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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended June 30, 1998 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from _______ to _______ .
Commission file number 0-26862
DEPOTECH CORPORATION
(Exact name of Registrant as specified in its charter)
CALIFORNIA 33-0387911
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(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Identification No.)
Organization)
10450 SCIENCE CENTER DRIVE
SAN DIEGO, CALIFORNIA 92121
(Address of principal executive offices, zip code)
(619) 625-2424
(Registrant's telephone number)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---- ----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock: No par value, 14,592,882 shares as of July 31, 1998
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DEPOTECH CORPORATION
TABLE OF CONTENTS
<TABLE>
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PAGE
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PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Condensed Balance Sheets as of
June 30, 1998 (Unaudited) and December 31, 1997...................... 1
Condensed Statements of Operations
for the Three and Six Months ended
June 30, 1998 and 1997 (Unaudited).................................... 2
Condensed Statements of Cash Flows
for the Six Months ended
June 30, 1998 and 1997 (Unaudited).................................... 3
Notes to Condensed Financial Statements............................... 4
Item 2 Management's Discussion and Analysis
of Financial Condition and Results of Operations..................... 7
PART II OTHER INFORMATION
Item 2 Changes in Securities................................................. 22
Item 3 Defaults Upon Senior Securities....................................... 22
Item 4 Submission of Matters to a Vote of Security Holders................... 22
Item 6 Exhibits and Reports on Form 8-K...................................... 24
Signatures..................................................................... 25
</TABLE>
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DEPOTECH CORPORATION
CONDENSED BALANCE SHEETS
<TABLE>
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JUNE 30, DECEMBER 31,
1998 1997
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(Unaudited) (Note)
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ASSETS
Current assets:
Cash and cash equivalents $ 2,360,960 $ 6,194,153
Short-term investments 12,691,672 21,166,402
Accounts receivable from collaborations 1,268,992 1,361,837
Other current assets 1,064,906 1,141,210
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Total current assets 17,386,530 29,863,602
Property and equipment, net 26,979,526 26,948,328
Deposits and other assets 940,258 857,756
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Total assets $ 45,306,314 $ 57,669,686
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LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and other accrued liabilities $ 2,547,756 $ 3,250,460
Current portion of obligations under capital leases 1,857,748 2,037,416
Current portion of note payable 2,850,094 2,509,467
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Total current liabilities 7,255,598 7,797,343
Obligations under capital leases, less current portion 1,260,911 2,089,931
Note payable, less current portion 6,441,249 6,901,982
Deferred rent 2,740,301 2,313,133
Other long-term liabilities 218,278 494,506
Shareholders' equity:
Common stock, no par value; 30,000,000 shares authorized,
14,592,882 and 14,237,216 shares issued and outstanding at
June 30, 1998 and December 31, 1997, respectively 102,498,917 101,970,346
Deferred compensation related to stock options, net (345,285) (109,472)
Unrealized gain on short-term investments 8,561 15,784
Accumulated deficit (74,772,216) (63,803,867)
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Total shareholders' equity 27,389,977 38,072,791
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Total liabilities and shareholders' equity $ 45,306,314 $ 57,669,686
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</TABLE>
See accompanying notes to condensed financial statements.
Note: The balance sheet at December 31, 1997 has been derived from the audited
financial statements at that date, but does not include all of the
disclosures required by generally accepted accounting principles.
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DEPOTECH CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
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THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1998 1997 1998 1997
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(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Revenues:
Contract revenue $ 850,469 $ 760,149 $ 2,065,202 $ 1,931,959
Licensing/milestone payments -- 1,000,000 -- 1,000,000
------------ ------------ ------------ ------------
Total revenues 850,469 1,760,149 2,065,202 2,931,959
Costs and expenses:
Research and development 5,277,088 5,698,303 10,688,226 10,081,206
General and administrative 1,050,400 1,022,009 2,311,183 1,955,604
Repurchase of marketing rights -- 2,000,000 -- 2,000,000
------------ ------------ ------------ ------------
Total costs and expenses 6,327,488 8,720,312 12,999,409 14,036,810
------------ ------------ ------------ ------------
Loss from operations (5,477,019) (6,960,163) (10,934,207) (11,104,851)
Interest income 233,887 390,718 593,965 844,511
Interest expense (268,626) (246,316) (628,107) (466,265)
------------ ------------ ------------ ------------
Net loss $ (5,511,758) $ (6,815,761) $(10,968,349) $(10,726,605)
============ ============ ============ ============
Basic and diluted net loss per share $ (0.38) $ (0.52) $ (0.76) $ (0.82)
============ ============ ============ ============
Shares used in computing
basic and diluted net loss per share 14,534,409 13,116,053 14,449,438 13,074,428
============ ============ ============ ============
</TABLE>
See accompanying notes to condensed financial statements.
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DEPOTECH CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
1998 1997
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(Unaudited)
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OPERATING ACTIVITIES
Net cash used by operating activities $(10,043,853) $ (7,638,495)
INVESTING ACTIVITIES
Purchases of short-term investments (6,015,311) (22,082,975)
Proceeds from sale of short-term investments 14,482,818 13,593,356
Purchases of property and equipment (1,330,030) (6,212,200)
Restricted cash 50,823 (37,119)
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Net cash provided (used) by investing activities 7,188,300 (14,738,938)
FINANCING ACTIVITIES
Repayments on capital lease obligations (1,053,705) (1,006,241)
Repayments on note payable (1,225,007) (275,412)
Proceeds from note payable 1,104,901 2,927,537
Proceeds from issuance of common stock, net 196,171 19,367,470
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Net cash (used) provided by financing activities (977,640) 21,013,354
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Net decrease in cash and cash equivalents (3,833,193) (1,364,079)
Cash and cash equivalents at beginning of period 6,194,153 1,966,626
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Cash and cash equivalents at end of period 2,360,960 602,547
Short-term investments at end of period 12,691,672 24,736,972
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Cash, cash equivalents and short-term investments at end of period $ 15,052,632 $ 25,339,519
============ ============
SUPPLEMENTAL INFORMATION
Property and equipment acquired through capital lease $ 45,016 $ --
============ ============
Interest paid $ 628,107 $ 466,265
============ ============
</TABLE>
See accompanying notes to condensed financial statements.
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DEPOTECH CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. Basis of Presentation and Significant Accounting Policies
The interim unaudited condensed financial statements contained herein
have been prepared in accordance with generally accepted accounting principles
for interim financial information. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. These interim unaudited condensed financial
statements should be read in conjunction with the Company's December 31, 1997
audited financial statements. In management's opinion, the unaudited information
includes all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of the financial position, results of
operations and cash flows for the periods presented. Interim results are not
necessarily indicative of results to be expected for the full year. Certain
prior year amounts have been reclassified to conform with the current year
presentation.
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
disclosures made in the accompanying notes to the financial statements. Actual
results could differ from those estimates.
2. Net Loss Per Share
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings Per Share" ("FAS 128"), which replaced
the calculation of primary and fully diluted net loss per share with basic and
diluted net loss per share. Basic and diluted net loss per share is calculated
using the weighted-average number of common shares outstanding.
3. New Accounting Standards
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS 130") and
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("FAS 131"). Comprehensive loss is not
materially different from the net loss disclosed on the statements of operations
and the Company operates in one business segment.
4. Chiron Collaboration
In March 1994, the Company entered into a collaboration agreement ("the
Collaboration Agreement") with Chiron Corporation ("Chiron") to develop and
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commercialize sustained-release formulations of DepoCyt(TM) and certain Chiron
proprietary products using the Company's drug delivery technology. Under the
agreement, Chiron purchased 400,000 shares of the Company's Series C preferred
stock for $6.25 per share, or an aggregate consideration of $2.5 million, and a
warrant to purchase 365,000 shares of Series C preferred stock at an exercise
price of $6.25 per share for $1.0 million. The warrant was terminated and
converted into a marketing rights fee to the Company upon the achievement of a
development milestone in January 1995.
In June 1997, DepoTech reacquired rights to DepoCyt in Canada and
Europe from Chiron for aggregate cash payments of up to $13.7 million. Chiron
retains exclusive marketing rights to DepoCyt in the United States. An initial
$2.0 million cash payment was paid by DepoTech to Chiron and expensed in 1997.
If, prior to December 31, 1998, the U.S. Food and Drug Administration ("FDA")
issues a letter or other notification to DepoTech indicating that DepoCyt is
approvable or approved, the remaining balance of $11.7 million shall be payable
no later than December 31, 1998. If no FDA notification is received prior to
December 31, 1998, the remaining amount shall be payable no later than six
months from the earlier of U.S. or European Union regulatory notification that
the application to market or sell DepoCyt is approvable or approved. If all
applications for regulatory approval to sell DepoCyt in the U.S. and European
Union are permanently withdrawn, DepoTech shall be relieved of any obligation to
pay the remaining $11.7 million. Therefore, such amount will be recorded upon
the receipt of the required notification.
Under the Collaboration Agreement, cumulative reimbursable clinical and
manufacturing scale-up costs for DepoCyt incurred by the Company totaled $11.2
million through June 30, 1998 and $10.0 million through June 30, 1997.
The Collaboration Agreement also provides for the joint development of
DepoFoam formulations of certain compounds proprietary to Chiron ("Chiron
Products"). The agreement provides that Chiron will pay the Company for its
feasibility efforts. Chiron must fund one feasibility program for a Chiron
Product per year or lose its option to develop DepoFoam formulations of
additional Chiron proprietary compounds. Through April 1997, the Company had
completed feasibility studies on four Chiron proprietary compounds. No further
feasibility studies on Chiron Products will be performed under the Collaboration
Agreement.
Both the Company and Chiron have the ability to terminate a portion or
all of the collaboration at certain intervals and with advance notice.
5. Pharmacia & Upjohn Agreement
In July 1997, DepoTech entered into a Marketing and Distribution
Agreement with Pharmacia & Upjohn S.p.A ("P&U"), an affiliate of Pharmacia &
Upjohn Inc., for rights to market and sell DepoCyt in countries outside the
United States. P&U will generally be responsible for submitting regulatory
filings, labeling, packaging, distribution, marketing and sales of DepoCyt in
this territory. Under the P&U Agreement,
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the Company will manufacture DepoCyt and receive a share of the net sales of
DepoCyt sold by P&U, if any. The Company received a cash payment of $2.0 million
upon execution of the agreement and may receive additional payments of up to
approximately $17.0 million upon achievement of certain regulatory milestones.
The agreement also provides for reimbursement by P&U of certain clinical trial
expenses and regulatory fees incurred by the Company. Cumulative reimbursable
costs incurred by the Company under the P&U Agreement totaled $1.7 million as of
June 30, 1998.
Both the Company and P&U have the ability to terminate the
collaboration at certain intervals and with advance notice.
6. Contingencies
In April 1998, a class action suit was filed against the Company and
two of its former officers in the United States District Court for the Southern
District of California. The lawsuit alleges violations of the federal securities
laws and purports to seek unspecified monetary damages on behalf of a class of
shareholders who purchased DepoTech common stock during the period April 1, 1996
through December 18, 1997. The Company believes that the lawsuit is without
merit and intends to defend it vigorously.
7. Debt Covenants
At June 30, 1998, the Company had capital lease obligations and a bank
note payable associated with capital expenditures totaling $12.4 million of
which principal payments of $4.7 million are payable over the next twelve
months. All borrowings are secured by the capital equipment financed. The terms
of the Company's bank loan and equipment lease agreements require the Company to
maintain certain cash balances. At June 30, 1998, the Company was not in
compliance with these covenants. The agreements require the Company to post cash
collateral if the covenants are violated. The Company is in discussion with its
lenders regarding the amount of such cash collateral.
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ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Since its inception in October 1989, DepoTech Corporation ("DepoTech"
or the "Company") has devoted substantially all of its resources to the
development of its potential products. To date, the Company has not received any
revenues from the sale of products. The Company has funded its development
programs primarily from equity-derived working capital and through strategic
alliances with other companies. The Company has been unprofitable since its
inception and expects to incur additional operating losses over at least the
next two years. As of June 30, 1998, the Company's accumulated deficit was
approximately $74.8 million.
The following discussion is qualified in its entirety by the more
detailed information and the Condensed Financial Statements and Notes thereto
appearing elsewhere in this Quarterly Report, including the information under
"Risks and Uncertainties." This Quarterly Report may contain, in addition to
historical information, forward-looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from the
results discussed in such forward-looking statements. Factors that could cause
or contribute to such differences include those discussed under "Risks and
Uncertainties."
RESULTS OF OPERATIONS
The Company had total revenues of $0.9 million for the three months
ended June 30, 1998 as compared to $1.8 million for the same period in 1997.
Total revenues for the six months ended June 30, 1998 were $2.1 million compared
to $2.9 million for the same period in 1997. Total revenues in 1998 were
principally generated by the Company's collaborative agreements with Chiron
Corporation ("Chiron") and Pharmacia & Upjohn S.p.A., an affiliate of Pharmacia
& Upjohn, Inc. ("P&U"). Total revenues for the three and six months ended June
30, 1997 were principally generated by the Company's collaborative agreement
with Chiron. Total revenues for the three and six months ended June 30, 1998
were primarily derived from reimbursement of certain clinical trial expenses for
the Company's lead product, DepoCyt(TM), an anti-cancer drug, under the
collaborative agreements with Chiron and P&U. Included in total revenue for the
second quarter of 1997 is a milestone payment from Chiron of $1.0 million paid
to DepoTech upon the filing of a New Drug Application for DepoCyt in the U.S. In
addition, Chiron reimbursed DepoTech for 100% of certain pre-clinical and
feasibility studies performed on their behalf during 1997 and the first quarter
of 1998. Further, DepoTech is reimbursed for conducting feasibility studies for
various pharmaceutical companies. Revenues may fluctuate from period to period
depending on the level of clinical and process development activity for projects
under collaborative agreements and the achievement of future milestones.
Research and development expenses for the second quarter ended June 30,
1998 were $5.3 million compared to $5.7 million for the same period in 1997.
Research and
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development expenses for the six months ended June 30, 1998 increased to $10.7
million from $10.1 million in 1997. Factors contributing to this increase
include expanded efforts in clinical trials, manufacturing scale-up and
preclinical development of potential DepoFoam(TM) products. In addition, the
Company incurred $0.7 million for severance and out-placement expense from
workforce reductions during 1998. A non-randomized Phase IV clinical trial of
DepoCyt in solid tumor patients is continuing, as are randomized trials of
DepoCyt in leukemia and lymphoma patients. DepoTech is also conducting a dose-
finding study of DepoCyt in pediatric patients. In addition, clinical trials and
manufacturing scale-up of DepoMorphine(TM) sustained-release encapsulated
morphine sulfate to treat acute post-surgical pain are underway. Further, the
Company is evaluating the feasibility of developing several early-stage
compounds for corporate partners.
General and administrative expenses for the second quarter ended June
30, 1998 were $1.1 million compared to $1.0 million for the same period in 1997.
General and administrative expenses for the six months ended June 30, 1998
increased to $2.3 million from $2.0 million for the comparable period in the
prior year. The increase for the six months ended June 30, 1998 compared to the
same period in 1997 is primarily attributable to $0.3 million for severance and
out-placement expense from workforce reductions.
Chiron and DepoTech had been jointly developing DepoCyt in the U.S.,
Canada and Europe since March 1994. In June 1997, DepoTech reacquired rights to
DepoCyt in Canada and Europe from Chiron. Chiron retains exclusive marketing
rights to DepoCyt in the U.S. Included in operating expenses for the six months
ended June 30, 1997 were expenses of $2.0 million associated with the repurchase
of DepoCyt which was paid to Chiron in December 1997 under the terms of the
agreement with Chiron.
Interest income was $0.2 million and $0.6 million for the three and six
months ended June 30, 1998 compared to $0.4 million and $0.8 million for the
same periods in 1997. The decrease in interest income was due to a decline in
short-term investments. Interest expense increased to $0.3 million and $0.6 for
the three and six months ended June 30, 1998 from $0.2 million and $0.5 million
for the comparable periods in 1997. The increase in interest expense was due to
a higher balance outstanding for the note payable.
LIQUIDITY AND CAPITAL RESOURCES
From its inception through June 30, 1998, DepoTech has financed its
operations primarily through public and private placements of equity securities,
which provided aggregate net proceeds of approximately $101.9 million, and
through capital equipment leases and a note payable.
Chiron and DepoTech had been jointly developing DepoCyt in the U.S.,
Canada and Europe since March 1994. In June 1997, DepoTech reacquired rights to
DepoCyt in Canada and Europe from Chiron for aggregate cash payments of up to
$13.7 million, of which $2.0 million was paid to Chiron in December 1997. Chiron
retains exclusive marketing rights to DepoCyt in the U.S. If, prior to December
31, 1998, the U.S. Food and Drug Administration ("FDA") issues a letter or other
notification to DepoTech indicating that DepoCyt is approvable or approved, the
remaining balance of $11.7
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million shall be payable no later than December 31, 1998. If no FDA notification
is received prior to December 31, 1998, the remaining amount shall be payable no
later than six months from the earlier of U.S. or European Union regulatory
notification that the application to market or sell DepoCyt is approvable or
approved. If all applications for regulatory approval to sell DepoCyt in the
U.S. and European Union are permanently withdrawn, DepoTech shall be relieved of
any obligation to pay the remaining $11.7 million.
In July 1997, DepoTech entered into a Marketing and Distribution
Agreement with P&U for rights to market and sell DepoCyt in countries outside
the U.S. P&U will be responsible for submitting regulatory filings, labeling,
packaging, distribution, marketing and sales of DepoCyt in this territory. The
Company will manufacture DepoCyt and receive a share of the net sales of DepoCyt
sold by P&U, if any. The Company received a cash payment of $2.0 million upon
execution of the agreement and may receive additional payments of up to
approximately $17.0 million upon achievement of certain regulatory milestones.
The agreement also provides for P&U to reimburse the Company for certain
clinical trial expenses and regulatory fees incurred by the Company. Future
milestone payments, if any, totaling up to the obligation to Chiron of $11.7
million will be set aside in a restricted cash account for payment to Chiron for
the repurchase of DepoCyt rights.
As of June 30, 1998, the Company had cash, cash equivalents and
short-term investments of $15.1 million as compared to $27.4 million at December
31, 1997. The decrease of $12.3 million in cash, cash equivalents and short-term
investments was due primarily to net cash used to fund operations of $10.0
million and repayment of capital lease obligations and a note payable totaling
$2.3 million. Working capital decreased to $10.1 million as of June 30, 1998
compared to $22.1 million as of December 31, 1997.
The Company has financed its capital expenditures through capital
leases and bank credit lines. At June 30, 1998, the Company has capital lease
obligations and a bank note payable associated with capital expenditures
totaling $12.4 million of which principal payments of $4.7 million is payable
over the next twelve months. All borrowings are secured by the capital equipment
financed. The terms of the Company's bank loan and equipment lease agreements
require the Company to maintain certain cash balances. At June 30, 1998, the
company was not in compliance with these covenants. The agreements require the
Company to post cash collateral if the covenants are violated. The Company is in
discussion with its lenders regarding the amount of such cash collateral. The
Company leases its headquarters which house most of its administrative,
research, clinical and manufacturing activities. The minimum rental commitment
for this facility ranges from $2.5 million to $4.3 million per year over the
next 18 years, based upon pre-established annual rent increases.
In April 1998, a class action suit was filed against the Company and
two of its former officers alleging violations of the federal securities laws
and purporting to seek unspecified monetary damages on behalf of a class of
shareholders. The Company believes that the lawsuit is without merit and intends
to defend it vigorously.
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The Year 2000 Issue is the result of computer programs written in the
past that use two digits rather than four to define the applicable year. As a
result, these computer programs may not properly recognize calendar dates
beginning in the Year 2000. This problem may cause systems to fail or
miscalculate causing disruptions of operations, including a temporary inability
to process transactions or engage in similar normal business activities.
The Company believes that the total internal Year 2000 Issue costs will
be minimal and that the Year 2000 conversion requirements will be achieved
through routine upgrades to its software programs. The Company expects to
complete these upgrades by the end of 1998. These costs and the expected
completion date are based on management's best estimates and there can be no
assurance that these estimates will be achieved and actual results could differ
materially from those anticipated. The Company has also initiated communications
with all of its significant suppliers to determine the extent to which the
Company's systems are vulnerable to those third parties' failure to remediate
their own Year 2000 Issues. There can be no assurance that the systems of other
companies on which the Company's systems rely will be timely converted and will
not have an adverse effect on the Company's systems.
The Company's operations to date have consumed substantial amounts of
cash, which is expected to continue over the foreseeable future. The amount of
net losses and the time required for the Company to achieve profitability are
highly uncertain. There can be no assurance that the Company will be able to
achieve profitability at all or on a sustained basis. DepoTech anticipates that
its existing available cash, cash equivalents and short-term investments,
committed future contract revenue, and interest income will be adequate to
satisfy its capital requirements and fund operating losses into the first
quarter of 1999. Any amounts required as cash collateral for a bank loan or
equipment leases would reduce the amount of cash available to fund operations.
The development and commercialization of the Company's potential products will
require substantial funds to conduct research and development and preclinical
and clinical testing of products and to manufacture and commercialize any
products that are approved for commercial sale. The Company's future capital
requirements will depend on many factors, including, without limitation,
additional regulatory requirements associated with approvals for any of the
Company's products, the time and costs involved in obtaining regulatory
approvals, continued scientific progress in its products and process development
programs and changes in existing collaborative programs. The Company anticipates
that it will be required to raise additional capital in the near-term in order
to continue to conduct its operations. Such capital may be raised through public
or private financings, as well as collaborative arrangements, borrowings and
other available sources. There can be no assurance that additional funding will
be available on favorable terms, or at all. If adequate funds are not available,
the Company will be required to curtail operations significantly or to obtain
funds through entering into arrangements with collaborative partners or others
that may require the Company to relinquish rights to certain of its
technologies, potential products or potential markets that the Company would not
otherwise relinquish. The failure to receive additional funding would have a
material adverse effect on the Company.
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RISKS AND UNCERTAINTIES
This Quarterly Report may contain, in addition to historical
information, forward-looking statements that involve risk and uncertainties. The
Company's actual results could differ materially from the results discussed in
such forward-looking statements. Factors that could cause or contribute to such
differences include those discussed below as well as those discussed elsewhere
in this Quarterly Report.
Early Stage Company. DepoTech's products are at an early stage of
development, and, to date, only three of the Company's DepoFoam formulations,
DepoCyt, DepoMorphine and DepoAmikacin(TM), have been subject to any human
clinical testing, although the Company is no longer actively developing
DepoAmikacin. The Company's potential products will require extensive research,
formulation, development, preclinical and clinical testing, and may involve a
lengthy regulatory approval process prior to commercialization. There can be no
assurance that DepoCyt, DepoMorphine, or any of the Company's other products or
potential products, will prove safe and effective in clinical trials, meet
applicable regulatory standards, be capable of being produced in commercial
quantities at acceptable cost or be successfully commercialized. In addition,
there can be no assurance that preclinical or clinical testing will accurately
predict safety or efficacy in broader human use, or that delays in the
regulatory approval process will not arise, delaying approval longer than
currently expected by the Company. Even if all of the Company's products prove
to be safe and effective and are approved for marketing by the FDA and other
regulatory authorities, there can be no assurance that health care providers,
payors and patients will accept the Company's products. Any failure of the
Company to achieve technical feasibility, demonstrate safety, achieve clinical
efficacy, obtain regulatory approval or, together with its partners,
successfully market any of its products would have a material adverse effect on
the Company.
Government Regulation; Uncertainty of Obtaining Regulatory Approval.
DepoTech's research and development activities are, and its future business will
be, subject to significant regulation by governmental authorities in the United
States, primarily by the FDA. Pharmaceutical products intended for therapeutic
use in humans are governed principally by the Federal Food, Drug, and Cosmetic
Act, as amended, and by the FDA regulations in the United States and by
comparable laws and regulations in foreign countries. DepoTech is also subject
to regulation under the food and drug statutes and regulations of the State of
California.
In April 1997, the Company completed a New Drug Application ("NDA") for
DepoCyt for the treatment of NM from solid tumors. In May 1998, the Company
received a "non-approvable" letter from the FDA for this NDA. There can be no
assurance that the data from the still ongoing arms of the pivotal Phase III
trial for NM from lymphomas and leukemia will be positive and/or confirm earlier
results or that other clinical trials of DepoCyt will generate positive results.
There can be no assurance that these results and data will meet the requirements
for regulatory approvals necessary to commercialize DepoCyt in the United
States, the European Union ("EU"), or otherwise. Failure to meet such
requirements could result in the termination of the Company's collaborative
agreements with Chiron and/or P&U. Any of these occurrences could have a
material adverse effect
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<PAGE> 14
on the Company and its ability to fund the further development and
commercialization of DepoCyt and its other products.
The clinical testing and FDA review process for new drugs or biologics
requires substantial time, effort and expense. There can be no assurance that
any approval will be granted to the Company on a timely basis, if at all. The
FDA may refuse to approve a product for commercial sale or shipment if
applicable statutory and/or regulatory criteria are not satisfied, or may
require additional testing or information. There can be no assurance that such
additional testing or the provision of such information, if required, will not
have a material adverse effect on the Company. Also, the regulatory process can
be modified by Congress or the FDA at any time in a manner that could materially
affect the Company.
In 1988, the FDA issued regulations intended to expedite the
development, evaluation and marketing of new therapeutic products to treat
life-threatening and severely debilitating illnesses for which no satisfactory
alternative therapies exist. These regulations provide for early consultation
between the sponsor and the FDA in the design of both preclinical studies and
clinical trials. At the present time, DepoCyt is being developed under such an
accelerated program. There can be no assurance, however, that any future
products the Company may develop will be eligible for evaluation by the FDA
under the 1988 regulations. In addition, there can be no assurance that DepoCyt
or any future products (if eligible) will be approved for marketing at all or,
if approved for marketing, will be approved for marketing sooner than would be
traditionally expected. Regulatory approval granted under these regulations may
be restricted by the FDA as necessary to ensure the safe use of the drug. In
addition, post-marketing clinical studies, sometimes called Phase IV studies,
will be required for products approved under this provision.
Under the Orphan Drug Act, the FDA may grant orphan drug designation to
drugs intended to treat a "rare disease or condition," which generally is a
disease or condition that affects populations of fewer than 200,000 individuals
in the United States. Under current law, orphan drug designation confers United
States marketing exclusivity upon the first company to receive FDA approval to
market such designated drug for the designated indication for a period of seven
years following approval of the NDA, subject to certain limitations. Orphan drug
designation does not convey any advantage in, or shorten the duration of, the
regulatory approval process. In June 1993, the Company obtained an orphan drug
designation for DepoCyt from the FDA to treat NM. There can be no assurance that
the Company will receive the first FDA approval to market DepoCyt to treat NM,
and thus, receive market exclusivity for DepoCyt to treat NM from leukemia,
lymphoma or solid tumor metastases. There can be no assurance that the scope of
protection or the level of marketing exclusivity that is currently afforded by
orphan drug designation and marketing approval will remain in effect in the
future.
For marketing outside the United States, the Company will be subject to
foreign regulatory requirements governing human clinical trials, manufacturing
and marketing approval for drugs and biologics in such foreign jurisdictions. In
January 1998, the Company's marketing partner outside the U.S., P&U, submitted a
Marketing
12
<PAGE> 15
Authorization Application for DepoCyt to the European Medicines Evaluation
Agency. P&U is responsible for regulatory filing for DepoCyt outside the U.S.
under the terms of the collaboration agreements. The requirements relating to
the conduct of clinical trials, manufacturing, product licensing, pricing and
reimbursement vary widely from country to country and there can be no assurance
that the Company or any of its partners will meet and sustain any such
requirements.
Future Capital Needs. The development and commercialization of the
Company's products will require substantial funds to conduct research and
development and preclinical and clinical testing of products and to manufacture
and commercialize any products that are approved for commercial sale. The
Company has a contractual commitment arising from the Chiron collaboration to
fund 50% of the sales and marketing expenses incurred for DepoCyt in the United
States. In June 1997, DepoTech reacquired rights to DepoCyt in Canada and Europe
from Chiron for aggregate cash payments of up to $13.7 million, of which $2.0
million was expensed and paid to Chiron in December 1997. If prior to December
31, 1998, the FDA issues a letter or other notification to DepoTech indicating
that DepoCyt is approvable or approved, the remaining balance of $11.7 million
shall be payable no later than December 31, 1998. If no FDA notification is
received prior to December 31, 1998, the remaining amount shall be payable no
later than six month from the earlier of U.S. or European Union regulatory
notification that the application to market or sell DepoCyt is approvable or
approved. If all applications for regulatory approval to sell DepoCyt in the
U.S. and European Union are permanently withdrawn, DepoTech shall be relieved of
any obligation to pay the remaining $11.7 million.
The company has financed its capital expenditures through capital
leases and bank credit lines. At June 30, 1998, the Company had capital lease
obligations and a bank note payable associated with capital expenditures
totaling $12.4 million of which principal payments of $4.7 million are payable
over the next twelve months. All borrowings are secured by the capital equipment
financed. The terms of the Company's bank loan and equipment lease agreements
require the Company to maintain certain cash balances. At June 30, 1998, the
Company was not in compliance with these covenants. The agreements require the
Company to post cash collateral if the covenants are violated. The Company is in
discussion with its lenders regarding the amount of such cash collateral. The
Company leases its headquarters housing most of its administrative, research and
clinical and manufacturing activities. The minimum rental commitment for this
facility ranges from approximately $2.5 million to $4.3 million per year, over
18 years, based upon pre-established annual rent increases.
The Company's additional future capital requirements will depend on
many factors, including continued scientific progress in its products and
process development programs, progress with preclinical testing and clinical
trials, additional regulatory requirements associated with approvals for any of
the Company's products, the time and costs involved in obtaining regulatory
approvals, the costs involved in filing patents, competing technological and
market developments, changes in existing collaborative relationships, the
ability of the Company to establish development arrangements and the cost of
establishing effective sales and marketing arrangements. To date, the Company
13
<PAGE> 16
has not received any revenues from product sales. The Company anticipates that
its existing available cash, cash equivalents and short-term investments,
committed future contract revenue and interest income will be adequate to
satisfy its capital requirements and fund operating losses into the first
quarter of 1999. Any amounts required as cash collateral for a bank loan or
equipment leases would reduce the amount of cash available to fund operations.
Uncertainty of Additional Funding. The Company anticipates that it will
be required to raise additional capital in the near-term in order to continue to
conduct its operations. Such capital may be raised through public or private
financings, as well as collaborative arrangements, borrowings and other
available sources. There can be no assurance that additional funding will be
available on favorable terms if at all. If adequate funds are not available, the
Company will be required to curtail operations significantly or to obtain funds
through entering into arrangements with collaborative partners or others that
may require the Company to relinquish rights to certain of its technologies,
potential products or potential markets that the Company would not otherwise
relinquish. The failure to receive additional funding would have a material
adverse effect on the Company.
Dependence Upon Partners for Development and Commercialization. The
Company does not currently possess all the resources necessary to develop,
complete the FDA approval process for and commercialize any of its potential
therapeutic products. The Company intends to enter into collaborative
arrangements with other companies to fund research, development and clinical
trials, to assist in obtaining regulatory approvals in the United States and
internationally and to commercialize its products. In addition, the Company's
ability to apply its drug delivery technology to a broad range of
pharmaceuticals will depend upon its ability to establish and maintain
collaborative arrangements because the rights to many of the pharmaceuticals
most suited to the Company's drug delivery technology are currently owned by
third parties. While the Company has entered into preliminary collaborations to
test feasibility of its delivery technology with certain compounds and has
entered into collaborations with Chiron and P&U, there can be no assurance that
the Company will be able to enter into additional collaborations to develop
commercial applications of its drug delivery technology. In addition, there can
be no assurance that the Company will be able to enter into or maintain existing
or future collaborations or that such collaborations will be successful. The
failure of the Company to enter into a collaboration with the owner of rights to
a particular formulation or pharmaceutical would preclude the Company from
developing its drug delivery technology with respect to such formulation or
pharmaceutical. The failure to enter into or maintain existing or future
collaborations would have a material adverse effect on the Company.
14
<PAGE> 17
The Company's partners may pursue parallel development of other drug
delivery technologies that may compete with the Company's drug delivery
technology. In addition, definitive agreements negotiated with such partners may
provide that these partners may terminate the collaboration at any time without
significant penalty. Both the Company and Chiron under the Chiron Agreement and
P&U under the P&U Agreement have the ability to terminate a portion or all of
the collaboration at certain intervals and with advance notice. Termination of a
portion or all of the Chiron Agreement and/or P&U Agreement would have a
material adverse effect on the Company. To date the Company has retained the
rights to formulate and manufacture its products and intends in the future
generally to formulate and manufacture pharmaceuticals for partners, however,
certain partners may choose to formulate or manufacture their own formulations,
thereby limiting one or more potential sources of revenue for DepoTech. In
addition, the Company believes that it may be precluded from entering into
arrangements with companies whose products compete with products sold by its
partners. The Company also will have limited or no control over the resources
that any partner may devote to the Company's products, over partners'
development efforts, including the design and conduct of clinical trials, or
over the pricing of products. There can be no assurance that any of the
Company's present or future collaborative partners will perform their
obligations as expected or will devote sufficient resources to the development,
clinical testing or marketing of the Company's potential products. Any parallel
development by a partner of alternate drug delivery technologies, preclusion
from entering into competitive arrangements, failure to obtain timely regulatory
approvals, premature termination of a collaborative agreement or failure by a
partner to devote sufficient resources to the development and commercialization
of the Company's products would have a material adverse effect on the Company.
Limited Manufacturing Experience, Risk of Scale-Up. The Company has no
experience manufacturing products for commercial purposes. The Company's
manufacturing operations will need to meet ongoing commercial requirements for
all markets in which products have been approved. The Company has been notified
by the FDA's District Office that they are recommending approval for commercial
manufacturing of DepoCyt; this does not imply FDA product approval of DepoCyt.
The manufacturing operations for DepoCyt may require passing pre-approval
inspections by regulatory agencies for countries in which there are regulatory
filings to market DepoCyt. For all other products, the Company will need to
significantly scale-up its current manufacturing operations and comply with
cGMPs and other regulations prescribed by various regulatory agencies in the
United States and other countries to achieve the prescribed quality and required
levels of production of such products and to obtain marketing approval. Failure
by the Company to successfully scale-up its manufacturing operations or to
comply with cGMPs and other regulations would have a material adverse impact on
the Company, including the loss of manufacturing rights under the Chiron
Agreement and the P&U Agreement.
History of Operating Losses; Uncertainty of Future Profitability. The
Company has incurred an accumulated deficit of $74.8 million through June 30,
1998. The Company expects to continue to incur substantial losses over at least
the next two years as the Company's research and development efforts, clinical
testing activities and manufacturing scale-up and sales and marketing
arrangement efforts expand. All of the Company's revenues to date have consisted
of contract revenues, milestone payments and interest income. No revenues have
been generated from product sales. There can be no assurance that the Company
can generate sufficient product or contract revenue to become profitable or
sustain profitability.
Legal Proceedings. In April 1998, a class action suit was filed against
the Company and two of its former officers in the United States District Court
for the Southern District of California. The lawsuit alleges violations of the
federal securities laws and purports to seek unspecified monetary damages on
behalf of a class of shareholders who purchased DepoTech common stock during the
period April 1, 1996 through December 18, 1997. The Company believes that the
lawsuit is without merit and intends to defend against it vigorously. The
pending litigation against the Company and any future litigation against the
company or its employees, regardless of the outcome, may result in substantial
costs and expense to the Company and significant diversions of time and effort
by the Company's personnel. Depending on the amount and timing, an unfavorable
resolution of such litigation could have a material adverse effect on the
Company.
15
<PAGE> 18
Reliance on Technology Rights from Research Development Foundation. In
February 1994, the Company entered into an Assignment Agreement with the RDF,
pursuant to which RDF assigned to DepoTech exclusive rights to the RDF
Technology. As consideration for the assignment of the RDF Technology, DepoTech
will pay RDF an earned royalty on gross revenues from the sale by DepoTech or
its collaborators of products incorporating the RDF Technology. The Company's
products, including DepoCyt, may incorporate the RDF Technology. In certain
other circumstances, DepoTech will pay RDF a percentage of the royalties or
other consideration received by DepoTech from licensees (or, if greater, the
amount of royalty DepoTech would have owed had it engaged in the same conduct as
the licensees). In addition, RDF retains the right to terminate the agreement or
to convert the exclusive nature of the rights granted under the agreement into a
nonexclusive license in the event that the Company does not satisfy its
contractual obligations, including making certain minimum annual payments.
Additional termination events include bankruptcy, a material uncured breach of
the agreement by DepoTech or a contest by DepoTech of the patents included in
the RDF Technology. The termination of the Assignment Agreement or the
conversion of its exclusive nature to a nonexclusive agreement would have a
material adverse effect on the Company.
Patents and Proprietary Technology. DepoTech relies on a combination of
technical leadership, patent, trade secret, copyright and trademark protection
and nondisclosure agreements to protect its proprietary rights. As of July 1,
1998, the Company owned or had exclusive rights to 10 issued or allowed United
States patents, 10 pending United States patent applications, 48 issued foreign
patents and 50 pending foreign applications on file covering various aspects of
its drug delivery technology. The Company intends to file additional patent
applications in the future. There can be no assurance that the Company will be
issued any additional patents or that, if any patents are issued, they will
provide the Company with significant protection or will not be challenged. Even
if such patents are enforceable, the Company anticipates that any attempt to
enforce its patents would be time consuming and costly. Moreover, the laws of
some foreign countries do not protect the Company's proprietary rights in the
products to the same extent as do the laws of the United States.
The patent positions of pharmaceutical, biotechnology and drug delivery
companies, including DepoTech, are uncertain and involve complex legal and
factual
16
<PAGE> 19
issues. Additionally, the coverage claimed in a patent application can be
significantly reduced before the patent is issued. As a consequence, there can
be no assurance that any of the Company's patent applications will result in the
issuance of patents or, if any patents issue, that they will provide significant
proprietary protection or will not be circumvented or invalidated. Because
patent applications in the United States are maintained in secrecy until patents
issue and publication of discoveries in the scientific or patent literature
often lag behind actual discoveries, the Company cannot be certain that it was
the first inventor of inventions covered by its pending patent applications or
that it was the first to file patent applications for such inventions. Moreover,
the Company may have to participate in interference proceedings declared by the
United States Patent and Trademark Office to determine priority of invention
that could result in substantial cost to the Company, even if the eventual
outcome is favorable to the Company. There can be no assurance that the
Company's patents, if issued, would be held valid by a court of competent
jurisdiction. An adverse outcome of any patent litigation could subject the
Company to significant liabilities to third parties, require disputed rights to
be licensed from or to third parties or require the Company to cease using the
technology in dispute.
There can be no assurance that third parties will not assert
infringement claims against the Company in the future or that any such
assertions will not result in costly litigation or require the Company to obtain
a license to intellectual property rights of such parties. There can be no
assurance that any such licenses would be available on terms acceptable to the
Company, if at all. Furthermore, parties making such claims may be able to
obtain injunctive or other equitable relief that could effectively block the
Company's ability to further develop or commercialize its products in the United
States and abroad and could result in the award of substantial damages. Defense
of any lawsuit or failure to obtain any such license could have a material
adverse affect on the Company. Finally, litigation, regardless of outcome, could
result in substantial cost to and a diversion of efforts by the Company.
Dependence on Suppliers. The Company currently relies on a limited
number of suppliers to provide the materials used to manufacture its DepoFoam
formulations. Certain of these materials are purchased only from one supplier.
In the event the Company could not obtain adequate quantities of necessary
materials from its existing suppliers, there can be no assurance that the
Company would be able to access alternative sources of supply within a
reasonable period of time or at commercially reasonable rates. Regulatory
requirements applicable to pharmaceutical products tend to make the substitution
of suppliers costly and time-consuming. The unavailability of adequate
commercial quantities, the inability to develop alternative sources, a reduction
or interruption in supply or a significant increase in the price of materials
could have a material adverse effect on the Company's ability to manufacture and
market its products.
Reliance on Manufacturing Process. To date, the Company has relied on a
particular proprietary method of manufacture. There can be no assurance that
this method will be applicable to all pharmaceuticals or biologics the Company
desires to commercialize. Further, the yield of product incorporated into the
delivery system may be highly variable for different therapeutic agents.
Finally, the Company will need to successfully meet any manufacturing challenges
associated with the characteristics of the
17
<PAGE> 20
drug to be encapsulated. The physical and chemical stability of the DepoFoam
formulation may vary with each therapeutic agent over time and under various
storage conditions. There can be no assurance that the manufacturing process
will result in economically viable yields of product or that it will produce
formulations of therapeutic products sufficiently stable under suitable storage
conditions to be commercially useful. In the event that the Company decides to
pursue alternative manufacturing methods for some or all of its drugs, there can
be no assurance that these methods will prove to be commercially practical or
that the Company will have or be able to acquire rights to use such alternative
methods.
Limited Sales and Marketing Capability. Commercialization of the
Company's products is expected to be expensive and time-consuming. In the event
that the Company elects to participate directly in sales and marketing efforts
for the Company's products, the Company will need to build such capability in
the targeted markets. There can be no assurance that the Company will be able to
establish an adequate sales and marketing capability in any or all targeted
markets or that it will be successful in gaining market acceptance for its
products. To the extent the Company enters into co-promotion or other licensing
arrangements, any revenues received by the Company will be dependent on the
efforts of third parties and there can be no assurance that such efforts will be
successful. To the extent the Company relies on its collaborators, there can be
no assurance that any of these collaborators or their sublicensees will
successfully market or distribute the Company's products or that the Company
will be able to establish a successful direct sales organization, co-promotion
or distribution arrangements.
Access to Drugs. The Company's ability to develop and commercialize its
technology will be affected by the Company's or its partners' access to the
drugs that are to be formulated. The Company intends in certain circumstances to
rely on the ability of its partners to provide access to the drugs that are to
be formulated for use with DepoFoam. There can be no assurance that the
Company's partners will be able to provide access to drug candidates for
formulation in DepoFoam, or that, if such access is provided, the Company or its
partner will not be alleged or determined to be infringing on third parties'
rights and will not be prohibited from using the drug or be found liable for
damages that may not be subject to indemnification. Any restriction on access or
liability for damages would have a material adverse effect on the Company. See
"--Dependence Upon Partners for Development and Commercialization."
Dependence on Key Personnel. The success of the Company is highly
dependent, in part, on its ability to retain highly qualified personnel,
including senior management and scientific personnel. Competition for such
personnel is intense and the inability to retain additional key employees or the
loss of one or more current key employees could adversely affect the Company.
There can be no assurance that the Company will be successful in retaining
required personnel in the future. Since February 1998, the Company has reduced
its workforce from 153 to 75 employees in order to minimize expenditures. There
can be no assurance that the Company will not be required to reduce its
workforce in the future. Any such further reductions could have a material
adverse effect on the Company.
18
<PAGE> 21
Highly Competitive Industry. The drug delivery, pharmaceutical and
biotechnology industries are highly competitive and rapidly evolving, with
significant developments expected to continue at a rapid pace. The Company's
success will depend upon maintaining a competitive position and developing
products and technologies for efficient and cost-effective drug delivery. The
Company's products will compete with other formulations of drugs and with other
drug delivery systems. There can be no assurance that any of the Company's
products will have advantages that will be significant enough to cause medical
professionals to use them. DepoTech believes that its products will compete on
the basis of quality, efficacy, cost, convenience, safety and patient
compliance. New drugs or further development in alternative drug delivery
methods may provide greater therapeutic benefits for a specific drug or
indication, or may offer comparable performance at lower cost than those offered
by the Company's DepoFoam drug delivery system. The Company is aware of many
other competitors in the field of drug delivery, including competitors
developing injectable or implantable drug delivery systems, oral drug delivery
technologies, passive transdermal systems, electrotransport systems, oral
transmucosal systems and inhalation systems. There can be no assurance that
developments by others will not render the Company's products or technologies
uncompetitive or obsolete. Many of the Company's existing or potential
competitors have substantially greater research and development capabilities,
experience, manufacturing, marketing, financial and managerial resources than
the Company. Furthermore, acquisitions of competing drug delivery companies by
large pharmaceutical companies could enhance competitors' financial, marketing
and other resources. Accordingly, the Company's competitors may succeed in
developing competing technologies, obtaining FDA approval or gaining market
share for products more rapidly than the Company.
Product Liability; Availability of Insurance. The design, development
and manufacture of the Company's products involve an inherent risk of product
liability claims and associated adverse publicity. The Company obtained clinical
trial product liability insurance for its human clinical trials and intends to
obtain insurance for future clinical trials of other products under development
and for potential product liability associated with the commercial sale of the
Company's products. There can be no assurance, however, that the Company will be
able to obtain or maintain insurance for any of its clinical trials or
commercial products. Although the Company currently maintains general liability
insurance, there can be no assurance that the coverage limits of the Company's
insurance policies will be adequate. Product liability insurance is expensive,
difficult to obtain and may not be available in the future on acceptable terms
or at all. A successful claim brought against the Company in excess of the
Company's insurance coverage would have a material adverse effect upon the
Company.
Year 2000 Compliance. The Year 2000 Issue is the result of computer
programs written in the past that use two digits rather than four to define the
applicable year. As a result, these computer programs may not properly recognize
calendar dates beginning in the Year 2000. This problem may cause systems to
fail or miscalculate causing disruptions of operations, including a temporary
inability to process transactions or engage in similar normal business
activities.
19
<PAGE> 22
The Company believes that the total internal Year 2000 Issue costs will
be minimal and that the Year 2000 conversion requirements will be achieved
through routine upgrades to its software programs. The Company expects to
complete these upgrades by the end of 1998. These costs and the expected
completion date are based on management's best estimates and there can be no
assurance that these estimates will be achieved and actual results could differ
materially from those anticipated. The Company has also initiated communications
with all of its significant suppliers to determine the extent to which the
Company's systems are vulnerable to those third parties' failure to remediate
their own Year 2000 Issues. There can be no assurance that the systems of other
companies on which the Company's systems rely will be timely converted and will
not have an adverse effect on the Company's systems.
Hazardous Materials. The Company's research and development involves
the controlled use of hazardous materials, chemicals and various radioactive
compounds. The risk of accidental contamination or injury from these materials
cannot be completely eliminated. In the event of such an accident, the Company
could be held liable for any damages that result and any such liability could
exceed the resources of the Company. The Company may incur substantial cost to
comply with environmental regulations.
No Dividends. The Company currently intends to retain any future
earnings for use in its business and does not anticipate paying any cash
dividends in the future. Pursuant to a bank credit facility, DepoTech may not,
without the bank's prior written consent pay or declare dividends except for
dividends payable solely in the Company's stock.
Possible Volatility of Stock Price. Factors such as the announcements
of technological innovations or new products by the Company, its competitors and
other third parties, the status of submissions to the FDA or its international
equivalent, as well as variations in the Company's results of operations, market
conditions, analysts' estimates and the stock market generally (and stock market
perceptions of the pharmaceutical, biotechnology and/or drug delivery industries
specifically) may cause the market price of the Company's Common Stock to
fluctuate significantly. Companies such as DepoTech have, in recent years,
experienced dramatic stock price volatility. Also, future sales of shares by
existing shareholders pursuant to Rule 144 of the Securities Act of 1933, as
amended, or through the exercise of outstanding registration rights, could have
an adverse effect on the price of the Company's Common Stock.
Possible Anti-Takeover Effect of Certain Charter Provisions. The
Company's Articles of Incorporation includes certain charter provisions which
may discourage certain types of transactions involving an actual or potential
change in control of the Company, including transactions in which shareholders
might otherwise receive a premium for their shares over the current market
prices, and may limit the ability of the shareholders to approve transactions
that they may deem to be in their best interests. The Board of Directors also
has the authority to issue up to 5,000,000 shares of Preferred Stock in one or
more series and to fix the rights, priorities, preferences, qualifications,
limitations and restrictions, including the dividend rates, conversion rights,
voting rights,
20
<PAGE> 23
terms of redemption, terms of sinking funds, liquidation preferences and the
number of shares constituting any series, without any further vote or action by
the shareholders, which could decrease the amount of earnings and assets
available for distribution to holders of Common Stock or adversely affect the
rights and powers, including voting rights, of the holders of the Common Stock.
The issuance of Preferred Stock may have the effect of delaying or preventing a
change in control of the Company and may adversely affect the rights of the
holders of Common Stock.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
None
21
<PAGE> 24
PART II - OTHER INFORMATION
Item 1 Legal Proceedings.
None
Item 2 Change in Securities.
In February 1998, the Company issued a warrant to purchase
100,000 shares of the Company's common stock to various entities managed by
Sanderling Ventures, exercisable at $4.375 per share. Mr. Middleton, the
Company's Chairman of the Board, Chief Executive Officer and a member of the
Executive Committee is a general partner of Sanderling Ventures. The warrant was
issued in return for services rendered to the Company by Mr. Middleton and in
lieu of receiving a cash salary from the Company. The warrant has a three-year
term and is not exercisable for 90 days following the date of issuance. The
issuance of the warrant is exempt from registration under the Securities Act of
1933, as amended (the "1933 Act"), under Section 4(2).
In March 1998, the Company issued 25,000 shares of its common
stock in consideration of Dr. Howell's past services to the Company, valued at
$5.938 per share. Dr. Howell serves as Medical Director, a member of the
Executive Committee and a Director of the Company. The issuance of the shares is
exempt from registration under the 1933 Act under Section 4(2).
Item 3 Defaults Upon Senior Securities.
At June 30, 1998, the Company had capital lease obligations
and a bank note payable associated with capital expenditures totaling $12.4
million of which principal payments of $4.7 million are payable over the next
twelve months. All borrowings are secured by the capital equipment financed. The
terms of the Company's bank loan and equipment lease agreements require the
Company to maintain certain cash balances. At June 30, 1998, the Company was not
in compliance with these covenants. The agreements require the Company to post
cash collateral if the covenants are violated. The Company is in discussion with
its lenders regarding the amount of such cash collateral.
Item 4 Submission of Matters to a Vote of Security Holders.
The Company's 1998 Annual Meeting of Shareholders ("Annual
Meeting") was held May 13, 1998. The matters voted on at the Annual Meeting
were:
1. To elect a Board of Directors.
2. To approve amendments to the Company's 1995 Stock
Option/Stock Issuance Plan.
3. To approve amendments to the Company's 1995 Employee Stock
Purchase Plan.
4. To ratify the appointment of Ernst & Young LLP as the
Company's independent public auditors for the fiscal year
ending December 31, 1998.
The results of the shareholders' vote on each matter set forth
below:
22
<PAGE> 25
1. Elect a Board of Directors
<TABLE>
<CAPTION>
Nominees For Withheld
-------- --------- --------
<S> <C> <C>
Roger C. Davisson 9,482,919 347,838
George W. Dunbar Jr. 9,482,919 347,838
Stephen B. Howell, M.D. 9,482,919 347,838
John P. Longenecker, Ph.D. 9,481,819 348,938
Fred A. Middleton 9,481,719 349,038
Peter Preuss 9,482,919 347,838
Pieter J. Strijkert, Ph.D. 9,482,319 348,438
</TABLE>
2. Approve amendments to 1995 Stock Option/Issuance Plan
<TABLE>
<CAPTION>
Votes
---------
<S> <C>
For 7,689,238
Against 2,072,804
Abstain 10,425
Broker Non-Votes 58,290
</TABLE>
3. Approve amendments to 1995 Employee Stock Purchase Plan
<TABLE>
<CAPTION>
Votes
---------
<S> <C>
For 9,094,147
Against 668,873
Abstain 9,447
Broker Non-Votes 58,290
</TABLE>
4. Ratify the appointment of Ernst & Young LLP as independent
public auditors
<TABLE>
<CAPTION>
Votes
---------
<S> <C>
For 9,816,321
Against 8,711
Abstain 5,725
</TABLE>
Item 5 Other Information.
None
23
<PAGE> 26
Item 6 Exhibits and Reports on Form 8-K.
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit
Number
<S> <C>
3.1 Fourth Restated Articles of Incorporation of the Company
(filed as Exhibit 3.2) (1).
3.2 Amended and Restated Bylaws of the Company (filed as
Exhibit 3.4) (1).
10.1 Retention Incentive Agreement between Williams Ettouati
and the Company dated June 10, 1998.
27.1 Financial Data Schedule.
</TABLE>
(1) Incorporated by reference to the above noted exhibit to the Company's
Registration statement on Form S-1 (No. 33-95890), as amended.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended June 30,
1998.
24
<PAGE> 27
DEPOTECH CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DEPOTECH CORPORATION
/s/ Fred A. Middleton
-------------------------------
Date: August 14, 1998 Fred A. Middleton
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
/s/ Dana S. McGowan
-------------------------------
Date: August 14, 1998 Dana S. McGowan
Vice President, Finance and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
25
<PAGE> 1
EXHIBIT 10.1
[DEPOTECH LETTERHEAD]
RETENTION INCENTIVE AGREEMENT
1. This Retention Incentive Agreement ("Agreement") is entered into by and
between DepoTech Corporation ("the Company") and Williams Ettouati
("Employee" or "Consultant" or "Employee/Consultant") as of June 10, 1998.
2. Employee is a current employee of the Company.
3. The Company desires to secure the commitment of Employee to continue
providing services to the Company through September 30, 1998. Employee is
willing to commit to continuing to be employed by the Company through July
31, 1998 and provide consulting services on an as needed basis (not to
exceed one day per week), from August 1, 1998 through September 30, 1998,
for the additional consideration specified herein.
4. Employee promises and agrees that he shall continue working for the Company
in his capacity as Vice President, Marketing and Business Development, or
in such other capacity as reasonably requested by the Company, at a base
salary of not less than $13,750 per month, until July 31, 1998, unless
employment is terminated earlier by the Company in accordance with the
provisions of paragraph (10) of this Agreement. On August 1, 1998,
Consultant will be free to commence employment with a new employer without
restriction, except for the disclosure of confidential information noted in
paragraph (12) of this Agreement.
5. In exchange for Employee's actual continued employment by the Company
through July 31, 1998, the Company shall pay to Employee a severance
payment in the amount of three (3) months base salary of not less than
$13,750 per month or $41,250. The severance payment shall be payable to
Employee on July 31, 1998.
6. In addition, in exchange for Employee's continued services as Consultant
through September 30, 1998, for marketing and business development efforts
on behalf of DepoTech, the Company shall pay Consultant a consulting fee of
forty one thousand, two hundred fifty dollars ($41,250).
7. Further, in the event of a strategic transaction with respect to the
Company on or before December 31, 1998, such transaction to be defined as
receipt by the Company of an agreed term sheet, an additional payment of
eighty two thousand, five hundred dollars ($82,500), will be provided to
Employee/Consultant within five business days after receipt of such term
sheet.
8. Finally, if a strategic transaction with respect to the Company occurs on
or before July 31, 1998, such transaction to be defined as receipt by the
Company of an agreed to term sheet, by initial agreement, Employee's
consulting services will not be required and Employee will receive a
payment equal to twelve (12) months of his current annual salary or one
hundred sixty five thousand dollars ($165,000) in lieu of all other
payments specified in paragraphs 5, 6 and 7 of this Agreement.
9. The Company will continue medical, dental and vision coverage through
September 30, 1998 at no additional charge to Employee/Consultant. Company
will reimburse Employee/Consultant for any reasonable business travel and
expenses according to Company policy.
10. In the event that Employee or Consultant engages in willful misconduct, the
Company may terminate her/his employment or consulting agreement
immediately, and Employee or Consultant shall not be entitled to the
retention incentive or any portion thereof or any other form of severance
or payments. For purposes of this Agreement, "willful misconduct" shall
include: (i) the commission of any act of
<PAGE> 2
Williams Ettouati
RETENTION INCENTIVE AGREEMENT
Page 2
fraud with respect to the Company or its business; (ii) Employee's or
Consultant's conviction of or being formally charged with the commission of
a crime which, in the good faith judgment of the Company's Board of
Directors, involved moral turpitude or has caused or will cause material
harm to the standing and/or reputation of the Company; (iii) Employee's or
Consultant's violation of any of the terms of his Proprietary Information
and Inventions Agreement; (iv) Employee's or Consultant's misappropriation
and/or unauthorized disclosure of the Company's confidential and/or
proprietary information; (v) Employee's or Consultant's violation of the
Company's policies concerning drugs and alcohol or unlawful
harassment/discrimination.
11. You agree that as a specific condition to the performance of this Agreement
by the Company, you will not disclose for any purpose, the terms of this
Agreement to any person, except to your immediate family or as may be
necessary for purposes of securing legal or tax advice or as otherwise may
be required by law.
12. You specifically agree to preserve as confidential and not use or disclose
any Company trade secrets, confidential knowledge, data or other
proprietary information relating to technology, customers, products,
pricing, business plans, financial or organizational information or other
subject matter pertaining to any business or the Company or any of its
clients, customers or licensees from this day forward.
13. Notwithstanding any other provision of this Agreement, the Company may
terminate Employee's employment at any time, with or without cause and with
or without notice. However, if the Company terminates Employee's employment
at any time prior to and including July 31, 1998 for any reason other than
for willful misconduct (as defined in paragraph (10) hereof), then Employee
shall be entitled to receive severance pay equal to six (6) months base
salary if no agreed term sheet has been signed. In the event that an agreed
term sheet is signed, however, Employee will receive severance pay equal to
twelve (12) months base salary. Severance pay shall be payable to Employee
on the effective date of termination of employment.
14. In addition, unless Employee's employment or Consultant's consulting
services are terminated prior to and including September 30, 1998, due to
any willful misconduct (as defined in paragraph (10) hereof), the following
unvested Stock Options will accelerate in entirety on September 30, 1998
and the exercise period will be extended to December 31, 1998. The exercise
period for vested options in all other ISO grants will be ninety (90 days)
from the date of termination of employment as per our Company policy.
ISO GRANT 30,000 SHARES GRANTED 02-25-98
EXECUTED AND AGREED TO:
/s/ WILLIAMS ETTOUATI
---------------------- Date: June 26, 1998
By:
DepoTech Corporation
/s/ JOHN P. LONGENECKER
------------------------ Date: June 26, 1998
By:
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<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 2,361
<SECURITIES> 12,692
<RECEIVABLES> 1,269
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 17,387
<PP&E> 33,258
<DEPRECIATION> (6,279)
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<CURRENT-LIABILITIES> 7,256
<BONDS> 0
0
0
<COMMON> 102,499
<OTHER-SE> (75,109)
<TOTAL-LIABILITY-AND-EQUITY> 45,306
<SALES> 0
<TOTAL-REVENUES> 2,065
<CGS> 0
<TOTAL-COSTS> 10,688
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<INTEREST-EXPENSE> 628
<INCOME-PRETAX> (10,968)
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