**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

##### **FORM 10-K**

 

| **ý** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|------------|-------------------------------------------------------------------------------------------|

 

**For the fiscal year ended December31, 2001**

 

**OR**

 

| **o** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**For the transition period from                  to                 **

** **

**CommissionFile Number**** 000-30493**

 

**RESTORAGEN, INC.**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**                                                                      |   | **47-0727668**                        |
|-----------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization)                   |   | (I.R.S. Employer  Identification No.) |
|                                                                              |   |                                  |
| **4130  N.W. 37th Street, Lincoln, Nebraska 68524-1922**                          |
| (Address of  principal executive offices)                                         |
|                                                                              |   |                                  |
| Registrant’s telephone number, including area code:  **(402) 470-2100** |

 

**Securitiesregistered pursuant to Section 12(b) of the Act:  None**

**Securities registered pursuant toSection 12(g) of the Act: Common Stock, $.01 par value.**

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for the past90 days.

Yes   ý                No   o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

As of March 25, 2002, theCompany had outstanding 7,379,408 shares of Common Stock, $.01 par value.

 

#####  

##### **TABLE OF CONTENTS**

 
| PART  I   |
|-----------|
|      |
| ITEM 1.   | BUSINESS |
| ITEM 2.   | PROPERTIES |
| ITEM 3.   | LEGAL PROCEEDINGS |
| ITEM  4.  | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS |
|      |   |
| PART  II  |
|      |
| ITEM  5.  | MARKET  FOR THE REGISTRANT’S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS |
| ITEM 6.   | SELECTED FINANCIAL  DATA |
| ITEM  7.  | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
| ITEM  7A. | QUALITATIVE  AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISKS |
| ITEM  8.  | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA |
| ITEM  9.  | CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
|      |   |
| PART  III |
|      |
| ITEM  10. | DIRECTORS  AND EXECUTIVE OFFICERS OF THE REGISTRANT |
| ITEM 11.  | EXECUTIVE  COMPENSATION |
| ITEM  12. | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT |
| ITEM  13. | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS |
|      |   |
| PART  IV  |   |
|      |   |
| ITEM  14. | EXHIBITS,  FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K |

 

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**PARTI**

 

**ITEM1.  BUSINESS**

 

**Introduction**

 

Restoragen Inc. (formerly BioNebraska, Inc.) is adevelopment stage biotechnology company focused on the development andproduction of peptide therapeutics.  TheCompany continues to develop its capabilities in production, purification andamidation of medium range peptides using proprietary recombinant technologiesand chemistries.  The Company believesits ability to produce medium range peptides at relatively low cost in thismanner will facilitate their development as therapeutic agents.

 

The Company’s principal pharmaceutical productcurrently under development is recombinant human GLP-1.  GLP-1 is believed to be an importantinsulinotropic peptide that regulates metabolism and has been shown to reducehigh blood glucose levels and to improve insulin secretion and action in typeII diabetics.  Restoragen hassuccessfully completed phase I and phase II (a) studies using its recombinantGLP-1 (“rGLP-1”) for the treatment of type II diabetes.  Previously the Company had intended toundertake a large phase II/III trial. In the first quarter of 2002, the Company modified the design of thetrial and is currently conducting a phase II (b) trial for patients with typeII diabetes who are failing oral therapy. Assuming satisfactory results from the phase II (b) trial, the Companyintends to enter phase III clinical testing with an appropriate development andcommercialization partner to fulfill the requirements for marketing approvalsin the United States and other countries.

 

Insulin resistance is also an underlying factor indisorders other than diabetes. Restoragen has conceived and patented several new and important uses forrGLP-1 in certain serious cardiovascular diseases and intends to pursue theclinical development of rGLP-1 for niche cardiovascular diseases.

 

The Company has previously conducted development workwith recombinant Human Growth Hormone Releasing Factor (“rGRF”) and rGRF incombination with parathyroid hormone (“PTH”) for the treatment of osteoporosisand other symptoms of aging.  At thepresent time, Restoragen’s clinical development of rGRF and PTH has beensuspended to concentrate the Company’s resources on the effective developmentof rGLP-1.

 

**Strategy**

 

In the first quarter of 2002, the Company restructuredand revised its business strategy in an effort to accelerate commercializationof its therapeutics, reduce risk, and conserve cash.  The revised strategy will focus on the Company’s ability todevelop commercially viable recombinant peptide production methods for contractcustomers and will involve strategic partnering to develop and commercializepeptide-based therapeutics for clinically and economically important diseases.

 

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Restoragen’s strategic intent is to become a leader inthe development, production and commercialization of peptide therapeuticsprimarily focused on cardiovascular and metabolic diseases, such as heartfailure and type II diabetes.

 

To achieve this objective, Restoragen is pursuing thefollowing strategies:

 

1)              Capitalize on the Company’s core competence of peptide production and processing methods to provide solutions to biopharmaceutical companies with proprietary peptides in return for milestone payments and royalties from net sales.

 

2)              Establish partnerships with market leading pharmaceutical and medical device companies to develop and commercialize Restoragen’s rGLP-1 as a standard of care for certain niche cardiovascular diseases in which insulin resistance is an underlying factor.

 

3)              Establish partnerships with market leading pharmaceutical and drug delivery companies to develop and commercialize sustained release formulations of rGLP-1 for type II diabetes and other metabolic diseases and cardiovascular disorders in which insulin resistance is an underlying factor.

 

4)              Maintain a tightly focused and streamlined corporate infrastructure and collaborate with industry leaders. By outsourcing many non-core aspects of its business, Restoragen believes that it will substantially reduce operating overheads and capital investment, accelerate commercialization of its products and reduce business risk.

 

Restoragen is currently pursuing discussions withpotential customers for the Company’s peptide production expertise andprocessing methods, and with potential strategic partners for the Company’srGLP-1 and other therapeutic peptides. No definitive contracts are in place.

 

Consistent with this revised strategic intent, onFebruary 21, 2002, the Company announced and implemented a restructuring andreduction in workforce from 121 to 60 employees.  This reduction was deemed necessary to restructure the Company ina focused and strategic manner and conserve cash.

 

**Peptide Production Capabilities**

 

Peptides are formed from amino acid building blocks invarious combinations and sequences. Peptides made up of less than 20 amino acid residues generally can beproduced in commercial quantities by conventional chemical synthesis and oftenat acceptable costs.  Peptidesconsisting of more than 60 amino acid residues are generally known as proteinsand tend to develop complex three dimensional structures.  Generally, proteins can be produced efficientlyby conventional biological means using recombinant production techniques atrelatively high but often acceptable costs for pharmaceutical applications.

 

Medium range peptides are made up of 20 to 60 or moreamino acid residues.  When more than 20amino acid residues are incorporated in a peptide, the cost of production with

 

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conventional chemical synthesis increases dramatically and theefficiency and yields rapidly decline. The difficulties associated with the manufacture of medium rangepeptides by chemical synthesis and the associated costs are often notacceptable for commercial pharmaceutical purposes, especially when the size ofthe peptide exceeds 25 amino acid residues.

 

The Company believes it has developed proprietarytechnologies and processes for the efficient production and purification ofmedium range peptides at relatively low costs, as compared to the reportedcosts using chemical synthesis.  Each ofthe Company’s proprietary manufacturing processes involves the introduction ofa gene into*E. coli*bacteria fora construct containing a proprietary leader connected to a precursor peptideprotein.  The bacteria are grown byfermentation in a carefully controlled environment in a fermentationvessel.  The bacteria are harvested andtheir cells broken apart.  Theexpression leader attached to the medium range peptide precursor is selectivelyremoved from the cell mass by proprietary purification methods.  The medium range peptide is cleaved from theexpression leader using proprietary techniques and further purified and oftenamidated to yield the natural human form.

 

Recombinant methods of producing medium range peptidesgenerally have not been successful due to an inability to amidate.  An important characteristic of many mediumrange peptides is that they end with an amide in their natural form.  This amide ending is often required toconstitute the natural peptide and develop full biological activity.  However, the amide ending cannot be maderecombinantly and must be added by chemical or enzymatic means.  The inability to add amide endings at anacceptable cost has been a major impediment to the efficient recombinantproduction of medium range peptides. The Company believes it has developed several efficient and proprietaryprocesses for adding this amide to medium range peptides that have beenproduced recombinantly.  In combinationwith the Company’s recombinant production methods, this makes possible theefficient and relatively low cost production of natural medium range peptidesof high purity that incorporate the amide.

 

Although Restoragen has successfully producedtherapeutic peptides in limited quantities for research and developmentpurposes, the Company has not produced commercial quantities and has limitedexperience with commercial scale manufacturing.  Restoragen does not have adequate facilities, managementexpertise or employees to produce peptides for commercial therapeuticspurposes.  The Company is currentlyevaluating potential sources for commercial-scale production.

 

**GLP-1 and Insulin Resistance**

 

Restoragen began its development program for type IIdiabetes because GLP-1 is an insulinotropic hormone.  During the course of evaluating the effects of rGLP-1 in diabeticpatients, an original discovery was made that indicated rGLP-1 reverses insulinresistance.  This effect is directlybeneficial for type II diabetics because rGLP-1 improves the response toinsulin in these patients and normalizes serum glucose.  While virtually all type II diabeticpatients have insulin resistance, most people who have insulin resistance donot develop diabetes.  However, insulinresistance is an underlying factor for several other serious disorders relatedto the hypersecretion of insulin, including Syndrome X and Polycystic OvarySyndrome.  Additionally, insulinresistance is a major risk factor for most serious and common cardiovasculardiseases,

 

3

 

including coronary artery disease, peripheral vascular disease andstroke.  Cognizant of thesewell-established facts and capitalizing on its own unique research findingswith rGLP-1, Restoragen has filed several patent applications (one of which hasissued) covering new and important uses for GLP-1 and its analogs in certaincardiovascular disorders.

 

Heart failure hospitalizes more patients than anyother disease in the United States and carries a 50% five-year survivalrate.  Because patients with heartfailure are known to develop insulin resistance, as well as a potentiallyreversible metabolic myopathy resulting from insulin resistance, Restoragen hasbegun to evaluate micro-infusion pump delivery of rGLP-1 as a potential therapyfor severe heart failure.  It should benoted that oral anti-diabetic agents such as metformin and the glitazones arecontraindicated in patients with this disease. By reversing the exaggerated utilization of fatty acids and promotingthe utilization of glucose as an energy source, GLP-1 specifically targets afundamental pathophysiological mechanism in the diseased heart that contributesto the cardiac dysfunction and debility of patients with heart failure.

 

**Sales and Distribution**

 

The Company’s distribution strategy is to develop acollaboration with one or more leading pharmaceutical companies for the finalmarketing and distribution of approved therapeutics.  Failure to initiate, develop and maintain effectivecommercialization partnerships will jeopardize the Company’s ability to selland distribute potential products.  Evenif suitable partnerships are established, successful commercialization of theCompany’s potential products will depend in part upon the extent to whichreimbursement for the costs of such products will be available from governmenthealth administrations, private health insurers, and other relevantorganizations.  There can be noassurance that any of the Company’s potential products, if developed, launchedand reimbursed, will be successfully promoted or achieve market acceptance.

 

**Medtronic Relationship**

 

Restoragen has a relationship with Medtronic and withits affiliate MiniMed Inc., the worldwide leader in subcutaneouscontinuous-flow microinfusion devices, to design, develop, optimize andimplement the delivery of rGLP-1 formulations for targeted clinicalpopulations.  To date, Medtronic hascontributed equity investment and loan financing to Restoragen exceeding $17million.  Medtronic has been granted theright to designate a person as a voting member of the Company’s Board ofDirectors, but has not yet exercised that right.  In exchange for its investment, Medtronic has also been grantedthe right of first offer and negotiation for the distribution rights to rGLP-1in the field of diabetes.

 

# **Intellectual Property**

 

Restoragen’s success will depend in part on itsability to obtain and maintain patent protection for its production processesand products, preserve trade secrets, prevent third parties from infringingupon its proprietary rights, and to operate without infringing upon theproprietary rights of others, both in the United States and internationally.

 

4

 

Restoragen has filed patent applications to covercertain aspects of its recombinant production technologies and peptidemodification methods, including basic elements of its amidationtechnology.  The Company intends towrite and file additional applications covering its processes.  There can be no assurance that any suchpatent applications will result in issued patents or that any issued patentwill provide meaningful protection for the Company’s technology or enhance theCompany’s competitive position.  TheCompany also owns or has exclusive rights to issued or allowed US patentspertaining to various elements of peptide production technology.  However, none of the issued or allowedpatents related to the Company’s production technology are used in theCompany’s current production process pertaining to rGLP-1.

 

The Company has a portfolio of one issued and severalpending patent applications covering GLP-1 and its analogs for use in bothacute and chronic cardiovascular disease and its prevention.  The issued patent covers the use of GLP-1 intreating reperfused tissue and patent applications cover the use of GLP-1 andits analogs for a wide-range of related cardiovascular problems, includingacute coronary syndromes, hibernating myocardium, diabetic cardiomyopathy,peripheral vascular disease with intermittent claudication, stroke anddisorders of insulin resistance.  Therecan be no assurance that any such patent applications will provide meaningfulprotection for the Company’s technology or enhance the Company’s competitiveposition.

 

The Company is aware of an issued U.S. patent claiming theuse of GLP-1 to treat patients who have suffered myocardial infarction and apublished patent application to treat congestive heart failure.  It may be necessary to seek licenses tothese intellectual properties and pay royalties if the Company wishes to sell rGLP-1for these indications.  If the Companycannot obtain such licenses or cannot successfully challenge the validity ofthese patents or prove non-infringement of them, then Restoragen will beprohibited from selling rGLP-1 for these indications in countries where suchpatents are in force.

 

Restoragen is aware of a U.S. patent issued toMassachusetts General Hospital in 1997 covering the use of GLP-1 (7-36) amidefor the treatment of type II diabetes and hyperglycemia and for the enhancementof pancreatic insulin expression.  Thispatent has been licensed exclusively to Scios, Inc., and subsequentlysublicensed to Novo Nordisk.  Thispatent is a continuation in part of a continuation in part and the Companybelieves that it should not have been given the benefit of the original filingdate.  The Company believes thatintervening art appeared between the original filing date and the filing of thefirst continuation-in-part, and consequently the patent should not have beenissued. The equivalent European patent was rejected by the European Patent Office,but the Company is aware that the applicant has appealed this decision. Certainunidentified parties have successfully opposed the issuance of the equivalentpatent in Japan.  Unless the U.S. patentis declared invalid, the Company will be required to obtain a license and pay aroyalty to carry out its plans for type II diabetes in the U.S.  Even if patent infringement litigation wasto ensue and the Company succeeded in demonstrating the patent’s invalidity,the defense would be expensive and time consuming.  There is no assurance that the patent will be declared invalid orthat the Company will be able to obtain a license on commercially reasonableterms.  Although preliminary discussionshave occurred, no definitive agreements have been reached.

 

5

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As development of rGLP-1 has progressed, the Company hasdetermined that rGLP-1 will be evaluated and used in combination with oralanti-diabetic agents for the treatment of type II diabetes.  Clinical development plans have beendesigned accordingly.  However,Restoragen is aware of several issued patents and patent applications relatingto the combined therapeutic use of GLP-1 and oral hypoglycemic agents to treatdiabetes.  These patents and applications,if issued, may restrict the Company from selling a combination of rGLP-1 and anoral hypoglycemic agent in the United States and other countries where suchpatents are in force.

 

Restoragen is aware of a US patent issued to Eli Lillyclaiming the use of GLP-1 for the treatment of obesity and correspondingfilings in other countries that may restrict the Company from selling rGLP-1for this indication in the United States and other countries where such patentsare in force.  The Company has suspendedits obesity program.

 

**Competition**

 

Many drugcompanies engage in research and development to commercialize products to treatcardiovascular and metabolic diseases. Restoragen competes with these companiesfor funding, access to licenses, personnel, third-party collaborators andproduct development. Almost all of these companies have substantially greaterfinancial, marketing, sales, distribution and technical resources, and moreexperience in research and development, clinical trials and regulatory matters,than Restoragen.  In addition,competitors may develop and commercialize additional products that compete withRestoragen’s products and may do so more rapidly than Restoragen.

 

**Governmental Regulation**

 

Government authorities in the United States and othercountries extensively regulate the research, development, testing, manufacture,promotion, marketing and distribution of drug products.  The steps ordinarily required before a newdrug may be marketed in the United States, which are similar to steps requiredin most other countries, include: preclinical laboratory tests, preclinicalstudies in animals and formulation studies and the submission to the FDA of aninvestigational new drug application for a new drug; adequate andwell-controlled clinical trials to establish the safety and efficacy of thedrug for each indication; the submission of a new drug application to the FDA;and FDA review and approval of the new drug application prior to any commercialsale or shipment of the drug.

 

Preclinical tests include laboratory evaluation ofproduct chemistry toxicity and formulation, as well as animal studies.  The results of preclinical testing aresubmitted to the FDA as part of an investigational new drug application.  A 30-day waiting period after the filing of eachinvestigational new drug application is required prior to the commencement ofclinical testing in humans.  At any timeduring this 30-day period or at any time thereafter, the FDA may halt proposedor ongoing clinical trials until the FDA authorizes trials under specifiedterms.  The investigational new drugapplication process may be extremely costly and substantially 

 

6

 

delay development of Restoragen’s products.  Moreover, positive results of preclinical tests will notnecessarily indicate positive results in clinical trials.

 

Clinical trials to support new drug applications aretypically conducted in three sequential phases, but the phases mayoverlap.  During Phase I, the initialintroduction of the drug into healthy human subjects or patients, the drug istested to assess metabolism, pharmacokinetics and pharmacological actions andsafety, including side effects associated with increasing doses.  Phase II usually involves studies in alimited patient population to assess the efficacy of the drug in specific,targeted indications; assess dosage tolerance and optimal dosage; and identifypossible adverse effects and safety risks.

 

If a drug candidate is found to be potentiallyeffective and to have an acceptable safety profile in Phase II evaluations,Phase III trials, also called pivotal studies, major studies or advancedclinical trials, are undertaken to further demonstrate clinical efficacy and tofurther test for safety within an expanded patient population at geographicallydispersed clinical study sites.

 

After successful completion of the required clinicaltesting, generally a new drug application is submitted to the FDA.  The FDA may request additional informationbefore accepting a new drug application for filing, in which case theapplication must be resubmitted with the additional information.  After the submission has been accepted forfiling, the FDA has 180 days to review the application and respond to theapplicant.  The review process is oftensignificantly extended by FDA requests for additional information orclarification.  The FDA may refer thenew drug application to an appropriate advisory committee for review,evaluation and recommendation as to whether the application should be approved,but the FDA is not bound by the recommendation of an advisory committee.

 

If FDA evaluations of the new drug application and themanufacturing facilities are favorable, the FDA may issue either an approvalletter or an approvable letter.  Anapprovable letter will usually contain a number of conditions that must be metin order to secure final approval of the new drug application and authorizationof commercial marketing of the drug for certain indications.  The FDA may refuse to approve the new drugapplication or issue a not approvable letter, outlining the deficiencies in thesubmission and often requiring additional testing or information.

 

Under a new regulatory system in the EU, a centralizedprocedure is mandatory for the approval of biotechnology products and hightechnology products and available at the applicant’s option for otherproducts.  The centralized procedureprovides for the grant of a single marketing authorization that is valid in allEU member states.

 

To date, the Company has not brought any productthrough the approval process of the FDA or equivalent European authorities andmay encounter unforeseen difficulties and delay in doing so.

 

7

 

**Corporate Information**

 

The Company was incorporated under the nameBioNebraska, Inc. in 1988 and began operations in 1989.  The corporation changed its name toRestoragen, Inc. in August 2001.  TheCompany currently employees 60 employees. No employees are represented by labor organizations and there are nocollective bargaining agreements.

 

Restoragen is subject to the informationalrequirements of the Securities Exchange Act of 1934, as amended, and inaccordance therewith files reports, proxy statements and other information withthe Securities and Exchange Commission. Reports, proxy statements and other information filed by Restoragen canbe inspected and copies of such material can be obtained at prescribed ratesfrom the Public Reference Section of the Commission, 450 Fifth Street N.W., Room1024, Judiciary Plaza, Washington D.C. 20549. The Commission also maintains a web site (http://www.sec.gov) at whichreports, proxy and information statements and other information regarding theCompany may be accessed.

 

**ITEM2.  PROPERTIES**

 

**Facilities**

 

The Company currently leases approximately 40,000square feet of facilities in the Lincoln, Nebraska Air Park.  The Company has two leases through the year2013, with options to renew the leases through the year 2018.  In these buildings, the Company has constructedoffices and research, quality control and quality acceptance laboratories andfermentation and downstream processing facilities.  Due to the Company’s reduction in workforce from 121 to 60employees in February 2002, space requirements are currently being evaluatedfor the Company’s downsized operations. If the Company determines that a second building is not required,Restoragen will review options to sub-lease the property.  The Company is evaluating potential sourcesfor commercial scale production of its products.

 

**ITEM3.  LEGAL PROCEEDINGS**

 

The Company is not a party to any legal proceedings.

 

**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

Notapplicable.

 

**PARTII**

 

**ITEM5.  MARKET FOR THE REGISTRANT’S COMMONSTOCK AND RELATED SECURITY HOLDER MATTERS**

 

**Holders**

 

There is no established trading market for the Company’s Common Stock.  As of March 25, 2002, the Company’s Common Stock was held of record by 456 persons.  In addition, a

 

8

 

number of shares were held in street name by nominees for a number of additional shareholders.  The Company also has seven series of outstanding convertible preferred stock and one series of non-convertible preferred stock.

 

**Dividends**

 

To date, the Company has not paid cash dividends on its Common Stock and does not intend to pay cash dividends in the foreseeable future.  Any future determination to pay cash dividends will be at the discretion of the Board of Directors and will be dependent upon the Company’s financial condition, results of operations, capital requirements and other such factors as the Board of Directors deems relevant.  As long as any Convertible Preferred Stock is outstanding, no dividend may be declared or paid upon, nor may any distribution be made upon Common Stock or any junior securities, unless payment in full of all cumulative dividends on the outstanding Convertible Preferred Stock has been paid.

 

**Sales of Unregistered SecuritiesSince September 30, 2001.**

 

On December 13, 2001, Restoragen, Inc. entered into a loan agreement with Medtronic International, Ltd. and various other lenders named therein (the “Loan Agreement”).  Under the terms of the Loan Agreement, the Company received loans in an aggregate principal amount of $18 million.

 

The loans are evidencedby secured convertible promissory notes that automatically convert (at theoption of the holder into common stock or preferred stock of the Company) upon(i) the occurrence of an initial public offering of common stock that resultsin gross proceeds to the Company of at least $50 million, (ii) the completionof qualified additional financing (as defined in the Loan Agreement) in anamount equal to $17 million, (iii) the election of the holder of at least 60%of the aggregate principal amount of loans outstanding at any time or (iv) theproposed prepayment by the Company of some or all of the outstanding principalamount of the notes.  The conversionratio applicable upon the occurrence of each of the foregoing events is set forthin the notes, but is generally the lower of $12.50 per share or the lowest pershare price at which the Company sells equity after the date of the notes.  The notes bear interest at a rate of primeplus 3% per annum and mature on the second anniversary of the date of theirissuance.

 

The notes are secured bya first priority security interest in (i) the proceeds arising out of the grantof any license rights in any of the Company’s intellectual property or othergeneral intangibles and (ii) the Company’s intellectual property.  Notwithstanding this first priority securityinterest, the Company may grant licenses to and enter into collaborativeagreements with respect to its intellectual property in the ordinary course ofbusiness.

 

In addition, the Companyissued warrants to the lenders to purchase common stock of the Company at a pershare warrant exercise price equal to the lower of $9.00 or the lowest percommon equivalent share price at which the Company sells equity after the dateof the warrants (the “Warrant Exercise Price”).  Each of the lenders initially received warrants to purchase anumber of shares of common stock equal to 50% of the outstanding loan held bysuch lender divided by the Warrant Exercise Price.  Commencing with the 90th day after the initial date of

 

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issuance of the warrants,the number of shares of common stock into which the warrants are exercisablewill increase by an additional 10% of the outstanding loan held by each lenderdivided by the Warrant Exercise Price for each 30-day period in which such loancontinues to remain outstanding and not converted, up to 100% of theoutstanding loan amount divided by the Warrant Exercise Price.

 

In connection with thefinancing, Mr. Coolidge stepped down as Chief Executive Officer of theCompany.  He currently serves as thenon-executive Chairman of the Board.  Inaddition, Mr. Grant Denison, Jr. and Mr. Stephen W. Jenks resigned from theBoard of Directors.

 

**ITEM6.  SELECTED FINANCIAL DATA**

 

The following tables setforth selected financial data of the Company, which should be read inconjunction with “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” and with the Company’s Consolidated Financial Statements.  The selected financial data as of and forthe years ended December 31, 2001, 2000, 1999, 1998 and 1997 are derived fromthe audited financial statements of the Company. The financial statements forthe years 2001 and 2000 have been audited by Deloitte & Touche LLP, whowere appointed as the Company’s independent auditors in November 2000.  The financial statements for all prior yearswere audited by Loren D. Swanson, CPA.

 

##### **Selected FinancialData**

 
|                                                              |   | **Year Ended  December 31,**                       |   |
|-------------------------------------------------------------------|--------|----------------------------------------------------|--------|
|                                                              |   | **2001**                                           |   | **2000** |   | **1999** |   | **1998** |   | **1997** |   |
| **Statement of Operations Data:**                                 |   | **(Dollars  in thousands, except per share data)** |   |
| Operating revenues & collaborative payments                   |   | $                                                  | 9      |   | $ | 10 |   | $ | 5 |   | $ | 12 |   | $ | 6 |   |
| Loss from continuing operations applicable to common shareholders |   | (24,608                                            | )      | (22,320 | ) | (15,388 | ) | (10,862 | ) | (5,984 | ) |
| Loss from operations per share applicable to common shareholders  |   | (3.34                                              | )      | (3.14 | ) | (3.04 | ) | (2.55 | ) | (1.41 | ) |
|                                                                   |        |                                                    |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                                 |   | **As of  December 31,** |   |
|--------------------------------------|--------|-------------------------|--------|
| **Balance Sheet Data:**              |   | **2001**                |   | **2000** |   | **1999** |   | **1998** |   | **1997** |   |
| Total assets                         |   | $                       | 22,411 |   | $ | 16,573 |   | $ | 23,505 |   | $ | 10,262 |   | $ | 3,050 |   |
| Long term debt                       |   | 19,509                  |   | 2,592 |   | 1,428 |   | 255 |   | 96 |   |
| Redeemable preferred stock           |   | 3,050                   |   | 16,676 |   | 15,453 |   | 14,125 |   | 3,158 |   |
| Shareholders’  equity (deficit) |   | (4,640                  | )      | (4,837 | ) | 3,478 |   | (7,359 | ) | (3,911 | ) |
|                                      |        |                         |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

 

The following analysis ofthe financial condition and results of operations of the Company should be readin conjunction with the preceding “Selected Financial Data,” the 

 

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Company’s ConsolidatedFinancial Statements and Notes thereto and the other financial data includedelsewhere in this document.  The dollaramounts below have been rounded in order to simplify their presentation.  However, the ratios and percentages arecalculated using the detailed financial information contained in theConsolidated Financial Statements and the Notes thereto and the financial dataincluded elsewhere in this document. References to years are for the respective fiscal years ended December31, unless otherwise noted.

 

**Resultsof Operations**

 

***Fiscal Years Ended December 31, 2001 and 2000***

* *

*Research and development expenses include thosecosts associated with the research, development, production and testing of theCompany’s therapeutic products under development and the protection ofproprietary rights.  Included inresearch and development expenses are direct costs incurred in conducting theCompany’s clinical trials. Total research and development costs increased from$14.5 million in 2000 to $17.4 million in 2001. The increase reflects increasedclinical trial activity and an increase in the Company’s medical departmentinfrastructure to support the higher level of clinical activity.  These higher costs have been partially offsetby lower compensation charges associated with the modification of stock optionswhich totaled $0.1 million in 2001 compared to $2.3 million in 2000.  General and administrative expensesdecreased from $5.3 million in 2000 to $3.5 million in 2001.  The decrease reflects a reduction incompensation charges associated with the modification of stock optionterms.  A charge of $0.2 million in 2001compares to a charge of $2.8 million in 2000. Other general and administrative expenses increased from $2.5 million in2000 to $3.3 million in 2001 as the Company strengthened its administrativesupport structure.*

 

Interest income decreasedfrom $0.7 million in 2000 to $0.3 million in 2001.  The average cash balance was higher in 2000, following the saleof equity securities in the fourth quarter of 1999. The Company incurred $0.8million in interest expense in 2001 as compared to $0.5 million in 2000. Theincrease reflects interest charges associated with the extension of certainpreferred stock terms, accrued interest on promissory notes and an increase inequipment financing costs.

 

***Fiscal Years Ended December 31, 2000 and 1999***

 

Total research anddevelopment costs increased from $10.4 million in 1999 to $14.5 million in2000. The increase primarily reflects increased clinical trial activity and acompensation charge of $2.3 million associated with the modification of stockoption terms. Additional costs were also incurred associated with increasedproduction scale-up activities and further development of the Company’sproduction technology.  General andadministrative expenses increased from $2.2 million in 1999 to $5.3 million in2000.  The increase primarily reflects acompensation charge of $2.8 million associated with the modification of stockoption terms, together with higher operating costs as the Company strengthenedits administrative support structure.

 

 

11

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Interest income increasedfrom $0.3 million in 1999 to $0.7 million in 2000 reflecting the higher averagecash balance in 2000, following the sale of equity securities in the fourthquarter of 1999. The Company incurred $0.5 million in interest expense in 2000as compared to $0.2 million in 1999. The increase reflects interest chargesassociated with the extension of certain preferred stock terms and an increasein equipment financing costs.

 

**Liquidityand Capital Resources**

 

Working captial was $7.6million as of December 31, 2000, compared to $10.7 million as of December 31,2001.  Cash and cash equivalents were$9.5 million as of December 31, 2000 compared to $15.0 million as of December31, 2001.

 

During 2001, the Companyused approximately $17.7 million of cash for operating activities and $0.9million for asset acquisitions.  Basedon its anticipated revised operating plan, the Company believes that existingcash and cash equivalents will be sufficient to fund operations until the thirdquarter of 2002.  Prior to that time,the Company plans to seek additionally financing from the sale of additionaldebt or equity securities or from collaboration payments from potentialstrategic partners.  Any additionalrequired financing may not be available to the Company on satisfactory terms,if at all.  If unable to obtainfinancing, the Company will be required to further modify the business plan andpossibly discontinue some or all of its operations.

 

The Company has financedits operations since inception primarily through sales of equity and debtsecurities and, to a lesser extent, collaboration payments and sales of metaldetection kits.  Collaboration and jointventure payments received and metal detection kit sales were $2.7 million and$1.0 million, respectively, from inception through 2001.  From inception through 2001, the Company hadnet cash flows from financing activities totaling approximately $96 million.

 

*In April 2001 Restoragen received net proceeds ofapproximately $7.4 million from the sale of 80,000 shares of Series HConvertible Preferred Stock.  From Maythrough September 2001, the Company undertook a private placement of preferredstock through a national investment banking firm with the goal of raisingapproximately $30 million to fund operations. Despite significant efforts, including road shows and individualinvestor meetings throughout the United States and Europe, the Company was notsuccessful in placing those securities.*

* *

*In December 2001 Restoragen entered into a bridgeloan agreement with several current shareholder and their affiliates, includingMedtronic, Inc., Rocky Mountain Associates, S.A. and Equity Four Life (Bahamas)Ltd.  Under the terms of the LoanAgreement, Restoragen received loans in an aggregate principal amount of $18million. Net proceeds received by the Company from the loans totaled $17.5million.  As described in Item 5, theloans are secured by a first priority security interest in (i) the proceedsarising out of the grant of any license rights in any of the Company’sintellectual property and (ii) the Company’s intellectual property.*

* *

*12*

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* *

*During 2001, warrants to purchase a total of 49,563shares were exercised realizing net proceeds of $0.3 million.  Proceeds from equipment financing totaled$0.2 million and capital repayments in respect of equipment financing totaled$1.2 million.*

 

In February 2002,Restoragen announced a restructuring and a reduction of total workforce from121 to 60 employees.  In connection withthe restructuring, the Company recorded restructuring costs of approximately $1.0million during the first quarter of 2002. The restructuring was required as the Company realigned its businessstrategy. The revised strategy will focus on the Company’s ability to developcommercially viable recombinant peptide production methods and will involvestrategic partnering to develop and commercialize peptide-based therapeuticsfor clinically and economically important metabolic diseases.  After the restructuring, it is anticipatedthat the Company’s ongoing net cash outflow for the remainder of the year willbe approximately $1.5 million per month.

 

At December 31, 2001, theCompany had a shareholders deficit accumulated during the development stage of$85.0 million. Historically the auditors’ reports on the Company’s financialstatements have contained an explanatory paragraph concerning the Company’sability to continue as a going concern and its status as a development stagecompany. The Company expects to incur additional losses and will requireadditional working capital as it incurs expenses related to production processdevelopment, process scale up and clinical trials.

 

**Contractual Obligationsand Commitments**

 

The following tablesummarizes Restoragen's outstanding contractual obligations as of December 31,2001.

 
|                        |   | **Payments Due by Period** |      |
|-----------------------------|--------|----------------------------|-----------|
| **Contractual Obligations** |   | **Total**                  |      | **2002** |   | **2003** |   | **2004** |   | **2005** |   | **2006** |   | **Thereafter** |   |
| Capital Lease Obligations   |   | $                          | 1,477,940 |   | $ | 728,405 |   | $ | 604,931 |   | $ | 118,737 |   | $ | 23,734 |   | $ | 2,133 |   | $ | — |   |
| Operating Lease Obligations |   | 3,964,633                  |      | 330,561 |   | 328,413 |   | 327,984 |   | 327,984 |   | 334,233 |   | 2,315,458 |   |
| Notes Payable               |   | 1,555,465                  |      | 696,127 |   | 607,766 |   | 251,572 |   | — |   | — |   | — |   |
| Convertible Notes Payable   |   | 18,000,000                 |      | — |   | 18,000,000 |   | — |   | — |   | — |   | — |   |
|                             |        |                            |           |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As disclosed in Note 11to the consolidated financial statements, we also have dividends accumulatedthrough December 31, 2001 of approximately $12.5 million.  Of this amount, approximately $750,000 ispayable to the holder of Series A Preferred Stock on May 31, 2003.  If the dividends are not paid by May 31,2004, the holder of Series A Preferred Stock acquires voting rights under theCertificate of Designation to elect one-third of the members of the Board ofDirectors.  The remaining dividends arepayable when declared by the Board of Directors or upon other qualifying eventsdescribed in the applicable Certificates of Designation for the PreferredStock.

 

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**NewAccounting Pronouncements**

 

The Company adoptedStatement of Financial Accounting Standards (SFAS) No. 133 “Accounting forDerivatives and Similar Financial Instruments and for Hedging Activities”, asamended by SFAS No. 137 and SFAS No. 138 on January 1, 2001.  There was no impact to the consolidatedfinancial statements as a result of adopting this standard.

 

In July 2001, the Financial Accounting Standards Board(“FASB”) issued SFAS No. 141 “Business Combinations.”  SFAS No. 141 requires the purchase method of accounting forbusiness combinations initiated after June 30, 2001 and eliminates thepooling-of-interests method.  There wasno impact to the consolidated financial statements as a result of adopting thisstandard.

 

In July 2001, the FASBissued SFAS No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets”, whichis effective January 1, 2002.  SFAS No.142 requires, among other things, the discontinuance of goodwillamortization.  In addition, the standardincludes provisions for the reclassification of certain existing recognizedintangibles as goodwill, reassessment of the useful lives of existingrecognized intangibles, reclassification of certain intangibles out ofpreviously reported goodwill and the identification of reporting units forpurposes of assessing potential future impairments of goodwill.  The Company does not believe that theadoption of SFAS No. 142 will have an impact on the consolidated financialstatements.

 

InJune 2001, the FASB issued SFAS No. 143, “Accounting for Asset RetirementObligations”.  This standard addressesfinancial accounting and reporting for obligations related to the retirement oftangible long-lived assets and the related asset retirement costs.  SFAS No. 143 is effective for fiscal yearsbeginning after June 15, 2002. The Company does not believe that the adoptionof SFAS No. 143 will have an impact on the consolidated financial statements.

 

InAugust 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets”.  Thisstandard addresses financial accounting and reporting for the impairment ordisposal of certain long-lived assets. SFAS No. 144 is effective for fiscal years beginning after December 15,2001.  The Company does not believe thatthe adoption of SFAS No. 144 will have an impact on the consolidated financialstatements.

 

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**CriticalAccounting Policies**

 

The Company reviews long-livedassets and certain intangibles for impairment whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable.  An evaluation ofrecoverability is performed by comparing the undiscounted cash flows associatedwith the asset to the asset’s carrying amount to determine if a writedown isrequired.

 

As permitted by SFAS No.123, “Accounting for Stock-based Compensation”, the Company accounts for itsstock-based awards to employees under the intrinsic value method in accordancewith Accounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees” and related interpretations. All stock-based awards to independent consultants are accounted for underthe fair value method as required by SFAS No. 123 and related interpretations.

 

**Impact of Inflation**

 

The impact of inflationon the financial position or results of operations of the Company was notmaterial for the years ended December 31, 2001, 2000, and 1999.

 

**CautionaryStatement About Forward-Looking Statements**

 

Certain statements inthis Annual Report on Form 10-K, particularly under this Item 7, may constitute“forward looking statements” within the Private Securities Litigation ReformAct of 1995 (the “Reform Act”).  Suchforward looking statements involve known and unknown risks, uncertainties andother factors which may cause the actual results, performance or achievementsof the Company to be materially different from any future results, performanceor achievements, expressed or implied by such forward-looking statements. Thewords “believe,” “expect,” “anticipate,” “seek” and similar expressionsidentify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-lookingstatements that speak only as of the date the statement was made.  These statements are subject to risks anduncertainties that could cause actual results to differ materially from thestatements, including the dependence of the Company on obtaining futurefinancing, uncertainties involved in the additional development of theCompany’s new pharmaceutical products, including securing strategic partners tofund further development, the outcomes of clinical trials, obtaining regulatoryapprovals or clearances, the ability of the Company’s products to bemanufactured in commercial quantities, availability of commercial productioncapacity, the development of partnerships for distribution and marketing,protection of the Company’s patent and proprietary rights, avoidinginfringement of competitor’s proprietary rights, potential competition and theextent to which reimbursement for the costs of the products and treatments willbe available from government health administration authorities, private healthinsurers and other organizations. The Company does not undertake responsibilityto update such forward-looking statements to reflect events that arise afterthe date of this report.  Following is adetailed discussion of these risks and uncertainties under the heading,“Additional Factors That May Affect Future Performance.”

 

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**AdditionalFactors That May Affect Future Performance**

 

Restoragen’s business issubject to various risks, including those described below.  Investors should carefully consider theserisk factors, together with all of the other information in this Form10-K.  Any of these risks couldmaterially adversely affect the Company’s business, operating results andfinancial condition.

 

**Sufficiencyof Working Capital; Dependence on Future Financing.**  Depending upon the circumstances and theprogress of the Company’s production and clinical development efforts, theCompany believes that existing funds should be adequate to finance operationsat the current levels into the third quarter of 2002.  The Company will require additional funding prior to that time,and the Company will seek additional funding through the sale of additionalequity or debt securities or from collaboration payments from potentialstrategic partners.  There can be noassurance that future funding will be available, or, if available, that it willbe on terms acceptable or favorable to the Company or its shareholders.  The Company also assumes that none of theholders of Preferred Stock will exercise any put rights that become availableto require the Company to repurchase such shares.  If future financing is required for operations and is unavailablefor any reason, the Company may be forced to discontinue some or all of itsoperations.

 

**DevelopmentStage Enterprise; Risks of New Product Development; Market Uncertainty.**  The Company is a development stageenterprise and its operations to date have been funded principally by sales ofequity and convertible debt securities to investors.  The Company’s planned pharmaceutical products will requireadditional development, cGMP production capacity, clinical testing andinvestment prior to commercialization. The pharmaceutical products require the approval of the FDA for sale inthe United States and of the relevant regulatory authorities for sale inEurope. Once approved as products, they must be manufactured in commercialquantities and marketed successfully. The Company has never submitted a new drug application to the FDA or equivalentEuropean authorities and has limited marketing capabilities, and will need toeither develop such capabilities internally or enter into arrangements with oneor more corporate partners for marketing and distribution.  Each of these steps involves significantamounts of time and expense and could be subject to unforeseen delays.  There can be no assurance that any of theCompany’s product development efforts will be successfully completed, thatregulatory approvals will be obtained where required, or that any products, ifdeveloped and introduced, will be successfully marketed or achieve marketacceptance.

 

**Historicaland Continuing Operating Losses.**  Historically, the auditor’s reports on the Company’s financialstatements have contained an explanatory paragraph concerning the Company’s abilityto continue as a going concern and its status as a development stage company.Operating as a development company, the Company has incurred significantoperating losses in each year since inception of its business in 1989 and,based on audited financial information, had an accumulated deficit of $85 million as of December 31, 2001.  The Company’s ability to achieve profitableoperations is dependent on obtaining regulatory approvals of its products andon its ability to commercialize its proprietary recombinant productiontechnology through

 

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contract processdevelopment and production agreements with third parties.  There can be no assurance that the Companywill ever achieve a profitable level of operations.

 

**Outcomeof Human Clinical Trials and Dependence Upon New Production Processes.**  The Company’s plans are based on (i)completing clinical studies of rGLP-1 which demonstrate that rGLP-1 has safeand effective therapeutic applications, (ii) obtaining approval from the FDA,European or other regulatory authorities to market new therapies, and (iii)further developing and scaling up processes for the production of therapeuticpeptides.  The Company has not yet accomplishedthe foregoing objectives and, as a result, its plans and processes have notbeen fully developed and tested. Failure (i) to efficiently produce therapeuticpeptides in appropriate amounts and (ii) to demonstrate that rGLP-1 hastherapeutic applications in its human studies, would each have a materialadverse effect on the Company.  There isno assurance that any of the Company’s programs will be successfully developedor marketed.

 

**Lackof Commercial Production Capabilities.**  The Company has successfully producedpeptides in limited quantities for research, development and clinical trialsand has completed the construction of its first fermentation plant and itsfirst small size down stream processing plant. However, the Company has determined that production of peptides on acommercial scale will only be achieved through partnerships with third partiesthat have the financial and human resources required for large scaleproduction.  There can be no assurancethat the Company will be able to enter into such partnerships.

 

**Dependenceon Patents and Proprietary Technology.**  The success of the Company will depend onits ability to maintain competitive technological positions in the areas of thetherapeutic applications of its products and its production technologies.  The Company has filed a number of patentapplications and has received several issued patents in the United States andother jurisdictions with respect to its production processes and sometherapeutic patents.  None of thepatents issued in respect of the Company’s production technology are used inthe Company’s current production process pertaining to rGLP-1.  The Company’s proprietary position is basedon trade secrets and know how.  Inaddition, patent protection is not available with regard to certain therapeuticuses of rGLP-1 and other therapeutic peptides which the Company may desire toproduce. There can be no assurance that the Company’s patent applications,whether domestic or foreign, will be granted or that, if granted, will providethe Company a significant competitive advantage.

 

The commercial success ofthe Company also will depend upon avoiding the infringement of patents issuedto competitors.  While the Company doesnot believe that it will infringe the intellectual property rights of others,there can be no assurance that such a claim will not be asserted against theCompany in the future or that the Company will be able to successfully defendagainst any such claim.  A United Statespatent was issued on March 25, 1997 to Massachusetts General Hospital with claimsdirected to the use of GLP-1 (7-36) amide for the treatment of type II diabetesand hyperglycemia and for the enhancement of beta-cell expression ofinsulin.  The Company may be required toobtain a license or a sublicense under this patent to carry out its plannedprograms in the United States. The Company can provide no assurance that itwill be able to obtain a license or a sublicense, on commercially reasonableterms, under this patent.  If a licenseor sublicense under this patent is necessary, and the

 

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Company cannot obtainsuch a license or sublicense, and cannot successfully challenge the validity ofsuch patent, the Company will be prohibited from selling GLP-1 (7-36) amide inthe United States, for treatment of the covered conditions, and the Company,and any marketing partners will be limited to marketing strategies in countrieswhere Massachusetts General Hospital has not obtained patent protection.

 

Even if the Companydetermines that a license or sublicense under this patent is unnecessary,patent infringement litigation may ensue. Even if an infringement claim by the Massachusetts General Hospital iswithout merit, and if the Company prevailed in demonstrating that the patent isinvalid and/or not infringed, defending a lawsuit will take significant time,and will be expensive and time consuming for management.  If the Company does not prevail in such alawsuit and sells products that are covered by the patent, then the Companywould have to pay substantial damages for past infringement in the UnitedStates.  Further, the Company would beprohibited from selling its products before it obtained a license, which, ifavailable at all, might require the Company to pay substantial royalties.

 

The Company is aware ofseveral issued patents and patent applications relating to the combinedtherapeutic use of GLP-1 and oral hypoglycemic agents (i.e., oral drugsexhibiting a glucose-lowering effect) to treat diabetes.  The Company now believes that rGLP-1 will beused in combination with oral hypoglycemic agents for the treatment of type IIdiabetes and the Company may therefore be required to obtain a license orsublicense to one or more of these patents. The Company can provide no assurance that it will be able to do so oncommercially reasonable terms.  If alicense or sublicense is necessary, and the Company cannot obtain such alicense or sublicense and cannot successfully challenge the validity of thepatent, then the Company will be prohibited from selling such a combination ofGLP-1 and an oral hypoglycemic agent in the United States and other countrieswhere such patents are in force.

 

There can be no assurancethat patents do not exist or that other patent applications could not be filedwhich would have an adverse effect on the Company’s ability to produce andmarket its products.  The Company mustalso avoid breach of the technology licenses upon which certain of theCompany’s planned future products are or will be based.  In the event the Company inadvertentlybreaches an existing license or fails to obtain a license for any technologythat it may require to commercialize its products, a material adverse effect onthe Company could result.  Litigation,which could result in substantial cost to the Company, may be necessary toenforce the Company’s patent and license rights or to determine the scope andvalidity of others’ proprietary rights. If competitors of the Company prepare and file patent applications inthe United States that claim technology also claimed by the Company, theCompany may have to participate in interference proceedings declared by thePatent and Trademark Office to determine priority of invention, which couldresult in substantial cost to the Company, even if the outcome is favorable tothe Company.  There can be no assurancethat the Company’s patents, if issued, would be held valid by a court ofcompetent jurisdiction.  An adverseoutcome could subject the Company to significant liabilities to third parties,require disputed rights to be licensed from third parties or require theCompany to cease using the relevant technology.

 

 

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The Company also relieson certain technologies which constitute proprietary trade secrets and know-howthat are not patentable and therefore may be available to the Company’scompetitors.  Although the Company hasalso taken steps to protect its unpatented trade secrets and know-how throughconfidentiality agreements, there can be no assurance that these agreements canbe effectively enforced.  There can beno assurance that the Company will maintain the confidentiality of itstechnology, dissemination of which could have a material adverse effect on theCompany, and  there can be no assurancethat others will not independently develop technologies similar to thosedeveloped by the Company or obtain access to the Company’s technologies.

 

**GovernmentRegulation.**  TheCompany’s planned pharmaceutical products will be subject to extensiveregulation by federal, state and local government authorities in the UnitedStates and any other countries where the Company’s products may be tested ormarketed.  The FDA and comparableagencies in other countries impose substantial requirements that must besatisfied before newly developed pharmaceutical products may be sold.  Approval by the FDA in most cases requireslengthy, detailed, and costly laboratory and clinical testing procedures todemonstrate a product’s efficacy and safety before the product can be sold.  There can be no assurance that the Companywill receive FDA approval for any of its planned pharmaceutical products or,even if it does receive FDA approval for a particular product, that the Companywill ever recover its costs in connection with obtaining such approval.  With respect to any of the Company’s plannedproducts, the failure of the Company to receive requisite FDA approval, orsignificant delays in obtaining such approval, could prevent the commercialdevelopment of such product and could have a material adverse effect on theCompany.  The Company has not appliedfor, and does not have, the approval of any foreign country to sell itsproducts.  To date the Company has notbrought any product through the FDA approval process and may encounter unforeseendifficulties or delays in doing so.

 

The Company’s ability tosuccessfully commercialize any pharmaceutical products will depend on itsability, through strategic partnerships, to meet the FDA’s current GoodManufacturing Practices (“cGMP”) and other regulations relating to advertisingand promoting, selling and marketing, labeling, and continual review byregulatory authorities. No assurance can be given that the Company’s currentproduction processes can be scaled-up to commercial levels under cGMP standardsat an acceptable cost.  If commercialscale cGMP processes and facilities cannot be attained, the Company’s abilityto commercialize its products through strategic partnering will be adverselyaffected.

 

**Dependenceon Health Care Reimbursement.**  The Company’s ability to commercialize its products successfullythrough strategic partnering may depend in part on the extent to whichreimbursement for the costs of such products and related treatments will be availablefrom government health administration authorities, private health insurers, andother organizations.  Government andother third-party payors are increasingly challenging the prices of medicalproducts and services.  Uncertaintyexists as to the reimbursement status of newly approved health care products,and there can be no assurance that adequate third-party coverage will beavailable to enable the Company to maintain price levels sufficient to realizean appropriate return on its investment in product development.  If adequate coverage and

 

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reimbursement levels arenot provided by government and other third-party payors for use of theCompany’s products, the market acceptance of these products could be adverselyaffected.

 

**RapidTechnological Change.** All of the Company’s business areas have been characterized by rapidtechnological change.  Changes intechnology may result in partial or total obsolescence of the Company’s presentand proposed products within time frames not anticipated by the Company.  The Company will be required to respond tothese changes by enhancing its existing products and developing and/ormarketing new products.  There can be noassurance that the Company will be able to respond successfully.

 

**Competition.** There can be no assurance thatpotential competitors, which have substantially greater financial resources,more extensive business experience and greater development, marketing andsupport capabilities than the Company, may not succeed in developing competitiveproduction capabilities and therefore competitive products.

 

**Dependenceon Key Personnel and Availability of Qualified Personnel.**  The future success of the Company isdependent upon the abilities and continued services of the executive officersand senior management personnel. Competition for personnel is intense and there is no assurance that theCompany will be able to continue to attract and retain the necessary qualifiedpersonnel.

 

**NoPublic Market for the Shares; Lack of Liquidity.**  There is currently no public market for theCompany’s Common Stock and there can be no assurance that a public market forthe Common Stock will develop in the future or that the outstanding shares canbe resold at or above the price at which they were purchased.  Further, all of the shares were issued basedon exemptions from registration under the Securities Act of 1933 and applicablestate law.  Consequently, theoutstanding shares cannot be sold unless they are registered or an exemptionfrom such registration is available. Accordingly, investors should anticipate holding their outstandingsecurities for an extended period of time.

 

**VotingControl.**  TheCompany’s current officers, directors and 5% shareholders collectively ownCommon Stock and Preferred Stock which, for practical purposes, provides votingcontrol and enables them to direct the affairs of the Company, including theappointment of officers and determination of officers’ compensation.  The issuance of additional Common Stock orPreferred Stock under certain circumstances could have the effect of changingcontrol of the Company.  See “PrincipalShareholders”.

 

**ITEM7A.  QUALITATIVE AND QUANTITATIVEDISCLOSURE ABOUT MARKET RISKS**

 

Restoragen is exposed tomarket risk related to changes in interest rates.  The Company does not use derivative financial instruments forspeculative or trading purposes.  Due tothe short-term nature of the cash equivalents, the Company believes that thereis no material exposure to interest rate risk. In December 2001, we issued $18 million of convertible notes

 

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with a variable interestrate tied to the prime interest rate. Each one percent increase in the prime interest rate would increase ourannual interest cost on the notes by approximately $180,000.

 

**ITEM8.  FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

The following financialstatements are included in the Form 10-K:

 
|                                                                                                                                                                                                   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Independent Auditors’  Reports                                                                                                                                                                    |
| Consolidated Balance  Sheets as of December 31, 2001 and 2000                                                                                                                                          |
| Consolidated  Statements of Operations for years ended December 31, 2001, 2000, and 1999  and for the period from April 15, 1988 (date of incorporation) to December  31, 2001                         |
| Consolidated  Statements of Cash Flows for years ended December 31, 2001, 2000 and 1999 and  for the period from April 15, 1988 (date of incorporation) to December 31,  2001                          |
| Consolidated  Statements of Shareholders’ Equity/(Deficit) for years ended December 31,  2001, 2000 and 1999 and for the period from April 15, 1988 (date of  incorporation) to December 31, 2001 |
| Notes to Consolidated  Financial Statements                                                                                                                                                            |

 

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##### **Loren D. Swanson**

**Certified Public Accountant**

**6120 Havelock Avenue, Suite A-2**

**Lincoln, Nebraska 68507**

 

Independent Auditor’sReport

 

TheBoard of Directors

Restoragen, Inc.

3820 N. W. 46thStreet

Lincoln, Nebraska 68524

 

I have audited the accompanying consolidated balance sheet ofRestoragen, Inc. (formerly BioNebraska, Inc.) and subsidiary as of December 31,1999 (not presented herein) and the related consolidated statements ofoperations, shareholders’ equity, and cash flows for the year then ended, and thecumulative period from April 15, 1988 (date of incorporation) to December 31,1999.  These financial statements arethe responsibility of the Company’s management.  My responsibility is to express an opinion on these financialstatements based on my audits.

 

I conducted my audits in accordance with generally accepted auditingstandards.  Those standards require thatI plan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made by management,as well as evaluating the overall financial statement presentation.  I believe that my audits provide areasonable basis for my opinion.

 

In my opinion, the financial statements referred to above representfairly, in all material respects, the financial position of Restoragen, Inc.and subsidiary as of December 31, 1999 and the results of their operations andtheir cash flows for the year then ended and for the cumulative period fromApril 15, 1988 (date of incorporation) to December 31, 1999, in conformity withgenerally accepted accounting principles.

 

The accompanying financial statements have been prepared assuming thatthe Company will continue as a going concern. As discussed in Note 12 to the financial statements, the Company, frominception, has incurred losses from development activities that raisesubstantial questions about its ability to continue as a going concern, unlesssupporting funds or assistance continue to become available to the Company fromexternal sources.  Management has in thepast and continues to rely on the proceeds of private investments anddevelopment collaborations to fund its operating deficit.  The financial statements do not include anyadjustments that might result from the outcome of this uncertainty.

 
| /s/ Loren D. Swanson |   |
|----------------------|--------|
|                 |
| Loren D. Swanson     |
| March 20, 2001       |

 

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**INDEPENDENTAUDITORS’ REPORT**

 

To the Board of Directors and Shareholders

Restoragen, Inc.

Lincoln, Nebraska

 

We have audited the accompanying consolidated balance sheets ofRestoragen, Inc. (formerly BioNebraska, Inc.) and subsidiary (a developmentstage company) as of December 31, 2001 and 2000, and the related consolidatedstatements of operations, shareholders’ equity (deficit), and cash flows forthe years then ended, and for the cumulative period from April 15, 1988 (dateof incorporation) to December 31, 2001. These financial statements are the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on these financial statements based on our audits.  The Company’s consolidated financialstatements for the cumulative period April 15, 1988 (date of incorporation)through December 31, 1999 were audited by another auditor whose report, datedMarch 20, 2001, is included herein.  Theconsolidated financial statements for the cumulative period April 15, 1988(date of incorporation) through December 31, 1999 reflect total revenues of$3,650,337 and a net loss of $43,960,043. Our opinion, insofar as it relates to the amounts included for suchprior periods, is based solely on the report of such other auditor.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits and the report of the other auditor provides areasonable basis for our opinion.

 

In our opinion, based on our audits and the report of the otherauditor, such financial statements present fairly, in all material respects,the financial position of Restoragen, Inc. and subsidiary as of December 31,2001 and 2000, and the results of their operations and their cash flows for theyears then ended, and for the period from April 15, 1988 (date ofincorporation) to December 31, 2001, in conformity with accounting principlesgenerally accepted in the United States of America.

 

The Company is in the development stage at December 31, 2001.  As discussed in Note 1 to the consolidatedfinancial statements, the Company has not earned significant revenues fromplanned principal operations.  Theaccompanying consolidated financial statements have been prepared assuming thatthe Company will continue as a going concern. The Company is a development stage therapeutics enterprise focused onthe development and production of peptide therapeutics.  As discussed in Note 12 to the financialstatements, the Company, from inception, has incurred losses from developmentactivities that raise substantial doubt about its ability to continue as agoing concern.  Management’s plansconcerning these matters are also described in Note 12.  The financial statements do not include anyadjustments that might result from the outcome of these uncertainties.

 
| /s/ Deloitte &  Touche LLP |   |
|--------------------------------|--------|
|                           |
| March 20, 2002                 |
| Lincoln, Nebraska              |

 

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**RESTORAGEN, INC.**

**AND SUBSIDIARY**

(a development stagecompany)

Consolidated Balance Sheets

 

 
|                                                                                                                                                                                                   |   | **December  31,** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|------------|
|                                                                                                                                                                                                   |   | **2001**          |       | **2000** |   |
| **ASSETS**                                                                                                                                                                                             |   |              |       |   |   |
|                                                                                                                                                                                                   |   |              |       |   |   |
| Current assets                                                                                                                                                                                         |   |              |       |   |   |
| Cash and cash equivalents                                                                                                                                                                              |   | $                 | 13,010,711 |   | $ | 9,492,135 |   |
| Short-term investments                                                                                                                                                                                 |   | 1,999,314         |       | — |   |
| Prepaid expenses                                                                                                                                                                                       |   | 146,655           |       | 174,499 |   |
| Other current assets                                                                                                                                                                                   |   | 41,100            |       | 45,734 |   |
| Total current assets                                                                                                                                                                                   |   | 15,197,780        |       | 9,712,368 |   |
|                                                                                                                                                                                                   |   |              |       |   |   |
| Property and equipment, net of accumulated depreciation of  $3,798,251and $2,973,722                                                                                                                   |   | 5,845,068         |       | 5,780,172 |   |
| Patents and patents licensed, net of accumulated amortization of  $222,007 and $170,529                                                                                                                |   | 663,637           |       | 663,437 |   |
| Deferred financing costs, net of accumulated amortization of $384,516  and $128,172                                                                                                                    |   | 628,173           |       | 384,517 |   |
| Other assets                                                                                                                                                                                           |   | 76,118            |       | 32,599 |   |
| Total assets                                                                                                                                                                                           |   | $                 | 22,410,776 |   | $ | 16,573,093 |   |
|                                                                                                                                                                                                   |   |              |       |   |   |
| **LIABILITIES AND SHAREHOLDERS’  DEFICIT**                                                                                                                                                        |   |              |       |   |   |
|                                                                                                                                                                                                   |   |              |       |   |   |
| Current liabilities:                                                                                                                                                                                   |   |              |       |   |   |
| Accounts payable                                                                                                                                                                                       |   | $                 | 2,803,131  |   | $ | 628,374 |   |
| Accrued expenses                                                                                                                                                                                       |   | 427,817           |       | 288,354 |   |
| Capital lease obligations – current portion                                                                                                                                                       |   | 564,362           |       | 617,251 |   |
| Notes payable – current portion                                                                                                                                                                   |   | 696,127           |       | 608,299 |   |
| Total current liabilities                                                                                                                                                                              |   | 4,491,437         |       | 2,142,278 |   |
|                                                                                                                                                                                                   |   |              |       |   |   |
| Long-term liabilities:                                                                                                                                                                                 |   |              |       |   |   |
| Capital lease obligations – less current portion                                                                                                                                                  |   | 649,984           |       | 1,036,871 |   |
| Notes payable – less current portion                                                                                                                                                              |   | 859,338           |       | 1,555,465 |   |
| Convertible notes payable                                                                                                                                                                              |   | 18,000,000        |       | — |   |
| Total long-term liabilities                                                                                                                                                                            |   | 19,509,322        |       | 2,592,336 |   |
|                                                                                                                                                                                                   |   |              |       |   |   |
| Total liabilities                                                                                                                                                                                      |   | 24,000,759        |       | 4,734,614 |   |
|                                                                                                                                                                                                   |   |              |       |   |   |
| Redeemable preferred stock                                                                                                                                                                             |   |              |       |   |   |
| Series A, F and A, E, F ($0.01 par value, 211,750 and 411,750 shares  authorized, 20,092 and 138,088 issued and outstanding in 2001 and 2000, at  redemption value)                                    |   | 3,050,277         |       | 16,675,502 |   |
|                                                                                                                                                                                                   |   |              |       |   |   |
| Shareholders’ deficit                                                                                                                                                                             |   |              |       |   |   |
| Common stock, ($0.01 par value, 40,000,000 shares authorized,   7,379,408 and 7,329,845 shares issued and outstanding in 2001 and 2000)                                                                |   | 73,794            |       | 73,298 |   |
| Convertible preferred stock, Series B, C, D, E, F, G, H and B, C, D, G   ($0.01 par value; 706,500 and 216,500 shares authorized, 346,100 and 148,104  shares issued and outstanding in 2001 and 2000) |   | 3,461             |       | 1,481 |   |
| Additional paid-in capital                                                                                                                                                                             |   | 80,281,920        |       | 58,603,886 |   |
| Deficit accumulated during development stage                                                                                                                                                           |   | (84,999,435       | )          | (63,515,688 | ) |
| Total shareholders’ deficit                                                                                                                                                                       |   | (4,640,260        | )          | (4,837,023 | ) |
|                                                                                                                                                                                                   |   |              |       |   |   |
| Total liabilities and shareholders’ deficit                                                                                                                                                       |   | $                 | 22,410,776 |   | $ | 16,573,093 |   |

 

See accompanying notes toconsolidated financial statements

 

24

----

 

**RESTORAGEN, INC.**

**AND SUBSIDIARY**

(a development stagecompany)

Consolidated Statementsof Operations

 

 
|                                                                                                                                                                                                                                       |   |                         |        |                   |   |        |   | **Cumulative  period** |        |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|-------------|------------------------|--------|-------------|--------|-----------------------------|-------------|
|                                                                                                                                                                                                                                       |   |                         |        |                   |   |        |   | **from April  15, 1988**    |        |
|                                                                                                                                                                                                                                       |   |                         |        |                   |   |        |   | **(date  of **         |        |
|                                                                                                                                                                                                                                       |   | **Year Ended  December 31,** |        | **incorporation)  to** |   |
|                                                                                                                                                                                                                                       |   | **2001**                     |        | **2000**               |   | **1999**    |   | **December  31, 2001**      |        |
| REVENUES                                                                                                                                                                                                                                   |   |                         |        |                   |   |        |   |                        |        |
|                                                                                                                                                                                                                                       |   |                         |        |                   |   |        |   |                        |        |
| Collaborative research agreements                                                                                                                                                                                                          |   | $                            | —      |                   | $      | —      |   | $                           | —      |   | $ | 1,528,583 |   |
| Joint venture sales and services                                                                                                                                                                                                           |   | —                       |        | —                 |   | —      |   | 1,150,000                   |        |
| Metal detection kit sales                                                                                                                                                                                                                  |   | 8,786                        |        | 10,040                 |   | 5,181       |   | 990,580                     |        |
|                                                                                                                                                                                                                                       |   |                         |        |                   |   |        |   |                        |        |
| Total                                                                                                                                                                                                                                      |   | 8,786                        |        | 10,040                 |   | 5,181       |   | 3,669,163                   |        |
|                                                                                                                                                                                                                                       |   |                         |        |                   |   |        |   |                        |        |
| OPERATING COSTS AND EXPENSES                                                                                                                                                                                                               |   |                         |        |                   |   |        |   |                        |        |
|                                                                                                                                                                                                                                       |   |                         |        |                   |   |        |   |                        |        |
| General and administrative                                                                                                                                                                                                                 |   | 3,521,925                    |        | 5,305,063              |   | 2,245,934   |   | 22,524,475                  |        |
| Research and development                                                                                                                                                                                                                   |   | 17,409,430                   |        | 14,501,332             |   | 10,435,131  |   | 65,696,013                  |        |
|                                                                                                                                                                                                                                       |   |                         |        |                   |   |        |   |                        |        |
| Total                                                                                                                                                                                                                                      |   | 20,931,355                   |        | 19,806,395             |   | 12,681,065  |   | 88,220,488                  |        |
|                                                                                                                                                                                                                                       |   |                         |        |                   |   |        |   |                        |        |
| OPERATING LOSS                                                                                                                                                                                                                             |   | (20,922,569                  | )           | (19,796,355            | )      | (12,675,884 | )      | (84,551,325                 | )           |
|                                                                                                                                                                                                                                       |   |                         |        |                   |   |        |   |                        |        |
| OTHER INCOME (EXPENSE)                                                                                                                                                                                                                     |   |                         |        |                   |   |        |   |                        |        |
|                                                                                                                                                                                                                                       |   |                         |        |                   |   |        |   |                        |        |
| Interest income                                                                                                                                                                                                                            |   | 267,681                      |        | 740,532                |   | 291,519     |   | 1,864,940                   |        |
| Interest expense                                                                                                                                                                                                                           |   | (828,859                     | )           | (499,822               | )      | (231,550    | )      | (2,313,050                  | )           |
|                                                                                                                                                                                                                                       |   | (561,178                     | )      | 240,710                |   | 59,969      |   | (448,110                    | )           |
|                                                                                                                                                                                                                                       |   |                         |        |                   |   |        |   |                        |        |
| NET LOSS                                                                                                                                                                                                                                   |   | $                            | (21,483,747 | )                      | $      | (19,555,645 | )      | $                           | (12,615,915 | ) | $ | (84,999,435 | ) |
|                                                                                                                                                                                                                                       |   |                         |        |                   |   |        |   |                        |        |
| Preferred stock dividends (accreted $169,460, $1,319,921 and $1,328,208  for 2001, 2000 and 1999, respectively,   and accumulating but not declared of $2,954,475, $1,444,014, and  $1,444,014 for 2001, 2000 and 1999, respectively) |   | (3,123,935                   | )           | (2,763,935             | )      | (2,772,222  | )      | (12,989,854                 | )           |
|                                                                                                                                                                                                                                       |   |                         |        |                   |   |        |   |                        |        |
| Net loss  applicable to common stock                                                                                                                                                                                                       |   | $                            | (24,607,682 | )                      | $      | (22,319,580 | )      | $                           | (15,388,137 | ) | $ | (97,989,289 | ) |
|                                                                                                                                                                                                                                       |   |                         |        |                   |   |        |   |                        |        |
| Basic and  diluted loss per common share                                                                                                                                                                                                   |   | $                            | (3.34       | )                      | $      | (3.14       | )      | $                           | (3.04       | ) | $ | (23.96 | ) |
| Average number  of common shares outstanding basic and diluted                                                                                                                                                                             |   | 7,366,178                    |        | 7,108,617              |   | 5,058,928   |   | 4,089,678                   |        |

 

See accompanying notes to consolidated financial statements.

 

25

----

 

**RESTORAGEN, INC.**

**AND SUBSIDIARY**

(a development stagecompany)

Consolidated Statements of Cash Flows

** **
|                                                                            |   |                        |        |        |   |        |   | **Cumulative  period from April 15,  1988(date of  incorporation) to  December 31, 2001** |        |
|---------------------------------------------------------------------------------|--------|-----------------------------|-------------|-------------|--------|-------------|--------|-------------------------------------------------------------------------------------------|-------------|
|                                                                            |   |                        |        |        |   |        |   |                                                                                      |
|                                                                            |   |                        |        |        |   |        |   |                                                                                      |
|                                                                            |   | **Year Ended  December 31** |        |        |
|                                                                            |   | **2001**                    |        | **2000**    |   | **1999**    |   |                                                                                      |
| CASH FLOWS FROM OPERATING ACTIVITIES                                            |   |                        |        |        |   |        |   |                                                                                      |        |
| Net loss                                                                        |   | $                           | (21,483,747 | )           | $      | (19,555,645 | )      | $                                                                                         | (12,615,915 | ) | $ | (84,999,435 | ) |
| Adjustments to reconcile net loss to net cash flows from operating  activities: |   |                        |        |        |   |        |   |                                                                                      |        |
| Depreciation and amortization                                                   |   | 876,855                     |        | 1,012,507   |   | 790,191     |   | 4,260,080                                                                                 |        |
| Amortization of deferred financing costs                                        |   | 256,344                     |        | 128,172     |   | —      |   | 884,516                                                                                   |        |
| Acquired in process research and development                                    |   | —                      |        | —      |   | 700,000     |   | 1,200,000                                                                                 |        |
| Stock-based compensation expense                                                |   | 348,344                     |        | 5,079,408   |   | —      |   | 6,237,752                                                                                 |        |
| Change in operating assets and liabilities:                                     |   |                        |        |        |   |        |   |                                                                                      |        |
| Prepaid expenses and other current assets                                       |   | 32,478                      |        | (171,163    | )      | (44,322     | )      | (687,753                                                                                  | )           |
| Accounts payable and accrued expenses                                           |   | 2,314,220                   |        | (720,876    | )      | 1,690,847   |   | 4,187,325                                                                                 |        |
|                                                                            |   |                        |        |        |   |        |   |                                                                                      |        |
| Net cash flows from operating activities                                        |   | (17,655,506                 | )           | (14,227,597 | )      | (9,479,199  | )      | (68,917,515                                                                               | )           |
|                                                                            |   |                        |        |        |   |        |   |                                                                                      |        |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                           |   |                        |        |        |   |        |   |                                                                                      |        |
| Purchase of property and equipment                                              |   | (890,273                    | )           | (2,325,646  | )      | (3,980,757  | )      | (9,644,167                                                                                | )           |
| Purchase of short-term investments                                              |   | (1,999,314                  | )           | —      |   | —      |   | (1,999,314                                                                                | )           |
| (Increase)/decrease in other assets                                             |   | (43,519                     | )           | 13,118      |   | (15,401     | )      | (307,797                                                                                  | )           |
| Increase in patents                                                             |   | (51,678                     | )           | (114,219    | )      | (117,188    | )      | (892,938                                                                                  | )           |
| Acquisition of R&C, Inc. and GRFCo                                          |   | —                      |        | —      |   | (700,000    | )      | (1,200,000                                                                                | )           |
| Net cash flows from investing activities                                        |   | (2,984,784                  | )           | (2,426,747  | )      | (4,813,346  | )      | (14,044,216                                                                               | )           |
|                                                                            |   |                        |        |        |   |        |   |                                                                                      |        |
| CASH FLOWS FROM FINANCING ACTIVITIES                                            |   |                        |        |        |   |        |   |                                                                                      |        |
| Net proceeds from issuance of common stock and exercise of warrants             |   | 346,941                     |        | 5,914,731   |   | 23,792,651  |   | 39,710,261                                                                                |        |
| Net proceeds from issuance of preferred stock                                   |   | 7,360,000                   |        | —      |   | —      |   | 34,591,371                                                                                |        |
| Restricted cash from Series G preferred stock                                   |   | —                      |        | —      |   | 3,114,774   |   | —                                                                                    |        |
| Proceeds from long-term obligations, net of issuance costs                      |   | 17,685,994                  |        | 2,765,502   |   | 1,799,791   |   | 23,125,426                                                                                |        |
| Payments on notes payable and capital leases                                    |   | (1,234,069                  | )           | (927,321    | )      | (300,525    | )      | (2,855,616                                                                                | )           |
| Proceeds from bridge notes payable                                              |   | —                      |        | —      |   | —      |   | 3,765,500                                                                                 |        |
| Payments on bridge notes                                                        |   | —                      |        | —      |   | (1,123,750  | )      | (2,364,500                                                                                | )           |
|                                                                            |   |                        |        |        |   |        |   |                                                                                      |        |
| Net cash flows from financing activities                                        |   | 24,158,866                  |        | 7,752,912   |   | 27,282,941  |   | 95,972,442                                                                                |        |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                            |   | 3,518,576                   |        | (8,901,432  | )      | 12,990,396  |   | 13,010,711                                                                                |        |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                                |   | 9,492,135                   |        | 18,393,567  |   | 5,403,171   |   | —                                                                                    |        |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                                      |   | $                           | 13,010,711  |        | $      | 9,492,135   |   | $                                                                                         | 18,393,567  |   | $ | 13,010,711 |   |
|                                                                            |   |                        |        |        |   |        |   |                                                                                      |        |
| Supplemental Disclosures of Investing and Financing Activities                  |   |                        |        |        |   |        |   |                                                                                      |        |
| Interest paid                                                                   |   | $                           | 572,515     |        | $      | 324,938     |   | $                                                                                         | 223,342     |   | $ | 1,649,962 |   |
| Conversion of bridge notes to common stock                                      |   | $                           | —      |        | $      | —      |   | $                                                                                         | 988,000     |   | $ | 1,401,000 |   |
| Conversion of preferred Series F to common stock                                |   | $                           | —      |        | $      | 105,721     |   | $                                                                                         | —      |   | $ | 105,721 |   |
| Conversion of SARs to options                                                   |   | $                           | —      |        | $      | 956,377     |   | $                                                                                         | —      |   | $ | — |   |
|                                                                                 |        |                             |             |             |        |             |        |                                                                                           |             |  |  |  |  |  |  |  |  |

 

See accompanying notes toconsolidated financial statements.

 

26

----

 

**RESTORAGEN, INC.**

**AND SUBSIDIARY**

(adevelopment stage company)

ConsolidatedStatements of Shareholders’ Equity/(Deficit)

 
| ** **                                                                                     | ** ** | ** ** | ** ** | ** **                       | ** ** | ** **        | ** ** | ** **    | ** **      | **Deficit**   | ** ** | ** **    | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------|------------|----------------------------------|------------|-------------------|------------|---------------|-----------------|---------------|------------|---------------|------------|
| ** **                                                                                     | ** ** | ** ** | ** ** | **Convertible  Preferred Stock** | ** ** | **Common  Stock** | ** ** | ** **    | **Accumulated** | ** **    | ** ** | ** **    |
| ** **                                                                                     | ** ** | **Number** | ** ** | **Par Value**                    | ** ** | **Par Value**     | ** ** | **Par Value** | ** **      | **Par Value** | ** ** | **Par Value** | ** ** | **Par Value** | ** ** | **Par Value** | ** ** | **Number** | ** ** |   | ** ** | **Additional  Paid-in** | ** ** | **During  Development** | ** ** |   | ** ** |
| ** **                                                                                     | ** ** | **of**     | ** ** | **Series B**                     | ** ** | **Series C**      | ** ** | **Series D**  | ** **      | **Series E**  | ** ** | **Series F**  | ** ** | **Series G** | ** ** | **Series H** | ** ** | **of** | ** ** | **Par** | ** ** | **Capital** | ** ** | **Stage** | ** ** | **Total** | ** ** |
| ** **                                                                                     | ** ** | **Shares** | ** ** | **Amount**                       | ** ** | **Amount**        | ** ** | **Amount**    | ** **      | **Amount**    | ** ** | **Amount**    | ** ** | **Amount** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Amount** | ** ** | **Amount** | ** ** | **Amount** | ** ** |
| INITIAL ISSUANCE                                                                               |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Issuance of common stock                                                                       |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   | 2,085,003 |   | $ | 20,850 |   | $ | 703,649 |   |   |   | $ | 724,499 |   |
| Debt conversion to common stock                                                                |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   | 821,992 |   | 8,220 |   | 1,953,443 |   |   |   | 1,961,663 |   |
|                                                                                           |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 1993 unit common stock offering                                                                |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   | 1,109,750 |   | 11,097 |   | 5,470,792 |   |   |   | 5,481,889 |   |
| 1995 warrants exercised                                                                        |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   | 242,370 |   | 2,424 |   | 1,494,211 |   |   |   | 1,496,635 |   |
| 1995 issuance of 16,365 shares of preferred stock, Series B                                    |       | 16,365     |       | $                                | 164        |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   |   | 1,472,686 |   |   |   | 1,472,850 |   |
| 1996 issuance of 21,000 shares of preferred stock, Series C                                    |       | 21,000     |       |                             |       | $                 | 210        |          |            |          |       |          |       |   |   |   |   |   |   |   |   |   | 1,889,790 |   |   |   | 1,890,000 |   |
| 1996 issuance of 60,739 shares of preferred stock, Series D                                    |       | 60,739     |       |                             |       |              |       | $             | 607             |          |       |          |       |   |   |   |   |   |   |   |   |   | 6,021,614 |   |   |   | 6,022,221 |   |
| 1998 issuance of 50,000 shares of preferred stock, Series H                                    |       | 50,000     |       |                             |       |              |       |          |            |          |       |          |       | $ | 500 |   |   |   |   |   |   |   | 4,999,500 |   |   |   | 5,000,000 |   |
| 1998 modification of stock options - 1993 plan                                                 |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   | 810,000 |   |   |   | 810,000 |   |
| 1998 conversion of bridge notes to common stock                                                |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   | 65,329 |   | 653 |   | 403,600 |   |   |   | 404,253 |   |
| Accretion of preferred stock, Series A and E to redemption value                               |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   | (1,278,505 | )  |   |   | (1,278,505 | ) |
| Net loss for the period from April 15, 1988 (date of  incorporation) to December 31, 1998 |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   |   |   | $ | (31,344,128 | ) | (31,344,128 | ) |
| BALANCE AT DECEMBER 31, 1998                                                                   |       | 148,104    |       | 164                              |       | 210               |       | 607           |            | 0             |       | 0             |       | 500 |   | 0 |   | 4,324,444 |   | 43,244 |   | 23,940,780 |   | (31,344,128 | ) | (7,358,623 | ) |
|                                                                                           |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Conversion of bridge notes to common stock                                                     |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   | 160,478 |   | 1,605 |   | 930,228 |   |   |   | 931,833 |   |
| Issuance of common stock                                                                       |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   | 2,234,311 |   | 22,343 |   | 23,826,475 |   |   |   | 23,848,818 |   |
| Accretion of preferred stock, Series A,E, and F to redemption value                            |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   | (1,328,208 | )  |   |   | (1,328,208 | ) |
| Net loss                                                                                       |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   |   |   | (12,615,915 | ) | (12,615,915 | ) |
| BALANCE AT DECEMBER 31, 1999                                                                   |       | 148,104    |       | 164                              |       | 210               |       | 607           |            | 0             |       | 0             |       | 500 |   | 0 |   | 6,719,233 |   | 67,192 |   | 47,369,275 |   | (43,960,043 | ) | 3,477,905 |   |
|                                                                                           |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Issuance of common stock                                                                       |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   | 370,516 |   | 3,705 |   | 4,549,780 |   |   |   | 4,553,485 |   |
| Warrants exercised                                                                             |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   | 229,471 |   | 2,295 |   | 1,358,951 |   |   |   | 1,361,246 |   |
| Conversion of 850 shares Series F to common stock                                              |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   | 10,625 |   | 106 |   | 97,327 |   |   |   | 97,433 |   |
| Modification of warrants and options                                                           |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   | 512,689 |   |   |   | 512,689 |   |
| Modification of stock options - 1993 Plan                                                      |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   | 5,032,534 |   |   |   | 5,032,534 |   |
| Conversion of SARs to stock options                                                            |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   | 1,003,251 |   |   |   | 1,003,251 |   |
| Accretion of preferred stock, Series A,E, and F to redemption value                            |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   | (1,319,921 | ) |   |   | (1,319,921 | ) |
| Net loss                                                                                       |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   |   |   | (19,555,645 | ) | (19,555,645 | ) |
| BALANCE AT DECEMBER 31, 2000                                                                   |       | 148,104    |       | 164                              |       | 210               |       | 607           |            | 0             |       | 0             |       | 500 |   | 0 |   | 7,329,845 |   | 73,298 |   | 58,603,886 |   | (63,515,688 | ) | (4,837,023 | ) |
|                                                                                           |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Warrants exercised                                                                             |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   | 49,563 |   | 496 |   | 346,445 |   |   |   | 346,941 |   |
| Issuance of preferred stock, Series H                                                          |       | 80,000     |       |                             |       |              |       |          |            |          |       |          |       |   |   | $ | 800 |   |   |   |   |   | 7,359,200 |   |   |   | 7,360,000 |   |
| Expiration of redemption feature, Series E                                                     |       | 17,070     |       |                             |       |              |       |          |            | $             | 171        |          |       |   |   |   |   |   |   |   |   |   | 2,120,250 |   |   |   | 2,120,421 |   |
| Waivers of mandatory redemption rights - Series F                                              |       | 100,926    |       |                             |       |              |       |          |            |          |       | $             | 1,009      |   |   |   |   |   |   |   |   |   | 12,698,891 |   |   |   | 12,699,900 |   |
| Amortization of unearned stock compensation                                                    |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   | 348,344 |   |   |   | 348,344 |   |
| Accretion of preferred stock, Series A,E, and F to redemption value                            |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   | (1,195,096 | ) |   |   | (1,195,096 | ) |
| Net loss                                                                                       |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   |   |   | (21,483,747 | ) | (21,483,747 | ) |
|                                                                                           |       |       |       |                             |       |              |       |          |            |          |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| BALANCE AT DECEMBER 31, 2001                                                                   |       | 346,100    |       | $                                | 164        |              | $          | 210           |            | $             | 607        |          | $          | 171 |   | $ | 1,009 |   | $ | 500 |   | $ | 800 |   | 7,379,408 |   | $ | 73,794 |   | $ | 80,281,920 |   | $ | (84,999,435 | ) | $ | (4,640,260 | ) |

 

 

See accompanying notes to consolidated financial statements.

 

27

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**RESTORAGEN, INC.**

**AND SUBSIDIARY**

(adevelopment stage company)

Notes to Financial Statements

December 31, 2001, 2000and 1999

 

Note 1.   Summary of Significant AccountingPolicies

 

**Description of Business****-**The Company is a biotechnology company focused on the development andproduction of peptide therapeutics. Business activities include the development and application of processesfor the production by biological means of middle-range peptide hormones and thedevelopment of pharmaceutical programs for therapeutic applications ofmiddle-range peptides.  The Company hasnot earned significant revenues from planned principal operations.  Accordingly, the Company’s activities havebeen accounted for as those of a “Development Stage Enterprise” as set forth inStatement of Financial Accounting Standards No. 7.  The Company operates and reports in one business segment,biotechnology development.

 

**Principles of Consolidation****-**The consolidated financial statements include accounts of Restoragen, Inc.(formerly BioNebraska, Inc.) a Delaware corporation, and its wholly-ownedsubsidiary GRF Corporation.  Allinter-company transactions have been eliminated.

 

**Use of estimates -** The preparation of thefinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from these estimates.

 

**Cash equivalents -** The Company considersall highly liquid investments with a maturity of less than three months whenpurchased to be cash equivalents.

 

**Short-term investments -** Short terminvestments consist of U.S. treasury bills that are carried at amortized costwhich approximates fair value.

 

**Property and Equipment -** Property andequipment are stated at cost less accumulated depreciation.  Depreciation of furniture, fixtures andequipment is computed using accelerated and straight line methods overestimated useful lives of 3 to 10 years. Leasehold improvements are depreciated using the straight line methodover the shorter of the lease arrangements or their estimated useful lives (15to 40 years).

 

**Patents and Patents Licensed** - The costs ofpatents issued and licensed are amortized over 17 years on a straight-linebasis.

 

**Long-lived Assets -** The Company reviewslong-lived assets and certain intangibles for impairment whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable.  An evaluation of recoverabilityis performed by comparing the undiscounted cash flows associated with the assetto the asset’s carrying amount to determine if a writedown is required.

 

**Deferred Financing Costs**- The Companyamortizes deferred financing costs on a straight line basis which approximatesthe interest method, over the term of the related financing.

 

28

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**Income Taxes** - The Company files aconsolidated income tax return with its subsidiary.  Deferred tax liabilities and assets are determined based on thedifferences between the financial statement carrying amounts and tax bases ofassets and liabilities using enacted tax rates.

 

**Loss per share -**Loss per share is computedby dividing the net loss applicable to common stock by the weighted-averagenumber of common shares outstanding for the period. Basic and diluted loss pershare are the same because options for 2,120,392, 1,864,392 and 1,631,005shares of common stock are excluded in 2001, 2000 and 1999, respectively, asall common equivalent shares would be antidilutive due to the losses.

 

**Stock-based Compensation**- As permitted by SFAS No. 123, “Accounting for Stock-based Compensation”, theCompany accounts for its stock-based awards to employees under the intrinsicvalue method in accordance with APB Opinion No. 25, “Accounting for StockIssued to Employees”, and related interpretations.  All stock-based awards to independent consultants are accountedfor under the fair value method as required by SFAS No. 123 and relatedinterpretations.

 

**Revenue Recognition** - Revenue related topayments from joint ventures and collaborative research agreements isrecognized when earned under the terms of the agreement and when performanceobligations have been met and related payments are receivable andnon-refundable.  The Company recognizesrevenue from kit sales when they are shipped.

 

**Research and development -** The Companyexpenses its research and development and clinical trial costs as incurred.

 

**Fair Value of Financial Instruments**- Thecarrying value of all financial instruments, except capital leases and notespayable, approximates fair value due to the short-term nature of theinstruments.  The carrying value ofcapital leases and notes payable approximates fair value due to the fixedinterest rates on these instruments being consistent with current interestrates available to the Company.

 

**Redeemable PreferredStock -**Preferred stock with redemption rights at the option of the holder areclassified as shareholders’ equity after such redemption rights have expired orthe rights to such redemptions have been waived.

 

**NewAccounting Pronouncements**- The Company adopted Statement ofFinancial Accounting Standards (SFAS) No. 133 “Accounting for Derivatives andSimilar Financial Instruments and for Hedging Activities”, as amended by SFASNo. 137 and SFAS No. 138 on January 1, 2001. There was no impact to the consolidated financial statements as a resultof adopting this standard.

 

29

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In July 2001, the Financial Accounting Standards Board (“FASB”) issuedSFAS No. 141, “Business Combinations.” SFAS No. 141 requires the purchase method of accounting for businesscombinations initiated after June 30, 2001 and eliminates the pooling-of-interestsmethod.  There was no impact to theconsolidated financial statements as a result of adopting this standard.

 

In July 2001, the FASB issued SFAS No. 142, “Goodwill and OtherIntangible Assets”, which is effective January 1, 2002.  SFAS No. 142 requires, among other things,the discontinuance of goodwill amortization. In addition, the standard includes provisions for the reclassificationof certain existing recognized intangibles as goodwill, reassessment of theuseful lives of existing recognized intangibles, reclassification of certain intangiblesout of previously reported goodwill and the identification of reporting unitsfor purposes of assessing potential future impairments of goodwill.  The Company does not believe that theadoption of SFAS No. 142 will have an impact on the consolidated financialstatements.

 

In June 2001, the FASB issued SFAS No. 143, “Accounting for AssetRetirement Obligations”.  This standardaddresses financial accounting and reporting for obligations related to theretirement of tangible long-lived assets and the related asset retirementcosts.  SFAS No. 143 is effective forfiscal years beginning after June 15, 2002. The Company does not believe that the adoption of SFAS No. 143 will havean impact on the consolidated financial statements.

 

In August 2001, the FASB issued SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets”. This standard addresses financial accounting and reporting for theimpairment or disposal of certain long-lived assets.  SFAS No. 144 is effective for fiscal years beginning afterDecember 15, 2001.  The Company does notbelieve that the adoption of SFAS No. 144 will have an impact on theconsolidated financial statements.

 

**Reclassifications**- Certain reclassifications have been made to the prioryears’ financial statements to conform to the current year’s presentation.

 

30

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Note 2.   Property and Equipment

 

Property and equipmentare comprised of the following:

 
|                           |   | **2001**   |      | **2000**   |   |
|--------------------------------|--------|------------|-----------|------------|--------|
| Buildings                      |   | $          | 250,181   |       | $      | 209,410 |   |
| Furniture  and fixtures        |   | 883,520    |      | 452,102    |   |
| Lab  and production equipment  |   | 6,905,644  |      | 4,261,815  |   |
| Leasehold  improvements        |   | 1,603,974  |      | 516,912    |   |
| Construction-in-progress       |   | —     |      | 3,313,655  |   |
|                           |   | 9,643,319  |      | 8,753,894  |   |
| Less  accumulated depreciation |   | (3,798,251 | )         | (2,973,722 | )      |
|                           |   | $          | 5,845,068 |       | $      | 5,780,172 |   |

 

Note 3.   Income Taxes

 

Deferred tax assets and(liabilities) are comprised of the following:

 
|                              |   | **2001**    |       | **2000**    |   |
|-----------------------------------|--------|-------------|------------|-------------|--------|
| Deferred  tax assets:             |   |        |       |        |   |
| Net  operating loss carryforwards |   | $           | 30,934,000 |        | $      | 22,609,000 |   |
| Accrued  liabilities              |   | 135,000     |       | 96,000      |   |
| Total  deferred tax assets        |   | 31,069,000  |       | 22,705,000  |   |
| Less:  Valuation allowance   |   | (31,039,000 | )          | (22,699,000 | )      |
| Deferred  tax liabilities:        |   |        |       |        |   |
| Prepaid  expenses                 |   | (30,000     | )          | (6,000      | )      |
| Net  deferred tax asset           |   | $           | —     |        | $      | — |   |

 

A valuation allowance has been provided against deferred tax assets asof December 31, 2001 and 2000 because realization of these amounts is dependenton generating future taxable income.  Atthe present time, the realization of these amounts is considered unlikely.  As of December 31, 2001, the Company has netoperating loss carryforwards of approximately $78,000,000 which expirebeginning in 2005 through 2021.

 

31

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A reconciliation ofincome taxes is as follows:

 
|                                        |   | **2001**   |       | **2000**  |   | **1999**   |   |
|---------------------------------------------|--------|------------|------------|-----------|--------|------------|--------|
| Federal  income taxes                       |   | $          | (7,519,000 | )         | $      | (6,844,000 | )      | $ | (4,416,000 | ) |
| State  income taxes, net of federal benefit |   | (1,074,000 | )          | (978,000  | )      | (631,000   | )      |
| Stock  compensation                         |   | 242,000    |       | 2,064,000 |   | 193,000    |   |
| Other                                       |   | 11,000     |       | 7,000     |   | —     |   |
| Change  in valuation allowance              |   | 8,340,000  |       | 5,751,000 |   | 4,854,000  |   |
|                                        |   | $          | —     |      | $      | —     |   | $ | — |   |

 

Note4.  Notes Payable

 

Notes payable consist ofthe following:

 
|                                                                                                                                                                                                                   |   | **December  31, 2001** |      | **December  31, 2000** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|-----------|------------------------|--------|
| Notes  payable to financial institutions; maturing February 1, 2003 through May 1,  2004; bearing interest between 13.07% and 13.87%; collateralized by lab and  production equipment, payable in monthly installments |   | $                      | 1,555,465 |                   | $      | 2,163,764 |   |
|                                                                                                                                                                                                                   |   |                   |      |                   |   |
| Less  current portion                                                                                                                                                                                                  |   | (696,127               | )         | (608,299               | )      |
|                                                                                                                                                                                                                   |   |                   |      |                   |   |
| Notes  payable, excluding current portion                                                                                                                                                                              |   | $                      | 859,338   |                   | $      | 1,555,465 |   |

 

Notes payable at December31, 2001 are payable as follows:

 
| **Year Ending December 31** |   |    |
|-----------------------------|--------|---------|
| 2002                        |   | $       | 696,127 |
| 2003                        |   | 607,766 |
| 2004                        |   | 251,572 |
|                        |   | $       | 1,555,465 |

 

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Note 5.  2001 ConvertibleNotes Payable

 

At December 31, 2001 the Company has outstanding $18 million ofconvertible notes payable.  The notesbear interest at prime plus 3% (7.75% at December 31, 2001) and mature onDecember 18, 2003.  The notesautomatically convert, at the option of the holder into common stock orpreferred stock of the Company, upon (i) the occurrence of an initial publicoffering of common stock that results in gross proceeds to the Company of atleast $50 million, (ii) the completion of qualified additional financing, asdefined in the loan agreements, in an amount equal to $17 million, (iii) theelection of the holder of at least 60% of the aggregate principal amount ofloans outstanding at any time or (iv) the proposed prepayment by the Company ofsome or all of the outstanding principal amount of the notes.  The conversion ratio applicable upon theoccurrence of each of the foregoing events is set forth in the notes, but isgenerally the lower of $12.50 per share or the lowest per share price at whichthe Company sells equity after the date of the notes.  The notes are secured by a first priority secured interest in (i)the proceeds arising out of the grant of any license rights in any of theCompany’s intellectual property or other general intangibles and (ii) theCompany’s intellectual property.  Inconnection with the issuance of the convertible notes, the Company issued999,997 warrants to purchase common stock of the Company (see note 9).

 

Note 6.       Lease Commitments 

 

The Company leases land, buildings and equipment under operating andcapital leases which expire at various dates from January 2002 through October2013.  The Company’s rent expense foroperating leases was approximately $321,000, $224,000 and $214,000 during theyears ended December 31, 2001, 2000 and 1999 respectively.

 

The Company pays insurance and maintenance costs associated with leasedreal estate.

 

Future minimum payments under non-cancelable operating and capitalleases with initial or remaining terms of one year or more and present value ofthe minimum capital lease payments are as follows:

 

33

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| **Year Ending December 31**                  |   | **Operating  Leases** |      | **Capital  Leases** |      |
|----------------------------------------------|--------|-----------------------|-----------|---------------------|-----------|
| 2002                                         |   | $                     | 330,561   |                | $         | 728,405 |   |
| 2003                                         |   | 328,413               |      | 604,931             |      |
| 2004                                         |   | 327,984               |      | 118,737             |      |
| 2005                                         |   | 327,984               |      | 23,734              |      |
| 2006                                         |   | 334,233               |      | 2,133               |      |
| Thereafter                                   |   | 2,315,458             |      | —              |      |
|                                         |   |                  |      |                |      |
| Total  minimum obligations                   |   | $                     | 3,964,633 |                | 1,477,940 |   |
| Less  interest at 10% to 20%                 |   |                  |      | (263,594            | )         |
| Present  value of net minimum lease payments |   |                  |      | 1,214,346           |      |
| Less  current portion                        |   |                  |      | (564,362            | )         |
|                                         |   |                  |      |                |      |
|                                         |   |                  |      | $                   | 649,984   |   |

 

Note 7.       Commitmentsand Contingencies

 

The Company has entered into license, clinical trial and supplyagreements with universities, research organizations and commercialcompanies.  Certain of the licenseagreements require payments of royalties on future sales of resulting productsand may subject the Company to minimum annual payments.  Payments under these license agreements havenot been significant and, at December 31, 2001, non-cancelable commitments areimmaterial.

 

The Company has entered into employment agreements with a number ofexecutive officers.  The agreementsprovide for annual base salary compensation, entitlement to stock options andseverance payments in the event of termination, other than for cause.

 

The Company monitors concentrations of credit risk associated withfinancial institutions with which it conducts business. Operating in adevelopmental stage, the Company has not yet been exposed to credit risks ofits customers in the normal course of business.  Concentrations of credit risk associated with trade receivablesare not yet a significant risk.

 

The Company has a 401(K) retirement plan covering substantially allemployees.  No contributions arerequired or allowed by the Company under the provisions of the plan.

 

The Company, from time to time, is involved in various legal mattersarising in the ordinary course of business. In management’s opinion, none of these matters, individually or in theaggregate, will materially affect the Company’s results of operations or itsfinancial position.

 

34

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Note 8.       1997and 1998 Convertible Bridge Notes

 

In 1997 and 1998, theCompany sold $3,765,500 in principal amount of Subordinated PromissoryNotes.  Each Note holder had the rightto convert to Common Stock up to 50% of the principal amount of the Notes at aprice of $7.00 per share.  Interestaccrued under the Notes at 10% per annum for the first six months and at 12%per annum during the six-month extension period.

 

As of December 31, 1998,$413,000 of principal plus accrued interest, had been converted into 65,329shares of common stock and principal of $1,240,750, plus accrued interest, hadbeen repaid by the Company in 1998.  Ofthe remaining $2,111,750 of principal at December 31, 1998, $988,000 ofprincipal, plus accrued interest, was subsequently converted into 160,478shares of common stock in 1999.  Thebalance of $1,123,750 of principal, plus accrued interest was repaid by theCompany, also in 1999.

 

Note 9.       Stock Options and Warrants

 

The 1993 Stock Plan, as originally adopted and subsequently amended,authorizes the grant of options to purchase up to 3,740,000 shares of commonstock.  Both incentive stock options andnon-qualified stock options may be granted under the Stock Plan.  All such options are exercisable at apurchase price equal to the fair market value of Company common shares, on the dateof the grant, as then determined by the Board of Directors.  At December 31, 2001, there were outstandingoptions under the Stock Plan to purchase a total of 1,931,000 shares, of whichoptions to purchase 1,299,346 shares were exercisable.  The non-qualified stock options becomeexercisable in three equal annual installments after the date of grant andexpire ten years from such date. Included in the 1,931,000 shares outstanding as of December 31, 2001 areoptions covering 112,000 shares granted to non-employee and former directors ofthe Company and stock options granted to seven non-employee members of theScientific Advisory Board and GLP-1 Medical Advisory Board, covering a total of47,000 shares.  Each of these grantsvests ratably over a three year period. The term of each such non-qualified option extends for the shorter ofthe term of service and thereafter for 180 days (to the extent vested at thetime), or ten years.  Also included areoptions covering 70,000 shares granted to six non-employee consultants of theCompany with terms consistent with those as stated above.  In addition, options to purchase 93,005shares of common stock have been issued outside of the 1993 Stock Plan.  These options have an exercise price of$2.42 per share and are currently exercisable through their expiration in July2002.

 

The Board of Directors approved the exchange of Stock AppreciationRights (“SARs”), previously issued to senior employees of the Company, fornon-qualified stock options, covering a total of 116,679 shares. During 1998, acash payment was made on SARs exercised for 20,292 shares, which left a balanceof 96,387 shares.  In the fourth quarterof 2000 the Company converted the outstanding stock appreciation rights tonon-qualified stock options to purchase a total of 96,387 shares of commonstock.  These options, which were issuedoutside of the 1993

 

35

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stock plan, have a weighted average exercise price of $2.58 per shareand a weighted average life of 5.84 years. The Company recorded an expense of $46,874 for the difference betweenthe accrued liability and the intrinsic value of the stock options (fair valuein the case of non-employees) which were fully vested when issued.

 

A summary of changes in outstanding options under the 1993 Plan foryears ended December 31, 2001, 2000 and 1999 are as follows:

 
|                                      |   | **2001**  |   | **2000**  |   | **1999**  |   |
|-------------------------------------------|--------|-----------|--------|-----------|--------|-----------|--------|
| Shares under option at  beginning of year |   | 1,675,000 |   | 1,538,000 |   | 829,000   |   |
| Options granted — 1993 Plan          |   | 291,000   |   | 170,000   |   | 767,000   |   |
| Options  exercised                        |   | —    |   | (1,000    | )      | (1,100    | )      |
| Options  canceled                         |   | (35,000   | )      | (32,000   | )      | (56,900   | )      |
| Shares  under option end of year          |   | 1,931,000 |   | 1,675,000 |   | 1,538,000 |   |
|                                      |   |      |   |      |   |      |   |
| Options  exercisable end of year          |   | 1,299,346 |   | 965,346   |   | 659,671   |   |

 

 

Stock optionweighted average exercise prices for the 1993 plan are summarized as follows:

 
|                            |   | **2001** |   | **2000** |   | **1999** |   |
|---------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Outstanding,  beginning of year |   | $        | 7.66   |     | $      | 7.13     |   | $ | 6.22 |   |
| Granted                         |   | $        | 12.50  |     | $      | 12.50    |   | $ | 8.12 |   |
| Exercised                       |   | —   |   | $        | 6.50   |     | $      | 7.00 |   |
| Canceled                        |   | $        | 7.66   |     | $      | 8.16     |   | $ | 7.05 |   |
| Outstanding,  end of year       |   | $        | 8.39   |     | $      | 7.66     |   | $ | 7.13 |   |

 

The followingtable summarizes information concerning options outstanding and exercisableoptions under the 1993 plan as of December 31, 2001:

 
|         |   |         |   | **Weighted**     |   |         |   |            |      |         |
|--------------|--------|--------------|--------|------------------|--------|--------------|--------|-----------------|-----------|--------------|
|         |   |         |   | **Average**      |   | **Weighted** |   |            |      | **Weighted** |
| **Range of** |   | **Options**  |   | **Remaining**    |   | **Average**  |   |            |      | **Average**  |
| **Exercise** |   | **Out-**     |   | **Contractual**  |   | **Exercise** |   | **Options**     |      | **Exercise** |
| **Price**    |   | **Standing** |   | **Life in Yrs.** |   | **Price**    |   | **Exercisable** |      | **Price**    |
| $ 5 - $8     |   | 1,458,000    |   | 5.0              |   | $            | 7.05   |            | 1,228,006 |         | $ | 6.88 |
| $ 12.50      |   | 473,000      |   | 9.0              |   | $            | 12.50  |            | 71,340    |         | $ | 12.50 |
| Totals       |   | 1,931,000    |   |             |   |         |   | 1,299,346       |      |         |

 

36

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The Company follows APB No. 25 for measurement and recognition ofstock-based transactions with employees. No compensation cost was recognized for stock options granted to employeesunder the 1993 Stock Plan because the exercise price for all options grantedwas at least equal to the fair value of the common stock at the grantdate.  All stock based awards toindependent consultants are accounted for under the fair value method asrequired by SFAS No. 123 and related interpretations.  In 2000, 1,118,167 options granted in previous years wereextended for a period of five years. Compensation expense of $348,344 and $5,032,534 was recorded in 2001 and2000, respectively, in connection with these extensions.  If compensation cost for the Company’s stockplans had been determined based on the fair value at the grant dates for grantsconsistent with the fair value method provided by SFAS No. 123, the Company’snet losses would have been as follows:

 
| **Net loss:**                          |   | **2001**    |        | **2000**    |   | **1999**    |   |
|----------------------------------------|--------|-------------|-------------|-------------|--------|-------------|--------|
| As  reported                           |   | $           | (24,607,682 | )           | $      | (22,319,580 | )      | $ | (15,388,137 | ) |
| Pro  forma                             |   | (25,619,649 | )           | (26,303,801 | )      | (15,622,506 | )      |
|                                   |   |        |        |        |   |        |   |
| Basic and diluted net  loss per share: |   |        |        |        |   |        |   |
| As  reported                           |   | $           | (3.34       | )           | $      | (3.14       | )      | $ | (3.04 | ) |
| Pro  forma                             |   | (3.48       | )           | (3.70       | )      | (3.08       | )      |

 

 

The fair value of options granted under the various option plans wasestimated on the date of the grant using the Black-Scholes option-pricing modelwith the following weighted average assumptions and results:

 
|                                           |   | **2001**  |    | **2000**   |   | **1999**  |   |
|------------------------------------------------|--------|-----------|---------|------------|--------|-----------|--------|
| Dividend yield                                 |   | None      |    | None       |   | None      |   |
| Expected  volatility                           |   | 0         |    | 0          |   | 0         |   |
| Risk-free  interest rate                       |   | 4         | %       | 7          | %      | 5         | %      |
| Expected life of option                        |   | 60 months |    | 120 months |   | 60 months |   |
| Fair  value of options granted during the year |   | $         | 655,000 |       | $      | 775,000   |   | $ | 1,279,000 |   |
|                                                |        |           |         |            |        |           |        |  |  |  |

 

In connection with the issuance of the convertible notes in December2001 (see note 5), the Company issued 999,997 warrants to purchase common stockof the Company at a per share warrant exercise price equal to the lower of$9.00 or the lowest per common equivalent share price at which the Companysells equity after the date of the warrants. Each party to the notes initially received warrants to purchase a numberof shares of common stock equal to 50% of the amount of notes held divided bythe warrant exercise price.  Commencingwith the 90th day after the initial date of issuance of the warrants, thenumber of shares of common stock into which the warrants are exercisableincreases by an additional 10% of the notes held divided by the warrant

 

37

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exercise price for each 30-day period in which the notes continue toremain outstanding and not converted, up to 100% of the outstanding notesdivided by the warrant exercise price.

 

Including the warrants issued in connection with the convertible notes,the Company had outstanding warrants to purchase 1,538,014 and 591,245 sharesof common stock as of December 31, 2001 and 2000, respectively.  Exercise prices for the warrants range from$7.00 to $12.50 per share (weighted average of $8.40 per share as of December31, 2001).  The warrants, which arecurrently exercisable, expire at various dates through December 2007 (4.19 yearweighted average life as of December 31, 2001).

 

Note 10.   Joint Ventures andGRF Corporation Acquisition

 

In July, 1991, the Company entered into a 50/50 contractual jointventure (referred to as Osteoporosis Therapy Company or “OT Company”) with R& C Enterprises, Inc., of Omaha, Nebraska (owned in part by Dr. Robert R. Recker,Director of the Hard Tissue Clinic of the Creighton University School ofMedicine).  OT Company was formed todevelop and market Growth Hormone Releasing Factor (GRF) therapy forosteoporosis pursuant to two patents issued in the United States to Dr. Reckerand other GRF therapies.  The GRF was tobe manufactured exclusively for OT Company by the Company using its proprietaryrecombinant peptide production and amidation technologies.  The Company was paid $500,000 and $650,000in 1992 and 1993, respectively, by OT Company for GRF and servicesrendered.  These amounts were accountedfor as revenues and are disclosed separately on the Statements ofOperations.  The Company’s contributionwas technology with no carrying value and no guaranty of the joint venture’sdebt.

 

In July, 1992, OT Company and the Company entered into a joint ventureagreement with Cambridge Biotech Corporation, of Worcester, Massachusetts, toform another joint venture company, GRF Corporation (GRFCO) to carry out aninitial pilot study of GRF therapy for patients with acute osteoporosis and, ifsuccessful, to carry out clinical trials with the therapy leading to the filingof an NDA with the United States Food and Drug Administration.  Pursuant to this joint venture agreement, Cambridgecontributed $2 million for the initial funding of GRFCO to cover the cost ofthe pilot study and other preliminary research activities and OT Companycontributed rights to patents with no carrying values. For these contributions,Cambridge received 19% of the GRFCO equity shares (Class A) and OT Companyacquired 81% of the equity shares (Class B). However, the parties had equal voting rights, and neither party hadvoting control.  Cambridge (now AcquilaBiopharmaceuticals, Inc., a wholly-owned subsidiary of Antigenics, Inc.) alsoacquired the right to a 20-year royalty, which may be bought out at theCompany’s option in a lump sum payment of $7,000,000 if paid before December31, 2002 or in a lump sum payment of $12,000,000 if paid between January 1,2003 and December 31, 2006.

 

 

38

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In 1996, theCompany acquired Cambridge’s entire 19% interest in GRFCO shares for$500,000.  This $500,000 was immediatelyexpensed as research and development because no tangible assets were acquiredand the intangible assets which were acquired did not relate to revenueproducing products or processes.

 

On January 6, 1999, the Company acquired all of the outstanding sharesof stock of R & C Enterprises, Inc. and a related entity, for the sum of$700,000.  This $700,000 was expensed asresearch and development because no significant tangible assets were acquiredand the rights to patents which were acquired did not relate to revenueproducing products or processes.  As a result,Restoragen became the 100% owner of OT Company and GRFCO.

 

Note 11.  Preferred Stock

 

The Company’s Certificate of Incorporation authorizes the Board ofDirectors to establish by resolution different classes or series of preferredstock and to fix the relative rights and preferences of said shares in anyclass or series.  The Company may notdeclare or pay dividends on its common stock unless dividends on all classes ofcumulative preferred stock have been paid.

 

Series A Redeemable Preferred Stock

The Series A Preferred Stock has no voting power, except in the eventthat at least one year’s dividends have not been paid on the stock prior to May31, 2003.

 

The holder of the Series A Preferred Stock is entitled to receivecumulative dividends at the rate of $7.50 per share per annum beginning May 31,1993, payable annually in preference and priority to any payment of dividendson Common Stock or any other shares ranking junior to the Series A PreferredStock as to dividends.  The Company wasrequired to begin paying dividends on the May 31 following the year in whichthe Company obtained gross proceeds in excess of $15 million from public orprivate offerings of equity securities. The holder of the Series A Preferred Stock, however, waived its right tohave such dividends paid until May 31, 2003.

** **

The Series A Preferred Stock may be redeemed by the Company at any timeat a redemption price equal to the $100 face value per share plus all unpaidand accumulated dividends.  In addition,the holder has the right to require the Company to redeem its Series APreferred Stock beginning after May 31, 2004 at a redemption price of the facevalue per share plus all unpaid and accumulated dividends.  As of December 31, 2001 and 2000, authorizedand outstanding Series A shares were 11,750 shares.

** **

** **

**39**

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** **

# **Series B Convertible Preferred Stock**

Holders of Series B Preferred Stock are entitled to vote on all matterssubmitted to the shareholders and receive one vote for each share of CommonStock into which such holder’s shares are then convertible (currently 14.286shares).

 

The Series BPreferred Stockholders are entitled to receive cumulative dividends at the rateof $9.75 per share per year, payable annually on a parity with the Series APreferred Stock and in preference and priority to any payment of any dividendon the Common Stock or any other shares junior to the Series B Stock.  Dividends begin to accrue on the date of theoriginal issue of the shares of Series B Stock.  As of December 31, 2001 and 2000, 16,500 Series B shares wereauthorized of which 16,365 were issued and outstanding.

 

The holders of theSeries B Preferred Stock have the right at any time to convert each share ofSeries B Preferred Stock into 14.286 shares of Common Stock, which rate isdetermined by multiplying the number of shares of Series B Preferred Stock tobe converted by $100 and dividing the product thereof by the Conversion Price,which is initially $7.00, subject to anti-dilution adjustment.  All outstanding shares of Series B PreferredStock will automatically convert into Common Stock if the Company closes anunderwritten public offering of its Common Stock with gross proceeds of atleast $10,000,000 and all accumulated dividends shall be paid.

 

The Company may redeem the Series B Preferred Stock, in whole or inpart at any time upon 30 days notice at its $100 face value plus all unpaid andaccumulated dividends.  Holders willhave the right to convert to Common Stock any Series B Preferred Stock that theCompany seeks to redeem.

 

# **Series C Convertible Preferred Stock**

The holders of theSeries C Preferred Stock have the same rights as Series B. As of December 31,2001 and 2000, 50,000 Series C shares were authorized of which 21,000 shareswere issued and outstanding.

 

The Company mayredeem the Series C Preferred Stock, in whole or in part at any time upon 30days notice at its $100 face value plus all unpaid and accumulateddividends.  Holders will have the rightto convert to Common Stock any Series C Preferred Stock that the Company seeksto redeem.  In addition, if the Companycloses an underwritten public offering of its Common Stock with gross proceedsof at least $10,000,000 the Company may, at its discretion, pay all accumulateddividends in the form of common stock, with the value of the common stock basedon the price of the public offering.

 

 

40

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Series D Convertible Preferred Stock

The holders of Series D Preferred Stock have the same rights as SeriesB.  As of December 31, 2001 and 2000,100,000 Series D shares were authorized of which 60,739 shares were issued andoutstanding.

 

The Company may redeem the Series D Preferred Stock, in whole or inpart, at any time upon 30 days notice at its $100 face value plus all unpaidand accumulated dividends.  Holders willhave the right to convert to Common Stock any Series D Preferred Stock that theCompany seeks to redeem.

 

Series E Convertible Preferred Stock

The holders of Series E Preferred Stock have the same rights as SeriesB  As of December 31, 2001 and 2000,200,000 Series E shares were authorized, of which 17,070 shares were issued andoutstanding.

 

The Company may redeem the Series E Preferred Stock, in whole or inpart, at any time upon 30 days notice at its $100 face value plus all unpaidand accumulated dividends.  Holders willhave the right to convert to Common Stock any Series E Preferred Stock that theCompany seeks to redeem.  In addition,if the Company closes an underwritten public offering of its Common Stock withgross proceeds of at least $10,000,000 the Company may, at its discretion, payall accumulated dividends in the form of common stock, with the value of thecommon stock based on the price of the public offering.

 

Series F Convertible Preferred Stock

The holders of Series F Preferred Stock have the same rights as SeriesB, except for the terms of redemption and the conversion price.  In December 2000 holders of 850 shares ofSeries F Preferred Stock exercised their right to convert each share of SeriesF Preferred Stock to 12.5 shares of common stock.  As of December 31, 2001 and 2000, 200,000 Series F shares wereauthorized, of which 109,268 were issued and outstanding, respectively.

 

The Company may redeem the Series F Preferred Stock, in whole or inpart, at any time upon 30 days notice on or after January 1, 2002, at its $100face value plus all unpaid and accumulated dividends.  Holders will have the right to convert to Common Stock any SeriesF Preferred Stock that the Company seeks to redeem.  From January 1, 2002 to March 31, 2002, holders of 8,342 sharesof Series F Preferred Stock may require the Company to redeem all, but not aportion of, the holders’ shares of Series F Convertible Preferred Stock at aredemption price of the face value per share plus all unpaid and accumulateddividends to the date of redemption.  Ifredeemed, proceeds are payable in three installments over 12 months.  In December 2001, holders of the remaining100,926 shares of Series F Preferred Stock waived their redemption rights.

 

 

41

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# ** **

Series G Convertible Preferred Stock

Under the terms of that certain Investment Agreement between theCompany and Medtronic, Inc. dated June 16, 1998, Medtronic purchased 50,000shares of Series G Preferred Stock at $100 per share.  Under the terms of the Investment Agreement, the gross proceedsreceived by the Company were to be used for peptide production scale up and cGMPdevelopment that is integral to the CHF/GRF clinical program of the Company,including but not limited to preclinical evaluation, drug compatibility of andwith Medtronic’s drug delivery systems, any clinical trials necessary to obtainregulatory approval for GRF, and animal feasibility studies.

 

All $5 million had been expended by December 31, 1999.  Under the Investment Agreement, the holdersof Series G Preferred Stock have a right of first refusal to purchase its prorata share of any New Securities that the Company may issue.  Holders of Series G Preferred Stock areentitled to receive cumulative dividends at the rate of $9.75 per share peryear.  In addition, if the Companycloses an underwritten public offering of its Common Stock with gross proceedsof at least $10,000,000 the Company may, at its discretion, pay all accumulateddividends in the form of common stock, with the value of the common stock basedon the price of the public offering. The Series G Preferred Stock does not have redemption rights.

 

# **Series H Convertible Preferred Stock**

In April 2001, theCompany sold 80,000 shares of Series H Convertible Preferred Stock at $100 pershare to an accredited investor outside the United States in an offshoreoffering in accordance with Regulation S under the Securities Exchange Act.  Each share of Series H Convertible PreferredStock is convertible at the option of the holder at any time into approximately6.666 shares of the Company’s common stock, which is based on an initialconversion price of $15.00 per share and is subject to adjustment.  Holders of Series H Preferred Stock areentitled to receive cumulative dividends at the rate of $6.00 per share peryear.  In the event the Company closesan initial public offering of common stock which raises at least $7 million,the Series H Convertible

 

Preferred Stockwill automatically convert to common stock and any accrued dividends will beextinguished.

 

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Accumulateddividends on preferred stock as of December 31, 2001 are as follows:

 
| **Preferred Stock Series** |   | **Accumulated Dividends** |       |
|----------------------------|--------|---------------------------|------------|
|                       |   |                      |       |
| A                          |   | $                         | 756,406    |   |
| B                          |   | 1,129,588                 |       |
| C                          |   | 1,402,118                 |       |
| D                          |   | 3,145,344                 |       |
| E                          |   | 748,946                   |       |
| F                          |   | 3,728,769                 |       |
| G                          |   | 1,218,750                 |       |
| H                          |   | 360,000                   |       |
|                       |   | $                         | 12,489,921 |   |

** **

No dividends havebeen declared on the Company’s preferred stock.  Accumulated dividends on Series A, F and Series A, E and F of$1,041,077 and $3,914,200 as of December 31, 2001 and 2000, respectively, areincluded in redeemable preferred stock. Because no dividends have been declared, accumulated dividends onconvertible preferred stock Series B, C, D, E, F, G and H are not recorded as aliability as of December 31, 2001.

 

Note 12.   Going Concern Considerations

 

The Company, frominception, has experienced losses from its activities in research anddevelopment, without fully offsetting revenues.  This and the fact that the Company is a development stagebusiness create a substantial doubt as to its ability to continue as a goingconcern.

 

The Company hasobtained financing through private equity and debt offerings, as reflected inthe statements of changes in shareholders’ equity/(deficit) and note 5 to thefinancial statements.  As in the past,the Company is pursuing additional equity or debt offerings to fund itsprograms as well as its corporate overhead.

 

The Company’s abilityto obtain profitability on substantial portions of its operations will alsodepend in large part on:  obtainingregulatory approvals of some of its products; entering into satisfactoryagreements for product commercialization; making the transition from adevelopmental stage business to a contract process development company, alsocapable of commercializing its own peptides through strategic partnerships; andobtaining additional financing through development collaborations or equity ordebt issues, as necessary.

 

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The financialstatements do not include any adjustments relating to the recoverability andclassification of recorded asset amounts or the amounts and classification ofliabilities that might be necessary should the Company be unable to continue asa going concern.

 

Note 13.   Subsequent Events

 

In February 2002,the Company announced a restructuring which included a reduction of totalworkforce from 121 to 60 employees.  Therestructuring was required as the Company realigned its business strategy.  Costs associated with the restructuringtotaled approximately $1.0 million and will be reported as operating expensesin the first quarter of 2002.

 

Note 14.  Quarterly Data (unaudited)

 

 
|                                 |   | **For the  year ended December 31, 2001** |   |
|--------------------------------------|--------|-------------------------------------------|--------|
|                                 |   | **First**                                 |   | **Second** |   | **Third** |   | **Fourth** |   |
|                                 |   | **Quarter**                               |   | **Quarter** |   | **Quarter** |   | **Quarter** |   |
| Revenues                             |   | $                                         | 1,318  |   | $ | 1,175 |   | $ | 4,503 |   | $ | 1,790 |   |
| Operating  costs and expenses        |   | 3,809,353                                 |   | 4,404,506 |   | 5,554,043 |   | 7,163,453 |   |
| Net  loss applicable to common stock |   | (4,594,314                                | )      | (5,319,008 | ) | (6,521,096 | ) | (8,173,264 | ) |
| Basic  and diluted loss per share    |   | (0.62                                     | )      | (0.72 | ) | (0.88 | ) | (1.11 | ) |
|                                      |        |                                           |        |  |  |  |  |  |  |  |  |  |  |

 
|                                 |   | **For the  year ended December 31, 2000** |   |
|--------------------------------------|--------|-------------------------------------------|--------|
|                                 |   | **First**                                 |   | **Second** |   | **Third** |   | **Fourth** |   |
|                                 |   | **Quarter**                               |   | **Quarter** |   | **Quarter** |   | **Quarter** |   |
| Revenues                             |   | $                                         | — |   | $ | 7,495 |   | $ | 2,545 |   | $ | — |   |
| Operating  costs and expenses        |   | 3,700,429                                 |   | 3,932,551 |   | 3,417,799 |   | 8,755,616 |   |
| Net  loss applicable to common stock |   | (4,257,112                                | )      | (4,489,547 | ) | (4,094,781 | ) | (9,478,140 | ) |
| Basic  and diluted loss per share    |   | (0.62                                     | )      | (0.64 | ) | (0.57 | ) | (1.31 | ) |
|                                      |        |                                           |        |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM9.  CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None

 

**PART III**

 

**ITEM10.  DIRECTORS AND EXECUTIVE OFFICERS OFTHE REGISTRANT**

 

Following is a briefsummary of the business experience of each of the officers, key personnel anddirectors of the Company.

 
| **Name**                                  |   | **Age** |   | **Offices**                                          |   |
|-------------------------------------------|--------|---------|--------|------------------------------------------------------|--------|
| Ashleigh W. Palmer                        |   | 39      |   | Chief Executive Officer  and Director                |   |
|                                      |   |    |   |                                                 |   |
| David S. Walker                           |   | 41      |   | Chief Financial Officer                              |   |
|                                      |   |    |   |                                                 |   |
| Fred W. Wagner, Ph.D.                     |   | 62      |   | Vice President,  Technology Development and Director |   |
|                                      |   |    |   |                                                 |   |
| Mario R.W. Ehlers,  M.B., Ch.B. and Ph.D. |   | 43      |   | Vice President,  Business Development                |   |
|                                      |   |    |   |                                                 |   |
| Roberta L. Schneider,  M.D.               |   | 50      |   | Vice President, Drug  Development                    |   |
|                                      |   |    |   |                                                 |   |
| David R. Hathaway,  M.D., F.A.C.C.        |   | 54      |   | Vice President,  Cardiovascular Diseases             |   |
|                                      |   |    |   |                                                 |   |
| Thomas R. Coolidge,  J.D.                 |   | 68      |   | Chairman of the Board  (Non-Executive)               |   |
|                                      |   |    |   |                                                 |   |
| Walter R. Barry, III                      |   | 36      |   | Director                                             |   |
|                                      |   |    |   |                                                 |   |
| Richard A. de Souza                       |   | 49      |   | Director                                             |   |
|                                      |   |    |   |                                                 |   |
| William J. Jenkins,  M.D.                 |   | 54      |   | Director                                             |   |
|                                      |   |    |   |                                                 |   |
| Erich Sager                               |   | 44      |   | Director                                             |   |
|                                      |   |    |   |                                                 |   |
| Peter T. Tattle                           |   | 60      |   | Director                                             |   |

 

**AshleighW. Palmer, MBA,** joined Restoragen as Chief Executive Officerin January, 2002.  From 1998-2001, Mr.Palmer was President & CEO of New Jersey based INO Therapeutics, Inc.,which successfully developed and commercialized the first selective pulmonaryvasodilator, INOmax (nitric oxide by inhalation).  Prior to founding INO Therapeutics, Mr. Palmer was VicePresident, Business Development for Ohmeda Pharmaceutical Products, Inc., aglobal leader in the development, manufacture and marketing of

 

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anesthesia and criticalcare products.  Mr. Palmer began hiscareer in pharmaceutical marketing and business development in the UK withReckitt & Coleman PLC and later Seton Healthcare Group PLC.  Mr. Palmer has an MBA from BradfordUniversity, England and a BSc in Biochemistry & Applied Molecular Biologyfrom Manchester University, England.

 

**DavidS. Walker,** joined the Company in June 2000 and serves as itsChief Financial Officer.  From 1996 to2000, he was Chief Financial Officer of Arbor Acres Farm, Inc., an agribusinesscompany, with overall responsibility for the finance and information technologyfunctions of the company.  From 1993 to1996, Mr. Walker served as Vice President Finance and Information Technology ofFisons Corporation, a pharmaceuticals company, having similar responsibilitiesand managing a staff of 40 persons.

 

**FredW. Wagner, Ph.D.,** a founder of the Company, has been employedby the Company since its inception in 1989 and currently serves as VicePresident of Technology Development.  Heserved as the President through December 2001. He became a faculty member of the University of Nebraska-Lincoln in theDepartment of Biochemistry in 1968, and a Professor in 1980.  Dr. Wagner retired as an active memberof the faculty at the end of 1995 and now works full time for the Company.  Dr. Wagner’s areas of research interestinclude metallo-proteins and metallo-enzymes, proteolytic enzymes and theimmobilization, manipulation and purification of proteins.  He is an author of more than 50 articles inscientific journals and of chapters in five books.  Dr. Wagner received his Ph.D. in Biochemistry from TexasA&M University.

 

**MarioR.W. Ehlers, M.B., Ch.B. (equivalent to M.D.) and Ph.D.,**joined the Company in June 1998 and serves as its Vice President of BusinessDevelopment.  Dr. Ehlers receivedhis M.B., Ch.B. and Ph.D. in biochemistry at University of Cape Town in SouthAfrica.  Subsequently he served forseven years as a researcher and instructor at the Center for Biochemical andBiophysical Sciences for Medicine at Harvard Medical School. From 1992 to 1998,he served as the Chairman of the Department of Medical Biochemistry at theUniversity of Cape Town. Dr. Ehlers combines strong credentials in the biochemistry ofendocrine peptides with extensive medical and clinical experience.

 

**RobertaL. Schneider, M.D.,** joined the Company in February 2001 andserves as its Vice President of Drug Development.  Dr. Schneider has over 15 years of pharmaceutical industryexperience.  Prior to joiningRestoragen, Dr. Schneider was Vice President of Drug Development for TakedaAmerica Research and Development Center for 4 years.  She directed the conduct of clinical trials for all of the Takedacompounds in US development including the clinical plan and NDA for ACTOS whichwas approved for marketing for Type 2 diabetes mellitus via expeditedreview.  Before joining Takeda, Dr.Schneider was Vice President, Medical and Professional Affairs and MedicalDirector for Novo Nordisk Pharmaceuticals Inc. for 4 years.  Dr. Schneider’s additional industryexperience includes Sterling Winthrop Pharmaceuticals as Director of ClinicalResearch and Merck Sharp & Dohme at Merck & Co as Senior AssociateDirector of Phase IV Medical Services.

 

**DavidR. Hathaway, M.D., F.A.C.C.,** joined the Company in May 2001and serves as its Vice President of Cardiovascular Disease.  Prior to joining Restoragen, Dr. Hathawayserved

 

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as Vice President ofMedical Affairs as Knoll Pharmaceutical Company, and before that he was VicePresident of Cardiovascular Drug Discovery at Bristol-Myers Squibb.  Dr. Hathaway is board-certified in internalmedicine and cardiovascular diseases and received his training in cardiology atthe National Institute of Health, Bethesda, Maryland.  Before entering the pharmaceutical industry, he was Chief ofCardiology and Director of the Institute of Cardiology at Indiana Universityfrom 1990-1995.

 

**ThomasR. Coolidge, J.D.,** a founder of the Company, served as ChiefExecutive Officer of the Company since its inception in 1989 until November2001. He continues to serve as non-executive Chairman of the Board. From 1987 through 1988, he wasPresident and CEO of Finn Sugar U.S., Inc., Schaumberg, Illinois, whichprovided specialty enzyme and sweetener products and specialty chemicals to theNorth American food markets.  From 1982through 1987, he was a Principal in the Stenbeck Group of New York City, wherehe was instrumental in winning the “private side” cellular radio telephonelicense for all of the United Kingdom with a U.K. partner and represented thatGroup’s ownership in connection with the successful building and launching ofthat cellular system known as “Vodafone” to cover the licensed market.  From 1975 through 1982, he served as theExecutive Vice President of Parsons & Whittemore, Inc., a large privately-heldpaper pulp and machinery producer, with offices in New York City, where amonghis responsibilities were the financing, construction and start up of one ofthe largest single-line pulp mills at the time, located in Alabama.  From 1960 through 1974, he practicedbusiness and financial law as an associate and partner of a Wall Street lawfirm.  He graduated from Harvard Collegeand Harvard Law School.

 

**WalterR. Barry, III,** has been a Director of the Company sinceDecember 1993.  Since 1999,Mr. Barry has been Chairman and Chief Executive Officer of viaMD.com, abusiness-to-business e-commerce company focused on the medical deviceindustry.  From March 1994 to August1998, Mr. Barry was a Vice President of Business Development for FirstPhysician Care, Inc., a physician group practice management company inAtlanta.  Prior to that, Mr. Barrywas Director of Communications of CareNetwork, a publicly-traded HMO, from July1991 to February 1994.  From July 1989to June 1991, Mr. Barry was an Analyst in the Corporate Finance Departmentat the New York investment banking firm of Dillon, Read & Company,Inc.  Mr. Barry graduated fromPrinceton University in 1989.

 

**RichardA. de Souza,** has been a director of the Company since June2000.  Mr. de Souza iscurrently President, Pharmaceuticals Europe and Asia, of WarnerLambert/Parke-Davis.  Prior to this hewas with SmithKline Beecham for 22 years, rising to the position of Chairman,European Pharmaceuticals. Mr. de Souza is a registered Pharmacist, and commenced his careerin Manufacturing, before moving to Marketing, then Business Development &Finance.  At SmithKline Beecham, he hasserved as Marketing Director/Vice President for Asia, Middle East and Africaand Senior Vice President and Director, Marketing for Europe and the USA.  He also held a broad range of GeneralManager/Regional Manager assignments throughout the world.  Additionally, Mr. de Souza serveson the academic advisory board of INSEAD in Fontainebleau, France and otheracademic advisory boards.  He is afrequent speaker on elements of corporate strategy and related topics.

 

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**WilliamJ. Jenkins, M.D.,** has been a director of the Company sinceNovember 1, 2000.  Since April 1999, Dr.Jenkins has been a pharmaceutical consultant. From 1996 to 1999, he served as the Head of Clinical Development andRegulatory Affairs Worldwide for Novartis Pharma AG, Basel.  From 1992 through 1996, Dr. Jenkins waswith Ciba Geigy, AG, Basel, as its Head of Medicine and Clinical DevelopmentWorldwide, remaining with Ciba through its merger with Sandoz to form Novartisin 1996.  Dr. Jenkins holds a B.A.,M.D., and other advanced degrees from Cambridge University, Cambridge, England,as well as advanced degrees from the Royal College of Physicians, UnitedKingdom, and London University.  He is amember of the Board of Directors of Tanox, Inc. Houston, Texas, a publicly-heldcompany which is a developer of monoclonal antibodies, and ViroLogic, Inc. ofSan Francisco, California, a publicly-held company which develops and sellsviral drug resistance testing services, principally for HIV.

 

**ErichSager,** has been a director of the Company since July1998.  He is the Managing Partner ofLaMont Asset Management SA, a private investment management firm.  Before joining LaMont, he was head ofprivate banking at Dresden Bank (Switzerland) Ltd. in Zurich.  He is a member of the board of directors ofBioMarin, Inc., and of Comptec Industries Ltd., a publicly held Canadiancompany which manufactures specialty plastic components.

 

**PeterT. Tattle**joined the board in 2001.  Mr. Tattle retired from Johnson & Johnson in July of 2001after 36 years with the company.  Hislast position was a company group chairman with responsibility for thepharmaceutical businesses in the Americas. This included Ortho-McNeil Pharmaceutical, Janssen Pharmaceutica, OrthoBiotech in the U.S., Janssen-Ortho in Canada and the pharmaceutical businessesin Mexico and Latin America.  He alsoserved as a member of the Johnson & Johnson Pharmaceutical Group OperatingCommittee from 1991 until his retirement. Mr. Tattle is currently a board member of several biotech companies andis also involved in the executive coaching of high potential corporate leadersin association with C.D.R. International.

 

**Section16(a) Beneficial Ownership Reporting Compliance**

 

To the Company’sknowledge, based solely on a review of the copies of such reports furnished tothe Company and written representations that no other reports were required, duringthe fiscal year ended December 31, 2001, all Section 16(a) filing requirementsapplicable to the officers, directors and greater than ten percent beneficialowners were complied with, except that Medtronic Inc. was late in filing a Form4 Statement of Changes in Beneficial Ownership.

 

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**ITEM 11.  EXECUTIVE COMPENSATION**

 

***Executive Compensation and Employment Agreements***

 

The following table setsforth the annual compensation for the fiscal years ended December 31, 2001,2000 and 1999 for the executive officers of the Company:

 
|                                           |   | **Annual  Compensation** |   | **Long Term  Compensation  Awards** |    |
|------------------------------------------------|--------|--------------------------|--------|-------------------------------------|---------|
| **Name and Principal Position**                |   | **Year**                 |   | **Salary**                          |    | **Bonus** |   | **Options  (#)** |   |
| **Thomas R. Coolidge,** Chairman of the Board  |   | 2001                     | (1)    | $                                   | 309,482 |   |   | — |   | — |   |
| (Non-Executive); Former Chief Executive        |   | 2000                     |   | $                                   | 309,482 |   |   | — |   | — |   |
| Officer                                        |   | 1999                     |   | $                                   | 294,745 |   | $ | 61,896 |   | 300,000 |   |
|                                           |   |                     |   |                                |    |   |   |   |   |
| **Fred W. Wagner,** Vice President, Technology |   | 2001                     |   | $                                   | 265,650 |   |   | — |   | — |   |
| Development                                    |   | 2000                     |   | $                                   | 265,650 |   |   | — |   | — |   |
|                                           |   | 1999                     |   | $                                   | 256,000 |   | $ | 53,130 |   | 100,000 |   |
|                                           |   |                     |   |                                |    |   |   |   |   |
| **David  S. Walker,** Chief  Financial Officer |   | 2001                     |   | $                                   | 233,185 |   | — |   | — |   |
|                                           |   | 2000                     | (2)    | $                                   | 118,134 |   | — |   | 50,000 |   |
|                                           |   | 1999                     |   |                                | —  |   | — |   | — |   |
|                                           |   |                     |   |                                |    |   |   |   |   |
| **Roberta L. Schneider,** Vice President, Drug |   | 2001                     | (3)    | $                                   | 190,077 |   | $ | 42,000 |   | 40,000 |   |
| Development                                    |   | 2000                     |   |                                | —  |   |   | — |   | — |   |
|                                           |   | 1999                     |   |                                | —  |   |   | — |   | — |   |
|                                           |   |                     |   |                                |    |   |   |   |   |
| **Mario Ehlers,** Vice President, Business     |   | 2001                     |   | $                                   | 200,000 |   | — |   | — |   |
| Development                                    |   | 2000                     |   | $                                   | 160,000 |   | — |   | — |   |
|                                           |   | 1999                     |   | $                                   | 144,000 | $ | 32,000 |   | 10,000 |   |
|                                                |        |                          |        |                                     |         |  |  |  |  |  |  |  |  |

 

----

(1)           Mr. Coolidge stepped down as theChief Executive Officer in 2001.

(2)           Mr. Walker joined the Companyfull-time in September 2000.  Salaryreflects a partial year and $19,416 of relocation expense.

(3)           Dr. Schneider joined the Company inFebruary 2001.  Salary reflects apartial year.

 

Dr. Wagner has enteredinto an employment agreement with the Company, under which either party mayterminate the contract on one year’s notice. Mr. Walker has also entered into an employment agreement with theCompany, under which either party may terminate the contract on nine monthsnotice.  The Company has also enteredinto employment agreements with Dr. Ehlers and Dr. Schneider, which can beterminated by either the employee or the Company, on six month’s notice.

 

All of the officers andemployees of the Company, including Dr. Wagner, Mr. Walker, Dr. Ehlers and Dr.Schneider have signed agreements with the Company which incorporate provisionsfor Company ownership of all inventions and technology conceived by them whichpertain to the Company’s business, and the safeguarding of the Company’sconfidential information and trade secrets. All of the employment agreements with the officers and key employeescontain covenants prohibiting the employee from (i) competing with the Company,

 

49

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(ii) interfering with itsbusiness or business relationships, and (iii) soliciting any Company personnel(employees and independent contractors) for employment elsewhere, duringemployment with the Company and thereafter for specified periods after terminationof employment and in the event certain compensation is paid to the officer orkey employee.

 

In November 2001, Mr.Coolidge stepped down as the Company’s Chief Executive Officer.  Mr. Coolidge is being paid his normal salaryand benefits under the termination provisions of his Employment Agreement,pending outcome of ongoing discussions regarding the terms of his severancefrom employment.

 

In January 2002, Ashleigh W. Palmer was appointedChief Executive Officer.  Mr. Palmerbrings to Restoragen over 18 years of corporate leadership, marketing andbusiness development experience in the biotech and pharmaceuticalindustries.  Mr. Palmer entered into anagreement with the Company, under which either party may terminate the contracton one year’s notice.

 

**StockPlan**

 

The Restoragen, Inc.Stock Plan (the “Stock Plan”), which was originally adopted in 1993 andsubsequently amended, authorizes the grant of options to purchase up to3,740,000 shares of Common Stock.  Bothincentive stock options and non-qualified stock options may be granted underthe Stock Plan. Exercise prices for incentive stock options must equal themarket value per share at the time of grant. The stock options are granted with the approval of the Board ofDirectors of the Company or a committee thereof. As of December 31, 2001 therewere outstanding options under the Stock Plan to purchase a total of 1,931,000shares, of which options to purchase 1,299,346 shares were exercisable, and189,392 outstanding options issued outside of the Stock Plan, which arecurrently exercisable.  Prior to July2000, options were generally granted for terms of five years.  In 1998, the Board approved the modificationof outstanding options issued to officers, directors, employees and consultantsto extend the terms for five additional years. Consistent with industry practice, the Board elected in July 2000 togrant all new options for ten-year terms and authorized the modification of alloutstanding options to extend the terms for five additional years, subject toconsent of the holders.

 

*OptionGrants*

The following tablecontains information concerning stock options granted under the Restoragen,Inc. Stock Plan to the Named Executive Officers during the year endedDecember 31, 2001.

 
| **Option  Grants in Last Fiscal Year Individual Grants** |   |                 |   |
|----------------------------------------------------------|--------|----------------------|--------|
| **Name**                                                 |   | **Options  Granted** |   | **% of Total  Options  Granted to  Employees  In Fiscal  Year** |   | **Exercise  Price  Per Share** |   | **Market  Price  on Date  of Grant** |   | **Expiration  Date** |   | **Potential  Realizable  Value at Assumed  Annual Rates of Stock  Price Appreciation  for Option Term** |   |
|                                                     |   |                 |   |   |   | **5%** |   | **10%** |   |
| Roberta Schneider                                        |   | 40,000               |   | 13.7 | % | $ | 12.50 |   | $ | 12.50 |   | 02/01/11 |   | $ | 314,400 |   | $ | 796,800 |   |
|                                                          |        |                      |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

50

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*OptionExercises and Year-End Values*

 

No stock options were exercisedby the Named Executive Officers during the year ended December 31,2001.  The following table sets forthcertain information regarding exercisable options held by each of the NamedExecutive Officers at the end of the year ended December 31, 2001.

 
|                |   | **Aggregated  Option Exercises in Last Fiscal Year and** |   |
|---------------------|--------|----------------------------------------------------------|--------|
|                |   | **Option  Values at Fiscal Year End**                    |   |
|                |   | **Number of Securities**                                 |   |   | **Value of Unexercised** |   |
|                |   | **Underlying Unexercised**                               |   |   | **In-the-Money Options** |   |
|                |   | **Options at December 31, 2001**                         |   |   | **at December 31, 2001 (1)** |   |
| **Name**            |   | **Exercisable**                                          |   | **Unexercisable** |   |   | **Exercisable** |   |   | **Unexercisable** |   |
| Thomas  R. Coolidge |   | 280,000                                                  |   | 100,000 |   | $ | 1,440,000 |   | $ | 450,000 |   |
| Fred  Wagner        |   | 146,667                                                  |   | 33,333 |   | $ | 840,002 |   | $ | 149,999 |   |
| Mario  Ehlers       |   | 46,667                                                   |   | 3,333 |   | $ | 250,002 |   | $ | 14,999 |   |
| David  Walker       |   | 16,667                                                   |   | 33,333 |   | $ | -0- |   | $ | -0- |   |
| Roberta  Schneider  |   | —                                                   |   | 40,000 |   | $ | -0- |   | $ | -0- |   |

 

----

(1)           Represents only options that were“in-the-money” on December 31, 2001. The value of unexercised options is calculated by determining thedifference between the fair market value of the shares underlying the optionsat December 31, 2001 and the exercise price of the options, times the number ofoptions outstanding.  For purposes ofmeeting applicable regulations, fair market value was determined based upon thelast sales price at which the Company sold Common Stock in a privateplacement.  The last sale occurred in1999.  There is no assurance that theCompany could currently sell Common Stock at this price.

 

***Compensation ofDirectors***

 

All directors hold officefor an indefinite term continuing until the next meeting of shareholders atwhich directors are elected. Non-employee directors are paid $1,000 per quarter and $1,000 permeeting attended, and are reimbursed for expenses and compensated forconsulting services.  In addition, thecurrent non-employee directors have received non-qualified stock options topurchase an aggregate of 70,000 shares of Common Stock at the fair market valueon the date of grant.

 

**ITEM12.  SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT**

 

##### **PRINCIPAL SHAREHOLDERS**

 

Thefollowing table sets forth certain information with respect to beneficialownership of the Company’s outstanding Common Stock, pursuant to therequirements of Item 403 of Regulation S-K under the Securities Act of 1933,and the Company’s outstanding voting stock (Common Stock and Series B, C, D, E,F, G and H Preferred Stock on an as converted basis) as of February 28, 2002,by (i) those shareholders known to be the beneficial owners of more than fivepercent of the Company’s outstanding capital stock, (ii) by each officer anddirector, and (iii) by all officers and directors as a group.  Except as otherwise noted, the Companybelieves

 

51

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thatall named persons have sole voting and sole investment power with respect tosuch shares.  The Series A PreferredStock normally has no voting rights.

* *
| **Name and Address or  Beneficial Owner**                                                                           |   | **Number of  Shares(1)(2)** |   | **Percent  (%) of  Shares(1)** |   | **Percent of  Shares on  As Converted Basis (1)** |   |
|---------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|--------|--------------------------------|--------|---------------------------------------------------|--------|
| Medtronic  International, Ltd.  710 Medtronic Parkway  Minneapolis, MN 55432                                        |   | 1,402,073                   | (5)    | 16.3                           | %      | 11.6                                              | %      |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| John N. Irwin III  405 Park Avenue  New York, NY 10022                                                              |   | 1,366,494                   | (3)    | 18.3                           | %      | 11.7                                              | %      |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| Thomas R. Coolidge  Beebe Hill Road  Falls Village,CT 06031                                                         |   | 913,429                     | (4)    | 11.8                           | %      | 7.6                                               | %      |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| Hillside Capital  Incorporated  405 Park Avenue  New York, NY 10022                                            |   | 860,885                     |   | 11.7                           | %      | 7.4                                               | %      |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| Rocky Mountain  Associates, S.A.  Calle 53, Urbanizacion Obarrio  Torre Swiss Bank, 16th Floor  Panama City, Panama |   | 699,999                     | (5)    | 8.7                            | %      | 6.0                                               | %      |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| EquityFourLife  (Bahamas) Ltd.  Ansbacher House, Bank Lane  PO Box N-7768  Nassau, Bahamas                          |   | 560,333                     | (5)    | 7.5                            | %      | 4.8                                               | %      |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| Ashleigh  W. Palmer                                                                                                 |   | 40,000                      |   | *                              |   | *                                                 |   |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| Fred  W. Wagner, Ph.D.                                                                                              |   | 354,819                     |   | 4.7                            | %      | 3.0                                               | %      |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| Mario  R.W. Ehlers, M.B., Ch.B, Ph.D.                                                                               |   | 50,000                      |   | *                              |   | *                                                 |   |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| David S. Walker                                                                                                     |   | 16,667                      |   | *                              |   | *                                                 |   |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| Roberta L.  Schneider, M.D.                                                                                         |   | 13,334                      |   | *                              |   | *                                                 |   |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| Walter R. Barry,  III                                                                                               |   | 20,000                      |   | *                              |   | *                                                 |   |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| Erich Sager                                                                                                         |   | 45,375                      |   |                           |   |                                              |   |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| Richard A. de  Souza                                                                                                |   | 5,000                       |   | *                              |   | *                                                 |   |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| William J.  Jenkins, M.D.                                                                                           |   | 5,000                       |   | *                              |   | *                                                 |   |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| Peter T. Tattle                                                                                                     |   | —                      |   | *                              |   | *                                                 |   |
|                                                                                                                |   |                        |   |                           |   |                                              |   |
| All officers and  directors   as a group  (11 persons)                                                         |   | 1,463,624                   |   | 18.0                           | %      | 11.9                                              | %      |

 

52

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----

*                                         Representsless than 1%

 

(1)                                  Thefirst column is based on the percentage of Common Stock deemed outstandingunder Rule 13d-3(d)(1) under the Exchange Act of 1934, and the second column isbased on (i) 7,379,408 shares of Common Stock (each with one vote per share)outstanding as of February 28, 2002, plus (ii) 4,189,687 votes based on thevoting rights of the outstanding shares of Series B, C, D, E, F, G and HPreferred Stock, which have voting power equal to the number of shares ofCommon Stock into which they are convertible. (Series A Preferred Stock normally has no voting rights.)

 

(2)                                  Includesthe following shares of convertible preferred stock and options which arecurrently exercisable or will become exercisable within 60 days of the date ofthis Form 10-K:  Mr. Coolidge -380,000 shares; Mr. Palmer — 40,000 shares; Dr. Wagner — 180,000shares; Dr. Ehlers — 50,000 shares; Mr. Walker — 16,667 shares; Dr. Schneider —13,334 shares; Mr. Barry — 20,000 shares; Mr. Sager — 45,375 shares;Mr. de Souza — 5,000 shares; Mr. Jenkins — 5,000 shares; and all officers anddirectors as a group — 755,376 shares. Mr. Tattle currently has no outstanding options.

 

(3)                                  Mr. Irwinis the Managing Director of Hillside Capital Incorporated.  Includes (i) 860,885 shares held by HillsideCapital Incorporated; (ii) 93,005 shares issuable upon an option from theCompany which is currently exercisable by Mr. Irwin; (iii) 40,584 sharesheld in trust for Mr. Irwin’s benefit; and (iv) 27,056 shares held by orfor the benefit of family members, as to which Mr. Irwin disclaimsbeneficial ownership.

 

(4)                                  Includes89,550****sharesheld by his spouse, as to which Mr. Coolidge disclaims beneficialownership.

 

(5)                                  Includes the following common stock purchasewarrants which are currently exercisable and subject to adjustment beginningJune 18, 2002:  Medtronic — 555,555warrants; Rocky Mountain — 166,666 warrants; and EquityFourLife — 83,333warrants.

 

**ITEM13.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

As described in Item 5,the Company entered into an $18 million loan agreement with various lenders inDecember 2001.  Mr. Sager, a member ofthe Company’s Board of Directors, is an executive officer of EquityFourLife(Bahamas) Ltd., which loaned $1.5 million to the Company pursuant to the LoanAgreement.

 

53

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Exhibit Index

 

### **PART IV**

 

**ITEM 14.****                            EXHIBITS,FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K**

 

(a)           Documents filed as part of thisreport.

 

(1)                                  FinancialStatements.  The financialstatements of the Company are listed at Item 8 of this Form 10-K.

 

(2)           Exhibits

 
| 3.1    | Certificate of  Incorporation of the Company as filed with the Delaware Secretary of State on  June 7, 1993. (1)                                                                                                                            |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                        |
| 3.2    | Amended and  Restated bylaws of the Company, dated April 25, 2000. (1)                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                        |
| 3.3    | Certificate of  Designation of Rights and Preferences of Series A Preferred Stock as filed  with the Delaware Secretary of State on August 30, 1993. (1)                                                                                    |
|   |                                                                                                                                                                                                                                        |
| 3.4    | Certificate of  Designation of Rights and Preferences of Series B Convertible Preferred Stock  as filed with the Delaware Secretary of State on December 5, 1994 and amended  with the Delaware Secretary of State on November 6, 1995. (1) |
|   |                                                                                                                                                                                                                                        |
| 3.5    | Certificate of  Designation of Rights and Preferences of Series C Convertible Preferred Stock  as filed with the Delaware Secretary of State on November 20, 1995. (1)                                                                      |
|   |                                                                                                                                                                                                                                        |
| 3.6    | Certificate of  Designation of Rights and Preferences of Series D Convertible Preferred Stock  as filed with the Delaware Secretary of State on June 3, 1996. (1)                                                                           |
|   |                                                                                                                                                                                                                                        |
| 3.7    | Certificate of  Designation of Rights and Preferences of Series E Convertible Preferred Stock  as filed with the Delaware Secretary of State on June 19, 1997. (1)                                                                          |
|   |                                                                                                                                                                                                                                        |
| 3.8    | Certificate of  Designation of Rights and Preferences of Series F Convertible Preferred Stock  as filed with the Delaware Secretary of State on May 28, 1998. (1)                                                                           |

 

54

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|    |                                                                                                                                                                             |
|---------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.9     | Certificate of  Designation of Rights and Preferences of   Series G Convertible Preferred Stock as filed with the Delaware  Secretary of State on  June 15, 1998.  (1) |
|    |                                                                                                                                                                             |
| 3.10    | Certificate of  Designation of Rights and Preferences of Series H Convertible  Preferred Stock as filed with the Delaware  Secretary of State on April 23, 2001. (4)        |
|    |                                                                                                                                                                             |
| 3.11    | Certificate of  Amendment to the Certificate of Incorporation of BioNebraska, Inc., as filed  with the Delaware Secretary of State on August 13, 2001. (4)                       |
|    |                                                                                                                                                                             |
| 10.1*   | BioNebraska, Inc. 1993  Stock Plan (1)                                                                                                                                           |
|    |                                                                                                                                                                             |
| 10.2*   | Employment Agreement  between the Company and Thomas R. Coolidge dated July 1, 1993. (1)                                                                                         |
|    |                                                                                                                                                                             |
| 10.3*   | Employment Agreement  between the Company and Fred W. Wagner, dated July 1, 1993. (1)                                                                                            |
|    |                                                                                                                                                                             |
| 10.4*   | Employment Agreement  between the Company and Mario Ehlers, dated March 1, 1998. (1)                                                                                             |
|    |                                                                                                                                                                             |
| 10.5    | Registration Rights Agreement  dated as of July 13, 1989 and amended as of November 22, 1989, between the  Company and certain security holders of the Company. (1)              |
|    |                                                                                                                                                                             |
| 10.6    | Lease Agreement between  the Company and Airport Authority of the City of Lincoln, Nebraska (1)                                                                                  |
|    |                                                                                                                                                                             |
|    | (a)                                                                                                                                                                              | Commercial Net Building  and Ground Lease of Lincoln Air Park executed November 16, 1998. |
|    |                                                                                                                                                                             |   |
|    | (b)                                                                                                                                                                              | Construction Agreement  entered into as of November 16, 1999. |
|    |                                                                                                                                                                             |   |
|    | (c)                                                                                                                                                                              | Lease Agreement between  the Airport Authority of the City of Lincoln, Nebraska and BioNebraska, Inc.,  dated November 18, 1999. |
|    |                                                                                                                                                                             |
| 10.7**  | Novation agreement  between the Company and the Board of Regents of the University of Nebraska  and Finnish Sugar Co., Ltd., dated effective January 1, 1989. (1)           |
|    |                                                                                                                                                                             |
| 10.8**  | License and Royalty  Agreement by and between the Company and Carlsberg A/S, Prof. Buchardt and  Dr. Henriksen, dated as of July 1, 1992. (1)                                    |
|    |                                                                                                                                                                             |
| 10.9**  | License Royalty and  Development Agreement by and between the Company and Carlsberg A/S dated as  of September 1, 1993. (1)                                                      |
|    |                                                                                                                                                                             |
| 10.10** | License Agreement  between the Company and PolyPeptide Laboratories dated February 17, 1997. (1)                                                                                 |
|    |                                                                                                                                                                             |

 

55

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| 10.11** | Settlement Agreement  among the Company, Cambridge Biotech Corporation, GRF Corporation and OT Company,  dated July 15, 1996. (1)                                               |
|---------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |                                                                                                                                                                            |
| 10.12   | Investment Agreement  between the Company and Medtronic, Inc. dated as of June 16, 1998. (1)                                                                               |
|    |                                                                                                                                                                            |
| 10.13   | Registration Rights  Agreement between the Company and Medtronic, Inc. dated as of June 16, 1998.  (1)                                                                          |
|    |                                                                                                                                                                            |
| 10.14   | Form of Warrant for  purchase of shares of Common Stock of the Company issued to R.J. Steichen  & Company on March 13, 1998. (1)                                            |
|    |                                                                                                                                                                            |
| 10.15   | Form of Incentive Stock  Option Agreement. (2)                                                                                                                                  |
|    |                                                                                                                                                                            |
| 10.16   | Form of Non-Qualified  Stock Option Agreement. (2)                                                                                                                              |
|    |                                                                                                                                                                            |
| 10.17   | Employment Agreement  between the Company and David S. Walker, dated as of May 15, 2000. (2)                                                                                    |
|    |                                                                                                                                                                            |
| 10.18   | Commercial Net Building  and Ground Lease of Lincoln Air Park West dated October 17, 2000, between the  Company and the Airport Authority of the City of Lincoln, Nebraska. (2) |
|    |                                                                                                                                                                            |
| 10.19   | Employment Agreement  between the Company and Roberta L. Schneider, dated as of February 06, 2001.  (4)                                                                         |
|    |                                                                                                                                                                            |
| 10.20   | Employment Agreement  between the Company and Ashleigh W. Palmer, dated as of December 20, 2001.  (4)                                                                           |
|    |                                                                                                                                                                            |
| 10.21   | Bridge Loan Agreement,  dated as of December 13, 2001, among Restoragen, Inc., Medtronic  International, Ltd. and various other lenders. (3)                                    |
|    |                                                                                                                                                                            |
| 10.22   | Form of Secured  Convertible Promissory Note issued to the lenders under the Bridge Loan  Agreement on December 18, 2001. (3)                                                   |
|    |                                                                                                                                                                            |
| 10.23   | Form of Security  Agreement dated December 18, 2001 between the Company and Medtronic  International, Ltd. as Agent. (3)                                                        |
|    |                                                                                                                                                                            |
| 10.24   | Form of Warrant issued  to the lenders under the Bridge Loan Agreement. (3)                                                                                                     |
|    |                                                                                                                                                                            |
| 21.1    | Subsidiaries of  Registrant (1)                                                                                                                                                 |

 

----

*                                         IndicatesCompensation Plan

 

56

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**                                  Certaininformation has been deleted from this exhibit and filed separately with theSecurities and Exchange Commission pursuant to a request for confidentialtreatment under Rule 24b-2.

 

(1)                                  Incorporatedby Reference from the BioNebraska, Inc. Registration Statement on Form 10, FileNo. 000-30493, as amended.

(2)                                  Incorporatedby Reference from the Company's Form 10-K filed with the Commission for theyear ended December 31, 2000.

(3)                                  Incorporatedby Reference from the Form 8-K filed with the Commission on December 18, 2001.

(4)                                  FiledHerewith

 

(b)           Reports on Form 8-K

 

The Company filed a Form8-K on June 22, 2001, attaching a letter to shareholders, which summarizedprogress in the Company’s medical programs, and a press release relating to theCompany’s name change.  No financialstatements were required to be filed with the Form.

 

The Company filed a Form8-K on December 18, 2001, describing a bridge loan transaction agreement, datedDecember 13, 2001, among Restoragen, Inc., Medtronic International, Ltd. andvarious other lenders.  Pursuant to abridge loan agreement, no financial statements were required to be filed withthe form.

 

57

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|   |   | **RESTORAGEN, INC.**         |
|--------|--------|------------------------------|
|   |   |                         |
|   |   |                         |
|   |   |                         |
|   |   | /s/  Ashleigh W. Palmer |   |
|   |   | By:                          | Ashleigh W.  Palmer |
|   |   |                         | Chief Executive Officer |
|        |        |                              |  |  |

 

Each person whosesignature appears below hereby constitutes and appoints Ashleigh W. Palmer andDavid S. Walker, and each of them his or her true and lawful attorney-in-factand agent, with full power of substitution, to sign on his or her behalf,individually and in each capacity stated below, all amendments andpost-effective amendments to this Form 10-K and to file the same, with allexhibits thereto and any other documents in connection therewith, with theSecurities and Exchange Commission, granting unto said attorneys-in-fact andagents full power and authority to do and perform each and every act and thingrequisite and necessary to be done in and about the premises, as fully and toall intents and purposes as each might or could do in person, hereby ratifyingand confirming each act that said attorneys-in-fact and agents may lawfully door cause to be done by virtue thereof.

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, this and on the date RegistrationStatement has been signed below by the following persons in the capacitiesindicated.

 

58

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| **Signature**                 |         | **Title**                 |           |   | **Date** |   |
|-------------------------------|--------------|---------------------------|----------------|--------|----------|--------|
|                          |         |                      |
| /s/ Ashleigh W. Palmer        |         | Chief Executive  Officer, | March 27, 2002 |
| Ashleigh W. Palmer            |         |                      |
|                          |         |                      |
| /s/ David S. Walker           |         | Chief Financial Officer   | March 27, 2002 |
| David S. Walker               |         |                      |
|                          |         |                      |
|                          |         | Non Executive Chairman    |           |
| Thomas R. Coolidge            | of the Board |                      |
|                          |         |                      |
| /s/ Walter R. Barry,  III     |         | Director                  | March 20, 2002 |
| Walter R. Barry, III          |         |                      |
|                          |         |                      |
| /s/ Richard A. deSouza        |         | Director                  | March 15, 2002 |
| Richard A. deSouza            |         |                      |
|                          |         |                      |
| /s/ William J. Jenkins,  M.D. |         | Director                  | March 25, 2002 |
| William J. Jenkins,  M.D.     |         |                      |
|                          |         |                      |
| /s/ Erich Sager               |         | Director                  | March 22, 2002 |
| Erich Sager                   |         |                      |
|                          |         |                      |
| /s/ Peter T. Tattle           |         | Director                  | March 26, 2002 |
| Peter T. Tattle               |         |                      |
|                          |         |                      |
| /s/ Fred. W. Wagner,  Ph.D.   |         | Director                  | March 21, 2002 |
| Fred W. Wagner, Ph.D.         |         |                      |
|                               |              |                           |                |        |          |        |  |

 

59

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