factors contributing to these increases include expanded efforts in clinical trials, manufacturing scale-up, and preclinical development of potential DepoFoam products. The Company is continuing Phase III clinical studies of DepoCyt in neoplastic meningitis from leukemia and lymphomas, as well as a Phase IV nonrandomized trial in solid tumor patients. In 1997, DepoTech began a dose-finding study of DepoCyt in pediatric patients, and completed a Phase I study of DepoMorphine sustained-release encapsulated morphine sulfate to treat acute post-surgical pain. Manufacturing scale-up of DepoMorphine is underway. The Company has completed a Phase I study of DepoAmikacin as well as certain preclinical and feasibility studies with partner, Chiron. Further, the Company is evaluating the feasibility of developing several early stage compounds internally and for corporate partners. Research and development expenses are expected to increase in 1998. General and administrative expenses increased to $6.8 million during 1997 from $4.1 million in 1996 and $2.8 million in 1995. The increases were primarily due to expansion in administrative staffing and higher facility cost and business development expenses. Included in general and administrative expenses for 1997 and 1996 are $1.5 million and $0.5 million, respectively, of pre-launch expenses incurred for DepoCyt prior to the onset of any product revenue. Under the collaborative agreement with Chiron, the Company is obligated to share in the funding of these expenses. Chiron and DepoTech have been jointly developing DepoCyt in the U.S., Canada and Europe since March 1994. 9 2 In June 1997, DepoTech reacquired rights to DepoCyt in Canada and Europe from Chiron. Chiron will retain exclusive marketing rights to DepoCyt in the U.S. Included in operating expenses for the year ended December 31, 1997 were expenses of $2.0 million associated with the repurchase of DepoCyt which was paid to Chiron in December 1997. Interest income was $1.7 million for the year ended December 31, 1997 compared to $1.7 million in 1996 and $1.1 million in 1995. The increase from 1995 to 1996 was principally due to higher average cash investment balances and increases in available market interest rates. Interest expense was $1.2 million for the year ended December 31, 1997 compared to $0.8 million in 1996 and $0.4 million in 1995. The increases in interest expense were due to higher balances outstanding for obligations under capital leases and a note payable. Liquidity and Capital Resources Since its inception, DepoTech has financed its operations primarily through public and private placements of equity securities, which provided aggregate net proceeds of approximately $101.9 million through December 31, 1997, and through capital equipment leases and notes payable. In October 1995, the Company completed its initial public offering of common stock with net proceeds of $38.1 million. In January 1997, the Company completed the private placement of 1.5 million newly issued shares of common stock raising net proceeds of $18.9 million. In September 1997, the Company raised net proceeds of $14.6 million through the sale of 1.0 million newly issued shares of DepoTech common stock to a private investment company. Chiron and DepoTech have been jointly developing DepoCyt in the U.S., Canada and Europe since March 1994. In June 1997, DepoTech reaquired rights to DepoCyt in Canada and Europe from Chiron for aggregate cash payments of up to $13.7 million, of which $2.0 million was paid to Chiron in December 1997. Chiron will retain exclusive marketing rights to DepoCyt in the U.S. If prior to December 31, 1998, the U.S. Food and Drug Administration ("FDA") issues a letter or other notification to DepoTech indicating that DepoCyt is approvable or approved, the remaining balance of $11.7 million shall be payable no later than December 31, 1998. If no FDA notification is received prior to December 31, 1998, the remaining amount shall be payable no later than six months from the earlier of U.S. or European Union regulatory notification that the application to market or sell DepoCyt is approvable or approved. If all applications for regulatory approval to sell DepoCyt in the U.S. and European Union are permanently withdrawn, DepoTech shall be relieved of any obligation to pay the remaining $11.7 million. In July 1997, DepoTech entered into a Marketing and Distribution Agreement with P&U for rights to market and sell DepoCyt in countries outside the U.S. P&U will be responsible for submitting regulatory filings, labeling, packaging, distribution, marketing and sales of DepoCyt in this territory. The Company will manufacture DepoCyt and receive a share of the net sales of DepoCyt sold by P&U. The Company received a cash payment of $2.0 million upon execution of the agreement and may receive additional payments of up to $17.0 million upon achievement of certain regulatory milestones. The agreement also provides for P&U to reimburse the Company for certain clinical trial expenses and regulatory fees incurred by the Company. Future milestone payments, if any, totaling up to the obligation to Chiron of $11.7 million will be set aside in a restricted cash account for payment to Chiron for the repurchase of DepoCyt rights. Working capital increased to $22.1 million as of December 31, 1997 compared to $14.9 million as of December 31, 1996. The increase in working capital in 1997 was primarily due to $33.5 million of net proceeds received from two private placements and $8.0 million of proceeds from a note payable, which was partially offset by net cash used to fund operations of $18.2 million, purchases of property and equipment of $12.0 million, and debt repayments totalling $2.9 million. As of December 31, 1997, DepoTech had cash, cash equivalents and short-term investments totaling $27.4 million. In May 1996, the Company signed a bank credit facility for $9.0 million to finance future capital equipment purchases, all of which was utilized through December 31, 1997. In October 1997, DepoTech expanded the bank credit facility by $4.5 million, of which $1.2 million was utilized through December 31, 1997. The Company believes the impact of inflation on its business activities has not been significant to date. Through December 31, 1997, the Company has invested an aggregate of $31.9 million in leasehold improvements, and manufacturing, laboratory and office equipment, of which $19.4 million has been funded through capital leases or bank credit facilities. The Company intends to continue to fund capital expenditures through external financing supplemented by internal cash resources where appropriate. The Company leases its headquarters which house most of its administrative, research and clinical and manufacturing activities. The minimum rental commitment for this facility 10 3 ranges from approximately $2.5 million to $4.3 million per year, over 18 years, based upon pre-established annual rent increases. The Company is installing a manufacturing line in this facility to support clinical and commercial production of DepoFoam products under development. The cost of equipment and tenant improvement expenses for this manufacturing line total approximately $7.5 million through 1997. DepoTech intends to finance such expenditures through existing bank credit facilities. Capital expenditures for 1998 are expected to be lower than the prior year. The Year 2000 Issue is the result of computer programs written in the past that use two digits rather than four to define the applicable year. As a result, these computer programs may not properly recognize calendar dates beginning in the Year 2000. This problem may cause systems to fail or miscalculate causing disruptions of operations, including a temporary inability to process transactions or engage in similar normal business activities. The Company believes that the total internal Year 2000 Issue costs will be minimal and that the Year 2000 conversion requirements will be achieved through routine upgrades to its software programs. The Company expects to complete these upgrades by the end of 1998. These costs and the expected completion date are based on management's best estimates and there can be no assurance that these estimates will be achieved and actual results could differ materially from those anticipated. The Company has also initiated communications with all of its significant suppliers to determine the extent to which the Company's systems are vulnerable to those third parties' failure to remediate their own Year 2000 Issues. There can be no assurance that the systems of other companies on which the Company's systems rely will be timely converted and will not have an adverse effect on the Company's systems. The Company's operations to date have consumed substantial amounts of cash, which is expected to continue over the foreseeable future. The amount of net losses and the time required for the Company to achieve profitability are highly uncertain. There can be no assurance that the Company will be able to achieve profitability at all or on a sustained basis. DepoTech anticipates that its existing available cash, cash equivalents and short-term investments, committed future contract revenue, projected funding from equipment financing and interest income will be adequate to satisfy its capital requirements and fund operating losses through 1998. The development and commercialization of the Company's potential products will require substantial funds to conduct research and development and preclinical and clinical testing of products and to manufacture and commercialize any products that are approved for commercial sale. The Company's future capital requirements will depend on many factors, including, without limitation, the time and costs involved in obtaining regulatory approvals, continued scientific progress in its products and process development programs and changes in existing collaborative programs. The Company anticipates that it will be required to raise additional capital in the near-term in order to continue to conduct its operations. Such capital may be raised through public or private financings, as well as collaborative arrangements, borrowings and other available sources. There can be no assurance that additional funding, if necessary, will be available on favorable terms, if at all. If adequate funds are not available, the Company will be required to curtail operations significantly or to obtain funds through entering into arrangements with collaborative partners or others that may require the Company to relinquish rights to certain of its technologies, potential products or potential markets that the Company would not otherwise relinquish. The failure to receive additional funding would have a material adverse effect on the Company. Risks and Uncertainties EARLY STAGE COMPANY. DepoTech's products are at an early stage of development, and, to date, only three of the company's DepoFoam formulations have been subject to human clinical testing. The Company's potential products will require extensive research, formulation, development, preclinical and clinical testing, and may involve a lengthy regulatory approval process prior to commercialization. There can be no assurance that DepoCyt, DepoMorphine, or any of the Company's other products or potential products will prove safe and effective in clinical trials, meet applicable regulatory standards, be capable of being produced in commercial quantities at acceptable cost or be successfully commercialized. In addition, there can be no assurance that preclinical or clinical testing will accurately predict safety or efficacy in broader human use, or that delays in the regulatory approval process will not arise, delaying approval longer than currently anticipated. Even if all of the Company's products prove to be safe and effective and are approved for marketing by the FDA and other regulatory authorities, there can be no assurance that health care providers, payors and patients will accept the 11 4 Company's products. Any failure of the Company to achieve technical feasibility, demonstrate safety, achieve clinical efficacy, obtain regulatory approval or, alone or together with its partners, successfully market products would have a material adverse effect on the Company. In April 1997, the Company completed a New Drug Application ("NDA") for DepoCyt for the treatment of neoplastic meningitis ("NM") from solid tumors. As with all drugs subject to accelerated approval, the FDA requested that the Company conduct a Phase IV clinical trial on DepoCyt which is in process. In December 1997, the Oncologic Drugs Advisory Committee to the FDA declined to recommend approval of DepoCyt for use in patients with NM from solid tumors. In March 1998, DepoTech reached an agreement with the FDA to submit an amendment to the NDA to provide data from the Phase IV study of NM from solid tumors, and interim data from a Phase III clinical trial of NM from lymphomas. Submission of the amendment will approximately double the number of patients treated with DepoCyt under review and extend the review time for a FDA decision by three months. The final decision regarding marketing approval of new therapeutics resides with FDA officials subsequent to any recommendation of the Committee. There can be no assurance that the data from the DepoCyt Phase III or Phase IV clinical trials will be sufficient to gain FDA approval for marketing for any indication, that additional results from ongoing pivotal Phase III trials will be consistent with earlier results or that the Phase IV and other clinical trials of DepoCyt will generate positive results. Any of these occurrences would have a material adverse effect on the Company. GOVERNMENT REGULATION; UNCERTAINTY OF OBTAINING REGULATORY APPROVAL. DepoTech's research and development activities are, and its future business will be, subject to significant regulation by governmental authorities in the United States, primarily by the FDA, and internationally. The clinical testing and the regulatory review process for new drugs or biologics requires substantial time, effort and expense. There can be no assurance that any approval will be granted to the Company's potential products on a timely basis, if at all. The FDA or its international equivalent may refuse to approve a drug or biological product for commercial sale or shipment if applicable statutory and/or regulatory criteria are not satisfied, or may require additional testing or information. There can be no assurance that such additional testing or the provision of such additional information, if required, will not have a material adverse effect on the Company. Also, the regulatory process can be modified by legislatures, the FDA or international regulators in a manner that could have a material adverse effect on the Company. LIMITED MANUFACTURING EXPERIENCE; RISK OF SCALE-UP; RELIANCE ON MANUFACTURING PROCESS. The Company has no experience manufacturing products for commercial purposes. The Company's manufacturing operations will need to meet ongoing commercial requirements for all markets in which products have been approved. The Company will also need to comply with current Good Manufacturing Practices ("cGMPs") and other regulations prescribed by various regulatory agencies in the United States and other countries to achieve the required levels of production of each of its products and to obtain and retain marketing approval, if any. Failure by the Company to successfully scale-up its manufacturing processes or to comply with cGMPs and other regulations would have a material adverse effect on the Company, including the loss of manufacturing rights to DepoCyt under the Chiron and P&U agreements. To date, the Company has relied on a particular proprietary method of manufacture. There can be no assurance that this method will be applicable to all pharmaceuticals or biologics the Company desires to commercialize. Further, the yield of product incorporated into the delivery system is likely to be highly variable for different therapeutic agents. Finally, the Company will need to successfully meet any manufacturing challenges associated with the specific characteristics of the drug to be encapsulated. FUTURE CAPITAL NEEDS. The development and commercialization of the Company's potential products will require substantial funds to conduct research and development and preclinical and clinical testing of products and to manufacture and commercialize any products that are approved for commercial sale. The Company's future capital requirements will depend on many factors, including, without limitation, the time and costs involved in obtaining regulatory approvals, continued scientific progress in its products and process development programs and changes in existing collaborative programs. The Company anticipates that it will be required to raise additional capital in the near-term in order to continue to conduct its operations. Such capital may be raised through public or private financings, as well as collaborative arrangements, borrowings and other available sources. There can be no 12 5 assurance that additional funding will be available on favorable terms, if at all. If adequate funds are not available, the Company will be required to curtail operations significantly or to obtain funds through entering into arrangements with collaborative partners or others that may require the Company to relinquish rights to certain of its technologies, potential products or potential markets that the Company would not otherwise relinquish. The failure to receive additional funding would have a material adverse effect on the Company. DEPENDENCE UPON PARTNERS FOR DEVELOPMENT AND COMMERCIALIZATION. The Company does not currently possess all of the resources necessary to develop, complete the FDA approval process and commercialize all of its potential therapeutic products. The Company hopes to enter into collaborative arrangements with other companies to fund research, development and clinical trials, to assist in obtaining regulatory approvals and to commercialize its products in the United States and internationally. In addition, the Company's ability to apply its drug delivery technology to a broad range of pharmaceuticals will depend upon its ability to establish and maintain collaborative arrangements because the rights to many of the pharmaceuticals most suited to the Company's drug delivery technology are currently owned or controlled by third parties. While the Company has entered into preliminary arrangements to test the feasibility of its delivery technology with certain pharmaceuticals and has entered into more extensive collaborations with Chiron and P&U, there can be no assurance that the Company will be able to enter into additional collaborations to develop commercial applications of its drug delivery technology. In addition, there can be no assurance that the Company will be able to enter into or maintain existing or future collaborations or that such collaborations will be successful. The failure of the Company to enter into a collaboration with the owner of rights to a particular formulation or pharmaceutical would preclude the Company from developing its drug delivery technology with respect to such formulation or pharmaceutical. The failure to enter into or maintain existing or future collaborations would have a material adverse effect on the Company. LIMITED SALES AND MARKETING CAPABILITY. Commercialization of the Company's products is expected to be expensive and time-consuming. To the extent the Company relies on its collaborators for sales, marketing or other capabilities, the Company will be dependent on the efforts of third parties and there can be no assurance that any of these collaborators will successfully perform their duties in commercializing the Company's products. PATENTS AND PROPRIETARY TECHNOLOGY. DepoTech relies on a combination of technical leadership, patents, trade secrets, copyright and trademark protection and nondisclosure agreements to protect its proprietary rights. There can be no assurance that any patents issued to the Company will provide significant protection or will not be challenged or that the Company will be issued any additional patents. Even if issued patents are enforceable, the Company anticipates that any attempts to enforce its patents would be time consuming and costly. Additionally, the coverage claimed in a patent application can be significantly reduced before the patent is issued. Defense of any lawsuit or failure to obtain a license to intellectual property rights of third parties required to commercialize the Company's potential products would have a material adverse affect on the Company. In February 1994, the Company entered into an Assignment Agreement with the Research Development Foundation ("RDF"), pursuant to which RDF assigned to DepoTech exclusive rights to certain intellectual property relating to the DepoFoam technology, including corresponding patents and patent applications for such property. RDF retains the right to terminate the agreement or to convert the exclusive nature of the rights granted under the agreement into a nonexclusive license in the event that the Company does not satisfy its contractual obligations, including making certain minimum annual payments. The termination of the Assignment Agreement or the conversion of its exclusive nature to a nonexclusive agreement would have a material adverse effect on the Company. POSSIBLE VOLATILITY OF STOCK PRICE. Factors such as the announcements of technological innovations or new products by the Company, its competitors and other third parties, the status of submissions to the FDA or its international equivalent, as well as variations in the Company's results of operations, market conditions, analysts' estimates and the stock market in general may cause the market price of the Company's common stock to fluctuate significantly. Also, future sales of shares by existing shareholders pursuant to Rule 144 of the Securities Act of 1933, as amended, or through the exercise of outstanding registration rights, could have a material adverse effect on the price of the Company's common stock. 13 6 STATEMENTS OF OPERATIONS DepoTech Corporation
Years Ended December 31, 1997 1996 1995 Revenues: Contract revenue $ 3,877,701 $ 4,391,024 $ 5,825,784 Licensing/milestone payments 3,000,000 -- -- Marketing rights fee -- -- 1,000,000 - ---------------------------------------------------------------------------------------------------------------- Total revenues 6,877,701 4,391,024 6,825,784 Costs and expenses: Research and development 20,058,158 17,951,636 12,699,247 General and administration 6,763,775 4,087,436 2,826,538 Repurchasing of marketing rights 2,000,000 -- -- - ---------------------------------------------------------------------------------------------------------------- Total costs and expenses 28,821,933 22,039,072 15,525,785 - ---------------------------------------------------------------------------------------------------------------- Loss from operations (21,944,232) (17,648,048) (8,700,001) Interest income 1,722,434 1,659,852 1,084,244 Interest expense (1,186,532) (787,409) (404,790) - ---------------------------------------------------------------------------------------------------------------- Net loss $(21,408,330) $(16,775,605) $ (8,020,547) ============================================== Basic and diluted net loss per share $ (1.59) $ (1.46) $ (0.94) ============================================== Shares used in computing basic and diluted net loss per share 13,433,915 11,451,334 8,492,711 ==============================================
See accompanying notes. 14 7 Balance Sheets DepoTech Corporation
December 31, 1997 1996 Assets Current assets: Cash and cash equivalents $ 6,194,153 $ 1,966,626 Short-term investments 21,166,402 16,231,471 Accounts receivable from collaborations 1,361,837 614,580 Other current assets 1,141,210 1,160,394 - --------------------------------------------------------------------------------------------------------------- Total current assets 29,863,602 19,973,071 Property and equipment, net 26,948,328 16,851,574 Restricted cash 216,516 289,023 Deposits and other assets 641,240 494,737 - --------------------------------------------------------------------------------------------------------------- Total assets $ 57,669,686 $ 37,608,405 ================================= Liabilities and shareholders' equity Current liabilities: Accounts payable $ 2,101,983 $ 1,633,756 Current portion of note payable 2,509,467 493,481 Current portion of obligations under capital leases 2,037,416 2,040,578 Other accrued liabilities 1,148,477 939,331 - --------------------------------------------------------------------------------------------------------------- Total current liabilities 7,797,343 5,107,146 Deferred rent 2,313,133 1,377,623 Deferred revenue -- 54,839 Note payable, less current portion 6,901,982 1,709,813 Obligations under capital leases, less current portion 2,089,931 4,129,750 Other long-term liabilities 494,506 -- Commitments Shareholders' equity Common stock, no par value; 30,000,000 shares authorized; 14,237,216 and 11,543,816 shares issued and outstanding at December 31, 1997 and 1996, respectively 101,970,346 67,797,617 Deferred compensation related to stock options, net (109,472) (161,960) Unrealized gain (loss) on short-term investments 15,784 (10,886) Accumulated deficit (63,803,867) (42,395,537) - --------------------------------------------------------------------------------------------------------------- Total shareholders' equity 38,072,791 25,229,234 - --------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 57,669,686 $ 37,608,405 =================================
See accompanying notes 15 8 Statements of Cash Flows DepoTech Corporation
Years Ended December 31, 1997 1996 1995 Operating activities Net loss $(21,408,330) $(16,775,605) $ (8,020,547) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation and amortization 1,959,210 1,512,151 837,168 Deferred revenue from collaboration -- -- (1,000,000) Amortization of deferred compensation 52,488 52,488 47,990 Deferred rent 935,510 989,676 275,602 Deferred revenue (54,839) 54,839 -- Forgiveness of employee notes receivable -- 39,283 56,333 Changes in operating assets and liabilities: Accounts receivable from collaborations (747,257) (214,580) (156,123) Other current assets 19,184 (632,753) (494,873) Deposits and other assets (158,947) (196,931) (115,614) Accounts payable and other accrued liabilities 1,171,878 125,495 1,376,791 - ------------------------------------------------------------------------------------------------------------------ Net cash used by operating activities (18,231,103) (15,045,937) (7,193,273) Investing activities Purchases of short-term investments (32,496,584) (17,244,027) (38,410,705) Proceeds from sale or maturities of short-term investments 27,588,323 33,573,121 11,171,032 Purchases of property and equipment (12,043,520) (6,395,815) (1,419,044) Restricted cash 72,507 131,837 16,740 - ------------------------------------------------------------------------------------------------------------------ Net cash (used) provided by investing activities (16,879,274) 10,065,116 (28,641,977) Financing activities Repayment of capital lease obligations (2,042,980) (1,803,637) (831,262) Repayment of note payable (834,015) -- -- Proceeds from note payable 8,042,170 2,203,294 -- Proceeds from issuance of common stock, net 34,172,729 663,879 38,163,652 Repayment of facilities payable -- -- (237,569) Proceeds from bank borrowing -- -- 4,000,000 Repayment of bank borrowing -- -- (4,000,000) - ------------------------------------------------------------------------------------------------------------------ Net cash provided by financing activities 39,337,904 1,063,536 37,094,821 - ------------------------------------------------------------------------------------------------------------------ Net increase (decrease) in cash and cash equivalents 4,227,527 (3,917,285) 1,259,571 Cash and cash equivalents at the beginning of year 1,966,626 5,883,911 4,624,340 - ------------------------------------------------------------------------------------------------------------------ Cash and cash equivalents at the end of year 6,194,153 1,966,626 5,883,911 Short-term investments at the end of year 21,166,402 16,231,471 32,777,623 - ------------------------------------------------------------------------------------------------------------------ Cash, cash equivalents and short-term investments at the end of year $ 27,360,555 $ 18,198,097 $ 38,661,534 ================================================== Supplemental information Property and equipment acquired through capital leases and loans $ -- $ 3,337,461 $ 3,677,018 ================================================== Issuance of common stock in exchange for note payable $ -- $ -- $ 231,938 ================================================== Interest paid $ 1,186,532 $ 787,409 $ 404,790 ==================================================
See accompanying notes. 16 9 Statements of Shareholders' Equity DepoTech Corporation
Convertible Preferred Stock Common Stock Shares Amount Shares Amount Balance at January 1, 1995 5,982,991 $ 26,560,830 1,531,263 $ 82,486 Issuance of common stock, net -- -- 78,908 36,306 Exercise of warrants -- -- 242,468 308,654 Deferred compensation related to issuance of stock options -- -- -- 262,438 Amortization of deferred compensation -- -- -- -- Accretion on convertible preferred stock -- 1,832,394 -- -- Unrealized gain on investments -- -- -- -- Issuance of common stock upon initial public offering, net -- -- 3,450,000 38,050,630 Conversion of convertible preferred stock upon initial public offering (5,982,991) (28,393,224) 5,982,991 28,393,224 Net loss -- -- -- -- ------------------------------------------------------------ Balance at December 31, 1995 -- -- 11,285,630 67,133,738 Issuance of common stock, net -- -- 258,186 663,879 Amortization of deferred compensation -- -- -- -- Unrealized loss on investments -- -- -- -- Net loss -- -- -- -- ------------------------------------------------------------ Balance at December 31, 1996 -- -- 11,543,816 67,797,617 Issuance of common stock, net -- -- 2,693,400 34,172,729 Amortization of deferred compensation -- -- -- -- Unrealized gain on investments -- -- -- -- Net loss -- -- -- -- ------------------------------------------------------------ Balance at December 31, 1997 -- $ -- 14,237,216 $101,970,346 ============================================================
Defered Unrealized Compensation Gain Total Related (Loss) on Accumulated Shareholders' to Stock Options Investments Deficit Equity Balance at January 1, 1995 $ -- $ 26,928 $(15,766,991) $ 10,903,253 Issuance of common stock, net -- -- -- 36,306 Exercise of warrants -- -- -- 308,654 Deferred compensation related to issuance of stock options (262,438) -- -- -- Amortization of deferred compensation 47,990 -- -- 47,990 Accretion on convertible preferred stock -- -- (1,832,394) -- Unrealized gain on investments -- 179,244 -- 179,244 Issuance of common stock upon initial public offering, net -- -- -- 38,050,630 Conversion of convertible preferred stock upon initial public offering -- -- -- -- Net loss -- -- (8,020,547) (8,020,547) --------------------------------------------------------------- Balance at December 31, 1995 (214,448) 206,172 (25,619,932) 41,505,530 Issuance of common stock, net -- -- -- 663,879 Amortization of deferred compensation 52,488 -- -- 52,488 Unrealized loss on investments -- (217,058) -- (217,058) Net loss -- -- (16,775,605) (16,775,605) --------------------------------------------------------------- Balance at December 31, 1996 (161,960) (10,886) (42,395,537) 25,229,234 Issuance of common stock, net -- -- -- 34,172,729 Amortization of deferred compensation 52,488 -- -- 52,488 Unrealized gain on investments -- 26,670 -- 26,670 Net loss -- -- (21,408,330) (21,408,330) --------------------------------------------------------------- Balance at December 31, 1997 $ (109,472) $ 15,784 $(63,803,867) $ 38,072,791 ===============================================================
See accompanying notes. 17 10 NOTES TO FINANCIAL STATEMENTS DepoTech Corporation - December 31, 1997 Note 1 - Summary of Significant Accounting Policies ORGANIZATION AND BUSINESS ACTIVITIES DepoTech Corporation (the "Company") was incorporated in California on October 30, 1989. The Company is a drug delivery company engaged in the development and manufacture of sustained-release therapeutic products based on its DepoFoam drug delivery technology. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS The Company invests its excess cash in deposit accounts, money market accounts, commercial paper and U.S. Government securities. The Company has established guidelines relative to diversification and maturities that maintain safety and an adequate level of liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates. The Company considers all highly liquid investments with a maturity of three months or less from the date of purchase that are readily convertible into cash to be cash equivalents. Short-term investments are classified as available-for-sale, and are carried at market value, in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The unrealized gain or loss on such investments is reported as a separate component of shareholders' equity. Realized gains and losses are included in interest income. The cost of securities is based on the specific identification method. PROPERTY AND EQUIPMENT Property and equipment consist primarily of manufacturing, laboratory and office equipment and leasehold improvements and are stated at cost. Property and equipment under capital leases are recorded at the present value of the minimum lease payments. Depreciation and amortization are calculated using the straight-line method over the shorter of the estimated useful life of the assets (ranging from three to fifteen years) or the lease term. RESTRICTED CASH Restricted cash consists of certificates of deposit maintained as collateral for letters of credit securing certain lease agreements. PATENT COSTS Included in deposits and other assets are patent and trademark filing costs totaling approximately $641,000 (net of accumulated amortization of approximately $55,000) and $453,000 (net of accumulated amortization of approximately $43,000) at December 31, 1997 and 1996, respectively, which are amortized over the estimated economic life of the patents or trademarks. DEFERRED RENT Rent expense is recognized on a straight-line basis over the term of the lease. Accordingly, rent expense incurred in excess of rent paid is accrued and recorded as deferred rent in the accompanying balance sheets. CONTRACT REVENUES AND EXPENSES Contract revenue is recorded as earned based on the performance requirements of the contract. Research and development costs are expensed as incurred. STOCK OPTIONS 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 the alternative fair value accounting provided for under Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123") requires the use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, when the exercise price of the Company's employee stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized. ACCOUNTING STANDARD ON IMPAIRMENT OF LONG-LIVED ASSETS Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 121 "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("FAS 121"), regarding the impairment of long-lived assets, identifiable intangibles and goodwill related to those assets. The adoption of FAS 121 had no effect on the accompanying financial statements. 18 11 USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. NET LOSS PER SHARE Effective December 31, 1997, the Company adopted Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("FAS 128"), which replaced the calculation of primary and fully diluted net loss per share with basic and diluted net loss per share. Basic net loss per share is calculated using the weighted average number of common shares outstanding. Diluted net loss per share is calculated using the weighted average number of common shares outstanding plus the dilutive effect of options and warrants, if any, using the treasury stock method. All net loss per share amounts for all periods have been presented, and where appropriate restated, to conform to the FAS 128 requirements and the recently effective Securities and Exchange Commission Staff Accounting Bulletin No. 98. Net loss per share information as presented on the Statements of Operations has been presented as if the convertible preferred stock that converted upon the Company's initial public offering had been converted from its original date of issuance. Basic net loss per share, without an adjustment for the assumed conversion of the convertible preferred stock, would have been $3.21 in 1995. RECENTLY ISSUED ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS 130"). This standard is effective for fiscal years beginning after December 15, 1997. FAS 130 requires that all components of comprehensive income, including net income, be reported in the financial statements in the period in which they are recognized. Comprehensive income is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources. Net income and other comprehensive income, including unrealized gains and losses on investments, shall be reported, net of their related tax effect, to arrive at comprehensive income. The Company intends to adopt FAS 130 in 1998. Operating results of prior periods will not be restated since the Company's only component of comprehensive income other than net income has been unrealized gains and losses on investments, which were not significant. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform with the current year presentation. Note 2 - Chiron Collaboration In March 1994, the Company entered into a collaboration agreement ("the Collaboration Agreement") with Chiron Corporation ("Chiron") to develop and commercialize sustained-release formulations of DepoCyt and certain Chiron proprietary products using the Company's drug delivery technology. Under the agreement, Chiron purchased 400,000 shares of the Company's Series C preferred stock for $6.25 per share, or an aggregate consideration of $2.5 million, and a warrant to purchase 365,000 shares of Series C preferred stock at an exercise price of $6.25 per share for $1.0 million. The warrant was terminated and converted into a marketing rights fee to the Company upon the achievement of a development milestone in January 1995. In June 1997, DepoTech reacquired rights to DepoCyt in Canada and Europe from Chiron for aggregate cash payments of up to $13.7 million. Chiron will retain exclusive marketing rights to DepoCyt in the United States. An initial $2.0 million cash payment was paid by DepoTech to Chiron and expensed in 1997. If, prior to December 31, 1998, the U.S. Food and Drug Administration ("FDA") issues a letter or other notification to DepoTech indicating that DepoCyt is approvable or approved, the remaining balance of $11.7 million shall be payable no later than December 31, 1998. If no FDA notification is received prior to December 31, 1998, the remaining amount shall be payable no later than six months from the earlier of U.S. or European Union regulatory notification that the application to market or sell DepoCyt is approvable or approved. If all applications for regulatory approval to sell DepoCyt in the U.S. and European Union are permanently withdrawn, DepoTech shall be relieved of any obligation to pay the remaining $11.7 million. Therefore, such amount will be recorded upon the receipt of the required notification. 19 12 Reimbursable clinical and manufacturing scale up costs for DepoCyt incurred by the Company totaled $1,662,000, $3,194,000 and $2,542,000 for the years ended December 31, 1997, 1996, and 1995, respectively. The cumulative amount due through December 31, 1994 became billable and was recognized as contract revenue upon the achievement of a development milestone in January 1995. In April 1997, the Company earned $1.0 million upon completing the filing of the New Drug Application for DepoCyt. The Collaboration Agreement also provides for the joint development of DepoFoam formulations of certain compounds proprietary to Chiron ("Chiron Products"). Chiron must fund one feasibility program for a Chiron Product per year or lose its option to develop DepoFoam formulations of additional Chiron proprietary compounds. Through 1997, the Company had completed feasibility studies on three Chiron Products. A fourth feasibility study is on-going. The agreement provides that Chiron will pay the Company for its feasibility efforts, and that Chiron will be responsible for all development costs thereafter. The agreement also provides for Chiron to make payments to the Company upon achievement of certain development milestones for the Chiron Products. Chiron will have exclusive, worldwide distribution rights to all Chiron Products and will manufacture the bulk unencapsulated drug. The Company will then encapsulate the bulk drug in DepoFoam particles creating the Chiron Products, and Chiron will market, sell and distribute the Chiron Products. Chiron will compensate the Company based on its manufacturing costs, including a manufacturing profit, and a percentage of Chiron's net sales of the Chiron Products. Both the Company and Chiron have the ability to terminate a portion or all of the collaboration at certain intervals and with advance notice. In addition, Chiron has the ability to terminate the development of a Chiron Product with a limited amount of advance notice. Note 3 - Pharmacia & Upjohn Agreement In July 1997, DepoTech entered into a Marketing and Distribution Agreement with Pharmacia & Upjohn S.p.A ("P&U"), an affiliate of Pharmacia & Upjohn Inc., for rights to market and sell DepoCyt in countries outside the United States. P&U will generally be responsible for submitting regulatory filings, labeling, packaging, distribution, marketing and sales of DepoCyt in this territory. The Company will manufacture DepoCyt and receive a share of the net sales of DepoCyt sold by P&U. The Company received a cash payment of $2.0 million upon execution of the agreement and may receive additional payments of up to $17.0 million upon achievement of certain regulatory milestones. The agreement also provides for reimbursement of certain clinical trial expenses and regulatory fees incurred by the Company. Cumulative reimbursable costs for clinical trial costs incurred by the Company under this agreement totaled $1,221,000 as of December 31, 1997. Note 4 - Balance Sheet Details SHORT-TERM INVESTMENTS The following is a summary of available-for-sale short-term investments:
================================================================================ Gross Gross Unrealized Unrealized Estimated Cost Gains Losses Fair Value ================================================================================ December 31, 1997 U.S. government securities $ 13,640,812 $ 22,442 $ -- $ 13,663,254 Corporate obligations 7,509,806 -- (6,658) 7,503,148 - -------------------------------------------------------------------------------- $ 21,150,618 $ 22,442 $ (6,658) $ 21,166,402 ================================================================================ December 31, 1996 U.S. government securities $ 12,208,677 $ -- $ (13,986) $ 12,194,691 Certificates of deposit 498,940 1,020 -- 499,960 Corporate obligations 3,534,740 2,080 -- 3,536,820 - -------------------------------------------------------------------------------- $ 16,242,357 $ 3,100 $ (13,986) $ 16,231,471 ================================================================================
The amortized cost and estimated fair value of short-term investments at December 31, 1997, by contractual maturity, are shown below:
================================================================================ Estimated Cost Fair Value ================================================================================ Due in one year or less $13,738,024 $13,759,317 Due after one year through three years 7,412,594 7,407,085 - -------------------------------------------------------------------------------- $21,150,618 $21,166,402 ================================================================================
20 13 PROPERTY AND EQUIPMENT Property and equipment consist of the following:
================================================================================ December 31, 1997 1996 ================================================================================ Manufacturing, laboratory and office equipment $ 15,630,844 $ 12,254,274 Leasehold improvements 4,085,399 2,041,001 Leasehold improvements and manufacturing equipment under construction 12,167,119 5,552,015 - -------------------------------------------------------------------------------- 31,883,362 19,847,290 Less accumulated depreciation and amortization (4,935,034) (2,995,716) - -------------------------------------------------------------------------------- $ 26,948,328 $ 16,851,574 ================================================================================
OTHER ACCRUED LIABILITIES Included in other accrued liabilities as of December 31, 1997 and 1996 are $783,723 and $774,754, respectively, of employee compensation related expenses. Note 5 - Commitments LEASE OBLIGATIONS The Company leases its facilities and certain equipment under operating and capital leases. Provisions of the facilities leases provide for abatement of rent during certain periods and escalating rent payments during the lease terms which extend to dates through August 1, 2015. Included in restricted cash and deposits and other assets are $228,000 and $301,000 related to these agreements at December 31, 1997 and 1996, respectively. Annual future minimum lease payments as of December 31, 1997 are as follows:
================================================================================ Operating Capital Leases Leases ================================================================================ 1998 $ 3,297,221 $ 2,407,967 1999 3,378,035 1,627,461 2000 3,423,641 631,866 2001 3,551,623 -- 2002 3,684,819 -- Thereafter 48,633,338 -- =========== Total $65,968,677 4,667,294 - -------------------------------------------------------------------------------- Less amount representing interest (539,947) - -------------------------------------------------------------------------------- Present value of net minimum payments 4,127,347 Less current portion (2,037,416) - -------------------------------------------------------------------------------- Amounts due after one year $ 2,089,931 ================================================================================
The Company subleased certain of its existing laboratory and administrative facilities. Rental income from the sublease agreement over the next three years will range from $223,000 to $290,000 per year. Assets acquired under capital leases consist of manufacturing, laboratory and office equipment and leasehold improvements with an aggregate cost of approximately $8.5 million and $9.1 million at December 31, 1997 and 1996, respectively. Accumulated amortization of assets acquired under these arrangements is included in total depreciation and amortization. Rent expense was approximately $4,074,000, $3,895,000 and $1,467,000 during the years ended December 31, 1997, 1996 and 1995, respectively. NOTE PAYABLE During June 1996, the Company established a credit line with a bank for borrowing up to $9.0 million to finance certain capital equipment and leasehold improvement expenditures. In October 1997, the Company expanded this credit line by $4.5 million. Borrowings under the credit line, which total $9,411,449 and $2,203,294 at December 31, 1997 and 1996, respectively, bear interest at a floating rate equal to prime plus 0.5% (8.5% and 8.75% at December 31, 1997 and December 31, 1996, respectively) on the outstanding balance. The credit line expires on March 31, 2002 and all borrowings are secured by the capital equipment financed. The terms of the Company's loan agreement contains a covenant requiring the Company to maintain minimum liquidity equal to 1.67 times the outstanding loan balance, except for during the draw down period, at which time the Company shall maintain 1.67 times the commitment amount. At December 31, 1997, the Company was in compliance with the terms of the covenant. At December 31, 1997, approximately $3,254,000 remains available for future equipment acquisitions and leasehold improvements. Annual future principal payments as of December 31, 1997 are as follows: ================================================================================ 1998 $2,509,467 1999 2,561,366 2000 2,561,366 2001 1,727,351 2002 51,899 - -------------------------------------------------------------------------------- Total $9,411,449 ================================================================================
21 14 Note 6 - Shareholders' Equity PRIVATE PLACEMENTS In January 1997, the Company completed the private placement of 1.5 million newly issued shares of DepoTech common stock raising net proceeds of $18.9 million. In September 1997, the Company raised net proceeds of $14.6 million through the private placement of 1.0 million newly issued shares of DepoTech common stock. STOCK PURCHASE WARRANTS In connection with various stock purchase or lease financing transactions, the Company has issued warrants to purchase shares of common stock of which 42,354, 22,400 and 453,335 shares remain outstanding as of December 31, 1997 at prices of $2.75, $6.25 and $7.00 per share, respectively. The warrants are generally exercisable through 2001. DEFERRED COMPENSATION Pursuant to certain provisions of the SEC regulations, the Company recorded and is amortizing over the related vesting periods deferred compensation representing the difference between the exercise price of stock options granted and the deemed fair value (for accounting purposes) of the Company's common stock at the date of grant. Stock options generally vest over four to five years. Shares included in the computation of deferred compensation include option grants to employees and officers of the Company from July 1994 through June 1995. STOCK OPTION PLANS The Company's 1995 Stock Option/Stock Issuance Plan has authorized the grant of options to employees, directors and consultants of the Company for up to 2,750,000 shares of the Company's common stock. No options granted under the Plan have a term in excess of ten years. In October 1997, the Company authorized the 1997 Supplemental Stock Option Plan. The Plan has authorized the grant of options to employees (other than directors and officers) and consultants of the Company of up to 141,000 shares of the Company's common stock. The options granted under the Plan are non-qualified and no options may have a term in excess of ten years. Pro forma information regarding net loss and net loss per share is required by FAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value of these options was estimated at the date of grant using the Black-Scholes option valuation model with the following weighted average assumptions for 1997, 1996 and 1995, respectively: risk-free interest rates of 6.3%, 6.1% and 6.5%; dividend yields of 0%; volatility factors of the expected market price of the Company's common stock of 56%, 58% and 73%; and a weighted-average life of the option of four years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma net loss for the years ended December 31, 1997, 1996 and 1995 reflects increases of approximately $807,000, $307,000 and $55,000, respectively. The pro forma net loss per share (basic and diluted) for the years ended December 31, 1997, 1996 and 1995 was $1.65, $1.49 and $0.93 per share, respectively. The results above are not likely to be representative of the effects of applying FAS 123 on reported net income or loss for future years as these amounts reflect the expense for less then four years vesting. A summary of the Company's stock option activity, and related information for the years ended December 31 follows: =======================================================================================================================
1997 1996 1995 ======================================================================================================================= Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price ======================================================================================================================= Outstanding- beginning of year 1,295,863 $ 8.03 1,102,439 $ 2.02 917,314 $ .68 Granted 943,266 $14.65 467,744 $19.77 258,300 $6.54 Exercised (79,245) $15.11 (209,848) $ .68 (48,908) $ .75 Forfeited (57,356) $12.18 (64,472) $14.46 (24,267) $1.84 - ----------------------------------------------------------------------------------------------------------------------- Outstanding- end of year 2,102,528 $11.22 1,295,863 $ 8.03 1,102,439 $2.02 ======================================================================================================================= Exercisable at end of year 897,219 547,407 415,790 ======================================================================================================================= Weighted average fair value of options granted during year $7.60 $ 9.69 $2.50 =======================================================================================================================
15 The following table summarizes information about stock options outstanding at December 31, 1997.
========================================================================================== Weighted Average Weighted Weighted Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Options Outstanding Life Price Exercisable Price ========================================================================================== $0.10 to $4.00 655,889 6.0 years $ 1.16 530,134 $ .94 $7.00 to $13.625 247,975 8.9 years $11.72 61,490 $10.08 $14.00 to $19.625 1,135,714 9.1 years $16.20 278,219 $17.38 $23.50 to $25.125 62,950 8.3 years $24.34 27,376 $24.20 - ------------------------------------------------------------------------------------------ 2,102,528 897,219 ==========================================================================================
The weighted average remaining contractual life of outstanding options is 8.1 years. At December 31, 1997, options for 227,236 shares were available for future grant under the 1995 and 1997 stock option plans. EMPLOYEE STOCK PURCHASE PLAN In June 1995, the Company adopted an Employee Stock Purchase Plan ("the ESPP") whereby employees, at their option, can purchase shares of Company common stock through payroll deductions at the lower of 85% of fair market value on the ESPP offering date or on certain other predetermined dates. The Company has reserved 250,000 shares of common stock for issuance under the ESPP, of which 132,731 shares have been issued as of December 31, 1997. Note 7 - Income Taxes At December 31, 1997, the Company had federal and California tax net operating loss carryforwards of approximately $59,117,000 and $31,804,000, respectively. The difference between the federal and California tax loss carryforwards is primarily attributable to the capitalization of research and development expenses for California franchise tax purposes and the fifty-percent limitation on California loss carryforwards prior to 1997. The federal tax loss carryforward will begin expiring in 2005 unless previously utilized, and the California tax loss carryforward will begin to expire in 1998. The Company also has federal and California research and development tax credit carryforwards totaling $1,919,000 and $998,000, respectively, which begins expiring in 2005 unless previously utilized. Pursuant to Internal Revenue Code Sections 382 and 383, annual use of the Company's net operating loss and credit carryforwards may be limited if a cumulative change in ownership of more than 50% occurs within any three-year period. Significant components of the Company's deferred tax assets and liabilities are shown below. A valuation allowance of $27,251,000, of which $9,629,000 is related to 1997, has been recognized to offset the deferred tax assets as realization of such assets is uncertain.
================================================================================ December 31, 1997 1996 ================================================================================ Deferred tax assets: Net operating loss carryforwards $ 22,599,000 $ 14,416,000 Research and development credit carryforwards 2,567,000 1,448,000 Capitalized research expenses 1,451,000 1,713,000 Other, net 1,920,000 558,000 - -------------------------------------------------------------------------------- Net deferred tax assets 28,537,000 18,135,000 Valuation allowance for deferred tax assets (27,251,000) (17,622,000) - -------------------------------------------------------------------------------- Total deferred tax assests 1,286,000 513,000 Deferred tax liabilities: Depreciation (1,286,000) (513,000) - -------------------------------------------------------------------------------- Net deferred tax assets $ -- $ -- ================================================================================
Approximately $1,059,000 of the valuation allowance for deferred tax assets relates to stock option deductions which, when recognized, will be allocated directly to common stock. Note 8 - 401(k) Retirement Savings Plan In January 1993, the Company adopted a 401(k) Retirement Savings Plan (the "Plan") covering substantially all employees who have completed certain service requirements. Participants may contribute a portion of their compensation to the Plan through payroll deductions. Company matching contributions, if any, are determined by the Company at its sole discretion. There have been no Company contributions under the Plan through December 31, 1997 22 16 SELECTED FINANCIAL DATA DepoTech Corporation
Years Ended December 31, (dollars, except share amounts) Statement of Operations Data: 1997 1996 1995 1994 1993 Total revenues $ 6,877,701 $ 4,391,024 $ 6,825,784 $ 582,120 $ 69,500 Total expenses 28,821,933 22,039,072 15,525,785 9,307,676 4,058,419 Net loss (21,408,330) (16,775,605) (8,020,547) (8,561,487) (3,896,906) Basic and diluted net loss per share (1.59) (1.46) (0.94) (1.33) (0.84) Shares used in computing basic and diluted net loss per share 13,433,915 11,451,334 8,492,711 6,441,003 4,657,157 Balance Sheet Data: Cash, cash equivalents and short-term investments $ 27,360,555 $ 18,198,097 $ 38,661,534 $ 9,983,046 $ 7,519,096 Total assets 57,669,686 37,608,405 48,977,573 15,346,654 10,107,087 Long-term liabilities 11,799,552 7,272,025 3,218,957 2,618,664 408,538 Shareholders' equity 38,072,791 25,229,234 41,505,530 10,903,253 8,702,521
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Shareholders DepoTech Corporation We have audited the accompanying balance sheets of DepoTech Corporation as of December 31, 1997 and 1996, and the related statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. 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 DepoTech Corporation at December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG, LLP San Diego, California February 6, 1998 23 17 CORPORATE INFORMATION DepoTech Corporation Board of Directors CHAIRMAN Fred A. Middleton General Partner, Sanderling Ventures Chief Executive Officer, DepoTech Corporation DIRECTORS Roger C. Davisson General Partner, Brentwood Associates George W. Dunbar, Jr. President and Chief Executive Officer, Metra Biosystems, Inc. Stephen B. Howell, M.D. Medical Director, DepoTech Corporation Professor of Medicine, University of California San Diego John P. Longenecker, Ph.D. President and Chief Operating Officer, DepoTech Corporation Peter Preuss President, Preuss Foundation Pieter J. Strijkert, Ph.D. Chairman, IntroGene BV Officers / Management Fred A. Middleton Chief Executive Officer John P. Longenecker, Ph.D. President and Chief Operating Officer David B. Thomas Senior Vice President, Quality Assurance and Regulatory Affairs Williams S. Ettouati, D.Pharm. Vice President, Marketing and Business Development Dana S. McGowan Vice President, Finance Chief Financial Officer, Treasurer and Assistant Secretary Sheldon A. Schaffer, Ph.D. Vice President, Pharmaceutical Development Faye H. Russell, Esq. Secretary Thomas E. Swedberg Senior Director, Human Resources CORPORATE HEADQUARTERS 10450 Science Center Drive, San Diego, CA 92121 619.625.2424 www.depotech.com SHAREHOLDER INQUIRIES General information regarding the Company can be obtained by contacting Investor Relations at DepoTech. Inquiries relating to lost certificates should be directed to the Transfer Agent. SEC FORM 10-K A COPY OF THE COMPANY'S ANNUAL REPORT ON FORM 10-K FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FORM 10-K IS AVAILABLE WITHOUT CHARGE BY CONTACTING INVESTOR RELATIONS AT DEPOTECH CORPORATION. TRANSFER AGENT AND REGISTRAR ChaseMellon Shareholder Services, L.L.C. Overpeck Centre, 85 Challenger Road Ridge?eld Park, NJ 07660 800.522.6645 INDEPENDENT AUDITORS Ernst & Young LLP, San Diego, California CORPORATE COUNSEL Brobeck Phleger & Harrison LLP, San Diego, California ANNUAL MEETING OF SHAREHOLDERS The annual meeting of shareholders will be held at 9:00 am PST on Wednesday, May 13, 1998, at DepoTech Corporation. PRICE RANGE OF COMMON STOCK The Company's Common Stock is listed on the Nasdaq National Market under the symbol DEPO. High and low sales prices are set forth below for the periods indicated:
High Low 1996 1st Quarter $25 1/2 $18 2nd Quarter $29 1/2 $22 1/2 3rd Quarter $25 1/2 $14 1/2 4th Quarter $17 $22 1/4 1997 1st Quarter $20 1/8 $15 1/4 2nd Quarter $17 1/4 $12 1/4 3rd Quarter $15 1/4 $11 3/4 4th Quarter $15 3/8 $ 3 11/32
At March 20, 1998, there were approximately 3,300 shareholders of record. The Company has never declared or paid dividends on its Common Stock. 25 EX-23.1 5 EXHIBIT 23.1 1 EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 10-K) of DepoTech Corporation of our report dated February 6, 1998, included in the 1997 Annual Report to Shareholders of DepoTech Corporation. We also consent to the incorporation by reference in (i) the Registration Statement (Form S-8 No. 333-42459) pertaining to the 1997 Supplemental Stock Option Plan; (ii) the Registration Statement (Form S-8 No. 333-28531) pertaining to the 1995 Stock Option/Stock Issuance Plan, as amended; (iii) the Registration Statement (Form S-8 No. 33-97488) pertaining to the 1995 Stock Option/Stock Issuance Plan and the 1995 Employee Stock Purchase Plan; and (iv) the Registration Statement (Form S-3 No. 333-16371) and related Prospectus, of our report dated February 6, 1998, with respect to the financial statements of DepoTech Corporation incorporated by reference in this Annual Report (Form 10-K) for the year ended December 31, 1997. ERNST & YOUNG LLP San Diego, California March 27, 1998 EX-27.1 6 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 6,194 21,166 1,362 0 0 29,864 31,883 (4,935) 57,670 7,797 0 0 0 101,970 (63,898) 57,670 0 6,878 0 20,058 0 0 1,187 (21,408) 0 0 0 0 0 (21,408) (1.59) 0.00
EX-27.2 7 RESTATED FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1995 JAN-01-1995 DEC-31-1995 5,884 32,778 400 0 0 39,628 10,114 (1,503) 48,978 4,253 0 0 0 67,134 (25,628) 48,978 0 6,826 0 12,699 0 0 405 (8,021) 0 0 0 0 0 (8,021) (0.94) 0.00
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