ISOTECHNIKA 2002 ANNUAL REPORT - University of Albertacsproat/Homework/ACCTG 311/Project 2... · PH.D., DIRECTOR, DRUG DISCOVERY ROBERT HUIZINGA DIRECTOR, CLINICAL RESEARCH PATRICK

I S O T E C H N I K A 2 0 0 2 A N N U A L R E P O R Tz

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RANDALL YATSCOFF PH.D., FCACB, PRESIDENT & CHIEF OPERATING OFFICER ROBERT FOSTER PH.D., CHAIRMAN & CHIEF EXECUTIVE OFFICER JOSEPH KOZIAK LLB, EXECUTIVE VICE PRESIDENT DANIEL TREPANIER

PH.D., DIRECTOR, DRUG DISCOVERY ROBERT HUIZINGA DIRECTOR, CLINICAL RESEARCH PATRICK MAYO PH.D., SENIOR SCIENTIST GORDON AGOPSOWICZ DIRECTOR, INVESTOR RELATIONS

DAVID KINNIBURGH PH.D., DIRECTOR, DIAGNOSTICS DEVELOPMENT & ANALYTICAL SERVICES DERRICK FREITAG PH.D., DIRECTOR, BIOPHARMACEUTICS DENNIS BOURGEAULT CA, CHIEF FINANCIAL OFFICER

LORRIE GIVEN MANAGER, REGULATORY AFFAIRS MARK ABEL PH.D., DIRECTOR, ORGANIC CHEMISTRY & DRUG SYNTHESIS LAUNA ASPESLET PH.D., RAC, VICE PRESIDENT, MEDICAL & REGULATORY AFFAIRS

Teamwork – driving Isotechnika forward Over the years we have

assembled a unique group of world-class pharmacologists, organic

chemists, pharmaceutical scientists, toxicologists, lawyers, marketers

and managers. These team members work as one, toward a common

goal of discovering, developing and commercializing treatments for

organ transplant patients and those who suffer from autoimmune

diseases. We all share a vision and have a strong sense of purpose

that drives us to work harder and has enabled us to progress faster

this year than we otherwise would have.

The year 2002 has been one of significant progress, and each member

of the Isotechnika team has been instrumental in moving the company

forward – from realizing the biggest biotech deal for a phase II

company in Canada’s history, to testing molecules that we believe

will someday become drugs that treat millions of patients. Everyone

at Isotechnika feels ownership of our lead drug candidate, ISA247, as

well as the company’s growth. Throughout this annual report you will

hear from seven of our team’s key players about the company’s past

successes and the vision towards which we all strive.

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Our team – unique expertise and deep understanding Isotechnika

has rare and profound knowledge in the area of transplantation.

Our significant expertise and deep understanding of cyclosporine

provided a uniquely promising starting point for our development

efforts; knowing the benefits and limitations of cyclosporine as a

molecule helped us engineer a new molecule that addresses these

specific challenges. ISA247 falls within the therapeutic window of

an acceptable margin of safety and efficacy for immunosuppression.

Isotechnika has always been committed to reaching our milestones

in a thorough and efficient manner. Our team’s skill set enabled us

to progress with relative speed and efficiency, advancing ISA247

through Phase II clinical trials for less than $30 million CAD. We firmly

believe ISA247 will revolutionize treatment for transplantation and

autoimmune diseases by increasing efficacy and decreasing toxicity,

compared to other drugs in this therapeutic class.

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Launa Aspeslet, Ph.D., RAC,

Vice President, Medical and Regulatory Affairs

Dennis Bourgeault, CA,

Chief F

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Being focused and making decisions quickly as a team That is

what has ensured that the Phase II clinical trials of ISA247 ran

smoothly. Patient enrollment for the Phase II psoriasis and Phase IIA

kidney transplantation clinical trials were successfully completed;

excitement from the scientific community about ISA247 was gener-

ated by preliminary trial data presented at key conferences.

Our clinical and regulatory teams are superb and constantly work with

trial sites to get things done quickly and to keep the FDA informed

at all times about our rapid development. We get involved early in

the drug discovery process, ensuring that all studies are conducted

and managed with regulatory issues in mind from the onset. Our

streamlined approach should benefit us as we move through the drug

approval process.

Achieving financial stability Obviously, the Roche partnership has

made a huge impact on our cash position. In total, the financial

contribution from Roche for 2002 amounted to $45.7 million com-

prised of equity investment, licensing and milestone payments, and

recovery of R&D expenses. Roche, as a partner for ISA247, provides

us with increased financial stability to meet our corporate goals,

including the development of other immunosuppressive drug

compounds. Heading into 2003, Isotechnika has a strong balance

sheet and a healthy financial outlook.

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Daniel Trepanier, Ph.D.,

Director, Drug Discovery

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Looking beyond ISA247 – creating new drugs As Isotechnika grows,

we seek to develop a portfolio of new immunomodulating drugs to ex-

pand the company’s pipeline and eventually, make those treatments

safer and more effective for patients. As 2002 progressed, our group

was able to focus on the development of new immunosuppressive

compounds. To meet the demands of our aggressive drug discovery

efforts, we have hired several well-qualified scientists to augment

our already strong team. We now have the expertise to delve even

deeper into how our target drug works, which enhances our ability to

rapidly identify new ways to screen for drugs. Our core team, having

vast expertise in immunomodulation, is central to our drug discovery

program. This team works closely with the organic chemists, using

results from screening to redesign potential compounds. This “back

and forth” process continues until a lead compound is selected for

pre-clinical studies.

Isotechnika’s relatively small size and entrepreneurial attitude

have freed us from the typical constraints of large pharmaceutical

organizations when looking for new drug candidates. And because

we have true in-house expertise in immunosuppressive drugs, we can

find novel compounds – like ISA247.

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Mark Abel, Ph.D.,

Director, Organic Chemistry and Drug Synthesis

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Working out the details – from the very beginning Our team continues

to approach the development of new drug candidate molecules the

same way we approached ISA247 – by moving quickly and working out

the details that allow us to effectively respond to the ever-changing

needs of a R&D program. Isotechnika’s chemists are involved in the

early stages of discovery by helping identify molecules of interest

and synthesizing small quantities of compounds for screening. Once

lead compounds are identified, our team then needs to shift gears, as

we start to look at how we can efficiently produce larger quantities

for continued development. Our in-house expertise and our experi-

ence with ISA247 leave us extremely well positioned for continued

development of new drug candidate molecules.

Isotechnika, developing more effective drugs What happens to a

drug after one takes it? How does the body get rid of it? Where does

the drug have its effect? A critical component of the drug discovery

process is to understand how the drug is handled by the body: A goal

of our team is to measure the activity of ISA247 at its site of action in

patients. This is how we have been able to determine ISA247’s potency.

Since people often take these drugs for the rest of their lives, we want

to measure these variables with a reliable, easy-to-use test in real

patients. By determining the “therapeutic window” where efficacy

can be achieved with minimal toxicity, a better drug can be produced.

It was Isotechnika’s goal to develop a drug that is more effective

than currently available treatments, with less toxicity. All evidence to

date demonstrates that ISA247 meets that goal.

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Joseph Kozia

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Roche – validating our technology Negotiating the collaboration

agreement with Roche was obviously both a personal and corporate

milestone in 2002. This deal provides Isotechnika with both financial

and pharmaceutical resources to continue the development of ISA247.

As true partners, we jointly decide on issues relating to the com-

mercialization of this product; we each bring our unique experience

and expertise to the table. Roche provides significant experience

in immunosuppression, as well as drug development, marketing,

clinical trial design and manufacturing. Isotechnika has expertise in

chemistry, regulatory and analytical skills focused in this field. The

combined and shared talents are a perfect fit, which we believe will

produce a better drug.

Prior to signing our joint development agreement, Roche conducted

very extensive due diligence, examining our science, our patent posi-

tion and all data on ISA247 available at that time. Our collaboration

lends credibility to the significance that this drug will have in the

pharmaceutical industry and to the quality of patients’ lives.

Going beyond ISA247, Isotechnika has positioned itself to take advan-

tage of the unique and changing landscape in the biopharmaceutical

market. The company is developing unique, patentable molecules for

clinical development. We are actively pursuing in-licensing activities

to broaden our product pipeline and are dedicated to expanding our

portfolio of compounds in clinical development while maintaining

our focus in immunosuppression and autoimmune diseases.

Highlights of Phase II studies in kidney transplant and psoriasis patients are shown in the following figures >

Isotechnika’s lead compound, ISA247, is a novel immunosuppressant designed to prevent transplant rejection and to treat autoimmune diseases. Pre-clinical animal studies demonstrated excellent potency combined w ith low toxicity suggesting this drug could have a wide therapeutic window in man. Phase I human studies in healthy volunteers confirmed excellent potency and tolerability.

2 - 10 years 4 years 1.5 years 1.5 years 3.5 years 2 years 1 year

Discovery Preclinical testing(lab and animal testing)

Phase I(20 - 30 healthy volunteers used to check for safety and dosage)

Phase II(100 - 300 patient volunteers used to check for efficacy and side effects)

Phase III(1,000 - 5,000 patient volunteers used to monitor reactions to long-term drug use)

FDA review and approval

Post-marketing testing

Faster than the industry average Isotechnika’s team approach is highly efficient and

we pride ourselves on the speedy development of ISA247. In only six years we have

brought ISA247 to Phase II clinical trials for both renal transplantation and psoriasis.

The industry average for bringing a compound to Phase II is approximately eight

years. We are moving at an accelerated speed, driven by passion for our work and

belief in our product – and we intend to continue this pace.

DRUG DISCOVERY PROCESS (INDUSTRY)*

*Source: Ernst and Young, Biotechnology Industry Report: Convergence, 2000

RENAL TRANSPLANTClinical Trials Phase IIAstart: 2 August 2001complete: 17 January 2003

PSORIASISClinical Trials Phase II start: 3 October 2001complete: 14 November 2002

Preclinical testing1997.06 - 2000.03

Phase I2000.03 - 2001.01

Discovery1997.01 - 1999.06

ISA247 in PsoriasisISA01-02 Psoriasis Area and Severity IndexISA247’s effectiveness is not limited to kidney transplant patients. ISA247 is demonstrating effectiveness against psoriasis, a skin disorder caused by a malfunction of the immune system. This slide shows how psoriasis patients improve after being treated with different amounts of ISA247 using the Psoriasis-Area-and-Severity-Index (PASI). This slide also shows that patients with blood concentrations in the range of 5-70ng of drug per ml of blood responded the best. As expected, patients not receiving drug (<5.0ng/ml, or placebo) had no improvement in their PASI scores.

0 14 28 42 56 70 84 98 112 126 140

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*Different from Baseline, p < 0.05, ANOVA, Bonferroni

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> 70 ng/mL < 5.0 ng/mL5 - 70 ng/mL

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[CsA] [ISA]

ISA247 and Cyclosporine PharmacokineticsConcentration vs Time (Mean ± SEM)This slide clearly demonstrates that lower blood concentrations of ISA247 are needed in treating stabilized renal transplant patients when compared to currently marketed Neoral.

Therapeutic Window of ISA247If ISA247 is more potent than cyclosporine a natural concern would be that it is more toxic. This slide shows the safety of ISA247. We refer to this enhanced safety, as a “therapeutic window”. By definition we have devel-oped a drug that can be dosed to achieve an optimum therapeutic effect with minimal deleterious effects on the kidney. This therapeutic window does not exist for other drugs within the class of “calcineurin inhibitors”.

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ISA247 and Cyclosporine Pharmacodynamics%Calcineurin Inhibition vs Time (Mean ± SEM)This slide illustrates the effect of ISA247 and cyclosporine on the human immune system, specifically on an enzyme called “calcineurin”. Calcineurin is one marker of immune system activity, and drugs like ISA247 that affect calcineurin are called “calcineurin inhibitors”. This slide confirms that even though ISA247 blood concentrations are lower than concentra-tions of cyclosporine, the effect of ISA247 on the immune system is the same. This demonstrates that ISA247 is at least three times more potent than Neoral, as adequate immune suppression only requires about 1/3 as much ISA247, compared with cyclosporine. Patients on ISA247 responded well to the drug, and no patients rejected their transplanted kidney.

ALL CLINICAL TRIAL PHOTOS SHOWN HERE ARE UNTOUCHED. THESE PHOTOS REPRESENT THE RESULTS OF ONE PATIENT ONLY AND SHOULD NOT BE CONSIDERED TO REPRESENT THE RESULTS OF ALL PATIENTS ENROLLED

IN THE CLINICAL TRIAL. THE STATIC GLOBAL ASSESSMENT IS A SCALE USED TO DETERMINE THE SEVERITY OF LESIONS ON A PSORIASIS PATIENT. THIS ASSESSMENT RATES THE SEVERITY OF THESE LESIONS ON A SCALE OF

ZERO TO FIVE, WHERE ZERO INDICATES NO LESIONS TO FIVE REPRESENTING THE WORST DEGREE. ACCORDINGLY, IT IS CONSIDERED BY THE FOOD AND DRUG ADMINISTRATION AS A PRIMARY ENDPOINT OF CHOICE.

Four-point Reduction / Post-treatmentFour-point Reduction / Pre-treatment

Two-point Reduction / Pre-treatment Two-point Reduction / Post-treatment

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Letter to the Shareholders

2002 was a very busy year for all of us here at Isotechnika. We completed Phase II

clinical trials for ISA247 – on time and cost-effectively. We increased our global

presence through presentations at international conferences where we were able

to showcase our scientific expertise and highlight the potential of ISA247. We

have aggressively expanded our drug discovery process to enhance our pipeline

of therapeutic products. We made key hires and we expanded our facilities to

meet our needs. And, we entered into the largest biotechnology deal in Canadian

history. All the while, our team was focused. We were focused on moving the

company forward and meeting the targeted goals needed to create sustainable

corporate growth.

It is probably clear to most of you that Isotechnika’s joint development partnership

with Roche is the major highlight of 2002 for our company. This deal was not only

the largest for the Canadian biotechnology industry; it was also one of the largest

global deals for an early Phase II drug. This indicates the significant potential

ISA247 offers as a safer and more effective treatment than other drugs in this class

for transplantation and autoimmune diseases. Roche evaluated the therapeutic

window for ISA247 and found preliminary evidence of an acceptable margin of

immunosuppression with no clinically serious side effects.

Isotechnika managed the Roche deal from start to finish. Apart from validating

our expertise in partnering negotiations, this collaboration has also provided us

with a wealth of knowledge and experience that will be invaluable as we continue

to grow and seek out new strategic collaborations that may be needed to support

our future corporate goals.

The total financial impact of our partnership with Roche is substantial. Isotechnika

will receive up to US$215 million in upfront and milestone payments. Roche will also

fund 70% of the Research & Development costs of ISA247. The potential market for

this class of drug is US$2.2 billion annually. When ISA247 is approved for marketing,

Isotechnika will also receive significant royalty payments. Most notably, from

a financial perspective, development of this drug is essentially self-sustaining,

allowing us to reallocate assets to focus on the critical process of expanding the

company’s pipeline of products.

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By the time you read this report, we will have completed Phase IIA trials of ISA247

in treatment of renal transplant and Phase II trials in treatment of psoriasis.

Preliminary data supports this drug’s potential to become one of the leading

immunosuppressive therapies in the prevention of organ rejection and in the

treatment of autoimmune diseases. To raise global awareness and to further

validate our drug development program through the independent recognition

of our peers, we continue to present our data at leading international scientific

conferences. During the year, we presented transplant data to the American Society

for Transplantation in Washington and to the Transplantation Society in Miami.

Interim psoriasis data was also presented at the International Dermatological

Conference in London. The feedback generated from these meetings indicates that

both the scientific and medical communities are excited about the potential of

ISA247 to treat patients.

Our goal is to additionally fill the pipeline with other compounds in the area of

immunosuppression. With the financial, development and manufacturing support

from Roche, we are able to free our assets to bring other compounds off the shelf

into aggressive pre-clinical development. We currently have a number of exciting

compounds that will complement the use of ISA247 in the area of transplantation

and autoimmune diseases. Our focus is to continue to use our unique expertise

to modify existing drugs and bring advanced therapeutics to market. We are

positioning Isotechnika to be a model of specialty pharmaceuticals.

In light of today’s marketplace, numerous opportunities exist for in-licensing

of other technologies. We are fortunate to have a very strong cash position,

which gives us the leverage we need to acquire strong technologies at good

value. Similarly, we will also evaluate mergers and acquisitions and in-licensing

opportunities that arise which complement our current pipeline. There are a

number of other transplant products that would complement ISA247, as well

as several immunomodulating products in the autoimmune disease fields that

would complement our core focus. We understand the importance of being in a

field that provides appropriate return on investment.

Coming into our 10th year, Isotechnika is proud to have again achieved the

timelines we indicated to our shareholders for completion of these trials. We have

met every milestone for the development of ISA247 from initial isolation until

now – all while spending less than $30 million CAD.

In this challenging market environment, we greatly appreciate the patience,

confidence and loyalty of our shareholders, and the total dedication and

commitment shown by our extraordinary employees. In the coming year, we intend

to build upon our accomplishments, and set and reach new goals that will move

the company forward to commercialization of its first product. Our focus remains

clear, our capabilities strong, and our potential limitless. For Isotechnika, the

future has never looked brighter.

Robert T. Foster, Ph.D. Randall W. Yatscoff, Ph.D., FCACBChairman and Chief Executive Officer President and Chief Operating Officer

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IsotechnikaBusiness Review & Financials

20 Management’s Discussion & Analysis

26 Consolidated Financial Statements

30 Notes to the Consolidated Financial Statements

43 Corporate Information

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Management Discussion and Analysisof Financial Condition and Results of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the audited consolidated financial statements and accompanying notes, which are prepared in accordance with generally accepted accounting principles in Canada (Canadian GAAP). The Management’s Discussion and Analysis provides information on the activities of Isotechnika Inc. (“Isotechnika” or the “Company”) on a consolidated basis and a comparison of the financial position and operating results for the years ended December 31, 2002 and December 31, 2001.

Overview

Isotechnika is an international biotechnology company headquartered in Edmonton, Alberta with additional operations in Arizona, USA and Barbados. The Company is focused on developing immu-nosuppressive drugs for use in organ transplant patients and in treating autoimmune diseases. Isotechnika’s lead product candidate, ISA247 is a novel, multi-platform drug currently under development for renal transplantation and psoriasis.

During 2002, a number of significant scientific and business developments have positioned the Company for further success.

On April 9, 2002 the Company entered into a strategic collaboration with F. Hoffmann-La Roche and Hoffmann-La Roche Inc. (collectively “Roche”) for the global co-development and commercial-ization of ISA247. This agreement represents the largest Canadian Phase 2 drug development deal between a large pharmaceutical company and a biotech company. Under the terms of the agreement, Isotechnika could receive up to an aggregate of $215 million USD comprised of license fees, development and commercial milestones, and equity investment. In addition, Roche is responsible for seventy percent of the shared development costs of ISA247, as defined by the Collaboration Agreement. The Company will also receive predetermined tiered, progressive sales-based royalties at escalating rates upon commercialization of ISA247.

In 2002, the total financial contribution from Roche amounted to $45.67 million comprised of development, milestone and option fee revenues of $17.28 million, $10.09 million in ISA247 development cost recoveries and $18.3 million in equity investment.

Throughout the year, Isotechnika has worked diligently and efficiently to advance ISA247 through the clinical development process. The Phase 2 human clinical trial for psoriasis was completed in November, 2002. On March 10, 2003, the Company released the final study data which showed very positive efficacy results and demonstrated that ISA247 met or exceeded all of the primary and secondary efficacy and safety endpoints of the study. The Phase 2A renal transplantation human clinical trial achieved full patient enrolment in 2002 with the last patient completing the trial in January, 2003. The data is currently being collated, verified and analysed with release of clinical results expected in the second quarter of 2003.

In 2002, the Company also commenced discovery stage research of additional novel, patentable immunosuppressive drug compounds that will complement the use of ISA247.

The financial position of the Company at December 31, 2002 is strong. Cash and short-term investments of the Company increased by $10.92 million to $64.20 million as at December 31, 2002 from $53.28 million as at December 31, 2001.

The strategic decision to sign the ISA247 Collaboration Agreement with Roche has considerably enhanced the Company’s financial and operating capabilities. The collaborative agreement will provide the Company with the necessary funds to cover its share of the future development costs of ISA247. It will also free up additional resources to develop other complementary immunosuppressive drug candidates, allowing the Company to build its pipeline more aggressively.

In summary, Isotechnika continues to make meaningful progress towards realizing its goal of building a leading edge, profitable company specializing in immunosuppressive drugs.

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Results of Operations

The Company’s operating results for 2002 were dramatically and positively impacted by the Roche collaboration as the consolidated net loss decreased to only $576,000 ($0.01 per share) in 2002 from $11.79 million ($0.23 per share) in 2001.

The significant reduction in the 2002 consolidated net loss when compared to 2001 was primarily attributable to the following:

Pursuant to the execution of the collaborative agreement on April 9, 2002 with Roche, the Company received an initial fee of $7.82 million.

In September, 2002 the Company also earned a scientific milestone under the terms of the agreement for the successful completion of a non-human toxicity study. The Company received an additional $6.28 million payment for this milestone.

The initial fee and the milestone payment have been recorded as revenue from Collaboration partner. Pursuant to the Company’s revenue recognition policy, revenue from Collaboration partner is recorded in accordance with the contingency adjusted performance model. As such, as the ratio of costs expended to total estimated development costs exceeded the ratio of revenue from the initial fee and milestone, to total initial and milestone fees under the agreement, none of the revenue was deferred.

Earlier in the year, on March 20, 2002, the Company signed an option agreement with Roche. As consideration for Roche to exercise its option to engage in advanced partnership discussions and enter an exclusive 45 day period to negotiate a definitive joint drug development agreement with the Company, Isotechnika received a $3.18 million option fee which was recorded as review and option fees revenue.

In addition, under the terms of the agreement related to funding of ISA247 development costs, Roche is responsible for seventy percent of eligible development costs as incurred by both parties. The Company and Roche reconcile joint development costs on a quarterly basis, and when it results in funding payments to Isotechnika, the Company records such amounts as development costs recovered from Collaboration partner and nets the recovery against research and development costs. For the year ended December 31, 2002 the ISA247 development costs recovered from Roche totalled $10.09 million.

Revenues

Revenues increased to $18.76 million for 2002 as compared to $7.01 million for 2001. Revenues from collaborative partner accounted for $14.10 million of the 2002 revenues as compared to nil for 2001. Review and option fees revenue for 2002 amounted to $3.18 million as compared to $4.71 million for 2001. The Company recorded as review and option fees revenue in 2002 the option fee from Roche of $3.18 million. In 2001, a $4.71 million non-refundable fee paid to Isotechnika in compensation for a review of ISA247 by a different pharmaceutical company was recorded as review and option fees revenue. Contract analysis and product sales revenues decreased to $1.48 million for 2002 as compared to $2.3 million for the year ended December 31, 2001. This decrease was primarily due to a decrease in Helikit breath kit and Isomax instrument sales to the Southeast Asia market resulting from license renewal delays in China, and reduced Middle East sales due to increased competition. The Company strategically has decided to focus its main efforts on development of speciality pharmaceuticals, such as ISA247 and not aggressively pursue increased diagnostic sales through increased investment of resources.

Expenses

Research and development

Net research and development expenses decreased by $2.22 million to $11.19 million for the year ended December 31, 2002 as compared to $13.41 million in 2001.

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Roche is responsible for seventy percent of shared ISA247 development costs incurred by Isotechnika, and Isotechnika is responsible for thirty percent of ISA247 development costs incurred by Roche, as defined, pursuant to the Collaboration Agreement. Roche’s seventy percent share of the eligible ISA247 development costs incurred by Isotechnika for the period April 9, 2002 (the date the agreement was signed) to December 31, 2002 totalled $11.84 million. Isotechnika’s thirty percent share of the eligible ISA247 development costs incurred by Roche from April 9, 2002 to December 31, 2002 amounted to $1.75 million. As such, the development costs recovered from Collaboration partner in 2002 totalled $10.09 million compared to nil in 2001.

Before the recovery from Roche, total research and development expenditures increased by $7.87 million to $21.28 million for the year ended December 31, 2002 compared to $13.41 million for the year ended December 31, 2001. The higher research and development expenditures were primarily attributable to increased expenditures in 2002 in conducting and completing the Phase 2 psoriasis and Phase 2A renal transplantation clinical trial studies for ISA247. The Phase 2 psoriasis trial was comprised of 201 patients with the last patient completed in November, 2002. The Phase 2A renal transplantation trial had 130 study patients, with the last patient enrolled in October, 2002 and completed in January, 2003. Research and development costs were also incurred in performing various non-clinical studies required for the ongoing advancement of ISA247, the costs of manufacturing ISA247 drug material for human clinical trials and other required preclinical studies. Research and development personnel costs increased due to salary increases, bonuses of $500,000 to certain key scientific and executive personnel upon the signing of the Roche Collaboration Agreement, and the hiring of fourteen additional scientists and technicians, allowing the Company to actively participate in the continued development of ISA247 with Roche and commence research and development of other new immunosuppressive drug compounds to complement the use of ISA247.

The Company, under an agreement with The National Research Council of Canada through the Industrial Research Assistance Program, received $269,000 in funding for research and development of its diagnostic breath kits and instruments in prior years (until March, 2000). The amount was repayable based on 1.5 % of the Company’s gross revenues to a maximum of $405,000. The Company has recorded $370,000 as research and development expense representing the balance owing under the agreement ($35,000 for 2001).

Corporate, administrat ion and market ing

Corporate, administration and marketing expenses increased by $2.96 million to $7.82 million for the year ended December 31, 2002 as compared to $4.86 million for the year ended December 31, 2001. The increase reflected the additional corporate and administrative expenses associated with negotiating the Roche Collaboration Agreement. These additional costs included executive bonus payments of $900,000 to compensate the executive team for the successful completion of the Roche agreement. The Roche agreement was negotiated by the executive team which eliminated the need to pay negotiation fees and commissions to third parties. The compensation was determined and approved by the Board of Directors with recommendations from a third party consultant. Professional fees including legal, accounting and consulting fees of approximately $500,000 were incurred in the process of reviewing and completing the agreement. Other specific costs which have increased corporate, administration and marketing expenses include the new head office facility, which the Company moved into on February 15, 2002, higher personnel costs attributable to salary increases, increased staff levels and direct costs such as travel related to working jointly with a Collaboration partner. Increased business development and investor relation activities have also contributed to higher corporate, administration and marketing costs in 2002 as compared to 2001.

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Other income (expenses)

Investment income of $1.69 million in 2002 was consistent with the amount reported in the previous year. Investment income remained unchanged as the income earned from the higher cash balances achieved in 2002 was offset by lower portfolio returns due to declining interest rates. The Company expects that in the coming year, investment performance will continue to reflect similar returns.

The Company recorded a foreign exchange translation gain of $250,000 for the year ended December 31, 2002 compared to loss of $14,000 for the year ended December 31, 2001, primarily as a result of foreign exchange gains on US dollar denominated holdings of cash and short-term investments in 2002. As at December 31, 2002, US denominated cash and cash equivalents and short-term invest-ments amounted to $26.29 million. As such, a change in the Canadian and the US dollar foreign currency rates can affect the Company’s operating and financial results.

Capita l expenditures

Capital expenditures on property and equipment were $8.59 million for the year ended December 31, 2002 as compared to $1.23 million for the year ended December 31, 2001.

Capital expenditures for the year ended December 31, 2002 included $4.49 million in lease-hold improvements and fixtures related to the Company’s new leased laboratory facility in south Edmonton. This new facility provides the scientific personnel with the space and facilities needed to carry out the ongoing clinical development work on ISA247 in conjunction with Roche, and expand the research efforts to develop additional immunosuppressive drugs designed to be used in combination with ISA247. The Company moved into this facility in December, 2002.

During the year, the Company purchased its existing laboratory facility for approximately $565,000 rather than entering into the required lease renewal with the previous landlord. This property was sold in December, 2002 subsequent to the Company moving into its new leased premises. A gain of $30,000 was recorded from the sale of the property.

The Company also acquired a one-eighth fractional ownership interest in a corporate airplane for $1.99 million. This acquisition provides the Company with access to transportation for its executives and staff where commercial air travel is not efficient, effective or practically feasible, such as when conducting investor road shows.

With the advancement of ISA247 and the discovery, research and development of new immuno-suppressive drug compounds, required scientific equipment totalling $980,000 was also purchased during 2002. A $441,000 Sciex triple quad mass spectrometer unit purchased under a capital lease arrangement, and reflected as an obligation under capital lease on the balance sheet, was the largest scientific piece of equipment acquired.

Liquidity and Capital Resources

As at December 31, 2002, the Company had cash and short-term investments of $64.20 million compared to cash and short term investments of $53.28 million as at December 31, 2001, an increase of $10.92 million.

The Company’s net cash used in operating activities for the year ended December 31, 2002 amounted to $1.34 million as compared to net cash used of $11.54 million for the year ended December 31, 2001. The improvement in net cash from operating activities reflected the reduction of the net loss to $576,000 in 2002 as compared to $11.79 million for the year ended December 31, 2001. This improvement was primarily from the $17.28 million in revenues earned from Roche in 2002 and the $10.09 million recovery of ISA247 development costs from Roche in 2002.

24 25

Accounts receivable increased to $3.51 million as at December 31, 2002 as compared to $616,000 as at December 31, 2001 due to the net $2.96 million receivable from Roche for their share of the ISA247 development costs not paid as at December 31, 2002 but approved as defined by the Collaboration Agreement. Accounts payable and accrued liabilities increased to $4.50 million as at December 31, 2002 as compared to $2.63 million as at December 31, 2001. The accounts payable and accrued liabili-ties as at December 31, 2002 included a non recurring $1.31 million payable to a construction company for completing the leasehold improvements at the new laboratory facility in Edmonton.

Significant uses of cash included $7.28 million for property and equipment purchases and $701,000 in capitalized patent and patent application costs.

Financing activities included the issuance of shares during the year. Share capital of the Company increased by $19.42 million to $107.18 million as at December 31, 2002 as a result of the following:

In conjunction with the Development Collaboration and Licensing Agreement signed with Roche on April 9, 2002, the Company issued 3.19 million shares to Roche at a price of $4.25 per common share for gross proceeds of $13.55 million. The Company also issued 3.01 million warrants that entitle the holder (Roche) to acquire one common share per warrant at an exercise price of $4.50 until June 30, 2003. Roche is required to exercise the warrants within thirty days of the Company achieving a specific milestone, as specified in the Collaboration Agreement. The fair value of the warrants, using the Black-Scholes option pricing model was determined to be $1.53 million. As such $1.53 million of the total equity subscription of the $13.55 million has been allocated to the warrants with the remainder of $12.02 million allocated to common shares.

Earlier in March, 2002 the Company had issued 1.19 million shares to Roche at a price of $4.00 per common share for gross proceeds of $4.75 million as partial consideration for Roche to exercise its option to engage in advanced partnership discussions and enter an exclusive 45 day period to negotiate a definitive joint drug development agreement with the Company.

The Company also issued 661,250 shares on the exercise of 661,250 stock options for proceeds of $1.59 million in 2002.

On September 26, 2002 the Company received approval for a Normal Course Issuer Bid allowing the Company to repurchase up to 2 million common shares, representing 3.07% of its issued and out-standing common shares during the period September 30, 2002 to September 29, 2003, at market price at the time of the purchase. All common shares acquired by the Company pursuant to the Normal Course Issuer Bid will be cancelled by Isotechnika. In 2002, the Company repurchased, for cancellation, 109,200 shares at an average price of $2.95 per common share.

Share issue costs for 2002 amounted to $291,000.

As at December 31, 2002, the Company had 65.26 million shares issued and outstanding as compared to 60.33 million shares as at December 31, 2001.

Outlook

Management believes that the Company’s position, together with anticipated cash inflows from its collaborative partner, investment income and revenues from its diagnostic division will be sufficient to meet working capital and capital requirements for at least the next two years. Isotechnika’s funding needs may, however, vary depending upon a number of factors including progress of Isotechnika’s research and development programs and the number and breadth of these programs, the costs associated with completing clinical studies and the regulatory process, collaborative and license agreements with third parties, Isotechnika’s potential decision to in-license or acquire additional products for development, competing technological and market developments, prosecuting and enforcing Isotechnika’s patent claims and other intellectual property rights. In the future, Isotechnika may need to raise additional funds to continue its research and development programs and to commence or to continue the preclinical studies and clinical trials necessary to obtain regulatory or marketing approval for ISA247 or new drug products. There can be no assurance that such funds will be available on favorable terms, if at all.


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Risks and Uncertainties

The future performance of Isotechnika is impacted by a number of important factors, including in the short term, its ability to continue to generate positive cash flow from operations and equity financing and the continued positive status of its Collaboration Agreement with Roche, and longer term, its ability to generate royalty or other revenues from licensed technology and bring new products to the market. The Company’s future success will require efficacy and safety of its products and regulatory approval for these products. Future success of commercialization of any product is also dependant on the ability of the Company to obtain patents, enforce such patents and avoid patent infringement.

The Company maintains clinical trial liability and product liability insurance; however, it is possible that this coverage might not provide full protection against all risks.

The Company’s investment earnings are exposed to financial market risks arising from volatility in interest and foreign currency exchange rates. The Company has exposure to exchange risk, as the Company earns a significant portion of its revenues in U.S. dollars (collaboration revenues and diag-nostic product sales) and incurs a significant portion of its expenses in U.S. dollars, (e.g., clinical development costs and subsidiary operations. As at December 31, 2002, the Company had U.S. denominated cash and short term investments amounting to $26.29 million. The Company does not currently engage in hedging or use derivatives to reduce financial risk. Interest rate risk is the exposure of interest revenue and expense to rate fluctuation; inflation risk is loss of purchasing power due to rising prices. Economic forecasts project a stable outlook for both inflation and interest rates in the near future; therefore, risks are expected to be negligible.

Isotechika’s share price is subject to equity market price risk, which may result in significant speculation and volatility of trading due to the uncertainty inherent in the Company’s business and the biotechnology industry. The expectations of securities analysts about the Company’s financial or scientific results could have a significant effect on the trading price of the Company’s shares.

Forward-Looking Statements

Except for historical information, certain matters discussed in this document are by their nature forward-looking and are therefore subject to risks and uncertainties, which may cause actual results to differ materially from the statements made. Various factors could cause actual results to differ materially from those projected or discussed in forward-looking statements. Such risks and uncer-tainties include, among others, the availability of funds and resources to pursue research and development projects, the potential of ISA247, the success and timely completion of clinical studies and trials, the Company’s ability to successfully commercialize ISA247, the inability of the Company to defend its patents from infringement by third parties, and the risk that the Company’s patents may be subsequently shown to be invalid or infringe the patents of others. Although the Company believes that the forward-looking statements contained herein are reasonable, it can give no assurance that the Company’s expectations are correct. Investors are cautioned against placing undue reliance on forward looking statements.

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Management Report

The accompanying consolidated financial statements of Isotechnika Inc. and all information in the annual report are the responsibility of management and have been approved by the Board of Directors.

The financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles. The financial statements include some amounts that are based on best estimates and judgements of management. Financial information used elsewhere in this annual report is consistent with that in the financial statements.

Management of the Company maintains a system of internal controls to provide reasonable assurance as to the reliability of financial information and the safeguarding of assets.

The Board of Directors is responsible for ensuring that management fulfils its responsibilities for financial reporting and internal controls principally through its Audit Committee. The Audit Committee is appointed by the Board and consists of four members, all of whom are not involved in the daily operations of the Company. The Committee meets quarterly with the management and the external auditors to discuss internal controls over the financial reporting process and financial report-ing issues, to make certain that each party is properly discharging its responsibilities and to review quarterly reports, the annual report and the annual financial statements. The Committee reports its findings to the Board for consideration when approving the financial statements for issuance to the shareholders. The Company’s auditors have full access to the Audit Committee, with and without management being present.

These financial statements have been audited by the Company’s auditors, PricewaterhouseCoopers LLP.

Robert Foster, M.Pharm., Ph.D. Dennis Bourgeault, C.A.

Chairman and Chief Executive Officer Chief Financial Officer

We have audited the consolidated balance sheets of Isotechnika Inc. as at December 31, 2002 and 2001 and the consolidated statements of operations, deficit and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our respon-sibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 2002 and 2001 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles.

Chartered AccountantsFebruary 14, 2003Edmonton, Canada

Auditors’ Report to the Shareholders of Isotechnika Inc.

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Consolidated Balance Sheets(expressed in thousands of Canadian dollars)

As at December 31, 2002 and 2001 2002 2001

ASSETSCurrent assets Cash and cash equivalents $ 31,252 $ 49,037 Short-term investments (quoted market value – $32,971; 2001 – $4,392) 32,952 4,239 Accounts receivable (note 4) 3,512 616 Inventories (note 5) 813 870 Prepaid expenses and other 471 938 69,000 55,700

Property and equipment (note 6) 8,993 1,935Patents (note 7) 1,791 1,368 $ 79,784 $ 59,003

LIABILITIES Current liabilities Accounts payable and accrued liabilities (note 8) $ 4,503 $ 2,629 Current portion of long-term debt and obligations under capital leases (note 9) 206 113 4,709 2,742Long-term debt and obligations under capital leases (note 9) 203 91 4,912 2,833

Commitments (note 10)

SHAREHOLDERS’ EQUITYShare capital (note 11) 107,184 87,761Deficit (32,312) (31,591) 74,872 56,170 $ 79,784 $ 59,003

(The accompanying notes are an integral part of these financial statements)

Approved by the Board

M. Douglas Walker Donald SchurmanDirector Director

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Consolidated Statements of Operations(expressed in thousands of Canadian dollars, except per share amounts)

For the Years ended December 31, 2002 and 2001 2002 2001

Revenue Revenue from Collaboration partner (note 2) $ 14,097 $ — Review and option fees (note 2) 3,180 4,710 Contract analysis and product sales 1,484 2,301 18,761 7,011

Expenses Research and development 21,281 13,409 Development costs recovered from Collaboration partner (note 2) (10,094) — 11,187 13,409 Corporate, administration and marketing 7,818 4,861 Contract analysis and product sales 1,080 1,597 Amortization 1,072 527 Interest on long-term debt and obligations under capital leases 33 12 21,190 20,406

Operating loss (2,429) (13,395)

Other income (expenses) Investment income 1,688 1,692 Foreign exchange translation gains (losses) 250 (14) Gain on sale of property and equipment 28 17 1,966 1,695Net loss before capital taxes (463) (11,700)Capital taxes (note 14) 113 88Net loss for the year (576) (11,788)

Basic and diluted loss per share (note 13) (0.01) (0.23)

Consolidated Statements of Deficit(expressed in thousands of Canadian dollars)


Balance – Beginning of year $ 31,591 $ 19,803 Net loss for the year 576 11,788 Cost of common shares repurchased in excess of stated capital 145 —Balance – End of year $ 32,312 $ 31,591


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CASH PROVIDED BY (USED IN)Operating activities Net loss for the year $ (576) $ (11,788) Items not affecting cash Amortization 1,072 527 Gain on sale of property and equipment (28) (17) 468 (11,278) Net change in other operating assets and liabilities (note 17) (1,806) (258) (1,338) (11,536)

Investing activities (Purchase) sale of short-term investments (28,713) 5,695 Purchase of property and equipment (7,280) (1,233) Proceeds on sale of property and equipment 764 102 Patents (701) (571) (35,930) 3,993

Financing activities Issuance of share capital 19,601 48,370 Purchase of share capital (323) — Proceeds from long-term debt and capital leases 441 120 Repayment of long-term debt and capital leases (236) (79) 19,483 48,411

(Decrease) increase in cash and cash equivalents (17,785) 40,868

Cash and cash equivalents – Beginning of year 49,037 8,169Cash and cash equivalents – End of year $ 31,252 $ 49,037

Supplementary cash flow information Interest paid $ 33 $ 12

Capital taxes paid $ 159 $ 16


Consolidated Statements of Cash Flows(expressed in thousands of Canadian dollars)

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1 Nature of operations

Isotechnika Inc. (the “Company”), incorporated under the Business Corporations Act of Alberta, is an international biotechnology company, which is in the business of developing immunosuppressive drugs for the prevention of organ rejection and for the treatment of autoimmune diseases. It also develops, licenses and sells diagnostic products and services.

2 Development Collaboration and Licensing Agreement

During 2002, the Company earned $17,277,000 in revenue and received $18,300,000 in equity investment from F. Hoffman-La Roche (“Roche”). The Company also recovered $10,094,000 in net research and development costs from Roche for a total contribution from Roche of $45,671,000.

On March 20, 2002, the Company signed an option agreement with Roche. As consideration for Roche to exercise its option to engage in advanced partnership discussions and enter an exclusive 45-day period to negotiate a definitive joint drug development agreement with the Company, Isotechnika received a $3,180,000 option fee, which has been recorded as review and option fees revenue. The Company also received, under the terms of a subscription agreement between Roche and the Company, an equity investment from Roche of $4,755,000 by the issuance of 1,188,675 common shares at $4.00 per common share.

On April 9, 2002, the Company entered into a Development Collaboration and Licensing Agreement (the “Collaboration Agreement”) with Roche for the global co-development and commercialization of the Company’s innovative immunosuppressive drug, ISA247. Under the terms of the Collaboration Agreement, Roche has the worldwide exclusive right to manufacture, market and sell the ISA247 product. The terms of the Collaboration Agreement provide for equity investments, milestone payments and sales based payments.

Pursuant to the execution of the Collaboration Agreement with Roche, the Company received an initial fee of $7,817,000. The Company also received, pursuant to the terms of a share subscrip-tion agreement with Roche, an additional equity investment of $13,545,000 from Roche by issuing 3,187,200 common shares at $4.25 per common share. In conjunction with the share subscription agreement, the Company issued 3,010,033 warrants entitling Roche to acquire one common share per warrant at an exercise price of $4.50 per common share until June 30, 2003. Roche is required to exercise the warrants within 30 days of the Company achieving a specific milestone as specified in the Collaboration Agreement.

In September 2002, the Company achieved a scientific milestone under the terms of the Collaboration Agreement for the successful completion of a non-human toxicity study. The Company received a $6,280,000 payment for this milestone.

The initial fee and milestone payment have been recorded as revenue from Collaboration partner. As the ratio of costs expended to total estimated development costs exceeded the ratio of revenue from the initial fee and milestone, to total initial and milestone fees under the agreement, none of the revenue was deferred.

Under the terms of the Collaboration Agreement related to funding of ISA247 development costs, Roche is responsible for 70% and Isotechnika is responsible for 30% of eligible development costs incurred by both Roche and Isotechnika as defined in the Collaboration Agreement. The Company and Roche reconcile joint development costs on a quarterly basis. The Company records such amounts as development costs recovered from Collaboration partner and nets the recovery against research and development costs. For the year ended December 31, 2002, the recovery of ISA247 development costs from Roche totalled $10,094,000.

Notes to Consolidated Financial Statements

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3 Significant accounting policies

Use of est imates

The consolidated financial statements have been prepared by management in accordance with accounting principles generally accepted in Canada. Because the precise determination of certain assets and liabilities is dependent upon future events, the preparation of these consolidated financial statements necessarily includes the use of estimates and approximations, which have been made using careful judgement. Actual results could differ from those estimates. The consolidated financial statements have, in management’s opinion, been prepared within reasonable limits of materiality and within the framework of the accounting policies summarized below.

Basis of consol idat ion

These consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Isodiagnostika Inc., Isotechnika US Inc., Isotechnika International Inc. and Isoleasing Inc.

Translat ion of foreign currencies

Foreign subsidiaries are considered financially and operationally integrated and are translated using the temporal method. The monetary assets and liabilities of Canadian operations and integrated foreign operations are translated into Canadian dollars at rates of exchange in effect at the end of the year. Revenues and expenses are translated at average rates of exchange during the year. Non-monetary assets and liabilities of integrated foreign operations are translated at historical rates of exchange. Exchange gains and losses arising on translation are included in earnings.

Revenue recognit ion

Revenue from the contract analysis and product sales is recognized upon performance of the service or delivery of the product when persuasive evidence of an arrangement exists, the price is fixed or determinable and collection is reasonably assured.

Revenue from Collaboration partner is recorded in accordance with the contingency-adjusted performance model. Payments received under this type of arrangement may include the following: non-refundable fees at the inception of the contract for prior research and technology rights; funding for services performed; milestone payments for specific achievements; and, payments based upon resulting sales of products. The Company recognizes collaborative research and development revenues as services performed consistent with the performance requirements of the contract. Revenue from non-refundable contract fees is deferred and recognized ratably over the development period based on the ratio of costs expended to total estimated development costs. Revenue from performance milestones is recognized upon achievement of the milestones as specified in the agreement, provided payment is proportionate to the effort expended as measured by the ratio of costs expended to total estimated development costs. The period and estimated cost of development are reviewed on a regular basis.

Review and option fees consist of deposits received in conjunction with intellectual property reviews by potential partners. These deposits are deferred until it is confirmed that they are not refundable.

Cash and cash equivalents

Cash and cash equivalents consist of cash on deposit and highly liquid money market securities and investment deposits, which are readily convertible into cash.

Short-term investments

Short-term investments comprise Government of Canada, provincial government, United States government and corporate bonds rated A or above with maturities ranging from April 7, 2003 to September 1, 2005 and are recorded at the lower of cost and quoted market value. Gains and losses on disposal of short-term investments are included in investment income in the period of realization.


32 33

Inventor ies

Inventories consist of diagnostic products and are recorded at the lower of cost, on a specific item basis or first in, first out basis depending on the nature of the item, and net realizable value.

Property and equipment

Property and equipment are recorded at cost net of investment tax credits. Amortization is provided over the estimated useful lives of the assets using the straight-line method at the following annual rates:

Building 5%Leasehold improvements Term of the lease plus one renewalAirplane fractional ownership interest 5%Scientific equipment 20%Scientific equipment under capital lease Term of the leaseOffice equipment and furniture 20%Computer equipment and software 33.3%Automotive equipment 20%

Patents

Patents consist of expenditures on specific patent applications. If the patent application is success-ful, the costs incurred on that application are amortized straight-line over a fifteen-year useful life, commencing in the year of the grant of the patent. If a patent application is rejected or the specific technology is no longer considered commercially viable, the costs incurred on that application are expensed at that time.

Research and development

Research costs are expensed in the period incurred. Development costs are also expensed in the period incurred unless technical and market viability of a development project has been established. No development costs have been deferred to date.

Under the terms of the Collaboration Agreement related to funding of ISA247 development costs, Roche is responsible for 70% and Isotechnika is responsible for 30% of eligible development costs incurred by both Roche and Isotechnika as defined in the Collaboration Agreement.

Net development costs recovered from Collaboration partner are offset against research and development expenses.

Future income taxes

The Company follows the liability method of income tax allocation. Under this method, future income taxes are recognized for the future income tax consequences attributable to differences between the carrying values of assets and liabilities and their respective income tax basis. Future income tax assets and liabilities are measured using substantively enacted income tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. The effect on future income tax assets and liabilities of a change in rates is included in earnings in the period that includes the date of substantial enactment. Future income tax assets are recorded in the financial statements if realization is considered more likely than not.


32 33


Loss per share

Loss per share is based on the weighted average number of common shares outstanding during the year. Diluted earnings (loss) per share is calculated using the treasury stock method. Under the treasury stock method, deemed proceeds from the exercise of options and warrants whose exercise prices are below the average market price of the shares, are considered to be used to reacquire common shares at the average market price during the year.

Commencing January 1, 2001, the Company adopted the treasury stock method for calculating diluted earnings (loss) per share in accordance with Section 3500 of the Canadian Institute of Chartered Accountants Handbook.

Stock-based compensat ion

The Company grants stock options to executive officers, directors, employees, consultants and scientific advisory board members pursuant to a stock option plan. Effective January 1, 2002, the Company adopted new CICA Handbook Section 3870 stock-based compensation and other stock-based payments. Consistent with the Company’s prior accounting policy for stock based compensation, the Company does not recognize compensation expense on the issuance of stock options to executive officers, directors, employees, consultants and scientific advisory board members under the stock option plan. The Company accounts for these stock options in its financial statements by crediting any consideration paid by the executive officers, directors, employees and scientific advisory board members to share capital, and not recognizing compensation expense. However, awards of stock options of warrants to non-employees will be accounted for in accordance with the fair value method of accounting for stock-based compensation, and will result in compensation expense when issued.

4 Accounts receivable

(in thousands of Canadian dollars) 2002 2001

Receivable from Collaboration partner $ 2,955 $ —Trade receivables 230 374Commodity taxes receivable 283 238Other 44 4 $ 3,512 $ 616

5 Inventories


Raw materials $ 239 $ 176Work in process 72 139Finished goods 502 555 $ 813 $ 870

Inventories consist of diagnostic products.

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6 Property and equipment

(in thousands of Canadian dollars) 2002

Accumulated

Cost amortization Net

Building and leasehold improvements $ 5,111 $ 171 $ 4,940Airplane fractional ownership interest 1,987 75 1,912Scientific equipment 1,701 790 911Scientific equipment under capital lease 575 108 467Office equipment and furniture 649 162 487Computer equipment and software 556 285 271Automotive equipment 30 25 5 $ 10,609 $ 1,616 $ 8,993

(in thousands of Canadian dollars) 2001

Accumulated

Cost amortization Net

Building and leasehold improvements $ 670 $ 112 $ 558Scientific equipment 1,641 1,036 605Scientific equipment under capital lease 272 63 209Office equipment and furniture 386 146 240Computer equipment and software 437 128 309Automotive equipment 30 16 14 $ 3,436 $ 1,501 $ 1,935

During the year, amortization of $794,000 (2001 – $483,000) was recorded.

7 Patents


Cost of patent applications $ 2,250 $ 1,663Less: Accumulated amortization 459 295 $ 1,791 $ 1,368

During the year, amortization of $278,000 (2001 – $44,000) was recorded.

8 Accounts payable and accrued liabilities


Trade payables $ 2,188 $ 1,839Construction payable 1,308 —Accrued liabilities 1,007 790 $ 4,503 $ 2,629

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9 Long-term debt and obligations under capital leases


Various leases with combined monthly payments of $19,827,due from June, 2003 to April 1, 2005, collateralized by specificequipment with a net book value of $467,000 (2001 – $209,000) $ 399 $ 186

Finance contract, payable in monthly installments of $684including interest at .99%, collateralized by automotive equipmentwith a net book value of $5,000, due April 10, 2004 10 18 409 204Less: Current portion 206 113 $ 203 $ 91

Future annual principal payments required to retire the lease obligations and debt are as follows:


2002 $ - $ 1132003 206 892004 150 22005 53 — $ 409 $ 204

10 Commitments

Operat ing lease commitments

Future minimum lease payments required in each of the next five years and in total under operating leases for office premises and equipment are as follows:

(in thousands of Canadian dollars)

2003 $ 7272004 6452005 6602006 6732007 283 $ 2,988

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11 Share capital

Authorized – Unlimited number of common, voting shares Issued and outstanding

(in thousands of Canadian dollars except share amounts) Common shares Warrants Total

# $ # $ $

Balance – December 31, 2000 46,248,544 39,391 6,887,502 — 39,391Issue of special warrants — — 5,700,000 23,415 23,415Shares issued for cash pursuant to exercise of warrants 12,587,502 46,507 (12,587,502) (23,415) 23,092Issue of compensation warrants — — 285,000 — —Shares issued on exercise of stock options 1,495,733 1,863 — — 1,863Balance – December 31, 2001 60,331,779 87,761 285,000 — 87,761Shares issued in private placement to Roche (note 2) 1,188,675 4,755 — — 4,755Shares and warrants issued in private placement to Roche (note 2) 3,187,200 12,016 3,010,033 1,529 13,545Shares issued on exercise of stock options 661,250 1,592 — — 1,592Shares repurchased and cancelled (109,200) (178) — — (178)Share issue costs — (291) — — (291)Balance – December 31, 2002 65,259,704 105,655 3,295,033 1,529 107,184

Compensat ion warrants

Pursuant to a special warrant offering which closed on July 19, 2001, the underwriters were granted 285,000 Compensation Warrants that entitle the holders to acquire one common share until February 28, 2003 at an exercise price of $4.70. At December 31, 2002, these Compensation Warrants remain unexercised.

Warrants issued to Col laborat ion partner

Pursuant to the Share Subscription Agreement (note 2), the Company issued 3,010,033 warrants that entitle Roche to acquire one common share per warrant at an exercise price of $4.50 per common share until June 30, 2003. Roche is required to exercise the warrants within 30 days of the Company achieving a specific milestone as specified in the Collaboration Agreement. The fair value attributed to the warrants using the Black-Scholes option pricing model was $1,529,000. As such, $1,529,000 of the total equity subscription by Roche of $13,545,000 has been allocated to the warrants. At December 31, 2002, these warrants remain unexercised.

Escrow agreements

At December 31, 2002, a total of 4,632,089 common shares of the Company are held in escrow for regulatory purposes and will be released on August 18, 2003.

Normal Course Issuer Bid

On September 26, 2002, the Company received approval for a Normal Course Issuer Bid allowing the Company to repurchase up to 2 million common shares, during the period of September 30, 2002 to September 29, 2003 at the market price at the time of the purchase. All common shares acquired by the Company pursuant to the Normal Course Issuer Bid will be cancelled by Isotechnika. During 2002, the Company purchased 109,200 common shares at an average price of $2.95 per share. The excess of the purchase price over the net book value of the common shares has been charged to the deficit.

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Stock opt ion plan

The Company has a stock option plan under which it can grant to its directors, officers, employees, scientific advisory board members and consultants non-transferable options for the purchase of common shares. The exercise price of each option is determined by the Board of Directors and cannot be less than the closing market price of the Company’s stock on the day immediately prior to the date of grant. The exercise date of an option may not be later than 10 years after the date it is granted. A maximum number of 8,157,500 options can be granted under the plan.

A summary of the status of the Company’s stock option plan as of December 31, 2002 and 2001 and changes during the years ended on those dates is presented below:

2002 2001

Weighted average Weighted average

exercise price exercise price

# $ # $Outstanding – Beginning of year 5,451,417 3.14 4,742,150 2.07Granted 1,600,100 3.79 2,226,000 4.13Exercised (661,250) 2.41 (1,495,733) 1.25Cancelled (401,700) 3.89 (21,000) 1.06Outstanding – End of year 5,988,567 3.59 5,451,417 3.14

Options exercisable – End of year 5,019,567 3.27 3,262,917 2.63

The following table summarizes stock options information as at December 31, 2002:

Options outstanding Options exercisable Exercise Number Weighted-average Number

prices outstanding remaining contractual life outstanding

$ # (years) #

0.90 25,000 3.96 25,000 1.06 451,800 2.39 451,800 1.25 5,000 1.30 5,000 1.79 299,000 0.75 299,000 2.99 1,780,867 6.51 1,780,867 3.20 400,000 1.30 325,667 3.70 1,220,000 2.75 460,000 3.95 100,000 2.08 50,000 4.30 1,149,000 7.38 1,097,667 4.35 157,900 2.05 157,900 4.60 400,000 1.80 366,666 5,988,567 5,019,567

As permitted by CICA Handbook Section 3870 Stock-Based Compensation and Other Stock-Based Payments, the Company has elected to continue to not recognize compensation expense when stock options are issued, as the exercise price of each option equals the minimum of the market value at the date immediately preceding the grant.

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If compensation costs had been determined based on the fair value of the options at the grant date, using the Black-Scholes option-pricing model, additional compensation expense would have been recorded in the statement of operations for the period, with pro forma results as presented below. Under the transitional provisions of Section 3870, comparative figures are not required.

Net loss for the year $ 576Additional compensation expense $ 1,633Pro forma net loss $ 2,209Pro forma loss per share $ 0.03

The following weighted-average assumptions were used in the Black-Scholes calculations for stock options granted during the period:

Annualized volatility 67.0%Risk-free interest rate 3.7%Expected life of options in years 2.7 yearsDividend rate 0.0%

12 Repayable grant

The Company has an agreement with the National Research Council of Canada (“NRC”) under the Industrial Research Assistance Program to jointly fund development of Breath kits and a point of care instrument for breath test analysis with Isotechnika Inc. owning and controlling all of the technology. Funding of $269,000 was provided by the NRC until March 2000 under the terms of the agreement. The Company is required to pay NRC 1.5% of the Company’s gross revenue from January 1, 2001 to a maximum of $404,730. For the year ended December 31, 2002, $370,223 (2001 – $34,507) is repayable to the NRC and has been netted against research and development expenses.

13 Loss per share

2002 2001

Loss attributable to common shareholders (numerator) $ 576,000 $ 11,788,000

Weighted average number of common shares outstanding (denominator) 63,747,445 50,681,448

Basic and diluted loss per share $ 0.01 $ 0.23

14 Income taxes

At December 31, 2002, the Company and its subsidiaries had approximately $15,762,000, of non-capital loss carry forwards and approximately $5,196,000 of federal investment tax credits available to reduce future Canadian income taxes otherwise payable.

The non-capital loss carry forwards expire in years ranging from 2004 to 2008 and the federal investment tax credits expire in years ranging from 2004 to 2012.

38 39


Scientific research and experimental development expenditures of approximately $25,062,000 are also available to reduce net income for Canadian tax purposes in future periods. These expenditures may be utilized in any period and may be carried forward indefinitely.

In addition, the Company’s U.S. subsidiary has approximately US$665,000 of net operating losses expiring in 2016, which may be used to reduce future US income taxes otherwise payable.

Significant components of the Company’s long-term future tax assets and liabilities are as follows:


Future tax assets Research and development deductions and credits $ 14,123 $ 8,072 Loss carry forwards 6,023 6,624 Share issue costs 732 1,019 Property and equipment 37 — 20,915 15,715Valuation allowance (20,419) (15,280)Total future tax assets 496 435Future tax liabilities Patents costs 421 304 Investments 75 — Property and equipment — 131Total future tax liabilities 496 435Net future tax assets $ — $ —

Potential income tax benefits in the amount of $20,419,000 (2001 – $15,280,000) have not been recognized in the accounts as the expectation of their realization did not meet the requirement of “more likely than not” under the liability method of tax allocation.

The reconciliation of income taxes attributable to operations using a 39.24% (2001 – 42.12%) statutory tax rate, is as follows:


Expected recovery at the statutory rate $ (182) $ (4,928)Unrecognized deductible temporary differences 3,035 3,147Non-taxable portion of capital gains (2,939) 1,743Capital tax 113 88Non-deductible expenses 86 38Total income taxes $ 113 $ 88

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15 Financial instruments

The Company’s financial instruments consist of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued liabilities, long-term debt and obligations under capital lease.

Fair values

The carrying value of cash and cash equivalents, short-term investments, accounts receivable and accounts payable and accrued liabilities approximate fair value due to the immediate or short-term maturity of these financial instruments. The fair value of the Company’s short-term investments is determined by quoted market prices at the balance sheet date. The fair value of the Company’s long-term debt and capital lease obligations are estimated based on quoted market prices for same or similar instruments and approximate carrying value.

Interest rate r isk

The Company is exposed to interest rate risk arising from fluctuations in interest rates on its cash and cash equivalents, as defined in note 3, and its short-term investments. The Company has considered, but does not use, derivative instruments to reduce its exposure to interest rate risk.

Currency r isk

Foreign exchange risk is the risk that variations in exchange rates between the Canadian dollar and the United States dollar will affect the Company’s operating and financial results. The Company earns a significant portion of its revenue and incurs a significant portion of its expenses in United States dollars and does not use derivative instruments to reduce its exposure to foreign exchange risk. As at December 31, 2002, U.S. denominated cash and cash equivalents and short-term invest-ments amounted to $26,287,000 (2001 – $1,033,000). U.S. denominated accounts receivable amounted to $3,110,000 (2001 – $136,000) and U.S. denominated accounts payable amounted to $1,648,000 (2001 – $1,394,000).

Credit r i sk

The Company is exposed to credit risk in the event of non-performance by customers, but does not anticipate such non-performance. The Company monitors the credit risk and credit rating of customers on a regular basis. The maximum credit risk is the fair value of the accounts receivable.

16 Segment disclosures

Operating segments are defined as components of an enterprise for which separate financial information is available and evaluated regularly by the Company’s chief decision maker in deciding how to allocate resources and assess performance. The Company’s chief decision maker is the Chief Operating Officer.

The Company’s reportable segments are its commercial operations related to the sale of diagnostic breath kits and contract research and analysis (Diagnostic division), its research and development operations, which are focused primarily on the development of ISA247 (Therapeutic drug division), and its corporate operations which include all interest income and any common costs for the Company. The accounting policies used in these business segments are the same as those described in note 3 – significant accounting policies.

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The Company assesses the performance of each segment based on net income (loss), which represents revenue less operating expenses, plus/less other income (expenses) and capital taxes. Intersegment sales are recorded at the exchange value, which is the amount agreed to by the parties. There were no significant intersegment sales during the year ended December 31, 2002 or 2001.

Report ing segments


Operating revenue Diagnostic $ 1,484 $ 2,301 Therapeutic drug 17,277 4,710 18,761 7,011

Amortization of property and equipment Diagnostic 60 77 Therapeutic drug 393 406 Corporate 341 — $ 794 $ 483

Net income (loss) Diagnostic 114 410 Therapeutic drug 6,213 (8,201) Corporate (6,903) (3,997) $ (576) $ (11,788)

Total assets Diagnostic 1,916 1,855 Therapeutic drug 10,576 2,418 Corporate (includes unallocated cash and equivalents) 67,292 54,730 $ 79,784 $ 59,003

Capital expenditures Diagnostic — 14 Therapeutic drug 6,105 919 Corporate 2,483 300 $ 8,588 $ 1,233

42


Geographic information


Revenue USA $ 14,097 $ 5 Europe 3,204 4,710 Canada 758 810 Southeast Asia 523 1,182 Middle East 179 304 18,761 7,011

Property and equipment Canada 8,352 1,149 USA 641 786 $ 8,993 $ 1,935

17 Net change in other operating assets and liabilities


Accounts receivable $ (2,896) $ (379)Inventories 57 (12)Prepaid expenses and other 467 (802)Accounts payable and accrued liabilities 566 935 $ (1,806) $ (258)

18 Comparative figures

Certain 2001 comparative figures have been changed to conform with the current year’s presentation. These changes do not affect the net loss for the year or deficit at end of the year.

Corporate Information

Corporate Officers

Robert Foster Ph.D.

Chairman & Chief Executive OfficerDirector

Randall Yatscoff Ph.D., FCACB

President & Chief Operating OfficerDirector

Joseph Koziak L.L.B.

Executive Vice PresidentDirector

Launa Aspeslet Ph.D., RAC

Vice President, Medical andRegulatory Affairs

Dennis Bourgeault C.A.

Chief Financial Officer

Head Office

2100 College Plaza8215 - 112 StreetEdmonton, AlbertaCanada T6G 2C8Tel: 780 487 1600Toll Free: 888 487 9944Fax: 780 484 4105

U.S. Office

Suite 10017301 N. Perimeter DriveScottsdale, ArizonaUSA 85255 - 6875Tel: 480 505 0540Fax: 480 505 0545

Web Site

www.isotechnika.com

Auditors

PricewaterhouseCoopers LLP1501 TD Tower10088 - 102 AvenueEdmonton, AlbertaCanada T5J 3N5

Legal Counsel

Bryan & CompanyBarristers and Solicitors2600 Manulife Place10180 - 101 StreetEdmonton, AlbertaCanada T5J 3Y2

Investor Relations

Gordon AgopsowiczDirector, Investor RelationsTel: 780 487 1600Fax: 780 484 [email protected]

Exchange Listing

Toronto Stock ExchangeTrading Symbol: ISA

Share Registrar and Transfer Agent

Computershare Trust Company of CanadaSuite 530, 8th Avenue SWCalgary, AlbertaCanada T2P 3S8

Annual General Meeting

Wednesday, May 21, 200310:00 amLe Royal Meridien King Edward HotelToronto, Ontario, Canada

Board of Directors

Robert FosterChairman & Chief Executive OfficerDirector

William HoskinsDirector 1,2,3

Joseph KoziakExecutive Vice PresidentDirector

Lawrence MeyerDirector 1,2,3

Donald SchurmanDirector 1,2,3

Douglas WalkerDirector 1,2,3

Randall YatscoffPresident & Chief Operating OfficerDirector

Scientific Advisory Board

Philip Belitsy M.D., FRCS(C)

Norman Kneteman M.D., FRSC

Arvind Koshal M.B.B.S., M.S., FRCS(C)

Walter Maksymowych M.D., FRCP(C)

1 Audit Committee

2 Compensation Committee

3 Corporate Governance Committee

H E A D O F F I C E 2100 COLLEGE PLAZA, 8215 - 112 STREET, EDMONTON, ALBERTA, CANADA T6G 2C8

TELEPHONE 780 487 1600 TOLL FREE 888 487 9944 FAX 780 484 4105 WWW.ISOTECHNIKA.COM

ISOTECHNIKA 2002 ANNUAL REPORT - University of Albertacsproat/Homework/ACCTG 311/Project 2... · PH.D., DIRECTOR, DRUG DISCOVERY ROBERT HUIZINGA DIRECTOR, CLINICAL RESEARCH PATRICK

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