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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 For the fiscal year ended December 31, 1997
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the transition period from to
Commission File Number: 0-22314
PENEDERM INCORPORATED
(Exact name of registrant as specified in its charter)
Delaware 77-0146116
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
320 Lakeside Drive, Foster City, California 94404
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 358-0100
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
$0.01 par value
Rights to purchase
Common Stock
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant on January 30, 1998, based upon the closing price of the Common Stock
on the Nasdaq National Market for such date, was approximately $85,322,000.
The number of outstanding shares of the registrant's Common Stock on January 30,
1998 was 8,154,098.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the Proxy Statement to be filed with the Securities and
Exchange Commission on or prior to April 30, 1998 and to be used in
connection with the Annual Meeting of Stockholders expected to be held
June 24, 1998 are incorporated by reference in Parts III and IV of this
Form 10-K.
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PENEDERM INCORPORATED
1997 FORM 10-K REPORT
TABLE OF CONTENTS
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PAGE
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PART I
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ITEM 1. BUSINESS.......................................................... 3
ITEM 2. PROPERTIES........................................................33
ITEM 3. LEGAL PROCEEDINGS.................................................33
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...............33
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS..............................................34
ITEM 6. SELECTED FINANCIAL DATA...........................................35
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.............................36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.......................40
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.............................55
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...............55
ITEM 11. EXECUTIVE COMPENSATION...........................................55
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...55
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...................55
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K........................................55
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THE STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-K AND OTHER STATEMENTS MADE
BY THE COMPANY FROM TIME TO TIME THAT RELATE TO FUTURE PLANS, EVENTS OR
PERFORMANCE ARE FORWARD-LOOKING STATEMENTS WHICH INVOLVE RISKS AND
UNCERTAINTIES. ACTUAL RESULTS, EVENTS OR PERFORMANCE MAY DIFFER MATERIALLY FROM
THOSE ANTICIPATED IN ANY FORWARD-LOOKING STATEMENTS AS A RESULT OF A VARIETY OF
FACTORS, INCLUDING THOSE SET FORTH UNDER "RISK FACTORS" AND ELSEWHERE IN THIS
ANNUAL REPORT ON FORM 10-K. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON
THESE FORWARD-LOOKING STATEMENTS WHICH SPEAK ONLY AS OF THE DATE HEREOF. THE
COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY RELEASE THE RESULT OF ANY REVISIONS
TO THESE FORWARD-LOOKING STATEMENTS THAT MAY BE MADE TO REFLECT EVENTS OR
CIRCUMSTANCES AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCE OF
UNANTICIPATED EVENTS.
PART I
ITEM 1. BUSINESS
COMPANY OVERVIEW
Penederm is developing and commercializing topically administered
prescription dermatology products that use the Company's proprietary drug
delivery technology or drug compounds to achieve enhanced patient safety or
clinical efficacy. In the fourth quarter of 1996, Penederm received clearance
from the United States Food and Drug Administration ("FDA") to market Mentax, a
once-a-day prescription topical treatment for the treatment of three skin fungal
conditions: tinea pedis (athletes' foot), tinea corporis (ringworm) and tinea
cruris (groin fungus). In May 1997, the Mentax product was approved as an
over-the-counter product by the Health Protection Branch of Health Canada, where
it is being marketed by Schering-Plough HealthCare Products, Inc.
(Schering-Plough) under the Dr. Scholl's Once-A-Day brand name. In January 1997,
Penederm received FDA clearance to begin marketing its Avita cream prescription
product for the treatment of acne. Penederm subsequently received clearance, in
January 1998, to market the gel formulation of Avita upon the expiration of a
patent held by a third party. In January 1998, Penederm also announced it had
licensed permethrin cream 5% from Alpharma, Inc. (Alpharma) for the treatment of
sarcoptes scabiei (scabies infection). Penederm will market this product under
its Acticin brand name. Penederm initiated phase III human clinical trials of a
combination product (project name: 501 cream) for the treatment of skin fungal
conditions in 1997. Products for nail fungus and psoriasis are in earlier stages
of clinical development along with Mentax skin treatment line extensions. The
Company also sells its patented TopiCare Delivery Compounds as specialty
ingredients to major cosmetic companies for incorporation into their commercial
products. The Company's goal is to become a leader in the United States
prescription dermatology market and compete in other skin care markets by
creating safer and more efficacious topical formulations using its versatile
drug delivery technology with selected novel and off-patent drug compounds
addressing niche markets and by successfully commercializing these formulations.
- ----------
The following trademarks of Penederm are used in this Annual Report on
Form 10-K: TopiCare Delivery Compounds(R), Avita(TM), Mentax(R), Penederm(R),
Vitinoin(R), Acticin(TM) and DuraScreen(R) (licensed to Pierre Fabre Inc. in the
United States).
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MARKET OVERVIEW
Prescription Products
The market for prescription treatments for dermatologic disorders, or
diseases of the skin, is estimated to be in excess of $2 billion annually in the
United States at the manufacturer level. In the United States, dermatological
diseases are treated primarily by 7,000 high-prescribing dermatologists and
general practitioners. It is estimated that dermatologists prescribe drug
therapies in approximately 65 percent of patient visits. In many instances, the
dermatological disease being treated is chronic, requiring continued use of one
or more prescribed products.
Dermatological treatments may be delivered topically, in the form of
creams, ointments, gels, liquids or patches, or orally, primarily in the form of
tablets and gelatin capsules. Dermatologists often prefer topical administration
of drugs to oral drug delivery for the treatment of many dermatological
conditions, since topical drug delivery may reduce the amount of drug required
and because targeted topical pharmaceutical application is often safer and less
expensive. In addition, topical administration may avoid side effects associated
with systemic ingestion of drug agents. The primary clinical approaches to
topical drug delivery include:
Traditional Penetrating Agents. Typically, formulating agents, including
ethanol, propylene glycol, surfactants and other agents are used to aid in
the penetration into the skin of active pharmaceutical compounds. Although
these formulating agents often initially provide enhanced penetration of
active ingredients, they may not provide long-term penetration enhancement,
and often cause irritation when used in doses concentrated enough to provide
clinical efficacy.
Specialized Delivery Technologies. A variety of topical drug delivery
technologies, including liposomes, microspheres, injectable matrices,
transdermal patches, electroporation and iontophoresis, have been developed
to enhance or enable the topical delivery of pharmaceuticals. Although many
of these technologies have demonstrated clinical efficacy for certain drugs
and disease indications, these technologies have generally not been
successfully developed for dermatological indications due to product
instability, side effects, toxicity, cost or difficulty of administration.
Although topical delivery is preferred by many dermatologists, the
development of new products and the market acceptance of topically delivered
dermatological therapies in many instances has been limited by side effects or
by the limited efficacy of existing topical formulations. Many effective active
ingredients may be irritating to the skin in traditional topical delivery
formulations. In addition, effective topical drug delivery is often difficult
because the skin provides a natural barrier to foreign substances, and because
topical therapies may be diluted or washed off by natural secretions or contact
with other liquids or may be rubbed off by contact with clothing.
Although the aggregate market for prescription dermatological products is
large, the markets for pharmaceuticals to treat specific dermatological diseases
are smaller and fragmented. Large pharmaceutical companies have historically
focused on the drug discovery process, including preclinical and clinical
development, regulatory approvals, and marketing of therapeutics to treat
diseases affecting large patient populations. The clinical focus on enhancing
the delivery of existing pharmaceuticals is a relatively new field, and may
provide opportunities for companies developing novel drug delivery technologies
or new formulations of existing therapeutics targeted to niche markets.
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Nonprescription Products
Technologies used for the delivery of drugs to treat dermatologic
indications may be applied to the nonprescription skin care market. Cosmetics
and skin and hair care products are primarily sold through mass merchandisers,
food and drug chains, department stores, independent specialty and convenience
stores, pharmacies, mail order, door-to-door sales, and direct to doctors. New
product introductions are frequent, with market acceptance based on such factors
as breadth of distribution, cost, product efficacy, safety and appealing use
characteristics. Important attributes of delivery agents used for such products
include safety, emolliency, duration of action, stability and ease of
formulation.
PENEDERM DRUG DELIVERY TECHNOLOGY
The Company's TopiCare Delivery Compounds represent a patented skin-loading
technology designed to target delivery to layers in the skin or other epithelial
tissue. TopiCare Delivery Compounds consist of a broad portfolio of liquid
polymers that can be designed to deposit an active ingredient and optimize
penetration at targeted levels of skin tissue where particular disease
conditions can be effectively treated. For example, formulations currently in
development containing TopiCare Delivery Compounds deliver an antifungal agent
to the upper epidermis, a skin layer where fungus predominates. Penederm has
developed another formula containing TopiCare Delivery Compounds which moderates
the delivery of retinoic acid into the follicular area for effective treatment
of acne. Laboratory, clinical or marketplace studies conducted by the Company
have indicated that products containing TopiCare Delivery Compounds possess one
or more of the following benefits:
Longer duration of action. Due to their unique chemistry, TopiCare
Delivery Compounds are resistant to accidental removal, causing them to
remain on and in the upper layers of the skin for an extended period,
thereby improving the duration of drug effects or delivery. Laboratory
studies conducted by the Company have indicated that TopiCare Delivery
Compounds upon application remain at or near the surface of the skin and
penetrate only in very low levels beyond the stratum corneum.
Reduced dosage requirements; improved safety profile. The Company
believes that its technology provides for more effective topical deposition
of certain drugs, thereby enabling the Company to develop topical treatments
that contain smaller doses of active drug agent than existing topical
treatments or that contain agents which previously have only been
administered orally. Under typical usage conditions, the reduction in
topical dosage and the administration topically of agents previously
administered orally result in a reduction in the systemic exposure to the
agent and, accordingly, a reduction in the potential for systemic toxicity
and adverse reactions with other drugs taken by the patient.
Fewer local adverse side effects. Clinical trials have shown the
TopiCare Delivery Compounds to be non-irritating and non-sensitizing to the
skin. In addition, the compounds have been shown to reduce the irritation
caused by certain drug and skin care agents currently delivered topically.
By tailoring the compound to the active agent and the skin condition, the
Company believes that its drug delivery system may more effectively target the
drug to the site of the disease and provide the benefits described above. These
benefits may thereby contribute to improved patient compliance and clinical
outcomes.
The Company also believes that its TopiCare Delivery Compounds provide the
Company with the following strategic advantages in developing and
commercializing a broad spectrum of dermatological treatments and skin care
products:
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Broad application. The Company believes the properties of the TopiCare
Delivery Compounds make them excellent candidates for inclusion in drugs,
skin and hair care products and cosmetics. Clinical trials and laboratory
studies have indicated that the TopiCare polymers hold to the skin, are
moisturizing, are non-occlusive and do not clog pores. The Company has
synthesized and evaluated numerous polymeric compounds, both water- and
oil-compatible, as a basis for further development. The Company believes
that the demonstrated flexibility and compatibility of the TopiCare Delivery
Compounds will allow them to meet the varying delivery needs of many
different drug compounds, skin care agents and cosmetics.
Ease of formulation. The TopiCare Delivery Compounds, along with other
product ingredients, are blended into the drug formulation during
manufacture. This procedure may be less costly and time-consuming than
delivery systems relying upon drug entrapment, such as liposome and
microsphere technologies.
Streamlined development. The ability of TopiCare Delivery Compounds to
be combined with existing drug compounds or agents may involve less cost,
time and risk than do the discovery, development and commercialization of
new drug compounds or skin care agents. The Company has compiled
considerable pre-clinical, clinical and market data which it believes may be
helpful in shortening the development time of products incorporating
TopiCare Delivery Compounds. To date, the Company has completed two
in-licensing arrangements for compounds with existing preclinical data
packages, enabling the Company to initiate clinical development.
New topical treatments. TopiCare Delivery Compounds may make possible
topical treatments with drugs that previously have not been effectively used
topically, such as antifungal agents for treatment of nail fungal
infections, chemotherapeutic agents for psoriasis and new Vitamin D
treatments for psoriasis.
New and expanded product markets. The attributes of TopiCare Delivery
Compounds may create new product markets or may expand existing prescription
and consumer markets by increasing the number of indications for which an
existing drug or skin care agent can be used, by providing potential
additional patent protection for off-patent drugs, by extending patent
protection for patented drugs or by increasing patient use of treatments.
PRODUCTS
The Company's marketed products and products under development include
prescription and nonprescription dermatology and skin care products. The
following charts summarize certain information regarding the products that the
Company currently is actively marketing or developing and should be read
together with the more detailed discussion of these products that follows.
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PRESCRIPTION PRODUCTS
PRODUCT INDICATION STATUS MARKETING RIGHTS
- ------------------- ---------- ---------------------- ------------------
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Avita (retinoic Acne U.S.: Cream and gel U.S.: Penederm
acid) cream and gel approved for marketing Canada: Pharmascience Inc.
Canada: Approved for ("Pharmascience")
marketing Europe: Penederm
Europe: Approved for Latin America: Allergan Inc.
marketing in the U.K.; filed ("Allergan")
as European Marketing
Authorization Application
("MAA")
Mentax Skin fungus U.S.: Approved for tinea U.S.: Schering-Plough
(butenafine) cream pedis; tinea corporis and HealthCare Products, Inc.
tinea cruris ("Schering-Plough")
Canada: Approved as (podiatrists), Mylan
over-the-counter (OTC) Laboratories Inc. (primary
care) and Penederm
Canada: Schering-Plough and
Penederm
501 Cream, a Inflammatory U.S.: Phase III human U.S.: Penederm
combination of fungal clinical testing in
butenafine and conditions progress.
betamethasone
dipropionate
Butenafine nail Nail fungus U.S.: Phase II human U.S.: Schering-Plough and
fungus formulation clinical testing completed. Penederm
Canada: Schering-Plough and
Penederm
Europe, Africa and the Middle
East: UCB Group of Belgium
("UCB")
Vitamin D analogs Psoriasis U.S.: preclinical testing; U.S.: Penederm
cream and ointment Investigtional New Drug Canada: Penederm
("IND") opened; Phase II
human clinical testing in
progress
NONPRESCRIPTION PRODUCTS
PRODUCT INDICATION STATUS MARKETING RIGHTS
- ---------------------- ------------ --------------------------- -----------------------------
DuraScreen SPF15 and Prevention Marketed in U.S. and Canada U.S.: Pierre Fabre, Inc.
SPF30 sunscreen of ("Pierre Fabre")
photo-damage
Canada: Pharmascience
Penederm Cream and Severe dry Marketed in U.S. and Canada U.S.: Penederm
Penederm Lotion skin
Canada: Pharmascience
Warner's Lubriderm Severe dry Marketed in Canada Canada: Warner
Alpha Hydroxy skin
Moisture Recovery
Creme and Lotion
OTC Product (Europe) Severe dry Marketed in Europe Europe: SmithKline Beecham
skin ("SmithKline")
Undisclosed OTC Undisclosed Development completed SmithKline
Product
TopiCare Delivery Sunscreens, Marketed worldwide U.S.: Barnet Products
Compounds (used with color Corporation
various agents) cosmetics Asia: Nikko Chemicals Co. Ltd.
and skin Europe and South Africa:
treatment Sederma, S.A.
products Australia and New Zealand:
Bronson & Jacobs, Pty. Ltd.
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There can be no assurance that the Company can successfully develop any
potential products or technologies or, if successfully developed, that they will
obtain regulatory approval or be successfully commercialized. See "Risk
Factors."
PRESCRIPTION PRODUCTS
Avita. The Company has developed Avita gel and cream as prescription
retinoic acid acne treatments that incorporate TopiCare Delivery Compounds.
According to industry sources, approximately 35 million people in the United
States are affected by acne each year. The Company estimates the United States
prescription acne market to be approximately $500 million and the topical
retinoic market to be approximately $200 million, or 40% of the prescription
acne market. Retinoic acid formulations are the leading prescription products
for the topical treatment of acne, and until late 1996 only Ortho McNeil
Pharmaceuticals, a subsidiary of Johnson & Johnson, marketed topical retinoic
acid products for the treatment of acne in the United States under the
Retin-A(R) brand. Studies indicate that a significant number of users experience
skin irritation (dryness, peeling and redness) from the Retin-A(R) products,
which is still the market leading product. The Company has completed human
clinical studies which the Company believes indicate that Avita retinoic acid
gel and cream treatments, which are formulated with TopiCare Delivery Compounds,
provide comparable effectiveness and less irritation than Retin-A(R). The
Company is aware of other companies that have developed prescription acne
treatments formulated with retinoids that are recently introduced and that may
also present substantial competition for Avita, including Differin(R) Gel
developed by Galderma Laboratories Inc. ("Galderma") that was launched in the
United States in November 1996 and a second Johnson & Johnson tretinoin gel
product, Retin-A(R) Micro, launched in the United States in February 1997. Both
of the recently introduced products are promoted as less irritating. The Company
does not have data from human clinical studies comparing the efficacy and
irritation of Avita with that of the more recently approved acne treatments with
retinoids and there can be no assurance that Avita will be as efficacious and
less irritating than those products or will achieve market acceptance.
In January 1997, the FDA notified the Company that Avita cream was approved
for marketing. In January 1998, Avita gel was also approved for marketing by the
FDA upon expiration of a third party patent. The Company has completed human
clinical studies to support marketing claims related to the products. The FDA
has granted an export license to ship these products out of the United States.
The Company has also submitted data to the FDA to expand its label claims to
Avita Gel. The Company has retained United States marketing rights to Avita and
launched the product in the United States in August 1997 using a pharmaceutical
specialty contract sales force. In early 1998, Penederm began recruiting its own
direct, employee-based sales force and is transitioning selling activities from
the contract sales force. Penederm pays a modest royalty on the sales of Avita,
subject to a specified maximum amount, pursuant to a 1995 termination agreement
with a company that originally had distribution rights to Avita. See "Risk
Factors -- Uncertainty of Commercial Launch and Market Acceptance of
Prescription Products," "-- Government Regulation; No Assurance of Product
Approvals" and "-- Uncertainty of Future Product Development."
The Company has also received approval to market Avita in Canada under the
trade name Vitinoin. The Company has licensed its rights to market the products
in Canada to Pharmascience. Pharmascience launched Vitinoin in June 1995 and is
promoting it with a less irritating label claim. In February 1997, the Company
received approval in the United Kingdom for this product. The U.K. will be
Penederm's sponsor country to seek approval in other European nations through
the European Mutual Recognition Process. See "Collaborative Arrangements."
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Mentax. The Company has licensed Mentax, a formulation of butenafine, from
Kaken Pharmaceutical Company, Ltd. ("Kaken") for sale as a topical treatment for
fungus. The Company estimates that the annual United States market for skin
fungus products is $400 million, of which approximately $300 million consists of
treatments for tinea pedis (athlete's foot). In the United States, the Company
believes that 18 million people experience skin fungus infections each year, and
that approximately 12 million of these indications are tinea pedis. Most
commercially available skin fungus treatments arrest the growth of fungus,
rather than result in cell death directly, and do not result in the complete
treatment of the disease. Mentax is a patented butenafine that has been shown to
result in the death of skin fungus cells. Kaken and a second Japanese partner
are marketing two brands of butenafine in Japan, having received approval of the
Japanese Ministry of Health and Welfare in 1992. The Company licensed from Kaken
exclusive rights to its butenafine compound in the United States and Canada for
topical administration of butenafine. See "Collaborative Arrangements."
In the fourth quarter of 1996, Penederm received clearance from the FDA to
market Mentax, a once-a-day prescription topical treatment for three skin fungal
conditions: tinea pedis (athletes' foot), tinea corporis (ringworm) and tinea
cruris (groin fungus). The Company also received approval from the Canadian
Health Protection Branch for the product as an over-the-counter treatment for
tinea pedis in Canada. In December 1997 Penederm received FDA approval of a
revised label claim for Mentax. The new label reflects revised dosage
instructions for the treatment of tinea pedis that allows topical application
either twice-a-day for seven days, or once-a-day for four weeks. Mentax is the
only topical antifungal product approved in the U.S. which has such a one-week
dosing regimen. In addition, the Company plans to pursue the development of
Mentax formulated with TopiCare Delivery Compounds as an extension of its skin
antifungal product line. See "Risk Factors -- Uncertainty of Commercial Launch
and Market Acceptance of Prescription Products," "-- Government Regulation; No
Assurance of Product Approvals" and "-- Uncertainty of Future Product
Development."
The Company has commenced marketing Mentax in the United States through a
pharmaceutical specialty contract sales force and has entered into an agreement
with Schering-Plough for the marketing and sale in the United States and Canada
of certain skin antifungal products. In early 1998, Penederm began recruiting
its own direct, employee-based sales force and to transition selling activities
from the contract sales force. The Company also expects that Mylan Laboratories
will begin co-promoting this product to primary care physicians in early 1998.
See "Sales and Marketing" and "Collaborative Arrangements."
501 Cream Project. The Company has under development a combination topical
formulation, incorporating the licensed butenafine compound, betamethasone
dipropionate (a synthetic adrenocorticosteroid widely used in dermatology to
reduce inflammation), and a TopiCare Delivery Compound for the treatment of
inflammatory skin fungal conditions. The Company believes that this product
could offer safety and compliance advantages over current 28-day therapies that
may expose patients to steroids for a very long dosing period. Prolonged use of
steroid can result in the pronounced appearance of capillaries and veins, skin
thinning, redness, bruising, and irreversible streaking of the skin, sometimes
referred to as "stretch marks." The Company announced in October 1997 favorable
Phase II clinical results and that it had initiated two pivotal phase III human
clinical studies. Penederm intends to file a New Drug Application (NDA) for this
product in the second half of 1998.
Butenafine nail fungus formulation. The Company has under development a
topical formulation of the licensed butenafine compound that incorporates
TopiCare Delivery Compounds for the treatment of nail fungus. The Company
believes that approximately ten million patients experience nail fungal
infections, a condition in which the nails become unsightly, malformed and, in
some cases, require removal. There currently are no FDA-approved topical drug
products for the treatment of nail fungus. The condition is
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generally treated with oral medication prescribed over many months. The Company
believes that some people with fungus in the nail area do not receive treatment
because of the potential side effects and costs associated with available oral
dosage forms or the difficulty of an extended treatment program.
The Company licensed from Kaken exclusive rights to its butenafine compound
for nail fungus treatments in the United States, Canada, Latin America, Western
Europe, Scandinavia, Australia and New Zealand. The Company is developing a
topical nail antifungal treatment that is designed to use the TopiCare Delivery
Compounds to hold the butenafine agent in the nail and surrounding skin for a
period of time sufficient to achieve significant clinical cure rates. The
Company has completed two Phase II human clinical trials of its butenafine nail
formulation. The Company entered into an agreement with Schering-Plough
involving the development and, upon regulatory approval, the manufacturing,
marketing and sale in the United States of certain nail antifungal products. The
Company has also entered into a licensing agreement with a subsidiary of UCB, a
multinational pharmaceutical and chemical company, to market certain topical
prescription butenafine nail antifungal formulations in Europe, Africa and the
Middle East. See "Collaborative Arrangements."
Vitamin D analogs. The Company is developing psoriasis therapies using
proprietary Vitamin D analogs and TopiCare Delivery Compounds. Psoriasis is a
chronic skin condition characterized by inflammation and an abnormally rapid
growth of skin cells that leads to dry, flaky, red, itchy skin. Industry sources
indicate that approximately four million people in the United States suffer from
psoriasis. Present treatments such as emollients and steroids either are
ineffective or are not indicated for long-term use because of safety problems or
because the skin stops responding to the treatment. Topical steroids, which are
currently prescribed to two-thirds of patients with moderate to severe
psoriasis, can cause side effects such as skin thinning and "rebound effect"
(condition worsening after cessation of treatment as compared to before
treatment) that limit long-term use of these products. A new promising area of
psoriasis therapies are Vitamin D analogs, certain of which have demonstrated
efficacy without the adverse side effects of steroids. One Vitamin D derivative
treatment is currently on the market. However, this treatment does not cause
total clearing of the psoriasis in most cases and should not be used on certain
parts of the body because it can cause irritation. The Company is exploring the
development of a therapy from a family of Vitamin D compounds which, when
formulated with TopiCare Delivery Compounds, may provide increased potency,
enhanced activity or duration of action, and better local safety than the
currently available Vitamin D treatment. The Company is currently conducting
preclinical and clinical testing of certain of these compounds in cream and
ointment formulations for the treatment of psoriasis. The Company is also
conducting preclinical testing of Vitamin D compounds for acne and photoaging
with funding from a Small Business Innovation Research Grant from the National
Institutes of Health. The Company has licensed rights to the Vitamin D analogs
from Wisconsin Alumni Research Foundation ("WARF") and Renaissance Corporation
("Renaissance"). See "Collaborative Arrangements."
NONPRESCRIPTION PRODUCTS
DuraScreen. The Company has developed DuraScreen SPF15 and SPF30 sunscreens
formulated with TopiCare Delivery Compounds, ultraviolet ("UV") absorbers and an
infrared blocker. Sunscreens with an SPF of 15 or higher are frequently
recommended by dermatologists. Tanning, burning and skin damage, such as
precancerous lesions, skin cancers, and accelerated skin aging, are a result of
exposure to the sun's UV light rays. More than 600,000 new cases of skin cancer
are diagnosed each year, and more than 90 percent of skin cancers are caused by
sun exposure. Sun protection products that contain UV-absorbing chemical
sunscreens can be very effective if they stay on the skin. However, many tend to
wash off with perspiration, contact with water, or rubbing and therefore require
frequent reapplication.
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The Company's DuraScreen products provide all-day waterproof protection with
one application in a formula that is cosmetically appealing. DuraScreen is
marketed in the United States by Pierre Fabre under an exclusive license. The
Company has licensed the rights to market DuraScreen in Canada to Pharmascience.
See "Collaborative Arrangements."
Dry skin treatment products. The Company has developed different treatments
for severe dry skin that incorporate TopiCare Delivery Compounds. Industry
sources estimate that skin lotions are used by approximately 80 percent of
households in the United States. Lactic acid (an alpha-hydroxy acid) is known to
be effective in the treatment of severe dry skin. The Company believes that the
tendency of lactic acid and its salts to be irritating to sensitive dry skin and
the lack of cosmetic appeal of certain existing formulations have generally
limited their use.
The Company has developed Penederm Cream and Penederm Lotion, formulations
containing lactic acid and TopiCare Delivery Compounds. These products have
demonstrated clinically effective relief of severe dry skin. In addition, these
products indicated statistically superior protection against the irritation
caused by detergents as compared to two leading over-the-counter products, as
measured by erythema (redness) and dryness. Penederm Cream and Penederm Lotion
have also been shown to be effective in treating dry skin associated with
psoriasis and atopic dermatitis. The Company sells these products direct to
retail chains and wholesalers in the United States. Penederm Cream and Lotion
are sold by Pharmascience Inc. in Canada. The Company licenses to Warner
proprietary product formulations containing TopiCare Delivery Compounds, which
Warner markets in Canada under the trade names Lubriderm Moisture Recovery Alpha
Hydroxy Formula Creme and Lotion, and has entered into an agreement with
SmithKline whereby SmithKline will market in Europe other formulations
containing TopiCare Delivery Compounds. See "Risk Factors -- Marketing and Sales
Uncertainties; Dependence on Collaborative Partners," "Sales and Marketing" and
"Collaborative Arrangements."
TopiCare Delivery Compounds. TopiCare Delivery Compounds can be designed in
formulations to provide effective moisturization of the skin, to bind to the
hair and skin, to be waterproof, non-occlusive and compatible with a broad range
of cosmetic formulations and not to clog pores. The Company believes these
advantages make the compounds candidates for use in cosmetics and skin care
products, such as sunscreens, makeups, mascara, moisturizers, lipsticks, nail
lacquers, soaps, shampoos and other hair care products. The Company has engaged
exclusive distributors in the Americas and in Europe for the sale of its
patented polymeric materials to the cosmetic and toiletry industries. Estee
Lauder, Inc., Mary Kay Cosmetics, Inc., Maybelline, Inc., and Clinique
Laboratories, Inc., among others, have purchased TopiCare Delivery Compounds for
commercial use in certain cosmetic products. The global distribution network is
comprised of Barnet Products Corporation, Nikko Chemicals Co., Ltd., Sederma
S.A., and Bronson and Jacobs, Pty. Ltd., acting as distributors of TopiCare
Delivery Compounds in the United States, Asia, Europe and South Africa, and
Australia/New Zealand, respectively. The Company is discussing additional
collaborative arrangements to commercialize TopiCare Delivery Compounds in
additional cosmetic and consumer skin care and hair care products worldwide.
PRECLINICAL RESEARCH AND EARLY CLINICAL RESEARCH AND DEVELOPMENT
The Company continues to evaluate new compound and product opportunities
utilizing its TopiCare Delivery Compounds. The Company is conducting research to
develop new types of butenafine formulations as line extensions to Mentax for
treatment of skin fungus. Laboratory and Phase II human clinical studies
conducted by the Company with corticosteroids, which are used for the topical
treatment of psoriasis and other inflammatory disorders have demonstrated
effective delivery of corticosteroids from TopiCare-containing formulations,
with the potential for reduced systemic absorption. The Company is also
conducting preclinical research on formulating TopiCare Delivery Compounds with
Vitamin D analogs,
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other anti-oxidants and UV blockers to develop products which may prevent sun
damage or reduce wrinkles.
Although the Company has focused its research efforts on dermatology and
skin care, the Company believes that there may be future opportunities for the
application of the TopiCare Delivery Compounds for treatment of disorders in
tissues other than skin. The Company has conducted preclinical research to
determine whether its TopiCare Delivery Compounds have utility in other
epithelial tissues, such as vaginal, oral or ophthalmic tissues. Laboratory
studies have indicated that TopiCare Delivery Compounds may be useful in holding
drugs in the eye for extended periods without being cleared by the natural
tearing of the eye. Additionally, laboratory work has indicated that TopiCare
Delivery Compounds may be used to deliver antifungal agents in a manner to
reduce the recurrence of yeast infections in vaginal tissue. Preclinical studies
are also ongoing to define the opportunities for TopiCare Delivery Compounds to
deliver and hold agents to hair and hair follicles to determine ways to enhance
the activity of those agents at targeted sites.
SALES AND MARKETING
The Company's United States product commercialization strategy is to promote
to dermatologists through its own sales organization and to primary care
physicians and institutions through corporate co-promotion partners. Outside of
the United States the company seeks suitable licensees for its products. For
nonprescription skin and hair care markets, the Company plans to license out its
technology worldwide.
PRESCRIPTION PRODUCTS
In the United States, the Company's strategy is to market its prescription
products directly to the approximately 7,000 high prescribers of dermatologic
products through its own pharmaceutical specialty sales force of approximately
50 full time and flex-time sales representatives. A contracted specialty
pharmaceutical sales force commenced detailing Mentax and Avita to physicians in
February 1997 and August 1997, respectively. In December 1997, Penederm
initiated the conversion of the sales force from a contracted organization by
hiring six experienced sales managers, primarily from larger dermatology and
pharmaceutical companies, and converted 15 of its contract sales representatives
to employee status. The Company expects to complete the majority of the
recruitment of its own sales force in the first quarter of 1998. In addition to
promoting directly to high prescribing physicians of dermatologic products, the
Company engages in an active advertising campaign geared towards these
physicians through medical journals, medical publications, direct mail,
conventions, electronic media and sampling of its products. The Company believes
that its market penetration will be determined by its success in gaining high
awareness and successful usage among these targeted customers. Sales and
marketing expenditures are expected to increase significantly as a result of
retaining the contract sales force and engaging in promotional activities
related to product launch.
In addition, the Company has entered into arrangements with collaborative
partners for the marketing of certain pharmaceutical products in the United
States. In June 1994, the Company entered into an agreement with Schering-Plough
for the development, prescription product co-promotion, OTC product marketing
and sale, and manufacture by Schering-Plough of certain Penederm nail antifungal
and skin antifungal products in the United States and Canada. Schering-Plough
has rights for promotion of the Mentax product to podiatrists in the U.S. In
December 1997, Penederm announced a co-promotion agreement with Mylan
Laboratories, Inc. (Mylan) under which Mylan will market Mentax to family care
physicians, general practitioners, internists and osteopaths through Bertek
Pharmaceuticals Inc., a subsidiary. See "Collaborative Arrangements."
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NONPRESCRIPTION PRODUCTS
The Company intends to compete in nonprescription markets in the United
States through corporate partners and distributors. The Company currently has
arrangements with Warner, Pierre Fabre, Schering-Plough and Barnet Products
Limited for the sale of nonprescription products or TopiCare Delivery Compounds
in the United States and is actively pursuing other arrangements in the United
States. See "Collaborative Arrangements."
MARKETS OUTSIDE OF THE UNITED STATES
The Company intends to use distribution partners to market its products in
geographies outside of the United States. The Company has agreements with
Pharmascience for the distribution of Avita (trade named Vitinoin in Canada),
Penederm Cream, Penederm Lotion and DuraScreen in Canada, with UCB for the
distribution of nail antifungal products in Europe and the Middle East, with
SmithKline to market certain OTC skin care products containing the Company's
patented TopiCare Delivery Compounds in Europe, and with Allergan Incorporated
(Allergan) to register and market Avita and Mentax in Central and South America.
Kaken has the rights to market certain future Mentax line extensions in Japan.
In addition, Nikko Chemicals Co., Ltd., Sederma S.A., and Bronson and Jacobs,
Pty. Ltd. distribute TopiCare Delivery Compounds in Asia, Europe and South
Africa, and Australia/New Zealand, respectively. See "Products -- Prescription
Products, -- Avita" and "-- Mentax," and "Products -- Nonprescription Products."
COLLABORATIVE ARRANGEMENTS
The Company's strategy for the research, development and commercialization
of certain of its products requires entering into various arrangements with
corporate collaborators, licensors, licensees and others. Set forth below is a
description of the Company's significant collaborative arrangements. The Company
is discussing additional collaborative arrangements to develop and commercialize
certain products and as part of its strategy expects to continue to pursue such
arrangements in the future. The Company believes that the establishment and
success of such arrangements is an important element in the long term success of
the Company. There can be no assurance that the Company will be able to maintain
its current collaborative relationships or establish new relationships on
acceptable terms, that the Company's current or future collaborative partners
will perform their obligations under such relationships, or that such
relationships will be commercially successful. Certain of the Company's
collaborative arrangements are terminable upon as few as 90 days notice, in
which event the product rights revert to Penederm without further consdideration
and become available for outlicense to another development or marketing partner.
See "Risk Factors -- Marketing and Sales Uncertainties; Dependence Upon
Collaborative Partners," "-- Uncertainty of Future Product Development."
IN-LICENSING AND CO-PROMOTION ARRANGEMENTS
University of California. The Company has licensed from the University of
California on a worldwide exclusive basis three United States and six foreign
patents providing coverage in 17 counties outside of the U.S. for the technology
underlying the TopiCare Delivery Compounds for the life of the patents. These
patents will expire during 2007 and 2008. Under the license arrangement, the
University of California is required to file, prosecute and maintain foreign
patent applications as requested by the Company at the Company's expense. The
University of California is entitled to royalties based on the revenues received
by the Company from the TopiCare Delivery Compounds and products that
incorporate the compounds. In
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general, these royalties range from 1.5 to 2.5 percent of net sales of the
delivery technology component, as defined in the license agreement.
Kaken. The Company has licensed from Kaken exclusive rights to develop skin,
nail, and other topical antifungal products incorporating Kaken's proprietary
butenafine compound in the United States, Canada, Mexico, and Central and South
America. In addition, the Company has the exclusive right to develop and market
nail antifungal products in additional territories, including Western Europe,
Scandinavia, Latin America, Australia, and New Zealand. The Company made a
payment of approximately $500,000 to Kaken in 1995 and an additional payment of
approximately $500,000 in 1996. Additional future payments of approximately
$1,200,000 would become due upon the achievement of certain other regulatory
milestones related to the nail products. The Company believes that the
achievement of these additional milestones would occur, if at all, over several
years. In addition, the Company has agreed to purchase butenafine raw material
from Kaken.
WARF and Renaissance. The Company has entered into an exclusive license with
WARF for the North American rights to develop topical and oral therapies for a
variety of skin diseases using Vitamin D metabolites and synthetic compounds and
to use a database of information regarding these metabolites and compounds. The
Company has licensed from WARF and Renaissance certain patents awarded to two
leading Vitamin D scientists. The Company's first disease target for these
Vitamin D analogs is psoriasis. The Company paid initial licensing fees to WARF
and certain patent licensing fees to Renaissance and will make payments
contingent upon achievement of product development and regulatory milestones and
will pay royalties upon any future product sales.
Alpharma. The Company entered into an agreement with Alpharma to market in
the United States permethrin cream 5% for the treatment of scabies. Under the
terms of the agreement, Alpharma will manufacture and supply the product to
Penederm, which will pay Alpharma upfront milestones and royalties based upon
product sales and profits.
The Merck KGaA Group/Center Laboratories. In January 1997, Penederm entered
into an arrangement with The Merck KGaA Group/Center Laboratories (Merck) to
co-promote in the United States Akne-Mycin, a topical cream ointment containing
erythromycin, and Cloderm, a mid-potency topical steroid. In September 1997, in
order to facilitate the sale of the products by Merck to a third party and to
allow the Company to focus on the promotion of its own brands, Penederm
terminated its co-promotion agreement with Merck at no cost to the Company.
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DEVELOPMENT AND DISTRIBUTION
Schering-Plough. The Company has entered into an agreement with
Schering-Plough for the development, prescription product co-promotion, OTC
product marketing and sale, and manufacture by Schering-Plough of certain
Penederm nail antifungal and, at Schering-Plough's option, skin antifungal
products in the United States and Canada. Pursuant to the agreement,
Schering-Plough and the Company will collaborate in the development of, and the
regulatory filing related to, the antifungal products, and Schering-Plough will
have co-promotion and marketing rights with respect to podiatrists and the
Company will maintain exclusive rights to promote and market the products to all
other prescription audiences. The Company and Schering-Plough are co-promoting
the products as one brand. The agreement provides for Schering-Plough to pay the
Company upfront fees, development support and milestone payments if certain
conditions are met, including, but not limited to, clinical development and
regulatory approval of, and option payments for, the antifungal products. In
addition, the Company would receive royalties upon product sales and the
exclusive right to supply certain raw materials. The agreement may be terminated
by Schering-Plough at any time. In that event, the marketing rights would revert
to the Company, including the right to sublicense to another development
partner.
UCB. The Company has entered into a licensing agreement with a subsidiary of
UCB to market certain topical prescription butenafine antifungal formulations in
Europe, Africa and the Middle East. UCB will complete clinical development and
seek regulatory approval in the countries under the agreement. The agreement
provides the Company with upfront and milestone payments, a royalty on sales and
a supply agreement for its TopiCare Delivery Compounds.
Pharmascience. The Company has entered into an agreement with Pharmascience
to market retinoic acid prescription products, DuraScreen and Penederm Lotion
and Penederm Cream in Canada. Pharmascience launched these products in 1995.
Terms of the license include supply arrangements and royalties payable to the
Company based on net product sales.
Mylan Laboratories Inc. In December 1997, Penederm entered into an
arrangement with the Bertek Pharmaceuticals Inc. subsidiary of Mylan
Laboratories Inc. (Mylan) to co-promote Mentax in the United States to family
care physicians, general practitioners, internists and osteopaths.
Allergan. The Company has entered into a November 1997 agreement with a
Brazilian subsidiary of Allergan Incorporated (Allergan) to pursue regulatory
approval and market retinoic acid and butenafine prescription products in
Central and South America. Terms of the license include milestones, supply
arrangements and royalties payable to the Company based on net product sales.
Warner. The Company has licensed to Warner proprietary formulations
containing TopiCare Delivery Compounds to create Lubriderm Moisture Recovery
Alpha Hydroxy Acid Creme and Lotion products. Warner markets these products in
Canada. Terms of the license include supply arrangements, fees and royalties
payable to the Company based on net product sales.
SmithKline. The Company has entered into an agreement with SmithKline
whereby SmithKline will market in Europe certain OTC products containing
TopiCare Delivery Compounds. The Company will receive certain milestone payments
and royalties on sales of these SmithKline products, in addition to sales from
the supply of TopiCare Delivery Compounds. The companies have completed the
initial development phase of a second collaboration and are discussing
commercialization alternatives for these products.
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Pierre Fabre. Pierre Fabre holds the U.S. marketing rights to the DuraScreen
product line in 1996, and will continue to pay the Company royalties based on
annual net sales of DuraScreen and purchase TopiCare Delivery Compounds from the
Company on the same terms as the original distributor.
TopiCare Delivery Compound Distributors. The Company has established a
global distribution network for the sale of its TopiCare Delivery Compounds for
use in cosmetics and skin care products. Barnet Products Corporation Limited,
Nikko Chemicals Co., Ltd., Sederma S.A., and Bronson and Jacobs, Pty. Ltd. act
as distributors of TopiCare Delivery Compounds in the United States, Asia,
Europe and South Africa, and Australia/New Zealand, respectively. TopiCare is
sold through these distributors on a purchase order basis.
RESEARCH AND DEVELOPMENT EXPENDITURES
Penederm charges research and development expenses to operations as
incurred. Such expenses for 1997, 1996 and 1995 were $6,950,000, $5,292,000, and
$5,713,000, respectively.
MANUFACTURING AND RAW MATERIALS
The Company contracts with third parties to manufacture its finished
products and the TopiCare Delivery Compounds, subject to strict industry and
governmental standards. By using contract manufacturers, the Company has avoided
the need to invest in substantial production equipment or hire a manufacturing
labor force to make its products. The Company currently has no plans to
establish internal manufacturing facilities, but does intend to continue
qualifying multiple contract manufacturers. The Company currently has two
qualified manufacturing sites for TopiCare Delivery Compounds, one qualified
manufacturing site for Avita and Mentax and two qualified manufacturing sites
for Penederm Cream, Penederm Lotion, DuraScreen and Lubriderm. The Company is in
the process of qualifying a second manufacturing site for Avita products.
Penederm intends to maintain rights to the manufacture of certain finished
products and TopiCare Delivery Compounds.
The Company is dependent upon third parties for the supply of raw materials
used to produce TopiCare Delivery Compounds and finished products. One of the
materials used in the compounds is currently available from only one supplier,
Bayer Corporation ("Bayer"). Bayer is a major worldwide chemical company, and it
supplies this ingredient as a commodity to the Company on a purchase order basis
and to many other users in much larger quantities than it supplies to the
Company. The Company currently obtains certain other raw materials, including
butenafine and retinoic acid, from other sole sources. The Company currently
secures many of these supplies pursuant to contracts that are terminable on
short notice or purchase orders. In the event of termination or breach by a
supplier or other failure to continue to supply materials, the Company would be
required to secure and qualify an alternate supplier. Although the Company has
not experienced difficulty acquiring the necessary raw materials, it maintains
significant inventories of the affected raw materials and believes it could
qualify alternate suppliers for these materials. The Company continues to
attempt to identify an alternate supplier for the material now available only
from Bayer. There can be no assurance that the Company would not experience a
disruption in manufacturing if it experienced a disruption in supply from any
sole source. Any significant interruption of supply or significant increase in
the cost of raw materials could have a material adverse effect on the Company's
ability to produce its compounds and finished products.
PATENTS AND PROPRIETARY TECHNOLOGY
The basic technology underlying the TopiCare Delivery Compounds was
originally discovered by researchers at the University of California, Irvine and
has been patented by the University of California. In
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1987, the University of California granted the Company an exclusive worldwide
license for the life of the applicable patents to use and develop this
technology. Under this license, the University of California is required to
maintain, at the Company's expense, all United States patent rights with respect
to the licensed technology and to file and prosecute patent applications in
foreign countries when requested by the Company. The University of California is
entitled to royalties based on the revenues received by the Company from the
TopiCare Delivery Compounds and products that incorporate the compounds. In
general, these royalties range from 1.5 to 2.5 percent of net sales of the
delivery technology component, as defined in the license agreement.
To date, the Company has exclusive rights to three United States patents and
six foreign patents covering 17 countries outside of the U.S. obtained by the
University of California and relating to the uses of the TopiCare Delivery
Compounds. These patents will expire in 2007 and 2008. In 1997, two U.S. patents
were issued covering retinoic acid-containing polyether-polyurethane
formulations which can be used in the treatment of acne vulgaris and certain
other disorders of the skin. In addition, the Company has applied for four
patents in Japan for cosmetic applications, and one foreign patent covering 19
countries outside of the U.S. covering retinoic acid-containing
polyether-polyurethane formulations used for the treatment of acne vulgaris and
certain other disorders of the skin. Also, in 1997, the Company filed one U.S.
patent application covering an antifungal/steroid combination drug product.
The Company's policy is to protect its technology by, among other things,
filing, or requiring the University of California to file, patent applications
for technology that it considers important to the development of its business.
The Company intends to file additional patent applications, when appropriate,
relating to its technology, improvements to its technology and to specific
products that it develops. There can be no assurance that any additional patents
will be issued, or, if issued, that they will be of commercial benefit to the
Company. In addition, it is impossible to anticipate the breadth or degree of
protection that any such patents will afford. Furthermore, there can be no
assurance that litigation seeking to challenge such patent protection will not
be brought against the Company or the University of California or that the
Company's or the University of California's patents will not be successfully
challenged. The expenses involved in any patent litigation can be significant
and cannot be estimated by the Company. In addition, there can be no assurance
that the Company will be successful in the current proceeding or that the scope
and validity of the Company's or the University of California's existing or
future patents, if any, will prevent third parties from developing similar or
competing products.
The Company has also licensed certain composition of matter, process and use
patents from WARF and Renaissance related to various Vitamin D compounds.
A substantial number of patents have been issued to other pharmaceutical and
drug delivery companies. Pharmaceutical companies, drug delivery system
companies and others, including competitors, may have filed applications for, or
may have been issued patents or may obtain additional patents and proprietary
rights relating to, products or processes competitive with those of the Company.
Accordingly, there can be no assurance that the Company's or the University of
California's future patent applications will result in issued patents or that
any patents will afford significant protection against competitors with similar
technology. There can be no assurance that any patents issued to the Company,
the University of California or other licensors of drug compounds or skin care
agents to the Company, such as Kaken, WARF and Renaissance, will not be
infringed or circumvented by others, or that others will not obtain patents that
the Company would need to license or circumvent. There can be no assurance that
licenses that might be required for the Company's processes or products would be
available on reasonable terms, or at all. In addition, there can be no assurance
that the Company's, the University of California's or other licensors' existing
or future patents, if any, would be held valid by a court of competent
jurisdiction.
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Third parties may hold or be issued patents which the Company's technology
may infringe. The Company could incur substantial costs in defending itself and
its collaborative partners against any resulting claims. Furthermore, parties
making such claims may be able to obtain injunctive or other equitable relief
which could effectively block the Company's ability to further develop or
commercialize its products in the United States and abroad, and could result in
the award of substantial damages. In the event of a claim of infringement, the
Company may be required to obtain one or more licenses from third parties. There
can be no assurance that the Company will be able to obtain such licenses at a
reasonable cost, if at all. Defense of any lawsuit or failure to obtain any such
license could have a material adverse effect on the Company.
The Company also relies upon unpatented trade secrets and know-how, and
there can be no assurance that others will not independently develop
substantially equivalent proprietary information and techniques, or otherwise
gain access to the Company's trade secrets or disclose such technology, or that
the Company can meaningfully protect its rights to its unpatented trade secrets.
The United States Patent and Trademark Office ("PTO") has recently adopted
changes to United States patent law which changed the term of issued patents,
subject to certain transition periods, to 20 years from the date of filing
rather than 17 years from date of issuance. For applications filed after June 7,
1995, the patent term will be 20 years from the earliest effective filing date
of the priority patent application. Such change may reduce the effective term of
protection for patents that are pending for more than three years in the PTO.
While the Company cannot predict the effect that such changes may have on its
business, the adoption of such changes could have a material adverse effect on
the Company's ability to protect its proprietary information and sustain the
commercial viability of its products. Furthermore, the possibility of shorter
terms of patent protection, combined with the lengthy FDA review process and
possibility of extensive delays in such process, could effectively further
reduce the term during which a marketed product could be protected by patents.
These changes in the patent law do not, however, affect the existing patents for
the technology underlying the TopiCare Delivery Compounds, for Mentax licensed
from Kaken, or for the Vitamin D analogs licensed from WARF and Renaissance.
It is the Company's policy to require its employees and consultants to
execute a confidentiality agreement upon the commencement of employment by or
consultancy to the Company. Each agreement provides that all confidential
information developed or made known to the employee or consultant during the
course of employment or consultancy will be kept confidential and not disclosed
to third parties except in specified circumstances and that all inventions
conceived by the employee or consultant shall be the exclusive property of the
Company. In addition, the Company enters into confidentiality agreements with
all collaborators and potential collaborators. There can be no assurance,
however, that these agreements will provide meaningful protection for the
Company's trade secrets in the event of unauthorized use or disclosure of such
information.
GOVERNMENT REGULATION
FDA Requirements for Drug Compounds. The research, testing, manufacture and
marketing of drug products are extensively regulated by numerous governmental
authorities in the United States and other countries. In the United States,
drugs are subject to rigorous regulation by the FDA. The federal Food, Drug and
Cosmetic Act, as amended (the "FDC Act"), and the regulations promulgated
thereunder, and other federal and state statutes and regulations, govern, among
other things, the research, development, testing, manufacture, storage,
recordkeeping, labeling, promotion and marketing and distribution of
pharmaceutical products. Failure to comply with applicable regulatory
requirements may subject a company to administrative or judicially imposed
sanctions such as civil penalties, criminal prosecution, injunctions, product
seizure or detention, product recalls, total or partial suspension of
production, and FDA refusal to approve pending premarket approval applications
or supplements to approved applications.
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Investigational New Drug (IND) Applications. The steps ordinarily required
before a new pharmaceutical product may be marketed in the United States
include: (i) preclinical laboratory tests, in vivo preclinical studies and
formulation studies; (ii) the submission to the FDA of an IND, which must become
effective before clinical testing may commence; (iii) adequate and
well-controlled clinical trials to establish the safety and effectiveness of the
drug; (iv) the submission of a New Drug Application ("NDA") to the FDA and (v)
FDA review and approval of the NDA prior to any commercial sale or shipment of
the drug. Preclinical tests include laboratory evaluation of product chemistry
and formulation, as well as animal studies to assess the potential safety and
efficacy of the product. Compounds must be formulated according to current Good
Manufacturing Practice ("cGMP") requirements, and preclinical tests must be
conducted in compliance with Good Laboratory Practice regulations. The results
of preclinical testing are submitted to the FDA as part of an IND. A 30-day
waiting period after the filing of each IND is required prior to the
commencement of clinical testing in humans. If the FDA has not commented on or
questioned the IND within this 30-day period, clinical studies may begin. If the
FDA has comments or questions, the questions must be answered to the
satisfaction of the FDA before initial clinical testing can begin. In addition,
the FDA may, at any time, impose a clinical hold on ongoing clinical trials. If
the FDA imposes a clinical hold, clinical trials cannot commence or recommence
without FDA authorization and then only under terms authorized by the FDA. In
some instances, the IND application process can result in substantial delay and
expense. The Company has filed INDs for retinoic acid and Mentax skin and nail
antifungal formulations and a Vitamin D analog formulation and has conducted
clinical testing of those formulations and other formulations incorporating
other drugs under IND submissions filed by others.
New and Abbreviated New Drug Applications. Clinical trials involve the
administration of the investigational new drug to healthy volunteers or patients
under the supervision of a qualified principal investigator. Clinical trials are
conducted in accordance with good clinical practices under protocols detailing
the objectives of the study, the parameters to be used in monitoring safety and
the effectiveness criteria to be evaluated. Each protocol must be submitted to
the FDA as part of the IND. Further, each clinical study must be conducted under
the auspices of an independent Institutional Review Board ("IRB") at the
institution at which the study will be conducted. The IRB will consider, among
other things, ethical factors, the safety of human subjects and the possible
liability of the institution. Clinical trials to support NDAs are typically
conducted in three sequential phases, but the phases may overlap. In Phase I,
the initial introduction of the drug into healthy human subjects or patients,
the drug is tested to assess metabolism, pharmacokinetics and pharmacological
actions and safety, including side effects associated with increasing doses.
Phase II usually involves studies in a limited patient population to (i)
determine the efficacy of the drug for specific, targeted indications, (ii)
determine dosage tolerance and optimal dosage and (iii) identify possible
adverse effects and safety risks. If a compound is found to be effective and to
have an acceptable safety profile in Phase II evaluations, Phase III trials are
undertaken to further evaluate clinical efficacy and to further test for safety
within an expanded patient population at geographically dispersed clinical study
sites. There can be no assurance that Phase I, Phase II or Phase III testing
will be completed successfully within any specified time period, if at all, with
respect to any of the Company's products subject to such testing.
After completion of the required clinical testing, an NDA is generally
submitted. FDA approval of the NDA (or, in the alternative an Abbreviated New
Drug Applications ("ANDA"), as described below) is required before marketing may
begin in the United States. The NDA must include the results of extensive
clinical and other testing and the compilation of data relating to the product's
chemistry, pharmacology and manufacture, the cost of all of which is
substantial. The FDA reviews all NDAs submitted before it accepts them for
filing and may request additional information rather than accepting an NDA for
filing. In such an event, the NDA must be resubmitted with the additional
information and, again, is subject to review before filing. Once the submission
is accepted for filing, the FDA begins an in-depth review of the NDA. Under
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the FDC Act, the FDA has 12 months in which to review the NDA and respond to the
applicant. The review process is often significantly extended by FDA requests
for additional information or clarification regarding information already
provided in the submission. The FDA may refer the application to the appropriate
advisory committee (typically a panel of clinicians) for review, evaluation, and
a recommendation as to whether the application should be approved. The FDA is
not bound by the recommendation of an advisory committee. During the review
process, the FDA generally will conduct an inspection of the relevant drug
manufacturing facilities to ensure that the facilities are in compliance with
applicable cGMP requirements. If FDA evaluations of the NDA application and the
manufacturing facilities are favorable, the FDA may issue either an approval
letter or an approvable letter, which usually contains a number of conditions
that must be met in order to secure final approval of the NDA. When and if those
conditions have been met to the FDA's satisfaction, the FDA will issue an
approval letter, authorizing commercial marketing of the drug for certain
indications. As a condition of NDA approval, the FDA may require postmarketing
testing and surveillance to monitor the drug's safety or efficacy. If the FDA's
evaluation of the NDA submission or manufacturing facilities is not favorable,
the FDA may refuse to approve the NDA or issue a not approvable letter,
outlining the deficiencies in the submission and often requiring additional
testing or information. Notwithstanding the submission of any requested
additional data or information in response to an approvable or not approvable
letter, the FDA ultimately may decide that the application does not satisfy the
regulatory criteria for approval. Once granted, product approvals may be
withdrawn if compliance with regulatory standards is not maintained or problems
occur following initial marketing.
In circumstances where a company submits an NDA for a novel formulation of
an active drug ingredient already approved by the FDA, clinical and preclinical
testing requirements may not be as extensive. Limited additional data about the
safety and/or effectiveness of the proposed new drug formulation, along with
chemistry and manufacturing information and public information about the active
ingredient, may be satisfactory for product approval. Consequently, the new
product formulation may receive marketing approval more rapidly than a
traditional full NDA, although there can be no assurance that a product will be
granted such treatment by the FDA or, if granted, will result in an approval.
Once patent and other statutory protections covering a drug approved under
an NDA have expired or have been demonstrated not to apply, a generic equivalent
to that drug may be approved under an ANDA. An ANDA usually is based upon
bioequivalence data that demonstrate that the rate and extent of absorption of
the active drug ingredient of the generic drug, usually measured in the blood
stream, is equivalent to that of the drug approved under an NDA. The
demonstration of bioequivalence and, therefore, ANDA approval generally requires
less time than safety and efficacy studies and NDA approval.
Although ANDAs are not available for the Company's retinoic acid products
because these products contain excipients not included in the marketed retinoic
acid products, the Company believes ANDAs may be available for the Company's
future topical formulations of drugs that have already been approved by the FDA.
Nevertheless, because there can be no assurance that other drugs utilizing the
TopiCare Delivery Compounds will be eligible for ANDAs, and because standard
bioequivalence studies may be of questionable utility in dermatologics, which
are generally non-systemically absorbed, the Company intends to perform clinical
studies to establish the safety, effectiveness, and therapeutic equivalence of
its new drugs to listed drugs in order to support the ANDAs it expects to file
for future products.
Premarket approval under section 505(b)(2) of the FDC Act may be appropriate
for certain future drugs developed by the Company. Section 505(b)(2) allows the
FDA to approve an NDA using shortened procedures, usually for drugs that have
proven safety profiles because of the market place performance among a large
population. In a 505(b)(2) application, a company may rely on clinical
investigations conducted by others to which it does not hold a right of
reference. In general, a 505(b)(2) application is
20
<PAGE> 21
supported by two or three clinical studies among the target population group
designed to verify the safety and efficacy of the drug product in that
population using that target dose and dose sequence. The cost of this approach
is typically much less than a standard NDA.
Until an NDA, ANDA or Section 505(b)(2) application is actually approved,
there can be no assurance that the information requested and submitted will be
considered adequate by the FDA to justify approval. It is impossible to
anticipate the amount of time that will be required to obtain approval from the
FDA to market any product.
OTC Drug Products. Most OTC drug products marketed in the United States are
exempt from the FDA's premarketing approval requirements. In 1972, the FDA
instituted the ongoing OTC Drug Review to evaluate the safety and effectiveness
of OTC drugs then on the market. Through this process, the FDA issues monographs
that set forth the specific active ingredients, dosages, indications and
labeling statements for OTC drugs that the FDA will consider generally
recognized as safe and effective and therefore not subject to premarket
approval. For certain categories of OTC drug products not yet subject to a final
monograph, the FDA usually will not take regulatory action against such a
product unless failure to do so poses a potential health hazard to consumers.
The active ingredients in DuraScreen are covered by the FDA tentative final
monograph for OTC sunscreen drug products issued May 12, 1993, and the Company
believes that it has formulated and labeled DuraScreen in accordance with that
proposed regulation. Changes in that monograph may require changes to the
product and its labeling. OTC drug products and manufacturing facilities are
subject to FDA inspection, and failure to comply with applicable regulatory
requirements may lead to administrative or judicially imposed penalties.
Manufacturing. Each domestic drug manufacturing facility must be registered
with FDA. Domestic drug manufacturing establishments are subject to inspection
by the FDA and must comply with cGMP. To supply products for use in the United
States, foreign manufacturing establishments must comply with cGMP and are
subject to periodic inspection by the FDA or corresponding regulatory agencies
in countries under reciprocal agreements with the FDA. Drug product
manufacturing establishments located in California must be licensed by the State
of California in compliance with local regulatory requirements. The Company uses
and will continue to use contract manufacturers to produce its products in
commercial quantities. The Company will audit its contract manufacturers
periodically to monitor their compliance with cGMP, although there can be no
guarantee that future FDA inspections will proceed without any compliance issues
requiring the expenditure of money or other resources.
Foreign Regulation of Drug Compounds. Whether or not FDA approval has been
obtained, approval of a product by comparable regulatory authorities may be
necessary in foreign countries prior to the commencement of marketing of the
product in such countries. The approval procedure varies among countries, can
involve additional testing, and the time required may differ from that required
for FDA approval. Although there are some procedures for unified filings for
certain European countries with the sponsorship of the country which first
granted marketing approval, in general each country has its own procedures and
requirements, many of which are time consuming and expensive. Thus, there can be
substantial delays in obtaining required approvals from foreign regulatory
authorities after the relevant applications are filed. The Company expects to
rely on corporate partners and licensees, external consultants, and Company
expertise to obtain governmental approval in foreign countries of drug
formulations utilizing its compounds.
Cosmetics. Cosmetics do not require approval by the FDA for marketing in the
United States. Cosmetic products must be safe under normal conditions of use and
must comply with FDA labeling regulations.
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<PAGE> 22
COMPETITION
In the development and marketing of dermatologic drugs, skin care products
and drug delivery systems, the Company faces significant competition from, among
others, large pharmaceutical companies with established dermatology divisions,
such as Ortho Pharmaceutical Company, a subsidiary of Johnson & Johnson,
Schering-Plough, Pharmacia & Upjohn, Inc. and Westwood Pharmaceuticals Inc., a
subsidiary of Bristol-Myers. The Company believes that its principal competition
with respect to Avita is the retinoic acid products marketed by Johnson &
Johnson under the Retin-A(R) brand name and to a lesser extent the newer
generation topical retinoic acid products introduced by Johnson & Johnson and
Galderma Laboratories Inc. The Johnson & Johnson Retin-A(R) products have been
on the market for many years and continue to have a significant portion of the
market share for prescription acne treatments. The Company expects that its
principal competition with respect to Mentax will be products marketed by Glaxo
Wellcome plc (Glaxo), Johnson & Johnson, and Novartis. Most of the Company's
competitors have substantially greater financial, technical, production,
marketing and regulatory experience and resources, larger sales and marketing
forces and more experience than the Company in developing, commercializing and
marketing drug and skin care products. The Company also competes with several
smaller companies which have been formed to develop unique delivery systems or
to produce competing drug or skin care products. In recent years, several other
companies have been formed and, in certain instances, are collaborating with
large pharmaceutical companies, to develop specific drug delivery systems or
drug or skin care products that might compete directly with the Company's
technologies and products. Drug delivery systems and products developed by the
Company's competitors may be superior to, or gain greater or faster market
acceptance than, the Company's drug delivery systems and products. The Company
also faces competition from universities and related entities seeking to develop
drug delivery technologies and to earn revenues from technology and patent
licensing. In addition, these companies and academic and research institutions
compete with the Company in recruiting and retaining highly qualified scientific
and management personnel.
Competition in the dermatology market is generally based on performance
characteristics and, to a somewhat lesser extent, price. Acceptance by doctors
and patients, of which there can be no assurance, is crucial to the success of a
product. There can be no assurance that the Company's current products and
products under development will be able to compete successfully with existing
products or that other companies, universities and other institutions will not
be able to develop products that compete effectively with the Company's current
products and products under development.
In licensing its compounds for use in cosmetics and consumer skin care
products, the Company faces strong competition both from specialty chemical
companies and from cosmetic companies with substantially greater resources that
develop their own formulating agents. The Company expects technological
developments to occur at a rapid rate and believes that competition may
intensify as technological advances in the field are made and become more widely
known.
SCIENTIFIC ADVISORY BOARD
The Company has established a Scientific Advisory Board composed of
individuals with expertise in the fields of dermatology, topical drug delivery
and non-prescription skin care. The Scientific Advisory Board was formed to
assist in establishing strategic research and development policy. The members of
the Scientific Advisory Board meet as a group periodically. In addition, members
of the Scientific Advisory Board also meet from time to time on an individual
basis with scientists and management of the Company to review projects and
programs. Individual members of the Scientific Advisory Board help guide the
Company's clinical and scientific evaluation programs. If appropriate, certain
members of the Scientific Advisory Board conduct clinical studies of the
Company's formulations as investigators and conduct
22
<PAGE> 23
experiments on behalf of the Company. The Company intends to expand the
Scientific Advisory Board and continue to use other external research
consultants as the number of its products increases.
As of December 31, 1997, the members of Penederm's Scientific Advisory
Board were as follows:
<TABLE>
<CAPTION>
NAME AFFILIATION
---- -----------
<S> <C>
Albert M. Kligman, M.D., Ph.D Professor of Dermatology, University of Pennsylvania
School of Medicine
Gerald G. Krueger, M.D Professor of Medicine, University of Utah School of
Medicine
James Leyden, M.D Professor of Dermatology, University of Pennsylvania
School of Medicine
Nicholas J. Lowe, M.D Clinical Professor of Dermatology, University of California,
Los Angeles, School of Medicine
Gerald D. Weinstein, M.D Professor and Chairman, Department of Dermatology, University
of California, Irvine, College of Medicine
</TABLE>
23
<PAGE> 24
HUMAN RESOURCES
As of December 31, 1997, the Company had 52 employees, 29 of whom were engaged
in research and development, 12 in marketing and sales activities, and 11 in
finance, administration and operations. The Company believes that its future
success will depend upon its ability to continue to attract and retain a team of
highly motivated and skilled individuals. None of the Company's employees is
represented by a labor organization. The Company believes that its employee
relations are good.
SUPPLEMENTAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company and their ages as of January 31,
1998 are as follows:
<TABLE>
<CAPTION>
Name Age Position with the Company
---- --- -------------------------
<S> <C> <C>
Lloyd H. Malchow.............. 44 Director, President and Chief Executive
Officer
John W. Quigley, Jr., Ph.D.... 57 Senior Vice President, Research and
Development
William T. Gutshall........... 54 Vice President, Operations
Edward Ebbers................. 40 Vice President, Sales and Marketing
Michael A. Bates.............. 39 Vice President, Finance and
Administration and Chief Financial
Officer
</TABLE>
There is no family relationship between any of the directors or executive
officers of the Company.
MR. MALCHOW has served as President, Chief Executive Officer and a director
of the Company since January 1995. Prior to that, he served as the Company's
President and Chief Operating Officer from May 1993 through January 1995. He was
the Vice President and General Manager of the Herbert Skin Care Division of
Allergan, Inc. from 1992 to May 1993. From 1983 to 1991 Mr. Malchow held various
positions, including Vice President, Sales of Allergan Medical Optics (formerly
American Medical Optics prior to acquisition by Allergan in 1985) and, most
recently, Vice President for Global Development, Skin Care. He holds a B.A. from
Carroll College, a M.A. from the University of Maryland and a M.B.A. from
Pepperdine University.
DR. QUIGLEY has served as Senior Vice President, Research and Development
since July 1996. From November 1987 to July 1996 he served as the Company's Vice
President, Research and Development. After 16 years in research and management
at Procter & Gamble Co., a consumer products company, he joined Bristol Myers
Co., a pharmaceuticals and toiletries company, in 1984 as Director of
Preclinical Research, Dermatology, a position he held until joining Penederm.
From 1984 through 1987 he also served as an adjunct professor in the Department
of Dermatology at the State University of New York, Buffalo. Dr. Quigley holds a
B.S. degree in Chemistry, an M.S. in Plant Biochemistry and Physiology and a
Ph.D. in Biochemistry from Rutgers University and was a post-doctoral fellow at
the University of Pennsylvania School of Medicine.
MR. GUTSHALL has served as Vice President of Operations since April 1993.
Prior to managing his own consulting business from 1990 to 1993, he served as
Vice President of Global Operations from 1986 to 1989 for the Optometric
Division of CooperVision, Inc., a former opthalmologic products subsidiary of
the Cooper Companies, Inc. From 1970 to 1985, he held various operations
management positions with Johnson & Johnson, a health care company, the last
being Director of Purchasing and Contract Manufacturing. Mr. Gutshall holds a
B.S. degree from East Central State University.
24
<PAGE> 25
MR. EBBERS has served as Vice President of Sales and Marketing since April
1996. From November 1994 to April 1996 he served as Director of Marketing for
the Company. From 1987 to 1994, Mr. Ebbers held various management positions
with Syntex Laboratories, the last being Group Product Director. From 1979 to
1987, he served in several capacities for a subsidiary of Minnesota Mining and
Manufacturing Company, Riker Laboratories, Inc. (now known as 3M Pharmaceuticals
Division). Mr. Ebbers holds a B.B.A. from the University of Wisconsin and an
M.B.A. in Information Systems from the University of Minnesota, Minneapolis.
MR. BATES has served as Vice President, Finance and Administration and Chief
Financial Officer since October 1997. From December 1996 to October 1997 he
served as Director of Finance and Administration and from February 1995 to
December 1996 as Controller for the Company. In 1994 Mr. Bates served as Vice
President, Finance and Administration for De Novo, Inc. and in 1993, Mr. Bates
served as Director of Finance and Controller for Pharmetrix Corporation. From
1988 to 1994 Mr. Bates served in various financial management positions with
Tandem Computers. From 1981 to 1988 Mr. Bates held various positions with
Deloitte & Touche. Mr. Bates holds a B.S. from the University of California,
Hayward and an M.B.A in Finance from the University of California, Berkeley. Mr.
Bates is a Certified Public Accountant.
25
<PAGE> 26
RISK FACTORS
The statements in this Annual Report on Form 10-K and other statements
made by the company from time to time that relate to future plans, events or
performance are forward-looking statements which involve risks and
uncertainties. Actual results, events or performance may differ materially from
those anticipated in any forward-looking statements as a result of a variety of
factors, including those set forth below and elsewhere in this Annual Report on
Form 10-K. The following risk factors should be considered carefully in
evaluating the Company and its business by the Company's stockholders and by
prospective investors in the Company.
Uncertainty of Early Commercialization Efforts and Market Acceptance of
Prescription Products. Although the Company has invested significant
expenditures in the launch of both Avita and Mentax in 1996 and 1997, the
products have achieved only modest market shares and will continue to face
manufacturing, sales and marketing, market acceptance and other risks associated
with the continued commercialization of prescription pharmaceutical products.
The Company will face certain risks related to the initial launch of its Avita
gel product and Acticin product in 1998. The Company relies on third-party
contract manufacturers for commercial production of all of its products. There
can be no assurance that the Company will be able to obtain contract
manufacturing of adequate quantities on a timely basis or on commercially
acceptable terms, if at all, for its products. The Company has commenced
marketing in the United States prescription products through a pharmaceutical
specialty contract sales force which will be replaced by its own direct,
employee-based sales force in early 1998. The Company has no experience
developing or managing a sales force and limited experience promoting
prescription products, and there can be no assurance that the Company will be
able to manage the sales force transition without customer disruption, or
establish and maintain a successful marketing and sales effort. A number of
factors may limit the market acceptance of the Company's products, including the
timing of market entry, the availability of alternative products, the price of
the Company's products relative to alternative products, the availability of
third-party reimbursement, acceptance by prescribing physicians, managed care
providers and patients, the nature of publicity regarding the products (if any),
and the extent of marketing efforts by the Company's collaborators or partners
(if any). The Company's products will be subject to continued post-market review
which may result in restrictions on marketing or withdrawal of any such products
from the market. There can be no assurance that prescribing physicians, managed
care providers or patients will demand the products in quantities consistent
with expectations of public market analysts and investors. The failure of such
products to receive market acceptance could have a material adverse effect on
the Company's operating results or the market price of the Company's Common
Stock.
Competition and Technological Change. The Company faces significant
competition from, among others, large pharmaceutical companies with established
dermatology divisions. The Company believes that its principal competition with
respect to Mentax are products marketed by Allergan Inc., Johnson & Johnson, and
Novartis (formerly Sandoz Pharmaceuticals). The Company believes that its
principal
26
<PAGE> 27
competition with respect to Avita initially are the retinoic acid products
marketed by Johnson & Johnson and Galderma. Such Johnson & Johnson products have
been on the market for many years and have substantially all of the market share
for prescription acne treatments. The Company is aware of other newly-approved
novel acne treatments that may present substantial competition for Avita,
including another Johnson & Johnson tretinoin gel product and a new topical
retinoid product from Galderma that are both being promoted as less irritating.
Most of the Company's competitors have substantially greater financial,
technical, production, marketing and regulatory experience and resources, larger
sales and marketing forces and more experience than the Company in developing,
commercializing and marketing drug and skin care products. There can be no
assurance that the Company's existing and proposed products, including Avita and
Mentax, will compete successfully with the existing and proposed products of the
Company's competitors, and the failure of the Company's products to do so would
have a material adverse effect on the Company's operating results.
The Company's current products and those under development are based on
relatively new technologies. The Company expects technological developments in
its business to occur at a rapid rate and believes that competition may
intensify as technological advances in the field are made and become more widely
known. In recent years, several other companies have been formed and, in certain
instances, are collaborating with large pharmaceutical companies, to develop
specific drug delivery systems or drug or skin care products that might compete
directly with the Company's technologies and products. Delivery systems and
products developed by the Company's competitors may be superior to, or gain
greater or faster market acceptance than, the Company's drug delivery systems
and products. There can be no assurance that the Company's competitors will not
succeed in developing technologies and products that are more effective than any
which have been or are being developed by the Company or that would render the
Company's products and technologies obsolete or noncompetitive. See "Business
- --Competition."
Dependence on Sole Suppliers and Third Party Manufacturers. The Company
is dependent on third parties for both the supply of raw materials used to
produce TopiCare Delivery Compounds and finished products and the manufacturing
of these compounds and products. One of the materials used in TopiCare Delivery
Compounds is currently available from only one supplier, Bayer. The Company
currently obtains certain other raw materials, including butenafine and retinoic
acid, from other sole sources. The Company currently secures many of these
supplies pursuant to purchase orders or contracts that are terminable on short
notice. In the event of termination or breach by a supplier or other failure to
continue to supply materials, the Company would be required to secure and
qualify an alternate supplier. Although the Company has not experienced
difficulty acquiring raw materials, maintains significant inventories of these
materials and believes it could qualify alternate suppliers for these materials,
there can be no assurance that interruptions in supplies will not occur in the
future or that the Company would be able to timely secure the materials
necessary to produce its products so as to not experience a disruption in
manufacturing if a supplier breached or terminated its contract and the Company
experienced a disruption in supply. Any significant interruption in the supply
of raw materials could have a material adverse effect on the Company's ability
to produce its compounds and finished products and its operating results.
The Company neither has nor plans to acquire the equipment and
facilities necessary to manufacture its current and future products and is and
will be dependent upon third-party contract manufacturers for commercial
production of all of its existing and proposed products. The Company currently
secures the manufacture of its products pursuant to contracts or purchase
orders. In the event of breach by a manufacturer or other failure to provide
manufacturing services, the Company would be required to secure and qualify an
alternate manufacturer, which could delay production and sale of the Company's
products. In addition, because the Company must contract for the manufacture of
its products, the Company has little control over the production of finished
products and the associated raw materials
27
<PAGE> 28
costs. There can be no assurance that the Company will continue to be able to
obtain contract manufacturing on commercially acceptable terms, if at all, for
its products in the quantities required. Quality control and manufacturing
problems have arisen from time to time, and there can be no assurance that
future manufacturing or quality control problems will not arise at the plants of
the Company's contract manufacturers or that such manufacturers will be able to
maintain the necessary licenses from governmental authorities to continue or to
commence manufacturing the Company's products. For example, in 1994 one of the
Company's contract manufacturers had certain regulatory deficiencies which led
to the Company removing the manufacturer from its drug application and
qualifying a new manufacturing site. There can be no assurance that the Company
will be able to secure the timely and cost-efficient manufacture of its products
in accordance with FDA requirements from these independent parties, and the
inability of the Company to do so could have a material adverse effect on the
Company's operating results. See "Business -- Manufacturing and Raw Materials."
Marketing and Sales Uncertainties; Dependence on Collaborative Partners
for Product Distribution. In 1997, the Company commenced marketing in the United
States prescription products through a pharmaceutical specialty contract sales
force specializing in pharmaceuticals and solely dedicated to Penederm products.
In early 1998, Penederm began the transition to a direct, employee-based sales
force. Although the sales force is partially comprised of representatives that
previously worked for the contract sales force, and that the reorganized sales
force consists of personnel with experience promoting principally dermatological
products, none of the sales representatives has experience working under the
direction of the Company or the experience promoting its products for a
substantial period of time and certain of its representatives may not have
experience promoting dermatological products. Accordingly, the ongoing training
and management of the sales force will require significant management attention
and cost. The Company has no experience establishing, training or managing a
sales force and has limited experience promoting prescription products. There
can be no assurance that the Company will be able to successfully train and
maintain a sales force or that such sales force will be able to commercialize
Avita, Mentax, Acticin or any of the Company's other products successfully. The
inability to establish a successful sales effort would have a material adverse
effect on the Company's operating results.
The Company's strategy for the distribution of certain of its products,
including prescription products in certain geographic territories, requires
entering into various arrangements with corporate collaborators such as
Schering-Plough, Warner, UCB, Pharmascience Inc., SmithKline, and Mylan.
Revenues from these agreements constituted substantially all of the Company's
revenues in 1996. These agreements often are of short duration, terminable with
little or no notice and subject to periodic amendment. Although the Company
believes parties to any such arrangements would have an economic motivation to
succeed in performing their contractual responsibilities, the amount and timing
of resources to be devoted to these activities are not within the control of the
Company. There can be no assurance that such parties will perform their
obligations, that the agreements will not be terminated or renegotiated or that
the Company will derive any revenue from such arrangements. Any such event could
have a material adverse effect on the Company's operating results. The Company
intends to seek additional collaborative arrangements to commercialize certain
of its products. There can be no assurance that the Company will be able to
negotiate acceptable collaborative arrangements in the future, or that current
or future collaborative arrangements will be successful.
In 1997, no customer accounted for more than 10% of the Company's
revenues. See "Business -- Sales and Marketing" and "-- Collaborative
Arrangements."
Fluctuations in Quarterly Results; History of Operating Losses. The
Company's future operating results may be subject to significant quarterly
variations based on a wide variety of factors, including, but
28
<PAGE> 29
not limited to, the timing of regulatory notifications and approvals, the
commercial success of the Company's products in the United States, the timing of
the commercial introduction of other products both in the United States and
abroad, the timing and extent of marketing efforts by the Company and its
partners, the timing of contract payments to and from the Company, the
introduction of competing products by other companies, the pricing of existing
and future products by the Company's competitors, the publication of clinical
results from the Company's products under development, interruptions in the
supply of raw materials necessary to produce the Company's products, and
interruptions or delays in the manufacturing of such products. In addition,
sales of a product upon initial market introduction generally include a
significant amount of initial orders for inventory by wholesalers and
distributors and are not necessarily indicative of actual demand for the product
by patients and physicians. There can be no assurance that distributors or
wholesalers will be able to forecast demand for product accurately. Fluctuations
in operating results will occur to the extent that resales do not meet
distributors' or wholesalers' expectations. The Company's expense levels are
based, in part, on its expectations of future sales levels and have increased
significantly in 1997 with the launch of Avita and Mentax. The Company's selling
expense will increase significantly in 1998 as the Company makes the transition
from a contract sales force in 1997 to a direct sales force that is employee
based. The Company may be unable to estimate accurately when revenues will be
realized from the sales of these and other products. If sales are below
expectations or the release of products is delayed, the Company's quarterly and
annual operating results will be adversely affected, which would have a material
adverse effect on the market price of the Company's Common Stock. In any event,
it is likely that in future quarters the Company's operating results may from
time to time be below the expectations of public market analysts and investors,
which also could have a material adverse effect on the price of the Company's
Common Stock.
The Company is in the early stages of commercializing its products and
developing collaborative relationships. To date, the Company has generated only
limited revenues from the sale of its products and from licensing arrangements.
As of December 31, 1997 the Company had accumulated net losses of approximately
$51.1 million. To achieve profitable operations, the Company must, among other
things, successfully market its existing products, develop and market new
products and may need to establish significant long-term collaborative
relationships with other pharmaceutical companies. The Company's products under
development will require significant additional development, laboratory and
clinical testing, regulatory approvals and investment prior to
commercialization. The Company may continue to incur significant additional
operating losses depending principally on the market acceptance of the Company's
products, the success of product development efforts, the timing of potential
FDA approvals and subsequent launch of the drug products, the timing of
expenditures and other related factors. There can be no assurance that the
Company will achieve profitability. See Item 5 "Market for the Registrant's
Common Equity and Related Stockholder Matters," Item 6 "Selected Financial Data"
and Item 7 "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Government Regulation; No Assurance of Product Approvals. The research,
testing, manufacture and marketing of drug products is subject to extensive
regulation by numerous regulatory authorities in the United States and other
countries. Failure to comply with FDA or other applicable regulatory
requirements may subject a company to administrative or judicially-imposed
sanctions such as civil penalties, criminal prosecution, injunctions, product
seizure or detention, product recalls, total or partial suspension of production
and FDA refusal to approve pending premarket approval applications or
supplements to approved applications. The process of obtaining FDA and other
required regulatory approvals, including foreign approvals, often takes many
years and can vary substantially based upon the type, complexity and novelty of
the products involved. Furthermore, such approval process is extremely expensive
and uncertain. There can be no assurance that the Company will be able to obtain
the labeling claims necessary or desirable for the promotion of those products.
FDA requirements prohibit the marketing or promotion of a
29
<PAGE> 30
drug for unapproved indications. Furthermore, regulatory marketing approval may
entail ongoing requirements for postmarketing studies. Even after regulatory
approval is obtained, whether for Avita or Mentax or potential future products
of the Company, a marketed product, its manufacture and its manufacturing
facilities are subject to continued regulatory review and periodic inspection by
the FDA. Later discovery of previously unknown problems or failure to comply
with applicable regulatory requirements may result in penalties such as
restrictions on a product's marketing or withdrawal of the product from the
market.
Prior to the submission of premarket approval applications, drugs
developed by the Company must undergo rigorous preclinical and clinical testing,
which may take several years and the expenditure of substantial resources.
Before commencing clinical trials in humans, the Company must submit to the FDA
and receive clearance of an IND. There can be no assurance that submission of an
IND for future clinical testing of any products under development or other
future products of the Company would result in FDA authorization to commence
clinical trials or that the Company will be able to obtain the necessary
approvals for future clinical testing in any foreign jurisdiction. Further,
there can be no assurance that if such testing of products under development is
completed, any such drug compounds will be accepted for formal review by the FDA
or any foreign regulatory body or approved by the FDA for marketing in the
United States or by any such foreign regulatory bodies for marketing in
particular foreign jurisdictions.
The Company's research and development involves the controlled use of
hazardous materials, including but not limited to chemicals, fungi and various
radioactive compounds. Although the Company believes that its safety procedures
for handling and disposing of such materials comply with the standards
prescribed by state and federal regulations, the risk of accidental
contamination or injury from these materials cannot be completely eliminated. In
the event of such an accident, the Company could be held liable for any damages
that result and any such liability could exceed the coverage limits of or not be
covered by the Company's insurance and could have a material adverse effect on
the Company's operating results. See "Business -- Government Regulation."
Uncertainty of Future Product Development. The future success of the
Company will be dependent upon development of new products that obtain
regulatory approval and market acceptance. Such development will require that
the Company successfully identify appropriate products, compounds or
technologies and that the Company obtain any necessary rights thereto. The
Company's strategy for the development of future products requires entering into
various arrangements with third party development partners, licensors and
licensees, such as Kaken, Schering-Plough WARF and Renaissance. The development
of new pharmaceutical products is subject to a number of significant risks and
uncertainties. Potential products, compounds or technologies that appear to be
promising at various stages of development may not receive regulatory approval,
reach the market or achieve widespread use for a number of reasons. In any
event, development of new products will subject the Company to significant
product development costs for which the Company may never receive revenue or for
which revenue may be significantly delayed. In addition, the Company may be
required to pay royalties or other license development or commercialization
fees, which could have a material adverse effect on the profitability of such
products to the Company. There can be no assurance that the Company will be able
to in-license products, compounds or technologies on terms financially
acceptable to the Company, successfully develop potential products, obtain
regulatory approval for any such products, obtain necessary support from third
party collaborators, or successfully commercialize such products, and the
inability of the Company to do so could have a material adverse affect on the
Company's operating results.
Proprietary Technology; Patent Protection. The Company's success,
competitive position, revenue and profits, if any, will depend in part upon its
ability to obtain patent protection in various jurisdictions
30
<PAGE> 31
related to the technologies and processes it possesses and the technologies and
products it develops. The University of California has obtained three United
States and six foreign patents covering 17 countries outside of the U.S. for the
technology underlying the TopiCare Delivery Compounds and has licensed these
patents to the Company on a worldwide exclusive basis for the life of the
patents. These patents will expire in 2007 and 2008. Under the license
arrangement, the University of California is required to file, prosecute and
maintain foreign patent applications as requested by the Company at the
Company's expense. The Company has licensed rights to certain patented compounds
from Kaken, WARF, and Renaissance and in the future may license patented
compounds from other parties. Any failure by these parties properly to file,
prosecute or maintain any such patents licensed by the Company could materially
adversely affect the Company's operating results.
The Company has filed and intends to file additional patent
applications, when appropriate, relating to its technologies, improvements to
its technologies and specific products that it develops and to direct the
University of California to file any additional patent applications where
appropriate. The Company has filed two United States patent applications, one of
which has a corresponding Patent Cooperation Treaty application, and also has
four foreign patent applications pending. The scope and breadth of patent
protection with respect to pharmaceutical products is uncertain and involves
complex legal, scientific and factual questions. Accordingly, it is impossible
to anticipate the breadth or degree of protection that any such patents will
afford. Furthermore, there can be no assurance that litigation seeking to
challenge such patent protection will not be brought against the Company or the
University of California or that the Company's or the University of California's
patents will not be successfully challenged. The expenses involved in any patent
litigation can be significant and cannot be estimated by the Company. In
addition, there can be no assurance that the scope and validity of the Company's
or the University of California's existing or future patents, if any, will
prevent third parties from developing similar or competing products.
Third parties may hold or be issued patents which the Company's
technology may infringe. The Company could incur substantial costs in defending
itself and its collaborative partners against any resulting claims. Furthermore,
parties making such claims may be able to obtain injunctive or other equitable
relief which could effectively block the Company's ability to further develop or
commercialize its products in the United States and abroad, and could result in
the award of substantial damages. In the event of a claim of infringement, the
Company may be required to obtain one or more licenses from third parties. There
can be no assurance that the Company will be able to obtain such licenses at a
reasonable cost, if at all. Defense of any lawsuit or failure to obtain any such
license could have a material adverse effect on the Company's operating results.
In July 1996, Johnson & Johnson filed a complaint in federal district
court alleging that the Company's Avita gel formulation infringes a Johnson &
Johnson patent. The parties entered into a settlement agreement in December 1996
pursuant to which the Company agreed not to market the Avita gel formulation
before the expiration of the Johnson & Johnson patent in January 1998.
The Company also relies upon unpatented trade secrets and know-how.
There can be no assurance that others will not independently develop
substantially equivalent proprietary information and techniques or otherwise
gain access to the Company's trade secrets or disclose such technology or that
the Company can meaningfully protect its rights to its unpatented trade secrets.
The PTO has recently adopted changes to United States patent law which
changed the term of issued patents, subject to certain transition periods, to 20
years from the date of filing rather than 17 years from date of issuance. For
applications filed after June 7, 1995, the patent term will be 20 years from the
earliest effective filing date of the priority patent application. Such change
may reduce the effective term of protection for patents that are pending for
more than three years in the PTO. While the Company cannot
31
<PAGE> 32
predict the effect that such changes will have on its business, the adoption of
such changes could have a material adverse effect on the Company's ability to
protect its proprietary information and sustain the commercial viability of its
products. Furthermore, the possibility of shorter terms of patent protection,
combined with the lengthy FDA review process and possibility of extensive delays
in such process, could effectively further reduce the term during which a
marketed product could be protected by patents. See "Business -- Products --
Prescription Products" and "-- Patents and Proprietary Technology."
Uncertainty of Pharmaceutical Pricing and Reimbursement. The Company's
business may be materially adversely affected by the continuing efforts of
governmental and third-party payers to contain or reduce the costs of health
care in general and drugs in particular. For example, in most international
markets, pricing of prescription pharmaceuticals is subject to government price
controls. In these markets, once marketing approval is received, pricing
negotiation could take another six to 12 months or longer. In the United States
there have been, and there may continue to be, federal and state proposals to
implement similar government price controls. In addition, an increasing emphasis
on managed care and consolidation of hospital purchasing in the United States
has and will continue to put pressure on pharmaceutical pricing. Such proposals,
if adopted, and such initiatives could decrease the price that the Company
receives for any current or future products and thereby have a material adverse
effect on the Company's business, financial condition and results of operations.
Further, to the extent that such proposals or initiatives have a material
adverse effect on pharmaceutical companies that are collaborators or prospective
collaborators for certain of the Company's products, the Company's ability to
commercialize its products may be materially adversely affected. In addition,
price competition may result from competing product sales, attempts to gain
market share or introductory pricing programs, which would have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company's ability to commercialize its products may depend in part
on the extent to which reimbursement for such products and related treatments
will be available from government health administration authorities, private
health insurers and other third-party payers. Significant uncertainty exists as
to the reimbursement status of newly approved health care products, and
third-party payers are increasingly challenging the prices charged for medical
products and services. There can be no assurance that any third-party insurance
coverage will be available to patients for any of the Company's products.
Government and other third-party payers are increasingly attempting to contain
health care costs by limiting the level of reimbursement for new therapeutic
products, and be refusing, in some cases, to provide coverage or reimbursement
for indications for which the FDA has not granted marketing clearance. Moreover,
reimbursement may be denied even for FDA-approved indications. If adequate
coverage and reimbursement levels are not provided by the government and
third-party payers for the Company's products, the Company's business, financial
condition and results of operations would be materially adversely affected.
Dependence on Key Personnel. The success of the Company is dependent
upon its ability to retain and attract highly qualified scientific, management
and marketing personnel. The Company faces intense competition for personnel
from other companies, academic institutions, government entities and other
organizations. There can be no assurance that the Company will be successful in
attracting and retaining key personnel. The loss of key personnel, or the
inability to attract and retain the additional, highly-skilled employees
required for the expansion of the Company's activities, could adversely affect
its business. See Item 10 "Directors and Executive Officers of the Registrant."
Risk of Product Liability Claims; No Assurance of Adequate Insurance.
Testing, manufacturing and marketing of the Company's products entail a risk of
product liability. In addition, third-party manufacturers of certain drugs and
skin care agents used by the Company in its products have limited
32
<PAGE> 33
contractual responsibility for product liability. Although the Company has
obtained aggregate product liability insurance coverage in the amount of
$3,000,000, there can be no assurance that the existing coverage is adequate for
current operations. Furthermore, this existing coverage may not be adequate as
the Company further develops products, and there can be no assurance that
additional insurance coverage will be available in the future at an acceptable
cost, if at all. Failure of the Company to prevail on a product liability claim
could have a material adverse effect on the Company's operating results. In
addition, the Company could incur substantial costs in defending a claim, even
where that claim was ultimately unsuccessful, and defense of any such claim
could divert management's efforts and attention from the Company's business and
have a material adverse effect on the Company's operating results.
Volatility of Stock Price. The Nasdaq National Market has from time to
time experienced significant price and volume fluctuations that may be unrelated
to the operating performance of particular companies. In addition, the market
price of the Common Stock, like the stock prices of many publicly traded
pharmaceutical and biotechnology companies, has been, and may continue to be,
highly volatile. Announcements of technological innovations or new commercial
products by the Company or its competitors, developments or disputes concerning
patent or proprietary rights, publicity regarding actual or potential medical
results relating to products under development by the Company or its
competitors, regulatory developments in both the United States and foreign
countries, public concern as to the safety of biotechnology and pharmaceutical
products and economic and other external factors, as well as period-to-period
fluctuations in financial results, among other factors, may have a material
adverse effect on the market price of the Common Stock.
ITEM 2. PROPERTIES
The Company currently leases approximately 19,000 square feet of laboratory
and office space in Foster City, California. Penederm's research and development
group occupies approximately 10,000 square feet. The remaining 9,000 square feet
is divided between administrative office space, sales and marketing offices, and
clinical and regulatory space.
ITEM 3. LEGAL PROCEEDINGS
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1997.
33
<PAGE> 34
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market tier of the
Nasdaq Stock Market under the symbol "DERM". The following table sets forth, for
the periods indicated, the high and low closing prices for the Company's Common
Stock as reported by the Nadaq Stock Market:
<TABLE>
<CAPTION>
1996 High Low
- ------------- ------- -------
<S> <C> <C>
First Quarter $17-1/4 $10-3/4
Second Quarter $17-1/2 $13
Third Quarter $13-1/4 $5-1/2
Fourth Quarter $12-1/2 $6-3/4
1997 High Low
- ------------- ------- -------
First Quarter $17-1/4 $11
Second Quarter $13-1/2 $10-1/4
Third Quarter $14-3/4 $10
Fourth Quarter $13-3/4 $9-5/8
</TABLE>
As of January 31, 1998, the number of stockholders of record of the Common Stock
was 164. The Company has never paid a cash dividend on its Common Stock and does
not anticipate paying any cash dividends for the foreseeable future.
34
<PAGE> 35
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Year Ended December 31,
(In thousands except per share data) 1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues $ 9,005 $ 2,905 $ 5,401 $ 5,123 $ 1,378
Costs and expenses:
Cost of product sales 2,661 1,472 2,034 2,887 502
Research and development 6,950 5,292 5,713 4,509 3,691
Selling, general and 12,535 4,317 3,623 3,625 2,954
administrative
-------- -------- -------- -------- --------
Total costs and expenses 22,146 11,081 11,370 11,021 7,147
-------- -------- -------- -------- --------
Loss from operations (13,141) (8,176) (5,969) (5,898) (5,769)
Interest income, net 424 533 933 905 230
-------- -------- -------- -------- --------
Net loss $(12,717) $ (7,643) $ (5,036) $ (4,993) $ (5,539)
======== ======== ======== ======== ========
Net loss per basic and diluted
share (1) $ (1.59) $ (1.05) $ (.70) $ (.71) $ (4.61)
======== ======== ======== ======== ========
Shares used in computing net
loss (basic and diluted) per share 7,995 7,275 7,171 6,990 1,202
======== ======== ======== ======== ========
December 31,
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
BALANCE SHEET DATA:
Cash, cash equivalents and investments $ 5,621 $ 6,420 $15,011 $20,801 $26,416
Total assets 10,231 10,694 17,968 23,538 27,498
Stockholders' equity 5,194 8,591 15,934 20,659 26,160
</TABLE>
(1) Net loss per share for the year ended December 31, 1993 has been
retrospectively restated to apply Staff Accounting Bulletin (SAB) 98. SAB 98 had
no impact on any other year presented.
35
<PAGE> 36
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The statements in "Management's Discussion and Analysis of Financial condition
and Results of Operations" that relate to future plans, events or performance
are forward-looking statements which involve risks and uncertainties. Actual
results, events or performance may differ materially from those anticipated in
these forward-looking statements as a result of a variety of factors, including
those set forth under "Item 1 - Risk Factors" and elsewhere in this Annual
Report on Form 10-K. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. The Company
undertakes no obligation to publicly release the result of any revisions to
these forward-looking statements that may be needed to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
OVERVIEW
Penederm is a pharmaceutical company that specializes in developing and
marketing dermatology products. In 1997, Penederm launched Mentax(R), a
once-a-day prescription topical treatment for three skin fungal conditions:
tinea pedis (athlete's foot), tinea corporis (ringworm) and tinea cruris (groin
fungus) and its Avita(TM) prescription cream product, a topical form of retinoic
acid for the treatment of acne. Penederm also received FDA contingent approval
to begin marketing its Avita gel product upon expiration of a third party patent
in January 1998. Penederm has several other pharmaceutical products for fungal
inflammatory conditions, psoriasis, nail fungus and Mentax skin treatment line
extensions in human clinical trials. The Company also sells its patented
TopiCare Delivery Compounds(R) for use in cosmetics and personal care products,
and markets its own over-the-counter (OTC) skin care products. Penederm has
established collaborative relationships with other pharmaceutical companies as
follows:
<TABLE>
<CAPTION>
COMPANY PRODUCT AREA TERRITORY
------- ------------ ---------
<S> <C> <C>
In-License and
Co-Development
Agreements:
Kaken Pharmaceutical Penederm in-licensed U.S., Canada, Mexico and Latin
Company Ltd. (Kaken) butenafine, the active America for skin antifungal;
ingredient incorporated in U.S., Canada, Europe, Mexico,
Mentax Latin America, Australia and New
Zealand for nail antifungal
SmithKline Beecham Undisclosed OTC product SmithKline option to market
(SmithKline) worldwide
Alpharma, Inc. (Alpharma) Acticin for scabies U.S.
Out-License Agreements:
Schering-Plough HealthCare Prescription and OTC Nail U.S. and Canada
Products, Inc. antifungal and co-promote
(Schering-Plough) prescription skin cream
antifungal
UCB Group of Belgium (UCB) Prescription antifungal Europe, Africa and Middle East
products
</TABLE>
36
<PAGE> 37
<TABLE>
<CAPTION>
<S> <C> <C>
Warner Wellcome Consumer OTC Dry Skin Canada
Health Products (Warner)
SmithKline Beecham OTC Consumer Products Europe and Eastern Europe
(SmithKline)
Pierre Fabre Inc. (Pierre DuraScreen sunscreen U.S.
Fabre)
Allergan, Inc. (Allergan) Butenafine topical antifungal Central and South America
and retinoic acid cream and gel
Mylan Laboratories, Inc. Co-promote Mentax cream to U.S.
(Mylan) primary care physicians
</TABLE>
The Company has been unprofitable since inception and expects to incur
significant additional operating losses in the near future. For the period from
inception through December 31, 1997, the Company incurred a cumulative net loss
of $51,110,000. Penederm's sources of working capital have been equity
financings, product sales to corporate partners, sales of Mentax, Avita and
over-the-counter products, product license fees, sales of TopiCare Delivery
Compounds and interest earned on investments.
RESULTS OF OPERATIONS
Total 1997 revenues of $9,005,000 increased 210% from total 1996
revenues of $2,905,000. 1996 revenues declined 46% from $5,401,000 in 1995. The
1997 revenue increase is due primarily to the initial product stocking shipments
of Mentax which was launched to trade in January and Avita which was launched to
trade in June and out-license milestone payments from corporate partners.
License revenues in 1997 of $2,664,000 increased 312% from $647,000 in
1996. License revenues decreased 68% in 1996 from 1995 license revenues of
$2,050,000. License fees were received from Schering-Plough, SmithKline, the
Merck KGaA Group/Center Laboratories, Allergan and Mylan in 1997; Warner and
SmithKline in 1996, and Schering-Plough, UCB and SmithKline in 1995.
Total product sales increased 181% to $6,341,000 in 1997 from $2,258,000
in 1996 due to the 1997 launch of Mentax and Avita. Total product sales declined
33% in 1996 from $3,351,000 in 1995 due primarily to lower quantities of
Lubriderm products shipped to Warner as compared to 1995. Slower sales to Warner
also negatively impacted sales of TopiCare Delivery Compounds in 1996.
The Company expects its future revenues in the near term to be derived
principally from the sale of its pharmaceutical products, and for the revenues
derived from OTC dry skin products and cosmetic products to become less
significant relative to total revenues.
The Company's cost of sales increased to $2,661,000 in 1997 from
$1,472,000 in 1996 as a result of the 1997 launch of Mentax and Avita. Cost of
sales declined in 1996 from $2,034,000 in 1995 due to the decrease in product
sales. Product gross margins improved in 1997 due to a product revenue mix
change toward higher-margin pharmaceutical products launched in 1997.
37
<PAGE> 38
The Company's research and development expenses increased 31% to
$6,950,000 in 1997 from $5,292,000 in 1996 The Company's research and
development expenses decreased 7% in 1996 from $5,713,000 in 1995. The 1997
increase is a result of the Company initiating two pivotal phase III human
clinical studies of its combination product for the treatment of skin fungal
conditions (project name 501 cream) at 32 clinical sites and involving
approximately 1,600 patients. The 1996 spending decrease is related to the
timing and size of later stage human clinical trials compared to the prior year.
Sales and marketing expenses increased 614% in 1997 to $10,103,000 from
$1,414,000 in 1996. Sales and marketing expenses increased 4% in 1996 from
$1,354,000 in 1995. The increase in 1997 is primarily due to marketing and other
expenses related to the commercial launch of Mentax and Avita. The 1996 increase
is primarily due to costs of pre-launch preparations for Mentax offset by
continued reductions in OTC promotions and reduced personnel costs.
General and administrative expenses decreased 16% in 1997 to $2,432,000
from $2,903,000 in 1996. General and administrative expenses increased 28% in
1996 from $2,269,000 in 1995. The 1997 decrease is primarily due to the
reimbursement of legal costs in a settlement of a case related to enforcement of
patent rights. The 1996 increase relates primarily to increased legal costs
related to enforcement of patent rights.
The Company had net interest income of $424,000, $533,000 and $933,000
in 1997, 1996 and 1995, respectively. Net interest income declined 20% in 1997
and 43% in 1996 primarily as a result of lower cash balances available for
investment from the prior year.
As of December 31, 1997, the Company had available net operating loss
carryforwards of approximately $49,000,000 for Federal income tax purposes.
Utilization of the net operating loss carryforwards may be subject to
substantial limitation due to the change in ownership provisions of the Internal
Revenue Code of 1986.
The Company expects that annual revenues, and costs and expenses will
continue to increase in the future, due principally to further commercialization
of its recently approved pharmaceutical products. Sales and marketing expenses
are expected to increase significantly from the prior year due to the
establishment of an employee-based sales force in 1998 and increased promotion
of these products in the marketplace. The Company expects a modest reduction in
research and development expenses in 1998 coinciding with the completion of its
two phase III clinical trials in the first quarter of 1998. The Company also
expects some expansion of research and development programs, increased patent
and regulatory costs, expansion of regulatory, clinical, and quality assurance
capabilities, and increased administrative support costs. Therefore, additional
operating losses are expected in the near future.
In addition, sales of a product upon initial market introduction
generally include a significant amount of initial orders for inventory by
wholesalers and distributors and are not necessarily indicative of actual demand
for that product by patients and physicians. There can be no assurance that
distributors and wholesalers will be able to forecast demand for product
accurately. Fluctuations in operating results will occur to the extent that sell
through of products does not meet distributors' or wholesalers' expectations.
The Company also expects that future operating results may be subject to
quarterly variations that may impact cash flow from operations. Operating
results for the year ended December 31, 1997 are not necessarily indicative of
future operating results.
38
<PAGE> 39
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of capital to date have been the
proceeds from public and private offerings of its equity securities, including a
1997 private placement for which the net proceeds were $8,975,000. At December
31, 1997, the Company had cash, cash equivalents and investments totaling
$5,621,000. In January 1998, the Company entered into an agreement with an
investment group for an equity line of credit which allows the Company to access
up to $10 million through sales of its common stock at a discount to market. The
equity line of credit will remain available for a period of two years, and the
decision to draw any funds and the timing for any such draw is solely at the
Company's discretion. Drawing under the equity line of credit is subject to the
satisfaction of certain conditions, including registration of the shares, a
minimum trading price per share, and certain limitations on the number of shares
of the Company's common stock being held by the investment group at any point in
time.
Cash expenditures related to operating activities, the acquisition of
fixed assets and repayment of long-term debt totaled $10,119,000 in 1997,
$8,272,000 in 1996 and $5,003,000 in 1995. Operating activities were comprised
of research and development, clinical trials, product sales, promotion and
general administration activities. The Company also made milestone payments of
$619,000 related to the in-licensing of drug compounds in 1996. The Company
expects that amounts expended historically are not indicative of future
expenditures by the Company, which the Company believes will increase. The
Company expects to continue to incur substantial expenditures related to the
further research and development of its technologies, development of its
products, acquisition of additional products and rights to drug compounds and
sales and marketing.
The Company does not expect to have significant computer software
malfunctioning issues in the year 2000 and thereafter. Based on preliminary
inquiries of Penederm's warehousing and logistics vendor, the Company does not
believe it is vulnerable to the vendor's failure to remediate its own year 2000
issues. The Company plans to upgrade its accounting system to year 2000
compliant software during 1998. The cost of these changes is not expected to be
significant.
The Company believes that existing capital resources, after giving
effect to the availability of proceeds of the equity credit line, including the
interest income earned on its invested cash balances, together with anticipated
revenues (consisting of product sales, license fees and royalties), will satisfy
the Company's working capital and identified capital expenditure requirements at
least through 1998. The Company's future capital requirements will depend on
many factors, including the commercial success of the Company's products,
progress of the Company's collaborative and independent research and development
programs, payments received under collaborative agreements with other companies,
if any, the results and costs of preclinical and clinical testing for the
Company's products, the costs associated with and the timing of regulatory
approvals, technological advances, the status of competitive products, and the
commercial success of Penederm's strategic relationships. There can be no
assurance that additional funds will be available to the Company on favorable
terms, if at all, to permit the Company to continue with its current plan for
operations.
39
<PAGE> 40
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>
<CAPTION>
Index to Financial Statements Page
- ----------------------------- ----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors 40
Consolidated Balance Sheets 41
Consolidated Statements of Operations 42
Consolidated Statement of Stockholders' Equity 43
Consolidated Statements of Cash Flows 44
Notes to Consolidated Financial Statements 45
</TABLE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders of Penederm Incorporated
We have audited the accompanying consolidated balance sheets of Penederm
Incorporated as of December 31, 1997 and 1996, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1997. 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, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Penederm
Incorporated at December 31, 1997, and 1996 and the consolidated results of its
operations and its cash flows for the three years in the period ended December
31, 1997 in conformity with generally accepted accounting principles.
Ernst & Young LLP
Palo Alto, California
January 27, 1998
40
<PAGE> 41
PENEDERM INCORPORATED
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
------------------------
(In thousands except share data) 1997 1996
----------- ----------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 1,519 $ 3,062
Short-term marketable securities 3,102 2,259
Accounts receivable (less allowance for doubtful
accounts of none in 1997 and 1996) 1,013 276
Inventory 1,501 1,539
Employee note receivable 125 125
Prepaid expenses and other current assets 341 524
---------- ---------
Total current assets 7,601 7,785
Marketable securities 1,000 1,099
Property and equipment, at cost, less accumulated
depreciation and amortization 267 277
Intangible assets (less accumulated amortization of
$378 in 1997 and $206 in 1996) 1,339 1,511
Other assets 24 22
========== =========
Total assets $ 10,231 $ 10,694
========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,264 $ 1,196
Accrued liabilities 3,745 863
Current portion of long-term obligations 18 16
---------- ---------
Total current liabilities 5,027 2,075
Long-term obligations, less current portion 10 28
---------- ---------
Total liabilities 5,037 2,103
---------- ---------
Commitments
Preferred stock, $.01 par value in 1997
and no par value in 1996;
10,000,000 shares authorized;
no shares issued and outstanding - -
Common stock, $.01 par value in 1997
and no par value in 1996; 30,000,000 shares
authorized; shares issued and
outstanding: 8,154,098 shares in 1997
and 7,315,697 shares in 1996 82 46,984
Additional paid-in capital 56,222 -
Accumulated deficit (51,110) (38,393)
---------- ----------
Total stockholders' equity 5,194 8,591
---------- ----------
Total liabilities and stockholders' equity $ 10,231 $ 10,694
========== ==========
</TABLE>
See accompanying notes
41
<PAGE> 42
PENEDERM INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ending December 31,
----------------------------------------
(In thousands except per share data) 1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Revenues:
Product sales $ 6,341 $ 2,258 $ 3,351
Licensing revenues 2,664 647 2,050
-------- -------- --------
Total revenues 9,005 2,905 5,401
-------- -------- --------
Costs and expenses:
Cost of product sales 2,661 1,472 2,034
Sales and marketing 10,103 1,414 1,354
Research and development 6,950 5,292 5,713
General and administrative 2,432 2,903 2,269
-------- -------- --------
Total costs and expenses 22,146 11,081 11,370
-------- -------- --------
Loss from operations (13,141) (8,176) (5,969)
Interest income, net 424 533 933
-------- -------- --------
Net loss $(12,717) $ (7,643) $ (5,036)
======== ======== ========
Basic and diluted net loss per share $ (1.59) $ (1.05) $ (.70)
======== ======== ========
Number of shares used in computing basic and diluted
net loss per share 7,995 7,275 7,171
======== ======== ========
</TABLE>
See accompanying notes.
42
<PAGE> 43
PENEDERM INCORPORATED
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Common Stock Additional Total
----------------------- Paid-In Accumulated Shareholders'
Shares Amount Capital Deficit Equity
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Balances, December 31, 1994 6,999 $ 46,373 $ -- $(25,714) $ 20,659
Issuance of common stock under
stock option and other employee
stock plans 229 311 -- -- 311
Net loss -- -- -- (5,036) (5,036)
-------- -------- -------- -------- --------
Balances, December 31, 1995 7,228 46,684 -- (30,750) 15,934
Issuance of common stock under
stock option and other employee
stock plans 88 300 -- -- 300
Net loss -- -- -- (7,643) (7,643)
-------- -------- -------- -------- --------
Balances, December 31, 1996 7,316 46,984 -- (38,393) 8,591
Creation of par value common
stock -- (46,911) 46,911 -- --
Issuance of common stock under
stock option and other
employee stock plans 86 1 344 -- 345
Issuance of stock in private
placement, net of offering costs 752 8 8,967 -- 8,975
Net loss -- -- -- (12,717) (12,717)
-------- -------- -------- -------- --------
Balances, December 31, 1997 8,154 $ 82 $ 56,222 $(51,110) $ 5,194
======== ======== ======== ======== ========
</TABLE>
See accompanying notes.
43
<PAGE> 44
PENEDERM INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Increase (decrease) in cash and cash equivalents (in thousands) 1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(12,717) $ (7,643) $ (5,036)
Adjustments to reconcile net loss to net cash
used in operating activities:
Loss on disposal of fixed assets -- -- 139
Depreciation and amortization of property
and equipment 154 132 173
Amortization of intangible assets 172 129 77
Decrease (increase) in accounts receivable (737) 586 (168)
Decrease (increase) in inventory 38 (1,238) 279
Decrease (increase) in prepaid expenses and other
current assets 183 (182) 80
Increase (decrease) in accounts payable, accrued
liabilities and rent 2,950 102 (352)
Decrease (increase) in other assets (2) 2 (1)
-------- -------- --------
Net cash used in operating activities (9,959) (8,112) (4,809)
-------- -------- --------
Cash flows from investing activities:
Purchases of available-for-sale securities (7,032) (6,901) (7,258)
Maturities of held-to-maturity securities -- -- 2,000
Maturities of available-for-sale securities 2,286 6,850 10,076
Sales of available-for-sale securities 4,002 3,009 2,939
Acquisition of intangible assets -- (619) (1,098)
Acquisition of fixed assets (144) (127) (131)
-------- -------- --------
Net cash provided by (used in) investing activities (888) 2,212 6,528
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock under stock plans 345 300 311
Issuance of common stock in private placement 8,975 -- --
Repayment of long-term obligations (16) (33) (63)
-------- -------- --------
Net cash provided by financing activities 9,304 267 248
-------- -------- --------
Net increase (decrease) in cash and cash equivalents (1,543) (5,633) 1,967
Cash and cash equivalents at beginning of year 3,062 8,695 6,728
======== ======== ========
Cash and cash equivalents at end of year $ 1,519 $ 3,062 $ 8,695
======== ======== ========
</TABLE>
See accompanying notes.
44
<PAGE> 45
PENEDERM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS OF THE COMPANY
Penederm is a pharmaceutical company that specializes in development and
marketing of dermatology products. The Company launched Mentax(R), a once-a-day
prescription topical cream for the treatment of skin fungal conditions and
Avita(TM), a topical form of retinoic acid for the treatment of acne during
1997. The Company has initiated pivotal phase III human clinical trials of a
combination product (project name: 501 cream) for the treatment of skin fungal
conditions. Products for nail fungus and psoriasis are in earlier stages of
clinical development along with Mentax skin treatment line extensions. The
Company also markets its patented TopiCare Delivery Compounds(R) as specialty
ingredients to major cosmetic companies for incorporation into their commercial
products.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiary in the United Kingdom,
Penederm Limited. All significant intercompany balances and transactions have
been eliminated in consolidation.
USE OF ESTIMATES: The preparation of the financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS: The Company considers all highly liquid investments
purchased with a remaining maturity of three months or less to be cash
equivalents.
MARKETABLE SECURITIES: All of the Company's marketable securities are classified
as available-for-sale with unrealized holding gains and losses, when material,
reported as a separate component of stockholders' equity. Unrealized gains and
losses on marketable securities were not material as of December 31, 1997 and
1996. Realized gains and losses on sales of investments are reported in interest
income and computed using the specific identification cost method. Short-term
marketable securities mature within one year of the balance sheet date.
Marketable securities typically have a maximum maturity of two years from the
purchase date.
CONCENTRATION OF CREDIT RISK: The Company's cash, cash equivalents, and
marketable securities are highly liquid and are diversified to ensure safety of
principal. The Company generally invests excess cash in deposits with major
banks, in various government or government agency obligations, and in
obligations of corporations with strong credit ratings and in a variety of
industries.
45
<PAGE> 46
INVENTORY: Inventories are stated at the lower of cost (first-in, first-out) or
market and consist of the following at December 31:.
<TABLE>
<CAPTION>
(In thousands) 1997 1996
- ------------- ------- -------
<S> <C> <C>
Raw materials $ 572 $ 907
Finished goods 929 632
------- -------
$1,501 $1,539
======= =======
</TABLE>
PROPERTY AND EQUIPMENT: Property and equipment are stated at cost and are
depreciated on a straight-line basis over their estimated useful lives of three
years for computing equipment and four years for all other property and
equipment. Property and equipment acquired under capital leases and leasehold
improvements are amortized on a straight-line basis over their estimated useful
lives or their lease terms, whichever is shorter.
<TABLE>
<CAPTION>
Property and equipment consists of the following at December 31:
<S> <C> <C>
(In thousands) 1997 1996
- ------------- -------- --------
Computers and equipment $ 1,191 $ 1,047
Furniture and fixtures 123 119
Leasehold improvements 284 288
-------- -------
1,598 1,454
Less accumulated depreciation
and amortization (1,331) (1,177)
-------- -------
Net property and equipment $ 267 $ 277
======== =======
</TABLE>
Property and equipment includes $574,000 of equipment under capital leases at
December 31, 1997 and 1996. Accumulated depreciation for such equipment was
$546,000 and $522,000 at December 31, 1997 and 1996, respectively.
INTANGIBLE ASSETS: Intangible assets consist principally of development and
marketing rights related to in-licensed pharmaceutical compounds and are
amortized on a straight-line basis over their estimated useful lives of ten
years.
ACCRUED LIABILITIES: Accrued liabilities consist of the following at December
31:
<TABLE>
<CAPTION>
(In thousands) 1997 1996
- -------------- --------- -------
<S> <C> <C>
Clinical studies $1,362 $219
Marketing programs 734 219
Contract sales force related 365 -
Accrued payroll and
related expenses 295 198
Other accrued liabilities 989 227
--------- -------
$3,745 $863
========= =======
</TABLE>
46
<PAGE> 47
REVENUE RECOGNITION: The Company recognizes product sales upon shipment of
product. License payments are generally recognized upon the execution of the
license agreement. Research and development milestones are recorded when the
underlying performance objective has been attained. License payments received
which are related to future performance are deferred and recorded as revenues as
they are earned over specified future performance periods. Payments received
under research and development agreements are recognized as revenue ratably with
the performance specified in the agreement, which approximates the incurrence of
related costs.
RESEARCH AND DEVELOPMENT: Research and development expenditures are charged to
operations as incurred.
ADVERTISING COSTS: Advertising costs are expensed as incurred and amounted to
approximately $689,000, $41,000 and $4,000 in 1997, 1996 and 1995 respectively.
NET LOSS PER SHARE: In February 1997, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings Per Share", which the Company has adopted. The Statement replaces the
presentation of Primary EPS with a presentation of basic EPS, which excludes
dilution and is computed by dividing net loss by the weighted average number of
common shares outstanding for the period. The Statement also requires the dual
presentation of basic and diluted EPS on the face of the income statement for
all entities with complex capital structures and requires a reconciliation of
the numerator and denominator of the basic EPS computation to the numerator and
denominator of the diluted EPS computation. SFAS No. 128 did not impact the
Company's current or previously reported loss per share.
STOCK-BASED COMPENSATION: In October 1995 the FASB issued Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation,"
which encourages, but does not require, companies to record compensation expense
for stock-based employee compensation plans at fair value. The Company has
chosen to continue to apply Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations in
accounting for its stock based plans and, accordingly, does not recognize
compensation expense related to employees or directors under its stock option
plans or employee stock purchase plan. Note 7 contains a summary of the pro
forma effects to reported net loss and net loss per basic and diluted share for
1997 and 1996 if the Company had elected to recognize compensation expense based
on the fair value of the options granted as described by SFAS No. 123.
ACCOUNTING PRONOUNCEMENTS: In June 1997, the FASB issued SFAS No. 130,
"Reporting Comprehensive Income." The Statement is effective for fiscal years
beginning after December 15, 1997. The Statement establishes standards for
reporting and display of comprehensive income and its components in a company's
consolidated financial statements. The Company will adopt this Statement in 1998
and does not believe it will have a material impact on its consolidated
financial statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information." This Statement is effective for fiscal
years beginning after December 15, 1997. This Statement establishes standards
for disclosure about operating segments, products and services, geographic areas
and major customers, as well as descriptive information on how the operating
segments were determined. The Company will adopt this Statement in 1998 and does
not believe it will have a material impact on its consolidated financial
statements.
RECLASSIFICATIONS: Certain prior year amounts have been reclassified to conform
to the current year presentation.
47
<PAGE> 48
3. MARKETABLE SECURITIES
At December 31, 1997 and 1996, marketable securities classified as
available-for-sale are summarized below (in thousands):
<TABLE>
<CAPTION>
Amortized
Cost Unrealized Unrealized Fair
December 31, 1997 Basis Gains Losses Value
------- ------- ------- -------
<S> <C> <C> <C> <C>
Available for sale:
U.S. Treasury and U.S.
agency securities $ 750 $ -- $ (1) $ 749
Corporate commercial paper,
notes and bonds 3,352 -- (4) 3,348
------- ------- ------- -------
$4,102 $ -- $ (5) $4,097
======= ======= ======= =======
Amortized
Cost Unrealized Unrealized Fair
December 31, 1996 Basis Gains Losses Value
------- --- ------- -------
<S> <C> <C> <C> <C>
Available for sale:
U.S. Treasury and U.S.
agency securities $1,248 $ -- $ (3) $1,245
Corporate commercial paper,
notes and bonds 2,110 2 (5) 2,107
------- ------- ------- -------
$3,358 $ 2 $ (8) $3,352
======= ======= ======= =======
</TABLE>
The amortized cost of marketable securities at December 31, 1997 totaling
$3,102,000 and $1,000,000 mature in 1998 and 1999, respectively. Realized gains
and losses on sales of available-for-sale securities during the year ended
December 31, 1997 and 1996 were immaterial.
4. LONG-TERM DEBT
The Company leases certain of its laboratory equipment and its phone system
under capital leases. The capital leases expire at various dates through 1999
and bear interest rates from 12% to 19%.
Future minimum lease payments under the capital lease obligations are not
material. Interest expense under these obligations totaled approximately $6,000,
$8,000, and $14,000 for each of the years ended December 31, 1997, 1996 and
1995, respectively.
In May 1997, the Company entered into a $2.5 million revolving credit facility
with a bank under which it can borrow at prime plus 2%. Borrowings are limited
to 75% of certain accounts receivable and all borrowings are collateralized by
essentially all of the Company's assets. Availability of the line is subject to
the Company maintaining certain reporting and financial covenants. There were no
borrowings or repayments under the line from inception to December 31, 1997.
48
<PAGE> 49
5. COMMITMENTS
FACILITY LEASE: The Company rents office and laboratory facilities under a
noncancelable operating lease expiring in April 2003. Under the terms of the
lease, the Company is responsible for its share of common area costs. Future
minimum lease payments are as follows:
<TABLE>
<CAPTION>
Year (In thousands)
- -------------------------------
<S> <C>
1998 $ 557
1999 391
2000 400
2001 409
2002 417
Thereafter 159
-------------
Total $2,333
=============
</TABLE>
Rent expense under operating leases amounted to approximately $312,000,
$300,000, and $342,000 in 1997, 1996, and 1995, respectively.
The Company may be obligated to make license and development milestone payments
in the future under certain license and collaborative research agreements, as
described further in Note 6.
6. LICENSE AND COLLABORATIVE RESEARCH AGREEMENTS
IN-LICENSE AGREEMENTS: Penederm has in-license agreements with the University of
California, Kaken Pharmaceutical Company, Ltd. (Kaken), and a group of entities
including the Wisconsin Alumni Research Foundation and Renaissance Corporation,
for certain topical drug delivery technology, the rights to develop and market
an antifungal butenafine drug compound, and the right to develop and market
patented Vitamin D compounds, respectively. These agreements generally require
the payment by the Company of nonrefundable license fees, additional milestone
payments contingent on the achievement of regulatory objectives and royalties on
future product sales resulting from commercialization of the technologies or
compounds. These license agreements are generally for specified skin disorders
and limited to specified territories. Royalties paid under these agreements were
not significant in any of the three years in the period ended December 31, 1997.
OUT-LICENSE AGREEMENTS: Penederm has agreements granting licenses to the
Company's proprietary technologies to Warner Wellcome Consumer Health Products
and SmithKline Beecham for certain over-the-counter skin care products and with
Schering-Plough HealthCare Products, Inc., UCB Group of Belgium, Allergan
Incorporated and Mylan Laboratories Inc. to develop and commercialize certain
antifungal skin and nail prescription products based on the butenafine compound
in-licensed from Kaken. The agreements generally provide for the licensee to
sell certain products incorporating the Company's proprietary TopiCare Delivery
Compounds, and/or in-licensed drug compounds in certain specified territories or
to specified medical specialties. Terms of the license agreements also generally
include supply agreements, license fees, performance milestone payments and
royalties due to Penederm. Certain of the agreements are terminable upon as few
as 90 days notice, in which event the product rights revert to Penederm without
further consideration and become available for out-license to another
development or
49
<PAGE> 50
marketing partner. The Company's agreement with Warner U.S. terminated on
December 31, 1997. For the years ending December 31, 1997, 1996, and 1995, the
Company recorded license fee milestone revenues of $2,664,000, $647,000, and
$2,050,000, respectively, under these agreements.
7. STOCKHOLDERS' EQUITY
SHAREHOLDER RIGHTS PLAN: On November 20, 1996, the Board of Directors adopted
the Shareholder Rights Plan ("Rights Plan") to assist its stockholders in
realizing fair value and equal treatment in the event of any attempted takeover
of the Company and to protect the Company and its stockholders against coercive
takeover tactics. In the event a third party or group were to acquire 20% or
more of the Company's outstanding Common Stock without the prior approval of the
Board of Directors, each Company stockholder, other than the acquirer, will have
the right to buy Common Stock of the Company with a market value of twice the
exercise price. In addition, if the Company were to be acquired in a merger,
stockholders with unexercised rights could purchase common stock of the acquirer
with a value of twice the exercise price of the rights.
STOCK OPTION PLANS: In September 1993, the Company adopted an Equity Incentive
Plan under which stock options, restricted stock, stock purchase rights or
performance shares may be awarded to employees and consultants. Shares
authorized under the Equity Incentive Plan include the shares previously
authorized under the 1987 Employee and Consultant Stock Option plans. Under the
plans, options may be granted at prices not less than 85% of the fair market
value at the date of grant in the case of nonqualified options and not less than
fair market value in the case of incentive options (110% of fair market value in
certain instances), as determined by the Board of Directors.
Options are generally exercisable upon grant, expire ten years from the date of
grant and vest over five years. Shares issued upon exercise of unvested options
are subject to the right of repurchase by the Company which lapses in accordance
with the option's vesting schedule.
In June 1994, the Company adopted the 1994 Nonemployee Directors Stock Option
Plan, under which nonqualified stock options may be granted to nonemployee
directors on a formula basis. At December 31, 1997, 200,000 shares of common
stock were reserved under this Plan. Options may be granted at an exercise price
equal to the fair market value of common stock on the date of the grant. Options
vest ratably over the period of one year from the date of grant, and have a term
of ten years.
Had compensation expense been recognized for the Company's employee stock
purchase plan and stock option plans based on the fair value at the grant date
for awards made in 1997, 1996 and 1995 consistent with the provisions of SFAS
No. 123, the Company's net loss and loss per share would have been increased to
the following pro forma amounts:
<TABLE>
<CAPTION>
(In thousands, except per share amounts)
1997 1996 1995
----------- ---------- ----------
<S> <C> <C> <C>
Net loss, as reported $(12,717) $(7,643) $(5,036)
Net loss, pro forma $(13,717) $(8,163) $(5,141)
Net loss per basic and diluted share,
as reported $ (1.59) $ (1.05) $ (.70)
Net loss per basic and diluted share,
pro forma $ (1.72) $ (1.12) $ (.72)
</TABLE>
50
<PAGE> 51
Because SFAS No. 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until 1998.
The weighted average fair value for stock options granted in 1997, 1996 and 1995
was $6.54, $7.20 and $4.10, respectively. The weighted average fair value for
shares issued under the employee stock purchase plan in 1997, 1996 and 1995 was
$3.03, $1.93 and $1.48, respectively.
The fair value of each option granted during the years 1997, 1996 and 1995 is
estimated at the grant date using the Black-Scholes option-pricing model
utilizing the following assumptions:
<TABLE>
<CAPTION>
Employee
Stock
Stock Purchase
Option Plans Plan
------------ --------
<S> <C> <C>
Expected stock price
volatiltiy 60% 60%
Risk-free interest rate 6.0% 6.0%
Expected option life 3-6 years .5-2 years
Expected dividend yield None None
</TABLE>
The activity under the stock option plans for the three years in the period
ended December 31, 1997 was as follows:
<TABLE>
<CAPTION>
Outstanding Options
--------------------------------------------------
Shares Number Price
Available of Per
for Grant Shares Share Total
---------- ------ ----- -----
(In thousands except for price per share)
<S> <C> <C> <C> <C>
Balance at December 31, 1994 158 635 $0.20-$14.25 $ 1,407
Additional shares
reserved 200 --
Options granted (201) 201 $4.75-$ 8.50 1,405
Options exercised -- (201) $0.20-$ 1.60 (133)
Options canceled 84 (84) $0.80-$14.25 (145)
---- ------- -------
Balance at December 31, 1995 241 551 $0.35-$14.25 2,534
Additional shares
reserved 400 --
Options granted (475) 475 $6.25-$16.875 5,924
Options exercised -- (45) $0.35-$ 8.375 (71)
Options canceled 74 (74) $0.80-$16.875 (648)
---- ------- -------
Balance at December 31, 1996 240 907 $0.35-$16.875 7,739
Additional shares
reserved 400 --
Options granted (166) 166 $10.375-$14.375 2006
Options exercised -- (59) $ 0.35 -$14.25 (180)
Options canceled 24 (24) $ 1.60 -$16.875 (275)
---- ------- -------
Balance at December 31, 1997 498 990 $ 0.35 -$16.875 $ 9,290
==== ======= =======
</TABLE>
51
<PAGE> 52
As of December 31, 1997, no shares exercised under the plans were subject to the
right of repurchase and 426,000 of the outstanding options were vested.
The following table summarizes information regarding outstanding stock options
all of which are exercisable, but subject to the right of repurchase by the
Company, at December 31, 1997:
<TABLE>
<CAPTION>
Shares
outstanding
at Weighted Weighted
Range of December Average Average
Exercise 31, 1997 Remaining Exercise
Prices (in thousands) Life (Yrs) Price
------ -------------- ---------- ------
<S> <C> <C> <C>
$ 0.35-$ 1.60 187 5.0 $ 1.46
$ 4.75-$ 7.875 156 7.9 $ 5.94
$ 8.00-$11.75 247 7.8 $10.24
$12.00-$13.375 252 9.1 $12.41
$13.75-$16.875 148 8.3 $16.46
- -------------- ---- --- ------
$ 0.35-$16.875 990 7.7 $ 9.39
============== ==== === ======
</TABLE>
EMPLOYEE STOCK PURCHASE PLAN: In May 1995, the Company adopted an Employee Stock
Purchase Plan (ESPP). The ESPP provides employees an opportunity to purchase
Company stock through payroll deductions, subject to a maximum percentage of
compensation, currently 7%. The purchase price per share is the lower of 85% of
market value on the enrollment date or on the date purchased. Under the plan,
150,000 shares of common stock have been reserved for issuance. For the years
ended December 31, 1997, 1996 and six-month period ended December 31,1995,
27,361, 37,074 and 15,049 shares were issued under the ESPP, respectively.
SHARES RESERVED FOR FUTURE ISSUANCE: As of December 31, 1997, the Company has
reserved approximately 71,000 and 1,488,000 shares of Common Stock for future
issuance under the Employee Stock Purchase Plan and the Company's Stock Option
Plans, respectively.
8. RELATED PARTY TRANSACTIONS
On June 15, 1990, the Company loaned an officer $125,000, bearing interest at
8.82% payable quarterly. The loan is repayable on demand or termination of
employment, whichever is earlier, and is collateralized by stock options with a
value equal to the loan.
9. EMPLOYEE BENEFIT PLANS
During 1989, the Company adopted a qualified profit-sharing plan and trust under
Internal Revenue Service Codes 401(a) and 401(k). The plan provides for
tax-deferred salary deductions whereby employees can elect to contribute up to
20% of their salary (subject to current statutory limits) to the plan. Beginning
in July 1994, the Company matched employee contributions up to 2% of their gross
salary with Company common stock. Such matching contributions become fully
vested when the employee completes five years of service. The Company has the
option to contribute up to an additional 2% based
52
<PAGE> 53
on the achievement of specified corporate goals. The Company contributed 4,651
shares (valued at $46,510), 5,561 shares (valued at $68,817), and 6,436 shares
(valued at $73,210) for the years ended December 31, 1997, 1996 and 1995,
respectively.
10. INCOME TAXES
As of December 31, 1997, the Company had federal net operating loss
carryforwards of approximately $49,000,000. The Company also had federal
research and development tax credit carryforwards of approximately $1,700,000 as
of December 31, 1997. The net operating loss and credit carryforwards will
expire at various dates beginning in 2002 through 2012 if not utilized.
Significant components of the Company's deferred tax assets and liabilities for
federal and state income taxes as of December 31, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
(In thousands) 1997 1996
--------- ---------
<S> <C> <C>
Net operating loss carryforwards $ 17,300 $ 12,900
Research credit
carryforwards (expire 2002-2012) 2,400 1,900
Capitalized research & development 700 700
Other - net 200 200
---------- ----------
Net deferred tax assets 20,600 15,700
Valuation allowance (20,600) (15,700)
---------- ----------
Total $ - $ -
========== ==========
</TABLE>
Because of the Company's lack of an earnings history, the deferred tax asset has
been fully offset by a valuation allowance. The net valuation allowance
increased by $4,900,000, and $3,500,000 for the years ended December 31, 1997
and 1996, respectively.
Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the "change in ownership" provisions of the
Internal Revenue Code of 1986 and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilization.
53
<PAGE> 54
11. MAJOR CUSTOMERS AND EXPORT SALES
In 1997, no customer accounted for more than 10% of the Company's revenues. In
1996, four unaffiliated customers accounted for approximately 28% ($816,000),
25% ($736,000), 18% ($519,000), and 15% ($430,000) of the Company's revenues. In
1995, four unaffiliated customers accounted for approximately 24% ($1,322,000),
18% ($955,000), 17% ($900,000), and 14% ($750,000) of the Company's revenues.
Export sales, principally to Canada and France, were $984,000, $1,115,000 and
$1,400,000 in 1997, 1996 and 1995, respectively.
12. SUBSEQUENT EVENTS
On January 21, 1998, the Company entered into an agreement with an investment
group for an equity line of credit which allows the Company to access up to $10
million through sales of its common stock over a two year period. The decision
to draw any funds and the timing of any such draw is solely at the Company's
discretion. Should the Company draw upon the equity line of credit, any shares
sold would be at a discount to the average trading price of the Company's stock
over a specified period at the time of the draw. Drawing under the equity line
of credit is subject to the satisfaction of certain conditions, including
registration of the shares, a minimum trading price per share, and certain
limitations on the number of shares of the Company's common stock being held by
the investment group at any point in time. In conjunction with the equity line
of credit agreement, the Company issued the investment group a three-year
warrant for 25,000 shares of common stock at an exercise price of $12.66.
In January 1998, Penederm announced that it had licensed Permethrin Cream 5%
from Alpharma Inc. for marketing under the brand name Acticin in the United
States. Under the terms of the agreement, Alpharma will manufacture and supply
the product to Penederm, and the Company will pay Alpharma upfront milestones
and royalties based upon product sales and profits.
54
<PAGE> 55
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item with respect to executive officers
is set forth in Part I of this report and the information with respect to
directors is incorporated by reference to the information set forth under the
caption "Election of Directors" in the Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by
reference to the information set forth under the caption "Executive
Compensation" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by
reference to the information set forth under the caption "Security Ownership of
Certain Beneficial Owners and Management" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by
reference to the information set forth under the caption "Certain Relationships
and Related Transactions" in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)1. FINANCIAL STATEMENTS.
Included in Part II Item 8 of this report.
(a)2. FINANCIAL STATEMENT SCHEDULES.
All schedules have been omitted because the required information is not
present or is not present in amounts sufficient to require submission of the
schedule, or because the information required is included in the consolidated
financial statements, including the notes thereto.
55
<PAGE> 56
<TABLE>
<CAPTION>
(a)3. EXHIBITS:
<S> <C>
3.1 (1) Certificate of Incorporation
3.2 (1) Bylaws
4.1 (2) Specimen Common Stock Certificate
10.1A (3) Employee Stock Option Plan, as amended
10.1B (3) Consultant Stock Option Plan, as amended
10.1C (4) Equity Incentive Plan
10.1D (3) 1994 Nonemployee Directors Stock Option Plan
10.1E (4) Employee Stock Purchase Plan
10.3 (2) Employment Agreement dated May 10, 1993 between the
Company and Lloyd H. Malchow
+10.4B (2) Incentive Stock Option Agreement dated September 12, 1991
between the Company and John W. Quigley, Jr., as amended
February 25, 1993
+10.4J (5) 1995 Performance Share Award Agreement - Lloyd H. Malchow
+10.4K (5) 1995 Performance Share Award Agreement - John W. Quigley
+10.4N (6) 1995 Performance Share Award Agreement - William Gutshall
+10.4O (7) 1996 Performance Share Award Agreement - Lloyd H. Malchow
+10.4P (7) 1996 Performance Share Award Agreement - John W. Quigley
+10.4R (7) 1996 Performance Share Award Agreement - William Gutshall
10.4S (8) Form of 1997 Performance Share Award Agreement between
the Company and each of Lloyd H. Malchow, John W.
Quigley, William Gutshall and Edward Ebbers
10.4T Form of 1998 Performance Share Award Agreement between
the Company and each of Lloyd H. Malchow, John W.
Quigley, William Gutshall, Edward Ebbers, Michael Bates
and William Thomas.
10.5A (2) Nonqualified Stock Option Agreement dated March 14, 1991
between the Company and William I. Bergman
10.5B (2) Nonqualified Stock Option Agreement dated September 12,
1991 between the Company and William I. Bergman
10.6 (2) Information and Registration Rights Agreement dated June
1, 1988, as amended through September 4, 1991
10.7 (2) License Agreement, effective April 27, 1988, between the
Company and the Regents of the University of California
10.8 (2) Research and Development Lease dated December 14, 1988,
as amended through February 1, 1991 between the Company
and Vintage Park Associates
10.8B (5) Amendment No. 4 to Vintage Park Research and Development
Lease dated September 30, 1994, between the Company and
Vintage Park Associates
10.8C Vintage Park Research and Development Lease dated May
</TABLE>
56
<PAGE> 57
<TABLE>
<CAPTION>
<S> <C>
21, 1997, between the Company and
WCB Sixteen Limited Partnership.
10.9 Common Stock Investment Agreement between the Company and
Promethean Investment Group L.L.C. dated January 21, 1998
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney (see pages 58-59)
27.1 Financial Data Schedule
</TABLE>
- ---------------
(1) Incorporated by reference to appendices to the Proxy Statement filed
on May 5, 1997 by Penederm Incorporated, a California corporation
which was the predecessor to the Company ("Penederm California").
(2) Incorporated by reference to exhibits to Penederm California's
Registration Statement on Form S-1 (No. 33-67950) effective November
2, 1993.
(3) Incorporated by reference to Exhibits to Registration Statement on
Form S-8 (No. 33-76100) filed on March 4, 1994.
(4) Incorporated by reference to Exhibits to Registration Statement on
Form S-8 (333-32689) filed on August 1, 1997.
(5) Incorporated by reference to Exhibits to Penederm California's Annual
Report on Form 10-K for the Fiscal Year Ended December 31, 1994.
(6) Incorporated by reference to Exhibits to Penederm California's
Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1995.
(7) Incorporated by reference to Exhibits to Penederm California's Annual
Report on Form 10-K for the Fiscal Year Ended December 31, 1995.
(8) Incorporated by reference to Exhibits to Penederm California's Annual
Report on Form 10-K for the Fiscal Year Ended December 31, 1996.
+ Confidential treatment requested.
(b) REPORTS ON FORM 8-K:
None.
57
<PAGE> 58
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant, Penederm Incorporated, a corporation organized and
existing under the laws of the State of California, has duly caused this report
to be signed on its behalf by the undersigned thereunto duly authorized, in the
City of Foster City, State of California, on the 26th day of February, 1998.
PENEDERM INCORPORATED
By /s/ LLOYD H. MALCHOW
-------------------------------------
Lloyd H. Malchow
President and Chief Executive Officer
POWERS OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Lloyd H. Malchow and Michael A. Bates, jointly
and severally, his attorneys-in-fact, each with the power of substitution, for
him in any and all capacities, to sign any amendments to this Annual Report on
Form 10-K and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report on Form 10-K has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ LLOYD H. MALCHOW Director, President and Chief February 26, 1998
- ------------------------- Executive Officer (Principal
Lloyd H. Malchow Executive Officer)
/s/ MICHAEL A. BATES Vice President of Finance and February 26, 1998
- ------------------------- Administration and Chief
Michael A. Bates Financial Officer (Principal
Financial and Accounting
Officer)
/s/ ROBERT F. ALLNUTT
- ------------------------- Director February 26, 1998
Robert F. Allnutt
/s/ WILLIAM I. BERGMAN
- ------------------------- Director February 26, 1998
William I. Bergman
</TABLE>
58
<PAGE> 59
<TABLE>
<CAPTION>
<S> <C> <C>
/s/ DAVID E. COLLINS Chairman of the Board February 26, 1998
- -----------------------------
David E. Collins
/s/ MARK J. GABRIELSON
- ----------------------------- Director February 26, 1998
Mark J. Gabrielson
/s/ HARVEY S. SADOW, Ph.D.
- ----------------------------- Director February 26, 1998
Harvey S. Sadow, Ph.D.
/s/ GERALD D. WEINSTEIN, M.D.
- ----------------------------- Director February 26, 1998
Gerald D. Weinstein, M.D.
</TABLE>
59
<PAGE> 60
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NO. DESCRIPTION PAGES
--- ----------- -----
<S> <C>
3.1 (1) Certificate of Incorporation
3.2 (1) Bylaws
4.1 (2) Specimen Common Stock Certificate
10.1A (3) Employee Stock Option Plan, as amended
10.1B (3) Consultant Stock Option Plan, as amended
10.1C (4) Equity Incentive Plan
10.1D (3) 1994 Nonemployee Directors Stock Option Plan
10.1E (4) Employee Stock Purchase Plan
10.3 (2) Employment Agreement dated May 10, 1993 between the
Company and Lloyd H. Malchow
+10.4B (2) Incentive Stock Option Agreement dated September 12,
1991 between the Company and John W. Quigley, Jr., as
amended February 25, 1993
+10.4J (5) 1995 Performance Share Award Agreement - Lloyd H. Malchow
+10.4K (5) 1995 Performance Share Award Agreement - John W. Quigley
+10.4N (6) 1995 Performance Share Award Agreement - William Gutshall
+10.4O (7) 1996 Performance Share Award Agreement - Lloyd H. Malchow
+10.4P (7) 1996 Performance Share Award Agreement - John W. Quigley
+10.4R (7) 1996 Performance Share Award Agreement - William Gutshall
10.4S (8) Form of 1997 Performance Share Award Agreement between
the Company and each of Lloyd H. Malchow, John W.
Quigley, William Gutshall and Edward Ebbers
10.4T Form of 1998 Performance Share Award Agreement between
the Company and each of Lloyd H. Malchow, John W.
Quigley, William Gutshall, Edward Ebbers, Michael Bates
and William Thomas.
10.5A (2) Nonqualified Stock Option Agreement dated March 14, 1991
between the Company and William I. Bergman
10.5B (2) Nonqualified Stock Option Agreement dated September 12,
1991 between the Company and William I. Bergman
10.6 (2) Information and Registration Rights Agreement dated June
1, 1988, as amended through June 4, 1991
10.7 (2) License Agreement, effective April 27, 1988, between the
Company and the Regents of the University of California
10.8 (2) Research and Development Lease dated December 14, 1988,
as amended through February 1, 1991 between the Company
and Vintage Park Associates
10.8B (5) Amendment No. 4 to Vintage Park Research and Development
Lease dated September 30, 1994, between the
</TABLE>
60
<PAGE> 61
<TABLE>
<CAPTION>
<S> <C>
Company and Vintage Park Associates
10.8C Vintage Park Research and Development Lease dated May
21, 1997, between the Company and WCB Sixteen Limited
Partnership.
10.9 Common Stock Investment Agreement between the Company
and Promethean Investment Group L.L.C. dated January 21,
1998
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney (see pages 58-59)
27.1 Financial Data Schedule
</TABLE>
- ---------------
(1) Incorporated by reference to appendices to the Proxy Statement filed
on May 5, 1997 by Penederm Incorporated, a California corporation
which was the predecessor to the Company ("Penederm California").
(2) Incorporated by reference to exhibits to Penederm California's
Registration Statement on Form S-1 (No. 33-67950) effective November
2, 1993.
(3) Incorporated by reference to Exhibits to Registration Statement on
Form S-8 (No. 33-76100) filed on March 4, 1994.
(4) Incorporated by reference to Exhibits to Registration Statement on
Form S-8 (333-32689) filed on August 1, 1997.
(5) Incorporated by reference to Exhibits to Penederm California's Annual
Report on Form 10-K for the Fiscal Year Ended December 31, 1994.
(6) Incorporated by reference to Exhibits to Penederm California's
Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1995.
(7) Incorporated by reference to Exhibits to Penederm California's Annual
Report on Form 10-K for the Fiscal Year Ended December 31, 1995.
(8) Incorporated by reference to Exhibits to Penederm California's Annual
Report on Form 10-K for the Fiscal Year Ended December 31, 1996.
+ Confidential treatment requested.
61
<PAGE> 1
EXHIBIT 10.4T
PENEDERM INCORPORATED
EQUITY INCENTIVE PLAN
PERFORMANCE SHARE AWARD AGREEMENT
This PERFORMANCE SHARE AWARD AGREEMENT (the "Agreement") is made and
entered into effective as of ___________, 1998 (the "Effective Date") by and
between PENEDERM INCORPORATED, a California corporation (the "Company"), and
_________________ ("Employee").
THE PARTIES AGREE AS FOLLOWS:
1. Award Grant. The Company hereby grants to Employee pursuant to the
Company's Equity Incentive Plan (the "Plan"), a copy of the prospectus for such
Plan being attached to this Agreement as Exhibit 1, a performance share award
(the "Award") on the terms and conditions set forth in this Agreement and in the
Plan, the terms and conditions of the Plan being hereby incorporated into this
Agreement by reference.
2. Terms of Award. Employee shall be paid, subject to Sections 4, 5 and
11, an amount equal to the product of (a) a target percentage of the Employee's
base salary (of up to 53%) paid by the Company to Employee during calendar year
1998 in accordance with, and subject to, the achievement of the goals set forth
on the attached Exhibit 2A, multiplied by (b) a weighting factor of 0.50 plus
the percentage of achievement of Employee's 1998 objectives set forth on the
attached Exhibit 2B multiplied by a weighting factor of 0.50.
Exhibit 2C sets forth examples illustrating this Award.
3. Award Determinations. The Compensation Committee of the Board of
Directors of the Company, in its discretion, shall determine whether any or all
of the goals set forth on Exhibits 2A and B have been attained, and all such
determinations shall be final, conclusive and binding upon the Company and
Employee.
4. Employment Condition. Employee must be employed by the Company as of
December 31, 1998, and as of the date of Award payment determined by the Company
so as to be eligible to be paid under the Award. The Award shall be paid on or
before March 31, 1999.
5. Award Payment. The Award shall be paid in cash unless the Board of
Directors of the Company, in its absolute discretion, determines that the Award
shall be paid, in whole or in part, by the issuance to Employee of that number
of shares of Company Common Stock having a value on the date of such
determination equal to the cash payment (or portion thereof) otherwise payable
under the Award.
62
<PAGE> 2
6. Nonassignability of Award. The Award is not assignable or
transferable by Employee.
7. Market Standoff. Employee hereby agrees that if so requested by the
Company or any representative of the underwriters in connection with any
registration of the offering of the securities of the Company under the
Securities Act of 1933, as amended (the "Act"), Employee shall not sell or
otherwise transfer any shares of Company Common Stock issued to Employee
pursuant to the Award for a period of 180 days following the effective date of a
Registration Statement filed under the Act; provided, that such restriction
shall apply only to the first Registration Statement to become effective under
the Act after the date of this Agreement that includes securities to be sold on
behalf of the Company in an underwritten offering under the Act. The Company may
impose stop-transfer instructions with respect to such shares subject to the
foregoing restrictions until the end of such 180-day period.
8. Restriction on Issuance of Shares. The Company shall not be obligated
to issue any shares of Company Common Stock pursuant to this Agreement if such
issuance, in the opinion of the Company and the Company's counsel, might
constitute a violation by the Company of any provision of law, including without
limitation the Act. The Company shall not be obligated to take any affirmative
action to the issuance of any shares pursuant hereto to comply with any law.
9. EMPLOYEE'S REPRESENTATION. EMPLOYEE HEREBY REPRESENTS AND WARRANTS TO
THE COMPANY THAT THE COMPANY HAS MADE NO REPRESENTATIONS OR WARRANTIES TO
EMPLOYEE WITH RESPECT TO THE INCOME TAX CONSEQUENCES OF THE AWARD OR AWARD
PAYMENT AND EMPLOYEE IS IN NO MANNER RELYING ON THE COMPANY OR THE COMPANY'S
REPRESENTATIVES FOR AN ASSESSMENT OF SUCH TAX CONSEQUENCES.
10. Withholding. The Company may withhold from Employee's wages, or
require Employee to pay to the Company, any applicable withholding or employment
taxes resulting from the payment of the Award, in cash or by issuance of Company
Common Stock.
11. Amendment; Termination. The Award may be amended or terminated at any
time in the absolute discretion of the Board of Directors of the Company.
12. Governing Law. This Agreement shall be governed by and construed in
accordance with the laws of the State of California applicable to contracts
entered into and wholly to be performed within the State of California by
California residents.
13. Notices. All notices and other communications under this Agreement
shall be in writing. Unless and until Employee is notified in writing to the
contrary, all notices, communications and documents directed to the Company and
related to this Agreement, if not delivered by hand, shall be mailed, addressed
as follows:
Penederm Incorporated
320 Lakeside Drive, Suite A
63
<PAGE> 3
Foster City, California 94404
Attn: Vice President, Finance and Administration
Unless and until the Company is notified in writing to the contrary, all
notices, communications and documents intended for Employee and related to this
Agreement, if not delivered by hand, shall be mailed to Employee's last known
address as shown on the Company's books. Notices and communications shall be
mailed by first class mail, postage prepaid; documents shall be mailed by
registered mail, return receipt requested, postage prepaid. All mailings and
deliveries related to this Agreement shall be deemed received only when actually
received.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
Effective Date.
PENEDERM INCORPORATED
By:
-------------------------------------------
Lloyd H. Malchow
Title: President and Chief Executive Officer
Employee hereby accepts and agrees to be bound by all of the terms and
conditions of this Agreement and the Plan.
----------------------------------
Employee
Employee's spouse indicates by execution of this Agreement his or her consent to
be bound by the terms hereof as to his or her interests, whether as community
property or otherwise, if any, in the Award granted hereunder and in payment
under the Award.
----------------------------------
Employee's Spouse
64
<PAGE> 4
EXHIBIT 2C
PENEDERM INCORPORATED
EQUITY INCENTIVE PLAN
PERFORMANCE SHARE AWARD AGREEMENT
Performance Share Award Example
The following examples are for an employee with a target percentage of 12.5% are
presented solely for the purpose of illustrating the Award:
Example 1. If 70% of the goals set forth on Exhibit 2A are achieved and
Employee achieves 100% of the objectives set forth on Exhibit 2B, Employee shall
receive 10.625% of base salary (as set forth in Section 2 of the Agreement)
12.5% x ([70% x .5] + [100% x .5]).
Example 2. If 30% of the goals set forth on Exhibit 2A are achieved and
Employee achieves 50% of the objectives set forth on Exhibit 2B, Employee shall
receive 5% of base salary (as set forth in Section 2 of the Agreement) 12.5% x
([30% x .5] + [50% x .5]).
65
<PAGE> 1
EXHIBIT 10.8C
VINTAGE PARK
Foster City, California
RESEARCH AND DEVELOPMENT LEASE
BASIC LEASE INFORMATION
DATE: May 21, 1997 LEASE REFERENCE
LANDLORD: WCB SIXTEEN LIMITED
PARTNERSHIP
TENANT: Penederm, Inc., a
California corporation
PREMISES AND BUILDING: 320 Lakeside Dr., Suite A PARAGRAPH I
Foster City, CA 94404
SQUARE FEET: Approximately 14,842 sq. ft.
TERM COMMENCEMENT: May 1, 1998 PARAGRAPH 2
TERM EXPIRATION: April 30, 2003 PARAGRAPH 2
BASE RENT: PARAGRAPH 3(a)
05/01/98 - 04/30/99 $29,684.00 per mo. $2.00/Sq.Ft.
05/01/99 - 04/30/00 $30,426.10 per mo. $2.05/Sq.Ft.
05/01/00 - 04/30/01 $31,168.20 per mo. $2.10/Sq.Ft.
05/01/01 - 04/30/02 $31,910.30 per mo. $2.15/Sq.Ft.
05/01/02 - 04/30/03 $32,652.40 per mo. $2.20/Sq.Ft.
TENANT'S PERCENTAGE SHARE: 57.69% PARAGRAPH 4(a)
INITIAL ESTIMATED MONTHLY OPERATING
EXPENSES AND PROPERTY TAXES: Not available at this time PARAGRAPH 4(c)
USE: Tenant shall use the Premises for laboratory research PARAGRAPH 6
and development, general office, storage and all other
legally related uses.
SECURITY DEPOSIT: $32,652.40 PARAGRAPH 15
66
<PAGE> 2
TENANT'S ADDRESS FOR NOTICES: PARAGRAPH 19
Penederm, Inc.
320 Lakeside Drive, Suite A
Foster City, California 94404
LANDLORD'S ADDRESS FOR NOTICES:
WCB Sixteen Limited Partnership PARAGRAPH 19
c/o Northwest Asset Management Company, Inc.
393 Vintage Park Drive, Suite 220
Foster City, CA 94404
EXHIBIT(S) AND ADDENDUM: PARAGRAPH 21
Exhibit A: Diagram of Premises
TENANT IMPROVEMENT ALLOWANCE: $50,000.00 PARAGRAPH 2
DATE FOR DELIVERY OF INSTRUCTIONS
The provisions of the Lease identified above in the margin are those provisions
where references to particular Basic Lease Information appear. Each such
reference shall incorporate the applicable Basic Lease Information. In the event
of any conflict between any Basic Lease Information and the Lease, the latter
shall control.
TENANT LANDLORD
Penederm, Inc., WCB SIXTEEN LIMITED PARTNERSHIP,
a Delaware corporation a Delaware corporation
By: WCB SIXTEEN, INC.,
a Delaware corporation
General Partner
By: /s/ William T. Gutshall By: /s/ Wallace G. Murfit
----------------------------- -------------------------
Its: Vice President, Operations Its: Vice President
67
<PAGE> 3
RESEARCH AND DEVELOPMENT
NET LEASE
---------------------
THIS LEASE, dated May 21, 1997 for purposes of reference only, is made and
entered into by and between WCB SIXTEEN LIMITED PARTNERSHIP, a Delaware limited
partnership ("Landlord") and Penederm, Inc., a California corporation
("Tenant").
WITNESSETH
1. PREMISES. Landlord hereby leases to Tenant, and Tenant hereby leases from
Landlord for the term of this Lease and at the rental and upon the conditions
set forth below, the premises described in the Basic Lease information and
identified on the floor plan attached hereto as Exhibit A. Subject to any
obligations of Landlord as set forth in an exhibit to this Lease relating to
initial improvement of the premises. Tenant shall accept the premises in its
"as-is" condition at the commencement of the term. The premises are located
within the building (the "Building") commonly known as described in the Basic
Lease Information.
2. TERM. The term of this Lease shall commence and, unless sooner terminated as
hereinafter provided, shall and on the dates respectively specified in the Basic
Lease Information. If Landlord, for any reason whatsoever, cannot deliver
possession of the premises to Tenant at the commencement of the term, this Lease
shall not be void or voidable, nor shall Landlord be liable to Tenant for any
loss or damage resulting therefrom, but in that event, subject to any contrary
provisions in any agreement with Landlord related to the initial improvement of
the premises, rental shall be waived for the period between commencement of the
term and the time when Landlord can deliver possession. No delay in delivery of
possession shall operate to extend the term.
3. RENT.
(a) Tenant shall pay to Landlord as rental the amount specified in the
Basic Lease Information as the Base Rent, payable in advance on the
commencement of the term and on or before the first day of each and
every successive calendar month during the term. If the term
commences on other than the first day of a calendar month, the first
payment of rent shall be appropriately prorated on the basis of a
30-day month.
(b) Tenant shall pay, as additional rent, all amounts of money required
to be paid to Landlord by Tenant hereunder in addition to monthly
rent, whether or not the same be designated "additional rent." If
such amounts are not paid at the time provided in this Lease, they
shall nevertheless be a collectable as additional rent with the next
installment of monthly rent thereafter falling due, but nothing
herein contained shall be deemed to suspend or delay the payment of
any amount of money at the time the same becomes due and payable
hereunder, or limit any other remedy of Landlord.
(c) Tenant hereby acknowledges that late payment by Tenant to Landlord of
rent and other amounts due hereunder after the expiration of any
applicable grace period will cause Landlord to incur costs not
contemplated by this Lease, the exact amount of which will be
extremely difficult to ascertain. Such costs include, but are not
limited to, processing and accounting charges, and late charges which
may be imposed on Landlord by the terms of any trust deed covering
the premises. Accordingly, if any installment of rent or any other
sums due from Tenant shall not be received by Landlord when due,
Tenant shall pay to Landlord a late charge equal to 6% of such
overdue amount. The parties hereby agree that such late charge
represents a fair and reasonable estimate of the costs Landlord will
incur by
68
<PAGE> 4
reason of late payment by Tenant. Acceptance of such late charge by
Landlord shall in no event constitute a waiver of Tenant's
default with respect to such overdue amount, nor prevent Landlord
from exercising any of the other rights and remedies granted
hereunder.
(d) Any amount due to Landlord, if not paid when due, shall bear
interest from the date due until paid at the rate of 10% per
annum or, if a higher rate is legally permissible, at the highest
rate legally permitted, provided that interest shall not be
payable on late charges incurred by Tenant nor on any amounts
upon which late charges are paid by Tenant to the extent such
interest would cause the total interest to be in excess of that
legally permitted. Payment of interest shall not excuse or cure
any default hereunder by Tenant.
(c) All payments due from Tenant to Landlord hereunder shall be made
to Landlord without deduction or offset in lawful money of the
United States of America at Landlord's address for notices
hereunder, or to such other person or at such other place as
Landlord may from time to time designate in writing to Tenant.
4. TAXES AND OPERATING EXPENSES.
(a) This Lease is a net lease and Base Rent and additional rent shall be
paid to and received by Landlord net of all costs and expenses to
Landlord other than taxes upon the income of Landlord from all
sources. Tenant shall pay its percentage share, as specified in the
Basic Lease Information, of all Property Taxes assessed in respect of
the Building during the term, and its percentage share of all
Operating Expenses paid or incurred by Landlord during the term. For
the purposes hereof, "Property Taxes" shall mean all real property
taxes and assessments or governmentally imposed fees or charges (and
any tax or fee levied wholly or partly in lieu thereof) levied,
assessed, confirmed, imposed, or which have become a lien against the
Building (which for the purposes of defining "Property Taxes" shall
include the land underlying the Building) or payable during the term.
For the purposes hereof, "Operating Expenses" shall mean all expenses
and costs of every kind and nature which Landlord shall pay or become
obligated to pay because of or in connection with the ownership and
operation of the Building and surrounding property and supporting
facilities, including, without limitation: (1) all costs of
operation, maintenance and repair of the Building, (2) the cost of
all Insurance maintained by Landlord with respect to the Building,
and (3) the share allocable to the Building of dues and assessments
payable under any reciprocal easement or common area maintenance
agreements or declarations or to any owners' associations affecting
the Building. Landlord shall not collect in excess of one hundred
percent (100%) of all of Landlord's Operating Expenses and Landlord
shall not recover, through Operating Expenses, any item of costs more
than once. Operating Expenses for each calendar year shall be
adjusted to equal Landlord's reasonable estimate of Operating
Expenses had the total rentable area of the Building been occupied.
(b) In the event the Building is not separately assessed for tax
purposes, then the Property Taxes to be paid by Tenant shall be
Tenant's percentage share of the product obtained by multiplying the
total of the real property taxes and assessments levied against the
tax parcel of which the Building is a part by a fraction the
numerator of which is the rentable area of the Building and the
denominator of which is total rentable area of all improvements
located within the tax parcel of which the Building is a part.
(c) Tenant shall pay to Landlord each month at the same time and in the
same manner as monthly rent Tenant's percentage share of 1/12th of
Landlord's estimate of Property Taxes and Operating Expenses for the
then current calendar year, which for the calendar year for term
commencement as set forth in the Basic Lease Information shall be the
monthly amount specified therein. Within 90 days after the
69
<PAGE> 5
close of each calendar year, or as soon after such 90-day period as
practicable, Landlord shall deliver to Tenant a statement of actual
Property Taxes and Operating Expenses for such calendar year. If on
the basis of such statement Tenant owes an amount that is less than
the estimated payments for such calendar year previously made by
Tenant, Landlord shall refund such excess to Tenant. If on the basis
of such statement Tenant owes an amount that is more than the
estimated payments for such calendar year previously made by Tenant,
Tenant shall pay the deficiency to Landlord within 30 days after
delivery of the statement. The obligations of Landlord and Tenant
under this subparagraph with respect to the reconciliation between
estimated payments and actual Property Taxes and Operating Expenses
for the last year of the term shall survive the termination of the
Lease.
5. OTHER TAXES. Tenant shall pay or reimburse Landlord for (i) any taxes upon,
measured by or reasonably attributable to the cost or value of Tenant's
equipment, furniture, fixtures, and other personal property located in the
premises or leasehold improvements made in or to the premises at Tenants
expense, (ii) any taxes, assessments, fees, or charges imposed by any public
authority or private community maintenance association upon or by reason of the
development possession, use or occupancy of the premises or the parking
facilities used by Tenant in connection with the premises, and (iii) any gross
receipts tax imposed with respect to the rental payable hereunder.
6. USE.
(a) The premises shall be used and occupied by Tenant solely for the use
set forth in the Basic Lease Information. Tenant shall, at Tenant's
expense, comply promptly with all applicable statutes, ordinances,
rules, regulations, orders, and requirements in effect during the
term regulating Tenant's activities or the use by Tenant of the
premises. Tenant shall not use or permit the use of the premises in
any manner that will tend to create waste or a nuisance, which shall
tend unreasonably to disturb other tenants of the Building, or which
shall violate the terms of any recorded restrictions affecting the
Building, nor shall Tenant place or maintain any signs on or visible
from the exterior of the premises without Landlord's written consent,
or use any corridors, sidewalks, or other areas outside of the
premises for storage or any purpose other than access to the
premises. Notwithstanding any other provision of this Lease, Tenant
shall not use, keep, or permit to be used or kept on the premises any
foul or noxious gas or substance or any hazardous or toxic material,
nor shall Tenant do or permit to be done anything in and about the
premises, either in connection with activities hereunder expressly
permitted or otherwise, which would cause a cancellation of any
policy of insurance maintained by Landlord in connection with the
premises or the Building or which would violate the terms of any
covenants, conditions, or restrictions affecting the Building or the
land on which it is located.
(b) Tenant shall not cause, or allow anyone else to cause, any hazardous,
toxic, or radioactive materials (collectively "Hazardous Materials")
to be used, generated, stored, or disposed of on or about the
premises or the Building without the prior written consent of
Landlord, which consent may be withheld in the sole discretion of
Landlord, and which consent may be revoked at any time. Tenant shall
strictly comply with all statutes, laws, ordinances, rules,
regulations, and precautions now or hereafter mandated or advised by
any federal, state, local or other governmental agency with respect
to the use, generation, storage, or disposal of Hazardous Materials.
As herein used, Hazardous Materials shall include, but not be limited
to, those materials identified in Sections 66680 through 66685 of
Title 22 of the California Administrative Code, Division 4, Chapter
30, as amended from time to time, and those substances defined as
"hazardous substances," "hazardous materials," "hazardous wastes," or
other similar designations in the Comprehensive Environmental
Response, Compensation and Liability Act of 1980, as amended, 42
U.S.C. Section 9601 et seq., the Resource Conservation and Recovery
Act, 42 U.S.C. Section 6901 et seq., the Hazardous Materials
Transportation Act, 49 U.S.C. Section 1801 et seq. and any other
governmental statutes, laws, ordinances, rules, regulations, and
precautions.
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7. UTILITIES.
(a) Tenant shall pay for all water, sewer, gas, electricity, heat,
cooling energy, telephone, refuse collection, and other utility-type
services furnished to Tenant or the premises, together with all
related installation or connection charges or deposits. Wherever it
is practical to do so such services shall be separately metered or
charged to Tenant by the provider thereof and paid for directly by
Tenant. To the extent any of the foregoing services are provided by
Landlord, Tenant shall reimburse Landlord for all costs incurred by
Landlord in connection with the provision of such services based on
Landlord's reasonable estimate of the level of Tenant's use or
consumption of such services. Landlord shall bill Tenant on a monthly
or other periodic basis for such services and payment shall be made
by Tenant within 10 days after submittal of Landlord's statement.
(b) Landlord shall not be in default hereunder or be liable for any
damages directly or indirectly resulting therefrom, and there
shall not be any rent abatement, by reason of any interruption or
curtailment whatsoever in utility services.
8. MAINTENANCE, REPAIRS AND ALTERATIONS.
(a) Subject to the provisions of paragraph 10 below, and except for
damages caused by Tenant, its agents or invitees, Landlord shall keep
in good condition and repair the foundations and exterior walls and
roof of the Building and all common areas within the Building not
leased to tenants. Tenant expressly waives the benefits of any
statute now or hereafter in effect which would otherwise afford
Tenant the right to make repairs at Landlord's expense or to
terminate this Lease because of Landlord's failure to keep the
premises or the Building in good order, condition, and repair.
(b) Tenant shall, at Tenant's expense, maintain the interior portion of
the premises (including, but not limited to, all plumbing and
electrical connections, outlets and lightbulbs) and any exterior
glass or skylights in good condition and repair. If Tenant fails to
do so Landlord may, but shall not be required to, enter the premises
and put them in good condition, and Landlord's costs thereof shall
automatically become due and payable as additional rent Tenant shall
be responsible for the provision, at its own expense, of appropriate
janitorial service for the premises. Tenant shall also cause to be
maintained, at its expense and in good operating condition and
repair, all heat, ventilating, and air conditioning equipment
installed in the premises. If Landlord so elects, Tenant shall retain
the services of Landlord or a maintenance company retained by it to
perform maintenance of Tenant's heating, ventilating and air
conditioning equipment and shall reimburse Landlord for the cost
thereof upon demand. At the expiration of the term Tenant shall
deliver up possession of the premises in good condition and repair,
only ordinary wear and tear excepted.
(c) Tenant shall not, without Landlord's prior consent, make any
alterations, improvements, or additions in or about the premises. In
requesting Landlord's consent, Tenant shall submit to Landlord
complete drawings and specifications describing such work and the
identity of the proposed contractor. As a condition to giving such
consent, Landlord may, among other things, require that Tenant remove
any such alterations, improvements or additions at the expiration of
the term, and to restore the premises to their prior condition.
Before commencing any work relating to alterations, additions, or
improvements affecting the premises, Tenant shall notify Landlord of
the expected date of commencement thereof and of the anticipated cost
thereof, and shall furnish such information as shall reasonably be
requested by Landlord substantiating Tenant's ability to pay for such
work. Landlord shall then have the right at any time and from time to
time to post and maintain on the premises such notices as Landlord
reasonably deems necessary to protect the premises and Landlord from
mechanics' liens or any other liens. In any
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event, tenant shall pay when due all claims for labor or materials
furnished to or for Tenant at or for use in the premises. Tenant
shall not permit any mechanics' liens to be levied against the
premises for any labor or materials furnished to Tenant or claimed to
have been furnished to Tenant or to Tenant's agents or contractors in
connection with work of any character performed or claimed to have
been performed on the premises by or at the direction of Tenant. All
alterations, improvements, or additions in or about the premises
performed by or on behalf of Tenant shall be done in a first-class,
workmanlike manner and in compliance with all applicable laws,
ordinances, regulations, and orders of any governmental authority
having jurisdiction therefor, as well as the requirements of insurers
of the premises and the Building. Upon Landlord's request, Tenant
shall remove any contractor, subcontractor, or material supplier from
the premises and the Building if the work or presence of such person
or entity results in labor disputes in or about the Building, or
damage to the premises or Building. Unless Landlord requires their
removal, as set forth above, all alterations, improvements, or
additions which may be made on the premises shall become the property
of Landlord and remain upon and be surrendered with the premises at
the expiration of the term; provided, however, that Tenant's
machinery, equipment, and trade mixtures, other than any which may be
affixed to the premises so that they cannot be removed without
material damage to the premises, shall remain the property of Tenant
and may be removed by Tenant.
9. INSURANCE AND INDEMNITY.
(a) Tenant shall obtain and maintain during the term of this Lease
general liability insurance on an occurrence basis with a combined
single limit for personal injury and property damage in a form and
with carriers acceptable to Landlord and an amount not less than
$1,000,000, and employer's liability and workers' compensation
insurance as required by law. Tenant's comprehensive general
liability insurance policy shall be endorsed to provide that (i) it
may not be canceled or altered in such a manner as adversely to
affect the coverage afforded thereby without 30 days' prior written
notice to Landlord, (ii) Landlord is named as additional insured,
(iii) the insurer acknowledges acceptance of the mutual waiver of
claims by Landlord and Tenant pursuant to subparagraph (b) below, and
(iv) such insurance is primary with respect to Landlord and that any
other insurance maintained by Landlord is excess and noncontributing
with such insurance. If, in the opinion of landlord's insurance
adviser, based on a substantial increase in recovered liability
claims generally, the specified amounts of coverage are no longer
adequate, such coverage shall be appropriately increased. Prior to
the commencement of the term, Tenant shall deliver to Landlord a
duplicate of such policy or a certificate thereof to Landlord for
retention by it, with endorsements, and at least 30 days prior to the
expiration of such policy or any renewal thereof, Tenant shall
deliver to Landlord a replacement or renewal binder, followed by a
duplicate policy or certificate within a reasonable time thereafter.
If Tenant fails to obtain such insurance or to furnish Landlord any
such duplicate policy or certificate as herein required, Landlord
may, at its election, without notice to Tenant and without any
obligation to do so, procure and maintain such coverage and Tenant
shall reimburse Landlord on demand as additional rent for any premium
so paid by Landlord.
(b) Landlord hereby waives all claims against Tenant, and Tenant's
officers, directors, partners, employees, agents and representatives
for loss or damage to the extent that such loss or damage is insured
against under any valid and collectable insurance policy insuring
Landlord or would have been insured against but for any deductible
amount under any such policy, and Tenant waives all claims against
Landlord including Landlord's officers, directors, partners,
employees, agents, and representatives for loss or damage to the
extent such loss or damage is insured against under any valid and
collectable insurance policy insuring Tenant or required to be
maintained by Tenant under this Lease, or would have been insured
against but for any deductible amount under any such policy.
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(c) As this Lease does not involve the public interest and insurance is
available to Tenant which will protect it against such claims,
damage, injury or death, Tenant hereby waives all claims against
Landlord for damage to any property or injury to or death of any
person in, upon or about the premises or the Building arising at any
time and from any cause. Tenant shall hold Landlord harmless from and
defend Landlord against all claims (except those arising from the
solo negligence or willful misconduct of Landlord, its agents,
employees or contractors) (i) for damage to any property or injury to
or death of any person arising from the use of the premises by
Tenant, or (ii) arising from the negligence or willful misconduct of
Tenant, its employees, agents, or contractors in, upon or about those
portions of the Building other than the premises, or (iii) any breach
or default by Tenant under this Lease. The foregoing indemnity
obligation of Tenant shall include reasonable attorneys' fees,
investigation costs, and all other reasonable costs and expenses
incurred by Landlord from the first notice that any claim or demand
is to be made or may be made. The provisions of this paragraph 9
shall survive the termination of this Lease with respect to any
damage, injury, or death occurring prior to such termination.
10. DAMAGE OR DESTRUCTION.
(a) If during the term the premises are totally or partially destroyed,
or any other portion of the Building is damaged in such a way that
Tenant's use of the premises is materially interfered with, from a
risk which is wholly covered by insurance the proceeds of which are
made available to Landlord, Landlord shall proceed with reasonable
diligence to repair the damage or destruction and this Lease shall
not be terminated; provided, however, that if in the opinion of
Landlord's architect the work of repair cannot be completed in 90
days Landlord may at its election terminate the Lease by notice given
to Tenant.
(b) If during the term the premises are totally or partially destroyed,
or any other portion of the Building is damaged in such a way that
Tenant's use of the premises is materially interfered with, from a
risk which is not wholly covered by insurance, Landlord may at its
election restore the premises or terminate this Lease.
(c) In case of destruction or damage which materially interferes with
Tenant's use of the premises, if this Lease is not terminated as
above provided, rent shall be abated during the period required for
the work of repair based upon the degree of interference with
Tenant's use of the premises. Except for abatement of rent, Tenant
shall have no claim against Landlord for any loss suffered by Tenant
due to damage or destruction of the premises or any work of repair
undertaken as herein provided. The provisions of this paragraph 10
shall supersede any provisions of Section 1932 and Section 1933(4) of
the California Civil Code (which might permit Tenant to terminate the
Lease or withhold rent) to the contrary.
11. EMINENT DOMAIN. If all or any part of the premises shall be taken as a
result of the exercise of the power of eminent domain or sold by Landlord under
threat of the exercise of such power, this Lease shall terminate as to the part
so taken as of the date of taking or sale, and, in the case of a partial taking,
either Landlord or Tenant shall have the right to terminate this Lease as to the
balance of the premises by notice to the other within 30 days after such date if
the portion of the premises taken shall be of such extent and nature as
substantially to handicap, impede or impair Tenant's use of the balance of the
premises for Tenant's purposes. In the event of any taking or such sale,
Landlord shall be entitled to any and all compensation, damages, income, rent,
awards, or any interest therein whatsoever which may be paid or made in
connection therewith, and tenant shall have no claim against Landlord for the
value of any unexpired term of this Lease or otherwise. In the event of a
partial taking or sale of the premises which does not result in a termination of
this Lease, the monthly rental thereafter to be paid shall be equitably reduced
on a square footage basis.
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12. ASSIGNMENT AND SUBLETTING.
(a) Tenant shall not assign this Lease or any interest herein or sublet
the premises or any part thereof without the prior consent of
Landlord, which consent shall not be unreasonably withheld; Tenant
shall not hypothecate this Lease or any interest herein or permit the
use of the premises by any party other than Tenant without the prior
consent of Landlord, which consent may be withheld by Landlord in its
absolute discretion. This Lease shall not, nor shall any interest
herein, be assignable as to the interest of Tenant by operation of
law without the consent of Landlord. Any of the foregoing acts
without such consent shall be void and shall, at the option of
Landlord, terminate this Lease. In connection with each consent
requested by Tenant, Tenant shall submit to Landlord the terms of the
proposed transaction, the identity of the parties to the transaction,
the proposed documentation for the transaction, current financial
statements of any proposed assignee or sublessee and all other
information reasonably requested by Landlord concerning the proposed
transaction and the parties involved therein.
(b) Without limiting the other instances in which it may be reasonable
for Landlord to withhold its consent to an assignment or subletting,
Landlord and Tenant acknowledge that it shall be reasonable for
Landlord to withhold its consent in the following instances:
(1) if the proposed assignee or sublessee is a governmental
agency;
(2) if, in Landlord's reasonable judgment, the use of the premises
by the proposed assignee or sublessee would entail any
alterations which would lessen the value of the leasehold
improvements in the premises, or would require increased
services by Landlord;
(3) if, in Landlord's reasonable judgment, the financial worth of
the proposed assignee or sublessee does not meet the credit
standards applied by Landlord for other tenants under leases
with comparable terms, or the character, reputation or
business of the proposed assignee or sublessee is not
consistent with the quality of the other tenancies in the
Building;
(4) in the case of a subletting of less than the entire premises,
if the subletting would result in the division of the premises
into more than two subparcels, would create a subparcel of a
configuration that is not suitable for normal leasing
purposes, or would require access to be provided through space
leased or held for lease to another tenant or improvements to
be made outside of the premises; or
(5) if at the time consent is requested or at any time prior to
the granting of consent, Tenant is in default under the Lease
or would be in default under the Lease but for the pendency of
any grace or cure period under paragraph 13 below.
(c) If at any time or from time to time during the term of this Lease
Tenant desires to sublet all or any part of the premises, Tenant
shall give notice to Landlord setting forth the terms of the proposed
subletting and the space so proposed to be sublet. Landlord shall
have the option, exercisable by notice given to Tenant within 20 days
after Tenant's notice is given, either to sublet from Tenant such
space at the rental and other terms set forth in Tenant's notice, or,
if the proposed subletting is for the entire premises for a sublet
term ending within the last year of the term of this Lease, to
terminate this Lease. If Landlord does not exercise such option,
Tenant shall be free to sublet such space to any third party on the
same terms set forth in the notice given to Landlord, subject to
obtaining Landlord's prior consent as hereinabove provided.
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(d) As used in this paragraph 12, the term "assign" or "assignment" shall
include, without limitation, any sale, transfer, or other disposition
of all or any portion of Tenant's estate under this Lease, whether
voluntary or involuntary, and whether by operation of law or
otherwise including any of the following:
(1) If Tenant is a corporation: (i) any dissolution, merger,
consolidation, or other reorganization of Tenant or (ii) a
sale of more than 50% of the value of the assets of Tenant or
(iii) if Tenant is a corporation with fewer than 500
shareholders, sale or other transfer of a controlling
percentage of the capital stock of Tenant. The phrase
"controlling percentage" means the ownership of, and the right
to vote, stocks possessing at least 50% of the total combined
voting power of all classes of Tenant's stock issues,
outstanding and permitted to vote for the election of
directors;
(2) If Tenant is a trust the transfer of more than 50% of the
beneficial interest of Tenant, or the dissolution of the
trust;
(3) If Tenant is a partnership or joint venture, the withdrawal,
or the transfer of the interest of any general partner or
joint venturer or the dissolution of the partnership or joint
venture;
(4) If Tenant is composed of tenants-in-common, the transfer of
interest of any co-tenants or the partition or dissolution of
the co-tenancy.
(e) No sublessee (other than Landlord if it exercises its option pursuant
to subparagraph(c) above) shall have a right further to sublet, and
any assignment by a sublessee of its sublease shall be subject to
Landlord's prior consent in the same manner as if Tenant were
entering into a new sublease.
(f) In the case of an assignment, all sums or other economic
consideration received by Tenant as a result of such assignment shall
be paid to Landlord after first deducting the unamortized cost of
leasehold improvements paid for by Tenant, and the cost of any real
estate commissions incurred in connection with such assignment in the
event such consideration is received by Tenant in installments, the
portion of each installment to be paid to Landlord shall be
determined by multiplying the installment by a fraction, the
numerator of which is the total amount of the foregoing permitted
deductions and the denominator of which is the total consideration
receivable by Tenant as a result of such assignment.
(g) In the case of a subletting, all sums or economic consideration
received by Tenant as a result of such subletting shall be paid to
Landlord after first deducting (i) the rental due hereunder, prorated
to reflect only rental allocable to the sublet portion of the
premises, (ii) the cost of leasehold improvements made to the sublet
portion of the premises at Tenant's cost, amortized over the term of
this Lease except for leasehold improvements made for the specific
benefit of the sublessee, which shall be amortized over the term of
the sublease, and (iii) the cost of any real estate commissions
incurred in connection with such subletting, amortized over the term
of the sublease.
(h) Regardless of Landlord's consent, no subletting or assignment shall
release Tenant of Tenant's obligation or alter the primary liability
of Tenant to pay the rental and to perform all other obligations to
be performed by Tenant hereunder. The acceptance of rental by
Landlord from any other person shall not be deemed to be a waiver by
Landlord of any provision hereof. Consent to one assignment or
subletting shall not be deemed consent to any subsequent assignment
or subletting. In the event of default by any assignee of Tenant or
any successor of Tenant in the performance of any of the terms
hereof, Landlord may proceed directly against Tenant without the
necessity of exhausting remedies against such assignee or successor.
Landlord may consent to subsequent assignments or subletting of this
Lease or amendments or modifications to this Lease with assignees of
Tenant, without notifying
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Tenant, or any successor of Tenant, and without obtaining its or
their consent thereto and such action shall not relieve Tenant of
liability under this Lease.
(i) In the event Tenant shall assign or sublet the premises or request
the consent of Landlord to any assignment or subletting or if Tenant
shall request the consent of Landlord for any act that Tenant
proposes to do, then Tenant shall pay Landlord's reasonable
attorneys' fees incurred in connection therewith.
13. DEFAULT BY TENANT.
(a) The following events shall constitute events of default under this
Lease:
(1) a default by Tenant in the payment of any rent or other sum
payable hereunder for a period of 10 days after the same is
due, provided that if Tenant has failed one or more times in
any twelve-month period to pay any rent or other sum within 10
days after the due date, no grace period shall thereafter be
applicable hereunder;
(2) a default by Tenant in the performance of any of the other
terms, covenants, agreements, or conditions contained herein
and, if the default is curable, the continuation of such
default for a period of 10 days after notice by Landlord or
beyond the time reasonably necessary for cure if the default
is of the nature to require more than 10 days to remedy,
provided that if Tenant has defaulted in the performance of
the some obligation one or more times in any twelve-month
period and notice of such default has been given by Landlord
in each instance, no cure period shall thereafter be
applicable hereunder:
(3) the bankruptcy or insolvency of Tenant, any transfer by Tenant
in fraud of creditors, assignment by Tenant for the benefit of
creditors, or the commencement of any proceedings of any kind
by or against Tenant under any provision of the Federal
Bankruptcy Act or under any other insolvency, bankruptcy or
reorganization act unless, in the event any such proceedings
are involuntary, Tenant is discharged from the same within 60
days thereafter; the appointment of a receiver for a
substantial part of the assets of Tenant; or the levy upon
this Lease or any estate of Tenant hereunder by any attachment
or execution; or
(4) the abandonment of the premises.
(b) Upon the occurrence of any event of default by Tenant hereunder,
Landlord may, at its option and without any further notice or demand,
in addition to any other rights and remedies given hereunder or by
law, do any of the following:
(1) Landlord shall have the right, so long as such default
continues, to give notice of termination to Tenant, and on the
date specified in such notice this Lease shall terminate.
(2) In the event of any such termination of this Lease, Landlord
may then or at any time thereafter, re-enter the premises and
remove therefrom all persons and property and again repossess
and enjoy the premises, without prejudice to any other
remedies that Landlord may have by reason of Tenant's default
or of such termination.
(3) In the event of any such termination of this Lease, and in
addition to any other rights and remedies Landlord may have,
Landlord shall have all of the rights and remedies of a
landlord
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provided by Section 1951.2 of the California Civil Code. The
amount of damages which Landlord may recover in event of such
termination shall include, without limitation, (i) the worth
at the time of award (computed by discounting such amount at
the discount rate of the Federal Reserve Bank of San Francisco
at the time of award plus one percent) of the amount by which
the unpaid rent for balance of the term after the time of
award exceeds the amount of rental loss that Tenant proves
could be reasonably avoided, (ii) all legal expenses and other
related costs incurred by Landlord following Tenant's default,
(iii) all costs incurred by Landlord in restoring the premises
to good order and condition, or in remodeling, renovating or
otherwise preparing the premises for reletting, and (iv) all
costs (including, without limitation, any brokerage
commissions) incurred by Landlord in reletting the premises.
(4) For the purpose of determining the unpaid rent in the event of
a termination of this Lease, or the rent due hereunder in the
event of a reletting of the premises, the monthly rent
reserved in this Lease shall be deemed to be the sum of the
rental due under paragraph 3 above and the amounts last
payable by Tenant pursuant to paragraph 4 above.
(5) After terminating this Lease, Landlord may remove any and
all personal property located in the premises and place such
property in a public or private warehouse or elsewhere at the
sole cost and expense of Tenant.
(c) Even though Tenant has breached this Lease and abandoned the
premises, this Lease shall continue in effect for so long as Landlord
does not terminate Tenant's right to possession, and Landlord may
enforce all its rights and remedies under this Lease, including the
right to recover rental as it becomes due under this Lease. Acts of
maintenance or preservation, efforts to relet the premises, or the
appointment of a receiver upon initiative of Landlord to protect
Landlord's interest under this Lease, shall not constitute a
termination of Tenant's right to possession.
(d) The remedies provided for in this Lease are in addition to any other
remedies available to Landlord at law or in equity, by statute or
otherwise.
14. DEFAULT BY LANDLORD. Landlord shall not be in default unless Landlord fails
to perform obligations required of Landlord hereunder within a reasonable time,
but in no event later than 30 days after notice by Tenant to Landlord specifying
wherein Landlord has failed to perform such obligation; provided, however, that
if the nature of Landord's obligation is such that more than 30 days are
required for performance, then Landlord shall not be in default if Landlord
commences performance within such 30 day period and thereafter diligently
prosecutes the same to completion.
15. SECURITY DEPOSIT. On execution of this Lease Tenant shall deposit with
Landlord the sum specified in the Basic Lease Information (the "deposit"). The
deposit shall be held by Landlord as security for the performance by Tenant of
all of the provisions of this Lease. If Tenant fails to pay rent or other
charges due hereunder, or otherwise defaults with respect to any provision of
this Lease, Landlord may use, apply, or retain all or any portion of the deposit
for the payment of any rent or other charge in default, or the payment of any
other sum to which Landlord may become obligated by reason of Tenant's default,
or to compensate Landlord for any loss or damage which Landlord may suffer
thereby. If Landlord so uses or applies all or any portion of the deposit, then
within 10 days after demand therefor Tenant shall deposit cash with Landlord in
an amount sufficient to restore the deposit to the full amount thereof, and
Tenant's failure to do so shall be a material breach of this Lease. Landlord
shall not be required to keep the deposit separate from its general accounts. If
Tenant performs all of Tenant's obligations hereunder, the deposit, or so much
thereof as has not theretofore been applied by Landlord, shall be returned,
without payment of interest for its use, to Tenant (or, at Landlord's option, to
the last assignee, if any, of Tenant's interest hereunder) at the expiration of
the
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term hereof, and after Tenant has vacated the premises. No trust relationship is
created herein between Landlord and Tenant with respect to the deposit.
16. ESTOPPEL CERTIFICATE.
(a) Tenant shall at any time upon not more than 10 days' prior notice
from Landlord execute, acknowledge and deliver to Landlord a
statement certifying (i) that this Lease is unmodified and in full
force and effect (or, if modified, stating the nature of such
modification and certifying that this Lease, as so modified, is in
full force and effect) (ii) the date to which the rent, security
deposit, and other sums payable hereunder have been paid, (iii)
acknowledging that there are not, to Tenant's knowledge, any uncured
defaults on the part of Landlord hereunder, or specifying such
defaults, if any, which are claimed, and (iv) such other matters as
may reasonably be requested by Landlord. Any such statement may be
conclusively relied upon by any prospective purchaser or encumbrancer
of the Building.
(b) Tenant's failure to deliver such statement within such time shall
be conclusive upon Tenant, (i) that this Lease is in full force
and effect, without modification except as may be represented by
Landlord, (ii) that there are no uncured defaults in Landlord's
performance, and (iii) that not more than one month's rent has
been paid in advance.
(c) If Landlord desires to finance or refinance the Building, Tenant
agrees to deliver to any lender designated by Landlord such
financial statements of Tenant as may be reasonably required by
such lender. All such financial statements shall be received by
Landlord in confidence and shall be used only for the purposes
herein set forth.
17. SUBORDINATION. This Lease, at Landlord's option, shall subordinate to any
ground lease, mortgage, deed of trust, or any other hypothecation for security
now or hereafter placed upon the Building and to any and all advances made on
the security thereof and to all renewals, modifications, consolidations,
replacements and extensions thereof. Notwithstanding such subordination,
Tenant's right to quiet possession of the premises shall not be disturbed if
Tenant is not in default and so long as Tenant shall pay the rent and observe
and perform all of the provisions of this Lease, unless this Lease is otherwise
terminated pursuant to its terms. If any mortgagee, trustee, or ground lessor
shall elect to have this Lease prior to the lien of its mortgage, deed of trust
or ground lease, and shall give notice thereof to Tenant, this Lease shall be
deemed prior to such mortgage, deed of trust, or ground lease, whether this
Lease is dated prior to or subsequent to the date of said mortgage, deed of
trust or ground lease or the date of recording thereof. If any mortgage or deed
of trust to which this Lease is subordinate is foreclosed or a deed in lieu of
foreclosure is given to the mortgagee or beneficiary. Tenant shall attorn to the
purchaser at the foreclosure sale or to the grantee under the deed in lieu of
foreclosure; if any ground lease to which this Lease is subordinate is
terminated. Tenant shall attorn to the ground lessor. Tenant agrees to execute
any documents required to effectuate such subordination or to make this Lease
prior to the lien of any mortgage, deed of trust or ground lease, as the case
may be, or to evidence such attornment.
18. ATTORNEYS' FEES. If as a result of any breach or default in the performance
of any of the provisions of this Lease, Landlord uses the services of an
attorney in order to secure compliance with such provisions or recover damages
therefor, or to terminate this Lease or evict Tenant, Tenant shall reimburse
Landlord upon demand for any and all attorneys' fees and expenses so incurred by
Landlord, provided that if Tenant shall be the prevailing party in any legal
action brought by Landlord against Tenant, Tenant shall be entitled to recover
for the fees of its attorneys in such amount as the court may adjudge
reasonable.
19. NOTICES. All notices, consents, demands, and other communications from one
party to the other given pursuant to the terms of this Lease shall be in writing
and shall be deemed to have been fully given when deposited in the United States
mail, certified or registered, postage prepaid, and addressed as follows: to
Tenant at the address specified in the
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Basic Lease Information or to such other place as Tenant may from time to time
designate in a notice to Landlord; to Landlord at the address specified in the
Basic Lease Information, or to such other place and with such other copies as
Landlord may from time to time designate in a notice to Tenant; or, in the case
of Tenant, delivered to Tenant at the premises.
20. GENERAL PROVISIONS.
(a) This Lease shall be governed by and construed in accordance with
the laws of the state of California.
(b) The invalidity of any provision of this Lease, as determined by a
court of competent jurisdiction, shall in no way affect the
validity of any other provision hereof.
(c) This Lease contains all agreements of the parties with respect to
any matter mentioned herein and only may be modified in a writing
executed by the parties.
(d) No waiver by Landlord of any provision hereof shall be deemed a
waiver of any other provision or of any subsequent breach by Tenant
of the same or any other provision. Landlord's consent to or approval
of any act shall not be deemed to render unnecessary the obtaining of
Landlord's consent to or approval of any subsequent act by Tenant.
The acceptance of rent hereunder by Landlord shall not be a waiver of
any preceding breach by Tenant of any provision hereof, other than
the failure of Tenant to pay the particular rent accepted, regardless
of Landlord's knowledge of such preceding breach at the time of
acceptance of such rent.
(e) If Tenant remains in possession of the premises or any part thereof
after the expiration of the term with the consent of Landlord, such
occupancy shall be a tenancy from month to month at a rental in the
amount of twice the last month's rental during the term plus all
other charges payable hereunder, and upon all of the terms hereof.
(f) Subject to the provisions of this Lease restricting assignment or
subletting by Tenant, this Lease shall bind the parties, their
personal representatives, successors, and assigns.
(g) Landlord and Landlord's agents shall have the right to enter the
premises at reasonable times for the purpose of inspecting the same,
showing the same to prospective purchasers or lenders, and making
such alterations, repairs, improvements, or additions to the premises
or to the Building as Landlord may deem necessary or desirable.
Landlord may at any time during the last 120 days of the term place
on or about the premises any ordinary "For Lease" sign.
(h) The voluntary or other surrender of this Lease by Tenant, the mutual
cancellation thereof or the termination of this Lease by Landlord as
a result of Tenant's default shall, at the option of Landlord,
terminate all or any existing subtenancies or may, at the option of
Landlord, operate as an assignment to Landlord of any or all of such
subtenancies.
(i) If Tenant is a corporation, each individual executing this Lease on
behalf of Tenant represents and warrants that he is duly authorized
to execute and deliver this Lease on behalf of the corporation in
accordance with a duly adopted resolution of the Board of Directors
and that this Lease is binding upon the corporation in accordance
with its terms.
(j) The term "Landlord" as used herein means the then owner of the
Building and in the event of a sale of the Building the selling owner
shall be automatically relieved of all obligations of Landlord
hereunder, except for acts or omissions of Landlord theretofore
occurring.
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<PAGE> 15
(k) Tenant covenants for itself, its heirs, executors, administrators.
and assigns, and all persons claiming under or through it, and this
Lease is made and accepted upon it subject to the condition that
there shall be no discrimination against or segregation of any person
or group of persons, on account of race, color, creed, religion, sex,
marital status, national origin, or ancestry in the leasing,
subleasing, transferring, use, occupancy, tenure, or enjoyment of the
premises herein leased nor shall the Tenant itself, or any person
claiming under or through it, establish or permit any such practice
or practices of discrimination or segregation with reference to the
selection, location, number, use, or occupancy of tenants,
subtenants, or vendees in the premises.
(l) The term "day" as used herein means a calendar day.
(m) The obligations of Landlord under this Lease do not constitute
personal obligations of the partners, directors, officers,
shareholders, or trustees of Landlord, and Tenant shall look solely
to the Building and to no other assets of the Landlord or any of its
trustees, partners, officers, directors, employees, or consultants
for satisfaction of any liability in respect of this Lease and Tenant
will not seek recourse against the individual partners, directors,
officers, shareholders, or trustees of Landlord or any of their
personal assets for such satisfaction.
(n) Within 10 days of Landlord's request therefor, Tenant shall execute
and deliver such amendments of this Lease as shall have been required
by Landlord's lender in connection with the making of a loan to be
secured by the premises or the Building, provided such amendment does
not increase the obligations of Tenant under this Lease or materially
adversely affect Tenant's leasehold interest. Such amendment shall
include, without limitation, one requiring Tenant to provide any such
lender with notices hereunder or a copy of notices sent to Landlord
hereunder, or granting any such lender reasonable opportunities to
cure any default by Landlord under this Lease.
21. EXHIBITS. The exhibits and addendum, if any, specified in the Basic Lease
Information are attached to this Lease and by this reference made a part hereof.
IN WITNESS WHEREOF, the parties have executed this Lease on the
respective dates indicated below.
TENANT LANDLORD
Penederm, Inc. WCB SIXTEEN LIMITED PARTNERSHIP,
a California corporation a Delaware limited partnership
By: WCB SIXTEEN, INC.
a Delaware corporation
General Partner
By: /s/ William T. Gutshall By: /s/ Wallace G. Murfit
------------------------------ -------------------------------
Its: Vice President, Operations Its: Vice President
By: ___________________________
Its: __________________________
Date of Execution Date of Execution
by Tenant: 6/18/97 by Landlord: 6/19/97
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EXHIBIT 10.9
PROPRIETARY AND CONFIDENTIAL
COMMON STOCK
INVESTMENT AGREEMENT
Between
Promethean Investment Group L.L.C.
And
Penederm Incorporated
Dated as of January 21, 1998
<PAGE> 2
INVESTMENT AGREEMENT dated as of January 21, 1998 between Promethean
Investment Group L.L.C., a limited liability company organized and existing
under the laws of the State of New York (together with its successors in
interest and assigns or its designees, the "Investor"), and Penederm
Incorporated, a corporation duly organized and existing under the laws of the
State of Delaware (the "Company").
WHEREAS, the parties desire that, upon the terms and subject to the
conditions contained herein, the Investor shall invest up to $10,000,000
(subject to increase as set forth in Section 2.2(a)) in shares (the "Shares") of
the Company's common stock, par value $.01 per share (collectively, the "Common
Stock"),
NOW, THEREFORE, the parties hereto agree as follows:
ARTICLE I
Definitions
Terms used herein which are not defined herein but are defined in the
Registration Rights Exhibit, which is annexed hereto, incorporated herein and
hereby made an integral part hereof shall have the same meaning herein as
therein. This Agreement and the Registration Rights Exhibit attached hereto are
referred to collectively herein as, the "Agreement".
ARTICLE II
Purchase and Sale of Common Stock
Section 2.1. Purchase and Sale of Common Stock. Upon the terms and conditions
set forth herein, the Company shall issue and sell to the Investor, and the
Investor shall purchase from the Company, up to those number of Shares having a
value of $10,000,000 (subject to increase as set forth in Section 2.2(a)).
Section 2.2. Delivery of Put Notices.
(a) At any time and from time to time during the period beginning
on the Business Day following the initial effective date of the Registration
Statement and ending on the earlier of (i) the date twenty-seven (27) months
after the date hereof and (ii) termination of this Agreement in accordance with
Article VIII (the "Open Period"), the Company may, in its sole discretion,
deliver written notices to the Investor (each such notice hereinafter referred
to as a "Put Notice") stating a dollar amount (the "Dollar Amount") of Common
Stock which the Company intends to sell to the Investor within the thirty-five
(35) Business Days (the "Purchase Period") following the date (the
<PAGE> 3
"Put Notice Date") on which the Put Notice is given to the Investor by the
Company in accordance with this Agreement. "Business Day" shall mean any day on
which the Company's Principal Market is open for trading. The Dollar Amount
designated by the Company in any given Put Notice shall be in increments of
$250,000. Notwithstanding anything herein to the contrary, (A) the Investor
shall not be required to purchase during the Purchase Period following a Put
Notice Date a dollar amount of Common Stock which exceeds the lesser of (i) the
Dollar Amount, subject to reduction during the Purchase Period as hereinafter
provided, (ii) $3,000,000, subject to reduction during the Purchase Period as
hereinafter provided, or (iii) twelve percent (12%) of the aggregate Trading
Dollar Value (hereinafter defined) during those of the first thirty (30)
Business Days of the Purchase Period during which the average per share Trading
Dollar Value is $4.50 or more (the lesser of (i), (ii) or (iii) above shall be
referred to herein as the "Required Dollar Amount"), but (B) the Investor may,
at its election and pursuant to its Purchase Notices (hereinafter defined),
purchase during any such Purchase Period up to one hundred thirty percent of the
Required Dollar Amount; provided that (x) the Investor may not, pursuant to
clause (B) of this Section, invest all or any portion of any amount in excess of
a Required Dollar Amount, and (y) a Required Dollar Amount may not in any event
include an amount which, if invested by the Investor hereunder, would result, in
the case of either (x) or (y), in the Investor purchasing, during a Purchase
Period, shares of Common Stock at a price determined in accordance with Section
2.3 hereof which, when aggregated with all other shares of Common Stock acquired
by the Investor pursuant to this Agreement in the 90 calendar days preceding
such Purchase Period, would result in the Investor having purchased pursuant to
this Agreement, during such Purchase Period and such period of 90 calendar days,
shares of Common Stock totaling more than 4.9% of the Common Stock outstanding
on the Put Notice Date for such Purchase Period, as determined in accordance
with Section 13(d) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") and the regulations promulgated thereunder. The Put Notice shall
include a representation of the Company as to the Common Stock outstanding on
the Put Notice Date as determined in accordance with Section 13(d) of the
Exchange Act. In the event that the amount of Common Stock outstanding as
determined in accordance with Section 13(d) of the Exchange Act and the
regulations promulgated thereunder is different on any date during a Purchase
Period than on the Put Notice Date associated with such Purchase Period, the
amount of Common Stock outstanding on such date during such Purchase Period
shall govern for purposes of determining whether the Investor, when aggregating
all purchases of Common Stock made pursuant to this Agreement in the 90 calendar
days preceding such date, would have acquired more than 4.9% of the Common Stock
during such period. The amount provided in clause (A)(i) of this Section 2.2(a)
shall be in effect at the beginning of each Purchase Period but shall be reduced
during such Purchase Period by an amount equal to one-thirtieth of the Dollar
Amount in effect at the beginning of such Purchase Period
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<PAGE> 4
for each trading day during such Purchase Period on which the average per share
Trading Dollar Value is less than $4.50 per share. The amount provided in clause
(A)(ii) of this Section 2.2(a) shall be in effect at the beginning of each
Purchase Period but shall be reduced during such Purchase Period by $100,000 for
each trading day during such Purchase Period on which the average per share
Trading Dollar Value is less than $4.50 per share. For purposes hereof "Trading
Dollar Value" shall mean the dollar value of the Common Stock traded on the
Principal Market for the applicable day or period, provided that individual
trades of 15,000 shares or more on any trading day shall, for this purpose, be
treated as a trade of 10,000 shares at the average per share price at which such
trades of 15,000 shares or more were actually made.
(b) Notwithstanding any of the foregoing, the Company may not deliver a
Put Notice and the Investor shall not be required to purchase any Common Shares
(i) if the Applicable Trading Price (hereinafter defined) on the Business Day
prior to delivery of such Put Notice was less than $4.50 per share, (ii) if
trading of the Common Stock on the Principal Market is suspended or the Common
Stock is delisted or the Company receives notification from the Principal Market
that the Company does not or will not meet the continued listing requirements
for such Principal Market (unless the Company has addressed the matters set
forth in such notification to the reasonable satisfaction of the Investor),
(iii) if the Common Stock is not registered under the Exchange Act or if the
Registration Statement is no longer effective or is subject to a stop order or
its use or the use of the prospectus which is a part thereof is otherwise
suspended, (iv) if a Market Standoff Agreement (as defined in the Registration
Rights Exhibit) is in effect or the Company has delivered a request to the
Investor to enter into a Market Standoff Agreement, or (v) if no trade of the
Common Stock on the Principal Market Occurred on the Business Day prior to the
Put Notice. If (a) the Applicable Trading Price on any trading day during the
Purchase Period associated with an effective Put Notice shall be less than $4.50
per share or (b) any of the events described in clauses (ii) and (iii) above
occurs after an effective Put Notice is so delivered, and if any such
circumstance described in (a) or (b) above so occurs before the entire Required
Dollar Amount of Common Stock covered by such Put Notice shall have been
purchased during the Purchase Period, then the Investor shall have no further
obligation to purchase the balance of such Required Dollar Amount of Common
Stock during such Purchase Period; provided, however, that on any day during the
balance of such Purchase Period upon which such events described in clauses (ii)
and (iii) above do not exist or which follows a trading day upon which the
Applicable Trading Price shall be $4.50 per share or more, the Investor may in
its sole discretion but shall not be required to give the Company one or more
Purchase Notices covering some or all of such balance of the Required Dollar
Amount, as well as some or all of the additional amounts of Common Stock which
the Investor may elect to purchase during such Purchase Period pursuant to
Section 2.2(a)(B) above. The "Applicable Trading Price" with respect to the
Common Stock on any day,
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<PAGE> 5
shall mean the dollar volume-weighted average price of Common Stock reported on
such Business Day (as calculated by Bloomberg Financial Markets through its
"Volume at Price" function) or, in case no sales take place on such day, the
average of the closing bid and asked prices on such prior day, in either case,
as reported on the Bloomberg Financial Markets for such day, or, if not reported
on the Bloomberg Financial Markets, the last quoted price on such prior day (or,
if not so quoted, the average of the last quoted high bid and low asked prices)
in the over the counter market, as reported by NASDAQ or such other system then
in use, or, if on any such prior day no bids are quoted by any such
organization, the average of the closing bid and asked prices on such prior day
furnished by a professional market maker making a market in Common Stock
selected by the Board of Directors of the Company, and, if on any such prior
day, no market maker is making a market in the Common Stock, the fair market
value of the Common Stock as of such prior day determined reasonably and in good
faith by the Board of Directors of the Company.
(c) During the Open Period, Put Notices may be delivered no more
frequently than once in each period of thirty-six (36) consecutive Business
Days, such that Put Notices and associated Purchase Periods do not overlap each
other.
(d) The Investor shall not in any event be required to invest
more than $10,000,000 in the aggregate (excluding additional purchases which may
be made at the election or option of the Investor pursuant to Section
2.2(a)(B)), under or pursuant to Put Notices given hereunder.
(e) During the Open Period, the Company shall deliver such number
of Put Notices to cause the Investor to purchase a Required Dollar Amount of
Common Stock equal to $2,500,000 (the "Minimum Investor Purchase Amount").
During the first twelve (12) months of the Open Period, the Company shall
deliver such number of Put Notices to cause the Investor to purchase a Required
Dollar Amount of Common Stock equal to $1,000,000 (the "First Year Minimum
Investor Purchase Amount").
Notwithstanding the provisions of Section 2.2(e) above, the Company
shall be under no obligation to issue any Put Notices during the term of this
Agreement. If the Company fails to deliver Put Notices sufficient to cause the
Investor to purchase the Minimum Investor Purchase Amount or the First Year
Minimum Investor Purchase Amount, as the case may be, the Company shall not be
considered in default of this Agreement, but the Company shall provide to the
Investor the Shortfall Compensation. For the purposes hereof, "Shortfall
Compensation" shall mean for each $1.00 of the Minimum Investor Purchase Amount
or First Year Minimum Investor Purchase Amount that the Investor is not able to
purchase due to lack of delivery of Put Notice(s), as the case may be, any one
of the following as the Company shall elect in its sole discretion: (i) such
number of shares of Common Stock that are registered and qualified for resale
5
<PAGE> 6
under applicable federal and state securities laws and that would equal $0.07,
(ii) a three-year Common Stock purchase warrant exercisable for such number of
shares of Common Stock that would result in such warrant having a value (using
the Black-Scholes model) equal to $0.07, or (iii) $0.07 in cash. The Shortfall
Compensation shall be due, in the case of the First Year Minimum Investor
Purchase Amount, ten (10) Business Days after the date which is the last day of
the fifteenth month after the date hereof and, in the case the Minimum Investor
Purchase Amount, ten (10) Business days after the date which is twenty-seven
months from the date hereof. The determination of the number of Common Stock
shares or warrant shares under (i) and (ii) above shall be made using the
Applicable Trading Price on the seventh (7th) Business Day of the ten (10)
Business Day period referenced in the preceding sentence. For each $0.07 in cash
or the equivalent amount in shares of Common Stock or a Common Stock purchase
warrant that the Company pays or issues (as the case may be) to the Investor as
Shortfall Compensation with respect to the First Year Minimum Investor Purchase
Amount, the Minimum Investor Purchase Amount shall be reduced by $1.00.
Section 2.3. Determination of Price Per Share. The prices (each, a
"Purchase Period Price Per Share") at which shares that the Company shall be
obligated to issue and sell and the Investor shall be obligated to purchase in
connection with a Put Notice (including, without limitations any such additional
purchases pursuant to Section 2.2(a)(B)) shall be 90.5% (the "Common Stock
Investment Percentage") of the Market Stock Price. For the purposes hereof, the
"Market Stock Price" shall mean the average of each Applicable Trading Price
during the five (5) Business Days immediately preceding a Purchase Notice Date
(hereinafter defined) upon which shares of the Common Stock were traded on the
Principal Market. The number of shares so to be purchased pursuant to each
Purchase Notice shall be rounded to the nearest whole number so as to avoid the
issuance of fractional shares.
Section 2.4. Purchase Closings.
(a) Purchases of Common Stock by the Investor during a Purchase
Period may be made at any time and from time to time during the Purchase Period
pursuant to one or more "Purchase Notices" given by the Investor to the Company
during the Purchase Period, each specifying the dollar amount to be invested by
the Investor pursuant to such Purchase Notice and the Purchase Period Price Per
Share at which Common Stock is to be so purchased pursuant to such Purchase
Notice. If the entire Required Dollar Amount of Common Stock required to be
purchased during such Period shall not have been covered by Purchase Notices
before the last day of the Purchase Period, the Investor shall be deemed so to
have given the Company a Purchase Notice on the last day of the Purchase Period
specifying therein the balance of such Required Dollar Amount of Common Stock so
to be purchased during such Period and the
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<PAGE> 7
Purchase Period Price Per Share applicable to such purchase. Each date upon
which a Purchase Notice is or is deemed so to have been given is herein referred
to as a "Purchase Notice Date."
(b) Each purchase and sale of Common Stock pursuant to a Purchase
Notice (a "Closing") shall take place on the third Business Day following the
delivery of the Purchase Notice to which such Closing relates, or the earliest
date thereafter on which all conditions to Closing have been satisfied. Each
date on which a Closing occurs is referred to herein as a "Closing Date."
(c) (i) On each Closing Date, the Company shall deliver to the
Investor certificates representing the shares of Common Stock to be issued and
sold to the Investor on such date and registered in the name of the Investor or
deposit such shares into the accounts (and the Investor has confirmation that
the shares are in such account) designated by the Investor for the benefit of
the Investor and (ii) on each Closing Date, the Investor shall deliver to the
Company the price to be paid for such shares (after receipt of confirmation of
delivery of such shares), determined as aforesaid, by cashier's check or wire
transfer in immediately available funds to such account as shall be designated
in writing by the Company. In addition, each of the Company and the Investor
shall deliver all documents, instruments and writings required to be delivered
by either of them pursuant to this Agreement at or prior to each Closing.
(d) In the alternative to physical delivery of certificates for
Common Stock, if delivery of the shares of Common Stock may be effectuated by
electronic book-entry through Depository Trust Company ("DTC"), then delivery of
the shares of Common Stock pursuant to such conversion shall, unless requested
otherwise by such Investor (or holder of such shares), settle by book-entry
transfer through DTC by the third Business Day following the Investor's delivery
of a Purchase Notice to the Company. The parties agree to coordinate with DTC to
accomplish this objective.
(e) Subject to the Company's compliance with all of the terms and
conditions of this Agreement, with respect to each Purchase Period, if the
Investor shall fail to purchase the entire Required Dollar Amount by the third
Business Day following the end of such Purchase Period, the Investor shall, in
addition to any other remedies under this Agreement, pay as additional damages
in cash to the Company, on the eighth Business Day following the end of such
Purchase Period and on each succeeding fifth Business Day thereafter until the
Required Dollar Amount is paid, an amount equal to one percent (1%) of the
balance of the Required Dollar Amount that was not paid to the Company for such
Purchase Period.
(f) Subject to the Investor's compliance with all of the terms
and conditions of this Agreement, with respect to each Closing, if the Company
shall
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<PAGE> 8
fail to deliver to the Investor the shares of Common Stock to be issued and sold
to the Investor by the third Business Day following delivery of a Purchase
Notice, whether by physical delivery of certificates or by book-entry transfer
through DTC for such shares of Common Stock, the Company shall, in addition to
any other remedies under this Agreement, pay as additional damages in cash to
the Investor, by the eighth Business Day following the delivery of a Purchase
Notice and on each succeeding fifth Business Day thereafter until the shares of
Common Stock are delivered, an amount equal to one percent (1%) of the value of
the shares not delivered to the Investor by the third Business Day following the
delivery of a Purchase Notice.
Section 2.5. Certain Adjustments. Applicable Trading Prices, Market
Stock Prices, Purchase Period Prices Per Share, the Maximum Common Stock
Issuance (hereinafter defined), the $4.50 amounts provided in Sections 2.2(a)
and 2.2(b) hereof and the $4.50 amounts provided in Section 5.2 shall be
adjusted appropriately to reflect stock splits, stock dividends, combinations
and like transactions affecting the Common Stock.
Section 2.6. Delisting/Deregistration/Suspension. If at any time during
the Open Period or within thirty days after the end of the Open Period, (i) the
Common Stock is delisted from the Principal Market or (ii) the Common Stock is
not registered under the Exchange Act or (iii) trading of the Common Stock on
the Principal Market is suspended for more than four (4) consecutive full
Business Days for any reason(s) specific to the Company which have or are likely
to have, individually or in the aggregate, an effect on the ongoing business,
operations, properties or financial condition of the Company and any other
entities controlled by the Company, taken as a whole, which is material and
adverse to the Company and such entities, taken as a whole or (iv) if any
registration statement with respect to the Common Stock issued or issuable
hereunder (including the Registration Statement) is no longer effective or
subject to a stop order or otherwise suspended by the Company as a result of
action or inaction by the Company, and if, in the case of the circumstances
described in clause (iv) of this Section 2.6, such circumstances shall exist for
periods in excess of those provided in Section 7 of the Registration Rights
Exhibit with respect thereto, the Investor shall have the right, at its option
in its sole discretion, which right shall be exercised within thirty days of
such event or occurrence, to sell to the Company, and the Company agrees to buy,
promptly upon the exercise of such right by the Investor, but in any event
within thirty (30) calendar days of the exercise of such right, and subject to
the limitations imposed by the Delaware General Corporation Law, all or any part
of the Common Stock issued to the Investor within 45 Business Days preceding the
Investor's exercise of the option provided to it in this Section 2.6 and then
held by the Investor at a price per share equal to the Market Stock Price at the
time such share was purchased (the "Payment Amount"); provided, however, that
the Company shall be under no obligation to repurchase such shares if the
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Board of Directors of the Company determines in good faith, and the Company
delivers written notice thereof to the Investor, that the repurchase is
prohibited by the provisions of Section 160 of the Delaware General Corporation
Law or any other provision of the Delaware General Corporation Law and further
provided that the number of Shares of Common Stock subject to the Investor's
option hereunder shall in no event exceed the number of such Shares acquired by
the Investor hereunder during the 45 Business Days preceding the Investor's
exercise of the option provided to it in this Section 2.6 and during no part of
which any of the circumstances described in clause (i) through (iv) of this
Section 2.6 existed. If the Company fails to purchase the number of Shares of
Common Stock from the Investor within thirty (30) calendar days of the exercise
of the Investor's option hereunder for any reason other than the repurchase
being prohibited pursuant to the Delaware General Corporation Law, the Company
shall pay to the Investor, on the first Business Day following such thirtieth
calendar day, in addition to and not in lieu of the amount payable by the
Company to the Investor upon exercise of the option, an amount equal to two
percent (2%) of the aggregate Payment Amount then due and payable to the
Investor, in cash or by certified check or wire transfer, plus compounded annual
interest of fifteen percent (15%) on such Payment Amount during the period,
beginning on the day following such thirtieth calendar day, during which such
amount, or any portion, is outstanding.
Section 2.7. Overall Limit on Common Stock Issuable; Minimum Dollar
Amount. Notwithstanding anything herein contained to the contrary, the number of
shares of Common Stock issuable by the Company hereunder shall not exceed twenty
percent of the outstanding Common Stock of the Company as of the date hereof,
subject to appropriate adjustment for stock splits, stock dividends,
combinations or other similar recapitalization affecting the Common Stock, (the
"Maximum Common Stock Issuance"), unless the issuance of Common Stock hereunder
in excess of the Maximum Common Stock Issuance shall first be approved by the
Company's stockholders in accordance with applicable law and the by-laws of the
Company. Without limiting the generality of the foregoing, such stockholders'
approval will duly authorize the issuance by the Company of shares of Common
Stock totaling twenty percent or more of the Company's Common Stock outstanding
on the date hereof. The parties understand and agree that the Company's failure
to obtain such approval shall in no way adversely affect the validity and due
authorization, as provided in Sections 4.4 and 4.6 hereof of the issuance and
sale of Common Stock hereunder, and that such approval pertains only to the
applicability of the Maximum Common Stock Issuance limitation provided in this
Section 2.7.
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ARTICLE III
Representations and Warranties of Investor
The Investor represents and warrants to the Company that:
Section 3.1. Intent. The Investor will be purchasing the Common Stock to
be purchased by it hereunder for its own account and the Investor has no present
intention or arrangement (whether or not legally binding) at any time to sell or
distribute any such Common Stock to or through any person or entity; provided,
however, that by making the representations herein, the Investor does not agree
to hold such Common Stock for any minimum or other specific term and reserves
the right to dispose of such Common Stock at any time in accordance with federal
and state securities laws applicable to such disposition. The Investor
understands that such Common Stock must be held indefinitely unless such Common
Stock is, either at the time of purchase or subsequently, registered under the
Securities Act or an exemption from registration is available. The Investor has
been advised or is aware of the provisions of Rule 144 promulgated under the
Securities Act.
Section 3.2. Sophisticated Investor. The Investor is a sophisticated
investor (as described in Rule 506(b)(2)(ii) of Regulation D promulgated under
the Securities Act ("Regulation D")) and an accredited investor (as defined in
Rule 501 of Regulation D), and the Investor has such experience in business and
financial matters that it is capable of evaluating the merits and risks of an
investment in such Common Stock. The Investor acknowledges that an investment in
the Common Stock is speculative and involves a high degree of risk.
Section 3.3. Authorization, Enforcement. (i) The Investor has the
requisite power and authority to enter into and perform this Agreement all in
accordance with the terms hereof, (ii) the execution and delivery of this
Agreement and the consummation by the Investor of the transactions contemplated
hereby to be performed and observed by the Investor have been duly authorized by
the Investor, (iii) this Agreement has been duly executed and delivered by the
Investor, and (iv) this Agreement constitutes the valid and binding obligation
of the Investor enforceable against the Investor in accordance with its terms,
except where such enforceability may be limited by applicable bankruptcy,
insolvency, or similar laws relating to, or affecting generally the enforcement
of, creditors' rights and remedies or by other equitable principles of general
application or the limitations on indemnification and contribution that may be
imposed by Federal securities laws.
Section 3.4. No Brokers. The Investor has taken no action which would
give rise to any claim by any person for brokerage commission, finder fees, or
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similar payments relating to this Agreement or the transactions contemplated
hereby.
Section 3.5. Not an Affiliate. The Investor is not an officer, director
or "affiliate" (as that term is defined in Rule 405 of the Securities Act) of
the Company.
Section 3.6. Organization and Standing. The Investor is duly organized,
validly existing, and in good standing under the laws of the place of its
organization set forth at the beginning of this Agreement. The Investor, if a
corporation, partnership, trust or other entity, has not been organized,
reorganized or recapitalized specifically for the purpose of investing in the
Company.
Section 3.7. Absence of Conflicts. The execution and delivery of this
Agreement and any other documents or instruments executed in connection
herewith, and the consummation of the transactions contemplated hereby and
thereby, and compliance with the requirements thereof, will not violate the
Investor's organizational documents or any law, rule, regulation, order, writ,
judgment, injunction, decree or award applicable to the Investor, or the
provision of any indenture, instrument or agreement to which the Investor is a
party or is subject, or by which the Investor or any of its assets is bound, or
conflict with or constitute a material default thereunder, or result in the
creation or imposition of any lien pursuant to the terms of any such indenture,
instrument or agreement, or constitute a breach of any fiduciary duty owed by
the Investor to any third party, or require the approval of any third party
pursuant to any material contract, agreement, instrument, relationship or legal
obligation to which the Investor is subject or to which any of its assets,
operations or management may be subject.
Section 3.8. Disclosure, Access to Information. The Investor has
received all documents, records, books and other information pertaining to
Investor's Common Stock investment in the Company that have been requested by
the Investor. The Investor further acknowledges that it understands that the
Company is subject to the periodic reporting requirements of the Exchange Act,
and the Investor has reviewed or received copies of any such reports that have
been requested by it. The Investor has carefully reviewed the representations
concerning the Company contained in this Agreement and has made inquiry
concerning the Company, its business and its personnel; the officers of the
Company have made available to the Investor any and all written information
which it has requested and have answered all inquiries made by the Investor; and
the Investor has sufficient knowledge and experience in investing in companies
similar to the Company so as to be able to evaluate the risks and merits of its
investment in the Company and is able financially to bear the risks thereof.
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Section 3.9. Manner of Sale. At no time was the Investor presented with
or solicited by or through any leaflet, public promotional meeting, television
advertisement or any other form of general solicitation or advertising with
respect to Investor's Common Stock investment.
Section 3.10. Reliance on Company. The Investor acknowledges that it has
had the opportunity to review this Agreement and the transactions contemplated
by this Agreement with its own legal counsel and tax advisors. Except for any
statements or representations of the Company made in this Agreement and the SEC
Documents (as defined below), the Investor is not relying on any other
statements or representations of the Company or any of its representatives or
agents with respect to such investment.
Section 3.11. Hart-Scott-Rodino. (A) The Person (as that term is defined
in 16 C.F.R. ss.801.1(a)(I)) of which the Investor is a part does not have total
assets or annual net sales of $100,000,000 or more, as measured under the
applicable rules and regulations interpreting the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended, ("HSR"), and/or (B) for purposes of
ss.802.9 of HSR, the Investor's acquisition of Common Stock will be made solely
for the purposes of investment and, as a result of such acquisition and any such
conversion or exercise, the Investor will hold ten percent or less of the voting
securities of the Company outstanding on the date hereof, and/or (C) as a result
of such acquisition and any such conversion or exercise, the Investor will not
hold assets or voting securities of the Company valued at more than $1,500,000,
and/or (D) the Investor is an Institutional Investor for purposes of ss.802.64
of HSR, such voting securities of the Company will be acquired directly by the
Investor in the ordinary course of its business and solely for the purpose of
investment (for purposes of such ss.802.64) and, as a result of any such
acquisition the Investor will hold fifteen percent or less of the voting
securities of the Company outstanding on the date hereof or voting securities of
the issuer valued at $25,000,000 or less.
Section 3.12. Ownership of Company Common Stock. Prior to execution of
this Agreement, the Investor does not beneficially own any Common Stock of the
Company.
ARTICLE IV
Representations and Warranties of the Company
The Company represents and warrants to the Investor that:
Section 4.1. Company Status. The Company has registered its Common Stock
pursuant to Section 12(b) or 12(g) of the Exchange Act, is in compliance in all
material respects with all reporting requirements of the Exchange Act, and the
Company has maintained all requirements for the continued listing of its
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Common Stock, and such Common Stock is currently listed on the Principal Market.
As of the date hereof the Company's "Principal Market" is the Nasdaq National
Market.
Section 4.2. Current Public Information. The Company has furnished the
Investor with true and correct copies of the Company's latest proxy statement
and Annual Report on Form 10-K and all reports and other documents filed with
the SEC by the Company since December 31, 1996, pursuant to Sections 13(a),
13(c), 14 and 15(d) of the Exchange Act (collectively, the "SEC Documents")
Section 4.3. General Solicitation in Regard to this Transaction. Neither
the Company nor any of its affiliates nor any distributor or any person acting
on its or their behalf has conducted any "directed selling efforts" (as that
term is defined in Rule 902(b) of Regulation S under the Securities Act) with
respect to the Common Stock which may be acquired hereunder, nor has the Company
conducted any general solicitation (as that term is used in Rule 502(c) of
Regulation D) with respect to any of such Common Stock, nor have they made any
offers or sales of any security or solicited any offers to buy any security,
under circumstances that would require registration of such Common Stock under
the Securities Act.
Section 4.4. Capitalization and Valid Issuance of Stock. As of December
31, 1997, the Company had an authorized capitalization consisting of 30,000,000
shares of Common Stock, par value $.01, and 10,000,000 shares of Preferred
Stock, par value $.01. As of December 31, 1997, the Company had issued and
outstanding 8,154,098 shares of Common Stock and no shares of Preferred Stock.
All options and warrants to acquire shares of the Company's Common Stock, which
were outstanding as of September 30, 1997 or which the Company was obligated to
issue as of September 30, 1997, are described to the extent required in the SEC
Documents. As of December 31, 1997, the Company had outstanding stock options to
acquire a total of 989,865 shares of the Company's Common Stock, which
outstanding options, to the extent issued or granted prior to September 30,
1997, are described to the extent required in the SEC Documents and, to the
extent granted since September 30, 1997, are upon terms which are not materially
different from the terms of those options as have been issued or granted on or
before September 30, 1997. Except as described in the SEC Documents, the Company
has not issued or granted and there are not as of the date hereof outstanding,
nor has the Company undertaken or become obligated to issue or grant, any
convertible securities or, apart from such stock options and warrants
outstanding on the date hereof, any options, warrants or other rights to acquire
Common Stock. All of the issued shares of Common Stock of the Company have been
duly and validly authorized and issued and are fully paid and non-assessable;
the Common Stock issuable pursuant to this Agreement, when issued, sold and
delivered against payment therefor in accordance with the terms of this
Agreement, will be duly and validly issued,
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fully paid and nonassessable; and the holders of outstanding Common Stock of the
Company are not and shall not be entitled to preemptive or other rights afforded
by the Company to subscribe for the capital stock or other securities of the
Company as a result of the sale of the Common Stock to the Investor hereunder.
Section 4.5. Organization and Qualification. The Company is a
corporation duly incorporated, validly existing and in good standing under the
laws of the State of Delaware and has the requisite corporate power to own its
properties and to carry on its business as now being conducted. The Company does
not have any subsidiaries, except for those listed in the SEC Documents. The
Company and each such subsidiary, if any, is duly qualified as a foreign
corporation to do business and is in good standing in every jurisdiction in
which the nature of the business conducted or property owned by it makes such
qualification necessary, other than those in which the failure so to qualify
would not have a Material Adverse Effect. "Material Adverse Effect" means any
effect on the ongoing business, operations, properties or financial condition of
the entity with respect to which such term is used and which is material and
adverse to such entity and other entities controlling or controlled by such
entity, taken as a whole, and/or any condition or situation which would prohibit
or otherwise interfere with the ability of the entity with respect to which said
term is used to enter into and perform its obligations under this Agreement,
including the Registration Rights Exhibit.
Section 4.6. Authorization, Enforcement. (i) The Company has the
requisite corporate power and authority to enter into and perform this Agreement
and to issue the Common Stock pursuant to this Agreement, all in accordance with
the terms hereof, (ii) the execution and delivery of this Agreement and the
issuance of such Common Stock by the Company and the consummation by the Company
of the transactions contemplated hereby to be performed and observed by the
Company have been duly authorized by all necessary corporate action, and no
further consent or authorization of the Company or its Board of Directors or
stockholders is required, (iii) this Agreement has been duly executed and
delivered by the Company, and (iv) this Agreement constitutes the valid and
binding obligation of the Company enforceable against the Company in accordance
with its terms, except as such enforceability may be limited by applicable
bankruptcy, insolvency, or similar laws relating to, or affecting generally the
enforcement of, creditors' rights and remedies or by other equitable principles
of general application or the limitations on indemnification and contribution
that may be imposed by Federal securities laws.
Section 4.7. Corporate Documents. The Company has furnished or made
available to the Investor true and correct copies of the Company's Certificate
of Incorporation, as amended and in effect on the date hereof (the
"Certificate"),
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and the Company's By-Laws, as amended and in effect on the date hereof (the
"By-Laws").
Section 4.8. No Conflicts. The execution, delivery and performance of
this Agreement by the Company and the consummation by the Company of the
transactions contemplated hereby, including without limitation the issuance of
the Common Stock, do not and will not (i) result in a violation of the Company's
Certificate or By-Laws or (ii) conflict with, or constitute a default (or an
event which with notice or lapse of time or both would become a default) under,
or give to others any rights of termination, amendment, acceleration or
cancellation of any material agreement, indenture or instrument to which the
Company or any of its subsidiaries is a party, or (iii) result in a violation of
any federal, state, local or foreign law, rule, regulation, order, judgment or
decree (including federal and state securities laws and regulations) applicable
to the Company or any of its subsidiaries or by which any property or asset of
the Company or any of its subsidiaries is bound or affected (except in the case
of any of clause (i), (ii) or (iii) for such conflicts, defaults, terminations,
amendments, accelerations, cancellations and violations as would not,
individually or in the aggregate, have a Material Adverse Effect). The business
of the Company is not being conducted in violation of any law, ordinance or
regulation of any governmental entity, except for possible violations which
either singly or in the aggregate do not and will not have a Material Adverse
Effect. The Company is not required under federal, state, local or foreign law,
rule or regulation to obtain any consent, authorization or order of, or make any
filing or registration with, any court or governmental agency in order for it to
execute, deliver or perform any of its obligations under this Agreement or issue
and/or sell such Common Stock in accordance with the terms hereof (other than
any SEC, NASD or state securities filings which may be required or permitted to
be made by the Company subsequent to this date hereof, and any registration
statement which may be filed incident to this Agreement), provided that, for
purposes of the representation made in this sentence, the Company is assuming
and relying upon the accuracy of the relevant representations and agreements of
the Investors herein. For purposes of the Company's representations and
warranties as to foreign law, rule or regulation made in clause (iii) above and
in the next preceding sentence of this Section 4.8, such representations and
warranties are made only to the best of the Company's knowledge insofar as the
execution, delivery and performance of this Agreement by the Company and the
consummation by the Company of the transactions contemplated hereby and thereby
are or may be affected by the status of the Investor under or pursuant to any
such foreign law, rule or regulation.
Section 4.9. SEC Documents. The Company has delivered or made available
to the Investor true and complete copies of the SEC Documents (including,
without limitation, proxy information and solicitation materials). The Company
has not provided to the Investor any information which, according
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to applicable law, rule or regulation, should have been disclosed publicly prior
to the date hereof by the Company but which has not been so disclosed. As of
their respective dates, the SEC Documents complied in all material respects with
the requirements of the Exchange Act and the rules and regulations of the SEC
promulgated thereunder, and none of the SEC Documents contained any untrue
statement of a material fact or omitted to state a material fact required to be
stated therein or necessary in order to make the statements therein, in light of
the circumstances under which they were made, not misleading. The financial
statements of the Company included in the SEC Documents comply as to form in all
material respects with applicable accounting requirements and the published
rules and regulations of the SEC. Such financial statements have been prepared
in accordance with generally accepted accounting principles applied on a
consistent basis during the periods involved (except (i) as may be otherwise
indicated in such financial statements or the notes thereto or (ii) in the case
of unaudited interim statements, to the extent they may not include footnotes or
may be condensed or summary statements or to the extent they are subject to
normal year-end audit adjustments) and fairly present in all material respects
the financial position of the Company as of the dates thereof and the results of
operations and cash flows for the periods then ended (subject, in the case of
unaudited statements, to normal year-end audit adjustments).
Section 4.10. No Material Adverse Change. Since December 31, 1996, no
event which had or is likely to have a Material Adverse Effect on the Company
has occurred or exists.
Section 4.11. No Undisclosed Liabilities. The Company and its
subsidiaries have no liabilities or obligations which are material, individually
or in the aggregate, and which are not disclosed in the SEC Documents, other
than those incurred in the ordinary course of the Company's or its subsidiaries'
respective businesses since December 31, 1996, and which, individually or in the
aggregate, have had or are likely to have a Material Adverse Effect on the
Company and upon any of its subsidiaries.
Section 4.12. No Undisclosed Events or Circumstances. No event or
circumstance has occurred or exists with respect to the Company or its
subsidiaries or their respective businesses, properties, prospects, operations
or financial condition, which, under applicable law, rule or regulation,
requires public disclosure or announcement prior to the date hereof by the
Company but which has not been so publicly announced or disclosed.
Section 4.13. No Integrated Offering. Prior to the date hereof, neither
the Company, nor any of its affiliates, nor any person acting on its or their
behalf has, directly or indirectly, made any offers or sales of any security or
solicited any offers to buy any security, other than pursuant to this Agreement,
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under circumstances that would require registration under the Securities Act of
the Common Stock issuable hereunder.
Section 4.14. No Brokers. The Company has taken no action which would
give rise to any claim by any person for brokerage commissions, finder's fees or
similar payments by the Investor relating to this Agreement or the transactions
contemplated hereby and thereby.
Section 4.15. Litigation and Other Proceedings. Except as may be set
forth in the SEC Documents, there are no lawsuits or proceedings pending or
threatened, against the Company, nor has the Company received any written or
oral notice of any such action, suit, proceeding or investigation, which, if
decided adversely, is reasonably expected to have a Material Adverse Effect on
the Company or which might materially and adversely affect this Agreement or the
transactions contemplated by this Agreement. Except as set forth in the SEC
Documents, no judgment, order, writ, injunction or decree or award has been
issued by or requested of any court, arbitrator or governmental agency which is
reasonably expected to result in a Material Adverse Effect on the Company or
which might materially and adversely affect the transactions contemplated by
this Agreement.
ARTICLE V
Covenants of The Company
Section 5.1. Registration Rights. The Registration Rights Exhibit is
hereby incorporated herein by reference and is hereby made an integral part
hereof as though fully set forth herein.
Section 5.2. Reservation of Common Stock. As of the date hereof, the
Company has reserved and the Company shall continue to reserve and keep
available at all times, free of preemptive rights, shares of Common Stock for
the purpose of enabling the Company to satisfy any obligation to issue shares of
its Common Stock hereunder; provided, however, that the number of shares of
Common Stock initially so reserved, as of the beginning of each such fiscal
quarter, on the date hereof shall not be less than 1,200,000 shares and provided
further that in no event shall the number of shares so reserved be less than the
number which might thereafter be issued at the Purchase Period Price Per Share
of the Common Stock on the Principal Market as of the last trading day of the
immediately preceding fiscal quarter. The number of shares so reserved from time
to time, as theretofore increased or reduced as hereinafter provided, may be
reduced by the number of shares of Common Stock actually delivered hereunder and
the number of shares so reserved shall be increased to reflect stock splits and
stock dividends and distributions and like transactions with respect to the
Common Stock. In the event that, notwithstanding the foregoing,
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the Company determines that it does not have a sufficient number of authorized
shares of Common Stock to reserve and keep available for issuance as described
in this Section 5.2, the Company shall use its best efforts to increase the
number of authorized shares of Common Stock by seeking stockholder approval for
the authorization of such additional shares.
Section 5.3. Listing of Shares. The Company hereby agrees, promptly
following the date hereof, to take such action required, if any, as may be
required to cause 1,200,000 shares of Common Stock which may be or become
issuable hereunder to be listed on the Principal Market as promptly as possible
but no later than ninety (90) days following the date hereof. The Company
further agrees, if the Company applies to have the Common Stock traded on any
other Principal Market, it will include in such application all of the Common
Stock so issuable and will take such other action as is necessary or desirable
to cause the Common Stock to be listed on such other Principal Market as
promptly as possible.
Section 5.4. Exchange Act Registration. The Company will use its best
efforts to cause its Common Stock to continue to be registered under Section
12(b) or 12(g) of the Exchange Act, will comply in all material respects with
its reporting and filing obligations under said Act, and will not take any
action or file any document (whether or not permitted by said Act or the rules
thereunder) to terminate or suspend such registration or to terminate or suspend
its reporting and filing obligations under said Act. The Company will take all
reasonable action necessary to continue the listing and trading of its Common
Stock on the Principal Market and will comply in all material respects with the
Company's reporting, filing and other obligations under the bylaws or rules of
the NASD and the Principal Market.
Section 5.5. A. Legends. Except as hereinafter provided, certificates
evidencing any Common Stock issued hereunder will bear the following legend (the
"Legend").
THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF
1933 OR ANY STATE SECURITIES LAWS. THEY MAY NOT BE SOLD OR OFFERED FOR
SALE EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT AS TO THE
SECURITIES UNDER SAID ACT AND ANY APPLICABLE STATE SECURITIES LAWS
UNLESS AN OPINION OF COUNSEL SATISFACTORY TO THE COMPANY IS OBTAINED TO
THE EFFECT THAT REGISTRATION UNDER SAID ACT IS NOT REQUIRED.
On the date hereof, the Company will issue to the transfer agent for its
Common Stock (and to any substitute or replacement transfer agent for its Common
Stock coterminous with the Company's appointment of any such
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substitute or replacement transfer agent) instructions in substantially the form
and substance of the Transfer Agent Irrevocable Instruction Exhibit which is
annexed hereto and hereby made a part hereof as Exhibit 5.5. Such instructions
shall be irrevocable by the Company from and after the date hereof or from and
after the issuance thereof to any such substitute or replacement transfer agent,
as the case may be, except as otherwise expressly provided in the Registration
Rights Exhibit. Notwithstanding the foregoing, such Irrevocable Instruction may
be revoked if required by a change in law, as determined mutually by counsel to
the Company and counsel to the Investor or the successors and assigns of the
Investor. It is the intent and purpose of such instructions, as provided
therein, to require the transfer agent for the Common Stock from time to time to
issue certificates evidencing Common Stock free of the Legend and/or stock
transfer restrictions during the following periods and under the following
circumstances and without consultation by the transfer agent with the Company or
its counsel and without the need for any further advice or instruction to the
transfer agent by or from the Company or its counsel:
(a) For so long as the Registration Statement remains effective,
other than during any period of time (a "Black-Out Period") during which the
Registration Statement is not effective, for any reason or no reason, or during
which the Company has suspended the use of the Registration Statement pursuant
to Section 7 of the Registration Rights Exhibit,
(i) incident to the issuance of Common Stock hereunder
by the Company; and
(ii) upon any surrender of one or more certificates
evidencing Common Stock and which bear the Legend;
provided that in connection with such event, a notice is provided to the
transfer agent and copied to the Company and its counsel representing that (i)
the holder of or the person or entity acquiring such shares of Common Stock has
sold or intends promptly to sell such shares pursuant to and in accordance with
the Registration Statement, including the prospectus delivery requirements
applicable thereto, and that (ii) to the holder's knowledge, which has been
confirmed in writing by the Company, the Registration Statement was or will be
effective on the date of the sale and the sale did not occur or will not occur
during a Black-Out Period, and requesting that certificates for the shares sold
or to be sold be issued free of the Legend to the transferee of the holder or to
the holder, as the case may be; and provided further that if, in the event of
any such representation in accordance with Clause (i) of the preceding proviso,
such certificate evidencing the Common Stock so sold or to be sold is not
delivered incident to or for purposes of the completion of such sale within ten
(10) Business Days after the receipt of such certificate by the Holder or by the
Holder's designee, the Holder will return such certificate to the transfer agent
for the purpose of enabling the transfer agent
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to add the Legend to such Certificate and then return the legended certificate
to the Holder.
(b) At any time from and after the date hereof, upon any
surrender of one or more certificates evidencing Common Stock and which bear the
Legend, to the extent accompanied by a notice requesting the issuance of new
certificates free of the Legend to replace those surrendered and containing or
also accompanied by an opinion of counsel satisfactory to the Company that (i)
the then holder thereof is permitted to dispose thereof pursuant to Rule 144(k)
under the Securities Act or (ii) such holder intends to effect the sale or other
disposition of such stock, whether or not pursuant to the Registration
Statement, to a purchaser or purchasers who will not be subject to the
registration requirements of the Act, or (iii) such holder or the disposition of
such Common Stock is not then subject to such requirements.
B. No Other Legend or Stock Transfer Restrictions. No other
restrictive legends have been or shall be placed on the share certificates
representing such Common Stock and no instructions or "stop transfers," so
called, "stock transfer restrictions," so called, or other restrictions have
been or shall be given to the Company's transfer agent with respect thereto,
other than as expressly set forth in Section 5.5 A. hereof.
C. Investor's Compliance. Nothing in this Section 5.5 shall
affect in any way each holder's obligations under and agreement to comply with
all applicable securities laws upon resale of such Common Stock.
Section 5.6. Corporate Existence. The Company will take all steps
reasonably necessary to preserve and continue the corporate existence of the
Company.
Section 5.7. Additional SEC Documents. The Company will furnish to the
Investors upon request, promptly after the originals thereof are submitted to
the SEC for filing, copies of all SEC Documents so furnished or submitted to the
SEC.
ARTICLE VI
Preliminary Put Notice
In order to provide the Investor's designated representatives adequate
opportunity to conduct appropriate due diligence in connection with each Put
Notice, the Company shall deliver to the Investor, at least seventeen (17)
calendar days prior to the delivery of each Put Notice, a Preliminary Put
Notice, which Notice shall state that the Company is considering delivery of a
Put Notice to the Investor seventeen (17) or more calendar days following
delivery of the Preliminary Put Notice (a "Preliminary Put Period"). In no event
shall
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delivery of a Preliminary Put Notice to the Investor obligate the Company to
deliver any Put Notice to the Investor, provided, however, that if the Company
fails on more than two occasions to deliver a Put Notice within thirty (30) days
of delivery of a Preliminary Put Notice, then the Company shall pay the
reasonable due diligence costs of the Investor with respect to each subsequent
Preliminary Put Notice delivered, not to exceed $15,000 in each such case.
ARTICLE VII
Conditions
Section 7.1. Conditions Precedent to the Obligation of the Company to
Sell Shares. The obligation hereunder of the Company to issue and/or sell the
Shares to the Investor is further subject to the satisfaction, at or before each
Closing, of each of the following conditions set forth below. These conditions
are for the Company's sole benefit and may be waived by the Company at any time
in its sole discretion.
(a) Accuracy of the Investor Representations and Warranties. The
representations and warranties of the Investor shall be true and correct in all
material respects as of the date when made and as of each Closing Date as though
made at that time (except for representations and warranties that speak as of a
particular date or refer to a particular point in time).
(b) Performance by the Investor. The Investor shall have
performed, satisfied and complied in all material respects with all covenants,
agreements and conditions required by this Agreement to be performed, satisfied
or complied with by the Investor at or prior to such date.
(c) No Injunction. No statute, rule, regulation, executive order,
decree, ruling or injunction shall have been enacted, entered, promulgated or
endorsed by any court or governmental authority of competent jurisdiction which
prohibits the consummation of any of the transactions contemplated by this
Agreement.
Section 7.2. Conditions Precedent to the Obligation of the Investor to
Purchase any Shares. The obligation of the Investor hereunder to acquire and pay
for Shares is subject to the satisfaction, at or before each Closing, of each of
the following conditions set forth below. These conditions are for the
Investor's sole benefit and may be waived by the Investor at any time in its
sole discretion.
(a) Accuracy of the Company's Representations and Warranties. The
representations and warranties of the Company shall be true and correct in all
material respects as of the date when made and as of each Closing Date, as
though made at that time (except for (i) representations and warranties that
speak as of a particular date or refer to a particular point in time and (ii)
with
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respect to the representations made in Sections 4.10, 4.11 and 4.15 hereof,
events which occur on or after the date of this Agreement and are disclosed in
SEC filings made by the Company prior to such Closing).
(b) Performance by the Company. The Company shall have performed,
satisfied and complied in all material respects with all covenants, agreements
and conditions required by this Agreement to be performed, satisfied or complied
with by the Company at or prior to such Closing.
(c) Principal Market. Trading in the Company's Common Stock shall
not then be suspended by the SEC or the Principal Market (except for any
suspension of trading of limited duration agreed to between the Company and the
Principal Market, solely to permit dissemination of material information
regarding the Company), and trading in securities generally as reported by the
Principal Market, shall not then be suspended or minimum prices shall not have
been established on securities whose trades are reported by the Principal
Market.
(d) No Injunction. No statute, rule, regulation, executive order,
decree, ruling or injunction shall have been enacted, entered, promulgated or
endorsed by any court or governmental authority of competent jurisdiction which
prohibits the consummation of any of the transactions contemplated by this
Agreement.
(e) Opinion of Counsel, Etc. At the first Closing to occur in
each Purchase Period and at the last Closing to occur in each Purchase Period,
the Investor shall have received an opinion of outside counsel to the Company,
in form attached hereto as Exhibit 7.2(e), dated the effective date of such
Closing.
(f) Effectiveness of Registration Statement. The Registration
Statement shall be effective at the time of each Closing and no stop order
suspending the effectiveness of the Registration Statement shall have been
instituted or shall be pending.
(g) Accuracy of Registration Statement. At the time of each
Closing, subject to Section 9.2(c) hereof, the Registration Statement (including
information or documents incorporated by reference therein) and any amendments
or supplements thereto shall not contain any untrue statement of a material fact
or omit to state any material fact required to be stated therein or necessary to
make the statements therein, in light of the circumstances under which they were
made, not misleading.
(h) Auditor's Letter. At the first Closing to occur in each
Purchase Period, the Investor shall have received a letter of the type, in the
form and with the substance of the letter described in Section 2(b)(iii) of the
Registration Rights Exhibit.
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(i) Officer's Certificate. At each Closing the Investor shall
have received a certificate(s) substantially in the form of the certificate
attached hereto as Exhibit 7.2(i) from the CEO and/or CFO of the Company
relating to the representations and warranties of the Company herein which shall
be satisfactory to the Investor in form and substance.
(j) No Bankruptcy Filing. There shall have been no filing of a
petition in bankruptcy, either voluntarily or involuntarily with respect to the
Company and there shall not have been commenced any proceedings under any
bankruptcy or insolvency laws, or any laws relating to the relief of debtors,
readjustment of indebtedness or reorganization of debtors, and there shall have
been no calling of a meeting of creditors of the Company or appointment of a
committee of creditors or liquidating agents or offering of a composition or
extension to creditors by, for, with or without the consent or acquiescence of
the Company.
ARTICLE VIII
Termination
Section 8.1. Optional Termination. This Agreement may be terminated (i)
at any time by the mutual written consent of the Company and the Investor and
upon payment by the Company to the Investor of the amount of the Shortfall
Compensation, if any, then due, or (ii) at any time upon written notice
delivered to the Investor by the Company and upon payment by the Company to the
Investor of the amount of the Shortfall Compensation, if any, then due. The
representations, warranties and covenants contained in or incorporated into this
Agreement, insofar as applicable to the transactions consummated hereunder prior
to such termination, shall survive its termination for the period of any
applicable statute of limitations.
Section 8.2. Automatic Termination. This Agreement shall automatically
terminate without any further action of either party hereto (a) when the
Investor has invested an aggregate of $10,000,000 in the Common Stock of the
Company pursuant to this Agreement, apart from additional amounts which may be
invested pursuant to Section 2.2(a); provided that the representations,
warranties and covenants contained in this Agreement insofar as applicable to
the transactions consummated hereunder prior to such termination, shall survive
the termination of this Agreement for the period of any applicable statute of
limitations or (b) on the date which is 27 months from the date hereof.
All representations, warranties and covenants shall survive the
termination of this Agreement.
Section 8.3. Change in Control. From and after the date hereof upon any
Change of Control (as defined below), the Company shall no longer have the right
to deliver any
23
<PAGE> 24
Put Notice to the Investor but shall pay to the Investor, in cash, on the
Business Day prior to such Change of Control the amount of any Shortfall
Compensation, if any, then due, unless otherwise agreed by the Investor. A
"Change of Control" shall mean any transaction or series of transactions which
results in any person or affiliated group of persons becoming the beneficial
owner of 50% or more of the voting stock of the Company or constituting 50% or
more of the Company's board of directors.
ARTICLE IX
Miscellaneous
Section 9.1. Fees and Expenses. (a) Upon execution of this Agreement (i)
the Company shall pay to the Investor an amount equal to $150,000 by cashier's
check or wire transfer in immediately available funds to such account as shall
be designated in writing by the Investor and (ii) the Company shall issue to the
Investor a three-year Common Stock purchase warrant exercisable for 25,000
shares of Common Stock at an exercise price equal to 125% of the closing market
price of the Common Stock on the Business Day immediately preceding the date
hereof.
(b) As a further inducement to the Investor to enter into this
Agreement, the Company agrees to reimburse the Investor or its designees or
clients, as applicable, for reasonable expenses relating to the negotiation and
execution of this Agreement and any closings hereunder up to $50,000 in the
aggregate. Such amounts to be paid promptly upon submission of an invoice by the
Investor to the Company.
(c) Except as otherwise set forth in this Section 9.1 and Article
VI, each party shall pay the fees and expenses of its advisers, counsel,
accountants and other experts, if any, and all other expenses incurred by such
party incident to the negotiation, preparation, execution, delivery and
performance of this Agreement. Any attorneys' fees and expenses incurred by
either the Company or by any Holder in connection with the preparation,
negotiation, execution and delivery of any amendments to this Agreement or
relating to the enforcement of the rights of any party, after the occurrence of
any breach of the terms of this Agreement by another party or any default by
another party in respect of the transactions contemplated hereunder, shall be
paid on demand by the party which breached the Agreement and/or defaulted, as
the case may be. The Company shall pay all stamp and other taxes and duties
levied in connection with the issuance of any Shares issued pursuant hereto.
Section 9.2. Specific Enforcement; Consent to Jurisdiction.
(a) The Company and the Investor acknowledge and agree that
irreparable damage would occur in the event that any of the provisions of this
24
<PAGE> 25
Agreement were not performed in accordance with their specific terms or were
otherwise breached. It is accordingly agreed that the parties shall be entitled
to an injunction or injunctions to prevent or cure breaches of the provisions of
this Agreement and to enforce specifically the terms and provisions hereof, this
being in addition to any other remedy to which either of them may be entitled by
law or equity.
(b) Each of the Company and the Investor (i) hereby irrevocably
submits to the exclusive jurisdiction of the United States District Court and
other courts of the United States sitting in New York City for the purposes of
any suit, action or proceeding arising out of or relating to this Agreement and,
if such court or courts shall lack or deny jurisdiction thereof, of the courts
of the State of New York sitting in New York City and having jurisdiction
thereof and (ii) hereby waives, and agrees not to assert in any such suit,
action or proceeding, any claim that it is not personally subject to the
jurisdiction of such court, that the suit, action or proceeding is brought in an
inconvenient forum or that the venue of the suit, action or proceeding is
improper. Each of the Company and the Investor consents to process being served
in any such suit, action or proceeding by mailing a copy thereof to such party
at the address in effect for notices to it under this Agreement and agrees that
such service shall constitute good and sufficient service of process and notice
thereof. Nothing in this paragraph shall affect or limit any right to serve
process in any other manner permitted by law.
(c) In the event that a dispute arises between the Company and
the Investor as to whether the condition set forth in Section 7.2(g) hereof has
been satisfied with respect to any Closing, the Investor shall not be required
to perform at such Closing unless such condition has been satisfied to the
Investor's reasonable satisfaction. If any dispute arises with respect to the
foregoing, the Company shall have the burden of proof in showing that the
Investor acted unreasonably.
Section 9.3. Entire Agreement; Amendments. Other than with respect to
matters described in the Registration Rights Exhibit and documents and
agreements relating thereto and hereto, this Agreement contains the entire
understanding of the parties with respect to the transactions contemplated
hereby and, except as specifically set forth herein, neither the Company nor the
Investor makes any representation, warranty, covenant or undertaking with
respect to such matters. No provision of this Agreement may be waived or amended
other than by a written instrument signed by the party against whom enforcement
of any such amendment or waiver is sought.
Section 9.4. Notices. Any notice or other communication required or
permitted to be given hereunder shall be in writing and shall be effective upon
hand delivery or delivery by facsimile at the address or number designated
25
<PAGE> 26
below (if delivered on a Business Day during normal business hours where such
notice is to be received), or the first Business Day following such delivery (if
delivered other than on a Business Day during normal business hours where such
notice is to be received). The addresses for such communications shall be:
to the Company: Penederm Incorporated
320 Lakeside Drive, Suite A
Foster City, CA 94404
Attn: Michael Bates, Chief Financial Officer
Fax: 650-358-0101
with copies to: Richard Friedman
Heller Ehrman White & McAuliffe
525 University Avenue, Suite 900
Palo Alto, CA 94301-1900
Fax: 650-324-0638
to the Investor: Promethean Investment Group, L.L.C.
40 West 57th Street, Suite 1520
New York, New York 10019
Attn: James F. O'Brien, Jr., Managing Member
Fax: 212-698-0505
with copies to: Bingham Dana LLP
150 Federal Street
Boston, Massachusetts 02110
Attn: James C. Stokes, Esq.
Fax: 617-951-8736
Any of the foregoing may from time to time change its address for notices under
this Section 9.4 by giving written notice of such changed address to the other
party hereto.
Section 9.5. Waivers. No waiver by either party of any default with
respect to any provision, condition or requirement of this Agreement shall be
deemed to be a continuing waiver in the future or a waiver of any other
provision, condition or requirement hereof nor shall any delay or omission of
either party to exercise any right hereunder in any manner impair the exercise
of any such right accruing to it thereafter. The parties hereto waive any and
all rights to a jury trial in connection with any action or proceeding arising
under this Agreement or transactions contemplated hereby or thereby.
26
<PAGE> 27
Section 9.6. Headings. The headings herein are for convenience only, do
not constitute a part of this Agreement and shall not be deemed to limit or
affect any of the provisions hereof.
Section 9.7. Successors and Assigns. This Agreement shall be binding
upon and inure to the benefit of the parties and their successors and assigns.
The parties hereto may amend this Agreement without notice to or the consent of
any third party. Neither the Company nor the Investor shall assign this
Agreement or any rights or obligations hereunder without the prior written
consent of the other (which consent may be withheld for any reason in the sole
discretion of the party from whom consent is sought); provided, however, that
the Company may assign its rights and obligations hereunder to any acquirer of
substantially all of the assets or a controlling equity interest of the Company
provided that such assignment shall be subject to (i) the Change of Control
provisions contained in Section 8.3 above, (ii) Investor's prior written consent
which consent may not be unreasonably withheld; and provided further that the
Investor may assign its rights and obligations hereunder to any person or entity
either controlled by the Investor or whose portfolio investments are made
through accounts over which the Investor has discretionary authority without the
Company's consent, and other than those described in the immediately preceding
clause, with the Company's prior written consent, which consent may not be
unreasonably withheld. The assignment by a party of this Agreement or any rights
hereunder shall not affect the obligations of such party under this Agreement.
Section 9.8. No Third Party Beneficiaries. This Agreement is intended
for the benefit of the parties hereto and their respective permitted successors
and assigns and is not for the benefit of, nor may any provision hereof be
enforced by, any other person.
Section 9.9. Governing Law. This Agreement shall be governed by and
construed and enforced in accordance with the internal laws of the State of New
York without regard to the principles of conflict of laws.
Section 9.10. Execution. This Agreement may be executed in two or more
counterparts, all of which shall be considered one and the same agreement and
shall become effective when counterparts have been signed by each party and
delivered to the other party, it being understood that both parties need not
sign the same counterpart. In the event any signature is delivered by facsimile
transmission, the party using such means of delivery shall cause four additional
executed signature pages to be physically delivered to the other party within
five days of the execution and delivery hereof.
Section 9.11. Publicity. The Company and the Investor shall obtain the
prior written consent of the other party before issuing any press releases or
27
<PAGE> 28
otherwise making public statements with respect to the transactions contemplated
hereby, provided the foregoing shall not interfere with the legal obligations of
either party with respect to public disclosure; and provided further, that
neither the Company nor the Investor shall be required to consult with the other
if any such press release or public statement does not specifically name the
other.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
duly executed by their respective authorized officers as of the date hereof.
PENEDERM INCORPORATED
By: /s/ MICHAEL A. BATES
--------------------------------------
Name: Michael A. Bates
Its Vice President, Finance and
Administration
PROMETHEAN INVESTMENT GROUP
L.L.C.
By: /s/ JAMES F. O'BRIEN, JR.
--------------------------------------
James F. O'Brien, Jr.
Managing Member
28
<PAGE> 1
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Forms S-8 File Nos. 33-76100, 33-92844, 333-14317, and 333-32689) pertaining to
Penederm Incorporated's Employee Stock Option Plan, Consultant Stock Option
Plan, Equity Incentive Plan, 1994 Non-Employee Directors Stock Option Plan, and
Employee Stock Purchase Plan, and in the Registration Statement (Form S-3 File
No. 333-22991) of Penederm Incorporated for the registration of 752,000 shares
of its common stock of our report dated January 27, 1998, with respect to the
consolidated financial statements of Penederm Incorporated included in the
Annual Report (Form 10-K) for the year ended December 31, 1997.
/s/ Ernst & Young LLP
Palo Alto, California
February 26, 1998
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<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 1,519
<SECURITIES> 3,102
<RECEIVABLES> 1,013
<ALLOWANCES> 0
<INVENTORY> 1,501
<CURRENT-ASSETS> 7,601
<PP&E> 1,598
<DEPRECIATION> (1,331)
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<CURRENT-LIABILITIES> 5,027
<BONDS> 0
0
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<COMMON> 56,304
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<TOTAL-LIABILITY-AND-EQUITY> 10,231
<SALES> 6,341
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<OTHER-EXPENSES> 6,950
<LOSS-PROVISION> 0
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<INCOME-PRETAX> (12,717)
<INCOME-TAX> 0
<INCOME-CONTINUING> (12,717)
<DISCONTINUED> 0
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