-----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, P4T7D72NJ5FLrbVl9ORclfkok2+WboRK012GHBWE4bEE7McDD/y68qq7JN4MczUW m32nILxlY3xdSdRdiaCk5A== 0000833299-97-000023.txt : 19971103 0000833299-97-000023.hdr.sgml : 19971103 ACCESSION NUMBER: 0000833299-97-000023 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19971031 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SERAGEN INC CENTRAL INDEX KEY: 0000833299 STANDARD INDUSTRIAL CLASSIFICATION: BIOLOGICAL PRODUCTS (NO DIAGNOSTIC SUBSTANCES) [2836] IRS NUMBER: 042662345 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 000-19855 FILM NUMBER: 97705751 BUSINESS ADDRESS: STREET 1: 97 SOUTH STREET CITY: HOPKINTON STATE: MA ZIP: 01748 BUSINESS PHONE: 5084352331 MAIL ADDRESS: STREET 1: 97 SOUTH ST CITY: HOPKINTON STATE: MA ZIP: 01748 10-K/A 1 SERAGEN, INC. UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K/A#1 Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 1996 Commission file number 0-19855 SERAGEN, INC. (Exact name of registrant as specified in its charter) Delaware 04-2662345 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 97 South Street, Hopkinton, MA 01748 (Address of principal executive offices)(Zip Code) (508) 435-2331 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value 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. [X] Aggregate market value, based upon the closing sale price of the shares as reported by the Nasdaq Stock Market, of voting stock held by non-affiliates at March 27, 1997: $9,478,775 (excludes shares held by executive officers, directors, and beneficial owners of more than 10% of the Company's Common Stock). Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of management or policies of the registrant, or that such person is controlled by or under common control with the registrant. Common Stock outstanding at March 27, 1997 was 18,048,881 shares. PART I ITEM 1. BUSINESS General Seragen is a leader in the discovery and development of a new class of therapeutic products called fusion proteins or fusion toxins ("fusion proteins"). This technology has led to the discovery of a number of molecules, two of which have been studied in clinical trials for the treatment of cancers and autoimmune diseases. The Company's lead molecule, DAB389IL-2, is currently completing Phase III clinical trials for cutaneous T-cell lymphoma ("CTCL") and a Phase I/II clinical trial for psoriasis. Seragen plans to file, in 1997, a Biologics License Application ("BLA") with the U.S. Food and Drug Administration ("FDA") for approval of the molecule's use in CTCL patients who have received previous treatment with other agents. The Company has requested consideration for accelerated approval from the FDA, a process which provides for a decision in as little as six months on applications for products intended to treat certain life-threatening illnesses. The FDA will decide at the time of filing if the Company's BLA qualifies for the accelerated approval process. A second molecule developed from the same technology, DAB389EGF, is in a Phase I/II clinical trial for non-small cell lung cancer. Seragen's proprietary fusion proteins consist of fragments of diphtheria toxin genetically fused to a ligand (a targeting and binding mechanism) that targets specific receptors on the surface of disease-causing cells. The fusion proteins are designed to: - bind to specific receptors present on the surface of disease-causing cells; - penetrate the target cells; and - destroy the target cells' ability to manufacture proteins, thereby killing the targeted cells and destroying their ability to spread disease. Seragen builds its fusion proteins from a template based on the genetic components of the diphtheria toxin molecule. Using this platform, the Company has genetically engineered six fusion proteins, each of which consists of fragments of diphtheria toxin fused to a different targeting ligand, such as a polypeptide hormone or growth factor. The Company has conducted clinical trials of two proteins, DAB389IL-2 and DAB389EGF, for applications in oncology, dermatology, HIV, and autoimmune disorders. Although it has created four other proteins, namely DAB389IL-4, DAB389IL-6, DAB389CD-4, and DAB389MSH, for oncology, infectious disease, and autoimmune disorders, the Company has, at this point, focused its clinical efforts on its two leading molecules, DAB389IL-2 and DAB389EGF. The Company entered into a strategic alliance with Eli Lilly and Company ("Lilly") in 1994 to develop DAB389IL-2 for cancer. The Lilly alliance has provided Seragen with funding to take its first product through Phase III clinical trials for CTCL. Through this alliance, Lilly has exclusive worldwide development, distribution, and marketing rights to DAB389IL-2 for the treatment of cancer, except in certain Asian countries. All pre-clinical and clinical programs other than those covered by the Lilly alliance have thus far been funded by the Company independently. During 1996, the Company effected three issuances of preferred stock to meet certain of its financing needs. On May 29, 1996, the Company raised net 2 proceeds of $3.8 million through the sale of 4,000 shares of the Company's non-voting convertible Series A Preferred Stock ("Series A Shares") to investors outside the United States. On July 1, 1996, the Company restructured its arrangement with certain guarantors of the Company's June 1995 $23.8 million bank financing so that the guarantors directly assumed the Company's liability to the banks. In exchange for the guarantors satisfaction of the Company's liability to the banks, the Company issued 23,800 shares of its Series B Preferred Stock ("Series B Shares") to the guarantors. The Series B shareholders also received warrants to purchase a total of 5,950,000 shares of Seragen Common Stock at an exercise price of $4.00 per share. In addition to these warrants, the investors may receive additional warrants pursuant to anti-dilution provisions. In connection with this, the Company entered into a number of transactions by which the Company transferred all of its patents to a subsidiary, which in turn made a collateral assignment of the patents to the Series B shareholders as security for dividend payments. See "Liquidity and Capital Resources." On September 30, 1996, the Company raised proceeds of $5 million through the sale of 5,000 shares of the Company's non-voting convertible Series C Preferred Stock ("Series C Shares") in a private placement with Boston University. On February 18, 1997, the Company entered into an agreement to sell its manufacturing and clinical operations facilities to Boston University ("Boston University" or "B.U.") or a designated affiliate for $5 million. The closing of the transaction is subject to, among other things, approval by the Company's stockholders. B.U. has paid the Company $4.5 million as a deposit and has assumed responsibility for the facility's operations, including responsibility for operating costs. The Company currently may use this deposit to fund its operations. At the closing, a majority of the Company's employees involved in the manufacturing and clinical operations will become employees of B.U. Both the deposit and the operating costs paid by B.U. are subject to refund in the event that conditions for closing are not met. Simultaneously, the Company entered into a service agreement with B.U. providing for the purchase by the Company of certain services related to product research, development, manufacturing, clinical trials, quality control, and quality assurance. This service contract expires in January 1999 and is subject to early termination provisions, as defined, including the option of B.U. to terminate the agreement if losses during a contract year exceed $9.0 million and the Company does not reimburse B.U. for the losses in excess of $9.0 million. The service contract may be renewed for two successive one-year terms at the option of the Company. The Company has the option to repurchase the assets comprising the manufacturing and clinical operations facilities. The Company has agreed to pay B.U. approximately $5.5 million and $6.6 million in years 1 and 2 of this contract, respectively. The fees can be mutually increased or decreased, but may not be reduced to less than $4.3 million per contract year. The service agreement is expected to substantially reduce operating costs in research and development as Seragen will be contracting solely for the services that the Company requires for clinical and manufacturing purposes. The Company was organized as a Massachusetts corporation in 1979 in a joint venture between Boston University and several of its scientific faculty members. It adopted its present name in 1980 and was reincorporated as a Delaware corporation in February 1982. Since 1985, the Company has focused substantially all of its efforts and resources on research and development of its fusion protein technology. Boston University became the Company's majority stockholder in 1987 and was the Company's principal source of working capital from that time until the Company's initial public offering in April 1992. The Company's executive offices and laboratories are located at 97 South Street, Hopkinton, Massachusetts 01748, and its telephone number is (508) 435-2331. 3 Product Development Update The Company's fusion protein technology has led to the discovery of a number of molecules, two of which have been subjects of clinical trials for the treatment of cancers and/or autoimmune diseases. The Company's lead molecule, DAB389IL-2, is currently in Phase III clinical trials for CTCL and a Phase I/II clinical trial for psoriasis. A second molecule developed from the same technology, DAB389EGF, is in a Phase I/II clinical trial for non-small cell lung cancer and may be applicable in a variety of solid tumor cancers. Interleukin-2 ("IL-2") Fusion Protein (DAB389IL-2) Seragen has designed two versions of an Interleukin-2 fusion protein that combine the cell-killing action of diphtheria toxin and the specific cell-targeting ability of the growth factor, IL-2. IL-2 Fusion Proteins bind to the IL-2 receptor ("IL-2R") on activated lymphocytes and malignant T-cells and B-cells. Once bound to the surface receptor, the molecule is internalized and the cell-killing portion of the fusion toxin passes into the cell where it inhibits protein synthesis, ultimately causing cell death. DAB486IL-2, Seragen's first version of IL-2 Fusion Protein to be studied, was evaluated in a series of Phase I/II clinical trials and established the Company's rationale for IL-2R targeted therapy. Clinical evaluation of DAB486IL-2 was discontinued shortly after the development of DAB389IL-2 because DAB389IL-2 is more potent biologically and more economical to manufacture. Cancer Cancer is characterized by uncontrolled growth of malignant cells capable of forming secondary tumors or metastases at remote sites. Conventional cancer therapy includes surgery, chemotherapy and radiation. Patients may be treated with one of these approaches but are more commonly treated with combinations. Although chemotherapy and radiation are effective methods for killing cells, they can not target specific cells and, therefore, they cause serious adverse effects in patients. Response rates to cancer therapy vary enormously depending on the stage of disease and the type of cancer. In the case of some solid tumors, early diagnosis and treatment can result in cures and/or long-term remissions. In later stage disease, treatment is generally ineffective. New therapies are particularly needed to induce remission of any duration in patients with solid tumors and refractory non-Hodgkin's lymphoma. Recent efforts to improve cancer therapy have focused on ways to target malignant cells more selectively. Seragen's receptor-targeted fusion proteins are part of the emerging field of targeted therapeutics, a field which also includes monoclonal antibodies and receptor antagonists. Research indicates that IL-2 receptors are expressed on the surface of some malignant cells in a variety of T-cell and B-cell leukemias and lymphomas, including non-Hodgkin's lymphoma and CTCL. In 1995, 50,900 new patients were diagnosed with non-Hodgkin's lymphoma alone in the U.S. (See Table I.) 4 Table 1 ESTIMATED NEW BLOOD AND LYMPH CANCER CASES, U.S. 1995 Leukemia: Lymphocytic Leukemia................... 11,000 Granulocytic Leukemia.................. 11,100 Other & Unspecified Leukemia........... 3,600 Total............................... 25,700 Other Blood & Lymph Tissues: Hodgkin's Disease...................... 7,800 Non-Hodgkin's Lymphoma................. 50,900 Multiple-Myeloma....................... 12,500 Total .............................. 71,200
Source: A Journal of the American Cancer Society. January/February 1996 Vol.46 No.1 Based on research data and screening studies conducted by Seragen, the Company estimates that approximately 50% of these new patients will have IL-2 receptors on the surface of their malignant cells. This population of patients represents the initial potential market for the use of DAB389IL-2 in treating cancer. Cutaneous T-Cell Lymphoma (CTCL) CTCL is an infrequent, low-grade, non-Hodgkin's lymphoma, composed of malignant T-lymphocytes, and typically manifesting itself in the skin. Worldwide, the prevalence and incidence are low. In the United States, estimates of prevalence range from 5,000 to 10,000 cases with an incidence of 500 to 1,000 new cases diagnosed each year. There is currently no formally approved drug therapy for CTCL. CTCL patients experience significant disability from frequent skin infection, disfigurement, pruritus (itching), and pain, and the disease is ultimately fatal. Patients with patch/plaque skin lesions alone are often treated with topical therapies such as nitrogen mustard, psoralen phototherapy, or electron beam radiation. However, remission without maintenance therapy is unusual, and patients often experience acute and chronic adverse effects and may eventually become unresponsive to these agents. Patients with generalized skin involvement, lymph node enlargement, and/or visceral involvement require combination and/or systemic therapies. These therapies (chemotherapy, interferon-alpha, and/or retinoids) are variably applied depending on the particular treating center's experience. Efficacy of these treatments is inconsistent and often associated with significant short and long term adverse effects. In addition, extension of survival does not appear to be influenced by aggressive combination therapy. There is a critical medical need, therefore, for an additional, more effective and less toxic therapy to manage this malignancy. 5 CTCL Clinical Trial Status Seragen has been investigating the usefulness of IL-2 fusion toxin proteins (DAB486IL-2 and DAB389IL-2) in patients with refractory IL-2 receptor-expressing lymphomas, including CTCL, since 1988. Treatment courses have consisted of an intravenous infusion of 15-60 minutes daily for five days, administered either once a month or every three weeks. Patients treated were no longer experiencing any clinical benefit from previously administered therapies. Six of 36 patients treated with the first molecule (DAB486IL-2) demonstrated a response as measured by at least a 50% reduction in tumor burden. The duration of response ranged from 3 months to more than six years in one patient who had a complete response and was still in remission as of this writing. Investigation continued in a Phase I/II dose-escalation trial of DAB389IL-2 in which 13 of 35 CTCL patients responded to treatment with at least a 50% reduction in tumor burden. Five of these patients cleared completely. Duration of response ranged from two to 23 months (as of the latest available information) with a median duration of six months; responses occurred at varying dose levels without a discernible difference in effectiveness among the doses used. These responses are notable because the patients enrolled in these early clinical trials were not receiving any clinical benefit from a variety of previously administered treatments. Based on the response rates seen in the Phase I/II patients, Seragen designed a Phase III program with extensive consultation from oncologists and dermatologists experienced in treating CTCL. Seragen designed this program together with its strategic alliance partner, Lilly. (See "Strategic Alliance with Eli Lilly and Company.") The FDA also provided guidance and comments. Seragen and Lilly finalized the protocol and initiated the Phase III program in May 1995. The first Phase III study targeted more seriously ill patients who have received extensive previous therapy and need immediate systemic (as opposed to topical) treatment. The second Phase III study is a placebo-controlled trial for earlier stage patients who have received less extensive therapy. Both of these studies are randomized and blinded to evaluate two dose levels of DAB389IL-2 in different CTCL patient populations. A third Phase III study is an open-label study for CTCL patients who have relapsed after a previous response to DAB389IL-2, patients with stable disease after eight courses of therapy in the second study and patients who had progressive disease while on placebo in the second study. The criteria for response in each of these studies have been strictly defined based on objective, measurable assessments of the patients' disease. Seragen believes these criteria set the standard for determining meaningful clinical responses among patients with CTCL. Enrollment in the first study was completed in July 1996, and approximately one-half of the number of patients sought have been enrolled in the second study. Thirty-two patients have enrolled in the third study. Based on a preliminary analysis of the first study and discussions with the FDA, Seragen plans to file a BLA during the third quarter of 1997. The BLA filing will be based on data from the first Phase III study together with data from the earlier Phase I/II clinical trials in CTCL. The Company will request consideration for accelerated approval from the FDA, a process which can provide for a decision in as little as six months on applications for products intended to treat certain life-threatening illnesses. The FDA will decide at the time of filing if the Company's BLA qualifies for the accelerated approval process. The FDA has already granted "Orphan Drug" status to DAB389IL-2 for the treatment of CTCL. This designation provides incentives to manufacturers to undertake development and marketing of products to treat relatively rare diseases and includes a seven-year marketing exclusivity for qualified products. Autoimmune Diseases 6 To defend the body against foreign agents, the human immune system employs specialized cells, including T-cells, which recognize disease-causing viruses, bacteria, and parasites as foreign. T-cells, an important component of the immune system, control the network of immune responses by regulating the activity of other cells in the immune system and by killing foreign cells. The same immune response that protects the body from foreign agents can also cause disease when it inappropriately attacks the body's own cells and proteins. In autoimmune diseases, the immune network mistakenly identifies "self" as "foreign" and, among other actions, produces T-cells that attack normal body cells. Such prevalent diseases as rheumatoid arthritis, psoriasis, multiple sclerosis and alopecia areata are autoimmune diseases. (See Table II) Table II
AUTOIMMUNE DISEASE PREVALENCE (U.S.) ----------------------------------------- Psoriasis(Total)................................... 6,000,000 (Moderate-to-Severe) ............................... 1,500,000 Rheumatoid Arthritis................................ 2,500,000 Multiple Sclerosis.................................. 350,000 Alopecia Areata..................................... 2,000,000 Other............................................... 1,500,000
Source: Scientific American Medicine and National Psoriasis Foundation Conventional approaches for treating autoimmune diseases rely on broadly active immunosuppressive agents, such as corticosteroids, cyclosporine A, and methotrexate. These agents do not have specific targets, may be difficult to tolerate, and are not selective in their suppression of the immune response. Typically, they must be administered continuously to achieve therapeutic effect; resistance may develop and/or toxicity may require discontinuation of therapy. Seragen believes that specifically targeted cytotoxic agents, such as DAB389IL-2, could induce remission in certain autoimmune diseases following a brief course of therapy and may not cause the long-term toxicity that can occur with broad spectrum immunosuppressants. Research indicates that activated, high affinity IL-2 receptor-expressing lymphocytes are present in the circulation and in the affected tissue of patients in acute phases of certain autoimmune diseases, including rheumatoid arthritis, psoriasis, multiple sclerosis and alopecia areata. These findings suggest that autoimmune disorders characterized by the presence of high affinity IL-2 receptor-bearing lymphocytes may, therefore, be treatable with DAB389IL-2. Psoriasis Psoriasis is one of the most common chronic skin disorders, with an estimated two to three percent of the world population affected, including approximately 6 million Americans. In the United States, some 150,000 to 260,000 new cases are reported annually. A 1993 estimate placed the overall cost of treating psoriasis in the U.S. at over $3.0 billion. The major markets for psoriasis treatments are in the United States and Europe, while incidence rates are much lower in Asia (<=0.3%). Psoriasis is a lifelong disease characterized by chronic recurrence of thickened, red patches of skin covered with silvery scales. Occurrence involves excessive proliferation of the outer layer of the skin, the 7 epidermis. Normally, a person's epidermis is renewed by the formation of new cells about once a month, unnoticeably. In psoriasis, however, new cell production speeds up and a new outer layer of skin is reproduced every three or four days, creating psoriatic lesions. Skin involvement can range from a few psoriatic plaques on less visible parts of the body to involvement of large, prominent areas. Treatment may be required for local symptoms (such as pain, itching and the reduction of manual dexterity), cosmetic problems (such as prominent and unsightly hand, leg, or facial lesions), or both. The social and economic impact of the disease is often underestimated by physicians, other health care providers, and the general public. Especially in more severe cases, the emotional and physical impact can be disabling. The majority (approximately 70%) of psoriatic cases are mild (with <=10% body surface area ("BSA") involvement); 20 to 25% of psoriasis cases are moderate (10-20% BSA) to severe (>=20% BSA). Standard treatment for mild cases is topical medication with steroids and emollients. Light treatment with augmented ultraviolet A ("UVA") and ultraviolet B ("UVB") irradiation of the skin and systemic drugs (methotrexate and etretinate), either alone or in combination, are used to treat the patient with moderate-to-severe psoriasis. Because psoriasis is a chronic disease, the treatment goal is first to induce remission and then to use maintenance therapy to sustain the remission for as long as possible. Many of the current treatments for moderate-to-severe psoriasis have toxic side effects. To keep the toxicity of the treatments under control and to extend their usefulness, a maintenance treatment strategy is frequently employed whereby light treatment and systemic drugs are rotated. Even with this rotational therapy, however, estimates indicate that treatment is ineffective or causes unacceptable side effects for 40-50% of the moderate-to-severely affected patient population. The most commonly used therapies to treat moderate-to-severe psoriasis are light treatments (known as "PUVA" and "Goeckerman" treatments). PUVA therapy is time-consuming, inconvenient, and expensive. Patients can receive these treatments only for a limited time because of the significantly increased risk of skin cancer. Although methotrexate is now being used to treat psoriasis, it has the potential for inducing serious adverse effects on the liver and can generally be prescribed for limited periods of time. Dermatologists are also apprehensive about treatment with cyclosporine because of its potent immunosuppression, and its toxicity to the kidneys. DAB389IL-2 Opportunity in Psoriasis Intravenous ("IV") Formulation Seragen believes that the opportunity for an intravenous formulation of DAB389IL-2 in the psoriasis market lies in the moderate-to-severe patient population. An agent like DAB389IL-2 could provide targeted immunomodulation therapy against the component of the immune system believed to be involved in the pathogenesis of psoriasis, the CD8+ cytotoxic T-lymphocyte. An IV product's market would probably be limited to administration by clinics and major hospitals. Cost comparisons to current therapies, however, suggest that treatment with DAB389IL-2 could compete successfully with other systemic therapies. Subcutaneous ("SC") Formulation Seragen believes that the market for DAB389IL-2 as a psoriasis therapeutic would be substantially increased if the agent did not require frozen storage and IV administration (as the Company's present formulation 8 does). For a subcutaneous product to capture a significant share of the psoriasis market, the product would have to be as effective as PUVA treatment, have a good safety profile and be easily administered. A lyophilized formulation would enable the dermatologist (or patient) to store the drug in a refrigerator. Subcutaneous delivery would eliminate the need for a professional trained in IV administration and could permit the local dermatologist, primary care physician, or even the patient to administer the drug. The Company is investigating subcutaneous administration of its newly developed lyophilized formulation of the agent to meet this need. Although there is no good animal model of psoriasis, encouraging results from subcutaneous administration of DAB389IL-2 in an animal tumor model have demonstrated that this route of administration can reduce tumor burden. This result is expected to be indicative of a potential anti-psoriatic effect. Seragen currently plans to initiate its first clinical trial of a subcutaneous formulation of DAB389IL-2 for psoriasis in 1998. Topical Administration Some 70% of psoriatics have mild disease, for which the primary current treatments are emollients and steroids. A topically applied product for patients with mild disease could generate a much larger market opportunity, estimated at 3 to 4 million patients in the U.S. Preliminary investigation of a topical delivery technology is currently under way at Seragen. Status of Clinical Trials of DAB389IL-2 in Psoriasis Two clinical studies of DAB389IL-2 in moderate-to-severe psoriasis patients who had received prior treatment with multiple systemic therapies have been completed. A third trial is currently under way. The studies are summarized below. In both of the two completed studies, the patients' psoriasis was evaluated according to the standard Psoriasis Area and Severity Index ("PASI"). Both dosing schedules investigated in these trials showed a significant decrease in disease severity with DAB389IL-2 administration. The trials recorded approximately 40% mean improvement in patients who had long-standing psoriasis, little or no history of spontaneous improvement or resolution, and a history of failure with treatments ranging from topical treatments to phototherapy to methotrexate and cyclosporine. In both trials, disease severity scores continued to decrease after the end of dosing. The weekly schedule of dosing produced a more rapid initial rate of improvement than the monthly schedule. Open-label, Dose Escalation Study The first clinical study of DAB389IL-2 in psoriasis was an open-label, dose-escalation trial evaluating DAB389IL-2 at dose levels of 2 to 9 micrograms per kilogram of body weight per day ("ug/kg/d") administered daily for five days a week every four weeks. Twenty-four patients (15 males and 9 females) were enrolled in the study. Ages ranged from 21 to 62 years with a mean age of 43. All patients had chronic, extensive plaque-type psoriasis of long-standing duration with a mean disease duration of 16.3 years. In 50% of the patients, psoriatic lesions covered 10% to 29% of the body surface area. Scalp and nails were affected in 22 of the 24 patients (92%), and 11 of the 24 patients (46%) had arthritis, a condition often associated with advanced psoriasis. The mean disease severity score declined steadily over the study period. By the end of the second course, the mean disease severity score had decreased by 34% from baseline in all dose groups. Improvement continued after the third course with a mean decrease in severity of 49%, after the fourth course 9 with a mean decrease in severity of 54%, and after the sixth course with a mean decrease in severity of 68%. All these decreases were statistically significant (p<0.05). This early trial, indicated that treatment with DAB389IL-2 could reduce disease severity scores in this severely affected group of patients and warranted further study. Double-blind, Placebo Controlled Study The second study of DAB389IL-2 in psoriasis was a randomized, double-blind, placebo controlled study with three dose groups of 5, 10, and 15 ug/kg/d administered three consecutive days per week for four consecutive weeks. Forty-one patients (22 males and 19 females) were enrolled in the study. Ages ranged from 20 to 75 years with a mean age of 45; the patients had suffered from psoriasis from one to 53 years, with a mean disease duration of 18.3 years. Patients were randomly assigned to one of four protocol groups at each of eight investigational sites. Twelve patients were assigned to the placebo group, 11 were assigned to the low dose group, ten were assigned to the mid-dose group, and eight were assigned to the high dose group. This trial was terminated prematurely (in December 1995) to allow the Company to conduct a broad safety review of DAB389IL-2 when one patient in the trial experienced unexpected blood clotting. After a review of this event, of the data from this trial, and the data from other trials of DAB389IL-2, the FDA authorized the Company to resume its investigation of DAB389IL-2 in psoriasis. Analysis of the available data indicated that the degree of patient improvement in this second psoriasis trial was consistent with the results of the earlier study. Overall, 12 of the 27 patients (44%) who received at least one dose of DAB389IL-2, and who had not been responding well to other therapies, exhibited at least 50% improvement from baseline disease severity scores. Statistical analysis of mean PASI scores showed that there was a statistically significant decrease in the mean disease severity score compared to baseline in all dose groups (p<0.05) and that the decrease in disease severity scores was statistically significant in DAB389IL-2 treated patients compared to placebo patients (p<0.05). Skin thickness of psoriatic plaque in the treated patients was reduced also (as measured by the difference in epidermal thickness observed in microscopic evaluation of specific plaques). Furthermore, quality-of-life index scores of patients treated with DAB389IL-2 suggested that quality of life improved with treatment. Similar responses were observed at all dose levels evaluated, although the frequency and severity of adverse events were less at lower doses. This suggested that efficacy of DAB389IL-2 in psoriasis should be further tested at the more economically desirable lower dose levels. Current Open-label, Dose Escalation Study The accumulated data from the first two psoriasis studies indicated that DAB389IL-2 induced meaningful clinical responses in as many as 50% of psoriasis patients who had previously been treated heavily with other therapies. Tolerability issues suggest that three doses per week administered weekly, especially at the higher doses tested, may be too frequent. Other observations indicate that clinical improvement after a single five-day treatment may induce maximum response two weeks after administration. These data suggest that monthly administration may not be frequent enough. Therefore, the Company designed a third psoriasis trial to evaluate the safety and efficacy of administration of the lower dose range of DAB389IL-2 on a bi-weekly schedule. This ongoing Phase I/II study is designed to enroll 30 patients. Based on previous enrollment rates, Seragen expects enrollment to be complete by mid-1997. If the data from this study, in combination with data from the previous two studies, warrant it, the Company plans to design a Phase III program in moderate-to-severe psoriasis to commence as early as the first half of 1998. 10 Other Potential Opportunities for DAB389IL-2 Rheumatoid Arthritis Rheumatoid arthritis ("RA") is a chronic, systemic disease characterized by persistent inflammation of the joints. RA is believed to be caused by an autoimmune response against joint tissue. Furthermore, expression of the high-affinity IL-2 receptor on activated lymphocytes is known to play a pivotal role in the pathogenesis of many autoimmune diseases, including RA. The Rheumatic Disease Clinics of North America report that RA affects approximately 1% of the world's population, including approximately 7,500,000 people in the United States, Western Europe and Japan. An estimated 20% of RA patients suffer from a severe form of the disease. The Company believes that this population may represent a potential market for DAB389IL-2, although the Company is not currently pursuing clinical development of this application for DAB389IL-2. In the past Seragen conducted three clinical trials of DAB389IL-2 in patients with rheumatoid arthritis: one double-blind, placebo-controlled dose-finding trial evaluating DAB389IL-2 at three dose levels versus placebo; one follow-up open-label study evaluating the safety of up to four courses per year; and one open-label study evaluating the safety of concurrent administration of DAB389IL-2 and methotrexate ("MTX") in patients using methotrexate as anti-arthritic therapy. Patients in the double-blind, placebo controlled trial had suffered from severe progressive RA for an average of ten years and were not experiencing clinical benefit from currently available therapies, including methotrexate. A number of patients who received DAB389IL-2 in that study demonstrated improvement according to at least four standard rheumatological criteria. As commonly noted in studies of RA, however, patients who received placebo in this study also showed some improvement, to the extent that the results in the treated patients were not deemed statistically significant. No additive toxicities were seen in the combination MTX study during concurrent administration of DAB389IL-2 and MTX. Depending on the availability of financial resources, the Company may evaluate further clinical development of DAB389IL-2 (including subcutaneous administration) in patients with RA. HIV Infection/AIDS Human immunodeficiency virus ("HIV") infection ultimately leads to severe life-threatening impairment of the immune system, resulting in the viral disease state known as acquired immune deficiency syndrome ("AIDS"). HIV causes immunosuppression by attacking and destroying T-cells, which coordinate much of the network of normal immune responses. The World Health Organization estimates that between 8,000,000 and 10,000,000 people are currently infected with HIV worldwide. Research has demonstrated that T-cell activation is required for replication of HIV. The activation event results in expression of the high affinity IL-2 receptor on HIV-infected lymphocytes. Seragen has performed a series of in vitro experiments which demonstrated the ability of DAB389IL-2 to target specifically and kill HIV-infected lymphocytes. Thus, administration of DAB389IL-2 may decrease the number of HIV-infected cells in the body, potentially reducing the amount of virus. 11 Because the target for DAB389IL-2 is a receptor present on the activated T-cells that reproduce HIV, the use of DAB389IL-2 is an approach to treating HIV infection that should not be affected by the high rate of viral mutation that is a hallmark of the disease. This approach, therefore, would presumably not lead to viral resistance. The HIV-related application for DAB389IL-2 may lie in adjunctive therapy in combination with the nucleotide analogs (AZT, ddC, ddI, 3TC) and protease inhibitors, all of which target viral replication but are expected eventually to become ineffective as viral resistance develops. A preliminary safety study of DAB389IL-2 has been conducted in HIV infected patients. Twenty four patients were enrolled in a double-blind, randomized, dose-ranging study in patients with HIV infection. DAB389IL-2 was found to be safe at the very low doses tested. An additional study is currently planned which will evaluate subcutaneous administration of DAB389IL-2. However, the Company currently lacks the financial resources to pursue development of this application for DAB389IL-2 at this time. There can be no assurance that DAB389IL-2 or any of the Company's other potential products will have an application in treating HIV. Subcutaneous administration, however, should lead to higher dose concentrations of DAB389IL-2 in the lymphatics at the sites of HIV replication. Additional Potential Applications for DAB389IL-2 Agents like DAB389IL-2, which specifically target immune system cells, may offer a new therapeutic approach to the treatment of other disorders, such as multiple sclerosis ("MS") and alopecia areata ("AA"). However, the Company has not conducted any trials to evaluate the efficacy of DAB389IL-2 or the Company's other potential products in treating these disorders. There can be no assurance that any of the Company's products will have an application in treating MS or AA. Multiple Sclerosis MS is a disorder that affects the central nervous system. The pathological hallmark of the disease are zones of demyelination of nerve tissue, known as plaques, that vary in size and location. The cause is unknown, but abnormal immune mechanisms appear to play a role in the disease, and a viral cause is possible. It is postulated that viral infection, followed by an autoimmune response in genetically susceptible individuals, initiates the disease process. MS is a disease that most commonly begins in young adulthood (onset of symptoms is rare before 15 years of age or after 40 years of age), and the course of disease is remarkably variable. There are approximately 350,000 cases in the U.S. now, and incidence of the disease appears to be increasing. Although new therapies have been approved to treat MS, therapy remains unsatisfactory. Agents like DAB389IL-2, which specifically target activated immune-system cells, may offer a new therapeutic approach to the treatment of MS. The Company is currently evaluating alternatives for studying the effects of DAB389IL-2 on this devastating disease. Alopecia Areata AA is an inflammatory disease of the hair follicle resulting in hair loss in small patches, or in the total scalp (alopecia totali), or in the total body (alopecia universalis). It affects both children and adults and affects both sexes equally. The total number of AA patients in the United States is 12 about two million, with 50,000 to 100,000 new cases occurring annually. It affects all races and is seen worldwide. Evidence indicates that an immune system mechanism may be involved in the process leading to AA. Scientists speculate that AA follows a path similar to psoriasis, where an inflammatory component contributes to the development and maintenance of the condition. Because there are currently no effective therapies for AA, there may be an opportunity for DAB389IL-2 in this market. Dermatologists may be interested in DAB389IL-2 because it is targeted against a key component believed to be involved in the pathogenesis of the disease, the activated T-cell. The Company is currently evaluating options for studying the effects of DAB389IL-2 in AA. Epidermal Growth Factor ("EGF") Fusion Protein (DAB389EGF) In the U.S., the American Cancer Society estimates approximately one million new cases of solid tumor cancers per year, with approximately 500,000 related deaths each year. A significant percentage of these cases are possible candidates for treatment with a targeted therapeutic approach utilizing DAB389EGF. In several carcinomas, research has indicated that the level of EGF-receptor expression correlates strongly with the progression of the disease. Increased EGF-receptor expression is associated with refractory tumors. Enhanced EGF-receptor expression may, therefore, characterize a subset of highly aggressive tumor cells with greater metastatic potential. DAB389EGF binds specifically to the EGF receptor on target cells and may have therapeutic potential in solid tumors, including breast, bladder, lung, colon, prostate, esophageal, thyroid, gastric, renal, endometrial, cervical, brain and ovarian carcinomas, all of which express the EGF receptor. A cell-killing agent such as DAB389EGF may be useful for a variety of solid tumors bearing EGF receptors, including a number of tumors that are inadequately treated by any currently available therapy. Pre-clinical tests involving animal models have indicated that DAB389EGF administration results in cell death and tumor regression of EGF-receptor expressing malignancies. Lung Cancer Lung cancer is the most common organ malignancy in the U.S., with an estimated 170,000 new cases occurring in 1995. The 1995 incidence rate for lung cancer worldwide was 517,000, with worldwide incidence expected to reach 2,000,000 by the year 2000. About 60% of newly diagnosed lung malignancies are non-small cell tumors. In 1995, 157,000 Americans died of lung cancer; worldwide deaths aggregate 457,000. Lung cancer is now the leading cause of cancer deaths in the U.S. Non-small cell lung cancer ("NSCLC") has been selected as the first cancer indication to be investigated for DAB389EGF, based upon: 1) in vitro studies comparing the sensitivity of various primary tumors to DAB389EGF, and 2) the clinical improvement of an NSCLC patient in the Company's Phase I clinical trial of DAB389EGF. If responses can be demonstrated, there may be an opportunity for DAB389EGF to be used in combination with the commonly used chemotherapeutic, cisplatin, as a first-line, post surgical therapy in stage II and III NSCLC. In the longer term, opportunities may exist for DAB389EGF to be used in combination with Lilly's gemcitabine, recently approved for pancreatic cancer. In early studies, gemcitabine in combination with other chemotherapeutic agents has demonstrated some promise in NSCLC. 13 Status of Clinical Trials of DAB389EGF in Solid Tumor Cancers To date, the Company has conducted two companion Phase I clinical trials in patients with EGF-receptor expressing malignancies. The trials enrolled 52 patients to evaluate the safety of five different doses administered either consecutively or episodically. The doses administered ranged from 0.3 to 15 ug/kg/d. The patients enrolled had varying types of EGF-receptor ("EGF-R") expressing tumors, most of which were prostate, gastrointestinal, or breast tumors. All patients had metastatic disease. One of two patients enrolled with lung cancer (adenocarcinoma) had a greater than 50% reduction in tumor burden at the 6.0 ug/kg/d dose level in the episodic schedule. Three additional patients judged to have stable disease for the six-month study period were one patient with head and neck cancer (0.6 ug/kg/d, episodic dosing schedule) and two patients with prostate cancer (1.2 and 4.2 ug/kg/d, consecutive dosing schedule). A Phase I/II study is currently being conducted in patients with NSCLC. This is a dose escalation study with projected enrollment of more than 30 patients. Results are expected late in 1997. Adverse Events Associated with Clinical Trials of Fusion Proteins In all clinical trials of Seragen's fusion proteins described in this document, and as commonly noted during investigation of and treatment with most, if not all, biological agents, adverse events associated with administration of the particular fusion protein under investigation did occur. These events included, but were not limited to, flu-like symptoms, rash, and transient elevation of liver enzyme (transaminase) levels. Some patients have experienced adverse events requiring hospitalization. These adverse events included problems associated with the patients' underlying disease as well as those associated with treatment. In some cases, patients experiencing adverse events discontinued participation in the trial. In the majority of cases, patients continued to participate. Further testing in a larger number of patients is required to determine the safety and effectiveness of Seragen's fusion proteins in psoriasis, rheumatoid arthritis, and lung cancer. Further testing may also be required to determine the safety and effectiveness of DAB389IL-2 in CTCL. Strategic Alliance with Eli Lilly and Company On August 3, 1994, the Company and Lilly signed an agreement to form a global strategic alliance that gives Lilly exclusive worldwide development, distribution, and marketing rights, except in certain Asian countries, to the Company's IL-2 Fusion Protein for the treatment of cancer. Lilly also has the option to obtain worldwide development, distribution, and marketing rights for additional indications for IL-2 Fusion Protein and for other Company products under development upon presentation of Phase II data. The Company retains exclusive rights to promote IL-2 Fusion Protein and future fusion proteins for dermatologic applications outside of oncology and will be responsible for bulk manufacturing for all indications. On August 4, 1994, under the terms of the alliance, Lilly made an initial payment to the Company of $10 million, $5 million representing payment for 787,092 shares of Company Common Stock at approximately $6.35 per share and $5 million representing an advance against Lilly's purchase of bulk product from the Company. Lilly is also required to pay the Company an additional $3 million based on the meeting of certain regulatory milestones in the development of IL-2 Fusion protein for cancer therapy. No regulatory 14 milestone payments have been achieved to date under the agreement. In addition, Lilly reimburses the Company for costs incurred in the clinical development of IL-2 Fusion Protein for cancer therapy, including costs for Phase III clinical trials, the preparation of an FDA application and any FDA filing fees. The Company recorded approximately $588,000, $3,337,000 and $3,979,000 of contract revenue for such reimbursed development costs during the years ended December 31, 1994, 1995 and 1996, respectively. On May 28, 1996, Lilly and the Company amended the Sales and Distribution Agreement relating to the $5.0 million advance paid by Lilly in August 1994 against Lilly's future purchases of bulk product from the Company. The amended agreement states that the $5.0 million payment is non-refundable and Seragen has no obligation to refund the advance should no bulk purchases be made by Lilly. To the extent Lilly purchases bulk product in the future, the Company is required to pay Lilly a royalty equal to 75% of the purchase price, up to $5.0 million of total royalties. The Company will recognize the $5.0 million non-refundable payment and amortize the related deferred commission upon the sale of bulk product to Lilly or at such time that Lilly acknowledges it will not purchase any bulk material. The Company previously recognized the $5.0 million non-refundable payment and expensed $2.06 million of deferred commission in the quarter ended June 30, 1996. Manufacturing The manufacture of the Company's fusion proteins originates at the genetic level. First, genes that direct production of the toxic and translocation domains of the diphtheria toxin molecule are fused with genes that direct production of the desired receptor targeting domain to create a new, recombinant gene. The recombinant gene is then placed in a strain of bacteria (E. coli) which is grown by fermentation using standard biotechnology techniques. During fermentation, the recombinant gene is expressed in the bacteria resulting in the production of fusion proteins. The fusion protein is then extracted from the bacteria and purified. Since fusion proteins are produced in recombinant bacteria using well established technology, the Company believes that its fusion proteins can be reliably produced in commercial quantities. To date the Company has produced all of its fusion proteins in the laboratory and has produced its IL-2 Fusion Protein and EGF Fusion Protein in its manufacturing facilities. The Company's manufacturing facilities are operated in accordance with current Good Manufacturing Practices ("CGMP"). The Company entered into an agreement to sell its manufacturing facility to Boston University in February 1997 pursuant to an asset purchase agreement (see "Business -- General"). Simultaneously, the Company entered into a service agreement with B.U. under which B.U. will provide certain services related to product research, development, manufacturing, clinical trials, quality control and quality assurance required by Seragen to continue clinical trials and to produce commercial quantities of DAB389IL-2 for sale. Such services will be performed to specifications outlined in the service contract. In order for this manufacturing facility to produce material that can be marketed, it must be inspected and licensed by the FDA. The Company regularly contracts with a variety of firms for certain quality control testing and fill-finish services, some of which services are essential to the Company. As of January 1996, Lilly is the Company's fill/finish contractor. Generally, these agreements may be terminated at any time by any of the parties thereto. Competition The therapeutic products which the Company is developing will compete with existing therapies for market share. In addition, a number of companies, 15 including biotechnology companies and pharmaceutical companies, acting independently or in collaboration, are pursuing the development of novel pharmaceuticals which target the same diseases which the Company is targeting. Furthermore, academic institutions, government agencies and other public organizations conducting research may seek patent protection, discover new drugs or establish collaborative arrangements for drug research which may be competitive with the targeted therapeutic products being developed by the Company. The Company's fusion proteins are designed to target cells bearing specific receptors implicated in a variety of diseases. Accordingly, competition will depend in part on the specific therapeutic applications for which the Company's compounds are developed and ultimately approved. Many of the Company's existing or potential competitors (including competitors that may be in the process of developing fusion protein products utilizing other toxins) have substantially greater financial, technical and human resources than the Company and may be better equipped to develop, manufacture and market products. In addition, many of these competitors have greater experience in pre-clinical testing and human clinical trials than the Company. These competitors may develop and introduce products and processes competitive with or superior to those of the Company. In addition, the Company expects that competition among products approved for sale will be based, among other things, on product efficacy, safety, reliability, availability, price and patent position. The development by others of new treatment methods for those diseases for which the Company is developing targeted therapeutic products could render such products non-competitive or obsolete. The Company's competitive position also depends upon its ability to attract and retain qualified personnel, obtain patent protection or otherwise develop proprietary products or processes and secure sufficient capital resources for the often substantial period between technological conception and commercial sales. A number of companies, including both large pharmaceutical companies and biotechnology companies, have been actively pursuing the development of monoclonal antibodies and immunotoxin conjugates for more than a decade. The Company is aware of two patents issued to the National Cancer Institute, United States Patent 4,892,827 and United States Patent 5,082,927 (the "Pastan Patents"), which relate to fusion proteins similar to those of the Company, in which the cytotoxic agent is pseudomonas exotoxin. Certain competitors of the Company, including certain large pharmaceutical companies, are known to have been engaged, at least in the past, in the development of fusion proteins under the Pastan Patents as potential therapeutic products for some of the same diseases which the Company is targeting. The Company is unable to assess the effect that such efforts may have on the Company's competitive position or business. Patents, Licenses and Proprietary Rights In November 1983, the Company entered into an agreement with Harvard University in Cambridge, Massachusetts, whereby the Company was granted a worldwide license under United States Patent 4,675,382 and all foreign patents and patent applications corresponding to United States Patent 4,675,382 (the "Murphy Patents"). The Harvard license provides the Company with the exclusive right to manufacture, have manufactured, sell or have sold, products made in accordance with the Murphy Patents for human and veterinary therapeutic and diagnostic uses for the life of the patents. Under certain circumstances, the license may become non-exclusive. Under the license, the Company has agreed to pay Harvard University an annual license fee until a product is marketed, and thereafter, a royalty on net sales, including a minimum royalty amount if certain sales levels are not met. The Murphy Patents relate to fusion proteins expressed as the product of a fused gene wherein the protein's naturally occurring binding domain is deleted and replaced at the genetic level by a gene encoding a cell-specific polypeptide ligand. The Company believes that the Murphy Patents are fundamental to the use of the genetically constructed diphtheria toxin molecules being developed by the Company. Although the scope of patent protection is difficult to quantify, the Company believes that, due in large part to the Murphy Patents, its patents or licenses to patents should afford adequate protection to conduct its business. The Company has also been prosecuting a patent application family directed to its core fusion protein technology which represents an improvement in the technology disclosed in the Murphy patents. Applications are pending in the United States and many foreign countries. The Company expects that several U.S. patents directed to these improvements will issue within the next twelve months. Once issued, these patents should provide intellectual property protection of the Company's core technology for many years after the expiration of the Murphy patents. The Company also has the rights to obtain licenses (many of which are, or will be, exclusive licenses) to patents and patent applications which have been filed by its institutional collaborators. Worldwide, the Company owns or holds exclusive licensing rights to over 40 issued patents, covering certain aspects of its technology, products, and the methods for their production and use. The Company intends to file patent applications with respect to subsequent developments and improvements when it believes patent protection is in its best interest. There can be no assurance that the Company's patent applications will result in patents being issued or that, if issued, the patents will afford protection against competitors with similar technology. Boston University acquired Nycomed's majority interest and technology rights in the Company in August of 1987. Under the terms of the purchase and sale agreement, Nycomed received a grant of a royalty on future sales of the Company's fusion protein products as well as a right of first negotiation to market the Company's fusion protein products in Norway, Denmark, Sweden, Finland, Iceland, Belgium, the Netherlands and Luxembourg (the "Territory"). The agreement provides that, when in the business judgment of the Company it is appropriate for the Company to enter into agreements with third parties with respect to the marketing of such products, the Company will negotiate exclusively with Nycomed for 90 days with respect to the rights to market the Company's fusion protein products in the Territory. The Company has conducted such negotiations with Nycomed regarding the Company's IL-2 Fusion Protein and EGF Fusion Protein, and no agreement was reached for the marketing of these products. The Company therefore believes that any rights Nycomed may have had for marketing of the Company's IL-2 Fusion Protein and EGF Fusion Protein in the Territory have expired. The Company may need to obtain other licenses to other patents of which it is unaware. There can be no assurance that licenses will be available from the owners of such patents, or, if available, will be available on terms acceptable to the Company. Moreover, there can be no assurance that all United States or foreign patents that may pose a risk of infringement have been identified. The Company pursues a policy of seeking patent protection to preserve its proprietary technology and its right to capitalize on the results of its research and development activities and, to the extent it may be necessary and 16 advisable, to exclude others from appropriating its proprietary technology. While the Company pursues such a policy, it also relies upon trade secrets, unpatented proprietary information and continuing technological innovation to develop and maintain its competitive position. There can be no assurance, however, that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to such trade secrets, proprietary information or technology or that the Company can meaningfully protect its rights in such secrets, information and technology. All employees of the Company have signed confidentiality agreements under which they agree not to use or disclose proprietary information of the Company without the consent of the Company. Relationships between the Company's scientific consultants and collaborative research partners provide access to the Company's know-how that is generally protected by confidentiality agreements with the parties involved. However, there can be no assurance that these confidentiality agreements will be honored. In December 1994, the Company entered into a license agreement with Ajinomoto Company, Inc. which provides the Company with exclusive worldwide rights under Ajinomoto's IL-2 gene patents for the Company's fusion proteins. The Company made an up-front payment of $100,000 under this agreement and is required to make a payment of $4.3 million by May 31, 1997, which it has not made. See "Management's Discussion and Analysis of Financial Condition And Results of Operations"). In addition, the Company is required to pay a royalty of 4% of Seragen revenues or end-user revenues depending on certain conditions. Seragen is required to pay minimum royalties of $100,000 in 1997, $200,000 in 1998 and $300,000 each year thereafter. In connection with the issuance of 23,800 shares of Series B preferred stock (the "Series B Shares"), the Company formed Seragen Technology, Inc. ("STI"). The Company transferred all of its exsisting and future United States patents and patent applications (the"Patents") to STI in exchange for 214,200 shares of STI's Class A Common Stock and 23,800 shares of STI's Class B Common Stock (the"Class B Shares"). Each share of STI Class A Common Stock is owned by the Company. The Company has transferred the Class B Shares to the holders of the Series B Shares. STI has no operations, and its sole asset is the Patents. Its authorized capital Stock consists of 214,200 shares of Class A Common Stock and 23,800 shares of Class B Common Stock, all of which, as described in the paragraph above, is issued and outstanding. Each share of STI Class A Common Stock and STI Class B Common Stock is entitled to one vote on all matters submitted to a vote of STI shareholders, voting together as a single class. Simultaneously with the contribution of the Patents to STI, the Company entered into a license agreement with STI pursuant to which STI granted to the Company an irrevocable worldwide exclusive license with respect to the Patents (the "Irrevocable License Argeement"). Under the terms of the Irrevocable License Agreement, the Company is obligated to pay quarterly royalties to STI in an amount equal to the amount of any dividend that the holders of the Series B Shares are entitled to receive but have not received by the royalty due date (which is one day after each quarterly dividend payment date for the Series B Shares). The shares of STI Class B Common Stock, in turn, are entitled to receive cumulative divends equal to any royalty payable to STI under the Irrevocable License Agreement. STI has executed a collateral assignment of the Patents in favor of the holders of the Class B Shares, which is being held by an escrow agent. The escrow agent is required to deliver collateral assignment to the holders of the Class B Shares if dividends on the Class B Shares are in arrears and STI 17 fails for 60 days, after the receipt of notice from the holders of the Class B Shares, to pay the dividends due. Likewise, the holders of Class B Shares have executed a reassignment of the Patents to STI, which also is being held by the escrow agent. The escrow agent is obligated to deliver the reassignment of the Patents to STI upon the redemption by STI of all of the Class B Shares. The Class B Shares are required to be redeemed upon the redemption or conversion of Series B Shares in a number equal to the number of Series B Shares redeemed or converted. The collateral assignment of the Patents secures only STI's dividend payment obligations on the Class B Shares and does not secure any other amounts (e.g., the liquidation preference of the Series B Shares). The collateral assignment of the Patents has no effect until the escrow agent is instructed to deliver it to the holders of the Class B Shares. The Company has not paid the cash dividends due Defcember 31, 1996 and March 31, 1997, on the Series B Shares, nor has the Company made the royalty payments due to STI on January 1, 1997, and April 1, 1997. Correspondingly, STI has not paid the dividends due January 1, 1997, and April 1, 1997, on the Class B Shares. Delivery of notice by the agent for the holders of the Class B Shares to the escrow agent in accordance with the collateral assignment of the Patents is the only condition to delivery of the collateral assignment of the Patents to the holders of the Class B Shares. If the holders of the Class B Shares were to deliver this notice to the escrow agent, they would thereafter have the right to foreclose on the Patents, subject to the Company's rights under the Irrevocable License Agreement. To the Company's knowledge, the holders of the Class B Shares have not delivered this notice to the escrow agent. Research and Licensing Agreements The Company has engaged in sponsored research programs through external research under agreements with various academic institutions and companies, and under consulting agreements with scientists affiliated with such institutions. Under the agreements, the Company provides periodic research funding and typically maintains options to obtain exclusive licenses to patents and patent applications which may be filed as a result of the sponsored research by the institutional partner. In general, where a patent is licensed, the license is co-terminus with the patent. From April 1, 1984, through December 31, 1996, the Company maintained a research agreement with Boston University Medical Center Hospital, formerly known as University Hospital, in Boston, Massachusetts (the "UH Research Agreements") in support of research on fusion proteins under the direction of Dr. John R. Murphy. The Company has entered into a license agreement with University Hospital (the "UH License Agreement") under which the Company has acquired exclusive rights to certain patent applications and patents arising out of the research under the UH Research Agreements. Under the UH License Agreement, the Company has been granted an exclusive license to six existing U.S. patents and patent applications and to their foreign counterparts. The Company maintained a research agreement with Beth Israel Hospital in Boston, Massachusetts (the "BIH Research Agreement"), which began August 1984 and continued until December 31, 1995, related to the control of T-cell mediated response by targeted agents under the direction of Dr. Terry B. Strom. Under the BIH Research Agreement, the Company was granted an option to obtain an exclusive license to any patent application filed on any invention conceived or reduced to practice during the course of the research. Several patent applications have been filed pursuant to the BIH Research Agreement. Two of these describe methods of treating immunological diseases and 18 transplant rejection and have been issued as United States Patents 5,011,684 and 5,336,489 and both have been exclusively licensed to the Company. The Company believes that this method will be broadly useful in the treatment of autoimmune diseases and allograft rejection. The third, which issued as United States Patent 5,152,980, relates to a method of inducing tolerance to a foreign antigen, which the Company believes will be useful in helping it to keep therapies from being disabled by the body's immune system. The Company has exercised its option on this patent to obtain an exclusive license. Including the arrangements described above, the Company has incurred consulting fees to a stockholder and directors of approximately $162,000, $173,000 and $181,000 in 1994, 1995 and 1996, respectively. The Company has also incurred expenses relating to research grants to, and clinical trials performed at, Boston University Medical Center Hospital and Beth Israel Hospital of approximately $367,000, $335,000 and $175,000 in 1994, 1995 and 1996, respectively. Government Regulation Regulation by governmental authorities in the United States and foreign countries is a significant factor in the future manufacturing and marketing of the Company's potential products and in its ongoing research and product development activities. All of the Company's products currently under development will require regulatory approval by governmental agencies prior to their commercialization. In particular, human therapeutic products are subject to rigorous pre-clinical and clinical testing and other premarket approval procedures by the FDA and similar authorities in many foreign countries. Various other federal, and in some cases state and local, statutes and regulations also govern or influence the manufacturing, safety, labeling, storage, transport, recordkeeping, promotion and marketing of such products. The lengthy process of seeking these approvals, and the subsequent ongoing compliance with applicable federal, state and local statutes and regulations, require the expenditure of substantial resources. There can be no assurance that, even after such time and expenditures, regulatory approvals will be obtained for any products developed by the Company. Moreover, if regulatory approval of a product is granted, such approval will entail limitations on the indicated uses for which it may be marketed. Further, even if such regulatory approval is obtained, a marketed product and its manufacturer are subject to continual review, and discovery of previously unknown problems with a product or manufacturer or non-compliance with FDA regulations may result in restrictions on such product or manufacturer, including withdrawal of the product from the market. The manufacturer is also subject to continuing FDA inspection, review and post-market requirements. In addition, there can be no assurance that this regulatory framework will not change or that additional regulation will not arise at any stage of the Company's product development which may affect approval or delay an application or require additional expenditures by the Company. Delays in obtaining regulatory approvals would adversely affect the marketing of products developed by the Company and the Company's ability to receive product revenues or royalties. The Company has entered into a strategic alliance with Lilly in connection with the development, production, marketing and sale of its IL-2 Fusion Protein for cancer and cancer related bone marrow transplantation. The Company may enter into additional corporate partnerships and other agreements in connection with the development, manufacturing, marketing and sale of the IL-2 Fusion Protein for other indications and for all other fusion proteins for any indications. Such arrangements would be subject to fair trade regulation by numerous governmental authorities in the United States and other countries. There can be no assurance that any agreements entered into by the Company and international pharmaceutical partners on terms favorable to the Company would 19 be found to be binding and enforceable if subject to any judicial or administrative action by any governmental authority. If the agreement with Lilly were terminated, and the Company failed to establish additional partnerships in developing, producing, marketing and selling certain of its products, such failure could have a material adverse effect on the Company. In both the U.S. and foreign markets, the Company's ability to commercialize its products successfully may also depend in part on the extent to which reimbursement for the cost of such products and related treatment will be available from government health administration authorities, private health insurers and other organizations. Third-party payors are increasingly challenging the price and cost-effectiveness of medical products and services. Significant uncertainty may exist as to the reimbursement status of newly approved health care products, and there can be no assurance that adequate third-party coverage will be available to enable the Company to maintain price levels or sales volume sufficient to realize an appropriate return on its investment in product development. Clinical Trials Process The Company expects that its potential products in the United States will be regulated by the Center for Biologics Evaluation and Research ("CBER") of the FDA. Currently, the steps required before a new biological product can be produced and marketed include pre-clinical studies, the filing of an Investigational New Drug ("IND") application, human clinical trials, and the approval of a Biologics License Application ("BLA"). Pre-clinical studies are conducted in the laboratory and in animal model systems to gain preliminary information on the drug's efficacy and metabolism and to identify potential safety issues. The results of these studies are submitted to the FDA as part of the IND application for review and approval before the commencement of testing in humans. Human clinical testing typically includes a three-phase process. In Phase I, clinical trials are conducted with a small number of subjects to determine a safety profile and the pattern of drug distribution and metabolism. In Phase II, clinical trials are conducted with groups of patients afflicted with a specific disease in order to develop preliminary efficacy data, optimal dosages and additional safety data. In Phase III, large scale, multicenter, well-controlled clinical trials are conducted with patients afflicted with a target disease in order to provide enough data for the statistical proof of efficacy and safety required by the FDA. In some cases, the initial human testing is in patients rather than in healthy volunteers. Since these patients are already afflicted with the target disease, it is possible that such studies may provide efficacy results traditionally obtained in Phase II clinical trials. These trials are frequently referred to as Phase I/II clinical trials. Phase II/III clinical trials refer to a combined phase of human pharmaceutical trials designed to provide evidence of efficacy and safety of a compound in patients with the targeted disease. In some instances, a product license application may be approved based on data from Phase II/III clinical trials. The FDA has issued regulations governing clinical trials, and the failure to comply with these regulations can result in delay in obtaining approvals or the denial of the application. The results of the pre-clinical and clinical testing, together with chemistry and manufacturing information, product labeling and other information are then submitted to the FDA in the form of a BLA. The Company's application may be subject to the provisions of the Prescription Drug User Fee Act of 1992 which would require payment at the time of submission. Commercial manufacturing and marketing of biologic products may occur only after approval of a BLA. In responding to a BLA, the FDA may grant marketing approval, request additional information, or deny the application if it determines that 20 the application does not satisfy its regulatory approval criteria. There can be no assurance that approvals will be granted on a timely basis, if at all, or if granted will cover all the clinical indications for which the Company is seeking approval. In addition, approvals may contain significant limitations in the form of warnings, precautions or contraindications with respect to conditions of clinical use. Seeking and obtaining regulatory approval, including the full clinical trial process, for a new therapeutic product may take at least several years and may require the expenditure of substantial resources. Orphan Drug Designation The Orphan Drug Act of 1983 generally provides incentives to manufacturers to undertake development and marketing of products to treat relatively rare diseases or conditions affecting fewer than 200,000 persons in the United States. These incentives include a seven-year marketing exclusivity and funding for qualified clinical trials. The Company has received Orphan Drug designation for DAB389IL-2 in CTCL and may seek Orphan Drug designation for other qualified products. From time to time, proposals have been introduced in Congress to limit Orphan Drug exclusivity. Accelerated Drug Approval Under current guidelines, the FDA will accelerate approval of certain new drugs and biological products for serious or life-threatening illnesses, with provisions for any necessary continued study of the drugs' clinical benefits after approval or with restrictions on use, if necessary. These procedures are intended to expedite marketing of drugs or biologicals for patients suffering from such illnesses when the product provides meaningful therapeutic benefit compared to existing treatment. Drugs or biological products approved under these procedures must meet the requisite standards for safety and effectiveness under the Federal Food, Drug, and Cosmetic Act or the Public Health Service Act, and thus will have full approval for marketing, but will be subject to significant post-approval limitations at least for some period of time. The Company believes that several of its intended products may qualify for accelerated approval under these regulations. The Company has requested consideration for accelerated approval from the FDA for DAB389IL-2 in heavily pretreated CTCL patients. No final decision will be made by the FDA until the time of BLA submission. National Institutes of Health Regulations The Company has complied with National Institutes of Health ("NIH") Recombinant DNA Guidelines on a voluntary basis and expects to continue to do so. Such guidelines, among other things, restrict or prohibit certain recombinant DNA experiments and establish levels of biological and physical containment that must be met for various types of research. The federal government has proposed a new interagency biotechnology science coordinating committee to obtain a unified approach to the regulation of recombinant DNA activities. Foreign Regulations Regulations concerning the marketing of human therapeutic products are generally imposed by foreign governments and may have an impact on the Company's anticipated operations. The requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement levels vary widely from country to country. The Company attempts to conduct its development activities in a manner that will comply with most foreign regulations. 21 Other Regulations The Company's activities will also be regulated in part by the Atomic Energy Act, the Occupational Safety and Health Act, the Environmental Protection Act, and other local, state and federal regulations, including those governing the use and disposal of hazardous materials. Any violation of, and the cost of compliance with, these regulations could adversely impact the Company's operations. From time to time other federal, state and local agencies have indicated an interest in implementing further regulation of biotechnology activities. There can be no assurance that additional regulations will not be adopted and, if adopted, that such regulations will not have a material adverse impact on the Company. Research and Development Spending During each of the three fiscal years ended December 31, 1994, 1995 and 1996, the Company spent approximately $18.1 million, $14.1 million and $14.0 million, respectively, on research and development activities. In 1994, approximately $2.8 million of the research and development activities related to a charge to licensed technology for research and development. None of this spending involved customer-sponsored research. Employees As of December 31, 1996, the Company had a total of 126 employees, each of whom has entered into a confidentiality agreement with the Company. Thirteen of them held Ph.D. degrees. None of the Company's employees is covered by a collective bargaining agreement. In connection with the agreement to sell the Company's manufacturing and clinical operations to B.U., at the closing, approximately 100 of the Company's employees involved in the manufacturing and clinical operations will become employees of B.U. Business Outlook This report contains forward-looking statements that are based on the Company's current expectations. Among the forward-looking statements in this report are (i) the statements in this "Business" section discussing the potential applications of the Company's fusion proteins existing or in development, (ii) the potential markets for the Company's products, (iii) the status and anticipated timing of the Company's product development, (iv) the potential efficacy of the Company's products, the methods by which the Company may develop its products, (v) the effect of the Company's patent and other intellectual property rights, (vi) the anticipated results of the Company's clinical trials and other tests, and (vii) the Company's arrangements with B.U., Lilly, Ajinomoto, the Company's agreement to sell a portion of its assets to B.U. and the contract with B.U. for the provision of certain services. Other forward-looking statements are the statements in the "Management's Discussion and Analysis" section including (i) the Company's anticipated future operating results and liquidity requirements, (ii) the Company's ability to fund operations, (iii) the Company's ability to restructure its agreements with Ajinomoto, (iv) the Company's agreement to sell a portion of its assets to B.U. and the contract with B.U. for the provision of certain services, (v) the Company's ability to restructure its obligations to its preferred shareholders, (vi) the Company's ability to satisfy its obligations under the Seragen Biopharmaceuticals, Ltd. ("SBL") Shareholders' Agreement, and (vii) the Company's ability to raise funds 22 through an equity offering or through collaborative or other arrangements with others. However, this paragraph does not necessarily include an exhaustive list of the forward-looking statements contained in this report. Because the Company's actual results may differ materially from any forward-looking statements made by or on behalf of the Company, this section discusses important factors that could affect the Company's actual future results, including its revenues, expenses, and net income. Early Stage of Product Development. Seragen has not yet marketed or generated revenues from the commercialization of its potential therapeutic products. All of the Company's potential products require significant development, laboratory and clinical testing and regulatory review prior to their commercialization, which takes a number of years. The Company expects that even its products currently at the most advanced stages of development will not be available for commercial sale or use for several years, if at all. The Company's products now in pre-clinical trials may not be successful in human clinical trials. Products currently in, or which in the future advance to, various phases of human clinical trials, may not prove to be efficacious, or unintended or toxic side effects may occur. There can be no assurance that regulatory approvals will be obtained for any products developed by the Company. Generally, only a small percentage of new pharmaceutical products are approved for sale. Moreover, if regulatory approval of a product is granted, the approval may limit the indicated uses for which the product may be marketed. Even if regulatory approval is obtained, a marketed product and its manufacturer are subject to continual review. Discovery of previously unknown problems with a product or manufacturer may result in restrictions on the use of this product or its manufacturer, including withdrawal of the product from the market. History of Operating Losses and Accumulated Deficit. The Company has experienced significant operating losses in each year since its inception and, as of December 31, 1996, had an accumulated deficit of approximately $189 million. The Company expects to incur significant additional operating losses over the next several years and expects cumulative losses to increase as the Company's research and development and clinical trial efforts continue. The Company's ability to achieve a profitable level of operations depends in large part on completing product development and commercialization, obtaining regulatory approvals for its products, and making the transition from research and development to manufacturing and marketing. There can be no assurance that the Company will ever achieve a profitable level of operations. Additional Financing Requirements and Access to Capital Funding. The Company has expended and will continue to expend substantial funds on the research and development of its products, establishment of commercial-scale manufacturing facilities and marketing of its products. It is assumed that the Company's strategic partner Lilly will provide the funds required for the CTCL clinical trial under the terms of its agreement with the Company. However, Lilly has the right to terminate its funding of this trial based on findings that occur as clinical trials progress and based on input from regulatory agencies. If Lilly exercises its option to terminate its funding of the CTCL trial, the Company may need additional funding in order to continue the trial if the Company elects to and the Company may not be able to negotiate other collaborative arrangements on acceptable terms. There can be no assurance that the Company's alliance with Lilly will continue. 23 The Company's ability to finance its operations beyond May 1997 is dependent upon its ability to raise additional capital primarily through additional financings or strategic alliances. No assurance can be given that additional funds will be available to the Company to finance its development on acceptable terms, if at all, or, if available, that such arrangements would not require the Company to relinquish rights to certain products or markets in exchange for funding. If adequate additional funds cannot be raised the Company's business will be materially and adversely affected and the Company may be required to suspend operations. Reliance on Fusion Protein Technology; Technological Change and Competition. The Company's future success is entirely dependent on the clinical and commercial viability of its fusion protein products. The biotechnology industry is subject to rapid and significant technological change. The Company has numerous competitors, including major pharmaceutical and chemical companies, specialized biotechnology firms, universities and other research institutions, and others. The Company's competitors may succeed in developing other fusion proteins, technologies and products that are more effective than any being developed by the Company, or that would render the Company's technology and products obsolete and noncompetitive. Many of these competitors (including certain competitors developing other fusion protein products) have substantially greater financial and technical resources, and production and marketing capabilities than the Company. Many of the Company's competitors have significantly greater experience than the Company in undertaking pre-clinical testing and human clinical trials of new or improved pharmaceutical products and obtaining FDA and other regulatory approvals of products for use in health care. The Company has limited experience in conducting and managing pre-clinical and clinical testing necessary to obtain these approvals. The Company's competitors may succeed in obtaining FDA approval for products more rapidly than the Company. If the Company commences significant commercial sales of its products, it will also be competing with respect to manufacturing and marketing capabilities, areas in which it has limited or no experience. Dependence on Boston University for Services. Assuming that the Company completes its planned sale of its manufacturing and clinical operations to B.U., the Company will have no independent manufacturing and clinical operations and will depend upon B.U.'s ability to provide certain services relating to product research, development, manufacturing, clinical trials, quality control, and quality assurance. The initial employees providing such services will be former employees of Seragen. B.U.'s success will depend, in large part, on its continued ability to attract and retain highly qualified scientific and business personnel. Competition for such personnel and relationships is intense. B.U. may terminate its service agreement if its annual losses exceed $9 million. The Company may not be able to contract with another party for these services in that event, may be required to pay more for these services, and may incur significant delays in its product development and clinical trial efforts if it should be unable to continue to utilize the services of the operating facilities it has agreed to sell to B.U. Dependence on Collaborative Partners. If Lilly terminates its funding of the CTCL clinical trials or declines to exercise its options with respect to other fusion protein indications, the Company may be required to seek other collaborative arrangements to develop and commercialize its products in the future. There can be no assurance that the Company will be able to negotiate any other collaborative arrangements on acceptable terms, or that any such collaborative arrangements will be successful. Patents, Licenses and Proprietary Rights. There can be no assurance that 24 any of the Company's licenses or issued patents will provide it with significant protection against competitors, that patent applications will result in patents being issued to the Company or its institutional collaborators, or that the Company will be able to exercise its rights to obtain such licenses. Moreover, in certain circumstances, exclusive licenses may become nonexclusive. The Company's success will depend, in part, on its ability to obtain patent protection for its products, both in the United States and in other countries. The patent position of biotechnology firms generally is highly uncertain and involves complex legal and factual questions. There can be no assurance that the Company's patent applications will result in patents being issued or that, if issued, patents will afford protection against its competitors. Competitors have filed applications for patents or have been issued patents, and they may obtain additional patents and other proprietary rights relating to products intended to be comparable in function to products being developed by the Company, as well as products or processes competitive with those of the Company. The scope and validity of these patents, the extent to which the Company may be required to obtain licenses under any such patents or other proprietary rights, and the cost and availability of license agreements are presently unknown. The Company is required to pay Boston University and Nycomed certain royalties on the sales by the Company of certain products. In addition, Boston University retains a security interest in certain technology and could reacquire all ownership rights in the technology upon a default by the Company under the terms of its agreement. The Company's Patents are the subject of a collateral assignment made by STI in favor of the Series B shareholders. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." If the Patents were to be transferred pursuant to this collateral assignment, the Company would not have any direct or indirect ownership interest in the Patents. If the Company failed in these circumstances to make all required payments under the Irrevocable License Agreement with STI, the Company could lose the right afforded by the Irrevocable License Agreement to use the Patents and could then be required to renegotiate the terms of its license for use of the Patents. There is no assurance that the Company would be able to renegotiate on terms advantageous to the Company. The Company may need to obtain licenses to certain other United States and foreign patents for certain products or processes contemplated by the Company. There can be no assurance that licenses will be available from the owners of such patents or will be available on terms acceptable to the Company. Moreover, there can be no assurance that all United States and foreign patents that may pose a risk of infringement have been identified. The Company also relies on unpatented proprietary technology. There can be no assurance that the Company can adequately protect its rights in unpatented proprietary technology, or that others will not independently develop substantially equivalent proprietary technology or otherwise gain access to the Company's proprietary technology. Absence of Manufacturing Experience. To be successful, the Company's products must be manufactured in commercial quantities, in compliance with regulatory requirements, and at acceptable costs. Production in commercial quantities will create technical, regulatory and financial challenges for the Company. The Company has never engaged in large-scale manufacturing. 25 The Company regularly contracts with a variety of firms for testing and manufacturing services, some of which services are essential to the Company. Generally, these agreements may be terminated at any time by any of these third parties. Need for Commercial Sales and Marketing Capabilities. Although the Company may market certain of its products through a direct sales force if and when regulatory approvals are obtained, it currently has no marketing or sales staff. Significant additional expenditures, management resources and time will be required to develop a sales force to the extent that the Company determines not to, or is unable to, arrange third party distribution for its products. Product Liability. The testing, marketing and sale of human health care products entail an inherent risk of product liability or allegations thereof. Product liability claims may be asserted against the Company. The Company's existing product liability coverage may not be adequate either currently or as and when the Company further develops products. There can be no assurance that the Company will be able to maintain or increase its current insurance coverage in the future on acceptable terms or that any claims against the Company will not exceed the amount of its coverage. ITEM 2. PROPERTIES The Company leases approximately 87,000 square feet of laboratory, office and production space in three buildings in Hopkinton, Massachusetts. A portion of this space contains production operations which the Company believes it operates in compliance with CGMP as defined by the FDA. One of the current leases on a portion of the larger of the Company's facilities (38,400 of 64,000 square feet) was guaranteed by Boston University. This guarantee expired in 1996. The lease on this 64,000 square foot facility expires in July 2002. The Company has options to renew this lease for two additional successive periods of five years each. The Company believes that these facilities are adequate for its operations as currently contemplated. In connection with the agreement to sell the Company's manufacturing and clinical operations to B.U., it is anticipated that the facility leases will be assigned to B.U. at the closing. The Company plans to sublease a portion of this space from B.U. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material legal proceedings and no proceedings are known to be contemplated by governmental agencies. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS A special meeting of Shareholders of the Company was held on December 18, 1996. The following matter was voted upon: (1) The shareholders approved an amendment to the Company's Restated Certificate of Incorporation to increase the number of shares of authorized common stock from 30 million shares to 70 million shares. This proposal was approved with 13,237,682 votes for the proposal, 1,245,018 votes against the proposal and 42,155 abstentions. PART II 26 ITEM 5. MARKET FOR THE REGISTRANT'S SECURITIES AND RELATED STOCK MATTERS The Company's common stock is quoted on the Nasdaq National Market System ("Nasdaq NMS") under the symbol SRGN. The following table sets forth for the periods indicated high and low reported sale prices for the Company's common stock as reported on Nasdaq.
High Low ---- --- 1995 First Quarter........................ 7 4 1/2 Second Quarter....................... 7 1/8 5 3/8 Third Quarter........................ 7 63/64 5 3/16 Fourth Quarter....................... 6 3/4 4 1/8 1996 First Quarter........................ 5 1/4 3 1/8 Second Quarter....................... 5 1/2 3 7/8 Third Quarter........................ 4 1/4 2 5/8 Fourth Quarter....................... 3 1/8 1
As of March 27, 1997, there were 682 holders of record of the Company's common stock. The last reported sale price of the common stock as reported on Nasdaq NMS on March 27, 1997 was $1.00. The Company has never paid cash dividends on its common stock. The Company pays cash dividends on its Series B Preferred Stock, although these dividends currently are in arrears, and pays common stock dividends on its Series A and C Preferred Stock. Among the criteria that must be satisfied in order to qualify for continued designation on the Nasdaq NMS is the requirement that the Company maintain net tangible assets of at least $4 million. As of December 31, 1996, the Company had net tangible assets deficit of $4.8 million. Therefore, the Company currently does not satisfy this requirement. Another requirement for continued designation on the Nasdaq NMS is that the Company's shares of Common Stock have a minimum bid price of at least $1.00 per share. On March 27, 1997, the Company's Common Stock price was quoted on Nasdaq NMS at a high bid price of $1.00 and a low bid price of $.938. Nasdaq has not yet notified the Company that the Common Stock fails to meet these requirements, but the Company anticipates receiving such a notification from Nasdaq in the near future. ITEM 6. SELECTED FINANCIAL DATA (As restated) The following table presents selected financial data for, and as of the end of, each of the years in the five-year period ended December 31, 1996 which have been derived from the audited financial statements of the Company (See Note O to Notes to Financial Statements for restatement discussion). Financial statements for the three fiscal years ended December 31, 1996 are included elsewhere in this report. This selected financial data should be read in conjunction with the financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this report. 27
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------------------------------------------------- 1992 1993 1994 1995 1996 ------------ ------------ ------------ ------------ ------------ (As Restated) STATEMENT OF OPERATIONS DATA: Contract revenue and license fees ........................... $ 12,500 $ 138,226 $ 588,350 $ 3,337,388 $ 5,542,315 Operating Expenses: Cost of contract revenue and license fees .................... - - 588,350 3,337,388 4,504,243 Research and development .............. 15,319,750 13,718,973 15,240,195 14,086,632 13,959,405 General and administrative ............ 5,096,643 4,357,563 4,903,963 4,904,226 5,148,465 Licensed technology for research and development ..................... - - 2,824,217 - - ------------ ------------ ------------ ------------ ------------ Total operating expenses ............ 20,416,393 18,076,536 23,556,725 22,328,246 23,612,113 ------------ ------------ ------------ ------------ ------------ Loss from operations .................. (20,403,893) (17,938,310) (22,968,375) (18,990,858) (18,069,798) Loss incurred in connection with Canadian affiliate .................. - - - (390,136) (2,923,864) Interest income ....................... 610,033 611,784 438,338 92,924 120,740 Interest expense ...................... (1,554,102) (53,505) (113,756) (1,813,128) (5,453,638) ------------ ------------ ------------ ------------ ------------ Net loss .............................. (21,347,962) (17,380,031) (22,643,793) (21,101,198) (26,326,560) ============ ============ ============ ============ ============ Preferred stock dividends ............. - - - - 10,394,918 ============ ============ ============ ============ ============ Net loss applicable to common stockholders ........................ $(21,347,962) $(17,380,031) $(22,643,793) $(21,101,198) $(36,721,478) ============ ============ ============ ============ ============ Net loss per common share ............. $ (2.13) $ (1.26) $ (1.45) $ (1.29) $ (2.20) ============ ============ ============ ============ ============ Weighted average common shares used in computing net loss per share ........................... 10,030,965 13,775,341 15,631,333 16,355,587 16,724,493 =========== =========== =========== ========== ==========
DECEMBER 31, ----------------------------------------------------------------------------------- 1992 1993 1994 1995 1996 (As Restated) BALANCE SHEET DATA: Cash and cash equivalents ............... $ 12,196,639 $ 10,104,179 $ 5,536,782 $ 435,460 $ 1,548,392 Marketable securities ................... - - 2,034,948 - - Working capital (deficit) ............... 10,605,189 8,612,996 3,859,854 (1,298,886) (5,927,902) Total assets ............................ 17,726,047 18,099,705 17,039,292 16,299,508 10,504,608 Short-term debt ......................... - 170,572 197,453 248,494 5,402,268 Long-term debt .......................... - 483,364 3,038,778 15,977,899 --- Deferred revenue ........................ - - 5,000,000 5,000,000 5,000,000 Canadian affiliate put option liability ............................. - - - 2,076,000 2,400,000 Total liabilities ....................... 2,007,588 2,893,194 13,255,070 26,741,003 17,091,212 Accumulated deficit ..................... (91,148,311) (108,528,342) (131,172,135) (152,273,333) (188,994,811) Total stockholders's equity (deficit) . 15,718,459 15,206,511 3,784,222 (10,441,495) (6,586,604)
28 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The Company is engaged in the discovery, research and development of pharmaceutical products for human therapeutic applications. Since 1985, the Company has focused substantially all of its efforts and resources on research and development of its fusion protein technology. The Company's fusion proteins were developed using proprietary technology and have potential applications in a wide range of human diseases. To date, the Company has not generated any revenues from the sale of fusion protein products, and the Company does not expect to receive any such revenues in 1997. The Company has generated no profit since its inception and expects to incur additional operating losses over the next several years. In February 1997, the Company entered into an agreement to sell its manufacturing and clinical operations facilities to B.U. or a designated affiliate for $5 million and in connection therewith entered into a service agreement with B.U. pursuant to which B.U. will provide the Company with certain services related to product research, development, manufacturing, clinical trials, quality control and quality assurance. The terms of this transaction are discussed more fully below under "Liquidity and Capital Resources". The Company's business is subject to significant risks, including the ability to raise additional capital, the uncertainties associated with the regulatory approval process and with obtaining and enforcing patents important to the Company's business. The Company expects to incur substantial operating losses over the next several years due to continuing expenses associated with its research and development programs, including pre-clinical testing and clinical trials. Operating losses may also fluctuate from quarter to quarter as a result of differences in the timing of expenses incurred. Restatement of December 31, 1996 Financial Statements In September of 1997, the Company restated its 1996 financial statements to reflect a change in the accounting treatment for the Company's amended Sales and Distribution Agreement with Lilly on May 28, 1996. The restatement consists of (1)recording the $5.0 million payment by Lilly in 1994 as an advance against future purchases of bulk product by Lilly (the Company had previously recorded such amount as revenue in the quarter ended June 30, 1996), (2)capitalizing as a deferred expense $2,060,000 of commissions paid by the Company in connection with the $5.0 million payment from Lilly in 1994, and (3) reversing a $1.2 million expense accrual associated with providing the bulk material to Lilly (previously recorded by the Company in the fourth quarter of 1996). (See Notes D and O in Notes to the Financial Statements.) Results of Operations 1996 to 1995 The Company incurred a net loss of $36.7 million for the year ended December 31, 1996 compared to $21.1 million for the year ended December 31, 1995. The increase in net loss during 1996 was primarily due to (i) the payment and accretion of a total of $10.4 million in dividends associated with the Series A, B and C Preferred Stock in 1996 including warrants valued at $8.6 million issued to the Series B shareholders, (ii) the expensing of $3.0 million of prepaid interest associated with the restructuring of the June 1995 29 guaranteed loans, and (iii) an increase of $2.5 million in the charge for the potential obligation of the Company to the investors in SBL in connection with certain put rights. The Company's revenues for the year ended December 31, 1996 were $5.5 million as compared to $3.3 million for the year ended December 31, 1995. This increase of $2.2 million in 1996 was primarily the result of the receipt of a one-time $1.5 million fee relating to the exercise by a third party of a prepaid option to license certain patents in the field of transplantation in the third quarter of 1996 and an increase of $700,000 primarily in contract revenue from Lilly associated with the Phase III clinical trial for IL-2 Fusion Protein for cancer therapy. Total operating expenses increased by $1.3 million to $23.6 million in 1996 from $22.3 million in 1995. Expenses associated with the cost of contract revenue and license fees increased by $1.2 million to $4.5 million in 1996 compared to $3.3 million in 1995. This increase reflects an increase of approximately $700,000 for the acceleration of clinical development activity under the Phase III clinical trial for IL-2 Fusion Protein for cancer therapy and an increase of $500,000 related to a sub-license fee payable on the $1.5 million patent license revenue mentioned above. Research and development expenses were substantially unchanged for the year ended December 31, 1996 as compared to the year ended December 31, 1995. However, there was a decrease of approximately $300,000 due to the decision by the Company in 1996 to focus its financial resources on IL-2 Fusion Protein for cancer and psoriasis therapies thereby reducing clinical development in other IL-2 Fusion Protein indications. There was also a decrease of $200,000 in non-reimbursable research grants and outside pre-clinical testing. These decreases were partially offset by an increase of $400,000 in facility engineering and validation fees. General and administrative expenses were substantially unchanged for the year ended December 31, 1996 as compared to the year ended December 31, 1995. Losses incurred in connection with the Company's Canadian affiliate increased $2.5 million to $2.9 million in 1996 from $400,000 in 1995. This increase reflects the Company's decision in 1996 to reduce its investment in the affiliate to zero and reflect a liability for the current put obligation of $2.4 million held by the shareholders of the Canadian affiliate. Interest income was substantially unchanged for the year ended December 31, 1996 as compared to the year ended December 31, 1995. Interest expense increased $3.7 million in 1996 to $5.5 million from $1.8 million in 1995 primarily due to the expensing of $3.0 million of prepaid interest and $475,000 of debt issuance costs associated with the repayment of the June 1995 loans and to higher loan balances in 1996 as compared to 1995. The Company recorded $10.4 million in preferred stock dividends in 1996 related to the Series A, B and C Preferred Stock issuances. The $10.4 million in preferred stock dividends consisted of (i) the value associated with the Series B Preferred Stock warrants of $8.6 million, (ii) cash dividends of $1.2 million, and (iii) stock dividends and issuance costs of $610,000. 1995 to 1994 The Company incurred a net loss of $21.1 million for the year ended December 31, 1995 compared to a net loss of $22.6 million for the year ended December 31, 1994. The Company's revenues for the year ended December 31, 1995 were $3.3 million associated with contract revenue from Lilly for certain development 30 costs of IL-2 Fusion Protein for cancer therapy, as compared to $588,000 for the year ended December 31, 1994. Total operating expenses decreased by $1.3 million to $22.3 million in 1995 from $23.6 million in 1994. The decrease in total operating expenses was primarily due to a 1994 non-cash charge in research and development for the acquisition of a license and reductions in research and development expenses, partially offset by increases in expenses associated with the cost of contract revenue. Expenses associated with the cost of contract revenue were $3.3 million in 1995 as compared to $588,000 in 1994. This increase of $2.7 million reflects the acceleration of clinical development activity under the corporate strategic alliance with Lilly. For comparative purposes, the following discussion of research and development expenses includes the cost of contract revenue. Research and development expenses increased $1.6 million to $17.4 million in 1995 from $15.8 million in 1994. This increase was primarily due to the cost associated with the Phase III clinical trial for IL-2 Fusion Protein for cancer therapy, the hiring of additional scientists and support staff, and the initiation of a Phase II clinical trial for IL-2 Fusion Protein for psoriasis. This increase was partially offset by reductions in external research grants, consulting fees and seminar expenses. In 1994, a non-cash charge of $2.8 million was charged to research and development for the acquisition of an exclusive worldwide license from Ajinomoto Company, Inc. for the rights to the IL-2 gene. General and administrative expenses were substantially unchanged for the year ended December 31, 1995 as compared to the year ended December 31, 1994. In 1995, a non-cash charge of approximately $390,000 was recorded to reflect the obligation by the Company to the shareholders of the Canadian affiliate. Interest income decreased approximately $345,000 to $93,000 in 1995 from $438,000 in 1994 primarily due to lower average balances of cash equivalents and marketable securities in 1995. Interest expense increased approximately $1.7 million in 1995 to $1.8 million due to borrowings under the lines of credit which commenced in June 1995. 31 Restatement of December 31, 1996 Financial Statements In September of 1997, the Company restated its 1996 financial statements to reflect a change in the accounting treatment for the Company's amended Sales and Distribution Agreement with Lilly on May 28, 1996. The restatement consists of (1) recording the $5.0 million payment by Lilly in 1994 as an advance against future purchases of bulk product by Lilly (the Company had previously recorded such amount as revenue in the quarter ended June 30, 1996), (2) capitalizing as a deferred expense $2,060,000 of commissions paid by the Company in connection with the $5.0 million payment from Lilly in 1994, and (3) reversing a $1.2 million expense accrual associated with providing the bulk material to Lilly (previously recorded by the Company in the fourth quarter of 1996). (See Notes D and O in Notes to the Financial Statements.) The following table presents the net loss, the net loss applicable to common stockholders, and the net loss per share as originally reported, and as restated. For the YearEnded December 31,1996 __________________ As reported As restated
Net loss $(24,586,560) $(26,326,560) Net loss applicable to common stockholders (34,981,478) (36,721,478) Net loss per share $(2.09) $(2.20)
Liquidity and Capital Resources As of March 28, 1997, the Company had approximately $2.4 million in cash and cash equivalents including a deposit of $4.5 million made by Boston University in connection with the sale of the Company's manufacturing and clinical operations. The net book value of the assets to be sold to Boston University was $4.6 million representing substantially all of the property and equipment, consisting primarily of leasehold improvements to the Company's manufacturing facility, laboratory facilities and laboratory equipment as of February 14, 1997. The Company expects to incur further substantial research and development expenses as it continues development of its fusion proteins. The Company also expects to incur substantial administrative and commercialization expenses in the future. The Company's continuing operating losses and requirements for working capital will depend on many factors, including the progress and costs associated with its research, pre-clinical and clinical development efforts, and the level of resources which the Company must devote to obtaining regulatory approvals to manufacture and sell its products. The Company began assembling the components of its operating division (the "Operating Division") over five years ago. The Company developed the Operating Division with excess capacity in order to meet anticipated commercial demand for the Company's products. In addition, the Company maintained a relatively high level of staffing in the Operating Division in order to comply with regulatory requirements. Historically, the Company has not utilized its Operating Division to full capacity principally because the Company has not yet begun manufacturing product for commercial purposes and 32 due to the limited financial resources that the Company has available to develop other products. The Company maintained the Operating Division, despite its high costs, because of the delays and disruptions in its clinical trial efforts that would have resulted from discontinuing the Operating Division and obtaining the services from third parties. The Company did not provide services to third parties using the services of the Operating Division due to regulatory guidelines that prevented it from doing so. In recent years, the FDA has relaxed these guidelines. However, the Company chose not to contract out excess capacity because this would not have led to a substantial and rapid reduction in expenditures and because of the potential resulting distraction to key management. As of February 14, 1997, the Company entered into the Asset Purchase Agreement to sell its manufacturing and clinical operations facilities to Boston University or a designated affiliate for $5.0 million. The closing of the transaction is subject to, among other things, approval by the Company's stockholders. Boston University has paid the Company $4.5 million as a deposit and, from the time of execution of the agreement, has assumed responsibility for the facility's operations, including responsibility for operating costs. These assets represent substantially all of the Company's property and equipment and consist primarily of leasehold improvements to the Company's manufacturing facility, laboratory facilities and laboratory equipment. Simultaneously with the execution of the Asset Purchase Agreement, the Company entered into the Service Agreement with Boston University providing for the purchase by the Company of certain services related to product research, development, manufacturing, clinical trials, quality control, and quality assurance. The Service Agreement expires in January 1999 and is subject to certain early termination provisions, including the option of Boston University to terminate the agreement if losses during a contract year exceed $9.0 million and the Company does not reimburse Boston University for the losses in excess of $9.0 million. The Service Agreement may be renewed for two successive one-year terms at the option of the Company. The Company has the option to repurchase the assets comprising the manufacturing and clinical operations facilities. The Company has agreed to pay Boston University fees of approximately $5.5 million and $6.6 million in years 1 and 2 of the Service Agreement, respectively. The fees can be increased or decreased by agreement of the parties, but may not be reduced to less than $4.3 million per contract year. The Service Agreement is expected to substantially reduce operating costs in research and development, as the Company will be contracting solely for the services that the Company requires for clinical and manufacturing purposes. The Company will give effect to this transaction in its financial statements after closing. At the closing, most of the Company's employees involved in the manufacturing and clinical operations will become employees of Boston University. Both the purchase price and the operating costs deposits are subject to refund to Boston University in the event that conditions for closing are not met. Upon the closing of this transaction, the Company will account for the gain and the sale of the operating facility and the excess of the reimbursed operating costs over the amount due to Boston University, pursuant to the Service Agreement dated as of February 14, 1997 for the period from February 14, 1997, until the closing of the transaction, as a contribution of capital. The Company expects that the transactions with Boston University discussed above will effectively out-source the Company's research and development activities, and reduce the Company's cash needs, both for capital 33 expenditures and operating expenses. The Company is subject to certain additional risks and expenditures, including termination of its contract service agreement if the Company does not reimburse Boston University for the losses in excess of $9.0 million in a contract year, provided that, after notice, the Company does not pay Boston University the difference between its actual losses for that year and $9.0 million. If the Company is unable to or chooses not to make the additional payments, it will be forced to change to a new service provider. This could adversely affect the Company's research and development efforts. On August 3, 1994, the Company and Lilly signed an agreement to form a global strategic alliance that gives Lilly exclusive worldwide development, distribution, and marketing rights, except in certain Asian countries, to IL-2 Fusion Protein for the treatment of cancer. Lilly reimburses the Company for costs incurred in the clinical development of IL-2 Fusion Protein for cancer therapy, including costs for Phase III clinical trials, the preparation of an FDA application and any FDA filing fees. The Company recorded approximately $588,000, $3,337,000 and $3,979,000 of contract revenue for such reimbursed development costs during the years ended December 31, 1994, 1995 and 1996, respectively. Lilly is also required to pay the Company an additional $3 million based on the Company meeting certain regulatory milestones in the development of IL-2 Fusion Protein for cancer therapy. No regulatory milestone payments have been achieved to date under the agreement. In December 1994, the Company entered into a license agreement with Ajinomoto Co., Inc. which provides the Company with exclusive worldwide rights under Ajinomoto's IL-2 gene patents for the Company's fusion proteins. The Company has made an up-front payment of $100,000 under this agreement. In addition, the Company is required to pay a royalty of 4% of Seragen revenues or end-user revenues depending on certain conditions. Seragen is required to pay minimum royalties of $100,000 in 1997, $200,000 in 1998 and $300,000 each year thereafter. Under the terms of the license agreement, the Company was required to make a payment of $4.3 million by March 31, 1997. However, Ajinomoto has deferred this payment to May 31, 1997. The Company is in discussions with Ajinomoto regarding amending the terms of the agreement. The Company also is exploring alternative sources of funding to make the May 31 payment. No agreement in principle has been reached, however, and there can be no assurance that the Company will be able to make the required payment. On November 21, 1995, the Company formed Seragen Biopharmaceuticals Ltd. ("SBL"), a privately held Canadian research and development company located in Montreal. In a private financing, a group of six Canadian investors contributed approximately $10.0 million, acquiring units representing 51% of SBL. The investors have the option to exercise one of three different put rights related to their SBL shares after January 1, 1999, or earlier upon the occurrence of certain events. Included among these certain events is any failure of the Company's common stock to be listed on a national security exchange or an inter-dealer quotation system. Issues regarding the Company's continued eligibility for listing on the Nasdaq National Market System (see "Market for the Registrant's Securities and Related Stock Matters") may make the investors' put rights currently exercisable. Put Right 1 obligates the Company to purchase the investors' 1,557,097 shares at $8.57 (Canadian $) plus 11.4% compounded annually. Put Right 2 obligates the Company to purchase the investors' shares at a price of 20 times SBL's per share income over the four most recent quarters. Put Right 3 obligates the Company to exchange the investors' shares for the Company's shares (or the value of such shares) using the product of $8.57 (Canadian $) and the number of puts exercised divided by 9.487. The Company has the option to settle Put Right 1 in cash or common stock, but the investor can require 50% of the price to be paid in cash. The 34 Company has the option to settle the Put Rights 2 and 3 in cash or Seragen common stock. In certain specific circumstances relating to the trading status of Seragen's common stock when the Company must settle the put rights in cash. The put rights will terminate if SBL sells shares in an initial public offering. As of December 31, 1996, the Company has recorded a $2.4 million liability which reflects the Company's current put obligation. The Company is currently in default of its obligation to file a registration statement relating to resale of shares underlying the put rights. On May 29, 1996, the Company raised net proceeds of $3.8 million through the sale of 4,000 shares of convertible Series A Preferred Stock ("Series A Shares") to investors outside the United States under Regulation S of the Securities Act of 1993. The Series A Shares are convertible at the option of the holders, beginning July 15, 1996, into shares of common stock. As of December 31, 1996, 895 Series A Shares had been converted into 566,400 shares of Common Stock at conversion prices ranging from $1.022 to $2.774 per share. The Series A Shares were reflected at $2,015,522 at December 31,1996 representing their liquidation value, which includes accrued dividends payable from the issuance date through December 31, 1996. See Note J to the Company's financial statements. On July 1, 1996, the Company restructured its arrangement with the guarantors of the Company's $23.8 million bank financing under which the guarantors directly assumed the liability with the banks and the Company was released from its liability to the banks. In exchange for the guarantors satisfying the Company's liability to the banks, the guarantors were issued 23,800 Series B Shares. Each Series B Share is convertible at any time at the holder's option into shares of Seragen common stock. In connection with the issuance of 23,800 Series B Shares the Company formed STI. The Company transferred the Patents to STI in exchange for 214,200 shares of STI's Class A Common Stock and 23,800 shares of STI's Class B Common Stock (the"Class B Shares"). Each share of STI Class A Common Stock is owned by the Company. The Company has transferred the Class B Shares to the holders of the Series B Shares. STI has no operations, and its sole asset is the Patents. Its authorized capital Stock consists of 214,200 shares of Class A Common Stock and 23,800 shares of Class B Common Stock, all of which as described in the paragraph above, is issued and outstanding. Each share of STI Class A Common Stock and STI Class B Common Stock is entitled to one vote on all matters submitted to a vote of STI shareholders, voting together as a single class. Simultaneously with the contribution of the Patents to STI, the Company entered into the Irrevocable License Agreement. Under the terms of the Irrevocable License Agreement, the Company is obligated to pay quarterly royalties to STI in an amount equal to the amount of any dividend that the holders of the Series B Shares are entitled to receive but have not received by the royalty due date (which is one day after each quarterly dividend payment date for the Series B Shares). The shares of STI Class B Common Stock, in turn, are entitled to receive cumulative divends equal to any royalty payable to STI under the Irrevocable License Agreement. STI has executed a collateral assignment of the Patents in favor of the holders of the Class B Shares, which is being held by an escrow agent. The escrow agent is required to deliver collateral assignment to the holders of the Class B Shares if dividends on the Class B Shares are in arrears and STI fails for 60 days, after the receipt of notice from the holders of the Class B Shares, to pay the dividends due. Likewise, the holders of Class B Shares have executed a reassignment of the Patents to STI, which also is being held 35 by the escrow agent. The escrow agent is obligated to deliver the reassignment of the Patents to STI upon the redemption by STI of all of the Class B Shares. The Class B Shares are required to be redeemed upon the redemption or conversion of Series B Shares in a number equal to the number of Series B Shares redeemed or converted. The collateral assignment of the Patents secures only STI's dividend payment obligations on the Class B Shares and does not secure any other amounts (e.g., the liquidation preference of the Series B Shares). The collateral assignment of the Patents has no effect until the escrow agent is instructed to deliver it to the holders of the Class B Shares. The Company has not paid the cash dividends due December 31, 1996 and March 31, 1997, on the Series B Shares, nor has the Company made the royalty payments due to STI on January 1, 1997, and April 1, 1997. Correspondingly, STI has not paid the dividends due January 1, 1997, and April 1, 1997, on the Class B Shares. Delivery of notice by the agent for the holders of the Class B Shares to the escrow agent in accordance with the collateral assignment of the Patents is the only condition to delivery of the collateral assignment of the Patents to the holders of the Class B Shares. If the holders of the Class B Shares were to deliver this notice to the escrow agent, they would thereafter have the right to foreclose on the Patents, subject to the Company's rights under the Irrevocable License Agreement. To the Company's knowledge, the holders of the Class B Shares have not delivered this notice to the escrow agent. The holders of the Series B shares also received warrants to purchase a total of 5,950,000 shares of Seragen common stock at an exercise price of $4.00 per share. The Company has estimated the average fair market value of the warrants to be $1.45 per warrant or $8,617,951 for the 5,950,000 issued and outstanding warrants. The value ascribed to the warrants and the restructuring costs have been accreted through a charge to retained deficit and an offset to additional paid-in capital. In addition, subject to the antidilution provisions of the warrants, the Company issued 2,217,196 warrants at an exercise price of $4.00 per share in the year ended December 31, 1996. Dividends payable of approximately $583,000 were outstanding at December 31, 1996 and are included in accrued expenses. See Note E to the Company's financial statements. The Company did not make the dividend payment of approximately $600,000 due on March 31, 1997. On September 30, 1996, the Company raised net proceeds of approximately $5 million through the sale of 5,000 shares of the Company's non-voting convertible Series C Preferred Stock ("Series C Shares") in a private placement with Boston University under Regulation D of the Securities Act of 1933. The Series C Shares are convertible at the option of the holder into shares of Seragen Common Stock. See Note J to the Company's financial statements. The Company anticipates that existing cash and cash equivalents and the reimbursement for clinical costs for the development of IL-2 Fusion Protein for cancer therapy will be sufficient to fund the Company's working capital requirements through approximately May 1997 provided that the Company is able to amend its current agreement with Ajinomoto or have the May 31, 1997 $4.3 million payment that is required under the agreement made by another party. In addition, the Company must complete the sale of its manufacturing and clinical operation facilities to B.U. or the $4.5 million deposit and operating expenses will be subject to refund to B.U. (See Notes B, E, I and L in the "Notes to the Financial Statements" regarding significant future obligations.) The Report of Independent Accountants on the Company's Financial Statements for the fiscal year ended December 31, 1996 includes an 36 explanatory paragraph concerning uncertainties surrounding the Company's ability to continue as a going concern. This may adversely affect the Company's ability to raise additional capital. See Note A in the "Notes to the Financial Statements." The Company's ability to finance its operations beyond May 1997 is dependent upon its ability to raise additional capital through debt or equity financings, possible additional payments under the strategic alliance with Lilly, or such other sources of financing, including strategic partnerships, as may be available. The Company is exploring a possible equity offering, although the terms of such offering have not been finalized. There can be no assurance that the Company will be successful in an equity offering or that the amount raised will be sufficient to fund the Company's operating expenses until other sources of funds can be secured. Management of the Company believes that to be able to complete a new equity financing successfully, the holders of the Company's Series A, Series B and Series C Preferred stock will be required to convert such securities in connection with the offering. Management is in discussions with such holders but there is no assurance that such agreements can be reached or if reached will be on satisfactory terms. The Company is seeking to obtain additional funds through collaborative or other arrangements with corporate partners and others. There can be no assurance that the Company will be successful in securing collaborative or other arrangements with corporate partners or others on acceptable terms, if at all. If the Company does not consummate an equity financing or additional collaborative or other arrangements with corporate partners, then the Company's current cash position may not be sufficient to meet its financial obligations and may fund operations only through May 1997. If adequate additional funds are not available, the Company may be required to delay, scale back or eliminate certain of its clinical trials, manufacturing or development activities or certain other aspects of its business and may be required to cease operations, which would have a material adverse affect on the Company. 37 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Index to Financial Statements and Schedule Reports of Independent Accountants. . . . . . . . . . . . . . . . . . . . 41 Financial Statements: Balance Sheets as of December 31, 1995 and 1996 (As Restated). . . . 43 Statements of Operations for the years ended December 31, 1994, 1995 and 1996 (As Restated). . . . . . . . . . . . . . . . . . . . 44 Statements of Stockholders' Equity (Deficit) for the years ended December 31, 1994, 1995 and 1996 (As Restated) . . . . . . . 45 Statements of Cash Flows for the years ended December 31, 1994, 1995 and 1996 (As Restated) . . . . . . . . . .. . . . . . . 47 Notes to Financial Statements. . . . . . . . . . . . . . . . . . . . 48 Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82 38 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Seragen, Inc.: We have audited the accompanying balance sheet of Seragen, Inc. (a Delaware Corporation) as of December 31, 1996, and the related statements of operations, stockholders' equity (deficit) and cash flows for the year ended December 31, 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 audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Seragen, Inc. as of December 31, 1996 and the results of its operations and its cash flows for the year ended December 31, 1996, in conformity with generally accepted accounting principles. The December 31, 1996 financial statements have been restated, (See Note O). The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As described in Note A, the Company has experienced significant operating losses since inception and has a working capital deficit as of December 31, 1996. These factors raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also discussed in Note A. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty. Arthur Andersen LLP Boston, Massachusetts October 22, 1997 39 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Seragen, Inc.: We have audited the balance sheet of Seragen, Inc. as of December 31, 1995 and the related statements of operations, stockholders' equity (deficit) and cash flows for each of the two years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Seragen, Inc. as of December 31, 1995 and the results of its operations and its cash flows for each of the two years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As described in Note A, the Company has experienced recurring operating losses and has a working capital deficit. These factors raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also discussed in Note A. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty. Coopers & Lybrand L.L.P. Boston, Massachusetts February 23, 1996 40 SERAGEN, INC. BALANCE SHEETS
DECEMBER 31, ASSETS 1995 1996 ------------- -------------- (As Restated) Current assets: Cash and cashequivalents......................................................... $ 435,460 $ 1,548,392 Restrictedcash................................................................... 435,318 610,318 Contractreceivable............................................................... 686,055 485,261 Unbilled contractreceivable...................................................... 496,147 833,983 Prepaid expenses and other currentassets......................................... 335,238 285,356 -------- --------- Total currentassets................................................. 2,388,218 3,763,310 Property and equipment,net......................................................... 5,198,136 4,604,115 Investment inaffiliate............................................................. 2,599,864 -- Deferredcommission................................................................. 2,060,000 2,060,000 Prepaidinterest.................................................................... 3,528,677 -- Other assets........................................................................ 524,613 77,183 --------- --------- Totalassets......................................................... $ 16,299,508 $ 10,504,608 ============= ============= LIABILITIES AND STOCKHOLDERS' (DEFICIT) Current liabilities: Accountspayable.................................................................. 725,326 1,111,477 Current maturities of long-termdebt.............................................. 248,494 37,418 Accrued commission payable........................................................ 300,000 -- Accrued expenses.................................................................. 2,413,284 3,177,467 Preferred stock redemptionliability............................................... -- 1,236,753 Short-term obligation, less unamortized discount.................................. -- 4,128,097 ------------- ------------- Total currentliabilities............................................ 3,687,104 9,691,212 Non-current liabilities: Long-term debt, less currentmaturities........................................... 12,537,417 -- Deferredrevenue.................................................................. 5,000,000 5,000,000 Long-term obligation, less unamortizeddiscount................................... 3,440,482 -- Canadian affiliate put option liability........................................... 2,076,000 2,400,000 ---------- --------- Total non-currentliabilities........................................ 23,053,899 7,400,000 ------------- ------------- Commitments and contignencles Stockholders' (deficit); Preferred stock, $.01 par value; 5,000,000 shares authorized Convertible preferred stock, Series A, $.01 par value; issued and outstanding 3,105 shares at December 31, 1996, $2,015,522 liquidationpreference........................................................ -- 2,015,522 Convertible preferred stock, Series B, $.01 par value; issued and outstanding 23,800 shares at December 31, 1996, $23,800,000 liquidationpreference........................................................ -- 23,800,000 Convertible preferred stock, Series C, $.01 par value; issued and outstanding 5,000 shares at December 31, 1996, $5,100,000 liquidationpreference........................................................ -- 5,100,000 Common Stock, $.01 par value; 70,000,000 shares authorized; issued 16,521,212 and 17,199,458 shares at December 31, 1995 and 1996,respectively................................................... 165,212 171,994 Additional paid incapital...................................................... 141,759,580 151,323,022 Accumulateddeficit............................................................. (152,273,333) (188,994,811) ------------- ------------- (10,348,541) (6,584,273) Less-treasury stock (14,632 and 777 shares at cost at December 31, 1995 and 1996,respectively).................................................. (92,954) (2,331) ------------- ------------- Total stockholders'(deficit)........................................ (10,441,495) (6,586,604) ------------- ------------- Total liabilities and stockholders'(deficit)........................ $ 16,299,508 $ 10,504,608 ============= ============== 41
The accompanying notes are an integral part of the financial statements. SERAGEN, INC. STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994 1995 1996 ----------- ------------ ------------ (As Restated)
Revenue: Contract revenue and license fees ....... $ 588,350 $ 3,337,388 $ 5,542,315 Operating expenses: Cost of contract revenue and license fees 588,350 3,337,388 4,504,243 Researcg and development ................ 15,240,195 14,086,632 13,959,405 General and administrative .............. 4,903,963 4,904,226 5,148,465 Licensed technology for research and development .......................... 2,824,217 - - ------------ ------------ ------------ 23,556,725 22,328,246 23,612,113 ------------ ------------ ------------ Loss from operations ................. (22,968,375) (18,990,858) (18,069,798) Loss incurred in connection with Canadian affiliate ............................... - 390,136 2,923,864 Interest Income ........................... 438,338 92,924 120,740 Interest expense .......................... 113,756 1,813,128 5,453,638 ------------ ------------ ------------ Net loss ........................ (22,643,793) (21,101,198) (26,326,560) ============ ============ ============ Preferred stock dividends and accretion ... - - (10,394,918) ============ ============ ============ Net loss applicable to common stockholders ............................ $(22,643,793) ($21,101,198) ($36,721,478) ============ ============ ============ Net loss per common share ................. $ (1.45) ($ 1.29) ($ 2.20) ============ ============ ============ Weighted average common shares used in computing net loss per share .... 15,631,333 16,355,587 16,724,493 ============ ============ ============
The accompanying notes are an integral part of the financial statements. 42 SERAGEN, INC. STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) For the Years Ended December 31, 1994, 1995 and 1996
Series A Series B Series C Convertible Convertible Convertible Additional Preferred Stock PreferredStock Preferred Stock Common Stock Paid-In Capital --------------- --------------- --------------- ------------ --------------- (As Restated) Balance, December 31, 1993 ................. - - - $142,698 $123,599,530 Private placement of units net of offering costs, exercise of stock options .................................. - - - 11,442 6,631,269 Shares issued under corporate partner agreement, net of costs .................. - - - 7,871 4,657,857 Purchase of treasury stock ................. - - - Sales of treasury stock .................... - - - 130 (20,342) Net loss ................................... - - - - - ----------- ----------- ---------- -------- ------------ Balance, December 31, 1994 ................. - - - 162,141 134,868,314 Exercise of stock options .................. - - - 572 84,216 Warrants issued in connection with lines of credit .......................... - - - - 4,164,996 Warrants issued in connection with investment in affiliate .................. - - - - 914,000 Shares issued for commission related to corporate partner agreement - - - 2,200 1,757,800 Purchase of treasury stock ................. - - - - - Sales of treasury stock .................... - - - 299 (29,746) Net loss ................................... - - - - - ----------- ----------- ---------- -------- ------------ Balance, December 31, 1995 ................. - - - 165,212 141,759,580 Exercise of stock options .................. - - - 1,068 79,144 Stock issuance ............................. - - - 50 20,452 Issuance of preferred stock ................ $ 4,000,000 $23,800,000 $5,000,000 - - Warrants issued in connection with Series B preferred stock ................. - - - - 8,618,000 Preferred stock redemption liability ....... (1,236,753) - - - - Dividends .................................. 171,688 - 100,000 - - Preferred stock conversion ................. (919,413) - - 5,664 913,749 Purchase of treasury stock ................. - - - - - Sale of treasury stock ..................... - - - - (67,903) Net loss ................................... - - - - - ----------- ----------- ---------- -------- ------------ Balance, December 31, 1996 ................. $ 2,015,522 $23,800,000 $5,100,000 $171,994 $151,323,022 =========== =========== ========== ======== ============ Accumulated Treasury Stockholder's Deficits Stock Equity (Deficit) -------- ----- --------------- Balance, December 31, 1993 ................. $(108,528,342) $ (7,375) $ 15,206,511 Private placement of units net of offering costs, exercise of stock options .................................. - - 6,642,711 Shares issued under corporate partner agreement, net of costs .................. - - 4,665,728 Purchase of treasury stock ................. - (150,500) (150,500) Sales of treasury stock .................... - 83,777 63,565 Net loss ................................... (22,643,793) - (22,643,793) -------------- --------- Balance, December 31, 1994 ................. (131,172,135) (74,098) 3,784,222 Exercise of stock options .................. - - 84,788 Warrants issued in connection with loss of credit .......................... - - 4,164,996 Warrants issued in connection with investment in affiliate .................. - - 914,000 Shares issued for commission related to corporate partner agreement ........... - - 1,760,000 Purchase of treasury stock ................. - (201,939) (201,939) Sales of treasury stock .................... - 183,083 153,636 Net loss ................................... (21,101,198) - (21,101,198) -------------- --------- ------------ Balance, December 31, 1995 ................. (152,273,333) (92,954) (10,441,495) 43 Exercise of stock options .................. - - 80,212 Stock issuance ............................. - - 20,502 Issuance of preferred stock ................ (338,640) - 32,461,360 Warrants issued in connection with Series B preferred stock ................. (8,618,000) - - Preferred stock redemption liability ....... - - (1,236,753) Dividends .................................. (1,438,278) - (1,166,590) Preferred stock conversion ................. - - - Purchase of treasury stock ................. - (107,750) (107,750) Sale of treasury stock ..................... - 198,373 130,470 Net loss ................................... (26,326,560) - (26,326,560) -------------- --------- ------------ Balance, December 31, 1996 ................. $(188,994,811) $ (2,331) $ (6,586,604) ============== ========= ============
The accompanying notes are an integral part of the financial statements. 44 SERAGEN, INC. STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1994 1995 1996 ------------ ------------ ------------ (As Restated) Cash flows from operating activities: Net loss ................................................... $(22,643,793) $(21,101,198) $(26,326,560) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization ............................ 1,131,144 969,104 945,225 Loss incurred in connection with Canadian affiliate ...... - 390,136 2,923,864 Loss on disposal of property and equipment ............... (49,229) 2,240 71,811 Loss from sale of marketable securities .................. 42,650 - - Compensation associated with stock issuance .............. - - 20,502 Purchase of technology license ........................... 2,724,217 - - Amortization of discount on long-term debt ............... 28,651 687,614 687,615 Amortization of prepaid interest ......................... - 636,319 3,528,677 Amortization of debt issuance costs ...................... - 79,719 442,117 Changes in operating assets and liabilities: Grant receivable ......................................... 121,139 - - Contract receivable ...................................... (246,571) (439,484) 200,794 Unbilled contract receivable ............................. (341,779) (154,368) (337,836) Prepaid expenses and other current assets ................ 51,416 192,955 49,882 Accounts payable ......................................... 26,760 94,701 386,151 Deferred commission ...................................... (2,060,000) - Accrued commission payable ............................... 2,360,000 (300,000) (300,000) Accrued expenses ......................................... 392,821 385,070 180,888 Deferred revenue ......................................... 5,000,000 - ------------ ------------ ------------ Net cash used in operating activities ...................... (13,462,574) (18,557,192) (17,526,870) ------------ ------------ ------------ Cash flows from investing activities: Purchase of marketable securities ........................ (20,878,601) - - Proceeds from sales of marketable securities ............. 18,800,903 2,034,948 - Purchases of property and equipment ...................... (348,398) (351,840) (423,015) Proceeds from sales of property and equipment ............ 9,000 - - Decrease in other assets ................................. 14,363 2,970 5,353 (Increase) decrease restricted cash account .............. (169,974) (47,445) (175,000) ------------ ------------ ------------ Net cash (used in) provided by investing activities ........ (2,572,607) 1,638,633 (592,662) ------------ ------------ ------------ Cash flows from financing activites: Proceeds from preferred stock issuances .................. - - 9,000,000 New proceeds from common stock issuances ................. 11,372,004 238,424 210,682 Purchases of treasury stock .............................. (150,500) (201,939) (107,750) Proceeds from sale/leaseback ............................. 416,853 - - Proceeds from issuance of long-term debt ................. - 12,500,000 11,300,000 Repayments of long-term debt ............................. (170,573) (197,452) (248,493) Debt and preferred stock issuance costs .................. - (521,796) (338,680) Dividends paid ........................................... - - (583,295) ------------ ------------ ------------ Net cash provided by financing activities .................. 11,467,784 11,817,237 19,232,464 ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents ....... (4,567,397) (5,101,322) 1,112,932 Cash and cash equivalents, beginning of period ............. 10,104,179 5,536,782 435,460 ------------ ------------ ------------ Cash and cash equivalents, end of period ................... $ 5,536,782 $ 435,460 $ 1,548,392 ============ ============ ============ Supplemental disclosures of cash flows information: Cash paid for interest ................................... $ 85,105 $ 489,195 $ 761,981 ============ ============ ============ Supplemental non cash activities: Issuance of common stock for strategic alliance with Lilly $ - $ 1,760,000 $ - Issuance of warrants and put rights to shareholders of Canadian affiliate ..................................... $ - $ 2,990,000 $ - Conversion of series A preferred stock to common stock ... $ - $ - $ 919,413 Conversion of long-term debt to series B preferred stock . $ - $ - $ 23,800,000 Issuance of warrants to series B preferred stockholders .. $ - $ - $ 8,618,000 Preferred stock dividends ................................ $ - $ - $ 271,688 45
The accompanying notes are an integral part of the financial statements. SERAGEN, INC. NOTES TO FINANCIAL STATEMENTS A. NATURE OF BUSINESS: Seragen, Inc. (the "Company" or "Seragen") is engaged in the research and development of a new class of therapeutic products known as fusion proteins. The Company was established in 1979 and became a majority-owned investment of Boston University ("Boston University" or "B.U.") in 1987. Substantially all of the Company's cash requirements from that time until the Company's initial public offering in April 1992 were funded by loans from B.U. The Company completed its initial public offering in April 1992, a second public offering of common stock in March 1993 and a private placement of units in February 1994. In August 1994, the Company signed an agreement to form a global strategic alliance with Eli Lilly and Company ("Lilly") (see Notes D and J). In June 1995, the Company finalized three separate lines of credit which guaranteed a total of $23.8 million in bank financing (see Note E) which were subsequently converted into Series B Preferred Stock. In November 1995, the Company formed Seragen Biopharmaceuticals Ltd. ("SBL"), an affiliate to conduct research and development and clinical trials of the Company's proprietary fusion protein products in Canada (see Note G). In May 1996, the Company raised $3.8 million through the sale of Series A Preferred Stock (see Note J). On September 30, 1996, the Company raised $5 million through the sale of Series C Preferred Stock (see Note J). In February 1997, substantially all property and equipment was sold to Boston University for $5 million (see Note B) and the Company entered into a service agreement under which B.U. will perform research and development activities on behalf of the Company. In connection with the sale, at closing, approximately 100 of the Company's employees will be transferred to B.U. The Board of Directors has determined to seek ratification of this sale by disinterested shareholders. The Company has incurred losses of approximately $187 million since inception and has funded these losses principally through the issuance of debt and equity securities. The Company has a working capital deficit as of December 31, 1996, and is dependent on raising additional capital in the short term to satisfy its ongoing capital needs and to continue its operations. Management continues to pursue additional funding arrangements and strategic partnerings; however, no assurance can be given that such financing will in fact be available to the Company. These conditions raise substantial doubt about the Company's ability to continue as a going concern. If the Company is unable to obtain financing on acceptable terms in order to maintain operations through the next fiscal year, it could be forced to curtail or discontinue its operations. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. In September 1997, the Company restated its December 31, 1996 financial statements to reflect a change in the accounting treatment for the Company's Amended Sales and Distribution Agreement with Lilly on May 28, 1996. Such restatement resulted in an increase in the net loss applicable to common stockholders of $1,740,000 for the year ended December 31, 1996.(See Note O) B. Sale of Manufacturing and Clinical Operations to Boston University On February 14, 1997, the Company entered into an asset purchase agreement (the "Asset Purchase Agreement") to sell its manufacturing and clinical operations facilities to Boston University or a designated affiliate for $5.0 million. The closing of the transaction is subject to, among other 46 things, approval by the Company's stockholders. Boston University has paid the Company $4.5 million as a deposit and, from the time of execution of the agreement, has assumed responsibility for the facility's operations, including responsibility for operating costs. Simultaneously with the execution of the Asset Purchase Agreement, the Company entered into a service agreement ("the Service Agreement") with Boston University providing for the purchase by the Company of certain services related to product research, development, manufacturing, clinical trials, quality control, and quality assurance. The Service Agreement expires in January 1999, and is subject to certain early termination provisions, including the option of Boston University to terminate the agreement if losses during a contract year exceed $9.0 million and the Company does not reimburse Boston University for the losses in excess of $9.0 million. The Service Agreement may be renewed for two successive one-year terms at the option of the Company. The Company has the option to repurchase the assets comprising the manufacturing and clinical operations facilities. The Company has agreed to pay Boston University fees of approximately $5.5 million and $6.6 million in years 1 and 2 of the Service Agreement, respectively. The fees can be increased or decreased by agreement of the parties, but may not be reduced to less than $4.3 million per contract year. The Service Agreement is expected to reduce substantially the Company's operating costs in research and development, as the Company will be contracting solely for the services that the Company requires for clinical and manufacturing purposes. The Company will give effect to this transaction in its financial statements after closing. At the closing, most of the Company's employees involved in the manufacturing and clinical operations will become employees of Boston University. Both the purchase price and operating cost deposits are subject to refund to Boston University in the event that conditions for closing are not met. Upon the closing of this transaction, the Company will account for the gain and the sale of the operating facility and the excess of the reimbursed operating costs over the amount due to Boston University, pursuant to the Service Agreement dated as of February 14, 1997 for the period from February 14, 1997, until the closing of the transaction, as a contribution of capital. On February 18, 1997, the Company entered into an agreement to sell its manufacturing and clinical operations facilities to Boston University ("Boston University" or "B.U.") or a designated affiliate for $5 million. The closing of the transaction is subject to, among other things, approval by the Company's stockholders. B.U. has paid the Company $4.5 million as a deposit and has assumed responsibility for the facility's operations, including responsibility for operating costs. The Company currently may use this deposit to fund its operations. At the closing, a majority of the Company's employees involved in the manufacturing and clinical operations will become employees of B.U. Both the deposit and the operating costs paid by B.U. are subject to refund in the event that conditions for closing are not met. Simultaneously, the Company entered into a service agreement with B.U. providing for the purchase by the Company of certain services related to product research, development, manufacturing, clinical trials, quality control, and quality assurance. This service contract expires in January 1999 and is subject to early termination provisions, as defined, including the option of B.U. to terminate the agreement if losses during a contract year exceed $9.0 million and the Company does not reimburse B.U. for the losses in excess of $9.0 million. The service contract may be renewed for two successive one-year terms at the option of the Company. The Company has the option to repurchase the assets comprising the manufacture and clinical operations facilities. The Company has agreed to pay B.U. approximately $5.5 million and $6.6 million in years 1 and 2 of this contract, respectively. The 47 fees can be mutually increased or decreased, but may not be reduced to less than $4.3 million per contract year. C. SIGNIFICANT ACCOUNTING POLICIES: Cash Equivalents The Company considers all highly liquid investments that have a maturity on date of acquisition of three months or less to be cash equivalents. Cash equivalents at December 31, 1995 and 1996 consist of money market funds. Restricted Cash The Company maintains a restricted cash balance of $610,318 at December 31, 1996, of which $435,318 is available under a letter of credit required by a lessor with whom the Company has entered into a sale/leaseback arrangement. The remaining $175,000 is available under a letter of credit required by an officer of the Company with whom the Company has entered into an employment agreement. Concentration of Credit Risk The Company invests its excess cash in deposits with federally insured banks and money market funds. At December 31, 1995 and 1996, all investments are in funds which have an average maturity of less than one year. The Company recorded revenues of greater than 10% of total revenues under its corporate alliance with Lilly and Novartis (see Note D). Property and Equipment Property and equipment are stated at cost. Betterments and major repairs are capitalized and included in property and equipment accounts while expenditures for maintenance and repairs are charged to expense. When assets are retired or otherwise disposed of, the cost of the assets and related accumulated depreciation and amortization are removed from the accounts and any resulting gain or loss is reflected in income. The accompanying statements of operations provides for depreciation and amortization using the straight-line method over their useful lives, as follows:
DECEMBER, 31 ESTIMATED ------------------------------ USEFUL LIFE 1995 1996 ----------- ----------- ----------- Laboratory equipment ....................... 3 - 7 Years $3,563,970 $ 3,302,145 Production equipment ....................... 3 - 7 Years 292,738 378,474 Furniture and fixtures ..................... 3 - 8 Years 595,887 627,989 Leasehold improvements ..................... Life of Lease 9,519,120 9,683,789 Laboratory equipment not placed in service .. - 67,200 - ----------- ----------- 14,038,915 13,992,397 Less accumulated depreciation and amortization (8,840,779) (9,388,282) ----------- ----------- $5,198,136 $ 4,604,115 =========== ===========
Subsequent to December 31, 1996, substantially all property and equipment was sold to B.U., in a transaction subject to shareholder approval. The Board of Directors has determined also to seek ratification of the sale by 48 disinterested shareholders. see Note B. Net Loss Per Common Share The net loss per common share is computed based upon the weighted average number of common shares outstanding. Preferred stock and common equivalent shares are not included in the per share calculation where the effect of their inclusion would be antidilutive. Income Taxes Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Revenue Recognition Contract revenue is recognized as earned under the contract provisions. License fees are recognized as earned. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date(s) of the financial statements and the reported amounts of revenues and expenses during the reporting period(s). Actual results could differ from those estimates. Industry Uncertainties The Company is subject to risks common to companies in the biotechnology industry including, but not limited to, the ability to raise additional capital, development by the Company or its competitors of new technological innovations, dependence on key personnel, protection of proprietary technology, and compliance with FDA government regulations. D. COLLABORATIVE ARRANGEMENTS: Eli Lilly On August 3, 1994, the Company and Lilly signed an agreement to form a global strategic alliance that gives Lilly exclusive worldwide development, distribution, and marketing rights, except in certain Asian countries, to the Company's Interleukin-2 Fusion Protein (IL-2 Fusion Protein) for the treatment of cancer. Lilly also has the option to obtain worldwide development, distribution, and marketing rights for additional indications for IL-2 Fusion Protein and for other Company products under development. The Company retains exclusive rights to promote IL-2 Fusion Protein and future fusion proteins for dermatologic applications outside of oncology and will be responsible for bulk manufacturing for all indications. On August 4, 1994, under the terms of the alliance, Lilly made an initial payment to the Company of $10 million, $5 million representing payment for 787,092 shares of common stock at approximately $6.35 per share and $5 million representing an advance against Lilly's purchase of bulk product from the Company. Lilly is also required to pay the Company an additional $3 million 49 based on the meeting of certain regulatory milestones in the development of IL-2 Fusion Protein for CTCL. No regulatory milestone payments have been achieved to date under this agreement. In addition, Lilly reimburses the Company for costs incurred in the clinical development of IL-2 Fusion Protein for cancer therapy, including costs for Phase III clinical trials. The Company recorded approximately $588,000, $3,337,000 and $3,979,000 of contract revenue for such reimbursed development costs during the years ended December 31, 1994, 1995 and 1996, respectively. In connection with this agreement, the Company paid $600,000 in cash and issued 220,000 shares of common stock valued at $1,760,000 to its investment bank for services provided in connection with the Lilly agreement. In 1995, the Company charged $300,000 of such payments to additional paid in capital and recorded the additional payments as prepaid expense to be recognized upon the recognition of contract revenues and license fees from Lilly in future periods. On May 28, 1996, Lilly and the Company amended the Sales and Distribution Agreement relating to the $5.0 million advance paid by Lilly in August 1994 against Lilly's future purchases of bulk product from the Company. Associated with the original agreement was $2,060,000 of deferred commission expense to be recognized upon the recognition of product revenue from Lilly. The amended agreement states that the $5.0 million payment is non-refundable and Seragen has no obligation to refund the advance should no bulk purchases be made by Lilly. To the extent Lilly purchases bulk product in the future, the Company is required to pay Lilly a royalty equal to 75% of the purchase price, up to $5.0 million of total royalties. The Company will recognize the $5.0 million non-refundable payment and amortize the related deferred commission upon the sale of bulk product to Lilly or at such time Lilly acknowledges it will not purchase any bulk material. The Company previously recognized the $5.0 million non-refundable payment and expensed $2.06 million of deferred commission in the quarter ended June 30, 1996 and expensed $1.2 million associated with providing the bulk product to Lilly in the quarter ended December 31, 1996. (See Note O) Novartis In March 1996, the Company entered into a license agreement with Novartis, formerly Sandoz Pharmaceutical, Limited, whereby the Company granted Novartis a non-exclusive sub-license of certain patents in exchange for a $1.5 million non-refundable payment. Under the terms of the license agreement, beginning on January 1, 2001 Novartis will be required to pay a 0.75% royalty on the net sales price of licensed products that are sold under the sub-license agreement. The agreement is to remain in effect until expiration of the Company's licensed patents, or earlier upon termination as defined. E. LOAN GUARANTEES AND SERIES B PREFERRED STOCK: On June 7, 1995, the Company finalized three separate lines of credit which were guaranteed by three different entities for a total of $23.8 million in bank financing for the Company. Boston University, the Company's majority stockholder, was the lead guarantor and provided a guaranty of $11.8 million. Two other guarantors guaranteed a total of $12 million. Upon the closing of the lines of credit, the Company issued warrants to the guarantors to purchase 2,776,664 shares of its common stock at an exercise price of $4.75 per share. The warrants were exercisable immediately and expire in 2005. The Company estimated the fair market value of the warrants on the date of issuance to be $1.50 per warrant or a total of $4,164,996. The Company recorded this amount as prepaid interest to be recognized as interest expense over the four-year life of the loan guarantees. As of December 31, 1995, the Company borrowed $12.5 million of the total 50 $23.8 million and recorded the borrowings as long-term debt. The Company borrowed the remaining $11.3 million available through June 30, 1996. On July 1, 1996, the Company restructured its arrangement with the guarantors of the Company's $23.8 million bank financing under which the guarantors directly assumed the liability with the banks and the Company was released from its liability to the banks. In exchange for the guarantors satisfying the Company's liability to the banks, the guarantors were issued 23,800 shares of Series B Convertible Preferred Stock ("Series B Shares"). Each Series B Share is convertible at any time at the holder's option into a number of shares of Seragen Common Stock determined by dividing $1,000 by the average of the closing sale prices of the Company's Common Stock as reported on the Nasdaq Stock Market for the ten consecutive trading days immediately preceding the conversion date. The holders of Series B Shares are entitled to receive a cumulative cash dividend payable quarterly in arrears on the last day of March, June, September, and December of each year commencing on September 30, 1996 at an annual rate equal to the prime rate plus 1 1/2% through June 1999 and at an increasing percentage rate thereafter up to a maximum rate of the prime rate plus 5% in July 2003. The Series B shareholders also received warrants to purchase a total of 5,950,000 shares of Seragen Common Stock at an exercise price of $4.00 per share. The Company has estimated the average fair market value of the warrants to be $1.45 per warrant or $8,617,951 for the 5,950,000 issued and outstanding warrants at the time of issuance. The value ascribed to the warrants and the issuance costs have been recorded as a preferred stock dividend with an offset to additional paid-in capital. The warrants are exercisable commencing on January 1, 1997 and expire on July 1, 2006. In addition to the warrants issued on July 1, 1996, the investors may receive additional warrants for certain dilutive events, subject to various provisions as defined. As of December 31, 1996 the investors received warrants to purchase an additional 2,217,196 shares of Seragen Common Stock related to the antidilution provisions. These additional warrants are priced, exercisable and expire under the same terms of the initial July warrants. The holders of the Series B Shares are entitled to vote, on any matter submitted to a vote of the shareholders of the Company, and are entitled to the number of votes equal to the product of (x) the number of Series B Shares held on the record date for the determination of the stockholders entitled to vote on such matters or, if no record date is established, in accordance with applicable provisions of Delaware law, and (y) $1,000, divided by $4.00. Each Series B Share has a liquidation preference equal to the sum of (a) $1,000, plus (b) an amount equal to any accrued and unpaid dividends from the date of issuance of the Series B Shares so that such amount must be paid on each Series B Share in the event of a voluntary or involuntary liquidation, dissolution or winding up of the Company before any distribution or payment is made to any holders of any shares of the Common Stock or any other class or series of the Company's capital stock which is junior to the Series B Shares. At any time, with the approval of the Company's Board of Directors, Audit Committee or comparable body, the Company may redeem any or all of the Series B Shares at a price of $1,000 per share plus any accrued and unpaid dividends from the date of issuance. In connection with the restructuring of the bank debt into Series B Preferred Stock, the Company expensed approximately $3.0 million of prepaid interest and $558,000 of debt issuance costs associated with the outstanding loans. Preferred stock dividends related to the Series B Shares were approximately $9.9 million in 1996, which consists of $8.6 million for the value ascribed to the warrants, $1.2 million in cash dividends and $99,000 in preferred stock issuance costs. Dividends payable of approximately $583,000 were outstanding at December 31, 1996 and are included in accrued expenses in the accompanying balance sheets. 51 F. TECHNOLOGY PURCHASE AND ROYALTY AGREEMENT: In 1988, B.U. sold to the Company all rights, title and interest to certain technology in exchange for a continuing royalty on all revenue derived from such technology, as defined, until the expiration of all patents relative to the technology. Upon the expiration of all patents, the Company will pay B.U. a royalty on revenues, as defined, for a period of 10 years after the expiration of all patents. B.U. has retained a collateral interest in the technology as long as royalties are due. Upon an event of default, the technology will revert to B.U. No royalty amounts were due or have been paid to date under this agreement. This technology has been assigned as collateral to the Series B Preferred Stockholders. G. INVESTMENT IN CANADIAN AFFILIATE: On November 21, 1995, the Company formed Seragen Biopharmaceuticals Ltd. ("SBL"), a privately held Canadian research and development company located in Montreal. In a private financing, a group of six Canadian investors contributed approximately $10.0 million, acquiring units representing 51% of SBL. Each unit consists of either a share of Class A or Class B Common Stock of SBL and a warrant to acquire of a share of Seragen Common Stock. The Company issued warrants to purchase 519,033 shares of Seragen Common Stock at an exercise price of $8.79 per share. The warrants become exercisable on October 1, 1997 and expire on September 30, 2005. The Canadian investors have the option to exercise one of three different put rights related to their SBL shares after January 1, 1999, or earlier upon the occurence of certain events as defined. The Company is currently in default of its obligation to register certain shares underlying certain put rights of SBL. Put Right 1 obligates the Company to purchase the investors' 1,557,097 shares at $8.57 (Canadian $) plus 11.4% compounded annually. The Company has the option to settle in cash or common stock but the investor can require 50% of the purchase price to be paid in cash. Put Right 2 obligates the Company to purchase the investors' shares at a price of 20 times SBL's per share income over the four most recent quarters. Put Right 3 obligates the Company to exchange the investors' shares for the Company's shares (or the value of such shares) using the product of $8.57 (Canadian $) and the number of puts exercised divided by 9.487. The Company has the option to settle Put Rights 2 and 3 in cash or Seragen common stock. The put rights will terminate if SBL sells shares in an initial public offering. The Company received 49% of SBL's Class A and Class B shares in exchange for the warrants to purchase Seragen Common Stock, granting of the put rights and granting SBL the exclusive right to promote, sell and distribute in Canada pharmaceutical formulations comprising fusion proteins for all indications of fusion proteins and for the treatment of HIV in certain countries (subject to the rights granted to Lilly). SBL, with the Company's assistance, will conduct research and development and clinical trials of the Company's proprietary fusion protein products in Canada. In 1995, the Company determined the fair market value of the warrants and the put rights to be $914,000 and $2,076,000, respectively. The Company recorded these amounts as an investment in affiliate under the equity method. Loss incurred in connection with Canadian affiliate consists of the Company's proportionate share of SBL's loss, based on the equity method and accretion of its obligation under the put rights. At December 31, 1996, the Company reduced its investment to zero and reflected an affiliate put option liability of $2,400,000 which reflects the Company's maximum current obligation under the put options as of December 31, 1996. The put option obligation liability less the net assets of the Canadian affliate available to satisfy such liability if the put option were exercised. 52 Summarized unaudited financial information for Seragen Biopharmaceuticals Ltd. for 1996 as follows:
BALANCE SHEET DATA AS OF STATEMENT OF OPERATIONS DATA ------------------------ ---------------------------- DECEMBER 31, 1996 FOR THE YEAR ENDED DECEMBER 31,1996 ----------------- ------------------------------------ (Unaudited) (Unaudited) Current assets $9,231,018 Investment income $419,111 Noncurrent assets 10,410 Operating expenses 440,338 Current liabilities 14,743 Net loss (21,227) Stockholders' Equity 9,226,685
H. INCOME TAXES: As of December 31, 1996, the Company had net operating loss carryforwards for federal income tax purposes of approximately $176 million expiring at various dates from 1997 through 2011 which are available to reduce future federal income taxes. Pursuant to a quasi-reorganization in 1985, approximately $11 million of these loss carryforwards will be credited to additional paid-in capital if realized. (Upon consummation of this quasi-reorganization, approximately $14 million of accumulated deficit was charged to additional paid-in capital.) In addition, the Company had research and experimental and investment tax credit carryforwards of approximately $5 million. The tax credits expire at various dates from 1997 through 2011. The Tax Reform Act of 1986 contains provisions which may limit the net operating loss and credit carryforwards available to be used in any given year as the result of significant changes in equity ownership. The net operating loss carryforwards and tax credits expire approximately as follows:
NET OPERATING RESEARCH INVESTMENT TAX LOSS TAX CREDIT CREDIT EXPIRATION DATE CARRYFORWARDS CARRYFORWARDS CARRYFORWARDS - - --------------- ------------- ------------- --------------- 1997 1,765,000 109,000 4,000 1998 2,504,000 168,000 7,000 1999 3,548,000 216,000 19,000 2000 2,224,000 - 15,000 2001 223,000 - - 2002 - 2011 165,408,000 4,419,000 - ------------ ---------- ------- $175,672,000 $4,912,000 $45,000 ------------ ---------- -------
The components of the Company's deferred tax assets are as follows: December 31, ---------------------------- 1995 1996 ---------- ----------
Net Operating loss carryforwards $ 62,631,000 $ 69,694,000 Research and development credits 4,625,000 4,912,000 Investment tax credits 49,000 45,000 Temporary differences 266,000 1,727,000 ------------ ------------ 67,571,000 76,378,000 Valuation allowance (67,571,000) (76,378,000) ------------ ------------ $ - $ - ============ ============ 53
The valuation allowance has been provided due to the uncertainty surrounding the realization of the deferred tax assets. I. SHORT-TERM OBLIGATIONS: Equipment Loan On February 19, 1993, the Company obtained an equipment loan of $750,000 collateralized by certain existing used equipment. The Company also issued a warrant to purchase 10,757 shares of common stock at a purchase price of $12.55 per share in connection with this equipment loan. The warrant expires on February 19, 2000. The loan bears interest at 10.68% per annum. Amounts outstanding under this loan were approximately $248,000 and $37,000 as of December 31, 1995 and 1996, respectively. License Fees In December 1994, the Company entered into a license agreement with Ajinomoto Company, Inc. which provides the Company with exclusive worldwide rights with respect to the Company's fusion proteins under Ajinomoto's IL-2 gene patents. As a result of this agreement, the Company has acquired the right to market IL-2 Fusion Protein products in Japan, Korea, China, Hong Kong and Taiwan. The Company has made an up-front payment of $100,000 under this agreement and is required to make a payment of $4.3 million by May 31, 1997. The future obligation has been discounted at a 20% discount rate, resulting in an obligation of $3.4 million and $4.1 million at December 31, 1995 and 1996, respectively. The present value of this license fee was recorded as research and development expense in the year ended December 31, 1994. J. CAPITAL STOCK: In December 1996, the stockholders approved an increase in the number of authorized shares of common stock to 70,000,000. The Company has 5,000,000 shares of preferred stock authorized to be issued from time to time in one or more series. Each series of preferred stock shall have such number of shares, designations, preferences, voting powers, qualifications and special or relative rights or privileges as shall be determined by the Board of Directors, which may include, among others, dividend rights, voting rights, redemption and sinking fund provisions, liquidation preferences, conversion rights and preemptive rights. On September 30, 1996, the Company raised $5 million through the sale of 5,000 shares of the Company's non-voting convertible Series C Preferred Stock ("Series C Shares") in a private placement to Boston University under Regulation D of the Securities Act of 1933. The Series C Shares are convertible at the option of the holder into shares of Seragen Common Stock at a per share conversion price equal to the lesser of $2.75 or 73 percent of the average closing bid prices for a five day period prior to the conversion date. Terms of the Series C Shares also provide for 8% cumulative dividends payable in shares of Seragen Common Stock at the time of each conversion. Each Series C Share has a liquidation preference equal to $1,000 plus an amount equal to any accrued and unpaid dividends from the date of issuance of the Series C Shares in the event of a voluntary or involuntary liquidation, dissolution or 54 winding up of the Company. Series C Shares which remain outstanding on March 30, 1998 will be automatically converted into shares of the Company's Common Stock. The Company's Series C Shares were reflected at $5,100,000 (including $100,000 dividend payable) at December 31, 1996. In July 1996, the Company issued 23,800 shares of Seragen convertible Series B Preferred Stock pursuant to the conversion of the loan guarantees (see Note E). On May 29, 1996, the Company raised gross proceeds of $4 million (approximately $3.8 million net of offering fees) through the sale of 4,000 shares of Seragen convertible Series A Preferred Stock ("Series A Shares") to investors outside the United States under Regulation S of the Securities Act of 1993. The Series A Shares are convertible at the option of the holders, beginning July 15, 1996, into shares of Seragen Common Stock at a per share conversion price equal to the lesser of $4.125 or 73 percent of the average closing bid prices for a five day period prior to the conversion date up to a maximum of 3,321,563 shares of Seragen Common Stock. Any shares the investor is unable to convert due to this limitation may be exchanged for $1,150 per share in cash. Terms of the Series A Shares also provide for 8% cumulative dividends payable in shares of Seragen Common Stock at the time of each conversion. The holders of the Series A Shares are not entitled to vote separately, as a series or otherwise, on any matter submitted to a vote of the shareholders of the Company. Each Series A Share has a liquidation preference equal to the sum of (a) $1,000, plus (b) an amount equal to any accrued and unpaid dividends from the date of issuance of the Series A Shares so that such amount must be paid on each Series A Share in the event of a voluntary or involuntary liquidation, dissolution or winding up of the Company before any distribution or payment is made to any holders of any shares of the Common Stock or any other class or series of the Company's capital stock which is junior to the Series A Shares. Any shares which remain outstanding on November 29, 1997 will be automatically converted into shares of Seragen Common Stock. As of December 31, 1996, 895 Series A Shares were converted into 566,400 shares of Common Stock at conversion prices ranging from $1.022 to $2.774 per share. The Series A Shares were reflected at $2,015,522 at December 31,1996 representing their liquidation value which includes accrued dividends payable from the issuance date through December 31, 1996. At December 31, 1996, $1,236,753 was reclassified to a current liability representing the 1,361,313 shares of common stock that would be required to be redeemed due to the conversion cap limitation as of December 31, 1996. In June 1995, the Company issued 220,000 shares of common stock at $8.00 per share in payment of commissions incurred in connection with the formation of the alliance with Lilly. In August 1994, under the terms of the alliance with Lilly, the Company received $5 million representing payment for 787,092 shares of common stock at approximately $6.35 per share. In February 1994, the Company completed a private placement of units consisting of 1,127,004 shares of common stock at $6.00 per share and warrants to purchase an additional 281,751 shares of common stock at an exercise price of $10 per share which were immediately exercisable and expire on February 4, 1999. The net proceeds of this private placement were approximately $6.5 million. K. STOCK OPTIONS AND WARRANTS: Employee Stock Option Plans 55 The Company's stock option plans allow for the grant of incentive stock options at prices not less than fair value on the date of grant, as determined by the Board of Directors, and nonqualified stock options at prices determined by the Board of Directors. The Company granted options under the 1981 Stock Option Plan until the plan termination in 1991. Accordingly, no additional grants may be made under this plan; however, options outstanding may still be exercised prior to their expiration date. The options generally vest ratably over 4 years and expire 10 years from date of issuance. The Company's 1992 Long Term Incentive Plan (the "1992 Plan") provides for the grant of incentive stock options, nonstatutory options, stock appreciation rights, restricted stock, deferred stock and other stock based awards. Officers, employees and consultants are eligible to receive awards under this plan; however, only officers and employees of the Company are eligible to receive incentive stock options. Incentive stock options will not be granted at less than fair market value or exercisable later than ten years from the date of the grant. Nonstatutory options will be exercisable at the price established by the Board of Directors or a committee thereof. Common shares in the amount of 2,300,000 were reserved for issuance pursuant to this plan in January 1992. In December 1996, the Board of Directors approved an amendment to the Company's 1992 Plan increasing the number of shares available under the plan from 2,300,000 to 8,000,000. The Company is seeking shareholder approval at its 1997 Annual Meeting of Shareholders for such amendment. All incentive stock options issued to date pursuant to this plan vest over a three to five-year period. Non-Employee Directors Non-Qualified Stock Option Plan The Company's 1992 Non-Employee Directors Non-Qualified Stock Option Plan provides for the granting of nonstatutory stock options at fair market value to Directors of the Company who are not officers or employees of the Company or Trustees of B.U. There are 200,000 common shares reserved for issuance pursuant to this plan. Commencing with the first date on which elected to serve as a director of the Company or on February 5, 1992, whichever is later, each eligible Director shall be granted an option to purchase 5,000 shares of Common Stock at the fair market value of the Common Stock on the date the option is granted, provided, however, that for any eligible Director who has previously been awarded options to purchase stock in connection with his service as a director of the Company, the grant shall be reduced by the number of shares underlying the previous grants. At the commencement of each subsequent twelve month period in which the Director is elected to continue in office, an additional option to purchase 1,000 shares at fair market value shall be granted. The options acquired under the plan shall be exercisable upon completion of a full term of office as a member of the Board of Directors after the grant and if for any reason the term is not completed, or if the Director has failed to attend at least seventy-five percent (75%) of the regularly called meetings of the Board of Directors during such term, the option will be forfeited. Employee Stock Purchase Plan The Company's Employee Stock Purchase Plan (the "Purchase Plan") allows employees to purchase the Company's common stock, and 200,000 common shares were reserved for issuance pursuant to this plan. All employees of the Company who have been employed for at least three months by the Company are eligible to participate in this plan. Shares are 56 purchased through the accumulation of payroll deductions of 1% to 10% of each participant's compensation (up to a maximum of $25,000 per year). The purchase price of the shares is 85% of the fair market value of the stock at certain predetermined dates, as defined. The Company issued 34,432, 29,864, and 42,855 shares under the Purchase Plan in the years ended December 31, 1994, 1995 and 1996, respectively. In February 1997, the Board of Directors voted to terminate the Purchase Plan. A summary of the status of the Company's stock options as of December 31, 1994, 1995 and 1996 and changes during the year ended on those dates is presented below:
1994 1995 1996 ------------------- ------------------- -------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE --------- -------- --------- -------- --------- -------- Outstanding at beginning of year.... 1,637,570 $10.02 1,954,330 $9.12 1,773,440 $8.36 Granted........................... 452,432 6.25 283,264 5.57 5,728,529 1.37 Exercised......................... (43,189) 1.50 (117,014) 0.98 (111,825) 0.72 Canceled.......................... (92,483) 13.38 (347,140) 12.46 (587,178) 9.79 --------- --------- - --------- Outstanding at end of year.......... 1,954,330 9.12 1,773,440 8.36 6,803,029 2.60 ========= ========= ========= Options exercisable at year-end..... 1,130,500 1,072,887 1,283,802 ========= ========= ========= Options available for future grant.. 901,759 904,349 1,416,006 ========= ========= =========
The Company applies APB Opinion No. 25 and related interpretations in accounting for its stock option and purchase plans. In October 1995, Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") was issued and requires the Company to elect either expense recognition or disclosure-only alternative for stock-based employee compensation. The expense recognition provision encouraged by SFAS No. 123 would require fair-value based financial accounting to recognize compensation expense for the employee stock compensation plans. The Company has determined that it will elect the disclosure-only alternative. The Company has computed the pro forma disclosures required under SFAS No. 123 for all stock options granted and stock issued pursuant to the employee stock purchase plan as of December 31, 1996 using the Black Scholes option pricing model prescribed by SFAS No. 123. The assumptions used and the weighted average information for the years ended December 31, 1995 and 1996 are as follows: The assumptions used and the weighted average information for the years ended December 31, 1995 and 1996 are as follows:
DECEMBER 31, 1995 DECEMBER31, 1996 ----------------- ----------------- Risk-free interest rates............... 6.01% - 7.47% 5.52% -6.73% Expected dividend yield................ - - 57 Expected lives......................... 7.5 years 7.5years Expected volatility.................... 96% 96% Weighted-average grant-date fair value options granted during the period........................... $5.57 $1.37 Weighted-average exercise price........ Weighted-average remaining contractual $8.36 $2.60 life of options oustanding........... 6.20 years 9.25years Weighted-average exercise price of 1,072,987 and 1,283,802 options exercisable at December 31, 1995 and 1996, respectively............... $8.16 $7.37 The effect of applying SFAS No. 123 would be as follows: DECEMBER 31, 1995 DECEMBER 31, 1996 ----------------- ----------------- Pro forma net loss applicable to common stockholders..... $(21,311,315) $(35,932,478) Pro forma net loss per common share...................... $ (1.30) $ (2.15)
The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions including expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. The total fair value of the options granted and stock issued under the employee stock purchase plan during 1995 and 1996 was computed as approximately $1,235,000 and $6,795,000, respectively. Of these amounts approximately $210,000 and $951,000 would be charged to operations for the years ended December 31, 1995 and 1996, respectively. The remaining amount, approximately $6,230,000 would be amortized over the remaining vesting periods. The resulting pro forma compensation expense may not be representative of the amount to be expected in future years as pro forma compensation expense may vary based upon the number of options granted. The pro forma net loss applicable to common stockholders and pro forma net loss per common share presented above have been computed assuming no tax benefit. The effect of a tax benefit has not been considered since a substantial portion of the stock options granted are incentive stock options and the Company does not anticipate a future deduction associated with the exercise of these stock options. 58 Warrants As of December 31, 1996, the following warrants were outstanding:
WARRANTS OUTSTANDING EXERCISE PRICE EXPIRATION DATE -------------------- -------------- --------------- Equipment Loan 10,757 $12.55 Feb. 2, 2000 Private Placement 281,751 10.00 Feb. 4, 1999 Loan Guarantee 2,776,664 4.75 Jun. 7, 2005 Canadian Affiliate 519,033 8.79 Sep. 30, 2005 Series B Preferred Stock 8,167,196 4.00 Jul. 1, 2006
L. COMMITMENTS AND CONTINGENCIES: Lease Commitments The Company has a renewable 10-year lease for its primary operating facility which expires in August 2002. Rent includes the Company's proportionate share of all real estate taxes and operating costs related to the facility. The Company leases certain other facilities and equipment under leases with varying terms and containing renewal options and escalation clauses related to increases in certain operating costs of the lessor. The rental expense for all operating leases was approximately $1,014,000, $1,281,000 and $1,420,000 for the years ended December 31, 1994, 1995 and 1996, respectively. Approximate future minimum lease payments at December 31, 1996 are as follows:
OPERATING LEASES 1997 ..................................................... 1,372,000 1998 ...................................................... 1,064,000 1999 ...................................................... 870,000 2000 ...................................................... 776,000 2001 ...................................................... 776,000 Thereafter ................................................ 5,891,000 Total minimum lease payments .............................. $5,891,000 ==========
Substantially all of the Company's operating leases and commitments were assumed by B.U. in connection with the sale of substantially all of the Company's assets to B.U. (see Note B). Royalty Arrangements The Company has various royalty arrangements with third parties which expire beginning in 1998 and ending in 2014. The Company's obligated to pay royalties ranging from .5% to 5% of net sales. To date, the Company has recognized no royalties under these arrangements. 59 Employment Contracts The Company has entered into employment contracts with key employees that provide for minimum salary and severance payments as defined. Employee Benefits The Company has a 401(k) savings plan in which substantially all of its permanent employees are eligible to participate. Participants may contribute up to 15% of their annual compensation to the plan, subject to certain limitations. Although the Company may make matching contributions, there were no such contributions to the plan in 1994, 1995 and 1996. M. RELATED PARTIES Consulting Contracts The Company incurred consulting fees to stockholders and directors of approximately $126,000, $155,000 and $169,000 for the years ended December 31, 1994, 1995 and 1996, respectively. The Company also incurred expenses relating to research grants to, and clinical trials performed at, the institution employing a stockholder and a director of approximately $219,000, $185,000 and $175,000 for the years ended December 31, 1994, 1995 and 1996, respectively. The Company also recorded $63,000 of grant revenue on an NIH grant relating to a subcontract from this institution in 1996. The full amount is paid as of December 31, 1996. The Company incurred consulting fees to other option holders of approximately $36,000, $18,000 and $12,000 for the years ended December 31, 1994, 1995 and 1996, respectively. The Company also incurred expenses relating to research grants to the institution employing one of the option holders of approximately $150,000 for each of the years ended December 31, 1994 and 1995, respectively. N. ACCRUED EXPENSES: Accrued expenses consist of the following:
DECEMBER 31, -------------------------- 1995 1996 --------- --------- Clinical and research .................. $ 845,426 $1,158,421 Professional service fees .............. 131,632 219,062 Payroll, vacation and benefits ......... 736,965 632,778 Other expenses ......................... 699,261 583,911 Dividends .............................. -- 583,295 ---------- ---------- $2,413,284 $3,177,467 ========== ==========
O. Restatement of December 31, 1996 Financial Statements In September of 1997, the Company restated its 1996 financial statements to reflect a change in the accounting treatment for the Company's amended Sales and Distribution Agreement with Lilly on May 28, 1996. The restatement consists of (1)recording the $5.0 million payment by Lilly in 1994 as an advance against future purchases of bulk product by Lilly (the Company had previously recorded such amount as revenue in the quarter ended June 30, 60 1996), (2) capitalizing as a deferred expense $2,060,000 of commissions paid by the Company in connection with the $5.0 million payment from Lilly in 1994, and (3) reversing $1.2 million expense accrual associated with providing the bulk material to Lilly (previously recorded by the Company in the fourth quarter of 1996). (See Notes D and O). The following table presents the net loss, the net loss applicable to common stockholders, and the net loss per share as originally reported, and as restated. For the YearEnded December 31,1996 ------------------ As reported As restated ----------- -----------
Net loss $(24,586,560) $(26,326,560) Net loss applicable to common stockholders (34,981,478) (36,721,478) Net loss per share $(2.09) $(2.20)
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES On March 12, 1997, the Board of Directors of the Company at the recommendation of the Company's Audit Committee voted to replace Coopers & Lybrand L.L.P. with Arthur Andersen LLP as the Company's independent accountants effective March 12, 1997. Coopers & Lybrand L.L.P.'s reports for the last two fiscal years contained no adverse opinions, disclaimers, or qualifications or modifications as to uncertainty, audit scope or accounting principles, except that the report on the 1995 financial statements included an explanatory paragraph concerning factors which raise substantial doubt about the Company's ability to continue as a going concern. During such two fiscal year period and the subsequent interim period since then, there have been no disagreements with Coopers & Lybrand L.L.P. on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure which, if not resolved to the satisfaction of Coopers & Lybrand L.L.P., would have caused it to make reference to the subject matter of disagreement in connection with its reports. 61 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following identifies the Company's current directors, each of the eight persons who has been nominated by the Board of Directors for election as a Director of the Company, and the Company's executive officers. All ages indicated are as of March 28, 1997.
NAME AGE POSITIONS WITH THE COMPANY - ---- --- -------------------------- Reed R. Prior ................ 46 Chairman of the Board of Directors, Chief Executive Officer and Director John E. Bagalay............... 63 Director Gerald S. J. Cassidy ......... 56 Director Elizabeth Chen ............... 33 Vice President of Business Development Kenneth G. Condon ............ 49 Director Norman A. Jacobs ............. 59 Director John R. Murphy, Ph.D.......... 55 Director Jean C. Nichols, Ph.D. ........ 46 President, Chief Technology Officer and Director John R. Silber, Ph.D. ......... 70 Director
Each director holds office until the next annual meeting of shareholders and until his or her successor is duly elected and qualified, or until his or her earlier resignation or removal. The Company's by-laws authorize the Board of Directors from time to time to determine the number of its members. The Company's officers are elected annually by the Board of Directors at a meeting held immediately following each annual meeting of shareholders or as soon thereafter as necessary and convenient in order to fill vacancies or newly created offices. Each officer holds office until his or her successor is duly elected and qualified, or until his or her earlier death, resignation, or removal. The Board of Directors may remove any officer elected or appointed by the Board whenever in its judgement the best interests of the Company will be served, but removal of an executive officer is to be without prejudice to any contractual rights of the person so removed. There are no family relationships among any of the Company's directors and executive officers. There are no arrangements or understandings between any director or executive officer and any other person pursuant to which that director or executive officer was or is to be selected. Reed R. Prior -- Mr. Prior was elected Chairman of the Board of Directors and a member of the Executive Committee of the Company and Chief Executive Officer and Treasurer in November 1996. Prior to joining the Company, Mr. Prior served as President and Chief Executive Officer of ActiMed Laboratories, 62 a privately-held medical diagnostics company. From 1992 to 1995, he was President and Chief Executive Officer of Receptor Laboratories, Inc., a start-up biopharmaceutical firm which was sold to Cytel Corporation in July 1995. From 1990 to 1991, Mr. Prior served as President and Chief Executive Officer of Genex Corporation, which merged with Enzon, Inc. in October 1991. From 1986 to 1990, Mr. Prior was President and Chief Executive Officer of i-Stat Corporation, a development stage medical diagnostics company. Mr. Prior earned a B.S. in biophysics from Lyman Briggs College, a residential science and mathematics college within Michigan State University, and received an M.B.A. from Harvard Business School. John E. Bagalay, Jr., Ph.D., Esq. -- Dr. Bagalay has served as a member of the Board of Directors of the Company since March 1991. Dr. Bagalay has been Managing Director of Community Technology Fund, the venture capital fund of Boston University, since 1989. From 1984 to 1988, Dr. Bagalay served as General Counsel of Lower Colorado River Authority, a regulated electric utility in Austin, Texas. Prior to that time, he was General Counsel of Houston First Financial Group and General Counsel of Texas Commerce Bancshares, Inc. He is a director of Cytogen Corp., a director and member of the Compensation Committee of Wave Systems Corp. and of Hymedix, Inc., and a director of several privately held companies. Gerald S.J. Cassidy -- Mr. Cassidy has served as a member of the Board of Directors of the Company since December 1987. Mr. Cassidy is the founder and Chairman, since 1975, of The Cassidy Companies, Inc., a holding company specializing in corporate public affairs services. Prior to the establishment of The Cassidy Companies, he worked as a Trial Attorney in the South Florida Migrant Legal Services Program, as Executive Director and General Counsel of the Democratic National Committee's 1973 Reform Commission, and on two separate occasions, from 1969 to 1973 and from 1974 to 1975, as General Counsel of the U.S. Senate's Select Committee on Nutrition and Human Needs. He has been a featured speaker on legislative issues at numerous governmental, university, industry, and trade association conferences. He is a member of the Board of Trustees of Tougaloo College, the Steering Committee of the Capital Campaign for Villanova University, the Board of Overseers for the School of Nutrition at Tufts University, the Board of Trustees of Fontbonne College, the Board of Directors of the Children's Inn at the National Institute of Health, and a member of the Board of Trustees of the Washington Theological Union. Mr. Cassidy holds a B.S. from Villanova University and a J.D. from the Cornell University School of Law. In 1995 he received an Honorary Doctor of Social Science Degree from Villanova University. Elizabeth C. Chen -- Ms. Chen joined the Company in January 1997 as Vice President of Business Development. Prior to joining the Company, Ms. Chen had been Vice President - General Manager of ActiMed Laboratories, Inc., a privately-held medical technology company. From 1992 - 1996, Ms. Chen was an independent consultant to a number of venture capital funds and a variety of start-up biotech companies. From 1985 - 1992, Ms. Chen held a number of positions in business development and marketing planning at Merck & Company, Inc., Migliara/Kaplan and T. Rowe Price. Ms. Chen holds a B.A. in Organizational Behavior from Yale and an M.B.A. from The Wharton School of the University of Pennsylvania. Kenneth G. Condon, C.P.A. -- Mr. Condon has served as a member of the Board of Directors of the Company since January 1992. Mr. Condon has also served as Boston University's Treasurer since 1992 and its Vice President for Financial Affairs since 1986. Prior to his serving in such capacity, Mr. Condon served as Associate Vice President for Financial and Business Affairs, Comptroller, Acting Comptroller and Manager of Unrestricted Funds of Boston University. Mr. Condon is Chairman of the Board and Director of Bayfunds, Inc. 63 and a member of several advisory boards of BayBanks, Inc. Mr. Condon also serves as Treasurer and as a Director of the Financial Executives Institute of Massachusetts, and as a member of the Board of Trustees of Newbury College. Mr. Condon is a Certified Public Accountant and holds a B.S. in Economics and Mathematics from Tufts University and an M.B.A. in Finance from the Wharton School of Finance. Norman A. Jacobs -- Mr. Jacobs has served as a member of the Board of Directors of the Company since 1990. Mr. Jacobs has served as President of Becton Dickinson Transdermal Systems, a unit of Becton Dickinson and Company, since September 1990. From January 1990 to September 1990, Mr. Jacobs acted as a consultant to biotechnology companies, including Seragen. From 1986 through 1989, Mr. Jacobs was President of BioTechnica International, a genetic engineering research company. Mr. Jacobs was one of the founders, in 1962, of Amicon Corporation, which is a manufacturer of laboratory separation systems and adhesives and polymer specialty materials. He served as President of Amicon from 1971 through 1983, and as President of the Amicon Division of W.R. Grace from 1983 to 1985. He earned an M.B.A. from Harvard Business School, an M.S. in Chemical Engineering from M.I.T., and a B.E. in Chemical Engineering from Yale. John R. Murphy, Ph.D. -- Dr. Murphy has served as a member of the Board of Directors of the Company since 1985. Since 1984, he has held various positions at the Boston University School of Medicine and is currently Professor of Medicine, Biochemistry and Microbiology at the Boston University School of Medicine, and Chief of Biomolecular Medicine at the Boston University Medical Center/University Hospital. From 1973 to 1984, he was an Assistant and Associate Professor of Microbiology and Molecular Genetics at Harvard University. Dr. Murphy holds a Bachelor of Arts degree in Zoology and a Masters degree in Microbiology from the University of Connecticut and a Doctorate degree from the University of Connecticut School of Medicine. Dr. Murphy completed his postdoctoral training at Harvard University as a Research Fellow of Biology. Jean C. Nichols, Ph.D. -- Dr. Nichols was elected President and Chief Technology Officer and a member of the Board of Directors of the Company in November 1996. From 1992 to 1996, she served as Senior Vice President, and from 1987 to August 1992, as Vice President of Development for the Company. From 1984 to 1987, Dr. Nichols was Director of Research and Development, and from 1983 to 1984, served as the Company's scientific liaison. Dr. Nichols received a B.S. in Biology and a Ph.D. in Bacteriology and Immunology from the University of North Carolina. Upon completion of her studies, Dr. Nichols was a Research Fellow at the Harvard Medical School. Before joining the Company, she held the position of Instructor in the Department of Microbiology and Molecular Genetics at the Harvard Medical School. John R. Silber, Ph.D. -- Dr. Silber has served as a member of The Board of Directors of the Company since August 1987. He is the Chancellor of Boston University and has been a member of its Board of Trustees since 1971. Dr. Silber received a B.A. from Trinity University and an M.A. and Ph.D. in philosophy from Yale University. Dr. Silber is Chairman of the Massachusetts State Board of Education, a Trustee of the WGBH Educational Foundation, Vice President of the United States Strategic Institute in Washington, D.C., and a director of U.S. Surgical Corporation. Dr. Silber is also Chairman of Americans for Medical Progress. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors and executive officers, and persons who own more than 10% 64 of the Company's Common Stock to file with the Securities and Exchange Commission (the "SEC") initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of the Company. Officers, directors and greater than 10% beneficial owners are required by SEC regulations to furnish the Company with copies of all Section 16(a) reports they file. To the Company's knowledge, based solely on review of the copies of such reports furnished to the Company and written representations that no other reports were required, there was compliance during the fiscal year ended December 31, 1996 with all Section 16(a) filing requirements applicable to its officers, directors and greater than 10% beneficial owners. ITEM 11. EXECUTIVE COMPENSATION Summary of Executive Compensation The following table summarizes the compensation for services rendered in all capacities to the Company during the fiscal years ended December 31, 1996, 1995, and 1994, of the chief executive officer of the Company and each of the four most highly compensated persons who served as executive officers of the Company during the last fiscal year (the "Named Executive Officers"). SUMMARY COMPENSATION TABLE SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION(1) ---------------------- OTHER LONG-TERM NAME AND ANNUAL COMPENSATION PRINCIPAL POSITION YEAR SALARY($) BONUS($) COMPENSATION SECURITIES - ------------------ ---- --------- -------- ------------ UNDERLYING OPTIONS # --------- Reed R. Prior 1996 $ 55,417(2) $100,000(3) $17,845(4) 4,885,747 Chairman, Chief Executive Officer and Treasurer George W. Masters(5) 1996 237,812(6) 30,000(7) 41,130(8) 50,000 Vice Chairman, Chief Executive 1995 300,000 - 42,248(9) 40,000 Officer and President 1994 275,000(10) 70,000(11) 44,716(12) 40,000 Jean C. Nichols, Ph.D. 1996 195,542(13) - - 692,752(14) President and Chief 1995 190,000 - - 18,000(15) Technology Officer 1994 175,000 38,500(11) - 17,500(15) Leonard F. Estis, Ph.D.(16) 1996 146,667 - - 9,328 Vice President for Research & 1995 160,000 - - 15,000 Development 1994 152,000 30,000(11) - 17,500 Thomas N. Konatich(17) 1996 138,125(18) - 21,372(19) 10,348 Vice President for Finance, 1995 145,000 - - 12,000 Chief Financial Officer 1994 130,000 26,000(11) - 15,000
65 (1) Portions of Annual Compensation have been deferred under the Company's Employee Savings Plan. These amounts are included in calculation of "Salary" and "Bonus" as reflected in the table. (2) In fiscal year 1996, Mr. Prior was paid $55,417 base salary for his partial year of service to the Company. His annual base salary was $350,000. (3) In fiscal year 1996, Mr. Prior was paid a $100,000 signing bonus. (4) Amount includes payment of a housing allowance of $17,845. (5) Mr. Masters served as Vice Chairman, Chief Executive Officer and President through November 5, 1996. Pursuant to the terms of his Retirement and Consulting Contract, he remained a consultant to the Company through February 28, 1997. (6) Mr. Masters was paid $237,812 for his partial year of service to the Company. His annual base salary was $300,000. Included in Mr. Masters' salary is $25,000 for consulting fees rendered to the Company in 1996 pursuant to Mr. Masters' Retirement and Consulting Agreement. (7) Pursuant to Mr. Masters' Retirement and Consulting Agreement, bonus payment for services rendered to the Company in fiscal 1996 were paid in fiscal year 1997. (8) Amount includes payment of a housing allowance of $21,130 and accrued vacation payment of $20,000. (9) Amount includes payment of a housing allowance of $35,248. (10) In fiscal year 1994, Mr. Masters was paid $275,000, which represents three months at $200,000 base salary, and nine months at $300,000 base salary. (11) Bonus payments for services rendered to the Company in fiscal year 1994 were paid in fiscal year 1995. (12) Amount includes payment of a housing allowance of $44,716. (13) In fiscal year 1996, Dr. Nichols was paid $195,542, which represents $190,000 base salary through November 5, 1996, and $225,000 base salary from November 6, 1996 through December 31, 1996. (14) Represents an option granted on December 18, 1996 comprised of (i) 514,164 shares and (ii) 164,409 shares which were granted upon cancellation of options for an equal number of shares. Also includes an option for 14,179 shares which was canceled on December 18, 1996. See "Aggregated Fiscal Year-end Option Values" table and "Ten-Year Option Repricings" table. (15) Represents options which were canceled as of December 18, 1996, and reissued at a lower price, such options are included in fiscal year 1996. See "Aggregated Fiscal Year-end Option Values" table and "Ten-Year Option Repricings" table. (16) Dr. Estis served as Vice President of Research and Development through November 29, 1996. (17) Mr. Konatich served as Vice President for Finance and Chief Financial Officer through November 15, 1996. 66 (18) In fiscal year 1996, Mr. Konatich was paid $138,125, which represents six months at $145,000 base salary, and four and one-half months at $175,000 base salary. (19) Amount includes payment of accrued vacation of $21,372. Option Grants The following table sets out the material terms of each grant of a stock option to a Named Executive Officer during the last fiscal year, including the number of options granted, the exercise price and the expiration date of each option, as well as the percent that the grant represents of total options granted to employees during the fiscal year. In addition, in accordance with SEC rules, the table discloses hypothetical gains that would exist for the respective options. These gains are based on assumed rates of annual compound stock price appreciation of 5% and 10% from the date the options were granted over the full option term. Actual gains, if any, on stock option exercises and Common Stock holdings are dependent on the future performance of the Common Stock and overall market conditions. OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS POTENTIAL REALIZED VALUE ------------------------- AT ASSUMED ANNUAL RATE % OF TOTAL OF STOCK PRICE NO. OF SECURITIES OPTIONS APPRECIATION FOR OPTION UNDERLYING GRANTED TO EXERCISE TERM OPTIONS EMPLOYEES IN PRICE EXPIRATION ---- NAME GRANTED(#)(1) FISCAL YEAR ($/SH) DATE 5%($) 10%($) - ---- ------------- ----------- ------ ---- ----- ------ Reed R. Prior 4,885,747 85.4% $1.31 12/18/06 4,034,350 10,223,835 George W. Masters(2) 50,000 0.9% $5.00 12/05/06 -- -- Jean C. Nichols, Ph.D. 14,179(3) 0.2% $4.25 04/26/06 37,897 96,040 678,573(4) 11.9% $1.31 02/18/06 560,324 1,419,970 Leonard F. Estis, Ph.D.(5) 9,328 0.2% $4.25 04/26/06 24,932 63,182 Thomas N. Konatich(6) 10,348 0.2% $4.25 04/26/06 27,658 70,091
(1) All options were granted under the Company's Amended 1992 Long Term Incentive Plan ("1992 Plan") and were based on the fair market value of the Company's Common Stock on the date of grant except in the case of the option granted to George Masters. All options vest either monthly or quarterly over a three to five year period. Under the terms of the 1992 Plan, upon a change in control or a potential change in control (each as defined in the 1992 Plan), the vesting of all options listed above will be accelerated such that the options will be fully vested and, unless otherwise determined by the committee administering the plan, those options will be cashed out. In the event of a merger or consolidation, the options terminate unless they are assumed by the merged or consolidated corporation or that corporation issues substitute options; however, if that corporation does not assume the options or issue substitute options, the options immediately vest in full. Additionally, under the 1992 Plan, optionees may settle any tax withholding obligations with the Company's Common Stock. The Committee that administers the 1992 Plan has authority: to substitute new options for previously granted options (including previously granted options having higher option exercise prices); to accelerate the vesting of options upon the occurrence of the optionee's termination due to death, disability or retirement; and generally to amend the terms of any option, including the exercise price (so long as the optionee consents to any amendment that impairs his or her rights). (2) Mr. Masters terminated employment with the Company on November 6, 1996. (3) Represents options which were canceled as of December 18, 1996 and reissued at a lower price. See "Summary Compensation Table" and "Ten-Year Option Repricings". (4) Represents an option granted on December 18, 1996 comprised of (i) 514,164 shares and (ii) 164,409 shares which were granted upon cancelation of options for an equal number of shares. See "Summary Compensation Table" table and "Ten-Year Option Repricings". (5) Dr. Estis terminated employment with the Company on November 29, 1996. (6) Mr. Konatich terminated employment with the Company on November 15, 1996. Fiscal Year-End Option Values The following table sets forth the number of shares covered by both exercisable and unexercisable stock options as of December 31, 1996, and the value of the "in-the-money" options, which represent the positive spread between the exercise price of any such existing stock options and the year-end price of Common Stock. AGGREGATED FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED IN-THE- UNDERLYING UNEXERCISED MONEY OPTIONS AT FISCAL YEAR OPTIONS AT FISCAL YEAR END(#) END($)(1) ----------------------------- ---------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---- ----------- ------------- ----------- ------------- Reed R. Prior 203,571 4,682,176 0 0 George W. Masters(2) 246,000 154,000 0 0 Jean C. Nichols, Ph.D. 87,698 640,874 0 0 Leonard F. Estis, Ph.D.(3) 115,903 0 0 0 Thomas N. Konatich(4) 48,198 0 0 0
67 (1) Amounts based on the last reported sale price of the Common Stock as of December 31, 1996 of $1.00. (2) Mr. Masters terminated employment with the Company on November 6, 1996. (3) Dr. Estis terminated employment with the Company on November 29, 1996. (4) Mr. Konatich terminated employment with the Company on November 15, 1996. 67 TEN-YEAR OPTION REPRICINGS The following table sets forth information regarding all repricing of options held by the Named Executive Officers during the last ten fiscal years. NUMBER OF MARKET PRICE EXERCISE SECURITIES OF STOCK AT PRICE AT TIME LENGTH OF ORIGINAL UNDERLYING TIME OF OFREPRICING OPTION TERM OPTIONS REPRICING OR OR NEW REMAINING AT DATE OF REPRICED OR AMENDMENT AMENDMENT EXERCISE REPRICING OR NAME DATE AMENDED(#) ($) ($) PRICE($) AMENDMENT NAME - ---- ---- ---------- --- --- -------- --------------- Reed R. Prior - - - - - - George W. Masters(1) - - - - - - Jean C. Nichols,Ph.D.(2) 12/18/96 19,230 1.313 15.00 1.313 1 Year & 9 Months 12/18/96 15,000 1.313 15.00 1.313 2 Years & 2 Months 12/18/96 80,500 1.313 15.00 1.313 5 Years & 1 Month 12/18/96 17,500 1.313 6.50 1.313 7 Years & 2 Months 12/18/96 18,000 1.313 5.50 1.313 8 Years & 4 Months 12/18/96 14,179 1.313 4.25 1.313 9 Years & 4 Months Leonard F. Estis, Ph.D.(3) - - - - - - Thomas N. Konatich(4) - - - - - -
(1) Mr. Masters terminated employment with the Company on November 6, 1996. (2) All prior vesting of original options for Dr. Nichols has been forfeited. All repriced options commenced vesting on December 18, 1996, and have a three year term. (3) Dr. Estis terminated employment with the Company on November 29, 1996. (4) Mr. Konatich terminated employment with the Company on November 15, 1996. Director Compensation Fees. The Company pays its Directors who are neither officers nor employees of the Company, nor Trustees of Boston University, an annual retainer of $10,000, plus $1,000 per meeting of the Board of Directors of the Company and $500 per meeting of any committee of the Board of Directors which occurs on a day other than that on which a Board of Directors meeting occurs. Non-Employee Director Stock Options. Under the Company's 1992 Non-Employee Director Non-Qualified Stock Option Plan (the "Director Plan"), Directors who are not officers or employees of the Company, or Trustees of Boston University (as long as Boston University owns greater than 5% of any 68 class of the Company's outstanding securities), and who are elected to serve as a Director of the Company on any date on or after February 5, 1992, are awarded options under the Director Plan. Commencing on the first date on which elected to serve, each such Director is granted an option to purchase 5,000 shares of Common Stock at a purchase price equal to the fair market value of the Common Stock (e.g., the last reported sale price on the Nasdaq NMS) on the day the option is granted, except that any such grant to a Director who was awarded options to purchase stock in connection with his service as a Director of the Company prior to February 5, 1993 is to be reduced by the number of shares underlying the previous grants. At the commencement of each subsequent 12 month period in which a Director is elected to continue in office, an additional option to purchase 1,000 shares of Common Stock at fair market value is to be granted. Each option has a term of five years and becomes exercisable in full upon the recipient's completion after the date of grant of a full term of office as a member of the Board of Directors. If the term is not completed, or if the Director has failed to attend at least 75% of the regularly called meetings during the term, the option will be forfeited. Options cease to be exercisable 60 days after the date the optionee ceases to be a Director for any reason other than death or disability. Options cease to be exercisable 180 days after the date the optionee ceases to be a Director by reason of disability or death. In no event, however, is an option exercisable after the expiration date of the option. On May 13, 1996, Dr. Bagalay, Mr. Cassidy, Mr. Condon, Mr. Jacobs and Dr. Murphy each received an option to purchase 1,000 shares at an exercise price of $4.625 per share under the Director Plan. As of March 21, 1997, no other directors have received options under the Director Plan. Other Director Arrangements. Dr. Murphy, a Director, and Dr. Howell, a former Director, have consulting agreements with the Company. See "Executive Compensation -- Employment and Consulting Agreements; Change in Control Arrangements" and "Certain Transactions." Employment and Consulting Agreements; Change in Control Arrangements Employment Agreement with Reed R. Prior. In November 1996, the Company entered into an employment agreement with Reed R. Prior pursuant to which Mr. Prior is serving as Chief Executive Officer and Chairman of the Board. Mr. Prior is also the Treasurer of the Company. Mr. Prior's initial annual base salary is $350,000. In addition, the Company pays Mr. Prior up to $4,500 per month as reimbursement for rental of an apartment, living expenses and weekly commuting between the Company's offices and his permanent residence. Mr. Prior was reimbursed for his moving expenses to relocate to an apartment in the Boston area. The Company will reimburse Mr. Prior for any additional taxes as a result of living, commuting or moving expenses. Mr. Prior is entitled to participate in the bonus and benefit programs that are available to the Company's employees, and is entitled to health, life and disability insurance. Pursuant to Mr. Prior's employment agreement, in December 1996, the Company issued to Mr. Prior an option to purchase 4,885,747 shares of common stock equal to 8.5% of the Company's common stock, on a fully diluted basis, at a price of $1.31 per share, to vest in 48 monthly increments during the term of the agreement. The agreement also provides for anti-dilution protections which, among other things, require the Company to issue additional options as necessary to cause the number of shares underlying his stock option to equal but not exceed 8.5% of the Company's outstanding Common Stock on a fully diluted basis. These anti-dilution provisions will be applicable until the Company sells $20,000,000 in equity or convertible securities to non-affiliated persons. The Company has the obligation to register and 69 maintain registration for resale of such shares on Form S-8. Mr. Prior is entitled to receive payments in the event of certain transactions that may be deemed a "change in ownership" of the Company. A "change in ownership" includes (1) any acquisition of all or substantially all of the Company's equity securities or operating assets, whether by way of merger, sale of assets, stock purchase, tender offer or otherwise, or (2) the sale or out-licensing of the majority (in value) of the Company's technology assets. In this event, Mr. Prior is entitled to receive an "Asset Value Realization Bonus" equal to 8.5% of the net proceeds from the change in ownership transaction. The amount that the Company must pay Mr. Prior will be reduced by the amount of gain recognized by Mr. Prior as a result of his sale of Common Stock of the Company acquired as a result of exercise of options (or deemed sales in certain circumstances when he is able to, but does not, sell). Mr. Prior has executed a waiver releasing the Company from any obligations that it may have under his employment agreement with respect to the Company's sale of its operating facility to B.U. The Company's agreement with Mr. Prior continues until terminated by either party on written notice of not less than 30 days. The employment agreement may be terminated by the Company with or without "just cause." In the event the Company terminates Mr. Prior's employment other than for "just cause," or in the event that Mr. Prior terminates his employment for "good reason," the Company is required to pay Mr. Prior as severance a lump sum payment equal to one year's salary based on the annual rate in effect on the date of termination. Upon such termination, the Company will also provide Mr. Prior with accelerated vesting of his stock options. "Just cause," as defined in the agreement, consists of fraud, a felony conviction, or a breach of a material term of the agreement or willful failure to perform material duties which are not cured following written notice (all as defined in the agreement). "Good reason," as defined in the agreement, includes (i) the refusal by the Board of Directors of a bona fide financing offer, (ii) refusal of the Board of Directors to approve major spending cuts or operational changes, (iii) breach by the Company of a material term under the employment agreement, (iv) a change in ownership, and (v) a change in control. Mr. Prior is entitled to receive a lump sum payment equal to one year's salary in the event of death or of physical or mental disability of a nature sufficient to result in his termination by the Board. Pursuant to the terms of the agreement, the Company established an irrevocable letter of credit in an amount equal to $175,000, naming Mr. Prior as the beneficiary as partial security for the payment of severance. The agreement also includes non-competition, confidentiality and indemnification provisions. Employment Agreement with Jean C. Nichols. On November 6, 1996, the Company entered into an employment agreement with Jean C. Nichols, Ph.D., pursuant to which Dr. Nichols was promoted to and serves as President and Chief Technology Officer of the Company. Dr. Nichols' agreement also provides that she serve as a director of the Company. Dr. Nichols' annual base salary is $225,000. Dr. Nichols is entitled to participate in the bonus and benefit programs that are available to the Company's employees, and is entitled to health, life and disability insurance. Pursuant to Dr. Nichols' employment agreement, in December 1996, the Company issued to Dr. Nichols an option to purchase 678,573 shares of common stock at a price of $1.31 per share, to vest in 36 equal monthly increments during the term of the agreement and canceled options for 164,409 shares of common stock. Such option in addition to an existing option for 50,000 shares equal to 1.275% of the Company's common stock, on a fully diluted basis. The agreement also provides for anti-dilution protections which, among other things, require the Company to issue additional options as necessary to cause 70 the number of shares underlying her stock options to equal but not exceed 1.275% of the Company's outstanding Common Stock on a fully diluted basis. These anti-dilution provisions will be applicable until the Company sells $20,000,000 in equity or convertible securities to non-affiliated persons. The Company has the obligation to register and maintain registration for resale of such shares on Form S-8. The Company's agreement with Dr. Nichols continues until terminated by either party on written notice of not less than 30 days. The employment agreement may be terminated by the Company for cause. In the event the Company terminates Dr. Nichols' employment other than for cause, the Company is required to pay to Dr. Nichols one year's salary based on the annual rate in effect on the date of termination. "Cause," as defined in the agreement, consists of fraud, a felony conviction, or a breach of a material term of the agreement or willful failure to perform material duties which are not cured following written notice (all as defined in the agreement). Dr. Nichols is entitled to receive one year's salary in the event of death or disability. The agreement also includes non-competition, confidentiality and indemnification provisions. Option plans. Under the Company's 1992 Plan, upon a change in control or a potential change in control (each as defined in the 1992 Plan), the vesting of options granted to the named executive officers under the 1992 Plan will be accelerated, and the value of the options will, unless otherwise determined by the Compensation Committee, be cashed out at a price to be determined at the time of the cash out. See footnote 1 to the "Option Grants in Last Fiscal Year" table. Although the exact amount to be paid by the Company cannot be determined, such amount could be in excess of $100,000 for each of the Named Executive Officers. Agreements with others. In November 1996, the Company entered into a retirement and consulting agreement with Mr. Masters, former chief executive officer and president. Pursuant to this agreement, Mr. Masters was paid a consulting fee of $12,500 per month during the initial consulting period beginning November 6, 1996 and ending December 31, 1996. Mr. Masters was paid $5,000 per month during the period beginning January 1, 1997 and ending February 28, 1997. Mr. Masters was also entitled to receive a $30,000 bonus for services rendered during fiscal year 1996, which was paid in 1997. The Company had a consulting agreement with Dr. Murphy, a Director of the Company who has declined to stand for reelection in 1997. Pursuant to this agreement, Dr. Murphy was paid a consulting fee of $100,000 per year, and was paid that amount during the fiscal year ended 1996, to provide consulting services on biotechnology matters. The agreement expired December 31, 1996. The Company anticipates extending this agreement into 1997 at a rate of $50,000 per year. The Company may elect to impose a two year noncompetition period following the termination or cancellation of the agreement, provided the Company compensates Dr. Murphy during such period at one-half the rate of compensation in effect at the time the termination or cancellation occurs. Dr. James M. Howell, former Chairman of the Board of Directors, also had a consulting agreement with the Company. Pursuant to this agreement, Dr. Howell was paid a consulting fee of $68,750 in fiscal year 1996 to provide consulting services on business matters. The agreement was terminated on November 30, 1996. Pursuant to the agreement, Dr. Howell agreed not to compete with the Company during the term of the agreement and for a period of one year following the termination of the agreement. Dr. Howell is also subject to certain confidentiality obligations. Compensation Committee Interlocks and Insider Participation 71 The members of the Compensation Committee during fiscal year 1996 were Messrs. Cassidy and Jacobs. In June 1995, the Company finalized three separate lines of credit which were guaranteed by three different entities for a total of $23.8 million in guaranteed bank financing for the Company. Seragen issued warrants to the guarantors for the purchase of 2,776,664 shares of Common Stock at an exercise price of $4.75 per share. These warrants are immediately exercisable and expire in 2005. Boston University, Seragen's majority stockholder, was the lead guarantor, providing a guaranty of $11.8 million in exchange for a warrant to purchase 1,376,666 shares of Common Stock. Two other guarantors provided guarantees to secure loans of $12 million. Gerald S.J. Cassidy, a member of the Company's Board of Directors, was one of the two guarantors, providing a guaranty of $2 million in exchange for a warrant to purchase 233,332 shares of Common Stock. Leon C. Hirsch and Turi Josefsen provided guaranties of the remaining $10 million in exchange for warrants to purchase an aggregate of 1,166,666 shares of Common Stock (see "Share Ownership"). In July 1996, the Company restructured its arrangement with the guarantors of the Company's $23.8 million loan financing obtained in June 1995 to release the Company of its liability to the banks involved. The new agreement replaced the lines of credit with shares of the Company's convertible Series B Preferred Stock ("Series B Shares"). Each Series B Share is convertible at any time at the investor's option into a number of shares of Seragen Common Stock determined by dividing $1,000 by the average of the closing sale prices of the Common Stock as reported on the Nasdaq Stock Market for the ten consecutive trading days immediately preceding the conversion date. The holders of Series B Shares are entitled to receive a cumulative dividend payable in arrears in cash quarterly on the last day of each calendar quarter commencing on September 30, 1996 at an annual rate equal to the prime rate plus 1 1/2% through June 1999 and at an increasing percentage rate thereafter up to a maximum rate of the prime rate plus 5% form and after July 1, 2003. The holders of Series B shares are entitled to vote on any matters submitted to the Company's shareholders. Each share is entitled to a vote equivalent to 250 shares of common stock. The investors also received warrants to purchase a total of 5,950,000 shares of Seragen Common Stock (250,000 warrants for every $1,000,000 of preferred stock purchased) at an exercise price of $4.00 per share. The warrants are exercisable commencing on January 1, 1997 and expire on July 1, 2006. In addition, each investor is entitled to receive additional warrants pursuant to certain anti-dilution provisions. Each additional warrant will be issued at an exercise price of $4.00 per share and will be exercisable commencing on January 1, 1997 and expiring on July 1, 2006 (see "Share Ownership"). Each Series B Share has a liquidation preference equal to $1,000, plus an amount equal to any accrued and unpaid dividends from the date of issuance of the Series B Shares. At any time, with the approval of the Company's Board of Directors, Audit Committee or comparable body, the Company may redeem any or all of the Series B Shares for cash. The redemption price per share of Series B Preferred Stock is $1,000, plus an amount equal to any accrued and unpaid dividends from the date of issuance of the Series B Preferred Stock. In connection with the issuance of 23,800 shares of Series B preferred stock (the "Series B Shares"), the Company formed Seragen Technology, Inc. ("STI"). The Company transferred all of its exsisting and future United States patents and patent applications (the"Patents") to STI in exchange for 214,200 shares of STI's Class A Common Stock and 23,800 shares of STI's Class B Common Stock (the"Class B Shares"). Each share of STI Class A Common Stock is owned by the Company. The Company has transferred the Class B Shares to the holders of the Series B Shares. 72 STI has no operations, and its sole asset is the Patents. Its authorized capital Stock consists of 214,200 shares of Class A Common Stock and 23,800 shares of Class B Common Stock, all of which as described in the paragraph above, is issued and outstanding. Each share of STI Class A Common Stock and STI Class B Common Stock is entitled to one vote on all matters submitted to a vote of STI shareholders, voting together as a single class. Simultaneously with the contribution of the Patents to STI, the Company entered into a license agreement with STI pursuant to which STI granted to the Company an irrevocable worldwide exclusive license with respect to the Patents (the "Irrevocable License Argeement"). Under the terms of the Irrevocable License Agreement, the Company is obligated to pay quarterly royalties to STI in an amount equal to the amount of any dividend that the holders of the Series B Shares are entitled to receive but have not received by the royalty due date (which is one day after each quarterly dividend payment date for the Series B Shares). The shares of STI Class B Common Stock, in turn, are entitled to receive cumulative divends equal to any royalty payable to STI under the Irrevocable License Agreement. STI has executed a collateral assignment of the Patents in favor of the holders of the Class B Shares, which is being held by an escrow agent. The escrow agent is required to deliver collateral assignment to the holders of the Class B Shares if dividends on the Class B Shares are in arrears and STI fails for 60 days, after the receipt of notice from the holders of the Class B Shares, to pay the dividends due. Likewise, the holders of Class B Shares have executed a reassignment of the Patents to STI, which also is being held by the escrow agent. The escrow agent is obligated to deliver the reassignment of the Patents to STI upon the redemption by STI of all of the Class B Shares. The Class B Shares are required to be redeemed upon the redemption or conversion of Series B Shares in a number equal to the number of Series B Shares redeemed or converted. The collateral assignment of the Patents secures only STI's dividend payment obligations on the Class B Shares and does not secure any other amounts (e.g., the liquidation preference of the Series B Shares). The collateral assignment of the Patents has no effect until the escrow agent is instructed to deliver it to the holders of the Class B Shares. The Company has not paid the cash dividends due Defcember 31, 1996 and March 31, 1997, on the Series B Shares, nor has the Company made the royalty payments due to STI on January 1, 1997, and April 1, 1997. Correspondingly, STI has not paid the dividends due January 1, 1997, and April 1, 1997, on the Class B Shares. Delivery of notice by the agent for the holders of the Class B Shares to the escrow agent in accordance with the collateral assignment of the Patents is the only condition to delivery of the collateral assignment of the Patents to the holders of the Class B Shares. If the holders of the Class B Shares were to deliver this notice to the escrow agent, they would thereafter have the right to foreclose on the Patents, subject to the Company's rights under the Irrevocable License Agreement. To the Company's knowledge, the holders of the Class B Shares have not delivered this notice to the escrow agent. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT COMMON STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information regarding the 73 beneficial ownership of the Company's Common Stock as of March 28, 1997 by (i) each person known by the Company to own beneficially 5% or more of its outstanding Common Stock, (ii) each Director of the Company, (iii) each named executive officer of the Company and (iv) all Directors and executive officers as a group. Except as otherwise indicated, the named beneficial owner has sole voting and investment power with respect to the shares beneficially owned. SHARE OWNERSHIP
PERCENTAGE BENEFICIALLY OWNED (1)(2) NAME(**) NUMBER OF SHARES PERCENT - -------- ---------------- Boston University 28,949,368(3)(4)(5) 74.8% 881 Commonwealth Avenue Boston, MA 02215 Leon C. Hirsch 10,247,681(3)(6) 36.2% 150 Glover Avenue Norwalk, CT 06856 Turi Josefsen 4,391,862(3)(7) 19.6% 150 Glover Avenue Norwalk, CT 06856 P.R.I.F., L.P. 1,905,042(8) 9.5% 175 Bloor Street East South Tower, 6th Floor Toronto, Canada AG John E. Bagalay, Jr 4,000(9) * Gerald S.J. Cassidy 2,958,084(3)(10) 14.1% 700 13th Street, N.W., Suite 400 Washington, DC 20005 Kenneth G. Condon, C.P.A. 5,200(5)(11) * Leonard F. Estis, Ph.D. 1,136 * Norman A. Jacobs 19,000(12) * Thomas N. Konatich 905(13) * George W. Masters 42,313(14) * John R. Murphy, Ph.D. 175,050(15) * Jean C. Nichols, Ph.D. 190,450(16) 1.0% Reed R. Prior 712,503(17) 3.8% John R. Silber, Ph.D. 178,500(18) * All Officers and Directors as a Group 4,287,141 19.4%
______________________ * Represents beneficial ownership of less than 1% of the Common Stock. ** Addresses are given for persons who beneficially own 5% or more of the Company's outstanding Common Stock only. (1) For purposes of this table, a person or group of persons is deemed to have "beneficial ownership" of any shares as of March 28, 1997 that such person or persons has the right to acquire within 60 days after such date. 74 (2) Percentage of ownership is based on 18,048,881 shares of Common Stock outstanding as of March 28, 1997. (3) Includes 23,494,571 shares of Common Stock issuable upon conversion of 23,800 shares of Series B Preferred Stock and assumes that shares of Series B Preferred Stock are convertible at a conversion price of $1.013, the conversion price in effect on March 28, 1997, based on the average of the closing sale prices of the Common Stock for the ten consecutive trading days preceding that date. (4) Includes 3,360,625 shares of Common Stock issuable upon conversion of 5,000 shares of Series C Preferred Stock and accrued dividends thereon (the maximum number of shares of Common Stock into which the Series C shares may convert). (5) The Boston University Nominee Partnership is a partnership that was created to act as the record holder of certain securities owned by Boston University. Dr. Bagalay and Mr. Condon are general partners of such partnership and are required to vote and take other actions with respect to such shares of Common Stock as instructed by duly authorized officers of Boston University. Officers of Boston University are duly authorized by the actions of the Trustees of Boston University. General partners of the Boston University Nominee Partnership (Dr. Bagalay and Mr. Condon) and the Trustees of Boston University (Dr. Silber) disclaim beneficial ownership of such shares. Includes 15,000 shares issuable upon exercise of stock options exercisable within 60 days, a warrant to purchase 1,376,666 shares exercisable at $4.75 per share, a warrant to purchase 4,249,431 shares exercisable at $4.00 per share, 11,648,569 shares of Common Stock issuable upon conversion of 11,800 shares of Series B Preferred Stock and 3,360,625 shares of Common Stock issuable upon conversion of 5,000 shares of Series C Preferred Stock. Boston University has entered into a Stockholders Agreement with respect to the election of directors and other matters (see "Certain Transactions"). (6) Represents a warrant to purchase 816,666 shares exercisable at $4.75 per share, a warrant to purchase 2,520,847 shares exercisable at $4.00 per share, and Series B Preferred Stock convertible into 6,910,168 shares of Common Stock. Does not include 1,430,362 shares issuable upon exercise of warrants and does not include 2,961,500 shares of Common Stock issuable upon conversion of 3,000 shares of Series B Preferred Stock held by Turi Josefsen, Mr. Hirsch's wife, as to which Mr. Hirsch disclaims beneficial ownership. Mr. Hirsch has entered into a Stockholders Agreement with respect to the election of directors. (See "Certain Transactions"). (7) Represents a warrant to purchase 350,000 shares exercisable at $4.75 per share, a warrant to purchase 1,080,362 shares exercisable at $4.00 per share, and Series B Preferred Stock convertible into 2,961,500 shares of Common Stock. Does not include 3,337,513 shares issuable upon exercise of warrants and does not include 6,910,168 shares of Common Stock issuable upon conversion of 7,000 shares of Series B Preferred Stock held by Leon C. Hirsch, Ms. Josefsen's husband, as to which Ms. Josefsen disclaims beneficial ownership. Ms. Josefsen has entered into a Stockholders Agreement with respect to the election of directors. (See "Certain Transactions"). (8) Includes 1,905,042 shares of Common Stock issuable upon conversion of 2,402 shares of Series A Preferred Stock and accrued dividends thereon (the maximum number of shares of Common Stock that the Series A shares may convert into). P.R.I.F., L.P. ("PRIF") is a limited partnership, the sole general partner of which is HB and Co., Inc. ("HB"). HB has the exclusive authority to manage, control and administer investments and affairs of PRIF. The holder of all issued and outstanding shares of HB is Lillian Brachfeld. Henry Brachfeld is the sole director of HB and, as the sole executive officer of HB,is its President and Secretary. This information is based solely on a Schedule 13D filed with the Securities and Exchange Commission and dated June 21, 1996. 75 (9) Represents 4,000 shares issuable upon exercise of options held by Dr. Bagalay that are exercisable within 60 days. (10) Includes 9,000 shares issuable upon exercise of options held by Mr. Cassidy that are exercisable within 60 days, a warrant to purchase 233,332 shares exercisable at $4.75 per share, a warrant to purchase 720,249 shares exercisable at $4.00 per share, and 1,974,334 shares of Common Stock issuable upon conversion of 2,000 shares of Series B Preferred Stock. Mr. Cassidy's shares of Series B Preferred Stock and warrant are owned jointly with his wife, Loretta P. Cassidy. Mr. and Mrs. Cassidy have entered into a Stockholders Agreement with respect to the election of directors and other matters (see "Certain Transactions"). (11) Represents 4,000 shares issuable upon exercise of options held by Mr. Condon that are exercisable within 60 days. (12) Represents 19,000 shares issuable upon exercise of options held by Mr. Jacobs that are exercisable within 60 days. (13) Mr. Konatich resigned as Chief Financial Officer effective November 15, 1996. (14) Includes 25,000 shares issuable upon exercise of options exercisable by Mr. Masters within 60 days and a warrant to purchase 1,250 shares exercisable at $10.00 per share. Mr. Masters retired from his position as Vice Chairman, Chief Executive Officer, President and a member of the Board of Directors effective November 6, 1996. (15) Represents 124,000 shares issuable upon exercise of options held by Dr. Murphy that are exercisable within 60 days. (16) Represents 181,944 shares issuable upon exercise of options held by Dr. Nichols that are exercisable within 60 days. (17) Represents 712,503 shares issuable upon exercise of options held by Mr. Prior that are exercisable within 60 days. Mr. Prior has entered into a Stockholders Agreement with respect to the election of directors. See "Certain Transactions." (18) Includes a warrant to purchase 7,500 shares exercisable at $10.00 per share. Dr. Silber's shares and warrant are owned jointly with his wife, Kathryn U. Silber. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS In August 1987, Boston University, Nycomed (formerly Nyegaard & Co. AS) and the Company entered into a purchase and sale agreement whereby Boston University, which then owned approximately 6% of the Company's outstanding Common Stock, acquired from Nycomed 1,691,761 shares of the Company's Common Stock, which represented all of Nycomed's ownership interest in the Company and approximately 71% of the then outstanding Common Stock of the Company. As 76 part of this transaction, Boston University acquired all of Nycomed's rights to technology, inventions, patents and other proprietary rights (the "Technology") which were primarily related to or useful in the development of the Company's fusion protein products and also acquired the world-wide exclusive rights to manufacture, use, sell and market the products (the "Products") which were derived from or include the Technology (the "Technology and Marketing Rights"). In exchange for the acquisition of these assets, Boston University paid $25,000,000 to Nycomed and assumed Nycomed's obligations to the Company, including a commitment to finance and carry out the Company's research and development program and an obligation to guaranty the Company's leases at its facilities in Hopkinton, Massachusetts. In addition, pursuant to the agreement, the Company is obligated to pay Nycomed a continuing royalty with respect to sales of the Products and to give Nycomed rights of first negotiation to market the Products in the territory covered by the agreement. In connection with this agreement, Nycomed and Boston University entered into a Noncompetition and Confidentiality Agreement, whereby Nycomed agreed to maintain in confidence proprietary information and intellectual property in connection with the Company's business and not to compete with the Company's business. The Noncompetition and Confidentiality Agreement expired in August 1992. The Company believes that the expiration of this Agreement will not materially adversely affect the Company's business. In connection with the sale of stock to Boston University, Nycomed also transferred to Boston University a debt owed to Nycomed by the Company in the principal amount of $1,050,000. In 1988, Boston University converted this debt plus accrued interest thereon into 95,488 shares of Common Stock, based on a conversion price equal to $15.00 per share of Common Stock. In connection with Boston University's acquisition of the majority interest in the Company in 1987, Boston University guaranteed the Company's obligations under a $10,000,000 line of credit with The First National Bank of Chicago (the "Bank") to provide short-term operating funds for the Company (the "Guaranty"). Boston University pledged certain collateral to the Bank to secure the Guaranty. In 1992, the Company repaid the Bank's line of credit and thereby terminated the Guaranty. In return for providing the Guaranty, the Company issued to Boston University a warrant (the "Bank Warrant"), which enabled Boston University to purchase up to 500,000 shares of Common Stock at an exercise price of $11.80 per share, at any time prior to January 28, 1993. The Bank Warrant expired unexercised. In January 1988, pursuant to a Technology Purchase and Royalty Agreement (the "Technology Agreement") which was contemplated at the time Boston University acquired the Technology from Nycomed, Boston University transferred to the Company the Technology and Marketing Rights obtained from Nycomed in exchange for a continuing royalty with respect to sales of the Products until the expiration of all patents relative to the Technology. Thereafter, the Company agreed to pay Boston University a reduced royalty based on a percentage of net sales for a period of 10 years after the expiration of such patents. The Technology Agreement provides Boston University with a security interest in the Technology and Marketing Rights, whereby upon a default by the Company in the terms of the Technology Agreement, the Technology and Marketing Rights would automatically be transferred back to Boston University. A default under the Technology Agreement shall occur if, among other things, the Company breaches its obligations under the Technology Agreement. As of March 28, 1997, Boston University beneficially owned 8,299,077 shares (or approximately 46%) of the Company's outstanding Common Stock. In addition, Boston University beneficially owns a stock option to purchase 15,000 shares, a warrant to purchase 1,376,666 shares, a warrant to purchase 2,950,000 shares subject to anti-dilution provisions (as defined), shares 77 issuable on conversion of 11,800 shares of Series B Preferred Stock and shares issuable on conversion of 5,000 shares of Series C Preferred Stock. As of March 28, 1997, if all securities were converted to common stock, Boston University would own 28,949,368 shares of common stock. Dr. John R. Murphy, a director of the Company who has declined to stand for reelection in 1997, had a consulting agreement with the Company pursuant to which he received consulting fees of $100,000 in the fiscal year ended 1996. Dr. James M. Howell, former Chairman of the Board of Directors, had a consulting agreement with the Company pursuant to which he received consulting fees of $68,750 in the fiscal year ended 1996. In June 1995, the Company finalized three separate lines of credit which were guaranteed by three different entities for a total of $23.8 million in guaranteed bank financing for the Company. Seragen issued warrants to the guarantors for the purchase of 2,776,664 shares of Common Stock at an exercise price of $4.75 per share. These warrants are immediately exercisable and expire in 2005. Boston University, Seragen's majority stockholder, was the lead guarantor, providing a guaranty of $11.8 million in exchange for a warrant to purchase 1,376,666 shares of Common Stock. Two other guarantors provided guarantees to secure loans of $12 million. Gerald S.J. Cassidy, a member of the Company's Board of Directors, was one of the two guarantors, providing a guaranty of $2 million in exchange for a warrant to purchase 233,332 shares of Common Stock. Leon C. Hirsch and Turi Josefsen provided guaranties of the remaining $10 million in exchange for warrants to purchase an aggregate of 1,166,666 shares of Common Stock (see "Share Ownership"). In July 1996, the Company restructured its arrangement with the guarantors of the Company's $23.8 million loan financing obtained in June 1995 to release the Company of its liability to the banks involved. The new agreement replaced the lines of credit with shares of the Company's convertible Series B Preferred Stock ("Series B Shares"). Each Series B Share is convertible at any time at the investor's option into a number of shares of Seragen Common Stock determined by dividing $1,000 by the average of the closing sale prices of the Common Stock as reported on the Nasdaq Stock Market for the ten consecutive trading days immediately preceding the conversion date. The holders of Series B Shares are entitled to receive a cumulative dividend payable in arrears in cash quarterly on the last day of each calendar quarter commencing on September 30, 1996 at an annual rate equal to the prime rate plus 1 1/2% through June 1999 and at an increasing percentage rate thereafter up to a maximum rate of the prime rate plus 5% form and after July 1, 2003. The holders of Series B shares are entitled to vote on any matters submitted to the Company's shareholders. Each share is entitled to a vote equivalent to 250 shares of common stock. The investors also received warrants to purchase a total of 5,950,000 shares of Seragen Common Stock (250,000 warrants for every $1,000,000 of preferred stock purchased) at an exercise price of $4.00 per share. The warrants are exercisable commencing on January 1, 1997 and expire on July 1, 2006. In addition, each investor is entitled to receive additional warrants pursuant to certain anti-dilution provisions. Each additional warrant will be issued at an exercise price of $4.00 per share and will be exercisable commencing on January 1, 1997, and expiring on July 1, 2006 (see "Share Ownership"). In connection with the issuance of 23,800 shares of Series B preferred stock (the "Series B Shares"), the Company formed Seragen Technology, Inc. ("STI"). The Company transferred all of its exsisting and future United States patents and patent applications (the"Patents") to STI in exchange for 214,200 78 shares of STI's Class A Common Stock and 23,800 shares of STI's Class B Common Stock (the"Class B Shares"). Each share of STI Class A Common Stock is owned by the Company. The Company has transferred the Class B Shares to the holders of the Series B Shares. STI has no operations, and its sole asset is the Patents. Its authorized capital Stock consists of 214,200 shares of Class A Common Stock and 23,800 shares of Class B Common Stock, all of which as described in the paragraph above, is issued and outstanding. Each share of STI Class A Common Stock and STI Class B Common Stock is entitled to one vote on all matters submitted to a vote of STI shareholders, voting together as a single class. Simultaneously with the contribution of the Patents to STI, the Company entered into a license agreement with STI pursuant to which STI granted to the Company an irrevocable worldwide exclusive license with respect to the Patents (the "Irrevocable License Argeement"). Under the terms of the Irrevocable License Agreement, the Company is obligated to pay quarterly royalties to STI in an amount equal to the amount of any dividend that the holders of the Series B Shares are entitled to receive but have not received by the royalty due date (which is one day after each quarterly dividend payment date for the Series B Shares). The shares of STI Class B Common Stock, in turn, are entitled to receive cumulative divends equal to any royalty payable to STI under the Irrevocable License Agreement. STI has executed a collateral assignment of the Patents in favor of the holders of the Class B Shares, which is being held by an escrow agent. The escrow agent is required to deliver collateral assignment to the holders of the Class B Shares if dividends on the Class B Shares are in arrears and STI fails for 60 days, after the receipt of notice from the holders of the Class B Shares, to pay the dividends due. Likewise, the holders of Class B Shares have executed a reassignment of the Patents to STI, which also is being held by the escrow agent. The escrow agent is obligated to deliver the reassignment of the Patents to STI upon the redemption by STI of all of the Class B Shares. The Class B Shares are required to be redeemed upon the redemption or conversion of Series B Shares in a number equal to the number of Series B Shares redeemed or converted. The collateral assignment of the Patents secures only STI's dividend payment obligations on the Class B Shares and does not secure any other amounts (e.g., the liquidation preference of the Series B Shares). The collateral assignment of the Patents has no effect until the escrow agent is instructed to deliver it to the holders of the Class B Shares. The Company has not paid the cash dividends due Defcember 31, 1996 and March 31, 1997, on the Series B Shares, nor has the Company made the royalty payments due to STI on January 1, 1997, and April 1, 1997. Correspondingly, STI has not paid the dividends due January 1, 1997, and April 1, 1997, on the Class B Shares. Delivery of notice by the agent for the holders of the Class B Shares to the escrow agent in accordance with the collateral assignment of the Patents is the only condition to delivery of the collateral assignment of the Patents to the holders of the Class B Shares. If the holders of the Class B Shares were to deliver this notice to the escrow agent, they would thereafter have the right to foreclose on the Patents, subject to the Company's rights under the Irrevocable License Agreement. To the Company's knowledge, the holders of the Class B Shares have not delivered this notice to the escrow agent. Each Series B Share has a liquidation preference equal to $1,000, plus an amount equal to any accrued and unpaid dividends from the date of issuance of the Series B Shares. At any time, with the approval of the Company's Board of 79 Directors, Audit Committee or comparable body, the Company may redeem any or all of the Series B Shares for cash. The redemption price per share of Series B Preferred Stock is $1,000, plus an amount equal to any accrued and unpaid dividends from the date of issuance of the Series B Preferred Stock. In September 1996, the Company raised $5 million through the sale of 5,000 shares of the Company's non-voting convertible Series C Preferred Stock ("Series C Shares") in a private placement with Boston University Regulation D under the Securities Act of 1933. The Series C Shares are convertible at the option of the holder into shares of Seragen Common Stock at a per share conversion price equal to the lesser of $2.75 or 73% of the average closing bid. Terms of the Series C shares also provide for 8% cumulative dividends payable in shares of Seragen Common Stock at the time of each conversion (see "Share Ownership"). Notwithstanding this, however, the maximum aggregate number of shares of Common Stock that the Company may issue on exercise of Series C Shares is 3,360,625. Any holder of Series C Shares unable to convert Series C Shares as a result of the limitation described in the preceding sentence is entitled to require the Company to repurchase those shares for $1,150 per Series C Share. Each Series C Shares has a liquidation preference equal to $1,000, plus an amount equal to any accrued and unpaid dividends from the date of issuance of the Series C Shares, in the event of liquidation, dissolution or winding up of the Company. Series C Shares that remain outstanding on March 30, 1998, will be converted automatically into shares of Common Stock. On November 6, 1996, the Company entered into a Stockholders Agreement (the "Stockholders Agreement") together with Boston University, Leon C. Hirsch, Turi Josefsen, Gerald S.J. Cassidy and Loretta P. Cassidy (collectively, together with Boston University, the "Stockholders"), and Reed R. Prior with respect to the election of directors and other matters. Pursuant to this agreement, the Stockholders have agreed to vote their respective shares to (i) maintain the number of persons comprising the Board of Directors at nine, (ii) not to elect more than two persons designated by or affiliated with Boston University to the Board of Directors, and (iii) to elect three outside directors with experience in the pharmaceutical industry reasonably acceptable to Mr. Prior. In addition, the agreement grants Mr. Prior rights of co-sale in the event Boston University chooses to sell over 50% of its stock in the Company to a third party. Boston University also agrees to pay its pro-rata share of Mr. Prior's Asset Value Realization Bonus (as defined in Mr. Prior's employment agreement) in the event that the Company fails to pay such bonus. On February 18, 1997, the Company entered into an agreement to sell its manufacturing and clinical operations facilities to B.U. or a designated affiliate for $5 million. The closing of the transaction is subject to, among other things, approval by the Company's stockholders. B.U. has paid the Company $4.5 million as a deposit and has assumed responsibility for the facility's operations, including responsibility for operating costs. The Company currently may use this deposit to fund its operations. At the closing, a majority of the Company's employees involved in the manufacturing and clinical operations will become employees of B.U. Both the deposit and the operating costs paid by B.U. are subject to refund in the event that conditions for closing are not met. Simultaneously, the Company entered into a service agreement with B.U. providing for the purchase by the Company of certain services related to product research, development, manufacturing, clinical trials, quality control, and quality assurance. This service contract expires in January 1999 and is subject to early termination provisions, as defined, including the 80 option of B.U. to terminate the agreement if losses during a contract year exceed $9.0 million and the Company does not reimburse B.U. for the losses in excess of $9.0 million. The service contract may be renewed for two successive one-year terms at the option of the Company. The Company has the option to repurchase the assets comprising the manufacture and clinical operations facilities. The Company has agreed to pay B.U. approximately $5.5 million and $6.6 million in years 1 and 2 of this contract, respectively. The fees can be mutually increased or decreased, but may not be reduced to less than $4.3 million per contract year. The service agreement is expected to substantially reduce operating costs in research and development as Seragen will be contracting solely for the services that the Company requires for clinical and manufacturing purposes. 81 EXHIBIT INDEX Exhibit Number Description Page - - ------- ----------- ---- (27) Restated Financial Data Schedule 84 82 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. Seragen, Inc. By: /s/ Reed R. Prior Dated: October 31, 1997 ------------------------------ Reed R. Prior Chairman of the Board And Chief Executive Officer 83 EX-27 2 RESTATED FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from financial statements for the twelve month period ended December 31, 1996 and is qualified in its entirety by reference to such financial statements. 1 U.S. DOLLARS 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 1 2,158,710 0 1,319,244 0 0 3,763,310 4,604,115 0 10,504,608 9,691,212 0 0 30,915,522 171,994 0 10,504,608 0 5,542,315 0 23,612,113 2,923,864 0 5,453,638 0 0 (36,721,478) 0 0 0 (36,721,478) (2.20) 0
-----END PRIVACY-ENHANCED MESSAGE-----