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UNITED STATES
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 September 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 No. 0-24936
ERGO SCIENCE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 04-3271667
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
Charlestown Navy Yard
100 First Avenue, Fourth Floor
Charlestown, Massachusetts 02129
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (617) 241-6800
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.
At October 25, 1998 there were 14,253,267 shares of common stock, par value $.01
per share, of the registrant outstanding.
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ERGO SCIENCE CORPORATION
TABLE OF CONTENTS
<TABLE>
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Balance Sheets as of September 30, 1998 and
December 31, 1997 ....................................... 3
Consolidated Statements of Operations for the three
months and nine months ended September 30, 1998
and September 30, 1997 .................................. 4
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1998 and September 30, 1997 ......... 5
Notes to Consolidated Financial Statements ....................... 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .............................. 9
PART II. OTHER INFORMATION ......................................................... 13
SIGNATURES ......................................................................... 14
</TABLE>
<PAGE>
ERGO SCIENCE CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
--------------------------------------------------------
ASSETS (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents .................................................... $ 21,983,261 $ 13,923,115
Short-term investments ....................................................... 15,170,459 9,536,995
Inventory .................................................................... -- 424,320
Prepaid and other current assets ............................................. 242,013 260,608
------------- -------------
Total current assets ................................................ 37,395,733 24,145,038
Equipment and leasehold improvements, net ............................................. 1,629,656 1,970,328
Deferred charges ...................................................................... -- 2,499,000
Other assets .......................................................................... 162,891 50,300
------------- -------------
Total assets ........................................................ $ 39,188,280 $ 28,664,666
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses ........................................ $ 3,098,766 $ 2,921,538
Deferred revenue ............................................................. 331,435 --
Current portion of capital lease obligations ................................. 292,750 280,305
------------- -------------
Total current liabilities ........................................... 3,722,951 3,201,843
Long-term portion of capital lease obligations ........................................ 214,931 327,442
Commitments and contingencies ......................................................... -- --
Stockholders' equity:
Preferred stock, $.01 par value, 10,000,000 shares authorized; 6,903
shares of Series D preferred stock issued and outstanding
at September 30, 1998 and December 31, 1997
(liquidation
preferences were $8,448,607 and $8,082,490 at September 30, 1998 and
December 31, 1997, respectively) ........................................ 5,573,937 5,207,820
Common stock, $.01 par value, authorized 50,000,000 at
September 30, 1998 and December 31, 1997; issued and outstanding
14,253,267 shares at September 30, 1998 and 13,493,262
shares at December 31, 1997 ............................................. 142,533 134,933
Additional paid-in capital ................................................... 111,991,087 101,469,182
Cumulative dividends on preferred stock ...................................... (3,564,370) (3,198,253)
Deferred compensation ........................................................ (501,867) (874,473)
Accumulated deficit .......................................................... (78,390,922) (77,603,828)
------------- -------------
Total stockholders' equity .......................................... 35,250,398 25,135,381
------------- -------------
Total liabilities and stockholders' equity .................. $ 39,188,280 $ 28,664,666
------------- -------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements
3
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ERGO SCIENCE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months Ended September 30
1998 1997 1998 1997
------------ ------------- ------------ -------------
<S> <C> <C> <C> <C>
Revenues:
Product revenue ........................ -- -- $ 2,488,520 --
Sponsored research revenue ............. $ 856,973 -- 5,585,438 --
License fees ........................... -- -- 10,000,000 --
------------ ------------- ------------ -------------
856,973 -- 18,073,958 --
Operating expenses:
Cost of product revenue ................ -- -- 2,488,520 --
Research and development ............... 2,710,304 $ 3,393,385 10,072,189 $ 9,637,674
Write-off related to renegotiated supply
agreement .......................... -- -- 2,499,000 --
General and administrative ............. 1,371,373 1,255,645 5,183,401 5,159,901
------------ ------------- ------------ -------------
4,081,677 4,649,030 20,243,110 14,797,575
------------ ------------- ------------ -------------
Net operating loss ............ (3,224,704) (4,649,030) (2,169,152) (14,797,575)
Other Income:
Interest ............................... 519,740 406,198 1,382,056 1,325,864
------------ ------------- ------------ -------------
Net loss ...................... (2,704,964) (4,242,832) (787,096) (13,471,711)
Accretion of dividends on preferred stock ....... (123,639) (116,541) (366,117) (345,095)
------------ ------------- ------------ -------------
Net loss to common stockholders ................. $ (2,828,603) $ (4,359,373) $ (1,153,213) $(13,816,806)
------------ ------------- ------------ -------------
Net loss per common share:
Basic ................................... $ (0.20) $ (0.33) $ (0.08) $ (1.05)
------------ ------------- ------------ -------------
------------ ------------- ------------ -------------
Diluted ................................. $ (0.20) $ (0.33) $ (0.08) $ (1.05)
------------ ------------- ------------ -------------
------------ ------------- ------------ -------------
Weighted average common shares outstanding:
Basic ................................... 14,253,267 13,181,249 14,032,080 13,160,469
------------ ------------- ------------ -------------
Diluted ................................. 14,253,267 13,181,249 14,032,080 13,160,469
------------ ------------- ------------ -------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements
4
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ERGO SCIENCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1998 1997
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net loss ................................................................ $ (787,096) $(13,471,711)
Adjustments to reconcile net loss to cash used by operating activities:
Depreciation and amortization ....................................... 677,745 1,068,857
Noncash compensation ................................................ 331,612 857,427
Noncash charge for write-off related to renegotiated supply agreement 2,499,000 --
Changes in operating assets and liabilities:
Inventory ...................................................... 424,320 --
Prepaid and other current assets ............................... 18,595 (120,146)
Other assets ................................................... (112,591) (6,314)
Accounts payable and accrued expenses .......................... 177,228 218,685
Deferred revenue ............................................... 331,435 --
-------------- --------------
Net cash provided by (used in) operating activities .............................. 3,560,248 (11,453,202)
-------------- --------------
Cash flows from investing activities:
Purchase of short-term investments ...................................... (47,351,893) (31,877,064)
Proceeds from maturity of short-term investments ........................ 41,718,439 43,717,307
Purchase of equipment and leasehold improvements ........................ (165,380) (564,920)
Proceeds received on sale of equipment .................................. -- 6,000
-------------- --------------
Net cash (used in) provided by investing activities .............................. (5,798,834) 11,281,323
-------------- --------------
Cash flows from financing activities:
Principal payments under capital lease obligations ...................... (271,762) (171,935)
Proceeds from issuance of common stock .................................. 10,000,000 --
Proceeds from stock options exercised ................................... 570,494 286,474
-------------- --------------
Net cash provided by financing activities ........................................ 10,298,732 114,539
-------------- --------------
Net increase (decrease) in cash and cash equivalents ............................. 8,060,146 (57,340)
Cash and cash equivalents at beginning of period ................................. 13,923,115 18,066,884
-------------- --------------
Cash and cash equivalents at end of period ....................................... $ 21,983,261 $ 18,009,544
-------------- --------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements
5
<PAGE>
ERGO SCIENCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying financial statements are unaudited and have been
prepared by Ergo Science Corporation ("Ergo" or the "Company") in accordance
with generally accepted accounting principles.
Certain information and footnote disclosure normally included in the
Company's annual financial statements have been condensed or omitted. The
interim financial statements, in the opinion of management, reflect all
adjustments (including normal recurring accruals) necessary for a fair statement
of the results for the interim periods ended September 30, 1998 and 1997.
The results of operations for the interim periods are not necessarily
indicative of the results of operations to be expected for the fiscal year.
These interim financial statements should be read in conjunction with the
audited financial statements for the year ended December 31, 1997, which are
contained in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission for the year ended December 31, 1997.
Prior to January 1, 1998, the Company was a development stage
enterprise as defined in Statement of Financial Accounting Standards No. 7
("SFAS 7"). As a result of the collaboration agreement entered into with Johnson
& Johnson in the first quarter of 1998, the Company is no longer considered a
development stage enterprise as defined in SFAS 7.
Reclassification
Certain amounts from prior years have been reclassified to conform to
the current year presentation.
2. Cash Equivalents
The Company considers all highly liquid investments with a maturity of
90 days or less at the date of purchase to be cash equivalents.
Debt securities are classified as held-to-maturity when the Company has
positive intent and ability to hold the securities to maturity. Held-to-maturity
securities are stated at amortized cost.
At September 30, 1998 and December 31, 1997, cash equivalents were
composed primarily of investments in money market funds, United States
government obligations and high grade commercial paper that mature within 90
days of purchase.
6
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3. Short-term Investments
The following is a summary of securities with maturities greater than
90 days not classified as cash and cash equivalents. All short-term investments
are classified as held-to-maturity.
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
<S> <C> <C>
Commercial paper .................... $ 3,671,338 $ 6,461,033
Federal agency note ................. 11,499,121 3,075,962
---------- ---------
Total short-term investments $15,170,459 $ 9,536,995
---------- ---------
---------- ---------
</TABLE>
The held-to-maturity securities are short-term in nature. Changes in
market interest rates would not have a significant effect on the fair value of
these securities. These securities are carried at amortized cost, which
approximates fair value.
4. Inventory
Pursuant to a supply agreement, the Company was responsible for the
purchase and supply of all active ingredient required for the manufacturing
of ERGOSET-Registered Trademark- tablets. In the fourth quarter of 1997, the
Company purchased $424,320 of active ingredient to be used in the
manufacturing of ERGOSET-Registered Trademark-tablets, all of which was held
as raw material at December 31, 1997. The inventory was sold to Johnson &
Johnson in the first quarter of 1998.
5. Deferred Charges
The deferred charges balance at December 31, 1997 represented the
capitalized fair value of stock issued in 1997 to the Company's drug supplier
in exchange for an improvement in the terms of the supply agreement. As a
result of the unfavorable recommendation given by the Endocrinologic and
Metabolic Drugs Advisory Committee of the Federal Food and Drug
Administration ("FDA") on May 14, 1998, the Company determined that the value
of this asset had been materially impaired due to the uncertainty that the
improved supply terms would be realized. As a result, the Company wrote-off
the balance of this asset in the second quarter of 1998.
6. Deferred Revenue
The deferred revenue balance at September 30, 1998 represents unearned
sponsored research payments received from Johnson & Johnson in conjunction
with the joint collaboration agreement.
7. Net Loss Per Common Share
Net loss per common share is computed based upon the weighted average
number of common shares outstanding. Common equivalent shares are not included
in the per share calculations where the effect of their inclusion would be
anti-dilutive. In the computation of net loss per common share, accretion of
preferred stock to the redemption amount is included as an increase to net loss
to common stockholders.
Basic loss per common share is the same as diluted loss per common share.
7
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8. Contingencies
On April 29, 1998, the Company and the Board of Supervisors of Louisiana
State University and Agriculture and Mechanical College ("LSU") entered into
dispute resolution under the provisions of the parties' Novated License and
Royalty Agreement dated May 1, 1995. The dispute relates to the amount of
payment owed to LSU arising from various payments received by the Company
from Johnson & Johnson. LSU is seeking payment of $4,138,000. The Company
believes that the payment owed to LSU is significantly less than this amount.
8
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
This discussion contains forward-looking statements. Forward-looking
statements reflect Ergo's current views with respect to future events. Actual
results may vary materially and adversely from those anticipated, believed,
assumed, estimated or otherwise indicated. Important factors that could cause
actual results to differ materially include, without limitation, (1) there
can be no assurance that Ergo will be able to submit clinical trial results
in the future that will produce an approval by the FDA of ERGOSET-Registered
Trademark- tablets for the treatment of Type 2 diabetes or obesity, (2) there
can be no assurance that Ergo will have sufficient capital to complete any
additional trials undertaken, (3) data obtained from clinical trials are
subject to varying interpretations, and there can be no assurance that the
FDA (or an FDA panel of experts) will agree with Ergo's assessment of future
clinical trial results, (4) uncertainty related to the scientific development
of a new medical therapy, (5) competition in the anti-diabetic and
anti-obesity markets is intense; other products have been recently approved
for these indications and other companies are developing competing products,
(6) the need for additional funding, (7) there can be no assurance that
ERGOSET-Registered Trademark- tablets, if approved for commercial marketing,
will be successful in the marketplace, or that Ergo will receive any profits
from its sale, (8) if approved for commercial marketing, Johnson & Johnson,
and not Ergo, is responsible for manufacturing and the timing and
implementation of marketing ERGOSET-Registered Trademark- tablets, (9) there
can be no assurance that Ergo will achieve any of the objectives required for
milestone payments by Johnson & Johnson, (10) Johnson & Johnson has the right
to terminate the collaboration at any time subject to the possibility of
paying penalties in certain circumstances, and (11) the uncertainty relating
to patent protection in the pharmaceutical and biotechnology industries.
Further information and additional important factors are set forth in reports
and other filings of Ergo with the Securities and Exchange Commission,
including, without limitation, the 1997 Annual Report on Form 10-K, generally
under the section entitled "Risk Factors." Ergo does not undertake to update
any forward-looking statement that may be made from time to time by or on
behalf of Ergo.
Overview
Since inception, Ergo has developed novel treatments for metabolic
disorders, including Type 2 diabetes and obesity, immune system disorders and
various forms of cancer based on its core technology, Neuroendocrine
Resetting Therapy-Registered Trademark- ("NRT-Registered Trademark-").
NRT-Registered Trademark- is based on the role of neurotransmitters in
regulating metabolism. The Company has dedicated most of its financial
resources to research and development of ERGOSET-Registered Trademark-
tablets, the Company's lead product candidate, general and administrative
expenses and the prosecution of patents and patent applications. To date, the
Company has not received any revenues from the sale of products and its
ability to receive any revenues from product sales is dependent upon
receiving market clearance from the FDA.
From inception through 1997, the Company had been unprofitable. On
February 23, 1998, Ergo and Johnson & Johnson entered into a worldwide Joint
Collaboration and License Agreement to develop and commercialize
ERGOSET-Registered Trademark- tablets as well as other potential collaboration
products for the treatment of Type 2 diabetes and obesity (the "Joint
Collaboration Agreement"). In conjunction with the Joint Collaboration
Agreement, Ergo received a $10 million license fee and approximately $5.6
million in sponsored research revenue.
On May 14, 1998, the Endocrinologic and Metabolic Drugs Advisory
Committee of the FDA found that there was not sufficient evidence to
recommend for approval the Company's NDA for ERGOSET-Registered Trademark-
tablets for Type 2 diabetes. The Company has been meeting with the
9
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FDA to review the committee's recommendation and to consider appropriate next
steps. In August 1998, the FDA notified the Company of a 90-day extension to
November 20, 1998 to review additional data submitted by the Company.
Results of Operations
Three Months and Nine Months Ended September 30, 1997 and 1998
Total revenues were $856,973 and $18,073,958 for the three and nine month
periods ended September 30, 1998, respectively. Revenues for the third quarter
of 1998 consisted of sponsored research payments. Total revenues for the first
nine months of 1998 consisted of a $10 million license fee, approximately $5.6
million in sponsored research revenue and approximately $2.5 million of product
revenue from raw material inventory sold at cost. All revenues in 1998 were
derived from the Joint Collaboration Agreement. In 1997, the Company did not
generate revenues.
Research and development expenses decreased from $3,393,385 to
$2,710,304 for the three month periods ended September 30, 1997 and 1998,
respectively. This decrease was mainly due to the reduction of expenses
related to various clinical trials. For the nine month periods ended
September 30, 1997 and 1998, expenses increased from $9,637,674 to
$10,072,189. Substantial costs were incurred in the first nine months of 1997
in relation to the preparation of the NDA for ERGOSET-Registered Trademark-
(bromocriptine mesylate) tablets for Type 2 diabetes. For the same period in
1998, significant expenditures were incurred due to the preparation for the
panel meeting with the Endocrinologic and Metabolic Drugs Advisory Committee
of the FDA and ongoing clinical trials of the Phase II weight-loss study in
obese subjects.
The "write-off related to renegotiated supply agreement" charge of
$2,499,000 represents the write-off of the capitalized fair value of stock
issued in the fourth quarter of 1997 to the Company's drug supplier. See
"Liquidity and Capital Resources" for further discussion.
General and administrative expenses remained relatively constant for the
three and nine month periods ended September 30, 1997 and 1998, increasing
from $1,255,645 to $1,371,373 and $5,159,901 to $5,183,401, respectively.
Liquidity and Capital Resources
Since its inception, the Company's primary source of cash has been from
financing activities, which have consisted of private placements of equity
securities, two public offerings and the Joint Collaboration Agreement. Private
placements of equity securities provided the Company with aggregate proceeds of
$42,999,000. On December 19, 1995, the Company raised $23,030,476 from the sale
of stock in an initial public offering, net of commissions and offering costs.
Subsequently, on August 14, 1996, the Company raised an additional $32,218,487,
net of commissions and offering costs, from the sale of stock in a second public
offering.
On February 23, 1998, Ergo and Johnson & Johnson entered into the Joint
Collaboration Agreement to develop and commercialize ERGOSET-Registered
Trademark- tablets as well as other potential collaboration products for the
treatment of Type 2 diabetes and obesity. In March 1998, Johnson
10
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& Johnson made payments to Ergo totaling $20 million, including payment of a
$10 million license fee and the purchase of $10 million of Ergo common stock.
In addition, Johnson & Johnson has committed to provide Ergo with
significant, additional financial support in the form of milestone payments
upon achievement of other specified development, regulatory and commercial
objectives and reimbursement of certain development expenses subject to the
terms of the Joint Collaboration Agreement.
Cash and cash equivalents were $21,983,261 and $13,923,115, while
short-term investments were $15,170,459 and $9,536,995, at September 30, 1998
and December 31, 1997, respectively. The overall increase in cash, cash
equivalents and short-term investments at September 30, 1998, was due primarily
to payments received in connection with the Joint Collaboration Agreement.
The Company's primary use of cash to date has been in operating activities
to fund research and development, including preclinical studies and clinical
trials, and general and administrative expenses.
In 1997, the Company initiated a Phase II clinical study at 14 clinical
sites across the United States enrolling approximately 300 clinically obese
subjects to evaluate the safety and efficacy of ERGOSET-Registered Trademark-
tablets to treat clinical obesity. In July 1998, enrollment for this study
was completed. Final study results are anticipated to be reported in the
first half of 1999. The Company is incurring and will continue to incur
additional research and development expenses associated with its various
clinical trials.
In 1997, the Company filed with the FDA an NDA for ERGOSET-Registered
Trademark- tablets to treat Type 2 diabetes and the FDA accepted the NDA for
filing. On May 14, 1998, the Endocrinologic and Metabolic Drugs Advisory
Committee of the FDA found that there was not sufficient evidence to
recommend for approval the Company's NDA for ERGOSET-Registered Trademark-
tablets for Type 2 diabetes. The Company has been meeting with the FDA to
review the committee's recommendation and to consider appropriate next steps.
In August 1998, the FDA notified the Company of a 90-day extension to
November 20, 1998 to review additional data submitted by the Company. During
1998, the Company incurred and will continue to incur costs associated with
the NDA review process.
As a result of the unfavorable recommendation given by the Endocrinologic
and Metabolic Drugs Advisory Committee of the FDA, the Company recorded a
noncash charge of $2,499,000 for the write-off of a deferred asset. This asset
represented the capitalized fair value of stock issued in 1997 to the Company's
drug supplier in exchange for an improvement in the terms of the supply
agreement. The Company had determined that the value of this asset had been
materially impaired due to the uncertainty that the improved supply terms would
be realized by the Company and, thus, fully expensed the amount in the second
quarter of 1998. (See Note 9 of the audited financial statements for the year
ended December 31, 1997, which are contained in the Company's Annual Report on
Form 10-K filed with the Securities and Exchange Commission for the year ended
December 31, 1997).
As of September 30, 1998, the Company's net investment in equipment and
leasehold improvements was $1,629,656. The Company expects that additional
equipment and facilities will be needed to the extent it increases its research
and development activities.
Based on the decision of the Endocrinologic and Metabolic Drugs Advisory
Committee of the FDA, discussed above, the Company is currently reevaluating its
development programs.
11
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However, the Company currently plans to manage any changes to such programs
so that the Company's available cash, cash equivalents, short-term
investments, and expected interest income will fund its operations through
1999. In the event that the costs of such development programs are higher
than expected, the Company may need additional capital prior to the end of
1999. There can be no assurance that the Company will be able to complete the
development and initial commercial launch of any product with such capital
resources and additional capital resources that may become available under
the terms of the Joint Collaboration Agreement. To the extent the Company
raises additional capital by issuing equity securities, ownership dilution to
existing stockholders will result, and future investors may be granted rights
superior to those of existing stockholders. There can be no assurance,
however, that additional financing will be available from any source or, if
available, will be available on acceptable terms.
The terms of the Company's Series D Preferred Stock prohibit the
Company from paying dividends on the common stock.
12
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PART II
OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits:
27 - Financial Data Schedule
Reports on Form 8-K:
None.
13
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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.
ERGO SCIENCE CORPORATION
By: /s/ Francis M. Ferrara, Jr.
-------------------------------------------
Francis M. Ferrara, Jr.
Controller (principal accounting officer)
Date: October 28, 1998
-------------------------------------------
14
<TABLE> <S> <C>
<PAGE>
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<S> <C>
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<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 21983261
<SECURITIES> 15170459
<RECEIVABLES> 0
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