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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED,
EFFECTIVE OCTOBER 7, 1996).
FOR THE FISCAL YEAR ENDED MARCH 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NO. 1-12362
U.S. DRUG TESTING, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 33-0539168
(State or other jurisdiction of (I.R.S. Employer
incorporation organization) I.D. Number)
10410 TRADEMARK STREET
RANCHO CUCAMONGA, CALIFORNIA 91730
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE:
(909) 466-8378
SECURITIES REGISTERED PURSUANT TO SECTION 12 (B) OF THE ACT:
Common Stock, $.001 par value
SECURITIES REGISTERED PURSUANT TO SECTION 12 (G) OF THE ACT:
None
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 files pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K.
As of June 30, 1997, there were 6,990,103 shares of the Common Stock
outstanding.
The Registrant has only one class of voting stock, the Common Stock. As of
June 30, 1997, the aggregate market value of the Common Stock held by
non-affiliates was $2,818,800 based upon the closing sale price of such stock on
May 12, 1997, the last date for which a market price was reported.
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PART I
ITEM 1. BUSINESS
GENERAL
U.S. Drug Testing, Inc. ("U.S. Drug") was incorporated on October 8, 1992
under the laws of the State of Delaware as a wholly-owned subsidiary of
Substance Abuse Technologies, Inc. ("SAT"). The Common Stock, $.01 par value of
SAT (the "SAT Common Stock") is currently traded on the American Stock Exchange.
Effective as of January 1, 1993, SAT sublicensed or transferred to U.S. Drug
certain rights or assets to develop drug testing products in exchange for
3,500,000 shares of U.S. Drug's Common Stock, $.001 par value (the "U.S. Drug
Common Stock"). In October and November 1993, U.S. Drug had a public offering of
the U.S. Drug Common Stock in which an aggregate of 1,721,900 shares were sold.
As of June 30, 1997, SAT owned 5,268,203 shares of the U.S. Drug Common Stock or
75.4% of the 6,990,103 outstanding shares of the U.S. Drug Common Stock.
U.S. Drug has not produced any revenues through March 31, 1997 because its
products are still in the developmental stage. U.S. Drug is developing
proprietary systems that will test for drug use, specifically the following five
commonly used drugs of abuse: cocaine, opiates (heroin, morphine and codeine),
phencyclidine hydrochloride (PCP), amphetamines (including methamphetamines),
and tetrahydrocannabinol (THC, marijuana) (collectively the "Drugs of Abuse").
As indicated below, U.S. Drug's first efforts were to develop a device to test
for the Drugs of Abuse using urine as the test medium; however, based on its
review of the potential market in 1995, U.S. Drug decided to develop a saliva
medium testing product first. In late 1996, it expanded the development program
to ascertain if the device would also test for the presence of alcohol.
In January 1992, the United States Navy ("USN") and SAT signed a ten-year
license agreement (the "License Agreement") covering the exclusive use by SAT of
the USN's technology for the five Drugs of Abuse and any other drugs that might
be added to the National Institute of Drug Abuse ("NIDA") list of drugs of
abuse. By an amendment dated March 15, 1994, the scope of the License Agreement
was broadened to permit SAT to use the technology for testing for methadone,
benzodiazapines, barbituates, propoxyphene, tricyclic antidepressants and
anabolic steroids. Except as set forth in the two preceding sentences, SAT under
the License Agreement cannot use the USN technology to test for other
substances. By an amendment dated June 16, 1995, the term of the exclusive right
under the License Agreement was extended to terminate ten years from June 27,
1995 and SAT has a nonexclusive right to use the technology thereafter for the
balance of the patent term, unless the License Agreement is terminated sooner
because of SAT's default. By letter dated May 15, 1995, the USN notified SAT
that, because the expiration date of the USN patent had been extended to
February 23, 2010 under the GATT/WTO treaty, the expiration date of the License
Agreement was extended to February 23, 2010. See the section "Material
Contracts -- License Agreement" under this caption "Business." U.S. Drug's line
of products under development are based on its sublicense from SAT for Drug of
Abuse detection utilizing the USN patent for flow immunosensor technology.
Because the USN refused to grant a novation to U.S. Drug of the License
Agreement as requested, the USN looks to SAT, not U.S. Drug, for performance
thereunder. In the event of a default under the sublicense, all rights would
revert to SAT. U.S. Drug is developing its own proprietary "Immunoassay
Chemistry" for these five drugs which will work with the USN-developed
technology.
U.S. Drug has received six approvals from the Food and Drug Administration
(the "FDA") covering its Model 9000 Flow Immunoassay System and the attendant
assays for each of the five Drugs of Abuse listed above, using urine as the test
medium. However, additional development work is required before the urine based
testing product can be marketed. U.S. Drug, based on its review of current
market conditions, has decided to defer completion of the calibrators and the
other elements required to be completed in order to market the urine medium
testing product until it can complete the assays for a saliva medium testing
product.
Until the saliva medium product is submitted to the FDA and marketing has
commenced, no revenues from product sales are likely to be produced. U.S. Drug
conducted an internal feasibility study as to the product which was completed in
November 1996. Based on the results of the feasibility study, U.S. Drug
proceeded to the next stage of development. Assuming subsequent success in the
remainder of the
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development program, U.S. Drug currently expects to submit its five-panel
screening assay to the FDA in February 1999 at the earliest, but there can be no
assurance that such submission will occur by such date or that the product will
be successfully developed. SAT commissioned an unaffiliated consulting firm in
June 1997 to review the product. The consultant confirmed U.S. Drug's
management's belief that the contemplated product could be developed and that
once developed there was a significant market therefor, especially with the
added alcohol testing capability; however, the consultant estimated that it may
take until August 1999 to bring the product to market and, as indicated in the
section "Need for Financing" under this caption "Business," at a higher cost
than had been estimated by U.S. Drug's management. Once the product is submitted
to the FDA, U.S. Drug will be able to market it in the United States for
non-medical purposes, such as employment screening and screening by correctional
and criminal justice agencies, and in Europe where no FDA approval is required,
although U.S. Drug will not be able to commence marketing of the product in
medical markets until FDA approval is obtained, which marketing should occur
approximately six months to a year later if such approval is obtained. There can
be no assurance as to when U.S. Drug will submit such assay to the FDA, if at
all, as to when the FDA will give its approval and as to when marketing in
either medical or non-medical markets will commence. Management recognizes that,
although FDA approval is not required for use of drug testing for non-medical
purposes, such as employment screening and screening by correctional and
criminal justice agencies, FDA approval of the product will assist U.S. Drug's
marketing in the United States to such customers. Marketing plans are in the
process of being developed.
U.S. Drug's screening tests are to be performed on a non-evidentiary basis.
If a Drug of Abuse is detected in the screening test, the sample will be
forwarded to a laboratory, where an expensive confirmatory analysis will be
performed. Usually gas chromatography/mass spectrometry ("GC/MS") is employed
for the evidentiary test. U.S. Drug's marketing analysis has indicated a greater
market potential for a saliva sample portable testing instrument for Drugs of
Abuse by law enforcement agencies, correctional facilities, hospitals and other
medical facilities than a urine sample instrument. However, because of the
expected limited life cycle of a saliva specimen, the use of this product in
other potential markets may be limited. Currently, to U.S. Drug's knowledge no
competitor is currently offering a saliva sample testing product on an "on site"
basis. However, management has been advised that two or more companies may have
such product under development. There can be no assurance that a competitor will
not begin to offer such a product in the future, whether before or after U.S.
Drug completes its research and development. See the section "Competition" under
this caption "Business."
SAT will seek to acquire the minority stock interests in U.S. Drug by an
offer of shares of the SAT Common Stock to the minority stockholders of U.S.
Drug (the "U.S. Drug Minority Stockholders") as consideration for their consent
to a merger (the "U.S. Drug Merger") of U.S. Drug with and into U.S. Drug
Acquisition Corp. ("U.S. Drug Acquisition"), a Delaware corporation and
wholly-owned subsidiary of the Company, pursuant to an Agreement and Plan of
Merger dated as of February 17, 1997 (the "U.S. Drug Merger Agreement") among
SAT, U.S. Drug and U.S. Drug Acquisition. Such consent will be sought from the
U.S. Drug Minority Stockholders pursuant to Section 228 of the General
Corporation Law of the State of Delaware (the "GCL") in lieu of holding a
meeting of stockholders of U.S. Drug.
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form S-4, File No. 333-4790 (the "U.S.
Drug Registration Statement"), under the Securities Act with respect to seeking
the consents of the U.S. Drug Minority Stockholders and with respect to the
shares of the SAT Common Stock to be issued upon consummation of the U.S. Drug
Merger. Amendment No. 2 to the U.S. Drug Registration Statement filed on April
21, 1997 called for SAT to issue 1.62 shares of the SAT Common Stock for each
share of the U.S. Drug Common Stock held by a U.S. Drug Minority Stockholder or
an aggregate of 2,789,478 shares of the SAT Common Stock for the 1,721,900
shares of the U.S. Drug Common Stock held by the U.S. Drug Minority
Stockholders. SAT has delayed filing of Amendment No. 3 in order to receive
comments from the Staff of the Securities and Exchange Commission as to
Amendment No. 2 and to include, because of the delay in receiving comments, the
audited financial statements for fiscal 1997 for SAT and its subsidiaries
(including U.S. Drug) and U.S. Drug. The U.S. Drug Registration Statement has
not been declared effective under the Securities Act and, accordingly, the
Company's offer to the U.S. Drug Minority Stockholders has not commenced as yet.
There can be no
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assurance as to when the U.S. Drug Registration Statement will be declared
effective in view of the past delays.
NEED FOR FINANCING
The latest estimates, both external (by the unaffiliated consultant
referred to in the section "General" under this caption "Business") and internal
(by U.S. Drug's management), which U.S. Drug's management has are that, to
complete the development of a saliva based drug testing product, will require
incremental costs ranging from $15,000,000 (internal estimate) to $18,400,000
(external estimate) and that the product is not expected to be launched until
some date in the first quarter of 1999 (internal estimate) or August 1999
(external estimate). This contrasts with SAT's previous and publicly announced
incremental costs for U.S. Drug (from April 1, 1997) of $10,000,000 to
$12,000,000 and a launch date of December 1998. As indicated in the preceding
section, the consultant's report in June 1997 confirmed U.S. Drug's management's
opinion that the product was developable and had market potential, especially
with an added feature of the device also testing for alcohol.
SAT's management until now believed that the best "partner" for U.S. Drug
was SAT, not only because it owned 67.0% (now 75.4%), but because of its related
synergistic operations which also would allow SAT and its subsidiaries
(including U.S. Drug) to operate while the development program proceeded and
because SAT appeared to be the best source for funding. The increase in
estimated costs and the further delay in the probable launch date have required
SAT's management to re-evaluate the methods of financing and request U.S. Drug
management to seek financing in which SAT's securities are not offered. A
probable source of such funding for a development stage company such as U.S.
Drug is investments by venture capital investors which would result in a
substantial dilution of SAT's ownership percentage in U.S. Drug and, if the U.S.
Drug Merger is not consummated, that of the U.S. Drug Minority Stockholders'
interests. In addition, SAT's management believes that a venture capital
investor would prefer to invest in a privately-owned company with an initial
public offering as the investor's exit strategy. Consummation of the U.S. Drug
Merger would facilitate that possibility.
U.S. Drug's management has also been requested to explore the possibility
of obtaining a strategic partner for U.S. Drug other than SAT. Current SAT and
U.S. Drug management have been of the opinion that obtaining one of the major
pharmaceutical or medical companies to assist in the product development at this
stage of development risked giving confidential data to potential competitors
that would not be fully protected by confidentiality agreements and also could
result in marketing rights demands that would later reduce the revenues to SAT
assuming successful consummation of the development program. Current management
also believed that a potential marketing partner could not be obtained on
acceptable terms until there was a working prototype for the instrument and the
disposables and certain preliminary clinical data is obtained. Current
management does not believe that the prototype will be produced until April 1998
at the earliest and that, at that stage of development, the greater part of the
estimated development and manufacturing build-out expenses would already have
been incurred, making it less beneficial to obtain a development partner at that
time. Despite these reservations, continuing management believes that the
consultant's report may resolve the concerns of these major companies as to
there being no prototype currently available and that U.S. Drug may have to
assume the risks of disclosing confidential data rather than not secure adequate
financing. U.S. Drug's management will pursue this potential avenue of funding,
but does not currently rate U.S. Drug's chances of succeeding in a timely manner
as high as those with venture capital investors or some other equity investor.
There can be no assurance that U.S. Drug will be successful in securing
financing, whether through a venture capital investor or otherwise, in which
event a decision would have to be made as to whether SAT would seek the
additional funds through sales of its own securities or U.S. Drug will have to
suspend its development program until funds became available, as to which there
can be no assurance. SAT's new investment bankers, L.H. Friend, Weinress,
Frankson & Presson, Inc. and Sutro & Co., Inc., have advised SAT's management
that it would be difficult to finance both the proposed acquisitions of third
party administration companies for the Employer Service Division of SAT and the
research and development program of U.S. Drug.
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To facilitate the possibility of U.S. Drug obtaining financing, SAT's Board
has requested that U.S. Drug study the feasibility of terminating certain of the
interlocking relationships between SAT and U.S. Drug and consider such actions
as (1) U.S. Drug building up a separate management team (Linda H. Masterson
resigned as the President of SAT to become the Chief Executive Officer of U.S.
Drug (she was already its President)) and (2) seeking independent directors.
There can be no assurance that these objectives will be achieved or, if
achieved, that they will facilitate financing.
DRUG TESTING PRODUCTS
(1) URINE SAMPLE TESTING. U.S. Drug's urine drug testing system can be
divided into two parts. The first part is the instrument into which the sample
is placed. The second part consists of the replaceable columns which will test
for the five Drugs of Abuse. The columns are easily replaceable by non-technical
personnel and, depending on a number of factors, are generally expected to have
a life of 50 to 75 tests.
FLOW IMMUNOASSAY SYSTEM. U.S. Drug's initial instrument system was the
Model 9000, which received marketing approval from the FDA. See the section
"Government Regulation" under this caption "Business of U.S. Drug." Resembling a
personal computer, the Model 9000 features one button operation which permits
low cost use of the system by non-technical personnel. The Model 9000
incorporates a U.S. Drug developed laser-excited fluorescence system which will
enhance detection of Drugs of Abuse. The Model 9000 will provide an analysis of
Drugs of Abuse present in the urine sample, if any are so present. All five
Drugs of Abuse or any combination thereof can be selected for testing. Testing
on a urine sample by the Model 9000 is anticipated to take approximately two
minutes per drug selected, or ten minutes if all five are selected.
DRUG ASSAYS FOR THE FLOW IMMUNOSENSOR SYSTEM. U.S. Drug is designing
disposable drug assay columns to be utilized in connection with the Model 9000.
Each flow through column, approximately one inch long by one-half inch wide,
will test for one drug (the "Target Drug"). The five separate columns each
contain antibodies specific for the Target Drug.
The life of each column is estimated at between 50 to 75 tests. This will
depend specifically on such factors as (i) the number of samples containing the
target drug; (ii) the amount of the Target Drug present; and (iii) the specific
drug targeted for testing. The Model 9000 will inform the operator, who does not
have to be highly skilled, when and which column to replace.
As indicated above, U.S. Drug intends to first complete its development of
the saliva sample testing product described below prior to undertaking further
development efforts with respect to the urine sample testing product.
Accordingly, the urine sample testing product is not currently marketable.
(2) SALIVA SAMPLE TESTING. Research is being conducted by U.S. Drug,
using the flow immunosensor technology, of testing for Drugs of Abuse from
saliva samples, and for submission to the FDA for approval to use saliva as a
testing medium. This research utilizes much of the development work done for
U.S. Drug's urine drug testing system. See the section "Government Regulation"
under this caption "Business" for information as to obtaining FDA approval.
Management anticipates that the earliest that the saliva testing system and
drugs assays for all five Drugs of Abuse will be ready for submission to the FDA
is in February 1999. There can be no assurance that U.S. Drug will meet such
timetable.
DESKTOP IMMUNOSENSOR ANALYZER. SAT anticipates manufacturing a small
desktop device in conjunction with the flow immunosensor technology. When used
with the drug assays described below, SAT expects that this unit will provide
portable, flexible and non-invasive detection capability when used with saliva
samples. It is expected that the assay time will be under five minutes per
sample. There can be, however, no assurance that the Company will be able to
develop and market this product. See the section "Research and Development"
under this caption "Business."
DRUG ASSAYS FOR DESKTOP IMMUNOSENSOR ANALYZER. U.S. Drug intends to
develop disposable assay cartridges for use with its desktop model using saliva
samples. After the sample has been collected, it will be transferred to an assay
cartridge containing up to ten Target Analytes (drug & alcohol) in one panel,
read by the instrument, and the results printed. The disposable cartridge will
be thrown away after use. Assay time is expected to be less than five minutes
per sample. U.S. Drug plans to continue its research and development
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efforts for the drug assays concurrently with the desktop unit. There can be no
assurance that U.S. Drug will be able to develop and market the assay
cartridges. See the section "Research and Development" under this caption
"Business."
MANUFACTURING
In manufacturing, U.S. Drug will be required in the United States to follow
current Good Manufacturing Practices ("GMP") as prescribed by the FDA. See the
section "Government Regulation" under this caption "Business." There can be no
assurance that U.S. Drug will be able to bring its plant into compliance and/or
cause its third party manufacturers to comply with GMP. U.S. Drug's future
dependence on third parties for the manufacture and supply of products could
have a material adverse effect on U.S. Drug's profit margins and its ability to
deliver its products on a timely and competitive basis. Management is currently
seeking a Vice President, Manufacturing to assist in the development program and
to plan for the anticipated manufacturing of the product assuming successful
development thereof, as to which there can be no assurance of success.
MARKETING AND DISTRIBUTION
Although U.S. Drug had engaged the services of a consultant to undertake a
marketing survey in 1995, because of the delays in the development of its
products due to the decision to have a test using a saliva sample, a definitive
marketing program has not been finalized or implemented. U.S. Drug has employed
a Vice President, Marketing to begin developing such a program and to advise on
the research and development program.
GOVERNMENT REGULATION
U.S. Drug's proposed screening and diagnostic products will be subject to
significant government regulation in the United States and other countries. In
order to conduct clinical tests, manufacture and market products for human
diagnostic use, U.S. Drug must comply with mandatory procedures and safety
standards established by the FDA and comparable foreign regulatory agencies.
Typically, such standards require that products be approved by the FDA or
comparable foreign regulatory agencies as appropriate, as safe and effective for
their intended use prior to being marketed.
The FDA regulates the introduction, manufacturing, labeling, recordkeeping
and advertising for all medical devices in the United States. There are two
principal methods by which FDA approval may be obtained to market medical device
products, such as the Company's proposed screening and diagnostic test kits, in
the United States. One method is to seek FDA approval through a pre-market
notification filing under Section 510(k) ("510(k)") of the Food, Drug and
Cosmetics Act. Applicants under the 510(k) procedure must prove that the device
for which approval is sought is "substantially equivalent" to devices on the
market prior to the Medical Device Amendments of 1976 or devices approved
thereafter pursuant to the 510(k) procedure. In some cases, data from clinical
studies must be included in the 510(k) application. The review period for a
510(k) application was supposed to be 90 days from the date of filing the
application. However, the FDA has recently been taking significantly longer in
approving other companies' products.
If the 510(k) procedure is not available, then pre-market approval ("PMA")
must be obtained from the FDA. Under the PMA procedure, the applicant must
obtain an Investigational Device Exemption ("IDE") before beginning the
substantial clinical testing which is required to determine the safety, efficacy
and potential hazards of the product. Safety and efficacy must be established
through extensive clinical studies, which are conducted after the FDA's
acceptance of an IDE application. On completion of all of the requirements of
the IDE and once the results are evaluated, a PMA application is submitted to
the FDA. The review period under a PMA application is generally 180 days from
the date of filing, but the application is not automatically deemed approved if
not rejected during that period. The FDA may grant marketing approval, request
additional data about the product's safety and efficacy or deny the application
if it determines that the product does not meet the regulatory approval
criteria. In addition, the preparation of a PMA application is significantly
more complex and time consuming than the 510(k) procedure and the FDA's review
of a PMA is more extensive than that required for a 510(k) application. Based on
its discussions with the FDA, U.S. Drug's management believes that the 510(k)
procedure will be followed.
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No assurance can be given that any agency will grant approval for the sale
of U.S. Drug's products for routine screening and diagnostic applications or
that the length of time the approval process will require will not be extensive.
The cost associated with the filing of applications with the FDA and of
research and development activities to support such applications, including
clinical trials, can be significant. There can be no assurance that the cost of
U.S. Drug's research and development activities will not exceed that which is
budgeted, nor that any of U.S. Drug's proposed products will ever obtain the
necessary FDA or foreign regulatory clearances for commercialization.
Pursuant to applications filed by U.S. Drug, to date, U.S. Drug has
received approval to manufacture and market the Model 9000 and five
assays -- the assay which detects the presence of cocaine (and its metabolite
benzoylecgonine), the assay which detects the presence of opiates (including
heroin, codeine and morphine) the assay which detects amphetamines, the assay
which detects phencyclidine hydrochloride (PCP) and the assay which detects
tetrahydrocannabinoids (THC, marijuana) in urine samples. However, as indicated
herein, further development work is necessary before the product can be marketed
and, because of the decision to complete development of a saliva sample testing
product prior to completing the development work with respect to the urine
sample testing product, no such manufacture or marketing has commenced. See the
section "General" under this caption "Business."
In addition, regulations implementing the Clinical Laboratory Improvement
Amendments of 1988 ("CLIA") and the Health Care Financing Administration on
February 28, 1992, which were to become effective September 1, 1992, require
that all employment drug testing, including on-site testing, be processed by a
federally approved laboratory. On August 28, 1992, HHS announced that the
application of CLIA to workplace testing would not go into effect on September
1, 1992 because of comments made on the final regulations. The comments raised
questions about, among other things, whether bringing employee drug testing
under CLIA might have an unintended chilling effect on efforts to encourage
drug-free workplace programs. As reported in the January 19, 1993 Federal
Register, the final decision on the regulations will be delayed until further
investigation is completed and has not been made as of the date hereof. U.S.
Drug believes that these regulations will not be made effective because (a) the
increased costs and burdensome procedures imposed by CLIA will significantly
reduce the volume of drug tests conducted, which is in direct conflict with the
government's long-standing war on drugs, (b) workplace testing is forensic in
nature (i.e., for the purpose of determining whether an individual is using
illegal drugs) and not for medical purposes (i.e., to make a health assessment
for diagnostic or treatment purposes) as was the original intent of CLIA and (c)
inclusion of employment drug testing may be a direct violation of the Federal
Administrative Procedures Act under Title 5 of the United States Code and the
United States Constitution. If the regulations are not adopted, on-site drug
testing in the workplace will not be subject to CLIA. Although SAT has a
laboratory through its BioTox Division, the U.S. Drug management believes that
the consequences of adoption of the regulations would add to U.S. Drug's costs
and, accordingly, this could have a material adverse impact upon its business
with respect to employment testing in the private sector.
RESEARCH AND DEVELOPMENT
During the fiscal year ended March 31, 1997 ("fiscal 1997"), U.S. Drug
spent approximately $1,735,000 on development of the drug testing technology.
During the fiscal year ended March 31, 1996 ("fiscal 1996"), U.S. Drug spent
approximately $949,439 on development of the drug testing technology. During the
fiscal year ended March 1995 ("fiscal 1995") U.S. Drug spent approximately
$1,261,219 on development of the technology by U.S. Drug. See the section "Need
for Financing" under this caption "Business" for information as to the estimated
expenses to complete the development project.
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PATENTS AND TECHNOLOGY
In addition to its rights under the USN patent as sublicensee of SAT (see
the section "General" under this caption "Business"), U.S. Drug has rights under
the following patents:
(1) U.S. Patent No. 5,183,740, "Flow Immunosensor Method and
Apparatus," issued on February 2, 1993; and
(2) U.S. Patent No. 5,354,654, "Lyophilized Ligand-Receptor Complexes
for Assay and Sensors" issued on October 11, 1994.
U.S. Drug previously had rights to use U.S. Drug Patent No. 5,066,859,
"Hematocrit and Oxygen Saturation Blood Analyzer," issued on November 19, 1992,
but the assignment agreement dated January 16, 1992 between SAT and Maurice N.
Karkur and James C. Velnosky was terminated on November 7, 1996. A copy of such
assignment agreement is filed (by incorporation by reference) as an exhibit to
this Report and is incorporated herein by this reference.
The expiration date of the USN patent is February 23, 2010, while the terms
of the other patents are 17 years from the respective dates of issuance, subject
to renewal. Termination of the Licensing Agreement for the USN patent, which
would occur only on a default by SAT or an invalidation of the USN patent, would
end U.S. Drug's rights to develop drug testing products. Termination of the
other patents or licenses to use the same would require the Company to make
changes to its products which could further delay development and marketing
thereof. For additional information, see the section "Material Contracts" under
this caption "Business."
The patent position of technology firms is highly uncertain and involves
complex legal and factual questions. Competitors have filed applications for,
and in some instances have been issued, patents and may obtain additional
patents and other proprietary rights relating to products or processes, such as
U.S. Drug's proposed immunoassay sensor, which may be competitive with those of
U.S. Drug. The scope and validity of these patents are presently unknown. U.S.
Drug is not aware of any patents covering an immunoassay sensor similar to U.S.
Drug's. Companies which have or may obtain patents relating to products or
processes competitive with those of U.S. Drug could bring legal actions against
U.S. Drug claiming damages and seeking to enjoin it from manufacturing,
licensing and marketing the affected product. To date, no claims have been made
against U.S. Drug for infringement of any patents. However, marketing of U.S.
Drug's products has not begun and claims, if any, would not be asserted until
market introduction of such products. If such a claim were to be made, its
defense would be costly and U.S. Drug's business would be adversely affected,
even if U.S. Drug were to prevail. No assurance can be given that U.S. Drug
would be able to prevail in any such action or that any license required under
any such patent would be made available on acceptable terms.
Process patents have certain disadvantages when compared with product
patents. It is more difficult to detect and prove infringement of process
patents because it is sometimes impossible to ascertain the method by which any
product has been produced. In addition, the value of U.S. Drug of receiving a
process patent may be reduced if products which can be derived from such
processes have been patented by others. The patents owned by, or licensed to,
U.S. Drug include both process patents and product patents.
U.S. Drug maintains a policy of seeking patent protection in the United
States and other countries in connection with certain elements of its technology
when it believes that such protection will benefit U.S. Drug. Lyophilization
patent applications have been filed in Canada, certain European countries and
Japan.
The patent laws of foreign countries may differ from those of the United
States as to the patentability of U.S. Drug's products and processes and,
accordingly, the degree of protection afforded by foreign patents, if issued,
may be different from protection afforded under associated United States
patents. There can be no assurance that patents will be obtained either in the
United States or in foreign jurisdictions with respect to U.S. Drug's inventions
or that, if issued, the patents will be of substantial protection or commercial
benefit to U.S. Drug.
Certain inventions of U.S. Drug may prove to be unpatentable or U.S. Drug
may conclude that it would be more advisable to retain a patentable invention as
a trade secret. In either case, U.S. Drug would have to
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rely on trade secrets, proprietary know how and continuing technological
innovation to develop and maintain its competitive position. All key employees
and consultants of U.S. Drug have executed, and project sponsors and
manufacturers will be required to execute, agreements to maintain the
confidentiality of U.S. Drug's proprietary information to which they have
access. There can be no assurance that these confidentiality agreements will be
honored or will be effective. Manufacturers, project sponsors and consultants
may be engaged in competing research projects outside the scope of their
agreements with U.S. Drug. There can be no assurance that such sponsors and
consultants will not develop similar or superior technology independently and to
the extent that such persons apply technical information independently developed
by them to projects undertaken by U.S. Drug, disputes may arise as to the
proprietary rights to such information.
COMPETITION
U.S. Drug has not received any revenues because its products are still in
the developmental stage. If the products are developed, U.S. Drug will compete
with many of the companies of varying size that already exist or may be founded
in the future which utilize urine samples as a medium of testing. U.S. Drug will
face competition from at least eight major pharmaceutical companies providing
substance abuse screening methods: (1) enzyme-multiplied immunoassay technique
(EMIT) manufactured and distributed by Syva, a division of Behring Diagnostics;
(2) radioimmunoassay (RIA) manufactured and distributed by Diagnostic Products
Corp. ("DPC") and others; (3) thin layer chromatography (TLC) manufactured and
distributed by Marion Laboratories, Inc. ("Marion"); (4) a fluorescence
polarization immunoassay (FPIA) manufactured by Abbott Laboratories, Inc.
("Abbott"); and other immunoassay tests provided by (5) Hoffman La Roche, Inc.
("Roche") Editek, Inc. ("Editek"); (6) Hycor Biomedical, Inc. ("Hycor"); (7)
Princeton Biotech, Inc. ("Princeton"); and (8) BioSite Inc. ("BioSite"). Almost
all of these companies (i.e., Syva, Roche, Marion, Abbott, Editek, Hycor,
Princeton and BioSite) have substantially greater financial resources available
to them than does U.S. Drug to develop and to market their products.
Management believes that saliva sample testing is unique in that, to
management's knowledge, no company is currently offering a substance abuse
detection method using saliva samples as a medium on an "on-site" basis.
However, U.S. Drug has been advised that such a product is under development by
two or more companies and, accordingly, there can be no assurance that such a
product will not be offered by a competitor. In addition, even if no such
product is developed, U.S. Drug anticipates, as indicated above, competition
from other substance abuse detection methods such as Syva's EMIT, Roche's RIA,
Marion's TLC, Abbott's FPIA methods, and other immunoassay tests provided by
Editek, Hycor, Princeton and BioSite. U.S. Drug's market research to date has
indicated a greater market potential for a saliva sample portable testing
instrument for use in detecting drugs of abuse by law enforcement agencies,
correctional facilities, hospitals and other medical facilities than a urine
sample instrument. However, because of the expected limited life cycle of a
saliva specimen, the use of this product in other potential markets may be
limited.
If U.S. Drug successfully develops first its saliva sample testing method
and second its urine sample testing method, as to which there can be no
assurance, it is not certain whether U.S. Drug will have the financial resources
to compete successfully with other companies which have greater financial
resources available to them.
MATERIAL CONTRACTS
Copies of all of the agreements hereinafter referenced in this section have
been filed (by incorporation by reference) as exhibits to this Report and are
incorporated by this reference.
(A) LICENSE AND SUBLICENSE AGREEMENTS
Pursuant to an amended sublicense agreement dated as of September 23, 1993,
superseding the sublicense agreement dated January 2, 1993, (the "Sublicense")
by and between SAT and U.S. Drug, U.S. Drug is the sole and exclusive
sublicensee of SAT under the License Agreement. In accordance with the terms and
provisions of the Sublicense, U.S. Drug has assumed all of SAT's rights and
undertaken all of
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SAT's obligations under the License Agreement. Because the USN refused to
recognize a novation to U.S. Drug of the License Agreement as requested, the USN
looks to SAT, not U.S. Drug, for performance thereunder. In the event of a
default under the Sublicense, all rights would revert to SAT.
The License Agreement initially provided that the USN shall be paid a
royalty equal to six percent of the Net Selling Price (as defined in the License
Agreement) for each Royalty-Bearing Product (as defined in the License
Agreement) made, used or sold by SAT or its sublicensees in the Licensed
Territory with minimum annual royalty payments of $180,000 for 1993, $375,000
for 1994, $600,000 for 1995 and $1,000,000 for 1996 and each calendar year
thereafter throughout the term of the License Agreement. The License Agreement
provides that the USN shall approve all sublicenses and, in accordance with such
provision, the Sublicense was approved by the USN on September 24, 1993. The
aforementioned minimum annual royalties were amended November 28, 1994 as
follows: the minimum annual royalty for 1995 was reduced to $375,000 and for
1996 it was reduced to $600,000. In June 1995, the License Agreement with the
USN was renegotiated and amended to provide for minimum annual royalties of
$100,000 per year commencing October 1, 1995 and terminating September 30, 2005.
Additional royalties will be paid pursuant to a schedule based upon sales of
products. By letter dated May 15, 1995, the USN notified SAT that, because the
expiration date of the USN patent had been extended to February 23, 2010 under
the GATT/WTO treaty, the expiration date of the License Agreement was extended
to February 23, 2010.
(B) CRDA
On April 16, 1992, SAT entered into a 12-month cooperative research
agreement ("CRDA") with the Naval Research Laboratory section of the USN (the
"NRL") to further develop the licensing technology of the "Flow Immunosensor".
Pursuant to an agreement dated as of January 1, 1993 by and between SAT and
U.S. Drug, SAT assigned to U.S. Drug all of its rights under the CRDA. The
purpose of the CRDA is to develop the prototype instruments based on the Flow
Immunosensor Method and Apparatus Technology. See the section "Research and
Development" under this caption "Business of U.S. Drug." Pursuant to the CRDA,
each party may retain title to any patent obtained by such party in the
performance of work under the CRDA. The NRL has the right of first election to
file a patent application in the United States on joint inventions made in the
performance of work under the CRDA and U.S. Drug, as assignee, has the right of
first election to file a patent application on such joint inventions in all
other countries. Pursuant to an amendment to the CRDA dated May 1993, the NRL
waived such right of first election with respect to the lyophilization process
for the freeze-drying of immunoassay chemicals, provided that SAT filed an
approved patent application on such process within three months from the date of
execution of the amendment. The approved patent application was filed on July
16, 1993 and issued as U.S. Patent No. 5,354,654 "Lyophilized Ligand-Receptor
Complexes for Assays and Sensors" on October 11, 1994. The Patent has been
assigned to U.S. Drug by SAT.
(C) MANAGEMENT AGREEMENT
On April 1, 1993, U.S. Drug and SAT entered into a formal Management
Agreement, pursuant to which SAT's fee for management and administrative
services to U.S. Drug was to be computed at ten percent of U.S. Drug's annual
net sales, with a minimum annual fee of $300,000. In July 1993, U.S. Drug and
SAT entered into an amended Management Agreement, effective retroactively to
April 1, 1993, pursuant to which the fee for management and administrative
services provided to U.S. Drug by SAT is a fixed annual fee of $420,000, plus
three percent of U.S. Drug's annual gross sales. Because U.S. Drug has no sales
to date, it has always paid the minimum fee under the Management Agreement. The
term of the amended agreement is five years which commenced April 1, 1993. Given
the related industry experience of SAT management, the immediate availability of
SAT personnel and belief of the management of U.S. Drug that the terms offered
by SAT were fair and reasonable, U.S. Drug did not investigate alternative
management services providers. The fee charged by SAT for its management
services was determined arbitrarily by its Board of Directors after taking into
consideration the anticipated SAT resources required to provide such services to
U.S. Drug, both in terms of employee time and allocated overhead costs. The
arbitrary formula used by SAT to determine the fee was 50% of the sum of SAT's
executive, accounting and clerical salaries, fringe benefits and related
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expenses. In March of 1997, the Management Agreement was again amended to
provide for a percentage of time and services agreement whereby the costs of
certain SAT employees and facilities are allocated to U.S. Drug based on a
percentage of usage. As the activity of U.S. Drug has been increasing, there has
been a tremendous increase in time required by SAT employees and expanded use of
leased space to satisfy U.S. Drug's needs. This new arrangement in the opinion
of management more accurately reflects the current cost to U.S. Drug. The
services provided to U.S. Drug by SAT pursuant to the Management Agreement
include management, administrative, accounting and other financial services and
advice, including, without limitation, the services currently performed by the
Treasurer of U.S. Drug (who is also the Treasurer of SAT), for which he is not
directly compensated by U.S. Drug; services relating to U.S. Drug's financial
and banking relationships; services relating to the preparation of financial
statements, budgets, forecasts and cash flow projections; cash management
advice; and other miscellaneous services and advice.
Since July 1992, four former members of SAT's senior management, James C.
Witham, Gary S. Wolff, Karen B. Laustsen and Michael J. Witham (until September
26, 1995), were the primary persons involved in the provision of services to
U.S. Drug under the Management Services Agreement. Because of the resignations
of Mr. Witham and Ms. Laustsen on April 18, 1996, the resignation of Mr. Wolff
on July 3, 1996 and the elections of Robert M. Stutman and Linda H. Masterson
(effective May 13, 1996) as described under "Summary -- Recent Developments,"
Mr. Stutman and Ms. Masterson have substituted for Mr. Witham and Ms. Laustsen
in performing these services on behalf of SAT, although Mr. Wittman and Ms.
Laustsen provided assistance until May 31, 1996 and Mr. Wolff continued to
assist SAT in providing services to U.S. Drug until July 3, 1996. Effective that
date, Joseph Bradley became Treasurer of both U.S. Drug and SAT, which position
he held until September 12, 1996. Effective that date, Dennis Wittman replaced
Mr. Bradley and began to perform the services as the Treasurer described in the
preceding paragraph. Effective with the resignation of Mr. Wittman on February
25, 1997, Robert Muccini replaced Mr. Wittman and began to perform the services
as the Treasurer described in the preceding paragraph. The management of U.S.
Drug believes that the Management Services Agreement with SAT is fair and
reasonable and that its costs would be greater if it had to obtain such services
from an unaffiliated party with commensurate industry experience, if available,
or maintain the internal staff required to provide such services itself.
RELATIONSHIPS WITH SAT
From January 1992 until January 1993 SAT conducted U.S. Drug's business
operations. Effective as of January 1, 1993, SAT transferred all of its drug
testing assets, including cash amounting to $11,626 and hard assets valued at
their carrying value of $437,060 and intellectual property rights associated
with the drug testing operations, to U.S. Drug for 3,500,000 shares of the U.S.
Drug Common Stock. SAT also granted U.S. Drug a sublicense with respect to the
USN technology.
As of June 30, 1997, 75.4% of the outstanding shares of the U.S. Drug
Common Stock was held by SAT. James C. Witham was the Chairman of the Board, the
Chief Executive Officer and a director of U.S. Drug from its incorporation until
May 31, 1996 and was also the Chairman of the Board, the President, the Chief
Executive Officer and a director of SAT from its incorporation until April 18,
1996. Karen B. Laustsen was a director of U.S. Drug from its incorporation until
May 28, 1996 and was an Executive Vice President and a director of SAT from its
incorporation until April 18, 1996. From U.S. Drug's incorporation until July 3,
1996, Gary S. Wolff was the Treasurer, the Chief Financial Officer, the Chief
Accounting Officer and a director of U.S. Drug and, from SAT's incorporation to
July 3, 1996, was the Treasurer, the Chief Financial Officer and the Chief
Accounting Officer of SAT and, prior to September 26, 1995, was also a director
of SAT. Glenn A. Bergenfield and William DiTuro, also directors of U.S. Drug
until November 15, 1995, were directors of SAT prior to September 26, 1995.
Michael J. Witham was a director of U.S. Drug and a Vice President of SAT prior
to September 26, 1995. On May 31, 1996, Robert M. Stutman, the Chairman of the
Board, the Chief Executive Officer and a director of SAT since April 18, 1996,
Linda H. Masterson, the President of SAT from May 13, 1996 to May 23, 1997, a
director of SAT since September 26, 1995 and, from May 13, 1996 to November 14,
1996, Chief Operating Officer of SAT, and Michael S. McCord, then a consultant
to the SAT Board of Directors and a former member of the Committee, were elected
directors of U.S. Drug, with
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Mr. Stutman also being elected as Chairman of the Board of U.S. Drug and,
effective August 1, 1996, Ms. Masterson as the President of U.S. Drug. On
October 22, 1996, Mr. McCord was elected as a director of SAT. All of the
foregoing persons except Messrs. Bergenfield, DiTuro and McCord were or are
employees of SAT and all are securityholders of SAT.
See the section "Need for Financing" under this caption "Business" for
information as to the current study being conducted as to the feasibility of
severing the interlocking relationships between SAT and U.S. Drug.
NO LOANS FROM U.S. DRUG TO SAT OUTSTANDING
During fiscal 1995, U.S. Drug made short-term loans to SAT in the amount of
$488,519. At March 31, 1996, the notes receivable from SAT to U.S. Drug were in
the amount of $282,295. The SAT notes were secured by a pledge of SAT's shares
of the U.S. Drug Common Stock. The loans were evidenced by notes which became
due on December 31, 1995, which maturity date was extended to June 30, 1996, and
bore interest at the rate of 8% per annum. The loans carried interest rates in
excess of those available to U.S. Drug on short-term money market investments.
SAT repaid the indebtedness to U.S. Drug in the quarter ended September 30,
1996. The pledge of SAT's shares of the U.S. Drug Common Stock was released.
LOANS FROM SAT TO U.S. DRUG
SAT had authorized loans to U.S. Drug not to exceed $2,000,000. The loans
bore interest at the rate of 8% per annum and were to become due on the earlier
of (1) five business days after the date the proposal for the U.S. Drug Merger
is rejected or (2) the Effective Date of the U.S. Drug Merger. On May 23, 1997,
the SAT and U.S. Drug Boards authorized the capitalization of $2,210,250 in
indebtedness owned by U.S. Drug to SAT as of April 30, 1997, which amount
included interest, in consideration of the issuance by U.S. Drug to SAT of
1,768,202 shares of the U.S. Drug Common Stock. The Boards had also authorized
the additional investment by SAT of $2,500,000 in exchange for 2,000,000 shares
of the U.S. Drug Common Stock on the same basis of one share of stock for each
$1.25 of investment; however, because of a delay in SAT receiving proceeds from
financings, such investment has not been made as yet. In view of the SAT's Board
recommendation to the U.S. Drug Board to explore the feasibility of obtaining
external financing without the use of SAT's securities, such investment may not
be made, whether in all or in part, depending on the results of such efforts
and/or SAT's own efforts to obtain financing.
EMPLOYEES
As of March 31, 1997, U.S. Drug utilized the services of 16 employees of
SAT, for which U.S. Drug paid their full compensation, to conduct U.S. Drug's
research and development program. As a result of the decision by SAT's Board of
Directors in May and June 1997 to explore the feasibility of separating the
interlocking relationships between SAT and U.S. Drug, these employees will be
transferred to the U.S. Drug payroll. In addition, U.S. Drug utilizes the
services of independent contractors and the personnel employed by SAT who
provide management and administrative services to U.S. Drug. Additional
personnel will be required to complete the development project and, if the
project is completed successfully, to manufacture the product.
ITEM 2. PROPERTIES
U.S. Drug maintains its principal executive offices, manufacturing space
and laboratory facilities in Rancho Cucamonga, California. The premises, which
consists of approximately 10,000 square feet, are sub-leased from SAT. U.S. Drug
may consider relocating to Orange County, California, however, where it may be
more likely to attract more experienced medical diagnostic and other qualified
personnel. U.S. Drug's operations and space are separated, and where necessary
isolated, from the operations and space of SAT. Management believes that
additional space will be required when and if manufacturing commences of the
drug testing product.
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ITEM 3. LEGAL MATTERS
U.S. Drug is not a party to any material litigation and is not aware of any
pending litigation that could have a material adverse effect on U.S. Drug's
business, results of operations or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
MARKET DATA
The U.S. Drug Common Stock was traded on the Pacific Exchange, Inc. (the
"Pacific Exchange") under the symbol "U.S.D.P" until May 12, 1997 (see the
section "Exchange Listing" under this caption "Market for Registrant's Common
Equity and Related Shareholder Matters"). The quarterly high and low sales
prices for the U.S. Drug Common Stock as reported by the Pacific Exchange are
set forth below during the periods indicated:
QUARTER ENDED HIGH LOW
- ------------- ------ ------
FISCAL 1995
June 30, 1994............................................... $7.375 $5.125
September 30, 1994.......................................... 8.50 5.50
December 31, 1994........................................... 9.00 5.25
March 31, 1995.............................................. 6.625 2.875
FISCAL 1996
June 30, 1995............................................... $5.50 $2.50
September 30, 1995.......................................... 4.75 2.50
December 31, 1995........................................... 4.50 2.625
March 31, 1996.............................................. 4.50 3.00
FISCAL 1997
June 30, 1996............................................... $4.25 $3.50
September 30, 1996.......................................... 3.75 2.375
December 31, 1996........................................... 2.875 .75
March 31, 1997.............................................. * *
- ---------------
*According to the National Quotation Bureau, Inc., there were no sales
reported during the quarter ended March 31, 1997 and the high bid and low asked
prices were $1.875 and $2.00, respectively. These quotations reflect
inter-dealer prices, without retain mark-up, mark-down or commission, and may
not represent actual transactions. On May 12, 1997, last day on which there was
a reported market price, the closing sales price was $1.6875 per share.
EXCHANGE LISTING
By letter dated February 3, 1997, the Pacific Exchange advised U.S. Drug
that the Equity Listing Committee of the Exchange would meet on March 4, 1997 to
review U.S. Drug's listing status and decide if continued listing on the
Exchange is appropriate. Among the Exchange's Tier II Securities maintenance
requirements for continued listing is that a company have tangible net assets of
at least $500,000 or a net worth of at least $2,000,000. As of December 31,
1996, U.S. Drug met neither criteria -- its liabilities exceeded tangible assets
by $815,617 and it had a stockholders' deficit of $775,000. In response to U.S.
Drug's request on February 7, 1997, the Equity Listing Committee granted a
compliance extension until May 6, 1997 (later postponed to May 12, 1997) in
order to permit the consent solicitation for the U.S. Drug Merger to proceed or,
if the U.S. Drug Merger is not approved, for the U.S. Drug Board of Directors to
consider what action is appropriate with respect to continuance of the listing.
On May 12, 1997, the Equity Listing Committee rejected U.S. Drug's request and
the U.S. Drug Common Stock has been suspended from trading on the Pacific
Exchange pending U.S. Drug's appeal of such rejection. The appeal is currently
expected to be heard during July 1997.
The U.S. Drug Board recognizes that, if delisting occurred, the U.S. Drug
Common Stock would not meet the requirements for listing on the American Stock
Exchange or reporting on the Nasdaq System and that, if the U.S. Drug Common
Stock was reported in the OTC Bulletin Board or in the "pink sheets," it was
unlikely that the U.S. Drug Common Stock would rise in market value in such
over-the-counter market until the saliva based testing product was developed or
close to completion. On the other hand, the U.S. Drug Board
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recognizes that, if the U.S. Drug Merger is consummated, the U.S. Drug Minority
Stockholders will be able to trade the SAT Common Stock on the American Stock
Exchange.
If the U.S. Drug Common Stock is delisted and, if at that time the bid
price is below $5.00 per share (which it has consistently been since the quarter
ended June 30, 1995), the security would become subject to Rule 15g-9
promulgated under the Exchange Act, which Rule imposes additional sales
practices requirements on a broker-dealer which sells Rule 15g-9 securities to
persons other than the broker-dealer's established customers and institutional
accredited investors (as such term is defined in Rule 501(a) under the
Securities Act). For transactions covered under Rule 15g-9, the broker-dealer
must make a suitability determination of the purchaser and receive the
purchaser's written agreement to the transaction prior to the sale. In addition,
broker-dealers, particularly if they are market makers in the Common Stock, have
to comply with the disclosure requirements of Rules 15g-2, 15g-3, 15g-4, 15g-5
and 15g-6 under the Exchange Act unless the transaction is exempt under Rule
15g-1. Consequently, Rule 15g-9 and these other Rules may adversely affect the
ability of broker-dealers to sell or to make markets in the U.S. Drug Common
Stock.
U.S. Drug management intends that, if the U.S. Drug Merger is consummated,
U.S. Drug will deregister the U.S. Drug Common Stock under Section 12(b) of the
Exchange Act and trading in the U.S. Drug Common Stock will cease on the U.S.
Drug Effective Date. In such event, the U.S. Drug Minority Stockholders will
thereafter be able to trade their shares of the Common Stock on the American
Stock Exchange.
HOLDERS
As of June 30, 1997, there were 87 holders of record (including SAT) and,
based on prior requests for Annual Reports, management believed there were
approximately 1,100 beneficial holders of the U.S. Drug Common Stock.
DIVIDENDS
U.S. Drug's Board of Directors has not declared any dividends on the U.S.
Drug Common Stock through June 30, 1997 and, in view of the continuing losses
and its cash requirements, the Board has no current intention to pay any such
dividends.
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ITEM 6. SELECTED FINANCIAL DATA
The following tables set forth selected financial data of U.S. Drug for the
four fiscal years ended March 31, 1997, 1996, 1995 and 1994 and for the period
October 8, 1992 (inception) to March 31, 1993 and cumulative from October 8,
1992 (inception) to March 31, 1997. This selected financial data should be read
in conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Financial Statements and related notes
thereto included elsewhere in this Report.
CUMULATIVE
FOR THE PERIOD FROM
YEARS ENDED MARCH 31, OCTOBER 8, 1992 OCTOBER 8, 1992
----------------------------------------------------- (INCEPTION) TO (INCEPTION) TO
1997 1996 1995 1994 MARCH 31, 1993 MARCH 31, 1997
----------- ----------- ----------- ----------- --------------- ---------------
Selected Statement of
Operations Data:
Revenues:................. $ -- $ -- $ -- $ -- $ -- $ --
Costs and Expenses:
Selling, General and
Administrative........ 268,668 318,510 475,400 604,185 146,316 1,813,079
Research and
Development........... 1,735,449 949,439 1,261,219 728,272 90,960 4,765,339
Depreciation and
Amortization.......... 143,634 143,969 162,871 92,245 16,939 559,658
Interest
Expense -- Parent..... 23,095 -- 3,319 31,639 3,207 61,260
Management Fees --
Parent................ 420,000 420,000 420,000 420,000 -- 1,680,000
Interest Expense........ 5,822 71,882 40,640 -- -- 118,344
----------- ----------- ----------- ----------- --------- -----------
Total Costs and
Expenses....... 2,596,668 1,903,800 2,363,449 1,876,341 257,422 8,997,680
----------- ----------- ----------- ----------- --------- -----------
Loss from Operations...... (2,596,668) (1,903,800) (2,363,449) (1,876,341) (257,422) (8,997,680)
Other Income (Expense).... (33,905) 262,995 31,232 (383,951) -- (123,629)
----------- ----------- ----------- ----------- --------- -----------
Net Loss......... $(2,630,573) $(1,640,805) $(2,332,217) $(2,260,292) $(257,422) $(9,121,309)
=========== =========== =========== =========== ========= ===========
Weighted Average Common
Shares Outstanding...... 5,221,900 5,221,900 5,221,900 4,342,458 3,500,000
=========== =========== =========== =========== =========
Net Loss per
Common Share... $ (.50) $ (.31) $ (.45) $ (.52) $ (.07)
=========== =========== =========== =========== =========
MARCH 31,
---------------------------------------------------------------
1997 1996 1995 1994 1993
----------- ---------- ---------- ---------- ----------
Selected Balance Sheet Data:
Working Capital (Deficit)..................... $(1,996,218) $ 536,880 $2,089,323 $4,360,362 $ (267,892)
=========== ========== ========== ========== ==========
Total Assets......................... $ 595,947 $1,175,390 $4,444,105 $5,268,820 $ 462,732
=========== ========== ========== ========== ==========
Stockholders' Equity (Deficit)................ $(1,573,686) $1,056,887 $2,697,692 $5,029,909 $ 191,264
=========== ========== ========== ========== ==========
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
U.S. Drug is a development stage enterprise with no earnings history and
which initially derived its capital resources from unsecured advances provided
by SAT. During October and November, 1993, U.S. Drug sold 1,721,900 shares of
the U.S. Drug Common Stock to the public at $5.00 per share and for net proceeds
of approximately $7,099,000. From the net proceeds of the offering U.S. Drug
repaid the advances made by SAT.
During fiscal 1997, U.S. Drug had outstanding loans payable to SAT to fund
continuing research and development. These advances were evidenced by notes due
after the results of the consent solicitation for the proposed acquisition of
the shares of the Minority U.S. Drug Common Stock are known. These advances bore
interest at the rate of 8% per annum. On May 23, 1997, the SAT and U.S. Drug
Boards authorized the capitalization of $2,210,250 in indebtedness owned by U.S.
Drug to SAT as of April 30, 1997, which amount included interest, in
consideration of the issuance by U.S. Drug to SAT of 1,768,202 shares of the
U.S. Drug Common Stock. The Boards had also authorized the additional investment
by SAT of $2,500,000 in exchange
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for 2,000,000 shares of the U.S. Drug Common Stock on the same basis of one
share of stock for each $1.25 of investment; however, because of a delay in SAT
receiving proceeds from financings, such investment has not been made as yet.
U.S. Drug is dependent on continuing advances from SAT or external financing to
continue the research, development and ultimate marketing of its products and to
fund its working capital requirements for the next 12 months.
The latest estimates, both external (by the unaffiliated consultant
referred to in the section "General" under this caption "Business") and internal
(by U.S. Drug's management), which U.S. Drug's management has are that, to
complete the development of a saliva based drug testing product, will require
incremental costs ranging from $15,000,000 (internal estimate) to $18,400,000
(external estimate) and that the product is not expected to be launched until
some date in the first quarter of 1999 (internal estimate) or August 1999
(external estimate). This contrasts with the previous and publicly announced
incremental costs for U.S. Drug (from April 1, 1997) of $10,000,000 to
$12,000,000 and a launch date of December 1998. As indicated in the preceding
section, the consultant's report in June 1997 confirmed U.S. Drug's management's
opinion that the product was developable and had market potential, especially
with an added feature of the device also testing for alcohol.
SAT's management until now believed that the best "partner" for U.S. Drug
was SAT, not only because it owned 67.0% (now 75.4%), but because of its related
synergistic operations which also would allow SAT and its subsidiaries
(including U.S. Drug) to operate while the development program proceeded and
because SAT appeared to be the best source for funding. The increase in
estimated costs and the further delay in the probable launch date have required
SAT's management to re-evaluate the methods of financing and request the U.S.
Drug management to seek financing in which SAT's securities are not offered. A
probable source of such funding for a development stage company such as U.S.
Drug is investments by venture capital investors which would result in a
substantial dilution of SAT's ownership percentage in U.S. Drug and, if the U.S.
Drug Merger is not consummated, that of the U.S. Drug Minority Stockholders'
interests. In addition, SAT's management believes that a venture capital
investor would prefer to invest in a privately-owned company with an initial
public offering as the investor's exit strategy. Consummation of the U.S. Drug
Merger would facilitate that possibility.
U.S. Drug's management has also been requested to explore the possibility
of obtaining a strategic partner for U.S. Drug other than SAT. Current SAT and
U.S. Drug management have been of the opinion that obtaining one of the major
pharmaceutical or medical companies to assist in the product development at this
stage of development risked giving confidential data to potential competitors
that would not be fully protected by confidentiality agreements and also could
result in marketing rights demands that would later reduce the revenues to SAT
assuming successful consummation of the development program. Current management
also believed that a potential marketing partner could not be obtained on
acceptable terms until there was a working prototype for the instrument and the
disposables and certain preliminary clinical data is obtained. Current
management does not believe that the prototype will be produced until April 1998
at the earliest and that, at that stage of development, the greater part of the
estimated development and manufacturing build-out expenses would already have
been incurred, making it less beneficial to obtain a development partner at that
time. Despite these reservations continuing, management believes that the
consultant's report may resolve the concerns of these major companies as to
there being no prototype currently available and that U.S. Drug may have to
assume the risks of disclosing confidential data as the lesser evil than not to
secure adequate financing. U.S. Drug's management will pursue this potential
avenue of funding, but does not currently rate U.S. Drug's chances of succeeding
in a timely manner as high as those with venture capital investors or some other
equity investor. There can be no assurance that U.S. Drug will be successful in
securing financing, whether through a venture capital investor or otherwise, in
which event a decision would have to be made as to whether SAT would seek the
additional funds through sales of its own securities or U.S. Drug will have to
suspend its development program until funds became available, as to which there
can be no assurance. SAT's new investment bankers, L.H. Friend, Weinress,
Frankson & Presson, Inc. and Sutro & Co., Inc., have advised SAT's management
that it would be difficult to finance both the proposed acquisitions of third
party administration companies for the Employer Service Division of SAT and the
research and development program of U.S. Drug.
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To facilitate the possibility of U.S. Drug obtaining financing, SAT's Board
has requested that U.S. Drug study the feasibility of terminating certain of the
interlocking relationships between SAT and U.S. Drug and consider such actions
as (1) U.S. Drug building up a separate management team (Linda H. Masterson
resigned as the President of SAT to become the Chief Executive Officer of U.S.
Drug (she was already its President)) and (2) seeking independent directors.
There can be no assurance that these objectives will be achieved or, if
achieved, that they will facilitate financing.
CHANGES IN FINANCIAL CONDITION
During fiscal 1996, U.S. Drug's investment in trading securities were sold
and U.S. Drug realized proceeds of $3,286,000 from the sale of the REMIC bonds,
resulting in a gain of $76,000 over the carrying value of the bonds on the March
31, 1995 balance sheet. U.S. Drug realized an overall loss of $628,000 from its
ownership of the bonds. Management will make no further investments in any high
risk trading securities. A brokerage loan payable in the amount of $2,570,000
was repaid from the proceeds of the sale of the REMIC bonds.
OPERATING CASH FLOWS
Cash used for operations during fiscal 1997 amounted to $2,119,000 as
compared to $1,656,000 in 1996 was primarily a result of the net loss of
$2,631,000 in 1997 as compared to $1,641,000.
INVESTING CASH FLOWS
Cash used by investing activities of $52,500 during fiscal 1997 were used
to purchase property and equipment. In 1996, cash provided by investing
activities totaled $3,248,000 primarily from the sale of marketable securities.
FINANCING CASH FLOWS
Cash provided by financing activities amounted to $1,922,000 during fiscal
1997. Financing cash flows were provided by loans from SAT of $1,668,000 and net
repayment of loans from SAT in the amount of $282,000. Cash used by financing
activities in 1996 totaled $1,392,000. This amount was comprised of a loan for
$1,000,000 and the payment of amounts due from SAT of $1,634,000 reduced by
payments on loans totaling $3,997,000.
RESULTS OF OPERATIONS
Fiscal 1997 vs. Fiscal 1996
During fiscal 1997, U.S. Drug continued as a development stage enterprise
with no revenues. Selling, general and administrative expenses were $269,000 in
fiscal 1997 as compared to $319,000 in fiscal 1996 or a decrease of $50,000,
primarily the result of lower travel, utility and telephone expenses. Research
and development expenditures totaled $1,735,000 in fiscal 1997 as compared to
$949,000 in fiscal 1996 or an increase of $786,000. The increase is primarily
the result of expanded people requirements to bring the saliva testing to the
next phase of development. Costs include engineering and chemist consulting time
as well as additional U.S. Drug full time employees. Management fees paid to SAT
were $420,000 in both fiscal 1997 and fiscal 1996. For a description of the
services rendered under the management agreement relating to these fees, see the
section "Material Contracts -- Management Agreement" in Item 1 to this Report.
As of March 31, 1997, U.S. Drug did not anticipate generating revenues from
product sales during fiscal 1998 and, accordingly, anticipated that operating
losses would continue for at least a 12 to 24-month period.
The net loss for fiscal 1997 was $2,631,000 as compared to $1,641,000 for
fiscal 1996. The increase of $990,000 was primarily the result of additional
people requirements. The costs include expenses for engineering and chemists
consulting time and additional employees.
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Fiscal 1996 vs. Fiscal 1995
During fiscal 1996, U.S. Drug continued as a development stage enterprise
with no revenues. Selling, general and administrative expenses were $319,000 in
fiscal 1996 as compared with $475,000 in fiscal 1995 or a decrease of $156,000,
resulting primarily from a general reduction in overall expenses to enable the
Company to focus its resources on research.
Research and development expenditures totaled $949,000 in fiscal 1996 as
compared with $1,261,000 in fiscal 1995, a decrease of $312,000. The decrease
was primarily from a reduction in royalty payments on the license with the USN
from $325,000 in 1995 to $50,000 in 1996.
Depreciation expense decreased $19,000 from $163,000 in fiscal 1995 to
$144,000 in fiscal 1996 as some assets became fully depreciated during the year.
Management fees paid to SAT were $420,000 in both fiscal 1996 and fiscal
1995. For a description of the services rendered under the management agreement
relating to these fees, see the section "Material Contracts of SAT with U.S.
Drug -- Management Services Agreement."
Interest expense on brokerage loans were $72,000 during fiscal 1996 as
compared with $41,000 during fiscal 1995 or an increase of $31,000, resulting
from increased borrowings during fiscal 1996.
Other income (expense) resulted in net income of $263,000 in fiscal 1996 as
compared with net income of $31,000 in the prior year or an increase of
$232,000. Fiscal 1996 other income (expense) is comprised of a gain of $76,000
on its sale of REMIC bonds over their earnings value at March 31, 1995, interest
income primarily relating to the REMIC bonds of $105,000 and interest income on
loans to SAT of $82,000. Fiscal 1995 other income (expense) was comprised of
interest income, primarily on the REMIC bond of $245,000, interest income from
SAT of $20,000 and an unrealized loss on the market value of the REMIC bonds in
the amount of $234,000.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Please see Item 14 of this Report for financial statements and
supplementary data.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
On November 3, 1995, the SAT Board of Directors named Ernst & Young LLP
("E&Y") as new independent auditors for SAT and its subsidiaries, which include
U.S. Drug, for fiscal 1996 replacing Wolinetz, Gottlieb & Lafazan, P.C.
("Wolinetz"), which firm had served as SAT's independent auditors since its
inception. The U.S. Drug Board authorized that the same action be taken with
respect to U.S. Drug.
The report of Wolinetz on the financial statements of U.S. Drug for fiscal
1995 did not contain an adverse opinion or disclaimer of opinion, nor was such
report qualified as to uncertainty, audit scope or accounting principles. There
had been no disagreements between U.S. Drug and Wolinetz in fiscal 1995 or any
subsequent interim period preceding the engagement of E&Y as the principal
auditors on any matter of accounting principles or practice, financial statement
disclosure, auditing scope or procedures.
Wolinetz has filed a letter to the Commission stating that it agreed with
the above statements.
U.S. Drug did not consult E&Y, prior to its engagement, regarding the
application of accounting principles to a specified transaction, either
completed or proposed, or the type of audit opinion that might be rendered on
U.S. Drug's financial statements, nor was a written report or oral advice
provided to SAT or U.S. Drug that E&Y concluded was an important factor
considered by SAT or U.S. Drug in reaching a decision as to an accounting,
auditing or financial reporting issue.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
DIRECTORS AND EXECUTIVE OFFICERS
The following table contains certain information relating to the directors
and executive officers of U.S. Drug as of March 31, 1997:
NAME AGE POSITION
- ---- --- --------
Robert M. Stutman......................... 54 Chairman of the Board and a Director
Linda H. Masterson........................ 46 President, Chief Executive Officer and a
Director
Steven J. Kline........................... 40 Vice President, Research and Development
Robert Muccini............................ 55 Vice President, Finance, Treasurer, Chief
Financial Officer and Chief Accounting
Officer
Michael S. McCord......................... 53 Director
Each director is elected to serve until the next Annual Meeting of
Stockholders or until his or her successor is elected and shall have qualified.
Of the directors named in the above table, none was elected by the stockholders
of the Company, all being elected by the Board to fill a vacancy. Each officer
of the Company is elected by the Board of Directors to serve at the discretion
of the Board.
BUSINESS HISTORY
Robert Stutman was elected Chairman of the Board and a director of SAT on
April 18, 1996 and designated as its Chief Executive Officer. For more than five
years prior thereto, he has been serving as the President of Robert Stutman &
Associates, Inc. ("RSA"), a provider of corporate "Drug-Free Workplace"
programs. Prior to forming RSA, he was Special Agent in charge of the New York
office of the United States Drug Enforcement Administration. He also currently
serves as a special consultant in substance abuse for the CBS News Division.
USAT acquired RSA on May 21, 1996. On May 31, 1996, he was elected as a director
and Chairman of the Board of the U.S. Drug and designated as its Chief Executive
Officer, which designation continued in effect until May 23, 1997.
Linda H. Masterson has had substantial experience in marketing, sales and
business development in the medical diagnostics, healthcare and biotechnology
fields. She was elected a director of SAT on September 26, 1995. Effective May
13, 1996, she became the President and Chief Operating Officer of SAT. Effective
November 19, 1996, she relinquished her duties as Chief Operating Officer in
order to devote more time to supervising the development program of U.S. Drug
and the operations of the Alcohol Products and BioTox Divisions of SAT. On May
31, 1996, she was elected as a director of U.S. Drug and became its President
and Chief Operating Officer on July 31, 1996. On May 23, 1997, she resigned as
the President of SAT in order to become Chief Executive Officer of U.S. Drug as
part of the program to study the feasibility of separating the interlocking
relationships between SAT and U.S. Drug. Until May 13, 1996, she was employed as
the Executive Vice President of Cholestech, Inc., a start-up diagnostic company,
for which she developed and restructured the company business strategy. In 1993,
Ms. Masterson founded Masterson & Associates, a company of which she was the
President and owner until she joined Cholestech, Inc. in May 1994, which was
engaged in the business of providing advice to start-up companies including the
preparation of technology and market assessments and the preparation of
strategic and five-year business plans for biotech, medical device,
pharmaceutical and software applications companies. From 1992 to 1993, Ms.
Masterson was employed as the Vice President of Marketing and Sales of BioStar,
Inc., a start-up biotech company focused on the commercialization of a new
detection technology applicable to both immunoassay and hybridization based
systems. From 1989 to 1992, she was employed as Senior Vice President of
Marketing, Sales and Business Development by Gen-Probe, Inc., a specialized
genetic probe biotechnology company focused on infectious diseases, cancer and
therapeutics. Prior to 1989, Ms. Masterson was employed for 12 years in various
domestic and international marketing and sales positions at Johnson & Johnson,
Inc., Baxter International Inc. and Warner Lambert Co. Ms. Masterson has a BS in
Medical Technology from the University of Rhode Island, an
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MS in Microbiology/Biochemistry from the University of Maryland and attended the
Executive Advanced Management Program at the Wharton School of Business at the
University of Pennsylvania.
Steven J. Kline joined U.S. Drug as Director of Research in July 1994 and
became its Vice President, Research in January 1995 (the title being changed to
Vice President, Research and Development in May 1996), a position he still
holds. From 1984 to July 1994, he served Abbott Laboratories in various chemical
research positions, the last being R&D Section Head, Abused Drugs/Toxicology
Business Unit, Diagnostics Division. Mr. Kline holds a B.S. in chemistry from
the University of Maryland and a Ph.D in medicinal chemistry from the University
of Florida. From March 25, 1997 to May 23, 1997, he also served as Vice
President, Research and Development of SAT, an officership he resigned as part
of the program to study the feasibility of separating the interlocking
relationships between SAT and U.S. Drug.
Robert Muccini was elected on February 17, 1997 as Vice President, Finance
and Treasurer of SAT and designated Chief Financial Officer and Chief Accounting
Officer of SAT effective with the then anticipated resignation of Dennis A.
Wittman (who had served since September 5, 1996) as a result of the then
intended relocation of SAT's Finance and Accounting Department from Rancho
Cucamonga, California to the corporate headquarters in Fort Lauderdale, Florida,
which resignation and, accordingly, Mr. Muccini's election and designation
became effective February 25, 1997. In anticipation of such contemplated
relocation, he joined SAT on December 16, 1996. From May 1996 until he joined
SAT, Mr. Muccini was a consultant on accounting matters to Precision Response
Corporation, a provider of telemarketing services. From December 1994 to April
1996, he was Chief Financial Officer of Expert Software, Inc., a developer of
consumer software. From November 1991 to July 1994, he was Vice President of
Finance of Bird Corporation, a building products manufacturer and environmental
services provider. From 1983 to 1990, he was Senior Vice President of Finance of
MicroAmerica, Inc. (now Merisel, Inc.), computer distributor. From 1981 to 1983,
he was Controller and Chief Financial Officer of Hyde Athletic Industries, an
importer and distributor of athletic Footwear. From 1979 to 1981, he was
Controller and Treasurer of Stride-Rite Corporation, also an importer and
distributor of athletic footwear. From 1967 to 1979, he was an accounting
manager in the Construction Products Division of W.R. Grace & Company. Mr.
Muccini holds a B.S./B.A. degree in accounting from Northeastern University.
Effective February 25, 1997, Mr. Muccini was elected Vice President, Finance and
Treasurer of U.S. Drug and designated as its Chief Financial Officer and Chief
Accounting Officer.
Michael S. McCord is the owner of McCord Investments, a sole proprietorship
formed in 1980 which primarily invests in various capital markets. Mr. McCord is
also a stockholder, director and officer of McCord Brothers, Inc., and a partner
of McCord Brothers Partnership, a privately-owned company and partnership,
respectively, each of which invests in oil, gas and real estate properties. From
1974 to 1980, Mr. McCord served as Financial Vice President of the Wedge Group,
a privately held holding company which acquired and held control of
international multi-industry (including agricultural, construction, energy,
manufacturing and service) companies with aggregate revenues in excess of $1
billion. On May 31, 1996, he was elected as a director of U.S. Drug. He is a
stockholder in the Company, SAT and Good Ideas and has been a director of U.S.
Drug since October 22, 1996, having previously served as a consultant to SAT's
Board of Directors from October 12, 1996 until his election as a director from
October 12, 1996 until his election as a director.
FAMILY RELATIONSHIPS
There are no family relationships among the directors and executive
officers of U.S. Drug.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Based solely on a review of Forms 3 and 4 furnished to U.S. Drug under Rule
16a-3(e) promulgated under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), with respect to fiscal 1997, U.S. Drug as is not aware of any
director or officer of U.S. Drug who failed to file on a timely basis, as
disclosed in such forms, reporting required by Section 16(a) of the Exchange Act
during fiscal 1997 or prior years. As of March 31, 1997, U.S. Drug is not aware
of any beneficial owner of 10% or more of the U.S. Drug
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Common Stock other than SAT which has advised U.S. Drug that it had no
transactions in the U.S. Drug Common Stock during fiscal 1997.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table provides certain summary information concerning
compensation paid or accrued by U.S. Drug to the sole executive officer of the
Company whose total annual salary and bonus exceeded $100,000 during fiscal
1997. During fiscal 1997, the Company did not pay any compensation to either
James C. Witham who served as Chief Executive Officer from April 1, 1996 to May
31, 1996 and Robert M. Stutman who served during the balance of fiscal 1997.
ANNUAL COMPENSATION
------------------------------------ LONG TERM COMPENSATION
OTHER -------------------------
ANNUAL SECURITIES ALL
COMPEN- UNDERLYING OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS SATION OPTIONS COMPENSATION
- --------------------------- ---- -------- -------- ------- ---------- ------------
Steven J. Kline...................... 1997 $125,000 $ -- $ -- 50,000 $ --
Vice President, Research 1996 117,000 -- -- 10,000 --
and Development 1995 63,231 -- -- 5,000
OPTION/SAR GRANTS IN LAST FISCAL YEAR
There were no grants of stock options or stock appreciation rights in
fiscal 1997. There have been stock appreciation rights granted in U.S. Drug.
AGGREGATE OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END
OPTION/SAR VALUES
There were no stock options outstanding at March 31, 1997 and, as indicated
in the preceding section, stock appreciation rights have never been granted in
U.S. Drug.
REPORT REPRICING OF OPTIONS/SAR'S
There was no repricing of options or stock appreciation rights during
fiscal 1997.
OTHER COMPENSATION
U.S. Drug currently has no pension plan in effect and has in effect no
stock option plan, no restricted stock plan, no stock appreciation rights nor
any other long-term incentive plan under which grants or allocations may be made
in fiscal 1997 or thereafter.
DIRECTOR COMPENSATION
U.S. Drug had a policy to pay each director who was not a compensated
officer of U.S. Drug $1,000 for each Board meeting attended. Such policy has
been suspended.
EMPLOYMENT CONTRACTS
Douglas G. Allen was employed as the President of U.S. Drug under a
three-year employment agreement through February 1996 at a base annual salary
which was $160,000 for the final year. At the conclusion of the contract period,
Mr. Allen's employment was continued without benefit of new contract at an
annual salary of $170,000. As additional consideration he had received Common
Stock purchase warrants expiring February 28, 1998 and February 29, 1999 to
purchase 10,000 and 20,000 shares, respectively, of the SAT Common Stock at
$1.63 per share, which exercise price was the fair market value on the date of
exercise. These warrants were exercised in May 1996. Mr. Allen also received a
monthly automobile allowance. The
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employment arrangement was terminable upon 45 days' notice and was terminated
effective July 31, 1996. He was succeeded by Linda H. Masterson, a director of
U.S. Drug and of SAT.
Clifford D. Bennett was employed under a three-year employment agreement
that expired in September 1995. During his employment, he was granted Common
Stock purchase warrants expiring May 1, 1998 to purchase 5,000 shares of the SAT
Common Stock at $2.19 per share and 7,500 shares of the SAT Common Stock at
$2.50 per share. Both of these exercise prices were equal to the fair market
value of the SAT Common Stock on the respective date of grant.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following table sets forth, as of June 30, 1997, certain information
with respect to (1) any person who beneficially owned more than 5% of the U.S.
Drug Common Stock, (2) each director of U.S. Drug, (3) the Chief Executive
Officer of U.S. Drug; (4) the only executive officer of U.S. Drug whose total
annual salary and bonus exceeded $100,000 in fiscal 1997; and (5) all directors
and executive officers as a group. Each beneficial owner who is a natural person
has advised U.S. Drug that he or she has sole voting and investment power as to
the shares of the U.S. Drug Common Stock reported in the table, except that,
with respect to the beneficial ownership of SAT's shares, the voting and
investment power is shared by the seven directors of SAT, a majority of whom
must approve any vote or disposition of each shares.
NUMBER OF SHARES PERCENTAGE OF
NAME AND ADDRESS OF COMMON STOCK COMMON STOCK
OF BENEFICIAL OWNER BENEFICIALLY OWNED BENEFICIALLY OWNED(1)
- ------------------- ------------------ ---------------------
Substance Abuse Technologies, Inc.......................... 5,268,203 75.4%
4517 N.W. 31st Avenue
Ft. Lauderdale, FL 33309
Robert Stutman(2).......................................... 5,268,203(3) 75.4
4517 N.W. 31st Avenue
Ft. Lauderdale, FL 33309
Linda H. Masterson(4)...................................... -0- -0-
10410 Trademark Street
Rancho Cucamonga, CA 91730
Michael S. McCord(5)....................................... 36,000 nil
2001 Kirby Drive
Suite 701
Houston, TX 77019
Steven J. Kline(6)......................................... -0- -0-
10410 Trademark Street
Rancho Cucamonga, CA 91730
All directors and executive officers as a group (4
persons)................................................. 36,000 nil
- ---------------
(1) The percentages computed in this column of the table are based upon
6,990,103 shares of the U.S. Drug Common Stock outstanding on June 30, 1997.
No effect is given, pursuant to Rule 13(d)(i) under the Exchange Act, to
shares issuable upon the exercise of the U.S. Drug Common Stock purchase
Warrants held because no person named in the table owns such a warrant.
(2) Chairman of the Board and a director of U.S. Drug since May 31, 1996, and
Chief Executive Officer of U.S. Drug from May 31, 1996 to May 23, 1997, as
well as an executive officer and director of SAT since April 18, 1996.
(3) Mr. Stutman, as the Chairman of the Board, the Chief Executive Officer and a
director of SAT, may be deemed to be the beneficial owner of the SAT shares
of the U.S. Drug Common Stock. See, however, the introductory paragraph to
this section.
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(4) A director of U.S. Drug since May 31, 1996; effective August 1, 1996, its
President; and, effective May 23, 1997, its Chief Executive Officer. She has
served as a director of SAT since September 26, 1996 and as its President
from May 13, 1996 to May 23, 1997.
(5) A director of U.S. Drug since May 31, 1996 and a director of SAT since
October 22, 1996 (formerly a consultant to the SAT Board from September 26,
1995 to October 22, 1996).
(6) Vice President, Research and Development of U.S. Drug and the only executive
officer of U.S. Drug who received $100,000 in compensation during fiscal
1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
See the sections "Material Contracts," "Relationships with SAT" and "Loans
from U.S. Drug to SAT" in Items 1 and 10 to this Report.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS:
The U.S. Drug's financial statements appear in a separate section of this
Annual Report on Form 10-K commencing on the pages referenced below:
PAGE
----
Report of Ernst & Young LLP................................. F-1
Report of Wolintz, Gottlieb & Lafazan PC.................... F-2
Balance Sheet as of March 31, 1997 and 1996................. F-3
Statements of Operations for the years ended March 31, 1997,
1996 and 1995 and for the Period from October 8, 1992
(inception) to March 31, 1997............................. F-4
Statements of Stockholders' (Deficit) Equity for the years
ended March 31, 1997, 1996 and 1995 and for the Period
from October 8, 1992 (inception) to March 31, 1997........ F-5
Statements of Cash Flows for the years ended March 31, 1997,
1996 and 1995 and for the Period from October 8, 1992
(inception) to March 31, 1997............................. F-6
Notes to Financial Statements............................... F-7
(2) FINANCIAL STATEMENT SCHEDULES
Financial Statement Schedules are omitted as they are not required, are
inapplicable, or the information is included in the financial statement or notes
thereon.
(3) EXHIBITS
All of the following exhibits designated with a footnote reference are
incorporated herein by reference to a prior registration statement filed under
the Securities Act or a periodic report filed by the Company or SAT pursuant to
Section 13 or 15(d) of the Exchange Act. If no footnote reference is made, the
exhibit is filed with this Report.
EXHIBIT
NUMBER EXHIBITS
- -------- --------
2(b) -- Agreement and Plan of Merger dated as of April 23, 1996 by
and among SAT, U.S. Drug Acquisition Corp. and U.S. Drug.(6)
2(b)(1) -- Agreement and Plan of Merger dated as of February 17, 1997
by and among SAT, U.S. Drug Acquisition Corp. and U.S. Drug.
3(a) -- Copy of Certificate of Incorporation of U.S. Drug as filed
in Delaware on October 8, 1992.(2)
3(a)(1) -- Copy of Amendment to the Certificate of Incorporation as
filed in Delaware on October 13, 1992.(1)
3(b) -- Copy of By-Laws of U.S. Drug.(1)
10(a) -- Copy of License Agreement dated January 24, 1992 by and
between the USN and USAT. (Confidential Treatment Requested
for Exhibit.)(1)
10(a)(1) -- Copy of Amendment dated March 15, 1994 to License Agreement
filed as Exhibit 10(a) hereto.(6)
10(a)(2) -- Copy of Amendment dated June 16, 1995 to License Agreement
filed as Exhibit 10(a) hereto.(6)
10(a)(3) -- Copy of Letter dated May 15, 1995 from the USN to SAT.(6)
10(b) -- Copy of Assignment dated as of January 1, 1993 between U.S.
Drug and USAT of Licensing Agreement filed as Exhibit 10(a)
hereto.(1)
10(b)(1) -- Copy of Amended Sublicense Agreement dated September 23,
1993 superseding the Assignment filed as Exhibit 10(b)
hereto.(6)
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EXHIBIT
NUMBER EXHIBITS
- -------- --------
--
10(b)(2) Copy of Approval dated September 24, 1993 by the USN of
Amended Sublicense Agreement filed as Exhibit 10(b)
hereto.(6)
10(c) -- Copy of Cooperative Research Agreement (the "CRDA
Agreement") dated April 16, 1992 by and between Naval
Research Laboratory Section, United States Department of the
Navy, and SAT.(1)
10(d) -- Copy of Management Agreement dated April 1, 1993 by and
between U.S. Drug and SAT.(1)
10(d)(1) -- Copy of Amendment dated July 20, 1993 to Management Services
filed as Exhibit 10(d) hereto.(1)
10(e) -- Copy of Lease expiring January 31, 1997 by and between
Rancho Cucamonga Business Park as landlord and SAT as
tenant.(2)
10(e)(1) -- Copy of Lease Modification Agreement to Lease filed as
Exhibit 10(e) hereto.(4)
10(e)(2) -- Copy of Sub-Lease Agreement dated as of January 1, 1993 by
and between SAT as sublandlord and U.S. Drug as
subtenant.(1)
10(f) -- Form of Warrant Agreement by and between U.S. Drug and
Baraban Securities, Incorporated.(1)
10(f)(1) -- Form of Common Stock purchase warrant expiring October 13,
1998 of U.S. Drug.(1)
10(g) -- Copy of U.S. Drug's 1994 Stock Option/Stock Issuance
Plan.(4)
10(g)(1) -- Form of Stock Option expiring October 2, 2004 of U.S.
Drug.(4)
10(h) -- Copy of Employment Agreement dated March 1, 1993 between
Doug Allen, SAT and U.S. Drug.
10(i) -- Copy of Employment Agreement dated September , 1992
between Clifford D. Bennett and U.S. Drug.(6)
16 -- Letter dated November 16, 1995 from Wolinetz, Gottlieb &
Lafazan, P.C. to the Securities and Exchange Commission
relating to SAT.(5)
- ---------------
(1) Filed as an exhibit to U.S. Drug's Registration Statement on Form SB-2, File
No. 33-617186, and incorporated herein by this reference.
(2) Filed as an exhibit to SAT's Annual Report on Form 10-K for the fiscal year
ended March 31, 1995 and incorporated herein by this reference.
(3) Filed as an exhibit to SAT's Registration Statement on Form S-1, File No.
33-47855, and incorporated herein by this reference.
(4) Filed as an exhibit to U.S. Drug's Registration Statement on Form S-B, File
No. 33-89346.
(5) Filed as an exhibit to SAT's' Current Report on Form 8-K/A filed on November
22, 1995 and incorporated herein by this reference.
(6) Filed as an exhibit to U.S. Drug's Annual Report on Form 10-K for the fiscal
year ended March 31, 1996.
26
27
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized, on July 12, 1997.
U.S. DRUG TESTING, INC.
(Registrant)
By: /s/ LINDA H. MASTERSON
------------------------------------
Linda H. Masterson
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Company and in
the capacities indicated on July 12, 1997.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ LINDA H. MASTERSON Principal Executive Officer and a
- --------------------------------------------------- director
Linda H. Masterson
/s/ ROBERT MUCCINI Principal Financial and Accounting
- --------------------------------------------------- Officer
Robert Muccini
/s/ MICHAEL S. MCCORD Director
- ---------------------------------------------------
Michael S. McCord
/s/ ROBERT M. STUTMAN Director
- ---------------------------------------------------
Robert M. Stutman
27
28
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
U.S. Drug Testing, Inc.
We have audited the accompanying balance sheet of U.S. Drug Testing, Inc.
(a development stage enterprise) (the "Company") as of March 31, 1997 and 1996,
and the related statements of operations, stockholders' (deficit) equity, and
cash flows for each of the two years in the period ended March 31, 1997, and for
the period October 8, 1992 (inception) through March 31, 1997. 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. The financial statements as of and for the year ended March 31,
1995, and for the period October 8, 1992 (inception) through March 31, 1995,
were audited by other auditors whose report dated May 26, 1995, expressed an
unqualified opinion on those statements. The financial statements for the period
October 8, 1992 (inception) through March 31, 1995 include total costs and
expenses and net loss of $4,497,000 and $4,850,000, respectively. Our opinion on
the statements of operations, and cash flows for the period October 8, 1992
(inception) through March 31, 1997, insofar as it relates to amounts for prior
periods through March 31, 1995, is based solely on the report of other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audit and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the financial position of U.S. Drug Testing, Inc. at March 31, 1997 and 1996,
and the results of its operations and its cash flows for the year then ended and
the period from October 8, 1992 (inception) through March 31, 1997, in
conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that U.S.
Drug Testing, Inc. will continue as a going concern. As more fully described in
Note 2, the Company has incurred recurring operating losses and at March 31,
1997, has a working capital deficiency and a deficiency in stockholders' equity.
Additionally, the working capital requirements of the Company have been and
continue to be provided by the Company's parent, Substance Abuse Technologies,
Inc. Substance Abuse Technologies, Inc. has also incurred recurring operating
losses and at March 31, 1997, has a working capital deficiency and a deficiency
in stockholders' equity. The aforementioned conditions raise substantial doubt
about the Company's ability to continue as a going concern. Management's plans
in regard to these matters are also described in Note 2. The financial
statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amounts and
classification of liabilities that may result from the outcome of this
uncertainty.
Miami, Florida
July 3, 1997
F-1
29
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors and Shareholders
U.S. Drug Testing, Inc.
Rancho Cucamonga, California
We have audited the accompanying statements of operations, stockholders'
(deficit) equity and cash flows for the year ended March 31, 1995 and the period
from October 8, 1992 (inception) through March 31, 1995 of U.S. Drug Testing,
Inc. (a Development Stage Enterprise). These statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the statements referred to above present fairly, in all
materials respects, the results of operations and cash flows of U.S. Drug
Testing, Inc. for the year ended March 31, 1995 and the period from October 8,
1992 (inception) through March 31, 1995, in conformity with generally accepted
accounting principles.
WOLINETZ, GOTTLIEB & LAFAZAN, P.C.
Rockville Centre, New York
May 26, 1995
F-2
30
U.S. DRUG TESTING, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
BALANCE SHEETS
MARCH 31
-----------------------
1997 1996
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents................................. $ -- $ 249,047
Note receivable -- parent................................. -- 282,295
Prepaid expenses and other current assets................. 49,996 120,802
---------- ----------
Total current assets.............................. 49,996 652,144
Property and equipment, net................................. 505,799 483,039
Patents and other assets, net............................... 40,152 40,207
---------- ----------
$ 595,947 $1,175,390
========== ==========
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
Current liabilities:
Book overdraft............................................ $ 119,514 $ --
Accounts payable.......................................... 216,687 71,285
Accrued expenses.......................................... 16,340 22,920
Current portion of capital lease obligations.............. 25,494 21,059
Note payable -- parent.................................... 1,668,179 --
---------- ----------
Total current liabilities......................... 2,046,214 115,264
Capital lease obligations................................... 123,419 3,239
---------- ----------
2,169,633 118,503
Commitments and contingencies
Stockholders' (deficit) equity:
Common stock, $.001 par value; 50,000,000 shares
authorized, 5,221,900 shares issued and outstanding at
March 31, 1997 and 1996................................ 5,222 5,222
Additional paid-in capital................................ 7,542,401 7,542,401
Deficit accumulated in the development stage.............. (9,121,309) (6,490,736)
---------- ----------
Total stockholders' (deficit) equity.............. (1,573,686) 1,056,887
---------- ----------
$ 595,947 $1,175,390
========== ==========
See Accompanying Notes.
F-3
31
U.S. DRUG TESTING, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF OPERATIONS
CUMULATIVE
FROM
OCTOBER 8,
1992
YEARS ENDED MARCH 31 (INCEPTION) TO
--------------------------------------- MARCH 31
1997 1996 1995 1997
----------- ----------- ----------- --------------
Revenues.................................... $ -- $ -- $ -- $ --
Costs and expenses:
Selling, general and administrative
expenses............................... 268,668 318,510 475,400 1,813,079
Research and development.................. 1,735,449 949,439 1,261,219 4,765,339
Depreciation and amortization............. 143,634 143,969 162,871 559,658
Interest expense-parent................... 23,095 -- 3,319 61,260
Management fees-parent.................... 420,000 420,000 420,000 1,680,000
Interest expense.......................... 5,822 71,882 40,640 118,344
----------- ----------- ----------- -----------
Total costs and expenses.......... 2,596,668 1,903,800 2,363,449 8,997,680
----------- ----------- ----------- -----------
Loss from operations........................ (2,596,668) (1,903,800) (2,363,449) (8,997,680)
Other income (expense):
Interest income........................... -- 104,787 245,139 435,621
Loss on sale of fixed assets.............. (33,905) -- -- (33,905)
Gain (loss) on sale of marketable
securities............................. -- 76,441 (234,307) (627,512)
Interest income-parent.................... -- 81,767 20,400 102,167
----------- ----------- ----------- -----------
Total other income (expense)...... (33,905) 262,995 31,232 (123,629)
----------- ----------- ----------- -----------
Net loss.................................... $(2,630,573) $(1,640,805) $(2,332,217) $(9,121,309)
=========== =========== =========== ===========
Weighted average common shares
outstanding............................... 5,221,900 5,221,900 5,221,900
=========== =========== ===========
Net loss per common share................... $ (.50) $ (.31) $ (.45)
=========== =========== ===========
See Accompanying Notes.
F-4
32
U.S. DRUG TESTING, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
FOR THE PERIOD OCTOBER 8, 1992 (INCEPTION) TO MARCH 31, 1997
DEFICIT
ACCUMULATED
ADDITIONAL IN THE
COMMON PAID-IN DEVELOPMENT
STOCK CAPITAL STAGE TOTAL
------ ---------- ----------- -----------
Balance at October 8, 1992....................... $ -- $ -- $ -- $ --
Issuance of 3,500,000 shares of common stock
for value of assets transferred from
parent...................................... 3,500 445,186 -- 448,686
Net loss for the period ended March 31, 1993... -- -- (257,422) (257,422)
------ ---------- ----------- -----------
Balance at April 1, 1993......................... 3,500 445,186 (257,422) 191,264
Sale of 1,721,900 shares of common stock in
connection with initial public offering, net
of offering costs of $1,510,663............. 1,722 7,097,215 -- 7,098,937
Net loss for the year ended March 31, 1994..... -- -- (2,260,292) (2,260,292)
------ ---------- ----------- -----------
Balance at March 31, 1994........................ 5,222 7,542,401 (2,517,714) 5,029,909
Net loss for the year ended March 31, 1995..... -- -- (2,332,217) (2,332,217)
------ ---------- ----------- -----------
Balance at March 31, 1995........................ 5,222 7,542,401 (4,849,931) 2,697,692
Net loss for the year ended March 31, 1996..... -- -- (1,640,805) (1,640,805)
------ ---------- ----------- -----------
Balance at March 31, 1996........................ 5,222 7,542,401 (6,490,736) 1,056,887
Net loss for the year ended March 31, 1997..... -- -- (2,630,573) (2,630,573)
====== ========== =========== ===========
Balance at March 31, 1997........................ $5,222 $7,542,401 $(9,121,309) $(1,573,686)
====== ========== =========== ===========
See Accompanying Notes.
F-5
33
U.S. DRUG TESTING, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CASH FLOWS
CUMULATIVE FROM
OCTOBER 8, 1992
YEARS ENDED MARCH 31 (INCEPTION) TO
--------------------------------------- MARCH 31
1997 1996 1995 1997
----------- ----------- ----------- ---------------
OPERATING ACTIVITIES
Net loss.................................. $(2,630,573) $(1,640,805) $(2,332,217) $(9,121,309)
Adjustments to reconcile net loss to net
cash used by operating activities:
Depreciation and amortization........... 143,634 143,969 162,871 559,658
Disposal of property and equipment...... 33,905 -- 25,475 59,380
(Gain) loss on marketable securities.... -- (76,441) 234,307 627,512
Amortization of bond discount........... -- (779) (3,116) (4,855)
Changes in operating assets and
liabilities:
Change in prepaid expenses and other
current assets..................... 20,203 (55,505) (23,467) (100,599)
Change in other assets............... 1,174 2,502 7,507 (3,819)
Change in bank overdraft............. 119,514 -- -- 119,514
Change in accounts payable........... 199,761 20,510 (4,075) 271,046
Change in accrued expenses........... (6,580) (49,868) 49,729 16,340
----------- ----------- ----------- -----------
Net cash used by operating activities..... (2,118,962) (1,656,417) (1,882,986) (7,577,132)
INVESTING ACTIVITIES
Sale of marketable securities............. -- 3,285,625 -- 3,285,625
Purchase of marketable securities......... -- -- -- (3,908,281)
Purchases of property and equipment....... (52,540) (21,514) (99,262) (537,397)
Additional patent costs................... -- (15,687) (9,635) (37,836)
----------- ----------- ----------- -----------
Net cash provided (used) by investing
activities.............................. (52,540) 3,248,424 (108,897) (1,197,889)
FINANCING ACTIVITIES
Sales of common stock..................... -- -- -- 8,621,226
Expenses of stock offering................ -- -- -- (1,510,663)
Payments of loan to parent................ -- (1,428,538) (488,519) (1,917,057)
Payment of loan by parent................. -- 1,634,762 -- 1,634,762
Proceeds of loan payable -- parent........ 1,668,179 -- -- 3,250,256
Payment of loan payable -- parent......... -- -- (81,121) (1,299,782)
Proceeds of note receivable -- parent..... 282,295 -- -- --
Proceeds of capital leases................ -- -- 11,707 101,572
Payments of capital leases................ (28,019) (28,960) (38,330) (105,293)
Proceeds of brokerage loan payable........ -- 1,000,000 1,674,683 2,674,683
Payments of brokerage loan payable........ -- (2,569,592) (105,091) (2,674,683)
----------- ----------- ----------- -----------
Net cash provided (used) by financing
activities.............................. 1,922,455 (1,392,328) 973,329 8,775,021
----------- ----------- ----------- -----------
Increase (decrease) in cash and cash
equivalents............................. (249,047) 199,679 (1,018,554) --
Cash and cash equivalents at beginning of
period.................................. 249,047 49,368 1,067,922 --
=========== =========== =========== ===========
Cash and cash equivalents at end of
period.................................. $ -- $ 249,047 $ 49,368 $ --
=========== =========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH
INFORMATION:
Cash paid for interest.................... $ 5,873 $ 71,882 $ 43,959 $ 156,560
=========== =========== =========== ===========
Noncash financing activities:
Value of common stock issued for the
transfer of assets at carrying value
from parent.......................... $ -- $ -- $ -- $ 437,060
=========== =========== =========== ===========
See Accompanying Notes.
F-6
34
U.S. DRUG TESTING, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
U.S. Drug Testing, Inc. (U.S. Drug) was incorporated on October 8, 1992
under the laws of the State of Delaware as a wholly-owned subsidiary of
Substance Abuse Technologies, Inc. ("SAT" or "Parent"), formally U.S. Alcohol
Testing of America, Inc., a publicly-owned corporation and, at June 30, 1997, is
a 75.4% owned subsidiary of SAT. U.S. Drug commenced activities on January 1,
1993 and is engaged in the design of certain patented technology known as the
"Flow Immunosensor" developed by U.S. Navy Department scientists for the
detection of drugs of abuse. As U.S. Drug is devoting its efforts to research
and the development of its products and there has been no revenue generated from
product sales as yet, U.S. Drug's financial statements are presented as
statements of a development stage enterprise.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid cash investments with an original
maturity of three months or less when purchased to be cash equivalents.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is computed by the
straight-line method over the estimated useful lives of the related assets which
range from 5 to 13 years. Expenditures for maintenance and repairs are charged
to expense as incurred whereas major betterments and renewals are capitalized.
Property and equipment under capital leases are included with property and
equipment and amortization of these assets are included in depreciation expense.
PATENTS
The cost of patents is being amortized over its expected useful life of 17
years using the straight-line method. At March 31, 1997 and 1996, accumulated
amortization of patents was approximately $2,600 and $4,000, respectively.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred.
ACCOUNTING FOR STOCK BASED COMPENSATION
The Company grants stock options for a fixed number of shares to employees
with an exercise price equal to or above the fair value of the shares at the
date of grant. The Company accounts for stock option grants in accordance with
APB Opinion No. 25, Accounting for Stock Issued to Employees, and accordingly,
recognizes no compensation expense for employee stock option grants.
F-7
35
U.S. DRUG TESTING, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NET LOSS PER COMMON SHARE
Loss per common share is based upon the weighted average number of common
shares outstanding during the periods reported. Common stock equivalents have
not been included in this calculation since their inclusion would be
antidilutive.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 128, Earnings Per Share. SFAS No.
128, which applies to entities with publicly held common stock, simplifies the
standard for computing earnings per share previously required in APB Opinion No.
15, Earnings Per Share, and makes them comparable to international earnings per
share standards. SFAS No. 128 is effective for financial statements issued for
periods ending after December 15, 1997, including interim periods; earlier
adoption is not permitted. Management is currently reviewing the provisions of
SFAS No. 128; however, it does not believe that adoption of this new accounting
pronouncement will have a material impact on the calculation and presentation of
earnings per share.
INCOME TAXES
The Company accounts for income taxes under Statement of Financial
Accounting Standards (SFAS) No. 109, Accounting For Income Taxes. In accordance
with SFAS No. 109, deferred tax assets and liabilities are established for the
temporary differences between the financial reporting basis and the tax basis of
the Company's assets and liabilities at enacted tax rates expected to be in
effect when such amounts are realized or settled.
RECLASSIFICATION
Certain prior year balances have been reclassified to conform with the
current year's presentation.
2. CONTINUING OPERATIONS
The Company has incurred recurring operating losses and at March 31, 1997
has a deficiency in working capital of approximately $2,000,000 and a deficiency
in stockholders' equity of approximately $1,600,000. To increase working
capital, in June 1997, the Company converted outstanding indebtedness to SAT of
approximately $2,000,000 into shares of the Company's stock. However, the
Company will require additional capital to continue the research, development
and ultimate manufacture and marketing of its product and to fund its working
capital requirements for the next 12 months.
Additionally, on a consolidated basis, SAT reported a net loss of
$15,443,814 for the year ended March 31, 1997 and has a working capital
deficiency and a deficiency in stockholders' equity. These conditions raise
substantial doubt about Substance Abuse Technologies, Inc.'s ability to continue
as a going concern. Because of the aforementioned conditions relating to
Substance Abuse Technologies, Inc., and the uncertainties surrounding its plans
to address its liquidity problems, the parent company's actions could have a
substantial effect on the Company's assets.
The aforementioned conditions raise substantial doubt about the Company's
ability to continue as a going concern. The financial statements do not include
any adjustments to reflect the possible future effects, if any, on the on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty.
SAT has funded U.S. Drug and continues to provide working capital as
needed. In May 1997, the Board of Directors of SAT also authorized the purchase
of 2,000,000 shares of U.S. Drug Common Stock for $2,500,000; however such
potential investment has been delayed pending additional financing by SAT. SAT
has also initiated a program to have U.S. Drug seek its own financing, with an
equity investment, debt
F-8
36
U.S. DRUG TESTING, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
financing or some combination. In connection with this program, SAT intends to
acquire the Common Stock of U.S. Drug owned by the minority shareholders by
exchanging shares of SAT's common stock for U.S. Drug Common Stock. In addition
to seeking a strategic partner, SAT also plans to seek independent directors for
U.S. Drug and establish an independent management team. There can be no
assurance that any of these additional sources of financing will be available
and, in such event, U.S. Drug will not be able to complete its research and
development on a timely basis.
3. PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
MARCH 31
-------------------
1997 1996
-------- --------
Furniture, Fixtures and Equipment........................... $363,229 $268,182
Test Equipment.............................................. 400,798 386,909
Leasehold Improvements...................................... 208,822 208,822
-------- --------
972,849 863,913
Less: Accumulated Depreciation.............................. 467,050 380,874
======== ========
$505,799 $483,039
======== ========
4. NOTES TO/FROM PARENT
Note Payable -- Parent at March 31, 1997 represents a loan made to the
Company by SAT. At the May 1997 meeting of the SAT Board of Directors, the board
agreed to convert the outstanding indebtedness, inclusive of interest as of June
24, 1997 into 1,768,202 shares of the Company's Common Stock. As a result, SAT's
ownership interest in U.S. Drug was increased to 75.4%.
Note Receivable -- Parent at March 31, 1996 represents a demand loan made
to SAT which matured on December 31, 1996. The note bore interest at a rate of
8% per annum. The note was secured by SAT's shares in the Company. SAT repaid
the loan in full during the quarter ended September 30, 1996.
5. CAPITAL LEASES
The Company owns certain equipment under lease that are classified as
capital leases. The following is a schedule of future minimum lease payments
under capital leases together with the present value of the net minimum lease
payments as of March 31, 1997:
1998........................................................ $ 47,739
1999........................................................ 42,303
2000........................................................ 42,303
2001........................................................ 42,303
2002........................................................ 31,728
--------
Total minimum lease payments................................ 206,376
Less amount representing interest........................... (57,463)
--------
Present value of minimum lease payment (including current
portion of $25,494)....................................... $148,913
========
F-9
37
U.S. DRUG TESTING, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
6. STOCKHOLDERS' EQUITY
COMMON STOCK
On October 5, 1993, U.S. Drug completed an initial public offering of its
Common Stock. U.S. Drug sold 1,500,000 shares at $5.00 per share and netted
approximately $6,143,000. In November 1993, an additional 221,900 shares were
sold pursuant to the offering's over-allotment provision and U.S. Drug netted an
additional $956,000. As a result of the sales of these securities, SAT had its
ownership reduced from 100% to 67.0%.
In connection with the offering, the underwriters were granted, for a
nominal fee, five-year Common Stock Purchase Warrants entitling the underwriters
to purchase up to 150,000 shares at $7.50 per share.
During May, 1996 SAT filed a Registration Statement on Form S-4 under the
Securities Act of 1933, as amended, in an attempt, through a consent
solicitation, to acquire the Common Stock of U.S. Drug owned by the minority
interest and thereby own 100% of U.S. Drug's Common Stock. There can be no
assurance that such solicitation will be successfully completed.
On June 24, 1997, the Company converted $2,210,254 of indebtedness,
inclusive of accrued interest, payable to SAT into 1,768,202 shares of the
Company's Common Stock. As a result, SAT's ownership interest increased to 80%.
STOCK OPTION/STOCK ISSUANCE PLAN
In September 1994, the stockholders ratified the 1994 Stock Option/Stock
Issuance Plan which covers 500,000 shares of the Common Stock. Options granted
under the Option Grant Program may be either incentive stock options designed to
meet the requirements of Section 422 of the Internal Revenue Code or
non-statutory options not intended to satisfy such requirements. The exercise
price per share for incentive stock options will not be less than one hundred
percent (100%) of the fair market value per share of the Common Stock on the
grant date. For non-statutory options, the exercise price per share may not be
less than eighty-five (85%) of such fair market value. No granted option will
have a maximum term in excess of ten (10) years.
In October 1994, the Board of Directors granted stock options to purchase
252,000 shares at an exercise price of $7.00 per share to certain officers,
directors and key employees of U.S. Drug. A summary of stock option activity for
the three years ended March 31, 1997 follows:
INCENTIVE STOCK OPTIONS NON-STATUTORY OPTIONS
----------------------- -----------------------
NUMBER OF PRICE RANGE NUMBER OF PRICE RANGE
SHARES PER SHARE SHARES PER SHARE
--------- ----------- --------- -----------
Outstanding -- April 1, 1994................ -- -- -- --
Granted................................... 242,000 $7.00 10,000 $7.00
Canceled.................................. (24,000) 7.00 -- --
-------- ----- ------- -----
Outstanding -- March 31, 1995............... 218,000 7.00 10,000 7.00
Canceled.................................. (66,000) 7.00 (10,000) 7.00
-------- ----- ------- -----
Outstanding -- March 31, 1996............... 152,000 7.00 -- --
Canceled.................................. (152,000) 7.00 -- --
======== ===== ======= =====
Outstanding -- March 31, 1997............... -- $ -- -- $ --
======== ===== ======= =====
F-10
38
U.S. DRUG TESTING, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7. INCOME TAXES
For income tax purposes, U.S. Drug has a net operating loss carry forward
at March 31, 1997 of approximately $8,390,000 expiring in 2008 to 2012 if not
offset against future federal taxable income. In addition, U.S. Drug has a
capital loss carryover of approximately $625,000 which expires in 2001 if not
offset against future capital gains.
Income tax benefit attributable to net loss differed from the amounts
computed by applying the statutory Federal Income tax rate applicable for each
period as a result of the following:
MARCH 31
1997 1996 1995
--------- --------- ---------
Computed "expected" tax benefit..................... $ 869,000 $ 557,000 $ 713,000
Decrease in tax benefit resulting from net operating
loss for which no benefit is currently
available......................................... (869,000) (557,000) (713,000)
========= ========= =========
$ -- $ -- $ --
========= ========= =========
The tax effects of temporary differences that give rise to significant
portions of the net deferred tax asset are presented below:
MARCH 31
1997 1996
---------- ----------
Deferred tax assets:
Net operating loss carryforwards.......................... $2,850,000 $1,981,000
Capital loss carryforwards................................ 213,600 213,600
---------- ----------
3,063,600 2,194,600
Less:
Valuation allowance under SFAS 109........................ 3,063,600 2,194,600
========== ==========
Net deferred tax assets..................................... $ -- $ --
========== ==========
SFAS No. 109 requires a valuation allowance to reduce the deferred tax
assets reported if, based on the weight of the evidence, it is more likely than
not that some portion or all of the deferred tax assets will not be realized.
After consideration of all the evidence, both positive and negative, management
has determined that a $3,063,600 valuation allowance at March 31, 1997 is
necessary to reduce the deferred tax assets to the amount that will more likely
than not be realized. The change in the valuation allowance for the current year
is $869,000.
8. COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
U.S. Drug has entered into an agreement with SAT commencing January 1, 1993
and terminating on January 31, 1997, subject to two five-year renewal options,
sub-leasing a portion of SAT's office and factory facilities in Rancho
Cucamonga, California. In addition to rent, U.S. Drug will pay for its
proportionate share of real estate taxes and other occupancy costs. Rent expense
for the fiscal years ended March 31, 1997, 1996 and 1995 was $45,000, $36,000,
and $54,000, respectively.
F-11
39
U.S. DRUG TESTING, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Approximate future minimum payments under this sub-lease are summarized as
follows:
Fiscal year ending March 31:
1998........................................................ $ 67,798
1999........................................................ 67,798
2000........................................................ 67,798
2001........................................................ 67,798
2002........................................................ 67,798
Thereafter.................................................. 56,499
========
$395,489
========
SIGNIFICANT CONTRACTS
Effective January 1, 1993 U.S. Drug entered into a sub-license agreement
with SAT in which U.S. Drug sublicensed all of SAT's rights under a license
agreement with the Department of the Navy (the License Agreement).
SAT and the Department of the Navy on January 24, 1992 had entered into a
ten-year agreement granting SAT a partial exclusive patent license to products
for drug testing in the United States and certain foreign countries. In June
1995, SAT's License Agreement with the Department of Navy was renegotiated and
amended to provide for minimum royalties of $100,000 per year commencing October
1, 1995 and terminating September 30, 2005. Additional royalties will be paid
pursuant to a schedule based upon sales of products. U.S. Drug is a sub-licensee
under this agreement from SAT and, accordingly, has an obligation to SAT for the
royalty payments required by the License Agreement. Royalties expensed under the
License Agreement by U.S. Drug were $100,000, $50,000 and $375,000 for the year
ended March 31, 1997, 1996 and 1995, respectively.
9. INTERCOMPANY ALLOCATIONS
U.S. Drug is obligated to pay a fixed annual management fee of $420,000
plus three (3%) percent of its gross revenues to SAT. The agreement is through
March 31, 1998. U.S. Drug paid $420,000 per year for the years ended March 31,
1997, 1996, and 1995. In addition, the Company is allocated overhead expenses
such as rent, utilities, etc. based on estimated usage. Management believes this
method of allocation is reasonable and represents management's best estimate of
what expenses would have been on a stand alone basis.
F-12
40
U.S. DRUG TESTING, INC.
ANNUAL REPORT ON FORM 10-K FOR
FISCAL YEAR ENDED MARCH 31, 1997
EXHIBIT FILED WITH REPORT
EXHIBIT PAGE
NUMBER EXHIBIT NUMBER
------- ------- ------
2(b)(1) -- Agreement and Plan of Merger dated as of February 17, 1997
by and among SAT, U.S. Drug Acquisition Corp. and U.S. Drug,
Inc......................................................... E-2
E-1