SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------
FORM 10-K
(Mark one)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended September 30, 1998
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from -------- to --------
Commission File No. 1-10492
EPITOPE, INC.
(Exact name of registrant as specified in its charter)
Oregon 93-0779127
(State or other jurisdiction of (I.R.S. employer identification no.)
incorporation or organization)
8505 S.W. Creekside Place
Beaverton, Oregon 97008
(Address of principal executive offices) (Zip code)
(503) 641-6115
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, no par value
(Title of Class)
Preferred Stock Purchase Rights
(Title of Class)
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. [ ]
State the aggregate market value of the voting and non-voting common
equity held by non-affiliates of the registrant, as of December 1, 1998: $
73,153,540
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of December 1, 1998: Common Stock, no par value,
13,609,961 shares.
Documents Incorporated by Reference:
Definitive Proxy Statement for 1999 Annual Shareholders' Meeting: Part III
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TABLE OF CONTENTS
PART I
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Page
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ITEM 1. Business 1
ITEM 2. Properties 13
ITEM 3. Legal Proceedings 13
ITEM 4. Submission of Matters to a Vote of Security Holders 13
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters 13
ITEM 6. Selected Financial Data 14
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 15
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk 18
ITEM 8. Financial Statements and Supplementary Data 19
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 19
PART III
ITEM 10. Directors and Executive Officers of the Registrant 20
ITEM 11. Executive Compensation 20
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 20
ITEM 13. Certain Relationships and Related Transactions 20
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K 20
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PART I
ITEM 1. BUSINESS.
Epitope, Inc. (Epitope or the Company), is an Oregon corporation incorporated in
1981. Epitope develops and markets oral specimen collection kits and related
diagnostic tests primarily for the detection of the Human Immunodeficiency Virus
(HIV), the cause of Acquired Immune Deficiency Syndrome (AIDS), and for the
detection of other medical conditions and analytes, including drugs of abuse.
Epitope's lead product, the patented OraSure(R) collection device, is used as
part of an oral specimen diagnostic system. The Company markets the device in
the United States and certain foreign countries for use in screening life
insurance applicants and for public health use, and plans to begin marketing for
drugs of abuse testing in 1999.
The OraSure device consists of a small, treated cotton-fiber pad on a nylon
handle that is placed in the patient's mouth for two minutes. The device
collects oral mucosal transudate (OMT), a serum-derived fluid that contains
higher concentrations of antibodies than saliva, including HIV antibodies in
people infected with the virus. As a result, OMT testing is a highly accurate
method for detecting HIV infection. Because OraSure uses a noninvasive,
needle-free collection method without need for privacy during the collection
process, the Company believes that oral fluid testing has several significant
advantages over blood or urine-based testing systems for both healthcare
professionals and patients.
Epitope also markets HIV-1 Western blot confirmatory test kits used to confirm
positive results of initial screening tests for HIV-1 infection. Its OraSure
HIV-1 Western blot confirmatory test kit is used in conjunction with
oral-specimen based screening tests, while its EPIblot(R) HIV-1 Western blot
confirmatory test kit is used in conjunction with blood-based screening tests.
The kits are distributed worldwide under an exclusive agreement with Organon
Teknika Corporation (Organon Teknika), a member of the Akzo Pharma group of Akzo
Nobel, NV., an international chemical and pharmaceutical manufacturer based in
Arnhem, The Netherlands.
The OraSure HIV-1 Oral Specimen Collection device and the OraSure HIV-1 Western
blot and EPIblot confirmatory tests have all received clearance from the U.S.
Food and Drug Administration (FDA) for sale to professional markets in the
United States. In 1998, the FDA granted clearance for use of the OraSure device
with enzyme immunoassays manufactured by STC Technologies, Inc. (STC) to test
for cocaine, methamphetamines, opiates and opiate metabolites, cannabanoids
(marijuana), and cotinine (a derivative of nicotine). The FDA has also allowed
the commercial sale of OraSure to test for phencyclidine (PCP), while the
Company and STC gather more clinical data.
Through December 1997, Agritope, Inc. (Agritope) was a wholly owned subsidiary
of Epitope. Agritope is a biotechnology company specializing in the development
of new fruit and vegetable plant varieties for sale to the fresh produce
industry. Epitope made a dividend distribution of all of its ownership interest
in Agritope to Epitope's shareholders (the Agritope Spin-off) on December 30,
1997. Epitope no longer owns or controls any shares of Agritope stock.
BACKGROUND
HIV attacks the immune system, slowly weakening the body's ability to ward off
infection and certain forms of cancer. When these complications develop, the HIV
infection has progressed to clinically diagnosed AIDS. HIV is spread through
sexual contact, blood transfusions, the sharing of intravenous needles,
accidental needle sticks, or contact between a mother and her child during
gestation, childbirth, or breast-feeding. There is currently no known cure for
HIV/AIDS. However, the introduction of a new class of anti-HIV drugs called
protease inhibitors, when used in combination with nucleoside analogs (e.g.,
AZT), has shown promising results in slowing progress of the disease. Clinical
studies have demonstrated that the early detection and treatment of HIV can help
to curb the effects of the disease and significantly prolong the life of the
patient. Other studies have shown that treatment with AZT of an HIV-infected
pregnant woman may prevent the transmission of HIV from the mother to her child.
Since the early 1980s more than 40 million individuals have contracted HIV, and
almost 12 million have died, according to UNAIDS, a program sponsored by the
United Nations. In 1997 alone, nearly 6 million people acquired HIV, and some
2.3 million perished from it, including 460,000 children. If the rate of new
infections continues at
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this pace, nearly 37 million people will be living with AIDS at the end of 1998.
In North America, an estimated 860,000 people are infected with HIV. The UNAIDS
report estimates that worldwide 1,600 children under 15 years old are infected
each day compared to 1,000 per day a year ago.
Based on industry estimates, the Company believes that approximately 100 million
HIV tests were performed in the U.S. in 1997, with blood banks accounting for
about 25 million. The Company feels that a large proportion of the non-blood
bank HIV testing market should be available to OraSure because of the accuracy
of the test and the benefits of not having to draw blood. Currently, most HIV
tests are performed by testing a patient's blood. There are a number of blood
tests for HIV, the most common of which is the enzyme immunoassay (EIA). In
order to reduce the possibility that an individual without HIV will be diagnosed
as having the virus (a false positive), most industrialized countries require
the re-testing of the blood sample using a second, more specific test to confirm
an initial positive test result. The most commonly used confirmatory test is the
Western blot.
The Company believes that blood-based testing, in a situation other than blood
donation, has a number of disadvantages which increase healthcare costs and
patient inconvenience, pose a risk of infection to healthcare professionals and
make testing uneconomic or unavailable in certain applications or settings, and
that the OraSure product overcomes these problems. The disadvantages of blood
testing include:
Risk of HIV Infection. Blood tests involve the use of needles or lancets to
obtain blood from the patient. Healthcare professionals collecting blood risk
contracting HIV if accidentally stuck by the needle or lancet used to obtain
blood from an infected patient.
Limited Access. Because blood must be collected by trained professionals, its
collection is often difficult or prohibitively expensive in certain settings.
For example, community-based outreach programs, homeless shelters, rural
communities, and other remote settings often lack healthcare professionals
trained in blood collection. As a result, blood testing may not be readily
available in some of these settings.
Higher Overall Cost. The cost of collecting a blood specimen represents a
significant component of the total cost of HIV testing. Furthermore, when a
healthcare professional must travel to the subject's office or home to collect a
blood sample, as is often the case with life insurance applicant testing, the
cost of collecting the blood specimen is substantially increased.
Patient Discomfort. Blood tests require the use of needles or lancets that are
uncomfortable for patients. In addition, patients with small or damaged veins,
such as intravenous drug users, the elderly and young children, may require
multiple needle sticks in order to obtain an adequate blood sample.
EPITOPE ORAL SPECIMEN COLLECTION TECHNOLOGY
In order to address the significant drawbacks associated with blood-based tests,
Epitope developed and patented a device to collect an oral specimen instead of
blood. The OraSure device, shaped like a small toothbrush, consists of a
cotton-fiber pad treated with a proprietary salt solution. The pad, which is
mounted on a nylon handle, is placed in the patient's mouth between the lower
cheek and gum for two minutes. The pad collects oral mucosal transudate, a
serum-derived fluid that contains higher concentrations of antibodies than
saliva. The OraSure sample contains approximately four times the amount of
antibodies found in saliva expectorated into a cup. Following collection, the
pad is sealed in a specimen vial containing a proprietary preservative solution.
The treated pad enhances the collection, and the preservative solution enhances
the stabilization, of antibodies and other analytes originating from the oral
mucosae. The specimen in the vial is stable for three weeks at room temperature,
although in most cases laboratory testing takes place within one to three days.
PRODUCTS
OraSure-HIV. In December 1994, the Company received clearance from the FDA to
sell OraSure to professional markets for use with the screening test for HIV-1
antibodies. The device is marketed by the Company for use by the life insurance
industry and public health programs in the United States and a number of other
countries. See "Marketing and Customers."
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The OraSure oral specimen collection and HIV-1 testing system is easily
administered and involves three steps: (i) collection of an oral specimen using
the OraSure collection device, (ii) screening of the specimen for HIV antibodies
at a laboratory, and (iii) laboratory confirmation of positive screening test
results with the FDA-cleared OraSure Western blot kit. A trained healthcare
professional then conveys test results and provides appropriate counseling to
the patient.
The OraSure HIV-1 testing system represents a highly accurate alternative to
traditional blood-based tests. In clinical trials, OraSure provided the correct
result or triggered appropriate follow-up testing in 3,569 out of 3,570 cases
(99.97 percent). The Company believes OraSure has several advantages over
blood-based tests, as outlined in the following table.
Feature Blood Collection OraSure
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<S> <C> <C>
Safety Poses risk of HIV infection Eliminates risk of needle-stick
through accidental needle sticks accidents
Invasiveness Requires use of a needle or lancet Uses noninvasive collection technique
Ease of use Requires blood collection by a Sample collection requires minimal
trained healthcare professional training
Portability Generally performed in a physician's Can be used rapidly and efficiently
office or other healthcare setting in almost any setting
Cost Requires a nurse or other healthcare Eliminates the need for and costs
professional trained in phlebotomy associated with a healthcare professional
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OraSure-Drug Testing. The FDA granted clearance in 1998 for use of OraSure with
enzyme immunoassays manufactured by STC Technologies, Inc. to test for cocaine,
methamphetamines, opiates and opiate metabolites, and cannabanoids (marijuana).
In addition, the FDA has also allowed STC to distribute OraSure for use with a
PCP test under "For Investigational Use Only" status in order to generate data
required for FDA review. Management anticipates final approval for use of the
OraSure device to test for PCP in 1999. STC has agreed to act as the exclusive
distributor of OraSure for use with STC's drugs-of-abuse assays in the United
States and much of Europe.
The OraSure device has also been approved in Japan for cotinine testing of life
insurance applicants. Cotinine is a derivative of nicotine that indicates
whether the tested subject is a smoker. The Finance Ministry of Japan announced
in February 1998 that life insurance companies could reduce premiums on new
nonsmoker policies by as much as thirty percent, effectively creating a larger
market for cotinine testing of life insurance applicants in Japan. The Company
also sells OraSure for cotinine testing of life insurance applicants in the
United States. Although cotinine is not currently regulated by the FDA for
insurance risk assessment, a 510(k) application for cotinine has been filed in
anticipation that the Company will sell OraSure for cotinine testing for
non-insurance purposes.
Oral-based and Serum-based Western Blot Confirmatory Tests. In June 1996, the
Company received FDA clearance to market an oral-based HIV-1 Western blot
confirmatory test. This test uses the original oral specimen to confirm positive
results of initial OraSure HIV-1 screening tests. The Company also markets
EPIblot, a serum-based Western blot HIV-1 confirmatory test kit. The kit is used
to confirm the positive results of initial blood-based screening tests for HIV-1
infection.
PRODUCTS UNDER DEVELOPMENT
OraSure. Oral mucosal transudate contains many constituents found in blood
serum. The Company therefore believes OraSure is a platform technology with a
wide variety of potential applications beyond HIV testing. For example, the
OraSure device may be useful for the diagnosis of a variety of infectious
diseases in addition to HIV, such as viral hepatitis and a number of childhood
diseases. In addition, the Company believes that the use of oral specimens may
allow physicians to diagnose diseases more readily in children without
subjecting them to the discomfort of drawing a blood sample, thereby increasing
the frequency of testing for diseases.
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The Company has demonstrated that the OraSure device is effective for the
collection of samples which can be tested for the NIDA-5 drugs of abuse and
cotinine, a derivative of nicotine. Under an agreement with Epitope, STC
Technologies, Inc., has developed enzyme immunoassays for the detection of
cocaine, methamphetamine, cannabanoids (THC), opiates, PCP, and cotinine present
in oral specimens. Five 510(k) notifications for cocaine, methamphetamines,
cannabanoids (THC), opiates, and cotinine have been cleared by the FDA. The FDA
has also allowed the Company to distribute OraSure for use with a PCP test under
"For Investigational Use Only" status that allows the Company to gather
additional samples for submission to the FDA. When all clearances have been
received, Epitope plans to market OraSure through STC for drugs of abuse
detection and directly to the life insurance industry to test applicants for the
presence of drugs of abuse. Although cotinine is not currently regulated by the
FDA for risk assessment, a 510(k) application for cotinine has been filed in
anticipation that the Company will sell OraSure for cotinine testing for
non-insurance purposes at some time in the future.
Physicians may also find the OraSure device useful for monitoring level of drugs
and hormones that must be maintained within narrow therapeutic ranges.
Monitoring of these substances currently requires frequent blood tests to
determine drug concentration. The Company believes that oral specimen testing
would eliminate the discomfort and inconvenience associated with this frequent
blood testing.
OraQuick. Epitope is currently developing OraQuick(R), a one-step, rapid-format
oral specimen testing system designed to provide test results within ten
minutes. The Company believes that OraQuick has significant potential as a rapid
test for professional use, and possibly as an OTC home-based test. Like OraSure,
OraQuick is a platform technology with a variety of potential applications in
addition to HIV testing. Prototype OraQuick devices, to be used for pre-clinical
testing, are in the final stages of development and the Company is establishing
manufacturing specifications for the device. One patent is pending on this new
platform technology and a second patent is in process. The Company is also
evaluating the regulatory hurdles and clinical trials required to bring this
product to market.
Modifications of the basic OraQuick technology may allow use of this approach
for detection of antibodies against the ulcer-causing bacterium Helicobacter
pylori, as well as for a variety of infectious diseases such as syphilis, viral
hepatitis, and childhood infections. The application of this technology to drugs
of abuse testing appears possible and is a high priority within the Epitope
development group, although some drugs are expected to present technical
difficulty to achieve desired results. The Company will carefully analyze each
application to determine the cost of development and regulatory approval
compared to the potential benefits of each market and will focus its efforts on
those with the best business return.
DNA Forensic Testing. During 1998, the Company entered into a research agreement
with Analytical Genetic Testing Center (AGTC) to explore the use of OraSure for
DNA collection. Results of this research have been positive, demonstrating that
OraSure collects a high quality DNA sample. This sample is in addition to the
antibody sample that is used to test for HIV, making it possible to test for
antibodies and produce a DNA "fingerprint" with a single OraSure collection. The
Company is now developing a beta-site testing program with AGTC to evaluate the
use of OraSure in several key user settings. Because there are limited
regulatory requirements in this market, it is anticipated that if the results of
research continue to be promising the commercial launch of OraSure for DNA
collection can be accomplished soon after customer testing is completed.
MARKETS
Life Insurance Industry. Epitope believes there is a significant need in the
life insurance industry for an easy-to-administer, noninvasive and
cost-effective HIV testing system such as OraSure. In the United States,
approximately 7 million HIV tests were administered in 1997 by the life
insurance industry in connection with the issuance of about 11 million new
policies. In addition, data from the American Council of Life Insurance and the
Health Insurance Association of America indicate that approximately $1 billion
in AIDS-related death benefits were paid in 1997. The organizations also
cautioned that, due to difficulty in identifying all AIDS-related claims, the
data may significantly understate the financial impact of AIDS on the insurance
industry.
Traditional HIV testing of life insurance applicants involves the use of a
paramedic or other trained healthcare professional to obtain a blood sample. The
cost to the insurance company for an HIV test includes the cost of the
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paramedic as well as the cost of the collection kit and laboratory testing
services. The cost of collecting and processing a blood sample is approximately
$70 per test versus a cost of $15 for an OraSure sample test. As a result of the
higher cost of collecting blood samples, insurance companies have generally
limited HIV testing to policies with face amounts of $100,000 or more. Based on
industry statistics, Epitope estimates that in 1997 approximately 8.9 million
policies were issued for face amounts of less than $100,000, representing 80
percent of all policies issued. The Company believes that the use of OraSure can
significantly reduce the cost of HIV testing to the insurance industry because
collection of an oral fluid specimen can be performed by insurance agents or
other persons without professional medical training, eliminating the cost of the
paramedic and making testing at policy levels below $100,000 a cost-effective
practice. Over the next several years insurance companies and testing
laboratories expect the market for oral fluid testing of applicants to grow by
at least 50 percent.
Epitope also believes that the use of OraSure will allow the insurance industry
to address "anti-selection." Anti-selection occurs when an individual who knows
that he or she is infected with HIV intentionally applies for one or more life
insurance policies that do not entail HIV testing. The Company believes that the
adoption of OraSure by a number of insurance companies, and the availability of
an over-the-counter (OTC) HIV blood test, may increase the incidence of
anti-selection. By allowing insurance companies to lower the policy level at
which HIV testing is cost-effective, the use of OraSure may allow insurance
companies to reduce their exposure to losses from anti-selection and thereby to
lower overall claims costs.
Insurance companies have also begun using the same OraSure specimen collected
for HIV testing to identify smokers and users of cocaine. Cotinine, a metabolite
of nicotine, and cocaine can be detected using OraSure. In a presentation at the
105th annual meeting of The American Academy of Insurance Medicine in 1997, a
major life insurance company reported results of the use of the OraSure testing
system in Canada and in the Bahamas from 1992 to 1995. The life insurance
company reported that OraSure sample collection by agents had significantly
reduced its testing costs per policy. During the four-year study period, the
insurer found that it saved $1.7 million by using OraSure for HIV and cocaine
testing. In addition, the life insurance company determined that it realized
$1.6 million in increased premiums as a result of identifying smokers who
claimed on their applications that they were nonsmokers. In another study
presented to this same Academy, Crown Life of Canada reported that the five year
savings from OraSure testing for cocaine, cotinine and HIV were approximately
$1.4 million.
Japanese Insurance Market. The Japanese life insurance market in 1996 was served
by 44 companies which sold approximately 35 million policies, of which about
one-third were new ordinary life policies, the type for which applicants are
most likely to be tested for smoking and other risk factors. While non-smoker
policies have been available in the U.S. insurance market since the mid-1960s,
it was only in early 1998 that Japanese regulators allowed premium reductions
for non-smokers. Some insurance companies have begun the process of applying for
new premium schedules and are using OraSure to test for evidence of smoking for
these policies.
Physician and Public Health Clinical Market. The physician market consists
primarily of individual doctors' offices which are supplied through the
physician's supply house network. Selling to this market requires a substantial
sales force to call on the many offices throughout the country, each making its
own purchasing decisions. Epitope has chosen not to focus on this market at this
time because of the high cost of selling to these customers as the product is
currently available to physicians through various physician supply channels. The
Company is exploring the feasibility of implementing a direct telemarketing
program to serve this market.
The public health market is more concentrated than the physician market, with
typically more purchasing power in each decision maker. The customers consist of
a broad range of clinics and laboratories and includes states, counties,
colleges and universities, prison systems and the military. There are also a
number of smaller organizations in the public health market such as AIDS Service
Organizations and various community based organizations set up for the primary
purpose of encouraging and enabling HIV testing to combat the spread of AIDS.
The OraSure device has received a warm welcome in the public health market
because of its ease of use and reliability.
The cost of OraSure had been an obstacle to its adoption by some providers in
the public health market. The small size of some public health organizations or
their decisions to begin OraSure testing on a small scale made volume discounts
for OraSure or related tests unavailable, so that the cost of OraSure testing
was higher than blood-based testing. In order to avoid having cost be a major
obstacle to growth in volume and adoption of this new testing
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format, Epitope has revised its volume pricing policy. In addition, both to
decrease the cost of testing and to provide fast turnaround with accurate test
methods, Epitope has entered into an agreement with LabOne, Inc. (LabOne) to
provide a prepackaged OraSure test kit with prepaid testing and sample shipment
to LabOne via Airborne Express. This product package is being sold directly to
public health customers by the Epitope sales force.
International. In light of the worldwide scope of the HIV epidemic, Epitope
believes there are significant opportunities for sale of OraSure in
international markets. The Company believes that the ease of use, portability,
and increased safety of OraSure, and aversion to blood draw in certain cultures
will provide significant advantages for oral fluid testing over blood tests in
international markets.
Drugs of Abuse Market. The analytic portion of the United States drugs-of-abuse
testing market, outside of the criminal justice system, is estimated to be over
$350 million, with approximately 36 million tests performed in 1997. The testing
is concentrated on a set of commonly abused drugs called the NIDA-5, consisting
of cocaine, methamphetimines, opiates, marijuana and PCP.
This market is currently based primarily on urine testing, which is susceptible
to adulteration of samples unless precautions are taken in the collection
process. The Company believes that oral fluid testing will succeed in this
market because of its non-invasive nature and ease of maintaining a chain of
custody without embarrassment to the person being tested, as well as the lack of
requirement for specially prepared collection facilities. The FDA has approved
tests for cocaine, opiates, methamphetimines and marijuana with an OraSure
sample. In addition, the FDA is allowing the Company to distribute OraSure for
use with a PCP test under "For Investigational Use Only" status in order to
generate data required for FDA review. Epitope has teamed with STC to distribute
products to this market. See "Marketing and Customers."
OTC Market. The over-the-counter market for HIV testing currently is served by
only one test, distributed by Home Access Health Care, which uses a dried blood
spot to provide the patient's sample. This sample is then sent to a laboratory
for testing and test results are communicated to the customer via an 800 number.
In July 1997, citing lower sales than expected and lower market estimates,
Johnson & Johnson dropped its Confide HIV test from the OTC market. Epitope has
significantly reduced the attention and resources it was devoting to preparation
for the OTC market because of the smaller than anticipated market size and the
high cost of setting up the required systems, support, and clinical trials
needed for FDA approval. The Company has shifted instead to the public health
markets, including colleges and corrections facilities. The Company has not
ruled out an eventual move into the OTC market, but it is not a high priority at
this time.
MARKETING AND CUSTOMERS
Life Insurance Industry. Epitope currently markets the OraSure device for use in
screening life insurance applicants for HIV, cocaine, and cotinine (a derivative
of nicotine). The Company maintains a direct sales force that markets OraSure
directly to insurance companies. Insurance companies then make their own
decision regarding which insurance reference laboratory to use to supply their
devices and testing service. The major laboratories currently using the OraSure
device include LabOne, Inc., Osborn Laboratories, Clinical Reference Laboratory
and Heritage Laboratories. As of November 1998, 30 of the top 100, and 5 of the
top 10 life insurance companies were using OraSure to varying degrees for
testing applicants for life insurance. As of that date there were 102 insurance
companies using OraSure. Because the insurance companies are in various stages
of their adoption of OraSure, there exists a wide range of policy limits where
the product is being applied. Some insurance companies have chosen to extend
their testing to lower policy limits where they did not test at all before,
while others have used OraSure to replace some of their blood-based testing. The
Company's sales focus is on converting additional insurance companies to the use
of OraSure, and extending its use within the companies already using OraSure.
Physician and Public Health Clinical Market. Through September 1997, SmithKline
Beecham, plc (SB) marketed Epitope's oral HIV testing system to the physician,
hospital and other professional healthcare provider markets. The Company resumed
responsibility for servicing these markets in October 1997. Epitope hired some
of SB's sales personnel that had been focused on the public health market, and
began selling its products directly to these customers. To better serve this
market, Epitope entered into an agreement with LabOne to provide a prepackaged
OraSure test kit, with prepaid specimen shipping costs and laboratory testing
included. The LabOne OraSure test kit
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is one of the primary products sold into this market and represented nearly half
of all the Company's sales to this segment in 1998.
International. Epitope markets to international customers primarily through
carefully chosen distributors with knowledge of their local market. The
distributor's expertise is supplemented by Epitope's contacts with testing
companies to assist in registering the necessary tests in each country, and
Epitope's assistance with training and support materials. Epitope's
international marketing program features direct assistance to distributors in
establishing OraSure programs that include laboratory services, cooperation from
screening test manufacturers, and provision of Western blot confirmatory kits in
each country. Epitope is currently marketing OraSure directly to customers in
Canada and through distributors in the United Kingdom (UK), Ireland, Thailand,
Argentina, Brazil, South Africa, Greece, the Philippines, Taiwan, Mexico and
Colombia.
The Company entered into a distribution agreement with Altrix Healthcare plc
(Altrix), a UK-based health diagnostic service provider, for the sale and
distribution of OraSure to the life insurance, public health, and laboratory
markets in the UK and Ireland. The agreement contemplates optional expansion of
the relationship to other European countries.
Epitope participates in a joint venture in Japan which markets both the OraSure
device and STC's cotinine test to the Japanese insurance market. Epitope holds
exclusive distribution rights in Japan for STC's laboratory-based test for
cotinine, sold for use in insurance risk assessment. Epitope has the option to
expand its exclusive distribution rights for the cotinine test worldwide,
excluding the U.S. In addition, OraSure is now being used for Hepatitis testing
in Argentina and the Company is exploring opportunities to distribute OraSure in
Brazil.
Drugs of Abuse Market. In November 1998, the Company entered a supply and
distribution agreement with STC, its research partner in the drugs-of-abuse
market. Under the terms of the agreement, Epitope will act as the exclusive
supplier of oral fluid collection devices for use with STC's laboratory-based,
NIDA-5 drugs-of-abuse tests in the U.S. and Europe, excluding the U.K. and
Ireland. STC will act as the exclusive distributor of the OraSure device for
drugs-of-abuse testing in the same territory. The agreement provides for Epitope
to sell OraSure devices to STC for a per-unit price. Epitope will receive a
percentage of STC's gross revenue from the resale of OraSure devices and STC
oral fluid drugs-of-abuse test sales. The agreement also covers any additional
laboratory-based drugs-of-abuse tests that STC may market, including those STC
is now developing using upconverting phospher technology. The agreement will
remain in effect for a minimum term of five years.
Epitope and STC will participate jointly in marketing activities and obtaining
required international regulatory approvals. The two companies plan to begin
evaluation of drugs-of-abuse testing products in selected test markets in early
1999. Feedback from these early users, along with the results of additional
laboratory testing, will help determine whether modifications in the OraSure
device or the STC tests might be needed for optimal performance in the market.
Western Blot Distribution. Epitope has entered into supply and distribution
agreements with Organon Teknika Corporation. The supply agreement provides that
Organon Teknika will supply the HIV-1 antigen used to manufacture Western blot
confirmatory test kits. The distribution agreement grants Organon Teknika the
exclusive right to purchase Western blot confirmatory test kits from Epitope and
to market them worldwide. Epitope and Organon Teknika recently extended the
expiration dates for the supply and distribution agreements to March 31, 2000.
Customer Concentration. In fiscal 1998, the Company's sales to LabOne, Inc.,
Osborn Laboratories, Clinical Reference Laboratory and Organon Teknika accounted
for over 62 percent of product revenues. The Company believes that its
relationship with each of these customers is strong and believes that they will
purchase comparable or increasing volumes of the Company's products for the
foreseeable future. There can be no assurance, however, that sales to these
customers will not decrease or that these customers will not choose to replace
the Company's products with those of competitors. The loss of any of these
customers or a significant decrease in the volume of products purchased by them
would have a material adverse effect on the Company.
7
<PAGE>
COMPETITION
Competition in the emerging market for HIV testing is intense and is expected to
increase. The Company believes that the principal competition will come from
existing blood-based HIV assays and from urine-based testing assays. Epitope's
competitors include specialized biotechnology firms as well as pharmaceutical
companies with biotechnology divisions and medical diagnostic companies, many of
which have considerably greater financial, technical, and marketing resources
than Epitope. Competition may intensify as technological advances are made and
become more widely known and as products reach the market in greater numbers.
Furthermore, new testing methodologies could be developed in the future that
render Epitope's oral-based HIV test impractical, uneconomical or obsolete.
There can be no assurance that Epitope's competitors will not succeed in
developing or marketing technologies and products that are more effective than
those developed by Epitope or that would render its technologies or products
obsolete or otherwise commercially unattractive. In addition, there can be no
assurance that competitors will not succeed in obtaining regulatory approval for
these products, or in introducing or commercializing them before Epitope. Such
developments could have a material adverse effect on the Company's business,
financial condition and results of operations.
Three companies have submitted applications to the FDA for OTC HIV blood
testing: Direct Access Diagnostics, Home Access Health Corp., and ChemTrak
Incorporated. The FDA has approved home collection kits for HIV blood testing
developed by Direct Access Diagnostics (Johnson & Johnson) and by Home Access
Health Corp. In July 1997, Johnson & Johnson withdrew its HIV home-test from the
market, citing weak sales.
Cambridge Biotech Corporation, BioRad Laboratories, Inc. and Genetic Systems
Corp. manufacture HIV Western blot confirmatory tests, and Waldheim
Pharmazeutika manufactures immunofluorescent HIV confirmatory tests, which
compete with Epitope's EPIblot HIV-1 Western blot serum-based confirmatory test
kits.
Several other companies market or have announced plans to market oral specimen
collection devices and tests outside the United States and have announced plans
to seek FDA approval of such tests in the United States. Epitope expects the
number of devices competing with its OraSure device to increase as the benefits
of oral specimen-based testing become more widely accepted. The Company expects
that FDA approval of the OraSure device will also encourage potential
competitors to develop oral diagnostic products. No such devices have yet been
approved by the FDA for HIV testing. See "Government Regulation."
The FDA has approved an HIV screening test for use with a urine sample. In June
1998, the FDA notified Cambridge Biotech Corp that it had approved the use of
its HIV-1 Western Blot confirmatory test for use with urine samples. Although
the sensitivity and specificity are less than blood-based or oral fluid tests,
urine testing will compete in the same markets as the Company's products. The
Company believes that urine collection can be logistically more difficult,
inconvenient and potentially embarrassing for the patient or life insurance
applicant, and that privacy and chain-of-custody issues are further impediments
to routine use of urine-based HIV tests. The Company cannot predict the impact
of the availability of urine-based tests on the HIV testing market or on sales
of the Company's products.
GOVERNMENT REGULATION
General. Many of Epitope's proposed and existing diagnostic products are subject
to regulation by the FDA, other federal, state, and local agencies, and
comparable bodies in foreign countries. Such regulation governs almost all
aspects of development and marketing, including the introduction, advertising,
promotion, manufacturing practices, labeling, distribution, and record keeping
for the products. In the United States, different types of diagnostic products
are regulated differently by the FDA, as discussed below. As part of the FDA
clearance process, Epitope often must demonstrate that its products are both
safe and effective for a particular indication or application.
Drugs and Biological Products. Generally, drugs and biological products require
FDA approval before marketing. The steps required before a drug or biological
product may be marketed in the United States include: (1) preclinical laboratory
and animal tests; (2) submission of an application for an investigational new
drug or biological product, which must become effective before human clinical
trials may commence; (3) human clinical trials; (4) submission of a Product
License Application (PLA) for the biological product or a New Drug Application
(NDA) for most other new drug products; and (5) approval of the PLA or NDA.
8
<PAGE>
Preclinical safety and initial efficacy testing is usually undertaken in
animals. Results of such preclinical and other laboratory tests are submitted to
the FDA before human clinical trials can begin. Clinical trials are typically
conducted in three phases. Phase I uses human subjects to determine safety and
tolerance. Phase II uses a limited patient population to determine effectiveness
and dosage and to identify side effects. Compounds found effective and safe in
Phase II are further tested in Phase III with an expanded patient population at
geographically dispersed clinical study sites. Each phase may last from one to
two years or more.
Most products are not approved because of the failure to demonstrate safety,
effectiveness, or both. The FDA may suspend clinical trials at any time if it is
felt that subjects or patients are being exposed to an unacceptable health risk.
Obtaining FDA approval requires substantial time and effort. There can be no
assurance that any approval will be granted to Epitope on a timely basis, if at
all. As part of the approval process, the FDA may require the Company to
initiate post-approval marketing studies.
Medical Devices. Medical devices are classified either in Class I, Class II, or
Class III. Class I devices are subject only to general control provisions of the
Federal Food, Drug, and Cosmetic Act, as amended (the FDC Act). These provisions
include requirements that a device not be adulterated or misbranded. Class II
devices are those for which general controls are insufficient to provide a
reasonable assurance of safety and efficacy and for which a "generic"
performance standard or other special controls are appropriate. Devices that do
not meet the criteria for Class I or II are placed in Class III. Class I and II
devices, those Class III devices initially marketed prior to passage of the
Medical Device Amendments of 1976 (MDA) for which premarket approval
applications (PMAs) are not yet required, and devices substantially equivalent
to such devices, may be marketed upon FDA clearance of a Premarket Notification
(a 510(k) Notice). Other Class III devices may be commercially marketed only
after FDA approval of a PMA. Generally, the process for obtaining FDA approval
of a PMA is similar to that for obtaining approval of a biological or other drug
product.
Based upon the information provided in a 510(k) Notice regarding the device's
intended use and technological features, the FDA will determine whether the
device is "substantially equivalent" to a predicate device, i.e., a device
legally marketed which did not require a PMA. If a device is found to be
substantially equivalent to a predicate device, it may be freely marketed in the
United States so long as the device is otherwise in compliance with the FDC Act.
If it is not so found, it will be considered a Class III device requiring a PMA.
Substantial equivalence means that the FDA has found that the device has the
same intended use as the predicate device, and either has the same technological
characteristics or has different characteristics, but there is information in
the 510(k) Notice that shows the device is as safe and effective as the
predicate and does not present different questions of safety and effectiveness.
OraSure Collection Device. Use of the OraSure collection device for applications
involving the detection of antibodies to HIV is regulated by the FDA as use of a
Class III medical device requiring a PMA. In December 1994, the FDA approved
Epitope's PMA for use of the OraSure device in HIV screening. Post-approval
marketing studies were completed and a final report submitted to the FDA on
August 28, 1997. In June 1996, the FDA approved the PMA for use of the OraSure
oral specimen-based Western blot confirmatory test kit for HIV-1 diagnosis. A
second generation HIV-1 antibody EIA test for OraSure samples is currently under
review by the FDA.
Western Blot Test Kits. Epitope's HIV-1 Western blot serum-based confirmatory
test kits are used to confirm whether individuals are infected with HIV-1. They
are regulated by the FDA as biological products, unlike most other diagnostic
tests which are regulated as medical devices. In March 1991, the FDA cleared the
EPIblot HIV-1 serum-based confirmatory test kit for commercial distribution. As
noted above, a PMA seeking permission to market the OraSure oral specimen-based
Western blot confirmatory test kit for HIV-1 diagnosis was approved by the FDA
in June 1996.
Manufacturing Regulations. Every company that manufactures drugs, biological
products, or medical devices distributed in the United States is subject to
inspections by the FDA and must comply with the FDA's Quality Systems
Regulations. These regulations govern, among other matters, manufacture,
testing, release, packaging, distribution, documentation, purchasing and design
control.
9
<PAGE>
FDA Warning Letter. Epitope received a warning letter from the FDA in June 1998,
noting that the Company had not fully adhered to the FDA's new Quality Systems
Regulations. These new regulations, which went into effect on June 1, 1997, are
part of the FDA's stepwise approach to international harmonization of quality
standards and include some new requirements such as design controls. The
inspections under these new regulations are part of an industry-wide standard
that the FDA has adopted to optimize compliance through more rigorous and
detailed inspection of companies operating in biologics industries. The items
cited in the warning letter mainly address incidents relating to failure to
strictly adhere to standard operating procedures in the production and
evaluation of products manufactured by Epitope.
Epitope is cooperating fully with the FDA to address all of the instances cited,
has already replied to each of the FDA's questions, and is aggressively making
changes in procedures and retraining personnel. It is the Company's belief that
none of the FDA's concerns affected the safety or effectiveness of its products,
and that the cost of compliance to make the required changes will not be
material.
Other. Epitope is also subject to regulation by the Occupational Safety and
Health Administration and may be subject to regulation by the U.S. Environmental
Protection Agency (EPA) under the Toxic Substances Control Act (TSCA), the
Resource Conservation and Recovery Act, and other legislation. Epitope is also
subject to foreign regulations governing, for example, human clinical trials and
marketing with respect to products distributed outside the United States.
Approval processes vary from country to country, and the length of time required
for approval or to obtain other clearances may in some cases be longer than that
required for U.S. governmental approvals. The extent of potentially adverse
governmental regulation affecting Epitope that might arise from future
legislative or administrative action cannot be predicted.
SUPPLIES
The HIV-1 antigen needed to manufacture Epitope's Western blot HIV confirmatory
test kits is available from only a limited number of sources. Organon Teknika,
the exclusive distributor of the test kits, is required to supply Epitope's
requirements for antigen for the term of its distribution agreement with
Epitope, which ends March 31, 2000. If for any reason Organon Teknika should no
longer be able to supply the Company's antigen needs, management believes
Epitope would be able to obtain its own supply of antigen at a competitive cost,
although a change in the antigen would require FDA approval. Epitope has
obtained a license from the National Technical Information Service which is
required for the production of the HIV-1 antigen currently used in the Company's
Western blot test kits. It is unlikely that Epitope would choose to manufacture
its own antigen because of its availability from other suppliers.
Other materials used by Epitope in manufacturing, production, and research and
development operations are widely available from a variety of sources.
GRANTS AND CONTRACTS
Epitope has received funding in the past from the National Institute of Allergy
and Infectious Diseases (NIAID), for work in developing a rapid test to detect
HIV antibodies in oral fluid specimens, and from the National Cancer Institute
(NCI), to fund research for the treatment of cancer by exploiting a deficiency
of certain compounds in cancer cells. The Company regularly makes applications
for new grants, but there is no assurance that additional grant support can be
obtained.
PATENTS AND PROPRIETARY INFORMATION
Epitope has obtained patents in the United States and certain foreign countries
for the OraSure device and related technology. Epitope has applied for
additional patents, both in the United States and in certain foreign countries,
on the OraSure collection device and a number of other technologies and
products. The Company anticipates filing patent applications for protection on
future products and technology. United States patents generally have a maximum
term of 20 years from the date an application is filed or 17 years from
issuance, whichever is longer.
10
<PAGE>
Much of the technology developed by the Company is subject to trade secret
protection. To reduce the risk of loss of trade secret protection through
disclosure, the Company requires its employees and consultants to enter into
confidentiality agreements.
The Company believes that patent and trade secret protection is important to its
business. However, the issuance of a patent or existence of trade secret
protection does not in itself ensure the Company's success. Competitors may be
able to produce products competing with a patented Company product without
infringing on the Company's patent rights. Issuance of a patent in one country
generally does not prevent manufacture or sale of the patented product in other
countries. The issuance of a patent to the Company or to a licensor is not
conclusive as to validity or as to the enforceable scope of the patent. The
validity or enforceability of a patent can be challenged by litigation after its
issuance, and, if the outcome of such litigation is adverse to the owner of the
patent, the owner's rights could be diminished or withdrawn. Trade secret
protection does not prevent independent discovery and exploitation of the secret
product or technique.
PERSONNEL
At September 30, 1998, the Company had 85 full-time employees, including 17
persons in research and product development, 27 in administration and marketing,
31 in manufacturing and production, and 10 in regulatory affairs and quality
assurance. The Company considers its relations with its employees to be
excellent. None of its employees are represented by labor unions.
The Company employs 5 persons holding Ph.D. degrees with specialties in the
following disciplines: virology/molecular biology, biochemistry, microbial
physiology, microbiology and organic chemistry. From time to time, the Company
also engages the services of scientists as consultants to augment the skills of
its scientific staff.
SCIENTIFIC ADVISORY BOARD
The Company also utilizes the services of a Scientific Advisory Board. The
Scientific Advisory Board meets periodically to review the Company's research
and development efforts and to apprise the Company of scientific developments
pertinent to the Company's business. The Scientific Advisory Board comprises
chair Daniel Malamud, Ph.D., Professor and Chair, Department of Biochemistry,
University of Pennsylvania School of Dental Medicine; J. Richard George, Ph.D.,
Chief Scientific Officer of Epitope; James I. Mullins, Ph.D., Professor of
Microbiology and Medicine, University of Washington; Wayne R. Wecksler, Ph.D.,
General Manager, Esoteric Testing Center, SmithKline Beecham Clinical
Laboratories, Van Nuys, CA; and John V. Parry, Ph.D., Deputy Director, Hepatitis
and Retrovirology Laboratory, Central Public Health Laboratory, Virus Reference
Division, London, England.
FORWARD-LOOKING STATEMENTS; RISK FACTORS
Statements above regarding future events or performance are "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. The Company's actual results could be quite different from those
expressed or implied by the forward-looking statements. Factors that could
affect results include the risk factors discussed below, those discussed in Item
7, and those described elsewhere in this Annual Report on Form 10-K. Although
forward-looking statements help to provide complete information about the
Company, readers should keep in mind that forward-looking statements are much
less reliable than historical information. Readers are cautioned not to place
undue reliance on the forward-looking statements.
Loss or Impairment of Sources of Capital. Although the Company has made
significant progress in the last fiscal year toward controlling expenses,
increasing product revenue, and achieving profitability, the Company has
historically depended to a substantial degree on capital raised through the sale
of equity securities to fund its operations. The Company's future liquidity and
capital requirements will depend on numerous factors, including the costs and
timing of expansion of manufacturing capacity, the success of product
development efforts, the costs and timing of expansion of sales and marketing
activities, the extent to which existing and new products gain market
acceptance, competing technological and market developments, and the scope and
timing of strategic acquisitions.
11
<PAGE>
If additional financing is needed, the Company may seek to raise funds through
the sale of equity securities. There can be no assurance that financing through
the sale of equity securities, or otherwise, will be available on satisfactory
terms, if at all. In particular, the fact that the Company's common stock has
recently traded at historically low levels may make it difficult for the Company
to raise necessary funds through the sale of common stock or other equity
securities.
Ability of the Company to Develop Product Distribution Channels. The Company has
marketed most of its products by collaborating with pharmaceutical and
diagnostic companies and distributors. For example, the Company's EPIblot and
OraSure Western blot confirmatory tests are distributed through Organon Teknika,
the OraSure collection device is distributed to the insurance industry through
major insurance testing laboratories, and the Company has entered an agreement
with STC to distribute the OraSure device for drugs-of-abuse testing. Except in
the public health market, the Company does not maintain a substantial sales or
marketing force. Accordingly, the Company's sales depend to a substantial degree
on its ability to develop product distribution channels and on the marketing
abilities of the companies with which it collaborates.
Ability of the Company to Develop New Products. The Company's OraSure collection
device is becoming recognized in the insurance and public health markets as a
reliable, effective test system. The Company's long-term strategy is based on
continued expansion of markets for OraSure and the development of new products.
OraQuick and other planned products are in various stages of development. In
some cases, the Company will be required to achieve difficult scientific or
technical objectives before the commercial or technological feasibility of new
products can be demonstrated. There can be no assurance that products under
development will perform in accordance with expectations, that necessary
regulatory approvals will be obtained, or that the products can be successfully
and profitably manufactured, distributed, and sold.
Development of Competing Products. Competition in the medical products business
is intense and will likely increase. The Company believes that the principal
competition for OraSure will come from blood-based and urine-based assays, and
could also come from other oral-fluid testing systems. New testing methods could
be developed in the future that render the Company's products uneconomical or
obsolete. Most of the Company's competitors have significantly greater
financial, manufacturing, technical, research, marketing, sales, distribution
and other resources than those of the Company. There can be no assurance that
the Company will not experience competitive pressures, particularly with respect
to pricing, that could have a material adverse effect on the Company's business,
results of operations and financial condition. See "Competition" above for
additional information.
Market Acceptance of Oral Testing Products. The Company has made significant
progress in gaining acceptance of oral testing for HIV in the insurance and
public health markets. The Company also expects that oral testing for drugs of
abuse will be accepted in employment testing. Other markets, particularly the
physician market, may resist the adoption of oral testing as a replacement for
other testing methods in use today. There can be no assurance that the Company
will be able to expand use of its oral testing products in these markets.
Changes in Federal or State Law or Regulations. As described more fully above
under "Government Regulation," many of the Company's proposed and existing
products are subject to regulation by the FDA and other governmental agencies.
The process of obtaining required approvals from these agencies varies according
to the nature of and uses for the product and can involve lengthy and detailed
laboratory and clinical testing, sampling activities, and other costly and
time-consuming procedures. Changes in government regulations could require the
Company to undergo additional trials or procedures, or could make it impractical
or impossible for the Company to market its products for certain uses, in
certain markets, or at all. Other changes in government regulations, such as the
adoption of the FDA's Quality Systems Regulations, may not affect the Company's
products directly but may nonetheless adversely affect the Company's financial
condition and results of operations by requiring that the Company incur the
expense of changing or implementing new manufacturing and control procedures.
Loss of Key Personnel. The Company depends to a large extent on the abilities
and continued participation of its executive officers and scientific personnel.
The loss of key personnel could have a material adverse effect on the Company's
business, financial condition, and results of operations. Competition for
management and scientific staff in the medical products field is intense. No
assurance can be given that the Company will be able to continue to attract and
retain personnel with sufficient experience and expertise to satisfy the
Company's needs.
12
<PAGE>
The previous discussion of the Company's business should be read in conjunction
with the Consolidated Financial Statements and accompanying notes included in
Item 14 of this Annual Report on Form 10-K.
ITEM 2. PROPERTIES.
The Company leases approximately 35,600 square feet of office, manufacturing,
and laboratory space in Beaverton, Oregon, under two leases that terminate
January 31, 2000. Each lease calls for fixed monthly payments over its term. The
Company also entered into a three-year lease, effective October 1, 1996, for
2,265 square feet of warehouse space used to store inventory and equipment. The
total amount of the Company's lease obligation through the term of the lease is
$456,348.
ITEM 3. LEGAL PROCEEDINGS.
On April 7, 1998, the Company's former subsidiary A&W instituted a lawsuit
against two former officers of the Company and an officer of Agritope in
connection with events surrounding the recission of the A&W acquisition (U.S.
District Court for the Southern District of California, Case No. 98 CV 0666 TW
(CGA)). The defendants were not served with notice of the lawsuit until October
1, 1998. A&W alleges improper acts by the officers, and seeks damages claimed to
be in excess of $5.7 million, an amount that corresponds to the liquidation
value of the preferred stock issued by A&W to the Company at the time the
acquisition was rescinded. The Company is defending the officers and believes
the lawsuit to be frivolous, without merit, and counter to a settlement
agreement signed by A&W at the time of the recission. The defendants have moved
for dismissal and will pursue the matter vigorously. The Company has filed an
action in Oregon state court (Multnomah County Circuit Court Civ. No.
9810-07537) against A&W for breaching the settlement agreement and is seeking as
damages the Company's costs of defending the California action.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is listed for trading on the National Market tier of
The Nasdaq Stock Market (NASDAQ) under the symbol EPTO. Prior to January 2, 1997
the Company's Common Stock was listed for trading on the American Stock Exchange
(AMEX) under the symbol EPT. High and low sales prices reported by NASDAQ and
AMEX during the periods indicated are shown below.
SALES PRICES PER SHARE
<TABLE>
YEAR ENDED SEPTEMBER 30 1998 1997
HIGH LOW HIGH LOW
<S> <C> <C> <C> <C>
First Quarter.................................. $ 8.125 $ 4.25 $ 16.375 $ 10.875
Second Quarter................................. 7.1875 4.75 17.375 9.75
Third Quarter.................................. 6.875 4.5625 11.125 6.25
Fourth Quarter................................. 7.00 2.875 8.625 4.625
</TABLE>
On December 1, 1998, there were 923 holders of record of the Common Stock, and
the closing price of the Common Stock was $5.375. The Company has never paid any
cash dividends, and the Board of Directors does not anticipate paying cash
dividends in the foreseeable future. The Company intends to retain any future
earnings to provide funds for the operation and expansion of its business.
13
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected consolidated operating results and
balance sheet data of Epitope, Inc. and its subsidiaries. The balance sheet data
at September 30, 1998 and 1997 and the operating results data for the years
ended September 30, 1998, 1997 and 1996 have been derived from audited
Consolidated Financial Statements and notes thereto included in this Annual
Report on Form 10-K. The balance sheet data at September 30, 1996, 1995, and
1994 and operating results data for the years ended September 30, 1995 and 1994
have been derived from audited Consolidated Financial Statements and notes
thereto not included in this Annual Report on Form 10-K. This information should
be read in conjunction with the Consolidated Financial Statements and notes
thereto included in Item 14 and Item 7 "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
COMPARATIVE FINANCIAL DATA
(In thousands, except per share data)
<TABLE>
YEAR ENDED SEPTEMBER 30 1998 1997 1996 1995 1994
OPERATING RESULTS
<S> <C> <C> <C> <C> <C>
Revenues......................................... $ 9,792 $ 9,360 $ 5,594 $ 2,856 $ 2,605
Operating costs and expenses..................... 12,042 14,323 10,881 14,464 8,890
Other income, net................................ 322 882 6,388(1) 1,157 456
(Loss) income from continuing operations......... (1,928) (4,081) 1,101 (10,451) (5,829)
Discontinued operations.......................... - (18,359) (2,501) (8,045) (9,804)
Net loss......................................... (1,928) (22,440) (1,400) (18,496) (15,633)
(Loss) income per share from continuing
operations..................................... (0.14) (.30) .08(2) (.88) (.58)
Net loss per share............................... (0.14) (1.67) (.11) (1.56) (1.56)
Shares used in per share
calculations.................................... 13,529 13,404 12,661(2) 11,886 10,050
BALANCE SHEET DATA
Working capital.................................. $ 6,510 $ 9,538 $ 24,793 $ 20,686 $ 16,766
Total assets..................................... 10,357 17,012 29,784 26,142 19,993
Accumulated deficit.............................. (103,046) (95,426) (72,985) (71,585) (53,090)
Shareholders' equity............................. 8,274 15,014 27,967 22,347 18,470
</TABLE>
(1) Includes one-time licensing fee of $5.0 million.
(2) 13,440,000 shares used in calculation of profit per share from continuing
operations due to common stock equivalents.
14
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Statements below regarding future events or performance are "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. The Company's actual results could be quite different from those
expressed or implied by the forward-looking statements. Factors that could
affect results include: loss or impairment of sources of capital; ability of the
Company to develop product distribution channels; ability of the Company to
develop new products; development of competing products; market acceptance of
oral testing products; changes in federal or state law or regulations;
uncertainties related to customers' and suppliers' ability to achieve year 2000
compliance; and loss of key personnel. These factors are discussed more fully
under "Forward-Looking Statements; Risk Factors" in Item 1, under "Year 2000
Readiness" in this Item 7, and elsewhere in this Annual Report on Form 10-K.
Although forward-looking statements help to provide complete information about
the Company, readers should keep in mind that forward-looking statements are
much less reliable than historical information. Readers are cautioned not to
place undue reliance on the forward-looking statements.
DISCONTINUED OPERATIONS
Agritope. On December 30, 1997, Epitope distributed all of its ownership
interest in Agritope, Inc. (Agritope) to Epitope's shareholders through a stock
dividend (the Agritope Spin-off). Epitope no longer owns or controls any shares
of Agritope stock.
Agritope's results of operations are presented as discontinued operations in the
Consolidated Financial Statements included in this Annual Report on Form 10-K
through the date of the spin-off. Agritope's net assets are presented in the
September 30, 1997 balance sheet as net assets of discontinued operations. All
intercompany loans from Epitope to Agritope have been reflected as capital
contributions to Agritope consistent with the separation agreement between
Agritope and Epitope dated December 1, 1997.
Andrew and Williamson Sales, Co. On December 12, 1996, a subsidiary of the
Company completed a merger with Andrew and Williamson Sales, Co. (A&W), a
producer and wholesale distributor of fresh and frozen fruits and vegetables
based in San Diego, California. Under the terms of the merger, the Company
issued 520,000 shares of Epitope common stock in exchange for all of the
outstanding common stock of A&W. On May 27, 1997, in accordance with the terms
of a rescission agreement, the former shareholders of A&W returned the 520,000
shares of Epitope common stock they received, and Epitope returned all of the
outstanding shares of A&W common stock. Epitope also received A&W preferred
stock in satisfaction of intercompany loans made to A&W between December 12,
1996 and March 19, 1997. This A&W preferred stock carries a $5.7 million
liquidation preference, dividend preferences, and various redemption features
and carries no value on the accompanying balance sheet based upon management's
estimate of fair value on the date it was received. In addition, the Company had
provided a guarantee to Wells Fargo Bank for a credit facility provided to A&W.
On June 16, 1998, the Company was released from any contingent liability with
regard to the guarantee.
RESULTS OF OPERATIONS
The table below shows the amount (in thousands) and percentage of Epitope's
total revenue contributed by each of its principal products and by grants and
contracts.
<TABLE>
FISCAL YEAR 1998 1997 1996
Product Sales
<S> <C> <C> <C> <C> <C> <C>
Oral specimen collection devices..................... $7,195 74% $6,279 67% $3,311 59%
Western blot HIV confirmatory tests.................. 2,370 24 1,791 19 1,540 28
Other product sales.................................. 214 2 14 - 14 -
------- ----- -------- ----- -------- -----
9,779 100% 8,084 86% 4,865 87%
Grants and contracts................................. 13 0 1,276 14 729 13
-------- ----- ----- ---- -------- ----
$9,792 100% $9,360 100% $5,594 100%
</TABLE>
15
<PAGE>
Revenues. Product sales increased by $1.7 million or 21 percent from 1997 to
1998 and by $3.2 million or 66 percent from 1996 to 1997 primarily as a result
of expanded sales volume of Epitope's lead product, the OraSure oral specimen
collection device. Approximately 34 percent of 1998 sales were attributable to
shipments in the fourth quarter. The increase in sales volume of the OraSure
device is primarily due to increased purchases of the device by the Company's
distributors for the life insurance testing market following the approval by the
FDA in June 1997 and the reduction of inventories built up beyond pilot
programs. This inventory build-up resulted in reduced OraSure device sales in
the second half of 1997 and the first half of 1998 as insurance customers
reduced their inventory levels. In addition, the Company's continued expansion
into the public health markets in 1998 contributed to the increase in sales.
OraSure device sales into the public health markets in 1998 totaled $2.5 million
or 25 percent of total product sales. The life insurance testing market
contributed $4.2 million or approximately 44 percent of total 1998 product
sales. OraSure device sales into the international market totaled $420,000 or 4
percent in 1998. The Company's total product sales into foreign markets,
including cotinine test devices and product components, represented 10 percent
of total sales in 1998.
Fiscal year sales are anticipated to continue rising in 1999. However, sales may
be affected by seasonality of certain market segments such as insurance.
Expectations for future sales are based primarily on forecasts provided to the
Company by individual customers rather than firm orders, as many of the
customers in the public health market do not have contractual arrangements with
the Company.
Sales of the Company's Western blot HIV confirmatory test increased by $579,000
or 32 percent from 1997 to 1998 and increased by $251,000 or 16 percent from
1996 to 1997. Sales in 1997 were negatively affected by a reduction in orders
from the Company's exclusive distributor for this product as the distributor
lowered inventory levels. In addition, 1998 sales of the Western blot HIV
confirmatory test have increased as a result of increased use of the related
oral specimen collection devices and screening tests.
As of September 30, 1998, the Company had firm orders and contractual
commitments for delivery within 90 days of OraSure devices and Western blot HIV
confirmatory tests totaling approximately $940,000 and $570,000, respectively,
as compared to firm orders for delivery within 90 days of $900,000 and $450,000,
respectively, as of September 30, 1997.
Grant and contract revenues decreased by $1.3 million or nearly 100 percent from
1997 to 1998 and increased $547,000 or 75 percent from 1996 to 1997. The
decrease in 1998 was due to the termination of the Company's development,
license and supply agreement with Smithkline Beecham, plc (SB) in July 1997. R&D
activities related to the SB agreement accounted for the increase in 1997.
Discussions are under way with other potential partners who may provide R&D
funding to the Company. Grant applications for additional funding are also being
considered.
Gross Margin on product sales was 62 percent in 1998, 57 percent in 1997, and 45
percent in 1996. The improvement in gross margins is attributable to increased
sales and production volumes for the OraSure device which resulted in lower per
unit costs and to the shift in product mix towards the OraSure device which
carries a higher gross margin than does the Western blot HIV confirmatory test.
The gross margin in the fourth quarter of 1998 was 65 percent as a result of
increased product sales volume.
Research and Development Expenses. Research and development expenses decreased
by $1.2 million or 30 percent from 1997 to 1998 and increased by $991,000 or 31
percent from 1996 to 1997. The decrease in 1998 was primarily the result of
decreased levels of research and clinical studies activity conducted the under
SB agreement. R&D expenses for 1999 should be near the 1998 level, unless
funding for additional R&D projects is forthcoming from potential new partners
or from research grants.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased by $1.2 million or 18 percent from 1997 to
1998 and expenses increased by $1.6 million or 32 percent from 1996 to 1997. The
decrease in 1998 was primarily a result of cost containment measures and a
reduction in compensation expense. The increase in 1997 was primarily
attributable to higher corporate and marketing expenses as the Company expanded
its direct sales efforts. 1999 sales expenses are expected to increase as a
result of increased
16
<PAGE>
advertising and promotion to support expansion in all markets.
Selling, general and administrative expenses have been reduced by $1.4 million
and $1.1 million in 1997 and 1996, respectively, for amounts allocated to
Agritope (see "Discontinued Operations").
Other Income (Expense), Net. Other income for 1996 included $5.0 million related
to license fees received from SB as a result of FDA approval of an extension of
dating for the OraSure device. Interest income decreased in 1998, primarily due
to lower levels of invested funds.
Year 2000 Readiness. Epitope is aware of the issues associated with the
programming code in existing computer systems and other electronic equipment as
the year 2000 (Y2K) approaches. The "year 2000 problem" is pervasive and
complex. Virtually every computer system and many electronic controlled devices
will be affected in some way by the rollover of the two-digit year value to 00.
The issue is whether these systems and devices will properly recognize
date-sensitive information when the year changes to 2000. Systems and devices
that do not properly recognize such information could generate erroneous data or
cause the system or device to fail.
The Company's management has conducted a review of Epitope's exposure to the Y2K
problem, including the development of a plan of identifying systems and devices
that are non-compliant and a systematic approach to replacing or upgrading those
systems and devices that are compliant. In addition, Epitope is in the process
of contacting all vendors, suppliers, and customers, the interruption of whose
businesses would have a material effect on the Company. All non-Y2K compliant
internal systems or devices, including those that affect technology, products or
service functions, will be replaced or upgraded in the ordinary course of
business (as part of a regular ongoing upgrade program) during fiscal 1999. The
Company is also working with computer and electronic device hardware and
software vendors to ensure that the replacement products are Y2K compliant. The
Company has not incurred any material costs to date and does not anticipate
incurring any material costs to resolve issues relating to the Y2K problem
internally. Such costs will be funded by cash flows from operations or available
cash and cash equivalents.
At the current time, the Company anticipates that all essential products and
internal systems and equipment are now or will be timely made Y2K compliant in
all material respects. This belief is based on the progress to date and the
assessed degree of difficulty associated with the remaining phases to achieve
Y2K readiness, the representations made by vendors and, where possible, by
testing. Significant uncertainty exists, however concerning the effects of the
Y2K problem, primarily with regards to assurances made by the Company's key or
significant vendors, suppliers, and customers. In addition, Epitope has not
investigated Y2K compliance of third parties that are either not critical or
significant to the Company's operations or are not currently vendors, suppliers,
or customers of the Company. Any failure of the Company or its vendors,
suppliers, customers, or any third party governmental or business entities to be
Y2K compliant could materially affect the business, results of operations,
financial conditions and prospects of Epitope, the impact of which cannot be
quantified at this time.
Contingency plans are under development at this time and the Company anticipates
that acceptable alternatives will be available in the event that a contingency
arises. These contingency plans anticipate using alternative vendors and
suppliers of goods and services. It is impossible, however, for the Company to
fully assess the likelihood or magnitude of consequences of Y2K issues, should
representations of vendors, suppliers, and customers prove to be inaccurate.
This section captioned "Year 2000 Readiness" as well as other statements herein
relating to Y2K issues are "Year 2000 Readiness Disclosures" pursuant to the
Year 2000 Information and Readiness Disclosure Act.
LIQUIDITY AND CAPITAL RESOURCES
<TABLE>
(IN THOUSANDS) 9/30/98 9/30/97
<S> <C> <C>
Cash and cash equivalents.............................................. $1,164 $ 1,934
Marketable securities.................................................. 4,455 7,142
Working capital........................................................ 6,510 9,532
</TABLE>
17
<PAGE>
Net cash flows used in operating activities decreased by $745,000 and the total
net decrease in cash and cash equivalents declined $2,995,000 from 1997 to 1998
as a result of improved operating results, no longer having the need to fund the
operations of subsidiaries, and continued control of expenses.
Proceeds from current assets, primarily the sale of marketable securities,
represented the primary sources of funds for meeting the Company's requirements
for operations, working capital and business expansion in 1998. The Company
received proceeds of $448,000, $1,668,000 and $5.9 million from the exercise of
warrants and options to purchase common stock in 1998, 1997 and 1996,
respectively. Research grant funding from strategic partners was $13,000, $1.3
million and $729,000 in 1998, 1997 and 1996, respectively. Funding of the
Company's discontinued operations, Agritope and A&W, required $2.1 million,
$13.9 million and $3.2 million in 1998, 1997 and 1996, respectively.
The Company anticipates that it will continue to need funds to support ongoing
research and development projects as well as to provide additional manufacturing
capacity and related increases in working capital to support growth. The Company
believes that its operating liquidity requirements for the foreseeable future
can be met by existing resources, including marketable securities and cash
generated by operations. The Company may also receive funds through the exercise
of outstanding stock options and warrants as well as research grants.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company does not hold material amounts of derivative financial instruments,
other financial instruments, or derivative commodity instruments, and
accordingly has no material market risk to report under this item. See Note 2 to
the Consolidated Financial Statements included under Item 14.
18
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Information with respect to this item is (i) set forth below and (ii) contained
in the Company's Consolidated Financial Statements included in Item 14 of this
Annual Report on Form 10-K.
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
(In thousands, except (loss) income per share)
The following table presents summarized quarterly results of operations for each
of the fiscal quarters in the Company's fiscal years ended September 30, 1998
and 1997. These quarterly results are unaudited, but, in the opinion of
management, have been prepared on the same basis as the Company's audited
financial information and include all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of the information set
forth therein. The data should be read in conjunction with the Consolidated
Financial Statements and related notes thereto included in Item 14 of this
Annual Report on Form 10-K.
<TABLE>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER TOTAL
YEAR ENDED SEPTEMBER 30, 1998
<S> <C> <C> <C> <C> <C>
Revenues........................................... 1,603 2,103 2,783 3,303 9,792
Operating costs and expenses....................... 2,653 2,921 3,109 3,360 12,043
Other income, net.................................. 95 84 66 78 323
Net income (loss).................................. (955) (734) (260) 21 (1,928)
Basic net loss per share........................... (.07) (.05) (.02) 0.00 (0.14)
Diluted net loss per share......................... (.07) (.05) (.02) 0.00 (0.14)
YEAR ENDED SEPTEMBER 30, 1997
Revenues........................................... 2,640 2,336 2,884 1,500 9,360
Operating costs and expenses....................... 3,250 3,574 4,005 3,494 14,323
Other income, net.................................. 319 274 173 116 882
Loss from continuing operations.................... (291) (964) (948) (1,878) (4,081)
Discontinued operations............................ (4,093) (9,202) (1,366) (3,698) (18,359)
Net loss........................................... (4,384) (10,166) (2,314) (5,576) (22,440)
Basic loss per share from continuing operations.... (.02) (.07) (.07) (.14) (.30)
Diluted loss per share from continuing operations.. (.02) (.07) (.07) (.14) (.30)
Basic and diluted net loss per share............... (.34) (.74) (.17) (.42) (1.67)
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
19
<PAGE>
PART III
The Company has omitted from Part III the information that will appear in the
Company's definitive proxy statement for its 1999 annual meeting of shareholders
(the Proxy Statement), which will be filed within 120 days after the end of the
Company's fiscal year pursuant to Regulation 14A.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this item is incorporated by reference to the
information under the captions "Election of Directors," "Executive Officers,"
"Compensation Committee Interlocks and Insider Participation," and "Section
16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated by reference to the
information under the caption "Executive Compensation" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is incorporated by reference to the
information under the caption "Principal Shareholders" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
None.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) and (a)(2) Consolidated Financial Statements and Schedules.
20
<PAGE>
<TABLE>
INDEX TO FINANCIAL STATEMENTS Page
<S> <C>
Report of Independent Accountants................................................................................22
Consolidated Balance Sheets at September 30, 1998 and 1997.......................................................23
Consolidated Statements of Operations for years ended
September 30, 1998, 1997, and 1996............................................................................24
Consolidated Statements of Changes in Shareholders' Equity for years ended
September 30, 1998, 1997, and 1996............................................................................25
Consolidated Statements of Cash Flows for years ended
September 30, 1998, 1997, and 1996............................................................................26
Notes to Consolidated Financial Statements.......................................................................27
</TABLE>
21
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Epitope, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of changes in shareholders' equity, and
of cash flows present fairly, in all material respects, the financial position
of Epitope, Inc. and its subsidiaries at September 30, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended September 30, 1998, in conformity with generally accepted
accounting principles. 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 of these
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
Portland, Oregon
November 12, 1998
22
<PAGE>
<TABLE>
EPITOPE, INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30 1998 1997
ASSETS
Current assets
<S> <C> <C>
Cash and cash equivalents.............................................. $ 1,164,275 $ 1,934,480
Marketable securities.................................................. 4,455,044 7,141,640
Trade accounts receivable, net (Note 2)................................ 1,519,652 928,047
Other accounts receivable.............................................. 47,818 128,949
Inventories (Note 2)................................................... 1,092,577 1,324,647
Prepaid expenses....................................................... 313,941 78,240
------------- -------------
Total current assets................................................... 8,593,307 11,536,003
Property and equipment, net (Note 4)................................... 819,095 1,200,988
Patents and proprietary technology, net (Note 2)....................... 596,169 657,487
Other assets and deposits.............................................. 348,733 55,099
Net assets of discontinued operations (Note 3)......................... - 3,562,726
------------- -------------
$ 10,357,304 $ 17,012,303
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable....................................................... $ 566,894 $ 110,285
Salaries, benefits and other accrued liabilities ...................... 1,516,395 1,887,825
------------- -------------
Total current liabilities.............................................. 2,083,289 1,998,110
Commitments and contingencies (Notes 3 and 9).......................... - -
Shareholders' equity (Note 5)
Preferred stock, no par value - 1,000,000 shares authorized; no
shares outstanding................................................... - -
Common stock, no par value - 30,000,000 shares authorized; 13,577,319
and 13,454,330 shares issued and outstanding, respectively........... 111,319,573 $ 110,439,726
Accumulated deficit.................................................... (103,045,558) (95,425,533)
------------- -------------
8,274,015 15,014,193
$ 10,357,304 $ 17,012,303
</TABLE>
The accompanying notes are an integral part of these statements.
23
<PAGE>
<TABLE>
EPITOPE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED SEPTEMBER 30 1998 1997 1996
Revenues
<S> <C> <C> <C>
Product sales............................................... $ 9,778,930 $ 8,083,606 $ 4,864,378
Grants and contracts........................................ 12,652 1,276,454 729,271
------------ ------------- ------------
9,791,582 9,360,060 5,593,649
Costs and expenses
Product costs............................................... 3,684,702 3,512,054 2,681,429
Research and development costs.............................. 2,917,742 4,156,996 3,165,838
Selling, general and administrative expenses................ 5,439,743 6,654,553 5,033,491
------------ ------------- ------------
12,042,187 14,323,603 10,880,758
Loss from operations........................................ (2,250,605) (4,963,543) (5,287,109)
Other income (expense), net
Interest income............................................. 362,694 885,583 1,386,968
Interest expense............................................ (8,868) (8,165) -
License fee................................................. - - 5,000,000
Other, net.................................................. (31,229) 4,861 1,493
------------- ------------- ------------
322,597 882,279 6,388,461
Net income (loss) from continuing operations................ (1,928,008) (4,081,264) 1,101,352
Discontinued operations (Note 3)
Loss from discontinued operations; Agritope................. - (9,890,599) (2,501,268)
Income from discontinued operations; A&W.................... - 170,646 -
Estimated loss on disposal of A&W........................... - (8,639,054) -
------------ ------------- ------------
- (18,359,007) (2,501,268)
Net loss.................................................... $ (1,928,008) $ (22,440,271) $ (1,399,916)
Basic (loss) income per share from continuing operations.... $ (.14) $ (.30) $ .09
Diluted (loss) income per share from continuing operations.. $ (.14) $ (.30) $ .08
Basic loss per share........................................ $ (.14) $ (1.67) $ (.11)
Diluted loss per share...................................... $ (.14) $ (1.67) $ (.11)
Weighted average number of shares
outstanding................................................ 13,528,596 13,404,402 12,661,420*
</TABLE>
*Diluted income per share from continuing operations calculated using 13,440,396
weighted average shares outstanding due to common stock equivalents.
The accompanying notes are an integral part of these statements.
24
<PAGE>
EPITOPE, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
COMMON STOCK ACCUMULATED
SHARES DOLLARS DEFICIT TOTAL
<S> <C> <C> <C> <C>
BALANCES AT SEPTEMBER 30, 1995 ............. 12,485,130 $ 93,931,947 $ (71,585,346) $ 22,346,601
Common stock issued upon
exercise of options....................... 386,550 4,886,118 - 4,886,118
Common stock issued as compensation......... 19,353 263,586 - 263,586
Compensation expense for stock
option grants............................. - 1,044,183 - 1,044,183
Common stock issued upon
exercise of warrants...................... 46,350 826,600 - 826,600
Equity issuance costs....................... - (152) - (152)
Net loss for the year....................... - - (1,399,916) (1,399,916)
---------- ------------- -------------- -------------
BALANCES AT SEPTEMBER 30, 1996 ............. 12,937,383 100,952,282 (72,985,262) 27,967,020
Common stock issued upon
exercise of options....................... 16,124 168,211 - 168,211
Common stock issued as
compensation.............................. 41,088 323,938 - 323,938
Compensation expense for
stock option grants....................... - 489,668 - 489,668
Common stock issued upon exchange
of convertible notes (Note 3)............. 250,367 4,529,009 - 4,529,009
Equity issuance costs....................... - (86,134) - (86,134)
Capital contributed in rescission (Note 3).. - 1,820,000 - 1,820,000
Common stock issued for cash................ 209,368 1,500,000 - 1,500,000
Minority interest investment in Vinifera.... - 742,752 - 742,752
Net loss for the year....................... - - (22,440,271) (22,440,271)
---------- ------------- -------------- -------------
BALANCES AT SEPTEMBER 30, 1997 ............. 13,454,330 110,439,726 (95,425,533) 15,014,193
Common stock issued upon
exercise of options....................... 91,278 411,052 - 411,052
Common stock issued for the Employee
Stock Purchase Plan....................... 14,451 54,814 - 54,814
Common stock issued as
matching savings plan contributions....... 17,260 80,740 - 80,740
Compensation expense for
stock option grants....................... - 333,241 - 333,241
Spin-off of Agritope, Inc. ................. - - (5,692,017) (5,692,017)
Net loss for the year....................... - - (1,928,008) (1,928,008)
---------- ------------- -------------- -------------
BALANCES AT SEPTEMBER 30, 1998 ............. 13,577,319 $ 111,319,573 $ (103,045,558) $ 8,274,015
</TABLE>
The accompanying notes are an integral part of these statements.
25
<PAGE>
EPITOPE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED SEPTEMBER 30
<TABLE>
1998 1997 1996
Cash flows from operating activities
<S> <C> <C> <C>
Net loss.................................................. $ (1,928,008) $ (22,440,271) $ (1,399,916)
Adjustments to reconcile net loss to net cash
used in operating activities:
Loss from discontinued operations......................... - 18,359,007 -
Depreciation and amortization............................. 669,839 729,970 1,045,632
Loss (gain) on disposition of property.................... 31,290 17,888 (1,098)
(Increase) decrease in receivables........................ (510,474) 264,686 125,025
Decrease (increase) in inventories........................ 232,070 (166,717) (233,929)
(Increase) decrease in prepaid expenses................... (235,701) 11,278 69,133
(Increase) decrease in other assets and deposits.......... (292,544) (32,340) 20,649
Increase (decrease) in accounts payable and accrued
liabilities............................................. 85,179 180,773 (1,656,478)
Common stock issued as compensation for services.......... - 323,938 263,586
Compensation expense for stock option grants and
deferred salary increases ........................... 431,482 489,668 1,044,183
------------- ------------- -------------
Net cash used in operating activities..................... (1,516,867) (2,262,120) (723,213)
Cash flows from investing activities
Investment in marketable securities....................... (13,524,782) (20,106,837) (47,608,270)
Proceeds from sale of marketable securities............... 16,213,797 31,783,317 45,870,396
Additions to property and equipment....................... (140,903) (196,910) (1,066,758)
Proceeds from sale of property............................ 37,629 - 7,432
Expenditures for patents and proprietary technology....... (157,063) (265,435) (770,262)
Investment in affiliated companies........................ (1,090) (6,702,299) (331,280)
Minority interest in affiliated companies................. - - 215,407
------------- ------------- -------------
Net cash provided by (used in) investing activities....... 2,427,588 4,511,836 (3,683,335)
Cash flows from financing activities
Principal payments under installment purchase and
capital lease obligations............................... - - (39,507)
Proceeds from issuance of common stock.................... 448,365 1,668,211 5,885,573
Cost of common stock issuance............................. - - (152)
Cash to Agritope.......................................... (2,129,291) (7,682,710) -
-------------- -------------- -------------
Net cash (used in) provided by financing activities....... (1,680,926) (6,014,499) 5,845,914
Net (decrease) increase in cash and cash equivalents...... (770,205) (3,764,783) 1,439,366
Cash and cash equivalents at beginning of year............ 1,934,480 5,699,263 4,259,897
------------- ------------- -------------
Cash and cash equivalents at end of year (Note 3)......... $ 1,164,275 $ 1,934,480 $ 5,699,263
</TABLE>
The accompanying notes are an integral part of these statements.
26
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 THE COMPANY
Epitope, Inc. (Epitope or the Company), is an Oregon corporation incorporated in
1981. Epitope develops and markets oral specimen collection kits and related
diagnostic tests primarily for the detection of the Human Immunodeficiency Virus
(HIV), the cause of Acquired Immune Deficiency Syndrome (AIDS), and for the
detection of other medical conditions and analytes, including drugs of abuse.
Epitope's lead product, the patented OraSure(R) collection device, is used as
part of an oral specimen diagnostic system. The Company markets the device in
the United States and certain foreign countries for use in screening life
insurance applicants and for public health use, and plans to begin marketing for
drugs-of-abuse testing in 1999. Epitope also markets HIV-1 Western blot
confirmatory test kits used to confirm positive results of initial screening
tests for HIV-1 infection.
See Note 3, Discontinued Operations, below.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation. The accompanying consolidated financial statements
include the accounts of the Company and its wholly and majority owned
subsidiaries. All significant intercompany balances and transactions have been
eliminated in consolidation.
Cash and Cash Equivalents; Marketable Securities. The Company considers all
highly liquid investments with maturities at time of purchase of three months or
less to be cash equivalents. At September 30, 1998, marketable securities
consisted of commercial paper and U.S. Treasury securities with an original
maturity period greater than three months, but generally less than 12 months.
The Company's policy is to invest its excess cash in securities that maximize
(a) safety of principal, (b) liquidity for operating needs, and (c) after-tax
yields.
Pursuant to Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," the Company has categorized
all of its investments as available-for-sale securities and, accordingly,
unrealized gains and losses on such investments, if material, are carried as a
separate component of shareholders' equity. Such unrealized gains and losses
were immaterial as of September 30, 1998 and 1997.
Trade Accounts Receivable. Accounts receivable are stated net of an allowance
for doubtful accounts of $49,513 and $32,284, respectively, at September 30,
1998 and 1997.
Inventories. Inventories are recorded at the lower of standard cost (which
approximates actual cost on a first-in, first-out basis) or market. Inventory
components are summarized as follows:
<TABLE>
SEPTEMBER 30 1998 1997
<S> <C> <C>
Raw materials.......................................................... $ 238,916 $ 296,432
Work-in-process........................................................ 627,503 343,585
Finished goods......................................................... 211,703 670,175
Supplies............................................................... 14,455 14,455
----------- -----------
$ 1,092,577 $ 1,324,647
</TABLE>
Depreciation and Capitalization Policies. Property and equipment are stated at
cost less accumulated depreciation. Expenditures for repairs and maintenance are
charged to operating expense as incurred. Expenditures for renewals and
betterments are capitalized.
Depreciation and amortization of property and equipment are calculated using the
straight-line method over the estimated lives of the related assets (three to
seven years). Leasehold improvements are generally amortized over the shorter of
estimated useful lives or the terms of the related leases. When assets are sold
or otherwise disposed of, cost and the related accumulated depreciation or
amortization are removed from the accounts and any resulting gain or loss is
included in operations.
27
<PAGE>
Patents and Proprietary Technology. Direct costs associated with patent
submissions and acquired technology are capitalized and amortized over their
minimum estimated economic useful lives, generally five years.
Amortization and accumulated amortization are summarized as follows:
<TABLE>
1998 1997 1996
<S> <C> <C> <C>
Amortization expense for the year ended September 30...... $ 218,381 $ 209,180 $ 172,095
Accumulated amortization at September 30.................. 1,048,671 830,290 621,110
</TABLE>
Fair Value of Financial Instruments. The carrying amounts for cash equivalents,
accounts receivable, and accounts payable approximate fair value because of the
immediate or short-term maturity of these financial instruments.
New Accounting Pronouncements. On June 15, 1997 the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)
No. 130, Reporting Comprehensive Income. SFAS No. 130 is effective for all
fiscal quarters of all fiscal years beginning after December 15, 1997 (October
1, 1998 for the Company). The Company will adopt this pronouncement subsequent
to that date. Also on June 15, 1997 the FASB issued SFAS No. 131, Disclosures
about Segments of an Enterprise and Related Information. SFAS No. 131 is
effective for all fiscal quarters of all fiscal years beginning after December
15, 1997 (October 1, 1998 for the Company). The Company will adopt this
pronouncement subsequent to that date. Both statements require additional
disclosures and reclassification of previously issued financial information but
will not have a material effect on the results of operations and financial
position of the Company. On June 15, 1998, SFAS No. 133 Accounting for
Derivative Instruments and Hedging Activities was issued. SFAS No. 133 is
effective for all fiscal quarters of all fiscal years beginning after June 15,
1999 (October 1, 1999 for the Company). Management of the Company anticipates
that, because the Company does not make use of derivative instruments, the
adoption of SFAS No. 133 will not have any effect on the Company's results of
operations or its financial position.
Revenue Recognition. Product revenues are generally derived from the sale of
products and are recognized as revenue when the related products are shipped.
Grant and contract revenues include funds received under research and
development agreements with various entities. Such revenues are recognized in
accordance with the contract terms.
Research and Development. Research and development expenditures are comprised of
those costs associated with the Company's own ongoing research and development
activities including the costs to prepare for, obtain and compile clinical
studies and other information to support product license applications.
Expenditures for research and development also include costs incurred under
contracts to develop certain products, including those contracts resulting in
grant and contract revenues. All research and development costs are expensed as
incurred.
Shared Services. For the years ended September 30, 1997 and 1996 certain
corporate overhead services were provided by Epitope on a centralized basis for
the benefit of the Company's subsidiaries (Shared Services). The related
subsidiaries' operating results are included in discontinued operations. See
Note 3, Discontinued Operations. Selling, general and administrative expenses
have been reduced by Shared Services allocated to the discontinued operations of
$1,402,895 and $1,069,249 for the years ended September 30, 1997 and 1996,
respectively.
Income Taxes. The Company accounts for certain revenue and expense items
differently for income tax purposes than for financial reporting purposes. The
Company accounts for income taxes under Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes," (SFAS 109) which requires the
use of the asset and liability method for accounting for income taxes. Under
SFAS 109, deferred tax assets and liabilities are recognized based on temporary
differences between the financial statement and the tax bases of assets and
liabilities using enacted tax rates in effect for the year in which the
temporary differences are expected to reverse.
Stock-Based Compensation. SFAS No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123) allows companies which have stock-based compensation
arrangements with employees to adopt a fair-value basis of accounting for stock
options and other equity instruments or to continue to apply the accounting
rules specified in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" (APB 25), but with additional financial statement
disclosure. The Company has elected to continue to account for its stock-based
compensation under APB 25. See Note 5, Shareholders' Equity.
28
<PAGE>
Income (Loss) Per Share. Basic and diluted income (loss) per share has been
computed using the weighted average number of shares of common stock and
potential common stock outstanding during the period. Potential common stock
consists of the number of shares issuable upon exercise of outstanding warrants,
options and convertible notes less the number of shares assumed to have been
purchased for the treasury with the proceeds from such exercise. Potential
common stock is excluded from the computation if its effect is anti-dilutive.
Basic and diluted net income (loss) per share are the same for the years ended
September 30, 1998, 1997, and 1996. On September 30, 1998, 1997, and 1996, the
weighted average shares outstanding were 13,528,596, 13,404,402, and 12,661,420,
respectively. Shares of potential common stock on September 30, 1998, 1997, and
1996, respectively of 6,206,279, 4,428,141, and 3,058,555 were not included in
the calculation of diluted loss per share as they were antidilutive. At
September 30, 1996, 778,878 of potential common shares were included in the
calculation of diluted earnings per share.
Statement of Cash Flows. Cash paid for interest approximated interest expense in
1998, 1997, and 1996. No cash was paid for income taxes in 1998, 1997, or 1996.
Compensation expense amounted to $431,482, $813,606, and $1,307,769 in 1998,
1997, and 1996, respectively, related to the issuance of compensatory equity
securities, which also represent non-cash transactions.
Management Estimates. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
relating to assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements as well as the reported amounts of revenues and
expenses during the reporting period. Actual results could vary from these
estimates.
Reclassifications. Certain reclassifications have been made to prior years' data
to conform with the current year's presentation. These reclassifications had no
impact on previously reported results of operations or shareholders' equity.
NOTE 3 DISCONTINUED OPERATIONS
On December 30, 1997, the Company distributed all of its shares of Agritope,
Inc. (Agritope) common stock through a stock dividend to Epitope shareholders of
record as of December 26, 1997. Epitope no longer owns or controls any shares of
Agritope stock. The costs of the spin-off and Agritope's operating losses
through December 30, 1997 were estimated and accounted for in fiscal year 1997.
Fiscal 1997 also included the loss from discontinued operations of Agritope and
Andrew and Williamson Sales, Co. (A&W).
Agritope. From its acquisition in 1987 through December 29, 1997, Agritope was a
wholly owned subsidiary of Epitope. Agritope's results of operations and net
assets are presented as discontinued operations in the accompanying consolidated
financial statements for the periods ended September 30, 1997 and 1996. All
intercompany loans from Epitope to Agritope were deemed to be terminated and
reflected as capital contributions to Agritope as of the spin-off date
consistent with the separation agreement between Epitope and Agritope dated
December 1, 1997. The 1997 loss from discontinued operations of Agritope
includes an accrual of $1.2 million for Agritope's operating losses, from
October 1, 1997 to December 1, 1997, and costs of the spin-off of Agritope which
occurred on December 30, 1997 in accordance with APB Opinion No. 30, Reporting
the Effects of Disposal of a Portion or Segment of a Business. This amount is
not included in the table below. All net expenses of Agritope subsequent to
December 1, 1997, were borne by Agritope.
Andrew and Williamson Sales, Co. On December 12, 1996, a subsidiary of the
Company completed a merger with Andrew and Williamson Sales, Co. (A&W), a
producer and wholesale distributor of fresh and frozen fruits and vegetables
based in San Diego, California. Under the terms of the merger, the Company
issued 520,000 shares of its common stock in exchange for all of the outstanding
common stock of A&W.
On May 27, 1997, in accordance with the terms of a rescission agreement, the
former shareholders of A&W returned the 520,000 shares of Epitope common stock
they received, and Epitope returned all of the outstanding shares of A&W common
stock. Epitope also received A&W preferred stock in satisfaction of intercompany
loans made to A&W between December 12, 1996 and March 19, 1997. This A&W
preferred stock carries a $5.7 million liquidation preference, dividend
preferences, and various redemption features. The A&W preferred stock carries no
29
<PAGE>
value on the accompanying balance sheet based upon management's estimate of fair
value on the date it was received. A&W's results of operations for the period
from December 13, 1996 through May 27, 1997 and the total estimated loss on
disposal are presented in the accompanying financial statements as discontinued
operations.
The components of Agritope's net assets are summarized as follows:
<TABLE>
SEPTEMBER 30 1997
<S> <C>
Cash.................................................................................. $ 4,384
Trade accounts receivable, net........................................................ 617,359
Inventories........................................................................... 2,081,295
Other current assets.................................................................. 281,778
-----------
Total current assets.................................................................. 2,984,816
Property and equipment, net........................................................... 2,749,788
Patents and proprietary technology, net............................................... 1,276,692
Investment in affiliates.............................................................. 246,962
Other assets.......................................................................... 26,797
-----------
7,285,055
Other current liabilities............................................................. 1,326,008
Long-term liabilities................................................................. 1,196,321
Accrued losses........................................................................ 1,200,000
-----------
Net assets of discontinued operations................................................. $ 3,562,726
</TABLE>
The summarized Statements of Operations for Agritope and subsidiaries is as
follows:
<TABLE>
SEPTEMBER 30 1997 1996
<S> <C> <C>
Revenue.................................................................... $ 1,551,190 $ 585,485
Operating costs and expenses............................................... 6,088,883(1) 2,821,397
Other income (expense), net................................................ (4,427,275) (265,356)
Minority interest in subsidiary net loss................................... 274,369 -
------------ ------------
Net loss from operations................................................... $ (8,690,599) $ (2,501,268)
</TABLE>
(1) Does not include $1.2 million of accrued operating losses and spin-off
costs for the period of October 1, 1997 to December 1, 1997. Such operating
losses and spin-off costs have been reflected in the consolidated statement
of operations in 1997.
NOTE 4 PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows:
<TABLE>
SEPTEMBER 30 1998 1997
<S> <C> <C>
Research and development laboratory equipment.......................... $ 1,014,015 $ 1,096,425
Manufacturing equipment................................................ 1,423,580 1,389,304
Office furniture and equipment......................................... 1,753,455 1,772,698
Leasehold improvements................................................. 1,102,895 1,102,895
Construction in progress............................................... 63,503 109,380
----------- -----------
5,357,448 5,470,702
Less accumulated depreciation and amortization......................... (4,538,353) (4,269,714)
----------- -----------
$ 819,095 $ 1,200,988
</TABLE>
NOTE 5 SHAREHOLDERS' EQUITY
Authorized Capital Stock. The Company's amended articles of incorporation
authorize 1,000,000 shares of preferred stock and 30,000,000 shares of common
stock. The Company's Board of Directors has authority to determine preferences,
limitations and relative rights of the preferred stock.
30
<PAGE>
On December 15, 1997, Epitope's Board of Directors approved a Shareholder Rights
Plan that would allow the Company to protect shareholders' interests in the
event of an attempted takeover of the Company. A dividend distribution of one
Right for each outstanding share of common stock was issued to shareholders of
record at the close of business on December 26, 1997. Each Right entitles the
registered holder to purchase from Epitope 1/1000 of a share of Series A Junior
Participating Cumulative Preferred Stock at a price of $60 per share subject to
adjustment. The Rights become exerciseable in the event a person or group of
affiliated or associated persons (other than the Company or its employee benefit
plans) acquires or obtains the right to acquire 15% or more of the outstanding
shares of common stock. With certain exceptions, if any person becomes the
beneficial owner of 15% or more of the Company's common stock, each of the
Rights (other than Rights held by that person and certain of its transferees,
all of which will be voided) entitles the holder to acquire shares of the
Company's common stock having a value equal to twice the Right's exercise price.
The Rights will expire on the earliest of the close of business on December 26,
2007, upon exchange by the Company for common stock, or upon redemption at the
option of the Company for $0.01 per Right.
Common Stock Reserved for Future Issuance. As of September 30, 1998, the
following shares of the Company's common stock were reserved for future
issuance, as more fully described below:
<TABLE>
PURPOSE SHARES
<S> <C>
Outstanding warrants................................................... 2,537,307
Outstanding stock options.............................................. 3,630,727
Employee Stock Purchase Plan subscriptions............................. 38,245
---------
6,206,279
</TABLE>
Common Stock Warrants. As of September 30, 1998, the following warrants to
purchase shares of common stock were outstanding:
<TABLE>
EXERCISE
DATE OF ISSUANCE SHARES PRICE EXPIRATION DATE
<S> <C> <C> <C>
September 26, 1991........................................ 159,150 5.91 September 30, 2000
December 23, 1992......................................... 988,390 5.91 September 30, 2000
July 20, 1993............................................. 375,000 5.91 September 30, 2000
August 1, 1993............................................ 200,000 5.91 September 30, 2000
October 17, 1994.......................................... 50,000 5.91 September 30, 2000
November 22, 1994......................................... 228,100 5.91 September 30, 2000
May 15, 1998.............................................. 416,667 5.91 December 30, 2000
September 30, 1998........................................ 120,000 6.13 September 30, 2008
---------
2,537,307
</TABLE>
Stock Award Plans. The Company's 1991 Stock Award Plan (the 1991 Plan) was
approved by the shareholders during 1991, replacing the Company's Incentive
Stock Option Plan (ISOP). The 1991 Plan provides for stock-based awards to
employees, outside directors and members of scientific advisory committees or
other consultants. Awards which may be granted under the 1991 Plan include
qualified incentive stock options, nonqualified stock options, stock
appreciation rights, restricted awards, performance awards and other stock-based
awards.
Options issued to employees under the ISOP were issued at prices not less than
the fair market value of a share of common stock on the date of grant. These
options generally expire ten years from the date of grant.
Under the terms of the 1991 Plan, qualified incentive stock options on shares of
common stock may be granted to eligible employees, including officers, of the
Company at an exercise price not less than the fair market value of the stock on
the date of grant. The maximum term during which any option may be exercised is
ten years from the date of grant. To date, options have generally been granted
with four-year vesting schedules. The options are generally exercisable after
one year from the date of grant at the rate of 25% after one year and the
balance at 1/36th monthly thereafter.
31
<PAGE>
The 1991 Plan also provides that nonqualified options may be granted at a price
not less than 75% of the fair market value of a share of common stock on the
date of grant. The option term and vesting schedule of such awards may either be
unlimited or have a specified period in which to vest and be exercised. For the
discounted nonqualified options issued, the Company amortizes, on a
straight-line basis over the vesting period of the options, the difference
between the exercise price and the fair market value of a share of stock on the
date of grant.
SFAS 123 requires the following financial statement disclosure:
Options granted and outstanding under the Company's stock option plans are
summarized as follows:
<TABLE>
1998 1997 1996
SHARES PRICE SHARES PRICE SHARES PRICE
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of period ....... 3,499,865 $3.50 - 20.38 3,365,726 $3.50 - 24.00 3,636,103 $1.09 - 24.00
Granted..................... 4,237,156 1.29 - 18.17 2,801,403 3.50 - 14.81 901,379 9.81 - 18.13
Exercised................... (91,278) 2.79 - 5.04 (16,124) 7.25 - 14.81 (386,550) 1.09 - 17.13
Canceled.................... (4,015,016) 3.50 - 20.38 (2,651,140) 3.50 - 24.00 (785,206) 14.38 - 24.00
---------- ------------ ---------- ------------ -------- -------------
Outstanding at end of period 3,630,727 1.29 - 18.17 3,499,865 $3.50 - 20.38 3,365,726 $3.50 - 24.00
Exercisable................. 2,621,613 1.29 - 18.17 2,474,623 $3.50 - 20.38 2,302,212 $3.50 - 24.00
</TABLE>
<TABLE>
Number of Weighted Average Remaining
Exercise Price Range Shares Average Price Contractual Life
------ ------------- ----------------
<S> <C> <C> <C> <C>
$1.29 - $4.04 461,950 3.25 8.98
$4.17 - $4.17 825,000 4.17 7.27
$4.22 - $4.97 201,150 4.48 23.37
$5.04 - $5.04 1,876,877 5.04 9.26
$5.75 - $18.17 265,750 7.84 8.71
</TABLE>
Option Repricing. On July 26, 1997, a repricing was approved for all outstanding
options held by directors or employees, including executive officers, for which
the exercise price was greater than the market value of the underlying stock on
that date. The Executive Compensation Committee of the Board of Directors
believed that, as a result of a decline in the price of the Common Stock,
outstanding options were ineffective to serve the purposes for which they were
granted under the 1991 Plan, namely to align the interests of option holders
with the long-term interests of the Company's shareholders. The options were
repriced using a price equal to fair market value, in order to restore the
utility of the options as effective incentives. In addition, the spin-off of
Agritope resulted in a price reduction of $2.21 for outstanding options and
warrants.
Options exercisable at September 30, 1998 totaled 2,621,613 shares at a weighted
average exercise price of $4.88. Options available for grant at September 30,
1998 totaled 892,304.
Pursuant to the 1991 Plan, 2478, 0, and 973 shares of common stock were also
awarded to consultants and members of the Company's scientific advisory
committees during 1998, 1997 and 1996, respectively.
Employee Stock Purchase Plan. In 1993, the shareholders approved the Company's
adoption of the 1993 Employee Stock Purchase Plan (1993 ESPP). The plan, as
subsequently approved and amended by the Company's shareholders, covers a
maximum of 500,000 shares of common stock for subscription over established
offering periods. The Company's Board of Directors was granted authority to
determine the number of offering periods, the number of shares offered, and the
length of each period, provided that no more than three offering periods (other
than Special Offering Subscriptions as described below) may be set during each
fiscal year of the Company. The purchase price for stock purchased under the
1993 ESPP for each subscription period is the lesser of 85% of the fair market
value of a share of common stock at the commencement of the subscription period
or the fair market value at the close of the subscription period. An employee
may also elect to withdraw at any time during the subscription period and
receive the amounts paid plus interest at the rate of 6%.
As of September 30, 1998, 38,245 shares of common stock were subscribed for
during two offerings under the 1993 ESPP. Shares subscribed for under these 1993
ESPP offerings may be purchased over 24 months and had initial
32
<PAGE>
subscription prices of $6.99 and $6.00 per share. The subscription prices were
adjusted in 1998 as a result of the spin-off of Agritope to $4.78 and $3.79.
During the year ended September 30, 1998, 14,451 shares were issued at prices
ranging from $4.78 to $3.79 under the 1993 ESPP.
The 1993 ESPP was amended to allow the Company, at its discretion, to provide
Special Offering Subscriptions whereby an employee's annual increase in
compensation could be deferred for a one-year period. At the end of the one-year
period, the employee can elect to receive the deferred compensation amount in
the form of cash or shares of the Company's common stock. The purchase price for
stock issued under a Special Offering Subscription is the lesser of 85% of the
fair market value of a share of common stock on the first day of the calendar
month the employee's increase was effective or the fair market value at the
close of the one-year subscription period. No shares were issued under a Special
Offering Subscription during 1998, 1997 or 1996.
The Company has elected to account for its stock-based compensation under the
provisions of APB 25. However, as required by SFAS No. 123, the Company has
computed for pro forma disclosure purposes the value of options granted during
1998 and 1997 using the Black-Scholes option pricing model. The weighted average
assumptions used for stock option grants for 1998 and 1997 were a risk-free
interest rate of 5.7% and 5.9%, respectively, no expected dividend yield, an
expected life of 3.9 and 4.3 years, respectively, and an expected volatility of
60% and 53%, respectively. The weighted average assumptions used for 1993 ESPP
rights for 1998 and 1997 were a risk-free interest rate of 5.6% and 6.1%,
respectively, no expected dividend yield, an expected life of 2 years and 2
years, respectively, and an expected volatility of 69% and 63%, respectively.
The weighted-average fair value of ESPP rights granted in 1998 was $55,066 and
$248,700 for ESPP rights granted in 1997.
Options were assumed to be exercised upon vesting for purposes of this
valuation. Adjustments are made for options forfeited prior to vesting. For the
years ended September 30, 1998 and 1997, the total value of the options granted
was computed to be $6,861,799 and $9,096,600, respectively, which would be
amortized on the straight-line basis over the vesting period of the options.
If the Company had accounted for these plans in accordance with SFAS 123, the
Company's net loss and pro forma net loss per share would have been reported as
follows:
<TABLE>
YEAR ENDED SEPTEMBER 30 1998 1997
BASIC AND BASIC AND
DILUTED DILUTED
NET LOSS NET LOSS NET LOSS NET LOSS
PER SHARE PER SHARE
<S> <C> <C> <C> <C>
As reported................................. $ (1,928,008) $ (0.14) $ (22,440,271) $ (1.67)
Pro forma................................... $ (4,957,178) $ (0.37) (26,958,371) (2.01)
</TABLE>
The effects of applying SFAS 123 in providing pro forma disclosure for 1998 and
1997 are not likely to be representative of the effects on reported net income
and earnings per share for future years since options vest over several years
and additional awards are made each year.
NOTE 6 INCOME TAXES
As of September 30, 1998, the Company had net operating loss carryforwards to
offset federal and state taxable income of approximately $48.6 million and $45.5
million, respectively. Approximately $7.0 million of the Company's net operating
loss carryforwards were generated as a result of deductions related to the
exercise of stock options. If utilized, such carryforwards, as tax effected,
will be reflected in the Company's financial statements as an increase in
shareholders' equity rather than a reduction of the provision for income taxes.
33
<PAGE>
Significant components of Epitope's deferred tax asset were as follows:
<TABLE>
SEPTEMBER 30 1998 1997
<S> <C> <C>
Net operating loss carryforwards....................................... $18,532,000 $17,030,000
Deferred compensation.................................................. 1,829,000 1,707,000
Research and experimentation credit carryforwards...................... 1,026,000 888,000
Accrued expenses....................................................... 269,000 868,000
Other.................................................................. 779,000 850,000
----------- -----------
Gross deferred tax assets.............................................. 22,435,000 21,343,000
Valuation allowance.................................................... (22,435,000) (21,343,000)
----------- -----------
Net deferred tax asset................................................. $ --- $ ---
</TABLE>
No benefit for these assets has been reflected in the accompanying consolidated
financial statements as they do not satisfy the recognition criteria set forth
in SFAS 109. Accordingly, a valuation allowance of $22.4 million, representing a
$1.1 million increase since the prior fiscal year end, has been recorded.
The tax benefit of approximately $0.6 million for the year ended September 30,
1998, calculated using the statutory tax rate, has been increased by
approximately $0.8 million for the effect of state and local taxes (net of
federal impact) and is reduced by approximately $1.1 million for the effect of
the increase in valuation allowance and $0.3 million for other permanent
differences.
NOTE 7 DISTRIBUTION AND SUPPLY CONTRACTS
The Company has entered into several contractual arrangements, including those
discussed in the following paragraphs, for distribution of certain of its
products to customers.
The Company maintains supply and distribution agreements with Organon Teknika
Corporation (Organon Teknika), whereby Organon Teknika supplies the Company's
antigen requirements and exclusively distributes the Company's EPIblot HIV
confirmatory tests (EPIblot) on a worldwide basis. The agreements have been
extended to March 31, 2000 and continue to renew each year thereafter unless
prior notice of cancellation is given by the Company or Organon Teknika. The
distribution agreement includes pricing incentives based on volumes purchased by
Organon Teknika and penalties for failure to purchase specified minimum
quarterly volumes. For the years ended September 30, 1998, 1997 and 1996,
respectively, revenues generated from sales of EPIblot to Organon Teknika were
$2,371,135, $1,791,290 and $1,539,164, including export sales of $1,250, $15,750
and $62,539.
LabOne, Inc. (LabOne) purchases oral specimen devices from the Company for use
in insurance testing in return for non-exclusive distribution rights in the
United States and Canada under an agreement which expires on March 31, 2000,
with an automatic five-year renewal, unless either party notifies the other of
intent not to renew at least 180 days prior to the expiration date. In 1998, the
Company entered into an additional agreement with LabOne to provide a
prepackaged OraSure test kit with prepaid testing and sample shipment to LabOne
via Airborne Express. This product package is sold directly to the public health
customers by the Epitope sales force. For the years ended September 30, 1998,
1997 and 1996, respectively, revenues generated from product sales to LabOne
were $2,773,351, $3,194,698, and $1,327,544 including export sales of $402,150,
$597,000 and $394,747.
In 1995, SmithKline Beecham plc (SB) and the Company entered an agreement giving
SB exclusive rights to market the Company's oral specimen collection device
worldwide, except in several foreign countries and to the insurance industry in
the U.S., Canada and Japan. In July 1997, SB and the Company terminated the
agreement. As a result, the Company acquired marketing rights for OraSure from
SB. In 1995, SB made an initial license fee payment of $1 million to the Company
and committed an additional license fee of $4 million to be paid upon FDA
approval of a pending request to amend the labeling of the Company's oral
specimen collection device to indicate a two-year shelf life. In April 1996, the
FDA granted the Company's request for extended dating and SB disbursed $4
million plus interest from escrow. Accordingly, the Company recognized income of
$5 million in 1996 operating results.
34
<PAGE>
NOTE 8 COMMITMENTS
The Company leases office, manufacturing, warehouse and laboratory facilities
under operating lease agreements which require minimum annual payments as
follows:
YEAR ENDING SEPTEMBER 30
<TABLE>
<S> <C>
1999...................................................................................... $ 346,356
2000...................................................................................... 109,992
---------
$ 456,348
</TABLE>
Under the agreements for the lease of its office and laboratory facilities, the
Company is obligated to the lessor for its share of certain expenses related to
the use, operation, maintenance and insurance of the property. These expenses,
payable monthly in addition to the base rent, are not included in the amounts
shown above. Rent expense aggregated $433,002, $409,970 and $538,665 for the
years ended September 30, 1998, 1997 and 1996, respectively.
NOTE 9 PROFIT SHARING AND SAVINGS PLAN
The Company established a profit sharing and deferred salary savings plan in
1986 and restated the plan in 1991. All employees are eligible to participate in
the plan. In addition, the plan permits certain voluntary employee contributions
to be excluded from the employees' current taxable income under the provisions
of Internal Revenue Code Section 401(k) and the regulations thereunder.
Effective October 1, 1991, the Company replaced a discretionary profit sharing
provision with a matching contribution (either in cash, shares of Epitope common
stock, or partly in both forms) equal to 50% of an employee's basic
contribution, not to exceed 2.5% of an employee's compensation. The Board of
Directors has the authority to increase or decrease the 50% match at any time.
During 1998, 1997 and 1996, respectively, the Company contributed $80,741
(17,260 shares), $101,737 (11,459 shares, totaling $101,721 and the remainder in
cash) and $73,315 (4,653 shares totaling $73,279 and the remainder in cash). As
of September 30, 1998, 33,554 shares of Epitope common stock are held by the
plan.
NOTE 10 GEOGRAPHIC AREA INFORMATION
The Company's products are all included in the medical products industry
segment. See Note 1 for a description of the Company's business. The Company's
products are sold principally in the United States, Canada, Asia and Latin
America. In 1997 and 1996 product sales to Asia were included in Other.
Operating loss represents revenues less operating expenses. No operating income
or loss is reflected for geographic areas other than the United States and Asia
as all revenues for other geographic areas are exports from the United States.
IN THOUSANDS
<TABLE>
GEOGRAPHIC REVENUES OPERATING LOSS IDENTIFIABLE ASSETS
AREAS 1998 1997 1996 1998 1997 1996 1998 1997 1996
United
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
States....... $8,774 $8,569 $4,903 $(2,264) $(4,935) $(5,244) $10,357 $17,012 $29,784
Canada....... 415 608 404 - - - - - -
Asia......... 341 130 122 13 (29) (43) - - -
Latin
America...... 202 4 100 - - - - - -
Europe....... 59 49 65 - - - - - -
Other........ 1 - - - - - - - -
------ ------ ------ ------- ------- ------- ------- ------- -------
$9,792 $9,360 $5,594 $(2,251) $(4,964) $(5,287) $10,357 $17,012 $29,784
</TABLE>
NOTE 12 CONTINGENCIES
On April 7, 1998, the Company's former subsidiary A&W instituted a lawsuit
against two former officers of the Company and an officer of Agritope in
connection with events surrounding the recission of the A&W acquisition (U.S.
District Court for the Southern District of California, Case No. 98 CV 0666 TW
(CGA)). The defendants were not served with notice of the lawsuit until October
1, 1998. A&W alleges improper acts by the officers, and
35
<PAGE>
seeks damages claimed to be in excess of $5.7 million, an amount that
corresponds to the liquidation value of the preferred stock issued by A&W to the
Company at the time the acquisition was rescinded. The Company is defending the
officers and believes the lawsuit to be frivolous, without merit, and counter to
a settlement agreement signed by A&W at the time of the recission. The
defendants have moved for dismissal and will pursue the matter vigorously. The
Company has filed an action in Oregon state court (Multnomah County Circuit
Court Civ. No. 9810-07537) against A&W for breaching the settlement agreement
and is seeking as damages the Company's costs of defending the California
action.
No schedules are included with the foregoing financial statements because the
required information is inapplicable or is presented in the financial statements
or related notes thereto.
(a)(3) Exhibits.
See Index to Exhibits following the signature page of this report.
(b) Reports on Form 8-K.
None.
36
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on December 23, 1998.
EPITOPE, INC.
By * JOHN W. MORGAN
John W. Morgan
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed on December 23, 1998, by the following persons on behalf of the
Registrant and in the capacities indicated.
SIGNATURE TITLE
*JOHN W. MORGAN President, Chief Executive Officer,
John W. Morgan and Director
(Principal Executive Officer)
/S/ CHARLES E. BERGERON Chief Financial Officer
Charles E. Bergeron (Principal Financial Officer)
/S/ THEODORE R. GWIN Controller
Theodore R. Gwin (Principal Accounting Officer)
*W. CHARLES ARMSTRONG Director
W. Charles Armstrong
*ANDREW S. GOLDSTEIN Senior Vice President and Director
Andrew S. Goldstein
*MARGARET H. JORDAN Director
Margaret H. Jordan
*MICHAEL J. PAXTON Director
Michael J. Paxton
*ROGER L. PRINGLE Director
Roger L. Pringle
*G. PATRICK SHEAFFER Director
G. Patrick Sheaffer
*ROBERT J. ZOLLARS Director
Robert J. Zollars
* /S/ CHARLES E. BERGERON
Charles E. Bergeron
(Attorney-in-Fact)
37
<PAGE>
INDEX TO EXHIBITS
Exhibit
Number Exhibit
- ------ -------
3.1 Restated Articles of Incorporation, as amended, of Registrant.
Incorporated by reference to Exhibit 3 to the Registrant's
Registration Statement on Form 8-A filed December 26, 1997
(Registration Statement No. 000-15337).
3.2 Restated Bylaws of Registrant. Incorporated by reference to
Exhibit 3.2 to the Registrant's Annual Report on Form 10-K for
the year ended September 30, 1997 (the 1997 10-K).
4.1 Stock Purchase Agreement dated November 9, 1990, between
certain investors and Registrant. Copies of the agreements
with individual investors shall be filed with the Commission
upon request pursuant to Instruction 2 of Item 601 of
Regulation S-K (Item 601, Instruction 2). Incorporated by
reference to Exhibit 4.2 to the Registrant's Annual Report on
Form 10-K for the year ended September 30, 1994 (the 1994
10-K).
4.2 Unit Purchase Agreement dated September 1991 between certain
investors and Registrant. Copies of the agreements with
individual investors shall be filed with the Commission upon
request pursuant to Item 601, Instruction 2. Incorporated by
reference to Exhibits 4.1 and 4.2 to the Registrant's Current
Report on Form 8-K dated September 17, 1991.
4.3 Warrant Purchase Agreement dated as of November 25, 1992,
between certain investors and Registrant. Copies of the
agreements with individual investors shall be filed with the
Commission upon request pursuant to Item 601, Instruction 2.
Incorporated by reference to Exhibit 4.5 to the Registrant's
Annual Report on Form 10-K for the year ended September 30,
1992 (the 1992 10-K).
4.4 1993 Technology Transfer Warrant Issuance Agreement dated as
of June 15, 1993, between certain investors and Registrant.
Copies of the agreements with individual investors shall be
filed with the Commission upon request pursuant to Item 601,
Instruction 2. Incorporated by reference to Exhibit 4.3 to the
Registrant's Registration Statement on Form S-3 (No. 33-68510)
(Registration Statement No. 33-68510).
4.5 Form of Letter dated August 1, 1993, from Registrant regarding
modification of the terms of the 1993 Technology Transfer
Warrants. Incorporated by reference to Exhibit 4.5 to
Registration Statement No. 33-68510.
4.6 1993 Warrant Purchase Agreement dated as of July 6, 1993,
between certain investors and Registrant. Copies of the
agreements with individual investors shall be filed with the
Commission upon request pursuant to Item 601, Instruction 2.
Incorporated by reference to Exhibit 4.6 to Registration
Statement No. 33-68510.
4.7 Notice to warrantholders and current form of warrant
certificate for warrants issued in September 1991 offering,
reflecting extension of expiration date. Incorporated by
reference to Exhibit 4.1 to the Registrant's Current Report on
Form 8-K dated September 12, 1997.
4.8 Notice to warrantholders and current form of warrant
certificate for warrants issued in December 1992 offering,
reflecting extension of expiration date. Incorporated by
reference to Exhibit 4.2 to the Registrant's Current Report on
Form 8-K dated September 12, 1997.
4.9 Notice to warrantholders and current form of warrant
certificate for warrants issued in July 1993 offering,
reflecting extension of expiration date. Incorporated by
reference to Exhibit 4.3 to the Registrant's Current Report on
Form 8-K dated September 12, 1997.
4.10 Notice to warrantholders and current form of warrant
certificate for warrants issued in August 1993 offering,
reflecting extension of expiration date. Incorporated by
reference to Exhibit 4.4 to the Registrant's Current Report on
Form 8-K dated September 12, 1997.
38
<PAGE>
10.1 Incentive Stock Option Plan of Registrant, as amended.
Incorporated by reference to Exhibit 10.1 to the 1994 10-K.*
10.2 Amended and Restated Epitope, Inc., 1991 Stock Award Plan.
Incorporated by reference to Exhibit 10.2 to the 1997 10-K.*
10.3 Form of Nonqualified Stock Option Agreement issued to John W.
Morgan pursuant to Epitope, Inc., 1991 Stock Award Plan.
Incorporated by reference to Exhibit 10.20 to the 1997 10-K.*
10.4 Lease dated July 17, 1990, among Registrant, Koll Woodside
Associates, a California general partnership, and Petula
Associates, Ltd., an Iowa corporation. Incorporated by
reference to Exhibit 10.5 to the 1994 10-K.
10.5 Fourth Amendment dated May 20, 1994, to Lease dated July 17,
1990, among Registrant, Koll Woodside Associates, a California
general partnership, and Petula Associates, Ltd., an Iowa
corporation. Incorporated by reference to Exhibit 10.1 to the
Registrant's Quarterly Report on Form 10-Q for the fiscal
quarterly period ended June 30, 1994 (June 1994 10-Q).
10.6 Business Park Lease dated May 5, 1994, among Registrant, Koll
Woodside Associates, a California general partnership, and
Petula Associates, Ltd., an Iowa corporation. Incorporated by
reference to Exhibit 10.2 to the June 1994 10-Q.
10.7 Distribution Agreement dated as of April 1, 1994, between
Registrant and Organon Teknika Corporation. Incorporated by
reference to Exhibit 10.3 to the June 1994 10-Q.
10.8 Supply Agreement dated as of April 1, 1994, between Registrant
and Organon Teknika Corporation. Incorporated by reference to
Exhibit 10.4 to the June 1994 10-Q.
10.9 Form of Indemnification Agreement for directors and officers.
Incorporated by reference to Exhibit 10.4 to the Registrant's
Registration Statement on Form S-4 (No. 333-15705).*
10.10 Amended and Restated Employment Agreement dated January 8,
1991 between Andrew S. Goldstein and Registrant. Incorporated
by reference to Exhibit 10.28 to the Registrant's Annual
Report on Form 10-K for the year ended September 30, 1991.*
10.11 Employment Agreement dated October 6, 1997, between John W.
Morgan and Registrant. Incorporated by reference to Exhibit
10.19 to the 1997 10-K .*
10.12 Employment Agreement dated January 19, 1998, between Charles
E. Bergeron and Registrant. Incorporated by reference to
Exhibit 10.21 to Amendment No. 1 to the 1997 10-K (the 1997
10-K Amendment).*
10.13 Employment Agreement dated January 13, 1998, between J.
Richard George, Ph.D. and Registrant. Incorporated by
reference to Exhibit 10.22 to the 1997 10-K Amendment.*
10.14 Employment Agreement dated as of March 9, 1998, between Edward
V. Collum and Registrant.*
10.15 Separation Agreement between Epitope, Inc. and Agritope, Inc,
dated December 1, 1997. Incorporated by reference to Exhibit
2.3 to the 1997 10-K.
10.16 Amended and Restated Employee Benefits Agreement between
Registrant and Agritope, Inc. (Agritope), dated December 19,
1997. Incorporated by reference to Exhibit 10.24 to the 1997
10-K.*
10.17 Transition Services and Facilities Agreement between
Registrant and Agritope, dated December 1,
39
<PAGE>
1997. Incorporated by reference to Exhibit 10.25 to the 1997
10-K.
10.18 Tax Allocation Agreement between Registrant and Agritope,
dated December 1, 1997. Incorporated by reference to Exhibit
10.26 to the 1997 10-K.
10.19 Settlement and Release Agreement among Epitope, Inc.,
Thamscoe, Inc., Andrew and Williamson Sales, Co., and the
shareholders of Andrew and Williamson Sales, Co., dated May 4,
1997. Incorporated by reference to Exhibit 10.1 of the
Registrant's Quarterly Report on Form 10-Q for the fiscal
quarterly period ended March 31, 1997.
23. Consent of PricewaterhouseCoopers LLP.
24. Powers of Attorney.
27. Financial Data Schedule.
* Management contract or compensatory plan or arrangement
40
EMPLOYMENT AGREEMENT
This Employment Agreement is entered into as of March 9, 1998,
between Edward V. Collom, Jr. ("Employee") and Epitope, Inc., an Oregon
corporation (the "Company").
1. SERVICES.
1.1 EMPLOYMENT. The Company agrees to employ Employee
as Vice President of Sales and Marketing, and Employee hereby accepts such
employment, in accordance with the terms and conditions of this Agreement.
1.2 DUTIES. Employee shall have the position named in
Section 1.1 with such powers and duties appropriate to that office (a) as may be
provided by the bylaws of the Company and (b) as determined from time to time by
the President and Chief Executive Officer or the board of directors of the
Company. Employee's position and duties may be changed from time to time during
the term of this Agreement, and Employee's place of work may be relocated at the
sole discretion of the President and Chief Executive Officer or the board of
directors.
1.3 OUTSIDE ACTIVITIES. Employee shall obtain the
consent of the President and Chief Executive Officer or the board of directors
before he engages, either directly or indirectly, in any other professional or
business activities that may require an appreciable portion of Employee's time
or effort to the detriment of the Company's business.
1.4 DIRECTION OF SERVICES. Employee shall at all
times discharge his duties in consultation with and under the supervision and
direction of the President and Chief Executive Officer of the Company.
2. COMPENSATION AND EXPENSES.
2.1 SALARY. As compensation for services under this
Agreement, the Company shall pay to Employee a regular salary of $11,666.67 per
month. Such salary may be adjusted from time to time in the discretion of the
President and Chief Executive Officer or the board of directors. Payment shall
be made on a bi-weekly basis, less all amounts required by law or authorized by
Employee to be withheld or deducted, in accordance with the Company's usual
payroll practices.
2.2 ADDITIONAL EMPLOYEE BENEFITS. To the extent
otherwise eligible, Employee shall also be entitled to receive or participate in
any additional benefits, including without limitation medical, dental, life, and
long-term disability insurance programs, medical reimbursement plans, and a
401(k) plan, which may from time to time be made available by the
- 1 -
<PAGE>
Company to corporate officers. The Company may change or discontinue such
benefits at any time in its sole discretion.
2.3 EXPENSES. The Company shall reimburse Employee
for all reasonable and necessary expenses incurred in carrying out his duties
under this Agreement. Employee shall present to the Company from time to time an
itemized account of such expenses in such form as may be required by the
Company. The Company shall further pay to Employee (a) a one-time relocation
allowance of $25,000, which includes moving and relocation expenses; and (b) a
temporary housing allowance through August 1998 in the amount of the most
economic rate reasonably available. To the extent the temporary housing
allowance described in this section is includable in Employee's net taxable
income, the Company shall pay Employee an additional amount so that the amount
paid to him under this section, less taxes at Employee's effective marginal tax
rate, equals the expenses to be reimbursed.
2.4 FEES. All compensation earned by Employee, other
than pursuant to this Agreement, as a result of services performed on behalf of
the Company or as a result of or arising out of any work done by Employee in any
way related to the scientific or business activities of the Company shall belong
to the Company. Employee shall pay or deliver such compensation to the Company
promptly upon receipt. For the purposes of this provision, "compensation" shall
include, but is not limited to, all professional and nonprofessional fees,
lecture fees, expert testimony fees, publishing fees, royalties, and any related
income, earnings, or other things of value; and "scientific or business
activities of the Company" shall include, but not be limited to, any project or
projects in which the Company is involved and any subject matter that is
directly or indirectly researched, tested, developed, promoted, or marketed by
the Company.
3. STOCK OPTIONS. The Company shall grant Employee an option
to purchase 75,000 shares of common stock of the Company at an exercise price
equal to the fair market value of the stock on the date of hire. In the event of
a change of control of the Company while Employee is employed by the Company,
Employee's unvested stock options will vest on the date of the change of
control, as defined in the option agreement.
4. CONFIDENTIAL INFORMATION.
4.1 DEFINED. "Confidential Information" is all
nonpublic information relating to the Company or its business that is disclosed
to Employee, that Employee produces, or that Employee otherwise obtains during
employment. "Confidential Information" also includes information received from
third parties that the Company has agreed to treat as confidential. Examples of
Confidential Information are:
4.1.1 Marketing plans.
4.1.2 Customer lists.
- 2 -
<PAGE>
4.1.3 Product design and manufacturing information.
4.1.4 Financial information.
4.2 ACCESS TO INFORMATION. Employee acknowledges that
in the course of his employment he will have access to Confidential Information,
that such information is a valuable asset of the Company, and that its
disclosure or unauthorized use will cause the Company substantial harm.
4.3 OWNERSHIP. Employee acknowledges that all
Confidential Information shall continue to be the exclusive property of the
Company (or the third party that disclosed it to the Company), whether or not
prepared in whole or in part by Employee and whether or not disclosed to
Employee or entrusted to his custody in connection with his employment by the
Company.
4.4 NONDISCLOSURE AND NONUSE. Unless authorized or
instructed in writing by the Company, or required by legally constituted
authority, Employee will not, except as required in the course of the Company's
business, during or after his employment, disclose to others or use any
Confidential Information, unless and until, and then only to the extent that,
such items become available to the public through no fault of Employee.
4.5 RETURN OF CONFIDENTIAL INFORMATION. Upon request
by the Company during or after his employment, and without request upon
termination of employment pursuant to this Agreement, Employee will deliver
immediately to the Company all written or tangible materials containing
Confidential Information without retaining any excerpts or copies.
4.6 DURATION. The obligations set forth in this
Section 4 will continue beyond the term of employment of Employee by the Company
and for so long as Employee possesses Confidential Information.
5. MATERIALS PREPARED AND INVENTIONS MADE DURING EMPLOYMENT.
The Company shall be the exclusive owner of all materials, concepts, and
inventions Employee prepares, develops, or makes (whether alone or jointly with
others) within the scope of his employment, and of all related rights (including
copyrights, trademarks, and patents) and proceeds. Without limitation,
materials, concepts, and inventions that (a) relate to the Company's business or
actual or demonstrably anticipated research or development, or (b) result from
any work performed by Employee for the Company, shall be considered within the
scope of Employee's employment. Employee shall promptly disclose all such
materials, concepts, and inventions to the Company. Employee shall take all
action reasonably requested by the Company to vest ownership of such materials,
consents, and inventions in the Company and to permit the Company to obtain
copyright, trademark, patent, or similar protection in its name.
- 3 -
<PAGE>
6. NONCOMPETITION. Employee covenants that Employee will not,
throughout the United States, either individually or as a director, officer,
partner, employee, agent, representative, or consultant with any business,
directly or indirectly during the term of employment and for one year
thereafter:
6.1 Engage or prepare to engage in any business that
sells products or services competing with those sold by the Company as of the
date of Employee's termination of employment with the Company;
6.2 Induce or attempt to induce any person who is an
employee of the Company during the term of this covenant to leave the employ of
the Company; or
6.3 Solicit, divert, or accept orders for products or
services that are substantially competitive with the products or services sold
by the Company from any customer of the Company.
7. TERMINATION. Employee's employment with the Company is at
will. Employee and the Company acknowledge that this Agreement does not create
any obligation on Employee's part to work for the Company, nor for the Company
to employ Employee, for any fixed period of time and that Employee's employment
with the Company and this Agreement may be terminated at any time and for any
reason by either Employee or the Company with or without cause and with or
without advance notice.
8. REMEDIES. The respective rights and duties of the Company
and Employee under this Agreement are in addition to, and not in lieu of, those
rights and duties afforded to and imposed upon them by law or at equity.
Employee acknowledges that breach of Sections 4 or 6 of this Agreement will
cause irreparable harm to the Company and agrees to the entry of a temporary
restraining order and permanent injunction by any court of competent
jurisdiction to prevent breach or further breach of Sections 4 or 6 this
Agreement. Such remedy shall be in addition to any other remedy available to the
Company at law or in equity.
9. SEVERABILITY OF PROVISIONS. The provisions of this
Agreement are severable, and if any provision hereof is held invalid or
unenforceable, it shall be enforced to the maximum extent permissible, and the
remaining provisions of the Agreement shall continue in full force and effect.
10. ATTORNEY FEES. In the event a suit or action is filed to
enforce Sections 4 or 6 of this Agreement, the prevailing party shall be
reimbursed by the other party for all costs and expenses incurred in connection
with the suit or action, including without limitation reasonable attorney fees
at trial or on appeal.
11. NONWAIVER. Failure of the Company at any time to require
performance of any provision of this Agreement shall not limit the right of the
Company to enforce the provision. No provision of this Agreement or breach
thereof may be waived by either party except by a writing signed by that party.
A waiver of any breach of a provision of this
- 4 -
<PAGE>
Agreement shall be construed narrowly and shall not be deemed to be a waiver of
any succeeding breach of that provision or a waiver of that provision itself or
of any other provision.
12. ARBITRATION.
12.1 CLAIMS COVERED. All claims or controversies,
except for those excluded by Section 12.2 ("claims"), whether or not arising out
of Employee's employment (or its termination), that the Company may have against
Employee or that Employee may have against the Company or against its officers,
directors, employees or agents, in their capacity as such or otherwise, shall be
resolved as provided in this Section 12. Claims covered by this Section 12
include, but are not limited to, claims for wages or other compensation due;
claims for breach of any contract or covenant (express or implied); tort claims;
claims for discrimination (including, but not limited to, race, sex, sexual
orientation, religion, national origin, age, marital status, or disability);
claims for benefits (except where an employee benefit or pension plan specifies
that its claims procedure shall culminate in an arbitration procedure different
from this one); and claims for violation of any federal, state, or other
governmental law, statute, regulation, or ordinance, except as provided in
Section 12.2.
12.2 NON-COVERED CLAIMS. Claims arising out of
Sections 4 or 6 of this Agreement and workers' compensation or unemployment
compensation benefits are not covered by this Section 12. Non-covered claims
include but are not limited to claims by the Company for injunctive and/or other
equitable relief for unfair competition and/or the use and/or unauthorized
disclosure of trade secrets or confidential information, as to which Employee
understands and agrees that the Company may seek and obtain relief from a court
of competent jurisdiction.
12.3 REQUIRED NOTICE OF ALL CLAIMS AND STATUTE OF
LIMITATIONS. Company and Employee agree that the aggrieved party must give
written notice of any claim to the other party within one year of the date the
aggrieved party first has knowledge of the event giving rise to the claim;
otherwise the claim shall be void and deemed waived even if there is a federal
or state statute of limitations which would have given more time to pursue the
claim. The written notice shall identify and describe the nature of all claims
asserted and the facts upon which such claims are based.
12.4 HEARING OR MEDIATION. Prior to any arbitration
proceeding taking place pursuant to this section, Company or Employee may, at
its respective option, elect to submit the claim to non-binding mediation before
a mutually agreeable mediation tribunal or mediator, in which event both parties
shall execute a suitable confidentiality agreement and abide by the procedures
specified by the mediation tribunal or mediator.
12.5 ARBITRATION PROCEDURES. Any arbitration shall be
conducted in accordance with the then-current Model Employment Arbitration
Procedures of the American Arbitration Association ("AAA"), modified to
substitute for AAA actions, the United States Arbitration and Mediation Service
("USA&MS"), before an arbitrator who is licensed to practice
- 5 -
<PAGE>
law in the state of Oregon (the "Arbitrator"). The arbitration shall take place
in or near Portland, Oregon.
12.5.1 SELECTION OF ARBITRATOR. The USA&MS
shall give each party a list of 11 arbitrators drawn from its panel of
labor-management dispute arbitrators. Each party may strike all names on the
list it deems unacceptable. If only one common name remains on the lists of all
parties, that individual shall be designated as the Arbitrator. If more than one
common name remains on the lists of all parties, the parties shall strike names
alternately until only one remains. The party who did not initiate the claim
shall strike first. If no common name remains on the lists of all parties, the
USA&MS shall furnish an additional list or lists until an Arbitrator is
selected.
12.5.2 APPLICABLE LAW. The Arbitrator shall
apply the substantive law (and the law of remedies, if applicable) specified in
this Agreement or federal law, or both, as applicable to the claim(s) asserted.
The Oregon Rules of Evidence shall apply. The Arbitrator, and not any federal,
state, or local court or agency, shall have exclusive authority to resolve any
dispute relating to the interpretation, applicability, enforceability or
formation of this Agreement, including but not limited to any claim that all or
any part of this Agreement is void or voidable. The arbitration shall be final
and binding upon the parties, except as provided in this Agreement.
12.5.3 AUTHORITY. The Arbitrator shall have
jurisdiction to hear and rule on pre-hearing disputes and is authorized to hold
pre-hearing conferences by telephone or in person as the Arbitrator deems
necessary. The Arbitrator shall have the authority to entertain a motion to
dismiss and/or a motion for summary judgment by any party and shall apply the
standards governing such motions under the Federal Rules of Civil Procedure. The
Arbitrator shall render an award and opinion in the form typically rendered in
labor arbitrations.
12.5.4 REPRESENTATION. Any party may be
represented by an attorney or other representative selected by the party.
12.5.5 DISCOVERY. Each party shall have the
right to take the deposition of one individual and any expert witness designated
by another party. Each party also shall have the right to make requests for
production of documents to any party. The subpoena right specified below shall
be applicable to discovery pursuant to this paragraph. Additional discovery may
be had only where the Arbitrator selected pursuant to this Agreement so orders,
upon a showing of substantial need. At least 30 days before the arbitration, the
parties must exchange lists of witnesses, including any experts, and copies of
all exhibits intended to be used at the arbitration. Each party shall have the
right to subpoena witnesses and documents for the arbitration.
12.5.6 REPORTER. Either party, at its
expense, may arrange for and pay the cost of a court reporter to provide a
stenographic record of proceedings.
- 6 -
<PAGE>
12.5.7 POST-HEARING BRIEFS. Either party,
upon request at the close of hearing, shall be given leave to file a
post-hearing brief. The time for filing such a brief shall be set by the
Arbitrator.
12.6 ENFORCEMENT. Either party may bring an action in
any court of competent jurisdiction to compel arbitration under this Agreement
and to enforce an arbitration award. Except as otherwise provided in this
Agreement, both the Company and Employee agree that neither shall initiate or
prosecute any lawsuit (other than for a non-covered claim) in any way related to
any claim covered by this Agreement. A party opposing enforcement of an award
may not do so in an enforcement proceeding, but must bring a separate action in
any court of competent jurisdiction to set aside the award, where the standard
of review will be the same as that applied by an appellate court reviewing a
decision of a trial court sitting without a jury.
12.7 ARBITRATION FEES AND COSTS. Company and Employee
shall equally share the fees and costs of the Arbitrator. Each party will
deposit funds or post other appropriate security for its share of the
Arbitrator's fee, in an amount and manner determined by the Arbitrator, 10 days
before the first day of hearing. Each party shall pay for its own costs and
attorneys' fees, if any, provided that the Arbitrator, in its sole discretion,
may award reasonable fees to the prevailing party in a proceeding.
13. GENERAL TERMS AND CONDITIONS. This Agreement constitutes
the entire understanding of the parties relating to the employment of Employee
by the Company, and supersedes and replaces all written and oral agreements
heretofore made or existing by and between the parties relating thereto. This
Agreement shall be construed in accordance with the laws of the state of Oregon,
without regard to any conflicts of laws rules thereof. This Agreement shall
inure to the benefit of any successors or assigns of the Company. All captions
used herein are intended solely for convenience of reference and shall in no way
limit any of the provisions of this Agreement. Employee acknowledges that he
signed this Agreement upon his initial employment with the Company.
The parties have executed this Employment Agreement as of the
date stated above.
EPITOPE, INC.
/s/ Edward V. Collom, Jr. By: -------------------------------------
EDWARD V. COLLOM, JR.
Title: ----------------------------------
- 7 -
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Prospectuses
constituting part of the Registration Statements on Forms S-3 (Numbers 33-68510,
33-67618, 33-57246, 33-52920, 33-42841, 33-39166, and 33-32673), and in the
Registration Statements on Forms S-8 (Numbers 33-63220, 33-63218, 33-41712,
33-13416, 33-21545, 33-82788, 33-63106, and 33-60789) of Epitope, Inc. of our
report dated November 12, 1998 appearing in this Form 10-K.
PricewaterhouseCoopers LLP
Portland, Oregon
December 23, 1998
POWERS OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS that each person whose
signature appears below constitutes and appoints JOHN W. MORGAN and CHARLES E.
BERGERON, and each of them, his or her true and lawful attorneys-in-fact and
agents, with full power of substitution and resubstitution for the undersigned
and in the undersigned's name, place, and stead, in any and all capacities, to
sign the Annual Report on Form 10-K of Epitope, Inc., for its fiscal year ended
September 30, 1998, and any and all amendments to the report and to file the
same, with all exhibits thereto, and other documents in connection therewith,
with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done, as
fully to all intents and purposes as the undersigned might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents or each of them or their or his substitute or substitutes may lawfully do
or cause to be done by virtue hereof.
IN WITNESS WHEREOF, this power of attorney has been signed by
the following persons in the capacities indicated effective as of December 14,
1998.
Name Title Name Title
---- ----- ---- -----
/s/ W. Charles Armstrong Director /s/ Michael J. Paxton Director
W. Charles Armstrong Michael J. Paxton
/s/ Andrew S. Goldstein Director, /s/ Roger L. Pringle Director
Andrew S. Goldstein Vice Roger L. Pringle
President
/s/ Margaret H. Jordan Director /s/ G. Patrick Sheaffer Director
Margaret H. Jordan G. Patrick Sheaffer
/s/ John W. Morgan Director, /s/ Robert J. Zollars Director
John W. Morgan President, Robert J. Zollars
and Chief
Financial Officer
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information
extracted from the consolidated financial statements
included herein and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> SEP-30-1998
<CASH> 1,164,275
<SECURITIES> 4,455,044
<RECEIVABLES> 1,569,164
<ALLOWANCES> (49,513)
<INVENTORY> 1,092,577
<CURRENT-ASSETS> 8,593,307
<PP&E> 5,357,447
<DEPRECIATION> (4,538,353)
<TOTAL-ASSETS> 10,357,304
<CURRENT-LIABILITIES> 2,083,289
<BONDS> 0
0
0
<COMMON> 111,319,573
<OTHER-SE> (103,045,558)
<TOTAL-LIABILITY-AND-EQUITY> 10,357,304
<SALES> 9,778,930
<TOTAL-REVENUES> 9,791,582
<CGS> 3,684,702
<TOTAL-COSTS> 12,042,187
<OTHER-EXPENSES> (331,465)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8,868
<INCOME-PRETAX> (1,928,008)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,928,008)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,928,008)
<EPS-PRIMARY> (0.14)
<EPS-DILUTED> (0.14)
</TABLE>
