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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended January 31, 2001

Commission file number: 1-8366

POLYDEX PHARMACEUTICALS LIMITED
(Exact Name of Registrant as Specified in Its Charter)

Registrant's telephone number, including area code (416) 755-2231

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: Same

    Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/  No / /

    Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. /x/

    The aggregate market value of the Registrant's voting stock held by non-affiliates of the Registrant, computed by reference to the average bid and ask prices of such stock as of April 23, 2001: $10,444,795.

    The number of Common Shares outstanding as of April 23, 2001: 3,027,477.

Documents Incorporated By Reference

    Portions of the Registrant's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on June 22, 2001, are incorporated by reference into Part III.

PART I

ITEM 1.  BUSINESS

Introduction

    Polydex Pharmaceuticals Limited (the "Registrant") was incorporated under the laws of the Commonwealth of the Bahamas on June 14, 1979 as Polydex Chemicals Limited, and changed its name on March 28, 1984. The address of its statutory office in the Bahamas is c/o Higgs & Johnson, 83 Shirley Street, Nassau, Bahamas: telephone (242) 322-8571. The Registrant's current business is conducted through two of its subsidiaries, Polydex Chemicals (Canada) Limited, a wholly-owned Canadian corporation incorporated in 1969, which itself conducts its business through its wholly-owned subsidiary, Dextran Products Limited ("Dextran Products") (incorporated in Ontario in 1966) and Chemdex, Inc. ("Chemdex"), a 90% owned Kansas corporation incorporated in 1987. On November 30, 1992, Chemdex acquired from Continental Grain Company 100% of the issued and outstanding share capital of Veterinary Laboratories Inc. ("Vet Labs"), a Kansas corporation, which previously had been wholly-owned by the Registrant. On December 1, 1992, Vet Labs and Sparhawk Laboratories Inc. ("Sparhawk") entered into a joint venture (the "Sparhawk Joint Venture") for the purpose of manufacturing and selling veterinary pharmaceutical products. Sparhawk is an affiliated company owned primarily by the management of the Sparhawk Joint Venture. The Registrant controls the Sparhawk Joint Venture through its control of the board of directors. On May 9, 1995, the Registrant acquired from its then Chairman (now Vice-Chairman), Thomas C. Usher, a 90% interest in Novadex International Inc. ("Novadex International"), a Bahamian corporation. The Registrant acquired the remaining 10% interest in Novadex International from an unaffiliated third person on July 14, 1997. The principal asset of Novadex International is a patent, developed by Mr. Usher, for the use of Cellulose Sulphate in a number of applications including the development of a new contraceptive gel.

General

    The current business of the Registrant is the manufacture and sale of Dextran and several of its derivatives, including Iron Dextran and Dextran Sulphate, veterinary pharmaceutical products and other specialty chemicals, and cosmetic raw materials, with some related research and development. The Registrant is investigating the potential human applications of some of its products although it is impossible to determine at this time if the products will reach market.

    Dextran, a generic name applied to certain synthetic compounds formed by bacterial growth on sucrose, is a polymer or giant molecule. The name Polydex combines the words "polymer" and "dextran."

Description, Usage and Regulated Aspects of the Products

    The operations of the Registrant are presently carried on through Dextran Products and Vet Labs. These subsidiaries operate in two industry segments: the manufacture and sale of Dextran and derivatives and the manufacture and sale of veterinary pharmaceutical products.

Iron Dextran

    Iron Dextran is a derivative of Dextran produced by complexing Iron with Dextran. Iron Dextran is injected into most pigs at birth as a treatment for anemia.

    Sales presently are being made by the Registrant in the following countries, which have approved the use of Iron Dextran for animals, require no approval, or accept the Canadian registration: Canada, Denmark, France, Switzerland, Hong Kong, Germany, the Netherlands, Finland, Ecuador, Thailand, Hungary, Italy, Malaysia, the Philippines, Japan, Brazil, Korea, Spain, Sweden, Israel, New Zealand, Mexico, Costa Rica, and Australia. In the United States, sale for veterinary use requires the approval

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of the U.S. Food and Drug Administration (the "FDA"). Chemdex has FDA approval for veterinary use of Iron Dextran in the United States. For classification purposes, the Registrant treats these sales of the Iron Dextran raw materials as sales of Iron Dextran.

Dextran Sulphate

    Dextran Sulphate is a specialty chemical which finds use in research applications of the pharmaceutical industry and other centers of chemical research.

    The Dextran Sulphate manufactured by the Registrant is sold in Australia, Switzerland, France, the Netherlands, New Zealand and the United States, where it is used in limited quantities in the manufacture of film, as well as analytical chemical applications. This usage requires no regulatory approval.

Veterinary Products

    The Registrant manufactures sterile injectable products, tablets and boluses, internal and external solutions, ointments and powders.

    The products are sold in the United States and are predominantly used by large animal veterinarians and by farmers for the treatment of various diseases and conditions that affect farm animals. The Vet Labs facility is regulated and inspected by the FDA and the U.S. Drug Enforcement Agency.

Sales, Distribution and Reliance Upon Foreign Countries

Iron Dextran and Dextran Sulphate

    The Registrant sells Iron Dextran on an exclusive basis in certain countries and on a non-exclusive basis elsewhere. Dextran Sulphate is sold on a non-exclusive basis throughout the world. For the fiscal year ended January 31, 2001, no single customer accounted for 10% or more of total sales.

    The Registrant has not changed its mode of distribution of Iron Dextran or Dextran Sulphate during the past fourteen fiscal years. The Registrant sells its product primarily to independent distributors and wholesalers throughout the world. Orders are forwarded to the Registrant's manufacturing facilities in Toronto, Ontario, Canada where they are processed and shipped. The Canadian Embassies and Consulates in various countries also assist the Registrant by making available information regarding the Registrant and its products.

Veterinary Products

    All of the sales of Vet Labs for the fiscal year ended January 31, 2001 were within the United States. Distribution is achieved through private label buying groups who then distribute to their own distributors, and through full service independent distributors who purchase products under Vet Labs' house labels. Private label products accounted for approximately 85% of sales with house label sales contributing approximately 11%. In addition, Vet Labs also does "contract filling" for other industry companies. Four customers (all private label buying groups) accounted for 69% of sales at Vet Labs, with individual customer shares ranging from less than 1% to 22%. Management does not anticipate a significant decrease in sales volume from any of these customers.

Working Capital Requirements

    There are no special inventory requirements or credit terms extended to customers that would have a material adverse effect upon the Registrant's working capital.

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Patents, Trademarks and Licenses

Iron Dextran

    Effective February 1, 1995, the Registrant entered into an agreement with Novadex Corp., an affiliated company, whereby Novadex Corp. granted the Registrant the exclusive worldwide license to use a certain process developed by Novadex Corp. for producing Iron Dextran. This process allows the Registrant to produce Iron Dextran at a lower cost than would otherwise be possible. The license agreement expires when the related patent expires. The Registrant pays a license fee based on production volumes. Upon the expiration of the license, the technology relating to the process described above will belong to the Registrant, with no further obligation to make royalty payments to Novadex Corp.

    During July 1999, Novadex Corp. was liquidated, and all assets and liabilities of Novadex Corp. were assumed by the sole shareholder of Novadex Corp., the Vice Chairman of the Registrant. The above-referenced license agreement was included in the assets transferred to the Vice Chairman. As of the effective date of the transfer, the Registrant is obligated to pay the license fee to the Vice Chairman.

    The technology in the field of Dextran and its derivatives is undergoing continuous expansion and development. The manufacture of Dextran and its derivatives may be achieved by different processes and variations (including glycoside, which is in the public domain). Therefore, the Registrant does not believe that the license agreement described above gives it any substantial competitive advantage.

Dextran Sulphate

    This material was patented under U.S. patent number 4,855,410 in August, 1989 and has been tested with other drugs for efficacy in controlling the HIV virus. At this time research has been halted so that the Registrant can focus its resources on projects relating to cystic fibrosis and Cellulose Sulphate. Once these projects have been completed, the Registrant expects to return its attention to Dextran Sulphate.

Veterinary Products

    Vet Labs holds a New Animal Drug Application from the FDA for the production of 10% Iron Hydrogenated Dextran for injection. In addition, Chemdex holds a Drug Master File for the manufacture of 10% Bulk Iron Hydrogenated Dextran which makes it the only approved source of Bulk Iron in the United States.

Elastin and Collagen

    These materials were patented under U.S. patent numbers 4,659,740 and 4,784,986 on April 21, 1987 and November 15, 1988, respectively. The patents cover a process whereby the materials are modified in such a way as to penetrate the skin and act as a hydrating agent.

Cellulose Sulphate

    During the fiscal year ended January 31, 1996, a patent for a new method of manufacture of Cellulose Sulphate was purchased for $1 million. The process was patented under U.S. patent number 5,378,828 in June of 1995. Prior to development of the patented process the manufacture of the compound required the use of dangerous and environmentally sensitive chemicals. The new method is safer, and appears to produce a more consistent product. This material appears to have applications in film manufacture and capsule production and is presently being investigated in conjunction with the Rush Medical Center in Chicago, Illinois as a potential contraceptive which also has antiviral capabilities.

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    During the last fiscal year U.S. patent number 6,063,773, was granted to the Registrant and Co-inventors entitled "Cellulose Sulphate for use as Antimicrobial and Contraceptive Agent". Further clinical trials are planned to show its safety and efficacy.

Cystic Fibrosis

    Effective April 1, 1994, the Registrant entered into a Research Agreement (the "UBC Research Agreement") with an affiliated company and the University of British Columbia ("UBC"). On April 1, 1996, the UBC Research Agreement was amended and expanded to include a number of Canadian hospitals. Under the terms of the UBC Research Agreement, the Registrant has agreed to provide equipment and funding in return for continuing research on cystic fibrosis to be carried out in connection with two patents issued in 1996. U.S. patent number 5,441,938 is held jointly by UBC and the Registrant, whereas U.S. patent number 5,514,665 is held by UBC and licensed to the Registrant. In conjunction with the UBC Research Agreement, UBC granted the Registrant, through a sub-licensing agreement with an affiliated company, an exclusive worldwide license to manufacture, distribute and sell products derived or developed from the research performed. During fiscal 2000, the Registrant and UBC licensed the cystic fibrosis product to BCY Lifesciences Inc. (formerly BCY Ventures Inc.) ("BCY Lifesciences") of Vancouver, British Columbia, Canada. Under this license agreement, BCY Lifesciences will pay a royalty to both the Registrant and UBC based on sales and sublicensing revenue in return for the exclusive right to sublicense, manufacture, distribute and sell the developed products.

Status of New Products or Industry Segments

    There has been no public announcement of, and no information otherwise has been made public about, a new product or industry segment that would require the investment of a material amount of the assets of the Registrant or that otherwise is material.

Suppliers and Sales

Iron Dextran and Dextran Sulphate

    With regard to its basic raw materials, the Registrant utilizes one basic supplier for its sugar requirements and one basic supplier for its Iron. Both of these materials, as well as others used by the Registrant, are readily available from numerous suppliers at competitive prices in the market. The Registrant has no long-term contracts with any of its suppliers.

    The Registrant is dependent upon a single source for a certain raw material used in the production of Dextran Sulphate. Such supply was adequate in fiscal 2001 and no shortages are anticipated in the near term. However, any curtailment in availability of such raw material could be accompanied by production or other delays as well as increased raw material costs, with consequent adverse effect on the Registrant's results of operations.

Veterinary Products

    The Registrant has no long-term contracts with any of its suppliers. Other than with respect to euthanasia products, raw materials are readily available from a variety of suppliers at competitive prices in the market. The sole supplier of euthanasia product Pentobarbital has experienced regulatory problems. Future sales of euthanasia products will be limited until the supplier resolves these issues or until another manufacturer is approved.

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Backlog and Seasonality

    The Registrant's backlog as at January 31, 2001 was approximately $1,600,000 whereas backlog as at January 31, 2000 was approximately $1,500,000. All of these orders are expected to be filled within the current fiscal year. The Registrant's business is not seasonal to any material extent.

Competition

    The Registrant is the only Canadian manufacturer of Iron Dextran and, as a result of its ownership of Vet Labs, the Registrant is also the only manufacturer of the 10% Bulk Solution in the United States. There exist several European sources of Iron Dextran. However, the only other major supplier of Iron Dextran is located in Denmark. Dextran Sulphate is also manufactured by several manufacturers in the U.S. and Europe. With regard to Iron Dextran and Dextran Sulphate, the Registrant competes on the basis of quality, service and price.

    The Registrant currently produces approximately 50 veterinary products including analgesics, anti-diarrheals, topical antiseptics, nutritional supplements, local and general anesthesia agents and euthanizing agents. Primary market segments include beef and dairy cattle, swine, equine and to a small extent, companion animals (dogs and cats). With the exception of Iron Dextran and Nitrofurazone ointment, the product offering is generic or non-licensed (non NADA). As such, all products are subject to numerous competitors. In addition to competing on the basis of quality, service and price, the Registrant differentiates itself from competitors through its ability to supply multiple product dosage forms (i.e., injectables, boluses, tablets, liquids and powders) and provide customers with technical and regulatory support and assistance from in-house quality control and regulatory departments.

Research and Development

    During the fiscal years ended January 31, 2001, 2000, and 1999, the Registrant expended $1,158,729, $677,111, and $234,825 respectively, on research and development relating primarily to the development of Cellulose Sulphate and a raw material for a human pharmaceutical product. The fiscal 2001 increase is due to the work on the Cellulose Sulphate product and ongoing work on the human pharmaceutical project. During the years ended January 31, 2001, 2000 and 1999, the Registrant recognized investment tax credit benefits of $52,246, $39,794 and $201,762.

Environmental Compliance

    The Registrant believes that it is in substantial compliance with all existing applicable foreign, federal, state and local environmental laws and does not anticipate that such compliance will have a material effect on its future capital expenditures, earnings or competitive position.

Governmental Contracts

    No portion of the Registrant's business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the U.S. Government.

Employees

    As of March 31, 2001, the Registrant employed 86 employees, of whom 55 were engaged in production, 18 in quality control, 2 in research and development, 9 in administration and 2 in marketing and sales activities. Of such employees, 57 were employed by Vet Labs and 29 by Dextran Products. None of the Registrant's employees are covered by collective bargaining agreements. Management considers its relations with employees to be good.

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Recent Developments—New Products

Activated Collagen and Elastin

    Collodex, a modified collagen, has been formulated as a principal ingredient of a cosmetic skin cream. During fiscal 2000, the Registrant engaged several marketing companies for the promotion of this product. To date, efforts by these companies have met with limited success. At the present time, minor sales are being made to cosmetic manufacturers in the Pacific Rim with the potential for increased sales in the future.

    Elastin, a material with similar applications, has been developed by the Registrant. It has not been commercialized, however, and no sales are expected to occur in the current fiscal year.

Cystic Fibrosis

    Cystic fibrosis is a genetic disease which causes a cascade of effects, the most severe being a build up of mucus in the lungs. This mucus is difficult to remove and also permits the colonization of bacteria which then cause secondary infections and often death. Research in collaboration with the University of British Columbia has shown that a special form of Dextran, Usherdex 4, is effective in preventing the colonization of bacteria in the mouth and in stimulating the macrophages in the lungs to remove the bacteria present and lessen secondary infections. BCY Lifesciences Inc. has been granted the exclusive right to sublicense, manufacture, distribute and sell any commercial products developed from Usherdex 4. BCY Lifesciences successfully completed an animal toxicology study during fiscal 2001.

Cellulose Sulphate

    As discussed above, research is underway in the United States to evaluate the use of this material as a contraceptive gel with antiviral capabilities. During fiscal year 2000, the Registrant successfully completed a Phase I human clinical trial with support from the Consortium for Industrial Collaboration in Contraceptive Research ("CICCR"). Should continued positive results be generated from this work, the Registrant has been advised that the funding from CICCR will continue through Phase II trials. The Registrant maintains an exclusive worldwide license for this product.

Segmented Information

    The information regarding the geographic distribution of revenue, operating results and assets set forth in Note 15 to the Registrant's Consolidated Financial Statements included in the Registrant's Annual Report to Shareholders for the fiscal year ended January 31, 2001 is incorporated herein by reference.

ITEM 2.  PROPERTIES

    The Registrant's wholly-owned subsidiary, Polydex Chemicals (Canada) Limited, maintains its executive and sales offices and its manufacturing plant of approximately 30,000 square feet in Toronto, Ontario, Canada.

    The Registrant operates a fermentation plant in Toronto, Ontario, Canada, having the capacity to produce both 10% and 20% Iron Dextran at the rate of up to 11,000 liters a week (there are 1.057 quarts in one liter). Present production is approximately 8,000 liters a week. Complexing of the Iron Dextran takes place in Toronto, Ontario, Canada.

    Dextran Sulphate presently is manufactured at the Registrant's plant in Toronto, Ontario, Canada where reactors and spray drying equipment are available. The Registrant presently manufactures approximately 250 kilos of Dextran Sulphate per quarter (there are 2.2 pounds in one kilo), and has

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the capacity to manufacture 500 kilos per month simultaneously with the 11,000 liters per week of Iron Dextran.

    The Toronto facility has been divided into 11 discrete production areas identified for refurbishment. During fiscal 2001 further planning was carried out but no significant work undertaken so that all available resources could be focussed on the research projects. It is planned that work will be started in fiscal 2002.

    Through its subsidiary, Vet Labs, the Registrant manufactures tablets and boluses, internal and external solutions, ointments, powders and injectable products. The manufacturing facility is located on 8 acres of land in Lenexa, Kansas. The plant is 55,000 square feet with separate production areas for each of the above product groups. The plant has the capacity to manufacture over 200,000 boluses per day, 4,000 gallons of liquids per day, 1,500 pounds of powder per day and 1,000 gallons of injectable products per day. The facility is currently running at approximately 50% of capacity.

    Each of the properties described above is owned by the Registrant. Management believes that the Registrant's facilities are adequate for its present requirements. These facilities have additional capacity for expansion of production of existing and new products. The Registrant considers its current equipment to be in good condition and suitable for the operations involved.

ITEM 3.  LEGAL PROCEEDINGS

    There are no pending legal proceedings to which the Registrant or any of its subsidiaries is a party, or to which any of their property is subject.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

    No matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the Registrant's fourth quarter ended January 31, 2001.

PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

    The Company's shares are listed for trading on the Nasdaq SmallCap Market System under the symbol POLXF, and on the Boston Stock Exchange under the symbol PXL.

    The reported high and low bid prices of the common shares on the Nasdaq SmallCap Market System for the past two calendar years were as follows (similar prices were quoted on the Boston Stock Exchange):

    The quotations set out above represent prices for the specific dates between dealers and do not include retail mark-up, mark-down or commission. They do not represent actual transactions. These quotations have been supplied by the National Association of Securities Dealers, Inc.

    As of April 23, 2001 there were approximately 726 holders of record of the Company's Common Shares.

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    The Company has paid no dividends in the past and does not consider likely the payment of any dividends in the foreseeable future.

    There are no governmental laws, decrees or regulations in the Commonwealth of the Bahamas applicable to the Registrant that restrict the export or import of capital, including foreign exchange controls, or that affect the remittance of dividends or other payments to nonresident holders of the Registrant's Common Shares. Furthermore, U.S. holders of the Registrant's Common Shares are not subject to taxes under Bahamian law.

ITEM 6.  SELECTED FINANCIAL DATA

Polydex Pharmaceuticals Limited

Financial Highlights

January 31, 2001

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ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

    The Company's fiscal year ends on January 31st therefore fiscal year 2001 refers to the Company's year ended January 31, 2001. The following discussion should be read in conjunction with the financial statements and notes thereto included elsewhere in this report.

Results of Operations

    The operations of the Company are carried on through Dextran Products Limited ("Dextran Products") in Canada and through Chemdex, Inc. ("Chemdex") in the United States. The operations of Chemdex are carried on through its wholly-owned subsidiary, Veterinary Laboratories, Inc. ("Vet Labs"). Each of Dextran Products and Chemdex operates as a strategic business unit. Dextran Products manufactures and sells bulk quantities of Dextran and several of its derivatives to large pharmaceutical companies throughout the world. Chemdex manuafactures and sells veterinary pharmaceutical products and specialty chemicals in the United States. The primary customers are distributors and private labelers, who in turn sell to the end-user of these products.

    Sales of the Company increased 4% or $549,709 to $13,646,158 in fiscal 2001 from $13,096,449 in fiscal 2000. The growth in sales was primarily due to a greater volume at Chemdex, where sales increased by 4% or $321,878 to $9,142,855 in fiscal 2001 from $8,820,977 in fiscal 2000, and accounted for 67% of the Company's sales in each of fiscal 2001 and 2000. Sales of the Company increased 12% or $1,375,429 to $13,096,449 in fiscal 2000 from $11,721,020 in fiscal 1999. The sales increase in 2000 was also primarily attributable to increased sales at Chemdex.

    Chemdex products are broken down into 4 product lines. Injectables is the largest product line accounting for 64% and 65% of Chemdex sales for fiscal 2001 and fiscal 2000, respectively. Sales of injectable products increased by 3% or $169,894 to $5,882,513 in fiscal 2001 from $5,712,619 in fiscal 2000 due to general market trends and a particularly strong fall market. Management expects the sales to continue to track with the general market in fiscal 2002. Management's expectations for the general market in fiscal 2002 are that sales will be consistent or slightly down. Management is planning for the introduction of two to three new products for the fourth quarter of fiscal 2002, pending regulatory approval. Sales trends are expected to increase in fiscal 2003 and beyond with the introduction of these and other new products in the coming years.

    Sales at Dextran Products increased by 5% or $227,831 to $4,503,303 in fiscal 2001 from $4,275,472 in fiscal 2000, and accounted for 33% of the Company's sales in each of fiscal 2001 and 2000. Demand for Dextran and related products remained strong during the year and management expects such strong demand to continue. Sales levels are expected to increase slightly next year.

    The Company's gross profit increased 1% or $23,783 to $3,647,296 in fiscal 2001 from $3,623,513 in fiscal 2000. As a percentage of sales, the Company's gross profit decreased to 27% from 28% in fiscal 2001. Chemdex' gross profit decreased 6% or $109,850 to $1,768,305 in fiscal 2001 from $1,878,155 in fiscal 2000. As a percentage of sales, Chemdex' gross profit decreased to 19% in fiscal 2001 from 21% in fiscal 2000. This decrease in gross profit at Chemdex was attributable to increases in energy costs, labor rates and product mix. Energy cost increases resulted in cost increases for utilities and freight. Chemdex had increased sales volume in its liquids and solid dosage product lines, which are more labor-intensive and lower margin product lines. Management anticipates the approval of several Abbreviated New Animal Drug Applications ("ANADAs") during the coming years. Management believes that these approvals will result in an increase in profit margins.

    Dextran Products' gross profit, excluding profit on intercompany sales, was $1,744,716 in fiscal 2001 as compared to $1,642,483 in fiscal 2000. As a percentage of sales, Dextran's gross profit increased to 39% in fiscal 2001 from 38% in fiscal 2000. Dextran Products' costs are incurred in

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Canadian dollars, while the majority of its sales are in U.S. dollars. Therefore if the Canadian dollar decreases in relation to the U.S. dollar, margins increase. In fiscal 2001 such currency fluctuations resulted in a 1% increase in margins.

    Other revenue of $182,400 in fiscal 2001 resulted from a payment from a collaborator on a research and development project. There were no similar payments received in fiscal 2000.

    Selling, promotion, general and administrative expenses increased by 4% to $1,776,925 in fiscal 2001 from $1,716,445 in fiscal 2000. This increase is a result of hiring an investor relations firm during the third quarter of fiscal 2000. Selling, promotion, general and administrative expenses decreased by 9% in fiscal 2000 from $1,881,378 in fiscal 1999 mainly due to a reduction in senior management salaries. As a percentage of sales, selling, promotion, general, and administrative expenses remained constant at 13% in both fiscal 2001 and fiscal 2000.

    In fiscal 2001, the Company spent $1,158,729 on research and development expenditures as compared to $677,111 in fiscal 2000 and $234,825 in fiscal 1999. This increase of $442,286 or 188% from fiscal 1999 to fiscal 2000 and the further increase of $481,618 or 71% from fiscal 2000 to fiscal 2001 is due primarily to new product development costs relating to the development of a raw material for a human pharmaceutical product and the cellulose sulfate project at Dextran Products, and the development of new products at Vet Labs. Development costs for new products are expected to continue in fiscal 2002, but at reduced levels.

    Investment tax credits are claimed by Dextran Products to offset the cost of research and development. The total investment tax credit benefit recognized in fiscal 2001 was $52,246 as compared to $39,794 in fiscal 2000 and $201,762 in fiscal 1999. The investment tax credit benefits recognized in fiscal 2001 and fiscal 2000 relate strictly to investment tax credits earned during the respective years. The large benefit recognized in 1999 was a result of utilizing previously unrecognized investment tax credit benefits. As a result, the company recorded research and development expense, net of investment tax credits, of $1,106,483, $637,317 and $33,063 in fiscal 2001, fiscal 2000 and fiscal 1999, respectively.

    Depreciation and amortization increased by 16% or $81,901 to $601,701 in fiscal 2001 from $519,800 in fiscal 2000. This increase is primarily attributable to the new production equipment constructed at Dextran Products in the fourth quarter of fiscal 2000.

    Interest expense increased by 94% or $138,791 to $286,779 in fiscal 2001 from $147,988 in fiscal 2000. This increase is primarily attributable to imputed interest of $107,025 on long-term payables incurred in the fourth quarter of fiscal 2000 and the financing of capital expenditures for production equipment constructed in the fourth quarter of fiscal 2000.

    Income from operations for the Company in fiscal 2001 totaled $57,808, a decrease of $544,155 or 90% from $601,963 in fiscal 2000. Income from operations at Chemdex decreased to $639,539 in fiscal 2001, a decrease of $45,116 or 7% from $684,655 in fiscal 2000. This decrease in income from operations is a result of the decrease in gross profit, as described above.

    Income from operations at Dextran Products in fiscal 2001 was $159,216, a decrease of $500,778 or 76% from $659,994 in fiscal 2000. This decrease in income from operations is a result of the significant increase in research and development expenses, primarily related to the human pharmaceutical project. In addition, there was an increase in depreciation expense due to the new production equipment constructed in the fourth quarter of fiscal 2000.

    Interest and other non-operating income decreased by 10% or $23,353 to $217,079 in fiscal 2001 from $240,432 in fiscal 2000. In fiscal 2000, the deferred gain of $192,892 on the sale of Novatek International Inc. shares was recognized as other income due to settlement of a lawsuit. This reduction

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in other income was partially offset by a foreign exchange gain at Dextran Products and the settlement of a class action lawsuit, in favor of Chemdex, against various vitamin suppliers.

    The provision for income taxes in fiscal 2001 was $143,603 as compared to a recovery of income taxes in fiscal 2000 of $127,448. A tax recovery of $400,000 was recorded in fiscal 2000 due to the reduction in the valuation allowance against the United States deferred tax assets.

    A tax provision of $27,405 relating to Dextran Products was recorded in fiscal 2001 as compared to $270,640 in fiscal 2000. The decrease in the Canadian tax provision is a result of the decrease in profitability of Dextran Products in fiscal 2001. The Canadian operations continue to have significant research and development tax pools to offset current taxes payable.

    As a result of the foregoing, the Company recorded net income of $131,284 in fiscal 2001 as compared to a net income of $969,843 in fiscal 2000.

    Certain events occurring in fiscal 2001 could have an impact on future results as follows.

    The Foot and Mouth disease problem in Europe, following so closely on the heels of the Bovine Spongiform Encephalopathy outbreak, may be of concern. Dextran Products has been in contact with its agents overseas and to date the problem seems to be more related to sheep and cattle. The modern practice of isolating pig units for health reasons and taking the animals directly to slaughter has limited the impact on this sector. The Iron Dextran sold by Dextran Products is mainly for treatment of pigs. The situation is, however, very fluid and the Company continues to be in contact with its distributors. Feedback from Asia, Europe and the United States shows limited effect to date. The impact of the Foot and Mouth disease problem has had minimal impact on Vet Labs.

    The Company is conducting part of its research through collaboration with scientists from the Program for the Topical Prevention of Conception and Disease (TOPCAD) based at the Rush-Presbyterian-St. Luke's Medical Center and the University of Illinois in Chicago. The Company continues to be supported by assistance from the Contraceptive Research and Development Program ("CONRAD"). During 1999, CONRAD and the company received approval to initiate a Phase I clinical trial for tolerance of the female contraceptive product, Ushercell, and this was successfully completed with minimal side effects. In fiscal 2000, the Company received a patent on the Antimicrobial and Contraceptive properties of Ushercell in conjunction with TOPCAD. CONRAD continues to support this project and management expects that funding for further clinical trials and research will continue due to the success of the work to date.

    The Company licensed the cystic fibrosis product, Usherdex, to BCY Lifesciences Inc. ("BCY Lifesciences") of Vancouver, British Columbia. Under this license agreement, BCY Lifesciences will provide funding for research and development and will pay a royalty to the Company based on sales and sublicensing revenue in return for the exclusive right to sublicense, manufacture, distribute and sell the product or products developed. BCY Lifesciences has since raised funds to continue the research and development of the product. BCY Lifesciences successfully completed an animal toxicology study during fiscal 2001 and expects to begin a phase I clinical trial in the next one to two years.

    Vet Labs has a raw material supplier that continues to have regulatory problems with their production of Pentobarbital used in euthanasia product. Consequently, this has limited the production and related sale of euthanasia products by Vet Labs during fiscal 2001. During the year, the United States Food and Drug Administration ("FDA") did grant an emergency release of raw materials by the supplier, which allowed Vet Labs to produce and sell some euthanasia products. The release by the FDA was granted because of the short supply of euthanasia products in the field. Management expects future sales of these products to remain limited until the supplier resolves their regulatory problems or until another manufacturer is approved. Sales of euthanasia products totalled $256,000 in fiscal 2001, as compared to $347,000 in fiscal 2000.

12

Liquidity and Capital Resources

    For fiscal 2001 the Company generated cash of $837,954 from its operating activities compared to $871,521 for fiscal 2000. The decrease in earnings in fiscal 2001 included an increase in non-cash expenses consisting of depreciation, amortization and imputed interest. In addition, the earnings in fiscal 2000 included non-cash income arising from the deferred tax recovery and the recognition of the deferred gain from the sale of the Novatek International Inc. shares. The Company maintained $1,639,513 of working capital and a current ratio of 1.7:1 as of January 31, 2001 compared to $1,663,725 of working capital and a current ratio of 1.7:1 as of January 31, 2000.

    At January 31, 2001, the Company had accounts receivable of $1,138,872 and $2,206,637 in inventory compared to $1,204,495 and $2,051,251, respectively, at January 31, 2000. The decrease in accounts receivable was due to timing of sales at year-end. There were large sales at Chemdex at year-end in fiscal 2000, which increased the year-end receivables balance. The increase in inventory levels was due to forecasted stocking for February sales.

    During fiscal 2001, capital expenditures totaled $595,293 as compared to $1,318,626 in fiscal 2000. This decrease is a result of the large additions of production equipment at the Dextran Products plant in Toronto in fiscal 2000.

    The change in the accumulated other comprehensive income is entirely attributable to the currency translation adjustment of Dextran Products. Dextran Products' functional currency is the Canadian dollar. This currency translation adjustment arises from the translation of Dextran Products' financial statements to U.S. dollars.

    During fiscal 2001, the Company negotiated an extension of payment terms on the long-term debt due to ContiGroup Companies, Inc. Under the new terms, semi-annual repayments of $90,000 will be required on May 1 and November 1 each year commencing May 1, 2001 with a final lump-sum payment of $105,343 on November 1, 2004. Management anticipates funding these payments with cash from existing operations.

    Dextran Products has a CDN$750,000 (US$500,000) line of credit. Management anticipates using the credit line for the purposes of funding a portion of the costs associated with the refurbishment of the Toronto facility. The Vet Labs—Sparhawk Joint Venture has a $75,000 line of credit to fund operations. Vet Labs has a loan commitment for $400,000 to be used for building construction. Management is not planning any construction at Vet Labs during fiscal 2002.

    Management expects the primary source of its future capital needs to be a combination of company earnings and borrowings. The Company, at present, does not have any material commitments for capital expenditures, although management intends to continue the plant refurbishment at Dextran Products.

    No changes in accounting principles or their application have been implemented in the reporting period that would have a material effect on reported income. Changes in the relative values of the Canadian dollar and the U.S. dollar occur from time to time and may, in certain instances, materially affect the Company's results of operations.

    The Company does not believe that the impact of inflation and changing prices on its operations are material.

Management Objectives

    Management's primary objectives for the coming year are to further clinical trials on Ushercell and to increase sales and profitability.

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    Management's primary objective for the coming year at Dextran Products is to continue with plant refurbishment and new product development. Management has performed extensive planning for the refurbishing process and believes that it will continue for another two years. This year, management plans to upgrade some production areas to increase capacity and install new production equipment. There are no scheduled production interruptions as a result of this refurbishing in fiscal 2002. Although management believes that production interruptions will be minimal, management is developing contingency plans in case there are unexpected production interruptions. When fully complete, management expects the refurbishing to increase capacity by 50 to 100% with increased operating efficiencies. Until the refurbishing is complete, however, there could be decreases in profit margins due to the increased overhead costs and unexpected production interruptions.

    Management's primary objective at Vet Labs is product development and marketing of licensed products. These licensed products require individual approval by the United States Food and Drug Administration ("FDA") and consequently offer greater profit margins. Primary emphasis will be placed on the approval of injectable ANADAs with secondary emphasis on the approval of solutions and powders.

Forward-looking Statements Safe Harbor

    This Annual Report, including the Management's Discussion and Analysis, contains various "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, which represent the Company's expectations or beliefs concerning future events, including, but not limited to statements regarding management's expectations of regulatory approval and the commencement of sales. In addition, statements containing expressions such as "believes", "anticipates" or "expects" used in this Annual Report and the Company's periodic reports on Forms 10-K and 10-Q filed with the Securities and Exchange Commission are intended to identify forward-looking statements. The Company cautions that these and similar statements in this Annual Report and in previously filed periodic reports including reports filed on Forms 10-K and 10-Q are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements. These factors include, without limitation, changing market conditions, the progress of clinical trials, and the results obtained, the establishment of new corporate alliances, the impact of competitive products and pricing, and the timely development, FDA approval and market acceptance of the Company's products, none of which can be assured. Results actually achieved may differ materially from expected results included in these statements as a result of these or other factors.

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ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

POLYDEX PHARMACEUTICALS LIMITED AND SUBSIDIARIES

January 31, 2001

Interest Rate Sensitivity

    The table below provides information about the Company's financial instruments that are sensitive to changes in interest rates. All financial instruments are held for other than trading purposes. The Company does not have a material exposure to interest rate risk.

    The table presents principal cash flows and related weighted average interest rates by expected maturity dates.

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POLYDEX PHARMACEUTICALS LIMITED AND SUBSIDIARIES

January 31, 2001

Exchange Rate Sensitivity

    The table below provides information about the Company's financial instruments that are sensitive to changes in foreign currency exchange rates. All financial instruments are held for other than trading purposes. The Company's major exposure to exchange rate risk is that the Canadian dollar rises dramatically in relation to the U.S. dollar and that this significantly reduces the gross margin experienced at Dextran Products. Management monitors the margin at Dextran to ensure that an acceptable margin level is maintained. Management has the ability, to some extent, to adjust sales prices to maintain an acceptable margin level.

    The table presents principal cash flows and related weighted average interest rates by expected maturity dates.

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ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Consolidated Financial Statements
[Expressed in United States Dollars]

Polydex Pharmaceuticals Limited
January 31, 2001, 2000 and 1999

17

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Shareholders of
Polydex Pharmaceuticals Limited

    We have audited the accompanying consolidated balance sheets of Polydex Pharmaceuticals Limited as of January 31, 2001 and 2000 and the related consolidated statements of shareholders' equity, operations and cash flows for each of the years in the three-year period ended January 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

    We conducted our audits in accordance with United States generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

    In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Polydex Pharmaceuticals Limited as of January 31, 2001 and 2000 and the consolidated results of its operations and its cash flows for each of the years in the three-year period ended January 31, 2001 in conformity with United States generally accepted accounting principles.

Chartered Accountants

Toronto, Canada,
March 9, 2001.

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Polydex Pharmaceuticals Limited

CONSOLIDATED BALANCE SHEETS

[Expressed in United States dollars]

As at January 31

See accompanying notes

19

Polydex Pharmaceuticals Limited

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

[Expressed in United States dollars]

Years ended January  31, 2001, 2000 and 1999

See accompanying notes

20

Polydex Pharmaceuticals Limited

CONSOLIDATED STATEMENTS OF OPERATIONS

[Expressed in United States dollars]

Years ended January 31

See accompanying notes

21

Polydex Pharmaceuticals Limited

CONSOLIDATED STATEMENTS OF CASH FLOWS

[Expressed in United States dollars]

Years ended January 31

See accompanying notes

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Polydex Pharmaceuticals Limited

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

[Expressed in United States dollars]

January 31, 2001

1.  GENERAL

    Polydex Pharmaceuticals Limited [the "Company"] is incorporated in the Commonwealth of the Bahamas and its principal business activities, carried on through subsidiaries, include the manufacture and sale of veterinary pharmaceutical products and specialty chemicals. These consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles.

2.  SIGNIFICANT ACCOUNTING POLICIES

Basis of consolidation

    The consolidated financial statements include the accounts of the Company and its subsidiaries. All inter-company accounts and transactions have been eliminated on consolidation.

Use of estimates

    The preparation of financial statements in conformity with United States 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 consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.

Inventories

    Inventories of raw materials are stated at the lower of cost and net realizable value, cost being determined on a first-in, first-out basis. Work-in-process and finished goods are valued at the lower of cost and net realizable value, and include the cost of raw materials, direct labour and overhead expenses.

Property, plant and equipment and patents

    Property, plant and equipment are recorded at cost. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets as follows:

    Patents are amortized on a straight-line basis over their estimated useful lives of ten years.

    Costs related to plant refurbishments and equipment upgrades that represent improvements to existing facilities are capitalized. Costs related to repair and maintenance of buildings and equipment are expensed. The Company has no major planned maintenance activity other than the plant refurbishment at one of its subsidiaries.

Revenue recognition

    All revenue is from sales of manufactured products and is recognized upon shipment to customers.

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    Product sold in bulk quantities is tested, prior to release for shipment, to ensure that it meets customer specifications, and in many cases, customers receive samples for their own testing. Approval is obtained from the customer prior to shipping. Further purchases by a customer of a bulk product with the same specifications do not require approvals. Returns of bulk product are rare and generally are not accepted.

    No testing and approval is required for finished dosage product because of its nature. Returns of finished dosage product are rare and generally are not accepted.

Shipping and handling costs

    Shipping and handling costs incurred by the Company for shipment of products to customers are classified as cost of goods sold.

Research and development

    Research and development costs are expensed as incurred and are stated net of investment tax credits earned.

Foreign currency translation

    The functional currency of the Company's Canadian operations has been determined to be Canadian dollars. All asset and liability accounts of these companies have been translated into United States dollars using the current exchange rates at the consolidated balance sheet dates. Revenue and expense items are translated using the average exchange rates for the year. The resulting gains and losses have been reported separately as other comprehensive income within shareholders' equity.

Stock options

    The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ["APB 25"] and related interpretations in accounting for its employee stock options rather than the alternative fair value accounting provided for under Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ["SFAS 123"]. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.

Earnings per common share

    Basic earnings per common share are computed using the weighted average number of shares outstanding of 3,027,049 at January 31, 2001 [2000 - 3,017,542; 1999 - 2,999,415]. Diluted earnings per common share are computed using the weighted average number of shares outstanding adjusted for the incremental shares, using the treasury stock method, attributed to outstanding options to purchase common stock. Incremental shares of 145,205, 1,228 and nil in 2001, 2000 and 1999, respectively, were used in the calculation of diluted earnings per common share. Options to purchase 25,000, 615,077 and 637,577 common shares in 2001, 2000 and 1999, respectively, were not included in the computation of diluted earnings per common share because the option exercise price was greater than the average market price of the common shares.

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3.  INVENTORIES

    Inventories consist of the following:

4.  PROPERTY, PLANT AND EQUIPMENT

    Property, plant and equipment consist of the following:

    Included in machinery and equipment are assets under capital lease with a total cost of $879,881 [2000 - $883,400] and accumulated depreciation of $108,724 [2000 - $23,000]. Depreciation of assets under capital lease is included in depreciation expense.

5.  PATENTS

    Patents consist of the following:

6.  RELATED PARTY TRANSACTIONS

    Amounts due from (to) related parties consist of the following:

[i]

Amounts due from Sparhawk Laboratories, Inc. ["Sparhawk"], a participant in a joint venture of the Company [note 11[b]], include interest charged at the U.S. banks' prime lending rate plus 1.5% [January 31, 2001 - 10.5%]. Interest income for the year on this loan approximates $14,000.

25

The Company is in the process of negotiating a formal loan agreement to document the terms of this loan.

[ii]

Amounts due from shareholder are due from an officer and director, who is also a major shareholder of the Company [the "Major Shareholder"] and bear interest at the Canadian banks' prime lending rate plus 1.5% [January 31, 2001 - 8.75%; January 31, 2000 - 8%], except for an amount of $791,119 [2000 - $798,100] which is non-interest bearing. These amounts have no fixed terms of repayment. The Major Shareholder has pledged 328,051 shares of the Company and has pledged future royalty payments from the iron dextran process license agreement [note 12[a]] as collateral for this loan.

[iii]

Amounts due to shareholder bear interest at the Canadian banks' prime lending rate plus 1.5% [January 31, 2001 - 8.75%; January 31, 2000 - 8%]. The Company is required to make monthly payments, inclusive of accrued interest, of $1,000. Upon the death of either the shareholder or the Major Shareholder, the required monthly payment increases to $5,000. This loan may not be called.

    Interest recorded with respect to amounts due from and due to related parties are as follows:

7.  BANK INDEBTEDNESS

    The Company has a Canadian operating line of credit of Cdn. $750,000 [$500,000] [January 31, 2000 - Cdn. $750,000, $516,000] and a U.S. operating line of credit of $75,000, none of which were utilized at January 31, 2001 and 2000. The Canadian line of credit bears interest at the Canadian banks' prime lending rate plus 1.25% [January 31, 2001 - 8.5%; January 31, 2000 - 7.75%]. The U.S. line of credit bears interest at the U.S. bank's prime lending rate plus 0.5% [January 31, 2001 - 9.5%]. Bank indebtedness is collateralized by a general security agreement over the Company's assets.

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8.  LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS

[a]

Long-term debt consists of the following:

    Principal repayments on the long-term debt are as follows:

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[b]

Capital lease obligations consist of the following:

    Future annual minimum lease payments on the capital lease obligations are as follows:

9.  COMMITMENTS AND CONTINGENCIES

Deferred gain

    During the year ended January 31, 1997, the Company sold its shares in Novatek International Inc., an unrelated company, for a gain of $878,412. Prior to April 28, 1996, these shares were subject to options held by unrelated parties. After April 28, 1996, these options expired and the Company sold the shares in the open market realizing the gain. Subsequently, the former option holders filed a lawsuit against the Company for unspecified damages alleging that the Company denied them the opportunity to exercise their options. A settlement agreement was reached effective January 31, 2000. Under the terms of the settlement agreement, the Company paid $150,000 on February 10, 2000 and will pay $325,000 in 24 equal monthly installments of $13,542 commencing March 15, 2000. The net present value of the amount owing under the settlement agreement, determined using a discount rate of 9% at the date of settlement, is included in long-term debt [note 8[a]].

    The Company had deferred the gain on this transaction prior to fiscal 2000 until the likelihood of the outcome of the lawsuit was determinable. As a result of the settlement of the lawsuit, a gain of $192,892 was recognized during the year ended January 31, 2000. The deferred gain had been reduced by legal fees of $33,684 in 2000 and $13,351 in 1999.

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Other

    During the year ended January 31, 2001, the Company received settlement as part of a class action lawsuit against a supplier, recording a gain of $83,266.

10. CAPITAL STOCK

[a]  Share capital issued and outstanding

[i]  Common shares

On January 11, 1999, the Company entered into an agreement to grant common shares and common share options to individuals involved in obtaining research grants for the Company. On January 11, 1999, 20,000 common shares were granted. A further 5,000 common shares were granted to these individuals on each of January 11, 2000 and January 11, 2001. The 5,000 common shares issued on January 11, 2000 and January 11, 2001 were valued at $21,415 and $20,600, respectively, using the closing market price on the issue date. The 20,000 common shares issued on January 11, 1999 were valued at $68,760, using the closing market price on that day. The value of the common shares issued was charged to research and development expense.

During the year ended January 31, 2001, the Company issued 8,800 common shares, through the exercise of common share options, for cash consideration of $29,887. During the same year, 8,240 common shares held in treasury were cancelled.

During the year ended January 31, 1999, the Company issued 20 common shares for no consideration to adjust for fractional shares created by the reverse share split.

[ii]  Class A preferred shares

The Class A preferred shares will carry dividends, will be convertible into common shares of the Company and will be redeemable, all at rates as shall be determined by resolution of the Board of Directors. No Class A preferred shares have been issued to date.

[iii]  Class B preferred shares

The Class B preferred shares carry no dividends, are non-convertible and entitle the holder to two votes per share.

[b]  Share option plan

[i]  Options outstanding

The Company maintains an incentive share option plan for management personnel for an unlimited number of options to purchase common shares. The Company also issues options to certain consultants for services provided to the Company.

Pursuant to the agreement entered into on January 11, 1999 to grant common shares and common share options to individuals involved in obtaining research grants for the Company [note 10[a]], 7,500 common share options were granted on January 11, 1999. A further 3,750 common share options were granted to these individuals on each of January 11, 2000 and January 11, 2001. The value of the common share options issued on January 11, 1999 was not significant and, therefore, was not recorded in the accounts. The common share options issued on January 11, 2000 and January 11, 2001 were valued at $9,878 and $6,615 respectively, using a Black-Scholes option pricing model. The value of these options was charged to research and development expense. All common share options granted to these individuals have an exercise price of $3.50 and a term of 5 years from the date of issue.

29

During the year ended January 31, 2001, 24,000 common share options were also issued to certain individuals for services provided to the Company. These options were valued at $42,888 using a Black-Scholes option pricing model.

All options granted have terms ranging from one to six years and vest immediately. At January 31, 2001, the Company has 420,600 options outstanding at exercise prices ranging from $3.50 to $6.80 and a weighted average price of $4.05. The options, which are immediately exercisable and expire on dates between May 31, 2001 and May 31, 2006, entitle the holder of an option to acquire one common share of the Company.

Details of the outstanding options, which are all currently exercisable, are as follows:

The following table summarizes information relating to the options outstanding at January 31, 2001:

[ii]  Pro forma information

As required by SFAS 123, pro forma information regarding net income and earnings per share has been determined as if the Company had accounted for its employee stock options under the fair value method. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 2001: risk-free interest rates of 6.22% [2000—4.94%; 1999—5.39%]; dividend yields of nil [2000—nil; 1999—nil]; volatility factors of the expected market price of the Company's common stock of 0.668 [2000—0.690; 1999—0.920], and an expected life of the options of 4.19 years [2000—1.13 years; 1999—4.81 years]. Since changes in subjective input assumptions can materially affect the fair value estimate, in management's opinion, the above pro-forma adjustments for SFAS 123 are not necessarily a reliable single measure of the fair value of the Company's employee stock options.

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For purposes of pro forma disclosures, the estimated fair value of the options is expensed immediately.

The Company's pro forma net income (loss) and earnings (loss) per share following SFAS 123 are as follows:

11. VETERINARY LABORATORIES, INC.

[a]  Purchase obligation to ContiGroup Companies, Inc. [formerly Continental Grain Company]

In 1992, the Company acquired 100% of the issued and outstanding share capital of Veterinary Laboratories, Inc. ["Vet Labs"] from ContiGroup Companies, Inc. [formerly Continental Grain Company] ["CGC"] for a total purchase price of $3,894,980, which was satisfied by issuing 194,749 common shares of the Company. The Company had guaranteed that CGC would realize a value of $3,894,980 on the eventual sale of these shares or CGC could put its remaining shares to the Company at such price to bring CGC's total consideration to $3,894,980.

As a result of a subsequent transaction with CGC during the year ended January 31, 1997, CGC agreed to reduce the maximum repurchase obligation of the Company to $2,000,000.

During the year ended January 31, 1999, CGC disposed of 56,000 common shares, and as a result, the purchase obligation was decreased and share capital increased by $571,267. In addition, the Company agreed to make periodic cash payments beginning in 2000, to reduce the remaining outstanding purchase obligations.

During the year ended January 31, 2000, CGC disposed of all its shareholdings of the Company for a cash consideration of $443,390, and therefore, the remaining purchase obligation is no longer contingent on the share price of the Company. Accordingly, the fair value of the remaining purchase obligation has been reclassified from redeemable capital stock to long-term debt [note 8[a]].

On January 25, 2001, the terms of the purchase agreement were revised whereby the repayment terms for the outstanding repurchase obligation was extended. The revised agreement requires the Company to make semi-annual payments of $90,000 on each of May 1 and November 1 until May 1, 2004 and a final payment of $105,343 on November 1, 2004.

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A continuity of this purchase obligation is as follows:

    Since then, the amount has been included in long-term debt.

[b]  Sparhawk

In 1992, Vet Labs and Sparhawk entered into a joint venture [collectively referred to as the "Joint Venture"] for the purpose of manufacturing and selling veterinary pharmaceutical products. Sparhawk is an affiliated company owned primarily by the management of the Joint Venture. The Company controls the Joint Venture through its control of the Board of Directors and therefore consolidated its assets, liabilities, revenue and expenses in these financial statements. The Company has funded the Joint Venture's losses since 1992 and, accordingly, has recorded 100% of these losses in the consolidated financial statements. As at January 31, 2001, future profits of approximately $840,000 will accrue to the Company until Sparhawk's share of losses since 1992 have been recovered. Subsequent income will be allocated 50% to Vet Labs and 50% to Sparhawk.

12. LICENSE AGREEMENTS AND RESEARCH AND DEVELOPMENT

    The Company has made claims for investment tax credits on research and development activities. Research and development expenditures have been reduced by investment tax credits as follows:

    During the year ended January 31, 2001, the Company received a payment of $182,400 from a collaborator on a research and development project. This amount was recorded as other revenue.

[a]  Iron Dextran process

Effective February 1, 1995, the Company entered into an agreement with Novadex Corp., a company controlled by the Major Shareholder, whereby Novadex Corp. granted the Company the exclusive worldwide license to use a certain process developed by Novadex Corp. for producing Iron Dextran. The term of this license agreement is 10 years. The Company pays a license fee based on production volumes. The total royalty expense incurred during the year was $72,087 [2000—$55,915; 1999—$63,897].

32

During July 1999, Novadex Corp. was liquidated. All assets and liabilities of Novadex Corp. were assumed by the Major Shareholder. This license agreement was included in the assets assumed by the Major Shareholder. The Company will now pay this license fee to the Major Shareholder. These payments will be applied to the balance owing by the Major Shareholder [note 6].

[b]  Cystic Fibrosis

Effective April 1, 1994, the Company had entered into a research agreement [the "Agreement"] with Polydex Pharmaceuticals (B.C.) Ltd. [formerly Novadex Pharmaceuticals Limited] ["Polydex B.C."], a company owned by the Major Shareholder. Under the terms of the Agreement, the Company agreed to provide equipment. The Agreement was amended on April 1, 1996 and expanded to include a number of Canadian hospitals.

During 2000, the Company, through Polydex B.C., entered into a license agreement with SYNSORB Biotech Ltd. ["SYNSORB"], a Canadian-based pharmaceutical company dedicated to drug development and manufacturing. SYNSORB agreed to fund the research and development to be performed by the University of British Columbia ["UBC"] in connection with research into Cystic Fibrosis in exchange for an exclusive license to market the resulting products. SYNSORB will pay a semi-annual royalty payment to both UBC and the Company, through Polydex B.C., based on revenue from product sales.

Subsequent to entering into the license agreement with SYNSORB, SYNSORB assigned the license agreement to BCY Lifesciences Inc. [formerly BCY Ventures Inc.] ["BCY"] of Vancouver, British Columbia. BCY has assumed all obligations to fund continuing research and development of this project in return for an exclusive license to market the resulting products.

It is expected that the Company will enter into a supply agreement to produce the active pharmaceutical ingredient for the final products once clinical testing is complete and the final products reach market.

13. INCOME TAXES

[a]

Substantially all of the Company's activities are carried out through operating subsidiaries in Canada and the United States. The Company's effective income tax rate is dependent on the tax legislation in each country and the operating results of each subsidiary and the parent company.

The components of income before income taxes are as follows:

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The provision for (recovery of) income taxes consists of the following: