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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
THIRD 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 OR OTHER JURISDICTION OF INCORPORATION OR (I.R.S. EMPLOYER
ORGANIZATION) 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 approximate aggregate market value of the Common Stock held by
non-affiliates of the registrant, based upon the closing price of the Common
Stock reported on the Nasdaq National Market on June 22, 1999, was
$3,896,748.
The number of shares of Common Stock outstanding as of June 22, 1999, was
4,867,083.
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PART I
ITEM 1. BUSINESS
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
SOME OF THE STATEMENTS IN THIS 10-K ARE FORWARD-LOOKING STATEMENTS.
THESE STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES, AND OTHER
FACTORS THAT MAY CAUSE OUR RESULTS, LEVEL OF ACTIVITY, PERFORMANCE OR
ACHIEVEMENTS TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, LEVEL OF
ACTIVITY, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY SUCH
FORWARD-LOOKING STATEMENTS. THESE FACTORS INCLUDE, AMONG OTHERS, THOSE
DISCUSSED BELOW UNDER "BUSINESS RISKS."
IN SOME CASES, YOU CAN IDENTIFY FORWARD-LOOKING STATEMENTS BY
TERMINOLOGY SUCH AS "MAY," "WILL," "SHOULD," "COULD," "EXPECTS," "PLANS,"
"ANTICIPATES," "BELIEVES," "ESTIMATES," "PREDICTS," "POTENTIAL," OR
"CONTINUE" OR THE NEGATIVE OF SUCH TERMS OR OTHER COMPARABLE TERMINOLOGY.
ALTHOUGH WE BELIEVE THAT THE EXPECTATIONS REFLECTED IN THE
FORWARD-LOOKING STATEMENTS ARE REASONABLE, WE CANNOT GUARANTEE FUTURE
RESULTS, LEVEL OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS. WE DO NOT ASSUME
RESPONSIBILITY FOR THE ACCURACY AND COMPLETENESS OF THE FORWARD-LOOKING
STATEMENTS. WE DO NOT INTEND TO UPDATE THIS 10-K AFTER IT IS FILED SO THAT
THE FORWARD-LOOKING STATEMENTS CONFORM TO ACTUAL RESULTS.
OVERVIEW
CoCensys, Inc. is a biopharmaceutical company dedicated to the discovery
and development of small molecule drugs to treat neurological and psychiatric
disorders. In addition, we provide product development expertise to our
collaboration partners and external clients.
CoCensys' technology is focused on the exploration of novel receptors
and their ligands and inhibitors through three technology platforms: specific
GABA(A) receptor modulators named epalons; glutamate receptor antagonists; and
sodium channel blockers. We are working to build a portfolio of products for
disorders of the central nervous system, both through discovery and
development of products utilizing the technical expertise and creativity of
our scientists and through the in-licensing of new technology and product
candidates.
We conduct discovery and development of our products through internal
resources and by licensing our technologies to collaboration partners who
fund further research and development of our products.
BACKGROUND ON COCENSYS TECHNOLOGIES
In the brain, chemical messengers called neurotransmitters carry signals
between nerve cells (neurons). The signals, which are received by cell
surface receptors, can be either excitatory or inhibitory. Excitatory
signals increase the electrical firing of neurons receiving the signals,
while inhibitory signals decrease firing. The proper functioning of the
brain hinges on a delicate balance between excitatory and inhibitory signals.
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Each neurotransmitter has a specific receptor, and we are working to
design products that are highly selective for specific receptor types. Many
of the current central nervous system ("CNS") drugs targeting the receptor
for a particular neurotransmitter also affect other receptors distributed
throughout the CNS or throughout the body. This lack of receptor specificity
produces unwanted CNS side effects such as sedation, anxiety, delirium,
hallucinations, impaired memory and learning and alcohol potentiation
(increased alcohol toxicity), along with the potential for cardiovascular
side effects.
TECHNOLOGY AND PRODUCT DEVELOPMENT
As described below, our product discovery and development programs are
focused on three technology platforms: specific GABA(A) receptor modulators
named epalons; glutamate receptor antagonists; and sodium channel blockers.
In March 1998, we transferred rights to our technology platform relating to
apoptosis (programmed cell death) to Cytovia, Inc. in exchange for equity
ownership in and royalties and certain future development rights from
Cytovia. The table on the next page sets forth the status of each of our
technologies.
GABA RECEPTOR MODULATORS OR EPALONS
Our proprietary epalon compounds are based on the discovery by CoCensys'
founding scientists of a novel neuroreceptor site located on the type A of
the gamma-amino butyric acid ("GABA(A)") receptor complex, and the molecules,
or ligands, that specifically interact with that receptor site. GABA is the
predominant inhibitory neurotransmitter in the brain. Numerous brain
activities are affected by the degree to which GABA opens the chloride
channels that allow the calming of neurons. A decrease in GABA activity
allows neurons to remain excited for longer periods, which can lead to
anxiety and, at the extreme, convulsions. A significant increase in levels
of GABA activity can result in sedation and sleep. GABA binds to GABA(A)
receptor complexes to calm excited neurons. When GABA binds with its
receptor, it opens a chloride channel in the membrane of the stimulated
neuron, admitting chloride ions that calm the excited neuron. Augmentation
of the functions of the GABA(A) receptor-gated chloride channel may be
beneficial in the treatment of disease states such as epilepsy, migraine,
anxiety and insomnia.
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COCENSYS PRODUCTS IN DEVELOPMENT
<TABLE>
<CAPTION>
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PRODUCTS INDICATIONS DEVELOPMENT STAGE COMMERCIALIZATION
RIGHTS
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<S> <C> <C> <C>
GABA(A) RECEPTOR
MODULATORS
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Ganaxolone Epilepsy, including Completed a series of Phase II CoCensys
(CCD 1042) complex partial seizures trials for infantile spasms,
and infantile spasms; complex partial seizures in adults
migraine prophylaxis and acute migraine; initiated
Phase II trial for catamenial
epilepsy and investigating
possible migraine prophylaxis
indication
CCD 3693 and back-up Insomnia Completed a series of Phase I CoCensys
compounds safety trials
Co 2-6749 and back- Anxiety disorders Pre-clinical development CoCensys/
Up compounds Wyeth-Ayerst
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GLUTAMATE RECEPTOR
ANTAGONISTS
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Licostinel Stroke; tinnitus Completed a series of Phase I CoCensys
(ACEA 1021) safety trials in stroke
SSNRAs Parkinson's disease, Pre-clinical development CoCensys/
epilepsy, chronic pain Warner-Lambert
and cerebral ischemia
Glutamate Receptor Ophthalmic disorders Research with Senju CoCensys/
Antagonists Pharmaceuticals Warner-Lambert
AMPA Receptor Neurodegenerative Research CoCensys
Modulators disorders; sexual
dysfunction
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SODIUM CHANNEL
BLOCKERS
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Co 102862 Neuropathic pain and Pre-clinical development CoCensys
epilepsy
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APOPTOSIS INHIBITOR
AND SCREENING
TECHNOLOGY
- --------------------
Apoptosis Degenerative disorders; Research Cytovia, a
Inhibitors; drug screening spin-off from
Apoptosis Screening CoCensys
Cells
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</TABLE>
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Our founders were among the first to demonstrate that an endogenous
(naturally occurring) class of related ligands (molecules that interact
specifically with receptors), called epalons, modulates the activity of GABA
in opening the chloride channel at the GABA(A) receptor complex. Studies
indicate that epalons themselves have limited activity on the chloride
channel. However, epalons modulate the GABA(A) receptor by enhancing the
ability of GABA to open the chloride channel. Thus, epalons work primarily
when GABA is present.
We have synthesized over one thousand analogs of endogenous epalons. We
have selected several development candidates from this group of synthetic
epalons. CoCensys' epalon development programs target epilepsy, migraine
prophylaxis, insomnia and anxiety. We are considering additional indications
for epalons, such as anesthesia.
GANAXOLONE (CCD 1042). We are developing ganaxolone to treat certain
types of epilepsy, including complex partial seizures and infantile spasms,
and as a potential drug for migraine prophylaxis. In November 1993, we filed
an investigational new drug application ("IND") with the United States Food
and Drug Administration for the treatment of epilepsy. We completed Phase I
clinical trials of ganaxolone in 210 healthy volunteers, providing
preliminary indications of the drug's safety, tolerability and
pharmacokinetics; no significant adverse effects were observed. We commenced
Phase II trials at the end of 1994 with pediatric epilepsy patients and at
the end of 1996 for adult epilepsy patients. Further, we filed an IND for
migraine in January 1997 and completed Phase II trials in migraine patients
in 1997 using a liquid formulation and 1998 using a tablet formulation.
GANAXOLONE FOR EPILEPSY. Epilepsy is a chronic brain disorder that
affects approximately one percent of the world population. Many drugs
currently available to treat epilepsy are administered in high doses and have
the potential for significant toxicity including teratogenicity. In
addition, these drugs have nonspecific interactions with receptors throughout
the brain, resulting in significant side effects such as adverse impacts on
learning and memory. Animal studies conducted by CoCensys, which included
side-by-side comparisons with existing anti-epileptic drugs, suggest that
ganaxolone has a broad profile of anti-seizure activity and a favorable
side-effect profile. Based upon these studies, we believe that ganaxolone may
have therapeutic potential in a variety of seizure types.
We completed our first Phase II clinical trial in France in pediatric
patients with epilepsy refractory to current treatments. In November 1996,
we announced that the study showed a clinically meaningful response in this
difficult to treat patient population. In 1997, we replicated those results
in similar Phase II pediatric trials in France and the United States.
In 1997, we also announced positive results from our Phase II U.S. trial
in adult epilepsy patients, which commenced at the end of 1996. The trial
included 52 epilepsy patients, ages 18 to 65, who had experienced such
debilitating seizures that they were candidates for possible surgical
treatment. Following their pre-surgical evaluations, while they were not
taking any other anti-epileptic medications, the patients were given oral
doses of either ganaxolone or a placebo for up to eight days or until a
predefined seizure frequency or type caused them to drop out of the study.
The patients who received placebo were twice as likely to experience an
unacceptable frequency or severity of seizures as those taking ganaxolone.
There were two serious adverse events reported. Both of the events appeared
to be related to withdrawal from the subjects' original drug regimen, and one
of the events occurred in a patient who received placebo.
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Currently, we have initiated a Phase II trial for female patients who
suffer from seizures around the time of their menstrual cycle, known as
"catamenial epilepsy." In addition, we are seeking a collaboration partner
to continue development of ganaxolone for epilepsy. Please see "Business
Risks" below for a discussion of risks associated with our ability to secure
a collaboration partner and continue the development of ganaxolone, including
without limitation the risk captioned "We depend on third parties to fund our
drug development."
GANAXOLONE FOR MIGRAINE PROPHYLAXIS. Migraine, a severe and frequently
debilitating headache, is the most common neurological disorder. It is
estimated that approximately 23 million people in the United States suffer
some degree of recurrent migraine headaches. The underlying cause of
migraine is poorly understood, but the pain has long been believed to arise
from the dilation of blood vessels in a layer of the brain lining. Research
has suggested that the local inflammation caused by substances released by
nerve endings attached to those blood vessels may exacerbate the pain. Based
on these pre-clinical studies conducted by researchers at Massachusetts
General Hospital, a teaching hospital affiliated with the Harvard Medical
School, that suggested the potential utility of ganaxolone to treat migraine
and using clinical data generated on ganaxolone through the epilepsy program,
we tested ganaxolone in two Phase II trials for migraine sufferers.
In the first trial, 252 pre-menopausal women were given oral doses of
placebo or one of four dose levels of ganaxolone. Preliminary results
released in November 1997 showed that, although there was no significant
difference among the treated and placebo groups overall, there was a
substantial increase in response as a function of plasma drug level at two
and four hours after the patients were dosed. In the trial, 14 of the 23
patients who achieved plasma drug levels of 80 ng/mL or more achieved pain
relief in two hours, while an additional six patients (for a total of 20 out
of 23) achieved pain relief in four hours. Importantly, no serious adverse
events or cardiovascular side effects were reported in the trial.
In the second trial, 325 female and male migraine patients were dosed
with a tablet formulation of either ganaxolone or a placebo. Our primary
endpoints were pain relief at two and four hours post dosing. While the
patients receiving ganaxolone reported pain relief at a rate in excess of
those receiving placebo, the difference was not statistically significant.
However, we did achieve statistically significant pain relief at two hours in
a subset of 45 female patients who were dosed with ganaxolone or placebo
within five days following start of menses.
Following these results, and based on our research regarding
similarities between ganaxolone and another drug approved for migraine
prophylaxis (divalproex sodium), we are investigating use of ganaxolone as a
prophylactic treatment for migraine. Further development of ganaxolone for
migraine prophylaxis will be determined in conjunction with any collaboration
agreement that we enter into for development of ganaxolone.
Co 2-6749 FOR ANXIETY. The market for drugs to treat anxiety is
currently served by a class of drugs called benzodiazepines, such as
Valium-Registered Trademark- and Xanax-Registered Trademark-, and to a lesser
extent, by drugs such as BuSpar-Registered Trademark-. Benzodiazepines cause
several serious side effects, including sedation, potentiation of alcohol
toxicity, cognitive impairment and abuse potential. BuSpar, while exhibiting
fewer side effects than benzodiazepines, requires up to several days of
administration before producing a therapeutic effect. Because of its highly
specific and natural mode of action, we believe that our class of anxiolytic
epalons may prove to have a more favorable ratio between efficacy and side
effects in treating anxiety disorders than existing drug therapies.
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In May 1997, CoCensys licensed to American Home Products Corporation,
through its Wyeth-Ayerst Laboratories Division, our epalon compound
Co 2-6749, along with its back-up compounds, for development as anxiolytics.
The program currently is in the pre-clinical development stage.
Under our agreement, Wyeth-Ayerst is required to fund the development of
Co 2-6749. In addition, Wyeth-Ayerst is obligated to support CoCensys'
research for up to three years at $3 million per year to identify additional
compounds that may have better efficacy or side-effect profiles than
Co 2-6749, generally referred to as "back-up" compounds. If Co 2-6749 fails to
meet certain criteria, then Wyeth-Ayerst may choose to develop a back-up
compound in place of Co 2-6749. Also, if Co 2-6749 fails to meet its
criteria, and if the back-up program fails to produce a back-up compound that
meets other pre-defined criteria, Wyeth-Ayerst has the right to terminate the
back-up program and require CoCensys to reimburse to Wyeth-Ayerst a portion
of the funds paid by Wyeth-Ayerst to CoCensys to fund the back-up program.
As of December 31, 1998, the portion of funds that may be subject to
repayment is $2.6 million.
Wyeth-Ayerst is obligated to pay to CoCensys certain nonrefundable
milestone payments under the Wyeth-Ayerst agreement upon the achievement of
key development events and the outcome of product labeling. CoCensys has the
right to co-promote in the United States Co 2-6749 or a replacement compound
and share any profits proportionally. Wyeth-Ayerst has the exclusive right
to develop, register and market the compound in the rest of the world,
subject to specified royalty payments.
CCD 3693 FOR INSOMNIA. Currently the prescription market for the
treatment of insomnia is largely served by Ambien-Registered Trademark-,
marketed by G.D. Searle & Co., which works on a specific sub-type of the
benzodiazepine receptor. Ambien is a "Schedule 4" drug, meaning it may have
limited potential to cause physical or psychological dependence. Current
hypnotic drugs may affect short-term memory, cause rebound insomnia and have
"day after" effects. CoCensys believes that, because CCD 3693 has a
different mechanism of action, it may have a better side-effect profile.
In 1996, we entered into a collaboration agreement with Searle to
develop CCD 3693 for the treatment of insomnia. Searle initiated Phase I
clinical studies in Europe in 1997 while we worked on an active back-up
program to identify additional compounds for the target indication. In July
1998, we received notification from Searle that it decided not to participate
further in the collaboration, stating that the program no longer met its
needs in light of its entire product pipeline. We retained all rights to the
compounds in the program, including CCD 3693, and we are continuing to
explore the potential use of epalons to treat insomnia.
GLUTAMATE RECEPTOR ANTAGONISTS
Our proprietary glutamate receptor antagonist program includes three
classes of compounds. To date, two programs are targeted at the
N-methyl-D-aspartate ("NMDA") receptor complex and a third focuses on the
a-amino-3-hydroxy-5-methyl-4-isoxazolepropionic acid ("AMPA") receptor.
Glutamate is the most abundant excitatory amino acid in the central
nervous system and is the principal excitatory neurotransmitter in the brain.
Glutamate triggers three major receptor complexes in the brain: NMDA, AMPA
and Kainate. Glutamate's effect on these receptors
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enables brain cells to direct cognition, memory, movement and sensation.
However, glutamate can over stimulate neurons, which can lead to neuronal
death. When over stimulated neurons die, they release more glutamate,
triggering a spreading cascade of glutamate over stimulation in other neurons
that may continue for hours or even days, thereby producing significant brain
damage in stroke patients or a worsening condition in individuals with
neurodegenerative disorders such as schizophrenia, epilepsy and Alzheimer's
disease.
The NMDA receptor has binding sites for a number of different agents,
including glutamate and glycine. When both of these neurotransmitters bind
to the NMDA receptor complex, a calcium ion channel is opened that permits
calcium ions to enter and stimulate the neuron. A number of compounds that
block the effect of glutamate on the NMDA receptor have been tested by others
in animal models of stroke and head trauma and have been found to be
effective in preventing the ischemic cascade, thereby limiting brain damage.
Some of these drugs block the influx of calcium ions to the neuron by binding
to the phencyclidine ("PCP") binding site located on the interior of the ion
channel associated with the NMDA receptor. While this leads to effective
nerve cell protection, it also produces the psychotic side effects, such as
hallucination and agitation, associated with the drug PCP.
Like the NMDA receptor/ion channel complex, the AMPA receptor responds
to glutamate binding by opening an ion channel. Long-lasting over-activation
of AMPA receptors by glutamate, which is believed to occur in chronic
neurodegenerative diseases and in global brain ischemia (e.g., after cardiac
arrest), is thought to result in a slow over-stimulation of the neurons by
calcium, resulting in slowly progressing nerve cell degeneration.
Research indicates that glycine acts as a modulator or co-transmitter
with glutamate on the NMDA receptor, so blocking its action would lessen the
effects of glutamate on neurons. CoCensys has synthesized a series of
proprietary compounds that are potent antagonists of the glycine receptor on
the NMDA receptor complex.
LICOSTINEL (ACEA 1021) FOR STROKE. Cerebral ischemia is oxygen
deprivation to the brain that may occur when blood flow is interrupted by
stroke. There are approximately 700,000 strokes per year in the United
States. It is estimated that costs associated with strokes exceed $25
billion annually in healthcare expenses and lost productivity in the United
States. The drug market for this indication is under served, with few
effective therapies for treating stroke.
We are developing our lead glycine antagonist, licostinel, to treat
stroke patients. In 1994, we began a development collaboration for
licostinel with Novartis Pharma A.G. (successor to Ciba-Geigy Ltd.) and filed
an IND for cerebral ischemia resulting from stroke. We completed short-term
infusion Phase I studies in healthy volunteers and in stroke patients in 1995
and 1996, respectively. Results of these studies showed no evidence of
serious side effects, including PCP-like psychosis, agitation or adverse
cardiovascular effects. In 1997, we reported that preliminary results from
additional safety trials involving long-term infusion showed crystals of
licostinel in the urine of some subjects, a potentially dose-limiting side
effect. However, the crystal formation occurred only in subjects with ten
times the blood plasma level of licostinel that was therapeutically effective
in animals. Influenced by the results of the later trials, Novartis ceased
further participation in the development efforts in April 1997.
Currently, we are completing an additional Phase I safety trial on
licostinel as we seek a new partner for further development of the licostinel
program. Please see "Business Risks" below
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for a discussion of risks associated with our ability to secure a
collaboration partner and continue the development of the licostinel program,
including without limitation the risk captioned "We depend on third parties
to fund our drug development." In addition, we are investigating possible
use of licostinel to treat patients who suffer from tinnitus, or ringing in
the ears, based on the existence of NMDA receptors in the inner ear. Often,
tinnitus is the result of sound-induced hearing damage. Tinnitus is a
significant health problem; it is estimated that in the United States 50
million adults suffer from tinnitus to some degree. Approximately 12 million
of those adults suffer from tinnitus severe enough to seek medical help.
SUBTYPE-SELECTIVE NMDA RECEPTOR ANTAGONISTS ("SSNRAs") are compounds
that selectively block only one of the NMDA receptor subtypes. Gene cloning
studies have identified at least four different NMDA receptor subtypes, each
of which has a distinct anatomical distribution in the brain. CoCensys has
discovered several novel classes of drugs that selectively target one subtype
without producing an effect on other subtypes. In animal models, our SSNRAs
appear to be free of side effects seen with other NMDA antagonists that block
all four subtypes.
SSNRAs effectively cross the blood-brain barrier and have exhibited
efficacy in animal models of cerebral ischemia, Parkinson's Disease, epilepsy
and chronic pain. Some SSNRAs have been shown to have IN VIVO efficacy after
oral administration in an animal model of Parkinson's disease, suggesting
oral bioavailability in this class of compounds. CoCensys believes SSNRAs
are potential drug candidates for a variety of neurological and psychiatric
diseases, including cerebral ischemia, Parkinson's disease, epilepsy and
chronic pain.
We have been working with our collaboration partner, Warner-Lambert
Company, since 1995 to identify and develop SSNRA product candidates for a
broad range of CNS diseases. Our initial agreement with Warner-Lambert,
through its Parke-Davis division, provided for a two-year research and
development program; we revised and extended that agreement for an additional
two years in October 1997 (the "Warner Collaboration Agreement"). The program
currently is in the pre-clinical development stage.
Under the Warner Collaboration Agreement, the parties are obligated to
devote the time of a specified number of scientists to conduct research
directed toward the identification of SSNRAs as drug development candidates.
Warner is obligated to pay for all costs to develop any development
candidates arising from the Agreement, subject to CoCensys' right to
re-engage in the development by funding a percentage of the development
costs. Warner is also obligated to pay for all costs to promote any product
developed under the Warner Collaboration Agreement, subject to CoCensys'
right to co-promote in the United States (including sharing promotion costs)
any product for which CoCensys re-engaged development rights. CoCensys will
receive royalties on sales of any products developed under the Warner
Collaboration Agreement, at rates based in part upon whether CoCensys
co-developed and co-promoted such product. In addition, upon achievement of
certain clinical development and regulatory milestones, Warner will make
nonrefundable milestone payments to CoCensys.
Either party may terminate its participation in the Warner Collaboration
Agreement voluntarily. In the event of a termination by either party during
the research period, the terminating party would forfeit all rights and
obligations to co-develop and co-promote any compounds arising thereunder,
subject to a specified royalty payment to the terminating party, and would be
precluded from conducting additional research in the SSNRA field for a fixed
period of time. After the research period, each party may terminate on a
product-by-product basis. In the event of such
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termination, the party electing to terminate would forfeit all rights and
obligations to co-develop and co-promote such product, subject to a specified
royalty payment to the terminating party. We cannot assure you that we will
have the substantial resources needed to fulfill our research, development
and commercialization obligations under the Warner Collaboration Agreement.
If CoCensys is unable to fulfill such obligations, we may be required to
terminate early under the Collaboration Agreement and forfeit our rights
thereunder; in such case, we would be entitled to royalties on future product
sales. Please see "Business Risks" below for a discussion of risks
associated with our ability to fulfill our obligations under the Warner
Collaboration Agreement.
AMPA RECEPTOR ANTAGONISTS prevent glutamate from activating the AMPA
receptor and are believed to prevent or slow calcium entry into neurons.
Calcium entry into neurons through AMPA receptors is believed to play a role
in nerve cell destruction in chronic neurodegenerative diseases. AMPA
receptor antagonists have shown neuroprotective efficacy in animal models of
global cerebral ischemia (such as may occur following cardiac arrest or near
drowning), epilepsy and pain. They also are believed to have potential as
therapeutic agents in chronic neurodegenerative diseases.
CoCensys scientists have discovered several different chemical classes
of novel AMPA receptor antagonists and AMPA receptor modulators. We are
working to develop compounds through this program that may prove useful in
the treatment of diseases such as epilepsy, schizophrenia, amyotrophic
lateral sclerosis (ALS or Lou Gehrig's disease) and other neurodegenerative
disorders. In addition, AMPA receptor modulators may have utility in certain
forms of sexual dysfunction.
In October 1997, as part of the extension of our collaboration agreement
with Warner-Lambert for development of SSNRAs, the companies agreed to expand
the collaboration to allow the companies to analyze and consider for
collaborative development each company's AMPA receptor modulator
technologies. In January 1998, the companies agreed to narrow the focus of
our collaboration agreement to its original scope of only the SSNRAs in
exchange for payment by CoCensys to Warner-Lambert of $1 million, which
amount is payable in common stock or cash, at the election of Warner-Lambert,
at the end of 1999. Our AMPA receptor antagonist and modulator technologies
remain available for partnership.
OTHER USES. Recently we announced that we entered into research
agreements with Senju Pharmaceutical Co., Ltd. and Warner-Lambert to explore
potential ophthalmic indications of glutamate receptor antagonists. One
agreement, between CoCensys and Senju, will look at our glycine antagonists
and AMPA receptor antagonists; the other agreement, among CoCensys, Senju and
Warner-Lambert, will explore the SSNRAs under development by CoCensys and
Warner-Lambert.
SODIUM CHANNEL BLOCKERS
Voltage-gated sodium channels ("VGSCs") are essential for the initiation
and propagation of nerve impulses and therefore play a fundamental role in
the normal function of the nervous system. Under conditions of abnormal
neuronal firing, such as during an epileptic seizure or during spontaneous
discharge from an injured sensory nerve fiber, VGSCs determine the threshold
for neuronal activation and modulate the frequency and duration of repetitive
neuronal firing. Drugs that selectively block the inactivated state of VGSCs
(such as Lamictal-Registered Trademark- and Tegretol-Registered Trademark-)
have therefore proven clinically effective in the treatment of epilepsy and
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neuropathic pain (including pain resulting from inflammation or damage to
peripheral nerve endings).
In 1997, we licensed from The University of Saskatchewan, through its
technology transfer company, University of Saskatchewan Technologies, Inc.,
rights to a class of novel, small molecule compounds that block the VGSCs.
The compounds licensed include Co 102862, a structurally-novel VGSC blocker
that is selective for the inactivated state of VGSCs. Co 102862 currently is
undergoing pre-clinical development at CoCensys for the treatment of
neuropathic pain and epilepsy. In several pre-clinical animal models,
Co 102862 demonstrates an anticonvulsant and side-effect profile superior to
that of Lamictal-Registered Trademark- and Tegretol-Registered Trademark- and
potent activity in neuropathic pain models. Also, both Lamictal-Registered
Trademark- and Tegretol-Registered Trademark- paradoxically lower seizure
threshold at high doses; however, Co 102862 does not. Therefore, we believe
that Co 102862 may have an advantage as a treatment for neuropathic pain
because effective doses for that indication are often greater than those that
are used in epilepsy.
Currently, we are preparing an IND for Co 102862. We also are in
negotiations regarding a potential collaboration to further develop
Co 102862. Please see "Business Risks" below for a discussion of risks
associated with our ability to secure a collaboration partner and continue
the development of Co 102862, including without limitation the risk captioned
"We depend on third parties to fund our drug development."
APOPTOSIS INHIBITORS AND SCREENING CELLS
Cell death can be a natural physiological process that occurs during
embryonic development as well as during remodeling of certain adult tissues.
This natural death of cells, called apoptosis or programmed cell death,
occurs by a discrete series of molecular events. Apoptosis also can be
triggered inappropriately in many diseases (including stroke, heart disease
and certain neurodegenerative disorders). This pathological form of
apoptosis is thought to play an important role in the loss of cells that
occurs in these diseases.
CoCensys discovered novel small molecules that may inhibit apoptosis.
In addition, we discovered certain compounds that permeate living cells and
fluoresce when apoptosis is triggered. Although promising for use in a
variety of disorders, we determined that the technology was outside of our
focus on development of therapeutics for disorders of the central nervous
system. Accordingly, in January 1998, we announced the formation of Cytovia,
Inc., as a technology spin-off to commercialize the apoptosis inhibitor and
screening cell technology; we completed transfer of technology in March 1998.
Cytovia is led by Eckard Weber, M.D., former head of research and
discovery for CoCensys and a current member of CoCensys' Board of Directors;
in addition, eleven other CoCensys employees joined Cytovia. CoCensys
retained an equity stake in Cytovia and a seat on Cytovia's Board of
Directors (currently held by our President and Chief Executive Officer, F.
Richard Nichol, Ph.D.). In addition, we retained the right to enter into
contracts on favorable terms with Cytovia to screen our neuroscience-related
therapeutic compounds and retained a right of first refusal for four years to
develop for central nervous systems disorders any compound discovered by
Cytovia. In addition to his continuing duties as a CoCensys Board member,
Dr. Weber also has continued as a leader and advisor to CoCensys on selected
scientific development projects.
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SALES AND MARKETING
In 1994, we established a Pharmaceutical Sales and Marketing Division to
co-promote other companies' commercialized drugs as part of our strategy to
generate non-equity funding. This Division focused on the neurological and
psychiatric markets, in part to establish a presence in CoCensys' target
markets in advance of CoCensys receiving FDA approval for marketing of any of
our compounds. In October 1997, in an effort to better focus our resources
and energies on our core competency of discovering and developing therapies
for brain and central nervous system disorders, we sold the Division to
Watson Pharmaceuticals, Inc.
In the future, CoCensys has the potential opportunity, through
collaborative relationships with Watson, to leverage the sales force and
Watson's manufacturing capacity as CoCensys products come to market. We
currently do not employ any sales personnel.
MANUFACTURING
We currently rely on third-party manufacturers to produce our compounds
for pre-clinical studies and clinical trials. We expect to continue in the
foreseeable future to rely on such third-party manufacturers for adequate
supply of products needed for subsequent clinical trials and, ultimately, for
commercial distribution. However, there can be no assurance that we will be
successful in arranging for adequate supplies of our products on acceptable
terms, or at all.
We believe that all of our compounds will be produced using traditional
pharmaceutical synthesis. We also believe that there is currently adequate
worldwide capacity for the production of our compounds and that CoCensys will
be able to establish commercially reasonable arrangements for the long-term
supply of our products for clinical trial purposes and for commercialization,
if such compounds receive required regulatory approvals. Generally, the
equipment required for the manufacture of our compounds is commercially
available and is widely used in pharmaceutical industry operations.
Please see "Business Risks" below for a discussion of risks associated
with our ability to manufacture our compounds.
PATENTS, PROPRIETARY RIGHTS AND LICENSES
Our success will depend in part on our ability to obtain patents,
maintain trade secrets and operate without infringing on the proprietary
rights of others, both in the United States and in other countries. Our
policy is to file patent applications to protect technology, inventions and
improvements that are important to the development of our business. We also
rely upon trade secrets, know-how, continuing technological innovations and
licensing opportunities to develop and maintain our competitive position.
CoCensys files and prosecutes patent applications both on our own behalf
and in connection with technology licensed from others. CoCensys has 23
issued patents with expiration dates ranging from June 9, 2009 to February
11, 2017; in addition, another 21 filed patents are pending. CoCensys has
made related patent filings in selected foreign countries, and intends to
file additional domestic and foreign applications as appropriate. Our patent
applications include claims for processes, methods and therapeutic uses, as
well as composition of matter claims for compounds which we believe are not
naturally occurring or previously known. There can be no assurance that
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we will develop additional products or processes that are patentable, that
patents will issue from any more of these applications, or that claims
allowed will be sufficient to protect our technology.
Certain of the pending, issued and allowed patents are owned by the
University of Southern California and the Rockefeller University, the
University of California, or the University of Oregon and have been
exclusively licensed to CoCensys. In December 1996 (as amended December
1997), CoCensys received an exclusive license to a patent application filed
by Massachusetts General Hospital for the use of GABA(A) receptor modulators,
including neuroactive steroids (epalons), to treat migraine. In June 1997,
CoCensys licensed from The University of Saskatchewan, through its technology
transfer company, University of Saskatchewan Technologies, Inc., rights to a
class of novel, small molecule sodium channel blockers which we are
developing to treat chronic pain and epilepsy. Each of these license
agreements continues until the last patent or patent application licensed
under the agreement expires. Currently, the year of expiration for each
license agreement is as follows: 2014 for the University of Southern
California and Rockefeller University license agreement; 2014 for the
University of California and University of Oregon license agreement; 2015 for
the Massachusetts General Hospital license agreement; and 2015 for The
University of Saskatchewan license agreement. Each of those expiration dates
may be further extended upon issuance of additional patents subject to those
license agreements.
We are aware of a patent application containing claims which, if covered
by a valid, issued patent, could block the use of our glutamate receptor
antagonists as adjunct therapy in an indication for which we are currently
conducting research. We also are aware of a patent that has issued that
contains claims which may, if valid, block us from selling certain compounds
for one particular indication not currently being pursued by CoCensys. If we
proceed with an interference or interferences, there can be no assurance that
we will be successful. There can be no assurance that our patents, if
issued, would be held valid and infringed by a court of competent
jurisdiction. An adverse outcome with regard to a third-party claim could
subject us to significant liabilities to third parties, require disputed
rights to be licensed from third parties or require us to cease using such
technology.
Please see "Business Risks" below for a discussion of risks associated
with our intellectual property, including without limitation the risk
captioned "Failure to adequately protect our proprietary technology or to
avoid infringing the rights of others could impair our competitive position."
GOVERNMENT REGULATION
Our research, pre-clinical development and clinical trials, as well as
the manufacturing and marketing of our potential products, are subject to
extensive regulation by governmental authorities in the United States and
other countries. We currently are conducting clinical trials in the United
States and Europe. Clinical trials and the marketing and manufacturing of our
potential products will be subject to the rigorous testing and approval
processes of the FDA and the independent processes of foreign regulatory
authorities. The process of obtaining FDA and other required regulatory
approvals is lengthy and expensive. We have received approvals in the past to
conduct clinical trials for certain of our potential products and to
manufacture the products for such trials; however, we will need to maintain
those approvals and achieve further approvals in the future to continue to
manufacture and test our potential products.
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Ganaxolone has been granted "orphan drug" designation by the FDA for the
treatment of infantile spasms. Under the Orphan Drug Act, the FDA has the
right to designate a product as an orphan drug if it addresses a "rare
disease or condition" affecting populations of fewer than 200,000 individuals
in the United States. The FDA can also designate a potential product as an
orphan drug if, despite the fact that the drug treats victims of a disease
numbering more than 200,000, the sponsor establishes that it does not
realistically anticipate product sales will be sufficient to recover costs.
If a product is designated an orphan drug, then the sponsor is entitled to
receive certain incentives to undertake the development and marketing of the
product. In addition, the sponsor that obtains the first marketing approval
for a designated orphan drug for a given rare disease is eligible to receive
marketing exclusivity for a period of seven years. Where appropriate, we may
apply for orphan drug designation for other indications and/or other drug
products.
To market our products abroad, we also must satisfy foreign regulatory
requirements, implemented by foreign health authorities, governing human
clinical trials and marketing approval. In the European Union ("EU"),
manufacturers of biotechnology products and certain high technology products
must submit an application to the European Medicines Evaluation Agency
("EMEA"). Approval by the EMEA will give the manufacturer access to the
markets of all EU member states. Manufacturers of medicinal products other
than those handled by the EMEA must utilize a "mutual recognition" procedure.
Under this procedure, an application is made first to the medicines agency
of any one member state, after which the approval gained in that state is
used as the basis for a request to the other member states to recognize the
first approval and grant a parallel authorization on the strength of that
initial approval. Approvals in the other member states are to follow as a
matter of course, unless there is an objection on the grounds of a safety or
efficacy problem. In the event that such an objection is made, the issue is
submitted to the EU's Committee on Proprietary Medicinal Products for
resolution. The foreign regulatory approval process includes all of the
risks associated with FDA approval set forth above. There is no assurance
that the EMEA or the national regulatory agency in any member state will
accept the data developed by us for any of our drug products and grant a
marketing authorization.
Please see "Business Risks" below for a discussion of risks associated
with government regulation applicable to CoCensys, including without
limitation the risk captioned "If we do not obtain FDA approval for our
product candidates, we will not be able to sell products and generate
revenues."
COMPETITION
Competition for therapeutic products that address brain disorders is
intense and expected to increase. Our most significant competitors are fully
integrated pharmaceutical companies and more established biotechnology
companies. Smaller companies may also prove to be significant competitors,
particularly through collaborative arrangements with large pharmaceutical
companies. In addition, we face competition from academic institutions,
governmental agencies and other public and private research organizations
that conduct research, seek patent protection and establish collaborative
arrangements for product and clinical development and marketing.
Furthermore, these companies and institutions compete with us in recruiting
and retaining highly qualified scientific and management personnel.
Many of our competitors have substantially greater financial, technical
and human resources and have significant products approved or in development.
In addition, many of these
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competitors have significantly greater experience in undertaking pre-clinical
testing and human clinical trials of new pharmaceutical products and
obtaining FDA approval for products. Furthermore, if we are permitted to
commence commercial sales of products, we will also be competing with respect
to manufacturing efficiency and marketing capabilities.
Any product that we succeed in developing and for which we gain
regulatory approval must then compete for market acceptance and market share.
For certain of our potential products, an important competitive factor will
be the timing of market introduction. Accordingly, we expect that important
competitive factors will be the relative speed with which companies can
develop products, complete the clinical testing and approval processes and
supply commercial quantities of the product to the market. With respect to
clinical testing, competition may delay progress by limiting the number of
clinical investigators and patients available to test our potential products.
In addition to the above factors, competition is based on product
efficacy, safety, the timing and scope of regulatory approvals, availability
of supply, marketing and sales capability, reimbursement coverage, price and
patent position.
HUMAN RESOURCES
As of March 1, 1999, we had 91 full-time employees, of which 64 are
directly involved in research and development programs and 27 provide general
and administrative support. Our staff includes 28 employees with doctoral
degrees, including four medical doctors. We believe our employee relations
are good.
BUSINESS RISKS
ANY OF THE FOLLOWING RISK FACTORS COULD MATERIALLY ADVERSELY AFFECT OUR
BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION.
OUR DRUG CANDIDATES ARE IN AN EARLY STAGE OF DEVELOPMENT USING UNPROVEN
TECHNOLOGY, AND THERE IS A SIGNIFICANT RISK THAT THEY MAY NEVER BECOME
COMMERCIAL PRODUCTS.
We have no products that have received regulatory approval for commercial
sale. All of our drug candidates are in the early stages of development, and
our technology is unproven. The physiology of brain disorders is highly
complex, and the causes of these disorders are not fully known. We will have
to conduct significant research and pre-clinical (animal) and clinical
(human) tests that must demonstrate that our products are safe and effective
before we can file applications for approval with the United States Food and
Drug Administration and foreign regulatory authorities. Any of our products
may fail in the testing phase or may fail to attain market acceptance.
Competitors may develop superior products. If research and testing is not
successful, our products are not commercially viable or we cannot compete
effectively, our business, financial condition and results of operations will
be materially adversely affected, and could force us to cease operations.
THE OUTCOME OF CLINICAL TRIALS IS HIGHLY UNCERTAIN; IF ANY OF OUR DRUG
CANDIDATES EXPERIENCE CLINICAL FAILURES, OUR BUSINESS COULD BE MATERIALLY
ADVERSELY AFFECTED.
Clinical trials, including pre-clinical testing, are lengthy, expensive
and uncertain. Failure can occur at any stage. We have no products that have
successfully completed all
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necessary clinical testing. Three of our drug candidates have undergone some
clinical testing, and three currently are in pre-clinical testing. We do not
know whether the FDA will allow us to begin human testing of our drug
candidates that have not been tested in humans or to continue human testing
of those candidates that have undergone some human testing. We cannot rely
on interim results of trials to predict their final results, nor can we count
on acceptable results at early stages of testing to be repeated at later
stages. Any of our drug candidates could have undesirable or unintended side
effects or other problems that may prevent or limit future testing, approval
or use of the product.
We have experienced safety and efficacy problems with drug candidates.
In a clinical trial of licostinel, our drug candidate to treat stroke,
crystals of licostinel occurred in the urine of some subjects, a potential
dose-limiting side effect. Although the crystal formation occurred only in
subjects with at least four times the blood plasma level of licostinel that
was necessary for the drug to be effective in animals, our development
partner, Novartis Pharma A.G., ceased its participation in the development of
licostinel. In addition, in October 1998 we announced that ganaxolone, our
drug candidate to treat migraine and epilepsy, was not effective in providing
relief to patients suffering migraine headaches. The results of a clinical
trial in which 325 migraine patients received either ganaxolone or a placebo
drug did not show a statistically significant difference in migraine headache
relief between those patients receiving ganaxolone and those patients
receiving the placebo.
We cannot assure you that any of our clinical trials will be completed
successfully or at all, or that they will result in marketable products. Any
significant delay or failure in the clinical development of our products will
materially adversely affect our business, financial condition and results of
operations.
IF WE DO NOT SUCCESSFULLY COMMERCIALIZE OUR PRODUCTS, WE MAY NEVER ACHIEVE
PROFITABILITY.
Since we started business in 1989, we have spent over $177 million
researching and developing our drug candidates. We have raised this money by
selling stock in CoCensys to private investors and the public, licensing
drugs and technologies to other companies and selling assets that we have
developed at CoCensys. We have never had operating revenues and have never
commercially introduced a product. Through March 31, 1999, we have incurred
a cumulative deficit of approximately $119 million.
We expect to continue to incur substantial and increasing losses over the
next several years as we continue our research and development programs. Our
ability to achieve and sustain profitable operations in the long term will
depend on our ability to, among other things:
- - establish collaborative relationships;
- - complete our product development;
- - obtain regulatory approvals; and
- - achieve market acceptance for our products.
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WE NEED SIGNIFICANT ADDITIONAL FUNDS AND MAY HAVE TO SELL ADDITIONAL STOCK OR
RELINQUISH RIGHTS TO SOME OF OUR DRUG CANDIDATES AND TECHNOLOGY TO OBTAIN
FUNDING; IF WE DO NOT OBTAIN FUNDING, WE MAY BE UNABLE TO CONTINUE OUR
BUSINESS.
Drug development is capital intensive and requires significant funding
commitments. We will need a substantial amount of funds to continue our
operations both in the near term and over the next several years. If we do
not raise additional funds by the end of 1999, we will be forced to curtail
our operations. Our cash needs beyond 1999 will vary depending on a number of
factors, including the following:
- the size and progress of our research and development programs;
- the results of our animal and human testing of our drugs;
- the time and costs of obtaining regulatory approvals for our drugs (if
approvals can be achieved);
- how good our drugs are compared to other drugs on the market that
treat the same disorders;
- the time, costs and success of establishing sales and marketing
capabilities; and
- the time, costs and success of establishing manufacturing
capabilities.
We do not know if we will be able to raise funds on terms that are
acceptable to us. If we sell additional stock, stockholders may experience
substantial dilution. If we raise cash through licensing additional drugs
and technologies to collaboration partners, we will be required to relinquish
rights to some of our drugs and technologies.
If we cannot raise enough cash to fund our operations, we may be forced
to delay, reduce the scope of or eliminate one or more of our research or
development programs. We may have to cease all operations if we are not
successful in obtaining funds.
WE DEPEND ON THIRD PARTIES TO FUND OUR DRUG DEVELOPMENT; IF FUNDS FROM THOSE
THIRD PARTIES ARE NOT AVAILABLE TO US IN THE FUTURE, WE MAY BE FORCED TO
CEASE OPERATIONS.
In order to fund the development, clinical testing, manufacturing and
commercialization of our products, we have entered into various
collaborations with corporate partners, licensors, licensees and others.
Currently, we are a party to a collaboration agreement with Warner-Lambert
Company for research and development of subtype-selective NMDA receptor
antagonists and with Wyeth-Ayerst Laboratories, a division of American Home
Products Corporation, for the development of epalons to treat anxiety. Under
each agreement, we depend on the collaboration partner to provide the funding
to develop drug candidates for potential approval and commercialization.
WE MAY BE UNABLE TO FULFILL OUR OBLIGATIONS UNDER THE COLLABORATION
AGREEMENTS. We do not know if we will be able to fulfill our research and
development obligations under each collaboration agreement. If we cannot
fulfill our obligations, we may be required to terminate early one or both of
the agreements and forfeit many of our rights under the agreements. In
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particular, our collaboration agreement with Wyeth-Ayerst provides that if
the lead compound under development to treat anxiety fails to meet certain
criteria, and if at that time we have not yet produced a back-up compound
that meets another set of criteria, Wyeth-Ayerst can demand repayment of a
portion of the funds paid to us under our collaboration agreement.
Currently, the amount that we may be required to pay back could be as much as
$3 million, in cash or common stock. Although we hope to fulfill our
obligations under the collaboration agreement so that Wyeth-Ayerst will not
be able to demand repayment, we cannot assure we will be able to do so.
EITHER OF OUR COLLABORATION PARTNERS MAY CANCEL ITS COLLABORATION
AGREEMENT WITH US AT ANY TIME. Each of our collaboration agreements allows
either CoCensys or our collaboration partner to voluntarily terminate its
participation in the collaboration at any time. If either of our current
collaboration partners terminates its agreement with us, that partner would
lose its right to further develop or sell drugs under that collaboration;
however, that partner also no longer would be required to fund development of
those drugs. If either Warner-Lambert or Wyeth-Ayerst cancels its agreement
with us, we would have to find a new collaboration partner to pay for further
development of our drug candidates. We cannot assure you that we would be
able to do so. Collaboration partners have, in the past, terminated their
agreements with us. In 1994, we entered into a development agreement with
Novartis Pharma A.G. to develop licostinel to treat stroke patients. In
1997, Novartis terminated its participation in the development agreement
based on side effects seen in human trials of licostinel. Also, in 1996, we
entered into an agreement with G.D. Searle & Co. to develop epalons to treat
insomnia. In July 1998, Searle terminated its participation in that
agreement, stating that the program no longer met its needs in light of its
entire product pipeline. Since termination of those two agreements, we have
not yet found new collaboration partners to develop those drugs, and we do
not have the money to complete development of those drugs. We do not know if
we will be able to find new collaboration partners for those drugs.
WE MAY BE UNABLE TO ENTER INTO COLLABORATION AGREEMENTS IN THE FUTURE.
We plan to continue to enter into collaboration agreements with
pharmaceutical companies to develop, market and sell our drug candidates. We
do not know if we will be able to find additional partners interested in
developing our drugs. Also, even if we find potential partners interested in
our drugs, we do not know if we will be able to enter into collaboration
agreements with these partners on terms and conditions that we find
acceptable. Even if we do enter into additional collaboration agreements, we
do not know if the collaborations will successfully develop drugs for
marketing and sale. If we are unable to secure collaboration partners, we
will not be able to develop our drug candidates.
IF WE DO NOT OBTAIN FDA APPROVAL FOR OUR PRODUCT CANDIDATES, WE WILL NOT BE
ABLE TO SELL PRODUCTS AND GENERATE REVENUES.
Our drug candidates are subject to extensive and rigorous regulation by
the FDA and state and local bodies in the United States and by foreign
regulatory authorities. These regulations cover, among other things, product
development, testing, manufacturing, labeling, sales, advertising and
promotion. The process of obtaining FDA and other required regulatory
approvals is long, expensive and uncertain. In order to market and sell our
drugs in the United States and other countries, we must successfully complete
rigorous testing in animals and humans to prove that the drugs are safe for
human use and are effective in treating one or more specific brain disorders.
We must conduct these tests in a large number of people, including both
healthy volunteers and people who suffer from the disorder for which the drug
is intended. All of our
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testing must be conducted strictly in accordance with standards set up by the
FDA and foreign regulators. If we successfully complete those tests for one
of our drugs, we then must go through an extensive regulatory approval
process with the FDA, and with foreign regulators, before we can begin
marketing and selling the drug.
Even if our drugs are approved for marketing and sale, the FDA and
foreign regulators may place limitations on the marketing and sale of our
drugs or require that we conduct additional testing on any or all of our
drugs after the drugs are approved for marketing and sale. In addition, each
drug, the manufacturer of that drug and the manufacturing facilities in which
the drug is made are subject to continual review and periodic inspections.
The FDA and regulatory agencies in other countries have the right to withdraw
approval for a drug later if, for example, patients taking our drug
experience serious side effects or we have problems in manufacturing the drug.
We do not know if we will successfully complete the required testing with
any of our drug candidates. Any of our drugs may have unacceptable side
effects or may not be effective in treating the targeted brain disorder. We
may have difficulty recruiting healthy or sick volunteers for our trials.
Either CoCensys or the FDA can halt a trial at any time if either of us
believes that the participants in the trial are being exposed to unacceptable
health risks. Even if we do successfully complete the testing for one or more
of our drugs and prove that our drug is safe for human use and is effective
in treating one or more specific brain disorders, we do not know if the FDA
or any other country's regulatory agency will approve the drug for marketing
and sale in that country. We cannot be sure that our drug candidates will
receive FDA approval in a timely manner, if at all. Regulatory agencies may
limit the uses, or indications, for which any of our products is approved.
Even if approvals are obtained, the marketing and manufacturing of drug
products are subject to continuing FDA and other regulatory requirements,
such as requirements to comply with good manufacturing practices. The
failure to comply with such requirements could result in enforcement action,
which could adversely affect us and our business. Later discovery of problems
with a product, manufacturer or facility may result in additional
restrictions on the product or manufacturer, including withdrawal of the
product from the market. The government may impose new regulations which
could further delay or preclude regulatory approval of our drug candidates.
We cannot predict the impact of adverse governmental regulation which might
arise from future legislative or administrative action. Also, we conduct
testing on our drugs both in the United States and in other countries
(principally European countries). The FDA in the United States and
regulatory agencies in other countries may be unwilling to accept the results
from trials not conducted in that agency's "home" country.
FAILURE TO ADEQUATELY PROTECT OUR PROPRIETARY TECHNOLOGY OR TO AVOID
INFRINGING THE RIGHTS OF OTHERS COULD IMPAIR OUR COMPETITIVE POSITION.
Our success depends in part on our ability to protect our technology from
unauthorized use by obtaining patents in the United States and other
countries and maintaining our trade secrets. Also, our drug candidates must
not infringe on the patent and other proprietary rights of others in the
United States and other countries where we may market and sell them. We work
hard to obtain appropriate patents and to maintain our trade secrets;
however, patents can be highly uncertain and involve complex legal and
factual questions. We do not know if our patent protection and trade secret
protection will be sufficient to allow CoCensys and our development partners
to develop, market and sell our drug candidates.
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We file and prosecute patent applications on our own behalf and in
connection with technology that we have licensed from third parties. We have
been issued 23 patents in the United States for our technologies, with
expiration dates ranging from June 9, 2009 to February 11, 2017, and another
21 filed patents are pending. We have also filed for patent protection in
selected foreign countries. We will continue to file and prosecute patent
applications in the United States and in other countries to protect our drug
candidates, but we do not know if we will be issued additional patents for
our technologies, either in the United States or in other countries. We also
do not know if we will invent any new products or processes for which we can
receive patent protection in the future.
The United States Patent and Trademark Office and similar agencies in
other countries have substantial backlogs of patent applications waiting for
consideration. In the United States, patent applications remain secret until
the patent is issued; in other countries, patent applications remain secret
for at least six months after filing. Therefore, we do not know whether any
of our competitors has filed patents that may interfere with our ability to
gain patent protection for our discoveries. We do not know whether our
competitors may have invented some of our technology prior to the time that
we invented the technology. Generally, only the person who first invents
technology is entitled to a patent for that technology. Even if we are the
first to invent certain technology and we have filed a patent application, we
do not know when that application will be considered by the United States
Patent and Trademark Office or any agency in other countries where we may
have filed a patent application for the technology.
Patents that have been issued to us are always subject to being
challenged, invalidated or circumvented; we do not know if any of our patents
or patents in which we have rights will provide adequate protection for
CoCensys. Also, we may have to participate in litigation or interference
proceedings to determine whether one or more of our patents is valid. Even
if we win the litigation or interference proceeding, we may be required to
spend substantial amounts of money defending the validity of our patents. We
do not know if we will have sufficient money to defend all of our patents if
they are challenged.
Our success will also depend, in part, on our not infringing patents
issued to others. We do not know if any patents held or patent applications
filed by other people or companies will force us to alter our drug candidates
or processes, stop development of one or more of our drug candidates or
obtain licenses, if possible, from those other people or companies.
A number of pharmaceutical companies, biotechnology companies,
universities and research institutions have filed patent applications or
received patents that may be competitive with the our patents and patent
applications. We do not know the effect that those patents and patent
applications may have on our ability to continue to develop and, eventually,
market and sell our drug products. If we attempt to obtain licenses to use
patents held by other people, we do not know if we will be granted licenses
or whether the terms of those licenses, if granted, will be fair and
acceptable to CoCensys.
If we infringe another person's patent, or we fail to obtain an
appropriate license to use any other person's technology that is required to
develop, market and sell our drug products, we may have to participate in
interference proceedings or litigation, which could result in substantial
costs, fines and penalties assessed against CoCensys and we may be forced to
cease all use of the other person's technology. In fact, we are aware of a
patent that has issued that contains claims that may, if valid, block us from
selling certain compounds for one particular indication.
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Although we are not currently pursing that indication for those compounds, if
we do decide to pursue that indication, we will have to either institute an
interference proceeding to determine the validity of the other patent or
attempt to license rights to the patent from the holder. We do not know if
we will be successful if we decide to institute an interference proceeding.
Also, we do not know if the patent holder would be willing to license us
rights to the patent, whether or not on terms acceptable to CoCensys.
We have developed a substantial amount of information constituting our
trade secrets. We rely on confidentiality agreements with our employees,
consultants and certain contractors to protect these trade secrets. We do
not know if the other parties to these agreements will abide by the
agreements or breach them. If any agreement is breached, we do not know
whether we will be able to adequately protect CoCensys from damage caused by
our trade secrets being disclosed to the public or to a competitor.
WE FACE SIGNIFICANT COMPETITION FROM COMPANIES WITH GREATER FINANCIAL
RESOURCES AND EXPERTISE; IF WE CANNOT COMPETE SUCCESSFULLY WITH THESE
COMPANIES, THE VALUE OF OUR COMPANY AND OUR STOCK MAY BE GREATLY REDUCED.
We are engaged in a highly competitive, rapidly changing field. Existing
products and therapies, as well as those under development by other
companies, will compete directly with products that we are seeking to develop
and market. Competition from fully integrated pharmaceutical companies,
including larger biotechnology companies and our collaboration partners, is
intense and is expected to increase. Most of these companies have
significantly greater financial resources and expertise than we do in
research and development, manufacturing, pre-clinical and clinical testing,
obtaining regulatory approvals, marketing and distribution. Many of our
competitors also have significant products to treat neurological and/or
psychiatric disorders approved or in development and operate large,
well-funded research and development programs. Academic institutions,
governmental agencies and other public and private research organizations
also conduct research, seek patent protection and establish collaborative
arrangements for product and clinical development and marketing. Further, we
face competition based on product efficacy, safety, the timing and scope of
regulatory approvals, availability of supply, marketing and sales capability,
reimbursement coverage, price and patent position. We do not know whether
our competitors will be able to develop more effective or more affordable
products, or achieve earlier patent protection or product commercialization
than us. If we are unable to compete successfully, our business, financial
condition and results of operations will be materially adversely affected.
IF OUR PRODUCTS ARE NOT COMMERCIALLY SUCCESSFUL OR REIMBURSED BY THIRD-PARTY
PAYORS, WE WILL BE UNABLE TO GENERATE SUFFICIENT REVENUES TO SUSTAIN OUR
BUSINESS.
Even if one or more of our products prove safe and effective, we do not
know if the products will be successful commercially. For example, our
products may be too difficult or expensive to make, or our products may not
be acceptable to patients, health care providers and third-party payors. In
both the United States any many foreign countries, sales of our products, if
any, will depend in part on the availability of reimbursement from
third-party payors, such as government health administration authorities,
private health insurers and other organizations. Third-party payors are
increasingly challenging the price and cost-effectiveness of medical products
and services. We do not know whether our drug products will be considered
cost effective or that adequate third-party reimbursement will be available
to enable us to maintain
21
<PAGE>
price levels sufficient to realize an appropriate return on our investment in
product development. In certain foreign countries, our products may be
subject to governmentally mandated prices. If governments and third-party
payors do not provide adequate reimbursement for our potential drug products
or if foreign governments force unreasonably low pricing for our drugs, our
business, financial condition and results of operations may be materially
adversely affected.
A PRODUCT LIABILITY CLAIM AGAINST US COULD CAUSE US TO INCUR SIGNIFICANT
LOSSES.
Our business exposes us to potential product liability risks if any of
our compounds or future products cause illness, injury or death. Although we
currently have liability insurance covering our clinical trials, our coverage
may not be sufficient to cover all potential claims. We do not know if we
will be able to obtain and maintain such insurance for all of our clinical
trials and future products. We will need to increase our insurance coverage
in the future if we begin to market and sell any of our drug products under
development. However, we do not know if we will be able to obtain or maintain
product liability insurance in the future on acceptable terms or with
adequate coverage against potential liabilities. A liability claim,
regardless of merit or eventual outcome, could cause us to incur significant
losses and materially adversely affect our business, financial condition and
results of operations.
OUR STOCK PRICE IS VERY VOLATILE, AND EXTREME PRICE FLUCTUATIONS COULD
MATERIALLY ADVERSELY AFFECT THE VALUE OF ANY INVESTMENT IN COCENSYS COMMON
STOCK.
The securities markets have 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 prices of the
common stock of many publicly traded biopharmaceutical companies, including
ours, have in the past been, and can in the future be expected to be,
especially volatile. Our stock price may fluctuate greatly as a result of a
number of factors, including:
- announcements of technological innovations or new products by us or by
our competitors;
- developments or disputes concerning patents or proprietary rights;
- publicity regarding actual or potential medical results relating to
drug products that we or our competitors are developing;
- regulatory developments in both the United States and foreign
countries;
- public concern as to the safety of biotechnology products; and
- economic and other external factors, as well as period-to-period
fluctuations in our financial results.
THE SALE OF A LARGE NUMBER OF SHARES OF OUR COMMON STOCK MAY FURTHER DEPRESS
OUR STOCK PRICE, WHICH COULD MATERIALLY ADVERSELY AFFECT THE VALUE OF ANY
INVESTMENT IN COCENSYS COMMON STOCK.
The sale of a large number of shares of our common stock in the public
market could depress the market price of our common stock. Substantially all
of the outstanding shares of our
22
<PAGE>
common stock may be sold at any time in the public markets. Approximately
650,000 freely tradable additional shares may be issued on exercise of vested
options to purchase CoCensys stock. Current and former employees,
consultants, officers and directors of CoCensys hold these options.
We may be required to issue millions of additional shares of CoCensys
common stock upon conversion of the Series E convertible preferred stock. As
of June 22, 1999, 1,567 shares of the preferred stock remained issued and
outstanding. Each share of the preferred stock is convertible into shares of
CoCensys common stock at discount to the current market price of our common
stock. If converted on June 22, 1999, based on the then-applicable
conversion price of $0.51 per share, the remaining preferred stock would have
been convertible into approximately 3.3 million additional shares of CoCensys
common stock. The number of shares of common stock that may be issued could
prove to be significantly greater if the market price of our common stock
declines. Stockholders may experience substantial dilution in their
investment from issuance of additional common stock on conversion of the
preferred stock.
We also may be required to issue additional shares of CoCensys common
stock in fulfillment of our obligations to Warner-Lambert Company. Under our
collaboration agreement with Warner-Lambert, we will owe Warner-Lambert $1
million, plus interest, on December 31, 1999. The $1 million plus interest
is payable in common stock or cash, at the election of Warner-Lambert. If
the amount had been paid on June 22, 1999, and Warner-Lambert elected to
receive the payment in stock, we would have had to issue to Warner-Lambert
approximately 1,227,000 shares of common stock. The number of shares of
common stock that may be issued could prove to be significantly greater if
the market price of our common stock declines. CoCensys stockholders could
experience substantial dilution from issuance of additional common stock in
satisfaction of our obligation to Warner-Lambert.
FAILURE TO MAINTAIN OUR LISTING ON THE NASDAQ NATIONAL MARKET MAY MATERIALLY
ADVERSELY AFFECT THE LIQUIDITY OF OUR COMMON STOCK AND THE VALUE OF COCENSYS
COMMON STOCK.
Our common stock is traded on the Nasdaq National Market under the symbol
"COCN." In order to maintain our listing on the Nasdaq National Market, we
must meet a number of listing requirements established by Nasdaq. Recently,
we have not met all listing requirements, and there is a significant risk
that we will not meet all listing requirements in the future.
One Nasdaq National Market listing requirement is that we must maintain a
minimum bid price of $1.00 per share. As of June 22, 1999, our closing bid
price was $0.84 per share. We do not know if our bid price will achieve or
sustain the required minimum price in the future. Nasdaq may remove our
shares from trading on the Nasdaq National Market based on the fact that our
bid price has recently been below $1.00 per share.
A second Nasdaq National Market listing requirement is that the value of
our shares held by the public must equal at least $5 million. As of June 22,
1999, the value of our publicly held shares equaled $3,896,748. Nasdaq may
remove our shares from trading on the Nasdaq National Market based on the
fact that the value of our publicly held shares is below $5 million.
A third Nasdaq National Market listing requirement is that the value of
our net assets must equal at least $4 million. As of March 31, 1999, our net
assets equaled $4,681,000. We do not know if the value of our net assets
will remain above $4 million. Nasdaq may remove our
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<PAGE>
shares from trading on the Nasdaq National Market if our net assets fall
below $4 million in the future.
On April 29, 1999, we attended a hearing before Nasdaq regarding our
continued listing on the Nasdaq National Market, based on the fact that our
closing bid price had been under $1.00 per share and the fact that the value
of our publicly traded stock was below $5 million. Nasdaq has not notified
us of the result of the hearing or whether Nasdaq intends to take any action
with respect to the continued listing of our common stock on the Nasdaq
National Market. We do not know what Nasdaq will decide to do.
We have discussed with Nasdaq whether it may be appropriate to move
CoCensys' common stock to the Nasdaq SmallCap Market. The Nasdaq SmallCap
Market also requires that the bid price per share for our common stock be at
least $1.00. However, the Nasdaq SmallCap Market has lower requirements for
the minimum value of publicly held shares ($1 million) and the minimum
required value of net assets ($2 million). We do not know if Nasdaq will
consider moving our common stock to the Nasdaq SmallCap Market or if we will
be able to satisfy the requirements for listing on that market.
If we cannot maintain continued listing of our common stock on the Nasdaq
National Market or the Nasdaq SmallCap Market, our common stock could trade
on the OTC Bulletin Board or in the over-the-counter market in what is
commonly referred to as the "pink sheets." If this occurs, a stockholder
will find it more difficult to dispose of the securities or to obtain
accurate quotations as to the price of the securities. In addition, our
common stock could become subject to the "penny stock" regulations of the
SEC, which impose additional restrictions on broker-dealers who trade in such
stock and could severely limit the liquidity of our common stock. If we do
not maintain our listing on the Nasdaq National Market or Nasdaq SmallCap, we
may be required to redeem the Series E preferred stock. Redemption of the
preferred stock would significantly deplete our cash reserves and materially
adversely affect our operations and financial condition.
24
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
a) Market Information
The Company's Common Stock, par value $ .001 per share, trades on the
Nasdaq National Market under the symbol "COCN." The following table presents
quarterly information on the price range of the Company's Common Stock. This
information indicates the high and low sale prices reported by the Nasdaq
National Market. These prices do not include retail markups, markdowns or
commissions.
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.
<TABLE>
<CAPTION>
High Low
-------- --------
<S> <C> <C>
1997
First quarter $ 62.00 $ 36.00
Second quarter $ 47.00 $ 21.50
Third quarter $ 50.00 $ 23.00
Fourth quarter $ 48.50 $ 23.50
1998
First quarter $ 36.00 $ 23.00
Second quarter $ 29.00 $ 16.50
Third quarter $ 21.50 $ 7.00
Fourth quarter $ 18.00 $ 2.00
</TABLE>
b) Holders
As of March 17, 1999 there were 400 holders of record of the Company's
Common Stock.
c) Dividends
The Company has not paid any dividends on its Common Stock since its
inception and does not intend to pay any dividends on its Common Stock in the
foreseeable future.
d) Recent Sales of Unregistered Securities
Pursuant to the terms of the Series E Convertible Preferred Stock
issued in June 1998, on November 4, 1998, the Company issued additional warrants
to the original investors to purchase 12,500 shares of common stock. The
warrants are exercisable into Common Stock at $5.04 per share and expire in
November 2002. The issuance was exempt from registration under section 4(2) of
the Securities Act of 1933, as amended, as a transaction not involving any
public offering.
ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes selected consolidated financial data. Certain
reclassifications have been made to prior year data to conform to the 1998
presentation.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ----------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA: (In thousands, except per share data)
Revenues:
Co-promotion revenues $ 540 $ 3,264 $ 9,085 $ 10,414 $ 7,402
Co-development revenues 2,046 8,650 6,073 1,970 -
----------- ----------- ----------- ---------- ----------
Total revenues 2,586 11,914 15,158 12,384 7,402
Operating expenses:
Research and development 15,745 23,308 20,949 17,662 11,569
Marketing, general and administrative 3,894 9,975 13,862 13,383 7,673
Acquired research and development - - - - 14,879
----------- ----------- ----------- ---------- ----------
Total operating expenses 19,639 33,283 34,811 31,045 34,121
----------- ----------- ----------- ---------- ----------
Operating loss (17,053) (21,369) (19,653) (18,661) (26,719)
----------- ----------- ----------- ---------- ----------
Gain on disposition of sales force (1) 1,000 4,728 - - -
Interest income 908 898 1,304 717 373
Interest expense (81) (78) (139) (178) (240)
----------- ----------- ----------- ---------- ----------
Net loss (15,226) (15,821) (18,488) (18,122) (26,586)
Accretion of preferred stock
for beneficial conversion feature 890 - - - -
Dividends on preferred stock 1,052 - - - -
----------- ----------- ----------- ---------- ----------
Net loss attributable to
common shareholders $ (17,168) $ (15,821) $ (18,488) $ (18,122) $ (26,586)
=========== =========== =========== ========== ==========
Basic and diluted loss per share (2) $ (5.60) $ (5.60) $ (6.79) $ (8.39) $ (18.64)
=========== =========== =========== ========== ==========
Shares used in computing basic
and diluted loss per share 3,066 2,822 2,723 2,161 1,426
=========== =========== =========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ----------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA: (In thousands)
Cash, cash equivalents and
investments $ 12,195 $ 12,960 $ 17,999 $ 13,449 $ 8,924
Working capital 5,315 8,374 14,434 6,753 3,766
Total assets 15,099 16,916 22,051 18,201 15,216
Long-term obligations 392 1,101 324 406 696
Accumulated deficit (116,151) (98,983) (83,162) (64,674) (46,552)
Total stockholders' equity 7,506 10,831 16,947 10,644 8,547
</TABLE>
(1) In October 1997, the Company sold its sales and marketing force as
discussed in Note 4 to the Financial Statements.
(2) The earnings per share amounts prior to 1997 have been restated as
required to comply with Statement of Financial Accounting Standard No. 128,
"Earnings per Share" ("SFAS No. 128"). For further discussion of earnings per
share and the impact of SFAS No. 128, see the Notes to Financial Statements.
25
<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.
26
<PAGE>
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.
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
27
<PAGE>
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
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
it 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.
28
<PAGE>
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.
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 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
29
<PAGE>
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.
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
30
<PAGE>
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.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has no financial instruments which are subject to market risk.
Although the Company's earnings and cash flows are subject to fluctuations due
to changes in the interest rates on its investments, a hypothetical 10% adverse
decrease in the interest rates would not have a material adverse effect on the
results of operations because the majority of the Company's investments are
short-term government and corporate obligations. A 10% reduction in interest
rates would reduce interest income by approximately $91,000 annually. Due to the
short period to maturity, the Company believes that the impact of a 10%
reduction in interest rates would not have a material effect on the carrying
value of its available-for-sale securities.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data of the Company are
provided at the pages indicated in Item 14 (a).
31
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) FINANCIAL STATEMENTS
The financial statements required by this item are submitted
in a separate section beginning on Page 34 of this report.
<TABLE>
<CAPTION>
Financial Statements of CoCensys, Inc.
--------------------------------------
<S> <C>
Report of Independent Auditors 34
Balance Sheets as of December 31, 1998 and 1997 35
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 36
Statements of Stockholders' Equity for the period from
inception (February 15, 1989) to December 31, 1998 37
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 40
Notes to Financial Statements 41
</TABLE>
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.
32
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
COCENSYS, INC.
Date: June 28, 1999 By: /s/ F. Richard Nichol, Ph.D.
-------------------------------------
(F. Richard Nichol, Ph.D.)
Chairman of the Board,
President and Chief Executive Officer
33
<PAGE>
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
and the second paragraph of Note 1,
as to which the date is April 15, 1999
34
<PAGE>
COCENSYS, INC.
(A development stage company)
BALANCE SHEETS
(In thousands, except share and par value amounts)
<TABLE>
<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
============ ============
</TABLE>
See accompanying notes
35
<PAGE>
COCENSYS, INC.
(A development stage company)
STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<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
======== ========= =========
</TABLE>
See accompanying notes
36
<PAGE>
COCENSYS, INC.
(A development stage company)
STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share and per share amounts)
<TABLE>
<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 - $ - - $ - $ (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
</TABLE>
See accompanying notes
37
<PAGE>
COCENSYS, INC.
(A development stage company)
STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
(In thousands, except share and per share amounts)
<TABLE>
<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
</TABLE>
See accompanying notes
38
<PAGE>
COCENSYS, INC.
(A development stage company)
STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
(In thousands, except share and per share amounts)
<TABLE>
<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 - - - - (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
========= ======= ========== ======== ========== ========= ============= =============
</TABLE>
See accompanying notes
39
<PAGE>
COCENSYS, INC.
(A development stage company)
STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<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
========== ========== ========== ==========
</TABLE>
See accompanying notes
40
<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.
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:
41
<PAGE>
<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):
<TABLE>
<CAPTION>
1998 1997
---------- ---------
<S> <C> <C>
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
========== ==========
</TABLE>
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.
42
<PAGE>
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-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
43
<PAGE>
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.
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
44
<PAGE>
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
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-
45
<PAGE>
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 C 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.
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
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.
46
<PAGE>
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):
<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.
47
<PAGE>
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
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.
48
<PAGE>
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):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1998 1997 1996
-------- --------- ---------
<S> <C> <C> <C>
Net loss $(19,516) $(17,974) $(19,745)
========= ========= ========
Net loss per share $ (6.40) $ (6.40) $ (7.28)
========= ========= ========
</TABLE>
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>
49
<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>
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>
$ 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
50
<PAGE>
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
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
51
<PAGE>
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
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.
52
<PAGE>
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
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.
53
<PAGE>
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.
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
Dug 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
============= ============= =============
</TABLE>
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.
54
