-----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, GIA4pbsCFyj0RlUVZjLfUyXZtESO8Rf7C6sl56Wcdtf3nnK1D7VPcVgw6g2L4JI/ Sjz7ZtWby+/msMTCNjwBlA== 0000936392-98-001181.txt : 19980817 0000936392-98-001181.hdr.sgml : 19980817 ACCESSION NUMBER: 0000936392-98-001181 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980814 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-Q SEC ACT: SEC FILE NUMBER: 033-85362 FILM NUMBER: 98691304 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-Q 1 FORM 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 1998 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from _______ to _______ . Commission file number 0-26862 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 Identification No.) Organization) 10450 SCIENCE CENTER DRIVE SAN DIEGO, CALIFORNIA 92121 (Address of principal executive offices, zip code) (619) 625-2424 (Registrant's telephone number) 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock: No par value, 14,592,882 shares as of July 31, 1998 2 DEPOTECH CORPORATION TABLE OF CONTENTS
PAGE ---- PART I FINANCIAL INFORMATION Item 1 Financial Statements Condensed Balance Sheets as of June 30, 1998 (Unaudited) and December 31, 1997...................... 1 Condensed Statements of Operations for the Three and Six Months ended June 30, 1998 and 1997 (Unaudited).................................... 2 Condensed Statements of Cash Flows for the Six Months ended June 30, 1998 and 1997 (Unaudited).................................... 3 Notes to Condensed Financial Statements............................... 4 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations..................... 7 PART II OTHER INFORMATION Item 2 Changes in Securities................................................. 22 Item 3 Defaults Upon Senior Securities....................................... 22 Item 4 Submission of Matters to a Vote of Security Holders................... 22 Item 6 Exhibits and Reports on Form 8-K...................................... 24 Signatures..................................................................... 25
3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS DEPOTECH CORPORATION CONDENSED BALANCE SHEETS
JUNE 30, DECEMBER 31, 1998 1997 ------------- ------------- (Unaudited) (Note) ASSETS Current assets: Cash and cash equivalents $ 2,360,960 $ 6,194,153 Short-term investments 12,691,672 21,166,402 Accounts receivable from collaborations 1,268,992 1,361,837 Other current assets 1,064,906 1,141,210 ------------- ------------- Total current assets 17,386,530 29,863,602 Property and equipment, net 26,979,526 26,948,328 Deposits and other assets 940,258 857,756 ------------- ------------- Total assets $ 45,306,314 $ 57,669,686 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and other accrued liabilities $ 2,547,756 $ 3,250,460 Current portion of obligations under capital leases 1,857,748 2,037,416 Current portion of note payable 2,850,094 2,509,467 ------------- ------------- Total current liabilities 7,255,598 7,797,343 Obligations under capital leases, less current portion 1,260,911 2,089,931 Note payable, less current portion 6,441,249 6,901,982 Deferred rent 2,740,301 2,313,133 Other long-term liabilities 218,278 494,506 Shareholders' equity: Common stock, no par value; 30,000,000 shares authorized, 14,592,882 and 14,237,216 shares issued and outstanding at June 30, 1998 and December 31, 1997, respectively 102,498,917 101,970,346 Deferred compensation related to stock options, net (345,285) (109,472) Unrealized gain on short-term investments 8,561 15,784 Accumulated deficit (74,772,216) (63,803,867) ------------- ------------- Total shareholders' equity 27,389,977 38,072,791 ------------- ------------- Total liabilities and shareholders' equity $ 45,306,314 $ 57,669,686 ============= =============
See accompanying notes to condensed financial statements. Note: The balance sheet at December 31, 1997 has been derived from the audited financial statements at that date, but does not include all of the disclosures required by generally accepted accounting principles. 1 4 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS DEPOTECH CORPORATION CONDENSED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 1998 1997 1998 1997 ------------------------------ ------------------------------ (UNAUDITED) (UNAUDITED) Revenues: Contract revenue $ 850,469 $ 760,149 $ 2,065,202 $ 1,931,959 Licensing/milestone payments -- 1,000,000 -- 1,000,000 ------------ ------------ ------------ ------------ Total revenues 850,469 1,760,149 2,065,202 2,931,959 Costs and expenses: Research and development 5,277,088 5,698,303 10,688,226 10,081,206 General and administrative 1,050,400 1,022,009 2,311,183 1,955,604 Repurchase of marketing rights -- 2,000,000 -- 2,000,000 ------------ ------------ ------------ ------------ Total costs and expenses 6,327,488 8,720,312 12,999,409 14,036,810 ------------ ------------ ------------ ------------ Loss from operations (5,477,019) (6,960,163) (10,934,207) (11,104,851) Interest income 233,887 390,718 593,965 844,511 Interest expense (268,626) (246,316) (628,107) (466,265) ------------ ------------ ------------ ------------ Net loss $ (5,511,758) $ (6,815,761) $(10,968,349) $(10,726,605) ============ ============ ============ ============ Basic and diluted net loss per share $ (0.38) $ (0.52) $ (0.76) $ (0.82) ============ ============ ============ ============ Shares used in computing basic and diluted net loss per share 14,534,409 13,116,053 14,449,438 13,074,428 ============ ============ ============ ============
See accompanying notes to condensed financial statements. 2 5 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS DEPOTECH CORPORATION CONDENSED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 1998 1997 ------------------------------ (Unaudited) OPERATING ACTIVITIES Net cash used by operating activities $(10,043,853) $ (7,638,495) INVESTING ACTIVITIES Purchases of short-term investments (6,015,311) (22,082,975) Proceeds from sale of short-term investments 14,482,818 13,593,356 Purchases of property and equipment (1,330,030) (6,212,200) Restricted cash 50,823 (37,119) ------------ ------------ Net cash provided (used) by investing activities 7,188,300 (14,738,938) FINANCING ACTIVITIES Repayments on capital lease obligations (1,053,705) (1,006,241) Repayments on note payable (1,225,007) (275,412) Proceeds from note payable 1,104,901 2,927,537 Proceeds from issuance of common stock, net 196,171 19,367,470 ------------ ------------ Net cash (used) provided by financing activities (977,640) 21,013,354 ------------ ------------ Net decrease in cash and cash equivalents (3,833,193) (1,364,079) Cash and cash equivalents at beginning of period 6,194,153 1,966,626 ------------ ------------ Cash and cash equivalents at end of period 2,360,960 602,547 Short-term investments at end of period 12,691,672 24,736,972 ------------ ------------ Cash, cash equivalents and short-term investments at end of period $ 15,052,632 $ 25,339,519 ============ ============ SUPPLEMENTAL INFORMATION Property and equipment acquired through capital lease $ 45,016 $ -- ============ ============ Interest paid $ 628,107 $ 466,265 ============ ============
See accompanying notes to condensed financial statements. 3 6 DEPOTECH CORPORATION NOTES TO CONDENSED FINANCIAL STATEMENTS 1. Basis of Presentation and Significant Accounting Policies The interim unaudited condensed financial statements contained herein have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. These interim unaudited condensed financial statements should be read in conjunction with the Company's December 31, 1997 audited financial statements. In management's opinion, the unaudited information includes all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented. Interim results are not necessarily indicative of results to be expected for the full year. Certain prior year amounts have been reclassified to conform with the current year presentation. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and disclosures made in the accompanying notes to the financial statements. Actual results could differ from those estimates. 2. 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 and diluted net loss per share is calculated using the weighted-average number of common shares outstanding. 3. New Accounting Standards Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS 130") and Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("FAS 131"). Comprehensive loss is not materially different from the net loss disclosed on the statements of operations and the Company operates in one business segment. 4. Chiron Collaboration In March 1994, the Company entered into a collaboration agreement ("the Collaboration Agreement") with Chiron Corporation ("Chiron") to develop and 4 7 commercialize sustained-release formulations of DepoCyt(TM) 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 retains 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. Under the Collaboration Agreement, cumulative reimbursable clinical and manufacturing scale-up costs for DepoCyt incurred by the Company totaled $11.2 million through June 30, 1998 and $10.0 million through June 30, 1997. The Collaboration Agreement also provides for the joint development of DepoFoam formulations of certain compounds proprietary to Chiron ("Chiron Products"). The agreement provides that Chiron will pay the Company for its feasibility efforts. 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 April 1997, the Company had completed feasibility studies on four Chiron proprietary compounds. No further feasibility studies on Chiron Products will be performed under the Collaboration Agreement. Both the Company and Chiron have the ability to terminate a portion or all of the collaboration at certain intervals and with advance notice. 5. 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. Under the P&U Agreement, 5 8 the Company will manufacture DepoCyt and receive a share of the net sales of DepoCyt sold by P&U, if any. The Company received a cash payment of $2.0 million upon execution of the agreement and may receive additional payments of up to approximately $17.0 million upon achievement of certain regulatory milestones. The agreement also provides for reimbursement by P&U of certain clinical trial expenses and regulatory fees incurred by the Company. Cumulative reimbursable costs incurred by the Company under the P&U Agreement totaled $1.7 million as of June 30, 1998. Both the Company and P&U have the ability to terminate the collaboration at certain intervals and with advance notice. 6. Contingencies In April 1998, a class action suit was filed against the Company and two of its former officers in the United States District Court for the Southern District of California. The lawsuit alleges violations of the federal securities laws and purports to seek unspecified monetary damages on behalf of a class of shareholders who purchased DepoTech common stock during the period April 1, 1996 through December 18, 1997. The Company believes that the lawsuit is without merit and intends to defend it vigorously. 7. Debt Covenants At June 30, 1998, the Company had capital lease obligations and a bank note payable associated with capital expenditures totaling $12.4 million of which principal payments of $4.7 million are payable over the next twelve months. All borrowings are secured by the capital equipment financed. The terms of the Company's bank loan and equipment lease agreements require the Company to maintain certain cash balances. At June 30, 1998, the Company was not in compliance with these covenants. The agreements require the Company to post cash collateral if the covenants are violated. The Company is in discussion with its lenders regarding the amount of such cash collateral. 6 9 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Since its inception in October 1989, DepoTech Corporation ("DepoTech" or 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 June 30, 1998, the Company's accumulated deficit was approximately $74.8 million. The following discussion is qualified in its entirety by the more detailed information and the Condensed Financial Statements and Notes thereto appearing elsewhere in this Quarterly Report, including the information under "Risks and Uncertainties." This Quarterly 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 $0.9 million for the three months ended June 30, 1998 as compared to $1.8 million for the same period in 1997. Total revenues for the six months ended June 30, 1998 were $2.1 million compared to $2.9 million for the same period in 1997. Total revenues in 1998 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 for the three and six months ended June 30, 1997 were principally generated by the Company's collaborative agreement with Chiron. Total revenues for the three and six months ended June 30, 1998 were primarily derived from reimbursement of certain clinical trial expenses for the Company's lead product, DepoCyt(TM), an anti-cancer drug, under the collaborative agreements with Chiron and P&U. Included in total revenue for the second quarter of 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 the U.S. In addition, Chiron reimbursed DepoTech for 100% of certain pre-clinical and feasibility studies performed on their behalf during 1997 and the first quarter of 1998. Further, DepoTech is reimbursed for conducting feasibility studies for various pharmaceutical companies. Revenues may fluctuate from period to period depending on the level of clinical and process development activity for projects under collaborative agreements and the achievement of future milestones. Research and development expenses for the second quarter ended June 30, 1998 were $5.3 million compared to $5.7 million for the same period in 1997. Research and 7 10 development expenses for the six months ended June 30, 1998 increased to $10.7 million from $10.1 million in 1997. Factors contributing to this increase include expanded efforts in clinical trials, manufacturing scale-up and preclinical development of potential DepoFoam(TM) products. In addition, the Company incurred $0.7 million for severance and out-placement expense from workforce reductions during 1998. A non-randomized Phase IV clinical trial of DepoCyt in solid tumor patients is continuing, as are randomized trials of DepoCyt in leukemia and lymphoma patients. DepoTech is also conducting a dose- finding study of DepoCyt in pediatric patients. In addition, clinical trials and manufacturing scale-up of DepoMorphine(TM) sustained-release encapsulated morphine sulfate to treat acute post-surgical pain are underway. Further, the Company is evaluating the feasibility of developing several early-stage compounds for corporate partners. General and administrative expenses for the second quarter ended June 30, 1998 were $1.1 million compared to $1.0 million for the same period in 1997. General and administrative expenses for the six months ended June 30, 1998 increased to $2.3 million from $2.0 million for the comparable period in the prior year. The increase for the six months ended June 30, 1998 compared to the same period in 1997 is primarily attributable to $0.3 million for severance and out-placement expense from workforce reductions. Chiron and DepoTech had been jointly developing DepoCyt in the U.S., Canada and Europe since March 1994. In June 1997, DepoTech reacquired rights to DepoCyt in Canada and Europe from Chiron. Chiron retains exclusive marketing rights to DepoCyt in the U.S. Included in operating expenses for the six months ended June 30, 1997 were expenses of $2.0 million associated with the repurchase of DepoCyt which was paid to Chiron in December 1997 under the terms of the agreement with Chiron. Interest income was $0.2 million and $0.6 million for the three and six months ended June 30, 1998 compared to $0.4 million and $0.8 million for the same periods in 1997. The decrease in interest income was due to a decline in short-term investments. Interest expense increased to $0.3 million and $0.6 for the three and six months ended June 30, 1998 from $0.2 million and $0.5 million for the comparable periods in 1997. The increase in interest expense was due to a higher balance outstanding for the note payable. LIQUIDITY AND CAPITAL RESOURCES From its inception through June 30, 1998, DepoTech has financed its operations primarily through public and private placements of equity securities, which provided aggregate net proceeds of approximately $101.9 million, and through capital equipment leases and a note payable. Chiron and DepoTech had been jointly developing DepoCyt in the U.S., Canada and Europe since March 1994. 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 paid to Chiron in December 1997. Chiron retains 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 8 11 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, if any. The Company received a cash payment of $2.0 million upon execution of the agreement and may receive additional payments of up to approximately $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. As of June 30, 1998, the Company had cash, cash equivalents and short-term investments of $15.1 million as compared to $27.4 million at December 31, 1997. The decrease of $12.3 million in cash, cash equivalents and short-term investments was due primarily to net cash used to fund operations of $10.0 million and repayment of capital lease obligations and a note payable totaling $2.3 million. Working capital decreased to $10.1 million as of June 30, 1998 compared to $22.1 million as of December 31, 1997. The Company has financed its capital expenditures through capital leases and bank credit lines. At June 30, 1998, the Company has capital lease obligations and a bank note payable associated with capital expenditures totaling $12.4 million of which principal payments of $4.7 million is payable over the next twelve months. All borrowings are secured by the capital equipment financed. The terms of the Company's bank loan and equipment lease agreements require the Company to maintain certain cash balances. At June 30, 1998, the company was not in compliance with these covenants. The agreements require the Company to post cash collateral if the covenants are violated. The Company is in discussion with its lenders regarding the amount of such cash collateral. The Company leases its headquarters which house most of its administrative, research, clinical and manufacturing activities. The minimum rental commitment for this facility ranges from $2.5 million to $4.3 million per year over the next 18 years, based upon pre-established annual rent increases. In April 1998, a class action suit was filed against the Company and two of its former officers alleging violations of the federal securities laws and purporting to seek unspecified monetary damages on behalf of a class of shareholders. The Company believes that the lawsuit is without merit and intends to defend it vigorously. 9 12 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, and interest income will be adequate to satisfy its capital requirements and fund operating losses into the first quarter of 1999. Any amounts required as cash collateral for a bank loan or equipment leases would reduce the amount of cash available to fund operations. 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, additional regulatory requirements associated with approvals for any of the Company's products, 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 will be available on favorable terms, or 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. 10 13 RISKS AND UNCERTAINTIES This Quarterly Report may contain, in addition to historical information, forward-looking statements that involve risk 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 below as well as those discussed elsewhere in this Quarterly Report. 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(TM), have been subject to any human clinical testing, although the Company is no longer actively developing DepoAmikacin. 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 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 any of its 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 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 a New Drug Application ("NDA") for DepoCyt for the treatment of NM from solid tumors. In May 1998, the Company received a "non-approvable" letter from the FDA for this NDA. There can be no assurance that the data 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 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, the European Union ("EU"), or otherwise. Failure to meet such requirements could result in the termination of the Company's collaborative agreements with Chiron and/or P&U. Any of these occurrences could have a material adverse effect 11 14 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 at any time 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 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. In January 1998, the Company's marketing partner outside the U.S., P&U, submitted a Marketing 12 15 Authorization Application for DepoCyt to the European Medicines Evaluation Agency. P&U is responsible for regulatory filing for DepoCyt outside the U.S. under the terms of the collaboration agreements. 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. 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 has financed its capital expenditures through capital leases and bank credit lines. At June 30, 1998, the Company had capital lease obligations and a bank note payable associated with capital expenditures totaling $12.4 million of which principal payments of $4.7 million are payable over the next twelve months. All borrowings are secured by the capital equipment financed. The terms of the Company's bank loan and equipment lease agreements require the Company to maintain certain cash balances. At June 30, 1998, the Company was not in compliance with these covenants. The agreements require the Company to post cash collateral if the covenants are violated. The Company is in discussion with its lenders regarding the amount of such cash collateral. 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 $2.5 million to $4.3 million per year, over 18 years, 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, additional regulatory requirements associated with approvals for any of the Company's products, 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 and the cost of establishing effective sales and marketing arrangements. To date, the Company 13 16 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 and interest income will be adequate to satisfy its capital requirements and fund operating losses into the first quarter of 1999. Any amounts required as cash collateral for a bank loan or equipment leases would reduce the amount of cash available to fund operations. 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 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 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 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. 14 17 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. 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. 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; this does not imply FDA product approval of DepoCyt. The manufacturing operations for DepoCyt may require passing pre-approval inspections by regulatory agencies for 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. History of Operating Losses; Uncertainty of Future Profitability. The Company has incurred an accumulated deficit of $74.8 million through June 30, 1998. 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. Legal Proceedings. In April 1998, a class action suit was filed against the Company and two of its former officers in the United States District Court for the Southern District of California. The lawsuit alleges violations of the federal securities laws and purports to seek unspecified monetary damages on behalf of a class of shareholders who purchased DepoTech common stock during the period April 1, 1996 through December 18, 1997. The Company believes that the lawsuit is without merit and intends to defend against it vigorously. The pending litigation against the Company and any future litigation against the company or its employees, regardless of the outcome, may result in substantial costs and expense to the Company and significant diversions of time and effort by the Company's personnel. Depending on the amount and timing, an unfavorable resolution of such litigation could have a material adverse effect on the Company. 15 18 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 July 1, 1998, the Company owned or had exclusive rights to 10 issued or allowed United States patents, 10 pending United States patent applications, 48 issued foreign patents and 50 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 patent positions of pharmaceutical, biotechnology and drug delivery companies, including DepoTech, are uncertain and involve complex legal and factual 16 19 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. 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 17 20 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. 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. 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. Since February 1998, the Company has reduced its workforce from 153 to 75 employees in order to minimize expenditures. There can be no assurance that the Company will not be required to reduce its workforce in the future. Any such further reductions could have a material adverse effect on the Company. 18 21 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. Year 2000 Compliance. 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. 19 22 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. 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. 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. 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. 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, 20 23 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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. None 21 24 PART II - OTHER INFORMATION Item 1 Legal Proceedings. None Item 2 Change in Securities. In February 1998, the Company issued a warrant to purchase 100,000 shares of the Company's common stock to various entities managed by Sanderling Ventures, exercisable at $4.375 per share. Mr. Middleton, the Company's Chairman of the Board, Chief Executive Officer and a member of the Executive Committee is a general partner of Sanderling Ventures. The warrant was issued in return for services rendered to the Company by Mr. Middleton and in lieu of receiving a cash salary from the Company. The warrant has a three-year term and is not exercisable for 90 days following the date of issuance. The issuance of the warrant is exempt from registration under the Securities Act of 1933, as amended (the "1933 Act"), under Section 4(2). In March 1998, the Company issued 25,000 shares of its common stock in consideration of Dr. Howell's past services to the Company, valued at $5.938 per share. Dr. Howell serves as Medical Director, a member of the Executive Committee and a Director of the Company. The issuance of the shares is exempt from registration under the 1933 Act under Section 4(2). Item 3 Defaults Upon Senior Securities. At June 30, 1998, the Company had capital lease obligations and a bank note payable associated with capital expenditures totaling $12.4 million of which principal payments of $4.7 million are payable over the next twelve months. All borrowings are secured by the capital equipment financed. The terms of the Company's bank loan and equipment lease agreements require the Company to maintain certain cash balances. At June 30, 1998, the Company was not in compliance with these covenants. The agreements require the Company to post cash collateral if the covenants are violated. The Company is in discussion with its lenders regarding the amount of such cash collateral. Item 4 Submission of Matters to a Vote of Security Holders. The Company's 1998 Annual Meeting of Shareholders ("Annual Meeting") was held May 13, 1998. The matters voted on at the Annual Meeting were: 1. To elect a Board of Directors. 2. To approve amendments to the Company's 1995 Stock Option/Stock Issuance Plan. 3. To approve amendments to the Company's 1995 Employee Stock Purchase Plan. 4. To ratify the appointment of Ernst & Young LLP as the Company's independent public auditors for the fiscal year ending December 31, 1998. The results of the shareholders' vote on each matter set forth below: 22 25 1. Elect a Board of Directors
Nominees For Withheld -------- --------- -------- Roger C. Davisson 9,482,919 347,838 George W. Dunbar Jr. 9,482,919 347,838 Stephen B. Howell, M.D. 9,482,919 347,838 John P. Longenecker, Ph.D. 9,481,819 348,938 Fred A. Middleton 9,481,719 349,038 Peter Preuss 9,482,919 347,838 Pieter J. Strijkert, Ph.D. 9,482,319 348,438
2. Approve amendments to 1995 Stock Option/Issuance Plan
Votes --------- For 7,689,238 Against 2,072,804 Abstain 10,425 Broker Non-Votes 58,290
3. Approve amendments to 1995 Employee Stock Purchase Plan
Votes --------- For 9,094,147 Against 668,873 Abstain 9,447 Broker Non-Votes 58,290
4. Ratify the appointment of Ernst & Young LLP as independent public auditors
Votes --------- For 9,816,321 Against 8,711 Abstain 5,725
Item 5 Other Information. None 23 26 Item 6 Exhibits and Reports on Form 8-K. (a) Exhibits
Exhibit Number 3.1 Fourth Restated Articles of Incorporation of the Company (filed as Exhibit 3.2) (1). 3.2 Amended and Restated Bylaws of the Company (filed as Exhibit 3.4) (1). 10.1 Retention Incentive Agreement between Williams Ettouati and the Company dated June 10, 1998. 27.1 Financial Data Schedule.
(1) Incorporated by reference to the above noted exhibit to the Company's Registration statement on Form S-1 (No. 33-95890), as amended. (b) Reports on Form 8-K. No reports on Form 8-K were filed during the quarter ended June 30, 1998. 24 27 DEPOTECH CORPORATION SIGNATURES Pursuant to the requirements 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 /s/ Fred A. Middleton ------------------------------- Date: August 14, 1998 Fred A. Middleton Chairman of the Board and Chief Executive Officer (Principal Executive Officer) /s/ Dana S. McGowan ------------------------------- Date: August 14, 1998 Dana S. McGowan Vice President, Finance and Chief Financial Officer (Principal Financial and Accounting Officer) 25 EX-10.1 2 EXHIBIT 10.1 1 EXHIBIT 10.1 [DEPOTECH LETTERHEAD] RETENTION INCENTIVE AGREEMENT 1. This Retention Incentive Agreement ("Agreement") is entered into by and between DepoTech Corporation ("the Company") and Williams Ettouati ("Employee" or "Consultant" or "Employee/Consultant") as of June 10, 1998. 2. Employee is a current employee of the Company. 3. The Company desires to secure the commitment of Employee to continue providing services to the Company through September 30, 1998. Employee is willing to commit to continuing to be employed by the Company through July 31, 1998 and provide consulting services on an as needed basis (not to exceed one day per week), from August 1, 1998 through September 30, 1998, for the additional consideration specified herein. 4. Employee promises and agrees that he shall continue working for the Company in his capacity as Vice President, Marketing and Business Development, or in such other capacity as reasonably requested by the Company, at a base salary of not less than $13,750 per month, until July 31, 1998, unless employment is terminated earlier by the Company in accordance with the provisions of paragraph (10) of this Agreement. On August 1, 1998, Consultant will be free to commence employment with a new employer without restriction, except for the disclosure of confidential information noted in paragraph (12) of this Agreement. 5. In exchange for Employee's actual continued employment by the Company through July 31, 1998, the Company shall pay to Employee a severance payment in the amount of three (3) months base salary of not less than $13,750 per month or $41,250. The severance payment shall be payable to Employee on July 31, 1998. 6. In addition, in exchange for Employee's continued services as Consultant through September 30, 1998, for marketing and business development efforts on behalf of DepoTech, the Company shall pay Consultant a consulting fee of forty one thousand, two hundred fifty dollars ($41,250). 7. Further, in the event of a strategic transaction with respect to the Company on or before December 31, 1998, such transaction to be defined as receipt by the Company of an agreed term sheet, an additional payment of eighty two thousand, five hundred dollars ($82,500), will be provided to Employee/Consultant within five business days after receipt of such term sheet. 8. Finally, if a strategic transaction with respect to the Company occurs on or before July 31, 1998, such transaction to be defined as receipt by the Company of an agreed to term sheet, by initial agreement, Employee's consulting services will not be required and Employee will receive a payment equal to twelve (12) months of his current annual salary or one hundred sixty five thousand dollars ($165,000) in lieu of all other payments specified in paragraphs 5, 6 and 7 of this Agreement. 9. The Company will continue medical, dental and vision coverage through September 30, 1998 at no additional charge to Employee/Consultant. Company will reimburse Employee/Consultant for any reasonable business travel and expenses according to Company policy. 10. In the event that Employee or Consultant engages in willful misconduct, the Company may terminate her/his employment or consulting agreement immediately, and Employee or Consultant shall not be entitled to the retention incentive or any portion thereof or any other form of severance or payments. For purposes of this Agreement, "willful misconduct" shall include: (i) the commission of any act of 2 Williams Ettouati RETENTION INCENTIVE AGREEMENT Page 2 fraud with respect to the Company or its business; (ii) Employee's or Consultant's conviction of or being formally charged with the commission of a crime which, in the good faith judgment of the Company's Board of Directors, involved moral turpitude or has caused or will cause material harm to the standing and/or reputation of the Company; (iii) Employee's or Consultant's violation of any of the terms of his Proprietary Information and Inventions Agreement; (iv) Employee's or Consultant's misappropriation and/or unauthorized disclosure of the Company's confidential and/or proprietary information; (v) Employee's or Consultant's violation of the Company's policies concerning drugs and alcohol or unlawful harassment/discrimination. 11. You agree that as a specific condition to the performance of this Agreement by the Company, you will not disclose for any purpose, the terms of this Agreement to any person, except to your immediate family or as may be necessary for purposes of securing legal or tax advice or as otherwise may be required by law. 12. You specifically agree to preserve as confidential and not use or disclose any Company trade secrets, confidential knowledge, data or other proprietary information relating to technology, customers, products, pricing, business plans, financial or organizational information or other subject matter pertaining to any business or the Company or any of its clients, customers or licensees from this day forward. 13. Notwithstanding any other provision of this Agreement, the Company may terminate Employee's employment at any time, with or without cause and with or without notice. However, if the Company terminates Employee's employment at any time prior to and including July 31, 1998 for any reason other than for willful misconduct (as defined in paragraph (10) hereof), then Employee shall be entitled to receive severance pay equal to six (6) months base salary if no agreed term sheet has been signed. In the event that an agreed term sheet is signed, however, Employee will receive severance pay equal to twelve (12) months base salary. Severance pay shall be payable to Employee on the effective date of termination of employment. 14. In addition, unless Employee's employment or Consultant's consulting services are terminated prior to and including September 30, 1998, due to any willful misconduct (as defined in paragraph (10) hereof), the following unvested Stock Options will accelerate in entirety on September 30, 1998 and the exercise period will be extended to December 31, 1998. The exercise period for vested options in all other ISO grants will be ninety (90 days) from the date of termination of employment as per our Company policy. ISO GRANT 30,000 SHARES GRANTED 02-25-98 EXECUTED AND AGREED TO: /s/ WILLIAMS ETTOUATI ---------------------- Date: June 26, 1998 By: DepoTech Corporation /s/ JOHN P. LONGENECKER ------------------------ Date: June 26, 1998 By: EX-27.1 3 FINANCIAL DATA SCHEDULE
5 1,000 6-MOS DEC-31-1998 JAN-01-1998 JUN-30-1998 2,361 12,692 1,269 0 0 17,387 33,258 (6,279) 45,306 7,256 0 0 0 102,499 (75,109) 45,306 0 2,065 0 10,688 0 0 628 (10,968) 0 0 0 0 0 (10,968) (.76) 0
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