-----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, UaWkjS9NwPIo8mgaGwP+HiVsG96/6XABXZHy94XJoUvZ1EOzOHBzfUsa0MUSItDG EYwQn9Ml5An7AA77eGaVIw== 0000892917-97-000055.txt : 19970313 0000892917-97-000055.hdr.sgml : 19970313 ACCESSION NUMBER: 0000892917-97-000055 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19960930 FILED AS OF DATE: 19970312 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: EPITOPE INC/OR/ CENTRAL INDEX KEY: 0000801555 STANDARD INDUSTRIAL CLASSIFICATION: IN VITRO & IN VIVO DIAGNOSTIC SUBSTANCES [2835] IRS NUMBER: 930779127 STATE OF INCORPORATION: OR FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 001-10492 FILM NUMBER: 97555546 BUSINESS ADDRESS: STREET 1: 8505 SW CREEKSIDE PL CITY: BEAVERTON STATE: OR ZIP: 97005-7108 BUSINESS PHONE: 5036416115 MAIL ADDRESS: STREET 1: 8505 S W CREEKSIDE PLACE CITY: BEAVERTON STATE: OR ZIP: 97008 10-K/A 1 AMENDMENT NO. 2 TO ANNUAL REPORT SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------ Amendment No. 2 FORM 10-K/A (Mark one) [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended September 30, 1996 OR [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ________ to ________ Commission File No. 1-10492 EPITOPE, INC. (Exact name of registrant as specified in its charter) Oregon 93-07479127 (State or other jurisdiction of (I.R.S. employer identification incorporation or organization) number) 8505 S.W. Creekside Place Beaverton, Oregon 97008 (Address of principal executive offices) (Zip code) (503) 641-6115 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] State the aggregate market value of voting stock held by non-affiliates of the registrant, as of January 31, 1997: $195,522,605. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of January 31, 1997: Common Stock, no par value, 13,713,939. Documents Incorporated by Reference: None
Table of Contents PART I Page ---- ITEM 1. Business 3 ITEM 2. Properties 21 ITEM 3. Legal Proceedings 21 ITEM 4. Submission of Matters to a Vote of Security Holders 21 PART II ITEM 5. Market for the Registrant's Common Stock and Related Stockholder Matters 22 ITEM 6. Selected Financial Data 22 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 25 ITEM 8. Financial Statements and Supplementary Data 35 ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 38 PART III ITEM 10. Directors and Executive Officers of the Registrant 38 ITEM 11. Executive Compensation 43 ITEM 12. Security Ownership of Certain Beneficial Owners and Management 45 ITEM 13. Certain Relationships and Related Transactions 46 PART IV ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 47 - 2 - PART I ITEM 1. Business. Epitope, Inc. ("Epitope" or the "Company"), is an Oregon corporation incorporated in 1981. Its Epitope Medical Products group ("Epitope Medical Products") develops and markets oral specimen collection kits and related diagnostic tests for the detection of the Human Immunodeficiency Virus ("HIV"), the cause of Acquired Immune Deficiency Syndrome ("AIDS"), and for the detection of other medical conditions and analytes. Epitope Medical Products' oral specimen HIV testing system is marketed by the Company under the name EpiScreen(TM) and by SmithKline Beecham plc ("SB") under the name OraSure(R). The Company's Agritope group ("Agritope") historically has focused its efforts on the development of novel agricultural products using plant genetic engineering and other modern methods. Through its acquisition of Andrew and Williamson Sales, Co. ("A&W") on December 12, 1996 and its majority ownership of Vinifera, Inc. ("Vinifera"), Agritope now conducts operations in each step of the production and distribution chain for a broad range of fruits, vegetables and plants and has an established infrastructure that will facilitate commercialization of the Company's genetically engineered agricultural products. Epitope Medical Products Epitope Medical Products' lead product, a patented collection device used as part of an oral fluid diagnostic system ("EpiScreen/OraSure"), is designed for use in the detection of HIV and other medical conditions and analytes. The Company markets the device under the brand name EpiScreen in the United States for use in screening life insurance applicants, and in certain foreign countries for use in professional markets. In February 1995, the Company entered into a Development, License and Supply Agreement with SB, under which SB is marketing the device in the U.S. and certain foreign countries as part of an integrated test system to physicians, hospitals and other healthcare professionals under the brand name OraSure. Subject to obtaining required regulatory approvals, the Company intends to market the system for over-the-counter sale through SB in the United States and through SB or other distributors in international markets. The EpiScreen/OraSure device consists of a small, treated cotton-fiber pad on a nylon handle that is placed in the patient's mouth for two minutes. The device collects oral mucosal transudate ("OMT"), a serum-derived fluid that, unlike saliva, contains high concentrations of HIV antibodies in people infected with the virus. As a result, OMT testing is a highly accurate method for detecting HIV infection. Because EpiScreen/OraSure uses a noninvasive, needle-free collection method, the Company believes that oral fluid testing has several significant advantages over blood-based testing systems for both healthcare professionals and patients. Epitope Medical Products also markets HIV-1 Western blot confirmatory test kits used to confirm positive results of initial screening tests for HIV-1 infection. Its OraSure HIV-1 Western blot confirmatory test kit is used in conjunction with oral-fluid based screening tests, while its EPIBlot(R) HIV-1 Western blot confirmatory test kit is used in conjunction with blood-based screening tests. The kits are distributed worldwide under an exclusive agreement with Organon Teknika Corporation ("Organon Teknika"), a member of the Akzo Pharma group of Akzo Nobel, NV. The EpiScreen/OraSure HIV-1 device and the OraSure HIV-1 Western blot and EPIBlot confirmatory tests have all received clearance from the U.S. Food and Drug Administration ("FDA") for sale to professional markets in the United States. Background Acquired Immune Deficiency Syndrome is caused by the Human Immunodeficiency Virus. HIV attacks the immune system, slowly weakening the body's ability to ward off infection and certain forms of cancer. When these complications develop, the HIV infection has progressed to clinically diagnosed AIDS. HIV is spread through sexual contact, blood transfusions, the sharing of intravenous needles, accidental needle sticks, or contact between a mother and her child during gestation, childbirth, or breast-feeding. There is currently no known cure for - 3 - HIV/AIDS. However, the recent introduction of a new class of anti-HIV drugs called protease inhibitors, when used in combination with nucleoside analogs (e.g., AZT), has shown promising results in slowing progress of the disease. Clinical studies have demonstrated that the early detection and treatment of HIV can help to curb the effects of the disease and significantly prolong the life of the patient. Other studies have shown that treatment with AZT of an HIV-infected pregnant woman may prevent the transmission of HIV from the mother to her child. According to the World Health Organization ("WHO"), an estimated 24 million adults and 1.5 million children have been infected with HIV worldwide, and approximately 10,000 new infections occur each day. WHO also estimates that over 6 million cases of AIDS have occurred worldwide to date. In North America, an estimated 1.3 million people have been infected with HIV. AIDS is currently the leading cause of death for Americans between the ages of 25 and 44. It is estimated that approximately 800,000 people in the United States are living with the HIV virus. According to the Centers for Disease Control and Prevention ("CDC"), total federal funding budgeted for HIV/AIDS in 1995 was over $2.7 billion. Based on industry estimates, the Company believes that approximately 60 million HIV tests were performed in the U.S. in 1995. Of these tests, approximately 30 million were performed in connection with blood donor screening, 20 million were performed in healthcare settings such as hospitals and clinics, 5 million were performed in connection with life insurance applications, and the balance were performed by public health departments and the military. Currently, substantially all HIV tests are performed by testing a patient's blood. There are a number of blood tests for HIV, the most common of which is the enzyme-linked immunosorbent assay ("ELISA"). In order to reduce the possibility that an individual without HIV will be diagnosed as having the virus (a false positive), most countries require the retesting of the blood sample using a second, more specific test to confirm an initial positive test result. The most commonly used confirmatory test is the Western blot. The Company believes that blood testing has a number of disadvantages which increase healthcare costs and patient inconvenience, pose a risk of infection to healthcare professionals and make testing uneconomic or unavailable in certain applications or settings. The disadvantages of blood testing include: Risk of HIV Infection. Blood tests involve the use of needles or lancets to obtain blood from the patient. Healthcare professionals collecting blood risk contracting HIV if accidentally stuck by the needle or lancet used to obtain blood from an infected patient. Limited Access. Because blood must be collected by trained professionals, its collection is often difficult or prohibitively expensive in certain settings. For example, community-based outreach programs, homeless shelters, rural communities, and other remote settings often lack healthcare professionals trained in blood collection. As a result, blood testing may not be available in some of these settings. Higher Overall Cost. The cost of collecting a blood specimen represents a significant component of the total cost of HIV testing. Furthermore, when a healthcare professional must travel to the subject's office or home to collect a blood sample, as is often the case with life insurance applicant testing, the cost of collecting the blood specimen is substantially increased. Patient Discomfort. Blood tests require the use of needles or lancets that are uncomfortable for patients. In addition, patients with small or damaged veins, such as intravenous drug users, the elderly and young children, may require multiple needle sticks in order to obtain an adequate blood sample. Epitope Oral Specimen Collection Technology In order to address the significant drawbacks associated with blood-based tests, Epitope developed and patented a device to collect oral fluid instead of blood. The EpiScreen/OraSure device, shaped like a small toothbrush, consists of a cotton-fiber pad treated with a proprietary salt solution. The pad, which is mounted on a nylon handle, is placed in the patient's mouth between the lower cheek and gum for two minutes. The pad collects oral mucosal transudate, a serum-derived fluid that, unlike saliva, contains high concentrations of antibodies. OMT contains approximately four times the amount of antibodies found in ordinary whole saliva. Following - 4 - collection, the pad is sealed in a specimen vial containing a proprietary preservative solution. The treated pad enhances the collection, and the preservative solution enhances the stabilization, of antibodies and other analytes originating from the oral mucosae. The specimen in the vial is stable for three weeks at room temperature, although in most cases laboratory testing takes place within one to three days. See "Epitope, Inc.--Patents and Proprietary Information." A schematic representation of the oral fluid collection procedure is shown below. [Graphic material demonstrating specimen collection procedure, containing illustrations and the following captions: Peel open package. Place pad between lower cheek and gum. Rub back and forth until moist. Keep the pad in place for 2 minutes (maximum 5 minutes) while timing. Open vial in upright position. Insert pad to bottom of vial. Break the pad handle by snapping it against the side of the vial. Replace the cap with a snap.] Products EpiScreen/OraSure. In December 1994, the Company received clearance from the FDA to sell EpiScreen/OraSure to professional markets for the ELISA screening of HIV-1 antibodies. The device is marketed directly by the Company under the trade name EpiScreen for use by the U.S. life insurance industry and in certain international markets, and is marketed by SB under the trade name OraSure to healthcare professionals in the United States and a number of other countries. See "Epitope Medical Products--Marketing." The EpiScreen/OraSure oral specimen collection and HIV-1 testing system is easily administered and involves three steps: (i) collection of an oral specimen using the EpiScreen/OraSure collection device, (ii) ELISA screening of the specimen for HIV antibodies at a laboratory, and (iii) laboratory confirmation of positive screening test results with the FDA-cleared OraSure Western blot kit. A trained healthcare professional then conveys test results and provides appropriate counseling to the patient. The EpiScreen/OraSure HIV-1 testing system represents a highly accurate alternative to traditional blood tests. In clinical trials, EpiScreen/OraSure provided the correct result or triggered appropriate follow-up testing in 3,569 out of 3,570 cases (99.97 percent). The Company believes EpiScreen/OraSure has several advantages over blood tests, as outlined in the following table.
Feature Blood Test EpiScreen/OraSure Safety Poses risk of HIV Eliminates risk of infection through needle-stick accidents accidental needle sticks Invasiveness Requires use of a Uses noninvasive needle or lancet collection technique Ease of use Requires blood Sample collection collection by a requires minimal trained healthcare training professional - 5 - Portability Generally performed in Can be used rapidly and a physician's office efficiently in almost or other healthcare any setting setting Cost Requires a nurse or Eliminates the need for other trained healthcare and costs associated professional with a trained healthcare professional
Oral-based and Serum-based Western Blot Confirmatory Tests. Epitope Medical Products has also developed, and in June 1996 received FDA clearance to market, an oral-based HIV-1 Western blot confirmatory test. This test uses the original oral specimen to confirm positive results of initial EpiScreen/OraSure HIV-1 ELISA screening tests. Epitope Medical Products has also marketed EPIblot, a serum-based Western blot HIV-1 confirmatory test kit, since 1987. The kit is used to confirm the positive results of initial blood-based screening tests for HIV-1 infection. Markets Insurance Industry. Epitope Medical Products believes there is a significant need in the life insurance industry for an easy-to-administer, noninvasive and cost-effective HIV testing system such as EpiScreen. In the United States, approximately 5 million HIV tests were administered in 1995 by the life insurance industry in connection with the issuance of new policies. In addition, data from the American Council of Life Insurance and the Health Insurance Association of America indicate that over $1.5 billion in AIDS-related death benefits were paid in 1994. These organizations also cautioned that, due to difficulty in identifying all AIDS-related claims, the data may significantly understate the financial impact of AIDS on the insurance industry. Current HIV testing of life insurance applicants involves the use of a paramedic or other trained healthcare professional to obtain a blood sample. The cost to the insurance company for an HIV test includes the cost of the paramedic as well as the cost of the collection kit and laboratory testing services. These costs average approximately $55 to $70, of which $35 to $50 is the cost of the paramedic. As a result, insurance companies have generally limited HIV testing to policies with face amounts of $100,000 or more. Based on industry statistics, Epitope Medical Products estimates that in 1994 over 9 million policies were issued for face amounts of less than $100,000, representing 68 percent of all policies issued. Epitope Medical Products believes that the use of EpiScreen can significantly reduce the cost of HIV testing to the insurance industry because collection of an oral fluid specimen can be performed by insurance agents or other persons without professional medical training, eliminating the cost of the paramedic and making testing at policy levels below $100,000 a cost-effective practice. Moreover, the Company believes that insurance companies may adopt EpiScreen for use in connection with applications for insurance policies with face amounts at and above $100,000. The Company is, however, in the early stages of rolling out its product and believes it is too early to predict the degree to which its product will be utilized by insurance companies. Epitope Medical Products also believes that the use of EpiScreen will allow the insurance industry to address "anti-selection." Anti-selection occurs when an individual who knows that he or she is infected with HIV intentionally applies for one or more life insurance policies that do not entail HIV testing. Epitope Medical Products believes that the availability of two recently approved over-the-counter ("OTC") HIV blood tests may increase the incidence of anti-selection. By allowing insurance companies to lower the policy level at which HIV testing is cost-effective, the use of EpiScreen may allow insurance companies to reduce their exposure to losses from anti-selection and thereby to lower overall claims costs. An additional advantage of the EpiScreen testing system is that the oral specimen used for HIV testing can also be used to identify smokers and users of cocaine. Cotinine, a metabolite of nicotine, can be detected using OraSure/EpiScreen. The FDA has advised Epitope Medical Products that EpiScreen may be used for cocaine testing for the purpose of life insurance risk assessment while a 510(k) notice is undergoing final review, and may be used - 6 - for cotinine testing generally. In a presentation at the 105th annual meeting of The American Academy of Insurance Medicine, a major life insurance company reported results of the use of the EpiScreen testing system in Canada and in the Bahamas from 1992 to 1995. The life insurance company reported that agent collection reduced its testing costs by $65 per application. During the four-year study period, the insurer found that it saved $1.7 million by using EpiScreen for HIV and cocaine testing. In addition, the life insurance company determined that it realized $1.6 million in increased premiums as a result of identifying smokers who claimed on their applications that they were nonsmokers. Physician and Clinical Market. Through SB, Epitope Medical Products is marketing its oral HIV testing system to the physician, hospital and other professional healthcare provider markets under the brand name OraSure. OraSure is now offered to physicians and hospitals in the United States by over 3,300 sales representatives in the SB distribution network. In connection with the introduction of OraSure to the physician community in August 1996, SB created the OraSure Confidential Testing Network, a nationwide network for consumers to identify doctors in their area who offer confidential HIV testing with OraSure. The Network is accessible to consumers through a toll-free number (1-800-OraSure) and on the Internet (www.OraSure.com). The SB product launch was accompanied by an advertising campaign featuring two-page spreads in major medical professional publications. The OraSure brand was also a major sponsor of the 1996 AIDS Candlelight March in Washington, D.C., conducted in connection with the display of the National AIDS Quilts. OTC Market. A recent study published in the New England Journal of Medicine reported that 44 percent of Americans age 18 to 24 and 33 percent of Americans age 25 to 44 were "very or somewhat likely" to purchase over-the-counter home-collection HIV tests. According to the United States Census Bureau, as of July 1996 there were 24.7 million Americans in the 18 to 24 age group and 83.7 million in the 25 to 44 age group. Thus, based on the study, the number of people "very or somewhat likely" to purchase OTC home-collection HIV tests in the U.S. exceeds 35 million individuals. Epitope Medical Products and SB are currently conducting clinical trials to support an application for FDA clearance to market OraSure as a home collection testing system. If FDA clearance is obtained, Epitope Medical Products and SB plan to market the OraSure device for OTC sale as part of an integrated system including laboratory testing and counseling. Epitope Medical Products believes the noninvasiveness and ease of use of OraSure represent significant benefits to the home user over traditional blood-based methods. There can be no assurance that Epitope Medical Products will receive FDA clearance to market OraSure to the OTC market on a timely basis, if at all. See "Epitope Medical Products--Government Regulation." If Epitope Medical Products receives FDA clearance of the OraSure home collection system, a consumer could purchase OraSure at retail outlets such as pharmacies, drug stores, and other commercial facilities or through a mail order program. The consumer would collect the specimen and mail it in a postage prepaid envelope to an SB laboratory for testing. The consumer would obtain his or her test results and counseling by calling a toll-free number and providing a confidential identification number included with the test. International. In light of the worldwide scope of the HIV epidemic, Epitope Medical Products believes there are significant opportunities for sale of EpiScreen/OraSure in international markets. Epitope Medical Products believes that the ease of use, portability, increased safety and lower cost of oral fluid testing will provide significant advantages over blood tests in international markets. Epitope Medical Products has initiated an international marketing program that offers a complete EpiScreen testing system. The program features direct assistance to distributors in establishing EpiScreen programs that include laboratory services, cooperation from screening test manufacturers, and provision of Western blot confirmatory kits in each country. Epitope is currently marketing EpiScreen to distributors in Canada, Thailand, Argentina and South Africa for use in professional markets. SB also markets OraSure to the professional market in several Latin American and African countries through its network of distributors. See "Epitope Medical Products--Marketing." - 7 - Products Under Development EpiScreen/OraSure. Oral mucosal transudate contains many constituents found in blood serum. Because of this feature, the Company believes EpiScreen/OraSure is a platform technology with a wide variety of potential applications beyond HIV testing. For example, the EpiScreen/OraSure device may be useful for the diagnosis of a variety of infectious diseases in addition to HIV, such as viral hepatitis and a number of childhood diseases. The Company recently applied for regulatory clearance in Canada to market EpiScreen for the detection of measles, mumps and rubella. In addition, the Company believes that the use of oral specimens may allow physicians to diagnose diseases more readily in children without subjecting them to the discomfort of drawing a blood sample, thereby increasing the frequency of testing for diseases. The Company believes the EpiScreen/OraSure device also has potential application in the detection of drugs of abuse, such as cocaine. A 510(k) notification for this use is currently undergoing FDA review and, if approved, will allow Epitope Medical Products to market EpiScreen/OraSure to professional markets in addition to the life insurance industry. Under an agreement with STC Technologies, Inc., Epitope Medical Products is conducting U.S. clinical trials for other drugs of abuse. Physicians may also find the device useful for monitoring levels and adjusting dosages of therapeutic drugs, such as those that are toxic at levels only slightly above the level at which they are effective. Monitoring of these drugs currently requires frequent blood tests to determine drug concentration. The Company believes oral fluid testing would eliminate the discomfort and inconvenience associated with this frequent blood testing. OraQuick. Epitope Medical Products is currently developing OraQuick(R) HIV, a one-step, rapid-format oral fluid testing system designed to provide test results within ten minutes. Epitope Medical Products believes that OraQuick has significant potential as a rapid laboratory-based HIV test and as an OTC home-based HIV test. Like EpiScreen/OraSure, OraQuick is a platform technology with a variety of potential applications in addition to HIV testing. Modifications of the basic OraQuick technology may allow use of this approach for detection of antibodies against the ulcer-causing bacterium Helicobacter pylori, as well as for a variety of infectious diseases such as syphilis, viral hepatitis, and childhood infections. There can be no assurance that Epitope Medical Products will complete development of any of these products or, in the event of successful development, will receive applicable regulatory clearances or will profitably market the products. Marketing Life Insurance Industry. Epitope Medical Products currently markets its EpiScreen device for use in screening life insurance applicants for HIV, cocaine, and nicotine. The Company maintains a six-member direct sales force that markets and sells EpiScreen to the main insurance testing laboratories in the United States and Canada. The major laboratories currently using the EpiScreen device include LabOne, Inc., Osborn Laboratories, and Clinical Reference Laboratory, Inc. Epitope Medical Products also markets the use of EpiScreen directly to life insurance companies. U.S. Professional and OTC. In February 1995, Epitope Medical Products entered into a Development, License and Supply Agreement with SB (the "Agreement") for the OraSure HIV-1 oral specimen collection device and certain future diagnostic products. Under the Agreement, SB will sell the OraSure device to the professional markets in the United States. In addition, if and when regulatory clearance is received, SB will market the OraSure device to the U.S. OTC market. SB paid Epitope Medical Products a one-time license fee of $5 million for the rights granted under the Agreement. The Agreement provides that SB generally has responsibility for advertising, promotion, distribution, and regulatory approval expenses in its markets. Epitope Medical Products will initially manufacture the OraSure devices for sale to SB at predetermined transfer prices and will receive certain royalties on SB product sales. A portion of SB's costs in obtaining and maintaining regulatory approvals will be credited against royalties payable to Epitope Medical Products. - 8 - The Agreement permits SB to fund Epitope Medical Products' ongoing development of diagnostic products and technology for its term, which lasts for a minimum of 15 years, subject to earlier termination on 60 days' notice if SB elects to stop marketing the products in all markets. SB has the option to market those products developed with SB funding, which Epitope will initially manufacture for agreed-upon prices and royalties. International. Epitope Medical Products also employs a direct sales force for the marketing and sale of EpiScreen in certain international markets. The Company complements its direct sales efforts through the use of selected international distributors who have the expertise and capabilities appropriate for marketing EpiScreen. In addition, SB will act as exclusive director of the OraSure HIV-1 oral specimen collection device in the professional markets in certain Latin American and African countries. Epitope Medical Products has retained all rights to distribute products in markets other than those reserved to SB. Western Blot Distribution. Epitope Medical Products has entered into supply and distribution agreements with Organon Teknika Corporation, a member of the Pharma Division of Akzo Nobel, NV, an international chemical and pharmaceutical manufacturer based in Arnhem, The Netherlands. The supply agreement provides that Organon Teknika will supply the HIV-1 antigen used to manufacture Western blot confirmatory test kits. The distribution agreement grants Organon Teknika the exclusive right to purchase Western blot confirmatory test kits from Epitope Medical Products and to market them worldwide. Epitope Medical Products and Organon Teknika are negotiating terms for continuing the supply and distribution arrangement after the existing agreements expire on March 31, 1997. Manufacturing Epitope Medical Products manufactures Western blot confirmatory tests at the Company's Beaverton, Oregon, facility. The Western blot operation is presently producing current requirements with a one shift operating schedule. If additional Western blot production is required, the Company can expand operating hours or add an additional shift. The EpiScreen/OraSure device is manufactured by a contract manufacturer which also manufacturers medical devices for other firms. Recent increases in demand for the EpiScreen/OraSure device have been met by increasing the frequency of production cycles and number of production shifts while continuing to use the equipment purchased by the Company for use in the manufacturing process. The Company believes that it will reach full capacity for its present equipment configuration during 1997. Additional equipment has been acquired and will be placed into service as required to meet increased demand. Company quality control personnel inspect products and maintain documentation for compliance with the FDA's current Good Manufacturing Practices ("GMP") and other government manufacturing regulations. Epitope's manufacturing facilities are subject to periodic inspection by regulatory authorities. See "Epitope Medical Products--Government Regulation." Contract manufacturing is overseen by an on-site employee of the Company who is responsible for monitoring compliance with Company standard operating procedures, reviewing the manufacturing process and assuring that the manufacture of Company product is in compliance with GMP. The Company conducts further quality control tests in its Beaverton, Oregon, facility. Competition Competition in the emerging market for HIV testing is intense and is expected to increase. The Company believes that the principal competition will come from existing blood-based HIV assays and from urine-based assays. Epitope Medical Products' competitors include specialized biotechnology firms as well as pharmaceutical companies with biotechnology divisions and medical diagnostic companies, many of which have considerably greater financial, technical, and marketing resources than Epitope Medical Products. Competition may intensify as technological advances are made and become more widely known and as products reach the market in greater numbers. Furthermore, new testing methodologies could be developed in the future that render Epitope Medical Products' oral-based HIV test impractical, uneconomical or obsolete. There can be no assurance that Epitope Medical Products' competitors will not succeed in developing or marketing technologies and products that are more effective than those developed by Epitope Medical Products or that would render its technologies or products obsolete or otherwise commercially unattractive. In addition, there can be no assurance that competitors will not succeed in - 9 - obtaining regulatory approval for these products, or in introducing or commercializing them before Epitope Medical Products. Such developments could have a material adverse effect on the Company's and Epitope Medical Products' business, financial condition and results of operations. Three companies have submitted applications to the FDA for OTC HIV blood testing: Direct Access Diagnostics, Home Access Health Corp., and ChemTrak Incorporated. The FDA has approved a home collection kit for HIV blood testing developed by Direct Access Diagnostics and another home collection kit for HIV blood testing developed by Home Access Health Corp. Cambridge Biotech Corporation and BioRad Laboratories, Inc. manufacture HIV Western blot confirmatory tests, and Waldheim Pharmazeutika manufactures immunofluorescent HIV confirmatory tests, which compete with Epitope Medical Products' EPIblot HIV-1 Western blot serum-based confirmatory test kits. In addition, Abbott Laboratories provides in-house testing services for customers of its HIV screening products. Several other companies market or have announced plans to market oral specimen collection devices and tests outside the United States and have announced plans to seek FDA approval of such tests in the United States. Epitope Medical Products expects the number of devices competing with its EpiScreen/OraSure device to increase as the benefits of oral specimen-based testing become more widely accepted. Epitope Medical Products expects that FDA approval of the EpiScreen device will also encourage potential competitors to develop oral diagnostic products. No such devices have yet been approved by the FDA for HIV testing. See "Epitope Medical Products--Government Regulation." The FDA recently approved an HIV ELISA screening test for use with urine. However, no Western blot or other confirmatory test using urine has been approved by the FDA to date. The Company believes that absence of an FDA-approved confirmatory test for urine poses a significant disadvantage to urine testing because a patient who receives an initial positive screening result must return to give a second, blood-based sample for confirmatory testing. The Company also believes that urine collection can be difficult, inconvenient and potentially embarrassing for the patient, and that privacy and chain-of-custody issues are further impediments to routine use of urine-based HIV tests. Government Regulation General. Many of Epitope Medical Products' proposed and existing diagnostic products are subject to regulation by the FDA, other federal, state, and local agencies, and comparable bodies in foreign countries. Such regulation governs almost all aspects of development and marketing, including the introduction, advertising, promotion, manufacturing practices, labeling, distribution, and record keeping for the products. In the United States, different types of diagnostic products are regulated differently by the FDA, as discussed below. As part of the FDA clearance process, Epitope Medical Products often must demonstrate that its products are both safe and effective for a particular indication or application. Drugs and Biological Products. Generally, drugs and biological products require FDA approval before marketing. The steps required before a drug or biological product may be marketed in the United States include: (1) preclinical laboratory and animal tests; (2) submission of an application for an investigational new drug or biological product, which must become effective before human clinical trials may commence; (3) human clinical trials; (4) submission of a Product License Application ("PLA") for the biological product or a New Drug Application ("NDA") for most other new drug products; and (5) approval of the PLA or NDA. Preclinical safety and initial efficacy testing is usually undertaken in animals. Results of such preclinical and other laboratory tests are submitted to the FDA before human clinical trials can begin. Clinical trials are typically conducted in three phases. Phase I uses human subjects to determine safety and tolerance. Phase II uses a limited patient population to determine effectiveness and dosage and to identify side effects. Compounds found effective and safe in Phase II are further tested in Phase III with an expanded patient population at geographically dispersed clinical study sites. Each phase may last from one to two years or more. - 10 - Most products are not approved because of the failure to demonstrate safety, effectiveness, or both. The FDA may suspend clinical trials at any time if it is felt that subjects or patients are being exposed to an unacceptable health risk. Obtaining FDA approval requires substantial time and effort. There can be no assurance that any approval will be granted to Epitope Medical Products on a timely basis, if at all. As part of the approval process, the FDA may require Epitope Medical Products to initiate post-approval marketing studies. Medical Devices. Medical devices are classified either in Class I, Class II, or Class III. Class I devices are subject only to general control provisions of the Federal Food, Drug, and Cosmetic Act, as amended (the "FDC Act"). These provisions include requirements that a device not be adulterated or misbranded. Class II devices are those for which general controls are insufficient to provide a reasonable assurance of safety and efficacy and for which a "generic" performance standard or other special controls are appropriate. Devices that do not meet the criteria for Class I or II are placed in Class III. Class I and II devices, those Class III devices initially marketed prior to passage of the Medical Device Amendments of 1976 ("MDA") for which premarket approval applications ("PMAs") are not yet required, and devices substantially equivalent to such devices, may be marketed upon FDA clearance of a section 510(k) notification (a "510(k) Notice"). Other Class III devices may be commercially marketed only after FDA approval of a PMA. Generally, the process of obtaining FDA approval of a PMA is similar to that for obtaining approval of a biological or other drug product. Based upon the information provided in a 510(k) Notice regarding the device's intended use and technological features, the FDA will determine whether the device is "substantially equivalent" to a predicate device, i.e., a device legally marketed which did not require a PMA. If a device is found to be substantially equivalent to a predicate device, it may be freely marketed in the United States so long as the device is otherwise in compliance with the FDC Act. If it is not so found, it will be considered a Class III device requiring a PMA. Substantial equivalence means that the FDA has found that the device has the same intended use as the predicate device, and either has the same technological characteristics or has different characteristics, but there is information in the 510(k) Notice that shows the device is as safe and effective as the predicate and does not present different questions of safety and effectiveness. EpiScreen/OraSure Collection Device. Use of the EpiScreen/OraSure collection device for applications involving the detection of antibodies to HIV is regulated by the FDA as use of a Class III medical device requiring a PMA. In December 1994, the FDA approved Epitope Medical Products' PMA for use of the Episcreen/Orasure device in HIV screening. Post-approval marketing studies are under way as required as part of the FDA's approval of the EpiScreen/OraSure device. In June 1996, the FDA approved the PMA for use of the OraSure oral specimen-based Western blot confirmatory test kit for HIV-1 diagnosis. In February 1995, Epitope Medical Products submitted a 510(k) Notice for use of EpiScreen for cocaine testing. The submission is currently undergoing FDA review. See "Epitope Medical Products--Products Under Development--EpiScreen/OraSure." In the meantime, the FDA has advised Epitope Medical Products that EpiScreen may be used for cocaine testing for the purposes of life insurance risk assessment. Western Blot Test Kits. Epitope Medical Products' HIV-1 Western blot serum-based confirmatory test kits are used to confirm whether individuals are infected with HIV-1. They are regulated by the FDA as biological products, unlike most other diagnostic tests which are regulated as medical devices. In March 1991, the FDA cleared the EPIblot HIV-1 serum-based confirmatory test kit for commercial distribution. As noted above, a PMA seeking permission to market the OraSure oral specimen-based Western blot confirmatory test kit for HIV-1 diagnosis was approved by the FDA in June 1996. Manufacturing Regulations. Every company that manufactures drugs, biological products, or medical devices distributed in the United States is subject to inspections by the FDA and must comply with the FDA's current Good Manufacturing Practices regulations. These regulations govern, among other matters, manufacture, testing, release, packaging, distribution, and documentation. Other. Epitope Medical Products is also subject to regulation by the Occupational Safety and Health Administration and may be subject to regulation by the U.S. Environmental Protection Agency ("EPA") under the - 11 - Toxic Substances Control Act ("TSCA"), the Resource Conservation and Recovery Act, and other legislation. Epitope Medical Products is also subject to foreign regulations governing, for example, human clinical trials and marketing with respect to products distributed outside the United States. Approval processes vary from country to country, and the length of time required for approval or to obtain other clearances may in some cases be longer than that required for U.S. governmental approvals. The extent of potentially adverse governmental regulation affecting Epitope Medical Products that might arise from future legislative or administrative action cannot be predicted. Agritope Historically, Agritope has focused on the development and commercialization of novel agricultural products using plant genetic engineering and other modern methods. Through its acquisition of A&W and its majority ownership of Vinifera, Agritope is positioned as a vertically integrated agribusiness with the production, distribution and marketing infrastructure necessary to realize better the value of its proprietary technology. Agritope's products now include a broad range of fruits, vegetables and plants produced using technologically advanced farming and plant propagation techniques designed to incorporate advances in biotechnology, plant breeding, and crop production. Agritope consists of three major units: Agritope Research and Development, A&W, and Vinifera. Agritope Research and Development contributes biotechnology and product development efforts to A&W and Vinifera as well as to its other business partners. Through A&W, Agritope produces, markets, distributes and sells a wide variety of fruits and vegetables throughout North America. Through Vinifera, Agritope believes that it offers one of the most technically advanced grapevine plant propagation and disease screening and elimination programs available to the worldwide wine and table grape production industry. Agritope Research and Development Agritope's biotechnology research and development program is focused on using the tools and techniques of plant genetic engineering to regulate the synthesis of ethylene in ripening fruits and vegetables. Ethylene gas is a plant hormone which in higher plant species is responsible for fruit ripening and vegetable senescence as well as numerous other physiological effects. Agritope has identified and patented a single gene that can be inserted into plants and expressed to regulate the plant's ability to produce ethylene. In addition, Agritope is conducting research in the area of disease control, including screening plants for the presence of disease and creating genetically engineered plants with resistance to pathogens. Ripening Control. The fresh produce industry is based largely upon rapid harvesting, processing and distribution of fruits and vegetables in order to prevent spoilage and ensure the arrival of product at retail outlets in acceptable condition for consumer purchase and use. The postharvest period for most fruits and vegetables is one of continuous ripening and senescence, as evidenced by rapid changes in color, texture, flavor, nutrient content, and other quality attributes. Product losses due to perishability during harvesting, processing, packing, shipping and distribution can reach substantial portions of overall crop yield. Growers frequently incur losses resulting from the abandonment of crops in the field or having shipments refused by receivers because the produce is overripe. In addition, wholesalers and retailers may be forced either to discard or sell overripe produce at reduced prices and consumers often must use produce shortly after purchase to avoid spoilage. Studies published in the United States Department of Agriculture ("USDA") Marketing Research Report have estimated postharvest losses of 30 percent and 40 percent, respectively, for strawberries shipped from Florida to the Chicago and New York markets. In the U.S. fruit and vegetable markets, postharvest losses are estimated to amount to several billion dollars annually. Postharvest losses are largely attributable to the effects of ethylene. Because ethylene is a gas, it not only affects the plant producing it, but also surrounding plants as well. The physiological effects of ethylene include initiation and enhancement of ripening, senescence, leaf abscission and drooping, and flower fading and wilting. Common examples include the ripening and subsequent rotting of tomatoes and apples, discoloration in lettuce and broccoli, and the short bloom life of cut flowers. - 12 - The importance of controlling ethylene production in plants has been recognized for decades, and has been addressed primarily through the use of controlled atmosphere storage, chemical treatment, and special packaging. Conventional techniques for controlling ethylene production have serious disadvantages that include high cost, time-critical handling requirements and lack of consistent ripening. For example, the majority of product sold in the fresh tomato market today is composed of "gas-green" tomatoes. These tomatoes are picked and packed while still green and firm. Prior to shipping to wholesale customers, green tomatoes are exposed to ethylene gas in order to initiate ripening of the product. In general, gas-green tomatoes are perceived by consumers to have less desirable taste and texture than vine ripened tomatoes. Agritope believes the ability to regulate ethylene and control ripening through genetic engineering represents an opportunity to provide a superior product to consumers while also improving profitability for growers and distributors. Growers may achieve higher marketable yields due to fewer losses to overripe product in the field and may lower labor costs by decreasing frequency of harvest. For packers/shippers, better control of product perishability may result in improved inventory flexibility and control, and more uniform product quality. Agritope Technology. Agritope's ethylene control technology is focused on the use of a patented gene known as SAMase. The expression of SAMase in plants produces an enzyme that acts to degrade one of the important precursor compounds (S-adenosylmethionine or "SAM") necessary for the production of ethylene. Agritope has genetically engineered plants to express the SAMase gene only when certain levels of rising ethylene concentrations are reached in the tissues of the fruit or plant. This feature causes the production of greater levels of the enzyme that degrades SAM in response to a correspondingly higher level of ethylene. Agritope believes that this technology thus offers a major advantage over other approaches to ripening control in that the production of ethylene may be specifically reduced to levels that allow for the initiation of ripening but delay the spoiling effects of excess ethylene. Therefore, the fruit can be maintained at an optimal level of ripeness for an extended period of time. An additional benefit of Agritope's technology is that the enzyme produced by the SAMase gene degrades SAM into compounds normally found in plants. Agritope believes its SAMase technology can be utilized for the control of ethylene in any plant species where ethylene affects ripening or senescence. Agritope's ripening control technology is protected by a U.S. patent covering the use of any gene that encodes S-adenosylmethionine hydrolase (the enzyme expressed by the SAMase gene) in any plant species. In addition to the patent on the SAMase gene, utility claims have been allowed on the promoter/gene combination used by Agritope in applications currently under development as well as potential applications in all other fruit-bearing plants. In the area of regulated ripening control, Agritope has additional U.S. and foreign patents pending. In addition, Agritope has U.S. and foreign patent applications pending in related areas. See "Epitope, Inc.--Patents and Proprietary Information." Development Programs. Agritope's research and development programs are directed toward several highly perishable fruit and vegetable crops described below. The development program comprises five stages, including gene isolation, transformation, product evaluation, seed/plant production and commercialization. - 13 - The following chart shows the approximate progress Agritope has made to date with various crops, which are described in more detail below. [Chart titled "Agritope Product Development Program" listing the stages of development (gene isolation, transformation, product evaluation, seed/plant production, and product launch). The chart shows that the following products are in the stages indicated: Tomato Product Evaluation Raspberry Product Evaluation Melon Transformation Brassica Transformation Additional Crops Gene Isolation] Gene Isolation: The initial stage of genetic engineering. Gene isolation involves the identification and characterization of genes and gene promoters for use in Agritope's development programs. These genetic elements are then combined for use in genetically engineered plants. Transformation: The stage at which the new genetic material is introduced into the plant. The transgenic plants which result are then available for product evaluation. Product Evaluation: The analysis of transgenic plants in both laboratory and field settings to determine commercial utility. This stage also involves the plant breeding and selection process to develop commercially competitive new varieties that incorporate the Agritope technology. Regulatory data are also collected and submitted at this stage. Seed/Plant Production: Propagation of selected plant material (either seed or plants) in quantities needed for commercial production. Product Launch: Commercial production and sale, following regulatory clearance. Tomato. The annual U.S. wholesale fresh market tomato business is estimated at $1.7 billion. In order to facilitate the commercialization of its ethylene control technology into this market, Agritope and A&W formed Superior Tomato Associates, L.L.C. ("STA"), a joint venture with Sunseeds Company, the developer and producer of several leading fresh market tomato varieties. Agritope provides genetic engineering technology and regulatory expertise, has responsibility for managing the joint venture, and owns a two-thirds equity ownership interest in STA. Sunseeds provides elite tomato germplasm and breeding expertise in the development of transgenic varieties. A&W contributes testing and production acreage and will oversee the production and wholesale distribution of fresh tomatoes to the fresh produce industry. STA is currently in the process of developing and testing transgenic cherry, roma, and large fruited vine ripe tomato varieties. Agritope has developed lines of elite tomato germplasm provided by Sunseeds. Recent field trials have successfully demonstrated the transfer of Agritope's SAMase ripening control technology to a number of Sunseeds' elite breeding lines. Sunseeds is conducting further breeding and field trials of these transgenic lines. These trials will be followed by production scale trials to be conducted by A&W that, if successful, will lead to regulatory submissions and, if regulatory clearances are received, commercial-scale seed production. Subsequently, A&W would commence commercial tomato production and sales to the industry. - 14 - Prior to the formation of STA, Agritope submitted safety, nutritional, and environmental information on a prototype transgenic tomato line to both the USDA and the FDA. In March 1996, the USDA issued its finding that this line has no significant environmental impact and would no longer be considered a regulated article. During the same month the FDA determined that the variety did not raise issues that would require pre-market review or approval by that agency. In addition to receiving these U.S. regulatory clearances, Agritope is also conducting field evaluations of SAMase tomato lines in Mexico under permits granted by the Mexican Ministry of Agriculture. In order to commence sale of selected varieties, Agritope will be required to make supplemental submissions to the USDA and FDA that establish that such varieties are comparable to the previously cleared lines. Raspberry. The wholesale raspberry market, estimated at $48 million annually in the United States, has experienced limited growth because of the extreme perishability of the fruit. Agritope believes that the successful development of raspberries containing its ethylene control technology could permit a significant expansion of the fresh raspberry market. In a collaboration with Sweetbriar Development, Inc. ("Sweetbriar"), the largest fresh raspberry producer in the U.S., Agritope has engineered several of Sweetbriar's proprietary commercial raspberry varieties to contain the SAMase gene. Initial field trials of transgenic raspberries are currently underway at Sweetbriar facilities in California and Agritope facilities in Woodburn, Oregon. Agritope has already demonstrated the ability to reduce ethylene synthesis in the fruit. Successful development of a commercial transgenic raspberry will require further demonstration of improved shelf life as well as additional field trials to obtain the appropriate regulatory clearances. If these conditions are met, Sweetbriar would produce the new raspberries for distribution and marketing by Driscoll Strawberry Associates, the largest distributor of fresh raspberries and strawberries in the U.S. Agritope would receive royalties on wholesale product sales. Separately, Agritope has integrated its ripening control technology into commercially successful public domain varieties. A&W would undertake commercial production and distribution of any improved raspberry products resulting from this program. Melon. The U.S. wholesale fresh melon market is estimated at $282 million annually. As with tomatoes, perishability results in substantial product losses during the processes of production, harvesting, and distribution. Agritope believes that melons represent a substantial market opportunity for implementation of its ripening control technology. Recent scientific reports have demonstrated a dramatic increase in shelf life for specialty type melons in which the ability to produce ethylene has been impaired. Using proprietary seed varieties supplied by two units of the French seed company Limagrain, Clause Semences, and its U.S. affiliate Harris Moran Seed Company ("Harris Moran"), Agritope is developing commercial melon varieties with controlled ripening and increased postharvest product life. Transgenic melons containing Agritope's ethylene control gene are currently being evaluated jointly by Harris Moran and Agritope technicians. If successfully developed, the melons will be distributed by A&W and third party distributors. Brassica. Agritope has an agreement with Sakata Seed America ("Sakata") to develop new varieties of certain Brassica species (broccoli and cauliflower). Sakata is the leading hybrid broccoli and cauliflower seed supplier in the U.S. Sakata provided Agritope with germplasm from selected breeding lines and funds to develop broccoli and cauliflower plants integrating Agritope ripening control technology. Agritope received payment from Sakata upon the transfer of genetically engineered plants to be used for the production of hybrid seeds. If the seeds are commercialized, Agritope will receive a royalty on sales made by Sakata. Additional Crops. Agritope is also pursuing research and development programs to incorporate its SAMase technology into other crops where perishability causes significant losses in the production and distribution process. These include strawberries, lettuce, bananas, peaches, pears, and apples. The estimated U.S. wholesale markets for these crops range from $325 million for pears to $2.4 billion for bananas. - 15 - Andrew and Williamson Sales, Co. As part of its vertical integration strategy, Agritope acquired A&W on December 12, 1996. A&W is a wholly owned operating subsidiary based in San Diego, California with sales offices in San Diego and Bakersfield, California and Nogales, Arizona. A&W, founded in 1986, produces fruits and vegetables and provides sales and distribution services for growers from both mainland and Baja, Mexico and the San Joaquin Valley in California. A&W produces and distributes a diversified mix of fresh fruits and vegetables including vine ripe cherry, roma and fresh market tomatoes, strawberries, raspberries, melons, tree fruits, table grapes, cucumbers, squash, green, red and yellow peppers, Brussels sprouts and asparagus. In addition to fresh strawberries, A&W processes and sells frozen strawberry products. A&W ships fresh produce every day of the year from its facilities in San Diego and ships seasonally from its other sites. A&W is one of the United States' largest distributors of vine ripe cherry and fresh market tomatoes. It is also a major shipper of fresh strawberries, melons and cucumbers throughout North America. In connection with its distribution operations, A&W also provides technical support and short-term loans to certain growers. See Note 13 to Financial Statements included herein. The Company acquired A&W pursuant to an Acquisition and Merger Agreement with A&W and its shareholders, under which a subsidiary of the Company was merged into A&W. The Company issued 520,000 shares of common stock of Epitope, Inc., in exchange for all the outstanding common stock of A&W. A&W also repaid certain loans due to its shareholders. The acquisition was accounted for as a pooling of interests and qualifies as a tax-free reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended. The Company has agreed to register for resale the shares issued to the shareholders of A&W, who have represented that they have no present intention to sell the shares. Fifteen percent of the shares will bear a legend prohibiting sale without the Company's consent. The shareholders have agreed that these shares will be returned to the Company to satisfy claims for breach of representations and/or warranties arising within approximately one year after closing. The four principals of A&W have entered into three-year employment and five-year noncompetition agreements with the Company. Fred L. Williamson, president of A&W, is an executive officer of the Company. Vinifera, Inc. Vinifera, Inc. was incorporated in 1993 to participate in the grapevine nursery business. Through proprietary processes, Vinifera propagates and grafts grape plants for sale to vineyards and to growers of table grapes. Industry sources have estimated that 44 million grafted wine grape plants were produced in California in 1996. This number is expected to increase to between 70 and 90 million by the year 2000. Traditionally, grapevine plants for sale to vineyards are produced seasonally using field grown, dormant cuttings that are grafted. In contrast, Vinifera uses year-round greenhouse propagation and a herbaceous grafting method that employs very young, actively growing cuttings. As a result of greenhouse propagation, Vinifera is able to develop in two years a quantity of new plants that is approximately ten times larger than can be produced with traditional techniques. In addition, herbaceous grafting with green cuttings could allow a vineyard to begin commercial production of grapes from a newly planted vineyard a year sooner than would otherwise be possible. This grafting process also produces sturdier unions than dormant grafting, resulting in significantly higher yields of successful grafts, both at the propagation stage and in the survival of actual plantings in the field. Agritope Research and Development provides disease testing services for Vinifera. Vinifera is headquartered in Napa, California, with facilities in Woodburn, Oregon, and Petaluma, California. Its library of grape plants includes 32 different phylloxera-resistant types of rootstock, 88 different wine varietal clones, and ten different table grape varietal clones. In addition, several French and Italian varietals are currently passing through quarantine and, when released, will be available to the U.S. market exclusively through Vinifera. Vinifera believes that this collection of different grapevine clones is one of the largest in the world. Vinifera's U.S. customer base consists of over 80 vineyards in California, Washington and Oregon. In 1995, Vinifera established a joint venture in Argentina (Vinifera Sudamericana S.A.) to begin the propagation of plant - 16 - material in that country. The first vines produced are expected to be sold in 1997. Vinifera is currently in the process of establishing similar ventures in other countries with large grape and wine production industries. Vinifera was formed in 1993 as a wholly owned subsidiary of Agritope, Inc. In June 1995, Agritope, Inc. agreed to sell its equity interest in Vinifera to VF Holdings, Inc., an affiliate of a Swiss investment group. The purchaser subsequently failed to make scheduled payments of the purchase price. As part of a settlement of claims based on the purchaser's default, the purchaser retained a four percent minority interest in Vinifera and relinquished the majority interest to Agritope, Inc. in August 1996. Competition The agribusiness and plant biotechnology industry is highly competitive. Competitors include independent companies that specialize in agribusiness or biotechnology; chemical, pharmaceutical and food companies that have biotechnology laboratories; universities; and public and private research organizations. Agritope believes that many companies including companies with significantly greater financial resources, such as Monsanto Company, Calgene Inc., DNAP Holding and Zeneca Seeds are engaged in the development of mechanisms to control the ripening and senescence of fruit and vegetable products. Technological advances by others could render Agritope's products less competitive. The Company believes that, despite barriers to new competitors such as patent positions and substantial research and development lead time, competition will intensify, particularly from agricultural biotechnology firms and major agrichemical, seed and food companies with biotechnology laboratories. Agritope believes that it can compete successfully with companies in these markets by developing products that offer unique and desirable attributes with superior quality. The produce markets in which Agritope sells its products are highly competitive. For example, competition in the fresh tomato market is expected to intensify as other companies introduce tomatoes developed through biotechnology and as existing "gas green" tomato producers react to competitive pressures by growing and marketing traditionally developed vine ripe tomatoes. In other crops, competition may intensify as technological developments occur within the agricultural biotechnology industry. In competing with such companies, Agritope relies primarily on the experience of its production, sales and marketing staff at A&W, the qualifications of its scientific staff, and its technological capabilities. Government Regulation Regulation by federal, state and local government authorities in the U.S. and by foreign governmental authorities will be a significant factor in the future production and marketing of Agritope's genetically engineered fruit and vegetable products. The federal government has implemented a coordinated policy for the regulation of biotechnology research and products. The USDA has primary federal authority for the regulation of specific research, product development and commercial applications of certain genetically engineered plants and plant products. The FDA has principal jurisdiction over plant products that are used for human or animal food. The EPA has jurisdiction over the field testing and commercial application of plants genetically engineered to contain pesticides. Other federal agencies have jurisdiction over certain other classes of products or laboratory research. The USDA regulates the growing and transportation of most genetically engineered plants and plant products. In March 1996 following a request from Agritope, the USDA issued a determination that allows the growing and shipping of its prototype variety of ripening controlled cherry tomato anywhere in the U.S. in the same manner as conventionally developed tomatoes. In May 1992, the FDA announced its policy on foods developed through genetic engineering (the "FDA Policy"). The FDA Policy provides that the FDA will apply the same regulatory standards to foods developed through genetic engineering as applied to foods developed through traditional plant breeding. Under the FDA Policy, the FDA will not ordinarily require premarket review of genetically engineered plant varieties of traditional foods - 17 - unless their characteristics raise significant safety questions, such as elevated levels of toxicants or the presence of allergens, or they are deemed to contain a food additive. In March 1996, the FDA announced its determination, based on its review of food safety data submitted by Agritope, that its prototype variety of ripening controlled cherry tomato expressing the SAMase gene has not been significantly altered with respect to food safety or nutritive value when compared to conventional tomatoes. The FDA has also issued a food additive regulation permitting the use of the kanr selectable marker gene, which encodes for the enzyme APH(3')II, in genetically engineering tomatoes, cotton and canola. Agritope tomato products will fall under this regulation. It is uncertain whether additional food additive regulations will need to be issued to cover additional fruit and vegetable products which use the kanr selectable marker gene. Currently, the FDA Policy does not require that genetically engineered products be labeled as such, provided that such products are as safe and have the same nutritional characteristics as conventionally developed products. However, there can be no assurance that the FDA will not reconsider its position, or that local, state or international authorities will not enact labeling requirements, any of which could have a material adverse effect on marketing of products derived using the tools and techniques of genetic engineering. The FDA is currently considering modifying its policy on foods developed through genetic engineering to include a Premarket Notification ("PMN") procedure. This policy modification could require companies that develop genetically engineered foods to inform the FDA that its safety evaluation is complete and that the company intends to commercialize the product. The objective of the PMN is to make the FDA and the public aware of all new genetically engineered food products entering the market. Agritope believes that any future requirement for a PMN should not delay plans to commercialize its genetically engineered fruit and vegetable products. Agritope's complete range of agribusiness and plant biotechnology activities is subject to general FDA food regulations and are, or may be, subject to regulation under various other laws and regulations. These include but are not limited to the Occupational Safety and Health Act, the Toxic Substances Control Act, the National Environmental Policy Act, other federal water, air and environmental quality statutes, import/export control legislation, and other laws. At the present time most states are generally deferring to federal agencies (USDA or EPA) for the approval of genetically engineered plant field trials, although states are provided a review period prior to the issuance of a field trial permit. Failure to comply with applicable regulatory requirements could result in enforcement action, including withdrawal of marketing approval, seizure or recall of products, injunction or criminal prosecution. The federal regulatory agencies most involved in the business of A&W, the production and marketing of fresh fruit and vegetables, are the USDA and the FDA. The USDA sets standards for raw produce and governs its inspection and certification. Under the Perishable Agricultural and Commodities Act ("PACA"), the USDA exercises broad control over the marketing of produce in domestic and foreign commerce, sets standards of fair conduct as to representations, sales, delivery, shipment and payment for goods and regulates the licensing of produce merchants and brokers. Almost every aspect of federal regulation is accompanied by regulation on the state level. In addition, in its Mexican operations, A&W must comply with the requirements of Mexican law, most importantly Mexico's environmental protection law. International regulatory policies for genetically engineered plants and plant products are not complete. Consequently, it is possible that additional data, labeling or other requirements will be required in countries where Agritope intends to grow and/or commercialize its genetically engineered products. Foreign regulatory agencies could require Agritope to conduct further safety assessments and potentially delay product development programs or commercialization of resulting products. To date, Agritope to the best of its knowledge has successfully functioned within the scope of applicable laws and regulations, including rules administered by the USDA, the FDA and the Mexican Ministry of Agriculture. - 18 - Agritope believes it is in compliance with all applicable laws and regulations pertaining to the development and commercialization of its products. Epitope, Inc. Supplies The HIV-1 antigen needed to manufacture Epitope Medical Products' Western blot HIV confirmatory test kits is available from only a limited number of sources. Organon Teknika, the exclusive distributor of the test kits, is required to supply Epitope Medical Products' requirements for antigen for the term of its distribution agreement with Epitope Medical Products, which ends in March 1997. The parties are negotiating terms for continuing the supply arrangement. If for any reason Organon Teknika should no longer be able to supply Epitope Medical Products' antigen needs, management believes Epitope Medical Products would be able to obtain or produce its own supply of antigen at a competitive cost. Epitope Medical Products has obtained a license from the National Technical Information Service which is required for the production of the HIV-1 antigen currently used in Epitope Medical Products' Western blot test kits. Other materials used by Agritope and Epitope Medical Products in manufacturing, production, and research and development operations are widely available from a variety of sources. Grants and Contracts The Company participates in United States Small Business Innovation Research ("SBIR") programs sponsored by either the Department of Health and Human Services or the Department of Agriculture. The SBIR programs have two phases. Phase I covers a six-month project period and a total award not to exceed $100,000. Phase II covers a two-year project period and a total award not to exceed $750,000. Epitope Medical Products has received funds in the past from the National Institute of Allergy and Infectious Diseases for work in developing a rapid test to detect HIV antibodies in oral fluid specimens and from the National Cancer Institute to fund research for the treatment of cancer by exploiting a deficiency of certain compounds in cancer cells. Agritope was awarded from the USDA a Phase I grant of $50,000 in 1994 and a Phase II grant of $200,000 in 1995 for development of diagnostic tests for the detection of grapevine leafroll virus. Agritope has been awarded grant support in the past from the Oregon Strawberry Commission and Oregon Raspberry and Blackberry Commission for antifungal biocontrol research. The Company also receives funds for research and development programs from its strategic partners. The Company intends to continue to participate in the SBIR programs, similar grant programs and projects with strategic partners, as it deems appropriate. The Company regularly makes applications for new grants, but there is no assurance that grant support will be continued. Patents and Proprietary Information Epitope Medical Products has obtained patents in the United States and certain foreign countries for the EpiScreen/OraSure and OraQuick devices and certain related technology. Epitope Medical Products has applied for additional patents, both in the United States and in certain foreign countries, on the EpiScreen/OraSure collection device and a number of other technologies and products. In 1995, Agritope received a U.S. patent relating to its ethylene control gene. Agritope has also applied for additional U.S. and foreign patent protection for its ethylene control technology. Agritope's ability to commercialize products depends in part on the ownership or right to use relevant enabling technology as well as the ownership or right to use genes of interest. The Company anticipates filing patent applications for protection on future products and technology. United States patents generally have a maximum term of 20 years from the date an application is filed or 17 years from issuance, whichever is longer. Much of the technology developed by the Company, including its proprietary preservative solution, is subject to trade secret protection. To reduce the risk of loss of trade secret protection through disclosure, the Company requires its employees and consultants to enter into confidentiality agreements. The Company believes - 19 - that patent and trade secret protection is important to its business. However, the issuance of a patent or existence of trade secret protection does not in itself ensure the Company's success. Competitors may be able to produce products competing with a patented Company product without infringing on the Company's patent rights. Issuance of a patent in one country generally does not prevent manufacture or sale of the patented product in other countries. The issuance of a patent to the Company or to a licensor is not conclusive as to validity or as to the enforceable scope of the patent. The validity or enforceability of a patent can be challenged by litigation after its issuance, and, if the outcome of such litigation is adverse to the owner of the patent, the owner's rights could be diminished or withdrawn. Trade secret protection does not prevent independent discovery and exploitation of the secret product or technique. Personnel At September 30, 1996, the Company and its subsidiaries had 113 full-time employees, including 66 persons in Epitope Medical Products, 29 in Agritope, and 18 in corporate administration and support. Epitope Medical Products employees included 18 persons in research and product development, eight in administration and marketing, 29 in manufacturing and production, and ten in regulatory affairs and quality assurance. Agritope employees included 19 in research and development and ten at the Vinifera grape plant nursery operation which also employs seasonal part-time employees as needed. The Company considers its relations with its employees to be excellent. None of its employees are represented by labor unions. The Company employs nine persons holding Ph.D. or M.D. degrees with specialties in the following disciplines: analytical chemistry, bacteriology and public health, biochemistry, biophysics, hematology and internal medicine, immunology, molecular biology, organic chemistry, plant biology and plant pathology. From time to time, the Company also engages the services of scientists as consultants to augment the skills of its scientific staff. Scientific Advisory Board The Company also utilizes the services of a Scientific Advisory Board. The Scientific Advisory Board meets periodically to review the Company's research and development efforts and to apprise the Company of scientific developments pertinent to the Company's business. The Scientific Advisory Board comprises chair Eugene W. Nester, Ph.D., Professor and Chair, Department of Microbiology, University of Washington; Roger N. Beachy, Ph.D., Member, Scripps Family Chair, and Head, Division of Plant Biology, The Scripps Research Institute, and Co-Director of International Laboratory for Tropical Agricultural Biotechnology; Peter R. Bristow, Ph.D., Associate Plant Pathologist, Washington State University; J. Richard George, Ph.D., Vice President of Scientific Affairs of Epitope Medical Products; Lesley M. Hallick, Ph.D., Vice President for Academic Affairs, Oregon Health Sciences University; Daniel Malamud, Ph.D., Professor and Chair, Department of Biochemistry, University of Pennsylvania School of Dental Medicine; and James I. Mullins, Ph.D., Professor of Microbiology and Medicine, University of Washington. - 20 - ITEM 2. Properties. The Company leases approximately 35,600 square feet of office, manufacturing, and laboratory space in Beaverton, Oregon, under two leases that terminate January 31, 2000. Each lease calls for fixed monthly payments over its term. The Company also entered into a five-year lease, effective October 1, 1996, for 2,265 square feet of warehouse space used to store inventory and equipment. Agritope owns a 15-acre farm which it leases to Vinifera for use in connection with Vinifera's grapevine micropropagation operations. Greenhouse capacity at the farm currently totals 60,000 square feet. Agritope also uses a portion of the Company's office space and research and development facilities in Beaverton, Oregon. In addition to leasing Agritope's Oregon farm and greenhouse, Vinifera leases 250,000 square feet of greenhouse space in Petaluma, California under a lease that expires January 31, 2001. The Vinifera California greenhouse is currently in the final stages of being upgraded to provide the capacity necessary to meet anticipated 1997 and 1998 production requirements. A&W leases its main distribution facility in San Diego, California, from Fred Andrew and Fred L. Williamson, under a lease agreement expiring August 31, 2001, with an option to extend the lease term for an additional five years. A&W also leases a 1,000 square foot sales office in Bakersfield, California, on a month-to-month basis. A&W utilizes 10,000 square feet of a cold storage facility in San Diego, California, for its frozen strawberry operations. A&W has the right to use the cold storage space through January 18, 1998. The Company believes that its present facilities are adequate to meet current requirements. See Item 1, "Epitope Medical Products--Manufacturing." 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 fourth quarter of the fiscal year covered by this Report. - 21 - PART II ITEM 5. Market for the Registrant's Common Stock and Related Stockholder Matters. The Company's Common Stock is traded on the national market tier of The Nasdaq Stock Market (the "Nasdaq National Market") under the symbol "EPTO." Prior to January 1, 1997, the Common Stock was traded on the American Stock Exchange ("AMEX"). High and low sales prices reported by AMEX or the Nasdaq National Market during the periods indicated are shown below.
Year ended September 30 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------- Sales price per share High Low High Low High Low First Quarter ...................... $16-3/8 $10-7/8 $18 $ 9-1/2 $26 $18-1/2 Second Quarter...................... 17-3/8* 10-3/4* 19-1/2 13-7/8 21-7/8 13-5/8 Third Quarter....................... - - 22-7/8 15-1/2 18-3/8 13-5/8 Fourth Quarter...................... - - 16-1/8 11-3/4 18 13-3/4 - ---------- * Through February 28, 1997.
On February 28, 1997, there were 1,074 holders of record of the Common Stock, and the closing price of the Common Stock as reported on the Nasdaq National Market was $12-7/8. The Company has never paid any cash dividends, and the Board of Directors does not anticipate paying cash dividends in the foreseeable future. The Company intends to retain any future earnings to provide funds for the operation and expansion of its business. ITEM 6. Selected Financial Data. Historical Comparative Financial Data (In thousands, except per share data) The following table sets forth selected historical consolidated income and balance sheet data of Epitope, Inc. and its subsidiaries; selected historical combined income and balance sheet data of Epitope Medical Products; and selected historical combined income and balance sheet data of Agritope. The balance sheet data at September 30, 1996 and 1995 and the operating results data for the years ended September 30, 1996, 1995, and 1994 have been derived from audited consolidated financial statements and notes thereto included in this Annual Report on Form 10-K. The balance sheet data at September 30, 1994, 1993 and 1992 and operating results data for the years ended September 30, 1993 and 1992 are unaudited, but, in the opinion of management, include all adjustments necessary for fair presentation. Net income (loss) per share for Epitope Medical Products and Agritope is presented on a proforma basis assuming that the distribution of Agritope Common Stock and redesignation of the Common Stock as Epitope Medical Products Common Stock had occurred on October 1, 1991. The following historical financial information has not been restated to give effect to the merger with Andrew and Williamson Sales, - 22 - Co. on December 12, 1996. The merger has been accounted for as a pooling of interests. See "Supplemental Comparative Financial Data" below.
Year ended September 30 1996 1995 1994 1993 1992 Epitope Medical Products Combined operating results Revenues..................................$ 5,594 $ 2,856 $ 2,605 $ 2,759 $ 2,985 Operating costs and expenses ............. 10,881 14,463 8,890 9,376 8,311 Other income (expense), net .............. 6,027 756 236 (1,276) 221 Net profit (loss) ........................ 739 (10,851) (6,048) (7,893) (5,106) Proforma net profit (loss) per share ..... .06 (.91) (.60) (.89) (.59) Proforma shares used in per share calculations ............................. 13,440 11,886 10,050 8,828 8,628 Combined balance sheet data Working capital ..........................$ 20,366 $ 15,449 $ 13,474 $ 7,029 $ 5,255 Total assets ............................. 24,350 21,831 17,183 10,381 7,954 Accumulated deficit ...................... (41,705) (42,444) (31,593) (25,545) (17,652) Group equity ............................. 22,532 18,035 15,661 9,280 7,178 Agritope Combined operating results Revenues .................................$ 585 $ 2,110 $ 2,213 $ 524 $ 58 Operating costs and expenses ............. 2,821 9,920 11,703 7,331 2,790 Other income (expense), net .............. 97 166 (94) (29) 72 Net loss ................................. (2,139) (7,645) (9,584) (6,836) (2,660) Proforma net loss per share .............. (.34) (1.29) (1.91) (1.55) (.62) Proforma shares used in per share calculations ............................. 6,331 5,943 5,025 4,414 4,314 Combined balance sheet data Working capital ..........................$ 1,264 $ 5,082 $ 3,710 $ 1,673 $ 4,368 Total assets ............................. 10,097 8,303 7,372 3,764 6,177 Long-term debt ........................... - 22 38 57 - Convertible notes, due 1997 .............. 3,620 3,620 4,070 4,630 5,495 Accumulated deficit ...................... (31,280) (29,141) (21,497) (11,912) (5,076) Group equity (deficit) ................... 5,435 4,312 2,810 (1,310) 482 Epitope, Inc. and Subsidiaries Consolidated operating results Revenues ................................. $ 6,179 $ 4,965 $ 4,819 $ 3,283 $ 3,043 Operating costs and expenses ............. 13,702 24,383 20,593 16,707 11,102 Other income (expense), net .............. 6,123 922 141 (1,305) 293 Net loss ................................. (1,400) (18,496) (15,633) (14,729) (7,765) Net loss per share ....................... (.11) (1.56) (1.56) (1.67) (.90) Shares used in per share calculations .... 12,661 11,886 10,050 8,828 8,628 Consolidated balance sheet data Working capital ..........................$ 21,630 $ 20,532 $ 17,184 $ 8,703 $ 9,623 Total assets ............................. 34,447 30,134 24,555 14,145 14,130 Long-term debt ........................... - 22 38 57 - Convertible notes, due 1997 .............. 3,620 3,620 4,070 4,630 5,495 Accumulated deficit ...................... (72,985) (71,585) (53,090) (37,457) (22,728) Shareholders' equity ..................... 27,967 22,347 18,470 7,970 7,660
- 23 - Supplemental Comparative Financial Data (In thousands, except per share data) The following table sets forth selected supplemental consolidated income and balance sheet data of Epitope, Inc. and its subsidiaries; selected supplemental combined income and balance sheet data of Epitope Medical Products; and selected supplemental combined income and balance sheet data of Agritope. The balance sheet data at September 30, 1996 and 1995 and the operating results data for the years ended September 30, 1996, 1995, and 1994 have been derived from audited consolidated financial statements and notes thereto included in this Annual Report on Form 10-K. The balance sheet data at September 30, 1994, 1993 and 1992 and operating results data for the years ended September 30, 1993 and 1992 are unaudited, but, in the opinion of management, include all adjustments necessary for fair presentation. Net income (loss) per share for Epitope Medical Products and Agritope is presented on a proforma basis assuming that the distribution of Agritope Common Stock and redesignation of the Common Stock as Epitope Medical Products Common Stock had occurred on October 1, 1991. The following supplemental financial information has been restated to give effect to the merger with Andrew and Williamson Sales, Co. on December 12, 1996. The merger has been accounted for as a pooling of interests.
Year ended September 30 1996 1995 1994 1993 1992 Epitope Medical Products Combined operating results Revenues ................................. $ 5,594 $ 2,856 $ 2,605 $ 2,759 $ 2,985 Operating costs and expenses ............. 10,881 14,463 8,890 9,376 8,311 Other income (expense), net .............. 6,027 756 236 (1,276) 221 Net profit (loss) ........................ 739 (10,851) (6,048) (7,893) (5,106) Proforma net profit (loss) per share ..... .05 (.87) (.57) (.84) (.56) Proforma shares used in per share calculations ........................... 13,960 12,406 10,570 9,348 9,148 Combined balance sheet data Working capital .......................... $ 20,366 $ 15,449 $ 13,474 $ 7,029 $ 5,255 Total assets ............................. 24,350 21,831 17,183 10,381 7,954 Accumulated deficit ...................... (41,705) (42,444) (31,593) (25,545) (17,652) Group equity ............................. 22,532 18,035 15,661 9,280 7,178 Agritope Combined operating results Revenues ................................. $ 63,057 $ 54,289 $ 62,918 $ 39,796 $30,348 Operating costs and expenses ............. 63,390 62,059 71,024 45,503 32,745 Other expense, net ....................... (671) (252) (444) (184) (76) Net loss ................................. (1,004) (8,022) (8,550) (5,891) (2,473) Proforma net loss per share .............. (.15) (1.29) (1.62) (1.26) (.54) Proforma dividends per share ............. .20 .05 .10 .15 .03 Proforma shares used in per share calculations ........................... 6,591 6,203 5,285 4,674 4,574 Combined balance sheet data Working capital .......................... $ 754 $ 5,765 $ 5,185 $ 2,553 $ 4,845 Total assets ............................. 20,861 15,597 11,500 9,554 10,103 Long-term debt ........................... 528 1,648 1,714 1,648 1,080 Convertible notes, due 1997 .............. 3,620 3,620 4,070 4,630 5,495 Accumulated deficit ...................... (30,585) (28,255) (19,900) (10,809) (4,219) Group equity (deficit) ................... 6,152 5,219 4,429 (186) 1,360 Epitope, Inc. and Subsidiaries Consolidated operating results Revenues ................................. $68,650 $ 57,144 $ 65,523 $ 42,554 $ 33,333 Operating costs and expenses ............. 74,271 76,522 79,913 54,878 41,057 Other income (expense), net .............. 5,356 504 (208) (1,460) 145 Net loss ................................. (265) (18,874) (14,598) (13,784) (7,578) Net loss per share ....................... (.02) (1.52) (1.38) (1.47) (.83) Dividends per share ...................... .10 .03 .05 .07 .02 Shares used in per share calculations .... 13,181 12,406 10,570 9,348 9,148 Consolidated balance sheet data Working capital .......................... $ 21,120 $ 21,214 $ 18,659 $ 9,583 $ 10,100 Total assets ............................. 45,211 37,427 28,682 19,935 18,056 Long-term debt ........................... 528 1,648 1,714 1,648 1,080 Convertible notes, due 1997 .............. 3,620 3,620 4,070 4,630 5,495 Accumulated deficit ...................... (72,290) (70,700) (51,492) (36,354) (21,871) Shareholders' equity ..................... 28,684 23,254 20,089 9,095 8,539
- 24 - ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The following discussion of operations and financial condition should be read in conjunction with the Financial Statements and Notes thereto included elsewhere in this Annual Report on Form 10-K. Special Note: Certain statements set forth below constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. See "Note Regarding Forward-Looking Statements" on page 34 for additional factors relating to such statements. At the 1997 annual meeting, shareholders will vote on a proposal to create two new classes of common stock, one that will track the performance of the Company's agricultural operations and one that will track the performance of the Company's medical products business. The accompanying consolidated financial statements have been prepared to reflect the operating results and financial condition of the Company and its subsidiaries. In addition, combined proforma financial statements have been prepared to reflect, on a separate basis, assuming shareholder approval of the proposal, the operating results and financial condition of the two business groups. Under the proposed plan, a new class of common stock called Agritope Common Stock will be distributed to Epitope shareholders in the ratio of one-half share of Agritope stock for each outstanding share of existing common stock. In addition, Epitope shareholders will retain their existing common stock which will be redesignated as Epitope Medical Products Common Stock on a share-for-share basis. The approval of the distribution will not result in any transfer of assets or liabilities of the Company. The Company and its subsidiaries will continue to hold title to all its assets and be responsible for all its liabilities. Holders of the Epitope Medical Products and Agritope common stock will have no specific claim against the assets attributed for financial statement presentation purposes to the group whose performance is associated with the class of stock they hold. Liabilities or contingencies of either group that affect the Company's resources or financial condition could affect the financial condition or results of operations of both groups. The combined operating statements include the cost of certain corporate overhead services which are provided on a centralized basis for the benefit of both groups (Shared Services). Such expenses have been allocated to each group using activity indicators which, in the opinion of management, represent a reasonable measure of the respective group's utilization of or benefit from such Shared Services. Interest earned on investments has been allocated to each group in direct proportion to the allocation of Shared Services. See Note 2 to Historical Financial Statements. On December 12, 1996, the Company merged with Andrew and Williamson Sales, Co. (A&W) in a transaction accounted for as a pooling of interests. Accordingly, this Annual Report on Form 10-K includes both historical financial statements and supplemental financial statements which are restated to include the financial position and results of operations of A&W as if the merger had occurred on the first day of the earliest period presented. See Note 13 to Supplemental Financial Statements. The following discussion is a summary of key factors management considers necessary in reviewing the results of operations, liquidity and capital resources of the Company and its Epitope Medical Products and Agritope groups. - 25 - Historical Financial Statements Epitope Medical Products Results of Operations Revenues. The table below shows the percentage of Epitope Medical Products' total revenue contributed by each of its principal products and by grants and contracts.
Fiscal Year 1996 1995 1994 Percentage of Revenues from: Oral Specimen Collection Devices. . . 59% 34% 34% HIV Confirmatory Tests. . . . . . . . . 28% 64% 65% Grants and Contracts. . . . . . . . . . . 13% 2% 1%
Epitope Medical Products' product sales increased 73 percent in 1996, to $4.9 million, and 9 percent in 1995 as a result of expanded sales volume of its lead product, the EpiScreen/OraSure oral specimen collection device. Approximately 39 percent of 1996 sales were attributable to shipments in the fourth quarter. Grant and contract revenues amounted to $729,000 in 1996 due to funding of research projects by the group's marketing partner, SmithKline Beecham plc (SB). The oral specimen collection device, which is sold by the Company under the trade name EpiScreen(TM) and by SB under the trade name OraSure(R), accounted for revenues of $3.3 million in 1996, as compared to $981,000 in 1995, and $833,000 in 1994. The significant increase in 1996 sales resulted from increased sales volume following the June FDA clearance of the OraSure Western blot HIV confirmatory test. For the quarter ended December 31, 1996, sales of EpiScreen/OraSure amounted to $1.9 million, primarily due to increased sales volumes to the insurance testing market. The Company believes that at least 12 U.S. insurance companies currently use EpiScreen for underwriting risk analyses, including three firms in the top 20 life underwriters, and it believes that additional companies plan to commence use of EpiScreen in fiscal 1997. The Company believes that such adoptions of EpiScreen will result in increased sales, but it does not know the magnitude of such increases. Epitope Medical Products' Western blot HIV confirmatory test produced sales revenues of $1.5 million for 1996, 15 percent below prior year levels. Reduced sales to international markets accounted for the decline. In 1995, on the strength of increased market share in the U.S., confirmatory tests produced revenues of $1.8 million, representing a 7 percent increase over the prior fiscal year. As of September 30, 1996, Epitope Medical Products had firm orders totaling $1.8 million and $450,000, respectively, for delivery within 90 days of oral specimen collection devices and HIV confirmatory tests, as compared to $488,000 and $329,000, respectively, of firm orders for delivery within 90 days as of September 30, 1995. Gross Margins. Gross margins on product sales improved to 44.9 percent of sales in 1996 as a result of increased sales volume of EpiScreen/Orasure devices. Margins on EpiScreen/OraSure sales were negative in 1995 and 1994. For the fourth quarter of fiscal 1996, gross margins for product sales were 53 percent. The Company expects gross margins to increase if EpiScreen/OraSure sales volumes increase. Research and Development Expenses. Research and development expenses declined 31 percent to $3.2 million in 1996 as a result of cost reductions associated with the Company's September 1995 restructuring program as well as lower levels of clinical trials activity. Research and development expenses increased from $3.7 million in 1994 to $4.6 million in 1995. The increase resulted primarily from increased research projects and clinical trial activities. - 26 - Selling, General and Administrative Expenses. Selling, general and administrative expenses declined 25 percent to $5.0 million in 1996 primarily due to cost reductions implemented in the Company's restructuring program. Selling, general and administrative expenses increased by $3.6 million to $6.7 million in 1995 as a result of increased sales and marketing expenses associated with product launch following the December 1994 FDA approval of the EpiScreen/OraSure device for use in HIV screening. Selling, general and administrative expenses for 1995 included approximately $607,000 for severance payments and other costs associated with implementing the restructuring program. Selling, general and administrative expenses also included $3.0 million, $3.6 million and $1.9 million for the allocation of Shared Services in 1996, 1995 and 1994, respectively. Other Income (Expense), Net. Other income for 1996 included a $5.0 million license fee and $200,000 interest income earned from SB as a result of FDA approval of an extension of dating for the EpiScreen/OraSure device. Interest income increased from $236,000 in 1994 to $756,000 in 1995 due to an increase in funds available for investment. Liquidity and Capital Resources Cash, cash equivalents and marketable securities allocated to Epitope Medical Products as of year-end totaled $19.6 million in 1996 and $17.1 million in 1995. At September 30, 1996, Epitope Medical Products had working capital of $20.4 million, as compared to $15.4 million at September 30, 1995. Cash flows from operating activities increased significantly in 1996 due to the receipt of a non-recurring $5 million licensing fee from SB, as well as improved operating results from product sales and research contracts. Fluctuations in working capital components were primarily the result of timing differences. The Company invests its excess cash in marketable securities, and liquidates these securities as cash is needed. 1995 additions to property and equipment reflected investments to expand manufacturing and administrative facilities. Proceeds from the issuance of equity securities of the Company, augmented by funding from strategic partners and other research grants, have represented the primary sources of funds for meeting Epitope Medical Products' requirements for operations, working capital and business expansion. Epitope Medical Products anticipates that it will continue to need funds to support its operations and ongoing research and development projects as well as to provide additional manufacturing capacity and related increases in working capital. Epitope Medical Products intends to utilize cash reserves, cash generated from sales of products and research funding from SB and other strategic partners to provide the necessary funds. Epitope may also receive additional funds from the sale of equity securities or from the exercise of outstanding stock options and warrants. Epitope Medical Products may also receive funds from or transfer funds to Agritope. Such transfers will be either considered as borrowings or as an increase or decrease in an Inter-Group Interest as determined by the Board of Directors, who will also determine the amount of compensatory charges for such transfers, if any. - 27 - Historical Financial Statements Agritope Results of Operations Revenues. The table below shows the percentage of Agritope's total revenue contributed by each of its principal products and by grants and contracts:
Fiscal Year 1996 1995 1994 Percentage of Revenues from: Grape Plants......................................... --% 4% 1% Packaged Fresh Flowers............................... --% 91% 97% Grants and Contracts................................. 100% 5% 2% Revenues declined from $2.1 million in 1995 to $585,000 in 1996. Revenues for 1994 were $2.2 million. Revenues in 1995 and 1994 included product sales of $2.0 and $2.2 million, respectively, from Agritope's unprofitable wholesale fresh flower packaging and distribution operations (Agrimax) which were divested in the third quarter of fiscal 1995. A grant from the U.S. Department of Agriculture and grants from strategic partners accounted for the increase of grant and contract revenues from $94,000 in 1995 to $585,000 in 1996. Research and Development Expenses. Research and development expenses in 1996, 1995 and 1994 totaled $1.3 million, $2.2 million and $2.4 million, respectively. The decrease from 1995 to 1996 resulted from the divestiture of two Agritope business units. See Note 3 to Historical Financial Statements. Selling, General and Administrative Expenses. Selling, general and administrative expenses in 1996, 1995, and 1994 were $1.5 million, $4.5 million and $4.8 million, respectively. Costs in 1995 and 1994 included $2.8 million and $4.1 million, respectively, of costs incurred in Agritope's Agrimax and Vinifera business units, which were divested in 1995. Selling, general and administrative expenses include $1.1 million, $1.9 million and $1.7 million for the allocation of Shared Services in 1996, 1995 and 1994, respectively. The amount of allocated Shared Services decreased in 1996 as a result of the disposition of Agrimax and Vinifera. With the reacquisition of Vinifera in August 1996, the amount of allocated Shared Services is expected to increase slightly in 1997 and subsequent years. Other Income (Expense), Net. Interest income increased from $217,000 in 1994 to $408,000 in 1995 due to an increase in funds available for investment. Liquidity and Capital Resources Cash allocated to Agritope totaled $4.9 million at September 30, 1996 and $4.2 million at September 30, 1995. At September 30, 1996, Agritope had working capital of $1.3 million, as compared to $5.1 million at September 30, 1995. The decrease in working capital was principally attributable to the reclassification to current liabilities of $3.6 million of convertible notes which are due June 30, 1997. In November 1996, the Company accepted an offer from a representative of the holders of $3.4 million principal amount of such notes to convert them into 250,367 shares of common stock of the Company at a reduced conversion price of $13.50 per share. Accordingly, the Company will recognize a charge of approximately $1.2 million representing the conversion expense in the first quarter of fiscal year 1997. See Note 13 to Historical Financial Statements. Cash flows from operating activities improved significantly in 1996 largely due to the divestiture of Agrimax and Vinifera. Fluctuations in working capital components were primarily the result of timing differences. Additions to property and equipment decreased in 1995 primarily due to the divestiture of Agrimax and Vinifera and increased in 1996 as a result of expansion of greenhouse capacity at Vinifera, which was reacquired in August 1996. Expenditures for patents and proprietary technology increased in 1996 primarily related to the Company's ethylene control technology. - 28 - Proceeds from the issuance of equity securities of the Company, augmented by funding from strategic partners and other research grants, have represented the primary sources of funds for meeting Agritope's requirements for operations, working capital and business expansion. Agritope expects to continue to require funds to support its operations and research activities. Agritope intends to utilize cash reserves, cash generated from sales of products and research funding from strategic partners and other research grants to provide the necessary funds. Agritope may also receive additional funds from the sale of equity securities or the exercise of outstanding stock options and warrants. Agritope may also receive funds from or transfer funds to Epitope Medical Products. Such transfers will be either considered as borrowings or as an increase or decrease in an Inter-Group Interest as determined by the Board of Directors, who will also determine the amount of compensatory charges for such transfers, if any. Agritope's investments include the book value of the investment in two affiliates. Agritope holds an equity interest of approximately 9 percent in UAF, Limited Partnership, a fresh flower distributor in Tampa, Florida and a 19.5 percent interest in Petals USA, Inc., which operates a similar business in St. Paul, Minnesota. These equity interests were obtained in connection with the divestiture of Agrimax. Recent events have caused the Company to determine that the value of such investments has been permanently impaired. Accordingly, the Company anticipates a non-cash charge to results of operations of approximately $1.9 million in the first quarter of fiscal 1997. See Notes 3 and 13 to Historical Financial Statements. Historical Financial Statements Epitope, Inc. and Subsidiaries Results of Operations The Company reported revenues of $6.2 million, $5.0 million and $4.8 million, respectively, for the years ended September 30, 1996, 1995 and 1994. Product sales in 1996 increased due to higher sales volume for Epitope Medical Products, which more than offset a $2.0 million reduction in product sales for Agritope. Grant and contract revenues increased $681,000 for Epitope Medical Products due to research funding received from SB and $491,000 for Agritope which was attributable primarily to a Phase II SBIR grant. Net losses for 1996, 1995 and 1994 amounted to $1.4 million, $18.5 million and $15.6 million, respectively. The significant improvement in operating results in 1996 was due to (1) increased sales volumes and improved gross margins for Epitope Medical Products' EpiScreen/OraSure oral specimen collection device, (2) a $5.2 million fee and accrued interest from SB to Epitope Medical Products, (3) cost reductions realized as a result of a September 1995 restructuring program, and (4) reduced operating losses as a result of divestiture of Agrimax and Vinifera. The Company incurred expenses of $4.1 million, $5.5 million and $3.6 million in 1996, 1995 and 1994, respectively, to provide Shared Services to Epitope Medical Products and Agritope. The decrease in such costs in 1996 represented cost savings realized from the restructuring program implemented in September 1995. Such costs increased in 1995 over 1994 levels as the Company increased its infrastructure to respond to current growth and anticipated levels of activity for both groups. See Note 2 to Historical Financial Statements. Liquidity and Capital Resources Cash, cash equivalents and marketable securities on hand as of September 30, 1996 and 1995 totaled $24.5 million and $21.3 million. At September 30, 1996, the Company had working capital of $21.6 million, as compared to $20.5 million at September 30, 1995. In the financial statements, cash equal to 20 percent of the Company's cash, cash equivalents and marketable securities has been allocated to Agritope. Historically, cash was transferred to the Agritope operations in the form of intercompany loans. For the purpose of preparing the separate statements of Epitope Medical Products and - 29 - Agritope, such transfers and intercompany balances have been reflected as equity investments in Agritope. If the creation of a second class of common stock is approved, the Company will allocate $7.0 million of total cash to Agritope as contributed capital. Cash flows from operating activities improved significantly in 1996 due to the receipt of a non-recurring $5 million licensing fee from SB, as well as improved operating results from product sales and research contracts. Fluctuations in working capital components were primarily the result of timing differences. The Company invests its excess cash in marketable securities, and liquidates these securities as cash is needed. Additions to property and equipment decreased in 1995 primarily due to the divestiture of two Agritope business units. Expenditures for patents and proprietary technology increased in 1996 primarily related to the Company's ethylene control technology. Proceeds from the issuance of equity securities of the Company, augmented by funding from strategic partners and other research grants, have represented the primary sources of funds for meeting the Company's requirements for operations, working capital and business expansion. During 1996, the Company received proceeds of $5.9 million from the exercise of warrants and options to purchase common stock, as compared to $21.1 million in 1995. The Company anticipates that it will continue to need funds to support ongoing research and development projects as well as to provide additional manufacturing capacity and related increases in working capital. The Company intends to utilize cash reserves, cash generated from sales of products and research funding from SB and other strategic partners to provide the necessary funds. The Company may also receive additional funds from the sale of equity securities or the exercise of outstanding stock options and warrants. The Company believes that it has sufficient capital resources to fund operations and capital expenditures for at least the next two years based on currently expected future cash requirements, although no assurance to that effect can be given. - 30 - Supplemental Financial Statements Epitope Medical Products The only modification to the Historical Financial Statements of Epitope Medical Products appearing in the Supplemental Financial Statements are those required to reflect the issuance of 520,000 shares of common stock of the Company in connection with the merger with A&W. The Supplemental Financial Statements are presented as if the shares were outstanding on the first day of the earliest period presented. See "Historical Financial Statements--Epitope Medical Products." Supplemental Financial Statements Agritope (merged with Andrew and Williamson Sales, Co. in a pooling of interests) Results of Operations Revenues. The table below shows the percentage of Agritope's total revenue contributed by each of its principal products and by grants and contracts:
Fiscal Year 1996 1995 1994 Percentage of Revenues from: Fresh or Frozen Produce.............................. 99% 96% 97% Packaged Fresh Flowers............................... --% 4% 3% Grants and Contracts................................. 1% --% --%
Revenues increased to $63.1 million in 1996 as compared to $54.3 million in 1995 and $62.9 in 1994, primarily attributable to produce sales of A&W. Produce sales increased 20 percent in 1996 due to increased sales volume of vine ripe tomatoes, peppers and strawberries. For 1995, produce sales declined as compared to 1994 as a result of scaling back volume of vine ripe tomatoes, coupled with the loss of one contract grower. Revenues in 1995 and 1994 also included packaged fresh flower sales of $2.0 and $2.2 million, respectively, from Agritope's unprofitable wholesale fresh flower packaging and distribution operations (Agrimax) which were divested in the third quarter of fiscal 1995. A grant from the U.S. Department of Agriculture and grants from strategic partners accounted for the increase of grant and contract revenues from $94,000 in 1995 to $585,000 in 1996. Gross Profits. Gross profits in 1995 and 1994 were adversely affected by negative margins of $1.2 million and $2.4 million, respectively, experienced by Agritope's former fresh flower packaging operations. A&W realized gross profit margins of 8 percent, 6 percent, and 8 percent in 1996, 1995, and 1994, respectively. Gross profits for A&W in 1995 declined by $1.8 million, primarily due to reduced sales volume as well as a tomato crop failure experienced by one of A&W's contract growers. A&W gross profits were adversely affected by charges for costs in excess of the estimated market value of growing crops of $1.8 million, $2.5 million and $2.1 million for 1996, 1995 and 1994, respectively, representing 3 percent, 5 percent, and 3 percent of A&W sales, respectively. Such losses arose primarily from crop failures due to disease or weather conditions. A&W attempts to mitigate the risk of such losses by (1) using contract growers who assume the primary risk of loss, (2) closely monitoring crops in the field, (3) providing technical assistance to growers, (4) spreading its risk over a variety of crops grown at various times throughout the year, (5) establishing limitations on advances for growing crops to a given grower, based on past performance and current financial condition, and (6) diversifying its risk by using a number of different growers located in different geographical locations. However, it is difficult to completely mitigate such risks and the Company expects to incur such losses in the future. Research and Development Expenses. Research and development expenses in 1996, 1995 and 1994 totaled $1.3 million, $2.2 million and $2.4 million, respectively. The decrease from 1995 to 1996 resulted from the divestiture of the Agrimax and Vinifera business units. See Note 3 to Supplemental Financial Statements. - 31 - Selling, General and Administrative Expenses. Selling, general and administrative expenses in 1996, 1995 and 1994 were $4.8 million, $7.5 million and $8.3 million, respectively. Costs in 1995 and 1994 included $2.8 million and $4.1 million, respectively, of costs incurred at Agritope's Agrimax and Vinifera business units, which were divested in 1995. Selling, general and administrative expenses include $1.1 million, $1.9 million and $1.7 million for the allocation of Shared Services in 1996, 1995 and 1994, respectively. The amount of allocated Shared Services decreased in 1996 as a result of the disposition of Agrimax and Vinifera. With the reacquisition of Vinifera in August 1996, the amount of allocated Shared Services is expected to increase slightly in 1997 and subsequent years. The Company does not expect to allocate significant Shared Services costs to A&W in 1997 since A&W currently performs many of these services on a stand alone basis. Other Income (Expense), Net. Interest income increased from $217,000 in 1994 to $408,000 in 1995 due to an increase in funds available for investment. Interest expense in 1996 increased primarily due to an increase in borrowings under the A&W bank credit line. Liquidity and Capital Resources Cash allocated to Agritope totaled $4.9 million at September 30, 1996 and $4.2 million at September 30, 1995. At September 30, 1996, Agritope had working capital of $0.8 million, as compared to $5.8 million at September 30, 1995. The decrease in working capital was principally attributable to the reclassifications to current liabilities of $3.6 million of convertible notes which are due June 30, 1997, and $2.2 million of subordinated notes which A&W repaid in fiscal 1997. In November 1996, the Company entered into an agreement with holders of $3.4 million of convertible notes to convert them into 250,367 shares of common stock of the Company at a reduced conversion price of $13.50 per share. Accordingly, the Company will recognize a charge of approximately $1.2 million representing the conversion expense in the first quarter of fiscal 1997. See Note 13 to Supplemental Financial Statements. Cash flows from operating activities improved significantly in 1996 largely due to the divestiture of Agrimax and Vinifera. Fluctuations in working capital components were primarily the result of timing differences and, in 1995, lower sales volume at A&W. Additions to property and equipment decreased in 1995 primarily due to the divestiture of Agrimax and Vinifera and increased in 1996 as a result of expansion of greenhouse capacity at Vinifera, which was reacquired in August 1996. Expenditures for patents and proprietary technology increased in 1996 primarily related to the Company's ethylene control technology. Proceeds from the issuance of equity securities of the Company and A&W bank borrowings, augmented by funding from strategic partners and other research grants, have represented the primary sources of funds for meeting Agritope's requirements for operations, working capital and business expansion. Agritope expects to continue to require funds to support its operations and research activities. Agritope intends to utilize bank borrowings, cash reserves, cash generated from sales of products and research funding from strategic partners and other research grants to provide the necessary funds. Agritope may also receive additional funds from the sale of equity securities or the exercise of outstanding stock options and warrants. Agritope may also receive funds from or transfer funds to Epitope Medical Products. Such transfers will be either considered as borrowings or as an increase or decrease in Inter-Group Interest as determined by the Board of Directors who will also determine the amount of compensatory charges for such transfers, if any. Agritope's investments include the book value of the investment in two affiliates. Agritope holds an equity interest of approximately 9 percent in UAF, Limited Partnership, a fresh flower distributor in Tampa, Florida and a 19.5 percent interest in Petals USA, Inc., which operates a similar business in St. Paul, Minnesota. These equity interests were obtained in connection with divestiture of Agrimax's fresh flower distribution business. Recent events have caused the Company to determine that the value of such investments has been permanently impaired. Accordingly, the Company anticipates a non-cash charge to results of operations of approximately $1.9 million in the first quarter of fiscal 1997. See Notes 3 and 13 to Supplemental Financial Statements. - 32 - Supplemental Financial Statements Epitope, Inc. and Subsidiaries (merged with Andrew and Williamson Sales, Co. in a pooling of interests) Results of Operations The Company reported revenues of $68.7 million, $57.1 million and $65.5 million, respectively, for the years ended September 30, 1996, 1995 and 1994. A&W recorded sales of $62.5 million, $52.2 million and $60.7 million, respectively for such periods. Grant and contract revenues increased $681,000 for Epitope Medical Products due to research funding received from SB and $491,000 for Agritope which was attributable primarily to a Phase II SBIR grant. Net losses for 1996, 1995 and 1994 amounted to $0.3 million, $18.9 million and $14.6 million, respectively. The significant improvement in operating results in 1996 was due to (1) increased sales volumes and improved gross margins for Epitope Medical Products' EpiScreen/OraSure oral specimen collection device, (2) a $5.2 million fee and accrued interest from SB to Epitope Medical Products, (3) cost reductions realized as a result of a September 1995 restructuring program, (4) reduced operating losses as a result of divestiture of Agrimax and Vinifera and (5) operating profits from A&W. The Company incurred expenses of $4.1 million, $5.5 million and $3.6 million in 1996, 1995 and 1994, respectively, to provide Shared Services to Epitope Medical Products and Agritope. The decrease in such costs in 1996 represented costs savings realized from the restructuring program implemented in September 1995. Such costs increased in 1995 over 1994 levels as the Company increased its infrastructure to respond to current growth and anticipated levels of activity for both groups. See Note 2 to Supplemental Financial Statements. Liquidity and Capital Resources Cash, cash equivalents and marketable securities on hand as of September 30, 1996 and 1995 totaled $24.5 million and $21.3 million. At September 30, 1996, the Company had working capital of $21.1 million, as compared to $21.2 million at September 30, 1995. In the financial statements, cash equal to 20 percent of the Company's cash, cash equivalents and marketable securities has been allocated to Agritope. Historically, cash was transferred to the Agritope operations in the form of intercompany loans. For the purpose of preparing the separate statements of Epitope Medical Products and Agritope, such transfers and intercompany balances have been reflected as equity investments in Agritope. If the creation of a second class of common stock is approved, the Company will allocate $7.0 million of total cash to Agritope as contributed capital. Cash flows from operating activities improved significantly in 1996 due to the receipt of a non-recurring $5 million licensing fee from SB, as well as improved operating results from product sales and research contracts. Fluctuations in working capital components were primarily the result of timing differences and, in 1995, lower sales volume at A&W. The company invests its excess cash in marketable securities, and liquidates these securities as cash is needed. Additions to property and equipment decreased in 1995 primarily due to the divestiture of Agrimax and Vinifera. Expenditures for patents and proprietary technology increased in 1996 primarily related to the Company's ethylene control technology. Proceeds from the issuance of equity securities of the Company and A&W bank borrowings, augmented by funding from strategic partners and other research grants, have represented the primary sources of funds for meeting the Company's requirements for operations, working capital and business expansion. During 1996, the Company received proceeds of $5.9 million from the exercise of warrants and options to purchase common stock, as compared to $21.1 million in 1995. The Company anticipates that it will continue to need funds to support ongoing research and development projects as well as to provide additional manufacturing capacity and related increases in working capital. The Company intends to utilize cash reserves, cash generated from sales of products and research funding from SB and other strategic partners to provide the necessary funds. The Company may also receive additional funds from the sale - 33 - of equity securities or the exercise of outstanding stock options and warrants. The Company believes that it has sufficient capital resources to fund operations and capital expenditures for at least the next two years based on currently expected future cash requirements, although no assurance to that effect can be given. NOTE REGARDING FORWARD-LOOKING STATEMENTS Certain statements contained in this Annual Report on Form 10-K, including without limitation statements containing the words "believes," "anticipates," "intends," "expects" and words of similar import, constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company or industry results to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. These factors with respect to the Company include unexpected interruption of supply or manufacturing operations, changes in marketing partners' and customers' strategy or emphasis, development of competing products, market acceptance of oral testing, changes in insurance industry practices, unexpected delays or changes in the Company's business strategy, adverse growing conditions affecting crops, and other risks and uncertainties described in this Annual Report on Form 10-K. Certain of these factors are discussed in more detail in the Company's Registration Statement on Form S-4 (File No. 333-15705), under the caption "Risk Factors" and elsewhere. Given these uncertainties, shareholders are cautioned not to place undue reliance on the forward-looking statements. - 34 - ITEM 8. Financial Statements and Supplementary Data. Information with respect to this Item is (i) set forth below and (ii) contained in the Company's Consolidated Financial Statements included in Item 14 of this Annual Report on Form 10-K. - 35 - HISTORICAL QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (In thousands, except net income (loss) per share) The following table presents summarized historical quarterly results of operations for each of the fiscal quarters in the Company's fiscal years ended September 30, 1996 and 1995. These quarterly results are unaudited, but, in the opinion of management, have been prepared on the same basis as the Company's audited financial information and include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the information set forth therein. The summarized historical quarterly results of operations have not been restated to give effect to the merger with Andrew & Williamson Sales, Co. on December 12, 1996. The merger has been accounted for as a pooling of interests. See Supplemental Quarterly Results of Operations below. The data should be read in conjunction with the Financial Statements and related notes included in Item 14 of this Annual Report on Form 10-K.
First Second Third Fourth Epitope Medical Products Quarter Quarter Quarter Quarter Total Year ended September 30, 1996 Revenues........................... $1,225 $1,207 $1,107 $2,055 $ 5,594 Operating costs and expenses....... 2,510 2,819 2,507 3,045 10,881 Other income, net.................. 224 218 5,345 240 6,027 Net income (loss).................. (1,061) (1,394) 3,945 (751) 739 Proforma net income (loss) per share. (.08) (.11) .29 (.06) .06 Year ended September 30, 1995 Revenues........................... $ 715 $ 722 $ 873 $ 546 $ 2,856 Operating costs and expenses....... 2,679 3,288 3,823 4,673 14,463 Other income, net.................. 101 149 277 229 756 Net loss........................... (1,863) (2,417) (2,673) (3,898) (10,851) Proforma net loss per share........ (.17) (.21) (.22) (.31) (.91) First Second Third Fourth Agritope Quarter Quarter Quarter Quarter Total Year ended September 30, 1996 Revenues............................ $ 87 $263 $165 $ 70 $ 585 Operating costs and expenses........ 675 690 690 766 2,821 Other income (expense), net......... (3) 5 79 16 97 Net loss............................ (591) (423) (446) (679) (2,139) Proforma net loss per share......... (.09) (.07) (.06) (.11) (.34) Year ended September 30, 1995 Revenues............................ $ 419 $ 953 $ 695 $ 43 $2,110 Operating costs and expenses........ 2,891 3,433 2,201 1,395 9,920 Other income, net................... 33 65 31 37 166 Net loss............................ (2,439) (2,415) (1,475) (1,316) (7,645) Proforma net loss per share......... (.44) (.41) (.24) (.21) (1.29) First Second Third Fourth Epitope, Inc. and Subsidiaries Quarter Quarter Quarter Quarter Total Year ended September 30, 1996 Revenues............................ $1,311 $1,470 $1,272 $2,126 $6,179 Operating costs and expenses........ 3,185 3,510 3,197 3,810 13,702 Other income, net................... 222 223 5,425 253 6,123 Net income (loss)................... (1,652) (1,817) 3,500 (1,431) (1,400) Net income (loss) per share......... (.13) (.14) .25 (.11) (.11) Year ended September 30, 1995 Revenues............................ $1,135 $1,675 $1,569 $ 586 $4,965 Operating costs and expenses........ 5,571 6,721 6,025 6,066 24,383 Other income, net................... 134 214 308 266 922 Net loss............................ (4,302) (4,832) (4,148) (5,214) (18,496) Net loss per share.................. (.39) (.41) (.34) (.42) (1.56)
- 36 - SUPPLEMENTAL QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (In thousands, except net income (loss) per share) The following table presents summarized supplemental quarterly results of operations for each of the fiscal quarters in the Company's fiscal years ended September 30, 1996 and 1995. These quarterly results are unaudited, but, in the opinion of management, have been prepared on the same basis as the Company's audited financial information and include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the information set forth therein. The summarized supplemental quarterly results of operations have been restated to give effect to the merger with Andrew and Williamson Sales, Co. on December 12, 1996. The merger has been accounted for as a pooling of interests. The data should be read in conjunction with the Financial Statements and related notes included in Item 14 of this Annual Report on Form 10-K.
First Second Third Fourth Epitope Medical Products Quarter Quarter Quarter Quarter Total Year ended September 30, 1996 Revenues............................ $1,225 $1,207 $1,107 $2,055 $5,594 Operating costs and expenses........ 2,510 2,819 2,507 3,045 10,881 Other income, net................... 224 218 5,345 240 6,027 Net income (loss)................... (1,061) (1,394) 3,945 (751) 739 Proforma net income (loss) per share. (.08) (.11) .27 (.06) .05 Year ended September 30, 1995 Revenues............................ $ 715 $ 722 $ 873 $ 546 $ 2,856 Operating costs and expenses........ 2,679 3,288 3,823 4,673 14,463 Other income net.................... 101 149 277 229 756 Net loss............................ (1,863) (2,417) (2,673) (3,898) (10,851) Proforma net loss per share......... (.16) (.20) (.21) (.30) (.87) First Second Third Fourth Agritope Quarter Quarter Quarter Quarter Total Year ended September 30, 1996 Revenues............................ $12,978 $10,291 $26,658 $13,130 $63,057 Operating costs and expenses........ 13,671 9,917 26,323 13,479 63,390 Other expense, net.................. (132) (189) (181) (169) (671) Net income (loss)................... (825) 184 154 (517) (1,004) Proforma net income (loss) per share. (.13) .03 .02 (.08) (.15) Year ended September 30, 1995 Revenues............................ $15,120 $ 9,682 $17,080 $12,407 $54,289 Operating costs and expenses........ 18,217 11,499 18,912 13,431 62,059 Other expense, net.................. (78) (19) (77) (78) (252) Net loss............................ (3,175) (1,836) (1,909) (1,102) (8,022) Proforma net loss per share......... (.55) (.30) (.30) (.17) (1.29) First Second Third Fourth Epitope, Inc. and Subsidiaries Quarter Quarter Quarter Quarter Total Year ended September 30, 1996 Revenues............................ $14,202 $11,498 $27,765 $15,185 $68,650 Operating costs and expenses........ 16,181 12,737 28,830 16,523 74,271 Other income, net................... 93 29 5,165 69 5,356 Net income (loss)................... (1,886) (1,210) 4,100 (1,269) (265) Net income (loss) per share......... (.14) (.09) .29 (.09) (.02) Year ended September 30, 1995 Revenues............................ $15,836 $10,404 $17,954 $12,950 $57,144 Operating costs and expenses........ 20,896 14,788 22,736 18,102 76,522 Other income, net................... 22 130 200 152 504 Net loss............................ (5,038) (4,253) (4,582) (5,001) (18,874) Net loss per share.................. (.44) (.35) (.36) (.39) (1.52)
- 37 - ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. PART III ITEM 10. Directors and Executive Officers of the Registrant. Directors The following table presents the name, age as of February 28, 1997, principal occupation, period of service, and term of office of each director of the Company.
DIRECTOR NAME PRINCIPAL OCCUPATION AGE SINCE - ---- -------------------- --- ----- Class I (Directors Whose Terms of Office Expire in 1997): W. Charles Armstrong Private Investor 52 1989 Adolph J. Ferro, Ph.D. President and Chief Executive 54 1990 Officer of the Company Roger L. Pringle President of The Pringle Company, 56 1989 a management consulting firm, Portland, Oregon Class II (Directors Whose Terms of Office Expire in 1999): Andrew S. Goldstein Senior Vice President of Advanced 48 1981 Technology Development - Epitope Medical Products R. Douglas Norby Executive Vice President and Chief 61 1989 Financial Officer of LSI Logic Corporation, a designer and producer of advanced custom semiconductors, Milpitas, California G. Patrick Sheaffer Chairman, President and Chief 57 1983 Executive Officer of Riverview Savings Bank, Camas, Washington Class III (Directors Whose Terms of Office Expire in 1998): Richard K. Donahue Vice Chairman of NIKE, Inc., a 69 1991 sporting goods manufacturer, Beaverton, Oregon Margaret H. Jordan President and Chief Executive 54 1995 Officer of Dallas Medical Resource, a not-for-profit medical referral firm, Dallas, Texas - 38 - Michael J. Paxton Chairman, President and Chief 50 1995 Executive Officer of O'Cedar Holdings, Inc., a manufacturer of household cleaning products, Springfield, Ohio
W. Charles Armstrong is a director of Pacificorp. He was Chairman and Chief Executive Officer of Bank of America Oregon from September 1992 until September 1996. From April to September 1992, he was Chairman and Chief Executive Officer of Bank of America Idaho. Mr. Armstrong served as President and Chief Operating Officer of Honolulu Federal Savings Bank from February 1989 to April 1992. Prior to February 1989, he was President and Chief Executive Officer of West One Bank, Oregon. Richard K. Donahue has been Vice Chairman of NIKE, Inc. since June 1994. Mr. Donahue served as President and Chief Operating Officer of NIKE, Inc. from 1990 to June 1994 and has served as a director of that company since 1977. Mr. Donahue is also a partner in the law firm of Donahue & Donahue, Lowell, Massachusetts, and a director of Courier Corp. Adolph J. Ferro, Ph.D., has been President and Chief Executive Officer of the Company since April 1990. Dr. Ferro was Senior Vice President from November 1988 until April 1990. From July 1987 until November 1988, he was Vice President of Research and Development. He was a cofounder of Agricultural Genetic Systems, Inc., which the Company acquired in 1987. Prior to joining the Company, he was a Professor in the Department of Microbiology at Oregon State University ("OSU"). From 1981 to 1986, he was an Associate Professor at OSU, and from 1978 to 1981, he was an Assistant Professor at OSU. From 1975 to 1978, he was Assistant Professor at the University of Illinois at Chicago in the Department of Biological Sciences. Dr. Ferro received a B.A. degree from the University of Washington in 1965, an M.S. degree in biology from Western Washington University in 1970, and a Ph.D. in bacteriology and public health from Washington State University in 1973. Andrew S. Goldstein is a Senior Vice President of the Company's Epitope Medical Products group, a position he has held since June 1990. Prior to that time, he had been Vice President of Product Development from December 1988, Vice President of Scientific Affairs from July 1987 to December 1988, and Vice President of Research and Development from 1981 until July 1987. He also has served as Secretary from December 1988 to February 1993 and from November 1995 to the present and served as Treasurer until March 1991. Mr. Goldstein was Research Associate and supervisor of the Histocompatibility Laboratory at the Oregon Health Sciences University ("OHSU"), where he was engaged in paternity testing and transplantation immunology, from 1974 to 1981. Mr. Goldstein received a B.S. degree in microbiology from Cornell University in 1969 and an M.S. degree in cytology from Fordham University in 1973. Margaret H. Jordan joined Dallas Medical Resource ("DMR") as President and Chief Executive Officer in February 1996. DMR is a not-for-profit alliance of major medical organizations of Dallas, Texas, created to make Dallas a regional, national and international center for medical referrals. Ms. Jordan had been Vice President of Health Care & Employee Services at Southern California Edison Co. since December 1992. She had been a Vice President and Regional Manager with the Kaiser Foundation Health Plan of Texas, Inc. beginning in 1986, and was an Associate Regional Manager of Kaiser Foundation Health Plan of Georgia, Inc. from 1984 to 1986. Ms. Jordan received a B.S. degree in Nursing from Georgetown University in 1964 and an M.S. degree in Public Health from the University of California, Berkeley, in 1972. She also serves on the board of directors of Eckerd Corporation. R. Douglas Norby became Executive Vice President and Chief Financial Officer of LSI Logic Corporation in October 1996. From July 1993 until assuming his present position, he was Senior Vice President and Chief Financial Officer of Mentor Graphics Corporation. Prior to joining Mentor Graphics Corporation, he had been President and Chief Executive Officer of Pharmetrix Corporation, a biopharmaceutical company in Menlo Park, California, since July 1992. Prior to that time, he had been President of Lucasfilm, Ltd., since 1985 and President and Chief Executive Officer of LucasArts Entertainment Company since 1990. - 39 - Prior to joining Lucasfilm, Ltd., Mr. Norby was Senior Vice President and Chief Financial Officer of Syntex Corporation from 1979 to 1985. Mr. Norby also serves on the board of directors of LSI Logic Corporation. Michael J. Paxton became Chairman, President and Chief Executive Officer of O'Cedar Holdings, Inc. in January 1996. From March 1992 until joining O'Cedar Holdings, Inc., he was President and Chief Executive Officer of The Haagen-Dazs Company, Inc. Prior to that he was President of the Baked Goods Division of The Pillsbury Company. Both companies are subsidiaries of Grand Metropolitan PLC. He has been a director of Agritope, Inc. since September 1992 and is also a director of Transport Corporation of America, Inc. Roger L. Pringle has been Chairman of the Board of the Company since April 1990, and is also a director of Agritope, Inc. He is President of The Pringle Company, a management consulting firm in Portland, Oregon, which he founded in 1975. G. Patrick Sheaffer has been President of Riverview Savings Bank in Camas, Washington, since 1979, and has served as a director of the bank since 1983. In 1993, Mr. Sheaffer also became Chairman and Chief Executive Officer of Riverview Savings Bank and Riverview Mutual Holding Company, a bank holding company. He has been a director of the Washington Savings League since 1980. - 40 - Executive Officers The following table presents the names, ages and positions of the Company's executive officers at February 28, 1997:
NAME OF EXECUTIVE OFFICER AGE POSITION Adolph J. Ferro, Ph.D. 54 President, Chief Executive Officer and Director(1) Gilbert N. Miller 55 Executive Vice President, Chief Financial Officer and Treasurer(1) John H. Fitchen, M.D. 51 Senior Vice President and Chief Operating Officer--Epitope Medical Products(1) Andrew S. Goldstein 48 Senior Vice President of Advanced Technology Development--Epitope Medical Products, Secretary and Director Richard K. Bestwick, Ph.D. 43 Senior Vice President and Chief Operating Officer--Agritope(1) Joseph A. Bouckaert 56 President and Chief Executive Officer-- Vinifera, Inc.(1) Byron A. Allen, Jr. 65 Vice President of Corporate Communications(1) Fred L. Williamson 60 President and Chief Executive Officer-- Andrew and Williamson Sales, Co.(1) - --------------- (1) Member of the Company's Business Policy Committee.
Officers of the Company hold office at the discretion of the Board. For biographical summaries of Dr. Ferro and Mr. Goldstein, see "Directors" above. Gilbert N. Miller joined the Company in June 1989 as Executive Vice President and Chief Financial Officer and has served as the Company's Treasurer since March 1991. He has also been a Senior Vice President of Agritope, Inc. since September 1992 and its Chief Financial Officer since December 1991. From 1987 to 1989, he was Executive Vice President, Finance and Administration, of Northwest Marine Iron Works, a privately held ship repair contractor located in Portland, Oregon. From 1986 to 1987, he was Vice President/Controller of the Manufacturing Group of Morgan Products, Ltd., a manufacturer and distributor of specialty building products based in Oshkosh, Wisconsin. He also held the position of Senior Vice President/Finance of Nicolai Company, a Portland wood door manufacturing concern which became a wholly owned subsidiary of Morgan Products, Ltd., in 1986. Mr. Miller received a B.S. degree from Oregon State University and a Master of Business Administration degree from University of Oregon. He is a certified public accountant. John H. Fitchen, M.D., joined the Company in July 1990 as Vice President of Research and Clinical Activities, was appointed Senior Vice President in September 1993, and assumed the additional position of Chief Operating Officer-Epitope Medical Products in November 1994. Prior to joining the Company, Dr. Fitchen was Associate Chief of Staff for Research at the Portland Veterans Administration Medical Center in Portland, - 41 - Oregon, and Professor of Medicine at OHSU. Dr. Fitchen received his M.D. degree from the University of Rochester School of Medicine and a B.A. degree from Amherst College. He completed his clinical training in Internal Medicine at OHSU in 1976 and in Hematology/Oncology at the University of California, Los Angeles, in 1978. Richard K. Bestwick, Ph.D., joined Epitope in August 1987 and was appointed Senior Vice President of Agritope, Inc. in September 1992. He was appointed to the additional position of Chief Operating Officer of Agritope, Inc. in October 1996. Prior to joining Epitope, he was a Research Assistant Professor in the Department of Biochemistry at the Oregon Health Sciences University, where he also completed his postdoctoral training. Dr. Bestwick received a Ph.D. in Biochemistry and Biophysics from Oregon State University and a B.S. degree from Evergreen State College. Joseph A. Bouckaert joined Vinifera, Inc. as its President and Chief Executive Officer at the inception of the Company in March 1993. From 1988 to 1991 he was Vice Chairman of DNA Plant Technology Corporation, a publicly held agricultural biotechnology company with offices in Cinnaminson, New Jersey, and Oakland, California. He also was a co-founder and member of the board of directors of Florigene, B.V., an agricultural biotechnology company focused on the flower business and located in the Netherlands. From 1985 to 1988, he served as President and Chief Executive Officer of Advanced Genetic Sciences Inc. a publicly held biotechnology company located in Oakland, California. In 1982, Mr. Bouckaert co-founded Plant Genetic Systems, N.V., a privately held agricultural biotechnology company located in Brussels, Belgium, and served as its first Managing Director from 1982 through 1986. Mr. Bouckaert received a Juris Doctor degree from the University of Leuven in Belgium and postgraduate degrees in Business Administration from the University of Ghent in Belgium, and the University of Kentucky in Lexington, Kentucky. Byron A. Allen, Jr., joined the Company in July 1995. Prior to joining the Company, from 1993 to 1995, Mr. Allen was Senior Vice President, Equity Portfolio Manager, for C.J. Lawrence/Deutsche Bank Securities Corporation, New York. From 1978 to 1993, he was Director of Retail Brokerage Service, C.J. Lawrence, Incorporated. Mr. Allen holds an A.B. degree from Dartmouth College and a Master of Business Administration degree from the Amos Tuck School of Business Administration. Fred L. Williamson has been President of Andrew and Williamson Sales, Co., which produces, markets, distributes and sells a wide variety of fresh fruits and vegetables throughout North America, since 1987. A&W was acquired by the Company in December 1996. Mr. Williamson has been involved in the business of marketing and shipping fresh produce since 1962. There are no family relationships between any of the Company's directors or executive officers. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Exchange Act requires the Company's officers and directors and persons who own more than 10 percent of the Epitope Common Stock (collectively, "Reporting Persons") to file reports of ownership and changes in ownership with the Securities and Exchange Commission (the "Commission"). Reporting persons are required by the Commission's regulations to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms and written representations regarding the absence of a filing requirement received from Reporting Persons, the Company believes that with respect to the 1996 fiscal year, all Reporting Persons complied with all applicable filing requirements, except that T. J. Paulsen, the Company's principal accounting officer until November 11, 1996, filed one report relating to one transaction after the filing deadline; Richard K. Bestwick, Ph.D., Senior Vice President and Chief Operating Officer--Agritope, and Joseph A. Bouckaert, President and Chief Executive Officer--Vinifera, Inc., each filed his initial report of his stockholdings upon becoming an executive officer of Epitope after the filing deadline; and Byron A. Allen, Jr., Vice President of Corporate Communications of the Company, and Richard K. Donahue, a director of the Company, each filed one report of an option grant after the filing deadline. - 42 - ITEM 11. Executive Compensation. SUMMARY COMPENSATION TABLE The following table summarizes the compensation for the last three fiscal years of the Chief Executive Officer and the four other most highly compensated executive officers of the Company (together, the "Named Executive Officers") during the 1996 fiscal year.
Long-Term Compensation Awards Annual Compensation Securities All Other Underlying Compen- Name and Principal Position Year Salary Bonus Options (#)(1) sation(2) Adolph J. Ferro, Ph.D. 1996 $214,183 $ 50,000 - $ 4,237 President and Chief Executive 1995 200,769 113,245 74,000 5,390 Officer 1994 135,000 - - 3,375 Gilbert N. Miller 1996 128,510 33,075 - 3,206 Executive Vice President, 1995 130,962 - 34,000 5,021 Chief Financial Officer, 1994 120,000 - - 3,000 and Treasurer John H. Fitchen, M.D. 1996 147,548 37,200 - 3,540 Senior Vice President and 1995 148,606 - 43,000 3,578 Chief Operating Officer-- 1994 131,250 - - 3,057 Epitope Medical Products Andrew S. Goldstein 1996 128,510 30,000 - 3,206 Senior Vice President of 1995 126,923 - 34,000 3,182 Advanced Technology 1994 105,000 - - 2,625 Development--Epitope Medical Products Richard K. Bestwick, Ph.D.(3) 1996 91,385 20,160 - 2,280 Senior Vice President and Chief Operating Officer-- Agritope (1) Represents the number of shares for which options were awarded. No SARs have been granted to any Named Executive Officer during the years indicated. (2) Represents amounts contributed to the Company's 401(k) Profit Sharing Plan as employer matching contributions in the form of Epitope Common Stock. (3) Dr. Bestwick was not an executive officer of Epitope during fiscal 1995 or 1994.
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AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES(1) Number of Securities Underlying Unexercised Value of Unexercised In-the-Money Shares Options at Fiscal Year-End Options at Fiscal Year-End(2) Acquired On Value Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable Adolph J. Ferro, Ph.D. 20,000 $173,722 496,061 60,143 $2,800,693 $69,583 Gilbert N. Miller 16,000 141,440 181,299 27,805 1,024,121 642 John H. Fitchen, M.D. - - 160,133 28,667 1,001,375 - Andrew S. Goldstein 25,000 188,034 165,444 28,556 1,092,090 37,910 Richard K. Bestwick, Ph.D. 2,750 32,313 57,632 18,472 31,058 642
- -------------------- (1) The Named Executive Officers did not hold any SARs at September 30, 1996. (2) In-the-money stock options are options for which the exercise price is less than the market value of the underlying stock on a particular date. The values shown in the table are based on the difference between $15.0625, which was the average of the high and low sales prices of the Epitope Common Stock on the AMEX on September 30, 1996, and the applicable exercise price. Compensation of Directors Under the terms of the Epitope, Inc. 1991 Stock Award Plan (the "Award Plan") in effect during the 1996 fiscal year, nonemployee directors of the Company were eligible to receive nonqualified stock options granted on a nondiscretionary basis, as described below. Initial Options. Upon becoming a nonemployee director, each such director has been granted a stock option to purchase 50,000 shares of Epitope Common Stock (an "Initial Option"). A newly-elected Chairman of the Board has been entitled to receive an Initial Option to purchase an additional 25,000 shares (75,000 shares if not previously a nonemployee director). Until December 1994, Initial Options were granted at an exercise price equal to 75 percent of the fair market value of a share of Epitope Common Stock on the date of grant; beginning in December 1994, Initial Options have been granted at an exercise price equal to the fair market value of a share on the date of grant minus the lesser of (a) $2.00 or (b) 25 percent of the fair market value. Each Initial Option becomes exercisable in annual installments based on continued service as a director and expires at the end of five years following the director's retirement or one year following the director's death, disability or cessation of service as a director for any other reason. An Initial Option will generally become fully exercisable by the date of the fourth annual meeting of shareholders through which the director has served on the Board. Initial Options become exercisable in full immediately upon the happening of a change in control of the Company. A change in control of the Company would occur on the happening of such events as the beneficial ownership by a person or group of 30 percent or more of the outstanding common stock, certain changes in Board membership affecting a majority of positions, certain mergers or consolidations, a sale or other transfer of all or substantially all the Company's assets, or approval by the shareholders of a plan of liquidation or dissolution of the Company, as well as any change in control required to be reported by the proxy disclosure rules of the Commission. Payment of the exercise price may be made in cash or by delivery of previously acquired shares of common stock having a fair market value equal to the aggregate exercise price. To the extent that payment is made in previously acquired shares, the director is automatically granted a replacement ("reload") option for a number of shares equal to the number delivered upon exercise with an exercise price equal to the fair market value of a share of common stock on the date of exercise. Reload options become exercisable in full six months after the grant date. Renewal Options. Additional nonqualified stock options are also granted to each nonemployee director to purchase 15,000 shares of Epitope Common Stock ("Renewal Options") as of the December 15 prior to the - 44 - annual meeting of shareholders at which the options most recently granted to the nonemployee director fully vest. Renewal Options vest in three equal annual installments beginning with the second annual meeting of shareholders following the date of grant, subject to acceleration of vesting upon the occurrence of a change in control of the Company. The other terms of Renewal Options are comparable to those of Initial Options, except that Renewal Options do not provide for reload options. Agritope Options. Mr. Paxton and Mr. Pringle, as nonemployee directors of Agritope, were each awarded nonqualified options for 50,000 shares of Agritope common stock under the Agritope, Inc. 1992 Stock Award Plan. The options have an exercise price of $5.625 per share, which was equal to 75 percent of the fair market value of Agritope, Inc. common stock on the date of grant, September 14, 1992, based on a good faith determination of fair market value by the Agritope, Inc. board of directors. The options are fully vested. Until Agritope, Inc. ceases to be a wholly owned subsidiary of the Company, shares of Agritope, Inc. common stock received upon exercise of the foregoing options must be exchanged for shares of Epitope Common Stock based on a ratio of 2.433 shares of Agritope, Inc. common stock for each share of Epitope Common Stock. Accordingly, upon exercise of the foregoing options in full, Messrs. Paxton and Pringle would each receive a total of 20,552 shares of Epitope Common Stock, or a corresponding number of shares of Medical Products Stock and Agritope Stock if the Agritope Stock Proposal is approved. Employment Agreements Pursuant to written employment agreements with the Company, the Named Executive Officers each are entitled to receive one year of salary in the event of termination without cause (two years in the case of Dr. Ferro) or two years of salary if terminated without cause within 12 months following a change in control (within the meaning of the Exchange Act) or sale of substantially all the assets of the Company (three years in the case of Dr. Ferro). The agreements in each case prohibit the officer from competing with the Company for one year unless the officer elects to waive the right to amounts otherwise payable. The agreements do not expire by their terms and are terminable by the Company on 90 days' notice with cause or, subject to payment of the salary amounts described above, without cause. ITEM 12. Security Ownership of Certain Beneficial Owners and Management. The following table sets forth information as of September 30, 1996, regarding the beneficial ownership of Epitope Common Stock by (a) each person who is known to the Company to be the beneficial owner of more than 5 percent of Epitope Common Stock outstanding, (b) each director and nominee for election as director, (c) each of the Named Executive Officers, and (d) all directors and executive officers of the Company as a group.
Amount and Nature Percent 5% Shareholders, Directors and of Beneficial of Officers Ownership(1)(2) Class Groupe des Assurances Nationales 1,242,108(3) 9.1% 61 Rue Monceau Paris 75008 France W. Charles Armstrong 59,540(4) * Richard K. Bestwick, Ph.D. 67,382 * Richard K. Donahue 57,000(4) * Adolph J. Ferro, Ph.D. 496,901(5) 3.7 John H. Fitchen, M.D. 164,461(4) 1.3 Andrew S. Goldstein 427,921(5) 3.3 - 45 - Margaret H. Jordan 10,000 * Gilbert N. Miller 182,961(5) 1.4 R. Douglas Norby 58,750 * Michael J. Paxton 30,552 * Roger L. Pringle 114,677 * G. Patrick Sheaffer 80,000 * All directors and executive officers as a group (15 persons) 1,794,545(4)(5) 12.5
*Less than 1% (1) Subject to community property laws where applicable, beneficial ownership consists of sole voting and investment power except as otherwise indicated. (2) Includes shares subject to options and warrants exercisable within 60 days of September 30, 1996, by directors and executive officers as follows: Mr. Armstrong, 55,000 shares; Dr. Bestwick, 67,382 shares (including options for 9,750 shares held by his wife); Mr. Donahue, 50,000 shares; Dr. Ferro, 496,061 shares; Dr. Fitchen, 160,133 shares; Dr. Goldstein, 165,444 shares; Ms. Jordan, 10,000 shares; Mr. Miller, 181,299 shares; Mr. Norby, 55,000 shares; Mr. Paxton, 30,552 shares; Mr. Pringle, 100,552 shares; Mr. Sheaffer, 67,500 shares; and all directors and executive officers as a group, 1,454,173 shares. (3) Includes 595,000 shares subject to warrants exercisable within 60 days of September 30, 1996 and 128,008 shares issuable upon conversion of convertible notes. (4) Includes shares as to which the individual has shared voting and dispositive power as follows: Mr. Armstrong, 165 shares; Mr. Donahue, 1,000 shares; Dr. Fitchen, 100 shares; and all directors and executive officers as a group, 2,265 shares. (5) Does not include 17,035 shares of Epitope Common Stock held in the 401(k) Plan, as to which Messrs. Ferro, Goldstein and Miller share voting power as trustees of the 401(k) Plan. Messrs. Ferro, Goldstein and Miller disclaim any economic beneficial interest in such shares other than the 798, 636, and 711 shares, respectively, allocated to their individual accounts under the 401(k) Plan. ITEM 13. Certain Relationships and Related Transactions. In connection with the December 1987 merger of Agricultural Genetic Systems, Inc. ("AGS"), with and into Agritope, Inc. Dr. Ferro, as an executive officer and principal shareholder of AGS, was granted a royalty equal to 4 percent of net sales of products resulting from the technology transferred to Agritope pursuant to the merger; royalties with respect to a particular product were to be paid for a period equal to the life of the patent on the product or an equivalent period if a patent is not issued. On November 11, 1996, Dr. Ferro agreed to accept a one-time payment of $590,000 in lieu of the royalties that would otherwise be due him. In September 1996, the Company extended the expiration date of certain warrants issued in private placement transactions in September 1991, December 1992, and July and August 1993, to purchase Epitope Common Stock at prices of $16.00, $16.00, $20.00 and $18.50 per share, respectively. The warrants would have otherwise expired in September 1996 and March 1997, if not exercised. The Company extended the - 46 - expiration date of the warrants to September 30, 1997. The warrants were extended because they represent a significant potential source of additional capital. Holders of the warrants included Groupe des Assurances Nationales ("GAN"), which beneficially owns more than 5 percent of the Epitope Common Stock outstanding. As of September 30, 1996, GAN held September 1991 warrants to purchase 80,000 shares of Epitope Common Stock, December 1992 warrants to purchase 270,000 shares of Epitope Common Stock, July 1993 warrants to purchase 195,000 shares of Epitope Common Stock, and August 1993 warrants to purchase 50,000 shares of Epitope Common Stock. On November 14, 1996, the Company agreed to exchange $3,380,000 principal amount of Agritope 4% Convertible Notes Due 1997 for 250,367 shares of Epitope Common Stock at a reduced exchange price of $13.50 per share. The original terms of the notes permitted the holders to exchange them for Epitope Common Stock at an exchange price of $19.53 per share. Holders exchanging their notes at the reduced exchange price included GAN, which exchanged $2,500,000 principal amount of notes for 185,185 shares of Epitope Common Stock. In connection with the acquisition of A&W on December 12, 1996, the Company renegotiated the terms of a $6.5 million line of credit extended to A&W by Wells Fargo Bank, National Association. The line of credit had previously been guaranteed by the four former shareholders of A&W, including Fred L. Williamson, now an executive officer of the Company. Under the renegotiated terms of the line of credit, Epitope, Inc. will guarantee A&W's obligations under the line of credit and the guarantees of the former shareholders will be released. See Note 13 to Historical Financial Statements included in Annex III. A&W leases its main distribution facility in San Diego, California, from Fred Andrew and Fred L. Williamson, under a lease agreement expiring August 31, 2001, with an option to extend the lease term for an additional five years. The lease calls for rent payments of $11,000 per month during the initial term. See Item 2, Properties. PART IV ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (a)(1) and (a)(2) Consolidated Financial Statements and Schedules. - 47 -
Index to Financial Statements Page ---- Historical Financial Statements Report of Independent Accountants......................................................................................49 Epitope Medical Products Combined Balance Sheets at September 30, 1996 and 1995.................................................................50 Combined Statements of Operations for years ended September 30, 1996, 1995, and 1994...................................51 Combined Statements of Changes in Group Equity for years ended September 30, 1996, 1995, and 1994......................52 Combined Statements of Cash Flows for years ended September 30, 1996, 1995, and 1994...................................53 Agritope Combined Balance Sheets at September 30, 1996 and 1995.................................................................54 Combined Statements of Operations for years ended September 30, 1996, 1995, and 1994...................................55 Combined Statements of Changes in Group Equity for years ended September 30, 1996, 1995, and 1994......................56 Combined Statements of Cash Flows for years ended September 30, 1996, 1995, and 1994...................................57 Epitope, Inc. and Subsidiaries Consolidated Balance Sheets at September 30, 1996 and 1995.............................................................58 Consolidated Statements of Operations for years ended September 30, 1996, 1995, and 1994...............................59 Consolidated Statements of Changes in Shareholders' Equity for years ended September 30, 1996, 1995, and 1994.............................................................................................................60 Consolidated Statements of Cash Flows for years ended September 30, 1996, 1995, and 1994...............................61 Notes to Historical Financial Statements...............................................................................62 Supplemental Financial Statements Report of Independent Accountants......................................................................................77 Report of Independent Auditors.........................................................................................78 Epitope Medical Products Combined Balance Sheets at September 30, 1996 and 1995.................................................................79 Combined Statements of Operations for years ended September 30, 1996, 1995, and 1994 ..................................80 Combined Statements of Changes in Group Equity for years ended September 30, 1996, 1995, and 1994......................81 Combined Statements of Cash Flows for years ended September 30, 1996, 1995, and 1994...................................82 Agritope (merged with Andrew and Williamson Sales, Co. in a pooling of interests) Combined Balance Sheets at September 30, 1996 and 1995.................................................................83 Combined Statements of Operations for years ended September 30, 1996, 1995, and 1994 ..................................84 Combined Statements of Changes in Group Equity for years ended September 30, 1996, 1995, and 1994......................85 Combined Statements of Cash Flows for years ended September 30, 1996, 1995, and 1994...................................86 Epitope, Inc. and Subsidiaries (merged with Andrew and Williamson Sales, Co. in a pooling of interests) Consolidated Balance Sheets at September 30, 1996 and 1995.............................................................87 Consolidated Statements of Operations for years ended September 30, 1996, 1995, and 1994 ..............................88 Consolidated Statements of Changes in Shareholders' Equity for years ended September 30, 1996, 1995, and 1994.............................................................................................................89 Consolidated Statements of Cash Flows for years ended September 30, 1996, 1995, and 1994...............................90 Notes to Supplemental Financial Statements.............................................................................91
- 48 - Historical Financial Statements Report of Independent Accountants To the Board of Directors and Shareholders of Epitope, Inc. In our opinion, the accompanying balance sheets and the related statements of operations, of changes in shareholders'/group equity, and of cash flows present fairly, in all material respects, the financial position of Epitope Medical Products group and Agritope group (as described in Note 1 to these financial statements) and Epitope, Inc. and its subsidiaries at September 30, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1996, in conformity with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP Portland, Oregon October 28, 1996, except for Note 13 as to which the date is November 14, 1996, November 25, 1996, December 12, 1996, and December 26, 1996. - 49 -
Historical Financial Statements Epitope Medical Products Combined Balance Sheets September 30 1996 1995 Assets Current assets Cash and cash equivalents (Note 2).................................... $ 795,787 $ 13,210 Marketable securities (Note 2)........................................ 18,818,120 17,080,246 Trade accounts receivable, net (Note 2)............................... 1,147,599 231,621 Other accounts receivable............................................. 174,083 382,753 Inventories (Note 2).................................................. 1,157,930 1,433,746 Prepaid expenses...................................................... 89,518 103,399 ------------ ------------- Total current assets.................................................. 22,183,037 19,244,975 Property and equipment, net (Notes 2 and 4)........................... 1,542,757 1,989,769 Patents and proprietary technology, net (Note 2)...................... 601,234 415,010 Investments in affiliated companies................................... - 142,510 Other assets and deposits (Note 5).................................... 22,758 38,328 ------------- ------------- $24,349,786 $21,830,592 Liabilities and Group Equity Current liabilities Accounts payable...................................................... $ 449,170 $ 819,424 Salaries, benefits and other accrued liabilities (Notes 2 and 9)..................................................... 1,368,166 2,976,167 ----------- ----------- Total current liabilities............................................. 1,817,336 3,795,591 Commitments and Contingencies (Notes 6,8,9,10 and 11)................. - - Group equity (Note 6) Contributed capital................................................... 64,237,350 60,479,315 Accumulated deficit................................................... (41,704,900) (42,444,314) ------------- ------------- 22,532,450 18,035,001 $24,349,786 $21,830,592
The accompanying notes are an integral part of these statements. - 50 -
Historical Financial Statements Epitope Medical Products Combined Statements of Operations For the Year Ended September 30 1996 1995 1994 Revenues Product sales........................................ $ 4,864,378 $ 2,806,850 $ 2,580,798 Grants and contracts ................................ 729,271 48,672 24,560 ------------ ------------ ----------- 5,593,649 2,855,522 2,605,358 Costs and expenses Product costs........................................ 2,681,429 3,163,012 2,141,319 Research and development costs....................... 3,165,838 4,617,246 3,681,326 Selling, general and administrative expenses......... 5,033,491 6,682,860 3,066,896 ------------ ------------- ------------- 10,880,758 14,463,118 8,889,541 Loss from operations................................. (5,287,109) (11,607,596) (6,284,183) Other income (expense), net Interest income...................................... 1,025,030 756,743 237,467 License fee.......................................... 5,000,000 - - Other, net .......................................... 1,493 (319) (1,541) ------------ -------------- -------------- 6,026,523 756,424 235,926 Net income (loss).................................... $ 739,414 $(10,851,172) $(6,048,257) Proforma net income (loss) per share................. $ .06 $ (.91) $ (.60) Proforma weighted average number of shares outstanding......................................... 13,440,396 11,886,234 10,050,129 The accompanying notes are an integral part of these statements.
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Historical Financial Statements Epitope Medical Products Combined Statements of Changes in Group Equity Contributed Accumulated capital deficit Total Balances at September 30, 1993..................... $34,167,582 $(25,544,885) $ 8,622,697 Common stock issued upon exercise of options.............................. 636,293 - 636,293 Common stock issued as compensation..................................... 318,386 - 318,386 Compensation expense for stock option grants.............................. 823,350 - 823,350 Common stock issued upon exercise of warrants............................. 9,718,259 - 9,718,259 Common stock issued in private placement................................ 17,057,563 - 17,057,563 Equity issuance costs.............................. (3,335,261) - (3,335,261) Net cash to Agritope............................... (12,132,173) - (12,132,173) Net loss for the year.............................. - (6,048,257) (6,048,257) --------------- -------------- -------------- Balances at September 30, 1994..................... 47,253,999 (31,593,142) 15,660,857 Common stock issued upon exercise of options.............................. 2,145,673 - 2,145,673 Common stock issued as compensation..................................... 196,802 - 196,802 Compensation expense for stock option grants.............................. 1,056,335 - 1,056,335 Common stock issued upon exercise of warrants............................. 18,892,750 - 18,892,750 Equity issuance costs.............................. (735,390) - (735,390) Net cash to Agritope............................... (8,330,854) - (8,330,854) Net loss for the year.............................. - (10,851,172) (10,851,172) ------------- --------------- -------------- Balances at September 30, 1995..................... 60,479,315 (42,444,314) 18,035,001 Common stock issued upon exercise of options.............................. 4,886,118 - 4,886,118 Common stock issued as compensation................ 249,086 - 249,086 Compensation expense for stock option grants.................................... 815,019 - 815,019 Common stock issued upon exercise of warrants............................. 826,600 - 826,600 Equity issuance costs.............................. (152) - (152) Net cash to Agritope............................... (3,018,636) - (3,018,636) Net income for the year............................ - 739,414 739,414 -------------- --------------- --------------- Balances at September 30, 1996..................... $64,237,350 $(41,704,900) $22,532,450 The accompanying notes are an integral part of these statements.
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Historical Financial Statements Epitope Medical Products Combined Statements of Cash Flows For the Year Ended September 30 1996 1995 1994 Cash flows from operating activities Net income (loss) ........................................ $ 739,414 $(10,851,172) $ (6,048,257) Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization ............................ 792,885 795,295 651,076 (Gain) loss on disposition of property ................... (1,098) 319 1,541 Increase in accounts receivable and other receivables ...................................... (707,308) (76,549) (180,767) Increase (decrease) in inventories ....................... 275,816 (375,640) (272,279) Decrease in prepaid expenses ............................. 13,881 38,031 43,354 Decrease (increase) in other assets and deposits.......... 15,570 (42,658) (6,227) Increase (decrease) in accounts payable and accrued liabilities ..................................... (2,151,110) 2,273,364 329,875 Common stock issued as compensation for services.......... 249,086 196,802 318,386 Compensation expense for stock option grants and deferred salary increases ............................... 815,019 1,056,335 915,351 ---------- ------------ ----------- Net cash provided by (used in) operating activities ...... 42,155 (6,985,873) (4,247,947) Cash flows from investing activities Investment in marketable securities ...................... (47,608,270) (16,194,994) (5,603,414) Proceeds from sale of marketable securities .............. 45,870,396 4,718,162 - Additions to property and equipment ...................... (180,112) (1,112,292) (461,914) Proceeds from sale of property ........................... 7,432 1,085 1,000 Expenditures for patents and proprietary technology .............................................. (358,319) (126,927) (185,805) Investment in affiliated companies ....................... 142,510 42,552 64,938 ----------- ------------ ----------- Net cash used in investing activities .................... (2,126,363) (12,672,414) (6,185,195) Cash flows from financing activities Proceeds from issuance of common stock ................... 5,885,573 21,060,912 24,387,702 Cost of common stock issuance ............................ (152) (757,877) (310,849) Cash to Agritope ......................................... (3,018,636) (8,330,854) (12,132,173) ------------ ------------- ------------- Net cash provided by financing activities ................ 2,866,785 11,972,181 11,944,680 Net increase (decrease) in cash and cash equivalents ..... 782,577 (7,686,106) 1,511,538 Cash and cash equivalents at beginning of year ........... 13,210 7,699,316 6,187,778 ----------- ------------- ------------ Cash and cash equivalents at end of year ................. $ 795,787 $ 13,210 $ 7,699,316 The accompanying notes are an integral part of these statements.
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Historical Financial Statements Agritope Combined Balance Sheets September 30 1996 1995 1996 Proforma (1) Assets Current assets Cash and cash equivalents (Note 2) ......................... $ 4,903,476 $ 4,246,687 $ 4,903,476 Trade accounts receivable, net (Note 2) .................... 264,986 135,866 264,986 Other accounts receivable .................................. 32,337 993,790 32,337 Inventories (Note 2) ....................................... 509,745 - 509,745 Prepaid expenses ........................................... 812 56,064 812 ------------- ------------- ------------ Total current assets ....................................... 5,711,356 5,432,407 5,711,356 Property and equipment, net (Notes 2 and 4) ................ 1,286,196 555,003 1,286,196 Patents and proprietary technology, net (Note 2) ........... 510,244 140,757 510,244 Investment in affiliated companies (Note 3) ................ 2,448,623 1,974,833 2,448,623 Other assets and deposits (Note 5) ......................... 140,513 200,430 54,379 ------------- ------------- ------------- $ 10,096,932 $ 8,303,430 $ 10,010,798 Liabilities and Group Equity Current liabilities Current portion of installment notes payable ...............$ - $ 17,758 $ - Convertible notes, due 1997 (Notes 5 and 13) ............... 3,620,003 - 240,003 Accounts payable ........................................... 91,474 125,971 91,474 Salaries, benefits and other accrued liabilities (Notes 2 and 9) .......................................... 735,478 206,349 735,478 ------------- ------------ ------------ Total current liabilities .................................. 4,446,955 350,078 1,066,955 Long-term portion of installment notes payable ............. - 21,749 - Convertible notes, due 1997 (Notes 5 and 13) ............... - 3,620,003 - Commitments and contingencies (Notes 6,8,9, and 10) ........ - - - Minority interest .......................................... 215,407 - 215,407 Group equity (Note 6) Contributed capital ........................................ 36,714,932 33,452,632 41,225,452 Accumulated deficit ........................................ (31,280,362) (29,141,032) (32,497,016) ------------- ------------- -------------- 5,434,570 4,311,600 8,728,436 $ 10,096,932 $ 8,303,430 $ 10,010,798
(1) Reflects the proforma effect of conversion of $3,380,000 principal amount of Agritope notes into 250,367 shares of common stock of Epitope at an exchange price of $13.50 per share (see Note 13). The accompanying notes are an integral part of these statements. - 54 -
Historical Financial Statements Agritope Combined Statements of Operations For the Year Ended September 30 1996 1995 1994 Revenues Product sales ............................................. $ - $ 2,015,318 $ 2,179,742 Grants and contracts ...................................... 585,485 94,370 33,642 ------------ ------------ ------------ 585,485 2,109,688 2,213,384 Costs and expenses Product costs ............................................. - 3,235,675 4,575,149 Research and development costs ............................ 1,338,703 2,204,993 2,368,880 Selling, general and administrative expenses............... 1,482,694 4,479,498 4,759,219 ----------- ----------- ----------- 2,821,397 9,920,166 11,703,248 Loss from operations ...................................... (2,235,912) (7,810,478) (9,489,864) Other income (expense), net Interest income............................................ 361,938 408,097 216,934 Interest expense........................................... (265,356) (241,775) (236,121) Other, net................................................. - (500) (75,280) -------------- ------------ ------------- 96,582 165,822 (94,467) Net loss ................................................. $(2,139,330) $(7,644,656) $(9,584,331) Proforma net loss per share .............................. $ (.34) $ (1.29) $ (1.91) Proforma weighted average number of shares outstanding ............................................ 6,330,710 5,943,117 5,025,064 The accompanying notes are an integral part of these statements.
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Historical Financial Statements Agritope Combined Statements of Changes in Group Equity Contributed Accumulated capital deficit Total Balances at September 30, 1993 .............................. $11,259,717 $(11,912,045) $ (652,328) Common stock issued as compensation .............................................. 50,392 - 50,392 Compensation expense for stock option grants ....................................... 343,922 - 343,922 Common stock issued upon exchange of convertible notes ............................. 559,964 - 559,964 Equity issuance costs ....................................... (40,267) - (40,267) Net cash from Epitope Medical Products ...................... 12,132,173 - 12,132,173 Net loss for the year ....................................... - (9,584,331) (9,584,331) --------------- -------------- -------------- Balances at September 30, 1994 .............................. 24,305,901 (21,496,376) 2,809,525 Common stock issued as compensation ......................... 69,998 - 69,998 Compensation expense for stock option grants ................ 318,375 - 318,375 Common stock issued upon exchange of convertible notes ..................................................... 449,991 - 449,991 Equity issuance costs ....................................... (22,487) - (22,487) Net cash from Epitope Medical Products ...................... 8,330,854 - 8,330,854 Net loss for the year ....................................... - (7,644,656) (7,644,656) --------------- ------------ ----------- Balances at September 30, 1995 .............................. 33,452,632 (29,141,032) 4,311,600 Common stock issued as compensation ......................... 14,500 - 14,500 Compensation expense for stock option grants ............................................. 229,164 - 229,164 Net cash from Epitope Medical Products ...................... 3,018,636 - 3,018,636 Net loss for the year ....................................... - (2,139,330) (2,139,330) --------------- ------------ ------------ Balances at September 30, 1996 .............................. $36,714,932 $(31,280,362) $ 5,434,570 The accompanying notes are an integral part of these statements.
- 56 -
Historical Financial Statements Agritope Combined Statements of Cash Flows For the Year Ended September 30 1996 1995 1994 Cash flows from operating activities Net loss .................................................. $(2,139,330) $(7,644,656) $(9,584,331) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization ............................. 294,045 663,380 505,135 Loss on disposition of property ........................... - 500 74,130 Decrease (increase) in accounts receivable and other receivables ....................................... 832,333 (945,501) (140,268) Decrease (increase) in inventories ........................ (509,745) 88,737 (385,928) Decrease (increase) in prepaid expenses ................... 55,252 (55,639) 36,965 Decrease (increase) in other assets and deposits........... (36,219) 9,137 6,562 Increase (decrease) in accounts payable and accrued liabilities ...................................... 494,632 (104,680) 67,457 Common stock issued as compensation for services........... 14,500 69,998 50,392 Compensation expense for stock option grants and deferred salary increases ................................ 229,164 318,375 343,922 ----------- ----------- ----------- Net cash used in operating activities ..................... (765,368) (7,600,349) (9,025,964) Cash flows from investing activities Additions to property and equipment ....................... (886,646) (238,558) (2,128,835) Proceeds from sale of property ............................ 13,258 Expenditures for patents and proprietary technology ............................................... (411,943) (178,208) 135 Investment in affiliated companies ........................ (473,790) 610,146 Minority Interest in affiliated companies ................. 215,407 - - ----------- ------------- ------------- Net cash (used in) provided by investing activities ....... (1,556,972) 206,638 (2,128,700) Cash flows from financing activities Principal payments under installment purchase and capital lease obligations ............................ (39,507) (16,137) (20,726) Cash from Epitope Medical Products ........................ 3,018,636 8,330,854 12,132,173 ----------- ----------- ----------- Net cash provided by financing activities ................. 2,979,129 8,314,717 12,111,447 Net increase in cash and cash equivalents ................. 656,789 921,006 956,783 Cash and cash equivalents at beginning of year ............ 4,246,687 3,325,681 2,368,898 ----------- ----------- ----------- Cash and cash equivalents at end of year .................. $ 4,903,476 $ 4,246,687 $ 3,325,681 The accompanying notes are an integral part of these statements.
- 57 -
Historical Financial Statements Epitope, Inc. and Subsidiaries Consolidated Balance Sheets September 30 1996 1995 1996 Proforma (1) Assets Current assets Cash and cash equivalents (Note 2) ........................ $ 5,699,263 $ 4,259,897 $ 5,699,263 Marketable securities (Note 2) ............................ 18,818,120 17,080,246 18,818,120 Trade accounts receivable, net (Note 2) ................... 1,412,585 367,487 1,412,585 Other accounts receivable ................................. 206,420 1,376,543 206,420 Inventories (Note 2) ...................................... 1,667,675 1,433,746 1,667,675 Prepaid expenses .......................................... 90,330 159,463 90,330 ------------ ------------ ------------ Total current assets ...................................... 27,894,393 24,677,382 27,894,393 Property and equipment, net (Notes 2 and 4) ............... 2,828,953 2,544,772 2,828,953 Patents and proprietary technology, net (Note 2) .......... 1,111,478 555,767 1,111,478 Investment in affiliated companies (Note 3) ............... 2,448,623 2,117,343 2,448,623 Other assets and deposits (Note 5) ........................ 163,271 238,758 77,137 ------------ ------------- ------------- $ 34,446,718 $ 30,134,022 $ 34,360,584 Liabilities and Shareholders' Equity Current liabilities Current portion of installment notes payable ..............$ - $ 17,758 $ - Convertible notes, due 1997 (Notes 5 and 13) .............. 3,620,003 - 240,003 Accounts payable .......................................... 540,644 945,395 540,644 Salaries, benefits and other accrued liabilities (Notes 2 and 9) ........................................... 2,103,644 3,182,516 2,103,644 ----------- ----------- ----------- Total current liabilities ................................. 6,264,291 4,145,669 2,884,291 Long-term portion of installment notes payable ............ - 21,749 - Convertible notes, due 1997 (Notes 5 and 13) .............. - 3,620,003 - Commitments and contingencies (Notes 6, 8, 9, 10 and 11) - - - Minority Interest ......................................... 215,407 - 215,407 Shareholders' equity (Note 6) Preferred stock, no par value - 1,000,000 shares authorized; no shares issued or outstanding ......................... - - - Common stock, no par value - 30,000,000 shares authorized; 12,937,383 and 12,485,130 shares issued and outstanding, respectively ............................... 100,952,282 93,931,947 105,462,802 Accumulated deficit ....................................... (72,985,262) (71,585,346) (74,201,916) ------------- ------------- -------------- 27,967,020 22,346,601 31,260,886 $ 34,446,718 $ 30,134,022 $ 34,360,584
(1) Reflects the proforma effect of conversion of $3,380,000 principal amount of Agritope notes into 250,367 shares of common stock of Epitope at an exchange price of $13.50 per share (see Note 13). The accompanying notes are an integral part of these statements. - 58 -
Historical Financial Statements Epitope, Inc. and Subsidiaries Consolidated Statements of Operations For the Year Ended September 30 1996 1995 1994 Revenues Product sales ............................................... $ 4,864,378 $ 4,822,168 $ 4,760,540 Grants and contracts ........................................ 1,314,756 143,042 58,202 ------------ ------------ ------------ 6,179,134 4,965,210 4,818,742 Costs and expenses Product costs .............................................. 2,681,429 6,398,687 6,716,468 Research and development costs ............................. 4,504,541 6,822,239 6,050,206 Selling, general and administrative expenses................ 6,516,185 11,162,358 7,826,115 ----------- ----------- ----------- 13,702,155 24,383,284 20,592,789 Loss from operations........................................ (7,523,021) (19,418,074) (15,774,047) Other income (expense), net Interest income ............................................ 1,386,968 1,164,840 454,401 Interest expense ........................................... (265,356) (241,775) (236,121) License fee................................................. 5,000,000 - - Other, net.................................................. 1,493 (819) (76,821) ------------ ------------ ------------ 6,123,105 922,246 141,459 Net loss ................................................... $(1,399,916) $(18,495,828) $(15,632,588) Net loss per share ......................................... $ (.11) $ (1.56) $ (1.56) Weighted average number of shares outstanding .............................................. 12,661,420 11,886,234 10,050,129 The accompanying notes are an integral part of these statements.
- 59 -
Historical Financial Statements Epitope, Inc. and Subsidiaries Consolidated Statements of Changes in Shareholders' Equity Common Stock Accumulated Shares Dollars deficit Total Balances at September 30, 1993 ......................... 9,091,922 $ 45,427,299 $(37,456,930) $ 7,970,369 Common stock issued upon exercise of options .................................. 52,488 636,293 - 636,293 Common stock issued as compensation ......................................... 19,678 368,778 - 368,778 Compensation expense for stock option grants .................................. - 1,167,272 - 1,167,272 Common stock issued upon exercise of warrants ................................. 618,291 9,718,259 - 9,718,259 Common stock issued upon exchange of convertible notes ........................ 28,672 559,964 - 559,964 Common stock issued in private placement .................................... 1,115,500 17,057,563 - 7,057,563 Equity issuance costs .................................. - (3,375,528) - (3,375,528) Net loss for the year .................................. - - (15,632,588) (15,632,588) --------------- --------------- ------------- ------------- Balances at September 30, 1994 ......................... 10,926,551 71,559,900 (53,089,518) 18,470,382 Common stock issued upon exercise of options .................................. 183,525 2,145,673 - 2,145,673 Common stock issued as compensation ......................................... 16,013 266,800 - 266,800 Compensation expense for stock option grants .................................. - 1,374,710 - 1,374,710 Common stock issued upon exercise of warrants ................................. 1,336,000 18,892,750 - 18,892,750 Common stock issued upon exchange of convertible notes ........................ 23,041 449,991 - 449,991 Equity issuance costs .................................. - (757,877) - (757,877) Net loss for the year .................................. - - (18,495,828) (18,495,828) ------------------------------- ------------- ------------- Balances at September 30, 1995 ......................... 12,485,130 93,931,947 (71,585,346) 22,346,601 Common stock issued upon exercise of options .................................. 386,550 4,886,118 - 4,886,118 Common stock issued as compensation .................... 19,353 263,586 - 263,586 Compensation expense for stock option grants ........................................ - 1,044,183 - 1,044,183 Common stock issued upon exercise of warrants ................................. 46,350 826,600 - 826,600 Equity issuance costs .................................. - (152) - (152) Net loss for the year .................................. - - (1,399,916) (1,399,916) -------------------------------- -------------- ------------- Balances at September 30, 1996 ......................... 12,937,383 $100,952,282 $(72,985,262) $27,967,020 The accompanying notes are an integral part of these statements.
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Historical Financial Statements Epitope, Inc. and Subsidiaries Consolidated Statements of Cash Flows For the Year Ended September 30 1996 1995 1994 Cash flows from operating activities Net loss ................................................... $ (1,399,916) $(18,495,828) $(15,632,588) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization .............................. 1,086,930 1,458,675 1,156,211 (Gain) loss on disposition of property ..................... (1,098) 819 75,671 Decrease (increase) in accounts receivable and other receivables ........................................ 125,025 (1,022,050) (321,035) Increase in inventories .................................... (233,929) (286,903) (658,207) Decrease (increase) in prepaid expenses .................... 69,133 (17,608) 80,319 Decrease (increase) in other assets and deposits ........... 20,649 (33,521) 335 Increase in accounts payable and accrued liabilities .............................................. (1,656,478) 2,168,684 397,332 Common stock issued as compensation for services............ 263,586 266,800 368,778 Compensation expense for stock option grants and deferred salary increases ................................ 1,044,183 1,374,710 1,259,273 ----------- ----------- ----------- Net cash used in operating activities ...................... (723,213) (14,586,222) (13,273,911) Cash flows from investing activities Investment in marketable securities ........................ (47,608,270) (16,194,994) (5,603,414) Proceeds from sale of marketable securities ................ 45,870,396 4,718,162 - Additions to property and equipment ........................ (1,066,758) (1,350,850) (2,590,751) Proceeds from sale of property ............................. 7,432 14,343 1,000 Expenditures for patents and proprietary technology ............................................... (770,262) (305,135) (185,670) Investment in affiliated companies ......................... (331,280) 652,698 64,938 Minority interest in affiliated companies .................. 215,407 - - ---------- ------------- ------------ Net cash used in investing activities ...................... (3,683,335) (12,465,776) (8,313,897) Cash flows from financing activities Principal payments under installment purchase and capital lease obligations ................................ (39,507) (16,137) (20,724) Proceeds from issuance of common stock ..................... 5,885,573 21,060,912 24,387,702 Cost of common stock issuance .............................. (152) (757,877) (310,849) ----------- --------------- ------------- Net cash provided by financing activities .................. 5,845,914 20,286,898 24,056,129 Net increase (decrease) in cash and cash equivalents ....... 1,439,366 (6,765,100) 2,468,321 Cash and cash equivalents at beginning of year ............. 4,259,897 11,024,997 8,556,676 ------------- ------------- ------------ Cash and cash equivalents at end of year ................... $ 5,699,263 $ 4,259,897 $ 11,024,997 The accompanying notes are an integral part of these statements.
- 61 - Notes to Historical Financial Statements Note 1 The Company Epitope, Inc. (the Company or Epitope) is an Oregon corporation utilizing biotechnology to develop and market medical diagnostic products through its Epitope Medical Products group (Epitope Medical Products) and superior new plants and related products through its Agritope group (Agritope). Upon approval of the proposal to create a new class of common stock (the Agritope Stock Proposal), the capital structure of Epitope will be modified to include two classes of common stock, Epitope Medical Products Common Stock and Agritope Common Stock. The Epitope Medical Products group (Epitope Medical Products) will include the medical products business conducted by the Company. The Agritope group (Agritope) will include the agribusiness and agricultural biotechnology operations of the Company. Note 2 Summary of Significant Accounting Policies Basis of Presentation. The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Assets and liabilities of majority-owned subsidiaries are included in these statements. Minority-owned investments and joint ventures are accounted for using the equity method. Investments of less than 20 percent are carried at cost. The accompanying combined financial statements of the Epitope Medical Products and Agritope groups have been prepared using the amounts included in the consolidated financial statements of the Company. Assets, liabilities, revenues and expenses of each group are included in the respective financial statements of the applicable group. Cash, cash equivalents and marketable securities have been allocated 80 percent to Epitope Medical Products and 20 percent to Agritope. Cash advanced and allocated by the Company to business units of the Agritope group has been reflected as contributed capital in the accompanying combined financial statements. Certain corporate overhead services such as accounting, finance, general management, human resources, investor relations, information systems and payroll are provided by the Company on a centralized basis for the benefit of both groups (Shared Services). Such expenses have been allocated between Epitope Medical Products and Agritope in the accompanying combined financial statements using activity indicators which, in the opinion of management, represent a reasonable measure of the respective group's utilization of such shared services. These activity indicators, which will be reviewed periodically and adjusted to reflect changes in utilization, include number of employees, number of computers, and level of expenditures. The accompanying combined financial statements also include an adjustment to allocate interest income in the same proportion as the allocation of Shared Services between the two groups. Future interest income will be based on amounts earned by each group. Shared Services are included under the caption "Selling, general and administrative expenses" as follows:
Year Ended September 30 1996 1995 1994 Epitope Medical Products .......................... $3,028,181 $3,575,069 $1,899,969 Agritope .......................................... 1,069,249 1,892,370 1,735,688 ------------ ------------ ------------ Consolidated ...................................... $4,097,430 $5,467,439 $3,635,657
If the Agritope Stock Proposal is approved, the Company will provide holders of Epitope Medical Products and Agritope common stock separate financial statements prepared in accordance with generally accepted accounting principles, management's discussion and analysis of financial condition and results of operations, descriptions of businesses and other relevant information for each group. Notwithstanding the attribution of assets and liabilities (including contingent liabilities) to each group for the purposes of preparing their respective historical and future financial statements, this attribution and the change in capitalization contemplated in the Agritope Stock Proposal will not affect legal title to such assets or responsibility for such liabilities of the Company or any of its subsidiaries. Holders of each class of common stock will be common shareholders of the Company and would be subject to risks associated with an investment in the Company and all its businesses, assets, and liabilities. Liabilities or contingencies - 62 - Notes to Historical Financial Statements, Continued of either group that affect the Company's resources or financial condition could affect the financial condition and results of operations of either group. Under the Agritope Stock Proposal, dividends to be paid to the holders of either class of common stock will be limited to the lesser of funds of the Company legally available for the payment of dividends or the Available Medical Products Dividend Amount or Available Agritope Dividend Amount as defined in the Company's Articles of Incorporation. The Company has never paid any cash dividends on shares of Epitope common stock. The Company currently intends to retain any of its earnings to finance future growth and, therefore, does not anticipate paying any cash dividends on either class of common stock in the foreseeable future. Except as stated in the amended Articles of Incorporation, the accounting policies applicable to preparation of financial statements of either group may be modified or rescinded at the sole discretion of the Board of Directors of the Company without the approval of shareholders, although there is no intention to do so. In addition, generally accepted accounting principles require that any change in accounting policy be preferable (in accordance with such principles) to the previous policy. Cash and Cash Equivalents; Marketable Securities. For purposes of the consolidated balance sheets and statements of cash flows, the Company considers all highly liquid investments with maturities at time of purchase of three months or less to be cash equivalents. At September 30, 1996, marketable securities consisted of commercial paper and U.S. Treasury securities with an original maturity period greater than three months, but generally less than 12 months. The Company's policy is to invest its excess cash in securities that maximize (a) safety of principal, (b) liquidity for operating needs, and (c) after-tax yields. Effective October 1, 1994, the Company adopted Financial Accounting Standards Board Statement No. 115 (SFAS 115), Accounting for Certain Investments in Debt and Equity Securities. Pursuant to SFAS 115, the Company has categorized all of its investments as available-for-sale securities and, accordingly, unrealized gains and losses on such investments, if material, will be carried as a separate component of shareholders' equity. Such unrealized gains and losses were immaterial as of September 30, 1996 and 1995. Inventories. Inventories are recorded at the lower of standard cost (which approximates actual cost on a first-in, first- out basis) or market. Inventory components are summarized as follows:
September 30 1996 1995 Epitope Medical Products Raw materials................................................. $ 522,824 $ 657,568 Work-in-process............................................... 389,642 379,470 Finished goods ............................................... 192,882 295,032 Supplies ..................................................... 52,582 101,676 ----------- ----------- $1,157,930 $1,433,746 Agritope Work-in-process .............................................. $ 471,208 $ - Finished goods ............................................... 38,537 - ----------- -------------- $ 509,745 $ - Consolidated Raw materials ................................................ $ 522,824 $ 657,568 Work-in-process .............................................. 860,850 379,470 Finished goods ............................................... 231,419 295,032 Supplies ..................................................... 52,582 101,676 ----------- ----------- $1,667,675 $1,433,746
- 63 - Notes to Historical Financial Statements, Continued Depreciation and Capitalization Policies. Property and equipment are stated at cost less accumulated depreciation. Expenditures for repairs and maintenance are charged to operating expense as incurred. Expenditures for renewals and betterments are capitalized. Depreciation and amortization of property and equipment are calculated primarily under the straight-line method over the estimated lives of the related assets (three to seven years). Leasehold improvements are amortized over the shorter of estimated useful lives or the terms of related leases. When assets are sold or otherwise disposed, cost and related accumulated depreciation or amortization are removed from the accounts and any resulting gain or loss is included in operations. Accounting for Long-Lived Assets. The Company reviews its long-lived assets for impairment periodically or as events or circumstances indicate that the carrying amount of long-lived assets may not be recoverable. If the estimated net cash flows are less than the carrying amount of the long-lived assets, the Company recognizes an impairment loss in an amount necessary to write down long-lived assets to fair value as determined from expected discounted future cash flows. This accounting policy is consistent with Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. There has been no significant impact to the Company's financial position or results of operations as the carrying amount of all long-lived assets is considered recoverable. Patents and Proprietary Technology. Direct costs associated with patent submissions and acquired technology are capitalized and amortized over their minimum estimated economic useful lives, generally five years. In August 1996, the Company amended an agreement pursuant to which it acquired Agritope's patented ethylene control technology in 1987. A co-inventor of the technology relinquished all rights to future compensation under the agreement in exchange for a one-time cash payment, a research grant and a limited non-exclusive license to use the technology for one crop. The total consideration of $365,000 is included in Agritope's combined balance sheet under the caption "Patents and proprietary technology" and is being amortized over 15 years, the remaining life of the related patent. Amortization and accumulated amortization are summarized as follows:
1996 1995 1994 Amortization for the year ended September 30, Epitope Medical Products ............................ $ 172,095 $ 130,313 $ 101,339 Agritope ............................................ 42,456 23,964 13,487 ----------- ---------- ---------- Consolidated......................................... $ 214,551 $ 154,277 $ 114,826 Accumulated Amortization at September 30, Epitope Medical Products ............................ $ 621,110 $ 449,015 $ 318,702 Agritope ............................................ 79,907 37,451 13,487 ---------- ---------- ---------- Consolidated......................................... $ 701,017 $ 486,466 $ 332,189
Fair Value of Financial Instruments. The carrying amount for cash equivalents, marketable securities, accounts receivable, borrowings under bank line of credit, subordinated notes, and accounts payable approximates fair value because of the immediate or short-term maturity of these financial instruments. The carrying amount for long-term debt and convertible notes approximates fair value because the related interest rates are comparable to rates currently available to the Company for debt with similar terms and maturities. - 64 - Notes to Historical Financial Statements, Continued Revenue Recognition. Product revenues are recognized when the related products are shipped. Grant and contract revenues include funds received under research and development agreements with various entities. These grants and contracts generally provide for progress payments as expenses are incurred and certain research milestones are achieved. Revenue related to such grants and contracts is recognized as research milestones are achieved. Accounts receivable are stated net of an allowance for doubtful accounts as follows:
September 30 1996 1995 Epitope Medical Products ..................................... $ 6,872 $ 6,872 Agritope ..................................................... 19,571 65,172 --------- --------- Consolidated ................................................. $ 26,443 $ 72,044
Research and Development. Research and development expenditures are comprised of those costs associated with the Company's own ongoing research and development activities including the costs to prepare for, obtain and compile clinical studies and other information to support product license applications. Expenditures for research and development also include costs incurred under contracts to develop certain products, including those contracts resulting in grant and contract revenues. All research and development costs are expensed as incurred. Income taxes. The Company accounts for certain revenue and expense items differently for income tax purposes than for financial reporting purposes. These differences arise principally from methods used in accounting for stock options and depreciation rates. Deferred tax assets and liabilities are recognized based on temporary differences between the financial statement and the tax bases of assets and liabilities using enacted tax rates in effect for the year in which the temporary differences are expected to reverse. To date, both Epitope Medical Products and Agritope have experienced operating losses. Actual tax payment is a liability of Epitope as a whole. The Agritope Stock Proposal provides that either group may be allocated the tax benefit of such losses and future losses to reduce current or deferred tax expense and that such losses will not be carried forward to reduce the losses of the group which incurred such losses. Accordingly, either group may report lower earnings than if such losses had been retained for the benefit of the group which incurred such losses. Net Income (Loss) Per Share. Net income (loss) per share has been computed using the weighted average number of shares of common stock and common stock equivalents outstanding during the period. Common stock equivalents consist of the number of shares issuable upon exercise of outstanding warrants, options and convertible notes less the number of shares assumed to have been purchased for the treasury with the proceeds from the exercise of such. Net income (loss) per share for Epitope Medical Products and Agritope is presented on a proforma basis assuming that the distribution of Agritope common stock and redesignation of Epitope, Inc. common stock as Epitope Medical Products common stock pursuant to the Agritope Stock Proposal had occurred on October 1, 1993. Common stock equivalents are excluded from the computation if their effect is anti-dilutive. Primary and fully diluted net income (loss) per share are the same. - 65 - Notes to Historical Financial Statements, Continued Supplemental Cash Flow Information. Non-cash financing and investing activities not included in the consolidated statements of cash flows are summarized as follows:
Year Ended September 30 1996 1995 1994 Epitope Medical Products Discount on private placement of common stock ............ $ - $ - $3,024,413 Agritope Conversion of notes to equity (Note 5) ................... $ - $ 427,496 $ 600,231 Investment in nonconsolidated subsidiary ................. - 2,584,979 -
Supplemental Profit and Loss Information. In September 1995, management announced a company-wide reduction in work force whereby 48 employees were terminated. The Company charged $607,000 to results of operations for severance payments and related expenses for this program. As of September 30, 1996 and 1995, $55,000 and $475,000, respectively, of these charges remain accrued and are included in the accompanying balance sheets of the Company and Epitope Medical Products under the caption "Salaries, benefits and other accrued liabilities." Management Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates relating to assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Actual results could vary from these estimates. Note 3 Investment in Affiliated Companies In June 1995, Agritope agreed to sell its wholly owned grape plant propagation subsidiary, Vinifera, Inc. to VF Holdings, Inc. (VF), an affiliate of a Swiss investment group, pursuant to a stock purchase agreement. VF subsequently failed to make all the payments required under the VF Agreement. As part of a settlement of claims based on VF's default, VF retained a 4 percent minority interest in Vinifera and relinquished the majority interest to Agritope in August 1996. The reacquisition of Vinifera in August 1996 has been accounted for under the purchase method. The net purchase price of $916,000 has been allocated to tangible net assets. Vinifera's results of operations are including in the Agritope Combined Statements of Operations and in the Consolidated Statements of Operations through May 1995, and for the month of September 1996. The following summarized proforma results of operations are presented as if the reacquisition had occurred on the first day of each period shown.
Year Ended September 30 1996 1995 Proforma Proforma Historical Adjustments Proforma Historical Adjustments Proforma Agritope Revenues................. 585,485 833,949 1,419,434 2,109,688 276,588 2,386,276 Net loss.................(2,139,330) (1,464,002) (3,603,332) (7,644,656) (460,296) (8,104,952) Proforma loss per share.. (0.34) (0.23) (0.57) (1.29) (0.08) (1.36) Consolidated Revenues................. 6,179,134 833,949 7,013,083 4,965,210 276,588 5,241,798 Net loss.................(1,399,916) (1,464,002) (2,863,918) (18,495,828) (460,296) (18,956,124) Loss per share........... (0.11) (0.12) (0.23) (1.56) (0.04) (1.59)
- 66 - Notes to Historical Financial Statements, Continued In May 1995, Agritope's wholly owned subsidiary, Agrimax Floral Products, Inc. (Agrimax), ceased operations as an independent entity. UAF, Limited Partnership (UAF), in which Agrimax obtained an 18 percent interest, was formed to combine the Agrimax operations in Charlotte, North Carolina, with those of Universal American Flowers, Inc. in Tampa, Florida and Hammond, Louisiana. In connection with the UAF transaction, Agrimax contributed inventory, operating assets and the right to use its proprietary floral preservative and certain trademarks. In May 1996, the equity interest of Agrimax was reduced to 9 percent as the result of a recapitalization of UAF. The St. Paul, Minnesota, facility of Agrimax ceased operations in June 1995. In June 1996, Agrimax contributed inventory and operating assets to Petals USA, Inc. (Petals), a newly formed affiliate of a Canadian fresh flower wholesaler, in return for a 19.5 percent equity interest in Petals. The investments by Agrimax are included in the accompanying consolidated balance sheets of the Company and combined balance sheets of Agritope under the caption "Investment in affiliated companies." See Note 13. For the years ended September 30, 1995, 1994 respectively, the accompanying financial statements of the Company and Agritope include revenues of $2.0 million and $2.2 million, and operating losses of $3.8 million, and $6.4 million attributable to the Agrimax and Vinifera business units. The accompanying statements of operations of the Company and Agritope for the year ended September 30, 1995, includes the results of operations of Agrimax and Vinifera through May and also includes a charge of $500,000 primarily attributable to the disposition of Agrimax. - 67 - Notes to Historical Financial Statements, Continued Note 4 Property and Equipment Property and equipment are summarized as follows:
September 30 1996 1995 Epitope Medical Products Research and development laboratory equipment ................ $ 1,056,883 $ 898,716 Manufacturing equipment ...................................... 1,291,546 1,296,416 Office furniture and equipment ............................... 1,899,948 2,041,897 Leasehold improvements ....................................... 1,084,660 1,084,660 Construction in progress ..................................... 134,557 70,961 ----------- ----------- 5,467,594 5,392,650 Less accumulated depreciation and amortization ............... (3,924,837) (3,402,881) ------------ ------------ $ 1,542,757 $ 1,989,769 Agritope Land ......................................................... $ 30,020 $ 30,020 Buildings and improvements ................................... 717,508 717,508 Research and development laboratory equipment ................ 220,919 196,255 Manufacturing equipment ...................................... 351,538 - Office furniture and equipment ............................... 140,452 95,338 Leasehold improvements........................................ 23,962 23,962 Construction in progress ..................................... 499,980 34,650 ----------- ----------- 1,984,379 1,097,733 Less accumulated depreciation and amortization ............... (698,183) (542,730) ------------ ------------ $ 1,286,196 $ 555,003 Consolidated Land ......................................................... $ 30,020 $ 30,020 Buildings and improvements ................................... 717,508 717,508 Research and development laboratory equipment ................ 1,277,802 1,094,971 Manufacturing equipment ...................................... 1,643,084 1,296,416 Office furniture and equipment ............................... 2,040,400 2,137,235 Leasehold improvements ....................................... 1,108,622 1,108,622 Construction in progress ..................................... 634,537 105,611 ----------- ----------- 7,451,973 6,490,383 Less accumulated depreciation and amortization ............... (4,623,020) (3,945,611) ------------ ------------ $ 2,828,953 $ 2,544,772
Note 5 Long-Term Debt On June 30, 1992, Agritope completed a private placement with several European institutional investors pursuant to which $5,495,000 of convertible notes were issued. The notes are unsecured, mature on June 30, 1997 and bear interest at the rate of 4 percent per annum which is payable on each June 30 and December 31 until all outstanding principal and interest on the notes have been paid in full. The notes are convertible into common stock of the Company at a conversion price of $19.53 per share. In the event of an initial public offering of Agritope common stock, the notes would be automatically converted to shares of Agritope common stock at 90 percent of the public offering price. - 68 - Notes to Historical Financial Statements, Continued During the years ended September 30, 1995 and 1994, respectively, investors exchanged $449,991 and $559,964 principal amount of convertible notes for the Company's common stock at a price of $19.53 per share. In conjunction with the exchanges, unamortized debt issuance costs of $22,487 and $40,267 related to such notes were recognized as equity issuance costs during 1995 and 1994, respectively. Debt issuance costs are included in other assets and are being amortized over the five-year life of the notes. Amortization expense of debt issuance costs for the years ended September 30, 1996, 1995 and 1994, respectively, totaled $108,257, $96,136 and $91,715, leaving an unamortized balance of $88,821 and $197,077 at September 30, 1996 and 1995, respectively. See Note 13. Note 6 Shareholders' Equity Authorized Capital Stock. The Company's amended articles of incorporation authorize 1,000,000 shares of preferred stock and 30,000,000 shares of common stock. The Company's Board of Directors has authority to determine preferences, limitations and relative rights of the preferred stock. Common Stock Reserved for Future Issuance. As of September 30, 1996, the following shares of the Company's common stock were reserved for future issuance, as more fully described below:
Purpose Shares Outstanding warrants ................................................................... 2,000,640 Outstanding stock options .............................................................. 3,365,726 Employee Stock Purchase Plan subscriptions ............................................. 42,820 Conversion of notes (Note 5) ........................................................... 185,356 --------- 5,594,542
If the Agritope Stock Proposal is approved, the Company will issue to the holders of the above rights to purchase shares of Epitope common stock or to convert notes into such shares, as applicable, the equivalent rights with respect to Agritope common stock on the basis of one-half share of Agritope common stock for each right to purchase one share of Epitope common stock. Common Stock Warrants. As of September 30, 1996, the following warrants to purchase shares of common stock were outstanding:
Date of Issuance Shares Price Expiration Date September 26, 1991 ....................... 159,150 $16.00 September 30, 1997 December 23, 1992 ........................ 988,390 18.50 September 30, 1997 July 20, 1993 ............................ 375,000 20.00 September 30, 1997 August 1, 1993 ........................... 200,000 18.50 September 30, 1997 October 17, 1994 ......................... 50,000 18.50 September 30, 1997 November 22, 1994 ........................ 228,100 18.50 September 30, 1997 ---------- 2,000,640
Stock Award Plans. The Company's 1991 Stock Award Plan (the 1991 Plan) was approved by the shareholders during 1991, replacing the Company's Incentive Stock Option Plan (ISOP). The 1991 Plan provides for stock-based awards to employees, outside directors and members of scientific advisory committees or other consultants. Awards which may be granted under the 1991 Plan include qualified incentive stock options, nonqualified stock options, stock appreciation rights, restricted awards, performance awards and other stock-based awards. - 69 - Notes to Historical Financial Statements, Continued Under the terms of the 1991 Plan, qualified incentive stock options on shares of common stock may be granted to eligible employees, including officers, of the Company at an exercise price not less than the fair market value of the stock on the date of grant. The maximum term during which any option may be exercised is ten years from the date of grant. To date, options have been granted with four-year vesting schedules. Options issued to employees under the Incentive Stock Option Plan (ISOP) were issued at prices not less than the fair market value of a share of common stock on the date of grant. The options are exercisable after one year from the date of grant at the rate of 25 percent per year cumulatively and expire ten years from the date of grant. The Agritope, Inc. 1992 Stock Award Plan (the 1992 Plan) was adopted by Agritope and approved by the Company in 1992. The 1992 Plan, which has provisions similar to those of the Company's 1991 Plan, authorizes issuance of 2,000,000 shares of Agritope common stock. Until Agritope is no longer a wholly owned subsidiary of the Company, shares issued pursuant to exercise of options under the 1992 Plan will be converted into shares of the Company's common stock based on the ratio of the fair market value of the Company's common stock to the fair market value of Agritope common stock on the date of the grant. The 1991 Plan and 1992 Plan also provide that nonqualified options may be granted at a price not less than 75 percent of the fair market value of a share of common stock on the date of grant. The option term and vesting schedule of such awards may either be unlimited or have a specified period in which to vest and be exercised. For the discounted nonqualified options issued, the Company amortizes, on a straight-line basis over the vesting period of the options, the difference between the exercise price and the fair market value of a share of stock on the date of grant. As of September 30, 1996, 197,181 shares of Epitope common stock remain available for grant under the Company's stock award plans. In October 1995, the Financial Accounting Standards Board issued SFAS 123, Accounting for Stock-Based Compensation. SFAS 123 allows companies which have stock-based compensation arrangements with employees to adopt a fair-value basis of accounting for stock options and other equity instruments or to continue to apply the existing accounting rules under APB Opinion 25, Accounting for Stock Issued to Employees, but with additional financial statement disclosure. The Company plans to elect the disclosure-only alternative commencing in fiscal 1997 and therefore does not anticipate that SFAS 123 will have a material impact on its financial position or results of operations. Options granted and outstanding under the Company's stock option plans are summarized as follows:
1996 1995 1994 Shares Price Shares Price Shares Price Outstanding at beginning of period....... 3,636,103 $ 1.09-24.94 3,483,432 $ 1.09-24.94 3,052,653 $ 1.09-24.94 Granted.................... 901,379 9.81-18.13 802,050 14.94-18.88 589,850 14.38-22.94 Exercised.................. (386,550) 1.09-17.13 (183,525) 1.84-22.50 (52,488) 12.43-22.50 Canceled................... (785,206) 14.38-24.00 (465,854) 7.38-22.94 (106,583) 8.50-22.94 --------- ------------ ------------ Outstanding at end of period............. 3,365,726 $ 3.50-24.94 3,636,103 $ 1.09-24.94 3,483,432 $ 1.09-24.94 Exercisable................ 2,302,212 $ 3.50-24.94 2,002,925 $ 1.09-24.94 1,557,505 $ 1.09-24.94
Pursuant to the 1991 Plan, 973, 3,680 and 11,741 shares of common stock were also awarded to consultants and members of the Company's scientific advisory committees during 1996, 1995, and 1994, respectively. - 70 - Notes to Historical Financial Statements, Continued Employee Stock Purchase Plans. In 1991, the shareholders approved the Company's adoption of the 1991 Employee Stock Purchase Plan (1991 ESPP) covering a maximum of 100,000 shares of common stock for subscription over two offering periods. The purchase price for stock purchased under the 1991 ESPP for each of the two 24-month subscription periods was the lesser of 85 percent of the fair market value of a share of common stock at the commencement of the subscription period or the fair market value at the close of each subscription period. An employee may also elect to withdraw at any time during the subscription period and receive the amounts paid plus interest at the rate of 6 percent. During April 1994, 676 shares, at a purchase price of $14.00 per share, were issued to employees for the second 1991 ESPP purchase period which closed March 31, 1994. The 1993 Employee Stock Purchase Plan (1993 ESPP), as amended and restated effective February 1, 1993, covers a maximum of 250,000 shares of common stock for subscription over established offering periods. The Company's Board of Directors was granted authority to determine the number of offering periods, the number of shares offered, and the length of each period, provided that no more than three offering periods (other than Special Offering Subscriptions as described below) may be set during each fiscal year of the Company. Other provisions of the 1993 ESPP are similar to the 1991 ESPP. During April, 1996, 10,106 shares were issued at a price of $11.90 per share. As of September 30, 1996, 42,820 shares of common stock were subscribed for during two offerings under the 1993 ESPP. Shares subscribed for under these 1993 ESPP offerings may be purchased over 24 months and have initial subscription prices of $12.33 and $8.77 per share for the various offerings. The 1993 ESPP was amended to allow the Company, at its discretion, to provide Special Offering Subscriptions whereby an employee's annual increase in compensation could be deferred for a one-year period. At the end of the one-year period, the employee can elect to receive the deferred compensation amount in the form of cash or shares of the Company's common stock. The purchase price for stock issued under a Special Offering Subscription is the lesser of 85 percent of the fair market value of a share of common stock on the first day of the calendar month the employee's increase was effective or the fair market value at the close of the one-year subscription period. During 1995 and 1994, respectively, 5,569 and 2,314 Special Offering Subscription shares were issued to employees at an average price of $15.26 and $15.24 per share. Note 7 Income Taxes As of September 30, 1996, the Company had net operating loss carryforwards of approximately $66.7 million and $50.0 million, respectively, to offset federal and state taxable income. These net operating loss carryforwards will generally expire from 2001 through 2011 if not used by the Company. Approximately $6.9 million of the Company's net operating loss carryforwards were generated as a result of deductions related to the exercise of stock options. When utilized, such carryforwards, as tax effected, will be reflected in the Company's financial statements as an increase in shareholders' equity rather than a reduction of the provision for income taxes. Significant components of the Company's deferred tax asset were as follows (in thousands):
September 30 1996 1995 Net operating loss carryforwards.......................... $ 24,489 $ 26,110 Deferred compensation..................................... 1,997 1,665 Research & experimentation credit carryforwards........... 1,151 1,151 Accrued expenses.......................................... 317 238 Other..................................................... 495 384 -------- --------- Gross deferred tax assets................................. 28,449 29,548 Valuation allowance....................................... (28,449) (29,548) -------- --------- Net deferred tax asset.................................... - -
- 71 - Notes to Historical Financial Statements, Continued No benefit for the Company's deferred tax assets has been recognized in the accompanying financial statements as they do not satisfy the recognition criteria set forth in SFAS 109. The valuation allowance decreased $1.1 million in 1996, increased $7.5 million in 1995, and increased $6.2 million in 1994. The research and development tax credit carryforwards will generally expire from 2001 through 2010 if not used by the Company. The expected federal statutory tax benefit of approximately $476,000 for the year ended September 30, 1996 is increased by approximately $61,000 for the effect of state and local taxes (net of federal impact), $1.1 million for the effect of the decrease in valuation allowance, and $840,000 for the effect of stock option deductions included in the valuation allowance and is reduced by approximately $2.5 million for the effect of Vinifera Inc.'s net operating loss carryforwards and certain state net operating loss carryforwards being removed from the consolidated tax group. Note 8 Research and Development Arrangements In February 1995, the Company entered into a Development, License and Supply Agreement with SmithKline Beecham, plc (SB) pursuant to which the Company will conduct research and development projects funded by SB. Agritope also performed research work in 1996 and 1995 with respect to raspberries which was partially funded by Sweetbriar Development, Inc. under a License Agreement dated October 18, 1994 and with respect to grapevine disease diagnostics funded by a grant from the U.S. Department of Agriculture under the Small Business Innovation Research Program. During 1994, the Company participated in a National Cancer Institute program whereby the Company received funding for research toward the treatment of cancer. Agritope has also received grant support from the U.S. Department of Agriculture, Oregon Strawberry Commission, and Oregon Raspberry & Blackberry Commission for antifungal biocontrol research and from several strategic partners. Revenues from research and development arrangements are included in the accompanying consolidated statements of operations under the caption "Grants and contracts." Expenses related to such arrangements are included under the caption "Research and development costs." The activity related to these arrangements is summarized as follows:
Year Ended September 30 1996 1995 1994 Epitope Medical Products SB research projects...................................... 712,000 40,000 - Other..................................................... 17,271 8,672 24,560 --------- -------- -------- 729,271 48,672 24,560 Project related expenses.................................. 1,087,713 108,645 46,493 Agritope Government research grants................................ 144,987 16,358 33,642 Research projects with strategic partners................. 326,462 40,000 - Other..................................................... 114,036 38,012 - --------- -------- ----------- 585,485 94,370 33,642 Project related expenses.................................. 461,460 318,401 35,728
Note 9 Distribution and Supply Contracts The Company has entered into several contractual arrangements, including those discussed in the following paragraphs, for distribution of certain of its products to customers. The Company continues to maintain supply and distribution agreements with Organon Teknika Corporation (Organon Teknika), whereby Organon Teknika supplies the Company's antigen requirements and exclusively distributes the - 72 - Notes to Historical Financial Statements, Continued Company's EPIblot HIV confirmatory tests (EPIblot) on a worldwide basis. As of April 1, 1994, the Company renewed the agreements which have an initial termination date of March 31, 1997 (with successive one-year renewal periods thereafter) and include pricing incentives based on volumes purchased by Organon Teknika and penalties for failure to purchase specified minimum quarterly volumes. For the years ended September 30, 1996, 1995 and 1994, respectively, revenues generated from sales of EPIblot to Organon Teknika were $1,539,164, $1,808,431, and $1,688,200, including export sales of $62,539, $72,369 and $320,700. The Company has notified Organon Teknika that it intends to renew the agreements on mutually acceptable, but revised, terms prior to the scheduled termination date. LabOne, Inc. (previously Home Office Reference Laboratory, Inc.) purchases oral specimen devices from the Company for use in insurance testing in return for non-exclusive distribution rights in the United States and Canada under an agreement which expires on March 13, 2000, with an automatic five-year renewal, unless either party notifies the other of intent not to renew at least 180 days prior to the initial expiration date. For the years ended September 30, 1996, 1995 and 1994, respectively, revenue generated from product sales to LabOne, Inc. was $1,327,544, $525,628 and $477,186 including export sales of $394,747, $58,500 and $110,933. SB has an exclusive agreement to market the Company's oral specimen collection device worldwide, except in several foreign countries and to the insurance industry in the U.S., Canada and Japan. In 1995, SB made an initial license fee payment of $1 million to the Company. SB also placed $5 million in escrow for future payment to the Company, of which $1 million was designated for reimbursement of future research project work and $4 million was designated as an additional license fee to be paid upon FDA approval of a pending request to amend the labeling of the Company's oral specimen collection device to indicate a two-year shelf life. The initial $1 million license fee was included as deferred revenue under the caption "Salaries, benefits and other accrued liabilities" in the accompanying consolidated balance sheets as of September 30, 1995. The escrowed funds are not reflected in the Company's financial statements. When such funds are disbursed they will be recognized as revenue in accordance with the Company's revenue recognition policy. See Note 2. In April 1996, the FDA granted the Company's request for extended dating and SB disbursed $4 million plus interest from escrow. Accordingly the Company recognized income of $5 million in 1996 operating results. Note 10 Commitments The Company leases office, manufacturing, warehouse and laboratory facilities under operating lease agreements which require minimum annual payments as follows:
Epitope Medical Year Ending September 30 Products Agritope Consolidated 1997 .............................................. $ 345,577 $189,551 $ 535,128 1998 .............................................. 345,576 185,394 530,970 1999 .............................................. 346,356 150,000 496,356 2000 .............................................. 109,992 150,000 259,992 2001............................................... - 50,000 50,000 ----------- ---------- ---------- $1,147,501 $724,945 $1,872,446
Under the agreements for the lease of its office and laboratory facilities, the Company is obligated to the lessor for its share of certain expenses related to the use, operation, maintenance and insurance of the property. These expenses, payable monthly in addition to the base rent, are not included in the amounts shown above. Rent expense aggregated $538,665, $749,530 and $616,750 for the years ended September 30, 1996, 1995 and 1994, respectively. - 73 - Notes to Historical Financial Statements, Continued The Company is also contingently liable for a lease which has been assigned to UAF and the lease of property which has been subleased to Petals in the following amounts:
Year Ending September 30 1997............................................................................................. $ 328,953 1998............................................................................................. 341,304 1999............................................................................................. 347,184 ---------- $1,017,441
Note 11 Profit Sharing and Savings Plan The Company established a profit sharing and deferred salary savings plan in 1986 and restated the plan in 1991. All employees are eligible to participate in the plan. In addition, the plan permits certain voluntary employee contributions to be excluded from the employees' current taxable income under the provisions of Internal Revenue Code Section 401(k) and the regulations thereunder. Effective October 1, 1991, the Company replaced a discretionary profit sharing provision with a matching contribution (either in cash, shares of Epitope common stock, or partly in both forms) equal to 50 percent of an employee's basic contribution, not to exceed 2.5 percent of an employee's compensation. The Board of Directors has the authority to increase or decrease the 50 percent match at any time. During 1996, 1995 and 1994, respectively, the Company contributed $73,315 (4,653 shares totaling $73,279 and the remainder in cash), $97,631 (5,562 shares totaling $97,607 and the remainder in cash), and $79,981 (4,632 shares totaling $79,807 and the remainder in cash to the plan. As of September 30, 1996, 17,035 shares are held by the plan. - 74 - Notes to Historical Financial Statements, Continued Note 12 Geographic Area Information The Company's products are included in the medical products and agricultural products industry segments. (See Note 1 for a description of the Company's business.) The Company's products are sold principally in the United States, Canada and Europe. Operating loss represents revenues less operating expenses. In computing operating loss, allocated corporate administration expenses have been included; however, other income and expense items such as interest expense, miscellaneous income, and other charges have not been added or deducted. Other assets primarily represent cash and cash equivalents, marketable securities, and prepaid insurance. Epitope Medical Products In thousands
Geographic Areas Revenues Operating Loss Identifiable Assets 1996 1995 1994 1996 1995 1994 1996 1995 1994 United States ......... $4,903 $2,630 $2,062 $(5,287) $(11,608) $(6,284) $4,604 $3,768 $3,464 Canada .......... 404 78 111 - - - - - - Latin America ........ 100 - - - - - - - - Europe .......... 65 72 329 - - - - - - Other ........... 122 76 103 - - - - - - ------- -------- ------- ---------- ---------- --------- ---------- --------- -------- $5,594 $2,856 $2,605 $(5,287) $(11,608) $(6,284) $4,604 $3,768 $3,464 Agritope In thousands Geographic Areas Revenues Operating Loss Identifiable Assets 1996 1995 1994 1996 1995 1994 1996 1995 1994 United States ..........$ 585 $2,110 $2,213 $(2,236) $(7,810) $(9,490) $5,351 $3,923 $4,050 ----- ----- ----- ------- ------- ------- ----- ----- ----- $ 585 $2,110 $2,213 $(2,236) $(7,810) $(9,490) $5,351 $3,923 $4,050 Consolidated In thousands Geographic Areas Revenues Operating Loss Identifiable Assets 1996 1995 1994 1996 1995 1994 1996 1995 1994 United States ..........$5,488 $4,739 $4,276 $(7,523) $(19,418) $(15,774) $9,955 $7,691 $7,514 Canada ........... 404 78 111 - - - - - - Latin America ......... 100 - - - - - - - - Europe ........... 65 72 329 - - - - - - Other ............ 122 76 103 - - - - - - ------- ------- ------- ---------- --------- ---------- ---------- --------- --------- $6,179 $4,965 $4,819 $(7,523) $(19,418) $(15,774) $9,955 $7,691 $7,514
- 75 - Notes to Historical Financial Statements, Continued Note 13 Subsequent Events On October 25, the Company received an offer from a representative of the holders of the $3.6 million convertible notes due June 30, 1997, whereby the holders proposed to convert such notes into common stock of the Company at a reduced exchange price. On November 14, 1996, the Company agreed to exchange $3,380,000 principal amount of Agritope notes for 250,367 shares of common stock of the Company at an exchange price of $13.50 per share. Accordingly, the Company will recognize a charge to income of approximately $1.2 million representing the conversion expense in the first quarter of fiscal 1997. On November 25, 1996, the Company negotiated an extension to the bank line of credit previously maintained by Andrew and Williamson Sales, Co. (A&W). Under terms of the commitment letter, the $6.5 million revolving credit line will be extended until February 5, 1998, and will bear interest at prime or LIBOR plus 2.5 percent at the Company's option. The new line will be secured by A&W's accounts receivable, inventory and equipment and will be guaranteed by Epitope, Inc. The new line will also contain various financial covenants including minimum working capital and tangible net worth levels and maximum debt to net worth ratios. On December 12, 1996, the Company merged with A&W. A&W is a producer and wholesale distributor of fruits and vegetables based in San Diego, California. Under the terms of the merger, the Company issued 520,000 shares of common stock of Epitope, Inc. in exchange for all of the outstanding common stock of A&W. The merger has been accounted for as a pooling of interests and will qualify as a tax-free reorganization (see supplemental financial statements). Based on information available on December 26, 1996, and due to continued operating losses at UAF in the four months ended October 31, 1996, coupled with a shortfall in sales and larger operating loss than expected at Petals in the fourth quarter of calendar 1996, the Company believes that the value of its investment in affiliated companies has more than temporarily declined as both companies are now expected to show operating losses in fiscal 1997. Accordingly, the Company anticipates a non-cash charge to results of operations of approximately $1.9 million in the first quarter of fiscal 1997, reflecting the permanent impairment in the value of its investment in affiliated companies. - 76 - Supplemental Financial Statements Report of Independent Accountants To the Board of Directors and Shareholders of Epitope, Inc. In our opinion, the accompanying balance sheets and the related statements of operations, of changes in shareholders'/group equity, and of cash flows present fairly, in all material respects, the financial position of Epitope Medical Products group and Agritope group (as described in Note 1 to these financial statements) and Epitope, Inc. and its subsidiaries at September 30, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1996, in conformity with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. As described in Note 13, on December 12, 1996, Epitope, Inc. merged with Andrew and Williamson Sales, Co. in a transaction accounted for as a pooling of interests. The accompanying supplemental financial statements give retroactive effect to the merger. In our opinion, based upon our audits and the report of other auditors, the accompanying supplemental balance sheets and the related supplemental statements of operations, of changes in shareholders'/group equity and of cash flows present fairly, in all material respects, the financial position of Epitope Medical Products group, Agritope group and Epitope, Inc. and its subsidiaries at September 30, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1996, in conformity with generally accepted accounting principles. 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 did not audit the financial statements of Andrew and Williamson Sales, Co., which statements reflect total assets of $10,774,100 and $7,293,256 at September 30, 1996 and 1995, respectively, and total revenues of $62,471,119, $52,178,973 and $62,704,601 for the years ended September 30, 1996, 1995 and 1994, respectively. Those statements were audited by other auditors whose report thereon has been furnished to us, and our opinion expressed herein, insofar as it related to the amounts included for Andrew and Williamson Sales, Co., is based solely on the report of the other auditors. We conducted our audits of these financial statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP Portland, Oregon October 28, 1996, except for Note 13 as to which the date is November 14, 1996, November 25, 1996, December 12, 1996, and December 26, 1996. - 77 - Supplemental Financial Statements Report of Independent Auditors To the Board of Directors of Andrew and Williamson Sales, Co. We have audited the accompanying balance sheets of Andrew and Williamson Sales, Co. as of September 30, 1996, and 1995, and the related statements of operations, changes in shareholders' equity, and cash flows for the three years in the period ended September 30, 1996. 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above presently fairly, in all material respects, the financial position of Andrew and Williamson Sales, Co. at September 30, 1996, and 1995, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 1996, in conformity with generally acceptable accounting principles. BOROS & FARRINGTON, APC San Diego, California November 6, 1996 - 78 -
Supplemental Financial Statements Epitope Medical Products Combined Balance Sheets September 30 1996 1995 Assets Current assets Cash and cash equivalents (Note 2) ....................... $ 795,787 $ 13,210 Marketable securities (Note 2) ........................... 18,818,120 17,080,246 Trade accounts receivable, net (Note 2) .................. 1,147,599 231,621 Other accounts receivable ................................ 174,083 382,753 Inventories (Note 2) ..................................... 1,157,930 1,433,746 Prepaid expenses ......................................... 89,518 103,399 ------------ ------------ Total current assets ..................................... 22,183,037 19,244,975 Property and equipment, net (Notes 2 and 4) .............. 1,542,757 1,989,769 Patents and proprietary technology, net (Note 2) ......... 601,234 415,010 Investments in affiliated companies ...................... - 142,510 Other assets and deposits (Note 5) ....................... 22,758 38,328 ----------- ----------- $24,349,786 $21,830,592 Liabilities and Group Equity Current liabilities Accounts payable .......................................... $ 449,170 $ 819,424 Salaries, benefits and other accrued liabilities (Notes 2 and 9) ......................................... 1,368,166 2,976,167 ----------- ----------- Total current liabilities ................................ 1,817,336 3,795,591 Commitments and contingencies (Notes 6, 8, 9, 10 and 11)............................................... - - Group equity (Note 6) Contributed capital ....................................... 64,237,350 60,479,315 Accumulated deficit ....................................... (41,704,900) (42,444,314) ------------- ------------- 22,532,450 18,035,001 $24,349,786 $21,830,592
The accompanying notes are an integral part of these statements. - 79 -
Supplemental Financial Statements Epitope Medical Products Combined Statements of Operations For the Year Ended September 30 1996 1995 1994 Revenues Product sales ....................................... $ 4,864,378 $ 2,806,850 $ 2,580,798 Grants and contracts ................................ 729,271 48,672 24,560 ---------- ----------- ----------- 5,593,649 2,855,522 2,605,358 Costs and expenses Product costs ....................................... 2,681,429 3,163,012 2,141,319 Research and development costs ...................... 3,165,838 4,617,246 3,681,326 Selling, general and administrative expenses......... 5,033,491 6,682,860 3,066,896 ---------- ----------- ----------- 10,880,758 14,463,118 8,889,541 Loss from operations ................................ (5,287,109) (11,607,596) (6,284,183) Other income (expense), net Interest income...................................... 1,025,030 756,743 237,467 License fee.......................................... 5,000,000 - - Other, net........................................... 1,493 (319) (1,541) ---------- ----------- ------------ 6,026,523 756,424 235,926 Net income (loss) ................................... $ 739,414 $(10,851,172) $(6,048,257) Proforma net income (loss) per share ................ $ .05 $ (.87) $ (.57) Proforma weighted average number of shares outstanding ....................................... 13,960,396 12,406,234 10,570,129
The accompanying notes are an integral part of these statements. - 80 -
Supplemental Financial Statements Epitope Medical Products Combined Statements of Changes in Group Equity Contributed Accumulated capital deficit Total Balances at September 30, 1993 ...................... $34,167,582 $(25,544,885) $ 8,622,697 Common stock issued upon exercise of options ............................... 636,293 - 636,293 Common stock issued as compensation ...................................... 318,386 - 318,386 Compensation expense for stock option grants ............................... 823,350 - 823,350 Common stock issued upon exercise of warrants .............................. 9,718,259 - 9,718,259 Common stock issued in private placement ................................. 17,057,563 - 17,057,563 Equity issuance costs ............................... (3,335,261) - (3,335,261) Net cash to Agritope ................................ (12,132,173) - (12,132,173) Net loss for the year ............................... - (6,048,257) (6,048,257) -------------- ------------- ------------- Balances at September 30, 1994 ...................... 47,253,999 (31,593,142) 15,660,857 Common stock issued upon exercise of options ............................... 2,145,673 - 2,145,673 Common stock issued as compensation....................................... 196,802 - 196,802 Compensation expense for stock option grants ............................... 1,056,335 - 1,056,335 Common stock issued upon exercise of warrants............................... 18,892,750 - 18,892,750 Equity issuance costs ............................... (735,390) - (735,390) Net cash to Agritope ................................ (8,330,854) - (8,330,854) Net loss for the year ............................... - (10,851,172) (10,851,172) ------------- ------------- ------------- Balances at September 30, 1995 ...................... 60,479,315 (42,444,314) 18,035,001 Common stock issued upon exercise of options ............................... 4,886,118 - 4,886,118 Common stock issued as compensation ................. 249,086 - 249,086 Compensation expense for stock option grants ..................................... 815,019 - 815,019 Common stock issued upon exercise of warrants .............................. 826,600 - 826,600 Equity issuance costs ............................... (152) - (152) Net cash to Agritope ................................ (3,018,636) - (3,018,636) Net income for the year ............................. - 739,414 739,414 ------------- ------------- ------------ Balances at September 30, 1996 ...................... $64,237,350 $(41,704,900) $22,532,450
The accompanying notes are an integral part of these statements. - 81 -
Supplemental Financial Statements Epitope Medical Products Combined Statements of Cash Flows For the Year Ended September 30 1996 1995 1994 Cash flows from operating activities Net income (loss) ....................................... $ 739,414 $(10,851,172) $(6,048,257) Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization ........................... 792,885 795,295 651,076 (Gain) loss on disposition of property .................. (1,098) 319 1,541 Increase in accounts receivable and other receivables ..................................... (707,308) (76,549) (180,767) Increase (decrease) in inventories ...................... 275,816 (375,640) (272,279) Decrease in prepaid expenses ............................ 13,881 38,031 43,354 Decrease (increase) in other assets and deposits......... 15,570 (42,658) (6,227) Increase (decrease) in accounts payable and accrued liabilities .................................... (2,151,110) 2,273,364 329,875 Common stock issued as compensation for services......... 249,086 196,802 318,386 Compensation expense for stock option grants and deferred salary increases .............................. 815,019 1,056,335 915,351 ---------- ----------- ---------- Net cash provided by (used in) operating activities ..... 42,155 (6,985,873) (4,247,947) Cash flows from investing activities Investment in marketable securities ..................... (47,608,270) (16,194,994) (5,603,414) Proceeds from sale of marketable securities ............. 45,870,396 4,718,162 - Additions to property and equipment ..................... (180,112) (1,112,292) (461,914) Proceeds from sale of property .......................... 7,432 1,085 1,000 Expenditures for patents and proprietary technology ............................................ (358,319) (126,927) (185,805) Investment in affiliated companies ...................... 142,510 42,552 64,938 ---------- ----------- ----------- Net cash used in investing activities ................... (2,126,363) (12,672,414) (6,185,195) Cash flows from financing activities Proceeds from issuance of common stock .................. 5,885,573 21,060,912 24,387,702 Cost of common stock issuance ........................... (152) (757,877) (310,849) Cash to Agritope ........................................ (3,018,636) (8,330,854) (12,132,173) ------------- ------------- ------------- Net cash provided by financing activities ............... 2,866,785 11,972,181 11,944,680 Net increase (decrease) in cash and cash equivalents .... 782,577 (7,686,106) 1,511,538 Cash and cash equivalents at beginning of year .......... 13,210 7,699,316 6,187,778 ------------- ------------ ------------ Cash and cash equivalents at end of year ................ $ 795,787 $ 13,210 $ 7,699,316 The accompanying notes are an integral part of these statements.
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Supplemental Financial Statements Agritope Combined Balance Sheets September 30 1996 1995 1996 Proforma (1) Assets Current assets Cash and cash equivalents (Note 2) ................ $ 4,903,476 $ 4,246,687 $ 4,903,476 Trade accounts receivable, net (Note 2) ........... 3,123,172 1,995,244 3,123,172 Other accounts receivable ......................... 32,337 1,249,554 32,337 Inventories (Note 2) .............................. 6,570,187 3,239,441 6,570,187 Prepaid expenses .................................. 90,656 143,792 90,656 ------------- ------------ ------------ Total current assets .............................. 14,719,828 10,874,718 14,719,828 Property and equipment, net (Notes 2 and 4) ....... 2,658,655 2,068,931 2,658,655 Patents and proprietary technology, net (Note 2) .. 510,244 140,757 510,244 Investment in affiliated companies (Note 3) ....... 2,651,294 2,185,630 2,651,294 Other assets and deposits (Note 5) ................ 321,011 326,650 234,877 ------------- ------------- ------------ $20,861,032 $15,596,686 $20,774,898 Liabilities and Group Equity Current liabilities Borrowings under bank line of credit (Note 5) ..... $ 4,125,000 $ 3,150,000 $ 4,125,000 Subordinated notes (Note 5) ....................... 2,236,628 - 2,236,628 Current portion of long-term debt (Note 5) ........ 98,368 196,134 98,368 Convertible notes, due 1997 (Notes 5 and 13) ...... 3,620,003 - 240,003 Accounts payable .................................. 2,677,881 1,488,940 2,677,881 Salaries, benefits and other accrued liabilities (Notes 2 and 9) ................................. 1,208,136 274,959 1,208,136 ------------ ------------ ------------ Total current liabilities ......................... 13,966,016 5,110,033 10,586,016 Long-term debt, less current portion (Note 5) ..... 527,973 632,515 527,973 Convertible notes, due 1997 (Notes 5 and 13) ...... - 3,620,003 - Subordinated notes (Note 5) ....................... - 1,015,461 - Commitments and contingencies (Notes 6, 8, 9, 10 and 11)....................................... - - - Minority interest ................................. 215,407 - 215,407 Group equity (Note 6) Contributed capital ............................... 36,736,343 33,474,043 41,246,863 Accumulated deficit ............................... (30,584,707) (28,255,369) (31,801,361) ------------- ------------ ------------ 6,151,636 5,218,674 9,445,502 $20,861,032 $15,596,686 $20,774,898
(1) Reflects the proforma effect of conversion of $3,380,000 principal amount of Agritope notes into 250,367 shares of common stock of Epitope at an exchange price of $13.50 per share (see Note 13). The accompanying notes are an integral part of these statements. - 83 -
Supplemental Financial Statements Agritope Combined Statements of Operations For the Year Ended September 30 1996 1995 1994 Revenues Product sales ....................................... $62,471,119 $54,194,291 $62,884,343 Grants and contracts ................................ 585,485 94,370 33,642 ------------- ------------- ----------- 63,056,604 54,288,661 62,917,985 Costs and expenses Product costs........................................ 57,262,340 52,337,266 60,374,171 Research and development costs ...................... 1,338,703 2,204,993 2,368,880 Selling, general and administrative expenses......... 4,789,096 7,516,458 8,280,756 ------------ ------------ ----------- 63,390,139 62,058,717 71,023,807 Loss from operations ................................ (333,535) (7,770,056) (8,105,822) Other income (expense), net Interest income...................................... 361,938 408,097 216,934 Interest expense..................................... (829,231) (681,859) (657,059) Other, net .......................................... (203,510) 21,356 (3,837) ------------- ------------- ------------- (670,803) (252,406) (443,962) Net loss ............................................ $(1,004,338) $(8,022,462) $(8,549,784) Proforma net loss per share ......................... $ (.15) $ (1.29) $ (1.62) Proforma weighted average number of shares outstanding ........................................ 6,590,710 6,203,117 5,285,064 The accompanying notes are an integral part of these statements.
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Supplemental Financial Statements Agritope Combined Statements of Changes in Group Equity Contributed Accumulated capital deficit Total Balances at September 30, 1993 ...................... $11,281,128 $(10,809,123) $ 472,005 Common stock issued as compensation ...................................... 50,392 - 50,392 Compensation expense for stock option grants .............................. 343,922 - 343,922 Common stock issued upon exchange of convertible notes ..................... 559,964 - 559,964 Equity issuance costs ............................... (40,267) - (40,267) Net cash from Epitope Medical Products............... 12,132,173 - 12,132,173 Distributions to S-corporation shareholders.......... - (540,000) (540,000) Net loss for the year ............................... - (8,549,784) (8,549,784) ------------- ------------- ------------- Balances at September 30, 1994 ...................... 24,327,312 (19,898,907) 4,428,405 Common stock issued as compensation ...................................... 69,998 - 69,998 Compensation expense for stock option grants ............................... 318,375 - 318,375 Common stock issued upon exchange of convertible notes ..................... 449,991 - 449,991 Equity issuance costs ............................... (22,487) - (22,487) Net cash from Epitope Medical Products .............. 8,330,854 - 8,330,854 Distributions to S-corporation shareholders ......... - (334,000) (334,000) Net loss for the year ............................... - (8,022,462) (8,022,462) ------------- ------------- ------------- Balances at September 30, 1995 ...................... 33,474,043 (28,255,369) 5,218,674 Common stock issued as compensation.................. 14,500 - 14,500 Compensation expense for stock option grants ..................................... 229,164 - 229,164 Net cash from Epitope Medical Products .............. 3,018,636 - 3,018,636 Distributions to S-corporation shareholders ......... - (1,325,000) (1,325,000) Net loss for the year ............................... - (1,004,338) (1,004,338) ------------- ------------- ------------- Balances at September 30, 1996 ...................... $36,736,343 $(30,584,707) $ 6,151,636
The accompanying notes are an integral part of these statements. - 85 -
Supplemental Financial Statements Agritope Combined Statements of Cash Flows For the Year Ended September 30 1996 1995 1994 Cash flows from operating activities Net loss ................................................ $(1,004,338) $(8,022,462) $(8,549,784) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization ........................... 474,256 859,641 714,420 Loss on disposition of property and investments ......... 64,126 29,560 74,130 Decrease (increase) in accounts receivable and other receivables ..................................... (166,475) (630,054) 1,306,977 Decrease (increase) in inventories ...................... (3,330,746) 222,991 (5,260,547) Decrease (increase) in prepaid expenses ................. 53,136 (100,940) 31,402 Decrease (increase) in other assets and deposits......... (36,219) 9,137 6,562 Increase (decrease) in accounts payable and accrued liabilities ................................... 2,122,118 (12,991) 1,678,494 Common stock issued as compensation for services......... 14,500 69,998 50,392 Compensation expense for stock option grants and deferred salary increases ............................. 229,164 318,375 343,922 ----------- ----------- ----------- Net cash used in operating activities ................... (1,580,478) (7,256,745) (9,604,032) Cash flows from investing activities Additions to property and equipment ..................... (925,388) (308,136) (2,240,743) Proceeds from sale of property .......................... - 13,258 - Expenditures for patents and proprietary technology ............................................ (411,943) (178,208) 135 Investment in affiliated companies ...................... (529,790) 548,876 (81,750) Other investments ....................................... (54,278) 48,990 (99,122) Minority Interest in affiliated companies ............... 215,407 - - ------------ ------------ ------------ Net cash (used in) provided by investing activities ..... (1,705,992) 124,780 (2,421,480) Cash flows from financing activities Net borrowings under bank line of credit ................ 975,000 500,000 1,075,000 Issuance of long-term debt .............................. 15,575 83,034 78,760 Principal payments on long-term debt .................... (217,883) (166,955) (116,020) Borrowings from shareholders ............................ 255,764 8,365 410,741 Principal payments on borrowings from shareholders........................................... (103,833) (368,327) (58,359) Distributions to S-corporation shareholders.............. - (334,000) (540,000) Cash from Epitope Medical Products ...................... 3,018,636 8,330,854 12,132,173 ----------- ----------- ----------- Net cash provided by financing activities ............... 3,943,259 8,052,971 12,982,295 Net increase in cash and cash equivalents ............... 656,789 921,006 956,783 Cash and cash equivalents at beginning of year .......... 4,246,687 3,325,681 2,368,898 ----------- ----------- ----------- Cash and cash equivalents at end of year ................ $4,903,476 $4,246,687 $3,325,681 The accompanying notes are an integral part of these statements.
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Supplemental Financial Statements Epitope, Inc. and Subsidiaries Consolidated Balance Sheets September 30 1996 1995 1996 Proforma (1) Assets Current assets Cash and cash equivalents (Note 2) ............... $ 5,699,263 $ 4,259,897 $ 5,699,263 Marketable securities (Note 2) ................... 18,818,120 17,080,246 18,818,120 Trade accounts receivable, net (Note 2) .......... 4,270,771 2,226,865 4,270,771 Other accounts receivable ........................ 206,420 1,632,307 206,420 Inventories (Note 2) ............................. 7,728,117 4,673,187 7,728,117 Prepaid expenses ................................. 180,174 247,191 180,174 ------------ ------------ ------------ Total current assets ............................. 36,902,865 30,119,693 36,902,865 Property and equipment, net (Notes 2 and 4) ...... 4,201,412 4,058,700 4,201,412 Patents and proprietary technology, net (Note 2) ........................................ 1,111,478 555,767 1,111,478 Investment in affiliated companies (Note 3) ...... 2,651,294 2,328,140 2,651,294 Other assets and deposits (Note 5) ............... 343,769 364,978 257,635 ----------- ----------- ----------- $45,210,818 $37,427,278 $45,124,684 Liabilities and Shareholders' Equity Current liabilities Borrowings under bank line of credit (Note 5) .... $ 4,125,000 $ 3,150,000 $ 4,125,000 Subordinated notes (Note 5) ...................... 2,236,628 - 2,236,628 Current portion of long-term debt ................ 98,368 196,134 98,368 Convertible notes, due 1997 (Notes 5 and 13) ..... 3,620,003 - 240,003 Accounts payable ................................. 3,127,051 2,308,364 3,127,051 Salaries, benefits and other accrued liabilities (Notes 2 and 9) ................................ 2,576,302 3,251,126 2,576,302 ----------- ------------ ----------- Total current liabilities ........................ 15,783,352 8,905,624 12,403,352 Long-term debt, less current portion (Note 5) .... 527,973 632,515 527,973 Convertible notes, due 1997 (Notes 5 and 13) ..... - 3,620,003 - Subordinated notes (Note 5) ...................... - 1,015,461 - Commitments and contingencies (Notes 6, 8, 9, 10 and 11)....................................... - - - Minority Interest ................................ 215,407 - 215,407 Shareholders' equity (Note 6) Preferred stock, no par value - 1,000,000 shares authorized; no shares issued or outstanding ................. - - - Common stock, no par value - 30,000,000 shares authorized; 13,457,383 and 13,085,130 shares issued and outstanding, respectively ................... 100,973,693 93,953,358 105,484,213 Accumulated deficit .............................. (72,289,607) (70,699,683) (73,506,261) ------------- ------------- ------------- 28,684,086 23,253,675 31,977,952 $45,210,818 $37,427,278 $45,124,684
(1) Reflects the proforma effect of conversion of $3,380,000 principal amount of Agritope notes into 250,367 shares of common stock of Epitope at an exchange price of $13.50 per share (see Note 13). The accompanying notes are an integral part of these statements. - 87 -
Supplemental Financial Statements Epitope, Inc. and Subsidiaries Consolidated Statements of Operations For the Year Ended September 30 1996 1995 1994 Revenues Product sales .................................... $ 67,335,497 $ 57,001,141 $ 65,465,141 Grants and contracts ............................. 1,314,756 143,042 58,202 ------------ ------------ ------------ 68,650,253 57,144,183 65,523,343 Costs and expenses Product costs .................................... 59,943,769 55,500,278 62,515,490 Research and development costs ................... 4,504,541 6,822,239 6,050,206 Selling, general and administrative expenses...... 9,822,587 14,199,318 11,347,652 ------------ ------------ ------------ 74,270,897 76,521,835 79,913,348 Loss from operations.............................. (5,620,644) (19,377,652) (14,390,005) Other income (expense), net Interest income................................... 1,386,968 1,164,840 454,401 Interest expense.................................. (829,231) (681,859) (657,059) License fee....................................... 5,000,000 - - Other, net........................................ (202,017) 21,037 (5,378) ------------ ----------- ----------- 5,355,720 504,018 (208,036) Net loss ......................................... $ (264,924) $(18,873,634) $(14,598,041) Net loss per share ............................... $ (.02) $ (1.52) $ (1.38) Weighted average number of shares outstanding ..................................... 13,181,420 12,406,234 10,570,129 The accompanying notes are an integral part of these statements.
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Supplemental Financial Statements Epitope, Inc. and Subsidiaries Consolidated Statements of Changes in Shareholders' Equity Common Stock Accumulated Shares Dollars deficit Total Balances at September 30, 1993.......................... 9,611,922 $ 45,448,710 $ (36,354,008) $9,094,702 Common stock issued upon exercise of options ........... 52,488 636,293 - 636,293 Common stock issued as compensation .......................................... 19,678 368,778 - 368,778 Compensation expense for stock option grants ................................... - 1,167,272 - 1,167,272 Common stock issued upon exercise of warrants .................................. 618,291 9,718,259 - 9,718,259 Common stock issued upon exchange of convertible notes ......................... 28,672 559,964 - 559,964 Common stock issued in private placement ..................................... 1,115,500 17,057,563 - 17,057,563 Equity issuance costs .................................. - (3,375,528) - (3,375,528) Distributions to S-corporation shareholders............. - - (540,000) (540,000) Net loss for the year .................................. - - (14,598,041) (14,598,041) ----------- ------------- ------------- ------------- Balances at September 30, 1994 ......................... 11,446,551 71,581,311 (51,492,049) 20,089,262 Common stock issued upon exercise of options ................................... 183,525 2,145,673 - 2,145,673 Common stock issued as compensation .......................................... 16,013 266,800 - 266,800 Compensation expense for stock option grants ................................... - 1,374,710 - 1,374,710 Common stock issued upon exercise of warrants .................................. 1,336,000 18,892,750 - 18,892,750 Common stock issued upon exchange of convertible notes ......................... 23,041 449,991 - 449,991 Equity issuance costs .................................. - (757,877) - (757,877) Distributions to S-corporation shareholders............. - - (334,000) (334,000) Net loss for the years ................................. - - (18,873,634) (18,873,634) ------------ ------------ ------------- ------------- Balances at September 30, 1995 ......................... 13,005,130 93,953,358 (70,699,683) 23,253,675 Common stock issued upon exercise of options ................................... 386,550 4,886,118 - 4,886,118 Common stock issued as compensation..................... 19,353 263,586 - 263,586 Compensation expense for stock option grants ......................................... - 1,044,183 - 1,044,183 Common stock issued upon exercise of warrants .................................. 46,350 826,600 - 826,600 Equity issuance costs .................................. - (152) - (152) Distributions to S-corporation shareholders............. - - (1,325,000) (1,325,000) Net loss for the year .................................. - - (264,924) (264,924) ------------ ------------ ------------- ------------- Balances at September 30, 1996 ......................... 13,457,383 $ 100,973,693 $(72,289,607) $ 28,684,086 The accompanying notes are an integral part of these statements.
- 89 -
Supplemental Financial Statements Epitope, Inc. and Subsidiaries Consolidated Statements of Cash Flows For the Year Ended September 30 1996 1995 1994 Cash flows from operating activities Net loss ............................................... $ (264,924) $(18,873,634) $(14,598,041) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization .......................... 1,267,141 1,654,936 1,365,496 Loss on disposition of property ........................ 63,028 29,879 75,671 Decrease (increase) in accounts receivable and other receivables .................................... (873,783) (706,603) 1,126,210 Increase in inventories ................................ (3,054,930) (152,649) (5,532,826) Decrease (increase) in prepaid expenses ................ 67,017 (62,909) 74,756 Decrease (increase) in other assets and deposits........ (20,649) (33,521) 335 Increase in accounts payable and accrued liabilities .......................................... (28,992) 2,260,373 2,008,369 Common stock issued as compensation for services.............................................. 263,586 266,800 368,778 Compensation expense for stock option grants and deferred salary increases ............................ 1,044,183 1,374,710 1,259,273 ----------- ----------- ----------- Net cash used in operating activities .................. (1,538,323) (14,242,618) (13,851,979) Cash flows from investing activities Investment in marketable securities .................... (47,608,270) (16,194,994) (5,603,414) Proceeds from sale of marketable securities ............ 45,870,396 4,718,162 - Additions to property and equipment .................... (1,105,500) (1,420,428) (2,702,657) Proceeds from sale of property ......................... 7,432 14,343 1,000 Expenditures for patents and proprietary technology ........................................... (770,262) (305,135) (185,670) Investment in affiliated companies ..................... (387,280) 591,428 (16,812) Other investments ...................................... (54,278) 48,990 (99,122) Minority interest in affiliated companies .............. 215,407 - - ------------ ----------- ----------- Net cash used in investing activities .................. (3,832,355) (12,547,634) (8,606,675) Cash flows from financing activities Net borrowings under bank line of credit ............... 975,000 500,000 1,075,000 Issuance of long-term debt ............................. 15,575 83,034 78,760 Principal payments on long-term debt ................... (217,883) (166,955) (116,020) Proceeds from issuance of common stock ................. 5,885,573 21,060,912 24,387,702 Cost of common stock issuance .......................... (152) (757,877) (310,849) Borrowings from shareholders ........................... 255,764 8,365 410,741 Principal payments on borrowings from shareholders ......................................... (103,833) (368,327) (58,359) Distributions to S-corporation shareholders............. - (334,000) (540,000) ------------ ------------ ------------ Net cash provided by financing activities .............. 6,810,044 20,025,152 24,926,975 Net increase (decrease) in cash and cash equivalents ... 1,439,366 (6,765,100) 2,468,321 Cash and cash equivalents at beginning of year ......... 4,259,897 11,024,997 8,556,676 ------------ ------------ ------------ Cash and cash equivalents at end of year ............... $ 5,699,263 $ 4,259,897 $ 11,024,997 The accompanying notes are an integral part of these statements.
- 90 - Notes to Supplemental Financial Statements Note 1 The Company Epitope, Inc. (the Company or Epitope) is an Oregon corporation utilizing biotechnology to develop and market medical diagnostic products through its Epitope Medical Products group (Epitope Medical Products) and superior new plants and related products through its Agritope group (Agritope). Agritope is also in the business of growing, marketing, selling, and distributing fresh and frozen produce, primarily tomatoes and strawberries. Upon approval of the proposal to create a new class of common stock (the Agritope Stock Proposal), the capital structure of Epitope will be modified to include two classes of common stock, Epitope Medical Products Common Stock and Agritope Common Stock. The Epitope Medical Products group (Epitope Medical Products) will include the medical products business conducted by the Company. The Agritope group (Agritope) will include the agribusiness and agricultural biotechnology operations of the Company. Note 2 Summary of Significant Accounting Policies Basis of Presentation. The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Assets and liabilities of majority-owned subsidiaries are included in these statements. Minority-owned investments and joint ventures are accounted for using the equity method. Investments of less than 20 percent are carried at cost. The accompanying combined financial statements of the Epitope Medical Products and Agritope groups have been prepared using the amounts included in the consolidated financial statements of the Company. Assets, liabilities, revenues and expenses of each group are included in the respective financial statements of the applicable group. Cash, cash equivalents and marketable securities have been allocated 80 percent to Epitope Medical Products and 20 percent to Agritope. Cash advanced and allocated by the Company to business units of the Agritope group has been reflected as contributed capital in the accompanying combined financial statements. On November 6, 1996 the Company agreed to merge with Andrew and Williamson Sales, Co. (A&W) in a transaction to be accounted for as a pooling of interests. See Note 13. The accompanying consolidated financial statements and the combined financial statements of the Agritope Group have been restated to reflect the merger as if it had occurred at the beginning of the earliest period presented. Certain corporate overhead services such as accounting, finance, general management, human resources, investor relations, information systems and payroll are provided by the Company on a centralized basis for the benefit of both groups (Shared Services). Such expenses have been allocated between Epitope Medical Products and Agritope in the accompanying combined financial statements using activity indicators which, in the opinion of management, represent a reasonable measure of the respective group's utilization of such shared services. These activity indicators, which will be reviewed periodically and adjusted to reflect changes in utilization, include number of employees, number of computers, and level of expenditures. The accompanying combined financial statements also include an adjustment to allocate interest income in the same proportion as the allocation of Shared Services between the two groups. Future interest income will be based on amounts earned by each group. Shared Services are included under the caption "Selling, general and administrative expenses" as follows:
Year Ended September 30 1996 1995 1994 Epitope Medical Products .......................... $3,028,181 $3,575,069 $1,899,969 Agritope .......................................... 1,069,249 1,892,370 1,735,688 ----------- ---------- ---------- Consolidated ...................................... $4,097,430 $5,467,439 $3,635,657
- 91 - Notes to Supplemental Financial Statements, Continued If the Agritope Stock Proposal is approved, the Company will provide holders of Epitope Medical Products and Agritope common stock separate financial statements prepared in accordance with generally accepted accounting principles, management's discussion and analysis of financial condition and results of operations, descriptions of businesses and other relevant information for each group. Notwithstanding the attribution of assets and liabilities (including contingent liabilities) to each group for the purposes of preparing their respective historical and future financial statements, this attribution and the change in capitalization contemplated in the Agritope Stock Proposal will not affect legal title to such assets or responsibility for such liabilities of the Company or any of its subsidiaries. Holders of each class of common stock will be common shareholders of the Company and would be subject to risks associated with an investment in the Company and all its businesses, assets, and liabilities. Liabilities or contingencies of either group that affect the Company's resources or financial condition could affect the financial condition and results of operations of either group. Under the Agritope Stock Proposal, dividends to be paid to the holders of either class of common stock will be limited to the lesser of funds of the Company legally available for the payment of dividends or the Available Medical Products Dividend Amount or Available Agritope Dividend Amount as defined in the Company's Articles of Incorporation. The Company has never paid any cash dividends on shares of Epitope common stock. The Company currently intends to retain any of its earnings to finance future growth and, therefore, does not anticipate paying any cash dividends on either class of common stock in the foreseeable future. The dividends reflected in these financial statements were paid by A&W to its shareholders prior to the merger of A&W with the Company. Except as stated in the amended Articles of Incorporation, the accounting policies applicable to preparation of financial statements of either group may be modified or rescinded at the sole discretion of the Board of Directors of the Company without the approval of shareholders, although there is no intention to do so. In addition, generally accepted accounting principles require that any change in accounting policy be preferable (in accordance with such principles) to the previous policy. Cash and Cash Equivalents; Marketable Securities. For purposes of the consolidated balance sheets and statements of cash flows, the Company considers all highly liquid investments with maturities at time of purchase of three months or less to be cash equivalents. At September 30, 1996, marketable securities consisted of commercial paper and U.S. Treasury securities with an original maturity period greater than three months, but generally less than 12 months. The Company's policy is to invest its excess cash in securities that maximize (a) safety of principal, (b) liquidity for operating needs, and (c) after-tax yields. Effective October 1, 1994, the Company adopted Financial Accounting Standards Board Statement No. 115 (SFAS 115), Accounting for Certain Investments in Debt and Equity Securities. Pursuant to SFAS 115, the Company has categorized all of its investments as available-for-sale securities and, accordingly, unrealized gains and losses on such investments, if material, will be carried as a separate component of shareholders' equity. Such unrealized gains and losses were immaterial as of September 30, 1996 and 1995. Inventories. Medical products inventories are recorded at the lower of standard cost (which approximates actual cost on a first-in, first-out basis) or market. Growing crops (included in work-in-process) are valued at the lower of cost (representing direct and indirect production costs) or estimated market. Harvested crops and frozen strawberry inventories (included in finished goods) are valued at the lower of average cost or market. Inventory components are summarized as follows: - 92 - Notes to Supplemental Financial Statements, Continued
September 30 1996 1995 Epitope Medical Products Raw materials................................................. $ 522,824 $ 657,568 Work-in-process .............................................. 389,642 379,470 Finished goods ............................................... 192,882 295,032 Supplies ..................................................... 52,582 101,676 ----------- ----------- $1,157,930 $1,433,746 Agritope Work-in-process............................................... $4,466,880 $2,201,073 Finished goods ............................................... 1,740,689 741,424 Supplies ..................................................... 362,618 296,944 ----------- ----------- $6,570,187 $3,239,441 Consolidated Raw materials ................................................ $ 522,824 $ 657,568 Work-in-process .............................................. 4,856,522 2,580,543 Finished goods ............................................... 1,933,571 1,036,456 Supplies ..................................................... 415,200 398,620 ----------- ----------- $7,728,117 $4,673,187
The Company grows crops primarily in Mexico in cooperation with various Mexican farmers. Under the agreements, the Company generally shares in the costs of growing, picking, packing, and distribution. The Company recovers its costs plus a gross profit percentage of approximately ten percent from the sale of the crops in the United States. Cost of sales is charged for costs in excess of estimated market. During 1996, 1995, and 1994, the Company charged to cost of sales growing costs in excess of estimated market of approximately $1,811,000, $2,544,037, and $2,106,181, respectively. Depreciation and Capitalization Policies. Land is stated at cost. Property and equipment are stated at cost less accumulated depreciation. Expenditures for repairs and maintenance are charged to operating expense as incurred. Expenditures for renewals and betterments are capitalized. Depreciation and amortization of property and equipment are calculated primarily under the straight-line method over the estimated lives of the related assets (three to seven years). Leasehold improvements are amortized over the shorter of estimated useful lives or the terms of related leases. When assets are sold or otherwise disposed, cost and related accumulated depreciation or amortization are removed from the accounts and any resulting gain or loss is included in operations. Accounting For Long-Lived Assets. The Company reviews its long-lived assets for impairment periodically or as events or circumstances indicate that the carrying amount of long-lived assets may not be recoverable. If the estimated net cash flows are less than the carrying amount of the long-lived assets, the Company recognizes an impairment loss in an amount necessary to write down long-lived assets to fair value as determined from expected discounted future cash flows. This accounting policy is consistent with Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. There has been no significant impact to the Company's financial position or results of operations as the carrying amount of all long-lived assets is considered recoverable. Patents and Proprietary Technology. Direct costs associated with patent submissions and acquired technology are capitalized and amortized over their minimum estimated economic useful lives, generally five years. - 93 - Notes to Supplemental Financial Statements, Continued In August 1996, the Company amended an agreement pursuant to which it acquired Agritope's patented ethylene control technology in 1987. A co-inventor of the technology relinquished all rights to future compensation under the agreement in exchange for a one-time cash payment, a research grant and a limited non-exclusive license to use the technology for one crop. The total consideration of $365,000 is included in Agritope's combined balance sheet under the caption "Patents and proprietary technology" and is being amortized over 15 years, the remaining life of the related patent. Amortization and accumulated amortization are summarized as follows:
1996 1995 1994 Amortization for the year ended September 30, Epitope Medical Products $ 172,095 $ 130,313 $ 101,339 Agritope 42,456 23,964 13,487 --------- --------- --------- Consolidated $ 214,551 $ 154,277 $ 114,826 Accumulated Amortization at September 30, Epitope Medical Products $ 621,110 $ 449,015 $ 318,702 Agritope 79,907 37,451 13,487 --------- ---------- ---------- Consolidated $ 701,017 $ 486,466 $ 332,189
Fair Value of Financial Instruments. The carrying amount for cash equivalents, marketable securities, accounts receivable, borrowings under bank line of credit, subordinated notes, and accounts payable approximates fair value because of the immediate or short-term maturity of these financial instruments. The carrying amount for long-term debt and convertible notes approximates fair value because the related interest rates are comparable to rates currently available to the Company for debt with similar terms and maturities. Revenue Recognition. Product revenues are recognized when the related products are shipped. Grant and contract revenues include funds received under research and development agreements with various entities. These grants and contracts generally provide for progress payments as expenses are incurred and certain research milestones are achieved. Revenue related to such grants and contracts is recognized as research milestones are achieved. Accounts receivable are stated net of an allowance for doubtful accounts as follows:
September 30 1996 1995 Epitope Medical Products $ 6,872 $ 6,872 Agritope 64,571 119,172 -------- --------- Consolidated $ 71,443 $126,044
Research and Development. Research and development expenditures are comprised of those costs associated with the Company's own ongoing research and development activities including the costs to prepare for, obtain and compile clinical studies and other information to support product license applications. Expenditures for research and development also include costs incurred under contracts to develop certain products, including those contracts resulting in grant and contract revenues. All research and development costs are expensed as incurred. - 94 - Notes to Supplemental Financial Statements, Continued Income Taxes. The Company accounts for certain revenue and expense items differently for income tax purposes than for financial reporting purposes. These differences arise principally from methods used in accounting for stock options and depreciation rates. Deferred tax assets and liabilities are recognized based on temporary differences between the financial statement and the tax bases of assets and liabilities using enacted tax rates in effect for the year in which the temporary differences are expected to reverse. As a separate company, A&W had elected S-Corporation tax treatment. As an S-Corporation, income or losses passed through to A&W's shareholders, and no provision for federal income taxes was reflected in the financial statements. State income taxes applicable to A&W were provided at a reduced rate under S-Corporation status. Following the merger (see Note 13), A&W will be taxed as a C-Corporation and will join with the Company in filing a consolidated federal income tax return. The termination of the S-Corporation status is not expected to have a material impact on future results of operations. As of September 30, 1996, the Company had net operating losses of approximately $66.7 million available to offset future federal and state taxable income, including taxable income of A&W. See Note 7. To date, both Epitope Medical Products and Agritope have experienced operating losses. Actual tax payment is a liability of Epitope as a whole. The Agritope Stock Proposal provides that either group may be allocated the tax benefit of such losses and future losses to reduce current or deferred tax expense and that such losses will not be carried forward to reduce the losses of the group which incurred such losses. Accordingly, either group may report lower earnings than if such losses had been retained for the benefit of then group which incurred such losses. Net Income (Loss) Per Share. Net income (loss) per share has been computed using the weighted average number of shares of common stock and common stock equivalents outstanding during the period. Common stock equivalents consist of the number of shares issuable upon exercise of outstanding warrants, options and convertible notes less the number of shares assumed to have been purchased for the treasury with the proceeds from the exercise of such. The weighted average number of shares has been adjusted to reflect the issuance of 520,000 additional shares issued in conjunction with the merger with A&W (see Note 13). Net income (loss) per share for Epitope Medical Products and Agritope is presented on a proforma basis assuming that the distribution of Agritope common stock and redesignation of Epitope, Inc. common stock as Epitope Medical Products common stock pursuant to the Agritope Stock Proposal had occurred on October 1, 1993. Common stock equivalents are excluded from the computation if their effect is anti-dilutive. Primary and fully diluted earnings per share are the same. Supplemental Cash Flow Information. Non-cash financing and investing activities not included in the consolidated statements of cash flows are summarized as follows:
Year Ended September 30 1996 1995 1994 Epitope Medical Products Discount on private placement of common stock......$ - $ - $3,024,413 Agritope Conversion of notes to equity (Note 5).............$ - $ 427,496 $ 600,231 Investment in nonconsolidated subsidiary........... - 2,584,979 - Distributions to S-corporation shareholders declared but not paid............................ 1,325,000 - -
In addition, Agritope paid $568,835; $455,783; and $407,929, for interest during the years ended September 30 1996, 1995, and 1994, respectively. - 95 - Notes to Supplemental Financial Statements, Continued Supplemental Profit and Loss Information. In September 1995, management announced a company-wide reduction in work force whereby 48 employees were terminated. The Company charged $607,000 to results of operations for severance payments and related expenses for this program. As of September 30, 1996 and 1995, $55,000 and $475,000, respectively, of these charges remain accrued and are included in the accompanying balance sheets of the Company and Epitope Medical Products under the caption "Salaries, benefits and other accrued liabilities." Management Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates relating to assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Actual results could vary from these estimates. Note 3 Investment in Affiliated Companies In June 1995, Agritope agreed to sell its wholly owned grape plant propagation subsidiary, Vinifera, Inc. to VF Holdings, Inc. (VF), an affiliate of a Swiss investment group, pursuant to a stock purchase agreement. VF subsequently failed to make all the payments required under the VF Agreement. As part of a settlement of claims based on VF's default, VF retained a 4 percent minority interest in Vinifera and relinquished the majority interest to Agritope in August 1996. The reacquisition of Vinifera in August 1996 has been accounted for under the purchase method. The net purchase price of $916,000 has been allocated to tangible net assets. Vinifera's results of operations are including in the Agritope Combined Statements of Operations and in the Consolidated Statements of Operations through May 1995, and for the month of September 1996. The following summarized proforma results of operations are presented as if the reacquisition had occurred on the first day of each period shown.
Year Ended September 30 1996 1995 Proforma Proforma Supplemental Adjustments Proforma Supplemental Adjustments Proforma Agritope Revenues 63,056,604 833,949 63,890,553 54,288,661 276,588 54,565,249 Net loss (1,004,338) (1,464,002) (2,468,340) (8,022,462) (460,296) (8,482,758) Proforma loss per share (0.15) (0.22) (0.37) (1.29) (0.07) (1.37) Consolidated Revenues 68,650,253 833,949 69,484,202 57,144,183 276,588 57,420,771 Net loss (264,924) (1,464,002) (1,728,926) (18,873,634) (460,296)(19,333,930) Loss per share (0.02) (0.11) (0.13) (1.52) (0.04) (1.56) In May 1995, Agritope's wholly owned subsidiary, Agrimax Floral Products, Inc. (Agrimax), ceased operations as an independent entity. UAF, Limited Partnership (UAF), in which Agrimax obtained an 18 percent interest, was formed to combine the Agrimax operations in Charlotte, North Carolina, with those of Universal American Flowers, Inc. in Tampa, Florida and Hammond, Louisiana. In connection with the UAF transaction, Agrimax contributed inventory, operating assets and the right to use its proprietary floral preservative and certain trademarks. In May 1996, the equity interest of Agrimax was reduced to 9 percent as the result of a recapitalization of UAF. The St. Paul, Minnesota, facility of Agrimax ceased operations in June 1995. In June 1996, Agrimax contributed inventory and operating assets to Petals USA, Inc. (Petals), a newly formed affiliate of a Canadian fresh flower wholesaler, in return for a 19.5 percent equity interest in Petals. - 96 - Notes to Supplemental Financial Statements, Continued The investments by Agrimax are included in the accompanying consolidated balance sheets of the Company and combined balance sheets of Agritope under the caption "Investment in affiliated companies." See Note 13. For the years ended September 30, 1995, 1994 respectively, the accompanying financial statements of the Company and Agritope include revenues of $2.0 million and $2.2 million, and operating losses of $3.8 million, and $6.4 million attributable to the Agrimax and Vinifera business units. The accompanying statements of operations of the Company and Agritope for the year ended September 30, 1995, includes the results of operations of Agrimax and Vinifera through May and also includes a charge of $500,000 primarily attributable to the disposition of Agrimax. Note 4 Property and Equipment Property and equipment are summarized as follows:
September 30 1996 1995 Epitope Medical Products Research and development laboratory equipment............. $ 1,056,883 $ 898,716 Manufacturing equipment .................................. 1,291,546 1,296,416 Office furniture and equipment ........................... 1,899,948 2,041,897 Leasehold improvements ................................... 1,084,660 1,084,660 Construction in progress ................................. 134,557 70,961 ----------- ----------- 5,467,594 5,392,650 Less accumulated depreciation and amortization ........... (3,924,837) (3,402,881) ------------- ------------- $ 1,542,757 $ 1,989,769 Agritope Land ..................................................... $ 420,817 $ 420,817 Buildings and improvements ............................... 717,508 717,508 Research and development laboratory equipment ............ 220,919 196,255 Manufacturing and transportation equipment ............... 2,088,669 1,789,933 Office furniture and equipment ........................... 188,251 196,119 Leasehold improvements ................................... 166,398 173,262 Construction in progress ................................. 499,980 34,650 ------------ ----------- 4,302,542 3,528,544 Less accumulated depreciation and amortization............ (1,643,887) (1,459,613) ------------- ------------- $ 2,658,655 $ 2,068,931 Consolidated Land ..................................................... $ 420,817 $ 420,817 Buildings and improvements ............................... 717,508 717,508 Research and development laboratory equipment ............ 1,277,802 1,094,971 Manufacturing and transportation equipment ............... 3,380,215 3,086,349 Office furniture and equipment ........................... 2,088,199 2,238,016 Leasehold improvements ................................... 1,251,058 1,257,922 Construction in progress ................................. 634,537 105,611 ------------ ----------- 9,770,136 8,921,194 Less accumulated depreciation and amortization............ (5,568,724) (4,862,494) ------------- ------------- $ 4,201,412 $ 4,058,700
- 97 - Notes to Supplemental Financial Statements, Continued Note 5 Debt Bank Line of Credit. At September 30, 1996, A&W had a bank line of credit which provided for borrowings of up to $6,500,000 and was to expire in August 1997. Borrowings under the line bore interest at the bank's prime interest rate plus .5 percent; were collateralized by substantially all of the assets of A&W; and were guaranteed by A&W's shareholders. The Company had the option to fix the interest rate for a specified period of time at the LIBOR rate for such period. See Note 13. Convertible Notes. On June 30, 1992, Agritope completed a private placement with several European institutional investors pursuant to which $5,495,000 of convertible notes were issued. The notes are unsecured, mature on June 30, 1997 and bear interest at the rate of 4 percent per annum which is payable on each June 30 and December 31 until all outstanding principal and interest on the notes have been paid in full. The notes are convertible into common stock of the Company at a conversion price of $19.53 per share. In the event of an initial public offering of Agritope common stock, the notes would be automatically converted to shares of Agritope common stock at 90 percent of the public offering price. During the years ended September 30, 1995 and 1994, respectively, investors exchanged $449,991 and $559,964 principal amount of convertible notes for the Company's common stock at a price of $19.53 per share. In conjunction with the exchanges, unamortized debt issuance costs of $22,487 and $40,267 related to such notes were recognized as equity issuance costs during 1996 and 1995, respectively. Debt issuance costs are included in other assets and are being amortized over the five-year life of the notes. Amortization expense of debt issuance costs for the years ended September 30, 1996, 1995 and 1994, respectively, totaled $108,257, $96,136 and $91,715, leaving an unamortized balance of $88,821 and $197,077 at September 30, 1996 and 1995, respectively. See Note 13. Long-term Debt. Long-term debt is summarized as follows:
September 30 1996 1995 Agritope Note payable, interest at 7%, due on demand, unsecured ......................................... $ - $ 50,000 Installment notes, interest at 5.9% to 12.75% due various, secured by equipment ................................ 59,824 138,976 Installment note, interest at 9.25%, due June 1997, secured by equipment .............................. 263,717 319,973 Note payable, interest at prime, due October 1997, unsecured ...................................... 100,000 100,000 Bank installment note, interest at prime plus 1.25%, due March 1998, secured by property ....................... 202,800 219,700 ---------- ---------- 626,341 828,649 Less current portion .............................................. (98,368) (196,134) ----------- ------------ $ 527,973 $ 632,515
The installment note payable of $263,717 at September 30, 1996 has a balloon payment of $217,989 due in June 1997. The amount of the balloon payment has been classified as long-term based on the Company's intent and ability to refinance this borrowing on a long-term basis. Certain of the notes above have been guaranteed by the shareholders of A&W. Certain of the note agreements provide various financial and other covenants including minimum working capital and net worth levels and restricted capital expenditures. - 98 - Notes to Supplemental Financial Statements, Continued
As of September 30, 1996, maturities for long-term debt are as follows: Year Ending September 30 1997.................................................................................................... $ 98,368 1998 ................................................................................................... 525,532 1999 ................................................................................................... 2,441 --------- $626,341
Subordinated Notes. The Company has notes payable to shareholders which are subordinated to the claims of its bank. These notes are due on demand and bear interest at 10 percent. The Company intends to pay these notes in full following the effective date of the merger. See Note 13. Note 6 Shareholders' Equity Authorized Capital Stock. The Company's amended articles of incorporation authorize 1,000,000 shares of preferred stock and 30,000,000 shares of common stock. The Company's Board of Directors has authority to determine preferences, limitations and relative rights of the preferred stock. Common Stock Reserved for Future Issuance. As of September 30, 1996, the following shares of the Company's common stock were reserved for future issuance, as more fully described below:
Purpose Shares Outstanding warrants ........................................................................... 2,000,640 Outstanding stock options ...................................................................... 3,365,726 Employee Stock Purchase Plan subscriptions ..................................................... 42,820 Conversion of notes (Notes 5 and 13) ........................................................... 185,356 ---------- 5,594,542
If the Agritope Stock Proposal is approved, the Company will issue to the holders of the above rights to purchase shares of Epitope common stock or to convert notes into such shares, as applicable, the equivalent rights with respect to Agritope common stock on the basis of one-half share of Agritope common stock for each right to purchase one share of Epitope common stock. Common Stock Warrants. As of September 30, 1996, the following warrants to purchase shares of common stock were outstanding:
Date of Issuance Shares Price Expiration Date September 26, 1991 .................................. 159,150 $16.00 September 30, 1997 December 23, 1992 ................................... 988,390 18.50 September 30, 1997 July 20, 1993 ....................................... 375,000 20.00 September 30, 1997 August 1, 1993 ...................................... 200,000 18.50 September 30, 1997 October 17, 1994 .................................... 50,000 18.50 September 30, 1997 November 22, 1994 ................................... 228,100 18.50 September 30, 1997 ---------- 2,000,640
- 99 - Notes to Supplemental Financial Statements, Continued Stock Award Plans. The Company's 1991 Stock Award Plan (the 1991 Plan) was approved by the shareholders during 1991, replacing the Company's Incentive Stock Option Plan (ISOP). The 1991 Plan provides for stock-based awards to employees, outside directors and members of scientific advisory committees or other consultants. Awards which may be granted under the 1991 Plan include qualified incentive stock options, nonqualified stock options, stock appreciation rights, restricted awards, performance awards and other stock-based awards. Under the terms of the 1991 Plan, qualified incentive stock options on shares of common stock may be granted to eligible employees, including officers, of the Company at an exercise price not less than the fair market value of the stock on the date of grant. The maximum term during which any option may be exercised is ten years from the date of grant. To date, options have been granted with four-year vesting schedules. Options issued to employees under the Incentive Stock Option Plan (ISOP) were issued at prices not less than the fair market value of a share of common stock on the date of grant. The options are exercisable after one year from the date of grant at the rate of 25 percent per year cumulatively and expire ten years from the date of grant. The Agritope, Inc. 1992 Stock Award Plan (the 1992 Plan) was adopted by Agritope and approved by the Company in 1992. The 1992 Plan, which has provisions similar to those of the Company's 1991 Plan, authorizes issuance of 2,000,000 shares of Agritope common stock. Until Agritope is no longer a wholly owned subsidiary of the Company, shares issued pursuant to exercise of options under the 1992 Plan will be converted into shares of the Company's common stock based on the ratio of the fair market value of the Company's common stock to the fair market value of Agritope common stock on the date of the grant. The 1991 Plan and 1992 Plan also provide that nonqualified options may be granted at a price not less than 75 percent of the fair market value of a share of common stock on the date of grant. The option term and vesting schedule of such awards may either be unlimited or have a specified period in which to vest and be exercised. For the discounted nonqualified options issued, the Company amortizes, on a straight-line basis over the vesting period of the options, the difference between the exercise price and the fair market value of a share of stock on the date of grant. As of September 30, 1996, 197,181 shares of Epitope common stock remain available for grant under the Company's stock award plans. In October 1995, the Financial Accounting Standards Board issued SFAS 123, Accounting for Stock-Based Compensation. SFAS 123 allows companies which have stock-based compensation arrangements with employees to adopt a fair-value basis of accounting for stock options and other equity instruments or to continue to apply the existing accounting rules under APB Opinion 25, Accounting for Stock Issued to Employees, but with additional financial statement disclosure. The Company plans to elect the disclosure-only alternative commencing in fiscal 1997 and therefore does not anticipate that SFAS 123 will have a material impact on its financial position or results of operations. Options granted and outstanding under the Company's stock option plans are summarized as follows:
1996 1995 1994 Shares Price Shares Price Shares Price Outstanding at beginning of period .. 3,636,103 $ 1.09-24.94 3,483,432 $ 1.09-24.94 3,052,653 $ 1.09-24.94 Granted ............... 901,379 9.81-18.13 802,050 14.94-18.88 589,850 14.38-22.94 Exercised ............. (386,550) 1.09-17.13 (183,525) 1.84-22.50 (52,488) 12.43-22.50 Canceled .............. (785,206) 14.38-24.00 (465,854) 7.38-22.94 (106,583) 8.50-22.94 ----------- ----------- ----------- Outstanding at end of period ........ 3,365,726 $ 3.50-24.94 3,636,103 $ 1.09-24.94 3,483,432 $ 1.09-24.94 Exercisable ........... 2,302,212 $ 3.50-24.94 2,002,925 $ 1.09-24.94 1,557,505 $ 1.09-24.94
- 100 - Notes to Supplemental Financial Statements, Continued Pursuant to the 1991 Plan, 973, 3,680 and 11,741 shares of common stock were also awarded to consultants and members of the Company's scientific advisory committees during 1996, 1995, and 1994, respectively. Employee Stock Purchase Plans. In 1991, the shareholders approved the Company's adoption of the 1991 Employee Stock Purchase Plan (1991 ESPP) covering a maximum of 100,000 shares of common stock for subscription over two offering periods. The purchase price for stock purchased under the 1991 ESPP for each of the two 24-month subscription periods was the lesser of 85 percent of the fair market value of a share of common stock at the commencement of the subscription period or the fair market value at the close of each subscription period. An employee may also elect to withdraw at any time during the subscription period and receive the amounts paid plus interest at the rate of 6 percent. During April 1994, 676 shares, at a purchase price of $14.00 per share, were issued to employees for the second 1991 ESPP purchase period which closed March 31, 1994. The 1993 Employee Stock Purchase Plan (1993 ESPP), as amended and restated effective February 1, 1993, covers a maximum of 250,000 shares of common stock for subscription over established offering periods. The Company's Board of Directors was granted authority to determine the number of offering periods, the number of shares offered, and the length of each period, provided that no more than three offering periods (other than Special Offering Subscriptions as described below) may be set during each fiscal year of the Company. Other provisions of the 1993 ESPP are similar to the 1991 ESPP. During April, 1996, 10,106 shares were issued at a price of $11.90 per share. As of September 30, 1996, 42,820 shares of common stock were subscribed for during two offerings under the 1993 ESPP. Shares subscribed for under these 1993 ESPP offerings may be purchased over 24 months and have initial subscription prices of $12.33 and $8.77 per share for the various offerings. The 1993 ESPP was amended to allow the Company, at its discretion, to provide Special Offering Subscriptions whereby an employee's annual increase in compensation could be deferred for a one-year period. At the end of the one- year period, the employee can elect to receive the deferred compensation amount in the form of cash or shares of the Company's common stock. The purchase price for stock issued under a Special Offering Subscription is the lesser of 85 percent of the fair market value of a share of common stock on the first day of the calendar month the employee's increase was effective or the fair market value at the close of the one-year subscription period. During 1995 and 1994, respectively, 5,569 and 2,314 Special Offering Subscription shares were issued to employees at an average price of $15.26 and $15.24 per share. Note 7 Income Taxes As of September 30, 1996, the Company had net operating loss carryforwards of approximately $66.7 million and $50.0 million, respectively, to offset federal and state taxable income. These net operating loss carryforwards will generally expire from 2001 through 2011 if not used by the Company. Approximately $6.9 million of the Company's net operating loss carryforwards were generated as a result of deductions related to the exercise of stock options. When utilized, such carryforwards, as tax effected, will be reflected in the Company's financial statements as an increase in shareholders' equity rather than a reduction of the provision for income taxes. - 101 - Notes to Supplemental Financial Statements, Continued Significant components of the Company's deferred tax asset were as follows (in thousands):
September 30 1996 1995 Net operating loss carryforwards.............................. $ 24,489 $ 26,110 Deferred compensation......................................... 1,997 1,665 Research & experimentation credit carryforwards............... 1,151 1,151 Accrued expenses.............................................. 317 238 Other......................................................... 495 384 --------- -------- Gross deferred tax assets..................................... 28,449 29,548 Valuation allowance........................................... (28,449) (29,548) --------- -------- Net deferred tax asset........................................ - -
No benefit for the Company's deferred tax assets has been recognized in the accompanying financial statements as they do not satisfy the recognition criteria set forth in SFAS 109. The valuation allowance decreased $1.1 million in 1996, increased $7.5 million in 1995, and increased $6.2 million in 1994. The research and development tax credit carryforwards will generally expire from 2001 through 2010 if not used by the Company. The expected federal statutory tax benefit of approximately $476,000 for the year ended September 30, 1996 is increased by approximately $61,000 for the effect of state and local taxes (net of federal impact), $1.1 million for the effect of the decrease in valuation allowance, and $840,000 for the effect of stock option deductions included in the valuation allowance and is reduced by approximately $2.5 million for the effect of Vinifera Inc.'s net operating loss carryforwards and certain state net operating loss carryforwards being removed from the consolidated tax group. Note 8 Research and Development Arrangements In February 1995, the Company entered into a Development, License and Supply Agreement with SmithKline Beecham, plc (SB) pursuant to which the Company will conduct research and development projects funded by SB. Agritope also performed research work in 1996 and 1995 with respect to raspberries which was partially funded by Sweetbriar Development, Inc. under a License Agreement dated October 18, 1994 and with respect to grapevine disease diagnostics funded by a grant from the U.S. Department of Agriculture under the Small Business Innovation Research Program. During 1994, the Company participated in a National Cancer Institute program whereby the Company received funding for research toward the treatment of cancer. Agritope has also received grant support from the U.S. Department of Agriculture, Oregon Strawberry Commission, and Oregon Raspberry & Blackberry Commission for antifungal biocontrol research and from several strategic partners. Revenues from research and development arrangements are included in the accompanying consolidated statements of operations under the caption "Grants and contracts." Expenses related to such arrangements are included under the caption "Research and development costs." The activity related to these arrangements is summarized as follows:
Year Ended September 30 Epitope Medical Products 1996 1995 1994 SB research projects...................................... 712,000 40,000 - Other..................................................... 17,271 8,672 24,560 --------- -------- -------- 729,271 48,672 24,560 Project related expenses.................................. 1,087,713 108,645 46,493
- 102 - Notes to Supplemental Financial Statements, Continued
Agritope 1996 1995 1994 Government research grants................................ 144,987 16,358 33,642 Research projects with strategic partners................. 326,462 40,000 - Other..................................................... 114,036 38,012 - --------- -------- ----------- 585,485 94,370 33,642 Project related expenses.................................. 461,460 318,401 35,728
Note 9 Distribution and Supply Contracts The Company has entered into several contractual arrangements, including those discussed in the following paragraphs, for distribution of certain of its products to customers. The Company continues to maintain supply and distribution agreements with Organon Teknika Corporation (Organon Teknika), whereby Organon Teknika supplies the Company's antigen requirements and exclusively distributes the Company's EPIblot HIV confirmatory tests (EPIblot) on a worldwide basis. As of April 1, 1994, the Company renewed the agreements which have an initial termination date of March 31, 1997 (with successive one-year renewal periods thereafter) and include pricing incentives based on volumes purchased by Organon Teknika and penalties for failure to purchase specified minimum quarterly volumes. For the years ended September 30, 1996, 1995 and 1994, respectively, revenues generated from sales of EPIblot to Organon Teknika were $1,539,164, $1,808,431, and $1,688,200, including export sales of $62,539, $72,369 and $320,700. The Company has notified Organon Teknika that it intends to renew the agreements on mutually acceptable, but revised, terms prior to the scheduled termination date. LabOne, Inc. (previously Home Office Reference Laboratory, Inc.) purchases oral specimen devices from the Company for use in insurance testing in return for non-exclusive distribution rights in the United States and Canada under an agreement which expires on March 13, 2000, with an automatic five-year renewal, unless either party notifies the other of intent not to renew at least 180 days prior to the initial expiration date. For the years ended September 30, 1996, 1995 and 1994, respectively, revenue generated from product sales to LabOne, Inc. was $1,327,544, $525,628 and $477,186 including export sales of $394,747, $58,500 and $110,933. SB has an exclusive agreement to market the Company's oral specimen collection device worldwide, except in several foreign countries and to the insurance industry in the U.S., Canada and Japan. In 1995, SB made an initial license fee payment of $1 million to the Company. SB also placed $5 million in escrow for future payment to the Company, of which $1 million was designated for reimbursement of future research project work and $4 million was designated as an additional license fee to be paid upon FDA approval of a pending request to amend the labeling of the Company's oral specimen collection device to indicate a two-year shelf life. The initial $1 million license fee was included as deferred revenue under the caption "Salaries, benefits and other accrued liabilities" in the accompanying consolidated balance sheets as of September 30, 1995. The escrowed funds are not reflected in the Company's financial statements. When such funds are disbursed, they will be recognized as revenue in accordance with the Company's revenue recognition policy. See Note 2. In April 1996, the FDA granted the Company's request for extended dating and SB disbursed $4 million plus interest from escrow. Accordingly the Company recognized income of $5 million in 1996 operating results. Note 10 Commitments and Contingencies The Company leases office, manufacturing, warehouse and laboratory facilities, and equipment under operating lease agreements which require minimum annual payments as follows: - 103 - Notes to Supplemental Financial Statements, Continued
Epitope Medical Year Ending September 30 Products Agritope Consolidated 1997 .............................................. $ 345,577 $ 399,731 $ 745,308 1998 .............................................. 345,576 317,394 662,970 1999 .............................................. 346,356 282,000 628,356 2000 .............................................. 109,992 282,000 391,992 2001 .............................................. - 182,000 182,000 ------------ --------- ---------- $1,147,501 $1,463,125 $2,610,626
Under the agreements for the lease of its office and laboratory facilities, the Company is obligated to the lessor for its share of certain expenses related to the use, operation, maintenance and insurance of the property. These expenses, payable monthly in addition to the base rent, are not included in the amounts shown above. The Company also incurs rent expense for the short-term storage of produce. Rent expense aggregated $1,466,368, $1,336,021 and $1,441,940 for the years ended September 30, 1996, 1995 and 1994, respectively. Rent expense and the future minimum lease commitments above include rent of $132,000 per year for facilities leased from certain shareholders. The Company is also contingently liable for a lease which has been assigned to UAF and the lease of property which has been subleased to Petals in the following amounts:
Year Ending September 30 1997 ............................................................................................ $ 328,953 1998 ............................................................................................ 341,304 1999 ............................................................................................ 347,184 --------- $1,017,441
Certain produce growers in the United States have alleged that Mexican growers of tomatoes are illegally dumping their crops into United States markets. United States regulatory authorities are investigating the allegations. Although it is not possible to determine the final outcome of this matter, the Company believes that its resolution will not have a material adverse effect on its operations or financial position. Note 11 Profit Sharing and Savings Plan The Company established a profit sharing and deferred salary savings plan in 1986 and restated the plan in 1991. All employees are eligible to participate in the plan. In addition, the plan permits certain voluntary employee contributions to be excluded from the employees' current taxable income under the provisions of Internal Revenue Code Section 401(k) and the regulations thereunder. Effective October 1, 1991, the Company replaced a discretionary profit sharing provision with a matching contribution (either in cash, shares of Epitope common stock, or partly in both forms) equal to 50 percent of an employee's basic contribution, not to exceed 2.5 percent of an employee's compensation. The Board of Directors has the authority to increase or decrease the 50 percent match at any time. During 1996, 1995 and 1994, respectively, the Company contributed $73,315 (4,653 shares totaling $73,279 and the remainder in cash), $97,631 (5,562 shares totaling $97,607 and the remainder in cash), and $79,981 (4,632 shares totaling $79,807 and the remainder in cash to the plan. As of September 30, 1996, 17,035 shares are held by the plan. - 104 - Notes to Supplemental Financial Statements, Continued Note 12 Geographic Area Information The Company's products are included in the medical products and agricultural products industry segments. (See Note 1 for a description of the Company's business.) The Company's products are sold principally in the United States, Canada and Europe. Operating loss represents revenues less operating expenses. In computing operating loss, allocated corporate administration expenses have been included; however, other income and expense items such as interest expense, miscellaneous income, and other charges have not been added or deducted. Other assets primarily represent cash and cash equivalents, marketable securities, and prepaid insurance. Epitope Medical Products In thousands
Geographic Areas Revenues Operating Loss Identifiable Assets 1996 1995 1994 1996 1995 1994 1996 1995 1994 United States . . . . $4,903 $2,630 $2,062 $(5,287) $(11,608) $(6,284) $4,604 $3,768 $3,464 Canada . . . . 404 78 111 - - - - - - Latin America . . . 100 - - - - - - - - Europe . . . . 65 72 329 - - - - - - Other . . . . . 122 76 103 - - - - - - -------- -------- -------- --------- --------- --------- -------- -------- -------- $5,594 $2,856 $2,605 $(5,287) $(11,608) $(6,284) $4,604 $3,768 $3,464 Agritope In thousands Geographic Areas Revenues Operating Loss Identifiable Assets 1996 1995 1994 1996 1995 1994 1996 1995 1994 United States . . . . $63,057 $54,289 $62,918 $ (333) $(7,770) $(8,106) $16,875 $13,396 $ 8,197 Latin America . . . - - - - - - 3,996 2,201 3,303 -------------------- ---------- -------- -------- -------- -------- -------- -------- $63,057 $54,289 $62,918 $ (333) $(7,770) $(8,106) $20,871 $15,597 $11,500 Epitope, Inc. Consolidated In thousands Geographic Areas Revenues Operating Loss Identifiable Assets 1996 1995 1994 1996 1995 1994 1996 1995 1994 United States . . . . $67,959 $56,918 $64,981 $(5,621) $(19,377) $(14,390) $41,825 $35,226 $25,379 Canada . . . . 404 78 111 - - - - - - Latin America . . . 100 - - - - - 3,396 2,201 3,303 Europe . . . . 65 72 329 - - - - - - Other . . . . . 122 76 103 - - - - - - -------- --------- --------- ----------- --------------------- ---------- ---------- ---------- $68,650 $57,144 $65,523 $(5,621) $(19,377) $(14,390) $45,221 $37,427 $28,682 - 105 -
Notes to Supplemental Financial Statements, Continued Note 13 Subsequent Events On October 25, the Company received an offer from a representative of the holders of the $3.6 million convertible notes due June 30, 1997, whereby the holders proposed to convert such notes into common stock of the Company at a reduced exchange price. On November 14, 1996, the Company agreed to exchange $3,380,000 principal amount of Agritope notes for 250,367 shares of common stock of the Company at an exchange price of $13.50 per share. Accordingly, the Company will recognize a charge to income of approximately $1.2 million representing the conversion expense in the first quarter of fiscal 1997. On November 25, 1996, the Company negotiated an extension to the bank line of credit previously maintained by A&W. Under terms of the commitment letter, the $6.5 million revolving credit line will be extended until February 5, 1998, and will bear interest at prime or LIBOR plus 2.5 percent at the Company's option. The new line will be secured by A&W's accounts receivable, inventory and equipment and will be guaranteed by Epitope, Inc. The new line will also contain various financial covenants including minimum working capital and tangible net worth levels and maximum debt to net worth ratios. On December 12, 1996, the Company merged with A&W, a producer and wholesale distributor of fruits and vegetables based in San Diego, California. Under the terms of the merger, the Company issued 520,000 shares of common stock of Epitope, Inc. in exchange for all of the outstanding common stock of A&W. The merger has been accounted for as a pooling of interests in the accompanying financial statements which have been restated as if the merger occurred on the first day of the earliest period presented. The merger will qualify as a tax-free reorganization for income tax purposes. Based on information available on December 26, 1996, and due to continued operating losses at UAF in the four months ended October 31, 1996, coupled with a shortfall in sales and larger operating loss than expected at Petals in the fourth quarter of calendar 1996, the Company believes that the value of its investment in affiliated companies has more than temporarily declined as both companies are now expected to show operating losses in fiscal 1997. Accordingly, the Company anticipates a non-cash charge to results of operations of approximately $1.9 million in the first quarter of fiscal 1997, reflecting the permanent impairment in the value of its investment in affiliated companies. - 106 - No schedules are included with the foregoing financial statements because the required information is inapplicable or is presented in the financial statements or related notes thereto. (a)(3) Exhibits. See Index to Exhibits following the signature page of this report. (b) Reports on Form 8-K. None. - 107 - SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this amendment to this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 12, 1997. EPITOPE, INC. By /s/ GILBERT N. MILLER Gilbert N. Miller Executive Vice President and Chief Financial Officer - 108 - INDEX TO EXHIBITS Exhibit Number Exhibit - ------- ------- 2.1 Stock Purchase Agreement among Vinifera, Inc., Agritope, Inc., Epitope, Inc., and VF Holding, Inc., dated May 31, 1995. Incorporated by reference to Exhibit 2.1 to the Registrant's Current Report on Form 8-K dated June 1, 1995. 2.2 Operating and Transition Agreement dated as of May 1, 1995, among Agrimax Floral Products, Inc., William C. McClure, Gary W. Butler, Dorothea J. Owens, Timothy C. Finn, John W. Suber, and Anthony J. Wright. Incorporated by reference to Exhibit 2.2 to the Registrant's Current Report on Form 8-K dated June 1, 1995. 2.3 Agreement and Plan of Reorganization dated as of October 27, 1995, by and among Fresche Blossoms L.L.C., UAF, L.P., Agrimax Floral Products, Inc., Universal American Flowers, Inc., William C. McClure, Gary W. Butler, Dorothea J. Owens, Timothy C. Finn, John W. Suber, Jr., Anthony J. Wright, Doug Bauer, and Roxanne E. Bakula. Incorporated by reference to Exhibit 2.3 to the Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1995 (the "1995 10-K"). 2.4 Acquisition and Merger Agreement among Epitope, Inc., Thamscoe, Inc., Andrew and Williamson Sales, Co., and the shareholders of Andrew and Williamson Sales, Co., dated November 6, 1996. Incorporated by reference to Exhibit 2 to the Company's Current Report on Form 8-K dated November 6, 1996. 3.1 Restated Articles of Incorporation, as amended, of Registrant. Incorporated by reference to Exhibit 3.1 to the Registrant's Current Report on Form 8-K dated May 29, 1991. 3.2 Restated Bylaws of Registrant.** 4.1 Stock Purchase Agreement dated November 9, 1990, between certain investors and Registrant. Copies of the agreements with individual investors shall be filed with the Commission upon request pursuant to Instruction 2 of Item 601 of Regulation S-K ("Item 601, Instruction 2"). Incorporated by reference to Exhibit 4.2 to the Registrant's Annual Report on Form 10-K for the year ended September 30, 1994 (the "1994 10-K"). 4.2 Unit Purchase Agreement dated September 1991 between certain investors and Registrant. Copies of the agreements with individual investors shall be filed with the Commission upon request pursuant to Item 601, Instruction 2. Incorporated by reference to Exhibits 4.1 and 4.2 to the Registrant's Current Report on Form 8-K dated September 17, 1991. 4.3 Note Purchase Agreement dated June 10, 1992, among Agritope, Inc., Registrant, and certain investors. Copies of the agreements with individual investors shall be filed with the Commission upon request pursuant to Item 601, Instruction 2. Incorporated by reference to Exhibit 4.2 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarterly period ended June 30, 1992. 4.4 Warrant Purchase Agreement dated as of November 25, 1992, between certain investors and Registrant. Copies of the agreements with individual investors shall be filed with the Commission upon request pursuant to Item 601, Instruction 2. Incorporated by reference to Exhibit 4.5 to the Registrant's Annual Report on Form 10-K for the year ended September 30, 1992 (the "1992 10-K"). - 109 - 4.5 1993 Technology Transfer Warrant Issuance Agreement dated as of June 15, 1993, between certain investors and Registrant. Copies of the agreements with individual investors shall be filed with the Commission upon request pursuant to Item 601, Instruction 2. Incorporated by reference to Exhibit 4.3 to the Registrant's Registration Statement on Form S-3 (No. 33-68510) ("Registration Statement No. 33-68510"). 4.6 Form of Letter dated August 1, 1993, from Registrant regarding modification of the terms of the 1993 Technology Transfer Warrants. Incorporated by reference to Exhibit 4.5 to Registration Statement No. 33-68510. 4.7 1993 Warrant Purchase Agreement dated as of July 6, 1993, between certain investors and Registrant. Copies of the agreements with individual investors shall be filed with the Commission upon request pursuant to Item 601, Instruction 2. Incorporated by reference to Exhibit 4.6 to Registration Statement No. 33-68510. 4.8 Forms of Notice to Warrantholders and Agreement Regarding Extension of Expiration Date. Incorporated by reference to Exhibit 4.1 to the Registrant's Current Report on Form 8-K dated March 29, 1995. 4.9 Notice to warrantholders and current form of warrant certificate for warrants issued in September 1991 offering, reflecting extension of expiration date. Incorporated by reference to Exhibit 4.1 to the Registrant's Current Report on Form 8-K dated September 17, 1996. 4.10 Notice to warrantholders and current form of warrant certificate for warrants issued in December 1992 offering, reflecting extension of expiration date. Incorporated by reference to Exhibit 4.2 to the Registrant's Current Report on Form 8-K dated September 17, 1996. 4.11 Notice to warrantholders and current form of warrant certificate for warrants issued in July 1993 offering, reflecting extension of expiration date. Incorporated by reference to Exhibit 4.3 to the Registrant's Current Report on Form 8-K dated September 17, 1996. 4.12 Notice to warrantholders and current form of warrant certificate for warrants issued in August 1993 offering, reflecting extension of expiration date. Incorporated by reference to Exhibit 4.4 to the Registrant's Current Report on Form 8-K dated September 17, 1996. 10.1 Incentive Stock Option Plan of Registrant, as amended. Incorporated by reference to Exhibit 10.1 to the 1994 10-K.* 10.2 Amended and Restated Epitope, Inc., 1991 Stock Award Plan. Incorporated by reference to Exhibit 10.2 to the 1994 10-K.* 10.3 Agritope, Inc., 1992 Stock Award Plan. Incorporated by reference to Exhibit 10.3 to the 1992 10-K.* 10.4 Form of Nonqualified Stock Option Agreement to be issued to certain officers and directors of Registrant pursuant to Agritope, Inc., 1992 Stock Award Plan. Incorporated by reference to Exhibit 10.4 to the 1992 10-K.* 10.5 Lease dated July 17, 1990, among Registrant, Koll Woodside Associates, a California general partnership, and Petula Associates, Ltd., an Iowa corporation. Incorporated by reference to Exhibit 10.5 to the 1994 10-K. 10.6 Fourth Amendment dated May 20, 1994, to Lease dated July 17, 1990, among Registrant, Koll Woodside Associates, a California general partnership, and Petula Associates, Ltd., an Iowa - 110 - corporation. Incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarterly period ended June 30, 1994 ("June 1994 10-Q"). 10.7 Business Park Lease dated May 5, 1994, among Registrant, Koll Woodside Associates, a California general partnership, and Petula Associates, Ltd., an Iowa corporation. Incorporated by reference to Exhibit 10.2 to the June 1994 10-Q. 10.8 Business Park Lease dated as of December 16, 1994, among Registrant, Petula Associates Ltd., an Iowa corporation, and Koll Portland Associates, a California general partnership. Incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarterly period ended December 31, 1994. 10.9 Lease Agreement dated as of October 15, 1993, between Kathryne L. Brown and Agrimax Floral Products, Inc. Incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarterly period ended December 31, 1993 ("December 1993 10-Q"). 10.10 Lease dated as of August 25, 1994, between Tonka Bay Associates as agent for M Corp. of Illinois and Agrimax Floral Products, Inc. Incorporated by reference to Exhibit 10.10 to the 1994 10-K. 10.11 Office/Warehouse lease dated as of December 12, 1996, between Williamson and Andrew and Andrew and Williamson Sales, Co.* 10.12 Agreement dated December 9, 1987, between Registrant and Adolph Ferro, Ph.D. Incorporated by reference to Exhibit 4.3 to the 1988 S-1.* 10.13 Amendment to Agreement of December 9, 1987, dated November 11, 1996, between Registrant and Adolph J. Ferro, Ph.D.* 10.14 Agreement dated October 3, 1989, between Sakata Seed America, Inc. and Agritope, Inc. Incorporated by reference to Exhibit 10.13 to the 1994 10-K. 10.15 Distribution Agreement dated as of April 1, 1994, between Registrant and Organon Teknika Corporation. Incorporated by reference to Exhibit 10.3 to the June 1994 10-Q. 10.16 Supply Agreement dated as of April 1, 1994, between Registrant and Organon Teknika Corporation. Incorporated by reference to Exhibit 10.4 to the June 1994 10-Q. 10.17 Superior Tomato Associates, L.L.C. Operating Agreement dated as of February 19, 1996, among Sunseeds Company, Andrew and Williamson Sales, Co., and Agritope, Inc.** 10.18 Development and Marketing Agreement dated as of February 19, 1996, among Superior Tomato Associates, L.L.C., Agritope, Inc., Sunseeds Company, and Andrew and Williamson Sales, Co.** 10.19 Form of Indemnification Agreement for directors and officers. Incorporated by reference to Exhibit 10.4 to the Registrant's Registration Statement on Form S-4 (No. 333-15705).* 10.20 Amended and Restated Employment Agreement dated January 8, 1991 between Andrew S. Goldstein and Registrant. Incorporated by reference to Exhibit 10.28 to the Registrant's Annual Report on Form 10-K for the year ended September 30, 1991 (the "1991 10-K").* 10.21 Amended and Restated Employment Agreement dated January 9, 1991, between Adolph J. Ferro, Ph.D., and Registrant. Incorporated by reference to Exhibit 10.29 to the 1991 10-K.* 10.22 Employment Agreement dated January 28, 1990, between Gilbert N. Miller and Registrant. Incorporated by reference to Exhibit 10.19 to the 1994 10-K.* - 111 - 10.23 Employment Agreement dated July 1, 1990, between John H. Fitchen, M.D. and Registrant. Incorporated by reference to Exhibit 10.20 to the 1994 10-K.* 10.24 Employment Agreement dated July 15, 1995, between Byron A. Allen, Jr., and Registrant. Incorporated by reference to Exhibit 10.23 to the 1995 10-K.* 10.25 Employment Agreement dated August 17, 1992, between Richard K. Bestwick, Ph.D., and Agritope, Inc. Incorporated by reference to Exhibit 10.21 to Registrant's Registration Statement on Form S-4 (No. 333-15705).* 10.26 Employment Agreement dated May 31, 1995, between Joseph A. Bouckaert and Vinifera, Inc. Incorporated by reference to Exhibit 10.20 to Registrant's Registration Statement on Form S-4 (No. 333-15705).* 10.27 Employment Agreement dated December 12, 1996, between Fred L. Williamson and Andrew and Williamson Sales, Co.* ** 10.28 Credit Agreement dated August 5, 1996, between Wells Fargo Bank, National Association and Andrew and Williamson Sales, Co.** 10.29 Development, License and Supply Agreement between Registrant and SmithKline Beecham plc dated February 24, 1995, as amended. Portions of this agreement have been granted confidential treatment. Incorporated by reference to Exhibit 10.1 to Amendment No. 2 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarterly period ended June 30, 1995. 21. The Registrant's subsidiaries are Agritope, Inc., an Oregon corporation, Vinifera, Inc., an Oregon corporation, Andrew and Williamson Sales, Co., a California corporation, and Agrimax Floral Products, Inc., a Minnesota corporation. The Registrant also owns a 67 percent interest in Superior Tomato Associates, L.L.C., a Delaware limited liability company, and a 60 percent interest in Epitope KK, a Japanese limited liability company. 23.1 Consent of Price Waterhouse LLP. 23.2 Consent of Boros and Farrington, APC. 24. Powers of Attorney.** * Management contract or compensatory plan or arrangement. ** Previously filed. - 112 - EX-23.1 2 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Prospectus constituting part of the Registration Statements on Form S-3 (Numbers 33-68510, 33-67618, 33-57246, 33-52920, 33-42841, 33-39166, and 33-32673), Form S-8 (Numbers 33-63220, 33-63218, 33-41712, 33-13416, 33-21545, 33-82788, 33-63106, and 33-60789), and Form S-4 (Number 333-15705) of Epitope, Inc. of our report dated October 28, 1996, except for Note 13 as to which the date is November 14, 1996, November 25, 1996, December 12, 1996, and December 26, 1996, relating to the financial statements of Epitope Medical Products group, Agritope group, and Epitope, Inc., which appears under Item 14 of this Form 10-K/A. Price Waterhouse LLP Portland, Oregon March 12, 1997 EX-23.2 3 CONSENT OF INDEPENDENT ACCOUNTANTS CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the use in this Form 10-K/A of Epitope, Inc., of our report dated November 6, 1996, relating to the financial statements of Andrew and Williamson Sales, Co., referenced in such Form 10-K/A. We also consent to the incorporation by reference in the Prospectus constituting part of the Registration Statements on Form S-3 (Numbers 33-68510, 33-67618, 33-57246, 33-52920, 33-42841, 33-39166, 33-631067, and 33-32673), Form S-8 (Numbers 33-63220, 33-63218, 33-41712, 33-13416, 33-21545, 33-82788, and 33-60789), and Form S-4 (Number 33-15705) of Epitope, Inc., of our report. Boros & Farrington, APC March 10, 1997 -----END PRIVACY-ENHANCED MESSAGE-----