<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1998 Commission file number 0-18044
PROCYTE CORPORATION
(exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Washington 91-1307460
(State of incorporation) (I.R.S. Employer Identification No.)
8511 154th Avenue N.E., Building A, Redmond, WA 98052-3557
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (425) 869-1239
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to the Section 12(g) of the Act: Common Stock,
par value $.01 per share
</TABLE>
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 delinquency filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the 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 {_}.
As of February 1, 1999 there were issued and outstanding 14,522,198 shares of
common stock, par value $.01 per share.
The aggregate market value of common stock held by non-affiliates as of February
1, 1999 was $12.3 million, based upon the average of the closing high and low
prices of such stock as reported by the NASDAQ National Market.
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the following documents are incorporated by reference in Parts II and
III of this Form 10-K report: (1) the Proxy Statement for the Registrant's 1999
Annual Meeting of Shareholders scheduled to be held May 26, 1999, and (2) the
Registrant's 1998 Annual Report to Shareholders.
1
<PAGE>
ProCyte Corporation
1998 Form 10-K
Table of contents
<TABLE>
<CAPTION>
<S> <C>
PART I........................................................................................... 3
Item 1. Business................................................................................ 3
Item 2. Properties.............................................................................. 13
Item 3. Legal Proceedings....................................................................... 13
Item 4. Submission of Matters to a Vote of Security Holders..................................... 13
PART II.......................................................................................... 13
Item 5. Market for Company's Common Stock and Related Shareholder Matters....................... 13
Item 6. Selected Financial Data................................................................. 14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations... 14
Item 7a Quantitative and Qualitative Disclosures About Market Risk.............................. 17
Item 8. Financial Statements and Supplementary Data............................................. 17
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.... 30
PART III......................................................................................... 30
PART IV.......................................................................................... 30
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K....................... 31
</TABLE>
2
<PAGE>
PART I
Item 1. Business
The entire discussion in this report, as well as other management
discussion of the Company's goals and expectations as reported in the Company's
1998 Annual Report to Shareholders contains Forward-Looking statements that are
subject to certain risks and uncertainties that could cause actual results to
differ materially from those projected. The words "believe", "expect",
"intend", "anticipate", variations of such words and similar expressions
identify Forward-Looking statements, but their absence does not mean that the
statement is not Forward-Looking. These statements are not guaranties of future
performance and are subject to certain risks, uncertainties and assumptions that
are difficult to predict. Factors that could affect the Company's actual
results include, among other things, the availability of adequate funding, the
availability of contract manufacturing opportunities, relationships with
corporate collaborators, the rate of market acceptance of the Company's
products, the availability of third-party reimbursement for the Company's
products, the ability to obtain and defend patent and related future products
and intellectual property rights and to market the Company's products and the
status of competing products. See "Important Factors Regarding Forward-Looking
Statements." Readers are cautioned not to place undue reliance on these
Forward-Looking statements, which speak only as of the date of this report.
ProCyte undertakes no obligation to update publicly any Forward-Looking
statement to reflect new information, events or circumstances after the date of
this report or to reflect the occurrence of unanticipated events.
General
ProCyte Corporation ("ProCyte" or the "Company") is a Washington
corporation organized in 1986. ProCyte is a healthcare company that develops,
manufactures and markets products for wound care, skin health and hair care.
Certain of the Company's products incorporate its patented copper peptide
technology or its patented hydropolymer technology.
The Company's products are targeted for use in specialty medical markets to
provide solutions for chronic wounds, skin health and hair conditions, and for
the related consumer markets. The Company's business currently focuses on three
target markets: chronic wound care; skin care including wound care associated
with plastic & cosmetic surgery and dermatology; and hair care.
ProCyte's goal is to generate profitability from the sale of products that
it develops, licenses or acquires. To augment the commercialization of its
products and technology, the Company has entered into and plans to continue to
enter into, distribution and license agreements primarily in the wound care and
consumer markets. Consistent with this goal, the Company intends to retain the
proprietary rights to its products and technologies.
Products and Markets
In 1998, ProCyte continued its focus on its copper peptide formulations in
products that address wound care, skin health and hair care needs. The Company
has identified three primary markets for its products.
Chronic Wound Care
Since inception, the Company has focused its energies on the chronic wound
care market. Worldwide this market is estimated to exceed $3 billion. It is
highly fragmented, with many competitors and price constraints. For these
reasons, ProCyte collaborates with partners to market its chronic wound care
products. The Company has chosen to negotiate comprehensive agreements with
major companies for the United States,
3
<PAGE>
Latin America, Europe and the Far East rather than individual agreements for
each country. In 1998, ProCyte continued to introduce new products to its
partners for wound care in hospitals, nursing homes and extended care
facilities.
In December 1997, ProCyte entered into an exclusive distribution agreement
covering the United States and Canada, with the Bard Medical Division ("Bard")
of C.R. Bard, Inc., for the hospital, nursing home and extended care markets.
Bard is required to make certain minimum annual purchases. ProCyte's Iamin(R)
Hydrating Gel, Iamin(R) Wound Cleanser, and OsmoCyte(R) Pillow Wound Dressings
became the first Company products to be added to the Bard sales effort, which
began in January 1998.
Subsequent to the Bard agreement, ProCyte has entered into exclusive
distribution agreements for the registration and distribution of certain of its
wound care products in various foreign countries, including Merck KGaA for Latin
America and South Africa, and Tanox Pharma for the Far East. ProCyte is seeking
a similar distribution partnership for Europe. The Company anticipates that
product registration in certain countries may take well over a year, and there
can be no assurance that registration will be obtained or that the products will
be commercially successful in all of the various countries. See "- Important
Factors Regarding Forward-Looking Statements - Government Regulation."
A related field of use for ProCyte's chronic wound care products is the
veterinary market. At present, the Company's products for veterinary care
applications are promoted through specialty distributors.
Dermatology, Plastic & Cosmetic Surgery and Skin Care
ProCyte believes its products are well suited for use in the medical
specialties of dermatology and plastic & cosmetic surgery. Most of the products
developed by ProCyte incorporate the Company's clinically tested copper peptide
formulations or its patented hydropolymer technology. The biological actions of
copper have been documented in the scientific literature and include its ability
to stimulate collagen synthesis, new blood vessel growth and tissue repair. The
Company believes its technology has potential value in the consumer skin care
market. There is an increasing consumer and physician awareness of the ability
to improve skin health and appearance with products designed specifically to
meet the needs of the aging population. In addition there are an increasing
number of cosmetic procedures performed each year as the baby boomer population
ages. ProCyte has introduced a number of products tailored to the needs of
these markets, including the GraftCyte(TM) System, Pillo(TM) Pro Absorbent
Dressings and the Complex Cu3(TM) System. With the acquisition of HumaTech
Corporation on April 27, 1998 the Company's product line expanded to include a
therapeutic skin care line comprised of prescription and over-the-counter
topical drugs, sun protection, and anti-aging skin care products.
Introduced in 1998, the Company's Complex Cu3(TM) Intensive Repair Creme
has been used to treat patients following chemical peels, dermabrasion and laser
treatments. In addition, the line includes Complex Cu3(TM) Hydrating Gel and
Complex Cu3(TM) Gentle Cleanser, providing a comprehensive approach to post-
procedure care. The Company's Pillo(TM) Pro Absorbent Dressings, which provide
moisture absorption required following liposuction, were also introduced in
1998.
ProCyte's GraftCyte(TM) System was inaugurated in 1997 to address the
special tissue repair needs of patients following hair restoration surgery. The
GraftCyte(TM) System currently consists of five differentiated products -
GraftCyte(TM) Moist Dressings for use during and after surgery; GraftCyte(TM)
Concentrated Spray to provide continuous hydration of the scalp after surgery;
GraftCyte(TM) Post-Surgical Shampoo and GraftCyte(TM) Post-Surgical Conditioner
to provide a gentle cleansing of the scalp. In 1998 the GraftCyte(TM) single
patient Pack was introduced to provide convenience to the patient and the
physician.
ProCyte markets these products for use in specialized surgical and
skin care practices through its own sales representatives and a contract sales
force.
In January 1999 the Company agreed to provide copper peptide formulations
to Neutrogena Corporation (Neutrogena) for evaluation of its potential for use
in consumer skin care products to be marketed by Neutrogena on a worldwide
basis. In the fourth quarter of 1997, ProCyte entered into an exclusive
worldwide supply and license agreement with Osmotics Corporation ("Osmotics"),
pursuant to which the Company granted Osmotics the right to introduce the
Company's copper peptide containing products to the
4
<PAGE>
prestige skin care market. Osmotics announced the first such product in January
1998, - Blue Copper(TM) -an anti-aging formulation sold at cosmetic counters in
such stores as Saks and Neimann Marcus.
Hair Care
The Company commenced shipping its Tricomin(R) line of triamino copper
complex containing hair care products to physicians' offices in the third
quarter of 1998. Tricomin(R) shampoos, conditioners, and follicle therapy
solution are positioned to participate in the rapidly growing $1.5 billion
United States hair care market as a program for the maintenance of thinning hair
in men and women. Hair follicles require high concentrations of biological
copper and the Tricomin(R) products deliver copper along with amino acids for
nourishing and stimulating the hair and scalp for improved health, strength, and
appearance. The Company has initiated a series of consumer advertisements
focused specifically on the hair care needs and concerns of an aging babyboomer
population. The release of these products provides the physicians a non-drug
alternative to the problem of thinning hair.
In January 1999 Neutrogena agreed to pay the Company for an exclusive
option to evaluate the proprietary triamino copper complex used in the
Tricomin(R) products in anticipation of an agreement to purchase and use this
material in hair care products that Neutrogena would market in the worldwide
consumer hair care market.
Additional Product Development and/or Acquisitions
The Company plans to continue its skin health and hair care product
development, and expects to introduce products in 1999 which incorporate the
tripeptide copper complex into anti-aging products. The Company reported
expenditures of $2,422,076, $3,774,415 and $6,738,922 on research and
development in 1998, 1997 and 1996, respectively.
The Company also plans to continue to evaluate companies, products and
technologies which offer synergistic opportunities for the Company to leverage
its position in the medical marketplace, for acquisition and/or distribution by
the Company.
Contract Manufacturing
The Company continues to optimize the use of its manufacturing facility by
offering services to industry clientele. During 1998, the Company continued to
provide contract manufacturing services to biotechnology and pharmaceutical
companies and has expanded its customer base significantly. ProCyte expects to
continue to provide contract manufacturing services in the future and to produce
clinical and commercial quantities of certain of its copper peptide compounds
for use by it and its partners. See "- Important Factors Regarding Forward-
Looking Statements."
Business Relationships
Bard Medical
In the fourth quarter of 1997 ProCyte entered into an exclusive
distribution agreement with the Bard Medical Division of C.R. Bard, Inc. (the
"Bard Agreement"), pursuant to which the Company granted to Bard the exclusive
rights in the United States and Canada to distribute wound care products
manufactured by ProCyte. The Bard Agreement, which has an initial term of three
years, specifies the products to be distributed by Bard in the hospital, nursing
home and home healthcare markets, and sets minimum purchases required of
5
<PAGE>
Bard during the initial three-year term. Bard's purchases of ProCyte products
during the year ended December 31, 1998 exceeded the minimum required.
Tanox Pharma
During the second quarter of 1998 ProCyte entered into a distribution
agreement with Tanox Pharma International, Inc., a division of Tanox Biosystems,
Inc., for sales of Iamin(R) Hydrating Gel and OsmoCyte(R) Pillow Wound Dressings
in China, Taiwan and Hong Kong. This agreement was expanded in September 1998
to include five additional countries. Approval of Iamin(R) Hydrating Gel as a
pharmaceutical in China has been received and the initial orders were shipped in
December 1998. Approval for OsmoCyte(R) Pillo Dressings is expected by the
second quarter of 1999.
Merck KGaA
In the first quarter of 1999, ProCyte entered into an exclusive
distribution agreement with a unit of The Merck Group, a $5 billion German
pharmaceutical company, for the registration, promotion and distribution of
ProCyte's wound care products to the chronic wound care markets in Latin America
and South Africa. The Merck agreement has a ten year term and establishes
milestones and minimum purchase quantities that are contingent upon product
registration in certain countries. The product registration process is
currently underway in several countries and initial shipments are expected in
1999.
Neutrogena Corporation
In the first quarter of 1999, ProCyte entered into two agreements with
Neutrogena Corporation, a Johnson and Johnson company, permitting evaluation of
ProCyte's patented copper peptide technology for skin care products and hair
care products. The first agreement is an option and product study agreement
covering the incorporation of ProCyte's AHK:cu technology into products that
Neutrogena would sell into the worldwide consumer hair care market. The other
agreement is a product study agreement to evaluate ProCyte's GHK:cu technology
for potential Neutrogena products for the worldwide consumer skin care market.
Osmotics Corporation
In the fourth quarter of 1997 ProCyte entered into a supply and marketing
agreement with Osmotics Corporation (the "Osmotics Agreement"), pursuant to
which the Company granted to Osmotics a limited, worldwide, non-transferable
right to purchase and use one of ProCyte's copper peptide compounds for making
and selling skin care products for prestige skin care markets. Such rights are
exclusive to the prestige skin care market where the ultimate sale of products
is at retail department store cosmetic counters and international perfumeries,
but nonexclusive where the ultimate sale of products is at prestige skin care
salons and spas. ProCyte has the exclusive right to manufacture the copper
peptide compound for sale to Osmotics and may purchase from Osmotics products
made to its specifications for sale in the dermatology, cosmetic/plastic
surgery, and related medical markets. The Osmotics Agreement sets forth certain
milestones, minimum payments and royalties payable by Osmotics to ProCyte. In
January 1999 ProCyte received a payment from Osmotics for the balance due on the
minimum payment for 1998.
ProCyte intends to establish corporate alliances with others who are
capable of pursuing registrations of the Company's copper-based wound care
products and technology in Europe and elsewhere. There can be no assurance that
the Company will be successful in attracting or retaining corporate alliances on
terms favorable to the Company, whether for the Company's wound care technology
or otherwise, that the interests and motivations of any corporate partner or
licensee would be or remain consistent with those of the Company, or that such
partners or licensees would successfully perform the necessary technology
transfer, clinical development, regulatory compliance, manufacturing, marketing
or other obligations. Suspension or termination of agreements with the Company's
current or future distributors, partners or licensees could have a material
adverse affect on the development of the Company's proposed products and could
materially adversely
6
<PAGE>
affect the Company's financial position. See "-Important Factors Regarding
Forward-Looking Statements - Uncertainty of Corporate Alliances."
Employees
At December 31, 1998, the Company had 37 full-time employees, of whom two
hold Ph.D. degrees. At year-end, 4 employees were engaged in product
development, 11 in manufacturing, distribution and quality control, 17 in sales
and marketing, and 5 in accounting, finance and administration. The Company
does not expect to increase staff in 1999, except in customer contact areas as
required by increases in sales volume. The Company has arranged with an
independent field sales organization to obtain five additional dedicated sales
representatives on a contract basis in markets not covered by the Company's
sales force. The Company believes that its relations with its employees are
good.
Important Factors Regarding Forward-Looking Statements
History of Operating Losses; Accumulated Deficit; Fluctuations in Future
Earnings
The Company launched its first product in 1996, launched additional wound
care products in 1997 and 1998 and expects further product launches of skin
health and hair care products in 1999. To date, however, the Company has
generated only minimal revenues from sales of products based on its proprietary
technology and there can be no assurance that the Company will be able to
generate sufficient product sales to achieve a profitable level of operations.
As of December 31, 1998, the Company's accumulated deficit was approximately
$66.8 million. The Company expects to incur additional operating losses at
least through 1999. Historically, the Company's revenues have principally been
from interest income, research fees, license fees and fees for contract
manufacturing services. The Company's ability to achieve a consistent,
profitable level of operations is dependent in large part on successfully
manufacturing its products, entering into agreements with corporate partners for
distribution and commercialization of the Company's products and out-licensing
of the Company's products and technology, of which there can be no assurance.
In addition, payments under corporate partnerships and licensing arrangements,
if any, will be subject to significant fluctuations in both timing and amounts.
The time required to reach sustained profitability is highly uncertain, and
there can be no assurance that the Company will be able to achieve profitability
on a sustained basis, if at all. Moreover, if profitability is achieved, the
level of profitability cannot be predicted and it may vary significantly from
quarter to quarter.
Need for Additional Capital
The Company expects negative cash flow from operations to continue for the
foreseeable future. The Company may require substantial additional funds to
expand or enhance its sales and marketing activities and to continue product
development. The Company's future capital requirements will depend on numerous
factors, including its efforts, and the efforts of its collaborative partners,
to commercialize its products; continued progress in the Company's research and
development programs; the results of research and development activities;
relationships with existing and future corporate collaborators, if any;
competing technological and market developments; the costs involved in filing,
prosecuting and enforcing patent claims; the time and costs of commercialization
activities; and other factors. At December 31, 1998 the Company had cash, cash
equivalents and securities available for sale of $6.9 million. The Company
estimates that at its planned rate of spending, its existing cash, cash
equivalents and securities available for sale and the interest income thereon
will be sufficient to meet its capital requirements at least through 1999.
There can be no assurance that the underlying assumed levels of revenue and
expense will prove accurate. Whether or not these assumptions prove to be
accurate, the Company will need to raise substantial capital to fund operations.
The Company may be required to seek additional funding through public or private
financing, including equity financing, and through collaborative arrangements.
Adequate funds for these purposes, whether obtained through financial markets or
from collaborative or other arrangements with corporate partners or other
sources, may not be available when needed or may not be available on terms
favorable to the Company, if at all. If
7
<PAGE>
issuing equity securities raises additional funds, dilution to existing
shareholders will result. In addition, in the event that additional funds are
obtained through arrangements with collaborative partners, such arrangements may
require the Company to relinquish rights to certain of its technologies or
potential products that it would otherwise seek to develop or commercialize
itself. If funding is insufficient at any time in the future, the Company may be
required to delay, scale back or eliminate some or all of its marketing and
research and development programs or to license third parties to commercialize
products or technologies that the Company would otherwise seek to develop
itself. Furthermore, the terms of any such license agreements might be less
favorable than if the Company were negotiating from a stronger position.
Moreover, if funding is insufficient at any time in the future, and the
Company's existing funds are depleted, the Company may be required to cease
operations.
Non compliance with NASDAQ National Market System listing criteria; Application
of Rule 15g-9 and Penny Stock Rules
The Company's common stock is listed on the NASDAQ National Market System.
In order to remain listed on the NASDAQ, an issuer must comply with the
"continued listing criteria" established by the NASDAQ. These criteria include,
among others, (i) net tangible assets of $4 million, (ii) a public float of
750,000 shares with market value of $5 million, (iii) 400 shareholders, (iv) two
market makers, and (v) a minimum bid price requirement of $1.00 per share.
Since August 14, 1998, the Company has not met the minimum bid price criterion
for continued listing. NASDAQ informed the Company that if it did not meet this
requirement by December 26, 1998, NASDAQ would delist the Company's securities
from the NASDAQ National Market System. The Company requested a continued
listing notwithstanding its failure the meet the bid price requirement and
presented it's plan to return to compliance at a hearing held on February 12,
1999. The NASDAQ delisting action was stayed pending the outcome of that
hearing which the Company expects to learn by the end of February 1999.
If delisted from the NASDAQ National Market System, the Company would seek
to list its securities on another securities exchange. If the Company were
unable to meet the eligibility requirements for such an exchange, trading of the
Company's securities could continue on the OTC Bulletin Board or in the non-
NASDAQ over-the-counter market. Because real-time price information may no
longer be available, an investor is likely to find it more difficult to dispose
of, or obtain accurate quotations on the market value of, the Company's
securities.
In addition, purchases and sales of the Company's securities may be subject
to Rule 15g-9 of the Exchange Act. This Rule imposes various sales practice
requirements on broker-dealers who sell securities governed by the Rule to
persons other than established customers and accredited investors (generally
institutions with assets exceeding $5 million or individuals with a net worth
exceeding $1 million or annual income exceeding $200,000 or $300,000 jointly
with their spouse). For transactions covered by Rule 15g-9, the broker-dealer
must specially determine the purchaser's suitability and obtain the purchaser's
written consent before the sale. Application of this Rule is likely to adversely
affect the ability of broker-dealers to sell the Company's securities, the
salability of the securities in the secondary market and the ability of the
Company to raise funds.
The Company's securities may also become subject to penny stock rules,
which could have a material adverse effect on their market liquidity. The
Securities and Exchange Commission regulates broker-dealer practices in
connection with transactions in "penny stocks," which generally are equity
securities priced at less than $5.00 per share (other than securities
registered on certain national securities exchanges or quoted on the NASDAQ
system, provided that the exchange or system gives current price and volume
information). The penny stock rules require a broker-dealer, before trading in
a penny stock not exempt from the rules, to give the customer a standardized
document providing information about penny stocks and the risks in the penny
stock market, current bid and offer quotations for the penny stock, and a
statement of the compensation of the broker-dealer and its salesperson in the
transaction. The broker dealer must also provide monthly account statements
showing the market value of each penny stock held in the customer's account. If
NASDAQ delists the Company's securities and its common stock continues to trade
below the $5.00 per share threshold, the
8
<PAGE>
Company's securities may fall within the definition of penny stocks. If the
penny stock rules were to apply, these disclosure requirements are likely to
reduce the level of trading activity in the secondary market for the Company's
securities and make selling the securities more difficult for an investor .
Uncertainties Related to Contract Manufacturing Operations
Since inception, a substantial portion of the Company's revenues have been
derived from its contract manufacturing operations as the Company has sought to
more fully utilize its existing facility's capacity while its own products were
under development. For the foreseeable future, ProCyte expects to continue to
have excess manufacturing capacity as it works to commercialize its potential
products. Accordingly, the Company will continue to seek contract manufacturing
opportunities. Contract manufacturing revenues will be adversely affected to
the extent the Company's customers decide to manufacture their products
themselves or choose to have them manufactured elsewhere. In addition, the
Company's contract manufacturing revenues may be adversely affected to the
extent its customers experience regulatory delays, product recalls, or
competitive pressures in the marketplace. There can be no assurance that
contract revenues in the future will be significant.
Uncertainties Related to Product Development
From the Company's inception in 1986 until it launched its first commercial
product in 1996, substantially all of its resources were dedicated to the
research and development of wound healing and tissue repair applications of its
topically administered copper peptide compounds. To date the Company has
generated relatively minor revenues from sales of copper peptide containing
products. There can be no assurance that the Company's current products or
potential products will be successfully commercialized and accepted for use by
physicians, healthcare providers and consumers.
The Company is dependent upon the successful development of its current and
potential products. Development of the Company's potential products is highly
uncertain, and unanticipated developments, clinical and regulatory delays,
adverse or unexpected side effects or inadequate therapeutic efficacy could slow
or prevent the successful completion of the Company's product and technology
development. There can be no assurance that the Company will obtain regulatory
approval, that an approved product can be produced in commercial quantities at
reasonable costs or gain acceptance for use by physicians, healthcare providers
and consumers or that any potential products will be successfully marketed at
prices that would permit the Company to operate profitably, the failure of any
of which would have a material adverse effect on the Company's business,
financial condition and results of operations.
Dependence on and Management of Existing and Future Corporate Alliances
The successful commercialization of the Company's existing and future
products will depend upon ProCyte's ability to enter into and effectively manage
corporate partnerships. ProCyte currently promotes certain of its products
through specialty distributors. Other products and technology are licensed for
incorporation into products sold by others. In November 1997, the Company
entered into an exclusive worldwide supply and marketing agreement with Osmotics
Corporation ("Osmotics"), pursuant to which the Company granted Osmotics the
right to introduce the Company's copper peptide containing products to the
prestige skin care market. In December 1997, the Company entered into an
exclusive distribution agreement with the Bard Medical Division ("Bard") of C.R.
Bard, Inc. Pursuant to this agreement, Bard will be the exclusive supplier of
the Company's wound care products to the hospital, nursing home and extended
care markets in the United States and Canada. Subsequent to the Bard agreement,
ProCyte entered into similar exclusive distribution agreements for the
registration and distribution of certain of its wound care products in the Far
East and Latin America with Tanox Pharma and Merck KGaA, respectively. ProCyte
plans to seek similar distribution partnerships in additional countries as well
as alliances for development, manufacturing, marketing and distribution of
products for the consumer market. There can be no assurance that any of the
Company's collaborators will perform their obligations under their agreements
with the Company or that the Company's products or the products of others that
incorporate the Company's products or technology, will be
9
<PAGE>
successfully commercialized, any of which could have a material adverse effect
on the Company's business, financial condition and results of operations .
There can be no assurance that the Company will be successful in
establishing corporate alliances in the future, or that it will be successful in
maintaining existing or any future corporate alliances. Moreover, there can be
no assurance that the interests and motivations of any corporate partner,
distributor or licensee would be or remain consistent with those of the Company,
or that such partners, distributors or licensees would successfully perform the
necessary technology transfer, clinical development, regulatory compliance,
manufacturing, marketing or other obligations. Failure of any of the foregoing
could have a material adverse effect on the Company's business, financial
condition and results of operations.
Uncertainty of Patent Position and Proprietary Rights
The patent positions of biotechnology, medical device and healthcare
products companies are often uncertain and involve complex legal and factual
questions, and the breadth of claims allowed in such patents cannot be
predicted. In addition, there is a substantial backlog of patents at the US
Patent and Trademark Office that may delay the review and the potential issuance
of patents. The Company's success will depend to a significant degree on its
ability to obtain patents and licenses to patent rights, to maintain trade
secrets and to operate without infringing on the proprietary rights of others,
both in the United States and in other countries. The failure of the Company or
its licensors to obtain and maintain patent protection for the Company's
technology could have a material adverse effect on the Company.
ProCyte's success depends in part upon its ability to protect its products
and technology under intellectual property laws in the United States and abroad.
As of December 31, 1998, the Company had 18 issued United States patents
expiring between 2005 and 2014, and 132 issued foreign patents and patent
registrations. The patents relate to use of the Company's copper-based
technology for a variety of healthcare applications, and to the composition of
certain biologically active, synthesized compounds. The Company's strategy has
been to apply for patent protection for certain compounds and their discovered
uses that are believed to have potential commercial value in countries, which
offer significant market potential. There can be no assurance that patent
applications relating to the technology used by the Company will result in
patents being issued. There can be no assurance that any patent issued to the
Company will not be subjected to further proceedings limiting the scope of the
rights under the patent or that such patent will provide a competitive advantage
or will afford protection against competitors with similar technology, or will
not be successfully challenged, invalidated or circumvented by competitors.
The Company's processes and potential products may conflict with patents
that have been or may be granted to competitors and others. As the
biotechnology, medical device and healthcare industries expand and more patents
are issued, the risk increases that the Company's processes and potential
products may give rise to claims that they infringe the patents of others. Such
other persons could bring legal actions against the Company claiming damages and
seeking to enjoin clinical testing, manufacturing and marketing of the affected
product or use of the affected process. Litigation may be necessary to enforce
patents issued to the Company, to protect trade secrets or know-how owned by the
Company or to determine the enforceability, scope and validity of proprietary
rights of others. If the Company becomes involved in such litigation, it could
result in substantial expense to the Company and significant diversion of effort
by the Company's technical and management personnel. In addition to any
potential liability for significant damages, the Company could be required to
obtain a license to continue to manufacture or market the affected product or
use the affected process. Costs associated with any licensing arrangement may
be substantial and could include ongoing royalties. There can be no assurance
that any license required under any such patent would be made available to the
Company on acceptable terms, if at all. If such licenses could not be obtained
on acceptable terms, the Company could be prevented from manufacturing and
marketing existing or potential products. Accordingly, an adverse determination
in such litigation could have a material adverse effect on the Company's
business, financial condition and results of operations.
10
<PAGE>
The Company also relies upon unpatented proprietary technology. There can
be no assurance that the Company can meaningfully protect its rights in such
unpatented technology, that any obligation to maintain the confidentiality of
such proprietary technology will not be breached by employees, consultants,
collaborators or others, or that others will not independently develop or
acquire substantially equivalent technology. To the extent that corporate
partners or consultants apply Company technological information independently
developed by them or by others to Company projects or apply Company technology
or know-how to other projects, disputes may arise as to the ownership of
proprietary rights to such information. Any failure to protect unpatented
proprietary technology or any breach of obligations designed to protect such
technology or development of equivalent technology may have a material adverse
effect on the Company's business, financial condition and results of operations.
Uncertainty of Government Regulatory Requirements
The manufacture and marketing of ProCyte's products and its research and
development activities in general are subject to extensive regulation in the
United States by the federal government, principally by the FDA, and in other
countries by similar health and regulatory authorities. The Federal Food, Drug
and Cosmetic Act and the regulations promulgated thereunder, and other federal
and state statutes govern, among other things, the testing, manufacture, safety,
labeling, storage, record-keeping, advertising and promotion of cosmetic
products and medical devices. Product development and approval or clearance
within the regulatory framework requires a number of years and involves the
expenditure of substantial resources.
In order to obtain FDA clearance to market a new device in the United
States for use in humans, it is necessary to proceed through several stages of
product testing, including research and development, clinical trials, and the
filing of a product 510(k) medical device application with the FDA to obtain
authorization to market a product. The Company's products and product
candidates may be regulated by any of a number of divisions of the FDA. The
process of obtaining and maintaining regulatory approvals for the manufacturing
or marketing of the Company's existing and potential products is costly and
time-consuming and is subject to unanticipated delays. Accordingly, delays,
rejections or unexpected costs may be encountered based on changes in the policy
or regulations of the FDA or foreign governmental authorities during the period
of product development and regulatory review, which changes may result in
limitations or restrictions on the Company's ability to utilize its technology
or develop product candidates. Regulatory requirements ultimately imposed could
also adversely affect the ability of the Company to clinically test, manufacture
or market products. Even if regulatory approval of a potential product is
obtained, such approval may entail limitations on the indicated uses for which
such product may be marketed, which may restrict the patient population for
which any product may be prescribed. In addition, a marketed product is subject
to continual FDA review. Later discovery of previously unknown problems or
failure to comply with the applicable regulatory requirements may result in
restrictions on marketing a product or withdrawal of the product from the
market, as well as possible criminal or civil sanctions.
In the United States, products that do not seek to make effectiveness
claims based on human clinical evaluation may be subject to review and
regulation under the FDA's cosmetic or 510(k) medical device guidelines.
Similar guidelines exist for such products in other countries. Such products,
which include wound care dressings, ointments and gels, must show safety and
substantial equivalency with predicate products already cleared to be marketed
by the FDA. There can be no assurance that such product applications submitted
to the FDA or similar agencies in other countries will receive clearance to be
marketed, or that the labeling claims sought will be approved, or that, if
cleared, such products will be commercially successful.
In addition to obtaining approval or clearance from the FDA or foreign
regulatory bodies to market a product, the prospective manufacturer's quality
control and manufacturing procedures must conform to current good manufacturing
practices ("cGMPs") guidelines, or ISO 9000 standards, when appropriate. In
comply ing with these regulations, which are subject to change at any time
without notice to the Company, ProCyte must continue to expend time, effort and
financial resources in production and quality control. In addition, ProCyte's
manufacturing plant is subject to the regulations of and inspections by other
foreign, federal, state or local agencies, such as local and regional water and
waste treatment agencies, and state and federal safety and health
11
<PAGE>
agencies. There can be no assurance that the Company's manufacturing facility or
its manufacturing operations will meet or continue to meet all appropriate
guidelines or to pass inspections by any government agency.
The Company also is or may become subject to various other federal, state,
local and foreign laws, regulations and policies relating to, among other
things, safe working conditions, good laboratory practices, animal welfare, and
the use and disposal of hazardous or potentially hazardous substances used in
connection with research, development and/or manufacturing.
Failure to obtain regulatory approvals for its product candidates or to
either attain or maintain compliance with cGMP or other manufacturing
requirements would have a material adverse effect on the Company's business,
financial condition and results of operations.
Intense Competition
Competition in the wound care, skin health and hair care markets is
intense. The Company's competitors include well-established pharmaceutical,
cosmetic and healthcare companies such as Bristol Myers Squibb's ConvaTec and
BioMatrix divisions, Johnson and Johnson, Obagi and Allergan. These competitors
have substantially more financial and other resources, larger research and
development staffs, and more experience and capabilities in researching,
developing and testing products in clinical trials, in obtaining FDA and other
regulatory approvals, and in manufacturing, marketing and distribution than the
Company. In addition, a number of smaller companies are developing or marketing
competitive products, some of which may have an entirely different approach than
products being marketed or developed by the Company. The Company's competitors
may succeed in developing and commercializing products or obtaining patent
protection or other regulatory approvals for products more rapidly than the
Company. If the Company is successful in commercializing its products, it will
be required to be competitive with respect to manufacturing efficiency and
marketing capabilities, areas in which it has very limited experience. The
Company's competitors may develop new technologies and products that are
available for sale prior to the Company's potential products or that are more
effective than the Company's existing or potential products. In addition,
competitive products may be manufactured and marketed more successfully than the
Company's potential products. Such developments could render the Company's
existing or potential products less competitive or obsolete, and could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The contract manufacturing service business is also highly competitive.
Competitors include major chemical and pharmaceutical companies, as well as
specialized biotechnology firms, smaller contract chemical manufacturers and
some universities. Many of these companies or institutions have greater
financial, technical and marketing resources than the Company.
Potential Volatility of Stock Price
The market prices for securities of healthcare, medical dressings,
pharmaceutical and biotechnology companies are subject to volatility, and the
market has from time to time experienced significant fluctuations that are
unrelated to the operations of the Company. ProCyte's market price has
fluctuated over a wide range since the Company's initial public offering in
1989. Announcements concerning the Company or its competitors, including
fluctuations in operating results, research and development program direction,
results of clinical trials, addition or termination of corporate alliances,
technology licenses, clearance or approval to market products, announcements of
technological innovations or new products by the Company or its competitors,
changes in government regulations, healthcare reform, developments in patent or
other proprietary rights of the Company or its competitors, litigation
concerning business operations or intellectual property, or public concern as to
safety of products, as well as changes in general market conditions and mergers
and acquisitions, may have a significant effect on the market price of ProCyte's
common stock.
12
<PAGE>
Item 2. Properties
The Company presently leases approximately 33,000 square feet of
production, laboratory and office space at its facility in Redmond, Washington.
In July 1997, the Company consolidated its facilities, moving from its 28,000
square foot laboratory and corporate office space in Kirkland, Washington to the
expanded Redmond site, which houses the Company's production facility. At that
time the Company executed a ten-year lease for the Redmond facility. The Company
completed the relocation of the acquired operations of HumaTech Corporation to
the Redmond facility during the fourth quarter of 1998.
Item 3. Legal Proceedings
The Company is not a party to any litigation that would have a material
adverse effect on the Company or its business.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to the shareholders for vote during fourth
quarter 1998.
PART II
Item 5. Market for Company's Common Stock and Related Shareholder Matters
The Company's common stock is traded on the NASDAQ National Market under
the symbol "PRCY." The following table sets forth the high and low bid prices
for the company's common stock as reported by the NASDAQ National Market for the
periods indicated. Such prices reflect inter-dealer prices, without retail
mark-up, mark-down or commission and may not necessarily represent actual
transactions.
<TABLE>
<CAPTION>
High Low
-----------------------------
<S> <C> <C>
1997
First quarter 2 3/8 1 3/4
Second quarter 1 7/16 1 1/8
Third quarter 1 7/16 1 1/32
Fourth quarter 1 1/16 1 5/32
1998
First quarter 1 23/32 7/8
Second quarter 1 7/8 13/16
Third quarter 1 3/16 13/16
Fourth quarter 25/32 11/32
1999
Through February 15, 1 3/32 7/16
</TABLE>
At the close of business on February 1, 1999 there were 458 holders of
record of the Company's common stock. ProCyte has not paid any cash dividends
on its common stock and does not intend to pay cash dividends in the foreseeable
future.
13
<PAGE>
Item 6. Selected Financial Data
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C>
Revenue........................ $ 2,720,444 $ 1,856,776 $ 3,275,957 $ 4,320,056 $ 4,472,983
Cost and expenses.............. 7,726,233 8,305,420 12,633,076 16,714,991 16,626,701
Net loss....................... (4,466,947) (6,448,644) (9,357,119) (12,394,935) (12,153,718)
Net loss per common share...... $(0.32) $(0.48) $(0.71) $(0.95) $(0.97)
Weighted average number
of common shares used in
computing net loss per
common share.................. 14,117,485 13,326,929 13,210,036 13,100,818 12,593,131
Cash, cash equivalents and
short term investments........ $ 6,938,981 $ 12,866,617 $ 20,846,836 $ 36,077,520 $ 43,014,137
Total assets................... 18,302,378 21,310,959 27,963,658 45,093,558 50,013,086
Total liabilities.............. 622,828 694,462 1,124,881 9,209,004 1,863,311
Stockholders' equity........... $ 17,679,550 $ 20,616,497 $ 26,838,777 $ 35,884,554 $ 48,149,775
</TABLE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Corporate Overview
During 1998 ProCyte continued its marketing and development efforts for an
array of wound care products, expanded its product line and channels of
distribution in cosmetic surgery with the acquisition of HumaTech Corporation
("HumaTech"), and continued the development of complementary skin health and
hair care products. As the Company's product line has expanded, it has
continued to focus its efforts on the specialty tissue repair sectors -
marketing its products primarily to dermatologists, plastic surgeons and
cosmetic surgeons.
The Company continued to refine its approach to marketing the GraftCyte(TM)
line of copper peptide containing wound care products for use following hair
restoration in 1998. Approximately 300,000 hair restoration procedures are
performed annually in the United States. ProCyte is the only company to provide
a line of products that address the importance of wound repair in the hair
transplant process. The Company's GraftCyte(TM) products are promoted through
specialty distributors and its own sales force.
During the first quarter of 1998 the Company introduced Complex Cu3(TM)
Intensive Repair Creme, a product used to treat patients following chemical
peels, dermabrasion and laser treatments. In addition, Complex Cu3(TM) Hydrating
Gel and Complex Cu3(TM) Gentle Cleanser were also launched to provide a
comprehensive approach to post-procedure care. The Company also began selling
its Pillo(TM) Pro Absorbent Dressings which provide moisture absorption
following liposuction procedures. Each year in the United States alone, an
estimated 500,000 such surgeries are performed. In December 1997, ProCyte
entered into an exclusive distribution agreement with the Bard Medical Division
("Bard") of C.R. Bard, Inc. Subject to certain minimum annual purchase
requirements, ProCyte granted Bard the exclusive rights to distribute its wound
care products in the hospital, nursing home and extended care markets in the
United States and Canada. ProCyte's Iamin(R) Hydrating Gel, Iamin(R) Wound
Cleanser, and OsmoCyte(R) Pillow Wound Dressings became the first Company
products to be added to the Bard sales effort. The Company shipped its first
orders to Bard in January 1998. During the second quarter ProCyte entered into a
distribution agreement with Tanox Pharma for sales of Iamin(R) Hydrating Gel and
OsmoCyte(R) Pillow Wound Dressings in China, Taiwan and Hong Kong. This
agreement was expanded in September 1998 to add five more countries. Approval as
a pharmaceutical in China has been received and the initial orders were shipped
in December 1998. In January 1999 the Company and Neutrogena signed a product
study agreement to evaluate ProCyte's GHK:cu technology for inclusion in
potential products that Neutrogena would sell in the worldwide consumer skin
care market.
During the second quarter of 1998 the Company purchased substantially all
the assets and business of HumaTech, a private company located in Boca Raton,
Florida, which distributed therapeutic skin care products and prescription and
over-the-counter topical drugs to dermatologists, plastic surgeons and cosmetic
surgeons. At the time of the acquisition the HumaTech product line included
therapeutic skin care products, dermatological agents and anti-aging products as
well as TiSilc(TM), an advanced sun protection product. Most HumaTech products
were private-labeled or custom-packaged with the doctor's name. The Company
expects that access to the HumaTech customer base and integration of its
marketing approach will improve the rate of increase of sales of the Company's
Complex Cu3(TM) and Tricomin(R) products. The Company also expects that as a
result of the acquisition there will be opportunities to enhance the sales of
the HumaTech product line by integrating the HumaTech products with the
Company's product line, reformulating certain of the HumaTech products, and
redesigning the HumaTech packaging and marketing materials.
14
<PAGE>
The Company commenced shipping its Tricomin(R) line of triamino copper
complex containing hair care products to physicians' offices in the third
quarter of 1998. Tricomin(R) shampoos, conditioners, and follicle therapy
solution are positioned to participate in the rapidly growing $1.5 billion
United States hair care market as a program for the maintenance of thinning hair
in men and women. Hair follicles require high concentrations of biological
copper and the Tricomin(R) products deliver copper along with amino acids for
nourishing and stimulating the hair and scalp for improved health, strength, and
appearance. The Company has initiated a series of consumer advertisements
focused specifically on the hair care needs and concerns of the aging babyboomer
population. In January 1999 the Company and Neutrogena signed an option and
product study agreement covering the evaluation of the Company's proprietary
triamino copper technology for use in potential consumer hair care products to
be marketed worldwide by Neutrogena.
Operating Losses
The Company is engaged in the development of healthcare products utilizing
copper peptide containing and polymer-based compounds. Such development has
historically been funded from the Company's equity-derived working capital and
through corporate partnerships. The Company has incurred operating losses since
its inception due to the costs of supporting research, development and clinical
studies of its proprietary technology. At December 31, 1998, the Company's
accumulated deficit was approximately $66.8 million. The Company expects to
incur additional operating losses until its product lines have been expanded and
have achieved market acceptance.
Revenue
During the year ended December 31, 1998, ProCyte generated total operating
revenue of $2,720,444 from product sales, contract manufacturing and royalties.
Comparable revenues were $949,148 for the year ended December 31, 1997, and
$1,653,013 for the year ended December 31, 1996. Sales of HumaTech products
amounting to approximately $1.29 million are included in ProCyte's 1998
operating revenue. The 1997 and 1996 amounts do not include any sales of
HumaTech products since the acquisition occurred on April 27, 1998.
Revenue from product sales was $2,177,784 during the year ended December
31, 1998, up from $184,034 during the year ended December 31, 1997 and $30,563
during the year ended December 31, 1996. The increase in 1998 was primarily a
result of revenue from HumaTech products, revenue from new products and revenue
from the sale of various wound care products to Bard. The increase in 1997
reflects the introduction of the Company's first products.
Contract manufacturing revenue decreased from $708,104 and $705,706 during
the years ended December 31, 1996 and 1997, respectively, to $436,167 during
1998. This decline resulted from the completion of a contract manufacturing
project in 1997 that did not carry over into 1998, and from product regulatory
delays faced by one of the Company's largest contract manufacturing customers
that have indefinitely delayed this customers need for the Company's services.
Revenue from royalties and licenses in 1996 includes final payments totaling
$900,000 from a single license agreement.
Interest income was $538,842 during the year ended December 31, 1998,
compared to $907,628 and $1,622,944 during the years ended December 31, 1997 and
1996, respectively. The decrease in interest income was primarily a result of
reduced funds available for investment.
Expenses
The cost of product sales increased from $13,910 in 1996 to $449,261 in
1997 and $963,733 in 1998. This reflects the increase in products sold and, in
1998, the introduction of HumaTech products with generally lower margins than
those based on proprietary technology. In 1997 cost of product sales includes
the establishment of a reserve for obsolete and excess inventory in the amount
of $380,000.
15
<PAGE>
Research and development expenses were $2,422,076, $3,774,415 and
$6,738,911 during the years ended December 31, 1998, 1997 and 1996,
respectively, reflecting the continuation of the Company's expenditures for
development of wound care, skin health and hair care product candidates. The
decreases resulted from reduced staffing levels and from the completion of
various research projects and studies. The Company anticipates that expenditures
for product development will remain at or near current levels during 1999.
Selling, general and administrative expenses were $4,340,424, $4,481,744
and $4,880,255 during the years ended December 31, 1998, 1997 and 1996,
respectively. Although selling, general and administrative expenses have not
changed significantly over the three years, the 1998 amount reflects the
additional costs of absorbing the HumaTech operation and expanded sales and
marketing efforts related to the launch of Tricomin(R), offset by reduced
staffing levels and the consolidation of the Company's facilities. The Company
anticipates that during 1999 expenditures will remain at or near current levels
as a proportion of product sales. The Company completed the closure of the Boca
Raton, Florida, office and the relocation of the HumaTech operations to Redmond,
Washington, during the fourth quarter of 1998.
Liquidity and Capital Resources
The Company has relied primarily on equity financing, interest income,
product sales, contract manufacturing revenue and corporate partnerships to fund
its operations and capital expenditures. At December 31, 1998, the Company had
approximately $6.9 million in cash, cash equivalents and securities available
for sale, as compared to $12.9 million at December 31, 1997. The principal
components of the $6 million decrease are approximately $1.9 million used for
the HumaTech acquisition and approximately $4.1 million used to fund ongoing
operations. The Company expects that its operating cash needs will continue at
similar levels in future periods.
The increase of $483,949 in accounts receivable during the year ended
December 31, 1998 reflects accounts attributable to the HumaTech acquisition and
the increase in sales of ProCyte products and services. For the year ended
December 31, 1998, finished goods inventory rose by $73,536 primarily as a
result of inventory purchased in the HumaTech acquisition.
On September 28, 1998 ProCyte received a non-compliance letter from the
NASDAQ Stock market ("NASDAQ") as a result of the price of its common stock
being below $1.00 per share for a period of 30 consecutive trading dates. The
company has requested continued listing despite the failure to meet the listing
criteria and presented its plan to return to compliance at a hearing on February
12, 1999. See "Important Factors Regarding Forward-Looking Statements
Potential Delisting from NASDAQ National market System."
The Company believes that its existing cash, cash equivalents,
securities available for sale, and interest thereon, will be sufficient to meet
its capital requirements at least through 1999. However, there can be no
assurance that the underlying assumed levels of revenue and expense will prove
accurate. Although the Company believes that its existing and potential
products appear promising, it is unknown whether any of such products will prove
commercially viable. In any event, substantial additional funds will be needed
to commercialize existing products and to continue development of potential
products. The Company will depend upon equity financing, contract manufacturing
fees, interest income, product revenues and funding from corporate partnerships
to meet its future capital needs. There can be no assurance that such funds
will be available as needed or on terms that are acceptable to the Company. In
addition, the Company's ability to raise funds is likely to be adversely
affected if it is unable to comply with the listing criteria on NASDAQ. If the
Company is unable to obtain sufficient funds to satisfy its cash requirements,
the Company will be required to delay, reduce or eliminate some or all of its
research and development activities and manufacturing and administrative
programs, or dispose of assets or technology. See "Important Factors Regarding
Forward-Looking Statements."
16
<PAGE>
Year 2000 Software Issue
The Company recognizes that its operations may be negatively affected by
the widely discussed software problems anticipated with the new millennium,
either from its own computer systems or its interactions with outside vendors,
service providers, customers and government agencies. In connection with the
relocation of the operations of HumaTech the Company has substantially upgraded
its computer hardware and implemented new accounting and distribution software
which are represented by the vendors to be year 2000 compliant. The Company
does not believe that it incurred any incremental cost specifically attributable
to Year 2000 issues in connection with the new hardware and software
installations and it expects that the costs to be incurred for monitoring and
testing remaining systems (including security systems, phone systems, machine
control systems, etc.) will not be significant. Moreover, the Company does not
anticipate that any significant capital expenditures will be required to
remediate any deficiencies revealed by the testing and monitoring currently in
process. The Company plans to implement any additional vendor upgrades and
modifications necessary to avoid year 2000 software issues and does not expect
that the incremental cost of such upgrades and modifications will be
significant. The Company believes that it has arranged for adequate stockpiles
of critical raw materials and that it is not dependent on any single source of
supply and consequently the Company does not intend to survey suppliers
concerning their preparedness. In the Company's judgement the most reasonably
likely worst case scenario would be short-term disruptions of the Company's
supply chain and customer payments. The Company presently believes that it is
well positioned to address these issues, but it intends to have a contingency
plan in place by the end of 1999 to allow operations to continue even if
significant disruptions are experienced. There can be no assurance that the
Company has accurately assessed the need for software and computer upgrades or
modifications in this regard and if such upgrades and modifications are not
made, or if they are not made on a timely basis, or if third parties fail to
adequately anticipate and remediate issues with software, computers and embedded
processors, or if there are severe disruptions of the overall business
infrastructure, year 2000 problems could have a material impact on the
operations of the Company.
Item 7a Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
Item 8. Financial Statements and Supplementary Data
<TABLE>
<CAPTION>
Page
<S> <C>
Index to Financial Statements and Schedules
Balance Sheets as of December 31, 1998 and 1997 18
Statements of Operations for the years ended December 31, 1998, 1997, and 1996 19
Statements of Cash Flows for the years ended December 31, 1998, 1997, and 1996 20
Statements of Stockholders' Equity for the years ended December 31, 1998, 1997, and 1996 21
Notes to Financial Statements 22
Report of Independent Accountants 29
</TABLE>
Note: All schedules have been omitted because of the absence of conditions
under which they are required or because the required information is
included in the Financial Statements or notes thereto.
17
<PAGE>
<TABLE>
<CAPTION>
ProCyte Corporation
Balance Sheets
December 31,1998 December 31,1997
-------------------------------------------------
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents.............................. $ 2,003,896 $ 3,003,524
Securities available for sale.......................... 4,935,085 9,863,093
Accounts receivable, net of reserve.................... 692,196 208,247
Finished goods inventory, net of reserve............... 489,333 415,797
Other.................................................. 85,634 154,887
-------------------------------------------------
Total current assets................................... 8,206,144 13,645,548
Raw materials and work in process, net of reserve....... 1,493,557 1,511,528
Property and Equipment
Equipment.............................................. 2,658,276 2,484,535
Leasehold improvements................................. 5,513,850 5,513,850
Less accumulated depreciation and amortization......... (3,008,159) (2,394,562)
-------------------------------------------------
Property and equipment, net............................ 5,163,967 5,603,823
Intangible Assets
Patents................................................ 290,930 290,930
Goodwill............................................... 3,150,000 -
Less accumulated amortization.......................... (281,829) (125,269)
-------------------------------------------------
Intangible assets, net................................. 3,159,101 165,661
Note Due From Employee.................................. 103,504 -
Security Deposits....................................... 176,105 384,399
-------------------------------------------------
Total Assets............................................ $ 18,302,378 $ 21,310,959
=================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable....................................... $ 107,726 $ 203,764
Accrued liabilities.................................... 389,885 470,643
-------------------------------------------------
Total current liabilities.............................. 497,611 674,407
Deferred Lease Payments................................. 125,217 20,055
Commitments............................................. - -
Stockholders' Equity
Preferred stock $.01 par value: 2,000,000 shares authorized; no
shares issued or outstanding. - -
Common stock $.01 par value: 30,000,000 shares authorized;
14,489,803 and 13,364,958 shares issued and outstanding at
December 31, 1998 and 1997, respectively.............. 144,898 133,650
Additional paid-in capital............................. 84,320,582 82,801,830
Accumulated deficit.................................... (66,785,930) (62,318,983)
-------------------------------------------------
Total stockholders' equity............................. 17,679,550 20,616,497
-------------------------------------------------
Total Liabilities and Stockholders' Equity.............. $ 18,302,378 $ 21,310,959
=================================================
See notes to financial statements
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
ProCyte Corporation
Statements of Operations
Twelve Months Ended December 31,
1998 1997 1996
----------------------------------------------
<S> <C> <C> <C>
Revenues
Product sales.................................... $ 2,177,784 $ 184,034 $ 30,563
Contract manufacturing........................... 436,167 705,706 708,104
Licenses, royalties and other.................... 106,493 59,408 914,346
--------------------------------------------
Total revenue.................................... 2,720,444 949,148 1,653,013
Cost of product sales............................ 963,733 449,261 13,910
----------------------------------------------
1,756,711 499,887 1,639,103
Operating Expenses
Selling, general & administrative................ 4,340,424 4,481,744 4,880,255
Research & development........................... 2,422,076 3,774,415 6,738,911
Litigation settlement............................ - (400,000) 1,000,000
----------------------------------------------
Total expenses................................... 6,762,500 7,856,159 12,619,166
----------------------------------------------
Operating Loss................................... (5,005,789) (7,356,272) (10,980,063)
Interest Income................................... 538,842 907,628 1,622,944
----------------------------------------------
----------------------------------------------
Net loss.......................................... ($4,466,947) ($6,448,644) ($9,357,119)
==============================================
Net loss per common share......................... ($0.32) ($0.48) ($0.71)
Weighted average number of common shares used in
computing net loss per common share.............. 14,117,485 13,326,929 13,210,036
</TABLE>
See notes to financial statements
19
<PAGE>
<TABLE>
<CAPTION>
ProCyte Corporation
Statements of Cash Flows
Twelve Months Ended December 31,
Operating Activities 1998 1997 1996
---------------------------------------------------
<S> <C> <C> <C>
Net Loss ($4,466,947) ($6,448,644) ($9,357,119)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization................................... 786,970 746,329 1,077,294
(Gain) loss on sale of securities............................... (683) (765) 50,036
Gain on sale of property & equipment............................ - (58,643) -
Stock issued to pay expenses.................................... 30,000 226,366 200,899
Changes in assets and liabilities:
(Increase) decrease in finished goods inventories, in 1998
net of $130,000 acquired from HumaTech Corporation........... (73,536) (235,603) (180,194)
(Increase) decrease in raw materials and work in process...... 147,971 (1,094,982) (416,546)
Increase in accounts receivables, in 1998 net of $115,000
acquired from HumaTech Corporation........................... (368,949) (59,616) -
Decrease in other current assets, in 1998 net of $30,000
acquired from HumaTech Corporation........................... 99,253 15,062 158,536
Decrease in accounts payable.................................. (96,038) (131,079) (343,855)
Increase (decrease) in accrued liabilities.................... (80,758) (309,247) 68,756
Decrease in litigation settlement payable, net of $3,000,000
insurance receivable......................................... - - (4,750,000)
Increase in note due from employee............................ (103,504) - -
Increase (decrease) in deferred lease payments................ 105,162 9,907 (59,024)
---------------------------------------------------
Net cash used in operating activities........................... (4,021,059) (7,340,915) (13,551,217)
---------------------------------------------------
Financing Activities
Proceeds from issuance of stock................................. - - 110,444
---------------------------------------------------
Net cash provided by financing activities....................... - - 110,444
---------------------------------------------------
Investing Activities
Purchase of property and equipment.............................. (190,554) (586,740) (1,739,875)
Sale of property and equipment.................................. - 171,671 -
Purchase of securities.......................................... (5,234,935) (45,652,513) (171,186,634)
Sale or maturity of securities.................................. 10,163,626 54,832,146 182,152,417
Purchase of assets of HumaTech Corporation...................... (1,925,000) - -
Decrease (increase) in security deposits........................ 208,294 (225,000) -
---------------------------------------------------
Net cash provided by investing activities...................... 3,021,431 8,539,564 9,225,908
---------------------------------------------------
Net Increase (Decrease) in Cash And Cash Equivalents............. (999,628) 1,198,649 (4,214,865)
Cash And Cash Equivalents:
At Beginning Of Period........................................... 3,003,524 1,804,875 6,019,740
---------------------------------------------------
At End Of Period................................................. $ 2,003,896 $ 3,003,524 $ 1,804,875
===================================================
</TABLE>
See notes to financial statements
20
<PAGE>
<TABLE>
<CAPTION>
ProCyte Corporation
Statements of Stockholders' Equity
Common Stock Additional Accumulated Unearned
------------
Shares Par Value Paid-in Capital Deficit Compensation Total
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1996 13,131,095 $131,311 $82,350,862 ($46,513,220) ($84,399) $35,884,554
---------------------------------------------------------------------------------------
Exercise of stock options.................. 46,463 465 109,978 - - 110,443
Stock issued at $2.59 per share to
Hymedix................................... 100,000 1,000 258,000 - - 259,000
Cancellation of compensatory stock
options and amortization of unearned
compensation.............................. - - (142,500) - 84,399 (58,101)
Net loss................................... - - - (9,357,119) - (9,357,119)
-------------------------------------------------------------------------------------
Balance, December 31, 1996 13,277,558 132,776 82,576,340 (55,870,339) - 26,838,777
-------------------------------------------------------------------------------------
Stock issued at $2.59 per share to
Hymedix................................... 87,400 874 225,490 - - 226,364
Net loss................................... - - - (6,448,644) - (6,448,644)
-------------------------------------------------------------------------------------
Balance, December 31, 1997 13,364,958 133,650 82,801,830 (62,318,983) - 20,616,497
-------------------------------------------------------------------------------------
Shares issued at $1.38 per share to acquire
HumaTech Corporation...................... 1,088,435 10,884 1,489,116 - - 1,500,000
Shares issued under the 1998 Non-
Employee Director stock plan.............. 36,410 364 29,636 - - 30,000
Net loss................................... - - - (4,466,947) - (4,466,947)
-------------------------------------------------------------------------------------
Balance, December 31, 1998 14,489,803 $144,898 $84,320,582 ($66,785,930) - $17,679,550
-------------------------------------------------------------------------------------
</TABLE>
See notes to financial statements
21
<PAGE>
ProCyte Corporation
Notes to Financial Statements
Note 1. Description of Business and Summary of Significant Accounting Policies
Nature of Operations
ProCyte Corporation ("ProCyte" or "the Company") is a health care
company dedicated to developing, manufacturing and marketing products for wound
care, skin health and hair care, many of which incorporate the Company's
proprietary copper peptide compounds or its patented hydropolymer technology.
Summary of Significant Accounting Policies
Revenue recognition
Product revenues are recognized when products are shipped, contract
manufacturing revenues are recognized when services are performed and license
fees are recognized when earned.
Research and development
Research and development costs are expensed as incurred. The Company
enters into contracts with outside laboratories for certain clinical,
biocompatibility, and toxicology studies. Payment for such contracts are
typically made in installments at the initiation, completion and other specified
stages of the studies. The Company recognizes the expenses associated with
these contracts when the related services are performed.
Inventories
Finished goods inventories and raw materials and work in process are
stated at the lower of cost, as determined by the first in, first out method, or
market. Inventory and work in process costs include material, direct labor and
overhead allocated on the basis of full capacity. The Company has provided a
valuation allowance for excess and obsolete finished goods inventory in the
amount of $80,000 at both December 31, 1997 and 1998. Raw materials and work in
process includes supplies and compounds that will be utilized after the current
operating cycle.
Depreciation and amortization
Equipment is depreciated using accelerated methods over the estimated
useful lives of the related assets, ranging from 5 to 20 years. Leasehold
improvements are amortized over the term of the facility lease. Patent
application costs are amortized on a straight-line basis over 17 years from the
date the related U.S. patents are issued. Application costs for abandoned
patents are expensed in the period abandoned. Goodwill is amortized on a
straight-line basis over 15 years.
Net loss per common share
Net loss per common share is based upon the weighted average number of
common shares outstanding. Shares issuable upon the exercise of stock options
are common stock equivalents, but including those shares in the computation of
the basic net loss per common share would have had an anti-dilutive effect and
consequently diluted earnings per share is not presented.
22
<PAGE>
Federal income taxes
The Company uses an asset and liability approach to account for income
taxes as provided for in SFAS 109, Accounting for Income Taxes. Under this
approach deferred tax assets and liabilities are created by differences between
basis for financial and tax reporting purposes. The Company has provided a full
valuation allowance for tax benefits of net operating losses and research and
development tax credit carry forwards.
Accounts Receivable
The Company has provided a valuation allowance for uncollectable accounts
receivable in the amount of $54,948 and $30,000 at December 31, 1998 and 1997,
respectively.
Cash equivalents
The Company considers all highly liquid investments purchased with a
maturity of three months or less to be cash equivalents. Such investments are
primarily in a United States Treasury money market fund.
Securities available for sale
The Company's investments, consisting of U.S. Treasury notes and bills and
investment-grade commercial paper, are all classified as "available for sale"
and are stated at fair value, with valuation adjustments recorded directly to
equity, if significant. Fair value is based upon quoted market prices and
approximates cost as of December 31, 1998 and 1997. For purposes of computing
realized gains and losses, the specific identification method is used to
determine the cost of investments sold.
Stock options
The Company has implemented SFAS No. 123, Accounting for Stock-Based
Compensation which defines a fair value method of accounting for employee stock
options. As permitted by SFAS No. 123, the Company follows the intrinsic value
accounting method for stock options contained in APB Opinion No. 25, Accounting
for Stock Issued to Employees. Under SFAS No. 123 certain disclosures about
stock-based compensation arrangements are made regardless of the method used to
account for them.
Use of estimates in financial statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of revenues and expenses during the
reporting period and the reported amounts of assets and liabilities at the date
of the financial statements, particularly with respect to the valuation of
inventory, goodwill and other non-current assets. Actual results could differ
from those estimates.
Reclassifications
Certain reclassifications have been made to items reported in prior years
to conform to the current year's presentation.
Recent Accounting Pronouncements
During 1998 the Company adopted SFAS 130, Reporting Comprehensive Income
which had no effect on the Company's financial statements. During 1998 the
Company also adopted SFAS 131, Disclosure about Segments of an Enterprise. The
Company does not currently measure operating performance on a segment basis and
separate segment disclosure is thus not required. In June 1998 SFAS 133,
Accounting for Derivative Instruments was issued with an effective date in the
year 2000. The Company does not believe that adoption of this pronouncement
will have a significant effect on its financial statements.
23
<PAGE>
Note 2. Acquisition of HumaTech Corporation
On April 27, 1998 the Company purchased substantially all of the assets
of HumaTech Corporation ("HumaTech"), a private distributor of specialty
dermatology products to the professional market. The acquisition was effected
through cash payments of $1.5 million and the distribution of 1,088,435 shares
of ProCyte common stock (valued at $1.5 million at the time of the acquisition)
to the selling HumaTech shareholders. Related acquisition costs amounted to
approximately $425,000. The acquisition has been accounted for using the
purchase method of accounting whereby the value of consideration paid has been
allocated among the assets acquired, principally inventory, accounts receivable
and other current assets. Goodwill of $3.15 million resulted from the
transaction. In connection with the acquisition ProCyte entered into employment
agreements with two of the HumaTech principals which, among other terms,
provided for payments contingent on future sales of HumaTech products.
The following table presents unaudited pro forma consolidated operating
results of the Company and HumaTech assuming the acquisition had been made at
the beginning of each of the periods presented:
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Pro forma revenue $ 3,295,000 $ 2,819,000 $ 2,792,000
Pro forma net loss ($4,476,900) ($7,443,000) ($11,073,000)
Pro forma loss per common share ($0.31) ($0.52) ($0.77)
</TABLE>
These unaudited pro forma results of operations have been prepared for
comparative purposes only and reflect certain adjustments including amortization
of the goodwill. The unaudited pro forma information is not necessarily
indicative of either the results of operations that would have occurred had the
acquisition been made at the beginning of the various periods presented, or that
may occur in the future.
Note 3. Investments
At December 31, 1998, the cost and estimated market value for investments
maturing in one year or less was $3,421,335 and those maturing in one through
five years was $1,513,750. Unrealized gains or losses at December 31, 1998 and
1997 were insignificant. Realized gains and losses from sales of investments
during 1998, 1997, and 1996 were $683, $765, and ($50,036), respectively.
Note 4. Raw materials and work in process
Because of federal Food and Drug Administration requirements for the cGMP
manufacturing process, and to take advantage of market conditions and scheduling
efficiencies, the Company procures materials and produces compounds in economic
order quantities. Raw materials and work in process at December 31, 1998 and
1997 consisted of the following:
<TABLE>
<CAPTION>
1998 1997
----------------------------------
<S> <C> <C>
Work in process $1,326,332 $1,440,215
Raw materials 467,225 371,313
Reserve for excess and obsolete items (300,000) (300,000)
----------------------------------
Total $1,493,557 $1,511,528
==================================
</TABLE>
24
<PAGE>
Note 5. Product and geographic information
The Company's wound care products are sold primarily to specialty
distributors and its skin health and hair care products are sold primarily to
physicians. During 1998, 1997 and 1996, a single customer accounted for
approximately 12%, 34% and 10%, respectively, of contract manufacturing revenue.
One customer, a wound care products distributor, accounted for approximately 15%
of product sales in 1998. License fees in 1996 include $900,000 from a single
license agreement. The Company has not made significant sales outside of the
United States.
Product sales consisted of the following:
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996
<S> <C> <C> <C>
---------------------------------------------------
Wound Care $ 314,893 $125,815 $30,563
Skin Health 1,776,830 58,219
Hair Care 86,061
---------------------------------------------------
$2,177,784 $184,034 $30,563
===================================================
</TABLE>
Note 6. Federal Income Taxes
The following is a summary of the components of deferred taxes at December
31, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
--------------------------------------------
<S> <C> <C>
Federal NOL carryforwards $ 22,200,000 $ 20,500,000
Research and development credit
carryforwards 1,500,000 1,500,000
Other 700,000 600,000
Valuation Allowance (24,400,000) (22,600,000)
--------------------------------------------
Total $ - $ -
============================================
</TABLE>
At December 31, 1998, the Company's deferred tax asset relates to net
operating losses and research and development tax credit carry forwards of
approximately $65.4 million and $1.5 million, respectively, which are scheduled
to expire from 2005 to 2018. As a result of issuing common stock subsequent to
inception, the Company's ability to use these net operating losses and tax
credit carry forwards in the future will be subject to limitations under
Internal Revenue Code Section 382. A full valuation allowance has been provided
since realization of the deferred tax asset is not reasonably assured.
Note 7. Litigation Settlement
In 1995 the Company accrued $4.75 million, net of a related insurance
claim receivable of $3.0 million in connection with a shareholder lawsuit filed
against the Company in October 1994. In 1996 the Company provided a full
valuation allowance for $1.0 million of the insurance claim which remained from
that dispute. In May 1997 the Company received a negotiated final settlement of
$400,000 from its insurance carrier.
Note 8. Lease Commitments
The Company presently leases approximately 33,000 square feet of
manufacturing, warehouse, laboratory, and administrative space in Redmond,
Washington under a lease executed in August 1993. As
25
<PAGE>
amended, the lease term extends through June 30, 2007 and contains a renewal
option for the Company to extend the term by an additional five years .
Future minimum annual lease payments are as follows:
<TABLE>
<S> <C>
1999 $ 387,378
2000 401,053
2001 419,232
2002 406,584
2003 400,752
Thereafter 1,442,856
-----------
Total $3,457,855
===========
</TABLE>
Rent expense in 1998, 1997, and 1996 was $528,730, $550,333, and $519,629,
respectively.
Note 9. 401(k) Plan
The Company sponsors the 1991 ProCyte Corporation Profit Sharing and
Salary Deferral 401(k) Plan which is funded by voluntary employee pretax salary
deferrals, to the extent permitted under law, and provides for employer matching
contributions, at the discretion of the Board of Directors. No employer
contribution has been made since the adoption of the plan.
Note 10. Note Due From Employee
At December 31, 1998 an employee owed the Company $103,504 plus
accrued interest at 4.28% under the terms of a promissory note dated December
16, 1998 which is due in full on June 30, 2002.
Note 11. Stockholders' Equity
Hymedix
In November 1995, the Company entered into an agreement with Hymedix
International, Inc. ("Hymedix") to obtain a license to certain absorbent polymer
technology. In connection with this agreement the Company issued 200,000 shares
of its common stock to Hymedix over a two-year period. In November 1997, the
Company renegotiated the license agreement with Hymedix, retaining a license to
certain of the Hymedix technology in exchange for a one-time payment of
$125,000.
Non-employee Director stock plan
In June 1998 the shareholders approved the 1998 Non-employee Director stock
plan reserving 200,000 shares for issuance to directors. Under this plan
eligible directors receive all or a portion of their quarterly retainer fees in
shares of the common stock of the Company. The number of shares each eligible
director receives is based on the average fair market value of the common stock
for the last 20 business days of the fiscal quarter. Stock grants were made
under the plan for the second and third quarters totaling 15,285 and 21,125
shares, respectively. After granting 32,395 shares in January 1999 in payment
of the retainer for the fourth quarter of 1998 there were 131,195 remaining
shares available for issuance under the plan.
26
<PAGE>
Shareholder Rights plan
In December 1994 the Board of Directors adopted a shareholder rights plan
declaring a dividend of one preferred share purchase right (the "Rights") for
each outstanding share of common stock of the Company. Each Right, initially
evidenced by and traded with the shares of common stock, entitles the registered
holder to purchase one one-hundredth of a share of preferred stock of the
Company at an exercise price of $14.00, subject to adjustment based on the
market price of the Company's common stock at the time the Rights become
exercisable. The Rights will be exercisable only if a person or group acquires
15% or more of the Company's common stock or announces a tender offer for the
Company. The Rights may be redeemed, at a redemption price of $0.01 per Right
at any time until any person or group has acquired 15% or more of the Company's
common stock. The Board of Directors may also elect to exchange the Rights for
shares of the Company's common or preferred stock. In the event the Company is
acquired, each outstanding Right will represent the right to acquire shares of
the surviving entity. The Rights expire on December 7, 2004.
Note 12. Stock Options
The Company has stock option plans for directors, officers, employees
and consultants that provide for grants of nonqualified and incentive stock
options. Options generally are granted at fair market value, expire between five
and ten years from grant date and vest ratably over three to five years.
The following table summarizes information about stock option activity
in 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
---------------------------------------------------------------------------------------
Number of Wtd. Avg. Number of Wtd. Avg. Number of Wtd. Avg.
Options Exercise Options Exercise Options Exercise
Price Price Price
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of year 1,304,374 $2.94 1,442,193 $3.50 1,536,957 $4.44
Granted 749,000 $1.21 415,500 $1.57 402,000 $2.94
Exercised - - - - (46,463) $2.38
Canceled or expired (435,313) $2.95 (553,319) $3.46 (450,301) $6.34
Outstanding, end of year 1,618,061 $2.18 1,304,374 $2.94 1,442,193 $3.50
Exercisable, end of year 681,407 $3.28 675,044 $3.71 742,383 $4.09
</TABLE>
The options outstanding at December 31, 1998 consisted of the following:
<TABLE>
<CAPTION>
Range of Number of Wtd. Avg. Wtd. Avg. Number of Wtd. Avg.
exercise Options Remaining Exercise Options Exercise
prices Outstanding Life Price Exercisable Price
<S> <C> <C> <C> <C> <C> <C>
$0.49 - $1.22 404,167 9.26 $1.01 54,339 $1.22
$1.25 - $1.25 22,500 8.56 $1.25 7,502 $1.25
$1.31 - $1.31 281,500 3.64 $1.31 - -
$1.39 - $2.59 270,394 8.64 $1.66 67,563 $2.11
$2.64 - $2.84 340,500 7.21 $2.79 257,167 $2.78
$2.84 - $11.88 299,000 5.55 $4.40 294,836 $4.41
------------------------------------------------------------------
1,618,061 7.05 $2.18 681,407 $3.28
===================================================================
</TABLE>
27
<PAGE>
The remaining number of shares reserved for issuance under the Company's
various option plans at December 31, 1998 was as follows:
<TABLE>
<CAPTION>
Number of shares
available for option
<S> <C>
1989 Restated Stock Option Plan 101,018
1996 Stock Option Plan 450,000
1991 Non-employee Director Stock Option Plan 16,000
------------
567,018
============
</TABLE>
As required by SFAS 123, the Company has determined the fair value of stock
options granted during 1998, 1997 and 1996 using the Black-Scholes option
pricing model and the following assumptions:
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------------------------
<S> <C> <C> <C>
Risk-free interest rate 4.28% 4.99% 5.88%
Expected option life (years) 5.81 5.81 5.81
Dividend yield 0.00 0.00 0.00
Expected volatility 96% 117% 79%
</TABLE>
The weighted average fair value of options granted during 1998, 1997 and
1996 was approximately $0.84, $1.35 and $2.04, respectively. The effect on the
reported net loss had the Company elected to adopt the measurement provisions of
SFAS 123 would have been an increase in the reported net loss for the periods
ending December 31, 1998, 1997 and 1996, by $626,090, $596,401 and $552,913,
respectively. On such a pro forma basis, net loss per share would have
increased by $0.04 to $0.36 in 1998, by $0.05 to $0.53 in 1997, and by $0.04 to
$0.75 in 1996.
28
<PAGE>
ProCyte Corporation
Independent Auditors' Report
Board of Directors
ProCyte Corporation
Redmond, Washington
We have audited the accompanying balance sheets of ProCyte Corporation (the
Company) as of December 31, 1998 and 1997, and the related statements of
operations, cash flows, and stockholders' equity for each of the three years in
the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 1998 and
1997, and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles.
DELOITTE & TOUCHE LLP
/s/ Deloitte & Touche LLP
Seattle, Washington
February 15, 1999
29
<PAGE>
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
The information required under Part III, Items 10, 11, 12, and 13, is
included in the Company's Proxy Statement relating to the Company's annual
meeting of shareholders, and is incorporated herein by reference. Such Proxy
Statement will be filed with the Securities and Exchange Commission not later
than 120 days after the close of the Company's fiscal year end, December 31,
1998.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
a. List of documents filed as part of this report:
(1) Financial Statements and Supplementary Data Reference is made to the
Index to Financial Statements and Schedules under Item 8 in Part II
hereof, where such documents are listed.
(2) Exhibits - see (c) below
b. Reports on Form 8-K
None
c. Exhibits
30
<PAGE>
<TABLE>
<CAPTION>
Exhibit Description Note
<C> <S> <C>
2.1 Asset Purchase and Sale Agreement dated April 27, 1998 between the Registrant and E
HumaTech Corporation
3.1 Restated Articles of Incorporation of the Registrant A
3.2 Restated Bylaws of the Registrant A
4.1 Rights Agreement between the Registrant and American Securities Transfer and Trust as G
of December 7, 1994
10.1* 1987 Stock Benefit Plan of ProCyte Corporation A
10.2* ProCyte Corporation 1989 Restated Stock Option Plan B
10.3* ProCyte Corporation 1991 Restated Stock Option Plan for Non-employee Directors and D
amendments thereto
10.4+ Teachers Insurance & Annuity Association Lease dated as of October 1, 1993 and second D
amendment thereto dated February 28, 1997
10.5* 1996 Stock Option Plan D
10.6* ProCyte Corporation 1998 Non-employee Director Stock Plan F
10.7* Change of Control Agreement for Ms. Robin Carmichael F
10.8* Change of Control Agreement for Mr. John Clifford D
10.9* Change of Control Agreement for Ms. Susan Browner F
10.10* Change of Control Agreement for Mr. Ken Tapman F
10.11* Employment Agreement, dated as of April 27, 1998, by and between ProCyte Corporation E
and Ms. Susan Browner
10.12* Employment Agreement, dated as of April 27, 1998, by and between ProCyte Corporation E
and Mr. Ken Tapman
10.13* Form of Indemnity Agreement dated February 23, 1995 between the Registrant and each of C
Dr. Blake, Mr. Patterson, Mr. Tierney, Mr. Clifford, and Mr. Sullivan
10.14* Form of Indemnity Agreement between ProCyte Corporation and each of various of its F
Officers and Directors
10.15* Form of Severance Agreement for Mr. John Clifford D
10.16* Form of Promissory Note between ProCyte Corporation and Mr John Clifford H
10.17+ Distribution & License Agreement dated December 12, 1997 between the Registrant and G
Bard Medical Division
23.1 Consent of Deloitte & Touche LLP H
27.1 Financial Data Schedule H
- ----------------------------------------------------------------------------------------------------------------
* Management contract or compensatory plan or arrangement.
+ Confidential treatment has been granted or requested with respect to portions of this exhibit.
A. Incorporated by reference to the Registrant's Registration Statement of Form S-1 (No. 33-31353).
B. Incorporated by reference to the Registrant's Registration Statement of Form S-1 (No. 33-46364).
C. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31,
1994.
D. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31,
1996.
E. Incorporated by reference to the Registrant's current Report on Form 8-K dated April 27, 1998
F. Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the Quarter ended June 30,
1998
G. Incorporated by reference to the Registrant's Amended Annual Report on Form 10-K/A dated December 31, 1997.
H. Filed herewith.
</TABLE>
31
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PROCYTE CORPORATION
(REGISTRANT)
By: /s/ John F. Clifford
-----------------------------------------------
Date: February 24, 1999 John F. Clifford
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Name Title Date
<S> <C> <C>
/s/ Jules Blake Director February 24, 1999
- -----------------------------------
Jules Blake, Ph.D.
/s/ John F. Clifford President and Chief Executive Officer February 24, 1999
- ----------------------------------- (Principal Executive Officer)
John F. Clifford
/s/ Matt Leavitt Director February 24, 1999
- -----------------------------------
Matt Leavitt
/s/ Robert E. Patterson Director February 24, 1999
- -----------------------------------
Robert E. Patterson
/s/ William M. Sullivan Director February 24, 1999
- -----------------------------------
William M. Sullivan
/s/ Susan Browner Director February 24, 1999
- -----------------------------------
Susan Browner
/s/ Thomas E. Tierney Chairman of the Board February 24, 1999
- -----------------------------------
Thomas E. Tierney
/s/ Jerry Scott Vice President and Chief Financial Officer February 24, 1999
- ----------------------------------- (Principal Finance and Accounting Officer)
Jerry Scott
</TABLE>
32
<PAGE>
Exhibit 10.16
$103,503.50 Seattle, Washington
- ----------- December 16, 1998
PROMISSORY NOTE
1. Promise to Pay
FOR VALUE RECEIVED, the undersigned, JOHN F. CLIFFORD, an individual
resident of Washington ("Borrower") promises to pay to PROCYTE CORPORATION, a
Washington Corporation ("Lender"), at P.O. Box 808, Redmond, Washington 98073-
0808 c/o the Chief Financial Officer, or such other place as Lender may from
time to time designate in writing, in legal tender of the United States of
America, the principal sum of One Hundred Three Thousand Five Hundred Three and
Fifty / One Hundredths Dollars ($103,503.50), together with interest thereon,
all as hereinafter provided and upon the following terms and conditions.
2. Interest Rate
This Note shall bear interest from the date hereof at the rate of Four and
Twenty Eight One Hundredth percent (4.28%) compounded semiannually.
3. Payments
The entire unpaid principal balance of this Note and all accrued and unpaid
interest shall be due and payable in full on June 30, 2002 (the "Due Date").
Borrower may prepay this Note at any time without penalty.
4. Business Purpose
Borrower hereby represents and warrants to Lender that the proceeds of this
Note shall be used by him exclusively for business and commercial purposes, and
that none of the proceeds of this Note shall be used by Borrower for personal,
family or household purposes.
5. Security
This Note is unsecured.
6. Default
Borrower's failure to pay the full unpaid principal and accrued interest of
this Note on the Due Date, or any default by Borrower in the observance or
performance of any term, covenant or provision under any instrument evidencing
this debt ("Default") shall, without notice, at the option of Lender, cause all
of the unpaid principal of this Note, and interest accrued thereon, to become
immediately due and payable, anything herein to the contrary notwithstanding.
Failure to exercise this option, or any other right Lender may have, shall not
constitute a waiver of the right to exercise such option or any other right in
the event of any subsequent Default.
Upon Default, this Note shall bear interest from the date of the Default at
the rate of eight percent (8%) per annum ("Default Rate"). After the entire
principal amount of the loan evidenced hereby shall have been due and payable,
whether by acceleration, at maturity or otherwise, this Note shall bear interest
at the Default Rate.
<PAGE>
7. Collection Costs and Expenses
Borrower shall be liable for all costs, expenses and fees incurred by
Lender in connection with compelling payment of this Note, including, without
limitation reasonable attorney's fees and costs for legal services incurred by
Lender. Any judgment recovered by Lender shall bear interest at the Default
Rate, not to exceed the highest rate then permitted by law on such a judgment.
8. Waiver of Presentment
Borrower hereby waives demand, presentment for payment and notice of
nonpayment, and specifically consents to and waives notice of any renewals or
extensions of this Note, and agrees that any such action by Lender shall not
affect the liability of Borrower or any persons liable or to become liable on
this Note. Such consent shall not alter or diminish the liability of any person
or the enforceability of this Note. This Note shall bind Borrower and his
successors and assigns, jointly and severally.
9. Maximum Interest
This Note shall not require the payment or permit the collection of
interest in excess of the maximum permitted by applicable law.
10. Governing Law and Jurisdiction and Venue
This Note is to be governed by the laws of the State of Washington. Venue
of any action hereunder shall like exclusively in state court located in King
County, Washington.
DATED as of the day and year first above written.
BORROWER:
/s/ John F. Clifford
_________________________
John F. Clifford
Acknowledged by:
ProCyte Corporation
/s/ Jerry Scott
By ______________________________
Jerry Scott
Its Chief Financial Officer
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
________________________________________________________________________________
Board of Directors
ProCyte Corporation
Redmond, Washington
We consent to the incorporation by reference in Registration Statements Nos.
333-64339. 33-59983, 33-48809, and 33-40565 on Form S-8 and Registration
Statement No. 333-52073 on Form S-3 of ProCyte Corporation of our report dated
February 15, 1999, included in this Annual Report on Form 10-K of ProCyte
Corporation for the year ended December 31, 1998.
/s/ Deloitte & Touche LLP
- --------------------------
DELOITTE & TOUCHE LLP
Seattle, Washington
February 24, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,003,896
<SECURITIES> 4,935,085
<RECEIVABLES> 747,144
<ALLOWANCES> 54,948
<INVENTORY> 489,333
<CURRENT-ASSETS> 8,204,894
<PP&E> 8,172,126
<DEPRECIATION> 3,008,159
<TOTAL-ASSETS> 18,302,378
<CURRENT-LIABILITIES> 497,611
<BONDS> 0
0
0
<COMMON> 144,878
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 18,302,378
<SALES> 2,177,784
<TOTAL-REVENUES> 2,720,444
<CGS> 963,733
<TOTAL-COSTS> 963,733
<OTHER-EXPENSES> 6,762,500
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (4,466,947)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,466,947)
<EPS-PRIMARY> (0.32)
<EPS-DILUTED> 0
</TABLE>
