-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QTFM5QbetkStjjkW6o4yohML0zjiq4hadSF1glrW/D9t+FL8PILPWMtTm6WF0zCM wtNPkq81We9rmS4k6CykOg== 0000743884-98-000011.txt : 19980326 0000743884-98-000011.hdr.sgml : 19980326 ACCESSION NUMBER: 0000743884-98-000011 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980325 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: MACROCHEM CORP CENTRAL INDEX KEY: 0000743884 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 042744744 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-13634 FILM NUMBER: 98572471 BUSINESS ADDRESS: STREET 1: 110 HARTWELL AVE CITY: LEXINGTON STATE: MA ZIP: 02173 BUSINESS PHONE: 6178624003 MAIL ADDRESS: STREET 1: 110 HARTWELL AVENUE CITY: LEXINGTON STATE: MA ZIP: 02173 10-K 1 FOR PERIOD ENDING DECEMBER 31, 1997 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------------- FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 1997 [ ] 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 0-13634 MACROCHEM CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 04-2744744 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 110 HARTWELL AVENUE LEXINGTON, MASSACHUSETTS 02173-3134 (Address of principal executive offices) (781) 862-4003 (Telephone number) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.01 PAR VALUE (Title of Class) CLASS A WARRANTS (Title of Class) CLASS AA WARRANTS (Title of Class) CLASS X WARRANTS (Title of Class) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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 the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the shares of Common Stock held by non-affiliates, based upon the closing price for such stock on February 27, 1998 was approximately $255,240,000. As of February 27, 1998, 22,194,865 shares of common stock, $.01 par value, were outstanding. Documents Incorporated By Reference Portions of the registrant's definitive Proxy Statement (the "Proxy Statement") for its 1998 Annual Meeting of Stockholders presently intended to be filed with the Securities and Exchange Commission by April 30, 1998, are incorporated by reference into Part III of this Form 10-K. Part III identifies the pages, paragraphs or captions of the Proxy Statement which contain information that is incorporated by reference. PART I ITEM 1. BUSINESS. THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED OR REFERRED TO IN "RISK FACTORS". MacroChem's primary business is the development of pharmaceutical products for commercialization by applying SEPA(R) (Soft Enhancer of Percutaneous Absorption), its patented topical drug delivery technology. SEPA compounds, when properly combined with drugs, provide pharmaceutical formulations (creams, gels, solutions, etc.) that enhance the transdermal delivery of drugs into the skin or into the bloodstream. SEPA formulations combined with the Company's polymers and adhesives can also be used with patch formats to achieve the transdermal delivery of selected drugs. The Company believes that SEPA compounds enhance the diffusion of drugs into and through the skin by making the outer layer of the skin (stratum corneum) more permeable to the drug molecule. Transdermal delivery provides an alternative to other methods of drug administration (injection, oral dosage forms, inhalation, etc.), and may allow selected drugs to be administered more effectively, at lower doses, with fewer adverse events and improved patient compliance. The Company is developing specific SEPA formulations for use with non-proprietary and proprietary drugs manufactured by pharmaceutical companies, and plans to commercialize these products through the formation of partnerships, strategic alliances and license agreements with those companies. In order to attract strategic partners, the Company is conducting clinical testing of certain SEPA-enhanced pharmaceuticals. The Company believes that if the clinical trials are successful the results will aid the Company in attracting partners to assist in the promotion of the product. Because of the substantial costs involved in bringing a new pharmaceutical product or a new formulation of an old drug to the market, the Company may be required to rely on pharmaceutical companies to conduct all or part of the clinical trials necessary to gain regulatory approval to manufacture and to market any resulting product. The Company has also developed a series of new low molecular weight polymers, termed MacroDermTM, for cosmetic use and the topical delivery of pharmaceuticals. The Company has developed, tested and evaluated prototypes of MacroDerms and is determining the full market opportunities for this technology. The Company does not maintain general product liability insurance, since the Company does not market drug products. The Company recently commenced clinical studies and obtained specific liability insurance relating to such studies. As of December 31, 1997, no asserted liability claims existed against the Company. However, in the future, incidents could give rise to claims which could exceed the Company's insurance coverage and resources. BUSINESS AGREEMENTS On January 22, 1997 the Company signed a license and supply agreement with Cytopharm, Inc., a California corporation. Cytopharm invented and is the owner of certain patent rights covering a photo-activated compound for the treatment of certain dermatological diseases. The Company will make available its enhancer for use by Cytopharm and its licensee in the agreed to photo-activated formulation. Cytopharm agrees to pay or cause its licensee to pay royalties to the Company on all license fees, milestone payments, advance royalty payments, other lump-sum payments and running royalty payments with respect to license and sale of such formulation for a period equal to the longer of the life of the Company's patent or ten years from the commencement of commercial marketing of the formulation in each country where the formulation is marketed. In addition, Cytopharm must pay a minimum royalty of $100,000 per year beginning January 22, 2002, subject to U.S. regulatory approval of the formulation. In September 1990, the Company entered into a license agreement with Ascent Pharmaceuticals, Inc. ("Ascent") in which Ascent received an exclusive license to develop, test and market the Company's SEPA compounds in combination with catecholamine bronchodilators for the treatment of respiratory disorders and, in combination with cromolyn sodium, to treat allergic disorders. No assurances can be given that the work conducted by Ascent will lead to the marketing of SEPA-containing products for these indications. RESEARCH AND DEVELOPMENT The Company conducts its research and development activities through its own staff and facilities, as well as through collaborative arrangements with universities, contract research organizations and independent consultants. As of March 1, 1998, the Company had 20 full-time employees, 11 of whom are devoted to research and development and regulatory affairs. In addition, two Company officers devote approximately 75% of their time to research and development. Research and developmental expenditures aggregated $2,084,800, $1,736,600 and $1,238,100 during the years ended December 31, 1997, 1996 and 1995, respectively. The Company is also dependent upon third parties to conduct clinical studies, obtain U.S. Food and Drug Administration ("FDA") and other regulatory approvals and manufacture and market a finished product. The Company anticipates incurring significant development expenditures in the future as it continues its efforts to develop its present compounds and new drug formulations and as it begins to research other technologies and to expand its toxicological and clinical studies of certain drugs. The Company conducts stability studies, tests its unique formulations and designs manufacturing processes for its SEPA compounds and adhesive and polymer technologies at its facility and other facilities. The Company has cGMP (current Good Manufacturing Practices) facilities for the manufacture of dosage forms for clinical evaluations. PRODUCTS AND TECHNOLOGIES BACKGROUND To be effective, drugs must reach an intended site in the body, at an effective concentration, and for an appropriate length of time. Traditional methods of drug administration, such as oral ingestion, intramuscular and intravenous injections and inhalation, are effective for a wide variety of drugs. However, depending upon the given drug, each method may have disadvantages. For example, in oral administration, a drug must pass through the gastrointestinal system to be absorbed and may be metabolized or broken down in the stomach, intestines or liver, resulting in the therapeutic availability of a lower amount of effective drug. As a result, higher dosages of the drug must be used to produce the desired effect, which may cause irritation of the gastrointestinal tract and systemic toxicity. In addition, the rate at which an orally administered drug is absorbed may vary depending on several factors, including the drug's chemical properties, the length of time the drug remains in the gastrointestinal tract and the patient's meal patterns. Although the pharmaceutical industry has investigated a variety of alternative approaches for dealing with drug adverse events and loss of efficacy following oral dosing, through enteric coating of tablets, formulating with various waxes and cellulosic materials, microencapsulation and compressing tablets in various layers, the desired effects of these approaches are not always reproducible from patient to patient or effective in modifying metabolic effects produced in the liver. TOPICAL DRUG DELIVERY Topical drug delivery is the process of delivering drugs into the skin (dermal delivery) so that they can be effective in the treatment of dermatological conditions and diseases, or through the skin (transdermal delivery) and into the bloodstream for the treatment of systemic diseases. The skin is made up of three layers: the outer layer, the stratum corneum; the middle layer or viable epidermis; and the inner layer, the dermis. The stratum corneum, which serves as the skin's primary barrier to the external environment, consists of closely packed dead cells and fatty (lipid) material. The epidermis is composed of several layers of active cells and the dermis consists, in part, of tissue containing hair follicles, nerve endings and blood capillaries. Within the stratum corneum, lipid layers bind the dead cells together to form a protective barrier. Research conducted by MacroChem shows that SEPA compounds affect drug delivery by acting, in part, upon the stratum corneum to disrupt the alignment of the lipid molecules within the lipid layers. This disruption increases the porosity of the lipid-cell layers, allowing drugs to diffuse through the stratum corneum through the more porous epidermis to the dermis, where they enter the blood stream through the capillaries. The rate and amount of drug absorbed can be controlled by varying the formulation used. THE COMPANY'S DRUG-DELIVERY SYSTEMS AND OTHER PROPOSED PRODUCTS SEPA COMPOUNDS The delivery of a drug through the skin depends on the drug's physical and chemical characteristics (molecular size and shape, the drug's solubility in lipids and water, its melting point and whether it is lipophilic or hydrophilic). Since some drugs move through the skin too rapidly, the transdermal system must retard the rate of drug absorption to ensure optimal efficacy with minimum toxicity. Since other drugs move through the skin with difficulty, the transdermal system must be formulated to increase a drug's rate of absorption through the skin. Common methods of transdermal delivery use common chemicals such as ethanol or fatty compounds to enhance penetration. Although certain delivery methods using chemicals have proven to be somewhat effective with specific drugs, such as drugs used for the treatment of motion sickness or hormone deficiencies, they have caused adverse events, such as skin irritation and sensitivity at the site of application. Some drugs, because of their physical characteristics or the amount of drug necessary to achieve the desired therapeutic effect, have not been successfully delivered transdermally to date. The Company has developed SEPA compounds that are designed to enhance the transport, penetration and controlled delivery of drugs through the skin. SEPA compounds are generally colorless, clear liquids that are intended to promote drug delivery by aiding drug molecules to penetrate the skin, diffuse into or through the skin layers and become absorbed into the bloodstream. The Company has its own facility for the IN VITRO testing of drug formulations containing SEPA, and therefore is less dependent on outside laboratories for this type of testing. The Company is conducting IN VITRO studies to evaluate the transdermal enhancing effect of SEPA in combination with a variety of drugs with differing physical and chemical characteristics, representing a broad spectrum of potential drug products. Although the Company's research and development efforts with SEPA are at an advanced stage, the Company must still conduct substantial additional studies to demonstrate the efficacy and safety of any SEPA-drug formulation. The Company has found that specific drugs administered transdermally with SEPA demonstrated increased transdermal absorption. Some of the drug formulations tested by the Company with SEPA contain compounds generally recognized as unlikely or difficult candidates for transdermal delivery because of their physical and chemical properties and molecular size. As these drug formulations are further developed, the Company plans to conduct additional studies to investigate the efficacy and safety of some of these formulations. Although IN VIVO testing has been conducted on SEPA compounds, more studies will be needed to demonstrate the safety and efficacy of SEPA in formulations with specific drugs. The Company is currently conducting clinical trials with a topical SEPA formulation of alprostadil for the treatment of erectile dysfunction. In addition to the ongoing clinical development programs cited above, the Company, in association with third parties, is currently conducting pre-clinical studies with SEPA formulations in combination with specific drugs for a variety of applications. The Company believes that SEPA compounds can be used with a broad variety of new and existing drugs to enhance their commercial value. The improved therapeutic effectiveness and convenience of a transdermal SEPA product may substantially expand the existing market for a drug. In addition, a formulation containing a SEPA compound may prove to be a superior alternative to the existing methods of administering certain drugs. MACRODERM(TM) DRUG DELIVERY SYSTEM The Company has developed a series of new low molecular weight polymers, termed MacroDerm, for use in cosmetics and in the superficial dermal delivery of pharmaceuticals. Potential applications include their use with sunscreens, moisturizers, and insect repellents. The Company has synthesized, tested and evaluated prototypes of MacroDerms and is determining the full market opportunities for this technology. COMPETITION The Company competes with numerous firms, many of which are large, multi-national organizations with worldwide distribution. The Company believes that its major competitors in the drug-delivery sector of the health care industry include ALZA Corporation, Cygnus Therapeutic Systems, Elan Corporation, plc., Ciba-Geigy Limited and Sandoz Limited. These firms have substantially greater capital resources, research and development and technical staffs, facilities and experience in obtaining regulatory approvals, as well as in manufacturing, marketing and distribution of products, than the Company. Recent trends in this area are toward further market consolidation of large drug companies into a smaller number of very large entities, further concentrating financial, technical and market strength and increasing competitive pressure in the industry. Academic institutions, hospitals, governmental agencies and other public and private research organizations are also conducting research and seeking patent protection and may develop competing products or technologies of their own through joint ventures or other arrangements. In addition, recently developed technologies or technologies that may be developed in the future may or could be the basis for competitive products. No assurance can be given that the Company's competitors will not succeed in developing technologies and products that are more effective or less costly to use than any that are currently being developed by the Company. Alprostadil, a synthetic prostaglandin E1, is the only drug approved for marketing in the U.S. for erectile dysfunction. It is available in two dosage forms. Caverject(R), marketed by Pharmacia & Upjohn, is administered by needle injection directly into the penis. The second product, developed by Vivus, is a pellet form of the drug administered through a tube inserted into the urethra. In contrast to the invasive forms now available, MacroChem believes that a topical gel formulation applied to the penis will be the preferred dosage form for treatment of this disorder. The Company expects products approved for sale, if any, to compete primarily on the basis of product efficacy, safety, patient compliance, reliability, price and patent position. Generally, the first pharmaceutical product to reach the market in a therapeutic or preventive area is often at a significant advantage relative to later entrants to the market. The Company's competitive position will also depend on its ability to attract and retain qualified scientific and other personnel, develop effective proprietary products, implement production and marketing plans, obtain patent protection and secure adequate capital resources. EMPLOYEES As of March 1, 1998, the Company had 20 full time employees, 11 of whom are devoted to research and development and regulatory affairs. In addition, two Company officers devote approximately 75% of their time to research and development. GOVERNMENT REGULATION The production and marketing of the Company's drug delivery systems and pharmaceutical products are subject to regulation for safety, efficacy and quality by numerous federal, state and local agencies and comparable agencies in foreign countries. In the United States, the Federal Food, Drug and Cosmetics Act, the Public Health Service Act, the Controlled Substances Act and other federal statutes and regulations govern or influence the testing, manufacture, safety, labeling, storage, record keeping, approval, advertising and promotion of the Company's proposed products and technologies. Non-compliance with applicable requirements can result in fines and other judicially imposed sanctions including recalls and criminal prosecutions based on products, promotional practices, or manufacturing practices that violate statutory requirements. In addition, administrative remedies can involve voluntary recalls or cessation of sale of products, administrative detention, public notice, voluntary changes in labeling, manufacturing or promotional practices, as well as refusal of the government to approve New Drug Applications (NDAs). The FDA also has the authority to withdraw approval of drugs in accordance with statutory procedures. The FDA approval procedure involves completion of certain pre-clinical and manufacturing/stability studies and the submission of the results of these studies to the FDA in an Investigational New Drug (IND) exemption in support of performing clinical trials. IND allowance is then followed by performance of human clinical trials, and additional pre-clinical and manufacturing quality control studies, supporting safety, efficacy and manufacturing quality control. The safety, chemistry, manufacturing and stability and clinical studies developed under the IND are compiled into an NDA or Abbreviated New Drug Application (ANDA) and submitted to FDA for approval to market. Pre-clinical studies involve laboratory evaluation of product characteristics and animal studies to assess the efficacy and safety of the product. Human clinical trials are typically conducted in three sequential phases, but the phases may overlap. Phase I trials consist of testing of the product in a small number of normal volunteers primarily for safety. In Phase II, in addition to safety, the efficacy of the product is evaluated in a small patient population. Phase III trials typically involve multicenter testing for safety and clinical efficacy in an expanded population of patients at geographically dispersed test sites. A clinical plan, or "protocol," accompanied by the approval of the institutions participating in the trials, must be submitted to the FDA prior to commencement of each clinical trial. The FDA may order the temporary or permanent discontinuation of a clinical trial at any time if adverse events that endanger patients in the trials are observed. In addition, the FDA may request Phase IV clinical trials, to be performed after marketing approval, to resolve any lingering questions. A 30-day waiting period after the filing of each IND application is required by the FDA prior to the commencement of clinical testing in human subjects. If the FDA has not commented on or questioned the IND application within 30 days, initial clinical studies may begin. However, any FDA comments or questions must be answered to the satisfaction of the FDA before initial clinical testing can begin. In some instances, this process could result in substantial delay and expense. The results of the pre-clinical and clinical studies on new drugs are submitted to the FDA in the form of NDAs for approval to commence commercial sales. Following extensive review, the FDA may grant marketing approval, require additional testing or information or deny the application. Continued compliance with all FDA requirements and the conditions in an approved application, including product specifications, manufacturing process and labeling requirements, are necessary for all products. Failure to comply, or the occurrence of unanticipated adverse events during commercial marketing, could lead to the need for labeling changes, product recall, seizure, injunctions against distribution or other FDA-initiated action, which could delay further marketing until the products are brought into compliance. In certain cases, an ANDA may be filed in lieu of filing an NDA. An ANDA relies on bioequivalency tests that compare the applicant's drug with an already approved reference drug, rather than on clinical trials. An ANDA may be available to the Company for a new formulation of a drug which has already been approved by the FDA in other topical dosage forms. By concentrating on drug delivery systems employing existing drugs, the Company expects that the time for regulatory approval of certain products should be shorter than for entirely new substances. The NDA itself is a complicated and detailed document and must include the results of extensive animal, clinical and other testing, the cost of which is substantial. Although the FDA is required to review applications within 180 days of filing, in the process of reviewing applications the FDA frequently requests that additional information be submitted and starts the 180 day regulatory review period anew when the requested additional information is submitted. The effect of such requests and subsequent submissions can significantly extend the time for the NDA review process. Until an NDA is actually approved, no assurance can be given that the information requested and submitted will be considered adequate by the FDA to justify approval. In addition, packaging and labeling of most of the Company's proposed products are subject to FDA regulation. The Company must get FDA approval for all labeling and packaging prior to marketing of a regulated product. Whether or not FDA approval has been obtained, approval of a product by a comparable regulatory authority must be obtained in most foreign countries prior to the commencement of marketing of the product in that country. The approval procedure varies from country to country and may involve additional testing, and the time required may differ from that required for FDA approval. Although some procedures for unified filings exist for certain European countries, in general each country has its own procedure and requirements, many of which are time consuming and expensive. Thus, substantial delays in obtaining required approvals from foreign regulatory authorities can result after the relevant applications are filed. After such approvals are obtained, further delays may be encountered before the products become commercially available. No assurance can be given that any required FDA or other governmental approval will be granted or, if granted, will not be withdrawn. Governmental regulation may prevent or substantially delay the marketing of the Company's proposed products, cause the Company to undertake costly procedures and furnish a competitive advantage to the more substantially capitalized companies with which the Company plans to compete. In addition, the extent of potentially adverse government regulations that may arise from future administrative action or legislation cannot be predicted. PATENTS AND LICENSE RIGHTS During 1997, the Company filed five U.S. patent applications, four foreign patent applications and one International PCT application. All of the foreign applications and two of the U.S. applications relate to the Company's MacroDerm polymers. Other applications filed in 1997 relate to the use of SEPA enhancers in the following: compositions and methods for treating penile erectile dysfunction; non-steroidal anti-inflammatory drug formulations for topical application to the skin; and hormone replacement therapy (HRT) drug formulations for topical application to the skin. Allowable subject matter was indicated by the U.S. Patent and Trademark Office for the Company's 1996 patent application for cationic MacroDerm polymers. The Company expects that the application will be allowed and that the patent will issue during 1998. In 1997, two U.S. patents issued: U.S. 5,620,980 - Method for treating hair loss by the application of minoxidil and SEPA enhancers (once a day treatment for baldness); and U.S. 5,631,336 - Chain-terminated N-vinyl lactam polymers and graft-copolymers and methods for making same. The Company's pending European application relating to the use of iontophoretic current in combination with SEPA enhancers was allowed in October, 1997 and will be registered in nine European countries. The Company believes that patent protection of its technologies, processes and products is important to its future operations. The success of the Company's proposed products may depend, in part, upon the Company's ability to obtain patent protection. The Company intends to enforce its patent position and intellectual property rights vigorously. The cost of enforcing the Company's patent rights in lawsuits, if necessary, may be significant and could interfere with the Company's operations. Although the Company intends to file additional patent applications as management believes appropriate with respect to any new products or technological developments, no assurance can be given that any additional patents will be issued or, if issued, will be of commercial benefit to the Company. In addition, to anticipate the breadth or degree of protection that any such patents may afford is impossible. To the extent that the Company relies on unpatented proprietary technology, no assurance can be given that others will not independently develop or obtain substantially equivalent or superior technology or otherwise gain access to the Company's trade secrets, that any obligation of confidentiality will be honored or that the Company will be able to effectively protect its rights to proprietary technology. Further, no assurance can be given that any products developed by the Company will not infringe patents held by third parties or that, in such case, licenses from such third parties would be available on commercially acceptable terms, if at all. In connection with the prior research and development efforts of the Company, the Company owns several patents and possesses certain license rights in connection with other technologies, which it is not currently pursuing. RISK FACTORS IN ADDITION TO THE OTHER INFORMATION IN THIS REPORT, THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING THE COMPANY AND ITS BUSINESS. THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS IN THIS REPORT AND IN FORWARD-LOOKING STATEMENTS MADE FROM TIME TO TIME BY THE COMPANY ON THE BASIS OF MANAGEMENT'S THEN-CURRENT EXPECTATIONS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED OR REFERRED TO BELOW. HISTORY OF OPERATING LOSSES; NEED FOR CONTINUED WORKING CAPITAL The Company has been engaged primarily in research and development since its inception in 1981 and has derived limited revenues from the commercial sale of its products and licensing of certain technology. The Company has had no revenues relating to the sale of any products currently under development. The Company has incurred net losses every year since its inception and the Company anticipates that losses may continue for the foreseeable future. See "Financial Statements and Supplementary Data." At December 31, 1997, the Company's accumulated deficit was approximately $21.7 million. The Company's ability to continue operations after its current capital resources are exhausted depends on its ability to obtain additional financing and achieve profitable operations, as to which no assurance can be given. However, the Company believes that its financial resources are sufficient to meet planned operating activities for at least the next 12 months. The Company continues to pursue the commercialization of its SEPA technology through discussion and presentation of its technology to potential licensees. No assurance can be given that these discussions will lead to any licenses or that any license fees will be received by the Company in the current fiscal year. For the foreseeable future, and until marketing approvals are obtained, and/or license agreements are entered into, if ever, the Company anticipates limited licensing revenue and no royalties from sales of products using SEPA for pharmaceutical purposes. TECHNOLOGY UNCERTAINTY AND EARLY STAGE DEVELOPMENT Although several systems have been developed by various pharmaceutical companies to enhance the transdermal delivery of specific drugs, relatively limited research has been conducted in the expansion of transdermal delivery systems to a wider range of pharmaceutical products. Although the Company has demonstrated in preclinical and clinical studies that its SEPA transdermal compounds may have applicability with a broad range of drugs, transdermal delivery systems are currently marketed for only a limited number of products. In addition, transdermal delivery systems used to date have often demonstrated adverse side effects for users, such as skin irritation and delivery difficulties. The Company's proposed products are in the early development stage, require significant further research, development, testing and regulatory clearances and are subject to the risks of failure inherent in the development of products based on innovative technologies. These risks include the possibilities that any or all of the proposed products may be found to be ineffective or toxic, or otherwise may fail to receive necessary regulatory clearances; that the proposed products, although effective, may be uneconomical to market; or that third parties may market superior or equivalent products. Due to the extended testing and regulatory review process required before marketing clearance can be obtained, the Company does not expect to be able to realize revenues from the sale of any drugs in the near term. NEED FOR SIGNIFICANT PRODUCT DEVELOPMENT EFFORTS AND ADDITIONAL FINANCING Before the Company or any of its licensees may market any products based upon the Company's technology, significant additional development efforts and substantial preclinical and clinical testing will be necessary. Unless substantial additional financing is obtained, the Company may not have sufficient working capital to complete clinical studies on any proposed products. No assurance can be given that the Company will be able to secure such financing on favorable terms, if at all. UNCERTAINTIES RELATED TO CLINICAL TRIALS Before obtaining regulatory approval for the commercial sale of any of its pharmaceutical products under development, the Company must demonstrate that the product is safe and efficacious for use in each proposed indication. The results of preclinical studies and early clinical trials may not be predictive of results that will be obtained in large-scale testing, and there can be no assurance that clinical trials of the Company's products will demonstrate the safety and efficacy of its products or will result in marketable products. A number of companies in the pharmaceutical industry have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials. If the Company were unable to demonstrate the safety and efficacy of certain of its products, the Company might be adversely affected. DEPENDENCE ON THIRD PARTIES FOR DEVELOPMENT; NO ASSURANCE OF LICENSE ARRANGEMENTS The Company intends to rely on licensees and joint venture arrangements to fund most of the costs relating to product development and clinical trials. Licensees may be expected to have the legal right to terminate funding a product at any time for any reason without significant penalty. The resources and attention devoted by a licensee to a product are not within the Company's control, and this can result in delays in clinical testing, the preparation and prosecution of regulatory filings and commercialization efforts. Further, no assurance can be given that the Company will be able to enter into new collaborative arrangements or that existing or future collaborative arrangements will be successful. PRIOR DEVELOPMENT EFFORTS HAVE NOT GENERATED SUSTAINED REVENUES OR ANY PROFITS Since its inception in 1981, the Company has engaged in research and development activities with respect to a variety of technologies and products, including polymers for medical and industrial use, dental adhesives, osteoporotic drugs and transdermal drug-delivery products. Although the Company has generated differing levels of revenue over the last several years, none of the Company's products or technologies has ever generated sustained revenues and the Company has never had profitable operations. The Company has expended a substantial amount of its resources in researching and developing technology relating to these products as well as in connection with the research and development of its transdermal delivery systems. No assurance can be given that the Company's development activities with respect to its transdermal delivery systems will be successful or that these efforts will not be eventually abandoned. LACK OF MARKETING EXPERIENCE; DEPENDENCE ON THIRD PARTIES FOR MARKETING AND DISTRIBUTION OF PRODUCTS The Company intends to market and distribute its proposed products through others pursuant to licensing, joint venture, or similar collaborative arrangements or distribution agreements. The Company has no sales force or marketing organization. If the Company directly markets and sells any of such products, it will, among other things, have to attract and retain qualified or experienced marketing and sales personnel. No assurance can be given that the Company will be able to attract and retain qualified or experienced marketing and sales personnel or that any efforts undertaken by such personnel will be successful. Any contractual arrangements with others may result in a lack of control by the Company over any or all of the marketing and sales of such products. DEPENDENCE ON THIRD PARTIES FOR MANUFACTURING The Company currently does not have facilities capable of manufacturing any proposed products in commercial quantities. Accordingly, the Company expects that it will be dependent to a significant extent on licensees, corporate partners or contract manufacturers for such manufacturing and for compliance with regulatory requirements for good manufacturing practices. The Company's dependence on third parties for manufacturing may adversely affect the Company's ability to develop and deliver products on a timely and competitive basis. If the Company decides to establish a commercial manufacturing facility, it will require substantial additional funds, will be required to hire and retain significant additional personnel and will be required to comply with extensive government regulations. No assurance can be given that the Company will be able to obtain additional capital to conduct such activities directly. RELIANCE ON KEY EMPLOYEES; LIMITED PERSONNEL; ABILITY TO ATTRACT AND RETAIN QUALIFIED SCIENTISTS The success of the Company is dependent on the efforts and abilities of Dr. Carlos M. Samour, its hairman of the Board of Directors and Scientific Director, Alvin J. Karloff, its Chief Executive Officer and President and Dr. Stephen J. Riggi, its Chief Operating Officer. Dr. Samour, Mr. Karloff and Dr. Riggi are employed by the Company under employment agreements that are of indefinite length and include non-disclosure and non-competition provisions. The loss of Dr. Samour, Mr. Karloff or Dr. Riggi could have a material adverse effect on the Company's business. The Company's business also depends on access to scientific talent, competition for which is intense and can be expected to increase. There can be no assurances that the Company will be able to retain its existing personnel or to attract additional qualified employees. COMPETITION, GOVERNMENT REGULATION, PATENTS AND LICENSE RIGHTS See these sections, above, for a description of risk factors relating to these matters. RISKS OF PRODUCT LIABILITY CLAIMS; LACK OF PRODUCT LIABILITY INSURANCE; EXPENSE AND DIFFICULTY OF OBTAINING ADEQUATE INSURANCE COVERAGE The design, development, manufacture and sale of the Company's products involve an inherent risk of liability claims and associated adverse publicity. The Company currently has liability insurance to cover claims that may result from clinical trials, but does not maintain product liability insurance and may need to acquire such insurance coverage prior to the commercial introduction of its products. No assurance can be given that the coverage limits of the Company's insurance policies will be adequate. Such insurance is expensive, is difficult to obtain and may not be available in the future on acceptable terms or at all. A successful claim brought against the Company if it is uninsured, or which is in excess of the Company's insurance coverage, if any, could have a material adverse effect upon the Company and its financial condition. UNCERTAINTY OF PHARMACEUTICAL PRICING AND RELATED MATTERS The future revenues and profitability of, and availability of capital for biomedical and pharmaceutical companies may be affected by the continuing efforts of governmental and third-party payors to contain or reduce the costs of health care through various means. For example, in certain foreign markets pricing or profitability of prescription pharmaceuticals is subject to government control and to reform in the health care system. In the United States, there have been, and the Company expects there will continue to be, a number of federal and state proposals to implement similar government control. While the Company cannot predict whether any such legislative or regulatory proposals will be adopted, the announcement or adoption of such proposals could have a material adverse effect on the Company's prospects. If the Company or one of its partners succeeds in bringing one or more of its products, based upon the Company's technology, to market, there can be no assurance that these products will be cost effective and that reimbursement to the consumer will be available or will be sufficient to allow the Company or its partners to sell such products on a profitable basis. ITEM 2. PROPERTIES. The Company leases 9,702 square feet of office and laboratory space in Lexington, Massachusetts. Details of the lease agreements are set out in Note 7 of the financial statements included in Item 8 of this Report and in the forms of lease and amendment included as exhibits to this Report. ITEM 3. LEGAL PROCEEDINGS. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of security holders during the three months ended December 31, 1997, through the solicitation of proxies or otherwise. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. MARKET PRICE OF SECURITIES AND RELATED MATTERS The Company's Common Stock is traded on NASDAQ under the symbol "MCHM." The following chart sets forth the range of high and low bid prices for the Common Stock, Class A Warrants, Class AA Warrants and Class X Warrants for the periods indicated as obtained from NASDAQ and the NASD Electronic Bulletin Board:
COMMON STOCK CLASS A WARRANTS CLASS AA WARRANT CLASS X WARRANTS MCHM MCHML MCHMM MCHMN YEAR ENDED HIGH LOW HIGH LOW HIGH LOW HIGH LOW DECEMBER 31, 1996 First Quarter $7 11/16 $3 3/4 $4 1/2 $2 $3 1/2 $1 $5 $3 1/2 Second Quarter 6 3/4 4 7/8 4 1/4 2 5/8 3 1/4 1 3/4 4 1/2 3 1/2 Third Quarter 5 3/4 3 11/16 3 5/8 1 3/4 2 3/4 1 1/4 3 1/2 3 1/4 Fourth Quarter 6 5/8 3 1/2 3 1/2 1 5/8 2 1/4 1 1/8 4 3/4 3 1/2 DECEMBER 31, 1997 First Quarter 7 3/4 4 15/16 4 3/4 2 3 1/2 1 1/4 5 1/2 3 1/2 Second Quarter 7 7/16 4 1/4 4 1/4 1 1/2 3 15/16 5 1/2 3 Third Quarter 9 1/2 4 3/4 6 5/8 2 5 1 1/8 4 1/4 3 1/4 Fourth Quarter 14 3/4 6 3/16 11 3/8 3 1/4 10 3/8 1 5/8 --- ---
The above quotations represent prices between dealers and do not include retail markups, markdowns or commissions and may not necessarily reflect actual transactions. As of December 31, 1997, there were 390 record holders of the Company's Common Stock. The Class A and Class AA Warrants expired on December 15, 1997 and the Class X Warrants expired on September 2, 1997. The Company has never paid dividends on its Common Stock and its Board of Directors does not contemplate declaring any dividends in the foreseeable future. The Company presently intends to retain earnings, if any, to finance research, development, and expansion of its business. RECENT SALES OF UNREGISTERED SECURITIES During 1997, the Company issued the following securities which were not registered under the Securities Act of 1933 at the time the securities were issued: - On June 5, 1997, 16,000 shares of the Company's Common Stock were issued to its investment banker in consideration of services to the Company. - On August 15, 1997, 25,000 shares of the Company's Common Stock were issued to a consultant in consideration of services to the Company. The transactions described above were effected in reliance upon the exemption from the registration requirements of the Securities Act of 1933 provided by section 4(2) thereof on the basis that such transactions did not involve any public offering. ITEM 6. SELECTED FINANCIAL DATA.
TRANSITION PERIOD FROM APRIL 1 TO DECEMBER 31, YEARS ENDED DECEMBER 31, - ----------------------------------------------- ------------------------------------------------------------ 1993 1994 1995 1996 1997 ---- ---- ---- ----- ---- STATEMENTS OF OPERATIONS DATA: Total revenue $ 123,819 $ 44,710 $ 17,493 $ 129,786 $ 120,350 Net loss (1,465,454) (1,969,442) (2,465,837) (3,139,796) (3,569,113) Basic and diluted net loss per share (0.13) (0.17) (0.20) (0.21) (0.21) Shares used to compute basic and diluted net loss per share 10,874,172 11,558,105 12,331,560 15,239,080 16,638,401 BALANCE SHEET DATA: Working capital $ 5,321,837 $ 3,615,608 $ 4,532,623 $ 7,127,252 $24,756,904 Current assets 5,633,155 3,955,357 4,962,562 7,495,715 25,069,804 Total assets 5,956,850 4,437,600 5,462,625 8,063,750 25,623,836 Current liabilities 311,318 339,749 429,939 368,463 312,900 Capitalized lease obligations -0- 59,715 91,861 57,038 18,408 Total liabilities 324,188 387,792 486,198 386,871 312,900 Stockholders' equity 5,632,662 4,049,808 4,976,427 7,676,879 25,310,936
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion of the financial condition and results of operations for the Company should be read in conjunction with the accompanying financial statements and related footnotes. GENERAL MacroChem's primary business is the development of pharmaceutical products for commercialization by applying SEPA(R) (Soft Enhancer of Percutaneous Absorption), its patented drug delivery technology. SEPA compounds, when properly combined with drugs, provide pharmaceutical formulations (creams, gels, solutions, etc.) that enhance the transdermal delivery of drugs into the skin or into the bloodstream. The Company currently derives no significant revenue from product sales, royalties or license fees. The Company plans to develop specific SEPA formulations for use with proprietary and non-proprietary drugs manufactured by pharmaceutical companies, and to commercialize these products through the formation of partnerships, strategic alliances and license agreements with those companies. In order to attract strategic partners the Company is conducting limited clinical testing of certain SEPA-enhanced pharmaceuticals. The Company's results of operations vary significantly from year to year and quarter to quarter, and depend, among other factors, on the signing of new licenses and product development agreements, the timing of revenues recognized pursuant to license agreements, the achievement of milestones by licensees, the progress of clinical trials conducted by licensees and the Company, and the degree of research, marketing and administrative effort. The timing of the Company's revenues may not match the timing of the Company's associated product development expenses. To date, research and development expenses have generally exceeded revenues in any particular period and/or fiscal year. RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996 For the year ended December 31, 1997, the Company's net loss was approximately $3,569,100 as compared to a loss of $3,139,800 for the previous year, a 14% increase. For 1997 and 1996, the Company realized operating revenues of approximately $120,400 and $129,800, respectively, which were primarily from the completion of feasibility studies. Marketing, general and administrative expenses for 1997 aggregated approximately $1,992,200, an increase of $99,600, or 5%, from 1996's total of $1,892,600, reflecting increased securities registration expenses offset in part by a reduction in general consulting expenses. The Company expects that marketing, general and administrative expenses will increase in 1998 resulting from increased patent costs and routine compensation adjustments. Research and development costs increased approximately $348,200 from $1,736,600 in 1996 to $2,084,800 in 1997, a 20% increase. This increase reflects the Company's continued acceleration of clinical testing of its products and increased internal research and development efforts. The Company expects that research and development costs will continue to increase substantially in 1998, reflecting increased clinical testing efforts. Other income increased from a net amount of $371,600 in 1996 to $417,500 in 1997. This increase reflects the increased cash which resulted primarily from the exercise of Class A and Class AA warrants. With the exception of outstanding stock options, at December 31, 1997 the Company does not have any outstanding equity instruments which may provide a source of funds in the future. YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE YEAR ENDED DECEMBER 31, 1995 For the year ended December 31, 1996, the net loss was approximately $3,139,800 as compared to a loss of $2,465,800 for the previous year, a 27% increase. For the 1996 and 1995 years, the Company realized operating revenues of approximately $129,800 and $17,500, respectively, which were from the completion of feasibility studies. Marketing, general and administrative expenses for 1996 aggregated approximately $1,892,600, an increase of $480,100, or 34%, from 1995's total of $1,412,500. The increase was due primarily to the adoption in 1996 of Statement of Financial Accounting Standards No. 123 "Accounting for Stock Based Compensation (SFAS 123)". Adoption of SFAS 123 increased expenses approximately $491,200, of which approximately $433,100 was attributable to the grant of a warrant to an investment banker for services to the Company. Research and development costs increased by approximately $498,500 from $1,238,100 in 1995 to $1,736,600 for 1996, representing a 40% increase. The Company has continued its emphasis on research and development of expanded uses of the Company's proprietary products. 1996 costs increased due to the hiring of a director of research and development and to increased clinical study costs and internal research and development efforts. The adoption of SFAS 123 increased expenses approximately $35,300. Other income increased from a net amount of $203,300 in 1995 to $371,600 in 1996. This increase reflected greater cash on hand. Interest expense was approximately $12,000 in 1996, a reduction of $30,600 from 1995, reflecting the lower capital lease debt outstanding. LIQUIDITY AND CAPITAL RESOURCES Since inception, the primary source of funding for the Company's operations has been the private and public sale of its securities, and to a lesser extent, the licensing of its proprietary technology and products, government grants and the limited sales of products and test materials. During 1997, the Company received aggregate net proceeds of approximately $20.8 million from the exercise of stock options, stock warrants, and unit purchase options, compared to approximately $5.3 million in 1996. At December 31, 1997 working capital was approximately $24.8 million, compared to $7.1 million at December 31, 1996. The increase in the Company's working capital, from the receipt of the net proceeds from the issuance of its securities, was somewhat offset by the net cash used by operating activities for the year ended December 31, 1997. Until such time as the Company obtains agreements with third-party licensees or partners to provide funding for the Company's anticipated business activities or the Company is able to obtain funds through the private or public sale of its securities, the Company's working capital will be utilized to fund its operating activities. Capital expenditures and additional patent development costs for the year ended December 31, 1997 were approximately $112,000. The Company anticipates capital expenditures of approximately $420,000 during the fiscal year ending December 31,1998. The Company's long term capital requirements will depend upon numerous factors including the progress of the Company's research and development programs; the resources that the Company devotes to self-funded early stage clinical testing of SEPA enhanced compounds, proprietary manufacturing methods and advanced technologies; the ability of the Company to enter into additional licensing arrangements or other strategic alliances; the ability of the Company to manufacture products under those arrangements and the demand for its products or the products of its licensees or strategic partners if and when approved for sale by regulatory authorities. In any event, substantial additional funds will be required before the Company is able to generate revenues sufficient to support its operations. There is no assurance that the Company will be able to obtain such additional funds on favorable terms, if at all. The Company's inability to raise sufficient funds could require it to delay, scale back or eliminate certain research and development programs. The Company believes that its existing cash and cash equivalents will be sufficient to meet its operating expenses and capital expenditure requirements for at least the next twelve months. The Company's cash requirements may vary materially from those now planned because of changes in focus and direction of the Company's research and development programs, competitive and technical advances, patent developments or other developments. It is not believed that inflation will have any significant effect on the results of the Company's operations. YEAR 2000 REMEDIATION The Company believes that it will be able to manage the year 2000 computer transition without a material effect on its business, operations or financial condition. THE FOREGOING STATEMENTS IN THIS REPORT INCLUDE FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED OR REFERRED TO IN ITEM 1, BUSINESS - "RISK FACTORS". ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The information required under this Item 8 is set forth on pages 22 through 36 of this report. INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of MacroChem Corporation: We have audited the accompanying balance sheets of MacroChem Corporation as of December 31, 1997 and 1996, and the related statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of MacroChem Corporation at December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. /s/Deloitte & Touche LLP - ------------------------ DELOITTE & TOUCHE LLP Boston, Massachusetts March 5, 1998
MACROCHEM CORPORATION BALANCE SHEETS DECEMBER 31, ASSETS 1997 1996 LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1996 - ------ ---- ---- ------------------------------------- ---- ---- CURRENT ASSETS: CURRENT LIABILITIES: Cash and cash equivalents $24,952,121 $7,329,881 Current portion of capitalized lease Marketable securities --- 21,824 obligations $ 18,408 $ 38,630 Accounts receivable --- 43,977 Accounts payable and accrued expenses 204,352 241,338 Prepaid expenses and other Deferred compensation and related current assets 117,683 100,033 accrued interest 90,140 87,481 ---------- --------- Deferred rent --- 1,014 ---------- ---------- TOTAL CURRENT LIABILITIES 312,900 368,463 TOTAL CURRENT ASSETS 25,069,804 7,495,715 CAPITALIZED LEASE OBLIGATIONS, Net of ---------- --------- current portion --- 18,408 ---------- ---------- PROPERTY AND EQUIPMENT (NET) 281,216 345,343 ---------- --------- TOTAL LIABILITIES 312,900 386,871 ---------- ---------- OTHER ASSETS: Patents, net 268,356 218,232 Deposits 4,460 4,460 COMMITMENTS & CONTINGENCIES (Note 7) ---------- --------- TOTAL OTHER ASSETS 272,816 222,692 STOCKHOLDERS' EQUITY: ---------- --------- Preferred stock --- --- Common stock, $.01 par value; authorized 60,000,000 shares; issued and outstanding, 22,182,865 shares and 15,601,274 shares at December 31, 1997 and 1996, respectively 221,829 156,013 Additional paid-in capital 46,923,677 25,839,675 Unearned compensation ( 169,322) ( 222,674) Accumulated deficit (21,665,248) (18,096,135) ---------- ---------- TOTAL STOCKHOLDERS' EQUITY 25,310,936 7,676,879 ---------- ---------- TOTAL LIABILITIES AND TOTAL ASSETS $25,623,836 $8,063,750 STOCKHOLDERS' EQUITY $ 25,623,836 $ 8,063,750 ========== ========= ========== =========== See notes to financial statements.
MACROCHEM CORPORATION STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, ----------------------- 1997 1996 1995 ---- ---- ---- REVENUES Research contracts $ 120,350 $ 129,786 $ 17,493 ---------- ---------- ---------- OPERATING EXPENSES Marketing, general and administrative 1,992,157 1,892,572 1,412,537 Research and development 2,084,826 1,736,561 1,238,070 Consulting fees with related parties 30,000 12,000 36,000 ---------- ---------- ---------- TOTAL OPERATING EXPENSES 4,106,983 3,641,133 2,686,607 ---------- ---------- ---------- LOSS FROM OPERATIONS ( 3,986,633) ( 3,511,347) ( 2,669,114) ---------- ---------- ---------- OTHER INCOME (EXPENSE) Interest income 424,742 383,596 246,018 Interest expense ( 7,222) ( 12,045) ( 42,644) Other --- --- ( 97) ---------- ---------- ---------- TOTAL OTHER INCOME 417,520 371,551 203,277 ---------- ---------- ---------- NET LOSS $( 3,569,113) $( 3,139,796) $( 2,465,837) ========== ========== ========== BASIC AND DILUTED NET LOSS PER SHARE $( .21) $( .21) $( .20) ========== ========== ========== SHARES USED TO COMPUTE BASIC AND DILUTED NET LOSS PER SHARE 16,638,401 15,239,080 12,331,560 ========== ========== ========== See notes to financial statements.
MACROCHEM CORPORATION STATEMENTS OF STOCKHOLDERS' EQUITY COMMON STOCK --------------------- ADDITIONAL NUMBER OF PAR PAID-IN UNEARNED ACCUMULATED SHARES VALUE CAPITAL COMPENSATION DEFICIT TOTAL - ----------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1994 11,569,643 $115,696 $16,424,614 $ --- $(12,490,502) $ 4,049,808 Issuance of common stock 1,000,000 10,000 2,740,000 --- --- 2,750,000 Stock based compensation 4,145 42 16,270 --- --- 16,312 Exercise of common stock warrants 51,700 517 90,358 --- --- 90,875 Exercise of common stock options 203,833 2,038 531,231 --- --- 533,269 Exercise of unit purchase options 300,000 3,000 522,000 --- --- 525,000 Costs associated with issuance of common stock and warrants --- --- ( 523,000 --- --- ( 523,000) Net loss --- --- --- --- ( 2,465,837) ( 2,465,837) ---------- ------- --------- ------- ---------- ---------- BALANCE, DECEMBER 31, 1995 13,129,321 131,293 19,801,473 --- (14,956,339) 4,976,427 Exercise of common stock warrants 726,667 7,267 2,227,984 --- --- 2,235,251 Exercise of common stock options 251,861 2,519 442,887 --- --- 445,406 Exercise of unit purchase options 1,492,500 14,925 2,596,950 --- --- 2,611,875 Stock based compensation 925 9 770,381 (222,674) --- 547,716 Net loss --- --- --- --- ( 3,139,796) ( 3,139,796) ---------- ------- ---------- ------- ---------- ---------- BALANCE, DECEMBER 31, 1996 15,601,274 156,013 25,839,675 (222,674) (18,096,135) 7,676,879 Exercise of common stock warrants 4,491,590 44,916 16,938,240 --- --- 16,983,156 Exercise of common stock options 291,501 2,915 692,087 --- --- 695,002 Exercise of unit purchase options 1,757,500 17,575 3,058,050 --- --- 3,075,625 Stock based compensation 41,000 410 395,625 53,352 --- 449,387 Net loss --- --- --- --- ( 3,569,113) ( 3,569,113) ---------- ------- ---------- ------- ---------- ---------- BALANCE, DECEMBER 31, 1997 22,182,865 $221,829 $46,923,677 $(169,322) $(21,665,248) $25,310,936 ========== ======= ========== ======= ========== ==========
See notes to financial statements.
MACROCHEM CORPORATION STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, ------------------------ 1997 1996 1995 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $( 3,569,113) $(3,139,796) $(2,465,837) ---------- --------- --------- Adjustments to reconcile net loss to net cash used by operating activities: Depreciation and amortization 123,888 116,967 79,475 (Gain) loss on disposal of equipment 1,800 --- ( 3,925) Abandoned patent costs --- --- 22,592 Stock-based compensation 448,977 547,716 16,312 Amortization of discounts on marketable securities --- ( 70,845) ( 152,316) Increase (decrease) in cash from: Accounts receivable 43,977 ( 43,977) --- Prepaid expenses and other current assets ( 17,650) 12,258 ( 21,767) Accounts payable and accrued expenses ( 36,986) ( 11,396) 126,773 Deferred compensation and related accrued interest 2,659 ( 47,180) ( 54,585) Deferred rent ( 1,014) ( 5,928) ( 5,928) Deposits --- --- ( 150) ---------- --------- --------- Total adjustments 565,651 497,615 6,481 ---------- --------- --------- Net cash used by operating activities ( 3,003,462) (2,642,181) (2,459,356) ---------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of equipment 100 --- 4,800 Purchases of marketable securities --- (5,743,755) (3,516,801) Purchase of certificates of deposit --- ( 734,732) ( 287,000) Proceeds from maturities of marketable securities 21,824 6,771,000 5,977,000 Proceeds from maturities of certificates of deposit --- 1,015,000 --- Expenditures for property and equipment ( 48,991) ( 136,306) ( 54,916) Additions to patents ( 62,794) ( 48,633) ( 16,558) ---------- --------- ---------- Net cash provided (used) by investing activities ( 89,861) 1,122,574 2,106,525 ---------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments on capital lease ( 38,630) ( 34,823) ( 16,992) Proceeds from issuance of common stock 410 --- 2,750,000 Proceeds from exercise of common stock options 695,002 445,406 533,269 Proceeds from exercise of common stock warrants 16,983,156 2,235,251 90,875 Proceeds from exercise of unit purchase options 3,075,625 2,611,875 525,000 Costs associated with the registration and issuance of common stock and warrants --- --- ( 523,000) ---------- --------- --------- Net cash provided by financing activities 20,715,563 5,257,709 3,359,152 ---------- --------- ---------
(Continued) MACROCHEM CORPORATION STATEMENTS OF CASH FLOWS (CONTINUED) YEARS ENDED DECEMBER 31, ----------------------------------- 1997 1996 1995 ---- ---- ---- NET INCREASE IN CASH AND CASH EQUIVALENTS $17,622,240 $3,738,102 $3,006,321 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 7,329,881 3,591,779 585,458 ---------- --------- --------- CASH AND CASH EQUIVALENTS, END OF YEAR $24,952,121 $7,329,881 $3,591,779 ========== ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for interest aggregated $4,563, $9,226 and $5,022, respectively, for the years ended December 31, 1997, 1996 and 1995. The Company did not pay any income taxes during those periods. SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Equipment acquired pursuant to a capital lease obligation $ --- $ --- $ 49,138 ========== ========= ========= See notes to financial statements. (Concluded) MACROCHEM CORPORATION NOTES TO FINANCIAL STATEMENTS 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES MacroChem Corporation (the "Company") develops and licenses transdermal drug delivery compounds and systems intended to promote the delivery of drugs from the surface of the skin into the skin or the bloodstream. The Company has been engaged primarily in research and development since its inception in 1981 and has derived limited revenues from the commercial sale of its products and licensing of certain technology. The Company has had no revenues relating to the sale of any products currently under development. The Company has incurred net losses every year since its inception and the Company anticipates that losses may continue for the foreseeable future. At December 31, 1997, the Company's accumulated deficit was approximately $21.7 million. The Company's ability to continue operations after its current capital resources are exhausted depends on its ability to obtain additional financing and achieve profitable operations, as to which no assurances can be given. However, the Company believes that its financial resources are sufficient to meet planned operating activities for at least the next twelve months. REVENUE RECOGNITION - Revenues are earned and recognized based upon completion of a contract, upon the sale or licensing of product rights, upon shipment of product, or upon the attainment of benchmarks specified in the related agreements. RESEARCH AND DEVELOPMENT - Research and development costs are charged to operations as incurred. Such costs include proprietary research and development activities and expenses associated with research and development contracts. CASH EQUIVALENTS - Cash equivalents consist of short-term, highly liquid investments with a maturity of three months or less when purchased. PROPERTY AND EQUIPMENT - Property and equipment are stated at cost. Depreciation and amortization are provided on the straight-line method over the estimated useful lives of the related assets which range from five to ten years. PATENTS - The Company has filed applications for United States and foreign patents covering aspects of its technology. Costs and expenses incurred in connection with pending patent applications are deferred. Costs related to successful patent applications are amortized over the estimated useful lives of the patents, not exceeding 20 years, using the straight-line method. Accumulated costs related to patents or deferred patent application costs that are considered to have limited future value are charged to expense. Accumulated amortization aggregated approximately $59,600 and $47,000, respectively, at December 31, 1997 and 1996. 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) On an on-going basis, the Company evaluates the recoverability of the net carrying value of various patents by reference to the patent's expected use in drug and other research activities as measured by outside interest in the Company's patented technologies and management's determination of potential future uses of such technologies. As a result of such evaluations, during 1995 the Company wrote off approximately $22,600 of costs associated with patents no longer having value. INCOME TAXES - The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes", which requires the use of the liability method. The objective of this method is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities using tax rates in effect in the year(s) in which the differences are expected to reverse. NET LOSS PER COMMON SHARE - In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings Per Share", which is effective for financial statements issued for periods ending after December 15, 1997. This statement required the adoption of new calculation methodologies and enhanced disclosures of basic and diluted earnings per share computations. As required, the Company has adopted SFAS No. 128 in the fourth quarter of 1997. The computation of the basic net loss per share in accordance with SFAS No. 128 did not require a restatement of the prior years' net loss per share to conform to SFAS No. 128. Due to the net losses of the Company, diluted earnings per share are not presented as the results would be anti-dilutive. Potential dilutive securities consist of the Company's outstanding stock options, warrants and unit purchase options which aggregate 3,557,504, 10,090,126 and 11,494,509 for the years ended December 31, 1997, 1996 and 1995, respectively. ACCOUNTING ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The primary estimates underlying the Company's financial statements include the useful lives of the Company's fixed assets and patents, the valuation allowance established for the Company's deferred tax assets, and the underlying assumptions to apply the pricing model to value stock options under SFAS No. 123. Management bases its estimates on certain assumptions, which it believes are reasonable in the circumstances, and while actual results could differ from those estimates, management does not believe that any change in those assumptions in the near term would have a significant effect on the financial position or the results of operations. STOCK-BASED COMPENSATION - SFAS No. 123 addresses the financial accounting and reporting standards for stock or other equity-based compensation arrangements. The Company has elected to continue to use the intrinsic value based method to account for employee stock option plans and provide disclosures based on the fair value method in the notes to the financial statements as permitted by SFAS No. 123. 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Stock or other equity based compensation for non-employees must be accounted for under the fair value based method as required by SFAS No. 123. Under this method, the equity based instrument is valued at either the fair value of the consideration received or from the equity instrument issued on the date of grant. The resulting compensation cost is recognized and charged to operations over the service period, which is usually the vesting period. RECLASSIFICATION - Certain 1996 and 1995 amounts have been reclassified to conform with the 1997 presentation. 2. MARKETABLE SECURITIES The Company had no marketable securities at December 31, 1997. However, as of December 31, 1996, marketable securities were classified as "held to maturity securities" and carried at amortized cost. The maturities of marketable securities held at December 31, 1996 were all one year or less. The carrying amounts and approximate market value of investment securities are as follows as of December 31: Amortized Cost Unrealized Gain Market Value -------------- --------------- ------------ 1996 ---- U.S. Treasury Securities $ 21,824 --- $ 21,824 ========= ======== ========= 3. PROPERTY AND EQUIPMENT Property and equipment consists of the following as of December 31: 1997 1996 ---- ---- Laboratory equipment $589,398 $562,183 Office equipment 167,331 158,929 Leasehold improvements 107,256 96,882 ------- ------- Total 863,985 817,994 Less: accumulated depreciation and amortization (582,769) (472,651) ------- ------- Property and equipment, net $281,216 $345,343 ======= ======= 4. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consists of the following as of December 31: 1997 1996 ---- ---- Accounts payable $ 17,154 $ 58,179 Payroll taxes --- 19,313 Accrued professional fees 173,814 130,046 Accrued clinical trial costs 13,384 33,800 ------- ------- $204,352 $241,338 ======= ======= 5. CAPITALIZED LEASE OBLIGATIONS Equipment held under capital lease obligations included with owned property on the balance sheet consists of the following as of December 31: 1997 1996 ---- ---- Laboratory equipment $ 113,758 $ 113,758 Less: accumulated amortization ( 62,219) ( 39,468) -------- -------- $ 51,539 $ 74,290 ======== ======== Future minimum lease payments under capital leases are as follows: Total payments for 1998 $ 19,653 Less: imputed interest (approximately 11%) ( 1,245) ------- Present value of minimum lease payments $ 18,408 ======= 6. STOCKHOLDERS' EQUITY AUTHORIZED CAPITAL STOCK - Authorized capital stock consists of 60,000,000 shares of $.01 par value common stock of which 22,182,865 shares are issued and 5,284,279 are reserved for issuance upon exercise of common stock warrants and options at December 31, 1997. Authorized and unissued preferred stock totals 6,000,000 shares. STOCK ISSUANCES - On May 30, 1995, the Company sold 1,000,000 shares of common stock, par value $.01 per share, to a single investor (the "Investor") in a private placement. The sale price was $2.75 per share. Pursuant to the Common Stock Purchase Agreement between the Company and the Investor, the Investor had the right to designate one person to serve on the Company's Board of Directors. The firm of Janssen-Meyers, L.P. ("J-M") received a brokers fee of $357,500 from the Company for this private placement. Mr. Janssen and Mr. Meyers are principals of J-M and own approximately 7.5% and 4.9%, respectively, of the Company's voting securities. In January 1993, the Company completed a private placement offering whereby 142 units (the "Units"), each consisting of 30,000 shares of common stock, 10,000 Class A common stock warrants and 10,000 Class AA common stock warrants, were sold, or issued in exchange for certain notes payable, for $52,500 per Unit. Additionally, options were issued to affiliates of the placement agent of the offering which were exercisable for 118 and one-third of these Units at a price of $52,500 per Unit. During 1995, options to purchase 10 Units were exercised by an affiliate of the placement agent, and 49 and three-quarters options to purchase Units were exercised during 1996. All the remaining Units were exercised prior to the expiration date in December 1997. 6. STOCKHOLDERS' EQUITY (CONTINUED) WARRANTS - As part of the January 1993 private placement, the Company issued 1,420,000 Class A and 1,420,000 Class AA common stock warrants. Each Class A and Class AA warrant was exercisable for one share of common stock at a price per share, subject to adjustment, of $3.00 and $4.50, respectively. In December 1997, the remaining Class A and Class AA common stock warrants which had not been exercised, expired. In connection with the issuance of $300,000 of subordinated notes payable in August 1992 (certain of the notes were issued to affiliates of the placement agent), of which $155,000 was repaid in January 1993 and $145,000 was converted to Units in the January 1993 offering described above, the Company issued warrants to purchase 300,000 shares of common stock at an initial exercise price of $1.75 per share. The remaining unexercised warrants expired in September 1997. In July 1995, the Company issued 240,000 four-year warrants to J-M to permit the holder to acquire 80,000 shares of the Company's common stock at exercise prices of $3.00, $4.00, and $5.00. Exercise of these warrants was permitted only if the Company and J-M entered into a new consulting agreement on or before April 1, 1996. The warrants expired April 1, 1996. In June 1996, in connection with services performed for the Company, J-M received a warrant, exercisable immediately and expiring June 17, 1999, for the purchase of 145,800 shares of the Company's common stock at a price of $6.075 per share. The market price per share on the grant date was $5.125. Effective January 1, 1996, the Company adopted SFAS No. 123 "Accounting for Stock-Based Compensation" which establishes fair value as the measurement basis for transactions in which an entity acquires goods or services from non-employees in exchange for equity instruments As a result, the 1996 net loss reflects compensation costs of $433,133 associated with the granting of this warrant. The compensation cost is based upon the fair value method calculated on the grant date using the Black/Scholes option pricing model. Key assumptions in applying this pricing model include an expected life of three years, expected volatility of the underlying stock of approximately 94%, and a risk free interest rate of 5.25%. Pursuant to an informal understanding, the Company paid J-M a monthly fee of $5,000 for consulting services from December 1996 through April 1997. STOCK OPTION PLANS - The Company has three stock option plans, the 1984 Incentive Stock Option Plan (ISO Plan), the 1984 Non-Qualified Stock Option Plan (Non-qualified Plan) and the 1994 Equity Incentive Plan (1994 Plan). Under the terms of the 1984 Plans the Company may no longer award any options. All options previously granted may be exercised at any time up to ten years from date of award. Under the terms of the 1994 Plan, the Company may grant options to purchase up to a maximum of 4,000,000 shares of common stock to certain employees, directors and consultants. The options may be awarded as incentive stock options (employees only) and non-incentive stock options (certain employees, directors and consultants). The exercise price of options under the ISO Plan and incentive options from the 1994 Plan may not be less than fair market value at the date of grant. The exercise price of the Non-Qualified 6. STOCKHOLDERS' EQUITY (CONTINUED) options and the non-incentive options from the 1994 Plan is determined by the Board of Directors. All options become exercisable as specified at the date of grant. The following table presents activity under all stock option plans: Weighted Average Number of Options Exercise Price ----------------- ---------------- Outstanding December 31, 1994 2,677,775 $1.558 Granted 325,000 3.197 Exercised ( 203,833) 2.616 Expired ( 13,000) 6.023 Canceled ( 141,401) 3.460 --------- Outstanding December 31, 1995 2,644,541 1.554 Granted 1,180,845 5.573 Exercised ( 251,861) 1.768 Canceled ( 20,000) 4.250 --------- Outstanding December 31, 1996 3,553,525 2.850 Granted 247,500 7.027 Exercised ( 291,501) 2.384 Expired ( 10,000) 4.250 Canceled ( 87,820) 5.682 --------- Outstanding December 31, 1997 3,411,704 3.126 ========= Exercisable at December 31: 1997 2,867,204 $2.582 ========= 1996 2,312,501 $1.610 ========= 1995 2,161,841 $1.216 ========= The weighted average fair values of options granted during 1997, 1996 and 1995 were $5.83, $2.37 and $4.93, respectively. All options granted during the three year period ended December 31, 1997 were granted at the market price of the stock except for 10,000 in 1995 which were issued at an option price higher than market with a weighted average exercise price of $6.75 and a market price of $3.75. The fair value of options on their grant date was measured using the Black/Scholes option pricing model. Key assumptions used to apply this pricing model are as follows:
1997 1996 1995 ---- ---- ---- Risk-free interest rate 5.35%-7.14% 5.25% 5.25% Expected life of option grants 10 years 5-10 years 5-10 years Expected volatility of underlying stock 65.3%-87.7% 59.3%-99.2% 48.2%-112.5% Expected dividend payment rate,as a percentage of the stock price on the date of grant --- --- ---
6. STOCKHOLDERS' EQUITY (CONTINUED) It should be noted that the option pricing model used was designed to value readily tradable stock options with relatively short lives. The options granted to employees are not tradable and have contractual lives of up to ten years. The following table sets forth information regarding options outstanding at December 31, 1997:
Weighted Ave. Weighted Ave. Range of Number of Number Exercise Price- Weighted Ave. Exercise Price- Exercise Options Currently Options Remaining Currently Prices Outstanding Exercisable Outstanding Life Exercisable --------------------------------------------------------------------------------------------- $.43 1,315,080 1,315,080 $ .43 3.17 $ .43 $1.50-$2.00 109,499 84,499 $1.82 6.58 $1.80 $2.75-$4.00 646,600 601,600 $3.18 6.42 $3.14 $4.875-$5.875 1,118,025 846,025 $5.59 8.15 $5.50 $6.064-$8.25 222,500 20,000 $7.08 8.52 $6.49
The Company uses the intrinsic value method to measure compensation expense associated with grants of stock options to employees and, prior to December 15, 1995, to suppliers of goods and services. Had the Company used the fair value method to measure compensation, the reported net loss and basic and diluted net loss per share would have been as follows: 1997 1996 1995 ---- ---- ---- Net loss as reported ($3,569,113) ($3,139,796) ($2,465,837) Compensation costs: Employee ( 2,495,545) ( 2,560,760) ( 108,735) Non-Employee ( 31,785) ( 58,273) ( 100,278) ---------- ---------- ---------- Proforma net loss ($6,096,443) ($5,758,829) ($2,674,850) ========== ========== ========== Proforma basic and diluted net loss per share ($ 0.37) ($ 0.38) ($ 0.22) ========== ========== ========== 6. STOCKHOLDERS' EQUITY (CONTINUED) It should be noted that the proforma amounts presented above are inexact in that the pricing model was designed to value freely-traded options rather than employee stock options. Proforma charges may be understated in relation to future years since these proforma charges do not reflect the financial impact of options granted prior to 1995. UNEARNED COMPENSATION - The following table sets forth the changes to the Company's reported compensation for the years ended December 31, 1997 and 1996: 1997 1996 ---- ---- Balance, January 1 $ 222,674 $ 0 Common stock granted to non-employees below fair market value 286,071 4,509 Options and warrants granted to non-employees at fair market value 378,422 765,881 Amortization of unearned compensation ( 448,977) ( 547,716) Unearned compensaton forfeited ( 268,868) --- -------- -------- Balance, December 31 $ 169,322 $ 222,674 ======== ======== STOCK AND STOCK ISSUANCES - During 1995, the Company issued 4,145 common shares and recorded compensation of $16,312 for services rendered. The Company issued 925 common shares and recorded compensation of $4,509 for services rendered in 1996. During 1997, the Company issued 41,000 common shares and recorded unearned compensation of $286,071 at the date of issuance. 7. COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS - The Company has a lease expiring on February 28, 2000 for its operating facility. At December 31, 1997, future minimum lease payments under this lease agreement are as follows: 1998, $174,816, 1999, $174,816, and 2000, $29,136. Total rental expense under all operating leases was approximately $162,500, $106,000 and $104,000 for the years ended December 31, 1997, 1996, and 1995, respectively. EMPLOYMENT AND CONSULTING AGREEMENTS - The Company has employment and consulting agreements with various consultants and certain key employees, with terms ranging from one year to an indefinite period of time. These agreements provide for annual payments of approximately $659,000. In addition, certain consulting agreements also provide for additional payments to certain consultants related to obtaining a financial placement, sale or licensing of the Company's product or technology to third parties. During the periods ended December 31, 1997, 1996 and 1995, no such additional amounts were earned by the related consultants. ROYALTY AGREEMENTS - The Company has entered into various license agreements which require the Company to pay royalties based upon a set percentage of certain product sales and license fee revenue. There were no such amounts paid in 1997, 1996 and 1995. CLINICAL TRIAL LIABILITY INSURANCE - A clinical liability policy was obtained as of November, 1995 and renewed in 1996 and 1997. 8. INCOME TAXES No income tax provision or benefit has been provided for federal income tax purposes as the Company has incurred losses since inception. As of December 31, 1997, the Company has available net operating loss carryforwards of approximately $20.3 million for federal income tax purposes, expiring through 2011 and $11.6 million for state income tax purposes, expiring through 2001. In addition, the Company, for federal and state income tax purposes, has unused investment and research and development tax credits aggregating $10,000 and $383,000, respectively. The use of the federal net operating loss may be restricted due to changes in ownership in accordance with definitions as stated in the Internal Revenue Code. Deferred income taxes consist of the aggregate operating loss and tax credit carryforwards and reflect the net tax effect of differences in the timing of certain revenue and expense items and the related carrying amounts of assets and liabilities for financial reporting and tax purposes are not material and, accordingly, are not displayed in the table below. The components of the Company's deferred tax assets and liabilities as of December 31, 1997 and December 31, 1996 are as follows: 1997 1996 ---- ---- Deferred Tax Assets: Net operating loss carryforwards $ 8,000,000 $ 6,700,000 Tax credit carryforwards 393,000 330,000 Other --- 23,000 ---------- ---------- 8,393,000 7,053,000 Valuation allowance (8,393,000) (7,053,000) --------- --------- Deferred tax asset, net $ --- $ --- ========= ========= For the years ended December 31, 1997, 1996 and 1995, the valuation allowance was increased by approximately $1,340,000, $1,313,000, and $660,000, respectively, due to the uncertainty of future realization of currently generated net operating loss and tax credit carryforwards. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item is incorporated by reference to "Proposal No. 1 - Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION. The information required by this item is incorporated by reference to "Report of Compensation Committee" and "Employment Contracts, Termination of Employment and Change-In-Control Arrangements" in the Company's Proxy Statement. ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this item is incorporated by reference to "Beneficial Ownership of Voting Securities" in the Company's Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this item is incorporated by reference to "Employment Contracts, Termination of Employment and Change-In-Control Arrangements" and "Certain Transactions" in the Company's Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a)(1) The following Financial Statements as of December 31, 1997 and 1996 and for the three years in the period ended December 31, 1997 are filed herewith: Page ---- Independent Auditors' Report 22 Balance Sheets 23 Statements of Operations 24 Statements of Stockholders' Equity 25 Statements of Cash Flows 26-27 Notes to Financial Statements 28-36 (a)(2) The following Financial Statement Schedules are filed herewith: None. Schedules not included herein are omitted because they are not applicable or the required information appears in the Financial Statements or Notes thereto. (a)(3) The following exhibits are filed herewith: 11 Statement of Earnings Per Share 23.1 Consent of Deloitte & Touche LLP 27 Financial Data Schedule 99.1 1994 Equity Incentive Plan as amended November 14, 1997* The following exhibit required to be filed herewith is incorporated by reference to the exhibits to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997: 3a Certificate of Incorporation as amended. The following exhibits required to be filed herewith are incorporated by reference to the exhibits to the Company's Annual Report on Form 10-K for the year ended December 31, 1996: 4 Stock Purchase Warrant 10.10.2 1984 Non-Qualified Stock Option Plan as amended November 15, 1996* 10.11.1 Second Amendment to Lease Agreement between Lexington BGK Associates, Limited Partnership and MacroChem Corporation for space located at 110 Hartwell Avenue, Lexington, MA 02173 10.13 Form of Employment Agreement between the Company and Dr. Stephen J. Riggi* The following exhibit required to be filed herewith is incorporated by reference to the exhibits to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997: 10.10.3 1984 Incentive Stock Option Plan as amended November 15, 1996* The following exhibit required to be filed herewith is incorporated by reference to the exhibits to the Company's Annual Report on Form 10-K for the year ended December 31, 1993: 10.11 Lease agreement between MacroChem Corporation and Phoenix Home Life Mutual Insurance Company for space located at 110 Hartwell Avenue, Lexington, MA 02173. The following exhibits required to be filed herewith are incorporated by reference to the exhibits to the Company's Registration Statement on Form S-1 (No. 33-62042): 3b Bylaws 10a Form of Employment Agreement between the Company and Dr. Carlos M. Samour* 10b Form of Employment Agreement between the Company and Mr. Alvin J. Karloff* The following exhibit required to be filed herewith is incorporated by reference to the exhibits to the Company's Annual Report on Form 10-K for the year ended March 31, 1988: 4.1 Form of Common Stock Certificate (b) No current reports on Form 8-K were filed in the three-month period ended December 31, 1997. - -------------------------- *Management contract or compensatory plan or arrangement 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. MACROCHEM CORPORATION Dated: March 23, 1998 By:/S/ALVIN J. KARLOFF ------------------- Alvin J. Karloff President, Chief Executive Officer and Principal Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated on . /S/ALVIN J. KARLOFF Chief Executive Officer, President, Alvin J. Karloff Principal Financial Officer and Director /S/CARLOS M. SAMOUR, PH.D. Chairman of the Board of Directors Carlos M. Samour, Ph.D. and Scientific Director /S/STEPHEN J. RIGGI, PH.D. Vice President, Operations and Stephen J. Riggi, Ph.D. Director /S/WILLARD M. BRIGHT, PH.D. Director Willard M. Bright, Ph.D. /S/PETER G. MARTIN Director Peter G. Martin /S/MICHAEL A. DAVIS, M.D. Director Michael A. Davis, M.D. EX-11 2 EARNING PER SHARE MACROCHEM CORPORATION COMPUTATION OF EARNINGS PER COMMON SHARE (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) BASIC LOSS PER SHARE WAS CALCULATED AS FOLLOWS: YEARS ENDED DECEMBER 31, 1997 1996 1995 ---- ---- ---- Total loss used for basic loss per share $( 3,569) $( 3,140) $( 2,466) ====== ====== ====== Shares used to compute basic loss per share 16,638 15,239 12,332 ====== ====== ====== Basic loss per share $( 0.21) $( 0.21) $( 0.20) ====== ====== ====== Diluted earnings per share are not presented since the results would be anti-dilutive. EX-23 3 INDEPENDENT AUDITORS' CONSENT INDEPENDENT AUDITORS' CONSENT MacroChem Corporation: We consent to the incorporation by reference in (i) Registration Statement No.33-48876 on Form S-8, (ii) Registration Statement No. 33-85818 on Form S-8, (iii) Registration Statement No. 333-28967 on Form S-8, (iv) Registration Statement No. 33-82298 on Form S-3, and (v) Registration Statement No. 333-34533 on Form S-3 of our report dated March 5, 1998, appearing in this Annual Report on Form 10-K of MacroChem Corporation for the year ended December 31, 1997. DELOITTE & TOUCHE LLP Boston, Massachusetts March 20, 1998 EX-27 4 FDS WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
5 This schedule contains summary financial information extracted from the Company's balance sheet, statement of operations, statement of stockholder's equity and statement of cash flows and is qualified in its entirety by reference to such financial statements. MacroChem Corporation 1 U.S. Dollars 12-MOS Dec-31-1997 Jan-1-1997 Dec-31-1997 1 24,952,121 0 0 0 0 5,069,804 863,985 582,769 25,623,836 312,900 0 0 0 221,829 25,089,107 25,623,836 0 120,350 0 0 0 0 7,222 (3,569,113) 0 (3,569,113) 0 0 0 (3,569,113) (0.21) (0.21)
EX-99.1 5 1994 EQUITY PLAN AS AMENDED NOV. 14, 1997 As amended November 14, 1997 MACROCHEM CORPORATION 1994 EQUITY INCENTIVE PLAN 1. PURPOSE The purpose of this 1994 Equity Incentive Plan (the "Plan") is to advance the interests of MacroChem Corporation (the "Company") by enhancing its ability to attract and retain employees and other persons or entities who are in a position to make significant contributions to the success of the Company and its subsidiaries through ownership of shares of the Company's common stock ("Stock"). The Plan is intended to accomplish these goals by enabling the Company to grant Awards in the form of Options, Stock Appreciation Rights, Restricted Stock or Unrestricted Stock Awards, Deferred Stock Awards, Performance Awards, Loans or Supplement Grants, or combinations thereof, all as more fully described below. 2. ADMINISTRATION Unless otherwise determined by the Board of Directors of the Company (the "Board"), the Plan will be administered by a Committee of the Board designated for such purpose (the "Committee"). The Committee shall consist of at least two directors. A majority of the members of the Committee shall constitute a quorum, and all determinations of the Committee shall be made by a majority of its members. Any determination of the Committee under the Plan may be made without notice or meeting of the Committee by a writing signed by a majority of the Committee members. So long as the Stock is registered under the Securities Exchange Act of 1934 (the "1934 Act"), all members of the Committee shall be non-employee directors within the meaning of Rule 16b-3 under the 1934 Act. The Committee will have authority, not inconsistent with the express provisions of the Plan and in addition to other authority granted under the Plan, to (a) grant Awards at such time or times as it may choose; (b) determine the size of each Award, including the number of shares of Stock subject to the Award; (c) determine the type or types of each Award; (d) determine the terms and conditions of each Award; (e) waive compliance by a Participant (as defined below) with any obligations to be performed by the Participant under an Award and waive any term or condition of an Award; (f) amend or cancel an existing Award in whole or in part (and if an award is canceled, grant another Award in its place on such terms as the Committee shall specify), except that the Committee may not, without the consent of the holder of an Award, take any action under this clause with respect to such Award if such action would adversely affect the rights of such holder; (g) prescribe the form or forms of instruments that are required or deemed appropriate under the Plan, including any written notices and elections required of Participants, and change such forms from time to time; (h) adopt, amend and rescind rules and regulations for the administration of the Plan; and (i) interpret the Plan and decide any questions and settle all controversies and disputes that may arise in connection with the Plan. Such determinations and actions of the Committee, and all other determinations and actions of the Committee made or taken under authority granted by any provision of the Plan, will be conclusive and will bind all parties. Nothing in this paragraph shall be construed as limiting the power of the Committee to make adjustments under Section 7.3 or Section 8.6. With respect to persons subject to Section 16 of the 1934 Act, transactions under this plan are intended to comply with all applicable conditions of Rule 16b-3 or its successors under the 1934 Act. To the extent any action by the Committee or Board fails to so comply, it shall be deemed null and void, to the extent permitted by law and deemed advisable by the Committee. 3. EFFECTIVE DATE AND TERM OF PLAN The Plan will become effective on the date on which it is approved by the stockholders of the Company. Grants of Awards under the Plan may be made prior to that date, subject to such approval of the Plan. No Award may be granted under the Plan after February 11, 2004, but Awards previously granted may extend beyond that date. 4. SHARES SUBJECT TO THE PLAN Subject to the adjustment as provided in Section 8.6 below, the aggregate number of shares of Stock that may be delivered under the Plan will be 4,000,000. If any Award requiring exercise for delivery of Stock terminates without having been exercised in full, or if any Award payable in Stock or cash is satisfied in cash rather than Stock, the number of shares of Stock as to which such Award was not exercised or for which cash was substituted will be available for future grants. The maximum number of shares (subject to adjustment as provided in Section 8.6 below) with respect to which Awards may be made to any one Participant during the term of the Plan shall be 750,000 shares. The preceding sentence shall be construed consistent with the regulations under Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code"). Stock delivered under the Plan may be either authorized but unissued Stock or previously issued Stock acquired by the Company and held in treasury. No fractional shares of Stock will be delivered under the Plan. 5. ELIGIBILITY AND PARTICIPATION Those eligible to receive Awards under the Plan ("Participants") will be persons in the employ of the Company or any of its subsidiaries ("Employees") and other persons or entities (including without limitation non-Employee directors of the Company or a subsidiary of the Company) who, in the opinion of the Committee, are in a position to make a significant contribution to the success of the Company or its subsidiaries. A "subsidiary" for purposes of the Plan will be a corporation in which the Company owns, directly or indirectly, stock possessing 50% or more of the total combined voting power of all classes of stock. 6. TYPES OF AWARDS 6.1. OPTIONS (a) NATURE OF OPTIONS. An Option is an Award entitling the holder on exercise thereof to purchase Stock at a specified exercise price. Both "incentive stock options," as defined in Section 422 of the Code (any Option intended to qualify as an incentive stock option being hereinafter referred to as an "ISO"), and Options that are not incentive stock options, may be granted under the Plan. ISOs shall be awarded only to Employees. (b) EXERCISE PRICE. The exercise price of an Option will be determined by the Board subject to the following: (1) The exercise price of an ISO shall not be less than 100% (110% in the case of an ISO granted to a ten-percent stockholder) of the fair market value of the Stock subject to the Option, determined as of the time the Option is granted. A "ten-percent stockholder" is any person who at the time of grant owns, directly or indirectly, or is deemed to own by reason of the attribution rules of section 424(d) of the Code, stock possessing more than 10% of the total combined voting power of all classes of stock of the Company or of any of its subsidiaries. (2) In no case may the exercise price paid for Stock which is part of an original issue of authorized Stock be less than the par value per share of the Stock. (3) The Committee may reduce the exercise price of an Option at any time after the time of grant, but in the case of an Option originally awarded as an ISO, only with the consent of the Participant. (c) DURATION OF OPTIONS. The latest date on which an Option may be exercised will be the tenth anniversary (fifth anniversary, in the case of an ISO granted to a ten-percent stockholder) of the day immediately preceding the date the Option was granted, or such earlier date as may have been specified by the Committee at the time the Option was granted. (d) EXERCISE OF OPTIONS. Options granted under any single Award will become exercisable at such time or times, and on such conditions, as the Committee may specify. The Committee may at any time and from time to time accelerate the time at which all or any part of the Option may be exercised. Any exercise of an Option must be in writing, signed by the proper person and delivered or mailed to the Company, accompanied by (1) any documents required by the Committee and (2) payment in full in accordance with paragraph (e) below for the number of shares for which the Option is exercised. (e) PAYMENT FOR STOCK. Stock purchased on exercise of an Option must be paid for as follows: (1) in cash or by check (acceptable to the Company in accordance with guidelines established for this purpose), bank draft or money order payable to the order of the Company or (2) if so permitted by the instrument evidencing the Option (or in the case of an Option which is not an ISO, by the Committee at or after grant of the Option), (i) through the delivery of shares of Stock which have been outstanding for at least six months (unless the Committee expressly approves a shorter period) and which have a fair market value on the last business day preceding the date of exercise equal to the exercise price, or (ii) by delivery of a promissory note of the Option holder to the Company, payable on such terms as are specified by the Committee, or (iii) by delivery of an unconditional and irrevocable undertaking by a broker to deliver promptly to the Company sufficient funds to pay the exercise price, or (iv) by any combination of the permissible forms of payment; PROVIDED, that if the Stock delivered upon exercise of the Option is an original issue of authorized Stock, at least so much of the exercise price as represents the par value of such Stock must be paid other than by the Option holder's promissory note. (f) DISCRETIONARY PAYMENTS. If the market price of shares of Stock subject to an Option (other than an Option which is in tandem with a Stock Appreciation Right as described in Section 6.2 below) exceeds the exercise price of the Option at the time of its exercise, the Committee may cancel the Option and cause the Company to pay in cash or in shares of Common Stock (at a price per share equal to the fair market value per share) to the person exercising the Option an amount equal to the difference between the fair market value of the Stock which would have been purchased pursuant to the exercise (determined on the date the Option is canceled) and the aggregate exercise price which would have been paid. The Committee may exercise its discretion to take such action only if it has received a written request from the person exercising the Option, but such a request will not be binding on the Committee. 6.2. STOCK APPRECIATION RIGHTS. (a) NATURE OF STOCK APPRECIATION RIGHTS. A Stock Appreciation Right is an Award entitling the recipient on exercise of the Right to receive an amount, in cash or Stock or a combination thereof (such form to be determined by the Committee), determined in whole or in part by reference to appreciation in Stock value. In general, a Stock Appreciation Right entitles the Participant to receive, with respect to each share of Stock as to which the Right is exercised, the excess of the share's fair market value on the date of exercise over its fair market value on the date the Right was granted. However, the Committee may provide at the time of grant that the amount the recipient is entitled to receive will be adjusted upward or downward under rules established by the Committee to take into account the performance of the Stock in comparison with the performance of other stocks or an index or indices of other stocks. The Committee may also grant Stock Appreciation Rights providing that following a change in control of the Company, as determined by the Committee, the holder of such Right will be entitled to receive, with respect to each share of Stock subject to the Right, an amount equal to the excess of a specified value (which may include an average of values) for a share of Stock during a period preceding such change in control over the fair market value of a share of Stock on the date the Right was granted. (b) GRANT OF STOCK APPRECIATION RIGHTS. Stock Appreciation Rights may be granted in tandem with, or independently of, Options granted under the Plan. A Stock Appreciation Right granted in tandem with an Option which is not an ISO may be granted either at or after the time the Option is granted. A Stock Appreciation Right granted in tandem with an ISO may be granted only at the time the Option is granted. (c) RULES APPLICABLE TO TANDEM AWARDS. When Stock Appreciation Rights are granted in tandem with Options, the following will apply: (1) The Stock Appreciation Right will be exercisable only at such time or times, and to the extent, that the related Option is exercisable and will be exercisable in accordance with the procedure required for exercise of the related Option. (2) The Stock Appreciation Right will terminate and no longer be exercisable upon the termination or exercise of the related Option, except that a Stock Appreciation Right granted with respect to less than the full number of shares covered by an Option will not be reduced until the number of shares as to which the related Option has been exercised or has terminated exceeds the number of shares not covered by the Stock Appreciation Right. (3) The Option will terminate and no longer be exercisable upon the exercise of the related Stock Appreciation Right. (4) The Stock Appreciation Right will be transferable only with the related Option. (5) A Stock Appreciation Right granted in tandem with an ISO may be exercised only when the market price of the Stock subject to the Option exceeds the exercise price of such option. (d) EXERCISE OF INDEPENDENT STOCK APPRECIATION RIGHTS. A Stock Appreciation Right not granted in tandem with an Option will become exercisable at such time or times, and on such conditions, as the Committee may specify. The Committee may at any time accelerate the time at which all or any part of the Right may be exercised. Any exercise of an independent Stock Appreciation Right must be in writing, signed by the proper person and delivered or mailed to the Company, accompanied by any other documents required by the Committee. 6.3. RESTRICTED AND UNRESTRICTED STOCK. (a) NATURE OF RESTRICTED STOCK AWARD. A Restricted Stock Award entitles the recipient to acquire, for a purchase price equal to par value, shares of Stock subject to the restrictions described in paragraph (d) below ("Restricted Stock"). (b) ACCEPTANCE OF AWARD. A Participant who is granted a Restricted Stock Award will have no rights with respect to such Award unless the Participant accepts the Award by written instrument delivered or mailed to the Company accompanied by payment in full of the specified purchase price, if any, of the shares covered by the Award. Payment may be by certified or bank check or other instrument acceptable to the Committee. (c) RIGHTS AS A STOCKHOLDER. A Participant who receives Restricted Stock will have all the rights of a stockholder with respect to the Stock, including voting and dividend rights, subject to the restrictions described in paragraph (d) below and any other conditions imposed by the Committee at the time of grant. Unless the Committee otherwise determines, certificates evidencing shares of Restricted Stock will remain in the possession of the Company until such shares are free of all restrictions under the Plan. (d) RESTRICTIONS. Except as otherwise specifically provided by the Plan, Restricted Stock may not be sold, assigned, transferred, pledged or otherwise encumbered or disposed of, and if the Participant ceases to be an Employee or otherwise suffers a Status Change (as defined at Section 7.2(a) below) for any reason, must be offered to the Company for purchase for the amount of cash paid for the Stock, or forfeited to the Company if no cash was paid. These restrictions will lapse at such time or times, and on such conditions, as the Committee may specify. The Committee may at any time accelerate the time at which the restrictions on all or any part of the shares will lapse. (e) NOTICE OF ELECTION. Any Participant making an election under Section 83(b) of the Code with respect to Restricted Stock must provide a copy thereof to the Company within 10 days of the filing of such election with the Internal Revenue Service. (f) OTHER AWARDS SETTLED WITH RESTRICTED STOCK. The Committee may, at the time any Award described in this Section 6 is granted, provide that any or all the Stock delivered pursuant to the Award will be Restricted Stock. (g) UNRESTRICTED STOCK. The Committee may, in its sole discretion, approve the sale to any Participant of shares of Stock free of restrictions under the Plan for a price which is not less than the par value of the Stock. 6.4. DEFERRED STOCK. A Deferred Stock Award entitles the recipient to receive shares of Stock to be delivered in the future. Delivery of the Stock will take place at such time or times, and on such conditions, as the Committee may specify. The Committee may at any time accelerate the time at which delivery of all or any part of the Stock will take place. At the time any Award described in this Section 6 is granted, the Committee may provide that, at the time Stock would otherwise be delivered pursuant to the Award, the Participant will instead receive an instrument evidencing the Participant's right to future delivery of Deferred Stock. 6.5. PERFORMANCE AWARDS; PERFORMANCE GOALS. (a) NATURE OF PERFORMANCE AWARDS. A Performance Award entitles the recipient to receive, without payment, an amount in cash or Stock or a combination thereof (such form to be determined by the Committee) following the attainment of Performance Goals. Performance Goals may be related to personal performance, corporate performance, departmental performance or any other category of performance deemed by the Committee to be important to the success of the Company. The Committee will determine the Performance Goals, the period or periods during which performance is to be measured and all other terms and conditions applicable to the Award. (b) OTHER AWARDS SUBJECT TO PERFORMANCE CONDITION. The Committee may, at the time any Award described in this Section 6 is granted, impose the condition (in addition to any conditions specified or authorized in this Section 6 or any other provision of the Plan) that Performance Goals be met prior to the Participant's realization of any payment or benefit under the Award. 6.6. LOANS AND SUPPLEMENTAL GRANTS. (a) LOANS. The Company may make a loan to a Participant ("Loan"), either on the date of or after the grant of any Award to the Participant. A Loan may be made either in connection with the purchase of Stock under the Award or with the payment of any Federal, state and local income tax with respect to income recognized as a result of the Award. The Committee will have full authority to decide whether to make a Loan and to determine the amount, terms and conditions of the Loan, including the interest rate (which may be zero), whether the Loan is to be secured or unsecured or with or without recourse against the borrower, the terms on which the Loan is to be repaid and the conditions, if any, under which it may be forgiven. However, no Loan may have a term (including extensions) exceeding ten years in duration. (b) SUPPLEMENTAL GRANTS. In connection with any Award, the Committee may at the time such Award is made or at a later date, provide for and grant a cash award to the Participant ("Supplemental Grant") not to exceed an amount equal to (1) the amount of any federal, state and local income tax on ordinary income for which the Participant may be liable with respect to the Award, determined by assuming taxation at the highest marginal rate, plus (2) an additional amount on a grossed-up basis intended to make the Participant whole on an after-tax basis after discharging all the Participant's income tax liabilities arising from all payments under this Section 6. Any payments under this subsection (b) will be made at the time the Participant incurs Federal income tax liability with respect to the Award. 7. EVENTS AFFECTING OUTSTANDING AWARDS 7.1. DEATH. If a Participant dies, the following will apply: (a) All Options and Stock Appreciation Rights held by the Participant immediately prior to death, to the extent then exercisable, may be exercised by the Participant's executor or administrator or the person or persons to whom the Option or Right is transferred by will or the applicable laws of descent and distribution, and all Options originally issued to the Participant and transferred pursuant to Section 8.5 hereof may be exercised by the person or persons to whom the Option has been so transferred, at any time within the one year period ending with the first anniversary of the Participant's death (or such shorter period as the Committee may determine), and shall thereupon terminate; provided, however, that an Option granted to a Participant who at the date of grant is an employee may be exercised at any time following such Participant's death. In no event, however, shall an Option or Stock Appreciation Right remain exercisable beyond the latest date on which it could have been exercised without regard to this Section 7. Except as otherwise determined by the Committee, all Options originally issued to a Participant and all Stock Appreciation Rights held by a Participant immediately prior to death that are not then exercisable shall terminate at death. (b) Except as otherwise determined by the Committee, all Restricted Stock held by the Participant must be transferred to the Company (and, in the event the certificates representing such Restricted Stock are held by the Company, such Restricted Stock will be so transferred without any further action by the Participant) in accordance with Section 6.3 above. (c) Any payment or benefit under a Deferred Stock Award, Performance Award, or Supplemental Grant to which the Participant was not irrevocably entitled prior to death will be forfeited and the Award canceled, as of the time of death, unless otherwise determined by the Committee. 7.2. TERMINATION OF SERVICE (OTHER THAN BY DEATH). If a Participant who is an Employee ceases to be an Employee for any reason other than death, or if there is a termination (other than by reason of death) of the consulting, service or similar relationship in respect of which a non-Employee Participant was granted an Award hereunder (such termination of the employment or other relationship being hereinafter referred to as a "Status Change"), the following will apply: (a) Except as otherwise determined by the Committee, all Options and Stock Appreciation Rights originally issued to the Participant that were not exercisable immediately prior to the Status Change shall terminate at the time of the Status Change. Any Options or Rights that were exercisable immediately prior to the Status Change will continue to be exercisable for a period of six months (or such longer period as the Committee may determine), and shall thereupon terminate, unless (i) the Award provides by its terms for immediate termination in the event of a Status Change, (ii) the Status Change results from (w) retirement of the Participant on or after age 65, (x) retirement on or after age 55 after 10 years of continuous employment by the Company, (y) disability (as determined by the Company), or (z) termination of the Participant's service as a director if the Participant is a non-Employee director, in which cases that portion of the Options originally issued to the Participant that was exercisable immediately prior to the Status Change will continue to be exercisable for the original term of the Option or (iii) unless the Status Change results from a discharge for cause which in the opinion of the Committee casts such discredit on the Participant as to justify immediate termination of the Award. In no event, however, shall an Option or Stock Appreciation Right remain exercisable beyond the latest date on which it could have been exercised without regard to this Section 7. For purposes of this paragraph, in the case of a Participant who is an Employee, a Status Change shall not be deemed to have resulted by reason of (i) a sick leave or other bona fide leave of absence approved for purposes of the Plan by the Committee, so long as the Employee's right to reemployment is guaranteed either by statute or by contract, or (ii) a transfer of employment between the Company and a subsidiary or between subsidiaries, or to the employment of a corporation (or a parent or subsidiary corporation of such corporation) issuing or assuming an option in a transaction to which section 424(a) of the Code applies. (b) Except as otherwise determined by the Committee, all Restricted Stock held by the Participant at the time of the Status Change must be transferred to the Company (and, in the event the certificates representing such Restricted Stock are held by the Company, such Restricted Stock will be so transferred without any further action by the Participant) in accordance with Section 6.3 above. (c) Any payment or benefit under a Deferred Stock Award, Performance Award, or Supplemental Grant to which the Participant was not irrevocably entitled prior to the Status Change will be forfeited and the Award canceled as of the date of such Status Change unless otherwise determined by the Committee. 7.3. CERTAIN CORPORATE TRANSACTIONS. 7.3.1. MERGERS, SALES ETC. In the event of a consolidation or merger in which the Company is not the surviving corporation or which results in the acquisition of substantially all the Company's outstanding Stock by a single person or entity or by a group of persons and/or entities acting in concert, or in the event of the sale or transfer of substantially all the Company's assets or a dissolution or liquidation of the Company (a "covered transaction"), all outstanding Awards will terminate as of the effective date of the covered transaction, and the following rules shall apply: (a) Subject to paragraphs (b) and (c) below, the Committee shall, at least twenty (20) days prior to the effective date of the covered transaction,(1) make each outstanding Option and Stock Appreciation Right exercisable in full, (2) remove the restrictions from each outstanding share of Restricted Stock, (3) cause the Company to make any payment and provide any benefit under each outstanding Deferred Stock Award, Performance Award, and Supplemental Grant which would have been made or provided with the passage of time had the transaction not occurred and the Participant not suffered a Status Change (or died), and (4) forgive all or any portion of the principal of or interest on a Loan. (b) If an outstanding Award is subject to performance or other conditions (other than conditions relating only to the passage of time and continued employment) which will not have been satisfied at the time of the covered transaction, the Committee may in its sole discretion remove such conditions. If it does not do so, however, such Award will terminate as of the date of the covered transaction notwithstanding paragraph (a) above. (c) With respect to an outstanding Award held by a participant who, following the covered transaction, will be employed by or otherwise providing services to a corporation which is a surviving or acquiring corporation in such transaction or an affiliate of such a corporation, the Committee may, in lieu of the action described in paragraph (a) above, arrange to have such surviving or acquiring corporation or affiliate grant to the Participant a replacement award which, in the judgment of the Committee, is substantially equivalent to the Award. 7.3.2. LIQUIDATION AND DISSOLUTION. In the event of a dissolution or liquidation of the Company, all outstanding Awards will terminate as of the effective date of such dissolution or liquidation, and the following rules shall apply: (a) Subject to paragraphs (b) and (c) below, the Committee may, prior to the effective date of such liquidation or dissolution, (1) make each outstanding Option and Stock Appreciation Right exercisable in full, (2) remove the restrictions from each outstanding share of Restricted Stock, (3) cause the Company to make any payment and provide any benefit under each outstanding Deferred Stock Award, Performance Award, and Supplemental Grant which would have been made or provided with the passage of time had the transaction not occurred and the Participant not suffered a Status Change (or died), and (4) forgive all or any portion of the principal of or interest on a Loan. (b) If an outstanding Award is subject to performance or other conditions (other than conditions relating only to the passage of time and continued employment) which will not have been satisfied at the time of such liquidation or dissolution, the Committee may in its sole discretion remove such conditions. If it does not do so, however, such Award will terminate as of the date of such liquidation or dissolution notwithstanding paragraph (a) above. (c) With respect to an outstanding Award held by a participant who, following such liquidation or dissolution, will be employed by or otherwise providing services to a corporation which is a surviving or acquiring corporation in such transaction or an affiliate of such a corporation, the Committee may, in lieu of the action described in paragraph (a) above, arrange to have such surviving or acquiring corporation or affiliate grant to the Participant a replacement award which, in the judgment of the Committee, is substantially equivalent to the Award. 8. GENERAL PROVISIONS 8.1. DOCUMENTATION OF AWARDS. Awards will be evidenced by such written instruments, if any, as may be prescribed by the Committee from time to time. Such instruments may be in the form of agreements to be executed by both the Participant and the Company, or certificates, letters or similar instruments, which need not be executed by the Participant but acceptance of which will evidence agreement to the terms thereof. 8.2. RIGHTS AS A STOCKHOLDER, DIVIDEND EQUIVALENTS. Except as specifically provided by the Plan, the receipt of an Award will not give a holder rights as a stockholder; the holder will obtain such rights, subject to any limitations imposed by the Plan or the instrument evidencing the Award, upon actual receipt of Stock. However, the Committee may, on such conditions as it deems appropriate, provide that a holder will receive a benefit in lieu of cash dividends that would have been payable on any or all Stock subject to the holder's Award had such Stock been outstanding. Without limitation, the Committee may provide for payment to the holder of amounts representing such dividends, either currently or in the future, or for the investment of such amounts on behalf of the holder. 8.3. CONDITIONS ON DELIVERY OF STOCK. The Company will not be obligated to deliver any shares of Stock pursuant to the Plan or to remove restrictions from shares previously delivered under the Plan (a) until all conditions of the Award have been satisfied or removed, (b) until, in the opinion of the Company's counsel, all applicable federal and state laws and regulations have been complied with, (c) if the outstanding Stock is at the time listed on any stock exchange, until the shares to be delivered have been listed or authorized to be listed on such exchange upon official notice of notice of issuance, and (d) until all other legal matters in connection with the issuance and delivery of such shares have been approved by the Company's counsel. If the sale of Stock has not been registered under the Securities Act of 1933, as amended, the Company may require, as a condition to exercise of the Award, such representations or agreements as counsel for the Company may consider appropriate to avoid violation of such Act and may require that the certificates evidencing such Stock bear an appropriate legend restricting transfer. If an Award is exercised by the Participant's legal representative, the Company will be under no obligation to deliver Stock pursuant to such exercise until the Company is satisfied as to the authority of such representative. 8.4. TAX WITHHOLDING. The Company will withhold from any cash payment made pursuant to an Award an amount sufficient to satisfy all federal, state and local withholding tax requirements (the "withholding requirements"). In the case of an Award pursuant to which Stock may be delivered, the Committee will have the right to require that the Participant or other appropriate person remit to the Company an amount sufficient to satisfy the withholding requirements, or make other arrangements satisfactory to the Committee with regard to such requirements, prior to the delivery of any Stock. If and to the extent that such withholding is required, the Committee may permit the Participant or such other person to elect at such time and in such manner as the Committee provides to have the Company hold back from the shares to be delivered, or to deliver to the Company, Stock having a value calculated to satisfy the withholding requirement. The Committee may make such share withholding mandatory with respect to any Award at the time such Award is made to a Participant. If at the time an ISO is exercised the Committee determines that the Company could be liable for withholding requirements with respect to a disposition of the Stock received upon exercise, the Committee may require as a condition of exercise that the person exercising the ISO agree (a) to inform the Company promptly of any disposition (within the meaning of section 424(c) of the Code) of Stock received upon exercise, and (b) to give such security as the Committee deems adequate to meet the potential liability of the Company for the withholding requirements and to augment such security from time to time in any amount reasonably deemed necessary by the Committee to preserve the adequacy of such security. 8.5. TRANSFERABILITY OF AWARDS. No Award (other than an Award in the form of an outright transfer of cash or Unrestricted Stock) may be transferred other than by will or by the laws of descent and distribution, and during an employee's lifetime an Award requiring exercise may be exercised only by the Participant (or in the event of the Participant's incapacity, the person or persons legally appointed to act on the Participant's behalf), except that Options awarded to Employees or members of the Board which are not ISOs may be transferred by a Participant to (i) the spouse, children or grandchildren of the Participant ("Immediate Family Members"), (ii) a trust or trusts for the exclusive benefit of such Immediate Family Members, or (iii) a partnership in which such Immediate Family Members are the only partners, provided that (x) there may be no consideration for any such transfer, and (y) subsequent transfers of Options shall be prohibited except those in accordance with Section 8.5 hereof. Following any such transfer, the transferred Option shall continue to be subject to all the terms and conditions of this Plan, including without limitation the provisions of Section 7 with respect to exercise of the Option following the death or termination of employment of the Participant to whom the Option was originally granted, and Section 8.4 with respect to tax withholding. 8.6. ADJUSTMENTS IN THE EVENT OF CERTAIN TRANSACTIONS. (a) In the event of a stock dividend, stock split or combination of shares, recapitalization or other change in the Company's capitalization, or other distribution to common stockholders other than normal cash dividends, after the effective date of the Plan, the Committee will make any appropriate adjustments to the maximum number of shares that may be delivered under the Plan, or with respect to which Awards may be made to any one Participant, under Section 4 above. (b) In any event referred to in paragraph (a), the Committee will also make any appropriate adjustments to the number and kind of shares of stock or securities subject to Awards then outstanding or subsequently granted, any exercise prices relating to Awards and any other provision of Awards affected by such change. The Committee may also make such adjustments to take into account material changes in law or in accounting practices or principles, mergers, consolidations, acquisitions, dispositions or similar corporate transactions, or any other event, if it is determined by the Committee that adjustments are appropriate to avoid distortion in the operation of the Plan. 8.7. EMPLOYMENT RIGHTS, ETC. Neither the adoption of the Plan nor the grant of Awards will confer upon any person any right to continued retention by the Company or any subsidiary as an Employee or otherwise, or affect in any way the right of the Company or subsidiary to terminate an employment, service or similar relationship at any time. Except as specifically provided by the Committee in any particular case, the loss of existing or potential profit in Awards granted under the Plan will not constitute an element of damages in the event of termination of an employment, service or similar relationship even if the termination is in violation of an obligation of the Company to the Participant. 8.8. DEFERRAL OF PAYMENTS. The Committee may agree at any time, upon request of the Participant, to defer the date on which any payment under an Award will be made. 8.9. PAST SERVICES AS CONSIDERATION. Where a Participant purchases Stock under an Award for a price equal to the par value of the Stock the Committee may determine that such price has been satisfied by past services rendered by the Participant. 9. EFFECT, DISCONTINUANCE, CANCELLATION, AMENDMENT AND TERMINATION Neither adoption of the Plan nor the grant of Awards to a Participant will affect the Company's right to grant to such Participant awards that are not subject to the Plan, to issue to such Participant Stock as a bonus or otherwise, or to adopt other plans or arrangements under which Stock may be issued to Employees. The Committee may at any time or times amend the Plan or any outstanding Award for any purpose which may at the time be permitted by law, or may at any time terminate the Plan as to any further grants of Awards, provided that (except to the extent expressly required or permitted by the Plan) no such amendment will, without the approval of the stockholders of the Company, effectuate a change for which stockholder approval is required in order for the Plan to continue to qualify for the award of ISOs under section 422 of the Code. -----END PRIVACY-ENHANCED MESSAGE-----