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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year 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
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Commission File No. 0-15271
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CISTRON BIOTECHNOLOGY, INC.
(Exact name of Registrant as specified in its Charter)
Delaware 22-2487972
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
10 Bloomfield Avenue, Pine Brook, New Jersey 07058
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
973-575-1700
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12 (g) of the Act:
Yes X No
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Common Stock, $0.01 par value
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes X No
---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this form
10-K or any amendment to this Form 10-K. [X]
The aggregate market value of the voting stock (Common Stock, $0.01
par value) held by non-affiliates of the Registrant was $3,901,896 on
August 31, 1998 based on the average of the closing bid and asked prices
of the Common Stock on such date.
The aggregate number of Registrant's outstanding shares on August 31,
1998 was 22,983,687 shares of Common Stock, $.01 par value.
Documents incorporated by reference:
None
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PART I
Item 1. Business.
General
Cistron Biotechnology, Inc. ("Cistron" or the "Company") is a
development stage, biotechnology company that uses recombinant DNA and
immunological techniques to explore certain cytokines that may have
therapeutic or diagnostic applications. Cytokines, consisting of
lymphokines and monokines, are proteins that are regulators of the human
immune response system released in the body by white blood cells. While
researching the therapeutic and diagnostic applications of these immune
regulators, Cistron manufactures a line of cytokine products that it sells
to the research market worldwide. Cistron's current research products are
sold to pharmaceutical companies, government agencies and academic
institutions in the United States, Europe and Asia for cancer, arthritis
and other autoimmune disease research.
The Company's principal research products consist of Interleukin-1
beta ("IL-1"), a lymphokine which initiates the immune response,
monoclonal and polyclonal antibodies to IL-1 ("IL-1 Antibodies"), and an
assay kit that measures IL-1 levels (the "IL-1 Assay"). The Company's IL-
1 products are based upon the technology derived from research funded by
Cistron on Interleukin-1 beta, the predominant form of IL-1 in humans, at
the New England Medical Center Hospitals, Inc., Tufts University,
Massachusetts Institute of Technology and Wellesley College (the
"Institutions"), patents assigned to the Company as part of a litigation
settlement and technology and patents developed by the Company. Cistron
also manufactures and sells assays which measure tumor necrosis factor-
alpha ("TNF"), which is a monokine that acts as a mediator of
inflammation, an assay which incorporates both TNF and IL-1 and an assay
to measure interleukin converting enzyme ("ICE"). ICE cleaves the IL-1
protein into fragments, which imparts its biologic activity. In addition,
the Company distributes in North America and Asia assays that measure
another lymphokine, Interleukin-6, which is principally manufactured by
another company. See Item 1 - Business - Products.
Cistron's research products are sold to pharmaceutical companies,
government agencies and academic institutions in the United States, Europe
and Asia for cancer, arthritis and other autoimmune disease research. For
the fiscal year ended June 30, 1998 ("Fiscal 1998"), 69% of Cistron's
gross sales were made to three major customers, Genzyme, Merck Frosst, and
Athena NeuroSciences. The loss of any of these companies, if a comparable
new customer were not found, would have a material adverse effect on the
Company's business.
The Company's ability to develop, produce, and distribute its
principal current research and potential therapeutic or diagnostic
products is derived from the following licenses: (i) an exclusive license
from the Institutions to make, use, sell, and to sublicense to others,
products based upon IL-1 under certain patents issued and pending in the
United States and patents pending internationally, patents assigned to the
Company as part of a litigation settlement and technology and patents
developed by the Company (collectively, the "IL-1 Patents"), (ii) an
exclusive license from Rijksuniversiteit of Limburg (Holland) under which
the Company is supplied TNF antibodies, and (iii) a non-exclusive license
from another company to develop and sell the ICE assay for research
purposes. The Company also has the following licenses under which no
products have been developed to date: (i) a non-exclusive royalty free
license from The DuPont Merck Pharmaceutical Company ("DuPont Merck") to
certain IL-1 mutants and related technology under certain patents pending
in the U.S. and internationally and (ii) an exclusive license from the
Institutions (part of the same license that relates to IL-1 products) to
develop an inhibitor to tissue plasminogen activator, which may have
clinical utility in treating some bleeding disorders or inflammatory
conditions. See Item 1 - Business - Licenses.
Cistron seeks strategic alliances with corporate or other partners to
develop or finance Cistron's development of therapeutic and diagnostic
applications of cytokine products. In June 1998, Cistron and Pasteur
Merieux Connaught ("PMC"), a subsidiary of Rhone-Poulenc Group, entered
into a letter of intent to fund an IL-1 vaccine adjuvant development
program and to make an equity investment in Cistron. The letter of intent
is subject to the execution of definitive agreements on or before October
30, 1998 and there can be no assurance that definitive agreements will be
executed. See Item 1 - Business - Marketing and Distribution. In May
1993, Cistron granted an exclusive sublicense to Biotech Australia Pty.
Limited ("Biotech"), a jointly owned subsidiary of Hoechst A.G. and
Hoecsht Australia Ltd., to make, use and sell plasminogen activator
inhibitor ("PAI-2") protein in the U.S. using technology contained in
Cistron's PAI-2 DNA patent. Cistron has recently initiated development of
a PAI-2 assay, using Biotech's reagents, which, if successfully developed,
Cistron would sell to the North American research market. In December
1994, Cistron granted a sublicense to another company for use of IL-1 in
its pharmaceutical research program. Cistron and Research and Diagnostic
Systems, Inc. ("R&D Systems") entered into a license and supply agreement
in March 1995. Under this agreement, R&D Systems is required to
exclusively purchase Cistron's IL-1 protein. Under an April 1995 research
and development agreement, R&D Systems funded some of Cistron's research
product development in exchange for certain
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co-marketing rights. Funding under this agreement concluded in the second
quarter of Fiscal 1998 and no co-marketing rights were exercised by R&D
Systems. See Item 1 - Business - Licenses.
During Fiscal 1997, the Company settled its litigation against
Immunex Corporation ("Immunex") and its litigation against PeproTech, Inc.
("PeproTech"). The Immunex settlement will provide aggregate payments to
Cistron of $21 million and the PeproTech settlement, a license fee of
$718,000. See Item 1 - Business - Patent Protection.
In September 1997, the Company engaged the services of BlueStone
Capital Partners, LP ("BlueStone") to act as Cistron's financial advisor
as to corporate strategic and financial initiatives. The initial
engagement was for a period of six months and was renewed for an
additional six months upon mutual consent of the parties. That agreement
expired in September 1998 and the Company is currently soliciting the
engagement of another investment banking firm. The Company paid BlueStone
Capital $90,000 for the initial six-month period and issued warrants to
purchase 400,000 shares of the Company's common stock at $.25 per share.
Cistron paid BlueStone $10,000 per month under the renewed agreement (or
$150,000 in the aggregate). The Company would be obligated to make
payments including certain percentage fees as well as to issue additional
warrants to BlueStone to purchase up to an additional 400,000 shares at
$.25 per share should BlueStone assist Cistron in completing a merger,
acquisition, joint venture, partnership, license or contract. Cistron
will be obligated to issue the additional warrants to purchase 400,000
shares of the Company's common stock at $.25 per share and pay 7% of the
equity and research payments ($133,000 in aggregate fees) to BlueStone
should the Company execute definitive agreements with PMC as BlueStone
assisted Cistron by introducing the parties. Cistron also would be
obligated to pay BlueStone 7% of any license fees or milestone payments
PMC may make to Cistron should PMC enter into definitive agreements and
exercise its option under such. Robert Naismith, Ph.D., who has been a
director of the Company since January 1998, was a Managing Director of
BlueStone until April 1998.
The Company is a development stage company, has not generated
significant revenues and none of its products have been submitted to or
received approval by the Food and Drug Administration ("FDA") for the sale
of such products to the diagnostic or therapeutic markets.
The Company was incorporated in Delaware in 1983 under the name
Cistron Technology, Inc. and commenced operations in May 1984 as successor
to a research and development partnership organized in 1982. The executive
offices of the Company are located at 10 Bloomfield Avenue, Pine Brook,
New Jersey 07058 (Telephone No. 973-575-1700, URL: www.cistronbio.com)
Products
Cistron is a biotechnology company that uses recombinant DNA and
immunological techniques to explore certain cytokines that may have
therapeutic or diagnostic applications and to manufacture a line of
cytokine products that it sells to the research market worldwide.
Cytokines, consisting of lymphokines and monokines, are proteins that are
regulators of the human immune response system released in the body by
white blood cells. The function of the immune system is to protect the
body against infectious agents, including viruses, bacteria, parasites and
malignant (cancer) cells. The normal immune system is finely tuned and
imbalances may lead to a variety of diseases.
Two classes of white blood cells, macrophages and monocytes (the
surveillance system) and lymphocytes (the antibody producing cells), are
primarily responsible for immunity. It is generally believed that the
activities of macrophages and lymphocytes are controlled, to a large
extent, by a specific group of regulators called lymphokines; the
lymphokines, in turn, are released by the class of white blood cells,
which constitute the surveillance system. The lymphokines attach to
specific sites, called receptors, on the surface of cells that constitute
the immune system, and impart their "messages" through these contact
points, controlling the growth and maturation of the cells and thereby
primes the immune system for response following infection or exposure to
noxious agents.
An important feature of the immune response is the detection of
noxious agents by macrophages and monocytes, which thereupon release IL-1.
The IL-1 then activates a subset of secondary cells, the T-lymphocytes,
which have two functions. T-lymphocytes can attack foreign cells and can
augment the antibody response of a second type of lymphocytic cell, the B-
lymphocyte. The B-lymphocytes secrete antibodies, which, if effective,
inactivate the invading bacteria, viruses or other noxious agents. The
interplay among macrophages, B-cells and T-cells determines the strength
and breadth of the body's response to infection.
Insufficient production of lymphokines may lead to immune deficiency
states. Over-production of lymphokines may promote severe allergies and
autoimmune diseases such as rheumatoid arthritis.
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IL-1 Related Products
The Company's principal research products consist of IL-1 proteins,
IL-1 Antibodies, IL-1 Assays and the ICE assay and are sold principally to
university or commercial research groups that use such products in
connection with their own immunological research and development or for
resale to the research market. The sale of IL-1 products accounted for
approximately 65% of Cistron's gross sales for Fiscal 1998 (which included
sales of TNF/IL-1 assays). See Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operations.
The Company had attempted to develop additional products, which might
have adapted the IL-1 Assay for certain diagnostic purposes. See Item 1 -
Business - Product Development.
Tumor Necrosis Factor-alpha
Since June 1989, the Company has been manufacturing and selling a TNF
assay through the same distribution network, except for Europe, as used
for sales of its IL-1 product line. The sale of TNF assays and TNF/IL-1
assays accounted for approximately 35% of gross sales for Fiscal 1998. See
Item 7-Management's Discussion and Analysis of Financial Condition and
Results of Operations. TNF, like IL-1, is a cytokine in the immune
system. TNF is a mediator of inflammation and may also play a role in the
destruction of cancer cells. The assay was developed under a license from
Rijksuniversiteit of Limburg, a Dutch university, which developed certain
antibodies used in this product. See Item 1 - Business - Licenses.
Other Products
The Company distributes another lymphokine assay, which measures
Interleukin-6 ("IL-6") to the North American, and Asian research markets.
This product, however, is substantially manufactured by another company,
and accounted for minimal gross sales in Fiscal 1998.
Product Development
In Fiscal 1996, Fiscal 1997, and Fiscal 1998 the Company incurred
research and development expenses of approximately $111,500, $177,500, and
$547,500 respectively, which amounts do not include project expenses
incurred by the manufacturing group, included under cost of sales.
Cistron's product development strategy with respect to its present
line of research products has been to contact university or commercial
research groups that have achieved results in the identification and
production of cytokines and for antibodies to those proteins and to fund
short-term, highly focused developmental research aimed at providing the
Company with protein and antibody supply. Once a supply level is
obtained, the Company's in-house scientists screen the materials and then
develop assays for sale to the research market.
Cistron has attempted to broaden its development strategy to include
development of cytokine-based therapeutic and diagnostic products for sale
to the therapeutic and diagnostic markets. The Company is seeking
corporate partners to develop, or to finance Cistron's development of,
cytokine-based therapeutic and diagnostic products.
Cancer Therapeutics
Tests on animals and isolated cancer cell preparations have indicated
that IL-1 has potential utility as an anti-cancer agent and that it may
also serve as an adjunct for use in combination with other cancer
therapeutics to kill cancer cells. In furtherance of the Company's
broader development strategy, Cistron, in March 1992, entered into a
license agreement with Genetic Therapy, Inc. ("GTI") under which Cistron
granted GTI an exclusive, worldwide sublicense under the IL-1 Patents to
make, use and sell genetic therapy products incorporating IL-1 for the
prevention or treatment of cancer in humans. No products were developed
for testing in clinical trials under this license and it was terminated in
Fiscal 1998. In May 1993, Cistron granted a license to the PAI-2 Patents
to Biotech to make, use and sell PAI-2 protein. PAI-2 is a protein
synthesized by white blood cells, which act to inhibit plasmin, an enzyme,
which dissolves blood clots, but also promotes tumor metastasis. Thus it
is felt that PAI-2 could be useful in treating cancer. For a discussion
of the Company's marketing strategy for products to be developed under the
license agreements. See Item 1 - Business - Marketing and Distribution
below.
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Vaccine Adjuvants
The Company contracted another company to test the adjuvant
(boosting) effect of IL-1 with an existing influenza vaccine. A two-month
study in rats was conducted. In this study, rats which received the
vaccine encapsulated with IL-1 had an antibody titer in excess of 10 fold
higher than rats receiving the vaccine without IL-1. The higher antibody
titer indicates a greater immune response to the vaccine, which provides a
stronger defense to the illness. There were no signs of IL-1 toxicity.
In Fiscal 1998, the Company continued the use of IL-1 as an adjuvant in
influenza studies. A ferret model system was employed and while IL-1
showed some positive effects, the activity of human IL-1 in ferrets was
sub-optimal. Further studies will be carried out only in animals that are
known to have a high response to human IL-1.
The Company has also funded research at two universities in which IL-
1 was tested in animals with experimental cancer vaccines being developed
at those universities. In Fiscal 1998, the Company contracted two outside
researchers to incorporate IL-1 as an adjuvant in melanoma model systems.
Researcher 1 used IL-1 as an adjuvant in a study employing an anti-Id
(antibody that acts like an antigen) melanoma vaccine. The IL-1 and anti-
Id vaccine were given to mice with and without encapsulation into
liposomes. Results showed a modest dose related increase in B and T
cell response in the group using IL-1 as an adjuvant over the control
groups. Researcher 2, in a second melanoma study, used IL-1 as an
adjuvant with shed antigens from melanoma cells. No reliable data were
generated. The Company will not repeat the experiment, but will
investigate other vaccine models to determine IL-1's adjuvanticity.
IL-1 Measurement
Elevated levels of IL-1 have been associated with rheumatoid
arthritis, periodontal disease and other autoimmune diseases. The IL-1
Assay was planned to be adapted as a diagnostic product for the detection
of periodontal disease, a condition that affects more than 75% of the
adult population over the age of 35 in the United States. In October
1991, Cistron received a Phase I research grant from the SBIR Program to
initiate development of such a product (the "Periodontal Assay"), adapting
Cistron's IL-1 Assay for in-office use by dentists and periodontists to
detect and monitor periodontal disease. A 132-patient study, which was
funded under the grant, was completed in August 1992 and was conducted by
Cistron and the University of Medicine and Dentistry of New Jersey. Under
its April 1995 research and development agreement with Cistron, R&D
Systems funded additional periodontal studies and assay development
conducted by Cistron. To this end, Cistron entered into a one-year
sponsored research agreement with a dental school in August 1995. Patient
enrollment in this study was not completed before January 1996 and
therefore, the completion date of this agreement was extended, informally,
without additional funding from the Company.
Based on the preclinical studies that the Company has performed as
well as independent research results reported in scientific literature by
others, the Company believes that IL-1 measurement will be a valuable tool
in the diagnosis and monitoring of periodontal disease. To advance this,
the Company had undertaken to design a clinical trial protocol. Prior to
initiation of the clinical trial, the Company received and analyzed the
results of the preclinical, longitudinal study initiated in August 1995.
Those results did not provide a strong correlation of IL-1 levels to the
disease/health states of specific tooth sites. Rather, IL-1 levels seemed
to rise generally. In the absence of compelling data, management
determined not to go forward with the anticipated clinical trial that
would have required significant funds.
The addition of the IL-1 precursor and ICE ELISA is expected to
provide researchers with a more comprehensive view of IL-1 synthesis. The
Company filed a U.S. patent application with respect to its IL-1 Assay in
May 1987 and in December 1995, U.S. Patent No. 5,474,899 and in August
1998, U.S. Patent No. 5,789,185 were issued.
Inhibitors of the Immune Response
Recombinant DNA technology enables the Company to produce human IL-1
in large quantities and to conduct research on modifying the molecule in
such a way as to act as a reversible, non-toxic inhibitor of the immune
response. Research sponsored by the Company has led to the discovery of a
molecule which, in preliminary experiments, was shown to have the same
ability to bind receptor sites as natural IL-1, but with greatly
diminished IL-1 activity. Theoretically, such a molecule would compete
with natural IL-1 for binding sites and would, therefore, reduce the
effects of the resulting IL-1 biologic response. Significant further
research will be needed to discover if this molecule will have any
clinical utility as an immune response inhibitor or as a potential vaccine
adjuvant. The Company is seeking a partner to develop this technology and
after obtaining the necessary regulatory approvals, to market the
resulting products.
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Inhibitors of the immune response have potential application in the
treatment of arthritis, periodontal disease, other autoimmune diseases,
severe allergies, septic shock and bleeding disorders although the Company
has not yet developed the related products.
Arthritis and Periodontal Disease. As overproduction of IL-1 promotes
the bone demineralization, cartilage degradation and joint inflammation
associated with rheumatoid arthritis and loss of attachment of the teeth
to the jaw in periodontal disease, compounds that inhibit IL-1 may be
useful in the treatment of these diseases. The therapeutic agents
currently available for treatment of these diseases may have serious side
effects that may limit their utility.
The Company has initiated research into the inhibition of IL-1 using
currently available antibiotics and non-antibiotic derivatives. The
Company in conjunction with a university to determine if it could inhibit
the production of IL-1 initiated a study utilizing doxycycline in Fiscal
1998. The results showed a significant decrease in IL-1 production caused
by doxycycline. This may be useful in some disease states where IL-1 is
being overly produced. Further studies are being considered.
Other Autoimmune Diseases. There are a number of other diseases in
which, it is believed, the body's immune system reacts to its own tissue
as if it were an antigen (foreign body) and against which it mounts an
immune response. Such diseases, termed autoimmune diseases, include (in
addition to rheumatoid arthritis) myasthenia gravis and lupus.
Therapeutics developed from IL-1 inhibitors may be of use in treating
these diseases.
Severe Allergies. Persistent severe allergies, such as bronchial
asthma, may be resistant to conventional therapy or require such high
doses of antihistamines and/or corticosteroids as to burden patients with
damaging side effects. Mutant forms of IL-1 or chemical inhibitors of the
actions of IL-1 on T-lymphocytes may block the hyperimmune response that
results in intractable allergic symptoms.
Septic Shock. It is estimated that approximately 100,000 people die
annually in the U.S. as the result of septicemia (commonly referred to as
septic shock). Increased levels of cytokines, especially IL-1, TNF, and
IL-6, have been indicated as mediators of septic shock. Neutralizing
monoclonal antibodies or inhibitors of IL-1 may prove useful, perhaps in
conjunction with other therapeutics, in treating sepsis patients.
Bleeding Disorders. The Company's license from the Institutions
includes an exclusive license to certain issued U.S. patents and
associated technology related to PAI-2 which may have clinical utility in
treating some bleeding disorders or as an anti-inflammatory agent. The
Company has not yet commenced any research in this area, and in May 1993,
Cistron granted a sublicense to the PAI-2 DNA Patents to Biotech to make,
use and sell PAI-2 protein for therapeutic products in the U.S.
Wound Healing. Cistron funded a preclinical animal study at a
university to determine if IL-1 has an effect in wound healing. This was
a small-scale project in which rats with surgical wounds were treated with
liposomes or IL-1 encapsulated within the liposomes. Wounds that received
the IL-1 showed accelerated levels of healing as compared to wounds
receiving the liposomes alone. The Company has begun planning additional
wound healing animal studies that will be conducted during Fiscal 1999.
Additionally, Biotech has conducted a preliminary safety study using
PAI-2 to treat leg ulcers and has initiated a 120 patient clinical trial
on patients with leg ulcers. This trial is being co-funded by the
Australian government.
Treatment of Immune Deficiency States
Insufficient production of cytokines may prove to be involved in some
immune deficiency states. Such conditions can occur at birth, be induced
following viral infection or be induced as a side effect of treatment for
a primary clinical condition. The Company believes that administration of
IL-1 may be effective in treating some immune deficiency states, but has
not commenced any research in this area.
Marketing and Distribution
The Company does not have a marketing department; its marketing
effort consists of direct mail and trade journal advertising to the
research market, the creation of a website (www.cistronbio.com) to
advertise on the Internet, and personal solicitation of potential
marketing partners. Cistron also uses distributors in the United Kingdom,
Europe, and Japan to sell the current product line outside of North
America.
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In June 1993, Cistron and Genzyme entered into a sponsored research
and supply agreement under which Genzyme co-marketed certain of Cistron's
current research products, under Genzyme's label, and received co-
marketing rights to new IL-1 based research products which might have been
developed by Cistron under funding from Genzyme. No such products were
developed to the state of marketing readiness under this agreement. In
July 1996, Cistron and Genzyme entered into a two-year Supply Agreement to
continue that portion of the 1993 agreement. On June 30, 1998, Genzyme
gave notice of its intention not to renew the Supply Agreement with
Cistron. In July 1998, Genzyme sold its research products business to R&D
Systems. In March 1995, Cistron entered into a license and supply
agreement with R&D Systems under which R&D Systems is obligated to
purchase Cistron's IL-1 protein and may purchase certain IL-1 assay
components for resale, under R&D System's label, to the research market.
R&D Systems has not commenced sales of assays using Cistron's components
and is not obligated to do so. Under the April 1995 research and
development agreement, R&D Systems may have had exclusive co-marketing
rights to additional cytokine research products and to the IL-1
periodontal assay that Cistron sought to develop with funding by R&D
Systems. The funding concluded in the second quarter of Fiscal 1998.
The Company's strategy has been to avoid costly selling and marketing
expenses, and to concentrate its resources on research and product
development, and it is anticipated that the Company's clinical and
therapeutic products, if developed, will be distributed through
pharmaceutical and diagnostic companies under licensing or joint venture
arrangements. In May 1993 Cistron entered into the Biotech agreement
under which Cistron will receive royalties on the net sales of therapeutic
PAI-2 products sold by Biotech or its affiliates in the U.S. Cistron
obtained a cross license from Biotech for development of PAI-2 diagnostic
products. Cistron has been advised by Biotech that it opened an
Australian manufacturing facility in October 1994, has conducted anti-
inflammatory animal studies, completed a Phase I human wound healing
clinical trial in Australia and is planning Phase II trial.
On June 30, 1998, Cistron and PMC, the world's largest vaccine
manufacturer, entered into a letter of intent for an option and license
agreement pertaining to the use of IL-1 as a vaccine adjuvant in the
fields of preventive and therapeutic vaccines. Under the terms of the
letter of intent, which is subject to execution of definitive agreements
on or before October 30, 1998, PMC intends to purchase 1.3 million shares
of Cistron's common stock at $.75 per share and Cistron intends to grant
PMC a three year warrant to purchase a number of additional shares (which
amount will be mutually agreed upon) such that if the warrant is
exercised, the weighted average price per share when combined with the
shares purchased at $.75 each, would be above Cistron's $.48 per share
book value at March 31, 1998. Additionally, PMC intends to fund $900,000
of research for IL-1 adjuvant related projects and, PMC intends to
independently perform preclinical work during the three-year option
period. The letter of intent also sets out license and milestone
payments, based on advancement of products through clinical trials and
regulatory approvals, which could entitle Cistron to receive an aggregate
$31 million. Should PMC market products using IL-1 as an adjuvant,
Cistron would also receive royalties. There can be no assurance that the
parties will enter into definitive agreements or if definitive agreements
are entered into that they will contain the terms and conditions set forth
above or that product devlopment milestones will be achieved.
Licenses
Cistron has an exclusive, worldwide license from the Institutions to
make, use and sell, and to sublicense to others, products adapting the
IL-1 Patents and to make, use and sell products incorporating related
technology. The Company was granted this license in return for funding
the research and development resulting in the issuance to the Institutions
of the IL-1 Patents. The term of such license is the life of the IL-1
Patents, with respect to the patents, and October 1, 2000, in the case of
the related technology, in each case excluding any time required for pre-
market clearance that may be required by a U.S. regulatory agency. The
Company pays a royalty on IL-1 sales to the Institutions. If the Company
enters into a joint venture with another company to commercialize IL-1,
the Company must pay a royalty to the Institutions on sales to the joint
venture partner and royalties received from such partner. If the Company
enters into sublicense arrangements with other companies that are not
joint ventures, the Company must pay a royalty of 50% of royalties
received from the sublicensee. Cistron has been involved in litigation
and a patent regulatory proceeding in order to protect its rights to the
IL-1 Patents from infringement. See Item 1 - The Company - Patent
Protection.
Cistron's ability to manufacture the TNF assays and TNF/IL-1 assays
is derived from its exclusive, worldwide license from Rijksuniversiteit of
Limburg (Holland), under which the university supplied Cistron with TNF
antibodies owned by the university. The Company pays this university a
royalty on sales of such products. The Company, at its sole discretion,
may expand its rights to use these antibodies in clinical diagnostic kits
upon the payment of a fee to Rijksuniversiteit of Limburg. The license
expires in September 1998 and the Company is seeking to extend it.
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The Company's license from the Institutions also includes an
exclusive license to certain issued U.S. patents and associated technology
relating to PAI-2 which may have clinical utility in treating cancer and
some bleeding disorders. The Company entered into the Biotech Agreement
in May 1993. Cistron is continuing its efforts to develop a PAI-2 assay,
using Biotech's reagents, which, if successfully developed, Cistron would
sell to the North American research market. See Item 1 - Business -
Product Development - Inhibitors of the Immune Response - Bleeding
Disorders.
In March 1996, the Company entered into a non-exclusive license with
another company under which the Company used that company's reagents to
develop an assay to measure ICE which the Company sells to the research
market worldwide and on which royalties are paid, based on sales, to the
licensor.
The Company currently sublicenses patents and related technology to
others under the Biotech, and R&D Systems license agreements. See Item 1
- - Business - Marketing and Distribution.
Patent Protection
Company investigators, both at universities and in-house, seek patent
protection for technology when deemed appropriate and have filed
applications for U.S. and foreign patents relating to several different
products and processes. Between 1988 and 1997, seven patents containing
claims directed to various aspects of human IL-1 technology and one
directed to the PAI-2 DNA were issued to the Institutions, from which the
Company received an exclusive worldwide license. The European equivalent
patent was issued in December 1993 and the Japanese equivalent in 1997.
In December 1995, a U.S. patent related to the Company's assay was issued.
In addition to the issued IL-1 patents, a number of applications of the
Institutions and Cistron are pending in the U.S. and foreign countries
covering an inhibitor to IL-1, certain IL-1 uses, IL-1 Antibodies, and
additional claims for the IL-1 Assay. The Company was assigned rights to
certain issued IL-1 U.S. patents of Immunex as part of litigation
settlement. There can be no assurance that the pending applications will
result in the issuance of any patents or that the patents issued to date
or any future patents issued will provide substantial protection or be of
commercial benefit to the Company or to licensees of the technology. The
Company is relying upon trade secrets, unpatented proprietary know-how and
continuing technological innovation to develop its competitive position.
However, there can be no assurance that others may not acquire or
independently develop similar technology.
In December 1991, the Company, together with the Institutions, filed
suit in U.S. District Court in Newark, New Jersey against PeproTech, Inc.,
alleging infringement of the Institutions' patent covering the production
of recombinant IL-1, to which the Company holds an exclusive license.
In March 1997, the Company and PeproTech settled all outstanding
litigation. Under the settlement, PeproTech paid the Company $718,000
(one-half of which Cistron then paid to the Institutions) for license fees
and other expenses. Cistron and PeproTech both withdrew their motions for
appeal.
In January 1992, the Company was notified by the Institutions that
the U.S. Patent and Trademark Office (the "Patent Office") had declared an
interference between a pending application owned by the Institutions and
licensed to the Company and a pending application owned by Immunex Corp.
("Immunex"). The subject matter of the interference, as defined by the
Patent Office, is "a substantially pure IL-1 beta protein." In October
1993, the Company was notified that the U.S. Patent and Trademark Office
Board of Appeals and Interferences had entered a judgment of "no
interference in fact" in the interference declared in January 1992 between
pending patent claims licensed to the Company by the Institutions and
pending patent claims of Immunex Corp. The pending claims were referred
back to the original examiners for further review. Claims in the
application owned by the Institutions and licensed to the Company that was
the subject of the interference were allowed and issued a U.S. Patent No.
5,510,462 in April 1996.
In January 1996, the Patent Office granted U.S. patent No. 5,484,887
(the '887 patent) owned by Immunex. The '887 patent includes claims to
purified, mature human IL-1 protein (claims 8-12). In March 1996, a
request for reexamination of the '887 patent was filed in the Patent
Office. An order granting the request for reexamination of the '887
patent was issued by the Patent Office in May 1996. These patent claims
are the subject of an ongoing reexamination proceeding at the U.S. Patent
and Trademark Office (PTO), which presently rejects certain claims over
scientific literature principally representing prior art considered by the
PTO previously, during primary examination. Cistron is seeking to have
the rejection withdrawn or overruled on the merits. Cistron also has
petitioned to terminate the reexamination as improper, because the PTO
relies on prior art invoked during primary examination, contravening what
Cistron deems controlling legal precedent. However, as part of settlement
of the Company's litigation against Immunex, this patent has been assigned
to Cistron.
8
<PAGE>
On September 28, 1993, the Company filed suit in the U.S. District
Court, District of New Jersey, against Immunex Corporation alleging
misappropriation of trade secrets related to IL-1 and seeking damages
therefor.
In November 1996, Cistron and Immunex agreed to settle all Cistron's
claims against Immunex and two former Immunex officers. Under the terms
of settlement, Immunex agreed to pay Cistron an aggregate of $21 million
($11 million November 1996, $3 million per year in November 1997, 1998,
and 1999, and $1 million in November 2000) and to assign certain IL-1
patents to Cistron. As of the date of this report, Immunex had paid
Cistron the installments due in November 1996 and 1997.
Government Regulation
The manufacturing and marketing of pharmaceutical products requires
the approval of the FDA and comparable agencies in foreign countries. The
FDA has established mandatory procedures and safety standards which apply
to the clinical testing, manufacture and marketing of pharmaceutical
products. The process of obtaining FDA approval for a new therapeutic
drug may take several years and often involves the expenditure of
substantial resources. The steps required before a product can be
produced and marketed for human use include preclinical studies, the
filing of an Investigational New Drug ("IND") application, human clinical
trials and the approval of a New Drug Application ("NDA"), a process which
may take several years.
Preclinical studies are conducted in the laboratory and in animal
model systems to gain preliminary information on the drug's efficacy and
to identify major safety problems. The results of these studies are
submitted to the FDA as part of the IND application before approval can be
obtained for the commencement of testing in humans.
The human clinical testing program involves three phases. Phase I
studies are conducted on volunteers or, in the case of antitumor agents,
on patients with terminal disease, to determine the maximum tolerated dose
and any side effects of the product. Phase II studies are conducted on
patients having a specific disease to determine the product's efficacy and
the most effective doses and schedules of administration. Phase III
involves wide-scale studies on patients with the same disease in order to
provide comparison with currently available drugs or biologics. Data from
Phase I, II and III trials are submitted in an NDA. The NDA involves
considerable data collection, verification and analysis, as well as the
preparation of summaries of the manufacturing and testing processes, pre-
clinical and clinical trials. The FDA must approve the NDA before the
drug may be marketed.
The manufacture and marketing of in-vitro diagnostic products
requires compliance with regulations, which, generally, are less difficult
to comply with then those covering pharmaceuticals. In the United States,
many diagnostic products may be accepted by the FDA pursuant to a 510(k)
application. Such application must contain information which establishes
that the product in question is "substantially equivalent" to similar
diagnostic products already in general use. The FDA has 90 days within
which to respond to such application. Failure to obtain acceptance under
the 510(k) application process would require an approval process involving
lengthy and detailed laboratory and clinical testing, other costly and
time-consuming procedures and extensive delays.
The manufacture, marketing and sale of the products sold by the
Company to the research market are not subject to FDA regulatory approval.
The Company's business is also subject to regulation under the
Occupational Safety and Health Act, the Environmental Protection Act, the
Nuclear Energy and Radiation Control Act, the Toxic Substance Control Act
and the Resource Conservation and Recovery Act.
The Company believes that it complies with the National Institutes of
Health guidelines for recombinant DNA research.
Competition
Many companies, including large pharmaceutical and biotechnology
firms with financial resources and research, development and marketing
staffs and facilities substantially greater than those of Cistron, are
engaged in researching and developing products similar to those under
development by the Company. The industry is characterized by rapid
technological advances and competitors may develop comparable products
more rapidly and/or effectively than those under development by Cistron.
There can be no assurance that there will not be technological
developments or break-through in the industry by others that would
significantly reduce the competitiveness of the Company's products.
9
<PAGE>
Several companies have introduced IL-1 products to the research
market in competition to those of the Company. The Company has notified
others engaged in IL-1 products of the Company's license to IL-1 patents.
Manufacturing
Although the Company's present manufacturing capacity is limited, it
produces substantially all the products it is selling to the research
market.
Employees
The Company has six full-time employees, consisting of its Chairman,
its Vice President of Operations and Product Development, an
Administrative Assistant, the Research Manager and two other scientists.
The Company also employs a part-time manufacturing worker. None of the
Company's employees are represented by a union or are covered by a
collective bargaining agreement. All employees of the Company have
entered into agreements under which they are required to keep all
information with regard to the business of the Company confidential and to
assign to the Company any inventions relating to the Company's business
made by them while in the Company's employment. The Company believes its
relations with its employees are excellent.
Item 2. Properties.
The Company leases approximately 12,500 square feet of combined
laboratory and office space at 10 Bloomfield Avenue, Pine Brook, New
Jersey at a base annual rental of approximately $126,000 (subject to
increases based on the Consumer Price Index) plus utilities and taxes.
The current lease agreement, as amended, is in effect through October
2002. The facility contains tissue culture, immunology, protein
biochemistry, molecular biology and product development laboratories, all
of which the Company believes are adequate for their present and
anticipated future use.
The Company owns all equipment required for its current operations;
such equipment is in satisfactory condition.
Item 3. Legal Proceedings.
See Item 1 - Business - Patent Protection.
On August 1, 1997, the Company filed suit in the circuit Court of
Fairfax County (Virginia) against Rebuild, L.L.C. ("Rebuild") and against
Henry Grausz, M.D., Cistron's former chairman, to collect $230,000 (plus
interest and attorney's fees) loaned to Rebuild under a short-term note,
originally due May 15, 1997. The loan was personally and unconditionally
guaranteed by Dr. Grausz who is a member of Rebuild. On October 10, 1997,
judgment was entered in favor of the Company in the Circuit Court of
Fairfax County (Virginia) against Rebuild, LLC and Henry Grausz. The
judgment was for $230,000 loan principal plus interest and attorneys'
fees. In December 1997, Dr. Grausz filed a petition under Chapter 11 of
the Federal Bankruptcy Code. The Company is an unsecured creditor as to
the judgment against Dr. Grausz entered in favor of the Company in October
1997. As of the date of this report, Dr. Grausz had not filed a
reorganization plan.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
10
<PAGE>
PART II
Item 5. Market for the Registrant's Securities and Related Stockholder
Matters.
The Company's Common Stock, par value $.01 per share (the "Common
Stock") is traded in the over-the-counter market through the National
Association of Securities Dealers' Non-NASDAQ OTC Electronic Bulletin
Board under the symbol "CIST". The following table sets forth the high
and low closing bid prices for the Common Stock, as reported by the
National Quotation Bureau, Inc., for each calendar quarter during the
period from July 1, 1996. The prices reflect inter-dealer quotations
without adjustment for retail markups, markdowns or commissions and may
not represent actual transactions.
<S> <C> <C>
Fiscal Year 1997 High Low
- ---------------- ----- -----
First Quarter (July 1996 - Sept. 1996)......... $ .44 $ .25
Second Quarter (Oct. 1996 - Dec. 1996).......... .43 .26
Third Quarter (Jan. 1997 - March 1997)......... .35 .23
Fourth Quarter (April 1997 - June 1997)......... .28 .19
Fiscal Year 1998 High Low
- ---------------- ----- -----
First Quarter (July 1997 - Sept. 1997)......... $ .30 $ .23
Second Quarter (Oct. 1997 - Dec. 1997).......... .29 .17
Third Quarter (Jan. 1998 - March 1998)......... .26 .16
Fourth Quarter (April 1998 - June 1998)......... .18 .16
Fiscal Year 1999
- ----------------
First Quarter (through August 31, 1998)......... $ .42 $ .24
On August 31, 1998, the closing bid and asked prices for the Common
Stock were $.24 and $.28
On August 31, 1998, there were approximately 735 holders of the
Common Stock, excluding beneficial holders registered in nominee or street
name.
No cash dividends have been declared or paid on the Common Stock.
The Company does not anticipate paying dividends on the Common Stock in
the foreseeable future.
Item 6. Selected Financial Data.
The following selected financial data are derived from the Company's
financial statements and should be read in conjunction with and are
qualified in their entirety by the financial statements, related notes and
other financial information included elsewhere in this report.
11
<PAGE>
Summary of Operations:
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1994 1995 1996 1997 1998
------------ ------------ ------------ ------------ -----------
Statement of Operations:
Sales........................................ $ 874,627 $ 649,949 $ 562,161 $ 620,180 $ 555,205
Cost of Sales................................. 359,177 341,041 320,429 320,749 309,678
---------- ---------- ---------- ---------- ---------
Gross Profits................................. 515,450 308,908 241,732 299,431 245,527
Other Income:
Litigation settlement, net................... - - - 14,684,206 -
License fee and funded research.............. 5,000 985,000 405,000 405,419 205,000
Expenses:
Research and development..................... 63,992 62,372 111,515 177,663 547,565
Administrative & marketing................... 546,968 768,101 1,473,523 1,394,377 1,045,820
Occupancy.................................... 184,250 187,024 194,779 210,516 198,515
---------- ---------- ---------- ---------- ---------
Total expenses................................ 795,210 1,017,497 1,779,817 1,782,556 1,791,900
---------- ---------- ---------- ---------- ---------
Operating income (loss)....................... (274,760) 276,411 (1,133,085) 13,606,500 (1,341,373)
Interest income.............................. 908 8,565 26,919 230,744 572,865
---------- ---------- ---------- ---------- ---------
Net income (loss) before income taxes......... (273,852) 284,976 (1,106,166) 13,837,244 (768,508)
Income taxes.................................. - 5,700 - 1,491,290 (292,029)
---------- ---------- ---------- ---------- ---------
Net income (loss) $ (273,852) $ 279,276 $ (1,106,166) $ 12,345,954 $ (476,479)
========== ========== ========== ========== =========
Per Share:
Net income (loss) - basic.................... $ (0.01) $ 0.01 $ (0.04) $ 0.42 $ (0.02)
Net income (loss) - diluted.................. $ (0.01) $ 0.01 $ (0.04) $ 0.40 $ (0.02)
Weighted average number of shares - basic..... 26,882,990 27,522,928 26,882,990 29,054,308 24,955,077
Weighted average number of shares - diluted... 26,882,990 28,162,207 26,882,990 31,227,049 24,955,077
Balance Sheet Data (at end of period):
---------------------------------------------------------------------
1994 1995 1996 1997 1998
----------- ------------ ------------ ------------ -----------
Cash and equivalents.......................... $ 154,270 $ 891,152 $ 359,600 $ 6,368,228 $ 5,832,031
Current assets................................ 319,031 1,050,928 601,986 9,428,290 9,207,222
Property and equipment (1).................... 31,023 10,564 6,006 31,284 26,218
Total assets.................................. 407,161 1,115,949 659,799 15,757,861 12,999,481
Total liabilities............................. 180,873 610,384 1,260,400 4,012,154 2,057,024
Shareholders' equity (deficiency) (2)......... 226,288 505,565 (600,601) 11,745,707 10,942,457
Working capital .............................. 138,158 708,642 89,224 7,807,206 8,052,372
------------------------------
(1) Net of depreciation.
(2) Net of deficit accumulated during development stage.
12
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
Certain statements in this discussion and analysis constitute
forward-looking statements, are not historical facts, and involve risks
and uncertainties that could cause actual results to differ from those
expected and projected. Such risks and uncertainties include but are not
limited to: (i) general economic conditions; (ii) conditions specific to
the biotechnology industry; (iii) the Company's ability to develop or
acquire new technology or products through licensing, merger or
acquisition and obtain regulatory approval to commercialize diagnostic or
therapeutic products; (iv) the effectiveness and ultimate market
acceptance of any such products; (v) limitations on third party
reimbursements with respect to any such products; and (vi) competition.
The Company does not undertake to update or revise any forward-looking
statements contained herein whether as a result of new information, future
events or otherwise.
Results of Operations
The Company sells its products to the research market and have not
generated significant revenues therefrom. None of its products have been
submitted to or received approval from the Food and Drug Administration
for the sale of such products to the diagnostic or therapeutic markets.
The Company believes it is a development stage enterprise because
planned principal operations has not yet commenced. The Company's planned
principal operations include the development of clinical and therapeutic
products for distribution through pharmaceutical and diagnostic companies.
This requires the approval of the Company's products by the Food and Drug
Administration ("FDA"). At June 30, 1998, none of the Company's products
had received such approval. In addition, the Company continues to devote
most of its efforts to activities such as research and development,
financial planning and developing markets which are typical activities for
a development stage enterprise. Specifically, the Company has expended
funds relating to the dental assay and vaccine adjuvant programs. With
respect to financial planning, in late 1997, the Company engaged the
services of BlueStone Capital Partners, LP ("Bluestone") to act as
Cistron's financial advisor as to corporate strategic and financial
initiatives. Accordingly, as the Company has not yet commenced principal
operations and is devoting most of its efforts to activities typical of a
development stage enterprise as outlined in Statement of Financial
Accounting Standards No.7, the Company believes that it continues to be in
the development stage.
Fiscal 1998 and Fiscal 1997 (Year Ended June 30, 1997)
Sales decreased $64,975 (10.5%) in Fiscal 1998 as the result of lower
sales of bulk cytokine proteins and individual cytokine assay units,
offset, in part, by sales of bulk cytokine assays. Worldwide competition
continues to exert downward pressure on sales prices. In Fiscal 1998,
three customers accounted for approximately 69% of Fiscal 1998 sales and
in Fiscal 1997 four customers accounted for approximately 65% of sales.
After the close of Fiscal 1998, one customer that accounted for
approximately 24% of 1998 sales and 28% of 1997 sales announced that it
had sold its research products business to another company engaged in
research products sales. Loss of this customer, if a comparable new
customer is not found, or if the acquiring company (a company which is a
protein customer of Cistron's) does not maintain the purchasing volume of
the lost customer, could have a material adverse effect on the Company's
research product sales. Domestic sales accounted for approximately 67% of
the Company's 1998 sales and 82% of 1997 sales while exports accounted for
approximately 33% of 1998 sales and 18% of 1997 sales.
Cost of sales decreased $11,071 (3.5%) due to the lower sales volume
and due to lower manufacturing salary expense, offset, in part, by higher
manufacturing material expense. The gross profit margin decreased to 44%
in Fiscal 1998 from 48% in Fiscal 1997.
In Fiscal 1998, the Company received $200,000 of funded research and
development fees which concluded the funding pursuant to the Research and
Development Agreement between the Company and R&D Systems, under which R&D
Systems was obligated to make 10 quarterly payments of $100,000 each to
the Company. During Fiscal 1997, the Company received $400,000 under this
agreement. The Company in its sole discretion may determine the timing
and amount of research and development expenditures from the ten, $100,000
quarterly funded research payments it received from R&D Systems. The
Company has no obligation to repay any of the funds, whether or not such
funds are expended by the Company. The Company settled litigation against
Immunex and PeproTech during Fiscal 1997 which resulted in an aggregate
$14.3 million being recorded as other income, net of amounts owed to
counsel and the Institutions, and discounted to reflect the current value
of amounts to be received in fiscal years 1998, 1999, 2000 and 2001.
13
<PAGE>
Operating expenses increased $9,344 (0.5%) in Fiscal 1998 from the
prior year. Research expenses increased $369,902 (208.2%) due to increased
external research funding and consulting expenses regarding the dental
assay, vaccine adjuvent and other research programs. Research salary
expense also increased compared to the prior year due to the hiring of an
additional scientist. Administrative and marketing expenses decreased
$348,557 (25.0%) as a result of lower legal expenses due to the settlement
of litigation in Fiscal 1997, offset, in part, by higher increased
insurance, travel and salary expenses. In addition, a reserve was
recorded in Fiscal 1997 for uncollectibility of a note receivable.
Occupancy expenses decreased $12,001 (5.7%) due to the closing of an
office temporarily leased during Fiscal 1997.
Interest income increased $342,121 due to the investment of cash
balances and net interest income of $274,524 recognized on accounts
receivable-other and accounts payable-other and other non-current
liabilities to reflect the increase in their present value.
Fiscal 1997 and Fiscal 1996 (Year Ended June 30, 1996)
Sales increased $58,019 (10.3%) in Fiscal 1997 as the result of
increased bulk cytokine protein sales, offset, in part, by lower sales of
bulk cytokine assays. Worldwide competition continues to exert downward
pressure on sales prices. In Fiscal 1997, four customers accounted for
approximately 65% of sales. In Fiscal 1996, two of these four customers
accounted for approximately 41% of 1996 sales. Loss of any of these
customers, if a comparable new customer is not found, would have a
material adverse effect on the Company's sales. Domestic sales accounted
for approximately 82% of the Company's 1997 sales and 75% of 1996 sales
while exports accounted for approximately 18% of 1997 sales and 25% of
1996 sales.
Cost of sales remained essentially unchanged, despite the increase in
sales as a result of higher sales of bulk protein products which have
lower material costs, offset by higher manufacturing salaries and use of
temporary personnel. The gross profit margin increased to 48% in Fiscal
1997 from 43% in Fiscal 1996.
In both Fiscal 1997 and 1996, the Company received $400,000 of funded
research and development fees, R&D pursuant to the Research and
Development Agreement between the Company and R&D Systems under which R&D
Systems is obligated to pay the Company $200,000 in Fiscal 1998. During
Fiscal 1997, the Company settled litigation against Immunex and PeproTech
which resulted in an aggregate $14.7 million being recorded as other
income, net of amounts owed to counsel and the Institutions, and
discounted to reflect the current value of amounts to be received in
fiscal years 1998, 1999, 2000 and 2001.
Operating expenses in aggregate remained essentially unchanged from
Fiscal 1996. Research expenses increased $66,148 (59.3%) due to increased
external research funding and consulting expenses regarding the dental
assay and vaccine adjuvent programs, and higher research material usage
and the hiring of an additional research scientist. Administrative and
marketing expenses decreased $79,146 (5.4%) due to lower legal expenses
due to the settlement of outstanding litigation, offset, in part, by
providing a reserve for uncollectibility of a note receivable, and by
higher salary, consulting and advertising expenses. Occupancy expenses
increased $15,737 primarily due to temporarily leasing office space.
Interest income increased $203,825 in Fiscal 1997 as a result of
investing higher cash balances.
The Company recorded taxes of $1.5 million in Fiscal 1997 of which
$885,000 was deferred for payment in subsequent years.
Liquidity and Capital Resources
At June 30, 1998, the Company had current assets of $9,207,222,
including cash of $5,832,031. The Company made an operating profit in
Fiscal 1997, but incurred a loss in Fiscal 1998. There can be no
assurance that operations will return to profitability. Fiscal 1997's
profit was largely due to favorable litigation settlements.
There were no capital expenditure commitments outstanding at June 30,
1998.
Under the terms of the settlement agreement with Immunex, the Company
received $11 million in Fiscal 1997 and $3 million in Fiscal 1998 and will
receive $3 million per year in each of Fiscal years 1999 and 2000 and $1
million in Fiscal 2001. From this aggregate $21 million settlement, the
Company is obligated to make payments to counsel and the Institutions,
resulting in net (pre-tax) proceeds of approximately $14.3 million to the
Company. Management intends to use these funds to add staff and to
support research programs through Fiscal 1999 and beyond.
14
<PAGE>
In September 1997, the Company engaged the services of BlueStone
Capital Partners, LP to act as Cistron's financial advisor as to corporate
strategic and financial initiatives. In this regard, the Company has held
exploratory discussions with several biotechnology and pharmaceutical
companies regarding possible strategic alliances including joint ventures,
mergers or the sale of the Company. The Company's agreement with BlueStone
was not renewed at its expiration in September 1998. Cistron has
solicited proposals from other firms to provide such services.
As a result of these discussions, on June 30, 1998, Cistron and PMC,
the world's largest vaccine manufacturer, entered into a letter of intent
for an option and license agreement pertaining to the use of IL-1 as a
vaccine adjuvant in the fields of preventive and therapeutic vaccines.
Under the terms of the letter of intent, which is subject to execution of
definitive agreements on or before October 30, 1998, PMC intends to
purchase 1.3 million shares of Cistron's common stock at $.75 per share
and Cistron intends to grant PMC a three year warrant to purchase a number
of additional shares (which amount will be mutually agreed upon) such that
if the warrant is exercised, the weighted average price per share when
combined with the shares purchased at $.75 each, would be above Cistron's
$.48 per share book value at March 31, 1998. Additionally, PMC intends to
fund $900,000 of research for IL-1 adjuvant related projects and, PMC
intends to independently perform preclinical work during the three-year
option period. The letter of intent also sets out license and milestone
payments, based on advancement of products through clinical trials and
regulatory approvals, which could entitle Cistron to receive an aggregate
$31 million. Should PMC market products using IL-1 as an adjuvant,
Cistron would also receive royalties. There can be no assurance that the
parties will enter into definitive agreements or if definitive agreements
are entered into that they will contain the terms and conditions set forth
above or that product development milestones will e achieved.
Management believes the Company will have sufficient funds to support
its current programs through Fiscal 1999 and beyond.
Impact of Inflation
For the Company's three most recent fiscal years, inflation and
changing prices have had no material impact on the Company's sales,
revenues or income from continuing operations.
Year 2000
The Company is aware of the issues associated with the programming
code in existing computer systems as the millennium ("Year 2000")
approaches.
The Company's accounting systems are primarily manual in nature,
however, the Company does utilize a PC based software package for certain
applications. In the event this software should become non-operational,
the Company would have the ability to record all transactions on a manual
basis due to the small number of transactions processed.
The Company has not yet determined the impact of the Year 2000 on its
customers and suppliers, nor has the Company developed a contingency plan
in the event its customers or suppliers are unable to conduct business as
a result of the Year 2000. However, management does not believe there
will be any material impact on the Company or its operations.
Item 8. Financial Statements and Supplementary Data.
The response to this Item is submitted in a separate section of
this Report on page F-1.
Item 9. Changes In and Disagreements with Accountants
on Accounting and Financial Disclosure.
Not applicable.
15
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant.
The following table sets forth each current Director and executive
officer of the Company, together with his age and office held:
Name Age Office
- ---- --- ------
<S> <C> <C>
Bruce C. Galton 46 Chairman and CEO,
Chief Financial Officer,
Treasurer and Director
Richard S. Dondero 48 Vice President of
Operations and
Product Development
Thomas P. Carney, Ph.D. 83 Director
Robert W. Naismith, Ph.D. 53 Director
Franklin J. Iris 68 Director
Frank G. Stout 49 Director
Bruce C. Galton has been Chairman and CEO since July 1998 and was
President, Chief Operating and Financial Officer and a director since
November 1988. Prior to November 1988, Mr. Galton was Vice President and
Chief Financial Officer, Secretary and Treasurer of the Company since
January 1985. From 1977 to 1984, Mr. Galton was employed in various
capacities by Becton Dickinson & Co. Mr. Galton was Manager of Cost and
Budgets at Becton's B-D Immunodiagnostics division from August 1983 to
December 1984 and Financial Manager of its Becton, Dickinson Laboratory
Systems Division from May 1981 to August 1983. He holds a B.S. from the
University of Virginia and an MBA from Fairleigh Dickinson University.
Richard S. Dondero has been Vice President-Operations and Product
Development since May 1991. Mr. Dondero joined the Company in 1985 and
was named Director of Operations in 1988. From 1977 to 1985, Mr. Dondero
was employed by Ortho Diagnostics. Mr. Dondero holds a master of science
degree (biology) from Seton Hall University and a bachelor of arts degree
(biology and chemistry) from Jersey City State College.
Thomas P. Carney, Ph.D. has been a director of the Company since
September 1989. Dr. Carney has been Chairman and CEO of Metatech
Corporation, which develops medical devices, since it was organized in
1976. Prior to forming Metatech Corporation, Dr. Carney was an Executive
Vice President of G.D. Searle & Company (1965-1976) and was Vice President
of Research and Development of Eli Lilly and Company prior to joining
Searle. Dr. Carney holds a B.S. in chemical engineering from the
University of Notre Dame and Masters and Ph.D. degrees from Pennsylvania
State University.
Frank G. Stout has been the Vice President-Research Administration of
New England Medical Center Hospitals, Inc. (Tufts University) since 1983.
Prior to 1983, Mr. Stout was Assistant Director of Research Administration
of the Center for the Advancement of Research and Biotechnology. Mr.
Stout received his B.Sc. in Biology from the University of South Dakota
and his MPH in Health Administration from the Tulane Medical Center.
Robert W. Naismith, Ph.D. was elected a director in January 1998.
Since July 1998, Dr. Naismith has been Chairman and CEO of Genome
Securities, Inc. an investment banking firm focused on healthcare and the
life sciences industry. From October 1996 to April 1998, he was Managing
Director of Healthcare at BlueStone Capital Partners, L.P. Dr. Naismith
serves as a director or trustee of several private and public companies
and was a co-founder and held senior management positions in private and
public companies during his over two decades in the biotech/pharmaceutical/
medical device industry. Organizations for which Dr. Naismith serves as
a director or trustee are Penn Security Bank and Trust Company, Marion
Nichols Corporation, Pennsylvania Regional Tissue Bank, International
Institute for the Advancement of Medicine, and the William Harvey Research
Foundation. He holds a Ph.D. in Genetics and maintains academic appointments
at three universities.
Franklin J. Iris was appointed as a director in July 1998. Mr. Iris
has over 25 years of experience as an executive and consultant in the
health care industry. He is founder (1985) and principal of Iris &
Associates, an investment consulting and acquisition services firm. He
also serves as a director of several health care companies, including
Photon Technology, Cytec Corporation, Serex, Inc. and Enzymatics. Mr.
Iris was previously president of the Laboratory Group and a corporate vice
president with Becton Dickinson and Company.
16
<PAGE>
All directors hold office until the next annual meeting of
stockholders and until their successors are elected and qualified.
Officers hold office until their successors are chosen and qualify,
subject to earlier removal by the Board of Directors and subject to
rights, if any, under contracts of employment. As part of the Company's
Chapter 11 settlement agreement, the Institutions have the right to
designate one individual nominated by management to the Board of
Directors. If Cistron is consolidated or merged or acquired by a third
party whose primary products and/or interest is in areas other than IL-1,
its variants, derivatives or applications, Cistron will no longer be
obligated to appoint such a representative and the representative of the
Institutions then acting as a Director of Cistron will resign. Currently,
Mr. Frank G. Stout is the Institutions' designee on the Board. Under its
agreement with the Company, BlueStone had the right to nominate Dr.
Naismith to the Company's Board of Directors after the initial six-month
engagement period providing that the agreement continued in effect. Dr.
Naismith was nominated and, at the stockholders meeting in January 1998
was elected a director.
___________________________________
Item 11. Executive Compensation
The following table sets forth a summary of the compensation earned
in each of the last three fiscal years by each Chief Executive Officer and
by the only other executive officer whose cash compensation during such
year exceeded $100,000 in fiscal year 1998.
SUMMARY COMPENSATION TABLE
===============================================================================
Long-Term Compensation
Annual ----------------------
Compensation Awards
-------------------------------------------
<S> <C> <C> <C> <C>
Name and Fiscal Common Stock
Principal Position Year Salary($) Bonus($) Underlying Options(#)
- -------------------------------------------------------------------------------
Henry Grausz, M.D. 1998 --- --- ---
former Chairman and CEO 1997 $ 31,385 (1) --- ---
1996 --- --- ---
Bruce C. Galton 1998 $ 210,000 $ 100,000 10,150
Chairman and CEO 1997 $ 187,500 $ 50,000 ---
Chief Financial Officer (2) 1996 $ 156,667 --- 784,000
Richard S. Dondero 1998 $ 101,000 --- ---
Vice President - 1997 $ 95,833 $ 50,000 ---
Operations and Product 1996 $ 90,000 --- 31,546
Development
===============================================================================
(1) Dr. Grausz resigned as Chairman and director in May 1997 and received
consulting fees of $10,000 per month from May 21 to July 31, 1997.
Prior to his resignation, Dr. Grausz received a salary of $10,000 per
month from the period of February 15 to May 20, 1997.
(2) Mr. Galton served as Acting Chairman and CEO from May 1997 to July
1998.
OPTION GRANTS IN LAST FISCAL YEAR (1998)
- -------------------------------------------------------------------------------
INDIVIDUAL GRANTS
===============================================================================
<S> <C> <C> <C> <C>
Percent of total
Number Of Securities Options Granted
Underlying Options to Employee In Exercise Price Expiration
Name Granted Fiscal Year ($/Share) Date
- -------------------------------------------------------------------------------
Bruce C. Galton 10,150 100% $ .255 2007
Chairman and CEO,
Chief Financial
Officer
===============================================================================
<PAGE> 17
The following table sets forth information concerning exercised options
in the fiscal year ended June 30, 1998 by the executive officer listed in
the Summary Compensation Table and certain information concerning
unexercised options held at June 30, 1998 by the executive officer listed
in the Summary Compensation:
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND OPTION VALUES AT JUNE 30, 1998
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Value of Unexercised
Number of Unexercised In-the-Money
Options at June 30, 1998 Options at June 30, 1998 (2)
Shares Acquired Value ------------------------- ----------------------------
Name On Exercise(#) Realized($) Exercisable Unexercisable Exercisable Unexercisable
=======================================================================================================
Henry Grausz, MD --- --- 259,587 --- $ 39,587 ---
Bruce C. Galton 45,197 $ 8,646(1) 171,810 1,194,150(3) $ 24,984 ---
Richard S. Dondero --- --- 150,176 281,546(3) $ 15,027 ---
=======================================================================================================
(1) Based on the average of the closing bid and asked prices on the
date of exercise of $.255 per share compared to the exercise price of
$.0637 per share.
(2) Based on the average of the closing bid and asked prices on June
30, 1998 of $.1725 per share.
(3) Unexercisable options for Mr. Galton to purchase 1,194,150
shares and for Mr. Dondero to purchase 281,546 shares are
out-of-the-money.
In April 1994, Mr. Galton and Mr. Dondero each entered into a new
five-year employment contract with the Company expiring in April 1999.
The employment agreements also contain a confidentiality provision that
requires Mr. Galton and Mr. Dondero to maintain as confidential any
confidential information obtained during the course of employment for the
period of such agreement and for three years after termination thereof.
The employment agreement of Mr. Galton provides that in the event the
employment of Mr. Galton is terminated without cause by the Board of
Directors, or if the Company refuses to renew the employment agreement of
Mr. Galton, then upon his written request, the Company will (i) pay Mr.
Galton an amount equal to six months of Mr. Galton's current salary in
equal monthly installments, commencing the month in which the termination
occurs or the salary which would be due under the remaining unexpired term
of the agreement, whichever is greater, (ii) enter into a consulting
contract with Mr. Galton at full pay and benefits for a minimum of three
months and (iii) lend Mr. Galton such amount as may be required to
exercise any stock options then exercisable by Mr. Galton to purchase
shares of the Company's Common Stock.
The employment agreement also provides that in the event the Company
relocates during the term of the employment agreement, and Mr. Galton
relocates with the Company, the Company will reimburse Mr. Galton for all
relocation costs and pay Mr. Galton a bonus of $25,000 upon completing
such relocation. If Mr. Galton chooses not to relocate with the Company,
he will receive the applicable termination pay described in clauses (i)
and (iii) of the preceding paragraph plus an additional three months
salary as severance pay.
During Fiscal 1998, the Company maintained a "key man" life insurance
policy on the life of Mr. Galton in the amount of $1,000,000. This policy
was renewed for Fiscal 1999.
Starting in Fiscal 1996, directors who are not employees received a
retainer fee of $1,200 per annum and $500 for each meeting of the Board of
Directors attended. From Fiscal 1996 through Fiscal 1998, Dr. Isidore Edelman,
who was a director until July 1998, was paid at the rate of $200 per hour for
any scientific consulting services he performed at the Company's request.
During Fiscal 1998, Dr. Edelman was paid an aggregate of $4,500 for such
consulting services. Directors who are independent of the Company also
receive options to purchase 50,000 shares of Common Stock for each year of
service as such, up to a total of 150,000 shares. Mr. Stout has agreed to
serve without cash compensation and without receipt of stock options.
18
<PAGE>
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth information as of August 31, 1998 with
respect to the beneficial ownership of Cistron's Common Stock by (i) each
person known by Cistron to own beneficially more than five percent of such
Common Stock, (ii) each Director, (iii) each executive officer named in
the Summary Compensation Table under Item 11, and (iv) all Directors and
executive officers as a group, together with their percentage ownership of
such shares:
Name and Address of Shares
Beneficial Owner Beneficially Owned Percent Outstanding
- --------------------------------------------------------------------------
Henry Grausz, M.D. 5,817,993 (1) 25.0%
5910 Bradley Boulevard
Bethesda, MD 20814
Isidore S. Edelman, M.D.(2) 2,411,681 (3) 10.5
Bruce C. Galton (4) 1,411,157 (5) 5.8
Thomas P. Carney, Ph.D. 150,000 (6) *
Frank G. Stout 600 (7) *
Robert S. Naismith, Ph.D. --- (8) ---
Richard S. Dondero 447,207 (9) 1.9
Frank J. Iris --- ---
All directors and executive 2,008,964 (10) 8.1
officers as a group (6 persons)
* less than 1%
(1) Includes 259,587 shares issuable upon currently exercisable options.
(2) Address is 464 Riverside Drive #61, New York, NY 10027.
(3) Includes 54,374 shares issuable upon currently exercisable
options, but does not include 194,935 shares owned by Dr. Edelman's
spouse, as to which he disclaims beneficial ownership.
(4) c/o Cistron Biotechnology, Inc. 10 Bloomfield Avenue, Pine Brook,
New Jersey 07058
(5) Includes 1,365,960 shares issuable upon exercise of currently
exercisable options.
(6) Consists of shares issuable upon exercise of currently exercisable
options.
(7) Mr. Stout disclaims beneficial ownership of 302,289 shares and
136,870 shares owned as of August 31, 1998 by the New England
Medical Center Hospitals, Inc. and Wellesley College, respectively,
the Institutions of which Mr. Stout serves as designee on the
Company's Board of Directors.
(8) Dr. Naismith disclaims beneficial ownership of currently exercisable
warrants to purchase 400,000 shares of Common Stock as held by
BlueStone Capital Partners, L.P. of which Dr. Naismith was a
consultant and a former Managing Director.
(9) Includes 431,722 shares issuable upon exercise of currently
exercisable options.
(10) Includes options described in notes (5), (6) and (9).
_____________________________
19
<PAGE>
Item 13. Certain Relationships and Related Transactions
On August 1, 1997, the Company filed suit against Rebuild, L.L.C.
("Rebuild") and against Henry Grausz, M.D., Cistron's former
chairman, to collect $230,000 (plus interest and attorney's fees)
loaned to Rebuild under a short-term note, originally due May 15,
1997. The loan was personally and unconditionally guaranteed by
Dr. Grausz who is a partner in Rebuild. On October 10, 1997,
judgment was entered in favor of the Company and in December 1997,
Dr. Grausz filed a petition under Chapter 11 of the Federal
Bankruptcy Code.
In September 1997, the Company engaged the services of BlueStone
Capital Partners, LP ("BlueStone")to act as Cistron's financial
advisor as to corporate strategic and financial initiatives. The
initial engagement was for a period of six months and was renewed
for an additional six months upon mutual consent of the parties.
That agreement expired in September 1998 and the Company is
currently soliciting the support of another investment banking
firm. The Company paid BlueStone Capital $90,000 for the initial
six-month period and issued warrants to purchase 400,000 shares of
the Company's common stock at $.25 per share. Cistron paid
BlueStone $10,000 per month under the renewed agreement (or
$150,000 in the aggregate). The Company would be obligated to make
payments including certain percentage fees as well as to issue
additional warrants to BlueStone to purchase up to an additional
400,000 shares at $.25 per share should BlueStone assist Cistron in
completing a merger, acquisition, joint venture, partnership,
license or contract. Cistron will be obligated to issue the
additional warrants to purchase 400,000 shares of the Company's
common stock at $.25 per share and pay 7% of the equity and
research payments ($133,000 in aggregate fees) to BlueStone should
the Company execute definitive agreements with PMC as BlueStone
assisted Cistron by introducing the parties. Cistron also would be
obligated to pay BlueStone 7% of any license fees or milestone
payments PMC may make to Cistron should PMC enter into definitive
agreements and exercise its option under such. Robert Naismith,
Ph.D., who has been a director of the Company since January 1998,
was a Managing Director of BlueStone until April 1998.
_________________________________________
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) and (d) Financial Statements and Schedules.
See Index to Financial Statements on page F-1.
(b) Reports on Form 8-K.
None.
(c) Exhibits.
See Index to Exhibits on page E-1.
Exhibits 10.2a, 10.3a, 10.9 and 10.17 relate to management
compensatory agreements
and stock option plans.
20
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report on
Form 10-K to be signed on its behalf by the undersigned, thereunto duly
authorized, in the town of Pine Brook, State of New Jersey, on the 24th day
of September, 1998.
CISTRON BIOTECHNOLOGY, INC.
By: BRUCE C. GALTON
---------------
Bruce C. Galton
Chairman of the Board, and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of
the registrants and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/BRUCE C. GALTON Chairman and Chief Executive September 24, 1998
- ---------------------------- Officer, Chief Financial
Bruce C. Galton Officer and Director
(Principal Financial and
Accounting Officer)
/s/THOMAS P. CARNEY, Ph.D. Director September 24, 1998
- ----------------------------
Thomas P. Carney, Ph.D.
/s/FRANK G. STOUT Director September 24, 1998
- ----------------------------
Frank G. Stout
/s/ROBERT W. NAISMITH, Ph.D. Director September 24, 1998
- ----------------------------
Robert W. Naismith, Ph.D.
/s/FRANKLIN J. IRIS Director September 24, 1998
- ----------------------------
Franklin J. Iris
21
<PAGE>
INDEX TO EXHIBITS
3.1 Registrant's Certificate of Incorporation.................... (1)
3.1a Registrant's Amendment to Certificate of Incorporation, dated
July 9, 1986.................................................. (1)
3.1b Registrant's Amendment to Certificates of Incorporation, dated
August 14, 1986............................................... (1)
3.2 Registrant's Amended By-laws.................................. (1)
10.1 Settlement Agreement, dated June 30, 1991, among Registrant,
E.I. du Pont de Nemours and Company and The DuPont Merck
Pharmaceutical Company........................................ (2)
10.2a Employment Agreement, dated April 30, 1994, between Registrant
and Bruce C. Galton........................................... (8)
10.3a Employment Agreement, dated April 30, 1994, between Registrant
and Richard S. Dondero........................................ (8)
10.5 Sponsored Research Agreement and License Agreement, effective
as of October 1, 1983 and December 1, 1983, respectively, each
between Registrant and the Institutions, named therein........ (1)
10.5a Amendments to Sponsored Research Agreement and License
Agreement, each dated July 9, 1986............................ (3)
10.5b Amendments to Sponsored Research Agreement and License
Agreement, each dated February 19,1987........................ (6)
10.5c Amendment to sponsored Research Agreement, dated May 6,1988... (4)
10.6 License Agreement, dated September 15, 1988, between Registrant
and Rijksuniversiteit of Limburg (Holland).................... (6)
10.6a License Agreement, dated September 15, 1993, between Registrant
and Rijksuniversiteit of Limburg (Holland).................... (6)
10.8 Lease, dated September 4, 1984, between Registrant and Stanley
Karczynski.................................................... (1)
10.8a First Amendment to Lease, dated February 10, 1989, between
Registrant and Stanley Karczynski............................. (6)
10.8b Second Amendment to Lease dated November 19, 1991, between
Registrant and Stanley Karczynski............................. (6)
10.8c Third Amendment to Lease dated November 1, 1997, between
Registrant and Stanley Karczynski............................. (11)
10.9 Registrant's 1985 Employee Stock Option Plan, as amended...... (5)
10.13 Settlement Agreement, dated May 17, 1993, between Registrant,
Biotech Australia Pty. Limited and the Institutions, named
therein....................................................... (7)
10.15 License Agreement, dated March 21, 1995, between Registrant and
Research and Diagnostic Systems,Inc........................... (9)
10.16 Research and Development Agreement, dated April 10, 1995,
between Registrant and Research and Diagnostics Systems, Inc.. (10)
10.17 1997 Incentive and Non-Incentive Stock Option Plan............ (12)
24.1 Consent of Deloitte & Touche LLP with respect to financial
information contained in the Registrant's Registration Statement
of Form S-8 (File No. 33-13704)............................... 41
27 Financial Data Schedule....................................... 42
____________________
(1) Filed as the same numbered Exhibit to the Registrant's Registration
Statement on Form S-1 (File No. 33-5824) (the "Form S-1") and
incorporated herein by reference thereto.
(2) Filed as Exhibit 10.2a to the Registrant's 1991 Report on Form 10-K
and incorporated herein by reference thereto.
E-1
<PAGE>
(3) Filed as Exhibit 10.12 to the Registrant's Form S-1 and incorporated
herein by reference thereto.
(4) Filed as Exhibit 28.1 to the Registrant's Report on Form 10-Q for the
quarter ended March 31, 1988 and incorporated herein by reference
thereto.
(5) Filed as Exhibit 4 to the Registrant's Registration Statement on Form
S-8 (File No. 33-13704) and incorporated herein by reference thereto.
(6) Filed as the same numbered Exhibit to the Registrant's 1992 Form 10-K
and incorporated herein by reference thereto.
(7) Filed as the same numbered Exhibit to Registrant's 1993 Form 10-K and
incorporated herein by reference thereto.
(8) Filed as the same numbered Exhibit to Registrant's 1994 Form 10-K and
incorporated herein by reference thereto.
(9) Filed as Exhibit 10.14 to the Registrant's Report on Form 10-Q for the
quarter ended March 31, 1995 and incorporated herein by reference
thereto.
(10) Filed as Exhibit 10.15 to the Registrant's Report on Form 10-Q for
the quarter ended March 31, 1995 and incorporated herein by reference
thereto.
(11) Filed as Exhibit 10.8c to the Registrant's Report on Form 10-Q for
the quarter ended March 31, 1998.
(12) Filed as Exhibit 10.17 to the Registrant's Report on Form 10-Q for
the quarter ended March 31, 1998.
E-2
<PAGE>
Cistron Biotechnology, Inc.
---------------------------
(A Development Stage Company)
-----------------------------
Index to Financial Statements and Schedules
-------------------------------------------
Years ended June 30, 1996, 1997 and 1998
----------------------------------------
<S> <C>
Financial Statements:
Independent Auditors' Report F-2
Balance Sheets F-3
Statements of Operations F-4
Statements of Shareholders' Equity F-5
Statements of Cash Flows F-8
Notes to Financial Statements F-10
* * * *
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To The Board of Directors and Shareholders
Cistron Biotechnology, Inc.
Pine Brook, New Jersey
We have audited the accompanying balance sheets of Cistron Biotechnology,
Inc. (a development stage company) as of June 30, 1998 and 1997, and the
related statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended June 30, 1998, and for the
period from February 2, 1982 (date of commencement of operations) to June
30, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of June 30, 1998 and
1997, and the results of its operations and its cash flows for each of the
three years in the period ended June 30, 1998, and for the period from
February 2, 1982 (date of commencement of operations) to June 30, 1998, in
conformity with generally accepted accounting principles.
The Company is in the development stage as of June 30, 1998. As discussed
in Note 1 to the financial statements, the Company has not generated
significant revenues and must obtain required regulatory approval of its
products for sale or license to the diagnostic and/or therapeutic market
in accordance with its business plan.
/Deloitte & Touche LLP/
Parsippany, New Jersey
September 11, 1998
F-2
<PAGE>
CISTRON BIOTECHNOLOGY, INC.
---------------------------
BALANCE SHEETS
--------------
June 30,
----------------------------
1997 1998
------------ ------------
ASSETS
- ------
<S> <C> <C>
CURRENT ASSETS:
Cash and equivalents $ 6,368,228 $ 5,832,031
Accounts receivable-trade 55,309 101,859
Accounts receivable-other 3,000,000 2,940,673
Inventories 4,278 3,635
Prepaid expenses 475 -
Taxes receivable - 329,024
Note receivable $230,000; reserve $230,000 - -
---------- ----------
TOTAL CURRENT ASSETS 9,428,290 9,207,222
ACCOUNTS RECEIVABLE - OTHER - Long Term 6,249,130 3,670,221
---------- ----------
<S> <C> <C>
PROPERTY AND EQUIPMENT:
Machinery and equipment 533,374 502,908
Furniture and fixtures 147,113 147,113
Leasehold improvements 77,674 77,674
---------- ----------
758,161 727,695
Less: Accumulated depreciation 726,877 701,477
---------- ----------
31,284 26,218
---------- ----------
SECURITY DEPOSIT 23,938 23,938
---------- ----------
PATENTS, Net of accumulated amortization of
$11,886 and $14,536 in 1997 and 1998, respectively 25,219 22,569
---------- ----------
DEFFERRED TAX ASSET - 49,313
---------- ----------
TOTAL ASSETS $ 15,757,861 $ 12,999,481
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
<S> <C> <C>
CURRENT LIABILITIES:
Accrued expenses and accounts payable $ 869,909 $ 114,894
Taxes payable 46,175 348,898
Other current liabilities 705,000 691,058
---------- ----------
TOTAL CURRENT LIABILITIES 1,621,084 1,154,850
---------- ----------
Deferred income taxes 885,090 -
---------- ----------
Other non-current liabilities 1,505,980 902,174
---------- ----------
COMMITMENTS AND CONTINGENT LIABILITIES (Note 7)
SHAREHOLDERS' EQUITY:
Common stock, $.01 par value 50,000,000 shares authorized,
issued and outstanding 26,884,990 shares and
26,930,187 shares, respectively 268,850 269,302
Additional paid-in capital 8,616,253 8,683,680
Earnings accumulated during the development stage 2,860,604 2,384,125
Treasury stock 3,946,500 shares at cost - (394,650)
---------- ----------
TOTAL SHAREHOLDERS' EQUITY 11,745,707 10,942,457
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 15,757,861 $ 12,999,481
========== ==========
See accompanying notes to financial statements
F-3
<PAGE>
CISTRON BIOTECHNOLOGY, INC.
---------------------------
STATEMENTS OF OPERATIONS
------------------------
February 2, 1982
(commencement of
Year ended June 30, operations) to
1996 1997 1998 June 30, 1998
-------------------------------------------------------------------
<S> <C> <C> <C> <C>
Sales $ 562,161 $ 620,180 $ 555,205 $ 9,414,985
Cost of sales 320,429 320,749 309,678 4,117,329
---------- ---------- ---------- ----------
Gross profit 241,732 299,431 245,527 5,297,656
Other income:
Litigation settlements, net - 14,684,206 - 14,684,206
License fees and funded research 405,000 405,419 205,000 4,111,149
Expenses:
Research and development 111,515 177,663 547,565 8,543,346
Administrative and marketing 1,473,523 1,394,377 1,045,820 11,207,062
Occupancy 194,779 210,516 198,515 2,470,965
---------- ---------- ---------- ----------
Total expenses 1,779,817 1,782,556 1,791,900 22,221,373
---------- ---------- ---------- ----------
Operating income/(loss) (1,133,085) 13,606,500 (1,341,373) 1,871,638
Interest (income)/expense - net (26,919) (230,744) (572,865) (880,564)
Other expense - - - 59,895
Amortization of deferred financing costs - - - 173,079
Acquisition expense - - - 429,620
---------- ---------- ---------- ----------
Income/(loss) before income taxes
and extraordinary credit (1,106,166) 13,837,244 (768,508) 2,089,608
Income tax provision/(benefit) - 1,491,290 (292,029) 1,467,799
---------- ---------- ---------- ----------
Income/(loss) before extraordinary credit (1,106,166) 12,345,954 (476,479) 621,809
---------- ---------- ---------- ----------
Extraordinary credit - benefit of tax loss
carry forward - - - 262,838
---------- ---------- ---------- ----------
Net Income/(loss) $ (1,106,166) $ 12,345,954 $ (476,479) $ 884,647
=========== ========== ========== ==========
Net income/(loss) per share $ (0.04) $ 0.42 $ (0.02)
=========== ========== ==========
Weighted average shares 26,882,990 29,054,308 24,955,077
Net income/(loss) per share- =========== ========== ==========
assuming dilution $ (0.04) $ 0.40 $ (0.02)
Weighted average shares outstanding - =========== ========== ==========
assuming dilution 26,882,990 31,227,049 24,955,077
=========== ========== ==========
See accompanying notes to financial statements
F-4
<PAGE>
CISTRON BIOTECHNOLOGY, INC.
---------------------------
STATEMENTS OF SHAREHOLDERS' EQUITY
----------------------------------
<S> <C> <C> <C> <C> <C> <C>
Earnings(Deficit)
accumulated Total
Partners' Capital/Common Stock Additional during the shareholders'
------------------------------ paid-in development equity/
Shares Amount capital stage Other (deficiency)
--------- -------------- ----------- ------------- ---------- --------------
Initial partners' contribution
- February 1982 - $ 74,929 $ - $ - $ - $ 74,929
Partnership net loss - - - (84,778) - (84,778)
---------- ---------- ---------- ----------- --------- -----------
BALANCE, June 30, 1982 - 74,929 - (84,778) - (9,849)
Partners' additional capital
contribution - 307,972 - - - 307,972
Partnership net loss - - - (313,776) - (313,776)
---------- ---------- ---------- ----------- --------- -----------
BALANCE, June 30, 1983 - 382,901 - (398,554) - (15,653)
Partners' additional capital
contribution - 924,392 - - - 924,392
Dissolution of partnership and
issuance of common stock 5,483,874 (1,252,454) 1,252,454 - - -
Issuance of common stock 6,594,331 65,943 1,486,105 (52,048) - 1,500,000
Partnership net loss - - - (1,152,972) - (1,152,972)
Reclassification of partnership
accumulated loss - - (1,551,526) 1,551,526 - -
Net loss - - - (418,697) - (418,697)
---------- ---------- ---------- ----------- --------- -----------
BALANCE, June 30, 1984 12,078,205 120,782 1,187,033 (470,745) - 837,070
Issuance of common stock 1,736,869 17,369 1,482,631 - - 1,500,000
Net loss - - - (2,039,016) - (2,039,016)
---------- ---------- ---------- ----------- --------- -----------
BALANCE, June 30, 1985 13,815,074 138,151 2,669,664 (2,509,761) - 298,054
Issuance of common stock 1,233,344 12,333 397,097 - - 409,430
Net loss - - - (1,962,251) - (1,962,251)
---------- ---------- ---------- ----------- --------- -----------
BALANCE, June 30, 1986 15,048,418 150,484 3,066,761 (4,472,012) - (1,254,767)
Initial public stock offering 5,750,000 57,500 4,539,212 - - 4,596,712
Issuance of common stock 623,772 6,238 396,686 - - 402,924
Net loss - - - (2,574,670) - (2,574,670)
---------- ---------- ---------- ----------- --------- -----------
BALANCE, June 30, 1987 21,422,190 214,222 8,002,659 (7,046,682) - 1,170,199
Issuance of common stock 231,157 2,311 253,693 - - 256,004
Note Receivable from director
for shares of stock - - - - (271,159) (271,159)
Net loss - - - (2,071,679) - (2,071,679)
---------- ---------- ---------- ----------- --------- -----------
BALANCE, June 30, 1988 21,653,347 $ 216,533 $ 8,256,352 $ (9,118,361) $ (271,159) $ (916,635)
========== ========== ========== =========== ========= ===========
See accompanying notes to financial statements
F-5
<PAGE>
CISTRON BIOTECHNOLOGY, INC.
---------------------------
STATEMENTS OF SHAREHOLDER'S EQUITY
----------------------------------
<S> <C> <C> <C> <C> <C> <C>
Earnings (Deficit)
accumulated Total
Additional during the shareholders'
Common Stock paid-in development equity/
Shares Amount capital stage Other (deficiency)
---------------------- ---------- ------------- ------------- -------------
BALANCE, June 30, 1988 21,653,347 $ 216,533 $ 8,256,352 $ (9,118,361) $ (271,159) $ (916,635)
Cancellation of note receivable
from director in exchange for
shares of stock (328,750) (3,287) (267,872) - 271,159 -
Net income - - - 301,391 - 301,391
---------- -------- --------- ---------- -------- ----------
BALANCE, June 30, 1989 21,324,597 213,246 7,988,480 (8,816,970) - (615,244)
Issuance of common stock 3,052,656 30,527 410,535 - - 441,062
Net income - - - 188,434 - 188,434
---------- -------- --------- ---------- -------- ----------
BALANCE, June 30, 1990 24,377,253 243,773 8,399,015 (8,628,536) - 14,252
Net income - - - 176,400 - 176,400
---------- -------- --------- ---------- -------- ----------
BALANCE, June 30, 1991 24,377,253 243,773 8,399,015 (8,452,136) - 190,652
Issuance of common stock -
net of legal fees of $8,039 2,505,737 25,057 216,904 - - 241,961
Net income - - - 30,695 - 30,695
---------- -------- --------- ---------- -------- ----------
BALANCE, June 30, 1992 26,882,990 268,830 8,615,919 (8,421,441) - 463,308
Net income - - - 36,833 - 36,833
---------- -------- --------- ---------- -------- ----------
BALANCE, June 30, 1993 26,882,990 268,830 8,615,919 (8,384,608) - 500,141
Net loss - - - (273,852) - (273,852)
---------- -------- --------- ---------- -------- ----------
BALANCE, June 30, 1994 26,882,990 268,830 8,615,919 (8,658,460) - 226,289
Net income - - - 279,276 - 279,276
---------- -------- --------- ---------- -------- ----------
BALANCE, June 30, 1995 26,882,990 268,830 8,615,919 (8,379,184) - 505,565
Net loss - - - (1,106,166) - (1,106,166)
---------- -------- --------- ---------- -------- ----------
BALANCE, June 30, 1996 26,882,990 268,830 8,615,919 (9,485,350) - (600,601)
Issuance of common stock 2,000 20 334 - - 354
Net income - - - 12,345,954 - 12,345,954
---------- -------- --------- ---------- -------- ----------
BALANCE, June 30, 1997 26,884,990 $ 268,850 $ 8,616,253 $ 2,860,604 $ - $ 11,745,707
========== ======== ========= ========== ======== ==========
See accompanying notes to financial statements
F-6
<PAGE>
CISTRON BIOTECHNOLOGY, INC.
---------------------------
STATEMENTS OF SHAREHOLDER'S EQUITY
----------------------------------
<S> <C> <C> <C> <C> <C> <C>
Earnings (Deficit) Total
Additional accumulated during shareholders'
Common Stock paid-in the development equity/
Shares Amount capital stage Other (deficiency)
----------------------- ----------- ------------------ ------------ -------------
BALANCE, June 30, 1997 26,884,990 $ 268,850 $ 8,616,253 $ 2,860,604 $ - $ 11,745,707
Issuance of common stock 45,197 452 2,427 - - 2,879
Issuance of warrants - - 65,000 - - 65,000
Net loss - - - (476,479) - (476,479)
Treasury stock at cost (3,946,500) - - - (394,650) (394,650)
----------- -------- --------- ------------ ---------- ----------
BALANCE, June 30, 1998 22,983,687 $ 269,302 $ 8,683,680 $ 2,384,125 $ (394,650) $ 10,942,457
========== ======== ========= ============ ========== ==========
See accompanying notes to financial statements
F-7
<PAGE>
CISTRON BIOTECHNOLOGY, INC.
---------------------------
STATEMENTS OF CASH FLOWS
------------------------
February 2, 1982
(commencement of
Year ended June 30, operations) to
1996 1997 1998 June 30, 1998
----------------------------------------------------------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers $ 614,226 $ 606,626 $ 520,957 $ 11,254,694
Cash paid to suppliers and employees (1,678,666) (6,926,542) (4,167,017) (31,118,770)
Interest received 26,919 230,744 298,353 606,057
Acquisition expenses paid - - - (429,620)
Royalties, research funding, license fees received 405,000 405,419 205,000 2,677,987
Other receipts 106,538 11,951,190 3,002,207 15,137,548
---------- ---------- ---------- ----------
Net cash provided by (used in) operating activities (525,983) 6,267,437 (140,500) (1,872,104)
---------- ---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Collection of note receivable - - - 15,097
Issuance of note receivable - (230,000) - (230,000)
Purchase of property and equipment (5,569) (29,163) (3,926) (762,472)
---------- ---------- ---------- ----------
Net cash used in investing activities (5,569) (259,163) (3,926) (977,375)
---------- ---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of capital stock and
additional contributions - 354 2,879 9,946,398
Principal payments on notes payable - - - (870,238)
Purchase of treasury stock - - (394,650) (394,650)
---------- ---------- ---------- ----------
Net cash provided by (used in) financing activities - 354 (391,771) 8,681,510
---------- ---------- ---------- ----------
Net change in cash and cash equivalents (531,552) 6,008,628 (536,197) 5,832,031
CASH AND CASH EQUIVALENTS, beginning of period 891,152 359,600 6,368,228 -
---------- ---------- ---------- ----------
CASH AND CASH EQUIVALENTS, end of period $ 359,600 $ 6,368,228 $ 5,832,031 $ 5,832,031
========== ========== ========== ==========
RECONCILIATION OF NET INCOME (LOSS) TO NET CASH
PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net income (loss) $ (1,106,166) $ 12,345,954 $ (476,479) $ 884,647
Adjustments to reconcile net income (loss) to net
cash provided used in operating activities:
Depreciation and amortization 12,777 6,535 7,090 742,865
Issuance of warrants - - 65,000 65,000
Deferred income taxes - 885,090 (934,403) (49,313)
Loss on disposal of property and equipment - - 4,552 8,531
Increase in reserve for note receivable - 230,000 - 230,000
Amortization of deferred financing costs and other - - - 195,179
Decrease (increase) in assets:
Accounts receivable 40,603 (26,370) (46,550) (101,859)
Inventory 1,071 2,059 643 (3,635)
Prepaid expenses (500) 25 475 -
Taxes receivable - - (329,024) (329,024)
Notes and other receivables (123,784) (9,042,520) 2,638,236 (6,626,594)
Security deposit - - - (23,938)
Intangible assets - - - (37,105)
Increase (decrease) in liabilities:
Accounts payable and accrued expenses 650,016 (344,316) (452,292) 1,579,910
Other current and non-current liabilities - 2,210,980 (617,748) 1,593,232
---------- ---------- ---------- ----------
NET CASH PROVIDED BY
(USED IN) OPERATING ACTIVITIES: $ (525,983) $ 6,267,437 $ (140,500) $ (1,872,104)
========== ========== ========== ==========
See accompanying notes to financial statements
F-8
<PAGE>
STATEMENTS OF CASH FLOW CONTINUED
---------------------------------
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES:
February 2, 1982 to June 30, 1998
- ---------------------------------
(1) The Company exchanged $870,238 of notes and 1,074,611 shares of Common
Stock (valued at $167,962) for pre-petition and post-petition Chapter 11
Bankruptcy debts in the amount of $1,038,201.
(2) The Company issued stock options for 639,938 shares of Common Stock in
exchange for pre-petition Chapter 11 Bankruptcy debts (to the Company's
present and former directors and employees) in the amount of $100,022.
(3) Deferred financing costs in the amount of $173,079 result from the
issuance of 1,978,045 shares of Common Stock to the Company's Former
Chairman of the Board in exchange for his guaranty of notes payable.
See accompanying notes to financial statements
F-9
<PAGE>
CISTRON BIOTECHNOLOGY, INC.
---------------------------
NOTES TO FINANCIAL STATEMENTS
-----------------------------
1. DESCRIPTION OF COMPANY AND FINANCIAL STATEMENT PRESENTATION
-----------------------------------------------------------
Cistron Biotechnology, Inc. ("Cistron" or the "Company") was organized
to develop, manufacture and license products based on recombinant DNA and
immunological techniques for use in various therapeutic applications and
for diagnostic purposes. The Company is a development stage enterprise
since its products are currently available only to the research market and
have yet to be approved for the diagnostic or therapeutic markets. The
Company operated as a debtor in possession under Chapter 11 of the
Bankruptcy Act for the period May 26, 1988 through April 27, 1990.
Cistron is a biotechnology company that uses recombinant DNA and
immunological techniques to explore certain cytokines that may have
therapeutic or diagnostic applications. Cytokines, consisting of
lymphokines and monokines, are proteins that are regulators of the human
immune response system released in the body by white blood cells. While
researching the therapeutic and diagnostic applications of these immune
regulators, Cistron manufactures a line of cytokine products that it sells
to the research market worldwide. Cistron's current research products are
sold to pharmaceutical companies, government agencies and academic
institutions in the United States, Europe and Asia for cancer, arthritis
and other autoimmune disease research.
The Company's principal research products consist of Interleukin-1
beta ("IL-1"), a lymphokine which initiates the immune response,
monoclonal and polyclonal antibodies to IL-1 ("IL-1 Antibodies"), and an
assay kit that measures IL-1 levels (the "IL-1 Assay"). The Company's IL-1
products are based upon the technology derived from research funded by
Cistron on Interleukin-1 beta, the predominant form of IL-1 in humans, at
the New England Medical Center Hospitals, Inc., Tufts University,
Massachusetts Institute of Technology and Wellesley College (the
"Institutions"), patents assigned to the Company as part of a litigation
settlement and technology and patents developed by the Company. Cistron
also manufactures and sells assays which measure tumor necrosis factor-
alpha ("TNF"), which is a monokine that acts as a mediator of
inflammation, an assay which incorporates both TNF and IL-1 and an assay
to measure interleukin converting enzyme ("ICE"). ICE cleaves the IL-1
protein into fragments, which imparts its biologic activity. In addition,
the Company distributes in North America and Asia assays that measure
another lymphokine, Interleukin-6, which is principally manufactured by
another company.
The Company believes it is a development stage enterprise because
planned principal operations have not yet commenced. The Company's planned
principal operations include the development of clinical and therapeutic
products for distribution through pharmaceutical and diagnostic companies.
This requires the approval of the Company's products by the Food and Drug
Administration ("FDA"). At June 30, 1998, none of the Company's products
had received such approval. In addition, the Company continues to devote
most of its efforts to activities such as research and development,
financial planning and developing markets which are typical activities for
a development stage enterprise. Specifically, the Company has expended
funds relating to the dental assay and vaccine adjuvant programs. With
respect to financial planning, in late 1997, the Company engaged the
services of BlueStone Capital Partners, LP ("Bluestone") to act as
Cistron's financial advisor as to corporate strategic and financial
initiatives. Accordingly, as the Company has not yet commenced principal
operations and is devoting most of its efforts to activities typical of a
development stage enterprise as outlined in Statement of Financial
Accounting Standards No.7, the Company believes that it continues to be in
the development stage.
2. SIGNIFICANT ACCOUNTING POLICIES
-------------------------------
a. Cash and Cash Equivalents
-------------------------
The Company classifies as cash equivalents all highly liquid
investments with maturities of three months or less.
F-10
<PAGE>
b. Inventories
-----------
Inventories consist of finished goods and are stated at the lower of
cost, determined on the first-in, first-out (FIFO) basis, or market.
c. Property and equipment
----------------------
Property and equipment are recorded at cost. Depreciation is
computed using the straight-line method over the estimated useful lives of
the related assets, which range from 5 to 10 years. Amortization of
leasehold improvements is computed over the remaining term of the lease.
Periodically, the Company reassesses the recoverability of recorded values
of long-lived assets. If the results of these periodic assessments
indicate that an impairment is likely, the Company recognizes a charge to
operations at that time. The Company assessed the recorded values of
long-lived assets and determined that the carrying value would be
recoverable at year-end June 30, 1998.
d. Patents
-------
Legal fees incurred in connection with obtaining patents are
capitalized when their future recovery is determinable. The costs are
amortized on the straight-line method over the life of the patent or
expected recovery period, if shorter.
e. Royalties
---------
Royalties payable to the Institutions, which have granted the Company
an exclusive license for IL-1, are recorded as cost of sales for product
sold and are included as accrued expenses.
f. Income taxes
------------
The Company files Federal and New Jersey state income tax returns.
Deferred income taxes reflect the net tax effects of (a) temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes,
and (b) operating loss and tax credit carryforwards.
g. Net income (loss) per share of Common Stock
-------------------------------------------
Net income (loss) per share has been computed by dividing the net
income (loss) for the periods presented by the weighted average number of
shares of common stock and equivalent common shares, if any, outstanding
in each period. Equivalent common shares include net shares issuable upon
the assumed exercise of options using the treasury stock method.
Equivalent common shares are not included in the net loss per share in
Fiscal 1996 or Fiscal 1998 since they are anti-dilutive.
h. Fair value of financial instruments
-----------------------------------
The carrying amounts in the financial statements for accounts
receivable, accounts payable and accrued liabilities approximate fair
value due to the short-term nature of these instruments. The carrying
amounts of other long term accounts receivable and other non-current
liabilities approximate their fair values as these amounts have been
discounted to their present value.
i. Estimates
---------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
F-11
<PAGE>
3. ACCRUED EXPENSES AND ACCOUNTS PAYABLE
-------------------------------------
June 30,
-----------------------
1997 1998
--------- ---------
<S> <C> <C>
Accounts payable $ 630,800 $ 62,750
Legal fees 176,447 16,969
Accrued compensated absences 13,488 18,236
Other 49,174 16,939
------- -------
$ 869,909 $ 114,894
======= =======
4. INCOME TAXES
------------
The provision for income taxes consist of the following:
Year ended June 30,
--------------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------------------------------------
FEDERAL:
-------
Current $ - $ 179,698 $ 540,122
Deferred - 771,617 (795,433)
--------- --------- ----------
- 951,315 (255,311)
STATE:
-----
Current - 426,502 102,252
Deferred - 113,473 (138,970)
-------- --------- ----------
- 539,975 (36,718)
$ - $ 1,491,290 $ (292,029)
======== ========= ==========
The net effect of significant items comprising the Company's net deferred
tax asset (liability) is as follows:
June 30,
---------------------------
1997 1998
------------ ----------
<S> <C> <C>
Operating loss carryforwards $ - $ 48,009
Tax credit carryforwards 372,000 -
Liabilities not currently deductible 2,630 3,415
Difference between book and tax basis
of property and equipment, and patents 822 (2,111)
Alternative Minimum Tax credit carryforwards 176,300 -
Deferred income (1,436,842) -
----------- --------
(885,090) 49,313
Valuation Allowance - -
----------- --------
New deferred tax asset (liability) $ (885,090) $ 49,313
=========== ========
A summary of the difference between the statutory rate and the
effective rate as of June 30, 1998 is as follows:
Statutory rate 34.00%
State Taxes 4.78%
Miscellaneous (0.78%)
--------
Effective rate 38.00%
========
F-12
<PAGE>
5. LICENSE FEE AND FUNDED RESEARCH
-------------------------------
In March 1995, the Company entered into a License Agreement with R&D
Systems under which the Company granted a sublicense to R&D Systems for
the manufacture and sale of IL-1 products to the research market. Under
this agreement, the Company received a $1 million license fee from
which the Company paid the Institutions a fee of $70,000. In April
1995, the Company also entered into a Research and Development Agreement
with R&D Systems which provided the Company with $1 million of research
funding payable over a two and one-half year period which began July 1,
1995. In Fiscal 1996, the Company received $400,000 of research funding
under this agreement, $400,000 funding in Fiscal 1997 and received
$200,000 in Fiscal 1998. The Company at its sole discretion may determine
the timing and amount of expenditures relating to this funding and is
under no obligation to repay any of the amounts received.
Net litigation settlement income of $14.7 million (pre-tax) was
recorded in the fiscal year ended June 30, 1997 representing the amounts
the Company will receive during the period November 1996 to November 2000
from the $21 million settlement agreement with Immunex Corporation
("Immunex"), after deducting amounts to be paid to counsel and the
Institutions and $359,000 received from PeproTech, Inc. ("PeproTech") in
February 1997.
6. INTEREST (INCOME)/EXPENSE - NET
-------------------------------
Net interest (income)/expense consists of the following:
February 2, 1982
(commencement of
Year ended June 30, operations) to
1996 1997 1998 June 30, 1998
---------- ----------- ----------- ----------------
<S> <C> <C> <C> <C>
Interest income $ (26,919) $ (230,744) $ (660,117) $ (1,160,239)
Interest expense - - 87,252 279,675
-------- --------- --------- -----------
$ (26,919) $ (230,744) $ (572,865) $ (880,564)
-------- ========= ========= ===========
7. COMMITMENTS AND CONTINGENT LIABILITIES
--------------------------------------
a. Lease commitments
-----------------
The Company leases its facility under an operating lease expiring in
October 2002, with a renewal option for five additional years. Rental
expenses were $123,000 for the years ended June 30, 1996 and 1997,
respectively and $125,000 for the year ended June 30, 1998. The future
minimum lease commitments are as follows:
<C> <C>
Year ended June 30,
-------------------
1999 $ 127,000
2000 127,000
2001 127,000
2002 127,000
2003 42,000
--------
$ 550,000
========
b. Employment agreements
---------------------
The Company has entered into employment agreements with its Chairman
and CEO and Vice President-Operations/Product Development for five-year
periods ending April 30, 1999. The agreements provide for annual
compensation of $210,000 and $104,000, respectively.
F-13
<PAGE>
c. Sponsored university research
-----------------------------
In August 1995, the Company entered into a sponsored research
agreement with a university to further study IL-1's role in periodontal
disease. Under this agreement, the Company made payments of $118,750 in
aggregate, which started in September 1995. This agreement terminated in
Fiscal 1998.
Under a sponsored research agreement signed in December 1997, the
Company agreed to fund an aggregate of $39,444 of IL-1 adjuvant studies.
During Fiscal 1998, $19,722 was paid. The remaining $19,722 is due upon
receipt of the study's final report which was not received by June 30,
1998.
d. Commitments
-----------
In September 1997, the Company engaged the services of BlueStone
Capital Partners, LP to act as Cistron's financial advisor as to corporate
strategic and financial initiatives. The initial engagement is for a
period of six months and may be renewed upon mutual consent of the
parties. The Company is obligated to pay BlueStone Capital $90,000 for
the initial six month period and issue warrants to purchase 400,000 shares
of the Company's common stock at $.25 per share. The Company would be
obligated to make payments including certain percentage fees as well as to
issue additional warrants to BlueStone to purchase up to an additional
400,000 shares, also at $.25 per share, should BlueStone assist Cistron in
completing a merger, acquisition, joint venture, partnership, license or
contract.
8. MAJOR CUSTOMERS AND EXPORT SALES
--------------------------------
Sales to three customers constituted 50% (25%, 15% and 10%) of Fiscal
1996 sales respectively. In Fiscal 1997, sales to four customers
constituted 65% (28%, 14%, 13% and 10%) of total sales and in Fiscal 1998,
sales to three customers constituted 69% (34%, 24%, 11%) respectively of
total sales. One of these customers has sold its research products
business, and, as such, after the first quarter of Fiscal 1999, the Company
will not have sales to this customer. Loss of any of these customers, if
a comparable new customer were not found, would have a material adverse
effect on the Company's sales.
Export sales amounted to 25%, 18%, and 33% of sales in 1996, 1997,
and 1998, respectively.
9. LITIGATION
----------
A. In December 1991, the Company, together with the Institutions, filed
suit in U.S. District Court in Newark, New Jersey against PeproTech, Inc.,
alleging infringement of the Institutions' patent covering the production
of recombinant IL-1, to which the Company holds an exclusive license.
The Company and the Institutions sought money damages for Cistron's lost
sales and an injunction against further infringement. In March 1997, the
Company and PeproTech settled all outstanding litigation. Under the
agreement, PeproTech paid the Company $718,000 (half of which Cistron then
paid to the Institutions) for licensing fees and other expenses.
B. On September 28, 1993, the Company filed suit in the U.S. District
Court against Immunex Corporation alleging misappropriation of trade
secrets related to IL-1 and seeking damages therefor.
In November 1996, the two companies agreed to settle all of Cistron's
claims against Immunex and two former Immunex officers. Under the
settlement, Immunex will pay Cistron a total of $21 million; $11 million
was paid in November 1996 and $3 million was paid in November 1997. The
remaining $7 million will be payable at $3 million each year for two
remaining years (November 1998 and 1999) and $1 million payable in
November 2000. Immunex also assigned certain IL-1 patents to Cistron
under the settlement.
Cistron is obligated to make payments under agreements with counsel and
the Institutions based on the settlement. Cistron will net approximately
$14.3 million (pre-tax) from the aggregate Immunex payments, which net
amount was recorded at its net present value in other income during Fiscal
year 1997.
F-14
<PAGE>
C. In August 1997, Cistron filed suite in Virginia against Rebuild,
L.L.C. ("Rebuild") and against Dr. Henry Grausz, Cistron's former
chairman, to recover $230,000 loaned to Rebuild in November 1996 and
repayment of which was personally and unconditionally guaranteed by Dr.
Grausz. Dr. Grausz is a partner in Rebuild. The loan was due to be
repaid on May 15, 1997. However, Rebuild did not repay the loan and Dr.
Grausz failed to repay the note on Rebuild's behalf. Cistron agreed to
forbear collection efforts until July 31, 1997. On July 31, 1997 the note
was not repaid by Rebuild or by Dr. Grausz. On October 10, 1997, judgment
was entered in favor of the Company in the Circuit Court of Fairfax County
(Virginia) against Rebuild, LLC and Henry Grausz. The judgment was for
$230,000 loan principal plus interest and attorneys' fees. The Company
was informed that in December 1997, Dr. Grausz filed a petition under
Chapter 11 of the Federal Bankruptcy Code. The Company is an unsecured
creditor as to the judgment against Dr. Grausz entered in favor of the
Company in October 1997. As of August 31, 1998, Dr. Grausz had not filed
a reorganization plan.
The Company has incurred legal fees (included in administrative and
marketing) in the amount of $845,000, $440,532, and $67,422 for the years
ended June 30, 1996, 1997, and 1998, respectively, in connection with
patents and litigation (the Fiscal 1997 and 1998 amounts exclude amounts
paid counsel as the result of settlement of the Immunex litigation).
10. EARNINGS PER SHARE
------------------
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS") No. 128, "Earnings per
Share". SFAS No. 128 specifies the computation, presentation and
disclosure requirements for earnings per share ("EPS") and became
effective for both interim and annual periods ending after December 15,
1997. All prior period EPS data has been restated to conform to the
provisions of SFAS No. 128. The following is a reconciliation of the
numerators and denominators used to calculate Earning per Share:
Year Ended June 30,
1996 1997 1998
-----------------------------------------------
<S> <C> <C> <C>
Earnings per common share:
- -------------------------
Net income (loss) (numerator) $ (1,106,166) $ 12,345,954 $ (476,479)
Weighted average shares (denominator) 26,882,990 29,054,308 24,955,077
Income (loss) per share $ (0.04) $ 0.42 $ (0.02)
=========== ========== ===========
<S> <C> <C> <C>
Earnings per common share - assuming dilution:
- ---------------------------------------------
Net income (loss) (numerator) $ (1,106,166) $ 12,345,954 $ (476,479)
Weighted average shares 26,882,990 29,054,308 24,955,077
Effect of dilutive options - 2,172,741 -
----------- ---------- -----------
Weighted average shares -
assuming dilution (denominator) 26,882,990 31,227,049 24,955,077
Income (loss) per share $ (0.04) $ 0.40 $ (0.02)
=========== ========== ===========
11. STOCK OPTIONS
-------------
In September 1994, the Board of Directors adopted an employee stock
option plan (the "Plan") for the granting of stock options. As of June
30, 1998, 1,079,376 shares of Common Stock were reserved for issuance in
connection with options under the Plan. Options are granted at not less
than fair market value of the stock at the date of the grant, vest and
generally become exercisable at the cumulative rate of 33% per annum
commencing one year from the grant and expire ten years after issuance.
Incentive stock options that fully vest and become exercisable six months
after the date of the grant (October 1996 and May 1998) have been granted
to two employees. Other options to purchase the Company's Common Stock
which are not part of the Plan have been granted to directors of the
Company, and to outside consultants at the then fair market value. The
options to the directors vest and become exercisable at the cumulative
rate of 33% per annum commencing in the year of the grant except for one
director's and one officer's options which fully vest and become
exercisable six months after the date of the grant.
F-15
<PAGE>
The activity in the plan is presented below:
</TABLE>
<TABLE>
Shares Under Employee Price Range Weighted Average
Incentive Stock Option Plan Per Share Price Per Share
----------------------------------------------------------------
<S> <C> <C> <C>
Outstanding Options, June 30, 1995 971,261 .06 to .44 .22
Granted 140,577 .38 .38
Exercised - - -
Expired or Canceled (140,577) .26 .26
------------- ---------- -----------
Outstanding Options, June 30, 1996 971,261 .06 to .44 .23
Granted - - -
Exercised (2,000) .13 to .44 .17
Expired or Canceled (15,651) .13 to .44 .30
------------- ---------- -----------
Outstanding Options, June 30, 1997 953,610 .06 to .44 .21
Granted 10,150 .26 .26
Exercised (45,197) .06 .06
Expired or Canceled - - -
------------- ---------- -----------
Outstanding Options, June 30, 1998 918,563 .06 to .44 .26
------------- ---------- -----------
Exercisable at June 30, 1998 918,563
-------------
Other Options Price Range Weighted Average
Warrants Per Share Price Per Share
-----------------------------------------------------------
<S> <C> <C> <C>
Outstanding, June 30, 1995 873,938 .02 to .30 .05
Granted 674,969 .19 .19
Exercised - - -
Expired or Canceled - - -
------------- ---------- -----------
Outstanding, June 30, 1996 1,548,907 .02 to .30 .11
Granted 250,000 .50 .50
Exercised - - -
Expired or Canceled (84,000) .30 .30
------------- ---------- -----------
Outstanding, June 30, 1997 1,714,907 .02 to .50 .16
Granted 400,000 .25 .25
Exercised - - -
Expired or Canceled - - -
------------- ---------- -----------
Outstanding, June 30, 1998 2,114,907 .02 to .50 .18
------------- ---------- -----------
Exercisable at June 30, 1998 2,114,907
-------------
The weighted average fair value of the stock options granted in 1996
and 1998 was $.18 and $.22 (no options were granted during the year ended
June 30, 1997), as determined using the Black-Scholes option pricing model
with the following range of assumptions:
Year Ended June 30,
1996 1997 1998
---------------------------------------
<S> <C> <C> <C>
Risk free interest rate 5.71% and 5.92% - 5.48%
Expected dividend yield - - -
Expected stock volatility 101% - 102%
Expected option life 10 years - 10 years
F-16
<PAGE>
The Company applies Accounting Principles Board (APB) Opinion 25 and
related interpretations in accounting for the Plan. Accordingly, no
compensation cost has been recognized by the Plan. Had compensation cost
for the Plan been determined consistent with Statement of Financial
Accounting Standards No. 123 "Accounting for Stock Based Compensation"
(SFAS 123), the Company's net loss would have been reduced to the pro
forma amounts indicated below:
Year Ended June 30,
1996 1997 1998
----------------------------------------------
<S> <C> <C> <C>
Net income (loss):
As reported $ (1,106,166) $ 12,345,954 $ (476,479)
Pro forma (1,256,892) 12,345,954 (478,743)
Net income (loss) per share:
As reported:
Basic $ (0.04) $ 0.42 $ (0.02)
Diluted (0.04) 0.40 (0.02)
Pro forma:
Basic $ (0.05) $ 0.42 $ (0.02)
Diluted (0.05) 0.40 (0.02)
The Company granted 250,000 stock warrants to non-employees that were
immediately exercisable at a price of $.50 per share in 1997. The fair
value of these warrants was determined to be approximately $60,000.
During 1998, the Company granted 400,000 stock warrants exercisable at
$.25 per share to non-employees that vested over a six-month period. The
fair value of these warrants was determined to be $65,000 which amount was
recorded as consulting expense. The Company utilized the Black-Scholes
option pricing model to determine the fair value of these grants.
During Fiscal 1998, the Company's shareholders approved the 1997
Incentive and Non-Incentive Stock Option Plan which reserved an additional
1,200,000 shares of common stock for options which the Board of Directors
may grant to employees and/or non-employees. As of June 30, 1998, no
options were granted under this plan.
F-17
<PAGE>
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
33-13704 of Cistron Biotechnology, Inc. on Forms S-8 of our report dated
September 11, 1998, appearing in this Annual Report on form 10-K of
Cistron Biotechnology, Inc. for the year ended June 30, 1998.
/Deloitte & Touche LLP/
Parsippany, New Jersey
September 28, 1998
41
<PAGE>
</TABLE>
<TABLE> <S> <C>
<S> <C>
<ARTICLE> 5
<LEGEND>
This Schedule contains summary financial information taken from the
balance sheed as of June 30, 1998 and the statement of operations for
the twelve-month period ended June 30, 1998, and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-END> JUN-30-1998
<CASH> 5,832,031
<SECURITIES> 0
<RECEIVABLES> 3,272,532
<ALLOWANCES> 230,000
<INVENTORY> 3,635
<CURRENT-ASSETS> 9,207,222
<PP&E> 727,695
<DEPRECIATION> 701,477
<TOTAL-ASSETS> 12,999,481
<CURRENT-LIABILITIES> 1,154,850
<BONDS> 0
0
0
<COMMON> 269,302
<OTHER-SE> 10,673,155
<TOTAL-LIABILITY-AND-EQUITY> 12,999,481
<SALES> 555,205
<TOTAL-REVENUES> 1,333,070
<CGS> 309,678
<TOTAL-COSTS> 309,678
<OTHER-EXPENSES> 1,791,900
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (768,508)
<INCOME-TAX> (292,029)
<INCOME-CONTINUING> (476,479)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (476,479)
<EPS-PRIMARY> (0.02)
<EPS-DILUTED> (0.02)
</TABLE>
