NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
NOTE 1. OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
I. Operations
Royce Laboratories, Inc. (the "Company") is a Florida corporation engaged in
developing, manufacturing and marketing generic prescription and
non-prescription drugs in solid dosage form (tablets and capsules). The
Company sells its products primarily to U.S. based drug wholesalers, generic
drug distributors, retail buying groups, managed care organizations and drug
chains.
In October 1991, the Company formed a wholly-owned subsidiary, Royce Research
Group, Inc. ("RRGI") to engage, through a licensing agreement with the
Company, in the development and marketing of five generic prescription drugs
(See Note 9).
II. Summary of significant accounting policies
A summary of the significant accounting policies followed by the Company in
the preparation of the accompanying financial statements is presented below.
(A) Principles of consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiary. All significant intercompany
balances and transactions have been eliminated.
(B) Fair value of financial instruments
The financial instruments included in the Company's balance sheets are cash
and cash equivalents and long-term debt. These instruments were carried at
amounts approximating fair value at December 31, 1995 and 1994. The fair
value of long-term debt was estimated based on future cash flows discounted
at current interest rates available to the Company for instruments with
similar maturities and characteristics.
(C) Concentration of credit risk
The Company is potentially subject to a concentration of credit risk
consisting of its accounts receivable, the entire balance of which is due
from generic drug distributors, wholesalers, retail buying groups, managed
care organizations and drug chains. The Company assesses the financial
strength of its customers and does not require collateral. The Company
maintains reserves for potential losses from uncollectible accounts.
(D) Cash and cash equivalents
Cash on hand, deposits in banks, and money market funds, and other highly
liquid investments with an original maturity of three months or less, are
considered cash and cash equivalents.
THE ACCOMPANYING NOTES ARE AN
INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-6
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(E) Inventory
Inventory is stated at the lower of cost or market. Cost is determined
principally by the first-in, first-out method.
(F) Property and equipment
Property and equipment is stated at cost, less accumulated depreciation and
amortization. Depreciation is computed using the straight-line method over
the estimated useful lives of the assets. Amortization of leasehold
improvements is computed using the straight-line method over the shorter of
the lease term or estimated useful lives of the related assets. Expenditures
for repairs and maintenance are charged to expense as incurred, while
expenditures which extend the useful lives of assets are capitalized.
(G) Income taxes
The Company records income taxes using the liability method. Under this
method, deferred tax assets and liabilities are determined based upon
differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted income tax rates that will be
in effect when the differences are expected to reverse. An allowance is
recorded when it is more likely than not that any or all of a deferred tax
asset will not be realized. The provision for income taxes includes taxes
currently payable plus the net change during the year in deferred tax assets
and liabilities recorded by the Company.
(H) Capital
The Company effected a 1-for-3 reverse stock split in December 1993. All
share amounts referred to in these financial statements and notes have been
adjusted for the stock split.
(I) Revenue recognition
Sales are recorded at the time goods are shipped.
(J) Research and development costs
All research and development costs are expensed as incurred.
(K) Loss per share
Loss per share amounts are computed by dividing net losses by the weighted
average number of shares of common stock outstanding during each of the
periods. Warrants, options and other common stock equivalents have not been
included in the calculation of loss per share because their effect would be
antidilutive.
(L) Reclassifications
Beginning in 1995, volume rebates awarded to customers have been recorded in
net sales. Prior to 1995, such rebates were recorded in selling expenses.
Prior year financial statements have been reclassified to reflect this
change. The effect of this reclassification was to decrease net sales and
selling, general and administrative expenses by $380,000 and $91,000 for the
years ended December 31, 1994 and 1993, respectively.
In addition, certain other amounts in the 1993 and 1994 financial statements
have been reclassified to conform to the 1995 presentation.
THE ACCOMPANYING NOTES ARE AN
INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-7
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(M) Stock based compensation
In October 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Account Standards No. 123, Accounting For Stock Based
Compensation ("SFAS 123"). SFAS 123, the disclosure provisions of which must
be implemented for fiscal years beginning subsequent to December 15, 1995,
establishes a fair value based method of accounting for stock based
compensation plans, the effect of which can either be disclosed or recorded.
The Company will adopt the provisions of SFAS 123 in 1996. Upon adoption, the
Company intends to retain the intrinsic value method of accounting for stock
based compensation, which it currently uses.
(N) Management estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
The most significant estimates made by management in the accompanying
financial statements relate to accounts receivable allowances. Actual results
could differ from those estimates.
NOTE 2. INVENTORIES
Inventories consisted of the following (in thousands):
1995 1994
Raw materials $ 2,439 $ 1,426
Work-in-process 783 284
Finished goods 990 339
$ 4,212 $ 2,049
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following (in thousands):
DECEMBER 31, ESTIMATED
----------------------------- USEFUL LIVES
1995 1994 (YEARS)
Leasehold improvements $ 529 $ 216 5 - 10
Machinery and equipment 1,948 1,501 3 - 7
Transportation equipment 17 13 3
Furniture and equipment 435 146 3 - 7
2,929 1,876
Less accumulated depreciation
and amortization ( 1,197) ( 896)
$ 1,732 $ 980
THE ACCOMPANYING NOTES ARE AN
INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-8
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4. LONG-TERM DEBT
Long-term debt consisted of the following (in thousands):
DECEMBER 31,
-----------------------
1995 1994
-------- --------
Notes payable to banks, payable in monthly installments, including
interest at rates ranging from 9.6% to 10.5% per annum for terms
expiring at various dates through March 2000, secured by furniture
and equipment. $ 186 $ 58
Capital lease obligations, net of imputed interest of $16, payable in
monthly installments including interest at imputed rates ranging from
10.8% to 13.0% per annum for terms expiring at various dates
through May 1999, secured by equipment. 85 -
---------- ------------
271 58
Less current maturities ( 90) ( 25)
---------- ------------
$ 181 $ 33
========== ============
Annual maturities of long-term debt including capital lease obligations at
December 31, 1995 were as follows:
1996 $ 90
1997 81
1998 59
1999 32
2000 9
$ 271
NOTE 5. MAJOR CUSTOMERS
The table below reflects the percentage of total net sales that major
customers (i.e., customers who accounted for more than 10% of the Company's
total net sales in any year) accounted for:
YEARS ENDED DECEMBER 31,
1995 1994 1993
Customer A 13% 14% 15%
Customer B - 10% -
Customer C 12% - 12%
THE ACCOMPANYING NOTES ARE AN
INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-9
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. INCOME TAXES
At December 31, 1995 and 1994, the Company had a deferred tax asset of
approximately $6.0 million and $5.4 million, respectively, attributable
primarily to net operating loss carryforwards. The Company has established a
valuation allowance for 100% of the deferred tax asset due to the
uncertainties related to its eventual realizability. The change in the
Company's net deferred tax asset and the related valuation allowance in 1995
was due to losses incurred for income tax purposes during the year. The
Company has net operating loss carryforwards of approximately $16.0 million
for tax purposes which expire between the years 2000 and 2010.
As a result of certain changes in the Company's ownership during 1991, the
utilization of net operating loss carryforwards has been limited to
approximately $350,000 per year for losses incurred prior to 1991. Future
changes in the Company's ownership, if any, may have the effect of further
limiting the annual utilization of loss carryforwards.
NOTE 7. OTHER MATTERS
I. Class action settlement
In April 1992, several class action lawsuits were filed against the Company
and certain of its officers and directors (the "Defendants"). The complaints
alleged that the Defendants had misrepresented the Company's prospects for
obtaining final approval from the Food and Drug Administration ("FDA") to
manufacture and market Piroxicam. On September 28, 1993, the U.S. District
Court approved a settlement of the class action lawsuits. Pursuant to the
settlement agreement, the company agreed to (i) pay $850,000 which was funded
by the Company's Directors and Officers liability insurance; (ii) issue
250,000 shares of free trading common stock; and (iii) issue five year
warrants (See Note 8(III)(E)), to purchase 658,333 shares of free trading
common stock at $15.00 per share. All such shares and warrants were
distributed in early 1995. In 1993, the Company recorded a charge to earnings
of $1,336,000 related to this settlement. Such charge represented the market
value of the 250,000 shares on the settlement date.
II. Write off of inventory and receivables
As a result of the Company's withdrawal of its abbreviated new drug
applications for Minoxidil, Haloperidol and Piroxicam, the Company wrote off
inventory and issued credits to customers in the amounts of $792,000 in 1993.
NOTE 8. CAPITAL STOCK
I. Capital stock - authorized and issued
At December 31, 1995, the Company had authorized 200,000 shares of preferred
stock, $.005 par value (the "Preferred Stock"), none of which was issued and
outstanding.
In addition to its 12,838,466 common shares issued, the Company had a total
of 3,047,143 warrants and options outstanding at December 31, 1995.
II. Stock offerings
A) 1995 Private Placement
During July 1995, the Company completed a $5 million private placement ("1995
Private Placement") of 833,333 units at a price of $6.00 per unit. Each unit
consisted of one share of common stock, $.005 par value, and a
THE ACCOMPANYING NOTES ARE AN
INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-10
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8. CAPITAL STOCK (CONTINUED)
twelve month warrant (the "Private Warrants") to purchase one share of common
stock at an exercise price of $6.50 per share. The price of the shares was
determined in arms-length negotiations between the Company and the placement
agent, Gruntal & Co., Incorporated ("Gruntal"). The Company received
aggregate net proceeds of approximately $4.4 million from this offering. In
addition to fees for serving as the placement agent, Gruntal received
three-year warrants (See Note 8(III)(C)) to purchase 83,333 shares of common
stock at an exercise price of $6.00 per share.
In August 1995, the Company filed a registration statement relating to the
shares of common stock sold in the 1995 Private Placement and the shares of
common stock underlying the warrants sold in the private placement. Such
registration statement was declared effective under the Securities Act of
1933, as amended, during October 1995. The Company has also agreed to use its
best efforts to maintain the effectiveness of the registration statement
until July 1997.
On December 12, 1995, the Company reduced the exercise price of the Private
Warrants from $6.50 to $6.00 for a 60 day period as an incentive for warrant
holders to exercise. Subsequent to December 31, 1995, the Company issued
581,333 shares of its common stock as a result of the exercise of 581,333
Private Warrants. Net proceeds from the exercise of these warrants amounted
to approximately $3.4 million.
B) 1994 Private Placement
During September 1994, the Company completed a private placement ("1994
Private Placement") in which the Company sold an aggregate of 2,000,000
shares of its common stock at a price of $2.50 per share. The price of the
shares was determined in arms-length negotiations between the Company and
Gruntal, which acted as the placement agent of this offering. In addition to
fees for serving as the placement agent, Gruntal also received 200,000
warrants (See Note 8(III)(D)). The Company received aggregate net proceeds of
approximately $4.1 million from this offering. A registration statement
relating to the shares sold in the 1994 Private Placement is effective as of
the date of these financial statements.
III. Stock options, warrants and rights
A) Employee and director stock option plans
(1) Description
In 1992, the Company established a stock option plan which provides for the
granting at the fair market value of the underlying shares at the date of
grant, of incentive options for its employees, officers and directors (the
"1992 Plan"). The 1992 Plan provides for the grant of up to 333,333 shares of
common stock to officers, directors and other key employees. The 1992 Plan
provides for mandatory grants to directors for serving on the Board of
Directors, committees of the Board of Directors, as chairman of committees
and as Chairman of the Board of Directors. Options granted pursuant to the
1992 Plan expire five years from the date they become vested, which is, in
most cases, over a three year period beginning with the grant date. The 1992
Plan is administered by the Compensation Committee of the Board of Directors.
At the Company's annual meeting of shareholders on July 25, 1995, the
shareholders approved the Board of Directors' adoption of a new stock option
plan (the "1995 Plan"). Under the 1995 Plan, the Board is authorized to issue
options to purchase up to 550,000 shares of common stock to officers,
directors, and other key employees. The 1995 Plan provides for mandatory
grants to directors for serving on the Board of Directors, committees of the
Board of Directors, as chairman of committees and as Chairman of the Board of
Directors, which mandatory grants of options superceded the options grants
provided for in the 1992 Plan. The exercise
THE ACCOMPANYING NOTES ARE AN
INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-11
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8. CAPITAL STOCK (CONTINUED)
price of options granted under the 1995 Plan must equal or exceed the fair
market value of the common stock on the date such options are granted. No
options issued under the 1995 Plan may be exercised more than ten years from
the date of grant. The Compensation Committee of the Board of Directors is
responsible for administering the 1995 Plan.
All employee and director options expire at various times between 1996 and
2005.
(2) Employee and director stock option activity in 1995
In 1995, the Board of Directors granted a total of 35,828 stock options under
its 1995 Plan to the President and the outside directors for their services
on the Board and its committees. These options are exercisable at $8.44 per
share and expire in April 2000. During 1995, the Company also granted 110,000
stock options to certain employees of the Company. These options vest
generally over three years, are exercisable at prices between $5.91 and $9.00
per share and expire five years from their vesting dates. All of the above
options were issued at or above the fair market value of the Company's common
stock at the date of grant.
Below is a table summarizing transactions and other relevant data pertaining
to employee and director stock options:
NUMBER OF PRICE PER
1992 PLAN OPTIONS SHARE
Options outstanding at December 31, 1992 97,494 $ 9.56 - $25.41
Options granted 113,329 $ 4.50 - $7.69
Options outstanding at December 31, 1993 210,823 $ 4.50 - $25.41
Options granted 85,829 $ 4.63 - $ 5.75
Options outstanding at December 31, 1994 296,652 $ 4.50 - $25.41
Options granted 103,761 $ 5.91 - $9.00
Options exercised ( 9,166) $ 5.75 - $6.63
Options canceled ( 67,080) $19.50 - $25.41
Options outstanding at December 31, 1995 324,167 $ 4.50 - 25.41
1995 PLAN
Options outstanding at December 31, 1994 - -
Options granted 42,067 $ 8.44 - $9.00
Options outstanding at December 31, 1995 42,067 $ 8.44 - $9.00
THE ACCOMPANYING NOTES ARE AN
INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-12
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8. CAPITAL STOCK (CONTINUED)
NON-PLAN STOCK OPTIONS
Options outstanding at December 31, 1992 446,137 $.75 - $25.41
Options granted 9,999 $6.56
Options exercised ( 137,560) $.75
Options outstanding at December 31, 1993 318,576 $.75 - $25.41
Options granted 462,500 $3.00 - $6.75
Options exercised ( 105,665) $.75
Options canceled ( 3,334) $.75
Options outstanding at December 31, 1994 672,077 $.75 - $25.41
Options exercised ( 29,499) $.75 - $6.56
Options outstanding at December 31, 1995 642,578 $.75 - $25.41
At December 31, 1995, 623,809 of the previously described options were
vested.
B) 1995 private placement warrants
As part of the Company's 1995 Private Placement, the Company issued 833,333
Private Warrants.
Each Private Warrant entitles the holder to purchase one share of common
stock at an exercise price of $6.50 per share. The exercise price is subject
to increase or decrease upon the happening of certain corporate events
including, but not limited to the payment of any stock dividend, stock split,
stock combination or similar transaction. The Private Warrants may be
exercised at any time through July 20, 1996, unless such period is extended
by the Company.
On December 12, 1995, the Company reduced the exercise price of the Private
Warrants from $6.50 to $6.00 for a 60 day period as an incentive for warrant
holders to exercise their Private Warrants. Subsequent to December 31, 1995,
the Company issued 581,333 shares of its common stock as a result of the
exercise of 581,333 Private Warrants. Net proceeds from the exercise of these
warrants amounted to approximately $3.4 million.
C) 1995 Gruntal warrant
As part of its compensation for acting as the placement agent in connection
with the 1995 Private Placement, Gruntal received the 1995 Gruntal warrant
which allows them to purchase 83,333 shares of common stock at an exercise
price equal to $6.00 per share, exercisable until July 21, 1998. The holder
of the 1995 Gruntal warrant may pay the exercise price in cash or use a
cashless exercise. In a cashless exercise, the holder of the 1995 Gruntal
warrant has the right at any time to exercise the warrant in whole or in part
by surrendering the warrant certificate in exchange for the number of shares
of common stock equal to (x) the number of shares as to which the 1995
Gruntal warrant is being exercised multiplied by (y) a fraction, the
numerator of which is the market price (as defined in the 1995 Gruntal
warrant) of the common stock at the date of exercise less the exercise price
and the denominator of which is such market price. The 1995 Gruntal warrant
provides for an adjustment of the
THE ACCOMPANYING NOTES ARE AN
INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-13
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8. CAPITAL STOCK (CONTINUED)
exercise price and the number and type of securities issuable upon the
exercise thereof upon the occurrence of certain events, including the payment
of any stock dividend stock split, stock combination or similar transaction.
D) 1994 Gruntal warrant
As part of its compensation for acting as the placement agent in connection
with the 1994 Private Placement, Gruntal received warrants which allow them
to purchase 200,000 shares of common stock at an exercise price equal to
$3.50 per share, exercisable until August 12, 1999. The holder of the 1994
Gruntal warrant may pay the exercise price in cash or use a cashless
exercise. The provisions for a cashless exercise and adjustments to the
exercise price are similar to those described above for the 1995 Gruntal
warrant.
E) Class action settlement warrants
In accordance with the settlement in 1993 of the class action lawsuit, during
the first quarter of 1995, the Company issued warrants to purchase 658,333
shares of common stock (See Note 7(I)). Each of these warrants (the "Series F
Warrants") entitles the holder to purchase one share of common stock at an
exercise price of $15.00 per share. The Series F Warrants are exercisable
through December 1999, unless such period is extended by the Company. The
exercise price and the number of shares of common stock to be purchased upon
the exercise of each Series F Warrant are subject to increase or decrease
upon the happening of certain corporate events, including but not limited to
the payment of any stock dividend, stock split, stock combination or similar
transactions.
The Series F Warrants may be called at the sole option of the Company upon
thirty days prior written notice to the registered holders thereof so long as
the common stock trades above $18.00 per share for 20 consecutive trading
days ending not more than 10 days prior to the date that the notice of
redemption is given. Any such redemption shall be for all outstanding Series
F Warrants. If the Company elects to redeem the Series F Warrants, then the
Warrant holders shall have the rights to exercise their Series F Warrants
until the redemption date, and thereafter, the holder shall only be entitled
to receive the redemption price therefor.
F) 1992 public offering warrants
As part of the Company's 1992 public offering, 1,150,000 warrants (the
"Public Warrants") were issued. Each Public Warrant entitled the holder to
purchase one sixth (1/6) of a share of common stock (six Public Warrants were
required to purchase one share of common stock) at an exercise price of $30
per Share. On July 8, 1995, all such warrants expired unexercised.
G) 1992 underwriters warrants
The Company has outstanding underwriters' warrants relating to its 1992
public offering ("the 1992 Underwriters Warrants"). Paradise Valley
Securities, Inc. ("PVS"), the managing underwriter of the Company's January
1992 public offering and designees of Chatfield Dean and Co., Inc., one of
the underwriters of such offering, own an aggregate of 33,333 1992
Underwriters Warrants to purchase units of the Company's securities at an
exercise price of $21.60 per unit. Each unit consists of 2 shares of common
stock and a warrant to purchase 1/2 of a share of common stock at an exercise
price of $30 per share. The exercise price and the number of shares of common
stock and warrants which can be purchased upon the exercise of the 1992
Underwriters' Warrants are subject to increase of decrease upon the happening
of certain events, and in the event that the Company issues shares of common
stock at less than $9.00 per share. The issuance of the shares of common
stock and, if issued, the warrants, will cause a reduction in the exercise
price of and an increase in the number of shares of common stock issuable
upon the exercise of this warrant. Issuances of securities subsequent to the
date of issuance of the 1992
THE ACCOMPANYING NOTES ARE AN
INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-14
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8. CAPITAL STOCK (CONTINUED)
Underwriters Warrants have reduced the exercise price of the units to
approximately $17.25 per unit and increased the number of units available for
purchase to approximately 40,000 units. The warrants are exercisable through
January 9, 1997.
H) 1991 public offering warrants
In August 1993, PVS exercised an "Underwriter's Warrant" issued in connection
with the Company's February 1991 public offering. The Underwriter's warrant
entitled PVS to purchase 15,300 Units of the Company's securities. Each unit
consisted of eight shares of common stock, $.005 par value, and two common
stock purchase warrants, at an exercise price of $7.68 per Unit. In
connection with the exercise of this Underwriter's Warrant, the Company
issued 122,400 shares of its common stock and a warrant to purchase 30,600
shares and received $117,504 from the Underwriter.
On May 2, 1994, PVS exercised their warrant to purchase 30,600 shares of the
Company's common stock. The exercise price of the warrant was $3.00 per
share, representing an aggregate exercise price of $91,800. PVS paid the
Company $45,225, which represents the difference between the aggregate
exercise price and a credit of $46,575, which the Company granted to PVS in
return for PVS agreeing to waive its right of first refusal contained in the
underwriting agreement relating to the Company's 1992 public offering. In
connection with this agreement, the Company and PVS executed mutual releases
with respect to all matters arising under the 1992 underwriting agreement and
with respect to the class action litigation.
I) Customer options
In June 1991, the Company entered into an option agreement with a customer,
which agreement was subsequently assigned to the customer's parent. Under the
agreement, the customer was granted a five-year option to purchase shares of
the Company's common stock at $1.875 per share, upon the satisfaction of
certain purchase targets. Options earned are determined as of June 30 of each
year based on the previous 12 months' purchases by the customer. As of
December 31, 1995, the maximum number of options the customer could earn
through the end of this agreement in June 1996 is 106,666 options. If the
customer earns options for the contract year ended June 30, 1996 and at that
date a spread exists whereby the fair market value per share exceeds the
option price (the "Spread"), the Company will record a charge to earnings
equal to the Spread times the number of options earned.
In February 1995, the Company entered into an agreement with another customer
whereby the customer agreed to engage the Company as its sole supplier of the
Company's present and future products for a five year period subject to
certain exceptions. In return, the Company granted the customer stock options
to purchase up to 50,000 shares of common stock at $6.00 per share, the
market price on the date of grant. Such options vest at the rate of 9,000 per
year, with 5,000 options vesting upon entering into this agreement. In
connection with this agreement, the Company has recorded a charge to earnings
of approximately $66,000 in 1995.
J) Anti-takeover right
Certain provisions of the Articles and Bylaws of the Company may be deemed to
have an anti-takeover effect and may delay, defer or prevent a tender offer
or takeover attempt, including an attempt that might result in a premium
being bid over the market price for the shares held by shareholders. Several
provisions may not be amended in the Company's Articles and Bylaws without
the affirmative vote of the shareholder of 80% of the outstanding shares of
common stock.
THE ACCOMPANYING NOTES ARE AN
INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-15
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8. CAPITAL STOCK (CONTINUED)
A supermajority (80%) vote of the shareholders is required to approve certain
transactions with an entity of which 10% or more is beneficially owned by a
10% or more shareholder of the company, unless such transaction is approved
by a majority of the continuing directors.
The Company has a classified Board of Directors divided into three classes
serving staggered terms. At each annual meeting, approximately one-third of
the director's terms of office expire for which elections are held. Directors
may be removed from office only for cause and only by supermajority vote of
the shareholders.
In addition, shareholder action must be effected at a duly called annual or
special meeting of the shareholders and may not be effected by written
consent. Special meetings are called by the Board of Directors pursuant to a
resolution approved by a majority of the entire Board of Directors.
NOTE 9. R&D LIMITED PARTNERSHIP
In 1991, the Company, through its subsidiary RRGI, completed the funding of a
research and development limited partnership (the "Partnership"). The
Partnership received net proceeds of $1,035,000 from its partners to develop
five generic prescription drugs ("Licensed Drugs"). The Partnership's funds
were paid, in part, to the Company for its services in developing the
Licensed Drugs and to obtain a one-percent royalty interest in the gross
revenue derived from the commercial sale of Piroxicam for a three-year
period, with the remainder paid to third party vendors used in the
development of the products. As remuneration for developing the Licensed
Drugs, the Company received $40,000 and $52,000 in 1994 and 1993,
respectively, from the Partnership. In return for funding the development of
the Licensed Drugs, the Partnership will receive a royalty of 10 percent of
the net revenues generated by sales of the Licensed Drugs over a five-year
period.
As of March 1, 1996, the Company had received FDA approvals for three of the
Licensed Drugs and Piroxicam. Applications are pending for the other two
Licensed Drugs. The Company incurred royalty expenses of $69,000 in 1995
related to the sales of the Licensed Drugs and Piroxicam.
NOTE 10. COMMITMENTS AND CONTINGENCIES
I. Operating leases
The Company leases its 25,000 square foot production facility under an
operating lease that expires on July 31, 2000 and provides for two five-year
renewal options. The Company has also agreed to lease an additional 10,228
square foot space contiguous to its existing space when it becomes available,
but no later than November 1996. Pursuant to the lease agreement, the Company
also has an option throughout the term of the lease, including renewal
periods, to purchase the entire building and an adjacent building at a
specified price. Annual rent under the lease is approximately $137,000,
subject to annual cost of living increases.
The Company also leases another nearby 40,000 square foot facility which
houses its executive offices, warehouse and in the future and, will house its
research and development laboratory. The lease is for a 10 1/2 year term,
with two five-year renewal options. The lease requires the Company to make
annual lease payments of approximately $195,000. The Company also has an
option to purchase the leased facility during the first twelve-months of the
lease and during the sixth year of the lease at a specified price.
Total rental expense for operating leases was $324,000, $178,000 and $167,000
for 1995, 1994 and 1993, respectively. The terms of the operating leases for
the Company's facilities require the Company to maintain minimum insurance
coverage and to pay property taxes and repair and maintenance expenses.
THE ACCOMPANYING NOTES ARE AN
INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-16
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
At December 31, 1995, future minimum lease payments under all non-cancelable
operating leases are as follows (in thousands):
1996 $ 256
1997 260
1998 265
1999 269
2000 216
Thereafter 750
Total minimum lease payments $ 2,016
II. Other commitments
A) Purchase commitments
The Company has entered into a development agreement with a raw material
supplier to develop two products and to purchase its raw material
requirements for these products from the supplier. So long as the Company
files ANDAs, obtains approval of same within a specified time period and
thereafter satisfies certain purchase requirements, the supplier has agreed
that the Company shall be its only customer for this raw material in the
United States, Canada and Mexico. The Company currently has ANDAs pending for
both products.
B) Product license agreement
In August 1993, the Company entered into a perpetual license agreement with
the formulator of a drug whereby the Company has agreed to pay the formulator
a sliding royalty with a maximum of 10 percent of net sales of this product
for a ten-year period. In 1994, the Company paid the formulator certain fees
($70,000 in cash) when the Company received an acceptable bioequivalency
study for this drug and charged such fees to expense. In 1995, the Company
issued the formulator 10,695 shares in unregistered common stock upon the
filing of an ANDA for this drug and accordingly charged $24,000 to expense.
In 1995, the royalty expense incurred for this product was $38,000.
C) Foreign distribution agreements
On July 31, 1994 the Company entered into a license agreement with an
Australian pharmaceutical manufacturer with respect to the licensing of one
or more products developed by the Company. The license permits the Australian
manufacturer to develop, manufacture and market the licensed products in the
Pacific Rim markets, including Australia, New Zealand, Japan, Taiwan and Hong
Kong (the "Territory").
Although the Company and the Australian manufacturer have agreed on the first
product to be licensed under the agreement, there can be no assurance that
any other products will be licensed under such agreement. The Company is not
obligated under such agreement to license any products to the Australian
manufacturer other than the first product, and the Australian manufacturer is
not obligated to accept and license any additional product from the Company.
Under the agreement, the Company will receive a royalty from the Australian
manufacturer with respect to any sales of the licensed products by such
manufacturer in the Territory.
THE ACCOMPANYING NOTES ARE AN
INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-17
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
In November 1994, the Company entered into a license agreement with a
Canadian pharmaceutical company. Pursuant to the agreement, the Canadian
company licensed the right to manufacture or purchase from the company at
normal selling prices and distribute eight of the Company's products under
its private label. Under the agreement, the Company will receive a royalty on
the Canadian company's sales of the licensed products in Canada.
III. Employment Contracts
In 1994, the Company entered into employment contracts with certain officers,
the most significant of which is with the Company's President. The
President's contract provides for an annual base salary, plus cost of living
increases, plus a bonus equal to three percent of pre-tax income, the total
not to exceed three times the President's base salary. Additionally, the
President was granted options to purchase up to 250,000 shares of common
stock at a price of $6.75 per share. Such options become exercisable at the
rate of 50,000 each January 1st, beginning January 1, 1994. The agreement and
these options expire December 31, 1998. The President has agreed not to
compete with the Company for a period of eighteen months after termination of
his employment.
Each contract with the Company's other officers provides for a minimum base
salary, bonuses and stock options, which generally vest over a three-year
period. These contracts expire at various dates between 1995 and 1997.
IV. Contingencies
A) Litigation
In February 1993, the Securities and Exchange Commission initiated a formal
investigation into possible violations of the federal securities laws by the
Company and certain of its officers and directors. The SEC's examination is
focusing on the Company's public disclosure during the period between July
1991 and April 1992 regarding the status of the Company's ANDAs for Piroxicam
and Minoxidil and on sales of securities during this period by certain
persons, including Company executive officers and/or directors. The Company
believes that the SEC's investigation is ongoing. While no assurances can be
given as to the outcome of the SEC's investigation, the Company does not
believe such outcome will have a material adverse effect on the Company's
financial condition or results of operations.
On January 12, 1994, the Company was served with a suit brought by one of its
shareholders who opted out of the Company's settlement of the class action
litigation settled during 1993. The suit, DINESH SHAH V. ROYCE LABORATORIES,
INC. AND CHATFIELD DEAN & CO., INC., 94 CIV 0061 (S.D. N.Y.) which has also
been brought against one of the underwriters of the Company's January 1992
public offering, alleges that the Company's Janu ary 9, 1992 prospectus was
false and misleading. The suit seeks rescissory damages for violations of
Section 11 of the Securities Act of 1933 in the amount of approximately
$40,000 plus interest. The Company is vigorously defending this suit and
believes it has a meritorious defense. No assurances can be given as to the
outcome of this matter.
On August 4, 1995, the Company was sued by Bristol-Myers Squibb Company, Inc.
and E.R. Squibb & Sons, Inc. (collectively, "Bristol-Myers") in the Southern
District of Florida with respect to Captopril (Case No. 95- 1682-CIV-Davis).
THE ACCOMPANYING NOTES ARE AN
INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-18
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
In March 1995, the Company received a tentative approval of its ANDA for
Captopril, the Company's generic equivalent to Bristol-Myers'
anti-hypertensive drug Capoten(R). Under the General Agreement on Tariffs anD
Trade ("GATT") treaty implementing legislation, patent protection for
Capoten(R) was extended from August 8, 1995 until February 13, 1996. The
Company asserted, in a certification (the "Certification") filed with the
FDA, that under GATT, the Company should have the right to market Captopril
after August 8, 1995, subject to the Company's possible obligation to pay
"equitable remuneration" to Bristol-Myers on the Company's sales of Captopril
during the period between August 8, 1995 and February 13, 1996 (the "Delta
Period"). Bristol-Myers suit against the Company was filed based upon the
Company's filing of the Certification.
On August 25, 1995, the District Court determined that under the GATT treaty,
the Company's manufacture, use or sale of Captopril during the Delta Period
would not infringe upon Bristol-Myers' patent for Capoten(R). Based upon this
determination, the District Court granted the Company's Emergency Motion to
set aside the statutory injunction which arises automatically upon the filing
of an infringement action. The District Court further dismissed
Bristol-Myers' complaint for patent infringement. However, the District Court
denied the Company's request that the District Court order an immediate
effective date of the Company's ANDA for Captopril.
Bristol-Myers appealed the decision of the District Court and on November 1,
1995, the United States Court of Appeals for the Federal Circuit (the
"Circuit Court") reversed and remanded, with instructions, the decision of
the District Court. The Circuit Court, in its ruling, determined that as a
matter of law, the safe harbor provisions of GATT do not permit the Company
to make, use or sell Captopril prior to February 13, 1996. The Circuit Court
further concluded that as a result of its finding, the statutory bar against
FDA approval of the Company's ANDA for Captopril prior to February 13, 1996
remained in effect. The Company appealed the Circuit Court's decision to the
U.S. Supreme Court however, the Supreme Court did not grant certiorari and
the matter has now been remanded to the District Court.
While there can be no assurance, the Company does not believe that this
litigation will have a material adverse impact on its financial position or
results of operations.
In the ordinary course of business, the Company is at times involved in other
legal actions and proceedings. Presently, there are no such actions which are
expected to have a significant effect on the Company's operations.
THE ACCOMPANYING NOTES ARE AN