ITEM 1. BUSINESS
FORWARD-LOOKING STATEMENTS
The information presented in this Annual Report on Form 10-K under the headings "Item 1. Business", "Item 2.
ITEM 2. PROPERTIES
The Company leases approximately 5,000 square feet of administrative and laboratory space at the Land O'Lakes corporate office located in Arden Hills, Minnesota. In addition, the Company leases a portion of the existing Land O'Lakes pilot plant facility in Arden Hills for its current manufacturing needs to process polyclonal antibody products for development, early stage clinical use and potential commercial use. At the end of 1996, the Company completed its GMP pilot plant facility and expects it to be fully validated and operational in the second quarter of 1997.* Management believes that the Company's facilities are suitable and adequate for current office, research and manufacturing requirements.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceeding.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM X. EXECUTIVE OFFICERS OF REGISTRANT
The executive officers of the Company are:
ROBERT A. HOERR, M.D., PH.D., was named President and Chief Operating Officer of the Company in February 1994 and became President and Chief Executive Officer in September 1994. He served as Vice
President, Medical and Regulatory Affairs of the Company from January 1993 to December 1993 and Senior Vice President from December 1993 to February 1994. Dr. Hoerr was Director of Medical Affairs for Sandoz Nutrition Corporation, a research-based nutrition company, from March 1990 to January 1993. From 1986 to 1990, Dr. Hoerr was Research Scientist and Assistant Program Director at the Clinical Research Center, Massachusetts Institute of Technology ("MIT"). Dr. Hoerr received his A.B. in Biology from Indiana University, his M.D. from Indiana University School of Medicine and his Ph.D. in Nutritional Biochemistry and Metabolism from MIT.
JOHN G. WATSON has served as Chief Operating Officer of the Company since September 1996. From February 1992 to August 1996, Mr. Watson was President of Bioconsult, a consulting company servicing the biotechnology and pharmaceutical industry. Mr. Watson was Chief Operating Officer at Vestar, Inc., a pharmaceutical company (now NeXstar Pharmaceuticals, Inc., a biopharmaceutical company), from October 1988 to January 1992. From January 1982 to September 1988, Mr. Watson held various positions with American Cyanamid Corporation, a pharmaceutical, medical device and agricultural products company (now American Home Products, a pharmaceutical and consumer products company), including Director of Pharmaceutical and Medical Device Operation, Far East and Australia, and Chief Executive Officer of Northern Europe Operations. From 1980 to December 1982, Mr. Watson was a Pharmaceutical Product Director at Johnson & Johnson, a manufacturer of pharmaceuticals and health, baby and other products. Prior to that time he held various positions with The Dow Chemical Company, a manufacturer of chemicals, plastics and household pharmaceutical products, in London, England, Zurich, Switzerland and Midland, Michigan. A graduate of Cambridge University, England, Mr. Watson earned his MBA as a Fulbright Scholar at Indiana University, Bloomington in 1973.
MICHAEL E. CADY has served as Vice President, Manufacturing and Engineering of the Company since July 1992. From January 1988 to July 1992, Mr. Cady served as Director of Operations for Procor Technologies, Inc., the Company's predecessor ("Procor"). From 1979 to 1988, Mr. Cady held engineering and planning positions within several operating groups at Land O'Lakes. Mr. Cady was a member of the Land O'Lakes group that evaluated and implemented the polyclonal antibody technology used as a basis for the Company's manufacturing process. Prior to joining Land O'Lakes Mr. Cady was an engineer at Swift & Company, a food processing company. Mr. Cady received his B.S. in Engineering from the University of Iowa and earned his M.B.A. from the University of St. Thomas in 1985.
FRANCOIS LEBEL, M.D. FRCPC has served as Vice President, Scientific and Regulatory Affairs of the Company since December 1996. From April 1991 to October 1992, Dr. Lebel was Medical Director of Burroughs Wellcome Inc., a research-based pharmaceutical company. In October 1992, he was promoted to Vice President, Scientific Affairs for its Canadian operations and became a core member of the Research Committee of Burroughs Wellcome Co. (U.S.A.), a post he held until May 1995. From July 1985 to November 1996, Dr. Lebel served as an Assistant Professor of Medicine at McGill University and as an Associate Physician in the Division of Infectious Disease at Montreal General Hospital, in Canada. Dr. Lebel earned his B.Sc. in Biology and his M.D. at the University of Ottawa, Canada. He completed his post-graduate and research training at McGill University and Harvard Medical School.
GREGG A. WALDON served as Controller of the Company from July 1992 to September 1992, and was elected Treasurer in September 1992, Secretary in March 1993, Vice President in December 1993 and Chief Financial Officer in November 1994. From April 1989 to April 1992, Mr. Waldon served as an Audit Manager with Price Waterhouse LLP, a public accounting firm, in its Middle Market and Emerging Growth Practice in Minneapolis, Minnesota and from 1986 to 1989 was Senior/Staff accountant with Price Waterhouse.
Officers of the Company are chosen by and serve at the discretion of the Board of Directors. There are no family relationships among any of the directors, officers or key employees of the Company.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock, par value $.01 per share ("Common Stock"), has been publicly traded since the closing of the Company's initial public offering on April 1, 1996 (the "Offering"). The Common Stock trades on the Nasdaq National Market tier of The Nasdaq Stock Market under the symbol GGEN. At February 28, 1997, the number of holders of the Common Stock was approximately 1,259 consisting of 190 record holders and 1,069 stockholders whose stock is being held by a bank, broker or other nominee. On February 28, 1997, the closing sale price of a share of the Common Stock was $4.00.
The high and low sale prices per share of the Common Stock for the three quarters during the year ended December 31, 1996 were as follows:
1996 SECOND THIRD FOURTH -------------------------------------------------------- High $ 10.375 $ 7.50 $ 6.125 Low $ 7.125 $ 3.8125 $ 4.00
The Company has never paid cash dividends on the Common Stock. The Board of Directors does not anticipate paying cash dividends in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below as of December 31, 1996 and 1995 and for each of the three years in the period ended December 31, 1996 are derived from the financial statements of the Company which have been audited by Ernst & Young LLP, independent auditors, and are included in the appendix attached hereto. The selected financial data as of December 31, 1994, 1993 and 1992 and for each of the two years in the period ended December 31, 1993 are derived from audited financial statements which are not included herein. The data set forth below should be read in conjunction with the financial statements and notes thereto included in the appendix and with "Management's Discussion and Analysis of Financial Condition and Results of Operations", included in Item 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company is developing oral therapeutics which target life-threatening and infectious diseases such as those caused by antibiotic-resistant and emerging pathogens. The Company's pathogen-specific polyclonal antibodies are produced in concentrated form from bovine colostrum. The Company's products in development address serious gastrointestinal infections which complicate cancer, antibiotic therapy, peptic ulcer disease and immunocompromised and HIV/AIDS patients. The Company's lead product in development, SPORIDIN-G, is a polyclonal antibody product with specificity for C. PARVUM, a parasite which causes chronic, life-threatening diarrhea in immunocompromised patients.
The Company believes that certain of its products in development face a shorter and less expensive path to regulatory approval than many other biopharmaceutical products.* The Company's lead product in development addresses a critical need of immunocompromised patients who are inadequately treated by existing technologies. The Company believes this product may, therefore, qualify for expedited regulatory review.* Because the Company's products are derived from cows' milk, they do not represent new chemical compounds with uncertain toxicity, but rather their components are constituents of dairy foods that are already widely consumed. Multiple products can be manufactured using a single, proprietary manufacturing process and facility, and as a result the Company believes that additional products will not require separate investments in manufacturing facilities or process techniques.*
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
GENERAL. The net loss applicable to common stockholders increased by $9,309,553, or 170%, in 1996 to $14,783,591 from $5,474,038 in 1995 and increased by $80,004, or 1.5%, in 1995 from $5,394,034 in 1994. The increase in 1996 was due primarily to a one time non-cash charge to earnings in April 1996 of $7,296,844 for a preferred stock dividend, as described below, relating to the value of additional shares issued to holders of certain preferred stock upon conversion into Common Stock at the closing of the Offering. Historical spending levels are not indicative of future spending levels because the Company is entering a period of rapid growth in product development activity, which is planned to include increases in costs relating to personnel, research and development activity, small-scale manufacturing and accelerated clinical trial activity. For these reasons, the Company believes its expenses and losses will increase before any material product revenues are generated.*
RESEARCH AND DEVELOPMENT EXPENSES. Expenses for research and development increased $1,526,543, or 40.9%, in 1996 to $5,257,620 from $3,731,077 in 1995 and increased $288,761, or 8.4%, in 1995 from $3,442,316 in 1994. The increase in 1996 was due primarily to increased expenses associated with the SPORIDIN-G Phase II/III clinical trial, as well as increased development and clinical expenses for the Company's other products, including CANDISTAT-G, DIFFISTAT-G and PYLORIMUNE-G and increased associated personnel expense. The increase in 1995 as compared to 1994 was due primarily to a $300,000 license fee paid to Chiron Corporation in 1995 in the form of 17,143 shares of Series Convertible Preferred Stock of the Company for use of Chiron's proprietary adjuvant in SPORIDIN-G. Excluding the license fee, there would have been a slight decrease from 1994 to 1995 due primarily to the termination of the Company's transgenics program in early 1995 offset by increases associated with the development of SPORIDIN-G, including clinical trials, colostrum procurement, processing and formulation. The Company incurred approximately $1,210,000, $559,000 and $191,000 in expenses related to regulatory consultants in 1996, 1995 and 1994 respectively. The Company expects research and development expenses to increase as the Company's clinical trials activity accelerates.*
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses decreased $132,840, or 6.6%, in 1996 to $1,889,359 from $2,022,199 in 1995 and increased $301,749, or 17.5%, in 1995 from $1,720,450 in 1994. The decrease in 1996 compared to 1995 was due primarily to a decrease of $136,200 in deferred compensation (see Note 7 of Notes to Financial Statements). The increase in 1995 compared to 1994 related primarily to $476,266 expensed as part of deferred compensation amortization and costs associated with hiring new employees.
INTEREST INCOME. Interest income was $605,548 in 1996, $30,526 in 1995 and $28,842 in 1994. The increase in interest income in 1996 was due to the investment of funds received by the Company from the Offering.
INTEREST EXPENSE. Interest expense was $945,316 in 1996, $506,709 in 1995 and $260,110 in 1994. Interest expense for 1996 was due primarily to warrants valued at $768,064 which were issued to guarantors of a line of credit for the Company and to purchasers of the Company's promissory notes and to interest over a period of approximately three months on the convertible promissory notes issued by the Company (the "Convertible Promissory Notes"). The Convertible Promissory Notes converted into Common Stock upon the closing of the Offering. Interest expense for 1995 and 1994 related primarily to interest on the Convertible Promissory Notes.
EXTRAORDINARY GAIN ON EXTINGUISHMENT OF DEBT. The extraordinary gain on extinguishment of debt of $605,421 in 1995 related to certain debt reduction settlements negotiated in connection with the termination of the Company's transgenics program.
PREFERRED STOCK DIVIDEND. The preferred stock dividend of $7,296,844 in 1996 related to the value of additional Common Stock received by the holders of Convertible Promissory Notes, Series E and Series Preferred Stock upon the conversion of such securities into Common Stock at closing of the Offering (the Convertible Promissory Notes converting first into Series D Preferred Stock which in turn converted immediately into Common Stock at the closing). The Convertible Promissory Notes and the Series D, Series E and Series Preferred Stock provided that their conversion prices be automatically adjusted to reflect the lower of their currently effective conversion price or 70% of the Offering price.
LIQUIDITY AND CAPITAL RESOURCES
The Company was incorporated in March 1992. On July 24, 1992, Procor, the Company's predecessor, was merged with and into the Company (the "Procor-GalaGen Merger"). At the time of the Procor-GalaGen Merger, Procor was a wholly-owned subsidiary of Land O'Lakes. Since the Company's inception through December 31, 1996, investments in the Company have totaled approximately $50.6 million, including approximately $7.1 million of inter-company obligations payable to Land O'Lakes which were forgiven and recorded as contributed capital at the time of the Procor-GalaGen Merger, $17.9 million from the Offering (after deducting underwriting discounts and offering expenses) and approximately $25.6 million from private placements of equity and convertible debt and from conversion of accrued interest on such debt and the exercise of stock options and warrants. The Company has invested funds received in the Offering and these private placements in investment-grade, interest-bearing obligations.
Cash used in operating activities increased by $2,903,924, or 89.9%, in 1996 to $6,135,812 from $3,231,888 in 1995 and decreased by $1,317,365, or 29%, in 1995 from $4,549,253 in 1994. Cash used in operations went primarily to fund operating losses and was offset slightly by changes in operating assets and liabilities.
In 1996, the Company invested $7,498,343 in available-for-sale securities and $1,264,342 in equipment and tenant improvements related to the Company's pilot plant manufacturing facility. The Company invested $193,012 in 1996, $36,311 in 1995 and $22,820 in 1994 in lab equipment, computer equipment and software and furniture used primarily to support the Company's operations.
The Company's five-year operating lease for manufacturing equipment requires future annual minimum payments of approximately $140,000 (see Note 8 of the Notes to the Financial Statements).
The Company anticipates that its existing resources and interest thereon will be sufficient to satisfy its anticipated cash requirements through approximately the first quarter of 1998.* The Company's working capital and capital requirements will depend upon numerous factors, including the progress of the Company's clinical trials and research and development programs and the timing of and cost of obtaining regulatory approvals. The Company's capital requirements also will depend on the levels of resources devoted to the development of manufacturing and marketing capabilities, technological advances, the status of competitive products and the ability of the Company to establish strategic alliances to provide research and development funding to the Company.
The Company expects to incur substantial additional research and development and other costs, including costs related to clinical studies, as well as capital expenditures necessary to obtain licensure of the existing GMP pilot plant facility and to establish additional commercial scale GMP manufacturing facilities. The Company will need to raise substantial additional funds for longer term product development, manufacturing and marketing activities it plans to undertake in the future. The Company's ability to continue funding its planned operations beyond the first quarter of 1998 is dependent upon its ability to obtain additional funds through equity or debt financing, strategic alliances, license agreements or from other financing sources. A lack of adequate funding could eventually result in the insolvency or bankruptcy of the Company. At a minimum, if adequate
funds are not available, the Company may be required to delay or to eliminate expenditures for certain of its product development efforts or to license to third parties the rights to commercialize products or technologies that the Company would otherwise seek to develop itself. Because of the Company's significant long-term capital requirements, it may seek to raise funds when conditions are favorable, even if it does not have an immediate need for such additional capital at such time. If the Company has not raised funds prior to such time as the Company's needs for funding become immediate, the Company may be forced to raise funds when conditions are unfavorable which could result in dilution to the Company's current stockholders.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company are included in Appendix A to this Annual Report on Form 10-K beginning on page 33.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by reference is the information appearing under the headings "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance", pages 5 to 7 and 16 in the Company's Proxy Statement dated March 28, 1997. See also Part I hereof under the heading "Item X. Executive Officers of Registrant".
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference is the information appearing under the headings "Report of the Compensation Committee", "Executive Compensation" and "Comparative Stock Performance", pages 8 to 15 in the Company's Proxy Statement dated March 28, 1997.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference is the information appearing under the heading "Security Ownership of Principal Stockholders and Management", pages 3 to 4 in the Company's Proxy Statement dated March 28, 1997.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference is the information appearing under the headings "Executive Compensation -- Compensation Committee Interlocks and Insider Participation" and "Certain Relationships and Related Transactions", pages 14 and 16 to 18 in the Company's Proxy Statement dated March 28, 1997.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. Financial Statements:
Report of Independent Auditors
Balance Sheets as of December 31, 1996 and 1995
Statements of Operations for the years ended December 31, 1996, 1995 and 1994
Statement of Changes in Stockholders' Equity (Deficiency) for the years ended December 31, 1996, 1995 and 1994
Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994
Notes to Financial Statements
2. Financial Statement Schedules:
Financial statement schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the fourth quarter of the year ended December 31, 1996.
(c) Exhibits:
The following exhibits are filed as part of this Annual Report on Form 10-K for the year ended December 31, 1996.
___________________________ (1) Incorporated herein by reference to the same numbered Exhibit to the Company's Registration Statement on Form S-1 (Registration No. 333-1032).
(2) Incorporated herein by reference to the same numbered Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1996 (File No. 0-27976).
(3) Incorporated herein by reference to the same numbered Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1996 (File No. 0-27976).
* Management contract or compensation plan or arrangement required to be filed as an exhibit to this Form 10-K.
# Contains portions for which confidential treatment has been granted to the Company.
+ Contains portions for which confidential treatment has been requested by the Company.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, on March 26, 1997.
GALAGEN INC.
By /s/ Robert A. Hoerr ------------------------------------- Robert A. Hoerr, M.D., Ph.D. Chief Executive Officer and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 26, 1997.
/s/ Robert A. Hoerr ------------------------------------- Robert A. Hoerr, Chief Executive Officer and President (Principal Executive Officer) and Director
/s/ Gregg A. Waldon ------------------------------------- Gregg A. Waldon, Vice President, Chief Financial Officer, Treasurer and Secretary (Principal Financial Officer and Principal Accounting Officer)
/s/ Arthur J. Benvenuto ------------------------------------- Arthur J. Benvenuto, Director
/s/ Arthur D. Collins, Jr. ------------------------------------- Arthur D. Collins, Jr., Director
/s/ Stanley Falkow ------------------------------------- Stanley Falkow, Director
/s/ Ronald O. Ostby ------------------------------------- Ronald O. Ostby, Director
/s/ John Pappajohn ------------------------------------- John Pappajohn, Director
/s/ R. David Spreng ------------------------------------- R. David Spreng, Director
/s/ Winston R. Wallin ------------------------------------- Winston R. Wallin, Director
(This page intentionally left blank.)
APPENDIX A
PAGE ----
Report of Independent Auditors ......................................... 34 Balance Sheets ......................................................... 35 Statements of Operations ............................................... 37 Statement of Changes in Stockholders' Equity (Deficiency) .............. 38 Statements of Cash Flows ............................................... 42 Notes to Financial Statements .......................................... 43
REPORT OF INDEPENDENT AUDITORS
Board of Directors GalaGen Inc.
We have audited the accompanying balance sheets of GalaGen Inc. (a development stage company) as of December 31, 1996, and 1995, and the related statements of operations, changes in stockholders' equity (deficiency) and cash flows for each of the three years in the period ended December 31, 1996, and for the period from November 17, 1987, (inception) to December 31, 1996. These financial statements are the responsibility of GalaGen'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 GalaGen Inc. at December 31, 1996 and 1995 and the results of its operations and cash flows for each of the three years in the period ended December 31, 1996 and for the period from November 17, 1987, (inception) to December 31, 1996, in conformity with generally accepted accounting principles.
Ernst & Young LLP
Minneapolis, Minnesota January 31, 1997
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
BALANCE SHEETS
ASSETS
DECEMBER 31 ----------------------- 1996 1995 ----------- --------- Current assets: Cash and cash equivalents . . . . . . . . . . . $ 3,869,549 $ 509,339 Available-for-sale securities . . . . . . . . . 7,498,343 - Prepaid expenses . . . . . . . . . . . . . . . 87,274 81,703 ----------- --------- Total current assets . . . . . . . . . . . . . . 11,455,166 591,042
Property, plant and equipment . . . . . . . . . . 1,687,838 230,484 Less accumulated depreciation . . . . . . . . . (195,483) (149,783) ----------- --------- 1,492,355 80,701
Deferred financing expenses . . . . . . . . . . . 11,944 146,487 ----------- ---------
Total assets . . . . . . . . . . . . . . . . . . $12,959,465 $ 818,230 ----------- --------- ----------- ---------
See accompanying notes.
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
BALANCE SHEETS (CONTINUED)
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
See accompanying notes.
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF OPERATIONS
See accompanying notes.
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY)
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY(DEFICIENCY) (CONTINUED)
See accompanying notes.
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF CASH FLOWS
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
GalaGen Inc. is developing oral therapeutics to treat and prevent a broad range of human gastrointestinal ("GI") diseases. Using its proprietary processes, the Company has produced polyclonal antibodies that target specific pathogens infecting the human GI tract, including bacteria and their toxins, parasites, fungi and viruses. These polyclonal antibodies are derived from bovine colostrum, the milk collected in the first few milkings of a dairy cow after its calf is born. When polyclonal antibodies are administered orally to humans, they can provide passive immunity within the GI tract. The Company believes that its pharmaceutical products could offer an attractive therapeutic alternative to traditional antibiotics at a time when increasing antibiotic resistance and emerging new pathogens are becoming more prevalent.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH EQUIVALENTS
Cash equivalents include short-term highly liquid investments purchased at cost, which approximates market, with original maturities of three months or less.
INVESTMENTS
Investments in debt securities with a remaining maturity of more than three months at the date of purchase are classified as marketable securities. Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Debt securities are classified as available-for-sale as of December 31, 1996. The book value of the investments approximates their estimated market value. The estimated market value of investments by security type are as follows:
Estimated Market Value Security Type As of December 31, 1996 ------------- ----------------------- Corporate debt securities $ 2,686,131 U.S. Government securities 2,012,987 U.S. Treasury securities 2,602,968 Investment grade debt securities 196,257 ------------ $ 7,498,343 ------------ ------------
All investments have a contractual maturity of one year or less.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost and depreciated primarily on a straight-line basis over their estimated useful lives of three to seven years.
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
At December 31, 1996, construction in progress consisted of leasehold improvements and manufacturing equipment in connection with the Company's pilot plant manufacturing facility. The Company anticipates transferring the construction in progress to its respective asset account and beginning depreciation in the second quarter of 1997 when the Company expects the pilot plant manufacturing facility to be ready for validation. At December 31, 1996 and 1995, property, plant and equipment consisted of the following:
1996 1995 ---------- ---------- Furniture, fixtures and equipment $ 423,496 $ 230,484 Construction in progress 1,264,342 - ---------- ---------- 1,687,838 230,484 Less accumulated depreciation (195,483) (149,783) ---------- ---------- $1,492,355 $ 80,701 ---------- ---------- ---------- ----------
RESEARCH AND DEVELOPMENT COSTS
All research and development costs are charged to operations as incurred.
INCOME TAXES
Income taxes are accounted for using the liability method. Deferred income taxes are provided for temporary differences between financial reporting and tax bases of assets and liabilities.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of shares of common stock outstanding during the periods presented. Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 83 ("SAB No. 83"), the fully diluted shares of common stock outstanding for the periods ended 1995 and 1994 have been calculated as the sum of the number of primary shares of common stock outstanding, the number of shares convertible into common stock upon the conversion of securities issued by the Company at conversion prices less than the initial public offering (the "Offering") price, using the treasury stock method, during the 12 months immediately preceding the Offering which closed on April 1, 1996 and the number of shares covered by stock options and warrants granted at exercise prices less than the Offering price during the same period.
STOCK BASED COMPENSATION
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK BASED COMPENSATION ("Statement 123"), but applies Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25"), and related interpretations in accounting for its stock plans. Under APB 25, when the exercise price of stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. MERGER
In March 1992, GalaGen was incorporated as a wholly-owned subsidiary of its predecessor, Procor Technologies, Inc.("Procor"), a wholly-owned subsidiary of Land O'Lakes Inc. ("Land O'Lakes"), and issued 270 shares of its $.01 par value common stock to Procor for $1.23 per share. In May 1992, GalaGen sold 941,148 shares of its common stock to certain outside investors and future officers, directors, and advisors of GalaGen for $1.23 per share. Effective July 24, 1992, GalaGen was merged with Procor and GalaGen was the surviving entity. As part of this merger, the 13,541 shares of Procor's common stock held by Land O'Lakes were converted into 812,502 shares of $.01 par value common stock of GalaGen. Additionally, the 270 shares of common stock of GalaGen issued to Procor were canceled and $7,127,720 of inter-company obligations owed to Land O'Lakes were forgiven and recorded as contributed capital.
4. RELATED PARTY TRANSACTIONS
During 1992, the Company entered into the following agreements with Land O'Lakes:
PURCHASE AND SALE OF ASSETS AGREEMENT
Land O'Lakes purchased from the Company all equipment, inventory, and certain other assets and assumed all current liabilities at book value, which approximated $1,636,000. The purchase price was paid by crediting against other indebtedness owed by the Company to Land O'Lakes.
ROYALTY AGREEMENT
The Company will pay to Land O'Lakes a royalty on net receipts from any product, other than infant formula, which is based on existing technology or technology improvements, as defined by the agreement. The Company will pay an additional royalty on net receipts from infant formula based on existing or improved technology and an additional royalty on net receipts from infant formula based on new technology, as defined by the agreement. This agreement will continue until terminated by both parties. Royalty payments range from one to two percent of net receipts.
LICENSE AGREEMENT
The Company has licensed to Land O'Lakes the rights to use the Company's existing technologies and technology improvements, as defined by the agreement, for Land O'Lakes' use in animal products, functional foods and infant formula. The Company received a lump sum license fee. The Company has agreed not to compete for fifteen years in the area of animal products and functional foods based on milk and colostrum based immunoglobulin technology. Land O'Lakes has agreed not to compete for fifteen years in the areas of prescription drugs and over-the-counter drugs regulated by the Food and Drug Administration. The term of this agreement is perpetual.
SUPPLY AGREEMENT
The Company has entered into an agreement with Land O'Lakes whereby the Company will purchase and Land O'Lakes will supply, at their option, all of the Company's commercial requirements for colostrum and milk. As part of this agreement, Land O'Lakes will provide expertise in dairy herd selection, on-farm management,
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
membership relations and procurement to the Company for the manufacture of antibody material. The agreement will last for ten years and Land O'Lakes, at its sole discretion, has the option to extend the agreement for an additional ten years.
MASTER SERVICES AGREEMENT
The Company has entered into an agreement with Land O'Lakes whereby the Company may purchase services from Land O'Lakes for certain administrative and research and development activities. This agreement will enable the Company to access expertise, on an as-needed basis, from Land O'Lakes. The agreement terminated on December 31, 1992 but has been renewed annually and is currently extended through December 31, 1997. The Company was charged approximately $682,000, $641,000 and $549,000 in 1996, 1995 and 1994, respectively, in accordance with the Master Services Agreement.
STRATEGIC ALLIANCE LETTER OF INTENT
The Company and Land O'Lakes have entered into a letter of intent for good faith discussions designed to lead to a definitive agreement regarding a strategic alliance to provide research, development, regulatory and product support, manufacturing, marketing, sales and distribution for certain functional food products.
PROMISSORY NOTE
The Company issued a promissory note to Land O'Lakes for $4,000,000 as part of the merger. This note had an interest rate of five percent and was due December 31, 1992. Payment of $3,000,000 plus accrued interest of $43,333 was made upon the sale of the Series A preferred stock. Land O'Lakes extended the remaining $1,000,000 note for consideration of $100,000. The $1,000,000, accrued interest of $50,959 and the $100,000 extension fee were paid in 1993.
Subsequent to 1992, the Company has entered into other related party agreements as noted below:
In 1995 and 1993, former officers of the Company exercised vested options to purchase the Company's common stock by issuing notes receivable to the Company for $43,333 and $18,333, respectively. These notes have subsequently been repaid.
In October 1993, the Company borrowed $1,000,000 from a lending institution under a line of credit. This line of credit had a variable interest rate of 6% at December 31, 1993. A director and an investor guaranteed this line of credit in return for two five year warrants to purchase 20,312 shares of the Company's common stock. This line of credit has subsequently been repaid by the Company and the line of credit terminated. See Note 7.
In 1993, certain investment funds controlled by Investment Advisers, Inc. ("IAI"), which has a representative serving on the board of directors of the Company, purchased preferred stock in two private placement transactions by the Company. In March 1993, funds controlled by IAI purchased 769,230 shares of Series B preferred stock at $3.25 per share. In December 1993, funds controlled by IAI purchased 150,000 shares of Series C preferred stock at $5.00 per share. See Note 6.
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Land O'Lakes, IAI, a director and a private foundation controlled by a director purchased Convertible Promissory Notes in the principal amounts of $1,450,000, $1,080,000, $740,000 and $100,000, respectively. Each of these note holders also received a five year warrant, exercisable at $11.07 per share on a post-split basis, to purchase that number of shares of common stock equal to 20% of the principal amount of such holder's Convertible Promissory Note divided by $11.07. See Notes 6 and 7.
In December 1995 and January 1996, Land O'Lakes, a director and certain investment funds controlled by IAI purchased 169,230, 46,154 and 76,923 shares, respectively, of Series E preferred stock at $3.35 per share. See Note 6.
In January 1996, the Company entered into a $2.7 million line of credit agreement with a commercial bank, which expired with the closing of the Company's Offering. Loans under this line of credit were to be guaranteed by six parties and the guarantee was collateralized by letters of credit posted by them in the aggregate amount of $2.7 million. In consideration for the guarantees and letters of credit posted by these parties, the Company issued warrants to purchase an initial aggregate of 162,011 shares of common stock at $7.00 per share. In connection with this transaction a director and Land O'Lakes each guaranteed $500,000 of the $2.7 million line of credit, and in exchange received a warrant to purchase 30,002 shares of common stock at $7.00 per share. See Note 7.
In January 1996, the Company issued two convertible promissory notes for $375,000 and $125,000 to two investment funds controlled by IAI. The notes became due on completion of the Offering. The notes were convertible into Series E preferred stock at the option of the holder. In connection with these notes, the Company issued warrants to purchase 30,001 shares which are identical to the line of credit warrants described above. The notes have been repaid.
In June 1996, the Company entered into a five-year lease agreement with Land O' Lakes for specified space within the Land O' Lakes facility in connection with the Company's pilot plant manufacturing facility. See Note 8.
In December 1996, the Company entered into an equipment operating lease which was guaranteed by Land O'Lakes. See Note 8.
5. REVERSE STOCK SPLIT
On January 19, 1996, the Board approved a reverse stock split of 3.6923-for-1 for the Company's outstanding common stock. The Company's stockholders approved this reverse stock split in March 1996. Certain information in the financial statements with respect to the common stock and to the conversion prices and ratios of the preferred stock have been adjusted to reflect this change. The reverse stock split had no effect upon the numbers of shares of preferred stock issued and outstanding (as opposed to the conversion prices of the preferred stock and the numbers of shares of common stock into which the preferred stock converted).
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. STOCK
INITIAL PUBLIC OFFERING
GalaGen Inc. consummated the Offering on April 1, 1996, which consisted of 2,000,000 shares of common stock at a $10 per share price to the public. All of the Company's preferred stock mandatorily converted into common stock immediately prior to the closing of the Offering as described below.
SERIES A PREFERRED STOCK
On July 24, 1992, the Company issued 2,500,000 shares of Series A preferred stock to investors at $2.00 per share, net of legal and accounting fees of $42,000. The Series A preferred stock had certain voting and registration rights, was converted into common stock on a one-for-one basis and had preference over common stock upon liquidation.
SERIES B PREFERRED STOCK
On March 1, 1993, the Company issued 1,234,748 shares of Series B preferred stock at $3.25 per share, net of legal and accounting fees of $18,460. Shares of Series B preferred stock had certain voting and registration rights, were converted into common stock as described below and had preference over common stock in liquidation.
SERIES C PREFERRED STOCK
On December 1, 1993 and March 1, 1994, the Company issued 539,000 shares and 12,000 shares, respectively, of Series C preferred stock to investors at $5.00 per share, net of legal and accounting fees of $30,795 and commissions of $108,000. The Series C preferred stock had certain voting and registration rights, was converted into common stock as described below and had preference over common stock upon liquidation.
SERIES D PREFERRED STOCK (CONVERTIBLE PROMISSORY NOTES)
From June 1994 to October 1995, the Company sold $8,275,000 of Convertible Promissory Notes (the "Notes") to investors. The Notes bore interest at 6.5% per annum and the principal and interest converted into Series D preferred stock. The Notes were secured by all tangible and intangible assets of the Company and were due June 1998. Shares of Series D preferred stock had certain voting and registration rights, were converted into common stock as described below and had preference over common stock in liquidation.
SERIES E PREFERRED STOCK
In December 1995, the Company issued 338,461 shares of Series E preferred stock at $3.25 per share, net of legal and accounting fees of $23,610, for cash proceeds of $676,387 and the conversion of approximately $400,000 of liabilities. In January 1996 the Company issued an additional 46,154 shares of Series E preferred stock at $3.25 per share for cash proceeds of $150,000. The Series E preferred stock had certain voting and registration rights, was converted into common stock as described below, and had preference over common stock in liquidation.
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SERIES F PREFERRED STOCK
In March 1995, the Company authorized 217,143 shares be reserved for a Series F preferred stock, convertible into the Company's common stock at 1.354 shares of common stock for each share of preferred stock, designating 34,287 shares as Series, 42,856 as Series, and 140,000 as Series. Also in March 1995, the Company issued 17,143 shares of Series preferred stock at $17.50 per share in exchange for a grant of exclusive use of certain technology. In March 1996, the Company issued an additional 17,144 shares of Series preferred stock at $17.50 per share for net proceeds of $300,020. Shares of Series F preferred stock had certain voting and registration rights, were converted into common stock as described below and had preference over common stock in liquidation. See Notes 7 and 10.
AUTHORIZED SHARES
In February 1995, the Company increased the authorized shares reserved for the Series D preferred stock from 2,200,000 to 3,600,000 and decreased the authorized shares reserved for the Series E preferred stock from 2,500,000 to 1,500,000. In November 1995, the Company increased the authorized shares reserved for the Series E preferred stock from 1,500,000 to 5,000,000. On or before March 20, 1996, the stockholders of the Company approved by written consent the authorization of 15,000,000 shares of preferred stock which was effective upon the closing of the Company's Offering.
REDUCTION IN CONVERSION PRICE AND REVERSE STOCK SPLIT
SERIES A PREFERRED STOCK:
The effect of the reverse stock split on the stock price of the Series A preferred stock was to change the conversion price of the Series A preferred stock from $2.00 per share to $7.38 per share and to change the conversion ratio from one share of common stock for each share of Series A preferred stock to 0.271 shares of common stock for each share of Series A preferred stock. All Series A preferred stock was converted into 677,063 shares of common stock upon the closing of the Offering.
SERIES B PREFERRED STOCK AND SERIES C PREFERRED STOCK:
In March 1994, in order to induce certain of the existing holders of the Series B and Series C preferred stock to purchase the Notes, the Company's Board of Directors voted to reduce the conversion price of the Series B preferred stock from $3.25 to $2.00 and the Series C preferred stock from $5.00 to $3.00. The effect of the reductions was to change the conversion ratio of the Series B preferred stock from one share of common stock for each share of Series B preferred stock to 1.625 shares of common stock for each share of Series B preferred stock, and to change the conversion ratio of the Series C preferred stock from one share of common stock for each share of Series C preferred stock to 1.667 shares of common stock for each share of Series C preferred stock.
The effect of the reverse stock split on the stock price of the Series B and Series C preferred stock, after the conversion price adjustment described above, was to change the conversion price of the Series B preferred stock from $2.00 per share to $7.38 per share and to change the conversion price of the Series C preferred stock from $3.00 per share to $11.07 per share. The effect of the reverse stock split on the conversion ratio, after the conversion price adjustment described above, is to change the conversion ratio of the Series B preferred stock from 1.625 shares of common stock for each share of Series B preferred stock to 0.440 shares of common stock
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
for each share of Series B preferred stock, and to change the conversion ratio of the Series C preferred stock from 1.667 shares of common stock for each share of Series C preferred stock to 0.451 shares of common stock for each share of Series C preferred stock. All Series B and Series C preferred stock were converted into 543,413 and 248,758 shares, respectively, of common stock upon the closing of the Offering.
SERIES D PREFERRED STOCK (CONVERTIBLE PROMISSORY NOTES), SERIES E PREFERRED STOCK AND SERIES PREFERRED STOCK:
On a pre-split basis, the conversion ratio of the Series D preferred stock, Series E preferred stock and Series preferred stock into common stock were, by their terms, automatically adjusted to reflect the lower of the currently effective conversion price of $3.00 per share of Series D preferred stock and $3.25 per share of Series E preferred stock and Series preferred stock or 70% of the Offering price.
The effect of the reverse stock split on the conversion price of the Series D, Series E and Series preferred stock was to change the conversion price of the Series D preferred stock to $11.07 per share and to change the conversion price of the Series E and F preferred stock to $12.00 per share or to 70% of the Offering price, whichever is lowest. Because the Offering price was $10.00 per share, the Series D, Series E and Series preferred stock converted into common stock at $7.00 per share. On a post-split basis, the effect of these reductions is to change the conversion ratio of 0.271 shares of common stock for each share of Series D preferred stock to 0.429 shares of common stock for each share of Series D preferred stock, to change the conversion ratio of 0.271 shares of common stock for each share of Series E preferred stock to 0.464 shares of common stock for each share of Series E preferred stock, and to change the conversion ratio of 1.458 shares of common stock for each share of Series preferred stock to 2.50 shares of common stock for each share of Series preferred stock. These reductions in the conversion prices of the Series D, Series E and Series preferred stock from $11.07, $12.00 and $12.00 per share, respectively, to $7.00 per share was valued at $7,296,844 and recorded as a preferred stock dividend to arrive at the net loss available to holders of common stock in the calculation of net loss per share. All Series D, Series E and Series preferred stock was converted into 1,434,495, 178,568 and 85,717 shares, respectively, of common stock upon the closing of the Offering.
EMPLOYEE STOCK PURCHASE PLAN
In March 1996, the Company adopted the Employee Stock Purchase Plan whereby 270,833 shares of common stock have been reserved. All employees who have met the service eligibility requirements are eligible to participate and may direct the Company to make payroll deductions of one to 10 percent of their compensation during a purchase period for the purchase of shares under the plan. Participants may purchase up to 5,000 shares of common stock for a given purchase period provided the fair market value of the stock is not more than $25,000 (determined at the beginning of each purchase period). The plan provides a participating employee the right, subject to certain limitations, to purchase the Company's common stock at a price equal to the lower of 85% of the fair market value of the Company's common stock on the first day, or the last day, of the applicable purchase period. The first purchase commenced on July 1, 1996 and ended on December 31, 1996, of which 3,642 shares of common stock were issued to employees for $13,548. Subsequent purchase periods will run for twelve months beginning on January 1.
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. OPTIONS AND WARRANTS
STOCK OPTION PLAN
The Company has established a 1992 stock option plan (the "1992 Plan") under which both incentive and non-qualified options may be granted and which it uses as an incentive for employees, directors and technical advisors. Options are granted at fair market value as determined on the date of grant and normally vest over three to five years.
The following plan and non-plan options are outstanding at December 31, 1996: 1992 PLAN NON-1992 WEIGHTED OPTIONS 1992 PLAN PLAN AVERAGE AVAILABLE OPTIONS OPTIONS OPTION FOR GRANT OUTSTANDING OUTSTANDING PRICE ---------- ----------- ----------- ------ Balance at December 31, 1993. . 282,412 366,234 27,082 $2.47 Granted. . . . . . . . . . . . (126,073) 126,073 13,541 7.38 Exercised. . . . . . . . . . . - (100,886) - 1.26 Canceled . . . . . . . . . . . 37,579 (37,579) (13,541) 11.32 -------- -------- ------- Balance at December 31, 1994. . 193,918 353,842 27,082 4.86 Shares reserved. . . . . . . . 203,144 - - Granted. . . . . . . . . . . . (272,076) 272,076 140,830 6.66 Exercised. . . . . . . . . . . - (36,684) - 1.25 Canceled . . . . . . . . . . . 238,101 (238,101) (13,541) 6.97 -------- -------- ------- Balance at December 31, 1995. . 363,087 351,133 154,371 5.67 Granted. . . . . . . . . . . . (477,476) 477,476 57,003 4.68 Exercised. . . . . . . . . . . - (39,902) - 1.66 Canceled . . . . . . . . . . . 118,479 (118,479) (25,730) 7.36 -------- -------- ------- Balance at December 31, 1996. . 4,090 670,228 185,644 $4.74 -------- -------- ------- -------- -------- -------
The following table summarizes information about the stock options outstanding at December 31, 1996:
Options expire in five years and three months to ten years from the grant date. Fully vested and exercisable options were 189,986, 161,426 and 150,105 as of December 31, 1996, 1995 and 1994, respectively. The weighted average exercise prices for the fully vested and exercisable options as of December 31, 1996 and 1995 were $3.80 and $2.63, respectively.
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Additionally, the Company granted 358,300 options under a proposed 1997 Stock Plan (the "Proposed Plan"), pending stockholder approval in May 1997. Total shares available under the Proposed Plan are 1,250,000. Options under the Proposed Plan were granted at fair market value, vest over three to five years and expire in ten years.
WARRANTS
In January 1993, the Company granted a warrant to purchase 13,541 shares of the Company's common stock at $12.00 per share to an investment banking firm for financial advisory services. This warrant expires May 1998.
In June 1993, the Company granted a warrant to purchase 9,479 shares of the Company's common stock at $.18 per share to a contract research organization for services rendered in 1993. Expense was recorded for the difference between the exercise price and fair market value of the common stock, as determined by the Board of Directors. This warrant expires December 1998.
In October 1993, the Company granted a warrant to purchase 20,312 shares of the Company's common stock at $18.46 per share to each of a board member and an investor in return for their guarantee for the Company's line of credit. These warrants expire October 1998.
In connection with the Notes issuance of $8,275,000, each Note holder received a warrant, exercisable at $11.07 per share, to purchase that number of shares of common stock equal to 20% of the principal amount of such holder's Note divided by $11.07. The Company granted warrants to purchase 149,384 shares of the Company's common stock. These warrants expire five years from the date of grant, which range from June 1999 to October 2000.
In March 1995, Chiron was issued warrants to purchase 200,000 shares of the Company's Series F preferred stock for which the Company was paid $150,000. The Company issued the warrants to purchase 200,000 shares of Series F preferred stock to Chiron as follows: (i) warrant to purchase 17,144 shares of Series preferred stock, exercise price of $17.50 per share (pre-Offering) or $24.00 per share (post-Offering); (ii) warrant to purchase 42,856 shares of Series preferred stock, exercise price of $18.70 per share (pre-Offering) or $27.00 per share (post-Offering); (iii) warrant to purchase 60,000 shares of Series preferred stock, exercise price of $25.00 per share (pre-Offering) or $33.00 per share (post-Offering); and (iv) warrant to purchase 80,000 shares of Series preferred stock, exercise price of $25.00 per share (pre-Offering) or $36.00 per share (post-Offering). If, after the Company's Offering, the market value (as defined in the purchase agreement for the warrants) of a share of common stock is less than the stated post-Offering exercise price of any such warrant, the exercise price is reduced to such per share market value and the number of shares of common stock covered by the warrant are increased proportionately. Based upon the warrant agreements, the ceiling price for the warrants described in clauses (ii), (iii) and (iv) above were set at the closing of the Offering at $10.11, $9.24 and $10.08, respectively, per share of common stock. Chiron exercised the warrant described in clause (i) above in March 1996 which converted into 42,860 shares of common stock at the closing of the Company's Offering. Assuming the remaining three warrants were exercised in full on December 31, 1996, 1,355,203 shares of the Company's common stock would have been issued upon such exercise based upon the twenty day average of the average of the high and low closing market price, as reported by Nasdaq National Market, prior to December 31, 1996 of $4.44 per share. The warrants expire on the earlier of six years from the date of issuance or 120 days after the warrant holder receives notice from the Company of the occurrence of certain defined milestone events. See Note 10.
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
In January 1996, the Company granted warrants to purchase 162,011 shares of common stock at $7.00 per share to six parties, one of whom is a Board member who received a warrant to purchase 30,002 shares of common stock and one of which is a company which has a representative on the Company's Board which received a warrant to purchase 30,002 shares of common stock, in return for their guarantee on the Company's $2.7 million line of credit. The Company also granted warrants to purchase 7,500 and 22,501 shares of the Company's common stock at $7.00 per share to certain investment funds associated with a representative on the Company's Board in return for their issuance of two convertible promissory notes totaling $500,000. These warrants expire February 2001. The difference between the Offering price and exercise price of these warrants multiplied by the number of warrants, plus the intrinsic value of the warrants was $768,064 which was recorded as interest expense in 1996.
STOCK OPTION AND WARRANT AGREEMENT REVISIONS
In March 1994, the Company canceled all common stock option and warrant agreements that were issued in 1993 that had exercise prices of $12.00 per share and $18.46 per share and issued new stock option and warrant agreements with the same terms and conditions except that the grant prices were $7.38 per share and $11.07 per share, respectively.
In August 1996, the Company canceled all common stock option agreements, totaling 57,715 shares of common stock under the Plan and 18,958 shares of common stock outside of the Plan, with the exception of officer and director options, that were issued with a grant price greater than the fair market value at the date of re-grant and issued new stock option agreements with the same terms and conditions except that the grant prices were $5.375 per share.
STOCK-BASED COMPENSATION
The Company has elected to follow APB 25 and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under Statement 123, requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, if the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
Pro forma information regarding net loss and loss per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of Statement 123. The fair value for these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions for 1996 and 1995: risk-free interest rates approximating 6.2%; volatility factor of the expected market price of the Company's common stock of .527 and a weighted-average expected life of the option of 5 years.
The Black-Scholes option valuation 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 valuation models require the input of highly subjective assumptions. 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 may not necessarily provide a reliable single measure of the fair value of its employee stock options.
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information is as follows:
The pro forma effect on net loss for 1996 and 1995 is not representative of the pro forma effect on net loss in future years because it does not take into consideration pro forma compensation expense related to grants made prior to 1995.
DEFERRED COMPENSATION
In December 1995, the Company canceled certain stock option agreements within the Plan and certain stock options that were outside of the Plan that had grant prices ranging from $7.38 per share to $11.07 per share and issued new stock option agreements with the same terms and conditions except that the grant prices were $3.69 per share. The Company recorded $1,657,000 as deferred compensation for the difference between the new grant price per share of common stock and the fair market value of the common stock per share on the date of grant, as determined by the board of directors, multiplied by the total number of options effected. In December 1996, the Company adjusted the deferred compensation balance to $1,395,800 to account for terminated employee options that were not vested. The deferred compensation is amortized ratably over the vesting period of the options. In 1996 and 1995, $340,066 and $476,266 was amortized, respectively.
The remaining deferred compensation is expected to be amortized as follows:
1997........................................... $ 273,868 1998........................................... 207,200 1999........................................... 96,400 2000........................................... 2,000 ---------- $ 579,468 ---------- ----------
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. COMMITMENTS
The Company has commitments under the following agreements:
RESEARCH
A one year research program agreement with Institut Pasteur which began in 1993 for specified research assistance and the right to certain future technology emerging from the collaboration. This agreement will automatically renew each year unless terminated by either party.
A one year agreement with the University of Minnesota for specified research assistance and laboratory space that began in 1996.
A one year research agreement with the University of Minnesota for product development assistance that began in 1996.
A one year research agreement, and associated consulting agreement, that began in 1996 with the Ohio State University Research Foundation for specified research assistance.
The above agreements require total minimum payments of approximately $77,000 in 1997.
CLINICAL
The Company entered into a clinical trial agreement with a European entity in October 1995. This agreement requires payment over the length of the clinical trial, which is anticipated to be completed in 1997.
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The Company entered into a clinical trial agreement with a contract research organization in January 1996. This agreement requires payment over the length of the clinical trial which is anticipated to be completed in 1997.
In conjunction with the clinical trial described immediately above, the Company has entered into a core lab agreement for analytical testing, which is anticipated to be completed in 1997.
In 1996 the Company entered into a clinical trial agreement with an institutional clinical trial unit. The agreement calls for payment over the term of the trial which is anticipated to be complete in 1997.
These agreements require minimum payments of approximately $600,000 in 1997.
OTHER
A five year service agreement that began in 1996 for specified raw material preparation assistance.
The Company entered into an exclusive five year supply agreement in October 1996 for one of its raw materials.
The Company entered into employment agreements with two employees in 1996.
The above agreements require minimum payments of approximately $299,000, $24,000 and $24,000 in 1997, 1998 and 1999, respectively.
LICENSE AGREEMENTS
In March 1993, Nestec, an affiliate of Nestle' Ltd., granted a license to the Company, including the right to grant sublicenses, relating to the production and use of bovine anti-rotavirus and anti-E. Coli antibodies derived from milk and colostrum for therapeutic and prophylactic applications. The license is exclusive in North America and semi-exclusive in the rest of the world and obligates the Company to pay royalties on products incorporating the licensed technology.
In September 1993, Institut Pasteur granted the Company an exclusive worldwide license to certain applications relating to human passive immunity. Conversely, the Company granted Institut Pasteur an exclusive worldwide license relating to certain technology regarding active immunity. Both license agreements expire upon the earlier of ten years from the date of the first commercial sale arising out of the use of these certain technologies or upon the expiration of the last to issue licensed patent on a country-by-country basis.
In July 1994, the Company entered into a non-exclusive license agreement with Wisconsin Alumni Research Foundation, including the right to sublicense, relating to proteins extracted from certain mammals. The initial payment for the license has been expensed as research and development. The Company will pay a royalty on certain future sales.
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
In March 1995, the United States Department of Agriculture granted the Company an exclusive worldwide license, including the right to sublicense, for certain technology generating or containing antibodies to a certain disease indication. The Company paid a onetime $25,000 license fee in 1995 and must pay an annual maintenance fee of $10,000 and royalty fees depending upon certain net sales as defined. The Company may terminate this agreement any time upon 90 days written notice.
The royalties on the above agreements range from one to four percent of certain net sales.
LEASE COMMITMENTS
The Company leases certain office equipment under operating leases.
During June 1996, the Company entered into a five year lease agreement with Land O' Lakes for specified space within the Land O' Lakes facility in connection with the Company's pilot plant manufacturing facility. The lease calls for annual payments of approximately $87,000 and can be extended for additional one year periods at the option of the Company.
In December 1996, the Company entered into an operating lease with Cargill Leasing Corporation for $835,393 of manufacturing equipment for the Company's pilot plant facility. Lease payments of $10,990 per month plus tax will continue for a period of seven years with the Company's option to extend for an additional 12 months. The rental percentage was computed on a weighted average of the 30 day LIBOR rate and the rate on five year U.S. Treasury Notes. The lease is guaranteed by Land O' Lakes.
The total lease expense was $3,133, $9,547 and $29,674 respectively, for the years ended December 31, 1996, 1995, and 1994. The future minimum annual lease payments are as follows:
1997................ $ 231,000 1998................ 230,000 1999................ 227,000 2000................ 227,000 2001................ 184,000 Thereafter.......... 281,000 ---------- $1,380,000 ---------- ----------
9. INCOME TAXES
Prior to the effective date of the merger with Procor, GalaGen's losses were utilized by Land O'Lakes in its consolidated tax return. Subsequent to the effective date of the merger and through December 31, 1996, GalaGen has operating loss carryforwards to offset future taxable income of approximately $27,650,000 which begin to expire in 2007. No benefit has been recorded for such loss carryforwards, and utilization in future years may be limited, if significant ownership changes have occurred.
GALAGEN INC. (A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Components of deferred tax assets are as follows:
DECEMBER 31 ------------------------------------------ 1996 1995 1994 ------------ ----------- ------------ Loss carryforwards $ 10,270,000 $ 7,500,000 $ 5,475,000 Less valuation allowance (10,270,000) (7,500,000) (5,475,000) ------------ ----------- ------------ Net deferred tax assets $ -- $ -- $ -- ------------ ----------- ------------ ------------ ----------- ------------
10. AGREEMENTS
In March 1995, the Company entered into a License and Collaboration Agreement with Chiron Corporation involving the licensing of Chiron adjuvant technology and a collaboration to research and develop passive immune therapies using bovine antibodies for certain products. Pursuant to this Agreement, Chiron has granted an exclusive worldwide license for certain of Chiron's proprietary adjuvant technology to the Company for which the Company issued 17,143 shares of its Series preferred stock to Chiron. Additionally, Chiron has been granted certain rights to exclusively market a certain product for which the Company was paid $100,000. See Note 7.
In October 1995, the Company licensed certain rights of certain technology to a worldwide developer and marketer of veterinary products. In return, the Company received an upfront license fee and will receive annual continuation fees and royalty fees based upon third party sales.
11. EXTRAORDINARY ITEM
In July 1995, the Company terminated its fund raising efforts for its wholly-owned subsidiary, Altra Bio Inc., and sold the Corporation to a former officer for the nominal consideration of $1.00. Altra Bio had no book value at the time of the sale and, accordingly, no gain or loss was recognized in the transaction. As part of the terminated fund raising efforts, the Company has negotiated debt reduction settlements with certain research collaborators and a vendor in the aggregate amount of $605,421.
EXHIBIT INDEX
- --------------------------------- (1) Incorporated herein by reference to the same numbered Exhibit to the Company's Registration Statement on Form S-1 (Registration No. 333-1032).
(2) Incorporated herein by reference to the same numbered Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1996 (File No. 0-27976).
(3) Incorporated herein by reference to the same numbered Exhibit to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1996 (File No. 0-27976).
* Management contract or compensation plan or arrangement required to be filed as an exhibit to this Form 10-K.
# Contains portions for which confidential treatment has been granted to the Company.
+ Contains portions for which confidential treatment has been requested by the Company.