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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
FOURTH AMENDMENT
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-20954
COCENSYS, INC.
(EXACT NAME OF REGISTRANT AS
SPECIFIED IN ITS CHARTER)
DELAWARE 33-0538836
(STATE OF INCORPORATION) (IRS EMPLOYER
IDENTIFICATION NO.)
213 TECHNOLOGY DRIVE, IRVINE, CA 92618
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
(949) 753-6100
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Securities registered pursuant to
Section 12(b) of the Act: NONE
Securities registered pursuant to
Section 12(g) of the Act: COMMON STOCK
PAR VALUE $0.001 PER SHARE
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 and 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 number of shares of Common Stock outstanding as of September 28, 1999,
was 1,000, all of which is held by the sole stockholder of the registrant. See
Item 7. "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - RECENT DEVELOPMENTS."
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<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION CONTAINS, IN ADDITION TO HISTORICAL INFORMATION,
CERTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY. FACTORS THAT COULD CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED
BELOW AND ELSEWHERE IN THIS REPORT.
OVERVIEW
Since its inception in February 1989, the Company has devoted substantially
all of its resources to the discovery and development of pharmaceutical products
for the treatment of disorders affecting the brain. The Company has incurred
losses since inception and expects losses to continue for the foreseeable
future, primarily due to the expansion of programs for research and development.
Operating results are expected to fluctuate as a result of uncertainty in the
timing and amount of expenses for product development and in the timing and
amount of revenues to be earned from the achievement of research and development
milestones and sales of Company products, if any. As of December 31, 1998, the
Company's accumulated deficit was approximately $116.2 million.
RESULTS OF OPERATIONS
1998 AS COMPARED TO 1997
The Company's revenues consist of co-promotion revenues and co-development
revenues. Co-promotion revenues arose from contractual agreements that called
for the Company to promote other pharmaceutical companies' products in return
for commissions. Co-development revenues arise from contractual agreements with
large pharmaceutical companies pursuant to which the Company licenses various
commercialization or development rights relating to compounds or performs
research activities in exchange for licensing fees, milestone payments or
research funding. In October 1997, the Company sold its sales and marketing
force to Watson Pharmaceuticals, Inc. ("Watson") and, except for certain
residual items recognized in fiscal 1998, is no longer involved in
co-promotional activities.
CO-PROMOTION REVENUES were $540,000 for the year ended December 31, 1998,
compared to $3.3 million in fiscal 1997. Co-promotion revenues in 1998 resulted
from a bonus related to fiscal 1997 activity that was received and recognized in
the first quarter of 1998.
CO-DEVELOPMENT REVENUES were $2.0 million for the year ended December 31,
1998, compared to $8.6 million in 1997. The decrease in co-development revenues
of $6.6 million, or 77 percent, compared to the prior year resulted primarily
from an agreement with the Wyeth-Ayerst Laboratories Division of American Home
Products Corporation in May 1997, which provided for a one-time license fee of
$5.0 million plus an additional $2.2 million during 1997 to fund research on a
back-up compound in connection with the Company's anxiolytic program.
RESEARCH AND DEVELOPMENT expenses were $15.7 million in fiscal 1998
compared to $23.3 million in 1997. This decrease of $7.6 million, or 32 percent,
is attributable to a lower level of external clinical trials and certain
headcount reductions in the current year in comparison to the prior year. In
fiscal 1997, the Company made significant external expenditures for the
development of compounds treating epilepsy, migraine, acute stroke and insomnia.
In fiscal 1998, external expenditures were focused on clinical trials of the
Company's compound to treat acute migraine and on preclinical testing of the
Company's compound to treat neuropathic pain.
MARKETING, GENERAL AND ADMINISTRATIVE expenses were $3.9 million in fiscal
1998 compared to $10.0 million in 1997. This decrease of $6.1 million, or 61
percent, is due to the disposition of the sales and marketing force in October
1997. As a result of this transaction, the Company incurred nine months of
expense associated with the sales function in fiscal 1997 compared to no expense
in fiscal 1998.
2
<PAGE>
GAIN ON DISPOSITION OF SALES FORCE was $1.0 million in fiscal 1998 compared
to a gain of $4.7 million in 1997. The fiscal 1998 gain related to two deferred
payments that were based on Watson's ability to retain certain percentages of
the sales and marketing force at specified dates subsequent to the sale. No
further payments are due to the Company from Watson.
ACCRETION OF PREFERRED STOCK FOR BENEFICIAL CONVERSION FEATURE was $890,000
in fiscal 1998 whereas there was none in the prior year. The beneficial
conversion feature allows holders of the Company's Series E Convertible
Preferred Stock to convert into common stock at a discount of 10% below the
market price of the common stock starting 122 days after issuance. At the time
the Series E Convertible Preferred Stock was issued in June 1998, $890,000 of
the $8.0 million in proceeds was allocated to the beneficial conversion feature.
This amount was amortized over the 122 day period ended October 8, 1998.
DIVIDENDS ON PREFERRED STOCK were $1.1 million in fiscal 1998 whereas no
dividends were recorded in the prior fiscal year. Of the fiscal 1998 total,
$562,000 related to dividends on the Company's Series D Convertible Preferred
Stock issued in October 1997 and January 1998 to Warner-Lambert Company
("Warner-Lambert") in connection with a research and development program, and
$490,000 related to the Company's Series E Convertible Preferred Stock issued in
June 1998 to private investors. All dividends result in an increase in the value
of outstanding preferred stock and do not involve the payment of any cash.
1997 AS COMPARED TO 1996
CO-PROMOTION REVENUES were $3.3 million for the year ended December 31,
1997, compared to $9.1 million in fiscal 1996. This $5.8 million, or 64 percent,
decrease in 1997 compared to 1996 resulted from the termination of the Novartis
Pharma, A.G. ("Novartis") co-promotion agreement in December 1996, the loss of
co-promotion rights for Cognex(R) in June 1997 and the sale of the sales and
marketing force in October 1997.
CO-DEVELOPMENT REVENUES were $8.6 million for the year ended December 31,
1997, compared to $6.1 million in 1996. This $2.5 million, or 41 percent,
increase in 1997 is primarily attributable to the May 1997 agreement with the
Wyeth-Ayerst mentioned above. In fiscal 1996, the Company recognized $3.6
million related to the G.D. Searle & Co. ("Searle") Development and
Commercialization Agreement in connection with its insomnia program and $2.5
million related to the Novartis Research and Development Agreement in connection
with its compound to treat stroke and traumatic brain injury. The program with
Searle was terminated in July 1998 and the program with Novartis was terminated
effective October 1997.
RESEARCH AND DEVELOPMENT expenses were $23.3 million in fiscal 1997
compared to $20.9 million in 1996. This increase of $2.4 million, or 11 percent,
is attributable to a higher level of clinical activity in the fiscal 1997 in
comparison to fiscal 1996. During 1997, the Company conducted significant
clinical trials for ganaxolone in the treatment of migraine and epilepsy,
licostinel in the treatment of stroke and CCD 3693 in the treatment of insomnia.
During 1996, clinical activities were focused mainly on licostinel for the
treatment of stroke and, to a lesser extent, ganaxolone for the treatment of
epilepsy.
MARKETING, GENERAL AND ADMINISTRATIVE expenses were $10.0 million in fiscal
1997 compared to $13.9 million in 1996. This decrease of $3.9 million, or 28
percent, is due to the disposition of the sales and marketing force in October
1997. As a result of this transaction, the Company incurred nine months of
expense associated with the sales function in fiscal 1997 compared twelve months
of expense in fiscal 1996.
GAIN ON DISPOSITION OF SALES FORCE was $4.7 million in fiscal 1997. This
amount relates entirely to the sale of the sales and marketing force to Watson.
LIQUIDITY AND CAPITAL RESOURCES
From its inception in February 1989 through December 31, 1998, the
3
<PAGE>
Company has financed its operations primarily through private and public
offerings of its equity securities, raising net proceeds of approximately $102.1
million through sales of these securities. At December 31, 1998, the Company's
balances of cash, cash equivalents and investments totaled $12.2 million,
compared to $13.0 million at December 31, 1997.
As of December 31, 1998, the Company had invested $7.7 million in leasehold
improvements, laboratory and computer equipment and office furnishings and
equipment. The Company has financed $3.6 million of these capital additions
through capital lease lines. In addition, the Company leases its laboratory and
office facilities under operating leases. While additional equipment will be
needed as the Company increases its research and development activities, the
Company has no material commitments for the acquisition of property and
equipment.
On June 8, 1998, the Company issued 8,000 shares of Series E Convertible
Preferred Stock with a stated value of $1,000 per share for an aggregate of $8.0
million in a private placement pursuant to Regulation D of the Securities Act of
1933, as amended. See Note 2 of the Notes to Financial Statements "Private
Placement of Preferred Stock," below.
Pursuant to an agreement with Watson, in October 1997, the Company sold its
sales and marketing force, related co-promotion agreements and certain other
assets to Watson for $8.0 million in cash with an additional $1.0 million due to
CoCensys contingent upon the occurrence of specified events. Of this contingent
amount, Watson paid the Company $750,000 in April 1998 and $250,000 in October
1998.
Pursuant to the 1995 collaboration agreement with Warner-Lambert, as
amended and extended in October 1997, Warner-Lambert is obligated to make
certain milestone payments for each compound selected for development, as well
as pay for its share of development costs. Under the terms of the 1995
agreement, Warner-Lambert purchased $2.0 million of CoCensys Common Stock in
October 1995 and an additional $2.0 million of CoCensys Common Stock in March
1997. Under the terms of the 1997 amendment, Warner-Lambert purchased preferred
stock with a face value of $7.0 million, of which Warner-Lambert paid the
Company $1.0 million in October 1997 and $6.0 million in January 1998. Of this
$7.0 million in total proceeds, the Company has allocated $1.6 million to be
recognized as co-development revenue during fiscal 1998, $4.4 million as
preferred stock and $1.0 million as a liability (payable in cash or common stock
at the election of Warner-Lambert) due to Warner Lambert on December 31, 1999.
The preferred stock accrues an imputed non-cash dividend at 12 percent per annum
until its mandatory conversion date in October 2001. If converted on the
mandatory conversion date, the Series D stock would have been converted into
such number of shares of common stock equal to the quotient of the aggregate
face value of the preferred stock divided by the average of the closing prices
of the common stock for a period of thirty (30) trading days ending on the third
trading day prior to the automatic conversion date. The preferred stock is
convertible at an earlier date at the Company's option into such number of
shares of common stock equal to the aggregate original issue price of such
shares divided by the greater of (a) the average of the closing prices of the
common stock for the 30 trading days during the period ending on the third
trading day prior to the date of original issuance of such shares or (b) the
average of the closing prices of the common stock for the 30 trading days during
the period ending on the third trading day prior to the date upon which the
Company notifies the holders of such optional conversion. On August 5, 1999, the
Company converted the Series D preferred stock into 227,425 shares of common
stock in accordance with the terms governing the Series D preferred stock.
Pursuant to the May 1997 Development and Commercialization Agreement with
Wyeth-Ayerst, Wyeth-Ayerst paid the Company a $5.0 million license fee and
purchased 100,000 shares of the Company's Series C Convertible Preferred stock
for $5.0 million. Furthermore, Wyeth-Ayerst is obligated to pay all development
costs associated with Co 2-6749, as well as make milestone payments upon the
occurrence of certain agreed upon events and pay the Company $3.0 million per
year for up to three years to identify back-up compounds. However, if Co 2-6749
fails to meet certain criteria, and the back-up program fails to produce a
back-up compound that meets other certain criteria, Wyeth-Ayerst has the right
to
4
<PAGE>
terminate the back-up program and require CoCensys to reimburse them for
a portion of the back-up funding. As of December 31, 1998, the Company had
$2.6 million of deferred revenue recorded on its balance sheet related to the
Wyeth-Ayerst back-up program.
Pursuant to the Company's Development and Commercialization Agreement with
Searle, both companies were obligated to pay a portion of the development costs
of CCD 3693 and its back-up compounds for the U.S. market. In addition, Searle
purchased 100,000 shares of the Company's Series B Convertible Preferred Stock
for $7.0 million during 1996. In May 1998, the preferred stock converted, in
accordance with its terms, into 200,000 shares of common stock at a conversion
price of $35.00 per share. In July 1998, Searle notified CoCensys that it had
decided not to participate further in the development of the Company's
proprietary compounds for the treatment of insomnia. CoCensys intends to
continue research and development of its compounds to treat insomnia and will
consider seeking a new partner for the program in the future.
CoCensys' operations to date have consumed substantial amounts of cash.
While the Company's cash forecasts for the twelve months ending December 31,
1999, project a positive cash balance, certain cash inflows included in these
forecasts are estimates and are not guaranteed. Should the Company not receive
these anticipated payments, or should the timing or amount of these payments
differ substantially from the forecasted amounts, or should the Company incur
expenses in excess of those currently forecasted, the ability of the Company to
continue funding its operations could be jeopardized. However, the Company is
actively considering three courses of action that management believes will
increase cash inflows, or decrease cash outflows, sufficiently to ensure
adequate funding for its operations through at least fiscal 1999.
First, the Company is aggressively seeking partners for several of its
compounds. The Company is in negotiations with several pharmaceutical companies
regarding Co 102862 for neuropathic pain. Management is actively working to sign
a licensing agreement within in the next six months for Co 102862 and is
attempting to secure initial payments that, when combined with the current cash
balance, will be sufficient to fund operations through at least fiscal 1999.
Other compounds may be licensed later in the year.
Second, the Company is attempting to generate revenues by selling clinical
and preclinical development services either to its collaboration partners or to
third parties. CoCensys currently employs over thirty individuals in the
development area who have extensive pharmaceutical development expertise in
numerous indications.
Third, in the absence of a revenue generating licensing or service deal,
the Company will take steps to reduce expenses through reductions in headcount
and other costs. Cost savings associated with these expense reductions, when
combined with our current cash balance, will be adequate to fund the Company's
operations through at least fiscal 1999.
The Company's future capital requirements will depend on many factors,
including the progress of the Company's research and development programs, the
scope and results of preclinical testing and clinical trials, the time and costs
involved in obtaining regulatory approvals, the rate of technological advances,
determinations as to the commercial potential of the Company's products under
development, the status of competitive products, the establishment of
third-party manufacturing arrangements and the establishment of additional
collaborative relationships. There are no assurances that the Company will
available to it the substantial capital resources necessary to continue product
development and other Company operations.
5
<PAGE>
IMPACT OF YEAR 2000
Some of the Company's older computer programs were written using two digits
rather than four to define the applicable year. As a result, those computer
programs recognize a date using "00" as the year 1900 rather than the year 2000.
This could cause a system failure or miscalculations causing disruptions of
operations, including a temporary inability to process transactions or engage in
normal business activities.
The Company has developed a plan to address the Year 2000 issues. The plan
is segregated into four phases:
1. Information collection.
2. Risk assessment and testing of mission critical systems.
3. Remediation.
4. Monitoring and contingency planning
The Company has completed the first two phases of the project and has
tested, upgraded or developed plans to upgrade all individual software and
hardware applications that fall within the mission critical category. All of the
Company's major software applications and hardware systems are purchased from
major vendors and the Company performs little or no customizations to those
applications and systems. The Company's major software providers have attested
to Year 2000 compliance. The Company has reviewed other equipment for embedded
technologies which may be Year 2000 susceptible and has already upgraded or
developed plans to upgrade all mission critical systems. The Company has spent
less than $50,000 to date on hardware and software upgrades to ensure Year 2000
compliance and it anticipates that further upgrades will cost less than
$100,000, most of which will be spent acquiring a Year 2000 compliant telephone
system. The funds for these upgrades will come from current cash or new capital
lease lines. The Company expects to be fully Year 2000 compliant by June 1999. A
contingency plan will also be developed by that date.
In addition to risks associated with the Company's own computer systems and
equipment, the Company has relationships with, as is to a varying degrees
dependent upon, a large number of third parties, that do not share information
systems with the Company (external agents), who provide information, services
and goods. These external agents include financial institutions, suppliers,
vendors, research partners and governmental agencies. The Company has instituted
programs, including internal records review and use of external questionnaires,
to identify third parties, assess their level of Year 2000 compliance, update
contracts and address potential non-compliance issues. To date, the Company is
not aware of any external agent with a Year 2000 issue that would materially
impact the Company's results of operations, liquidity, or capital resources.
However, the Company has no means of ensuring that external agents will be Year
2000 ready. The inability of external agents to complete their Year 2000
resolution process in a timely fashion could materially impact the Company. The
effect of non-compliance by external agents is not determinable.
Based upon its efforts to date, the Company believes that the vast majority
of both its IT and its non-IT systems, including all critical and important
systems, will remain up and running after January 1, 2000. Accordingly, the
Company does not currently anticipate that internal systems failures will result
in any material adverse effect to its operations or financial condition. During
1999, the Company will also continue and expand its efforts to ensure that major
third-party businesses and public and private providers of infrastructure
services will also be prepared for the year 2000, and to develop contingency
plans to address any failures on their part to become Y2K compliant. At this
time, the Company believes that the most likely "worst- case" scenario involves
potential disruptions in areas in which the Company's operations must rely on
such third parties whose systems may not work properly after January 1, 2000.
While such failures could affect important operations of the Company, either
directly or indirectly, in a significant manner, the Company cannot at present
estimate either the likelihood or the potential cost of such failures.
RECENT DEVELOPMENTS
6
<PAGE>
On August 5, 1999, the Company, Purdue Pharma L.P., a Delaware limited
partnership, and Purdue Acquisition Corporation, a Delaware corporation and an
indirect wholly owned subsidiary of Purdue Pharma, entered into an Agreement and
Plan of Merger. On August 12, 1999, Purdue Acquisition Corporation commenced a
cash tender offer for all outstanding shares of common stock, par value $0.001
per share, including the associated rights to purchase Series A Junior
Participating Preferred Stock, of the Company at $1.16 per share. Purdue
Acquisition Corporation acquired 91.4% of the outstanding shares of common stock
pursuant to the tender offer, which expired on September 23, 1999, and on
September 28, 1999, merged with and into the Company in a short-form merger
pursuant to Section 253 of the General Corporation Law of the State of Delaware.
As a result of the merger, Purdue Pharma L.P., which owned indirectly all
the outstanding stock of Purdue Acquisition Corporation, became the indirect
holder of 100% of the outstanding equity of the Company, and all shares of
common stock held by stockholders (other than Purdue, the Company or their
respective affiliates) were converted into the right to receive $1.16 per share
in cash. As a result of the merger, the public stockholders no longer possess
any interest in, or rights as stockholders of, the Company other than their
right to receive $1.16 per share in cash, or, if they perfect their dissenter's
appraisal rights, the right to receive the value of their shares as determined
by the Chancery Court of the State of Delaware.
Prior to the consummation of the merger, the shares of common stock were
registered under Section 12(g) of the Exchange Act and were traded on the OTC
Bulletin Board. On September 29, 1999, the Company informed the OTC Bulletin
Board of the merger and requested that the common stock be removed from listing
on the OTC Bulletin Board.
7
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PART IV
ITEM 14. (A) EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
FINANCIAL STATEMENTS
The financial statements required by this item are submitted
in a separate section beginning on Page 10 of this report.
Financial Statements of CoCensys, Inc.
--------------------------------------
Report of Independent Auditors 10
Balance Sheets as of December 31, 1998 and 1997 11
Statements of Operations for the years ended
December 31, 1998, 1997 and 1996; and the period from
inception (February 15, 1989) to December 31, 1998 12
Statements of Stockholders' Equity for the period from
inception (February 15, 1989) to December 31, 1998 13
Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996; and the period from
inception (February 15, 1989) to December 31, 1998 16
Notes to Financial Statements 17
Schedules are omitted as 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 financial statements or notes
thereto.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
COCENSYS, INC.
Date: November 2, 1999 By: /s/ Stuart D. Baker
-------------------------------------
Stuart D. Baker
Vice President
9
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Report of Independent Auditors
Board of Directors and Stockholders
CoCensys, Inc.
We have audited the accompanying balance sheets of CoCensys, Inc. (a development
stage company) as of December 31, 1998 and 1997, and the related statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1998, and the period from inception (February 15,
1989) to December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of CoCensys, Inc. at December 31,
1998 and 1997, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1998, and for the period from
inception (February 15, 1989) to December 31, 1998, in conformity with generally
accepted accounting principles.
/s/ ERNST & YOUNG LLP
Orange County, California
January 29, 1999, except for the
last paragraph of Note 2 as to
which the date is March 24, 1999,
the second paragraph of Note 1,
as to which the date is April 15, 1999
10
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<TABLE>
COCENSYS, INC.
(A development stage company)
BALANCE SHEETS
(In thousands, except share and par value amounts)
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1997
----------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 2,222 $ 3,410
Short-term investments 9,973 9,050
Other current assets 321 898
------------ ------------
TOTAL CURRENT ASSETS 12,516 13,358
Property and equipment, net 2,466 2,823
Investments - 500
Notes receivable from officers 56 178
Other noncurrent assets 61 57
------------ ------------
$ 15,099 $ 16,916
============ ============
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 534 $ 866
Accrued compensation and benefits 748 1,107
Due to corporate partners 1,322 747
Other accrued liabilities 1,326 1,911
Deferred revenue 2,955 -
Capital lease obligations - current portion 316 353
------------ ------------
TOTAL CURRENT LIABILITIES 7,201 4,984
Capital lease obligations, less current portion 366 567
Other liabilities 26 534
Commitments and contingencies
Stockholders' equity:
Convertible nonvoting preferred stock, $.001 par value Authorized shares -
5,000,000 Issued and outstanding shares - 206,445 at December 31, 1998
and 214,286 at December 31, 1997 16,386 13,000
Common stock, $.001 par value
Authorized shares - 9,375,000
Issued and outstanding shares - 3,422,773 at December 31, 1998
and 2,857,188 at December 31, 1997 107,381 97,230
Deficit accumulated during the development stage (116,151) (98,983)
Deferred compensation (138) (430)
Accumulated other comprehensive income 28 14
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 7,506 10,831
------------ ------------
$ 15,099 $ 16,916
============ ============
See accompanying notes
</TABLE>
11
<PAGE>
<TABLE>
COCENSYS, INC.
(A development stage company)
STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<CAPTION>
PERIOD FROM
INCEPTION
(FEBRUARY 15,
YEAR ENDED DECEMBER 31, 1989) TO
--------------------------------------- DECEMBER 31,
1998 1997 1996 1998
-------- --------- --------- ------------
<S> <C> <C> <C> <C>
REVENUES
Co-promotion revenues from corporate partners $ 540 $ 3,264 $ 9,085 $ 30,705
Co-development revenues from corporate partners 2,046 8,650 6,073 18,739
-------- --------- --------- -----------
Total revenues 2,586 11,914 15,158 49,444
-------- --------- --------- -----------
OPERATING EXPENSES
Research and development 15,745 23,308 20,949 106,674
Marketing, general and administrative 3,894 9,975 13,862 52,050
Acquired research and development - - - 14,879
-------- --------- --------- -----------
Total operating expenses 19,639 33,283 34,811 173,603
-------- --------- --------- -----------
Operating loss (17,053) (21,369) (19,653) (124,159)
Gain on disposition of sales force 1,000 4,728 - 5,728
Interest income 908 898 1,304 5,361
Interest expense (81) (78) (139) (1,139)
-------- --------- --------- -----------
Net loss (15,226) (15,821) (18,488) (114,209)
Accretion of preferred stock
for beneficial conversion feature 890 - - 890
Dividends on preferred stock 1,052 - - 1,052
-------- --------- --------- -----------
Net loss applicable to common stockholders $(17,168) $ (15,821) $ (18,488) $ (116,151)
======== ========= ========= ===========
Basic and diluted loss per share $ (5.60) $ (5.60) $ (6.79)
======== ========= =========
Shares used in computing basic
and diluted loss per share 3,066 2,822 2,723
======== ========= =========
See accompanying notes
</TABLE>
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<TABLE>
COCENSYS, INC.
(A development stage company)
STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share and per share amounts)
<CAPTION>
DEFICIT ACCUMULATED
CONVERTIBLE ACCUMULATED OTHER
PREFERRED STOCK COMMON STOCK DURING THE DEFERRED COMPREHENSIVE TOTAL
------------------ -------------------- DEVELOPMENT COMPEN- INCOME STOCK HOLDERS'
SHARES AMOUNT SHARES AMOUNT STAGE SATION (LOSS) EQUITY
---------- ------- --------- -------- ----------- -------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Net loss - $ - - $ - $ (147) $ - $ - $ (147)
Issuance of common stock for
cash at $0.04 per share - - 122,500 5 - - - 5
--------- ------- --------- -------- ----------- -------- ------------- -----------
BALANCE AT DECEMBER 31, 1989 - - 122,500 5 (147) - - (142)
Net loss - - - - (910) - - (910)
Issuance of Series A convertible
preferred stock upon conversion
of promissory note, net of
offering costs of $5 at $.25
per share 400,000 95 - - - - - 95
Issuance of Series B convertible
preferred stock for $3,110 cash
and conversion of $515 of
convertible promissory notes, net
of offering costs of $46 at $1.50
per share 2,416,666 3,579 - - - - - 3,579
Issuance of warrants to purchase
30,100 shares of Series B
convertible preferred stock in
connection with a note payable - 8 - - - - - 8
Common stock issued in connection
with services rendered - - 834 - - - - -
--------- ------- --------- -------- ----------- -------- ------------- -----------
BALANCE AT DECEMBER 31, 1990 2,816,666 3,682 123,334 5 (1,057) - - 2,630
Net loss - - - - (2,369) - - (2,369)
Common stock issued in connection
with services rendered - - 417 - - - - -
--------- ------- --------- -------- ----------- -------- ------------- -----------
BALANCE AT DECEMBER 31, 1991 2,816,666 3,682 123,751 5 (3,426) - - 261
Net loss - - - - (6,267) - - (6,267)
Issuance of Series C convertible
preferred stock for cash, net
of offering costs of
$60 at $5.00 per share 2,631,218 13,096 - - - - - 13,096
Issuance of Series C convertible
preferred stock in exchange for
services at $5.00 per share 3,332 17 - - - - - 17
Issuance of Series C convertible
preferred stock in exchange for
stock purchase
option at $5.00 per share 20,000 100 - - - - - 100
Deferred compensation related to
the issuance of certain stock
options - - - 2,842 - (2,842) - -
Amortization of deferred compensation - - - - - 152 - 152
--------- ------- --------- -------- ----------- -------- ------------- ------------
BALANCE AT DECEMBER 31, 1992 5,471,216 16,895 123,751 2,847 (9,693) (2,690) - 7,359
Net loss - - - - (10,273) - - (10,273)
Issuance of Series B convertible
preferred stock in exchange for
noncash exercise of warrants 25,083 226 - - - - - 226
Conversion of convertible preferred
stock into common stock at the
close of the initial public
offering (5,496,299) (17,121) 687,037 17,121 - - - -
Issuance of common stock for cash
in initial public offering at
$72.00 per share, net of offering
costs and underwriters' discount
of $2,193 - - 312,500 20,307 - - - 20,307
Common stock issued in connection
with stock options - - 14,600 18 - - - 18
Issuance and termination of
certain stock options - - - 43 - (43) - -
Amortization of deferred
compensation - - - - - 760 - 760
---------- ------- --------- -------- ----------- -------- ------------- -------------
BALANCE AT DECEMBER 31, 1993 - - 1,137,888 40,336 (19,966) (1,973) - 18,397
See accompanying notes
</TABLE>
13
<PAGE>
<TABLE>
COCENSYS, INC.
(A development stage company)
STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
(In thousands, except share and per share amounts)
<CAPTION>
DEFICIT ACCUMULATED
CONVERTIBLE ACCUMULATED OTHER
PREFERRED STOCK COMMON STOCK DURING THE DEFERRED COMPREHENSIVE TOTAL
------------------ -------------------- DEVELOPMENT COMPEN- INCOME STOCK HOLDERS'
SHARES AMOUNT SHARES AMOUNT STAGE SATION (LOSS) EQUITY
--------- ------- --------- -------- ------------ -------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net loss - - - - (26,586) - - (26,586)
Unrealized loss on investments - - - - - - (25) (25)
----------
Comprehensive income - - - - - - - (26,611)
Purchase of common stock by Acea
shareholders pursuant to merger
agreement at $36.48 and $40.88 per share - - 51,921 2,002 - - - 2,002
Acquisition of Acea in exchange for
common stock at $24.00 per share - - 473,042 11,353 - - - 11,353
Exchange of Acea options and warrants
for equivalent options and warrants - - - 592 - - - 592
Purchase of common stock by corporate
partner at $36.08 per share - - 55,402 2,000 - - - 2,000
Common stock issued in connection with:
Stock options - - 8,548 32 - - - 32
Other employee programs - - 2,500 75 - - - 75
Issuance and termination of certain
stock options - - - 110 - (110) - -
Amortization of deferred compensation - - - - - 707 - 707
--------- ------- --------- -------- ----------- --------- ------------- -------------
BALANCE AT DECEMBER 31, 1994 - - 1,729,301 56,500 (46,552) (1,376) (25) 8,547
Net loss - - - - (18,122) - - (18,122)
Unrealized gain on investments - - - - - - 3 3
---------
Comprehensive income - - - - - - - (18,119)
Purchase of common stock by corporate
partner at $27.84 per share - - 179,372 5,000 - - - 5,000
Issuance of common stock and related
warrants for cash at $26.00 per share,
net of cost of $149 - - 463,462 11,901 - - - 11,901
Purchase of common stock by corporate
partner at $56.00 per share, net of
costs of $14 - - 35,746 1,986 - - - 1,986
Common stock issued in connection with:
Stock options - - 11,072 109 - - - 109
Employee Stock Purchase Plan - - 4,966 152 - - - 152
Other employee programs - - 500 29 - - - 29
Issuance and termination of certain
stock options - - - 619 - (619) - -
Amortization of deferred compensation - - - - - 1,039 - 1,039
--------- ------- --------- -------- ----------- --------- ------------- -------------
BALANCE AT DECEMBER 31, 1995 - - 2,424,419 76,296 (64,674) (956) (22) 10,644
Net loss - - - - (18,488) - - (18,488)
Unrealized gain on investments - - - - - - 50 50
---------
Comprehensive income - - - - - - - (18,438)
Issuance of common stock for cash
at $52.00 per share, net of costs
of $1,162 - - 303,750 14,633 - - - 14,633
Issuance of Series B convertible
preferred stock for cash to
corporate partner 100,000 7,000 - - - - - 7,000
Common stock issued in connection
with:
Stock options - - 17,345 194 - - - 194
Employee Stock Purchase Plan - - 14,093 446 - - - 446
Other employee programs - - 813 54 - - - 54
Issuance and termination of
certain stock options - - - 2,363 - (629) - 1,734
Amortization of deferred
compensation - - - - - 680 - 680
--------- ------- ---------- -------- ----------- --------- ------------- -------------
BALANCE AT DECEMBER 31, 1996 100,000 7,000 2,760,420 93,986 (83,162) (905) 28 16,947
See accompanying notes
</TABLE>
14
<PAGE>
<TABLE>
COCENSYS, INC.
(A development stage company)
STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
(In thousands, except share and per share amounts)
<CAPTION>
DEFICIT ACCUMULATED
CONVERTIBLE ACCUMULATED OTHER
PREFERRED STOCK COMMON STOCK DURING THE DEFERRED COMPREHENSIVE TOTAL
------------------ -------------------- DEVELOPMENT COMPEN- INCOME STOCK HOLDERS'
SHARES AMOUNT SHARES AMOUNT STAGE SATION (LOSS) EQUITY
--------- ------- --------- -------- ----------- -------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Net loss - - - - (15,821) - - (15,821)
Unrealized loss on investments - - - - - - (14) (14)
---------
Comprehensive income - - - - - - - (15,835)
Issuance of Series C convertible
preferred stock for cash to
corporate partner 100,000 5,000 - - - - - 5,000
Issuance of Series D convertible
preferred stock for cash to
corporate partner 14,286 1,000 - - - - - 1,000
Issuance of common stock for
cash at $49.28 per share to
corporate partner - - 40,558 2,000 - - - 2,000
Common stock issued in connection with:
Services rendered - - 2,914 8 - - - 8
Stock options - - 41,934 202 - - - 202
Employee Stock Purchase Plan - - 11,362 251 - - - 251
Issuance and termination of certain
stock options - - - 783 - 206 - 989
Amortization of deferred compensation - - - - - 269 - 269
--------- ------- ---------- -------- ----------- --------- ------------- -------------
BALANCE AT DECEMBER 31, 1997 214,286 13,000 2,857,188 97,230 (98,983) (430) 14 10,831
Net loss - - - - (17,168) - - (17,168)
Unrealized gain on investments - - - - - - 14 14
--------
Comprehensive income - - - - - - - (17,154)
Conversion of Series B convertible
preferred into common stock by
corporate partner (100,000) (7,000) 200,000 7,000 - - - -
Issuance of Series D convertible
preferred stock for cash to
corporate partner 85,714 3,429 - - - - - 3,429
Issuance of Series E convertible
preferred stock, related warrants
and beneficial conversion feature
for cash, less offering costs 8,000 6,611 - 1,280 - - - 7,891
Conversion of Series E convertible
preferred into common stock by
investors (1,555) (1,596) 320,383 1,596 - - - -
Accretion of preferred stock for
beneficial conversion feature - 890 - - - - - 890
Dividends accrued on preferred stock - 1,052 - - - - - 1,052
Common stock issued in connection with:
Services rendered - - 3,416 126 - - - 126
Stock options - - 24,419 48 - - - 48
Employee Stock Purchase Plan - - 17,055 135 - - - 135
Other employee programs - - 312 10 - - - 10
Issuance and termination of certain
stock options - - - (44) - 148 - 104
Amortization of deferred compensation - - - - - 144 - 144
--------- ------- ---------- -------- ----------- --------- ------------- -------------
BALANCE AT DECEMBER 31, 1998 206,445 $ 16,386 3,422,773 $ 107,381 $ (116,151) $ (138) $ 28 $ 7,506
========= ======= ========== ======== ========== ========= ============= =============
See accompanying notes
</TABLE>
15
<PAGE>
<TABLE>
COCENSYS, INC.
(A development stage company)
STATEMENTS OF CASH FLOWS
(In thousands)
<CAPTION>
PERIOD FROM
INCEPTION
(FEBRUARY 15,
YEAR ENDED DECEMBER 31, 1989) TO
------------------------------------ DECEMBER 31,
1998 1997 1996 1998
---------- ----------- ----------- -------------
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss $ (15,226) $ (15,821) $ (18,488) $(114,209)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 907 936 2,072 7,732
Amortization of deferred compensation 144 269 680 3,751
Issuance of stock, stock options and warrants for services 240 419 1,788 2,576
Loss on sale of fixed assets - 74 - 100
Gain on disposition of sales force (1,000) (4,728) - (5,728)
Acquired research and development - - - 12,279
Decrease (increase) in other current assets 191 72 (101) (365)
Decrease (increase) in receivables from partners 386 245 (659) (28)
Increase (decrease) in amounts due to partners 575 301 (2,698) 1,322
Increase in deferred revenue 2,955 - - 2,955
Increase (decrease) in accounts payable and other accrued liabilities (1,784) (991) 685 982
---------- ----------- ----------- ---------
NET CASH USED IN OPERATING ACTIVITIES (12,612) (19,224) (16,721) (88,633)
---------- ---------- ---------- ---------
INVESTING ACTIVITIES
Decrease (increase) in investments (409) 7,386 (10,343) (9,945)
Purchases of property and equipment (566) (1,475) (812) (7,666)
Decrease (increase) in other assets and notes receivable from officers 118 (1,083) 199 (1,273)
Cash received on sale of fixed assets 16 1 - 36
Cash received on disposition of sales force 1,000 8,000 - 9,000
Increase in deferred costs - - - (2,475)
Acquisition of Acea, net of cash acquired - - - (62)
---------- ----------- ----------- ---------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 159 12,829 (10,956) (12,385)
---------- ---------- ------------ ---------
FINANCING ACTIVITIES
Net cash proceeds from issuance of common stock 183 2,460 15,273 61,428
Net cash proceeds from issuance of preferred stock 11,320 6,000 7,000 40,701
Proceeds from sales/leaseback of fixed assets and notes payable 281 1,002 649 5,516
Payments on capital lease obligations and notes payable (519) (707) (1,090) (4,405)
----------- ---------- ---------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 11,265 8,755 21,832 103,240
------------ ---------- ---------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,188) 2,360 (5,845) 2,222
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 3,410 1,050 6,895 -
----------- ----------- ----------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,222 $ 3,410 $ 1,050 $ 2,222
========== ========== ========== =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest $ 81 $ 66 $ 139 $ 901
========== ========== =========== ==========
Non-Cash Financing Activity:
Accretion of preferred stock for beneficial conversion feature $ 890 $ 0 $ 0 $ 890
========== ========== ========== ==========
See accompanying notes
16
</TABLE>
<PAGE>
COCENSYS, INC.
(A development stage company)
NOTES TO FINANCIAL STATEMENTS
December 31, 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
CoCensys, Inc. ("CoCensys" or the "Company") was incorporated in 1989 for the
purpose of discovering, developing and commercializing novel products to treat
disorders of the brain. Since inception, the Company has devoted substantially
all of its resources to the discovery and development of such products. The
Company has not generated any revenues from the development of its own products
and has sustained continuing operating losses from its development activities.
Such losses could continue for several years. The Company plans to finance its
future development activities through a combination of sales of equity
securities, payments from corporate development partners and revenues from
performing product development services. There can be no assurance that the
Company will be successful in these areas.
REVERSE STOCK SPLIT
At the Special Meeting of Stockholders held on January 27, 1999, stockholders
authorized the Board of Directors to effect a reverse stock split within a range
of one new share of common stock for every six, seven or eight outstanding
shares of stock. The Board subsequently approved a reverse split of
one-for-eight effective April 15, 1999. All share and per share amounts have
been restated to reflect this reverse stock split.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates. Significant estimates made in
preparing the financial statements include the determination of co-promotion and
co-development revenues and the valuation allowance for deferred tax assets.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Financial investments that subject the Company to concentration of credit risk
consist principally of cash, cash equivalents and investments, of which
$12,095,000 is not federally insured as of December 31, 1998.
CASH EQUIVALENTS AND INVESTMENTS
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
Short-term investments consist of debt securities classified as "available for
sale" and have maturities greater than three months and less than twelve months
from the date of acquisition. Investments classified as "available for sale" are
reported at fair value with unrealized gains and losses reported as a separate
component of other comprehensive income (loss) in the statement of stockholders'
equity.
17
<PAGE>
The Company invests primarily in U.S. government securities and corporate
obligations. The following table summarized unrealized gains and losses on the
Company's investments:
<TABLE>
<CAPTION>
Gross Gross
unrealized unrealized Fair
Cost loss gain value
-------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
As of December 31, 1998 $ 11,342,471 $ (15,045) $ 43,433 $ 11,507,135
As of December 31, 1997 $ 11,694,727 $ (3,401) $ 18,150 $ 11,855,580
</TABLE>
Realized gains and losses were not significant for the years ended December 31,
1998, 1997 and 1996.
In October 1998, the Company established an escrow account to hold funds that
are committed to satisfy an obligation related to the purchase of certain drug
marketing rights and new drug approvals (NDAs) in connection with the
disposition of its sales and marketing force in October 1998. The escrow account
held $552,400 and $1,005,900 at December 31, 1998 and 1997, respectively. Under
the terms of the escrow agreement, $500,000 will be paid in October 1999 to
satisfy the remaining obligation and all excess funds will be released to the
Company.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost and consists of the following at
December 31, (in thousands):
1998 1997
---------- ---------
Laboratory equipment $ 2,271 $ 2,218
Computer equipment and software 1,483 1,107
Office equipment 924 930
Leasehold improvements 2,206 2,105
---------- ----------
6,884 6,360
Less accumulated depreciation (4,418) (3,537)
---------- ----------
Net property and equipment $ 2,466 $ 2,823
========== ==========
The carrying value of leased assets (treated as capital leases) at December 31,
1998 and 1997 were $1,082,000 and $1,007,000 respectively, net of accumulated
amortization of $204,000 and $130,000 respectively.
Depreciation of property and equipment, including assets under capital lease
obligations, has been provided using the straight-line method over the estimated
useful lives of the assets which range from three to five years, except for
leasehold improvements which are amortized over the lease term.
REVENUE AND EXPENSE RECOGNITION
See Notes 4, 5, 6, 7, 8 and 9 for revenue recognition policies related to
co-promotion and co-development revenues from corporate partners. Co-promotion
revenue is a commission earned for marketing products of another company to a
specified class of medical doctors. The amount of commission earned is,
generally, a base fee with a bonus calculated by reference to an agreed upon
measure of activity such as sales volume or prescriptions written. The Company
recognizes revenue from co-promotion activities in the period in which the
promotional services are provided.
Co-development revenue is earned pursuant to agreements with other
pharmaceutical companies to develop and commercialize CoCensys' compounds.
Revenue is earned in the form of licensing fees, payment for the attainment of
developmental milestones or funding for research. The Company recognizes
co-
18
<PAGE>
development revenue in the period in which the underlying event occurs.
COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). SFAS 130
establishes new rules for the reporting and display of comprehensive income and
its components; however, the adoption of this Statement had no impact on the
Company's net income or stockholders' equity. SFAS 130 requires unrealized gains
and losses on available-for-sale securities, which prior to adoption were
reported separately on stockholders' equity, to be included in other
comprehensive income. Prior financial statements have been restated to conform
to the requirements of SFAS 130.
LOSS PER SHARE
In 1998, Statement of Financial Accounting Standards No. 128, "Earnings per
Share" ("SFAS No. 128"), replaced the calculation of primary and fully diluted
earnings per share with basic and diluted earnings per share. Unlike primary
earnings per share, basic earnings per share exclude any dilutive effect of
options, warrants and convertible securities. All per share amounts for all
prior periods have been presented and, where appropriate, restated to conform to
the SFAS No. 128 requirements.
Both basic and diluted loss per share are computed using the weighted average
number of shares of common stock outstanding. Common equivalent shares from
stock options and warrants are excluded from the computation of diluted earnings
per share as their effect would be antidilutive.
STOCK OPTION PLANS
Effective January 1, 1996, the Company has adopted the disclosure-only
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS No. 123") and accordingly, is continuing to
account for its stock-based compensation plans under previous accounting
standards. The adoption of SFAS No. 123 had no impact on the Company's results
of operations or financial position.
NOTES RECEIVABLE FROM OFFICERS
The Company advanced funds to certain officers in exchange for notes secured by
mortgages on real property. Interest on these notes accrues at 8.5% per annum.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year data to conform to the
1998 presentation.
2. PRIVATE PLACEMENT OF PREFERRED STOCK
In June 1998, the Company raised $8.0 million through the private placement of
Series E Convertible Preferred Stock (the "Series E Preferred"). The Series E
Preferred is convertible into common stock on June 8, 2001, or earlier at the
holder's option at a price which is discounted from the fair market value of the
Company's common stock at the time of conversion, subject to a maximum price of
$31.44 per share. The terms of the private placement included the issuance of
warrants to purchase 43,750 shares of common stock at $36.00 per share issued in
June 1998 and 12,500 shares at $5.00 per share in November 1998.
The Series E Preferred carries an annual dividend of 7.5 percent of the face
value of the outstanding shares, subject to reductions in the dividend rate if
the market price of Company's common stock increases to certain levels.
Dividends are payable quarterly in cash or, at the election of the Company, by
adding the amount of the dividend to the conversion value of the Series E
Preferred. Additionally, $390,000 of the $8.0 million in proceeds was allocated
to the warrants and $890,000 was allocated to a beneficial conversion feature
that allows investors to convert at 90% of the market price of the common stock
starting 122 days after issuance. These two allocated amounts have been credited
to additional paid in capital and will be treated as issuance discounts.
19
<PAGE>
Accordingly, the $890,000 was amortized over the first 122 days and the $390,000
will be amortized over three years, in the form of additional noncash preferred
dividends.
During fiscal 1998, the holders of the Series E Preferred converted
approximately $1.6 million, including accrued dividends, into approximately
320,000 shares of common stock. Through March 24 of fiscal 1999, the holders of
the Series E Preferred converted approximately $1.5 million, including accrued
dividends, into approximately 835,000 shares of common stock. The impact of the
conversion on loss per share would be anti-dilutive.
3. CYTOVIA LICENSING AGREEMENT
In January 1998, the Company licensed certain non-core technology to Cytovia,
Inc., a new company that focuses on the commercialization of patented drug
screening technology, using living cells, in the area of apoptosis or programmed
cell death. In exchange, CoCensys received shares of common stock of Cytovia,
will be entitled to receive certain royalties and will retain certain rights
relating to the development of future therapeutic agents for central nervous
system disorders. As of December 31, 1998, CoCensys' interest in Cytovia was
less than twenty percent and is accounted for on a cost basis and is valued at
zero.
4. DISPOSITION OF SALES AND MARKETING FORCE
On October 8, 1997, the Company entered into an Asset Purchase Agreement (the
"Agreement") to sell its sales and marketing force (the "Force") to Watson
Laboratories, Inc. ("Watson"), a wholly owned subsidiary of Watson
Pharmaceuticals, Inc. Under the terms of the Agreement, Watson assumed the
Force's co-promotion agreements, acquired certain of its operating assets and
the right to hire approximately 70 employees of the Force. As consideration for
these assets, the Company received $8.0 million from Watson in October 1998 with
up to $1.0 million more due to the Company if Watson retained, as of specified
future dates, certain percentages of the employees from the Force. Pursuant to
this contingency arrangement, Watson paid CoCensys $750,000 in April 1998 and
$250,000 in October 1998.
In order to satisfy certain provisions of the Agreement, the Company entered
into, and transferred to Watson, agreements with two pharmaceutical companies
for marketing rights and NDAs for two drugs with an aggregate cost of $2.0
million. Of this total, the Company paid $1.0 million in October 1997.
Additionally, $1.0 million of the $8.0 million of proceeds from the sale of the
Force was placed into an escrow account to satisfy the future obligations
related to these acquisitions. In October 1998, the Company made the first
$500,000 payment against this obligation and will make the final $500,000
payment in October 1999.
5. DEVELOPMENT AND COMMERCIALIZATION AGREEMENT WITH WYETH-AYERST LABORATORIES
In May 1997, the Company entered into a development and commercialization
agreement for Co 2-6749, its lead anxiolytic compound, with the Wyeth-Ayerst
Laboratories Division ("Wyeth-Ayerst") of American Home Products Corporation
("AHP"). Under the terms of the agreement, Wyeth-Ayerst paid CoCensys a
non-refundable $5.0 million licensing fee and AHP paid $5.0 million to purchase
100,000 shares of the Company's Series C Convertible Preferred Stock.
Additionally, CoCensys will receive specified milestone payments dependent upon
the achievement of key development events and $750,000 per quarter for up to
three years to identify back-up compounds. However, if Co 2-6749 fails to meet
certain criteria, and the back-up program fails to produce a back-up compound
that meets other certain criteria, Wyeth-Ayerst has the right to terminate the
back-up program and require CoCensys to reimburse it for a portion of the
back-up funding. As of December 31, 1998, the Company had $2.6 million recorded
as deferred revenue related to the Wyeth-Ayerst back-up program; this deferred
amount will be recognized as revenue when Co 2-6749 or a back-up compound meets
applicable criteria for acceptance by Wyeth-Ayerst.
Wyeth-Ayerst is responsible for the costs associated with developing Co 2-6749.
Wyeth-Ayerst and the Company will co-promote any resulting product in certain
market segments in the United States, while Wyeth-Ayerst will have rights to
develop, register and market any drugs derived from the collaboration in the
20
<PAGE>
rest of the world, subject to royalty obligations to CoCensys. The preferred
stock is convertible into common stock after May 12, 1999, at the election of
Wyeth-Ayerst, at a conversion price based on the market price of the common
stock at that time (subject to certain minimum and maximum limits).
6. MARKETING AND DEVELOPMENT COLLABORATION WITH WARNER-LAMBERT COMPANY
In October 1995, the Company entered into a collaboration with Warner-Lambert
Company ("Warner-Lambert") and its Parke-Davis division to develop and market
therapeutic drugs for the treatment of certain central nervous system disorders.
This arrangement consists of the Research, Development and Marketing
Collaboration Agreement (the "1995 Warner Collaboration Agreement"), for the
worldwide development and commercialization of a new class of neurological and
psychiatric drugs, termed subtype selective NMDA receptor antagonists
("SSNRAs"), and the Parke-Davis Promotion Agreement. Pursuant to the Parke-Davis
Promotion Agreement, the Company co-promoted Parke-Davis' central nervous system
drug, Cognex(R), until June 1997 when Parke-Davis terminated the co-promotion
agreement. In October 1997, the 1995 Warner Collaboration Agreement was amended,
restated and extended until October 1999 (the "1997 Amended Warner Collaboration
Agreement").
Under the 1997 Amended Warner Collaboration Agreement, both companies share
technology and resources to develop SSNRA candidates. The parties are obligated
to make specified contributions to development costs with respect to any
development candidates. Promotion costs of, and profits from any products
developed under the agreement will be shared equally in the United States and
Japan. Warner-Lambert will have the exclusive right to develop and market any
product, at its own cost, for markets outside the United States and Japan,
subject to a specified royalty payment to the Company. Warner-Lambert is
obligated to pay its specified portion of the development costs and to make
certain milestone payments, upon achievement of certain clinical development and
regulatory milestones, for each development compound. Payments received under
both the 1995 Warner Collaboration Agreement 1997 Amended Warner Collaboration
Agreement are recognized as co-development revenues and payments made are
recognized as expenses.
Pursuant to the 1995 Warner Collaboration Agreement, Warner-Lambert purchased
$2.0 million of CoCensys Common Stock in October 1995 and an additional $2.0
million of CoCensys Common Stock in March 1997. Pursuant to the 1997 Amended
Warner Collaboration Agreement extension of the Warner Collaboration Agreement,
Warner-Lambert purchased 14,286 shares of the Company's Series D Convertible
Preferred Stock for $1.0 million in October 1997 and an additional 85,714 shares
of the same series of convertible preferred stock for $6.0 million in January
1998. If converted on the mandatory conversion date, the Series D stock would
have been converted into such number of shares of common stock equal to the
quotient of the aggregate face value of the preferred stock divided by the
average of the closing prices of the common stock for a period of thirty (30)
trading days ending on the third trading day prior to the automatic conversion
date. The preferred stock is convertible at an earlier date at the Company's
option into such number of shares of common stock equal to the aggregate
original issue price of such shares divided by the greater of (a) the average of
the closing prices of the common stock for the 30 trading days during the period
ending on the third trading day prior to the date of original issuance of such
shares or (b) the average of the closing prices of the common stock for the 30
trading days during the period ending on the third trading day prior to the date
upon which the Company notifies the holders of such optional conversion.
As part of the extension of the Warner Collaboration Agreement in October 1997,
the companies agreed to expand the collaboration to allow the companies to
analyze and consider for collaborative development each company's AMPA modulator
technologies. In January 1998, the parties agreed to return the focus of their
collaboration agreement solely to SSNRAs. Each party retained all rights to its
respective AMPA modulator technology. In addition, as part of removal of the
AMPA modulator technology from the Warner Collaboration Agreement, the Company
is obligated to pay to Warner-Lambert $1 million on December 31, 1999. The due
date for this amount, which originally was January 1999, has been extended to
December 31, 1999 and is payable in common stock (based on the then current
stock price) or cash at the election of Warner-Lambert and is secured by the
21
<PAGE>
Company's assets. This $1.0 million amount is included in "Due to corporate
partners" on the accompanying balance sheet.
7. DEVELOPMENT AND COMMERCIALIZATION AGREEMENT WITH G.D. SEARLE & CO.
In May 1996, the Company entered into an agreement with G.D. Searle & Co.
("Searle") to co-develop and co-promote CCD 3693, the Company's lead compound
for the treatment of insomnia along with its back-up compounds. Pursuant to the
agreement, Searle paid a $3.0 million license fee and purchased 100,000 shares
of the Company's Series B Convertible Preferred Stock for $7.0 million. The
license fee was recognized as co-development revenue in 1996. In May 1998, the
Series B Convertible Preferred Stock converted, in accordance with its terms,
into 200,000 shares of common stock at a conversion price of $35.00 per share.
In July 1998, Searle notified CoCensys that it had decided not to participate
further in the development of the Company's proprietary compounds for the
treatment of insomnia. CoCensys intends to continue research and development of
its compounds to treat insomnia and will seek a new partner for the program in
the future.
8. PROMOTION AGREEMENT WITH SOMERSET PHARMACEUTICALS, INC.
In January 1996, the Company and Somerset Pharmaceuticals, Inc. ("Somerset")
entered into the Somerset Promotion Agreement, pursuant to which the Company,
through its Sales Force, promoted Somerset's drug Eldepryl(R) to neurologists in
the United States for the treatment of Parkinson's disease. Effective January 1,
1997, the initial agreement was superseded by the 1997 Somerset Promotion
Agreement. Under the 1997 Somerset Promotion Agreement, CoCensys had the
exclusive right to detail Eldepryl to certain neurologists and other physicians
in the United States and was compensated based upon the number of details
undertaken and gross sales of Eldepryl. In October 1997 the Company sold its
sales and marketing force, and all related co-promotion agreements, to Watson.
9. MARKETING AND DEVELOPMENT COLLABORATION WITH NOVARTIS PHARMA, A.G.
In May 1994, the Company entered into a marketing and development collaboration
with Novartis Pharma, A.G. (formerly Ciba-Geigy Limited) ("Novartis") for the
co-promotion by the Company of certain Novartis products and the development and
commercialization of ACEA 1021, a compound being developed by the Company. This
collaboration consisted of the Novartis Promotion Agreement and the Novartis
Research and Development Agreement.
Pursuant to the Novartis Promotion Agreement, CoCensys established a sales force
to co-promote and market certain Novartis products in the United States
initially to psychiatrists. The agreement provided for the advance of funds to
the Company to cover a portion of the expenses incurred by the CoCensys sales
force in promoting the Novartis products. CoCensys realized co-promotion
revenues from its share of sales of Novartis products above certain baseline
levels specified in the contract. The Novartis Promotion Agreement terminated at
the end of 1996.
In connection with the Novartis Research and Development Agreement, Novartis
purchased $7.0 million of CoCensys common stock and agreed to make certain
nonrefundable milestone payments in connection with specified events in the
course of the development of ACEA 1021. In April 1999, Novartis advised the
Company that it would not continue the development of ACEA 1021, and the
agreement terminated effective October 1999. The Company is seeking a new
partner to develop ACEA 1021. There can be no assurance that the Company will be
able to secure another partner to continue the development of this compound.
10. COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
The Company leases office and research facilities and certain equipment under
operating leases and capital leases with varying terms extending through July
2002. Annual future minimum payments under operating and capital leases as of
December 31, 1998, are as follows (in thousands):
22
<PAGE>
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASES
---------- ---------
<S> <C> <C>
Year ending December 31,
1999 $ 890 $ 372
2000 886 320
2001 879 72
2002 548 -
---------- ----------
Total minimum payments $3,203 764
==========
Less amount representing interest (82)
----------
Present value of future minimum payments 682
Current portion (316)
----------
Long-term portion $ 366
==========
</TABLE>
Rent expense for the years ended December 31, 1998, 1997 and 1996 was
$1,006,000, $1,040,000, and $1,082,000, respectively.
CONTINGENT BONUSES
In December 1998, the Board of Directors approved a broad-based 1999 employee
bonus program whereby an aggregate of approximately $390,000 may be paid to
employees contingent upon the occurrence of certain events.
11. COMMON STOCK
The Company has reserved 1.6 million shares of common stock for issuance upon
exercise of options and warrants, for issuance under the 1995 Employee Stock
Purchase Plan and for conversion of all preferred stock except the Series E
Preferred. The Series E Preferred is convertible at a rate based on the market
price of the common stock and is not subject to a minimum conversion price.
Based on the December 31, 1998 closing price for the Company's common of $2.50
per share, the Series E Preferred outstanding at year end, including accrued
dividends, was convertible into approximately 3.0 million shares of common
stock.
STOCKHOLDER RIGHTS PLAN
In April 1995, the Company adopted a Stockholder Rights Plan (the "Plan") which
provides for the distribution of rights ("Rights") to holders of outstanding
shares of common stock. Pursuant to the Plan, a portion of Convertible Preferred
Stock was designated as Junior Preferred Stock, of which 350,000 shares were
reserved for issuance upon exercise of the Rights. The Rights will become
exercisable only in the event, with certain exceptions, that an acquiring party
accumulates or announces an offer to acquire 20 percent or more of the Company's
voting stock. Each Right entitles the holder to buy one-hundredth of a share of
Junior Preferred Stock at a price of $25. In addition, upon the occurrence of
certain events, holders of Rights will be entitled to purchase either CoCensys'
stock or shares in an "acquiring entity" at half of market value. The Company
will generally be entitled to redeem the Rights at $.001 per right at any time
until the tenth day following acquisition of a 20 percent position in its voting
stock. The Rights expire in April 2005.
12. STOCK OPTION PLANS
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided under SFAS No.
123 requires use of option valuation models that were not developed for use in
valuing employee stock options. Under APB 25, for certain options the Company
recognizes as deferred compensation expense the excess of fair market value of
the common stock at the date of grant over the aggregate exercise price of such
23
<PAGE>
options. This deferred compensation expense is amortized ratably over the
vesting period of each option. During the years ended December 31, 1998, 1997
and 1996, the Company recorded deferred compensation of $223,000, $579,000 and
$629,000, respectively, in connection with the issuance and termination of
certain stock options.
Pro forma information regarding net income and earnings per share is required by
SFAS No. 123, and has been determined as if the Company has accounted for its
employee stock options under the fair value method of that Statement. Had
compensation cost for the Company's grants since 1995 under the stock-based
compensation plans been determined based on SFAS No. 123, the Company's pro
forma net income, and pro forma diluted earnings per share for the years ending
December 31, would be as follows (in thousands except per share data):
YEARS ENDED DECEMBER 31,
-----------------------------------------
1998 1997 1996
-------- --------- ---------
Net loss $(19,516) $(17,974) $(19,745)
========= ========= ========
Net loss per share $ (6.40) $ (6.40) $ (7.28)
========= ========= ========
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. SFAS 123 does not apply to awards prior to 1995,
and additional awards in future years are anticipated. The fair value for these
options was estimated at the date of grant using the Black-Scholes
option-pricing model with the following assumptions:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1998 1997 1996
--------- ---------- ----------
<S> <C> <C> <C>
Expected dividend yield 0.0% 0.0% 0.0%
Expected stock price volatility 85.0% 72.1% 44.2%
Risk-free interest rate 4.8% 6.1% 6.2%
Expected option term 4.5 years 4.6 years 5.0 years
</TABLE>
24
<PAGE>
A summary of the Company's stock option activity, including those issued outside
of plans, and related information is as follows (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
WEIGHTED-
AVAILABLE SHARES OPTION AGGREGATE AVERAGE
FOR OUT- PRICE EXERCISE EXERCISE
GRANT STANDING PER SHARE PRICE PRICE
--------- --------- --------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1995 87 301 $ 0.40 - $65.04 $ 7,195 $ 23.92
Authorized 475 - - - -
Granted (120) 120 $26.00 - $73.04 5,719 47.52
Exercised - (17) $ 1.60 - $41.68 (193) 11.12
Canceled and forfeited 23 (23) $ 4.00 - $67.04 (943) 40.96
---------- ---------- ----------
BALANCE, DECEMBER 31, 1996 465 381 $ 0.40 - $73.04 11,778 30.88
Granted (213) 213 $24.00 - $57.04 8,698 40.88
Exercised - (39) $ 0.40 - $41.68 (199) 5.04
Canceled and forfeited 26 (26) $20.00 - $67.04 (1,114) 42.96
---------- ---------- ----------
BALANCE, DECEMBER 31, 1997 278 529 $ 0.40 - $73.04 19,163 36.24
Authorized 250 - - - -
Retired (82) - - - -
Granted (245) 245 $ 2.00 - $31.04 3,107 12.64
Exercised - (21) $ 1.04 - $26.32 (49) 2.40
Canceled and forfeited 146 (146) $12.24 - $73.04 (5,199) 35.84
---------- ---------- ----------
BALANCE, DECEMBER 31, 1998 347 607 $ 0.40 - $73.04 $ 17,022 $ 28.00
========== ========== ==========
</TABLE>
The weighted-average fair value of options granted was $12.72, $24.48 and $26.00
during 1998, 1997 and 1996, respectively. The weighted-average remaining
contract life was 6.4 years, 7.3 years and 6.8 years for 1998, 1997 and 1996,
respectively.
The following table summarizes information about stock options outstanding at
December 31, 1998:
<TABLE>
<CAPTION>
RANGE WEIGHTED WEIGHTED
OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
PRICES (IN THOUSANDS) LIFE PRICE (IN THOUSANDS) PRICE
-------- ------------- ----------- --------- -------------- --------
<S> <C> <C> <C> <C> <C> <C>
$ 0.40 to 12.00 253 7.2 $ 6.96 105 $ 4.56
16.24 to 24.00 20 5.7 20.80 17 20.80
24.56 to 36.00 109 7.5 28.16 56 27.92
37.04 to 73.04 225 5.6 52.24 175 52.48
</TABLE>
Options to purchase approximately 353,000, 238,000 and 188,000 million shares of
common stock were exercisable as of December 31, 1998, 1997 and 1996,
respectively.
1990 STOCK OPTION PLAN
Under the Company's 1990 Stock Option Plan, as amended, options granted to
purchase common stock of the Company may be either incentive stock options to
employees or nonqualified stock options to employees, directors or consultants,
at the discretion of the Board of Directors. The plan permits the Company to
grant incentive stock options at 100% of the fair value at the date of grant,
while statutory stock options may be granted at 50% of the fair value at the
grant date. Options granted to date generally vest at the rate of 25% of the
total shares upon the first anniversary of the vesting commencement date, and
2.08% of the total shares per month thereafter. Vesting begins on either the
grant date or, if different, on the vesting commencement date specified by the
Board of Directors. Such vesting is subject to continued employment with the
Company. The options expire ten years from the date of grant or 90 days from
termination, if sooner.
1992 NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN
25
<PAGE>
In December 1992, the Company adopted the 1992 Non-Employee Directors' Stock
Option Plan (the "Directors' Plan"), as amended, to provide for the automatic
grant of options to purchase shares of common stock to non-employee directors of
the Company. Each such director is granted an option to purchase 2,500 shares of
common stock (5,000 shares for the Chairman of the Board). At the beginning of
each fiscal year, each non-employee director will be granted an option to
purchase an additional 1,000 shares of common stock (1,500 for the Chairman).
Vesting on the initial grant occurs in five equal annual installments from the
date of the grant for each year that the optionee remains a director. Annual
grants vest in full one year from the date of grant. Vesting accelerates upon
certain changes in ownership of the Company. The exercise price of options under
the Directors' Plan must equal or exceed the fair market value of the common
stock on the date of the grant.
1995 EMPLOYEE STOCK PURCHASE PLAN
In March 1995, the Company adopted the 1995 Employee Stock Purchase Plan and
reserved 43,750 shares of common stock for issuance thereunder. In June 1997,
the Company reserved an additional 25,000 shares for issuance under the plan,
which was approved by shareholders in June 1998. Pursuant to the provision of
the plan, employees purchased 17,055, 11,362 and 14,093 shares of common stock
in 1998, 1997 and 1996, respectively, at $1.92 to $56.96 per share.
1996 EQUITY INCENTIVE PLAN
In December 1996, the Company adopted the 1996 Equity Incentive Plan to provide
for the issuance of stock options, restricted stock, stock bonuses and stock
appreciation rights to employees, directors or consultants, at the discretion of
the Board of Directors. The plan permits the Company to grant incentive stock
options at 100% of the fair value at the date of grant, while nonqualified stock
options may be granted at 85% of the fair value at the grant date. Options
granted will generally vest at the rate of 25% of the total shares upon the
first anniversary of the vesting commencement date, and 2.08% of the total
shares per month thereafter. Vesting will begin on either the grant date or, if
different, on the vesting commencement date specified by the Board of Directors.
Such vesting will be subject to continued employment with the Company. The
options will expire ten years from the date of grant or 90 days from
termination, if sooner. The Company has reserved 350,000 shares of common stock
for issuance under this plan.
1998 NON-OFFICER EQUITY INCENTIVE PLAN
In September 1998, the Company adopted the 1998 Non-Officer Equity Incentive
Plan to provide for the issuance of stock options, restricted stock and stock
bonuses to employees or consultants, at the discretion of the Board of
Directors. Officers of the Company are not eligible to receive any benefits
under this plan. The plan permits the Company to grant nonqualified stock
options with an exercise price of not less than 85% of the fair value at the
grant date. Options granted will generally vest at the rate of 25% of the total
shares upon the first anniversary of the vesting commencement date, and 2.08% of
the total shares per month thereafter. Vesting will begin on either the grant
date or, if different, on the vesting commencement date specified by the Board
of Directors. Such vesting will be subject to continued employment with the
Company. The options will expire ten years from the date of grant or 90 days
from termination, if sooner. The Company has reserved 250,000 shares of common
stock for issuance under this plan.
OTHER OPTIONS AND WARRANTS
In September 1990, the Company granted to a director of the Company an option to
purchase 2,500 shares of common stock at $0.40 per share, outside of any plans.
The option is fully vested and expires in September 2001, or three months after
termination as a director, if sooner.
In November 1995, the Company granted to an officer of the Company an option to
purchase 3,125 shares of common stock at $4.00 per share, outside of any plans.
The option is fully vested and expires in November 2005.
In connection with the June 1994 purchase of Acea Pharmaceuticals, Inc., the
Company issued warrants to purchase 3,998 shares of common stock at $0.32 per
26
<PAGE>
share. The warrants were exercised on October 2, 1998.
In July 1992, the Company issued a warrant to purchase 5,250 shares of common
stock at $40.00 per share in connection with a capital lease agreement. The
warrant expires in July 2002.
As part of a private offering in June 1995 that included the sale of 463,462
shares of common stock, the Company issued 185,385 warrants. Each warrant
entitles the holder to purchase one share of common stock at a pre-determined
price ranging from $31.20 per share to $35.20 per share during the five-year
exercise period. As of December 31, 1998, 173,870 of these warrants were
outstanding.
As discussed above in Note 2, as part of a private offering in June 1998 that
included the sale of $8.0 million of convertible preferred stock, the Company
issued warrants to purchase 43,750 shares of common stock at $36.00 per share
and in November 1998 issued warrants to purchase 12,500 shares at $5.00 per
share.
13. DEFERRED INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax assets and liabilities at
December 31, are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
---------- -----------
<S> <C> <C>
DEFERRED TAX LIABILITIES
Book/tax depreciation difference $ (117) $ (161)
---------- -----------
Total deferred tax liabilities (117) (161)
DEFERRED TAX ASSETS
Net operating loss carryovers 32,797 27,860
Research and development credit carryovers 5,704 4,822
Capitalized state research and development costs 6,301 5,376
Other 92 152
---------- -----------
Total deferred tax assets 44,894 38,210
Valuation allowance for deferred tax assets (44,777) (38,049)
---------- -----------
Net deferred tax assets 117 161
---------- -----------
Net deferred taxes $ - $ -
========== ===========
</TABLE>
At December 31, 1998, the Company had operating loss carryovers of approximately
$96 million for federal income tax purposes. The federal loss carryovers begin
to expire in 2004. For federal and California income tax purposes, the Company
also had unused research and development credits of approximately $4.0 million
and $1.7 million respectively, which expire beginning in 2004. The difference
between the financial reporting and tax loss carryforwards for California
purposes is attributable to the capitalization of research and development
expenses and the 50% limitation on loss carryforwards for California tax
purposes.
The Tax Reform Act of 1986 includes provisions which significantly limit
potential use of net operating losses and tax credit carryovers in situations
where there is a change in ownership, as defined in Internal Revenue Code
Section 382, of more than 50% during a three-year period. Accordingly, if a
change in ownership occurs, the ultimate benefit realized from these carryovers
may be significantly reduced in total, and the amount that may be utilized in
any given year may be significantly limited. California has enacted similar
legislation. The Company has had stock issuances and an ownership change
occurred as a result of the Acea acquisition in June 1994. The annual limitation
is approximately $2.4 million on accumulated net operating losses of
approximately $24.6 million.
14. EMPLOYEE SAVINGS PLAN
27
<PAGE>
The Company has an employee savings plan that permits participants to make
contributions by salary reduction pursuant to section 401(k) of the Internal
Revenue Service. During 1996, the Company began matching 50% of a participant's
contribution up to a maximum participant contribution of 4% of eligible
compensation. In connection with this matching contribution, the Company
recognized expense of $63,000, $176,000 and $51,000 in 1998, 1997 and 1996,
respectively.
15. BUSINESS SEGMENTS
Effective January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information" (SFAS 131), which superseded Statement of Financial Accounting
Standards No. 14, "Financial Reporting for Segments of a Business Enterprise."
SFAS No. 131 also establishes standards for related disclosures about products
and services, geographic areas and major customers. The adoption of SFAS 131 did
not affect results of operations or financial position, but did affect the
following disclosure of segment information.
Historically, the Company has operated in two business segments, drug promotion
and drug development. Promotion revenues arise from contractual agreements under
which the Company promotes other pharmaceutical companies' products in return
for commissions. Development revenues arise from contractual agreements with
large pharmaceuticals companies pursuant to which the Company licenses various
commercialization or development rights relating to compounds or performs
research activities in exchange for licensing fees, milestone payments or
research funding. In October 1997, the Company sold its sales and marketing
force to Watson and ceased all drug promotion activities. The accounting
policies of these segments are the same as those described in the summary of
significant accounting policies except that interest income and certain expenses
are not allocated to the segments. Assets allocated to the segments include only
other current and noncurrent assets and net property and equipment.
28
<PAGE>
Selected financial information for the Company's business segments as of and for
the years ended December 31, 1998, 1997 and 1996 follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Revenues from external partners
Drug promotion segment $ 540 $ 3,264 $ 9,085
Drug development segment 2,046 8,650 6,073
------------- ------------- -------------
$ 2,586 $ 11,914 $ 15,158
============= ============= =============
Operating income
Drug promotion segment $ 540 $ (4,408) $ (3,140)
Drug development segment (17,593) (16,961) (16,513)
------------- ------------- -------------
$ (17,053) $ (21,369) $ (19,653)
============= ============= =============
Assets
Drug promotion segment $ - $ - $ 605
Drug development segment 2,819 3,364 2,663
------------- ------------- -------------
$ 2,819 $ 3,364 $ 3,268
============= ============= =============
Depreciation and amortization
Drug promotion segment $ - $ 29 $ 738
Drug development segment 907 907 1,334
------------- ------------- -------------
$ 907 $ 936 $ 2,072
============= ============= =============
Expenditures for long-lived assets
Drug promotion segment $ - $ 121 $ 80
Drug development segment 566 1,354 732
------------- ------------- -------------
$ 566 $ 1,475 $ 812
============= ============= =============
In fiscal 1998, three partners represented 96 percent of revenues. In fiscal
1997, three partners represented 88 percent of revenues. In fiscal 1996, four
partners represented 100 percent of revenue.
</TABLE>
29
<PAGE>
