ANNUAL REPORT
Published on March 31, 1999
[LOGO] COMMONWEALTH
BIOTECHNOLOGIES, INC.
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1998
Annual
Report
[GRAPHIC]
ABBOTT LABS, INC.
ALCON LABS, INC.
ALL INDIA INSTITUTE OF MEDICAL SCIENCES
ALLEGHENY UNIVERSITY HEALTH SCI. CTR.
ALLERGAN
ALPHA THERAPEUTICS
AMHERST UNIVERSITY
ANAGEN
ANIMUNE
ANTEX BIOLOGICALS
ANTIGEN EXPRESS, INC.
ARRENHIUS UNIVERSITY
BAXTER HEALTHCARE, INC.
BAYER CORPORATION
BAYLOR COLLEGE MEDICINE
BIOMOLECULES, INC.
BIOSCREEN TESTING
BIOTECH RESEARCH LABS
BLM GROUP
BOSTON UNIVERSITY
BREASTEK, INC.
BRISTOL MYERS SQUIBB
BROWN UNIVERSITY
CASE WESTERN RESERVE UNIVERSITY
CENTERS FOR DISEASE CONTROL
CENTRAL N.Y. STATE RESEARCH INSTITUTE
CERELA
CHICAGO INSTITUTE NEURO SURG. & NEURO RES.
CHILDREN'S HOSPITAL PITTSBURGH
CHINESE UNIVERSITY HONG KONG
CIENCI ESTEVES
CKD RESEARCH INSTITUTE
CLEVELAND CLINIC
COLUMBIA UNIVERSITY
CONTHERAPEUTICS
CORNELL UNIVERSITY
CORNING DIAGNOSTICS
CYTOS PHARMACEUTICALS, INC.
DADE BEHRING, INC.
DARTMOUTH UNIVERSITY
DEKALB GENETICS, INC.
DEMETER BIOTECHNOLOGIES, INC.
DIONEX CORPORATION
DNAX, INC.
DUKE UNIVERSITY
DUPONT EXPERIMENTAL STATION
DUQUESNE UNIVERSITY
DYAD PHARMACEUTICALS, INC.
EAST CAROLINA SCHOOL MEDICINE
EASTERN VA MEDICAL SCHOOL
EDITEK, INC.
EMISPHERE, INC.
FLORIDA STATE UNIVERSITY
FRESENIUS MEDICAL CENTER
GE CORPORATE RESEARCH CENTER
GENELABS TECHNOLOGIES, INC.
GENEWORKS, LLC
GENOME THERAPEUTICS
GEORGETOWN UNIVERSITY
GEORGIA INSTITUTE TECH
GLAXO WELLCOME CORPORATION
GLIATECH
GLYCOMED, INC.
GREENHARBOR MEDICAL GROUP
HARVARD SCHOOL OF PUBLIC HEALTH
HENRY FORD HOSPITAL
HERSHEY MEDICAL CENTER
HOFFMAN LA ROCHE
HONG KONG UNIVERSITY SCIENCE & TECHNOLOGY
HOPE HEART INSTITUTE
IDEXX LABS
IMMCO DIAGNOSTICS
IMMUNO CONCEPTS
IMMUNODIAGNOSTICS LABS
IMPERIAL COLLEGE OF LONDON
INCYTE PHARMACEUTICALS
INDIA INSTITUTE MED. EDUC. AND RES.
INDIANA UNIVERSITY
INNOVAGEN
INSMED PHARMACEUTICALS, INC.
INTESCO, INC.
ISIS PHARMACEUTICALS
ITP PARTNERS
JOSLIN DIABETES RESEARCH CENTER
KOREA UNIVERSITY
KYOTO UNIVERSITY
KYUNPOOK NATIONAL UNIVERSITY
LAB BIOQUIMICO JARDIN PAULISTA
LABBIOMEX
LEUKOSITE, INC.
LIFE TECHNOLOGIES, INC.
LOFSTRAND LABS
LOS ALAMOS NATIONAL LABS
LSU MEDICAL CENTER
MASSACHUSETTS GENERAL HOSPITAL
MASSACHUSETTS INTITUTE TECHNOLOGY
MAYEE WOMEN'S RESEARCH INSTITUTE
MAYO FOUNDATION
MCGILL UNIVERSITY
MCMASTER UNIVERSITY
MEDAREX, INC.
MEDICAL COLLEGE OF GEORGIA
MEDICAL COLLEGE OF SOUTH CAROLINA
MERCATOR GENETICS
MERCK AND CO.
MIAMI UNIVERSITY
MIAMI UNIVERSITY OF OHIO
MICROSCIENCES INC.
MIWON, INC.
MOLECULAR CARDIOLOGY INSTITUTE
MONSANTO CORPORATION
MOUNT HOLYOKE COLLEGE
MOUNT SINAI HOSPITAL BALTIMORE
MOUNT SINAI MEDICAL CENTER
NATIONAL CANCER INSTITUTE
NATIONAL INSTITUTES OF HEALTH
NEMOURS RESEARCH FOUNDATION
NEUROTHERAPEUTICS, INC.
NEW YORK UNIVERSITY
NIAGRA UNIVERSITY
NORTH AMERICAN VACCINE
NORTH CAROLINA STATE UNIVERSITY
NORTHERN ARIZONA STATE UNIVERSITY
NOVARTIS, INC.
NPS PHARMACEUTICALS, INC.
OHIO STATE UNIVERSITY
ONCOGENESIS
ORAVAX, INC.
OREGON STATE UNIVERSITY
ORTHO DIAGNOSTICS, INC.
PATERNITY AND FORENSIC LABS
PATHOGENESIS CORPORATION
PENN STATE UNIVERSITY
PERSEPTIVE BIOSYSTEMS, INC.
TO THE SHAREHOLDERS
OF COMMONWEALTH
BIOTECHNOLOGIES, INC.
[GRAPHIC]
What an amazing first full year
of operations as a publicly
traded corporation!
We are proud and excited to present
to you our 1998 scientific
marketing and financial results.
The year has been one of
growth, innovation,
and unprecedented recognition
for the company.
[GRAPHIC]
1998 Highlights
January
A Richmond Times Dispatch article announced that we would construct a
new $4 million facility in Gateway Centre, Chesterfield County.
March
We received "Notice of Allowance" of all claims from the U.S. Patent Office for
our lead human pharmaceutical product, HepArrest(TM). (The full patent was
issued in March 1999.) We received exceptional news press for that patent,
including Reuters, PRNewswire, and the Times Dispatch, to mention a few. This
coverage brought us to the attention of other potential client pharmaceutical
companies.
April
Pharmaceutical News Daily and the Washington Post both acknowledged
HepArrest(TM). The Post noted that the rise in the market price of CBI stock
"outpaced the broader market."
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May
CBI was named winner of the Emerging Technology award sponsored by the Greater
Richmond Technology Council. Former Virginia Governor George Allen accepted a
directorship on our Board of Directors.
June
HepArrest(TM) was again featured in Emerging Pharmaceuticals, and CBI was named
the recipient of two new Small Business Innovative Research awards from the
National Institutes of Health and the United States Department of Agriculture.
[GRAPHIC]
September
CBI was featured in the Wall Street Transcript, a retail investors equity
research publication. WST features Wall Street's top analysts discussing key
sectors and stock picks, as well as money manager and CEO interviews.
October
CBI was accredited under the Clinical Laboratories Improvement Act (CLIA) to
perform analysis of human clinical samples for the presence of known genetic
markers. We also anticipate accreditation by the American Association of Blood
Banks, and have participated in a validation study of the College of American
Pathologists.
November
The Mattson Jack Group, an independent consulting firm, issued its report
indicating a market potential of over $250 million in worldwide sales for
HepArrest(TM), assuming it meets approval by the Food and Drug Administration
following clinical trials.
CBI's new facility was finished on time and on budget. We took occupancy on
November 25th.
[GRAPHIC]
December
All operations and personnel were relocated in our new state-of-the-art facility
by December 7.
We filed for U.S. patent protection for our new product, AccuTrac(TM).
January 1999
CBI launched AccuTrac(TM) with introduction at The Institute for Genomic
Research meeting. Free samples were distributed to the major sequencing
facilities in the country and around the world. AccuTrac(TM) sales represent a
strong new revenue stream for CBI.
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New Products Assist in Heart Surgery and DNA Sequencing
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HepArrest(TM)
CBI's lead human pharmaceutical, HepArrest(TM) is a new heparin binding peptide
compound used primarily during open-heart surgery. During cardiovascular
procedures, the intense blood thinning effects of the anticoagulant heparin must
be reversed to restore normal blood clotting at the end of the surgery. This
reversal prevents unwanted bleeding and related post-operative complications.
Protamine, the only available approved antidote, causes frequent toxic side
effects. If approved by the FDA, HepArrest(TM) is intended for use as a safe,
effective antidote for the anticoagulant effects of heparin.
AccuTrac(TM)
AccuTrac(TM) is a new tool used as an aid in automated DNA sequencing. During
DNA sequencing, a process called electrophoresis is applied to a sequencing
reaction mixture. Molecules move quickly through an acrylamide gel because of
the electric fields. AccuTrac(TM) uses a fluorescent dye label to mark each DNA
"lane." DNA fragments migrate through any of 96 lanes - or tracks - within that
gel. Those lanes in the gel hold the samples that are read by the automated
sequencer.
With AccuTrac(TM), all 96 lanes are identified whether they contain data or not.
By preventing the possible misidentifications caused by "skipped" lanes,
AccuTrac(TM) removes the need for manual review and lane assignment.
AccuTrac(TM) enables organizations to optimize data quality and reduce both cost
and time required to process DNA samples.
[GRAPHIC]
Our Core Business
The mainstay of CBI continues to be its core technology business for life
sciences investigations. We utilize such tools as custom synthetic organic and
bioorganic chemistries, spectroscopy services, and a full complement of protein,
DNA/RNA and genetic identity and analysis testing services. The resulting
research generally develops into new diagnostics, new pharmaceuticals and/or
greater understanding of molecular structure and function.
We have successfully recruited internationally known Senior Scientists,
including most recently, a Group Leader for Human Genetic Identity and Analysis.
This new scientist is charged with growing the Human Genetics aspect of our
business, which we view as an expanding market.
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PHONE 800.735.9224
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FAX 804.648.2641
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ADDRESS
601 Biotech Drive
Richmond, Virginia 23235
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Email
cbi@i2020.net
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WEB PAGE
www.cbi-biotech.com
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Expanded Marketing Efforts
In the last quarter of 1998, nine firms signed new long-term contracts or
agreements valued between $1,245,177 and $1,756,277 (depending on the final
scope of the actual work). Also in that quarter, we contracted for 13 new
molecular biology projects. By the end of December, we had 19 additional
contracts and/or grants under consideration with total valuation of over $6
million dollars. We are now adding new molecular biology projects at a rate of
3-5 per month, and serve over 700 clients worldwide.
We have done a great deal in 1998 to expand our marketing efforts. We have
revised and improved our web page, and developed a new Company brochure. Fully
40% of our work comes to us over the Internet, and our new building is
completely networked to our own computer server.
We look forward to 1999 with excitement. We are well on target toward another
very successful year. We will continue to expand our marketing and research
efforts. In 1999, we will complete the pre-clinical trials of HepArrest(TM), and
are seeking strategic partners to help us commercialize it. To that end, we have
retained the services of the Mattson Jack Group to assist CBI in negotiations
for licensing and royalty rights. We have also filed for Canadian, European, and
Japanese patent protection for HepArrest(TM).
Thanks for Your Support
We invite your questions and inquiries. You may reach us by phone, fax or
e-mail. We encourage you to visit our web page or drop by our offices in
Chesterfield County. We look forward to seeing you at the 1999 Annual Meeting of
Shareholders, which we're holding in our new facility.
To all our hard-working employees, to our consultants, our Board of Directors
and our stockholders, we say thanks.
With best regards,
/s/ Richard J. Freer, Ph.D. /s/ Robert B. Harris, Ph.D
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Richard J. Freer, Ph.D. Robert B. Harris, Ph.D
Chairman of the Board President
/s/ Thomas R. Reynolds /s/ James H. Brennan
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Thomas R. Reynolds James H. Brennan
Senior Vice-President, Secretary Controller
[GRAPHIC]
PART I - THE COMPANY
Company Overview
CBI is an example of the "new biotechnology model." Let us explain.
Traditionally, biotechnology companies are established with venture capital or
seed funds, and are dependent upon getting a product to market within the first
3-5 years of their existence. By contrast, CBI was founded in 1992 to provide
sophisticated research and development services on a contract basis to the
biotechnology industry.
In other words, CBI does not depend on commercialization of any product for this
revenue. Rather, cash generated from contract services is used to operate the
Company, with small amounts used to supplement government and private grants.
These grants are used to develop CBI's own intellectual properties through
research and development of proprietary products.
At first, CBI was one of only a few taking this approach to biotechnology. Over
time several companies have realized the merit to this business strategy. Others
are now beginning to support in-house R&D efforts through development and sales
of chemicals and reagents. Reagents are specialty chemicals such as AccuTrac(TM)
used in the course of research.
Our clients come from private companies, academic institutions and government
agencies throughout the world. Virtually all our clients are engaged in some
form of Life Sciences Research, and use our technologies to provide data and
results to support their individual research programs.
In general, clients fall into one of two categories: those who require a
discrete set of analyses ("short-term projects"), and those who contract with
the Company on an extended basis for a variety of integrated analytical services
("long-term projects"). A strong measure of customer satisfaction, both short-
and long-term project customers frequently send us repeat business.
[PHOTO]
5
Analytical Support Services
Our core business provides state-of-the-art DNA/RNA and protein/peptide
technologies. We often combine these technologies with sophisticated biophysical
techniques, such as calorimetry, spectroscopy and mass spectral analysis. These
supplementary techniques help us understand the fundamental molecular nature of
the compounds we study. This combination allows CBI to provide clients with
"one-stop shopping" for biotechnology services.
We market our services using promotional brochures and our web site. Many of our
clients come to us through the Web. As a matter of fact, a full 40% of all
orders received in the last half of 1998 came from clients who found us on the
Internet!
Short-Term Research Projects
On average in 1998, CBI added 24 new customers per month. Of its domestic
customers, 53.3% were from private companies, while 46.7% came from university
or government labs. CBI added 31 new foreign clients in 1998 from all over the
world, including North and South America, Europe, Asia and the Near East.
Customer Sources
CBI advertises through professional journal ads, trade show exhibits and our web
site. Potential customers are able to download order forms directly from the web
site, or actually place the order electronically if desired. CBI is also
cross-listed on several biotechnology, biochemistry, and molecular biology
search services, allowing customers to find us using simple key-word search
terms.
[GRAPHIC]
WORLD MAP
Total new foreign clients in 1998: 31
Biotechnology is truly a global industry!
Argentina, Australia, Canada, China, Columbia, Denmark, Germany, Greece, Hong
Kong, India, Israel, Italy, Japan, Korea, Mexico, Malaysia, Norway, Spain,
Sweden, Switzerland, United Kingdom, Uruguay
6
[PHOTO]
Favorable word-of-mouth advertising has brought us many new customers. We often
receive inquiries from several new investigators within a single research-based
institution.
All inquiries receive immediate and personal attention. With our "fax on demand"
service, clients can easily request information about our services 24 hours a
day. Customers continue to comment favorably on their phone, fax, and e-mail
interactions with CBI staff.
Long-Term Research Projects
CBI is committed to identifying long-term contracts. These provide a reliable
revenue source, often allowing us to add to our scientific staff. During 1998,
one of our major long-term contractual clients took much of their work back
"in-house" due to a change in their corporate philosophy. Loss of this revenue
stream did affect CBI's bottom line throughout fiscal year 1998.
We mounted a recovery by signing nine new long-term contracts or agreements in
the last quarter, valued up to $1,756,277 (depending on the scope of the work to
be done). As of December, we had over 19 additional long-term contracts pending
with a total valuation of over $6 million dollars. CBI will continue to focus on
signing long-term contractual clients throughout 1999.
New Technologies
at CBI
Genetic Analysis
After establishing a Genetic Testing Group, CBI was registered under the
Clinical Laboratories Act (CLIA), with pending accreditation by the Virginia
Department of Health. Registration under the CLIA guidelines enables CBI to
accept human clinical samples, and to perform
7
[GRAPHIC]
"In 1997 paternity testing performed at AABB-certified laboratories was an $87
million market!"
analyses of those samples for the presence of genetic markers for known human
pathologies. For example, we have already begun analysis for a long-term
contract client to detect the presence of the "p53 gene," a marker for cancer.
CBI is also prepared to begin sample analysis for the presence of many other
marker genes. In 1999, we will focus our marketing efforts on making Genetic
Analysis a larger revenue-producing technology for CBI.
Identity Testing and Paternity
Testing by Genetic Analysis
We have established a DNA Reference Laboratory in our new facility containing
all the necessary work areas required to provide genetic identity and paternity
testing.
DNA Identity Testing
In 1998, the National Forensic Science Technology Center (NFSTC) accredited CBI
to perform DNA identity testing for submission of data into the Combined DNA
Index System (CODIS) database. CODIS is used by the FBI to compare DNA
fingerprints (traces) from crime scenes with that of known felons. CBI is one of
only eight commercial facilities nationwide NFSTC has accredited to perform
criminal DNA database testing for submission into CODIS. CBI has already
submitted bids for performing DNA fingerprint analysis for the Departments of
Criminal Justice in different states.
Paternity Testing
We expect accreditation soon by the American Association of Blood Banks (AABB).
We have also participated in validation study through the College of American
Pathologists (CAP). Through these two organizations, we are now ready to begin
offering paternity testing to the general public and to various state and
federal agencies. A fact well worth noting, according to a 1998 report from the
AABB, paternity testing in 1997 performed at AABB-certified laboratories was an
$87 million market! In 1999, CBI will aggressively market its capabilities in
these areas.
[PHOTO]
8
Agricultural/Veterinary Genetic
Testing Services
CBI has also been accredited by the U.S. Department of Agriculture to receive
bovine DNA samples from Europe. We can now perform bovine genetic, lineage, and
identity analysis. CBI participated in an international study to validate bovine
DNA identity testing in conjunction with a study group located in Denmark. We
are also establishing the capacity for DNA identity testing in horses.
Molecular Biology
Our recent focus on identifying clients who are looking for comprehensive
molecular biology services is beginning to pay off. In the last quarter of 1998,
we initiated more than 15 individual molecular biology projects, more than five
times the number of projects undertaken at CBI since its inception. Often, these
contracts call for CBI to clone a gene, overproduce the protein, and
characterize the particular protein product. Many proteins are vaccines,
antibodies, or components of diagnostic kits. CBI is unique in that it has all
of the services in-house to complete this type of project.
We attribute this success in the molecular biology services to concerted
marketing efforts, to the addition of highly competent scientists, and to
favorable word-of-mouth advertising. Throughout 1999, we intend to expand these
services by offering large scale bacterial fermentation to our clients, which
allows us to overproduce large amounts of particular proteins.
Proprietary Research
& Development
As a rule, CBI does not retain intellectual property rights on work done for its
short-term clients, and rarely retains intellectual property rights for work
done for its long-term clients. However, CBI is actively pursuing R&D programs
to develop its own products. HepArrest(TM) is a prime example, the U.S. patent
for which was issued in March 1998. In addition, CBI has filed for Canadian,
Japanese, and European patents for HepArrest(TM). CBI has also filed for U.S.
patent protection for AccuTrac(TM).
Growth Strategy
In 1999, our focus will be to increase our various revenue lines through
expanded advertising and marketing efforts. We will be more select in the trade
shows we attend, to carefully target our markets. We have also hired a West
Coast sales account executive to help move CBI to the forefront of
biotechnology contract firms in that region.
We have identified a director for the Human Genetics and Identity division of
CBI. Dr. Douglas Oliveri, formerly of Applied Genetics, Inc., Austin, Texas, is
a recognized leader in the field of Human Genetics and Identity, who will help
grow this segment of CBI's services.
Dr. Oliveri can provide expert testimony in paternity and forensic court cases.
We continue to expand our instrumentation capacity to both maintain and expand
our long-term client base, and to attract additional customers as well. The
Company continually seeks to identify trends, and to develop related new
products and services to meet the changing needs of our customers.
[GRAPHIC]
CBI has been accredited by the United States Department of Agriculture to
receive bovine DNA samples from Europe to perform genetic, lineage, and identity
analysis.
[PHOTO]
9
PART II - Stockholder Matters
Market for Common Equity
The Company completed its initial public offering of Common Stock on October 28,
1997 at a price per share of $6.00. Since that time, the Common Stock has traded
on the NASDAQ Small Cap Market ("NASDAQ"). The following table sets forth the
range of high and low sales price per share of Common Stock for 1998.
On March 1, 1999, the last reported sales price for a share of the Company's
Common Stock on NASDAQ was $8.625. As of March 1, 1999, there were 70 holders of
record of the Company's Common Stock and approximately 771 beneficial holders.
The Company has not paid any cash dividends on its Common Stock. The Company
intends to retain its earnings to finance the growth and development of its
business and does not expect to declare or pay dividends in the foreseeable
future. The declaration of dividends is within the discretion of the Company.
However, the Company's ability to pay dividends may be constrained by certain
provisions of its industrial revenue bond financing.
Selected Financial Data
Set forth below is selected financial data with respect to the Company for the
years ended December 31, 1998 and December 31, 1997, which has been derived from
the audited financial statements of the Company. The selected financial data set
forth below should be read in conjunction with "Management's Discussion and
Analysis of Financial Conditions and Results of Operation."
Management's Discussion
and Analysis of Financial
Condition and Results
of Operation.
The following should be read in conjunction with "Selected Financial Data" and
the Company's Audited Financial Statements and Notes thereto included herein.
10
Overview
The Company's revenues are derived principally from providing macromolecular
synthetic and analytical services to researchers in the biotechnology industry
or who are engaged in life sciences research in government or academic labs
throughout the world. Development of innovative technologies for biotechnology
requires sophisticated laboratory techniques and the Company provides these
services to customers on a contract basis.
The Company generally derives revenue from two types of customers: those who
require a discrete set of services ("short-term projects"), and those who
contract with the Company on an extended basis for performance of a variety of
integrated services ("long-term projects"). More often than not, the Company's
customers provide repeat business to the Company.
The Company also derives revenues from government grants which fund the bulk of
the Company's research efforts for its proprietary technologies. Unlike its
short-term or long-term contract services, research and development on the
Company's proprietary technologies focuses on commercializing technologies the
Company owns or licenses from third parties. All government grants are expense
reimbursement grants which provide for reimbursement on a monthly basis of the
Company's direct costs incurred in a research project, plus indirect costs
stated as a percentage of direct costs.
During 1998, the Company developed AccuTrac(TM), a new reagent, which
facilitates the process of automated DNA sequence analysis. In this respect, the
Company hopes to broaden its revenue base by direct sales of this reagent to its
customers and anticipates selling AccuTrac(TM) to its customers in 1999.
Revenues
Gross revenues decreased by $157,041 or 8.9% from $1,761,308 during the year
ended December 31, 1997 ("1997") to $1,604,267 during the year ended December
31,1998 ("1998").
Short-Term Projects
Revenues realized from short term projects, which is included in the Statement
of Operations as Laboratory Services, increased by $22,698, or 2.7%, from
$853,810 during 1997 to $876,508 during 1998. Revenues from peptide synthesis
increased by $47,424 or 34.6% from $137,210 during 1997 to $184,632 during 1998.
Revenues attributable to protein sequencing increased by $43,840, or 55.1%, from
$79,545 during 1997 to $123,385 during 1998. Revenues derived from both peptide
synthesis and protein sequencing increased primarily due to new customers
placing orders with the Company, and to repeat large orders from existing
customers.
Revenues from amino acid analysis decreased by $18,368, or 28.1%, from $65,282
during 1997 to $46,914 during 1998. This decrease is primarily due to one of the
Company's major clients ceasing its out-source research program with the
Company.
Other "uncategorized" revenues decreased by $50,214 or 36.8% from $136,541
during 1997 to $86,327 during 1998. This decrease is primarily due to
administrative changes in invoicing; revenues previously identified as "Other"
are now more properly classed under defined work items within the Company.
Revenues realized from other core technologies remained essentially constant.
Long-Term Projects
Revenues realized from various long-term projects, which is included in the
Statement of Operations as Contract Research, decreased by $94,552, or 16.8%,
from $561,007 during 1997 to $466,455 during 1998. This decrease is primarily
due to the delay in the awarding of new research contracts for 1998, which has
the effect of shifting revenue from 1998 to future periods. As mentioned under
the category of Short-Term Projects, this decrease is also due to the cutbacks
in outsourced services by one of the Company's principal clients. As of December
1998, the Company had approximately 15 additional long-term contract proposals
pending with many different potential customers. Although the Company's
Management is taking an active role in negotiating these new contracts,
management is unable to say with certainty when or whether these other new
long-term contracts will be awarded.
11
Research Grants
The Company experienced a decrease in revenue realized from government grants in
the amount of $85,187, or 24.6%, from $346,491 during 1997 to $261,304 during
1998. This decrease is primarily due to completion of work on two grants. During
1998, the Company had one ongoing Phase II Small Business Technology Research
grant (SBTR) grant from the National Institutes of Health (NIH). In addition,
during 1998, the Company was awarded a ($200,000) Phase II Small Business
Innovative Research Award (SBIR) from the United States Department of
Agriculture (USDA) for development of a Diagnostic for Equine Infectious Anemia
Infection. Revenues earned through December 31, 1998 amounted to $32,500. The
Company anticipates to complete the project by August, 2000. The Company was
also awarded a Phase I SBIR ($100,000) from the NIH for development of rapid
assay methods for the detection of Botulism. Revenues earned through December
31, 1998 amounted to $62,421. The Company anticipates completion of the project
by April 1999. Work began in late September on both grants.
The biotechnology industry is currently progressing through a consolidation
stage wherein some potential customers are cutting back on research and
development, while others are trying to perform their own research services
in-house. In either situation, there is a reduced dependence on the Company to
perform its services for customers. If this trend continues, the Company expects
that it may derive a larger portion of its revenues from laboratory services.
Thus, the Company may experience a pronounced shift from contract research to
laboratory services, which may result in a less predictable revenue stream.
The Company experiences quarterly fluctuations in all revenue categories.
Engagements for all future projects are highly dependent upon the customer's
satisfaction with the services previously provided, and upon factors beyond the
Company's control, such as the timing of product development and
commercialization programs of the Company's customers. The Company is unable to
predict for more than a few months in advance the volume and dollar amount of
future projects in any given period. The combined impact of commencement and
termination of research contracts from several large customers and unpredictable
fluctuations in revenue for laboratory services can result in very large
fluctuations in financial performance from period to period.
Expenses
Cost of services consists primarily of labor and laboratory supplies. The cost
of services increased by $331,328, or 41.7%, from $794,236 during 1997 to
$1,125,564 during 1998. The cost of services as a percentage of revenue was
45.1% and 70.2% during 1997 and 1998, respectively.
Direct Labor
Labor costs increased by $172,670, or 50.9%, from $338,994 during 1997 to
$511,664 during 1998. The increase in labor costs reflects the Company's growth
strategy as more qualified personnel are hired full-time to perform the
laboratory services. In 1998, the Company was fully staffed for the entire year,
but 1997 labor costs reflect only nine months operations with the same number of
employees. In addition, in 1998, fringe benefits for all employees associated
with laboratory services were allocated to compensation and benefits under
labor. Total costs associated with the increase in fringe benefits amounted to
$42,492. Fringe benefits during 1997 were recorded under general and
administrative.
Direct Materials
The costs for direct materials increased by $106,357, or 25.2%, from $421,612
during 1997 to $527,969 during 1998. These increased costs are directly
attributable to the increased purchase of reagents, chemicals and miscellaneous
materials used in all the laboratories, and increases in market prices of raw
materials as well as relatively higher costs for specialized reagents necessary
to perform analyses that the Company was not offering in 1997, such as automated
C-terminal sequence analysis.
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Other Costs
"Other costs" (travel, equipment rental, maintenance of equipment, etc.)
increased by $58,906 or 218.0% from $27,025 during 1997 to $85,931 during 1998.
This increase was due to the rental of instrumentation necessary to be validated
for a particular set of DNA analysis ($20,293). The Company sought validation on
this particular instrument because it was required for submission of a long-term
contract proposal. The instrument was returned and the lease terminated when the
Company was not awarded the contract. Other increases included, repairs and
maintenance on equipment ($23,164), and freight delivery to the Company's
clients ($5,861).
Selling, General, and Administrative
Sales, general and administrative expenses ("SGA") consist primarily of
compensation and related costs for administrative, marketing and sales
personnel, facility expenditures, professional fees, consulting, taxes, and
depreciation. Total SGA costs increased by $947,610, or 73.1%, from $1,297,005
during 1997 to $2,244,615 during 1998. As a percentage of revenue, these costs
were 73.6% and 139.9% during 1997 and 1998, respectively.
Compensation and Benefits
Total Compensation and Benefits increased by $162,111 or 26.1% from $620,722
during 1997 to $782,833 during 1998. The increase is primarily attributable to
addition of the Company's executive officers to the payroll on a full-time basis
during 1998. These executive officers were full time employees of the Company
for only six months during 1997. Salary and benefit costs also increased due to
various support personnel hired to assist in implementing the Company's growth
strategy.
Facility Costs
Costs for facilities increased by $151,861, or 168.8%, from $89,984 during 1997
to $241,845 during 1998. The costs for leasing of additional laboratory space
for its operations increased by $95,104 from 1997 to 1998. Additional space
during 1998 was necessary to support the Company's expanded technology
offerings. Once the Company relocated to its new facility in late November,1998,
the Company cancelled its contract on all its leased space. Other facility costs
include increases in telephone use ($8,767), waste disposal ($32,402), and
electricity ($18,909).
Professional Services
Professional fees increased by $10,221 or 7.9%, from $128,946 during 1997 to
$139,167 during 1998. This increase was primarily due to legal and accounting
costs associated with the year-end audit, quarterly accounting reviews, general
legal support, legal costs associated with obtaining patents, and corporate
liability insurance costs. Consulting fees increased by $11,496 or 23.2 from
$49,504 during 1997 to $61,000 during 1998. Consulting fees include payments
made to Board members for four regularly scheduled Quarterly Board meetings
during 1998, compared to two meetings during 1997. Taxes and License fees
increased by 31,901 or 267.3% from 11,934 during 1997 to $43,835 during 1998.
This increase is associated with the paying of property taxes based on equipment
purchased during 1997 and 1998.
Depreciation Expense
Depreciation increased by $153,735 or 98.4% from $156,198 during 1997 to
$309,933 during 1998. Increased depreciation costs are attributable to the
purchase of additional laboratory equipment consistent with expanding the
Company's technology base, and the first month of depreciation on the Company's
new corporate facility.
Other Costs
Other costs increased by $61,618 or 169.1% from $36,436 during 1997 to $98,054
during 1998. This increase was primarily attributable to the relocation costs
from the move to the new corporate offices.
13
Marketing
Marketing costs increased by $254,780 or 257.4%, from $98,982 during 1997 to
$353,762 during 1998. Salaries and fringe benefits, expenditures for a new
brochure, additional advertising in the professional journals, contract costs
with a media relations firm, travel, and trade show expenditures contributed to
these increased costs.
In September, 1998, the Company entered into a contract with the Mattson Jack
Group to perform a global market assessment of the Company's potential human
therapeutic, HepArrest(TM). Total costs during 1998 of the Mattson Jack Group
contract amounted to $101,083.
Selling
Expenditures during 1998 for selling amounted to $76,351. Costs associated with
selling include personnel, travel, and office expenses. During 1998, the Company
hired an Account Executive for the Eastern Region to identify new clients. There
were no expenses for Selling during 1997. Selling expenditures have been
incurred in 1998 as part of the Company's growth strategy.
Research and Development
Research and development costs within the Company fall into two general
categories: grant-related research and development, and in-house research and
development. These categories are distinguished in the Company by those
performed in support of government grant-sponsored programs, and those performed
in the absence of such grants and funded from working capital. Total
expenditures for these two categories decreased by $99,862, or 17.4%, from
$574,860 during 1997 to $474,998 during 1998. Total grant-related research and
in-house research as a percentage of revenue were 32.6% and 29.6% during 1997
and 1998, respectively.
Grant Related Research Activities
Expenditures to perform grant-related research activities decreased by
$195,017,or 49.0%, from $397,974 during 1997 to $202,957 during 1998. All of the
Company's grant-related expenditures are reimbursed from the appropriate
governmental agency. This decrease is mainly due to completion of on-going
research programs during 1998.
In-house Research Activities
Expenditures made by the Company for in-house research activities increased by
$95,155 or 53.8%, from $176,886 during 1997 to $272,041 during 1998. The Company
is actively engaged in establishing fundamental methods for genetic testing for
agricultural and human applications, in developing methods of genome sequence
analysis, and in pursuing fundamental research related to potential uses of
HepArrest in drug formulation.
During 1998, as a direct result of the Company's in-house research and
development efforts, the Company perfected AccuTrac(TM) as a reagent to
facilitate automated DNA sequence analysis. The Company's in-house research
efforts in 1998 resulted in registration under the Clinical Laboratories
Improvement Act (CLIA), with pending accreditation by the Virginia Department of
Health. Registration under CLIA guidelines allows the Company to perform
analysis of human clinical samples for the presence of known genetic markers.
Further, in 1998, as a result of the Company's in-house research and development
efforts, the Company received accreditation by the United States Department of
Agriculture to receive bovine DNA samples from Europe to perform genetic,
lineage, and identity analysis and lastly, the Company passed another
accreditation level with the National Forensic Science Technology Center (NFSTC)
to perform DNA identity testing for submission of data into the Combined DNA
Index System (CODIS) data base.
Other Interest Income and
Interest Expenses
Interest income is derived from investing the unused portion of the funds
realized by the Company from the private placement of convertible notes in June
1997, and initial public offering of common stock in October 1997. Interest
income is also derived from investing the unused portion of the funds realized
by the Company from the successful sale (March 1998) of Industrial Revenue Bonds
(IRBs) for construction of the Company's new facility.
14
Interest Income
Interest income to the Company increased by $236,631, or 257.2% from $91,997
during 1997 to $328,628 during 1998. Interest income realized from unused funds
from the IPO increased by $148,056, or 160.8% from $92,039 during 1997 to
$240,095 during 1998. Interest income earned from the unused portion of the
funds realized from the sale of IRBs amounted to $88,532. There was no interest
income earned from the unused portion of the funds realized from the sale of
IRBs during 1997.
Interest Expense
Interest costs incurred by the Company during 1998 included (1) interest paid to
financial institutions on loans made to the Company; (2) interest paid to the
Trustee for the Company's IRBs; and (3) amortization of bond costs incurred as a
consequence of the completion of the Company's IRB financing. Interest costs
incurred by the Company during 1997 included (1) interest paid to financial
institutions on loans made to the Company; (2) interest expense related to a one
time charge as a result of issuance of the Notes in June 1997; and (3)
amortization of loan costs associated with the Company's private placement of
$3,000,000 aggregate principal amount of convertible notes.
Interest expenses decreased by $54,871 or 23.7% from $231,108 during 1997 to
$176,237 during 1998. During 1997, the Company experienced a one-time charge to
interest expense amounting to $204,039 as a result of issuance of the
convertible notes in June 1997. Interest paid to financial institutions remained
relatively constant in both 1997, $27,069, and 1998, $29,425. The total
outstanding principal amount of these loans as of December 31, 1998, was
$249,680. Interest expense paid to the Trustee for the Company's IRBs was
$146,812 during 1998. There was no interest expense associated with the IRB's in
1997. Bond amortization cost decreased by $116,500 from $124,918 during 1997 to
$8,418 during 1998. The 1998 amortization represents loan amortization costs for
the new facility as compared to 1997 costs for the amortization of loans
associated with the Company's private placement of $3,000,000 aggregate
principal amount of convertible notes.
For the Year Ended December 31, 1997
versus December 31,1996
Revenues
Gross revenues increased by $771,382 or 77.9%, from $989,925 during the fiscal
year ended December 31, 1996 ("1996") to $1,761,308 during the fiscal year ended
December 31, 1997 ("1997").
Revenues realized from laboratory services increased $371,224 or 76.9% from
$482,586 in 1996 to $853,810 in 1997, with the DNA sequence analysis service
showing the largest percentage revenue increase, in the amount of $220,599 or
144.9% from $152,256 in 1996 to $372,855 in 1997. Revenues attributable to
peptide synthesis increased by $74,572 or 119.1%, from $62,638 in 1996 to
$137,210 in 1997.
Revenue realized from various contract research projects increased by $234,232
or 71.7%, from $326,776 in 1996 to $561,007 in 1997. This increase was due
primarily to funds received in early 1997 from one major private industry
customer.
In addition, the Company experienced an increase in revenue realized from
government grants in the amount of $165,928 or 91.9% from $180,563 in 1996 to
$346,491 in 1997. These grants were provided by the National Institutes of
Health and the United States Department of Agriculture, under the auspices of
two different Small Business Technology Transfer Research Grants and a Small
Business Innovative Research award. The government grants are expense
reimbursement grants which provide for reimbursement of the Company's direct
costs incurred, plus indirect costs as a percentage of direct costs. The Company
generally receives grant payments semi-monthly, with the amount of each payment
being determined by the amount of the costs incurred in the immediately
preceding two week period.
Management believes that this increase in revenue is primarily attributable to
an expanded customer base and to larger orders from individual customers, both
of which result from the Company's enhanced reputation in the industry, and to
more effective advertising activities.
15
The Company experiences quarterly fluctuations in revenues which arise primarily
from variations in research contracts. Revenue fluctuations also result from the
dynamic nature of the Company's laboratory services. Engagement for subsequent
projects is highly dependent upon the customer's satisfaction with the services
previously provided, and upon factors beyond the Company's control, such as the
timing of product development and commercialization programs of the Company's
customers. The Company is unable to predict for more than a few months in
advance the volume and dollar amount of future projects in any given period. The
combined impact of commencement and termination of research contracts from
several large customers and unpredictable fluctuations in revenue for laboratory
services can result in very large fluctuations in financial performance from
quarter to quarter.
The biotechnology industry is currently progressing through a consolidation
stage wherein some potential customers are cutting back on research and
development, while others are trying to perform their own research services
in-house. In either situation, there is a reduced dependence on the Company to
perform its services for customers. If this trend continues, the Company expects
that it may derive a larger portion of its revenues from laboratory services.
Thus, the Company may experience a pronounced shift from contract research to
laboratory services, which may result in a less predictable revenue stream.
Performance of contract research for five customers was completed in 1997. Two
of these customers have initiated new contract research projects with the
Company, and in addition, the Company has signed three additional research
contracts which began in January 1998. The Company has bids for several
contracts pending, an award of any of which would have a significant impact on
revenues.
Expenses
Cost of services consists primarily of labor and laboratory supplies. Cost of
services increased by $556,510 or 234.1% from $237,726 in 1996 to $794,236 in
1997. The cost of services as a percentage of revenue was 24.0% and 45.1% in
1996 and 1997, respectively. These increased costs are directly attributable to
hiring new personnel, to acquisition of reagents, chemicals, materials and so
forth necessary to implement the Company's growth strategy. Labor costs
increased by $234,291 or 223.8% from $104,703 in 1996 to $338,994 in 1997. The
cost of reagents increased by $131,338 or 307.6% from $42,700 in 1996 to
$174,038 in 1997. The cost of miscellaneous materials increased by $142,236 or
500.8% from $28,404 in 1996 to $170,641 in 1997. The cost of services is subject
to fluctuation and can cause results of operations to fluctuate from quarter to
quarter, particularly if the Company purchases supplies but does not record the
revenue from the performance of services until a subsequent quarter.
Sales, general and administrative expenses consist primarily of compensation and
related costs for administrative personnel, depreciation and amortization,
professional fees and advertising. Sales, general and administrative expenses
increased by $973,186 or 300.5% from $323,820 in 1996 to $1,297,005 in 1997.
Sales, general and administrative expenses as a percentage of revenue were 32.7%
in 1996 and 73.6% in 1997. Compensation and benefit expenses increased by
$507,739 or 449.4% from $112,983 in 1996 to $620,722 in 1997. This was due in
large part to the full-time employment of the four founders of the Company and
to payment of bonuses to the executive officers totalling $150,000. Also
included in compensation and benefit expenses is a $60,000 bonus paid to a
former officer of the Company. Rent payments increased by $60,850 or 733.9% from
$8,291 in 1996 to $69,641 in 1997. Professional fees increased by $62,025 or
145.8% from $42,544 in 1996 to $104,569 in 1997. This increase was primarily due
to the Company's need for additional outside business and scientific consulting
expertise. Depreciation increased by $104,262 or 200.8% from $51,936 in 1996 to
$156,198 in 1997. Increased depreciation was attributable to the purchase of
additional equipment in the latter part of 1997.
16
Expenditures for government grant-related research and development activities
increased by $138,911 or 118.2% from $117,544 in 1996 to $256,455 in 1997.
Expenditures to perform research and development for establishing fundamental
technologies in the Company, or expended in performance of grant-related
research activities supplemented by the Company increased by $149,683 or 550.2%
from $27,203 in 1996 to $176,886 in 1997. Expenditures for research and
development performed on behalf of contract research customers decreased by
13.6% or $22,219 from $163,737 in 1996 to $141,518 in 1997. Research and
development activities performed by third parties at the behest of the Company
amounted to $56,750 in 1997, and were zero in 1996. Total research and
development costs as a percentage of revenue were 31.2% in 1996 and 32.6% in
1997.
Other Income and
Expenses
The Company realized interest income in 1997 of $91,997; there was essentially
no interest income in 1996. The increase in interest income was primarily due
from investing the funds from the Private Placement (as described below) and the
Company's initial public offering.
Interest paid by the Company in 1997 included (1) interest paid to financial
institutions on loans made to the Company; (2) interest expenses associated
incurred as a consequence of completion of the Private Placement in June, 1997;
and (3) interest expenses for amortization of loan costs also incurred as a
consequence of the completion of the Private Placement.
Interest paid to financial institutions on loans made to the Company increased
by $16,968 or 167.9% from $10,101 in 1996 to $27,069 in 1997. The Company
experienced an increase in interest expenses associated with the Private
Placement of $204,039 in 1997, and an increase in amortization of loan costs
associated with the Private Placement of $124,918.
Liquidity and Capital
Resources
Consistent with the Company's implementation of its growth strategy, 1998 showed
a decrease in net operating cash flow in the amount of $1,788,671, as compared
to a decrease of $711,615 in 1997. This decrease in both years is due to
substantial investments being made by the Company in personnel, equipment,
sales, and marketing efforts, and these cost outlays were made possible by
capital realized from the Company's Private Placement of convertible notes and
initial public offering of common stock. The use of cash in 1998 was fully
anticipated by management. However based on expected cash out-flow, management
anticipates that unless the Company becomes profitable, the remaining cash
available invested by the Company will be needed for general operations.
Net working capital as of December 31, 1997 and December 31, 1998 was $5,865,715
and $1,356,458 respectively. This decrease is a direct result of capital
expenditures on new scientific instrumentation, computers, and furniture and
fixtures ($956,547), costs associated with the new facility ($1,694,868),
implementation of marketing and selling divisions within the Company ($430,113),
and costs associated with additional staffing and direct materials necessary to
expand the Company's technology offerings ($1,427,719).
IRBs sold by the Company (in the amount of $4,000,000) were issued by the
Virginia Small Business Financing Authority. The IRBs were issued pursuant to an
Indenture of Trust dated March 15,1998, between the Virginia Small Business
Financing Authority and Crestar Bank, a Virginia banking association, the named
Trustee. The IRBs were issued and sold to facilitate construction of the
Company's facility in the Gateway Centre Development at 601 Biotech Drive in
Chesterfield County, Virginia. Funds generated by the sale of the IRBs are
restricted and may only be used for the construction of the Company's new
facility. Construction of the new facility began in early June and was completed
in late November 1998. Of the $4,000,000 issued by the Virginia Small Business
Financing Authority, $402,991 remains as restricted cash on the balance sheet of
the Company as of December 31, 1998. All of the Company's administrative and
research operations have been consolidated into this facility and were fully
operational by mid December 1998.
17
Year 2000 Project
The Company is working to resolve the potential impact of the Year 2000 on the
ability of the Company's computerized information systems to accurately process
information that may be date-sensitive. Any of the Company's programs that
recognize a date using "00" as the year 1900 rather than 2000 could cause errors
or system failures. The Company is in the process of making its assessment of
the potential impact of the Year 2000 issue. As of March 1, 1999:
o The Company's financial institutions are in the process of addressing Year
2000 compliance issues. These financial institutions anticipate completion
of this review in the first quarter of 1999.
o During 1998, the Company upgraded its general accounting system to a Year
2000 compliant version.
o The Company is in the process of updating its payroll system to meet Year
2000 compliance standards, and will complete this effort by the end of the
first quarter of 1999.
o The Company is currently evaluating older equipment to see if such
equipment meets Year 2000 compliance standards and anticipates completion
of this review during the second quarter of 1999.
o The Company believes that all equipment purchased during 1998 is Year 2000
compliant.
o The Company believes that equipment performing analytical data research is
not date sensitive, and, therefore, will not have to be replaced or
improved.
o The Company is currently communicating with suppliers and customers to
determine the extent to which they have addressed Year 2000 issues. Of the
Company's 10 major suppliers, a majority is either Year 2000 compliant or
expects to be in compliance by the end of the second quarter of 1999. The
Company is in the process of contacting customers to see if their business
operations are Year 2000 compliant. As of March 1, 1999, the Company
contacted twenty three percent of its customers. The Company expects to
complete its Year 2000 compliance assessment of its suppliers and customers
during the first and second quarters of 1999.
The Company believes that it will complete its Year 2000 program by the end of
the third quarter of 1999. The Company expects that the costs associated with
Year 2000 compliance will not exceed $30,000, and will not have an adverse
material impact on the Company's financial position.
Forward Looking
Statements
Management has included herein certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. When used, statements
not historical in nature, including the words "anticipated," "estimate,"
"should," "expect," "believe," "intend," and similar expressions are intended to
identify forward-looking statements. Such statements are, by their nature,
subject to certain risks and uncertainties.
Among the factors that could cause the actual results to differ materially from
those projected are the following:
o Business conditions and the general economy
o The development and implementation of the Company's long-term business
goals, including new areas of expertise, such as paternity testing, DNA
testing in horses, and large scale bacterial fermentation
o The federal, state and local regulatory environment
o Lack of demand for the Company's services
o The ability of the Company's customers to perform services similar to those
offered by the Company "in-house"
o Potential cost containment by the company's customers resulting in fewer
research and development projects
o The Company's ability to receive accreditation to provide various services,
including, but not limited to paternity testing
o The Company's ability to hire and retain highly skilled employees
o The Company's ability to obtain foreign patent protection for HepArrest
Other risks, uncertainties, and factors that could cause actual results to
differ materially from those projected are detailed from time to time in reports
filed by the Company with the Securities and Exchange Commission, including
Forms 8-K, 10-QSB, and 10-KSB.
18
[LOGO]
McGLADREY & PULLEN, LLP
--------------------------------------------
Certified Public Accountants and Consultants
Independent Auditor's Report
To the Board of Directors and Stockholders
Commonwealth Biotechnologies, Inc.
Richmond, Virginia
We have audited the accompanying balance sheet of Commonwealth Biotechnologies,
Inc. as of December 31, 1998 and the related statements of operations, changes
in stockholders' equity, and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. The financial statements of Commonwealth Biotechnologies, Inc. for
the year ended December 31, 1997 were audited by other auditors whose report,
dated February 9, 1998, expressed an unqualified opinion.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 1998 financial statements referred to above present fairly,
in all material respects, the financial position of Commonwealth
Biotechnologies, Inc. as of December 31, 1998, and the results of its operations
and its cash flows for the year then ended, in conformity with generally
accepted accounting principles.
/s/ McGLADREY & PULLEN, LLP
Richmond, Virginia
January 22, 1999
19
Commonwealth Biotechnologies, Inc.
BALANCE SHEETS
December 31, 1998 and 1997
See Notes to Financial Statements.
20
Commonwealth Biotechnologies, Inc.
STATEMENTS OF OPERATIONS
Years Ended December 31, 1998 and 1997
See Notes to Financial Statements
21
Commonwealth Biotechnologies, Inc.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 1998 and 1997
See Notes to Financial Statements.
22
Commonwealth Biotechnologies, Inc.
STATEMENTS OF CASH FLOWS
Years Ended December 31, 1998 and 1997
See Notes to Financial Statements.
23
COMMONWEALTH BIOTECHNOLOGIES, INC.
Notes to Financial Statements
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Significant Accounting Policies
Nature of business: Commonwealth Biotechnologies, Inc., (the "Company"), was
formed on September 30, 1992, for the purpose of providing specialized
analytical laboratory services for the life scientist. The Company provides
basic research services in the general areas of protein/peptide and DNA/RNA
chemistries. Such services include synthesis, sequence analysis, composition
analysis, protein purification and biophysical characterization of biologically
relevant materials. The Company also pursues its own research and development
intended to lead to intellectual properties.
A summary of the Company's significant accounting policies follows:
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 period.
Actual results could differ from those estimates.
Revenue recognition: The Company recognizes revenue and related profit upon the
completion of laboratory service projects, or upon the delivery and acceptance
of biologically relevant materials that have been synthesized in accordance with
project terms. Laboratory service projects are generally administered under
fee-for-service contracts or purchase orders. Any revenues from research and
development arrangements, including corporate contracts and research grants, are
recognized pursuant to the terms of the related agreements as work is performed,
or as scientific milestones, if any, are achieved. Amounts received in advance
of services to be performed or acceptance of a milestone, are recorded as
deferred revenue.
Cash and cash equivalents: The Company considers all highly liquid debt
instruments purchased with an original maturity of three months or less to be
cash equivalents. At times, the Company maintains cash balances in excess of
FDIC insured amounts.
Property and equipment: Property and equipment are recorded at cost.
Depreciation is computed principally by the straight-line method over the
following estimated useful lives providing depreciation and amortization for
financial reporting purposes. The cost of repairs and maintenance is expensed as
incurred. The estimated useful lives of assets are as follows:
Other assets: Bond issuance costs consist of origination costs associated with
the 1998 bond issue and are being amortized over twenty-five years using the
straight-line method, which is not materially different than the effective
interest method. Amortization expense was $8,418 for the year ended December 31,
1998.
Income taxes: The Company elected Subchapter S Corporation status from its
inception through June 1997. Accordingly, the taxable income of the Company has
been "passed-through" to its stockholders, and they have been subject to the tax
on any income earned by the Company.
As more fully described in Note 10, the Company organized a private placement
offering of convertible subordinated notes in June, 1997, which caused the
income tax status of the Company to change from S Corporation status to C
Corporation status. Therefore, at June 25, 1997, the undistributed earnings were
treated as a constructive distribution to the original stockholders and as a
contribution to additional paid-in capital.
As a C Corporation, the Company is responsible for income taxes payable
resulting from earnings subsequent to June 25, 1997.
Deferred taxes are provided on a liability method whereby deferred tax assets
are recognized for deductible temporary differences and deferred tax liabilities
are recognized for taxable temporary differences. Temporary differences are the
differences between the reported amounts of assets and liabilities and their tax
bases. Deferred tax assets are reduced by a
24
COMMONWEALTH BIOTECHNOLOGIES, INC.
Notes to Financial Statements
- --------------------------------------------------------------------------------
valuation allowance when, in the opinion of management, it is more likely than
not that some portion or all of the deferred tax assets will not be realized.
Deferred tax assets and liabilities are adjusted for the effects of changes in
tax laws and rates on the date of enactment.
Research and development: Costs incurred in connection with research and
development activities are expensed as incurred. These consist of direct and
indirect costs associated with specific research and development projects.
Internal research and development cost, which are included in research and
development cost in the statement of operations, were $272,041 and $176,886 for
the years ended December 31, 1998 and 1997, respectively.
Loss Per Common Share: Basic loss per share has been computed on the basis of
the weighted-average number of common shares outstanding. Common shares issuable
upon exercise of the employee stock options (see Note 11) have not been included
in the computation because their inclusion would have had an anti-dilutive
effect applicable to the net loss. Following is information regarding the
computation of loss per share data for the years ended December 31, 1998 and
1997, respectively.
Reclassifications: Certain amounts in the 1997 financial statements have been
reclassified, with no effect on the results of operations or stockholders'
equity, to conform to the classifications adopted in 1998.
Fair Value of Financial Instruments: The Company has determined, based on
available market information and appropriate valuation methodologies, that the
fair value of its financial instruments approximates carrying value. The
carrying amounts of cash and cash equivalents, accounts receivable and accounts
payable approximate fair value due to the short-term maturity of the
instruments. The carrying amounts of debt approximates fair value because the
interest rates under the credit agreement are predominantly variable, based on
current market conditions.
Note 2. Property and Equipment
Property and equipment consisted of the following:
Depreciation expense was $309,933 and $156,918 for the years ended December 31,
1998 and 1997, respectively.
25
COMMONWEALTH BIOTECHNOLOGIES, INC.
Notes to Financial Statements
- --------------------------------------------------------------------------------
Note 3. Demand Notes Payable
The Company has a demand note payable with a bank, which bears interest at the
bank's prime rate plus 1% (8.75% at December 31, 1998). The note has no stated
maturity and is collateralized by a security interest in the Company's accounts
receivable, equipment and intangibles. The balance was $249,680 and $314,680 at
December 31, 1998 and 1997, respectively.
Note 4. Bonds Payable
- --------------------------------------------------------------------------------
The total interest expense reported in the Statements of Operations for the
years ended December 31, 1998 and 1997 was $184,655 and $356,026, respectively.
During 1998, $53,815 of interest was capitalized as part of the cost of the
Company's new laboratory facility. No interest was capitalized in 1997.
Note 5. Commitments and Contingencies
Leases: During 1997 through November 1998, the Company leased its laboratory and
office space under an operating lease. Upon moving to its new facility in
November 1998, the leases were cancelled. Total rent expense for all operating
leases for each of the years ended December 31, 1998 and 1997, was $174,662 and
$69,141, respectively.
Sales commitments: At December 31, 1998, the Company is performing services
under contract with several companies. These companies include Insmed
Pharmaceuticals (Richmond, Virginia), BLM Group (Cambridge, Massachusetts),
Strategic Diagnostics (Newark, Delaware), Creative Bio Molecular (Hopkinton,
Massachusetts), Santa Cruz Aids Research Foundation (Santa Cruz, California),
Sulzer Carbomedics (Austin, Texas), AXO Diagnostics (Gaithersburg, Maryland),
Clayton Foundation (Houston, Texas), Genetic Therapy, Inc. (Gaithersburg,
Maryland), Lofstrand Labs (Gaithersburg, Maryland), Bristol Meyers Squibb
(Princeton, New Jersey), and Dupont Pharmaceuticals (Wilmington, Delaware).
Employment Agreements: On June 24, 1997, the Company entered into employment
agreements with its founders. Each of the agreements has a term of five years
with specified base salaries and provide for successive one-year terms. In
addition, except for 1997, the employment agreements provide the Company's
executive officers with annual bonuses equal to, in the aggregate,
26
COMMONWEALTH BIOTECHNOLOGIES, INC.
Notes to Financial Statements
- --------------------------------------------------------------------------------
15% of the Company's pretax net income for the preceding fiscal year. For the
fiscal year ended December 31, 1998, there were no bonuses for the Company's
executive officers.
In connection with the aforementioned employment agreements, the Company has
recognized the fair value for services rendered by its founders in its financial
statements. The financial statement recognition is achieved by reflecting a
charge against income for contributed services and a contribution to additional
paid-in capital for 1997. The fair value of the charges have been established
based on the approximate number of hours worked by the Company's founders
annually, and application of a base hourly rate that increases approximately 5%
annually to the approximate hourly rate reflected in the agreement applied at
June 24, 1997.
Note 6. Retirement Plan
The Company maintains a 401(k) Plan (the "Plan") which covers substantially all
employees. Under the Plan, employees may elect to defer a portion of their
salary, up to the maximum allowed by law, and the Company will match the
contribution up to 1% of the employee's salary. The Company made contributions
of $6,309 to the Plan in 1998 (None in 1997).
Note 7. Major Customers
During 1997, the Company derived revenues from two customers amounting to
$377,932 and $226,239, respectively, and comprised of 34% of the total revenue
for 1997. For the year ended December 31, 1998, there were no revenue
concentrations.
Note 8. Compensation and Benefit Costs
Compensation and benefit costs are included in the statements of operations as
follows:
Note 9. Income Taxes
The difference between expected income tax benefits and income tax benefits
recorded in the financial statements is explained below:
27
COMMONWEALTH BIOTECHNOLOGIES, INC.
Notes to Financial Statements
- ----------------------------------------------------------------------------
The significant components of deferred income tax assets and liabilities as of
December 31 consist of the following:
Operating loss carryforwards of approximately $2,382,000 and $1,119,000 may be
used to offset future taxable income, which were generated in the years ended
December 31, 1998 and 1997, respectively. The loss carryforwards expire in 2018
and 2012, respectively.
Note 10. Private Placement and Initial Public Offering
On June 24, 1997, the Company declared a 93.78-for-1 stock split which has been
retroactively reflected in the accompanying financial statement and related
notes.
On June 25, 1997, the Company sold 60 convertible subordinated notes ("notes"),
with a principal amount of $50,000, in a private placement offering at an
offering price of $50,000 per note. The Company received net proceeds of
$2,626,269, after underwriting and other offering costs of $373,731. Each note
carried interest at the rate of 20% and was converted into shares of the
Company's common stock. Interest was paid through the date of the conversion in
the form of additional shares of common stock, which were issued based on a
conversion price of $6.00 for each share of common stock. Each note was
automatically converted into a minimum of 8,333.33 shares of the Company's
common stock.
Upon the closing of the private placement offering, the Company issued warrants
to members of management for the purchase of 100,000 shares of common stock. The
warrants were issued at $.001 per share, and will be exercisable for a period of
ten years expiring June 2007 at an exercise price of $9.90 per share.
On October 25, 1997, the Company completed its initial public offering (IPO) and
received net proceeds of $5,417,578, after underwriting and other offering costs
of $844,922, which includes $172,500 representing the approximate fair value of
warrants issued to the underwriters, as described in the following paragraph.
On November 13, 1997, Anderson & Strudwick the ("Underwriters") purchased
warrants for 101,500 shares of common stock. The warrants were issued to the
Underwriter at $.001 per share, and will be exercisable for a period of five
years at an exercise price of $9.90 per share.
Note 11. Stock Compensation
The Company adopted its Stock Incentive Plan (the "Plan") on June 24, 1997. The
Plan provides for the granting to employees, officers, directors, consultants
and certain other nonemployees of the Company of options to purchase shares of
common stock. A maximum of 410,000 shares of common stock may be issued pursuant
to the Plan. Of the maximum number of shares to be issued under the Plan,
270,000 will be reserved for incentive awards to be granted to the founders of
the Company, and 140,000 shares will be reserved for incentive awards to be
granted to others.
Incentive awards may be in the form of stock options, restricted stock,
incentive stock or tax offset rights. In the case of incentive stock options
(within the meaning of Section 422 of the Internal Revenue Code of 1986, as
amended), the exercise price will not be less than 100% of the fair market value
of shares covered at the time of the grant, or 110% for incentive stock options
granted to persons who own more than 10% of the Company's voting shares. Options
granted under the Plan generally vest over a five-year period from the date of
grant and are exercisable for ten years, except that the term may not exceed
five years for incentive stock options granted to persons who own more than 10%
of the Company's outstanding common stock.
28
COMMONWEALTH BIOTECHNOLOGIES, INC.
Notes to Financial Statements
- --------------------------------------------------------------------------------
The Company applies Accounting Principles Board Opinion No. 25 and related
accounting interpretations in accounting for its Plan and accordingly, no
compensation cost has been recognized. Had compensation cost for the Company's
Plan been determined based on the fair value at the grant dates for awards under
the Plan consistent with the method prescribed by FASB No. 123, Accounting for
Stock-Based Compensation, the Company's net loss and loss per share would have
increased to the proforma amounts indicated below as if the Plan had been in
effect for the periods presented:
Under FASB No. 123, the fair value of each management stock option and warrant
is estimated on the date of grant using the Black-Scholes option pricing model.
The following weighted-average assumptions were used for grants in 1998 and
1997, respectively: No dividend yield, expected volatility of 76% and 34%,
risk-free interest rate of 5.1% and 5.5%, and expected lives of 5 years.
Stock option and warrant transactions are summarized as follows:
The following table summarizes information about stock options and warrants
outstanding at December 31, 1998:
29
[PHOTO]
The Executive Officers and Board of Directors
Executive Officers
Richard J. Freer, Ph.D Robert B. Harris, Ph.D.
Chairman of the Board President
Thomas R. Reynolds James H. Brennan, MBA
Senior Vice President and Secretary Controller
Directors
Richard J. Freer, Ph.D. Robert B. Harris, Ph.D.
Chairman of the Board President
Thomas R. Reynolds Charles A. Mills
Senior Vice President and Secretary Director and CEO,
Anderson & Strudwick, Inc.
Peter Einselen The Honorable George F. Allen
Director, and Senior Vice President, Director, and Partner,
Anderson & Strudwick, Inc. McGuire, Woods, Battle & Boothe, LLP
30
[PHOTO]
Corporate Information
Corporate Office: Transfer Agent and Registrar
Commonwealth Biotechnologies, Inc. American Securities Transfer
601 Biotech Drive and Trust, Inc.
Richmond, Virginia 23235 938 Quail Street, Suite 101
Denver, Colorado 80215-5513
phone: 800-735-9224; 804-648-3820
fax: 804-648-2641
email: cbi@i2O2O.net Independent Auditors
web site: www.cbi-biotech.com
McGladrey and Pullen, LLP
General Counsel 1051 East Cary Street
Richmond, Virginia 23218
LeClair Ryan
A Professional Corporation
707 East Main Street
Richmond, Virginia 23219
31
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SIGNET LABS
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SMALL MOLECULE THERAPEUTICS
SMITH KLINE BEECHAM
SOMATIX THERAPEUTICS
ST. ELIZABETH'S MEDICAL COLLEGE
ST. JUDE'S RESEARCH HOSPITAL
ST. LOUIS UNIVERSITY
STAR BIOCHEMICALS
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UNIVERSITY OF KENTUCKY
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UNIVERSITY OF CALIFORNIA AT SAN DIEGO
UNIVERSITY OF CALIFORNIA AT SAN FRANCISCO
UNIVERSITY OF CALIFORNIA AT BERKELEY
UNIVERSITY OF CALIFORNIA AT LOS ANGELES
UNIVERSITY OF CAPETOWN
UNIVERSITY OF CINCINNATI
UNIVERSITY OF COLOGNE
UNIVERSITY OF COLORADO
UNIVERSITY OF CONNECTICUT
UNIVERSITY OF FLORIDA HEALTH SCI. CTR.
UNIVERSITY OF GENEVA
UNIVERSITY OF ICELAND
UNIVERSITY OF IDAHO
UNIVERSITY OF ILLINOIS
UNIVERSITY OF ILLINOIS CHICAGO CIRCLE
UNIVERSITY OF IOWA
UNIVERSITY OF KANSAS
UNIVERSITY OF LOUISVILLE
UNIVERSITY OF MANITOBA
UNIVERSITY OF MARYLAND BALTIMORE
UNIVERSITY OF MARYLAND COLLEGE PARK
UNIVERSITY OF MEDICINE AND DENTISTRY N.J.
UNIVERSITY OF MICHIGAN
UNIVERSITY OF MINNESOTA
UNIVERSITY OF NEW MEXICO
UNIVERSITY OF OKLAHOMA
UNIVERSITY OF PENNSYLVANIA
UNIVERSITY OF PITTSBURGH
UNIVERSITY OF RICHMOND
UNIVERSITY OF ROCHESTER
UNIVERSITY OF SAO PAULO
UNIVERSITY OF SASSAIRI
UNIVERSITY OF SOUTHERN CALIFORNIA
UNIVERSITY OF SOUTHERN MISSISSIPPI
UNIVERSITY OF TEXAS
UNIVERSITY OF TEXAS HEALTH SCI. CTR.
UNIVERSITY OF TORONTO
UNIVERSITY OF VIRGINIA
UNIVERSITY OF WATERLOO
UPPSALA UNIVERSITY
VA MEDICAL CENTER, RICHMOND
VA MEDICAL CENTER, SYRACUSE
VANDERBILT UNIVERSITY
VERTX PHARMACEUTICALS
VIMS
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